External control and their failures

There are two external control failures identified below that allowed Madoff to successfully pull of the biggest fraud of a decade.

David Friehling

Auditor

Bernard Madoff had hired David Friehling - who was a certified public accountant and the head of Friehling and Horowitz (which was an accounting firm) - as the auditor of Madoff Securities. Both had been working together in between 1991 to 2008 (U.S Securities and Exchange Commission, 2009), whereby Friehling and Horowitz wrongly portrayed Madoff Securities as a profitable investment company. Madoff had also misled the public by stating that Friehling and Horowitz were independent auditors of Madoff Securities (Complaint: David G Friehling, Friehling & Horowitz, CPA's, P.C., 2009). In paperwork that was distributed to the stakeholders of Madoff Securities, Friehling and Horowitz had deliberately or had untruthfully claimed that:

Friehling and Horowitz had followed the Generally Accepted Auditing Standard (GAAS) and Generally Accepted Accounting Principles (GAAP), fulfilled the conditions of sustaining independence as an auditor and performed audit duties according to the stipulated laws and regulations (Complaint: David G Friehling, Friehling & Horowitzs, CPA's, P.C., 2009).
They had allegedly assessed the internal control environment of Madoff Securities and deemed it to be working sufficiently without reasons to believe otherwise (Complaint: David G Friehling, Friehling & Horowitzs, CPA's, P.C., 2009).

Despite these claims, Friehling and Horowitz in actuality had not done any critical evaluation or proper audit procedures as the audit firm had simply done bogus audit procedures of a certain accounts to stimulate a proper evaluation of audit procedures (Complaint: David G Friehling, Friehling & Horowitzs, CPA's, P.C., 2009). Furthermore, Friehling had dishonestly informed the American Institute of Certified Public Accountant (AICPA) that he was not involved in any of the audit procedures Friehling and Horowitz had done for Madoff Securities. Moreover, Friehling himself had shirked responsibilities to sit for the peer review applicable to auditors by denying his involvement in the audits (Complaint: David G Friehling, Friehling & Horowitzs, CPA's, P.C., 2009). All of these actions made by Friehling had conscientiously helped Madoff Securities from avoiding suspicions of fraud from regulators, employees and auditors. Consequently, Friehling received bonuses worth millions of dollars from the account that he held at Madoff Securities using the name of his family (Azim & Azam, 2016).

As an auditor, Friehling had not complied with the three principles of threats to objectivity and independence. The first principle which he had crossed was the self-interest threat as he had essentially invested $14 million dollars in Madoff scheme using the name of his wife (Azim & Azam, 2016). This causes a threat to Friehling's independence as he would act in his interest to generate returns from his investment. The second principle crossed was the self-review threat. In an interview with Friehling, it was observed that he had difficulty in maintaining his judgement. He had not done proper re-evaluation of any previous audit procedures as he had trusted Bernard Madoff unconditionally or approved the procedures “without asking questions” (Goldstein, 2015). As an auditor, Friehling was also compromised by the threat of familiarity or trust. Friehling and Madoff had fundamentally known each other for almost 17 years. It is unavoidable that their many years of partnership had strengthened their trust in and willingness to collude with one other.

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U.S. Securities exchange and commission (SEC)

As an important regulatory body, the SEC has the responsibilities to interpret and enforce federal securities laws, issue and amend rules, and monitor any private or public firms involving in field such as; securities, accounting and auditing (U.S Securities Exchange and Commission, 2016). However, possibly partly due to Madoff's stellar reputation and charisma that made him out to be trustworthy in the eyes of others (Azim & Azam, 2016), the SEC was irresponsible and showed a lackadaisical attitude while investigating the fraud cases claims for Madoff securities raised by insiders and third parties (U.S. Securities Exchange and Commission, 2019)

Harry Markopolos

Notably, the SEC ignored Harry Markopolos; a certified fraud examiner (CFE) who started to have suspicions about Madoff Securities way back in 1999. He would then make multiple memos to SEC in 2000, 2001 and 2005 about his suspicions. Although some of Markopolo's claims were possibly ignored because at that time he was working for the competitor of Madoff securities (Clark, 2010), the SEC failed to objectively investigate following his claims. It was revealed later that an employee from SEC New York office was prohibited by a superior from pursuing the case on Madoff and was told that they do not investigate investment management companies (Fingleton, 2013), which suggested that the SEC was possibly influenced by Madoff's reputation in their choice to not do an in-depth examination. As a result, the SEC failed to uncover the fraud because of negligence in their duties and there were weak regulations imposed on fraud claims for investment management companies (Taibbi, 2013).

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