On March 19th, Bloomberg published an article entitled, Ponzi Scheme Victims All Missed an Easy Clue: Bogus Auditors. The article discussed how victims could have easily discovered that they were investing in ponzi schemes simply by calling the accounting firms that purported audited the financial of the bogus investments sold by Bernie Madoff, Allen Stanford and James Nicholson. According to the article, had victims done this, investors would have learned that no one answered the phone at Stanford’s auditing firm in Antigua; Madoff’s auditing firm was a sole proprietor of Friehling & Horowitz, an accounting firm run from a 13-by-18-foot storefront in the New York City suburb of New City.
These examples were followed by a quote from an accounting professor at Ohio State University in Columbus which stated, “Due Diligence 101 should demand that you check out the auditing firm and find out if it exists” […] “Then, you have to find out if they are qualified.”
The implications from this article are disturbing because it suggests that investors should have known better than to invest with people who turned out to be crooks. The truth is that “due diligence 101” should require accounting firms who “audit” books of investment entities to make sure that the Bernie Madoffs of the world are accurately reporting the scope and nature of the audit.
A subtle but disturbing undertone of this article is that investors should have known better. This mindset is dangerous to the integrity of the laws designed to protect investors. For example, a common claim brought by victims of ponzi schemes is common law fraud and section 10b-5 securities fraud claims. Both of these claims require investors to prove that they justifiably relied on the misrepresentations contained in the prospectus or other sales literature. Whether reliance is justifiable is a defense commonly raised to defend these actions.
It is disturbing to think that investors could lose a lawsuit because they failed call the accounting firm who conducted the audit of the books just to make sure that the work was done properly. This goes against the heart of the securities laws. These laws were meant to abolish the “buyer beware” mindset and shift the burden to the seller of securities and other parties involved in the sales process (including accounting firms) to make sure that the information contained in the prospectus is accurate and truthful.
While it is true that it is be a good idea for investors to call those firms to verify that the representations made in any prospectus or investment sales document are accurate, investors who do not should not be penalized.