Madoff shows why managers shouldn't write their own report cards

I often feel pretty stupid. One reason is that ideas that seem obvious to me make no sense to just about everyone else. This comes to mind today in reading about a well-known thief -- Bernie Madoff. It now appears that he defrauded his customers of $64.8 billion. How did he do it? He created fake financial statements for his customers -- in effect, he was grading himself.

Here's where I feel stupid -- in my 2003 book Value Leadership, which came out in the wake of Enron, I argued that companies should not write their own report cards. (I've posted about this here and here.) Instead, we should create an independent auditing group which is part of the government. These auditors would produce financial statements for companies and money managers and would be funded by taxes. As long as managers write their own report cards, fraud is inevitable. And as long as so-called independent auditors are paid by the companies they audit, there is too much of a financial incentive for them to go along with management.

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