Madoff Never Had `Thorough and Competent' SEC Probe, Agency ...
Sept. 2 (Bloomberg) -- The U.S. Securities and ExchangeCommission repeatedly missed chances to catch Bernard Madoff’s$65 billion fraud over 16 years by assigning inexperiencedinvestigators and accepting “implausible” explanations aftercatching him in lies, the agency’s internal watchdog said.
At least six warnings from sources including a moneymanager, a “respected hedge-fund manager” and a firm thatstudied Madoff’s business failed to spur a “thorough andcompetent” probe, Inspector General H. David Kotz wrote in asummary of a report released today. Madoff, in an interview withKotz, said even he “was astonished” when investigators failedto check trading records that would have exposed his scam.
“Despite numerous credible and detailed complaints, theSEC never properly examined or investigated Madoff’s trading andnever took the necessary, but basic, steps to determine ifMadoff was operating a Ponzi scheme,” Kotz wrote.
The report is the most exhaustive look yet into the SEC’sfailure to detect a fraud that spanned decades and burnedthousands of investors, including universities, charities andaffluent clients. Lawmakers crafting a regulatory overhaul haveawaited Kotz’s findings since agency officials rebuffedquestions at hearings in January and February, citing thecontinuing Madoff inquiry.
Kotz, in the 22-page summary, said he didn’t find thatsenior SEC officials tried to improperly influence or interferewith inquiries. Nor did he find that an SEC employee’s romanticrelationship with Madoff’s niece had any affect on the agency’sexaminations. The full 451-page investigative report includesmore than 500 exhibits, according to his office.
‘Lessons Learned’
“It is a failure that we continue to regret, and one thathas led us to reform in many ways how we regulate markets andprotect investors,” SEC Chairman Mary Schapiro said in astatement, adding that the agency is overhauling its enforcementand inspection units and reforming how it handles tips. “Wehave been reviewing our practices and procedures, addressingshortcomings, and implementing the lessons learned.”
Madoff, 71, is serving a 150-year prison sentence afterpleading guilty to a fraud that federal investigators said datedto at least the 1980s. The scam funneled funds from new clientsto pay returns that were purportedly generated by a stock andoptions trading strategy known as a split-strike conversion. SECinvestigators have said Madoff and employees at his New York-based firm, Bernard L. Madoff Investment Securities LLC, used avariety of ruses, such as creating sham trading records, toavoid detection.
SEC Chairmen
Kotz faults the agency’s efforts since 1992, a period thatspanned the tenure of five SEC chairmen, Richard Breeden, ArthurLevitt, Harvey Pitt, William Donaldson and Christopher Cox.Levitt, the only Democrat among the five, is a board member ofBloomberg LP, the parent of Bloomberg News.
In June 1992, the agency was alerted to an investment firmthat was raising funds by selling unregistered securities andfunneling the money to Madoff, who purportedly managed it. An“inexperienced” team of investigators focused on thefundraisers, ignoring “red flags,” such as Madoff’ssuspiciously consistent returns, Kotz said.
Another chance came in 2000, when former money managerHarry Markopolos approached the SEC with an eight-page report,suggesting that Madoff’s purported returns weren’t possible. Ata congressional hearing in February, Markopolos described yearsof frustration in dealing with the agency’s “investigativeineptitude and financial illiteracy,” saying the agencyrepeatedly refused to look into his warnings.
‘Inexperienced Staff’
In that case, Kotz wrote, “the relatively inexperiencedenforcement staff failed to appreciate the significance of theanalysis in the complaint, and almost immediately expressedskepticism and disbelief.” Though investigators soon caughtMadoff in lies, they failed to look into inconsistencies andaccepted his explanations. They also rebuffed Markopolos’s offerto provide more evidence, and remained “confused about certaincritical and fundamental aspects of Madoff’s operations.”
In May 2003, a hedge-fund manager presented the SEC withanother series of “red flags” that his fund had identifiedwhile performing due diligence to two so-called feeder fundsthat invested with Madoff, Kotz wrote.
That time, the SEC’s examinations office appointed aWashington-based group of brokerage inspectors, rather thanstaff who specialize in examining money managers, according tothe report. The team focused on whether Madoff was front-running, or trading ahead of client orders. When the leader wasasked why, he said “that was the area of expertise for mycrew,” Kotz wrote in the report.
Mutual-Fund Focus
The examiners discovered that Madoff’s money managementbusiness dwarfed his market-making operations, Kotz said. Theyfailed to collect trading data before they were “abruptly”instructed put the review on the backburner and focus on mutual-fund issues then making headlines.
About the same time, a New York-based SEC examiner stumbledonto a cache of e-mails while inspecting another firm, providing“a step-by-step analysis” that cast doubt on Madoff’s reportedoptions trading. A team formed, and again focused on front-running. When they asked Madoff about his options trades, hesaid that was no longer part of his strategy.
“Madoff made efforts during the examination to impress andeven intimidate the junior examiners from the SEC,” Kotz noted.One of the examiners “characterized Madoff as ‘a wonderfulstoryteller’ and ‘very captivating speaker,’” he wrote. Anotherexaminer said Madoff “would repeatedly drop the names of high-up people in the SEC.”
New Laws
U.S. Representative Paul Kanjorski, a Pennsylvania Democratand head of the House Financial Services capital marketssubcommittee, said the report will guide efforts to revampfinancial regulation.
The case “highlights the need to adopt new securities lawsto reward internal and external whistleblowers,” Kanjorskisaid, adding that revisions should be made to increase the moneyrecovered by defrauded investors.
Kotz’s report “reminds us how essential it is that weimprove both financial regulation and the competence of theregulator,” said Senate Banking Committee Chairman ChristopherDodd, a Connecticut Democrat whose committee oversees the SEC.Dodd’s panel will hold a hearing on Sept. 10 about ways to“modernize financial regulations,” he said.
Madoff’s scheme unraveled in December as he struggled tomeet mounting investor withdrawals. Days after Madoff’s arrest,the SEC chairman, Cox, faulted staff for failing to act on“credible and specific allegations” about the operation for atleast a decade.
Recommendations Readied
Kotz told Congress he will issue recommendations this monthfor improving the SEC’s oversight and inquiries. The review wasrequested by Cox before he stepped down as chairman in January.
Schapiro, who took the SEC’s helm seven weeks afterMadoff’s arrest, has focused on overhauling the agency. Sherepealed policies blamed for slowing investigations, hired anoutside firm to create a system for screening tips aboutmisconduct and appointed Robert Khuzami, a former federalprosecutor to oversee enforcement.
Khuzami last month announced the unit’s biggestreorganization in at least three decades, aimed at speedinginvestigations and honing expertise. The overhaul will leavefewer management layers, more front-line investigators, and atleast five specialist teams focused on emerging and complexareas of the market. The SEC is also taking steps to make iteasier for investigators to issue subpoenas and reward peoplefor aiding probes.
The criminal case against Madoff is U.S. v. Madoff, 09-cr-213, U.S. District Court, Southern District of New York(Manhattan).
To contact the reporter on this story:David Scheer in New York at dscheer@bloomberg.net.
Last Updated: September 2, 2009 17:35 EDTSource: Bloomberg
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