The SEC, a tiny auditing firm, and some of the most sophisticated financial companies and hedge funds are just some of the players who missed the warning signs in the Bernard Madoff scandal.

The mushrooming affair, in which a former Nasdaq chairman was responsible for scamming his wealth management clients out of an estimated $50 billion, has been dominating the financial headlines in recent days.

While the SEC was warned repeatedly by whistleblowers over the course of at least nine years about red flags that indicated Madoff’s investment strategy had serious inconsistencies, the commission seems to have dropped the ball on whatever limited investigations it did conduct. Madoff, by all accounts, had a sterling reputation with not only the SEC, which turned to him for advice on the markets, but with banks and reputable firms who steered business his way. His clients included well-heeled investors such as New York Mets owner Fred Wilpon and charitable foundations associated with movie director Steven Spielberg and Nobel laureate Elie Weisel.

Madoff’s business did have an auditing firm, Friehling & Horowitz, but it was a small three-employee operation, and has now stopped answering phone calls. The auditing firm’s small size was apparently one tip-off that influenced some wary investors to steer clear of Madoff’s services.

But apparently their fears were not well publicized until the scandal broke last week, when Madoff’s own sons turned him in after he admitted that he had run a giant Ponzi scheme and that nearly all the money he managed for his clients was gone. That included money that many clients had counted on for their retirement and their day-to-day living expenses.

Besides the damage to the SEC’s already tarnished reputation and that of the other watchdogs and regulators who were supposed to safeguard against such abuses, auditing firms like Friehling & Horowitz will also be coming in for their share of criticism. No doubt there have been scandals with auditing firms of all sizes, most notoriously Arthur Andersen. It’s not the size of a firm that guarantees a reliable audit. It’s the integrity of the auditor and the client. In the case of Madoff, the appearance of integrity was dangerously misleading, and will hurt the confidence of investors in an already shaky financial market.

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