A childhood friend summed up the driving force in Bernie Madoffs life: Bernie wanted to be rich. As a youngster growing up in New York City, Bernie realized that Wall Street was the greatest wealth creation machine the world had ever known. So, after graduating from college in 1960, he set his sights on joining the exclusive fraternity that ran Wall Street by organizing his own one-man brokerage firm, Madoff Securities. Madoff was one of the first individuals to recognize that computer technology provided the means to democratize Wall Street by establishing a system that made securities trading much more efficient and much cheaper. In the early 1970s, Madoff and several other individuals organized the NASDAQ exchange, which was destined to become the world’s largest electronic stock market. Years later, the NYSE would be forced to follow suit and switch to electronic securities trading. Literally millions of investors have benefitted from the lower transaction costs of electronic securities trading that were in large part a result of the pioneering efforts of Bernie Madoff. Unfortunately, Bernie Madoff will not be remembered as a pioneer of electronic securities trading. Instead, the word Madoff will always be associated with the phrase Ponzi scheme. Although his stock brokerage firm was extremely lucrative, Madoff eventually established a parallel business, investment advisory services. Over a period of several decades, Madoff became known as the Wizard of Wall Street for the incredibly consistent and impressive returns that he earned on the billions of dollars entrusted to him by investors. However, those returns and Madoffs secretive investment strategy that produced them were fraudulent. This case documents the Madoff fraud with a particular focus on its implications for the nation’s financial reporting system. Many critics have insisted that the ineffectiveness of the SEC was a major factor that allowed Madoff to sustain his fraud for so long. Likewise, those critics insist that Madoffs independent auditor played a major role in allowing the fraud to go unchecked for decades. Throughout most of its existence, Madoff Securities was audited by a small accounting firm with one professional accountant. That accountant, David Friehling, would become the second individual arrested by federal prosecutors investigating Madoffs massive fraud. Friehling was charged with flouting the accounting professions auditor independence rules and with performing sham audits of Madoff Securities. 87
Case 1.12 Madoff Securities Madoff Securities
1. The driving force in Bernie Madoffs life was his desire to become wealthy. 2. Madoff founded Madoff Securities, which was one of the first brokerage firms to employ computer technology to reduce the cost of securities transactions; Madoff is also credited as one of the founders of the NASDAQ, the worlds largest electronic stock exchange. 3. The investment advisory division of Madoff Securities grew dramatically over the life of the firm due to the incredibly consistent and impressive rates of return that it earned for investors. 4. In early December 2008, Madoff confessed to family members that his firms impressive investment results were fraudulent, the product of a massive Ponzi scheme that he had carried out over decades. 5. News of the massive fraud prompted an angry public to question why the nations watchdog function for the capital markets, particularly the independent audit function, had failed once again. 6. Madoffs auditor had been a tiny CPA firm, Friehling & Horowitz, with one professional accountant, David Friehling; accounting and auditing experts insisted that it was preposterous that one person could audit a firm the size of Madoff Securities. 7. In March 2009, Friehling was arrested and charged with securities fraud and aiding and abetting an investment fraud due to his allegedly sham audits of Madoff Securities;...