Bloomington accounting firm faces double whammy over Petters, Madoff

What are the odds?

The Bloomington accounting firm of McGladrey & Pullen has now been sued in relation to both of the top two alleged Ponzi schemes in U.S. history: the $50 billion securities fraud case against Wall Street broker Bernard L. Madoff and the $3.5 billion investment fraud scheme allegedly run by Wayzata businessman Tom Petters.

An investment fund that placed $280 million with Madoff filed suit last week in a state court in Bridgeport, Conn., saying its auditors -- Goldstein Golub Kessler, in 2006, and McGladrey & Pullen LLP, in 2007 -- failed to detect the fraud.

In October, the Ellerbrock Family Trust filed a similar suit in a Minnesota federal court saying that McGladrey & Pullen failed to conduct thorough audits or take other actions that would have uncovered alleged fraud by the Petters companies.

According to the Connecticut lawsuit, McGladrey & Pullen and several auditors who joined the firm in 2007 failed to detect red flags in Madoff's supposedly sophisticated trading and investment strategy on behalf of Maxam Absolute Return Fund, which says it lost more than $200 million with the now-notorious money manager.

"Perhaps most significantly, the procedures and testing that [the auditors] conducted in order to detect fraud and verify the [client's] assets fell far short of what a reasonable auditor should have done," the lawsuit states.

In the Minnesota case, the Ellerbrock Family Trust claimed it lost several million dollars that it had invested with a larger fund that collapsed in September when the Petters operation was halted by federal authorities. The trust is seeking damages of $15 million in that lawsuit, which is pending in U.S. District Court in Minneapolis.

In a prepared statement, McGladrey & Pullen said it could not comment on pending litigation, but added, "We acted with due care and conformed to professional standards."

'Negligent audits' alleged

In the Connecticut case, McGladrey & Pullen is codefendant with a New York accounting firm, Goldstein Golub Kessler, and several McGladrey partners who brought the Maxam fund business with them when they joined the firm in 2007. Maxam claims that its auditors conducted "negligent audits" that allowed "a massive criminal scheme" to go undetected.

According to Maxam, the auditors missed several signs that should have alerted them to the existence of a fraud. These signs included the lack of electronic access to client accounts, lack of time stamps on trading tickets, the use of a Bahamas-based controller instead of an internally based one and the hiring of an outside auditing firm that had just three employees -- including one who was 78 years old and lived in Florida.

The Maxam lawsuit alleges that Goldstein and McGladrey each "relied solely on Madoff's word to satisfy themselves that the [client's] assets existed and to substantiate the purported gains."

In big fraud cases, investors who lost money often turn to ancillary players like accountants, lawyers and financial advisers, who may have deeper financial pockets than the individual or group that directed the scams.

"Who should have done what when? That's what it's all about," said Geoffrey Jarpe, the Winthrop & Weinstine attorney representing the Ellerbrock Family Trust. "We had audited financial statements that were provided to the fund's partners and we're suing on behalf of the partners," Jarpe said.

Herbert Kritzer, a professor at William Mitchell College of Law, said anyone with deep pockets connected to the case could end up a defendant in a civil lawsuit.

"When someone gets screwed, they're going to look for any possible source of recovery. A law firm will go after anybody who was involved in providing information to their clients or the public that said the investment was good," Kritzer said.

The lawsuits arising from the Petters and Madoff sagas likely will increase.