Trust, but verify - The Bernard Madoff Fallout
Trust, but verify - The Bernard Madoff Fallout
We have all heard the phrase "Trust, but verify." With the Bernard L. Madoff fallout, it is hard not to ask, "when did we stop verifying?" When did word-of-mouth become the norm for verifying whether a financial deal is in your best interest? When did friendship supersede the need to do additional checking when your financial future is involved?
The Madoff situation was not just segregated to New York or Florida, but has affected many individuals, funds and organizations on a global basis. I will not speculate about the mental state of Mr. Madoff and whether he feels remorse - I will leave that to the experts in the field of psychology. But, I am curious about the various players who kept this scheme going for such a long time…
We are learning that Mr. Madoff continued to produce positive financial returns for his clients year after year, without having a slow or down period.
This law alone is not only a "red-flag" but it falls into the "common sense" category, and should have gotten the attention of more than just a few brave individuals who spoke up years ago. We now know that this scheme could have been shut-down if Mr. Madoff’s firm had been investigated sooner. The following are just a few red-flags:
- Lack of segregation of duties
- Oversight lacking
- Conflict of interest
- Nepotism
- Returns that are impossible to independently replicate
Testing methods that might have been used by the auditors to detect these red-flags include:
Reperformance - This testing method is used to independently verify a control, a report, a query, or a calculation - independent of the source system. The Madoff formula for continuous positive returns could not be replicated.
Benford’s Law (CAAT) - Running a batch of transactions through this algorithm could have alerted the auditors that something was amiss.
A few months back, I had the opportunity to train an individual on how to be an auditor and what makes a good auditor. Among my training materials, I chose footage of the Enron congressional hearings, and one book in particular that I used was Blink: The Power of Thinking Without Thinking. In selecting this material, my goal was to talk about real-life examples of red-flags, peer pressure, and how the promise of making lots of money might cloud a person’s judgment. We all know about Enron, so I will not comment further, but I found that the recurring theme from Blink was ‘instinct‘. As an auditor, we must use common sense, use CAAT tools, ask whether something is ethical and sometimes following our instincts. If something does not feel right - dig deeper until you are comfortable before you walk away from an audit.
The Madoff scheme will be studied and taught to future auditors so that this type of scandal does not go undetected.
Auditors function as an independent, objective source that companies rely on to tell the real story about whether proper controls and practices are in place and functioning.
- Sometimes we are not popular.
- Sometimes we are branded as the bad guys/gals.
- Sometimes we have to communicate the bad news.
But at the end of the day, the auditors are just doing their job. If companies cannot trust the auditors, then who can they trust to verify internal controls and practices?
According to Reuters, members of the House Financial Services Committee will be looking at the Madoff situation as a case study for regulatory reform of the financial markets.
Content: Vashti Horvat, CISA
Email: Info@orrconsulting.us
Blog: http://LHVblog.orrconsulting.us/
Stamp: January 4, 2009_1021
Blink: The Power of Thinking Without Thinking can be purchased on Amazon.com. Click here to buy.
For more information on the Bernard Madoff $50 Billion dollar scheme, here are a few sources:
No questions asked from the Financial Times
Compliant: United States of America vs. Bernard L. Madoff
Foxnews Ex-Nasdaq Chair
Financial Times - Madoff Scandal
Austria takes control of Bank Medici
Accountancy Magazine.com
Auditor resources:
American Institute of Certified Public Accountants (AICPA)
Bendford’s Law
Following Benford's Law, or Looking Out for No. 1 by Malcolm W. Browne - The New York Times published: August 4, 1998
ACL data Analysis Software (CAAT tool)
Idea Data Analysis Software by Audimation (CAAT tool)
The Institute of Internal Auditors
Created on ... January 04, 2009
