Unnamed Defendants in Mortgage Meltdown: Accountants for Banks and Investment Bankers

Posted on December 23, 2008 by Neil Garfield

Some time ago we mentioned on these pages that the auditors who certified the financial statements (KPMG, here) would come under intense scutiny simply because they MUST have known, by simple common sense, that the economics of mortgage lending had been turned on its head. The worse the loan quality the more they made leaving hapless investors, who put up the money, and hapless borrowers, who put up their homes, in unworkable investment schemes devised to decieve, manipulate and steal. Here, laid bare, along with the IndyMac story, shows the outright complicity of the big accounting firms in the major frauds to jolt our economy in the past few years. regulators, virtually owned by the banks, of course played the game. As former, current or future employees of the banks they knew who was writing their paychecks, directly or indirectly. $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ December 22, 2008

In Madoffs Wake, Scrutiny of Accounting Firms

By MICHAEL J. de la MERCED As more details unfurl in the Bernard L. Madoff fraud case, so do the lawsuits. And the big accounting firms, which oversaw many of the feeder funds that funneled billions of dollars into what prosecutors describe as the largest Ponzi scheme ever perpetrated, are likely to be among the defendants. Though Bernard L. Madoff Investment Securities itself was audited by small firms, questions are arising over how major firms like PricewaterhouseCoopers and KPMG overlooked several red flags related to

the operations over a number of years. The big accounting firms are likely to face queries about why they gave their seal of accounting to the astoundingly steady positive returns booked by a fund manager whose investment strategy was nearly completely opaque. One investor in a feeder fund, New York Law School, has already sued BDO Seidman, the auditor of one of its money managers, arguing that the firm failed to notice warning signs related to the $50 billion scandal. The district attorney for Rockland County, N.Y., Thomas P. Zugibe, has also begun inquiries into Friehling & Horowitz, the three-person accounting firm that provided services to Mr. Madoffs firm. Many have asked how a company as small as Friehling a three-employee firm based in New City, N.Y., that occupies a 13-foot-by-18-foot storefront space in an office plaza could have handled an operation as large as Bernard L. Madoff Investment Securities. Friehling & Horowitz is also the subject of a preliminary ethics investigation by the American Institute of Certified Public Accountants started after the scandal broke. Another small accounting firm, Sosnik Bell, handled paperwork for investors in Mr. Madoffs firm, according to Clusterstock, a financial news blog. Sosnik Bell, based in Fort Lee, N.J., processed forms for these investors, and then forwarded its work to the investors own accountants. Executives from Sosnik Bell could not be reached for comment. A more lucrative place for victims of the fraud, however, are at the giant accounting firms that audited the investment managers who directed money into Mr. Madoffs firm. In several other fraud cases, accounting firms, which are responsible for scrutinizing the financial underpinnings of companies, have become targets for investor lawsuits. Ernst & Young paid $300 million to settle a lawsuit filed by Cendant related to fraud at one of the conglomerates subsidiaries. It had earlier paid $335 million to settle a lawsuit filed by Cendant shareholders. Also last year, Pricewaterhouse agreed to pay $225 million to settle auditing malpractice claims tied to the Tyco scandal, which saw the convictions of top executives for grand larceny, conspiracy and securities fraud. Pricewaterhouses payment amounted to about 7 percent of total amount paid in Tyco lawsuits. But the Madoff case presents an unusual situation, said Scott M. Berman, a partner at the law firm Friedman Kaplan Seiler & Adelman who represents

investors in several feeder funds. Previous cases focused on the auditors of the firm at the center of the scandal, not the auditors of investment managers one rung removed. I expect that this is an issue that has not been litigated before, Mr. Berman said. With many of the feeder funds managers having taken losses from their own personal exposure to Mr. Madoffs firm, the accounting firms may be a likely target for investors seeking to recoup at least some of their money. PricewaterhouseCoopers was the main auditor for Sentry, the largest fund run by Fairfield Greenwich Group, the $14.1 billion investment manager that has lost the most money so far in the Madoff scandal. The accounting firm was tasked with minding Sentry, which had about $7.5 billion invested in Mr. Madoffs firm. The company has not yet settled on a legal strategy, said a Fairfield spokesman, Thomas Mulligan. A spokesman for PricewaterhouseCoopers, Mike Davies, said, No claim has been asserted against the PWC member firm in relation to Madoff, and we know of no valid basis for any claim. The lawsuit by New York Law School, filed in federal court in Manhattan last week, names J. Ezra Merkin, the money manager who placed $3 million of the schools money into Mr. Madoffs firm. But it also sues BDO Seidman, the American arm of BDO International and the auditor for one of Mr. Merkins funds, Ascot Partners. In its lawsuit, New York Law School said that BDO Seidman had utterly failed in its auditing of Ascot Partners. The lawsuit says that BDO Seidman failed to flag Ascots reliance on a single money manager, Mr. Madoff, as well as Mr. Madoffs reliance on Friehling & Horowitz. BDO Seidman has said that it never audited Mr. Madoffs firm, just Mr. Merkins, and that its audits of Ascot Partners conformed to all professional standards. Mr. Berman, however, said the firm had a duty to dig deeper. I dont think that they can simply, blindly accept what Madoff did without doing their own auditing work, he said.