Bernard Madoffheaded a brokerage firm with an investment advisory wing. In whatamounted to an elaborate Ponzi scheme, offeredunusually high returns to investors. In late 2008, the total value ofcustomer funds invested in amounted to over $65billion dollars. In the same year, a mortgage crisis hit Americanbanks and shrunk credit markets. In the wake of Madoff’sconfession, global stock markets were destabilized even further(Sander, 2009). The eventual revelation of the Ponzi scheme causedplenty of turbulence in the financial markets due to its scope andseverity. Credit markets crumbled, and stock prices dropped sharply.The volatile situation threatened to hurl the global economy intodepression.
The regulatory scheme existing during the operation of the Ponzischeme could not detect the fraud. Various incompetencies contributedto this lapse in the regulatory framework. Friehling & Horowitzserved as the auditors of . David Friehling was thesole certified accountant in the firm. However, in his annual reportsto American Institute of Certified Public Accountants (AICPA), hedenied having done any audits. Therefore, his audit firm was notrequired to submit to a peer review program undertaken by AICPA.Additionally, Friehling & Horowitz were never required to submitto periodic peer review organized at the state level (Sander, 2009).At the time of the scheme’s operation, New York State was one ofthe few states in the country which did not have obligatory peerreviews for their accounting firms.
The massive fraudperpetrated by the Ponzi scheme was labeled as the largest indocumented history. This assertion was due to the tens of billions ofdollars of estimated funds either stolen or misappropriated. Variousreasons could be mentioned to explain why the scheme remainedundetected for decades. First, Madoff had an outstanding pedigree asa Wall Street icon. He had pioneered the implementation of electronicsecurities trading in an era where the New York State Exchange (NYSE)fostered restrictive rules. Madoff was able to reduce transactioncosts and democratize trading of securities. He also served multipleone-year terms as the head of NASDAQ (Sander, 2009). As the leadingmarket maker on both the NYSE and NASDAQ, Madoff earned a reputationthat protected him from an investigation.
Madoff was ableto target unsuspecting investors whose primary concern was profit.Besides, many investors were so enticed by the incredible returnssuch that they failed to conduct due diligence. It is noteworthy thatsome realistic investors declined to invest with due to the mystique surrounding the source of the high returns. Thenegligent actions of Friehling & Horowitz as an audit firm alsocontributed to the Ponzi scheme staying undiscovered for as long asit did. The US Securities and Exchange Commission (SEC) bear theultimate responsibility for failing to conduct competent checks andbalances (Turner, 2010). The liability of the SEC was especiallygrave since they had failed to act on previous evidence submitted byHarry Markopolos, a prominent fraud investigator.
As an auditor ofa firm, I would adopt several audit procedures to an investment of$10 million dollars. The first procedure involves determining whetherthe firm has sufficient audit trail. This means acquiring paper andelectronic documents that outline the history of transactionsconducted by the business. An audit trail helps to trace financialdata from ledger accounts to sources of funds and operations. Theaccounting practices used by the company should be able to track thecomprehensive process of a transaction as supported by relevantdocumentation. Using accounting software would help to formulate anelectronic audit trail for the business (Louis, 2010). In thisregard, I would seek to know how the $10 million dollars wasinvested. Moreover, I would also pursue the investment to determinethe securities into which the money was invested.
All documentscontaining financial information should be stored securely andreliably so as to facilitate smooth processing by the accountingdepartment. It is also important to create a reliable system that canmonitor the internal controls of the firm. Such provisions would helpto safeguard business assets against theft and fraud. Bookkeeping andcash payments should be handled by different persons (Louis, 2010).This would make it relatively easier to account for missing money.Adopting such fundamental audit procedures would protect the $10million investment from misappropriation in a Ponzi scheme.
A peer review ofFriehling & Horowitz would have revealed the massive fraudoperated by . Firstly, a review would haveestablished that one person would certainly not suffice to audit thefinancial accounts of a firm such as . As stated,the company had investment funds worth over $65 billion dollars. Itwas quite impossible for one individual to track all the cash flowsassociated with the invested funds for 17 years. A peer review wouldalso have uncovered the fact that David Friehling had a conflict ofinterest with regards to his audit of . Both Davidand his audit firm held 17 accounts with . This factshows a clear violation of auditor independence rules recognized bythe audit profession. Rather than recusing himself from auditing theaccounts, Friehling continued in their illegitimate role (Sander,2009). A thorough peer review would also have revealed theincompetence of Friehling & Horowitz as an accounting firm.Friehling conducted sham audits and signed unqualified opinions.
Markopolos hadraised various concerns to SEC concerning the suspiciously highreturns offered by to his clients. Nevertheless,his points were never fully considered. The SEC was severely blamedfor its reluctance to investigate the claims made by Markopolos. Asstated, New York State was one of the few states in the country thatlacked mandatory reviews of all accounting firms (Turner, 2010).Markopolos would have adopted the strategy of lodging his concernswith the New York Senate office. The state leadership would have beenforced to change their legislature sooner. As it were, SECaccountants could not comprehend a Ponzi scheme based on derivatives(Turner, 2010). Therefore, they would never be obliged to act on suchallegations. Nevertheless, the New York Senate office would haveharmonized their legislature with that adopted in other states withinthe country. Employing this strategy would have exposed the massiveinvestment fraud undertaken by .
Roleof Audit Committee
An auditcommittee is a group comprising of persons charged with overseeingthe integrity and quality of a company’s reporting practices andaccounting procedures. An audit committee ensures the firm iscompliant with legal and regulatory statutes. This committee is alsoresponsible for maintaining fraud control mechanisms. It advises theBoard of Directors on the reliability and accuracy of financialinformation. Additionally, it oversees the internal audit process andhandles external auditors (Louis, 2010). The audit committee for should have examined the competence andindependence of Friehling & Horowitz. Such an investigation wouldhave revealed the aiding and abetting of fraud by the audit firm.Consequently, Friehling & Horowitz would have been disqualifiedas company auditors. The massive fraud perpetrated under the Ponzischeme would have been severely mitigated by the appointment of newauditors.
As discussed,Bernard Madoff managed to steal and misappropriate billions ofdollars through the workings of a derivative-based Ponzi scheme. Thisoccurred for decades due to a combination of unique factors. Hisexcellent reputation and the incompetence of the SEC concealed hiswrongdoing (Sander, 2009). Nevertheless, his eventual confession andincarceration brought to an end the most devastating fraud inAmerican history.
Louis, S. L. (2010). Securities fraud: Detection, prevention, andcontrol. Hoboken, N.J.: John Wiley & Sons.
Sander, P. J. (2009). Madoff: Corruption, deceit, and the makingof the world`s most notorious Ponzi scheme. Guilford, Conn.:Lyons Press.
Turner, R. B. (2010). Madoff Ponzi scheme: SEC failure and why.New York, NY: Nova Science Publishers.