Canada's connection to Bernie Madoff continues through the courts a decade later

bernard-madoff

Originally posted on Financial Post

Bernard Madoff 10 years ago this week confessed to running a massive Ponzi scheme that defrauded investors of billions and billions of dollars. The wave of litigation that followed has still not completely receded, and at least one lawsuit has fallen into the Canadian court system.

Why this is the case is due to the usually sedate subject of auditing financial statements, in this case statements reviewed by a branch of PricewaterhouseCoopers, one of the world’s largest professional services firms.

It was around 12 years ago that the manager of three offshore investment funds — Fairfield Sentry, Fairfield Sigma and Fairfield Lambda — turned to a Canadian arm of PwC to look over the funds’ financial statements, switching the task from a PwC office in the Netherlands.

It should have been a relatively unremarkable move if not for one fatal fact. The funds, all incorporated in the British Virgin Islands, had assets worth billions of dollars, the bulk of which were ultimately invested with Bernard L. Madoff Investment Securities LLC (BLMIS)

Madoff, of course, revealed his Ponzi scheme in 2008, rocking the financial world and sending his investors reeling, including the three Fairfield funds, which were placed into liquidation in the British Virgin Islands in 2009.

The funds and their liquidator launched a lawsuit against an Ontario limited liability partnership of the PwC network in 2012, and the matter had been winding its way through the province’s courts even since.

In the lawsuit, the funds and their liquidators alleged a breach of contract and negligence on the part of their auditor. The plaintiffs claimed that PwC should have discovered Madoff’s scheme when the funds’ financial statements were audited, and that because this didn’t happen, the funds continued to invest with Madoff and incurred damages.

PwC, though, has disputed the claims, arguing it is being taken to task “based on information only disclosed after Madoff’s admission of guilt and with the benefit of 20/20 hindsight.” It also contended that the funds didn’t actually suffer any damage, since during the relevant period of time, they allegedly took more out of BLMIS than they put in.


Bernard Madoff walks out from Federal Court after a bail hearing in Manhattan Jan. 5, 2009. Madoff is serving a 150-year prison sentence as part of a multi-billion Ponzi scheme that defrauded investors. Hiroko Masuike/Getty Images

A lower-court judge sided with PwC’s arguments in 2017 and dismissed the lawsuit. Ontario’s appeals court dismissed a challenge to the ruling this past August.

But in October, the liquidators made a push to take the case to the next level, filing an application for leave to appeal to the Supreme Court of Canada.

In asking for the court’s permission to hear their case, the liquidators argued legal matters have been raised that are of “public importance,” such as what a party must do to put its “best foot forward” and keep a lawsuit from being thrown out on a summary judgment motion, which can see a case resolved without a full trial.

It could be that Canada’s highest court takes a pass (and most applications for leave to the Supreme Court are indeed dismissed), but one of the liquidators of the funds sees the lawsuit as trying to hold PwC accountable “for what we feel is basically a job that was not up to scratch,” Kenneth Krys said.

“The effort here is really to get money back in the hands of the people, the victims who suffered significant losses,” he said in an October interview.

If nothing else, the case has served to underscore just how much grief Madoff’s Ponzi scheme caused.

Though the application to the Supreme Court has yet to be dealt with, the particulars could be enough to stoke the interest of more than just legal buffs.

For one thing, is it possible that auditors in Canada could have caught Madoff’s fraudulent activity before it all came tumbling down? Was it their job to?

PwC certainly doesn’t believe so, arguing in its 2013 statement of defence and counterclaim (posted online, along with other legal documents, by the Fairfield funds’ liquidators) that, among other things, it was engaged “late in the day” for the audits.

“The fact that PwC did not discover the fraud which took place at a third party and not at PwC’s client does not mean that PwC was negligent or that it failed to meet the applicable audit standards,” the firm argued.

“Rather, it means that PwC was deceived by Madoff, like everyone else, including other professional accounting firms faced with similar audits.”

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It was Dec. 10, 2008, when Bernie Madoff admitted to orchestrating “one of the largest and longest running ‘Ponzi’ schemes in history,” according to a decision by Ontario Superior Court Justice Frank Newbould.

Ponzi schemes take money from new and existing investors to fund withdrawals by and “profit” for other customers.

“Madoff never invested customer funds,” Newbould wrote in his June 2017 decision, which dismissed the Fairfield funds’ lawsuit. “Returns to investors were fictitious and the corresponding documentation fabricated.”

U.S. federal authorities arrested Madoff on Dec. 11, 2008, and he would be charged with 11 felony counts, including investment adviser fraud.But until his fall, Madoff had been thought of as one of the more trustworthy people on Wall Street. His firm had been around for decades and he had even served as chairman of the Nasdaq Stock Market.

“His reputation for honesty has to be the starting point of the story, because it was the quicksand into which all that followed sank,” said Diana Henriques, a financial journalist and author of The Wizard of Lies, which was recently adapted into an HBO movie.

“He was such a trusted and credible figure that there was a tendency to give him the benefit of the doubt in almost every circumstance.”

Fairfield Sentry was in deep with Madoff. It largely functioned as a “feeder fund” for him, and had invested around 95 per cent of its assets with his firm, or approximately US$7.2 billion.

The two other related funds audited by PwC, Fairfield Lambda and Fairfield Sigma, were essentially feeder funds for Sentry. They invested in Sentry, thus they were also invested in Madoff.

These funds were not investment opportunities for small-timers. Fairfield Sentry’s investors, for example, needed to have a minimum net worth of $1 million and make a minimum investment of $100,000. The investors also could not be citizens or residents of the United States.

But the funds were placed into liquidation shortly after Madoff pleaded guilty in March 2009 to the charges against him, “admitting that he had turned his wealth management business into the world’s largest Ponzi scheme,” the U.S. Department of Justice noted as recently as a Nov. 29, 2018, press release. He was sentenced to 150 years in prison.

Efforts to claw back investor losses had already begun by then. As of Nov. 30, the trustee for the liquidation of Madoff’s firm said it had managed to recover, or reached agreements to recover, approximately US$13.3 billion for his former customers.

But the trustee’s efforts are not the only attempt to try to recoup the alleged cost of doing business with Madoff.

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Where Canada enters the story of a New York-based fraudster doing business with funds based in the British Virgin Islands comes down to the auditing of financial statements.

“The (Fairfield) Liquidators allege PwC should have uncovered Madoff’s Ponzi scheme no later than April 24, 2007, when it delivered the Funds’ audited 2006 financial statements,” the Court of Appeal for Ontario noted in its August decision on the Fairfield funds’ case against PwC.

“Because PwC did not do so, the Funds remained invested in BLMIS, as a result of which they contend they suffered damages of approximately $2.5 billion.”

PwC, however, has denied the funds sustained any damage at all around the time of their audits, and claimed that the Fairfield funds actually withdrew around a billion dollars more from Madoff’s firm than they invested in the time between the first audit to when Madoff’s scheme collapsed.

Complicating matters is that the arguments over determining how much (if any) damage was done also involve a settlement struck between the funds and the liquidator of Madoff’s firm, which had been trying to recover money from Fairfield Sentry, among others.

A settlement was struck between the Madoff trustee and the Fairfield funds’ liquidator to try to resolve the situation. This truce included judgments that were entered against the three Fairfield funds in the U.S., the impact of which has been fought over by the funds and PwC in the Ontario courts.


Bernard Madoff New York Mets baseball jacket is displayed during a press preview of a U.S. Marshals Service auction of personal property seized from Bernard and Ruth Madoff Nov.13, 2009 in New York City. Mario Tama/Getty Images

Justice Newbould granted the motion for summary judgment of the lawsuit in 2017, a decision that dismissed the Fairfield funds’ case (and which was later upheld by the Ontario appeals court).

In doing so, Newbould found “that the Liquidators have not established any damages and that there is no genuine issue regarding damages that requires a trial.”

But the Canadian angle to Madoff’s scheme is not just confined to the courts.

After Madoff confessed, two Fairfield Sentry shareholders complained about the auditing of the fund to the Institute of Chartered Accountants of Ontario (the then-governing body of chartered accountants in Ontario, which has since been merged into what is now the Chartered Professional Accountants of Ontario) in June and October of 2009.

In October 2012, following an investigation, a professional conduct committee made two allegations of professional misconduct against Stephen Wall, a partner at PwC. Wall is also named in the Fairfield lawsuit, and, along with PwC, is a respondent in the appeal to the Supreme Court.

According to the resulting tribunal, the audits done by PwC for 2006 and 2007 had been under the direction and supervision of Wall.

A disciplinary panel found Wall, who denied the allegations, guilty of professional misconduct in 2017. Wall has launched an appeal of the matter.

“The ultimate determination the panel had to make was whether or not Mr. Wall complied with the applicable auditing standards when he accepted the information (confirmations) provided by Bernard L. Madoff Securities Limited, LLC (‘BLMIS’) about the assets of and income for Fairfield Sentry Limited (‘Fairfield Sentry’) for the years ended December 31, 2006, and December 31, 2007,” the panel’s decision said.

“The panel concluded that he failed to comply with the applicable auditing standards, i.e. United States Generally Accepted Auditing Standards (US GAAS) and as a result there was an audit failure.”

Although the professional conduct committee had accepted that “neither Mr. Wall nor anyone at PwC knew about the Madoff fraud or participated in any way in the fraud” — and the decision noted that the applicable auditing standard “does not require an auditor to find fraud, if there is fraud” — the panel’s decision also said Wall “accepted representations from (Madoff’s firm, BLMIS) without any evidence that the information provided by BLMIS was reliable.”

In other words, it added, “Basically, all Fairfield Sentry had was what BLMIS said it had.”

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Stephen Wall’s appeal of the CPAO matter is ongoing. A representative from the CPAO said in an email that there is another date set for deliberations on Jan. 8.

The panel’s decision also noted that “issues of negligence or breach of contract and liability, if any, for the losses suffered by the investors (shareholders) of Fairfield Sentry is a matter for the courts, not the Discipline Committee, a professional discipline tribunal.”

A decision on whether or not the Supreme Court will hear the case of the Fairfield funds and liquidators is still to come.

Canada’s highest court is not being asked to judge Bernie Madoff. Instead, it is being asked to weigh in on the state of summary judgments.

This area of law was affected by a landmark decision nearly five years ago, in a case known as Hryniak v Mauldin, wherein a Supreme Court decision said summary judgment motions “must be granted whenever there is no genuine issue requiring a trial.”

But the Fairfield funds now claim that lower-court decisions have shown the use of summary judgment “has gotten out of hand.”

Krys said they are not expecting to hear back from the Supreme Court until the beginning of 2019. The liquidators also launched a lawsuit against PwC in the Netherlands, which has been dismissed for different reasons, he said in an email, adding that decision is being appealed as well.

PwC, meanwhile, previously came to terms with Fairfield investors in the U.S. “to settle claims it failed to audit properly the books of Fairfield Greenwich Group,” the firm that launched Fairfield Sentry approximately 28 years ago, Reuters reported in January 2016. PwC “denied wrongdoing in agreeing to settle,” and the settlement reportedly resolved investor claims against Canadian and Dutch arms of PwC.

In a written response to questions from the Financial Post, PwC said it agreed with the decisions of the Ontario courts and is contesting the liquidators’ application to the Supreme Court, as it believes the case does not raise any issues of broad public or national importance.

“All other actions naming the Canadian firm have either been dismissed or resolved,” PwC added, “and no other government or regulatory authority with jurisdiction over the Madoff fraud has alleged that our work was not performed in accordance with applicable rules and audit standards.”

PwC said it is not a party to the CPAO matter — a civil proceeding that, according to the decision, hinges on the “balance of probabilities, i.e., that on the evidence it is more likely than not that the particulars of the Allegations made are true” — but said it believes that its audit team’s work fully complied with professional standards.

The firm added that because the matter is still before the courts and the Chartered Professional Accountants of Ontario, both it and Wall (whom PwC said “is a senior and respected partner in our Assurance practice, and has been so throughout the course of this matter”) are limited in what they can publicly state. Attempts to question Wall were answered by PwC’s general counsel.

Furthermore, in a November reply to the Fairfield funds’ application the Supreme Court, PwC alleged it was “incontrovertible that the Fairfield Funds did not put their best foot forward and that the findings of the lower courts are fully supported by the evidence.”

But the Fairfield funds’ liquidators have warned of a “perverse scenario” of parties having to engage in an endless back-and-forth with their evidence on a summary judgment motion.

Krys claimed it is unlikely PwC wants a full airing of the lawsuit. (Justice Newbould also wrote that a trial on the issue of the auditor’s alleged negligence “would no doubt be long and expensive.”)

“If they can get this kicked out … on the basis that there are no damages, then this will solve their problem for them,” Krys said. “And the question of whether they were negligent or not will never see the light of day.”