Question one: Responsibility Principle
From the case study, due care was not observed during the audit process of Bernard L. Madoff Investment and Securities’ (BLMIS). Due care mandates auditors’ to be prudent in the job performance and at the same time put enough effort in their evaluation. Based on the Responsibilities Principles, auditors are supposed to exercise professional judgment throughout as well as maintain professional skepticism as they execute plan and audit performance. It requires that assessors should have skepticism, a situation of asking questions based on the information provided, and have judgment capacity, a condition of applying training prowess, subject knowledge, and gathered experience in the field. Notably, this is was not observed by the auditors at Friehling & Horowitz.
Furthermore, the auditing firm failed to conduct independent confirmations of assets belonging to BLMIS, its revenues and income, liabilities, and even sales. As a result, they failed to test and validate the true existence of line items in the firm. During auditing, while observing professional skepticism, Friehling & Horowitz auditors did not check on the control measures put in place at BLMIS to detect and prevent fraud activities. In fact, having mastered fundamentals of accounting, the auditors are expected to have a critical mind and questioning ability on everything. It is prudent to assess everything in a manner that obeys all principles. For example, the performance of the company based on returns and other parameters such as standard deviation should be determined to ascertain its authenticity while using correct judgment.
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Finally, the auditing firm did not send independent and reliable confirmations on the firm’s bank statement information. While using the case information they had at hand, the auditors failed to critically evaluate the company and render this kind of option. In totality, they did not observe the responsibilities principles as stated in the Generally Accepted Auditing Standards (GAAS). Based on the performance principle, the auditors could easily detect any sign of misstatements in the BLMIS’ financial reports.
Question Two: Post-Madoff Reforms
After massive Ponzi scheme, perpetrated by BLMIS, the Securities and Exchange Commission stipulated guidelines known as Post-Madoff Reforms aimed at reducing chances of such frauds in future. The comprehensive reforms provide effective ways of realizing any fraud activity of any kind in any firm.
First one is Encouraging Greater Cooperation by ‘insiders’ (The US. Securities and Exchange Commission, n.d.). In comparison, it is similar to those legislations that are used in criminal and investigation matters. It delves much on protection of the ‘insider’ used to mean a person who works within a firm under investigation and may have some pertinent information based on the ongoing probe. Benefits quoted for such persons include reduction of sanctions, and offering them enough security during evaluation of fraudulent activities. In application to BLMIS’ case, Bernie Madoff cheated his consumers to buy bonds and at the same time, he explained fake rising economic activities. If there was a person who knew this, he or she would be of fundamental use during the probe. In fact, this section will prevent firms from engaging in such activities for the fear that there must be a whistleblower around who may inform the relevant authorities.
The second reform is Enhancing Safeguards for Investors' Assets (The US. Securities and Exchange Commission, n.d.) . It is aimed at protecting clients of investment advisers from abuse and theft. The rule mandates that there should be no lies when it comes to account information of the customer and it should reflect as is said by the investment adviser. Also, the rule fosters the investment firms to place the customer’s assets on the custody of an independent firm. In relevant to BLMIS’ case, Madoff did not have a third party review, which is aimed at protecting the consumer’s investments.
Question Three: Charging Friehling & Horowitz
Based on Security Act 1933, Section 24, there can be possible imposed criminality elements on the auditors. In brief, it stipulates that for an auditor to be criminally liable to the fraud charges, then they must have shown willful violations, that is to say, they must have willfully done material misstatement. Based on this, it is hard to prove whether Friehling violated this section of the law.
Based on the Security Exchange Act 1934, Section 32, there is the possibility of imposing criminal charges on the auditor. The test is enacted to find out whether the auditor knowingly and willfully knew of the misstatements provided in the financial statements. Notably, this section of the Act, hold them “knowingly” responsible. As an auditor, you should be aware of all fundamentals of accounting, and interpret them properly. Based on Harry Markopolos’s analysis, he found out various anomalies in the BLMIS’s financial statements such as Ponzi scheme, something that Friehling would have detected, unless they acted “knowingly” or alternatively, their capacity to serve as auditors would be in question, which would draw an attention to another section of the Act, which would query their capability to serve as auditors. Either way, they must come out clear. However, they told the American Institute of Certified Public Accounts (AICPA) that they did not audit BLMIS, which may exonerate them of charges; therefore, rendering this section of the Act inapplicable.
On the whole, it is not easy to hold them criminally liable to the violations since all facts are not known. To avoid peer review, Friehling lied to AICPA and this makes it very difficult to unravel all facts related to the issue. In its entirety, it is not possible to ascertain if they are criminally liable.
References
The Security Act 1933
The Security Exchange Act 1934
The US. Securities and Exchange Commission. (n.d.). The Securities and Exchange Commission: Post-Madoff Reforms. Retrieved from https://www.sec.gov/spotlight/secpostmadoffreforms.htm
