IntroductionMadoff SecuritiesCase 1.11

1

Case explanation

Early life

Bernard L.Madoff Securities & Career

Timeline

Case answers

Q1

Q2

Q&A

Auditing-related points

Q3Q4Q5

2 Outline

Born in 1938 in NYC

Sets up Madoff Investment Securities

LLC in 1960

Early Life3

Middle-class neighbourhood

Enrolled in Alabama Univ.

Transferred to Hofstra Univ.

Graduated with POS

‘’Bernie wanted to be rich; he dedicated his

life to it’’

Career Timeline 4

1960

Ambitious beginning (1960)

❖ Bernard L. Madoff Investment Securities was established

❖ Trading securities of only small companies aka ‘’Penny Stocks’’

❖ Pursuing the ultimate goal of becoming a major Wall Street player

Career Timeline 5

1962

Expansion (1962)

❖ Expanded significantly through offering investment advisory

services

❖ Investment advisory services became most important part of

its business

Career Timeline6

2001

Professional Scepticism (2001)

❖ Madoff disclosed minimum amount of information; the only

information he gave was that he used “split-strike conversion’’ strategy

❖ Since his strategy could not be duplicated, it caused immense

scepticism

Career Timeline 7

19902005

‘’No One would listen’’(1999-2005)

❖Harry Markopolos repeatedly warned SEC referring to Madoff Securities as the ‘’world’s largest Ponzi scheme’’

❖ In 2000, he submits SEC an 8 page memo, but SEC does not further investigate into the matter

❖ In 2005, he provides SEC with a lengthy report pointing out 29 specific ‘’red flags’’

Red Flags 8

❖ Madoff refused to allow Big Four Audits to review his financial records

❖ Madoff securities was audited by a one-person accounting firm (Friehling & Horowitz)

❖ Despite his prominent leadership role in NASDAQ electronic stock exchange, he only provided monthly account reports by mail

❖ Split-strike conversion strategy would require a lot more volume for it to generate the claimed return

Career Timeline 9

20082009

‘’Dark days’’(2008-2009)

❖ Dec.10, 2008, Madoff confessed to his two sons that earnings for his investment advisory division was fraudulent

❖ Following day, he was arrested by FBI ❖ In June 2009, he was sentenced to 150 years in

prison, he said there was no innocent explanation for what he did

10 Rubber-stamped statements

Auditor: Friehling & Horowitz

❖ David Friehling had issued unqualified opinions on the financial statements

❖ AICPA had been reported that Friehling did not perform any audits, so no peer review programme was required

❖ David Friehling’s family had another 17 accounts with Madoff and 15million investment in Madoff

11 Rubber-stamped statements

11 Answer 1

Q.1 Research recent developments involving this case

● As of March 4th, 2016, total investments of $17.5 billion remained unpaid to investors. Irving Picard, the head of bankruptcy lawyers was able to collect $11 billion

● Bernie Madoff revealed to have a heart attack and is currently suffering from stage 4 cancer in prison

● Ruth Madoff, a wife of Bernie Madoff, cut off contact with her husband

● Madoff’s eldest son, Mark Madoff committed a suicide in 2010

● Younger son, Andrew died of lymphoma● His brother Peter Madoff, is serving a ten year

sentence

11 Answer 2

● The nature and amount of assets, liabilities, and transactions executed

● The materiality of investment ● The specific risks that presents a reasonable

possibility of material misstatements to the company's consolidated financial statements

Q.2 Suppose that a large investment firm had approximately 10% of its total assets invested in funds managed by Madoff securities. What audit procedures

should the investment firm’s independent auditors have applied to those assets?

11 Answer 2 (Detailed)● To establish the accuracy of accounts presented and

confirm the actual existence of assets recorded. To achieve this, a number of audit tools should be employed including a review of the audit procedures used, analytical measures adopted, risk assessments and materiality decisions.

● Such processes will identify inherent and control risks that contribute to misstatements in balance sheets and accounting information. To ensure that detection risk is as low as possible, a careful audit of key transactions should be undertaken to confirm the degree of accuracy.

● By addressing issues of materiality, the review will further qualify the accounts presented and ensure that the investment firm is not being hoodwinked by the investment advisor. This exercise will eliminate misstatements that overstate the financial health of an investment fund and provide crucial evidence that will guide the investment firm’s financial decisions.

11 Answer 2 (Detailed)● Furthermore,the independent auditors should

conduct banking reconciliations on all operative accounts. This audit procedure will establish the actual bank balances held and reveal any discrepancies in the accounts presented.

11 Answer 3

● Peer review is a periodic outside review, performed by another accounting firm, of a firm’s quality control system in accounting and/or auditing services performed by firms. Peer reviews are required of all firms that are member of the American Institute of CPS.

Then why wasn’t it peer-reviewed?

★ At that time, New York was one of the states that did not require PRP (peer review program)

★ Friehling & Horowitz was enrolled in the PRP but hadn’t submitted application to review

Q.3 Describe the nature and purpose of a ‘’peer-review’’. Would peer reviews of Friehling & Horowitz have likely resulted in the discovery of the Madoff

fraud? Why or Why not?

11 Answer 3❖ A peer review would have detected Madoff’s fraud

because questions would have been raised about the resource capability of the firm to handle such a large account effectively given that it had one accountant.

❖ Banking reconciliations would have revealed check kiting and established the actual amounts held by the company in various banks. Comparing the firm’s payouts with that of similar firms in the industry would have identified a major disparity that required further investigation. Based on investigative reports, evidence would have emerged showing that Madoff’s firm engaged in illegal practices.

11 Answer 4Q.4 Briefly explain the difference between a fraud

‘’condition’’ and ‘’fraud risk factor’’ and provide examples for each

Fraud conditions RationalisationIncentive

Opportunity

11 Answer 4 Q.4 Briefly explain the difference between a fraud

‘’condition’’ and ‘’fraud risk factor’’ and provide examples for each

Fraud risk factors:● Emphasis on meeting goals ● Client operates in a highly competitive industry ● Experiencing negative cash flows

11 Answer 5Q.5 Recommend other financial reporting and

auditing-related reforms that would likely be effective in preventing or detecting frauds similar to that

perpetrated by Madoff.

● Continuous education for employees● Improving annual reviews of investment advisers

and their work● Improving public disclosure of the firm’s auditor for

transparency● Recruiting staff with specialised experience,

competitive pay ( at SEC)

11 References

● http://www.dailymail.co.uk/news/article-2544071/Bernie-Madoff-heart-attack-suffering-stage-4-cancer.html

● http://time.com/3626632/madoff-where-are-they-now/

● https://www.coursehero.com/file/p5ijhv2/2-Madoff-founded-Madoff-Securities-which-was-one-of-the-first-brokerage-firms/

● https://prezi.com/uunvkbky5_0j/madoff-securities/● https://www.quora.com/How-has-Irving-Picard-the-

trustee-for-the-Bernie-Madoff-liquidation-managed-to-collect-so-much-money

Thank you for listening

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