Did Madoff's feeder fund shop for friendly audits?
Whistleblower Markopolos testifies that Fairfield Greenwich had three auditors in three years. The fund group tells it differently.
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NEW YORK (Fortune) -- When Madoff whistleblower Harry Markopolos testified before Congress Wednesday, he blasted the Securities and Exchange Commission, gave gripping testimony about his nine-year quest to reveal Bernard Madoff's alleged $50 billion scheme, and predicted that more of Madoff's web would be uncovered soon. But one of his most provocative accusations was about the auditing practices of Madoff's biggest feeder fund, Fairfield Greenwich Group.
Markopolos is the Cassandra-like investigator who tried in vain to get the SEC to pay attention to what he was saying about Bernard Madoff. Few people paid attention, even though he laid the whole thing out with uncanny accuracy over the years. Now people are listening. And buried in his prepared remarks to the House Financial Services subcommittee are potentially damaging accusations - page 20 on the original document - about Fairfield Greenwich and its accounting of its accounting, specifically its choice of auditors and the frequency with which it switched them, which he said has the appearances of "auditor shopping."
Fairfield Greenwich is an alternative-asset specialist that had invested with Madoff about half of its total assets of $14.1 billion. Given the scale of those assets, one would expect the firm to hire a major accounting firm, or at least an auditor commonly used by the big funds of funds.
Instead, in 2004, Fairfield Greenwich appeared to embark on a three-year auditing shopping spree, according to Markopolos, in which it first entrusted its auditing needs to Berkow, Schecter & Co. of Stamford, Conn. According to its site today, the firm is remarkably small to be handling multibillion-dollar accounting jobs: two partners, four accountants, two paraprofessionals, and two secretarial and support staff. In size, the firm is reminiscent of Madoff's accounting firm, situated in a strip mall.
Next up for 2005 was PricewaterhouseCoopers in the Netherlands. Then in 2006 it was still PricewaterhouseCoopers, but in Canada. This alleged auditor shopping would not be an encouraging sign.
For those unacquainted with it, it's a very old practice predating Sarbanes-Oxley in which a firm would choose to switch auditors at the drop of a hat. The excuses could be anything from "the auditor didn't understand," "wasn't thorough enough," "had a conflict of interest." Generally you can shift once. You get a free pass. But continuing to do so? That could suggest that some deception was going on.
Fairfield Greenwich disputes the "auditor shopping" characterization. Among their funds, said a spokesman, only one had three auditors in three years: Greenwich Sentry, a domestic fund which the spokesman said had a few hundred million dollars in assets.
Fairfield Sentry, a much larger offshore fund for foreign investors, made only the switch from one unit of PricewaterhouseCoopers in the Netherlands to another in Canada during the time period Markopolos outlined. The firm does not consider that move to be a change of auditors, the spokesman said. Fairfield Greenwich switched to the Toronto office of PricewaterhouseCoopers because its fund administrator, Citco, was switching its administrative funtion to Toronto. (As for Citco, said its spokesman, "Citco has not changed auditors in seven years.") "Harry Markopolos simply got it wrong," said the Fairfield Greenwich spokesman. "Fairfield Sentry, by far the largest fund, had the same Big Four auditor for the last 15 years."
Why does switching auditors raise eyebrows? When you lose auditors on a yearly basis, accounting experts say, you're breaking the sequential chain, prohibiting the auditors from really seeing what your numbers look like year after year. What you're doing is allowing breaks and adding in assumptions. This kind of activity can be devastating to credibility and accuracy. Investigators may want to ask: What could possibly be the purpose for this kind of hop-scotching? What customer service was performed?
"The longer you stay with same auditor the more they know about you. When a new auditor comes in, they have to learn about your company. This allows you to conceal some information," says Pornsit Jiraporn, assistant professor of finance at Pennsylvania State University, who co-wrote the 2004 study, "Causes and Consequences of Audit Shopping." "Sometimes there is a legitimate reason for switching once, but this is very suspicious." An accounting source close to the situation, however, argues that "auditor shopping" wouldn't involve a jump from a small auditor to a Big Four accounting firm.
Another problematic thing about the audit-switching is that, by common practice, senior officers would have had to sign off on this. At Fairfield Greenwich, this would have included founding partner Jeffrey Tucker, who is a former SEC official and a lawyer.
The days ahead will be busy ones for Fairfield Greenwich. In a note to investors dated Jan. 8, the firm expressed its "shock and dismay" at the arrest of Madoff and what "appears to be a highly sophisticated and massive fraud." It continued: "We are currently assessing the extent of potential losses and will pursue on behalf of our investors the recovery of all assets" associated with Madoff's fund. But in the past, it looks as if Fairfield Greenwich didn't want to know. Testified Markopolos: "The feeder funds were preying on the people they were close to."