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Originally published December 18, 2008 at 12:00 AM | Page modified December 18, 2008 at 1:21 AM

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Madoff's financial empire audited by tiny firm: one guy

Authorities said Madoff has confessed to running a $50 billion Ponzi scheme. That such a small firm was the main auditor for a multibillion-dollar operation has emerged as one of the most mysterious elements.

The Associated Press

What's a Ponzi scheme?

Named for Charles Ponzi, who was one of the biggest financial crooks in American history, it's a type of pyramid scheme in which early investors are paid off with money from later victims, until no more money can be raised and the scheme collapses.

NEW CITY, N.Y. — The office for Bernard Madoff's sole auditor exudes anything but wealth and intrigue: It is next door to a pediatrician in a drab suburban building. The tiny storefront is discreetly labeled "Friehling & Horowitz" on its glass door.

The people milling outside are not high-end investors; they are mothers with children, waiting for the doctor's office to open.

But the auditor, accountant David Friehling, 49, is enmeshed in one of Wall Street's biggest scandals and is under criminal investigation in a case that has left people in financial ruin around the world.

Authorities said Madoff has confessed to running a $50 billion Ponzi scheme. That such a small firm was the main auditor for a multibillion-dollar operation has emerged as one of the most mysterious elements.

Experts said it would be preposterous for a tiny firm to properly audit an operation the size of Madoff's.

"What if General Motors had a three-person accounting firm doing its audits?" said Jim Vos, CEO and head of research at the hedge-fund consulting firm Aksia in New York City, 30 miles south of New City.

Madoff, meanwhile, will not be going to jail even though he failed to meet the original terms of his $10 million bail agreement.

Federal prosecutors said they had modified the terms of his agreement so he would not need four people to co-sign his bond. Madoff was unable to meet that condition, prosecutors said. Even his sons, Andrew and Mark, apparently were unwilling to help.

Instead, Madoff has agreed to a nightly curfew, and his wife, Ruth, will surrender her passport, according to a federal court filing Wednesday.

Madoff has already given up his passport. He must remain at his Manhattan apartment from 7 p.m. to 9 a.m.

Charities, individual investors, universities, hedge funds and banks have already reported losses of more than $20 billion in the case. On Wednesday, Hadassah, a Jewish women's charity, became the latest group to report falling victim, saying it had lost $90 million.

The scope of the case makes the role of the auditor even more peculiar. Vos' colleague Jake Walthour said, "Most hedge funds, even when they are small, use one of four or five big-name firms. And this wasn't one of them."

Storefront stays locked

Calls to the firm have gone unanswered this week, and the storefront has been locked every day. On Wednesday, a notice of a failed UPS delivery was hung on the door.

Friehling's home nearby is on a private road that was blocked by a security car, and no one answered the phone.

Rockland County District Attorney Thomas Zugibe, who is investigating the firm, said he did not know where Friehling was and had not had any contact with him.

Zugibe's investigators were at the Friehling office Monday, knocking fruitlessly at the door.

If Friehling's independent audit reports were fraudulent, "you're dealing with some very serious felony offenses under state law," Zugibe said.

The accounting firm has not been charged, and the U.S. Attorney's Office would not confirm whether the business is under investigation.

Vos' company looked into Madoff's firm last year and warned investors off, finding several "red flags." One was the size of Friehling's firm.

A private investigator told Aksia there seemed to be one person working there. Phone calls were not returned until someone finally answered and said the firm was not open for business, Vos said.

"We found that there were just three employees, the two principals and a secretary."

One of the principals, Jerome Horowitz, 80, left in 1997, state records show. He lives in Florida and may be Friehling's father-in-law.

This stands in sharp contrast to big auditors such as Ernst & Young, PricewaterhouseCoopers and KPMG, with the staffing to handle a huge client like Madoff.

Vos also noted Madoff had used a pre-existing licensed firm, unlike other frauds where swindlers created fictional auditing firms that issued fraudulent reports.

"It's a real firm, that's what's hilarious," he said. "Their story is going to be that they were fooled. ... It is possible."

Asked if the accountant could have been fooled by Madoff, the district attorney said, "Independent auditors don't depend on what they're given. They're supposed to dig into things."

The firm seems to have a clean record. Jane Briggs of the state Education Department, which licenses certified public accountants, said there has never been any disciplinary action — and none is pending — against Friehling or the firm.

Federal authorities had a long meeting with Madoff on Tuesday and hope to resolve some questions in the near future, including whether he had assistance in the scheme, according to one person briefed on the matter.

Experts on the brokerage industry and money management have said it would be nearly impossible for Madoff to have carried out the fraud, which encompassed thousands of clients and lasted for many years, without substantial help.

They have also questioned why auditors and regulators at the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority did not notice Madoff's firm had far fewer assets in 2007 than the $17 billion he claimed to be managing.

The authorities also would like to determine Madoff's motivation for the fraud, when it began and how much of the stolen money he had spent on himself.

Mukasey recuses self

In Washington, U.S. Attorney General Michael Mukasey recused himself from the Madoff investigation because his son, Marc Mukasey, is representing Frank DiPascali, a top financial officer at Madoff's investment firm.

The Justice Department refused to say when Mukasey became aware of the conflict but confirmed Wednesday he was removing himself from all aspects of the case.

DiPascali was the Madoff employee who had the most day-to-day contact with the firm's investors. Several described him as the man they reached by phone when they had questions about the firm's investment strategy or wanted to add or subtract money from their accounts.

SEC Inspector General David Kotz is looking into the agency's failure to uncover the suspected fraud in Madoff's operation.

One area Kotz said he will examine is the relationship between a former SEC attorney, Eric Swanson, and Madoff's niece, Shana, who are now married.

Swanson was part of a team that examined Madoff's securities brokerage operation in 1999 and 2004. Neither review resulted in any action against Madoff.

Information from The New York Times is included in this report.

Copyright © 2008 The Seattle Times Company

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