BERNARD LAWRENCE MADOFF •At first firm traded only securities of small over the counter companies – penny stocks. •Pioneer of electronic securities trading. • •Chairman of the NASDAQ (National Association of Securities Dealers Automated Quotations) PONZI SCHEME •Lure investors in by guaranteeing unusually high returns. •Used the money from new, incoming investors to pay off the promised returns to older ones. •No real actual profit is being made. •Funds earned an average annual rate of return from 10 to 15 percent - some of them never had a lost even when stock market in 2008 collapsed. •Clients requested a total of $7 billion back in returns, Madoff only had $200 million to $300 million. WHY SCHEME WORKED? •Hired very small audit firm called Friehling & Horowitz with one accountant David Friehling •He didn’t report any audits, as result he was not required to submit to AICPA peer review •SEC started investigate firm after Madoff confession not after series of complaints filed by individual Harry Markopolos. RED FLAGS •Madoff refuse to allow the big four auditors to review his financial reports. •Auditing the firm by one auditor. •Firm didn’t provide to clients online access to their accounts just account statements by mail. •If such as investment strategy existed, it would be Holy Grail of investing. QUESTIONS Q1: Research recent developments involving this case- Q2: 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 firms independent auditors have applied to those assets? Q3: 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? Q4: Difference between a fraud “condition” and a “fraud risk factor”. Q5: In addition to the reforms mentioned in this case recommend other financial reporting and auditing – related reforms that would likely be effective in preventing or detecting frauds similar to that perpetrated by Madoff.