Identifying Bernie Madoff Ahead of Time

Benjamin Graham once said that you should never invest in companies that have engaged in malfeasance involving their earnings results, citing the necessity to have accurate numbers in order to make an investment. Since reports of outstanding debt, net profits, and cash flow are necessary prerequisites for determining what a business is worth, unreliable accounting would render business valuation nothing more than a guessing game.

And that brings me back to Benie Madoff’s selection to have a firm called Friehling & Horowitz serve as the auditors for the investment funds held through the Bernard L. Madoff Investment Securities, LLC. And what did Friehling & Horowitz consist of? A small 500-square building previously used for medical billing that consisted of nothing but Jerome Horowitz and David Friehling, who essentially were retirees chilling in Miami.

If you look at the auditing firms for operations that either control or are worth more than $100 million, you will see the same dozen auditors appear over and over again. You can even narrow it down further—there are three names in particular that show up again and again.

Currently, there is no Fortune 500 company audited by a two-person auditing shop. There are no investment funds worth hundreds of millions of dollars that are audited by retirees purportedly out of an office smaller than a college kid’s apartment or dorm room.

This truly was something unique to Madoff. Auditors of this size serve small family businesses and do not in any way serve publicly traded corporations that generate millions of dollars in annual profit.

The SEC did maintain records identifying Madoff’s usage of this firm, and there was an article in a trade magazine as well as Barron’s that pointed to the opacity of Madoff’s investment operations and lack of typical accounting protections for its investor base (which was a double warning sign when compared with Madoff’s desire for secrecy regarding information that is typical available to investors, such as basic strategy explanations and daily performance logs).

If there is proper auditing, a Madoff-like creature cannot rise. Therefore, if a sizable chunk of your net worth will be invested throughout a particular advisor, fund, or investment, it is advisable to confirm that a reputable auditing firm is being used as a way to authenticate the results you are being given.