David Friehling, the accountant who ran the tiny auditing firm that serviced Bernard Madoff’s broker/dealer firm, has been arrested and charged with securities and investment advisor fraud.

 In a complaint filed in federal court in Manhattan, the Securities and Exchange Commission alleges that from 1991 through 2008, the CPA and his New City, N.Y.-based firm, Friehling & Horowitz, purported to audit the financial statements and disclosures of Bernard L. Madoff Investment Securities LLC. The SEC has previously charged Madoff and his firm with committing securities fraud through a Ponzi scheme estimated to have defrauded clients out of $65 billion. Friehling surrendered to authorities and prosecutors, according to The New York Times. He faces up to 105 years in prison. Friehling is currently free on $2.5 million bail.

“As the new chairman, I will ensure that we continue this investigation and hold accountable all those who helped to facilitate this massive fraud,” said SEC Chairman Mary L. Schapiro, who took office in January.

Madoff pleaded guilty last week to 11 fraud charges (see Madoff Goes to Jail). Coincidentally, Friehling’s father-in-law and former partner, Jerome Horowitz, died of cancer in Florida the same day. The 80-year-old reportedly cooperated with authorities and felt that the Madoff scandal had tarnished his family’s reputation in the last months of his life. Both he and Friehling invested and lost money in Madoff’s firm. Horowitz was Madoff’s auditor for 30 years.

Friehling took over the practice after Horowitz retired, and was a past president of the Rockland County Chapter of the New York State Society of CPAs. The American Institute of CPAs said Wednesday after the charges against Friehling were announced that he has been expelled. "The AICPA today concluded its ethics investigation of david Friehling's conduct as an auditor of a broker-dealer, resulting in expulsion from membership for failure to cooperate," said a statement from the institute.

“Friehling essentially sold his license to Madoff for more than 17 years while Madoff's Ponzi scheme went undetected,” said James Clarkson, acting director of the SEC’s New York Regional Office, in a statement. “For all those years, Friehling deceived investors and regulators by declaring that Madoff's enterprise had a clean audit record."

The SEC’s complaint alleges that Friehling, 49, enabled Madoff’s Ponzi scheme by falsely stating, in annual audit reports, that F&H audited the Madoff firm’s financial statements pursuant to generally accepted auditing standards, including the requirements to maintain auditor independence and perform audit procedures regarding custody of securities.

F&H also made representations that Madoff’s financial statements were presented in conformity with generally accepted accounting principles and that Friehling reviewed internal controls at Madoff’s firm, BMIS, including controls over the custody of assets, and found no material inadequacies. According to the SEC’s complaint, Friehling knew that BMIS regularly distributed the annual audit reports to Madoff customers and that the reports were filed with the SEC and other regulators.

The SEC’s complaint alleges that all of these statements were materially false because Friehling and his firm did not perform a meaningful audit of Madoff’s firm, and did not perform procedures to confirm that the securities Madoff purportedly held on behalf of his customers even existed.

Instead, the SEC alleges that Friehling merely pretended to conduct minimal audit procedures of certain accounts to make it seem like he was conducting an audit, and then failed to document his purported findings and conclusions as required under GAAS. If properly stated, those financial statements, along with Madoff-related disclosures regarding reserve requirements, would have shown that Madoff’s firm owed tens of billions of dollars in additional liabilities to its customers, and was therefore insolvent.

According to the SEC's complaint, Friehling similarly did not conduct any audit procedures with respect to BMIS internal controls, and had no basis to represent that BMIS had no material inadequacies. Afraid that his work for BMIS would be subject to peer review, as required of accountants who conduct audits, Friehling lied to the American Institute of CPAs for years and denied that he conducted any audit work.

The SEC further alleges that Friehling and F&H obtained ill-gotten gains through compensation from Madoff and BMIS, and also from withdrawing investment returns from accounts held at BMIS in the name of Friehling and his family members.

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