Why Wasn't Madoff's Auditor Peer Reviewed or Inspected?

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New Bill Seeks to Close Loophole

On March 12, 2009, Bernard L. Madoff pleaded guilty to 11 counts of fraud, perjury, and money laundering connected with the largest Wall Street Ponzi scheme ever recorded a reported $65 billion. Madoff faces a potential prison sentence of 150 years. But since December 2008, attention has turned to David G. Friehling, Madoffs accountant Friehling was arrested on March 19, 2009, and charged with securities fraud and with aiding the investment advisor fraud committed by Madoff.

A civil case was filed by the Securities and Exchange Commission (SEC) against Friehling and his accounting firm, Friehling & Horowitz, CPAs, P.C., on March 18, 2009. The SEC alleges that Friehling (and Friehling & Horowitz) purported to audit and certify the financial statements and disclosures of Bernard L. Madoff Investment Securities LLC (BMIS) from 1991 to 2008, thereby enabling Madoffs Ponzi scheme to go undetected.

Why No AICPA Peer Review?

For the past 15 years, the firm had been telling the AICPA that it did not conduct audits (Alyssa Abkowitz, "Madoffs auditor ... doesn't audit?" CNNMoney.com, December 19, 2008).

AICPA members who are engaged in the practice of public accounting in the United States are required to be enrolled in an approved practice-monitoring program. (The AICPA' s standards do not apply to organizations that are not public accounting firms.) Oversight of audit quality is accomplished via the AICPA' s peer review program. Most state boards of accountancy also require their licensees to undergo peer review (sometimes called compliance assurance) to practice in their states. Prior to the Friehling case, New York was one of only six states that did not require accounting firms to be peer reviewed. On January 27, 2009, New York Governor David Paterson signed the first significant accountancy reform in 61 years into law. Beginning January 1, 2012, New York firms with three or more accounting professionals will be required to undergo a peer review once every three years.

Under the AICPA's program, auditors are monitored through mandatory peer review every three years. The focus of peer reviews is remedial and corrective rather than punitive. (The AICPA has no legal authority or federal and state regulatory power over its members. AICPA membership is not required to conduct public audits. Instead, CPAs are licensed by their state boards of accountancy.) Some 33,000 firms are enrolled in the AICPA's peer review program (Abkowitz 2008). Friehling & Horowitz was enrolled in the AICPA's peer review program, but the firm had not submitted to a review since 1993, because the firm had reported every year, in writing, that it did not perform audits (Abkowitz 2008). Since December 2008, the AICPA has been investigating the accounting firm for ethics violations related to the BMIS Ponzi scheme. On March 18, 2009, the AICPA concluded its ethics investigation of Friehling's conduct as BMIS's auditor, "resulting in expulsion from membership for failure to cooperate," according to an AICPA release.

Why No PCAOB Inspection?

Bernard Madoff was the sole owner of BMIS. He oversaw and controlled the investment advisor services and controlled the finances of the organization. On December 11, 2008, the SEC charged Madoff (and BMIS) with securities fraud related to his Ponzi scheme. Madoff and BMIS were both a broker-dealer and investment advisor registered with the SEC. But how could such a Ponzi scheme go undetected in today's regulatory environment? The Public Company Accounting Oversight Board (PCAOB) is a private-sector, nonprofit corporation created by the Sarbanes-Oxley Act of 2002 (SOX) to oversee the auditors of public companies "in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports." If Friehling (and Friehling & Horowitz) failed to uncover the BMIS Ponzi scheme, why didn't the PCAOB question the audits of BMIS, via its inspection process, sometime after the board was established in 2003? …

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