Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, January 5, 2009

SEC's Inspector General Testifies on Madoff Investigation

H. David Kotz, the SEC's Inspector General, testified today before the U.S. House of Representatives Committee on Financial Services on its ongoing Madoff investigation.  According to his written statement:

On the late evening of December 16, 2008, SEC Chairman Christopher Cox contacted me and asked my office to undertake an investigation into allegations made to the SEC regarding Mr. Madoff, going back to at least 1999, and the reasons that these allegations were found to be not credible. The Chairman also asked that we investigate the SEC's internal policies that govern when allegations of fraudulent activity should be brought to the Commission, whether those policies were followed, and whether improvements to those policies are necessary. In addition, he requested that the investigation include all staff contact and relationships with the Madoff family and firm, and any impact such relationships had on staff decisions regarding the firm.

It is our opinion that the matters that must be analyzed regarding the SEC and Bernard Madoff may go beyond the specific issues that SEC Chairman Cox has asked us to investigate. We believe that in addition to conducting a thorough and comprehensive investigation of the specific complaints that were allegedly brought to the SEC's attention regarding Mr. Madoff and the reasons for the SEC's apparent failure to act upon these complaints, as well as the staff's contact and relationships with the Madoff family and firm and their impact on Commission decisions regarding Mr. Madoff, our oversight efforts must include an evaluation of broader issues regarding the overall operations of the Division of Enforcement and OCIE that would bear on the specific questions we are examining, and provide overarching and comprehensive recommendations to ensure that the Commission fulfills its mission of protecting investors, facilitating capital formation and maintaining fair, orderly and efficient markets.

The following are specific issues that we currently intend to investigate:

The SEC's response to complaints it received regarding the activities of Bernard Madoff, including any complaints sent to the Division of Enforcement, OCIE, the Office of Risk Assessment and/or the Office of Investor Education and Advocacy. We plan to trace the path of these complaints through the Commission from inception, reviewing what, if any, investigative or other work was conducted with respect to these allegations, and analyze whether the complaints were handled in accordance with Commission policies and procedures and whether further work should have been conducted;

Allegations of conflicts of interest regarding relationships between any SEC officials or staff and members of the Madoff family, including examining the role a former SEC official who allegedly had a personal relationship with a Madoff family member may have played in the examination or other work conducted by the SEC with respect to Bernard Madoff or related entities, and whether such role or such relationship in any way affected the manner in which the SEC conducted its regulatory oversight of Bernard Madoff and any related entities;

The conduct of examinations and/or inspections of Bernard Madoff Investment Securities LLC by the SEC and an analysis of whether there were "red flags" that were overlooked by SEC examiners and inspectors (which may have been identified by other entities conducting due diligence), that could have led to a more comprehensive examination and inspection, including a review of whether the SEC violated its own policies and procedures by not conducting timely reviews or examinations of Bernard Madoff's activities and filings; and

The extent to which the reputation and status of Bernard Madoff and the fact that he served on SEC Advisory Committees, participated on securities industry boards and panels, and had social and professional relationships with SEC officials, may have affected Commission decisions regarding investigations, examinations and inspections of his firm.

In addition to these specific issues and depending upon the information that we learn during the course of our investigation, we plan to consider analyzing the following broader issues, as appropriate:

The complaint handling procedures of the Division of Enforcement, including a review of how complaints are processed, internal incentives that may affect the decision whether to take action with respect to a complaint, an analysis of which complaints are brought to the Commissioners' and Chairman's attention, and whether tangible and specific complaints are being reviewed and followed-up on appropriately;

The OCIE examination and inspection procedures, including an analysis of what policies and procedures were then and are currently in place, whether these policies and procedures are being followed and/or whether there are gaps in these policies and procedures relating to operations involving voluntary private investment pools, such as hedge funds, because they are subject to limited oversight by the SEC, and whether any such gaps may lead to fraudulent activities not being detected; and

The relationships between different divisions and offices within the Commission and whether there is sufficient intra-agency collaboration and communication between the Agency components to ensure comprehensive oversight of regulated entities.

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