Securities Law Prof Blog

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

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Wednesday, September 2, 2009

SEC Releases Inspector General's Summary of Agency's Failures to Detect Madoff Fraud

The SEC released today the REPORT OF INVESTIGATION, UNITED STATES SECURITIES AND EXCHANGE COMMISSION OFFICE OF INSPECTOR GENERAL, Case No. OIG-509, Investigation of Failure of the SEC To Uncover Bernard Madoff's Ponzi Scheme. (This is the executive summary.  The entire report should be released in a few days.) Bottom line:  the SEC staff was not corrupt, but incompetent.  Here are some excerpts:

The OIG investigation did not find evidence that any SEC personnel who worked on an SEC examination or investigation of Bernard L. Madoff Investment Securities, LLC (BMIS) had any financial or other inappropriate connection with Bernard Madoff or the Madoff family that influenced the conduct of their examination or investigatory work. The OIG also did not find that former SEC Assistant Director Eric Swanson's romantic relationship with Bernard Madoff's niece, Shana Madoff, influenced the conduct of the SEC examinations of Madoff and his firm. We also did not find that senior officials at the SEC directly attempted to influence examinations or investigations of Madoff or the Madoff firm, nor was there evidence any senior SEC official interfered with the staff's ability to perform its work.

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 Madoffs 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 Madoffs investment operations that appeared in reputable publications in 2001 and questioned Madoffs unusually consistent returns.

* * *

The OIG retained an expert in accordance with its investigation in order to both analyze the information the SEC received regarding Madoff and the examination work conducted. According to the OIG's expert, the most critical step in examining or investigating a potential Ponzi scheme is to verify the subject's trading through an independent third party.

The OIG investigation found the SEC conducted two investigations and three examinations related to Madoff's investment advisory business based upon the detailed and credible complaints that raised the possibility that Madoff was misrepresenting his trading and could have been operating a Ponzi scheme. Yet, at no time did the SEC ever verify Madoff's trading through an independent third-party, and in fact, never actually conducted a Ponzi scheme examination or investigation of Madoff.

* * *

As the foregoing demonstrates, despite numerous credible and detailed complaints, the SEC never properly examined or investigated Madofi's trading and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme. Had these efforts been made with appropriate follow-up at any time beginning in June of 1992 until December 2008, the SEC could have uncovered the Ponzi scheme well before Madoff confessed.

SEC Chair Mary Schapiro released a statement in response, stating that "[h]is report makes clear that the agency missed numerous opportunities to discover the fraud. 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."  The statement goes on to describe various SEC changes to improve examinations and investigations.

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