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CASE 2.5
LIPPER HOLDINGS, LLC
Synopsis
Media reports described Kenneth Lipper as a “bon vivant” and “renaissance man.” Lipper,
the son of a shoe salesman, grew up in a modest working-class neighborhood in the South Bronx. A
childhood friend of Al Pacino and a contemporary of Bernie Madoff, Lipper made a name for
himself both on Wall Street and in Hollywood. Lipper served as a partner of Lehman Brothers and
then Salomon Brothers during the 1970s and 1980s before becoming a pioneer of the emerging
hedge fund “industry.” After collaborating on Oliver Stone’s popular film Wall Street in the late
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Lipper Holdings, LLC—Key Facts
1. Kenneth Lipper, the son of a shoe salesman, was raised in a modest working-class
neighborhood in the South Bronx community within New York City.
2. In addition to establishing a prominent Wall Street investment firm and serving several years
3. Lipper was a leader of the rapidly growing hedge fund industry during the 1990s; his firm,
Lipper Holdings, managed three hedge funds, the largest of which was Lipper Convertibles.
5. To inflate the reported rates of return earned by the three Lipper hedge funds Strafaci began
overstating the year-end market values of the investments they held.
7. Lipper Holdings’ longtime audit firm, PwC, became a focal point of the SEC’s investigation
of Strafaci’s fraud.
9. Despite that audit evidence, PwC issued unqualified audit opinions on the hedge funds’
financial statements throughout its tenure as their independent auditor.
122 Case 2.5 Lipper Holdings, LLC
Instructional Objectives
1. To identify audit risk factors posed by sophisticated financial services clients such as hedge funds.
Suggestions for Use
As the opening prologue for this case suggests, hedge funds are easily among the most
controversial investment vehicles in today’s capital markets. They are also among the most
mysterious and least understood Wall Street “creatures.” For those reasons alone, I believe this case
will pique your students’ interests. Consider having a student or group of students provide a five–
Suggested Solutions to Case Questions
1. The three categories of fraud risk factors discussed in AU 316, “Consideration of Fraud in a
Financial Statement Audit,” are “incentives/pressures,” “opportunities,” and
“attitudes/rationalizations.” (Of course, collectively these three categories of fraud risk factors are
often referred to as the “fraud triangle.”) The appendix to AU 316 provides numerous examples of
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subjective judgments or uncertainties that are difficult to corroborate” (As noted in a footnote to the
case, many of the hedge funds’ investments were in “thinly–traded” securities that often did not have
readily determinable market values.)
—“Domination of management by a single person” (In this case, Strafaci.)
—“Ineffective oversight over the financial reporting process and internal control by those
charged with governance” (One could argue that Kenneth Lipper should have exercised
more effective oversight of the hedge funds including Strafaci’s role in managing the funds.)
How should PwC have responded to these and other risk factors posed by the audits of the
Lipper hedge funds? By making proper adjustments in the audit NET for those audits, that is, the
nature, extent and timing of the audit procedures to be applied during those engagements. Granted,
in some cases audit firms may simply choose not to be associated with an audit client for which an
2. Paragraph 15 of AU 326, “Audit Evidence,” identifies thirteen specific management assertions
that are relevant to independent auditors. The “audit objectives” on any given audit engagement
involve collecting sufficient appropriate evidence to corroborate these assertions for specific
financial statement line items or disclosure items. (You may want to point out to your students that
Auditing Standard No. 15, “Audit Evidence,” issued by the PCAOB identifies only five broad
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Example of a relevant audit procedure: “If quoted market prices are not available for the
derivative or security, estimates of fair value frequently can be obtained from broker-dealers or other
third-party sources based on proprietary valuation models or from the entity based on internally or
externally developed valuation models.” AU 332.38
Audit objective: Audit objectives related to “assertions about rights and obligations address
whether the entity has the rights and obligations associated with derivatives and securities, including
pledging arrangements, reported in the financial statements.” AU 332.25
3. Listed next are examples of specific factors that may have contributed to the alleged flaws in
the audit procedures applied by the PwC auditors while testing the year-end market values of the
Lipper hedge funds’ investments.
—Kenneth Lipper’s prominence and influence in the hedge fund industry or sector of the investment
community (History has proven that auditors are sometimes prone to give prominent audit clients or
audit client executives the “benefit of the doubt.” Auditors may do so because they don’t want to
jeopardize losing the given client and/or because they believe that a prominent client or client
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rigorous quality control mechanisms in place to ensure that generally accepted auditing standards are
complied with on each and every audit engagement. Examples of such quality controls include a