Spreading Blame in Ponzi Scheme
When word of Bernard Madoff’s alleged $50 billion Ponzi scheme broke last Friday, my systemic worry was whether the fund was audited by a prominent auditing firm. Public revelation of an auditor’s involvement in such a fraud would almost certainly destroy it. Cf. Arthur Andersen amid Enron (2002).
If one of the four very largest auditing firms (Deloitte, Ernst, KPMG or PWC) were involved, the world would face an additional crisis by reducing from 4 to 3 the number of auditing firms capable of auditing most global companies. Indeed, such added crisis could occur if one of the next three largest firms (BDO Seidman, Grant Thornton or McGladrey Pullen) were implicated in such a fraud.
Fortunately, Madoff’s vehicle was not audited by one of those 7 firms (it was apparently audited by a storefront neighborhood accountant). Yet there is continuing fallout from this fraud that, some assert, does implicate one of the large 7 firms. In a putative class action lawsuit filed yesterday, New York Law School is suing investment advisor, Ezra Merkin, and his outside auditor, BDO Seidman.
Merkin has reportedly acknowledged that his investment fund, Ascot Partners, was substantially invested with Madoff. But the fund’s disclosure documents never said so. They allegedly described a more comprehensive investment philosophy that, given the acknowledged approach, may well amount to securities law violations (among other problems, such as breach of fiduciary duty).
By also naming, BDO Seidman, the plaintiffs’ lawyers may simply be covering all bases or hunting for a deep pocket. After all, BDO Seidman would be responsible for conducting a financial audit of Ascot. That means probing reported investment holdings, not attesting to the veracity of the fund’s investment philosophy or how it was implemented.
Still, this is a disturbing development. So far, when assigning blame for the current economic upheaval, leading culprits are bankers (charged with stupidity), regulators (charged with laxity) and rating agencies (charged with both and sometimes worse). Traditional financial market gatekeepers, including lawyers and auditors, have been spared rebuke.
But as indirect and remote consequences of the upheaval emerge, including discovery of deceptive or fraudulent practices by the likes of Mr. Madoff, there is rising risk that more and more professionals will be assigned blame.