Professional Skepticism & Madoff

Professional skepticism is the hallmark of the auditing profession. In order to apply professional skepticism, you must first consider what it really is. Skepticism is just a questioning mind. Professional skepticism includes being alert for information that raises a question about the reliability of documents and responses to inquiries, conditions indicating possible fraud, and circumstances suggesting the need for additional audit procedures beyond those ordinarily required. With this in mind, please read the following information regarding the fraud perpetrated by Bernard Madoff.

Since the collapse of the Ponzi scheme ran by Bernie Madoff, there have been questions about the liability for losses by auditing firms that didnt catch that there were no underlying assets. The problem arose because there were feeder funds that were supplying money to Madoff that had high-profile accounting firms such as KPMG, PricewaterhouseCoopers, BDO Seidman and McGadrey & Pullen, but Madoff himself only employed a three-person accounting firm, Freiling & Horowitz, that operated out of strip mall. These large accounting firms relied on the audit report of this same firm consisting of a secretary, accountant and a 70-year old partner. These feeder funds represented more than half of the $25 billion lost by Madoff. Now the investors want to know why they signed off on Madoff.

The accounting firms themselves state that they did not do anything wrong. They say that they met all professional standards and are not responsible for the investment decisions made. The Center for Quality audit agrees with the accounting firms and stated that "It is not the responsibility of the accountant for a capital-management firm to audit the underlying investments of the firms it invests in," says Fornelli. "The auditor is not in a position to test the existence of the underlying securities especially in a fund-of-funds situation."

The lawyers who represent the investors disagree "All they really had to substantiate the gains of these funds was Madoff's own statements," says Harry Susman, a lawyer at Houston-based Susman Godfrey. "They were supposed to be the watchdogs. Why did they sign off on these funds' books?"

Other accountants agree. Accountant Ronald Niemaszyk, whose firm, Jordan Patke & Associates, specializes in reviewing the books of hedge funds, agrees that in many cases it is common to rely on brokerage statements when auditing funds. But in this case, Niemaszyk says, the auditors most likely should have looked deeper. "You have to look at the auditors' work that you are relying on," he says. What's more, Madoff acted as his own broker instead of going through another firm. Review this video of the questioning by Congressman Sherman of Harry Markopolous who was a whistleblower of Madoff's scheme to see his perspective as a CPA concerning the legitimacy of the Freiling and Horowitz accounting firm: https://www.youtube.com/watch?v=soy96dRjwZs

Was professional skepticism correctly employed by the large accounting firms in accepting the opinion of Madoffs auditors at face value? Just as a disinterested person, do you feel that the large accounting firms hired by the feeder funds should have looked into the underlying assets and gains reported by Madoff or do you believe that if they strictly followed the auditing standards as the Center for Quality Audit indicated they should not be held liable for negligence under common law? If you lost money yourself, would it change your opinion?