Bernie Madoff's Blog!

Yes, we have located Bernie Madoff’s blog. Although the authenticity of the blog (and that of its ‘commenters’) is a stretch, it makes for a change of pace in what is otherwise a very somber subject.

The House Financial Services Committee has scheduled a hearing for Jan. 5, 2009 on Assessing the Madoff Ponzi and the Need for Regulatory Reform. Bloomberg’s Ian Katz was among the first to report this development in his Dec. 29 article, “Madoff Hearing Set as House Weighs Regulatory Changes.”

Katz quotes Rep. Paul Kanjorski, chair of the Capital Markets Subcommittee of the House Financial Services Committee saying, “These proceedings will help us to discern whether or not the Securities and Exchange Commission had the resources needed to get the job done, how such a sizable scheme could have evaded detection for so long, and what new safeguards we need to put in place to protect investors.”

Diana B. Henriques of the New York Times notes in her article today, Madoff Case Faces Crucial Disclosure Deadline, that: “[Today is] the deadline for Mr. Madoff to provide federal securities regulators with a full accounting of his and his New York firm’s assets — from real estate to art works to bank accounts.” Additionally, she notes: “Judge Louis L. Stanton of United States District Court, who is handling the civil case against Mr. Madoff, is being urged to consider broadening the protections normally available to investors in failed Wall Street firms to allow for the ‘devastating’ circumstances of the Madoff scandal.”

She reports: “Because Mr. Madoff operated a brokerage firm, some of his direct investors may be covered under the Securities Investor Protection Corporation [SIPC], a federal fund created to cover fraud losses in brokerage accounts.“ However, she notes that many of the victims were not direct customers of the Madoff brokerage firm, but instead had invested in various “feeder funds.” One such investor, Daniel Goldenson, says Henriques: “urged Judge Stanton to consider looking past those feeder funds to the individuals ultimately affected by Mr. Madoff’s collapse,” as far as qualifying for SIPC coverage.

Separately, some, including former SEC Chief Accountant Lynn Turner, have questioned how audit firms like Friehling & Horowitz, the three person firm that allegedly audited Madoff’s books (with one active CPA, former New York State Society of CPAs Rockland County Chapter President David Friehling), could have avoided peer review at the state and federal level.
AICPA spokesman William Roberts has been quoted in various articles (including Madoff's Auditor Under Ethics Probe by CPAs Group by Emily Chasan of Reuters) noting the Friehling & Horowitz firm committed in writing to the AICPA for a number of years that the firm was not engaged in audits – and thus was not subject to AICPA peer review requirements. The fact that the Friehling & Horowitz firm signed off on the Madoff audit reports has triggered the ethics investigation by the AICPA.

As far as state peer review requirements are concerned, I had read in WebCPA on Dec. 18 that the New York State legislature recently passed a bill which was awaiting the governor’s signature which would include some beefed up peer review and other requirements. The article, New York Passes Education Law, stated, “The New York State Senate and Assembly have unanimously passed a groundbreaking bill that would amend the laws governing CPAs and provide greater public protections for their clients.” Regarding peer review, the article said “The bill will also require all New York State CPA firms to register and those that provide attest services will have to undergo peer review every three years (exempting sole proprietors and firms with two or fewer accounting professionals, except if they perform state or municipal governmental audits).” Given the exemption as so described, it would appear firms like Friehling & Horowitz would still not be required to have peer review under the State of New York’s new requirements. I checked with AICPA’s Roberts to see if there was a similar exemption at the AICPA for firms with two or fewer audit professionals as far as peer review is concerned, he replied there was no such exemption.

Human Nature
More recently in WebCPA, Howard Wolosky, Editor in Chief of Practical Accountant, wrote about the Madoff saga and other scandals of recent memory, in an article entitled, Human Nature at Work. Wolosky cited in turn an article by William Barrett in the Jan. 12, 2009 issue of Forbes, Madoff Mess is Nothing New – subtitled: ‘The big lesson in the Madoff scandal? How little financial scams change over time.’

I’ve thought about this phenomena as: in this complex world – based on Madoff’s own admission of committing a Ponzi scheme according to the SEC’s press release – he did it the old fashioned way: he simply lied, and apparently falsified documents to backup his story.

This concept of human nature in connection with the Madoff fraud, including concepts carefully constructed by the perpetrator, characterized by Forbes’ writer Barrett, such as the ‘reputation ruse,’ and the ‘affinity quagmire,’ got me to thinking about an interview I listened to recently of incoming SEC Chairwoman Mary L. Schapiro. It’s actually the Nov. 2, 2005 oral history of Schapiro taken by the SEC Historical Society, one of the links we provided about her in our post on Dec. 18 when she was named incoming chair (subject to Senate confirmation) by President elect Barack Obama. At the time of her interview Schapiro had formerly served as an SEC commissioner and as Chair of the CFTC.

One thing Schapiro talked about, right at the beginning of her 2005 interview conducted by Kenneth Durr, was the relevance her undergraduate major in cultural Anthropology held for her as a law student and then securities regulator. I highly recommend you listen to the entire interview, or you can read the transcript. I remember taking one class in cultural anthropology in college, and it was one of my favorite classes; our term paper assignment was to write about how the characters on a TV show of our choice represented a facet(s) of society or something like that. I distinctly remember picking Gilligan’s Island as the chosen microcosm for my paper. (Maybe you remember: ‘Gilligan, the Skipper too, the Millionaire, and his Wife, the Movie Star, the Professor and Marianne, here on Gilligan’s Isle?) Anyway, it really is relevant today, why, even Thurston Howell III can be found as a commenter on Bernie Madoff’s blog.

As we end a tough year for the economy and the markets, I’ll borrow a phrase often used by outgoing SEC Chairman Christopher Cox when he speaks about and to various groups, beginning with his first public remarks as Chair in August, 2005, speaking to the SEC staff, and I’ll say to all those who serve the broader population in regulatory, enforcement, standard-setting, public policy-making and compliance roles, whether incoming, outgoing, or staying the pace, thank you for all you do, and to all our readers, Happy New Year to You!

SEC Releases Report on Mark-to-Market Accounting

On Dec. 30, 2008, three days ahead of a Congressionally imposed deadline, the U.S. Securities and Exchange Commission released its 211 page SEC study and recommendations on mark-to-market accounting. See related SEC press release. The formal title of the report is: Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-To-Market Accounting.

In brief, although the SEC does not recommend suspending FAS 157, Fair Value Measurement, or mark-to-market accounting, the SEC recommends that further improvements can be made to impairment standards and recommends further guidance on application of fair value accounting standards in illiquid or inactive markets. The SEC also recommends certain improvements to the standard-setting process, such as those recommended by SEC’s Advisory Committee on Improvements to Financial Reporting (CIFiR), such as formation of a Financial Reporting Forum consisting of users, preparers and others, to meet periodically with FASB, the SEC and PCAOB. Further details can be found in these FEI summaries: Six Areas Addressed In SEC Study On Mark-to-Market; and Eight Recommendations In SEC’s Report On Mark-to-Market Accounting

My two cents
Here are a few of my own observations (may I remind you of the disclaimer on the side of this blog):

• Exit value, market participants notion: Although the SEC staff concluded that FAS 157 should not be suspended, but that further guidance is needed, the report gives FASB a broad mandate by recommending: “In determining how to address the above issues, [e.g. impairment, fair value in illiquid markets] the FASB should consider which issues could be resolved through a review of the objectives of SFAS No. 157 and which issues would be best addressed by the valuation community.” Some of the SEC's roundtable panelists and commenters, including Kevin Spataro of Allstate (representing GNAIE at SEC's Nov. 21 roundtable) noted the concept of exit value and market participants, pushed forward by the requirement to determine hypothetical market participants' values in illiquid markets, essentially put you in a never-ending continuum of hypothetical values which were not necessarily consistent with the going concern notion. Support for a reexamination of FAS 157, in light of lessons learned through application in the real world during the past year-plus, was voiced in a joint comment letter filed with FASB on Nov. 25, 2008 by FEI’s Committee on Corporate Reporting and the U.S. Chamber of Commerce’s Center for Capital Market Competitiveness. (See FEI CCR-USCC CCMC letter.) The SEC’s Dec. 30 mark-to-market report also reiterated CIFiR’s call for a post-adoption or post-implementation review of accounting standards.
  
• Bright line? I found it interesting that the SEC refers to 45% as a minority in the following sentence: “From the sample of financial institutions studied …the Staff observed that fair value measurements were used to measure a minority of the assets (45%) and liabilities (15%) included in financial institutions’ balance sheets.” The report continues: ”The percentage of assets for which changes in fair value affected income was significantly less (25%), reflecting the mark-to-market requirements for trading and derivative investments,” and adds: “[F]or those same financial institutions, the Staff observed that fair value measurements did significantly affect financial institutions’ reported income.” Many charts are provided in the report, showing breakdowns by size and type of financial institution and the type and percent of assets carried at fair value with the change in fair value recorded in income vs. Other Comprehensive Income (OCI, a component of equity).
  
• “Directionally consistent” vs. pro-cyclicality: The SEC acknowledges that there was a diversity in views among panelists at its roundtables and in comment letters as to whether fair value accounting contributed to pro-cyclicality, although the SEC found a general consensus that fair value accounting per se was not the proximate cause of the credit crisis. However, a number of panelists and commenters have referred to fair value accounting as an ‘accelerant’ igniting liquidity spirals, and I am not sure how much comfort those in that camp will receive from the SEC’s finding that: “[W]hile fair value is used to measure certain assets such as trading securities and impairment losses on AFS [available for sale] securities, such declines in value were directionally consistent with the losses on the underlying loans and the current economic conditions, which impacted the value of these securities.”

Whether you agree or disagree with the SEC’s findings, or find yourself somewhere in the middle, the SEC is to be commended for writing a study on a complicated matter in plain English, including a section devoted to The Financial Reporting Framework, which the SEC describes as “a short primer …including the basic accounting concepts necessary to understand the issues discussed in this study.”

It can also be a pleasant addition to find an Appendix which is as interesting as the study itself; that is the case with the SEC’s summary of the 185 comment letters it received on this subject as of December 15, 2008, which appears in Appendix A of the report.

The SEC’s study on mark-to-market accounting may make a best seller’s list (among accountants, some lawyers, and public policy types, at least) as the FASB-IASB joint Financial Crisis Advisory Group begins to meet, and as FASB considers comments received on two proposals issued in December relating to impairment of certain financial instruments (Proposed FSP EITF 99-20-a) and proposed disclosures relating to fair value (Proposed FSP FAS 107-a). Congress will no doubt take an interest in the report, which it expressly required as part of the Emergency Economic Stabilization Act of 2008, as it continues to monitor the health and well-being of the economy.

FASB-IASB Fin. Crisis Adv. Group Members Announced; SEC Approves Final Oil & Gas Rules

Earlier today, FASB and the IASB announced the members of their joint Financial Crisis Advisory Group. U.S. members include investor reps and former regulators such as Vanguard founder Jack Bogle, Jerry Corrigan (formerly President of NY Fed) and Gene Ludwig (former Comptroller of the Currency) and Don Nicolaisen (former SEC Chief Accountant, and co-chair of the U.S. Treasury Advisory Committee on the Auditing Profession which issued its report earlier this year). Another U.S. rep is Raudline Etienne, Chief Investment Officer, New York State Common Retirement Fund. As previously announced, the joint advisory group will be co-chaired by former SEC Commissioner Harvey Goldschmid, and Hans Hoogervorst, Chairman, AFM (the Netherlands Authority for the Financial Markets).

According to today's announcement:

• "The primary function of the advisory group is to advise the boards about standard-setting implications of (1) the global financial crisis and (2) potential changes to the global regulatory environment. The group will conclude its activities within approximately six months (or less) and will conduct advisory meetings during that time."

Matters to be considered by the advisory group include FASB-IASB priorities, the SEC's upcoming study of mark-to-market, and issues relating to due process, independence, and governance of the standard setters.

In terms of timing, some of the comment letters filed with the SEC relating to its mark-to-market study ask for certain actions to be taken with respect to fair value or mark to market accounting to impact year-end reporting this year, and that other longer-term actions be taken. See, for example, this joint comment letter filed Dec. 19 with the SEC by various industry groups.

Although the FASB-IASB advisory group will consider "significant accounting issues that require urgent and immediate attention by the boards, as well as issues for longer-term consideration," the fact that their first meeting will be held in January 2009, and that they will operate as an advisory group to inform subsequent action of the FASB and IASB may indicate that any 'urgent and immediate actions' following from their advice may not necessarily impact year-end reporting as of 12/31/08, especially in terms of how financial statement items are actually measured and reported, although there could be some impact on disclosures that are subsequently provided, e.g. in 10-Ks.

Comment deadline today on FASB 99-20 Impairment Proposal
However, there is a FASB proposal out for comment that could impact year-end reporting with respect to certain financial instruments. As we reported on Dec. 20, FASB released Proposed FSP EITF 99-20-a, Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20, on Dec. 19, and the comment deadline is today (Dec. 30).

We noted previously that the 99-20 proposal will only have an impact if it is ultimately approved by the FASB board after they review comment letters, and that some board members were not entirely in favor of the proposal when it was first discussed, but were willing to propose it for public comment and reach a final decision afterward. The FASB calendar currently shows a board meeting scheduled for Wed. Jan. 7, and that a meeting that had been added Mon. Jan. 5 has now been cancelled.

Separately, FASB and the IASB released on Dec. 24 proposed disclosure guidance in the form of Proposed FSP FAS 107-a, Disclosures about Certain Financial Instruments. (See also the related IASB Exposure Draft: Investments in Debt Securities - an Amendment of IFRS 7, and IASB's related press release. ) The comment deadline deadline on the proposed disclosures in this FASB FSP (and the related IASB ED) is January 15.

SEC Approves Changes To Oil and Gas Company Reporting Requirements
In other news, the SEC issued a press release yesterday announcing "SEC Modernizes Oil and Gas Company Reporting Requirements to Provide Investors With More Meaningful and Comprehensive Disclosure." This action culminates the process taken with SEC's earlier Concept Release and Rule Proposal in this area. SEC states in yesterday's press release: "The full text of the adopting release concerning these amendments will be posted to the SEC Web site as soon as possible."

Euro. Comm. Grants Equivalence To U.S. GAAP, More

On Dec. 12, 2008, the European Union (EU) issued a press release announcing: European Commission Grants Equivalence In Relation To Third Country GAAPs. (GAAP refers to Generally Accepted Accounting Principles.) The [European] Commission Decision and related [European] Commission Regulation (EC) No. 1289/2008 were published in the Journal of the European Union on December 19.

Had the European Commission (EC) not reached this equivalency decision, all foreign (non-EU based) companies listed in the EU, which file financial statements with authorities such as stock exchanges in the EU, would have had to begin filing those financial statements in the EU in International Financial Reporting Standards (IFRS), rather than in their home country GAAP (referred to as ‘third country GAAP’).

Like their EU-based counterparts, who were required to file their financial statements in IFRS in the EU beginning in 2005, foreign (non-EU based) companies listed in EU markets would have been required to file in the EU in IFRS as of Jan.1, 2009, to create a level playing field or harmonization.

However, in recognition of ongoing convergence efforts by the countries addressed in the December 12 equivalence decision, the EC, after consultation with the Commission of European Securities Regulators (CESR), made the finding of equivalence in accordance with the ‘equivalence mechanism’ established by the EC one year ago.

U.S., Japan GAAP Found Equivalent; China, Canada, South Korea, India on Transitional Basis
According to the EU’s December 12, 2008 press release, "The measures adopted today, which fall under the Prospectus Directive and Transparency Directive, determine that the GAAPs of US, Japan, China, Canada, South Korea and India are found to be equivalent to International Financial Reporting Standards (IFRS) as adopted by the EU. The Commission will review the situation of some of these countries (China, Canada, South Korea, India) by 2011 at the latest. The Commission will also regularly monitor the ongoing status of equivalence and report to Member States and Parliament where necessary." The press release continues:“Today's measures will mean that foreign companies listed on EU markets will continue to be able to file their financial statements prepared in accordance with those GAAPs (the transitional provisions allowing the use of these GAAPs in the EU would otherwise have expired at the end of 2008).”

Based on the status of convergence efforts (e.g. under the updated Memorandum of Understanding (MOU) between the Financial Accounting Standards Board and the International Accounting Standards Board, and based on the agreement between the Accounting Standards Board of Japan and the IASB), and the fact that the U.S. (under the SEC’s Nov. 2007 decision) and Japan do not require foreign filers to provide a reconciliation from IFRS to U.S. or Japanese GAAP, respectively, the EC found U.S. GAAP and Japan GAAP to be equivalent to IFRS.
Canada, South Korea and India have all formally announced plans to move to IFRS by 2011, and China’s Accounting Standards for Business Enterprises are ‘substantially converged’ with IFRS, and ‘cover nearly all topics under current IFRS,’ notes the EC Regulation adopted on December 12. Therefore, the Regulation states, the EC has approved the equivalency of Canada, China, South Korea and India’s IFRS on a transitional basis until 2011.

Equivalent Appears To Mean No “Remedy” Or Explanation of Significant Differences Required
Marie Leone of CFO.com reported the European Commission (EC) decision on December 12 in her article, “A Holiday Reconciliation Gift From the EU.”

We were wondering if there is still any possibility the EC/EU may require any type of ‘remedy’ or disclosure of significant differences between the equivalent third country GAAP and IFRS, as such ‘remedies’ had been contemplated in earlier draft advice documents issued by the Committee of European Securities Regulators (CESR).

As background, in an evolving series of recommendations (formally called ‘advice’ documents), beginning with CESR’s June, 2005 advice, CESR had initially proposed that countries filing in the EU in ‘equivalent’ GAAP – based on the status of IFRS-GAAP convergence and other factors at that time – would have to provide ‘remedies’ to investors in the form of disclosure of significant differences in reported results based on the third country GAAP vs. IFRS. Some, including FEI’s Committee on Corporate Reporting, in a comment letter filed with CESR on June 24, 2005, found CESR’s 2005 proposed ‘remedy’ tantamount to a reconciliation requirement.

Subsequently, in consideration of the furtherance of convergence efforts between FASB and the IASB and other developments including the U.S. Securities and Exchange Commission’s November, 2007 decision to drop the reconciliation requirement for foreign private issuers in the U.S., and in light of the European Commission’s publication in December, 2007 of a mechanism by which the equivalence of third country GAAPs would be determined, CESR’s March, 2008 advice stated, “It is CESR's view that the EU legislators' approach … reflected in the [European] Commission’s Regulation on the [equivalence] mechanism potentially requires a more holistic outcome-based approach to third country GAAP equivalence to be taken rather than an approach based on an analysis of differences in standards and remedying those differences.”

CESR concluded in March, 2008: “CESR now believes that it is best to base a decision on equivalence on an holistic assessment of the ability of investors to make similar decisions on investments irrespective of the existence of potential lingering differences in presentation and measurement, as long as such differences are taken into account in a sensible long-term work programme between the standard setters concerned and the IASB and there is evidence of such programmes being active pursued.”

We invited some experts to share with us their views on whether the EC Regulation issued on December 12 (published on December 19) requires any explanation of significant differences between IFRS and third country GAAPs (e.g., U.S. or Canadian GAAP) found equivalent to IFRS.

Paul Munter, a partner at audit firm KPMG (see also KPMG’s IFRS Institute) told us, “From my reading of the regulation, it appears that a company can use US GAAP without any reconciliation or other explanation, other than a clear and unreserved statement of compliance with US GAAP. He added, “Nothing in the regulation suggests to me that a company using US GAAP would be required to provide any explanation of the differences between their US GAAP financial statements and what the results would be under IFRS.”

Bruce Pounder, CMA, CFM, DipIFR (ACCA) and president of Leveraged Logic, a provider of IFRS convergence training, told us, “In the [European Commission’s] decision, I see no indication of a requirement to reconcile, provide supplementary financial statements, or provide additional disclosures regarding differences between U.S. GAAP and IFRS.” However, he added, “It will be interesting to see whether a requirement for explanatory disclosures makes it into a subsequent legislative act, which is always a possibility.”

As far as particular requirements are concerned, see the NOTE at the bottom of this post.

Canada, Mexico Already Moving to IFRS
Darla Sycamore, author of the blog “IFRS Canada: The Devil is in the Details,” [see her related website: The IFRS Exorcist] told us, “As you know we [Canada] have a requirement for conversion for public entities [to IFRS] for years beginning January 1, 2011.” She added, that as a practical matter, during the interim period (1.1.09, when the EU would have originally required IFRS by all foreign filers, and 1.1.11 when Canada will have adopted IFRS), “I am delighted that the EU has given recognition to Canada’s convergence efforts.”

Additionally, she believed the regulation would be responsive to a question some had about the applicability of the looming requirement for IFRS reporting in the EU that would have become effective as of 1.1.09 (barring the equivalency decision) with respect to certain non-calendar year-end companies as well. According to her reading of the EC Regulation, Sycamore added, “I think it would seem to allow non calendar year companies such as our banks (that have October 31 year ends) to file in Canadian GAAP for their October 31 year ends.”

By the way, Sycamore's blog was among the first to report on Mexico's Nov. 11 decision to adopt IFRS from 2012 onward, and to permit early adoption. She includes a link courtesy of Bruce Pounder to CINIF's Nov. 11 press release, with a translation by Pounder, in the comments section of the above-linked post.

SEC Roadmap Not Mentioned, But Euro. Comm. Says “Countries Should Be Encouraged To Adopt IFRS”
The EC’s December 12 decision does not mention the U.S. Securities and Exchange Commission’s proposed roadmap released in November, 2008 which proposes various milestones that would be considered by the SEC in determining whether to mandate IFRS filings by U.S. public companies, and proposes a timetable in which the SEC would potentially reach that decision in 2011, and require such filings beginning in 2014 (including some prior year comparative information in IFRS). Additionally, the SEC roadmap proposed permitting certain companies in industries in which IFRS is the most predominantly used standard to ‘early adopt’ IFRS.

By being silent on the SEC roadmap and detailing a rationale for the finding of equivalence based on the status of FASB-IASB convergence and the fact that the SEC dropped the reconciliation requirement for foreign issuers, some may say further progress on the roadmap appeared not to be a condition precedent for the EU’s equivalence decision.

However, the EC regulation does state, “The [European] Commission should continue to monitor, with the technical assistance of CESR, the development of those third country GAAPs in relation to adopted IFRS.” They add: “Countries should be encouraged to adopt IFRS,” and “The EU may determine that the national standards which have been determined to be equivalent may no longer be used in preparing information required … when those respective countries have adopted IFRS as their sole accounting standard.”

The EC’s equivalence decision is welcome news for companies that are listed in the EU that wish to continue filing there in one of the third country GAAPs deemed equivalent to IFRS.

NOTE: We recommend (as always), that reference be made to documents and legislation issued by the EU/EC, and that companies consult with their auditors and legal advisors in determining what the requirements are for filing financial statements and related disclosures in the EU, U.S. or elsewhere.

FASB Releases Proposed Impairment Guidance (Re: 99-20); Today’s Madoff Update

FASB issued a press release Friday night Dec. 19 that it has released the first of two proposed FSPs to address concerns arising from the current financial crisis relating to accounting for financial instruments, and that a second proposed FSP will be issued this week.

• Proposed FSP EITF 99-20-a, Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20, was posted Friday night and the comment deadline is December 30, 2008.
• Proposed FSP FAS 107-a, Disclosures about Certain Financial Instruments, will be released within a week, according to FASB, with a comment deadline of January 15, 2009.

It is impressive that FASB kept to its promise of releasing the proposed FSP on Friday, even with the snow-storm that closed FASB’s offices (according to the outbound voice message on their main number) as well as many other offices in the NY-NJ-CT area.

IASB Posts Proposals, Other Documents Relating to Credit Crisis

In the past few days, the IASB has posted a number of documents relating in part to the credit crisis:

• IASCF publishes update on responses to the G20 conclusions (Dec. 17)
• IASB publishes proposed new Consolidation standard as part of comprehensive review of off balance sheet risk (Dec. 18)
• IASB provides update on steps taken in response to the global financial crisis (Dec. 19

Today’s Madoff Update…
Perusing the New York Post for an article on yesterday’s snowstorm (linked in the first item above) – a newspaper not routinely cited in accounting and legal blogs but appreciated by some as giving a more colorful take on things - I noticed they have an article today on, “Madoff’s Auditor Gave Lessons on Ethics.” The article, by Paul Tharp, says of David Friehling, one half of audit firm Friehling & Horowitz, (and by some accounts, one-third of the three person firm) which purportedly audited Madoff’s investment company, states:

• “The little storefront accountant who was supposed to have audited Bernard Madoff's books may have had a blind eye for numbers - but his mouth seemed to work overtime boasting about ethics…. In an accounting magazine, The Trusted Professional, he wrote an article exhorting colleagues not to cheat. “When we see our clients and they ask us to stretch the truth, we are just cheating ourselves," he wrote in the magazine's April issue. "When those clients . . . ask you to stretch (or shrink) the numbers a little bit, remember not only your professional ethics and responsibilities, but your personal ones as a citizen of the United States. If nothing else, remember your basic math."

We told you about Friehling’s April column which appeared in the New York State Society of CPA’s newsletter, Cheating on Taxes is Cheating on Ourselves and his May column, The More You Give, The More You Receive in our post, Madoff: Mystique or Mistake, when the story first broke last week.

The latest news about Madoff’s audit firm, and about some major audit firms that audited “feeder funds” into the Madoff fund, comes via Francine McKenna’s Re: The Auditor’s blog, in her post “If Its Not One Thing, It’s Another – Auditors Getting Sued Over Madoff. Among other info, McKenna provided a link to Madoff’s Auditor… Doesn’t Audit?, by Alyssa Abkowitz, which notes that the AICPA requires member firms registered to audit to submit to the AICPA’s peer review program, and states:

• "Friehling & Horowitz is enrolled in the program but hasn't submitted to a review since 1993, says AICPA spokesman Bill Roberts. That's because the firm has been informing the AICPA -- every year, in writing -- for 15 years that it doesn't perform audits.
• "Meanwhile, Friehling & Horowitz has reportedly done just that for Madoff. For example, the firm's name and signature appears on the 'statement of financial condition' for Madoff Securities dated Oct. 31, 2006. 'The plain fact is that this group hasn't submitted for peer review and appears to have done an audit,' Roberts says. AICPA has now launched an 'ethics investigation,' he says."

The only way I can imagine audit firm Friehling & Horowitz getting out of this unscathed, is if Madoff pulled a Dreier and falsified documents – in Madoff’s case, if he falsified a Friehling & Horowitz auditor’s report. That would also explain the failure of the audit firm to submit to peer review.

However, if the audit firm did in fact conduct the audit, even if they claim they were defrauded by Madoff, - e.g. by being shown fake documents - there is the possibility they could be found negligent for performing inadequate audit procedures (and more specifically, for not performing an audit in accordance with professional standards as established by the AICPA, which sets standards for audits of non-public companies) that may have established the veracity of the claimed assets through some type of third party confirmation. Determining the role of other audit firms with respect to their professional responsibilities in auditing feeder funds may be more complex, as discussed at more length, including a quote by Cynthia Fornelli, Executive Director of the Center for Audit Quality, in McKenna’s Re:The Auditors blog.

Securities Mosaic also posted a Spotlight on Bernard Madoff this week, gathering together a host of documents on the case, including SEC releases and court orders in the Southern District of New York, law firm memos, news stories, blog posts and more.

Party Time

In a break from our regular news (which so far this week has consisted of Madoff: Mystique or Mistake? FASB to Release Proposed Amendment to EITF 99-20 This Week, To Address Concerns About Impairment; SEC Votes to Mandate XBRL, Launches IDEA; SEC Launches Survey of Section 404 Costs, Benefits; and Mary L. Schapiro Named SEC Chair by President-Elect Obama, Subject to Senate Confirm, and FEI Names Marie Hollein President & CEO) we at FEI had our annual Holiday Party (actually, Holiday Luncheon) yesterday.

The office holiday party is a time honored tradition in many firms and associations, although there have been various reports (like this one from CNN) that some firms (particularly TARP bailees) have cut out their parties entirely, and others have cut back.

Maybe not surprisingly, some law firms have taken to distributing memos reminding their employees of the rules of conduct at their holidays, like this one posted on Above The Law (which I'm pretty sure I first saw posted on one of the blogs on Securities Mosaic Blogwatch). There are still some reports of over-the-top parties taking place, but there seem to be more reports of firms cutting back and in some cases redirecting a more limited amount of dollars to charities instead of parties, and encouraging their employees to do the same, as noted in this article in the Atlanta Journal-Constitution.

This Year's Most Popular Gift: The Barack Obama Action Figure!
FEI’s holiday party was pretty much in keeping with our past tradition, which is fun but totally professional. As noted in my post earlier today, FEI staff were the first given the news of our new President and CEO, Marie Hollein being appointed. Our holiday gift from FEI was a shirt (FEI emblem of course) and service awards are given out. The highlight of the party is the gift exchange - and by ‘gift exchange’ - I mean its one of those party activities where you bring in a present you might have received from somebody else at some point and would really like to exchange for something else in some other nicely wrapped package. To add an element of drama, people can ‘steal’ each other’s presents and make the person you ‘steal’ from go back to the table to pick another present.

I was pretty happy with the gift I got in the gift exchange, a Barack Obama Action Figure , until somebody ‘stole’ it from me – I won’t name any names (but it was the Director of Tax and Economic Policy in our Washington D.C. office) - and it was stolen from him as well – a very popular item this year! Although I don’t have a photo from the office party (not that photos were banned as I assume they may be at some office parties…) here’s a photo of some of my colleagues at our staff breakfast this morning – notice how we came in bright and early before the expected 6-12 inches of snow falls!

Music For Your Office Party!
Another perennial item in the gift exchange is a CD from The Singing CPA – whose real name I learned only last year when I picked his CD in the gift exhange -is Steven Zelin. Zelin was featured on the front page of the Wall Street Journal on April 15 this year, and in a related video segment on WSJ.com . This morning, he was interviewed on NPR.

“No Accounting for the Holidays” is the new CD issued this year by Zelin, and it provides some great holiday music that would be appreciated by accountants and others who can relate to the profession. I recommend it for your holiday parties (your office parties, at least) and Zelin has been gracious enough to provide some exclusive clips to us to share with you.

Imagine opening your party with Deck The Halls With Calculators, followed by The Most Deductible Time of the Year. Let’s not forget that favorite, Joy To The World, The Client's Paid, and for a little variety, try Hava Tequila. After all the frivolity, when its time to close (the party, or the books), you can play Go Home Ye Weary CPAs.

If you’d like to order “No Accounting for the Holidays,” priced at $10.40 - you can order it as an mp3 download or CD via CDbaby.com here http://cdbaby.com/cd/zelin4 . Zelin also told us that if you have a rush order for a CD, he’ll fed ex it to you if you add the shipping fee, his contact info (email, phone) are on his website http://www.stevenzelin.com/.

FEI Names Marie Hollein President & CEO

Financial Executives International (FEI) issued this press release last night that Marie Hollein has been appointed President and CEO of the organization of 15,000 senior financial executives. Hollein, currently a Managing Director for KPMG's Treasury Practice, will take the helm at FEI effective January 12. Jim Abel served as President and CEO on an interim basis since July while the search was conducted. FEI announced the news to staff first at our holiday luncheon yesterday (more about that in my next post), and staff are very excited to welcome Hollein as our leader, with many of us knowing her as an active and dedicated member of FEI . We also wish Jim Abel well and thank him for his leadership during the search period.

Mary L. Schapiro Named SEC Chair By President-Elect Obama, Subject To Senate Confirm

At a press conference earlier today, President Elect Barack Obama named Mary L. Schapiro, currently Chief Executive Officer of the Financial Industry Regulatory Authority (FINRA), as his pick for chair of the U.S. Securities and Exchange Commission. Her appointment is still subject to Senate confirmation. Schapiro's prior experience includes serving as an SEC commissioner, as well as serving as chair of the Commodity Futures Trading Commission. Links to further info can be found below.
UPDATE: The text of Obama's remarks at the press conference was posted on the Transition website this afternoon, Schapiro's remarks have also been posted, and here is the CNBC video of the press conference.
(photo courtesy FINRA)

Mary L. Schapiro, Biography posted on FINRA
http://www.finra.org/AboutFINRA/Leadership/p009733

Related Materials Posted by SEC Historical Society:

November 2, 2005 oral histories interview: www.sechistorical.org/museum/oralhistories/interviews/schapiro.php

October 20, 2005 Enforcement Remedies program, in which she was a panelist: www.sechistorical.org/museum/programs/programs2005.php

Photos in www.sechistorical.org/museum/photos/photos2000.php

SEC Launches Survey Of Section 404 Costs, Benefits

Last week, the SEC launched its online survey of the costs and benefits of internal control reporting under Sarbanes-Oxley Section 404 and related rules of the SEC and PCAOB. The survey is available here: http://www.sec.gov/spotlight/404survey.htm. Responses to the survey are voluntary, and the SEC seeks responses from interested parties by year-end. As noted in SEC’s June 20, 2008 press release, the SEC extended the implementation date of the external audit of internal control under Sarbanes-Oxley Section 404(b) for smaller companies, in part to provide time to conduct and analyze the results of this survey, and determine if any further improvements to the rules can be made (following the 2007 SEC management guidance and PCAOB’s AS5 replacing AS2). Small co’s are currently subject to the requirement to provide a management report on internal control under Sarbox 404(a), and they are still subject to the regular audit of the financial statements, just not the additional audit of internal control under Sarbox 404(b) at this time. The SEC's survey could provide information that may potentially result in changes to the rules under Sarbox or the implementation thereof, and could potentially impact large as well as small public companies. Read more about the SEC’s Sarbox survey here.

SEC Votes To Mandate XBRL; Launches IDEA

At an open commission meeting on Dec. 17, 2008 the SEC voted to issue a final rule requiring financial statements and certain other information to be filed with the SEC in interactive data format, specifically, using eXtensible Business Reporting Language (XBRL). In related news, the SEC also launched its IDEA system, which will supplement, and eventually replace, the EDGAR system.

SEC Mandates XBRL
Four of the five commissioners agreed with the decision to mandate XBRL; Commissioner Luis Aguilar dissented due to the limited liability provision that will be offered during the first two years of companies’ XBRL filings, which he believed was in conflict with investor protection. Following are some highlights of the XBRL rule, further details are in remarks of Corp Fin staff. See also SEC Chairman Christopher Cox' opening remarks, and Commissioner Aguilar's dissent. (We will update this post to add links to other commissioner statements if posted, and to an SEC press release if posted.)

Effective date

• Three year phase-in by company size (described further below), with the first interactive data reports due beginning with the first quarterly report on Form 10-Q (or annual report on Form 20-F or Form 40-F, as applicable), for fiscal periods ending on or after June 15, 2009.
  
• For a calendar year-end company, the first required interactive data would be in connection with its June 30 Form 10-Q.

Three year phase in by company size and GAAP vs. IFRS filing status

• In year 1, the new rules would apply only to domestic and foreign large accelerated filers that use U.S. GAAP and have a worldwide public float above $5 billion, which the SEC estimates would cover approximately 500 companies.
  
• In year 2, all other domestic and foreign large accelerated filers using U.S. GAAP would be subject to interactive data reporting.
  
• In year 3, all remaining filers using U.S. GAAP, including smaller reporting companies, and all foreign private issuers that prepare their financial statements in accordance with IFRS as issued by the IASB would be subject to the same interactive data reporting requirements.
  Interactive Data Provided in Exhibit Filed With SEC, and on Corporate Website

Interactive data will be provided in a new Exhibit to the financial statements.

• The interactive data also would be required to be posted on the company’s corporate website, if it maintains one.
  
• Disclosure in interactive data format would supplement, but not replace or change, disclosure using the traditional electronic filing formats of ASCII or HTML.

Face of Financial Statements, Block Tagged Footnotes & Schedules In First Year

• The face of the financial statements would be tagged in each filer’s first year of interactive data reporting.
  
• The financial statement footnotes and financial statement schedules would be block tagged in companies first year of XBRL filing, with detailed tagging beginning in the second year.
  
• In a change from the proposal issued in May, tagging of narrative disclosures would be permitted but not required.

Limited Liability For Two Years Only

• Data in the interactive data file submitted to the SEC would be subject to liability similar to that of the SEC’s XBRL voluntary filer program. However, in a change from the proposal issued in May, the limited liability provision would be phased out after two years for each company.
  

No Auditor Assurance Required; Exclusion from Certs

• Issuers would not be required to obtain auditor assurance on their interactive data exhibits. Interactive data files would be excluded from the officer certification requirements under the Exchange Act rules.

Grace Period For First Interactive Data Filing

• A 30 day grace period (vs. the required filling date for the related form for which an interactive data exhibit is required) is provided for the company’s first interactive data exhibit (i.e., with block tags for footnotes and block tagged schedules) and a 30 day grace period will also be provided for the first exhibit required to have detailed tagging of footnotes and schedules.

IDEA System Launched, Will Supplement, and Eventually Replace EDGAR
Also on December 17, the SEC launched its IDEA system. IDEA stands for Interactive Data, Electronic Applications. IDEA will initially supplement, and eventually replace, the EDGAR system. (EDGAR = Electronic Data Gathering, Analysis and Retrieval System). Further information about IDEA is on the SEC's "What Is IDEA?" webpage, and the IDEA system can be directly accessed at: http://idea.sec.gov/

The SEC is working on moving ahead in all aspects of technology, as exhibited by their naming Mark Story to the position of Director of New Media. In that role, Story organized a conference call of bloggers on the afternoon of Dec. 17th following the Commission vote. Bloggers were invited to hear some additional insights by – and raise some questions of - David Blaszkowsky, Director of the Office of Interactive Disclosure, Walter Hamscher, Taxonomies and Development, Office of Interactive Disclosure, and Ann Sulzberg, Office of Investor Education and Assistance. [NOTE: corrected spelling of Hamscher's name, spelled incorrectly in our original post, we apologize for this error, thank you to Bob Schneider and Neal Hannon for pointing it out.]

Blaszkowsky gave some brief highlights from the XBRL rule, but much of the call was focused on Hamscher walking attendees through a live demo (via GoToMeeting) of the SEC’s new IDEA system.

To show the power of IDEA, the SEC’s demo used actual data from General Electric Company. (I’m not sure if GE was chosen for this reason - but like the SEC’s march forward on XBRL and IDEA, led by Chairman Christopher Cox, GE stresses innovation and imagination.)

As an aside, it was interesting to hear Commissioner Elisse Walter note in her remarks during the open commission meeting - when she noted her support for the final rule on XBRL - that for those who are concerned about the move to XBRL, similar trepidation was expressed by some when the SEC first launched EDGAR. She added that back when EDGAR was first adopted, some wondered if all the Commissioners would even use a computer.

I think it’s great that the SEC is reaching out through its Director of New Media to provide information to bloggers – and I also want to take the opportunity to thank John Heine, in the SEC’s Office of Public Affairs (I guess you call that ‘old media’?) who is always helpful to me, e.g. in finding information on SEC’s website and answering other questions.

Others scheduled to be on the SEC bloggers call included: Bill Cara (CaraCommunity), Christian Gross, David Janowski (Investment News), Michele Leder (Footnoted.org), Cate Long (ShopYield.com), Francine McKenna (Re: The Auditors) - who, by the way, recently interviewed FEI President & CEO Jim Abel on FEI's list of the Top 10 Challenges for 2009 - and Todd Sullivan (ValuePlays).

FASB To Release Proposed Amendment to EITF 99-20 This Week, To Address Concerns About Impairment

At its board meeting yesterday, FASB discussed issues raised during its three recent joint roundtables with the IASB on accounting issues in the credit crisis, and voted to take certain long- and short-term actions in response.

The first such action FASB agreed to yesterday that can potentially take effect this year-end is the release of a proposed amendment to EITF 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets.(EITF is FASB’s Emerging Issues Task Force.)

Certain language in EITF 99-20, an issue which arose in the late 1990's in a different market environment, has been alleged to cause excessive writedowns that are not only in excess of estimated incurred losses or credit losses, but are said to be inconsistent with losses calculated under another standard, FAS 115, Accounting for Certain Investments in Debt and Equity Securities.

FASB was particularly sympathetic with the point made about the potential inconsistent application of its standards in agreeing to propose the following amendment to EITF 99-20:

• Amend paragraph 12b of Issue 99-20 to be consistent with paragraph 16 of Statement 115 by removing “market participants” and requiring that there has been a “probable” adverse change in estimated cash flows. In addition, a similar amendment would be required for paragraph 12a with regard to interest income recognition.

The proposed effective date for this amendment is interim periods ending after December 15, 2008 (that is, for the period beginning October 1, 2008), with transition on a prospective basis.
FASB staff said they expect to release the Exposure Draft of the proposed amendment to EITF 99-20 by this Friday Dec. 19, and there will be at least a 10 day comment period (potentially ending Dec. 30 or 31).

The board expects to vote on a final amendment at its first board meeting in January. (NOTE: Yesterday, the board indicated their first meeting of 2009 would be Wed. Jan. 7; based on a look at the FASB calendar today, it appears they added a board meeting for Monday Jan. 5 – potentially to discuss this issue.) Staff members stated yesterday the goal would be to issue a final amendment by Jan. 8, which they believed would be in time for companies to rely on in their year-end earnings releases issued in January.

It is important to note that approval of the final amendment is not necessarily a fait accompli (as is always the case, technically) since board members will vote on a final amendment after reviewing comment letters and other feedback. However, in this case, some board members expressed a fair amount of reluctance on whether they would ultimately support the proposal, but were willing to release it to see what the comments would say.

A FASB staff member said the staff had polled a group of 12 users, who were evenly split on this proposed change, with some strongly supporting it as a way to enhance comparability (with FAS 115) and thereby reduce complexity, and other users strongly opposed to such a potential change.

Board member Tom Linsmeier, one of those who expressed reluctance on issuing the proposal, said, “I would be willing to expose this proposal, but I would like to see out of the comment letters, before (we) finalize vote to affirm, that there are really economic circumstances being accounted for improperly, that is, mis-timing of losses, I would look for that in comment letters. I remain skeptical, but for reasons (FASB staff) put forward, I’d be willing to explore (the proposal) for the reason (that) some users said it would be beneficial.”
Separate Exposure Draft of Disclosures proposed for year-end

Disclosures Proposal Also Coming This Month, More

Also at yesterday’s board meeting, FASB voted to release for public comment an Exposure Draft which would propose certain disclosures for financial instruments, which would also become effective as of this year-end - described further in the board handout), to provide information on fair value of financial instruments for which the accounting rules do not currently require those instruments to be carried at fair value with the valuation change going through earnings.

Additionally, FASB agreed to add a long-term project - a joint project with the IASB - to its agenda, to take a comprehensive look at reporting of financial instruments.

Separately, FASB also discussed whether to add a project to its agenda on permitting recoveries of Other than temporary impairment, and whether to add a project to issue a clarification of FAS 133 on derivatives.

Complete results of FASB’s meeting will be published in FASB’s Summary of Decisions Reached, which are generally posted on FASB’s News Center within a day of FASB board meetings. We will also post additional information in a summary on FEI’s website.

Madoff: Mystique or Mistake?

The stunning fraud allegedly confessed last week by investment advisor Bernard L. Madoff, resulting in up to $50 billion of losses by his own estimate, has investors reeling and questions being asked about the role of regulators and auditors. SEC's Dec. 11 press release, SEC Charges Bernard L. Madoff for Multi-Billion Dollar Ponzi Scheme notes:

• “According to regulatory filings, the Madoff firm had more than $17 billion in assets under management as of the beginning of 2008. It appears that virtually all assets of the advisory business are missing.”

The scale of the alleged fraud, according to Madoff’s own confession to at least one of his senior employees (said in various reports to be his sons) indicates he may have made off with $50 billion.

“Madoff told these employees that he was "finished," that he had "absolutely nothing," that "it's all just one big lie," and that it was "basically, a giant Ponzi scheme," as cited by the SEC.

According to the SEC’s press release:

• Andrew M. Calamari, Associate Director of Enforcement in the SEC's New York Regional Office, added, "Our complaint alleges a stunning fraud that appears to be of epic proportions."
• SEC Enforcement Director Linda Chatman Thomsen stated, "We are alleging a massive fraud — both in terms of scope and duration.” She added, “We are moving quickly and decisively to stop the fraud and protect remaining assets for investors, and we are working closely with the criminal authorities to hold Mr. Madoff accountable."

Jesse Westbrook and Saijel Kishan of Bloomberg have compiled a list showing Madoff’s Investors Had More Than $24 Billion With Firm: Table. Among other Bloomberg reports, see Madoff Confessed $50 Billion Fraud Before FBI Arrest by David Voreacos and David Glovin.

Mystique
How did Madoff, a man of such stature – incuding serving as the former chairman of Nasdaq – fall so far? And how did investors and others not see this coming? The Wall Street Journal has a whole collection of stories in its Complete Coverage: Bernard Madoff. One such article, How Bernie Madoff Made Smart Folks Look Dumb, (the weekend Intelligent Investor column by Jason Zweig) explains:

• “The accounts managed by Bernard L. Madoff Investment Securities LLC reported gains of roughly 1% a month like clockwork, with nary a loss, for two decades. Why did that freakishly smooth return not set off alarms among current and prospective investors? Of all people, sophisticated investors like Mr. Madoff's clients should know that if something sounds too good to be true, then it's not. But they believed it anyway. Why?”

Here is the answer, according to Zweig:

• “Mr. Madoff emphasized secrecy, lending his investment accounts a mysterious allure and sense of exclusivity… If you did get invited in, then you were anointed a member of this particular club of ‘sophisticated investors.’ Once someone you respect went out of his way to grant you access, says Prof. Cialdini, it would seem almost an ‘insult’ to do any further investigation. Mr. Madoff also was known to throw investors out of his funds for asking too many questions, so no one wanted to rock the boat. This members-only feeling blinded many buyers of Mr. Madoff's funds to the numerous red flags fluttering around his operation.”

Although some of the firm’s webpages are no longer directly visible from the homepage (but come up in search results) Madoff’s professional stature was formerly described on his firm’s website on a webpage entitled Madoff Securities: Quality Executions and Service Through Innovative Technology, which linked to a webpage entitled, The Owner’s Name is On the Door, providing this information about the prestigious roles held by Madoff, who founded the firm in 1960, and his brother Peter, who joined the firm in 1970:

• “Bernard L. Madoff has been a major figure in the National Association of Securities Dealers (NASD), the major self-regulatory organization for US broker/dealer firms. The firm was one of the five broker/dealers most closely involved in developing the NASDAQ Stock Market. He has been chairman of the board of directors of the NASDAQ Stock Market as well as a member of the board of governors of the NASD and a member of numerous NASD committees…
  
  Peter B. Madoff has also been deeply involved in the NASD and other financial services regulatory organizations. He has served as vice chairman of the NASD, a member of its board of governors, and chairman of its New York region. He also has been actively involved in the NASDAQ Stock Market as a member of its board of governors and its executive committee and as chairman of its trading committee. He also has been president of the Security Traders Association of New York. He is a member of the board of directors of the Depository Trust and Clearing Corp. He is a member of the board of the Securities Industry Association.”

The webpage closes: “These positions of leadership not only indicate the deep interest Madoff Securities has shown in its industry, they also reflect the respect the firm and its management have achieved in the financial community.”

Visitors to the home page of the Bernard L. Madoff Investment Securities LLC, www.madoff.com, will now simply see a message saying:

• “The Honorable Louis L. Stanton, Federal Judge in the United States District Court for the Southern District of New York, has appointed Lee S. Richards of the law firm Richards Kibbe & Orbe LLP receiver over the assets and accounts of Bernard L. Madoff Investment Securities LLC (“BMIS”) as per the attached order. Link to Order”

Mistake
Various articles have reported how wealthy investors and charities, have in some cases virtually been wiped out by their losses of funds invested with Madoff. How could such investors, many supposedly sophisticated investors, have not suspected something was amiss with the year-in, year-out steady returns? Zweig, author of WSJ”s Intelligent Investor column quoted above, posits:

• “The biggest dirty secret of the ‘sophisticated investor’ [is that] due diligence often goes undone.”

There were some warning signs, as noted in Gregory Zuckerman’s report in the WSJ, “Fees, Even Returns, and Auditor All Raised Red Flags.” He notes:

• “The first tip-off for some was the steady returns generated by the firm in every kind of market. Mr. Madoff would buy a basket of stocks resembling an S&P index while simultaneously selling options that pay off for the buyer if these stocks soar, while also buying options that pay off if the index tumbles. The supposed goal was to have smooth, steady returns.”
• “Harry Markopolos, who years ago worked for a rival firm, researched Mr. Madoff's stock-options strategy and was convinced the results likely weren't real. ‘Madoff Securities is the world's largest Ponzi Scheme,’ Mr. Markopolos, wrote in a letter to the U.S. Securities and Exchange Commission in 1999. Mr. Markopolos pursued his accusations over the past nine years, dealing with both the New York and Boston bureaus of the SEC, according to documents he sent to the SEC reviewed by The Wall Street Journal. In a statement late Friday, the SEC said ‘staff from the Division of Enforcement in New York completed an investigation in 2007, and did not refer the matter to the Commission for enforcement action.’ The SEC said it reopened the investigation Thursday. It's not clear what the focus of the 2007 investigation was, or why it was closed. A person familiar with the matter said it related to issues raised by Mr. Markopolos.”

The role of regulators with respect to Madoff is also addressed in Marcy Gordon’s Associated Press article, carried by www.washpost.com Friday night, “Madoff Case Raises Questions About SEC.”

Perhaps, as posited by WSJ’s Zweig, investors simply trusted Madoff, overwhelmed by the mystique factor.

But Jim Vos, CEO and Head of Research of Aksia LLC, an independent hedge fund research and advisory firm, was not among those who took things at face value, as noted in the WSJ. Vos is becoming something of a celebrity now, (see Vos on this Bloomberg video)since he advised his clients not to invest with Madoff.

It is well worth reading Aksia’s letter to its clients and friends, posted by the New York Times among others, which explains why Aksia dissuaded its own clients from investing in Madoff’s funds. Some red flags noted in Aksia’s letter, summarized by Peter Cohan in BloggingStocks, include:

• “Unknown accounting firm. Madoff used an accounting firm Friehling & Horowitz that employed three people -- one was a 78 year old living in Florida.
• Incomprehensible investment strategy too good to be true. Madoff employed a "split conversion strategy" which was never clearly defined and whose returns other traders could not duplicate.
• Deception about technology. Madoff claimed it was technologically sophisticated but a visitor to its offices found paper tickets sent through the mail.
• Family control of key jobs. Madoff staffed key control jobs with family members and it was extremely secretive.
• Violation of segregation of control principles. Madoff failed to separate the jobs of initiating trades, holding assets, and reporting on their condition.”

Audit Firm Under Scrutiny
The three person audit firm – Friehling & Horowitz - cited in Aksia’s letter, is discussed further in the Bloomberg article, Bernard L. Madoff Securities’ Auditor Prompted ‘Red Flags.’ The authors of the article, David Glovin, Karen Freifeld and David Voreacos describe Madoff’s audit firm as follows:

• “Friehling & Horowitz operates from a storefront office in the Georgetown Office Plaza in New City, sandwiched between a pediatrician’s office and another medical office. An office for the Rockland County Bar Association is also in the building.
• A woman who works in a nearby office, who didn’t want to be identified, said Friehling doesn’t come to the office regularly.
• When he does, he is the only person there. Another woman in a nearby office, Leslie Cousar, said the man who comes to the office does so for 10-to-15 minute periods, and wears tight pants and tie-dyed shirts. Cousar said she never saw anyone else going to the office during the day, but at about 5:30 p.m. another man would use the office.”

Friehling, the immediate past-president of the Rockland County Chapter of the New York State Society of CPAs, wrote occasional columns in the NYSSCPA newsletter, including The More You Give, The More You Receive (May 15, 2008) and Cheating on Taxes is Cheating on Ourselves (April 1, 2008).

The Rockland County District Attorney has opened an investigation on the audit firm, reports Karen Freifeld in Madoff Auditor Under Investigation by New York State Prosecutor. She notes:'

“We’re trying to determine if there have been any state crimes here,” Rockland County District Attorney Thomas Zugibe said in a telephone interview today. “When you have a key player like that operating in your county, you have to look.”

Further Analysis, Recommendations
Roger Ehrenberg, managing partner of IA Capital Partners Inc. and former Managing Director and Co-head of Deutsche Bank’s Global Strategic Equity Transactions Group, makes some interesting observations and recommendations about the Madoff matter in his Information Arbitrage blog in his post, The Real Take-Away From the Madoff Scandal. Ehrenberg says:

• “Madoff is a completely different kind of firm. It is a broker/dealer with an asset management division, enabling it to rely entirely on itself for trading and settlement. Further, it used a no-name, three-person accounting firm, unheard of for a firm of Madoff's size, scope and complexity.
• A purely rational trader of Madoff's stature would have set up a hedge fund business to extract 2/20 from his clients. I guess we now understand why; it would have subjected his portfolio to the unwanted scrutiny of his prime brokers.
• By keeping his game completely in-house and on the down low, it essentially fell through the cracks of our regulatory structure. Will this cause the SEC to redouble its efforts in regulating broker/dealers? Force changes in transparency, similar to what I've pushed for in the OTC derivatives market to the broker/dealer community? Or is it simply a matter of creating rules that ensure credible third-party involvement in the validation of assets under management/NAV in order that Madoff's brand self-dealing couldn't be sustained?

To prevent a scandal like the Madoff case from happening again, Ehrenberg recommends focusing on what's needed, such as segregated custodial funds validated by third parties,rather than regulatory or other solutions that are based on public relations.

SEC To Vote on XBRL Dec. 17

The SEC posted a Sunshine Act notice late yesterday (props to XBRL-US for circulating link to the Sunshine Act Notice) that they will hold an open commission meeting on Dec. 17 to “consider whether to adopt amendments to provide for companies' financial statement information to be filed with the Commission in interactive data format, according to a specified phase-in schedule.” Additionally, the commission will vote on whether to approve the PCAOB budget, and certain other matters.

TARP COP's Top Ten

The Congressional Oversight Panel (COP) established under the Emergency Economic Stabilization Act of 2008 (EESA) to “review the current state of the financial markets and the regulatory system” released the first in a series of reports yesterday. The report, “Questions About The $700 Billion Emergency Economic Stabilization Funds,” raises 10 issues about Treasury’s Troubled Asset Relief Program (TARP) and the various programs thereunder including the Capital Purchase Program and the Significant Failing Institutions (SSFI) program. Here are the Ten Questions from COP:

1. What is Treasury’s Strategy?
2. Is the Strategy Working to Stabilize Markets?
3. Is the Strategy Helping to Reduce Foreclosures
4. What Have Financial Institutions Done with the Taxpayers’ Money Received So Far?
5. Is the Public Receiving a Fair Deal?
6. What is Treasury Doing to Help the American Family?
7. Is Treasury Imposing Reforms on Financial Institutions that are taking Taxpayer Money?
8. How is Treasury Deciding Which Institutions Receive the Money?
9. What is the Scope of Treasury’s Statutory Authority?
10. Is Treasury Looking Ahead?

The report was presented by the panel’s chair, Elizabeth Warren, at a House Financial Services Committee hearing yesterday on “Oversight Concerns Regarding Treasury Department Conduct of the Troubled Assets Relief Program.” The current members of the panel include three appointed by the majority party, who, as noted in a Nov. 14 post in The Gavel, are Harvard Law Prof. Elizabeth Warren, New York State Banking Commissioner Richard Neiman, and AFL-CIO Associate General Counsel Damon Silvers.

The COP on the beat has not been without controversy itself, since one of its original appointees from the minority party bowed out of consideration, and the other minority member, Rep. Jeb Hensarling testified separately yesterday that he withheld signing off on this first COP report. His objection, he explained, was due in part to some procedural concerns about the panel, and concern about certain language which he believed “could be interpreted as a panel expectation that Treasury should make credit more expensive and less available for Americans.” He noted his concern that such a recommendation “could delay the recovery of our housing market at exactly the wrong time in our nation’s economic history.”

Also testifying at yesterday’s House Financial Services Committee hearing, chaired by Rep. Barney Frank, were Gene Dodaro, Acting Comptroller General, U.S. General Accountability Office, on GAO’s own oversight report on the TARP program, (see GAO testimony and GAO report), and Neel Kashkari, Interim Assistant Secretary for Financial Stability and Assistant Secretary for International Affairs at the U.S. Treasury Department, in charge of overseeing Treasury’s efforts on TARP on behalf of Treasury Secretary Henry Paulson.

Feedback Sought Through Roundtables, Website
As noted in COP’s report, the panel intends to issue another report within 30 days (on Jan. 10) which will endeavor to provide answers to questions such as those raised above regarding TARP. They will accomplish their mission by continuing to interview representatives of the Treasury Department and other officials, and by holding a series of field hearings -the first of which is set to take place next week in Las Vegas, Nevada. Not only is Nevada home to Senate Majority Leader Harry Reid, but the metaphor of gambling will no doubt not be lost on attendees. In fact, FASB Chairman Robert Herz spoke of institutions who were willing to ‘bet the ranch’ in his keynote address at an AICPA conference earlier this week.

COP has also established a website, which can be found at http://www.cop.senate.gov/. The panel notes it intends to use the website not only to post information, but to facilitate public comment and feedback.

Roadmap to Regulatory Reform
As also directed by Congress in Section 125 of EESA, COP has also been charged with issuing a special report to examine the financial regulatory system, and make related recommendations for reform. COP states it will release that report on January 20 (coincidentally, Inauguration Day). “This report will provide a roadmap for a regulatory system that would revitalize Wall Street, protect consumers, and ensure financial stability in our markets,” says the panel.

Recent speeches emanating from the SEC and FASB have cautioned all those considering regulatory reform to consider the separate roles of the SEC (as the investors’ advocate), FASB (as an independent, private sector organization charged with developing accounting standards to enhance transparency) and other agencies such as the banking agencies (charged with prudential supervision and oversight of safety and soundness of financial institutions. See, e.g. the Dec. 8 speech of SEC Chairman Christopher Cox, (see related article by Tim Reason of CFO.com, "Cox: Accounting is Not a Fiscal Policy Tool,") as well as the Nov. 21 speech of SEC Corp Fin Director John White (speech aptly named: “Don’t Throw the Baby Out With the Bathwater”), and in the above-cited Dec. 8 speech by FASB Chairman Robert Herz.

Herz noted in his remarks at the AICPA conference, “[T]o what extent are there contradictory objectives, for example, between safety and soundness vs. investor protection built into our current regulatory architecture.?” He cited similar views of forrmer SEC Chairman Arthur Levitt, in which Levitt had said: “banking regulators have one concern, but it is not investor protection.”

“I believe that it is imperative that this point be borne in mind in any redesign of our regulatory system so that the interests of investors and consumers don’t get shoved aside in favor of other public policy goals,” said Herz. He added, “In that regard, it is critical that accounting standard setting remains independent and oriented toward establishing standards that promote useful and transparent financial information for investors and other users and not be geared to fulfilling other objectives, as some have suggested.”

An example of the intersection of accounting standards and public policy can be seen in the Dec. 3 joint comment letter of the federal banking agencies to FASB on the upcoming changes to FAS 140 and FIN 46R which will impact securitization accounting and transfers of assets. The proposed elimination of the exception for ‘Q’s’ (qualified special purpose entities) has been estimated by some to potentially add billions and possibly trillions of dollars of mortgage-backed and certain other assets back on the balance sheets of financial institutions and other transferees, raising capital adequacy and other concerns.

The banking agencies advise FASB in their letter to work with the IASB on a long term solution, to: “provide financial statement users with a stable and reliable source of information about asset transfers including securitizations.” They add: “We recognize the need for improved transparency of financial reporting for securitization transactions and other off-balance sheet activities. We also understand the desire of the [SEC] and the FASB to provide a short-term fix for the accounting in this complex area in response to the financial turmoil observed since mid-2007.” However, they note, “we are concerned that making short-term changes to the U.S. accounting standards for financial asset transfers and consolidation could have an impact on credit markets in the U.S.”

More Guidance on Fair Value or Impairment Coming by Year-End?
We previously cited the comment letter of the American Bankers Association to U.S. Treasury Secretary Henry Paulson asking that the SEC take immediate action to provide certain guidance on fair value in time for year-end reporting. We also previously we cited the joint comment letter field by FEI’s Committee on Corporate Reporting and the U.S. Chamber of Commerce asking FASB to further defer the effective date of FAS 157, Fair Value Measurement, with respect to nonfinancial assets and liabilities, and to reexamine FAS 157 in its entirety.

In his remarks at the AICPA conference earlier this week, SEC Chairman Christopher Cox noted that preliminary findings in SEC’s Congressionally mandated study of mark to market (fair value) accounting are that further guidance on impairment and on fair valuing in illiquid markets is needed. He stated that the SEC had made a formal request of FASB in October to provide additional guidance on impairment (e.g. Other than temporary impairment or OTTI under FAS 115). Cox added: “Since our October letter, we have encouraged the FASB to address issues including impairment, the convergence of IFRS and U.S. GAAP on this and related topics, and the treatment of so-called EITF 99-20 securities including CDOs and other structured instruments.” He then noted: “As you will hear from Bob Herz and others later today, the FASB is working diligently on these issues, and is mindful of the importance of providing guidance in time for the preparation of annual reports at the end of this year.”

More Reading On…
Further reading on the subject of regulatory reform can be found in the Washington Insights column (this month authored by yours truly) in Financial Executive Magazine, “Congressional Hearings on Financial Regulation on Tap.” (Non-FEI members will be prompted to create a free online login account to read articles from our magazine.)

There are many other thought provoking articles in this month’s Financial Executive Magazine, including the cover story, Fraud’s House of Cards, by former Enron Executive (and founder of The Integrity Institute) Lynn Brewer. There’s also an interview of PCAOB Board Member Charles Niemeier – “Can More… or Less Regulation Fix What’s Wrong,” by Cheryl Graziano, Vice President-Research and Operations of the Financial Executives Research Foundation (FERF) and Ellen Heffes, Editor-in-Chief of the magazine.

You can also read timely updates on international financial reporting issues by Alfred M. King, vice chairman, Marshall & Stevens, and David M. Morris, a member of the International Auditing and Assurance Standards Board’s (IAASB’s) Consultative Advisory Group (CAG) and CEO of MORRIS Consulting. And, don’t miss Managing Editor Marian Raab’s writeup “Treat All Bank Failures Equally, Says Former FDIC Chief,” along with some news about one of my favorite CFO’s, Dunder Mifflin’s David Wallace, in this month’s In Brief column.

PCAOB Alert On Current Economic Environment; Inspection Reports

On Friday, the Public Company Accounting Oversight Board announced that it had issued Staff Audit Practice Alert No. 3, Audit Considerations in the Current Economic Environment, which addresses six matters:

1. Overall audit considerations
2. Auditing fair value measurements
3. Auditing accounting estimates
4. Auditing the adequacy of disclosures
5. Auditor’s consideration of a company’s ability to continue as a going concern
6. Additional audit considerations for selected reporting areas, listed further below.

Fraud risk considerations, and internal control considerations, are among the issues discussed under overall audit considerations.

Within the guidance on fair value measurements are cites to the SEC-FASB Sept. 30 clarification on fair value in inactive markets, and FASB’s FSP FAS 157-3 on the same topic issued on Oct. 10. Additionally, the PCAOB states its Audit Practice Alert No. 2 issued last year on Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists (which in turn cites other auditing literature) is still relevant.

On the related issue of auditing accounting estimates, PCAOB references existing auditing literature (AU 316, Consideration of Fraud in a Financial Statement Audit) in stating: “When assessing audit differences between estimates best supported by the audit evidence and the estimates included in the financial statements, the auditor should consider whether such differences, even if they are individually reasonable, indicate a possible bias on the part of the company's management, in which case the auditor should reconsider the estimates taken as a whole.”

“As part of the audit, the auditor also should perform a retrospective review of significant accounting estimates reflected in the financial statements of the prior year to determine whether management judgments and assumptions relating to the estimates indicate a possible bias on the part of management,” adds the PCAOB, citing again AU 316 on fraud. “With the benefit of hindsight,” says PCAOB, “a retrospective review should provide the auditor with additional information about whether there may be a possible bias on the part of management in making the current year estimates.”

The discussion in the alert about auditing the adequacy of disclosures specifically cites, among other requirements, AICPA Statement of Position No. 94-6 ("SOP 94-6"), Disclosure of Certain Significant Risks and Uncertainties. The PCAOB adds, citing to AU 431: “If management omits from the financial statements, including the accompanying notes, information that is required by GAAP, the auditor should express a qualified or adverse opinion and should provide the information in his or her report, if practicable, unless its omission from the auditor's report is recognized as appropriate by a specific PCAOB auditing standard.”

The alert cites existing literature on going concern. [In related news, today is the comment deadline to FASB on its Exposure Drafts released Oct. 8 on Going Concern and Subsequent Events. FASB's ED's would move the guidance on these matters from the auditing literature to accounting literature or GAAP, with some changes. Only a few comment letters have been filed so far, here and here, which is not unusual prior to a comment deadline, although a FASB board member recently noted at a board meeting that some constituents have indicated it is difficult to respond to all matters open for comment at the current time.]

“Additional audit considerations” covered in the PCAOB alert include: Consolidation, Contingencies and guarantees, Credit derivatives, Debt obligations, Deferred tax assets, Derivatives (other than credit derivatives), Goodwill, intangible assets and other long-lived assets, Inventory, Other-than-temporary impairment, Pension and other postretirement benefits, Receivables, Restructuring, Revenue recognition, Share-based payments.

Reports on Inspections of Eight Largest Firms, More
In other news, the PCAOB also released on Friday its “Repot on the PCAOB’s 2004, 2005, 2006 and 2007 Inspections of Domestic Annually Inspected Firms.” As noted in PCAOB’s press release, the report summarizes the findings of PCAOB’s inspections of the eight largest U.S. audit firms during the past four years. The PCAOB also posted some new inspection reports (generally, dated in November) on its inspections of firms other than the largest eight firms. See Top Audit Firms Still Have Room to Improve,PCAOB Says in Reviewing Inspection Findings, by Tina Chi in today's BNA Daily Report for Executives. In other news on the audit firm front, see Denise Lugo's article in BNA, Co-Chairman of Treasury Audit Panel Says Big Four Weak on Their Own Disclosure, reporting on former SEC Chief Accountant and co-chair of the Treasury Advisory Committee on the Auditing Profession (ACAP) remarks at a conference last week. ACAP published its final report in October, approving the report for release at its final meeting on September 26, as we reported here.

Also last week, the PCAOB voted to adopt an amendment to Rule 4003 and to issue for public comment a separate proposed amendment to that rule relating to the timing of certain inspections of registered non-U.S. firms. Further details are in PCAOB’s press release