Ernst & Young loses trial for not vetting Madoff-tied audits

Ernst & Young's failure to vet financial audits backed by con man Bernie Madoff's accountant may cost the consulting firm $25 million, based on the verdict in the first trial of an auditor over losses tied to the biggest Ponzi scheme in US history.

FutureSelect Portfolio Management, which sued Ernst & Young in 2010 over faulty audits of a Madoff-linked feeder fund, is entitled to recoup a portion of the $112 million it lost in its investment in the fund, jurors in Seattle state court ruled Friday.

The jury found Ernst & Young liable for half of the $20.3 million in damages it awarded. With interest added, the firm is on the hook for about $25 million, a FutureSelect lawyer said.

While negligence cases against Big Four accounting firms are rare, this one was brought under a Washington state securities law that is more protective of investors than similar state and federal statutes. In the end, the jury issued mixed findings on the state securities claims while ruling in FutureSelect's favour on Ernst & Young's negligent misrepresentation.

Amy Call Well, a spokeswoman for Ernst & Young, said the firm is pleased the jury rejected the "vast majority" of FutureSelect's claims. She said Ernst & Young is considering whether to appeal.

Ernst & Young audited Rye Funds, which were managed by Tremont Group Holdings. The accounting firm audited Rye from 2000 to 2003 and performed surprise audits of Tremont during that period until 2008, FutureSelect said in court documents.

FutureSelect accused the accounting firm of failing to perform adequate audit procedures to test the existence of assets on Rye's financial statements. Instead, it relied on assurances made by Madoff to whom Rye had outsourced everything from investment decisions to record keeping.

Ernst & Young was accused of relying on audit reports done by Madoff's accounting firm Friehling & Horowitz, which was located at the time in a strip mall in a New York City suburb. Ernst & Young failed to inquire about Friehling & Horowitz's professional reputation, Steven Thomas, FutureSelect's attorney, said in closing arguments. Had it done so it would have found out that the accountant wasn't vetted to do audits as required by industry standards, Thomas said.

"It's clear that the one jury that has heard these facts has said that an auditor's job is to be the gatekeeper and Ernst & Young didn't do it job," Thomas said after the verdict. "In the biggest fraud in history Ernst & Young didn't do its job. They were negligent." The jury concluded that Madoff's crimes weren't the superseding cause of FutureSelect's losses.

"We continue to believe EY was not responsible for any of these investors losses," Call Well said in an e-mailed statement. "EY was not the auditor of any Madoff entity; we were among the many auditors of funds that chose to use Madoff as their investment adviser. While we regret the investors' losses, no audit of a Madoff-advised fund could have detected this Ponzi scheme."

Madoff is serving a 150-year prison term for stealing billions of dollars from thousands of investors. David Friehling, Madoff's accountant for more than 20 years, pleaded guilty to fraud in 2009 and was sentenced to two years' probation after cooperating with prosecutors.