(Bloomberg) Ernst & Young LLP was found liable by a jury for its failure to vet financial audits backed by con man Bernie Madoff’s accountant in the first trial of an auditor over losses tied to the biggest Ponzi scheme in U.S. history.

FutureSelect Portfolio Management Inc., which sued Ernst & Young in 2010 over faulty audits of a Madoff-linked feeder fund, is entitled to recoup a portion of the $112 million it lost in its investment in the fund, the state court jury in Seattle ruled Friday. The jury found Ernst & Young liable for half of the $20.3 million in damages it awarded.

Ernst & Young audited Rye Funds, which were managed by Tremont Group Holdings Inc. The accounting firm audited Rye from 2000 to 2003 and performed surprise audits of Tremont during that period until 2008, FutureSelect said in court documents.

The company sued Ernst & Young along with Tremont and its parent Oppenheimer Acquisition Corp., which later reached confidential settlements.

FutureSelect accused the accounting firm of failing to perform adequate audit procedures to test the existence of assets on Rye’s financial statements. Instead, it relied on assurances made by Madoff to whom Rye had outsourced everything from investment decisions to record keeping.

Ernst & Young allegedly relied on audit reports done by Madoff’s accounting firm Friehling & Horowitz, which was located at the time in a strip mall in a New York City suburb. Ernst & Young failed to inquire about Friehling & Horowitz’s professional reputation, Steven Thomas, an attorney for FutureSelect, said in closing arguments. Had it done so it would have found out that the accountant wasn’t vetted to do audits as required by industry standards, Thomas said.

Ernst & Young has stood by its auditing decisions, arguing that no one could have detected Madoff’s sophisticated fraud. James Bennett, a lawyer for the firm, said in closing arguments that any criticism of Ernst & Young’s audits is “all based on hindsight” and a “flat out misreading of the rules.”

Tremont was the second-biggest feeder into Madoff’s multibillion-dollar fraud after Fairfield Greenwich Group. Tremont and the liquidator of Madoff’s brokerage agreed in 2013 to a $1 billion settlement, freeing up money to repay some investors. FutureSelect, based in Redmond, Washington, opted out of that deal and pursued its own case.

Madoff is serving a 150-year prison term for stealing billions of dollars from thousands of investors. David Friehling, Madoff’s accountant for more than 20 years, pleaded guilty to fraud in 2009 and was sentenced to two years’ probation after cooperating with prosecutors.

The case is FutureSelect Portfolio Management Inc. v. Ernst & Young, 10-2-30732-0, Superior Court of the State of Washington for King County (Seattle).

Register or login for access to this item and much more

All Accounting Today content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access