Since Madoff was arrested last December, it’s still not clear where all the money is, or how the 70 year old financier was able to pull off a crime on such a grand scale
supposedly single-handedly. Most eyes have turned on his sons, who held senior roles at Madoff Investment Securities, but apparently that’s not who the Feds are after next…

On March 18, Madoff’s accountant, David Friehling, was arrested for his role – intentional or not – in helping the ponzi scheme take place.

Friehling, and his small accounting firm Friehling & Horowitz, were the auditors for Madoff Investment Securities since the early 1990s. What prosecutors only recently found out, however, was just how small Friehling’s firm was – it consisted of three people set up in a New York suburb storefront, with Friehling the sole certified public accountant.

That’s startling news considering that this scamming CPA was supposed to be responsible for making sure that Madoff’s reported operations were accurate for shareholders and regulators; a job much bigger than any single person can handle.

Audits of large financial institutions require entire teams of accountants, sometimes sequestered at their clients’ offices year-round. It seems as though Friehling did little more than rubber stamp Madoff’s stories with a good audit opinion.

While the government doesn’t content that Friehling knew about the fraud, as the sole CPA on the audit, Friehling bears the entire liability for not performing a complete audit that falls within generally accepted accounting principles.

What This Means For Small Cap Investors

The reverberations of Friehling’s arrest are sure to be felt throughout the financial services community – after all, it’s very uncommon for accountants to be held criminally responsible for a lousy audit. Remember Enron? The accounting scandal caused the collapse of Arthur Anderson, one of the biggest public accounting firms in the world.

One of the more immediate results of this will likely be tightened accounting standards, especially for over the counter penny stocks. After all, OTC stocks – too small to justify exacting financial reporting – have been known for having shifty books for a long time. It’s one of the biggest reasons most investors have eschewed OTC stocks, which don’t trade on major exchanges, in favor of “listed” stocks that hold tickers on exchanges like NYSE or NASDAQ.

Part of the reason for that accounting irregularity has been the fact that stocks that trade over the counter are able to get away with being delinquent with their SEC filings. Another is the fact that audit standards are so subjective.

The powers that be require auditors to exercise “due care” when performing an audit, but what that means isn’t entirely clear. It’s possible that Friehling will use the vagueness of due care as a defense to his incompetence in the Madoff case.

Tightening restrictions for audits isn’t without its downsides – namely the added costs that smaller companies will have to pay to get audited by a reputable firm. Still, getting an audit should be seen as a necessary cost to those who look to raise capital by issuing stock to investors.

We’ll keep you updated on the latest small cap happenings in the coming months.

Cheers,
Jonas Elmerraji

What the Latest Madoff Arrest Means for Penny Stock Investors was originally featured in the Penny Sleuth.

But the most important piece of news for small-cap investors thus far has been overlooked…liquidity is returning to the market.

My colleague Greg Guenthner summed it up best the other day: “FINALLY, people are buying stocks again!”

We have battled low volume for months now. There was simply no one trading. In this economy, it’s understandable. It’s a common reaction to get rid of as much as you can and hold onto the rest as tightly as possible. Unfortunately, that’s not how people make money.

As Greg put it to his Bulletin Board Elite readers back in November, “Stock prices will not line up with a company’s performance. With high volatility and low trading volume on the bulletin boards, this just isn’t going to happen right now.”

The massive sell-off, followed by this severe liquidity drought, has given small-cap investors the largest headache over the past few months.

No one likes to lose money or see investments lose 40% of their value. But small-cap traders can handle it. After all, who cares if a few of your stocks fall a bit if you also own some multipliers? A single 300% gain wipes out a dozen losers.

The problem isn’t whether or not you lose money on some investments. The problem is whether you can invest at all. As Greg was referring to above, small caps — especially those on the bulletin boards — have completely seized up. No trading means no gains. If no one is willing to buy your stake of a company, you can’t cash in on any profits you might be holding.

We’ve stared at stock charts for hours and wished volume would pick up so we could recommend certain companies. As frustrating as it’s been, nothing compares with what it’s like to see so many insane bargains left untouched. Without volume, it doesn’t matter if a $20 company is trading for $3. We just can’t touch it without buyers and sellers.

The bulletin board volume has been even worse. I’ll use an example from Greg’s Bulletin Board Elite service. One of his companies jumped from 16 cents to 32 cents on a single 2,000-share trade Wednesday morning. By yesterday morning, that same company fell back to 25 cents on another 2,000-share trade. That’s a 100% gain followed by a 22% fall on a little over $1,000 worth of trading.

While we may not be back to full volume capacity yet, this is still an improvement from the last two months of 2008. There were six full days in November and December (not including Thanksgiving and Christmas) when absolutely no shares of this company changed hands. There were many other days that only a few bucks worth of stock was traded.

We think this is the turning of the tide. Liquidity should continue to pick up, which will open up a brand-new stream of options for smart investors.

As volume continues to rush back into the market, small-cap investors must be ready to strike anytime. The market is starting to give us a chance to buy. You don’t want to miss it.

Sincerely,
Jim Nelson

January 9, 2009

Rise in Penny Stock Volume Spells Opportunity was originally featured in the Penny Sleuth.