SEC bungled Madoff probes, agency watchdog says

By MARCY GORDON, AP Business Writer Marcy Gordon, Ap Business Writer – Wed Sep 2, 9:26 pm ET
WASHINGTON – Pushing past years of "red flags," investigators at the Securities and Exchange Commission bungled their probes of Bernard Madoff so badly that his multibillion-dollar fraud not only flourished but he used the exams to suck in new investors, an agency watchdog declared Wednesday.
The report by the SEC inspector general shows that no smoking gun of corruption was found in the agency's conduct toward the disgraced financier. Instead it painted a grim picture of an agency hobbled by incompetence — failing to pursue the most obvious leads — that cleared the way for Madoff to continue what could be the biggest Ponzi scheme in U.S. history for more than a decade.
One of the most striking points in the report is that the investigations actually may have made things worse.
"Madoff proactively informed potential investors that the SEC had examined his operations" and found nothing amiss, it says. The fact that three SEC inspections and two investigations failed to detect the fraud gave credibility to Madoff's operations and encouraged more people to give him their money.
The report by inspector general David Kotz cites no evidence of improper ties between agency officials and Madoff, nor of senior SEC officials trying to influence the agency's probes of his business. Speculation had raged in December, when Madoff confessed to the scheme, that the financier's influence and ties to the SEC as a prominent Wall Street figure had prompted agency officials to pull their punches in investigations of his business.
The SEC enforcement staff "almost immediately caught (him) in lies and misrepresentations but failed to follow up on inconsistencies" and rejected whistleblowers' offers to provide additional evidence, the report says.
"The fact that for 16 years (the SEC) had on blinders and earmuffs is mind-numbing," said Jacob Frenkel, a former SEC enforcement attorney and federal prosecutor now in private law practice.
Four high-ranking SEC officials who were lambasted over the Madoff affair at a congressional hearing in February — including the enforcement director and the head of the inspections office — have left the agency.
SEC Chairman Mary Schapiro, appointed by President Barack Obama, took the helm in January. Enforcement efforts have been strengthened, and the agency has started a number of initiatives meant to protect investors in the wake of the financial crisis, officials say.
Madoff, who pleaded guilty in March, has begun serving a 150-year sentence in federal prison in North Carolina for a pyramid scheme that destroyed thousands of people's life savings, wrecked charities and gave the financial system yet another big jolt. The legions of investors who lost money included Hollywood celebrities, ordinary people and famous names in business and sports — as well as big hedge funds, international banks and charitable foundations worldwide.
Revelations in December of the SEC's failure to uncover Madoff's massive scheme over more than a decade touched off one of the most painful scandals in the agency's 75-year history.
The inspector general plans to issue separate audits that will include recommendations for changes in the agency's enforcement and inspection operations.
His report "makes clear that the agency missed numerous opportunities to discover the fraud," new chairman Schapiro said in a statement. "It is a failure that we continue to regret, and one that has led us to reform in many ways how we regulate markets and protect investors."
Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, said the panel has scheduled a hearing for Sept. 10 on Kotz's report, at which the inspector general is expected to testify. The testimony will "guide us as we continue our work on a bill to modernize financial regulations," Dodd said.
Between June 1992 and last December, the SEC received six "substantive complaints that raised significant red flags" regarding Madoff's operations. But "a thorough and competent investigation or examination was never performed," the Kotz's report says.
For example, Harry Markopolos, a fraud investigator who had worked in the securities industry, brought his allegations to the SEC about improprieties in Madoff's business starting in 2000 after determining there was no way Madoff could have been making the consistent returns he claimed. Markopolos and his investigators raised 29 specific warnings regarding Madoff's operations to SEC staff members in Boston, New York and Washington.
The agency also received complaints from a number of other sources, all containing specific information that called for a thorough examination of Madoff's business, the report says.
Many of the SEC staff members who conducted the investigations were "inexperienced," according to the report.
It cites examinations of Madoff's business done in 2004 and 2005 by the agency's inspections office. In both exams, the staff "made the surprising discovery" that Madoff's mysterious investment business was making far more money than his well-known wholesale brokerage operation. "However, no one identified this revelation as a cause for concern," the report says.
Even more surprising, the two exams were being conducted in different SEC offices without either location being aware of the other's action. It was Madoff himself who told one of the inspection teams that he'd already given the information they sought to the other team, according to the report.
Madoff himself, who was once chairman of the Nasdaq Stock Market and had sat on SEC advisory committees, had boasted of his ties to the agency.
The inspector general's investigation found no evidence, though, that any SEC staff who worked on the exams or investigations of Madoff's business had financial or other improper connections with him that influenced the probes.
Nor did Kotz find evidence that the relationship between a former SEC attorney and assistant inspections director, Eric Swanson, and Madoff's niece, Shana, who married in 2007, influenced the exams. Swanson was part of a team that examined Madoff's securities brokerage operation in 1999 and 2004. Neither review resulted in any action against Madoff.
The SEC's inspections office has said it has strict rules prohibiting employees from participating in cases involving firms where they have a personal interest.
The disclosure in December of the agency's failure in the Madoff affair, coming after the financial crisis struck last fall, buttressed the mounting criticism from lawmakers and investor advocates that Wall Street and regulators in Washington had grown too close.
Christopher Cox, then the SEC chairman, responded by delivering a stunning rebuke to his own career staff, blaming them for the failure to uncover Madoff's wrongdoing.
Cox's critics said targeting the staff was his attempt to salvage his own reputation, and Senate Majority Leader Harry Reid, D-Nev., suggested that Cox bore at least some of the responsibility for what went wrong.
"The SEC's utter failure to follow up aggressively on detailed and specific information about Madoff's fraud is further evidence of a culture of deference toward the Wall Street elite at the SEC," Republican Sen. Charles Grassley of Iowa, a senior member of the Senate Finance and Judiciary committees and a longtime agency critic, said Wednesday. "Until that culture is transformed, the SEC will not be the tough cop-on-the-beat that the public needs."