Inspector general’s report describes how SEC flubbed Madoff investigations
The Securities and Exchange Commission had more than enough information to lead them to an effective investigation of Bernard Madoff’s operation of a Ponzi scheme, but the agency fumbled several chances over a span of more than 16 years to uncover the evidence, according to the executive summary (pdf, 9.5mb) of SEC Inspector General David Kotz’s investigative report.
The investigation found no evidence that personal or financial ties to Madoff influenced the agency’s scrutiny of Madoff’s business.
“The OIG investigation did find, however, that the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six substantive complaints that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading. Finally, the SEC was also aware of two articles regarding Madoff’s investment operations that appeared in reputable publications in 2001 and questioned Madoff’s unusually consistent returns.”
According to the report, an SEC manager thought one of the complaints, received in 2003, “laid out issues that were ‘indicia of a Ponzi scheme,’” and another complaint a year later led some SEC examiners to “some suspicion as to whether Madoff is trading at all.” In 2005, the SEC received a complaint entitled “The World’s Largest Hedge Fund is a Fraud” which detailed “approximately 30 red flags indicating that Madoff was operating a Ponzi scheme.”
“The complaints all contained specific information and could not have been fully and adequately resolved without thoroughly examining and investigating Madoff for operating a Ponzi scheme,” the report said. “The journal articles should have reinforced the concerns about how Madoff could have been achieving his returns.”
The report said examiners focused investigations too narrowly, failed to follow up on even the most “seemingly implausible” and inconsistent answers Madoff gave to their questions, and never launched a third-party investigation to verify Madoff’s trading, a step the report cited as “the most critical step in examining or investigating a potential Ponzi scheme.”
The report described two “remarkably similar” investigations of two separate complaints conducted in 2004 and 2005. “Astoundingly, both examinations were open at the same time in different offices without either knowing the other one was conducting an identical examination,” the report said. “In fact, it was Madoff himself who informed one of the examination teams that the other examination team had already received the information they were seeking from him.”
SEC Chairman Mary Schapiro released a statement which said the Madoff scandal was “a failure that we continue to regret” and listed a number of “post-Madoff reforms” the agency has undertaken “to reduce the chances that such frauds will occur or be undetected in the future.” The SEC will release the full 450-page report “in the coming days,” Schapiro said.
UPDATE: The full report (pdf, 3.6mb) is now available on the SEC website. On September 10, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing on the SEC’s mishandling of the Madoff case.