Why Accounting Firms and Investment Bankers Should Be Sued

Originally posted in September 2008, here is my update of issues that lawyers, regulators, judges and even borrowers have still not quite absorbed:

Some time ago we mentioned on these pages that the auditors who certified the financial statements (KPMG, here) would come under intense scrutiny 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 money was created by investment bankers — leaving hapless investors, who put up the money, and hapless borrowers, who put up their homes, in unworkable investment schemes devised to deceive, 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.

The article that follows is all about Bernie Madoff and the potential liability of accounting forms. The Madoff scandal came at the perfect time for the banks. His scheme was easily provable and even confessed. It was large by prior standards. But more importantly it distracted attention from an economic crime by investment bankers acting in tacit and overt agreements that constituted an epic distortion of economic and legal realities.
Madoff’s scheme involved $60 billion. The press jumped on it because they understood it. In his case he simply lied about ever making any transaction, falsifying account statements sent out to thousands of “investors”.
So far the investment bank scam which they call securitization involves $1 quadrillion.
Instead of no transactions there were hundreds of them for each loan that were hidden from the only true parties in interest — the investors who put up the cash buying bogus mortgage certificates and borrowers who put up their homes and in the process became the unwitting issues of unregulated securities in which the borrowers’ names, signatures, reputations and lives were traded on the open market.
This was not only contrary to law. It was contrary to good sense for everyone except the investment bankers who kept all the trading profit and left the investors and borrowers with little or nothing compared to the actual size of the venture. Adding insult to injury, the investment banks have succeeded in convincing  investors and borrowers it was their own fault they lost money while the investment bank profited by pornographic production of cash equivalent  instruments.
Now 11  years later I renew my call to hold the investment banks, their accountants and their lawyers accountable for the largest economic crime in human history.
December 22, 2008

In Madoff’s Wake, Scrutiny of Accounting Firms

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. Madoff’s 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. Madoff’s 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. Madoff’s 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 conglomerate’s 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. Pricewaterhouse’s 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. Madoff’s 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. Madoff’s 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 school’s money into Mr. Madoff’s firm. But it also sues BDO Seidman, the American arm of BDO International and the auditor for one of Mr. Merkin’s 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 Ascot’s reliance on a single money manager, Mr. Madoff, as well as Mr. Madoff’s reliance on Friehling & Horowitz.

BDO Seidman has said that it never audited Mr. Madoff’s firm, just Mr. Merkin’s, 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 don’t think that they can simply, blindly accept what Madoff did without doing their own auditing work,” he said.

5 Responses

  1. corruptionpedia2, — you are right. Big problem with title companies. They escaped all.

  2. Don’t forget about Title Companies – they all knew about the scam but still continue to issue Title insurances for stolen properties and refuse to compensate illegally foreclosed homeowners.

  3. Banks know about this scam. They created a perfect slavery under glimpse of “ownership” without property rights.

    Free slaves (borrowers who purchased home loans), free labor (“homeowners work very hard to keep banks’ property in good condition), free money (30 Trillion taxpayers money plus nearly zero percent loans from FedRes), free houses, enormous profits from selling slaves’ homes behind their backs, no responsibility (plantation owners had to provide slaves some housing, food, clothes – but none for banks’ slaves); zero liability for any crimes – and banks even get paid for it when homeowners pay 50% of its monthly mortgage as interest to the bank!


  4. […] Source: Why Accounting Firms and Investment Bankers Should Be Sued […]

  5. Bernie was a crook who took the hit for big banks that were scamming far more than him. Odd, know people who were affected, and none of them think that the financial crisis was worth investigation. Only “their Investments” were worth investigation. Bernie said otherwise. Would love to talk to Bernie. Bernie- are you listening?

    And, those accounting “law firms”. Spoke with one big law firm many, many, many years ago. Law firm went defunct. Name on numerous PSAs and prospectus. You know what they told me back then?

    “ALL A “SHELL.””

    Bernie got caught. Bernie – it was a great movie. I, honestly, feel bad for you. Why would the privileged get any special investment and investigation treatment to begin with? And, why were you the only one to take the fall? Maybe should have cooperated — not like Loughlin.

    Bob G is right. The attorneys. Honestly, don’t even think banks and servicers KNOW what the attorneys are doing. They DON”T KNOW.

    Where are the regulators?? .Who paid who? Where is the money trail? Laundered? What are THEY doing??? a) Lazy b) stupid c) paid off d) covering up. e) all of the above.

    Thank you Neil.

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