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Auditors spotted Madoff Fraud Years Before Story Broke


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Bloomberg News,

HSBC Was Told About Madoff ‘Fraud Risks’ in KPMG Reports

 

March 18 (Bloomberg) -- HSBC Holdings Plc, Europe’s biggest lender, was warned twice by auditors that entrusting as much as $8 billion in client funds to Bernard Madoff opened it up to “fraud and operational risks.”

 

KPMG LLP told the London-based bank about the risks in 2006 and 2008 reports. The firm was hired to review how Madoff invested and accounted for the funds, for which HSBC served as custodian. KPMG reported 25 such risks in 2006, and in 2008 found 28, according to copies of the reports obtained by Bloomberg News, which was allowed access to them on the condition they not be published.

 

Twenty-five “fraud and related operational risks were identified throughout the process whereby Madoff LLC receive, check and account for client funds,” KPMG said in the 56-page report dated Feb. 16, 2006. The limited controls in place “may not prevent fraud or error occurring on client accounts if management or staff at Madoff LLC either override controls or undertake activities where appropriate controls are not in place,” according to the report.

 

A 66-page KPMG report dated Sept. 8, 2008, cited 28 risks and described them in the same words as the 2006 document.

 

Irving H. Picard, the trustee liquidating Bernard L. Madoff Investment Securities LLC, sued HSBC and a dozen feeder funds for $9 billion in December in U.S. Bankruptcy Court in Manhattan. The suit was partly based on the KPMG reports and alleges the bank knew of concerns Madoff’s business was a fraud and didn’t protect investors. KPMG’s reports haven’t been made public. Picard has filed more than $50 billion in so-called clawback suits to compensate victims.

 

Reviews ‘Foiled’

In the reports, KPMG didn’t present evidence the risks it identified had materialized or that it found signs of actual fraud, and said HSBC had told the firm “no allegations of fraud or misconduct have been raised.”

 

HSBC confirmed hiring KPMG in 2005 and 2008 to review Madoff’s firm, adding it now believed Madoff had tricked the auditors. “It appears from U.S. government filings that Madoff and his employees foiled these reviews by, among other things, providing forged documentation to KPMG,” the bank said in an e- mailed statement.

 

“KPMG did not conclude in either of its reports that a fraud was being committed by Madoff,” HSBC said. “HSBC did not know that a fraud was being committed and lost $1 billion of its own assets as a victim.”

 

HSBC Spokesman Patrick Humphris, KPMG spokesman Mark Hamilton and Amanda Remus, a spokeswoman for Picard’s lawyers Baker & Hostetler LLP, all declined to confirm the authenticity of the reports obtained by Bloomberg.

 

Custodian

At the time of the first report, HSBC was custodian for eight funds that had invested $2 billion with Madoff, KPMG said. By 2008, the bank was custodian for 12 funds with as much as $8 billion invested.

 

“We continue to believe that we have strong defenses to the claims made against us and we will defend ourselves,” the London-based bank added.

 

Madoff, 72, pleaded guilty to using money from new investors to pay old ones and is serving a 150-year sentence in federal prison. Investors lost about $20 billion in principal.

 

In the list of risks in KPMG’s report, number 2 was that “BLM embezzles client funds,” using the initials as shorthand for Bernard L. Madoff. To prevent it, KPMG recommended in both 2006 and 2008 that HSBC “establish a process to monitor monthly statements” and reconcile them with contributions from clients.

KPMG didn’t perform tests to check that risk.

 

‘A Sham’

The 2006 report listed fraud risk number 5 as “client cash is diverted for personal gain” and risk number 18 as “trade is a sham in order to divert client cash.” It went on to say there were concerns “Madoff LLC falsely reports buy/sell trades without actually executing in order to earn commissions” and “BLM falsifies accounting records which are provided to HSBC.”

 

KPMG reviewed samples of trades and account statements for both its 2006 and 2008 reports to test the risks and detected no discrepancies, the reports said. Even so, the firm suggested HSBC “consider undertaking a periodic review which includes tracing a sample of client trades back to the bulk order.”

 

HSBC declined to comment on individual risks cited in the reports, citing the pending lawsuit.

 

In prefaces to the reports, KPMG said it wasn’t hired to audit Madoff LLC and based its reports on information Madoff and his staff provided, which wasn’t independently verified.

 

HSBC units in Bermuda, Luxembourg and Dublin acted as custodian for 12 funds including: Pioneer Investment’s Primeo Select, Bank Medici’s Herald (Lux) and Thema International, as well as Herald USA, Alpha Prime, Lagoon Investment, Senator, Kingate Global, Defender and Global Investments.

 

The bank was also sued in Ireland and Luxembourg by investors over Madoff investments.

 

In its 2010 annual report, HSBC said that by Nov. 30, 2008, the aggregate value of those funds was $8.4 billion, including fictitious profits Madoff reported.

 

HSBC said that it was impossible to estimate the range of potential liabilities that could arise from lawsuits including Picard’s, adding that “they could be significant.”

 

To contact the reporter on this story: Boris Groendahl in Vienna bgroendahl@bloomberg.net

To contact the editor responsible for this story: Angela Cullen at acullen8@bloomberg.net and; Anthony Aarons at aaarons@bloomberg.net .

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Guest Bronco

Reminds me of Parmalat (I believe) where the company just made up a bank account in either word or excel. 

 

 

 

 

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Reminds me of Parmalat (I believe) where the company just made up a bank account in either word or excel.

 

I don't understand how that happens?  Doesn't the auditor actually contact the institution?  Our auditors actually contact Morgan Stanley Smith Barney and request all of the account documents directly.  Did they have fake phone numbers that the auditors contacted, or did the auditors not even attempt contact?  Just basic due diligence that is absent.  Cheers!

 

 

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Guest Bronco

Parsad - give me a 1% ownership in your hedge funds and I'll answer the phone as a contact for any "bank accounts" you decide to create.

 

 

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No, that's what I mean Bronco.  Did both Madoff and Parmalat have fake numbers, contacts, etc set up?  Like, how does this occur with such expansive forgery and fraud, and no one catches on after so much time and such large sums...not the auditors, not the investors, and definitely not the security regulators and lawyers.  It's just unfathomable!  Cheers!

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Reminds me of Parmalat (I believe) where the company just made up a bank account in either word or excel.

 

I don't understand how that happens?  Doesn't the auditor actually contact the institution?  Our auditors actually contact Morgan Stanley Smith Barney and request all of the account documents directly.  Did they have fake phone numbers that the auditors contacted, or did the auditors not even attempt contact?  Just basic due diligence that is absent.  Cheers!

 

 

 

I dont think so. If the statement looks real then ......

 

Also I am guessing you have a none big 4 auditor and the auditor didnt know you from a can of paint early on. The bigger you are they more they trust you, I mean who would of that Madoff would have fake accounts he is working with billions would be what most would be thinking.

 

Also I think his audit firm was a small shop in a strip mall. I doubt there was a real audit, he probably just paid some guy. I think that was one of the things that tipped off the guy who kept bugging the SEC.

 

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Guest Bronco

Parsad - of course I am kidding, but there was obvious fraud in both cases.  To what extent I don't know, but it would be easy to get a fake contact person.

 

As Myth suggests, you may have some green kid out of college doing this testing.  And they don't want to ask any "stupid questions" because, well, it makes them look stupid. 

 

In general, accountants exclude to an extent company fraud from their "scope".  So add all this up, and with a little luck you can screw your shareholders or partners or whatever.

 

Still shocking, as you suggested.

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In general, accountants exclude to an extent company fraud from their "scope".  So add all this up, and with a little luck you can screw your shareholders or partners or whatever.

 

This is not correct.  All public companies (or companies that issue debt securiies), through the accountant and auditor have to implement SOX controls, including fraud prevention.  Not only that, they need to have full disclosure and documentation on their executives, directors and key personnel, as well as documents on their website describing their corporate governance policy, whistle-blowers policy, confidentiality, etc. 

 

If those controls are not in place, then the auditor, along with the CEO, CFO, controller and audit committee are fully culpable in the fraud, as they are required to make sure properly designed controls are in place.  As I said, it is complacency and lack of due diligence by all parties involved.  Cheers!   

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Reminds me of Parmalat (I believe) where the company just made up a bank account in either word or excel.

 

I don't understand how that happens?  Doesn't the auditor actually contact the institution?  Our auditors actually contact Morgan Stanley Smith Barney and request all of the account documents directly.  Did they have fake phone numbers that the auditors contacted, or did the auditors not even attempt contact?  Just basic due diligence that is absent.  Cheers!

 

 

to

 

I think those behind the Parmalat fraud actually set up or acquired a real shell bank on some Mediterranian island that was approved to execute bank transfers etc.  That bank was staffed with a Madoff type accountant.  The bank was not subject to audits by reputable firms.  It pretended to produce the statements with the phony balances.  Parmalat's big time auditors simply accepted the bank's statements as true.  They weren't employed to audit the bank, which was outside their jurisdiction.  It was similar to Deloite's recent situation when they signed off on a fraudulent Chinese company's financials.  

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Holy smokes!  How is that possible with someone managing such a large sum of money?  So many people were unaccountable.  Nuts!  Cheers!

 

 

Rudy Guliani is the one to blame for Madoff's not being exposed in the early to mid 1980's.  Seriously.   :o

 

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