Ponzi scheme litigation continues its spread through accounting firms
Ponzi scheme litigation continues its spread through accounting firms
Pamela A. MacLean / Staff reporter

February 5, 2009

A Minnesota accounting firm has been hit by lawsuits alleging that it failed to detect problems in two separate Ponzi schemes — the purported $50 billion investment scam by New York financier Bernard Madoff and the $3.5 billion alleged "electronics" scheme by Thomas Petters.

The suits against McGladrey & Pullen, a national 100-office auditing firm in Bloomington, Minn., and similar suits stemming from the Madoff scandal against accounting firms KPMG, Ernst & Young and BDO Seidman, point up the likely spread of litigation as financial victims attempt to recover massive losses.

The size of the losses will produce "a lot of creativity by plaintiffs' lawyers as they try to expand the scope of liability to others," said Brian Timmons, who is heading up the Madoff task force at Quinn Emanual Urquhart Oliver & Hedges in Los Angeles.

In addition, the spread of individual suits against accountants, banks or insurers may run head on into conflict with the bankruptcy trustee liquidating Madoff's assets because the trustee has an independent right to bring similar claims.

Competing suits by individuals and the trustee "may bring a big battle over assets," said Margaret Mann, a commercial litigator and bankruptcy specialist in the San Diego office of Los Angeles' Sheppard, Mullin, Richter & Hampton.

"The trustee in charge of liquidation may decide himself to bring claims against auditors, insurers and banks, and then you have a tension between investor claims and the trustee claims," said Timmons.

McGladrey & Pullen was accused of negligence and failure in its professional duty of care in audits of two investment firms that financed the allegedly fraudulent electronics purchasing scheme by Petters in a federal suit in October. Ellerbrock family Trust v. McGladrey & Pullen, No. 08-cv-5370 (D. Minn.). Petters, founder of Petters Group Worldwide, was indicted last year on 20 counts of fraud, conspiracy and money laundering.

A second lawsuit was filed in Connecticut state court on Jan. 30 by Maxam Capital Management. Maxam accuses its own accountants of negligence for failing to detecting the Madoff fraud, in which Maxam invested all its $280 million assets. Maxam Absolute Fund v. McGladrey & Pullen, No. FBT-cv-09-5021972-5 (Bridgeport, Conn., Super. Ct.).

McGladrey's attorney, Steven M. Farina, of Williams & Connolly in Washington, declined to comment on the allegations against the accounting firm. A call directly to the McGladrey firm seeking comment was not returned.

Madoff, the disgraced financier, told authorities in December that he ran a vast international Ponzi scheme that may have reached $50 billion. Securities regulators seized firm assets and forced him into bankruptcy liquidation under control of a trustee. Madoff remains under house arrest in New York while he faces criminal investigation.

Federal prosecutors indicted Petters, a Minneapolis businessman, in December on charges of orchestrating a Ponzi scheme that promised to purchase high-end electronics and resell them to large retailers. The merchandise never existed, according to the charges, though investors allegedly supplied $3.5 billion over 13 years.

"The question is: Who should have done what and when should they have done it?," said Geoffrey P. Jarpe, a securities litigator at Winthrop & Weinstine in Minneapolis. "That will be the question in this case, and we think the auditing standards will govern that," he said.

Timmons, whose firm as been asked by a number of clients to investigate claims against Madoff, said the favorite defense by auditors accused of negligence is that they were victims of the fraud too.

"That defense generally doesn't stack up well with jurors that have the general feeling that auditors are out to detect fraud," he said.

"In this case, there is reason to be concerned that auditors acted negligently or acted with some level of requisite knowledge because, for the most part, they appear to have accepted financial statements generated by Madoff's auditor from a very small unknown accounting firm," he said.

Mann pointed out that there are three levels of financial reviews: audited, reviewed and compiled. An accounting firm that compiles financial information just plugs numbers into a spreadsheet, but a full-blown audit tries to independently verify financial claims, she said. "The question, in addition to what duty an accountant had, is what exactly did they take on for the client," she said.

Timmons pointed out that some of the big four accounting firms have used offshore affiliates to conduct audits of offshore feeder funds. That may be an attempt to structure the accounting business to avoid global liability, he said.

Mann said jurisdiction claims could be raised when offshore auditing entities are involved. It would depend on how close the offshore entity is to the primary company in the United States, she said.

Litigation so far has named BDO Seidman, KPMG and Ernst & Young in five lawsuits.

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