Monday, September 21, 2009

Securities: IG Finds Incompetence Not Corruption in SEC's Madoff Failure

The Inspector General of the Securities and Exchange Commission has released his report of the investigation of the SEC's failure to uncover Bernard Madoff's Ponzi scheme. The IG did not find evidence that any SEC personnel benefited financially or in any other inappropriate capacity from a connection with Madoff that influenced the examinations and investigations. Additionally, there was no evidence that the romantic relationship between an SEC assistant director and Madoff's niece influenced the conduct of the SEC investigations and examinations. Finally, the IG's investigation did not uncover evidence that senior management of the SEC attempted to influence or interfere with the Commissions investigations and examinations of Madoff.

The report did find that, despite "more than ample information" in the form of detailed complaints, three examinations, and two investigations, the Commission utterly failed to perform "a thorough and competent investigation or examination" of Madoff and Bernard L. Madoff Investment Securities. The SEC received six substantive complaints that raised significant questions about Madoff's operation. Moreover, the Commission was aware of two articles in 2001 questioning Madoff's unusually consistent returns and secretive operations. One article was published by MARHedge and the other by Barron's.

Among the evidence ignored by the SEC were a series of emails uncovered in an investigation of a hedge fund, Avellino & Bienes, that invested solely with Madoff. The emails stated that Madoff had to be misrepresenting his options trading because 1) the volume on the options exchanges was insufficient to support the massive amount of trading Madoff purported to be undertaking and 2) the trading could not be over-the-counter because Madoff's purported volume was so large that no contra-party could be found for such large volumes of trades.

Although significant evidence came to the SEC's attention that Madoff may have been operating a Ponzi scheme, the SEC never conducted a Ponzi scheme investigation nor even verified Madoff's claimed trading by looking at third party records. The report concludes the following about the examination of Madoff: 1) the examinations of Madoff's operation by the SEC were handled by inexperienced examiners, 2) these examinations were too narrow in focus, and 3) they did not proceed with a sense of urgency considering the information known to the SEC from complaints that it had received. Investigation of questions raised went no further than inquiring of Madoff and accepting his responses at face value.

The enforcement staff of the SEC was no more diligent than its examiners. The enforcement investigators also accepted Madoff's evasive or contradictory statements as plausible explanations. The enforcement staff did try to obtain evidence from third parties in some instances. However, for example, when the NASD sent a report indicating that Madoff had no options positions on a certain date that he had claimed having positions, the SEC investigators failed to follow up on this crucial evidence. In other instances the enforcement investigators completely failed to obtain evidence from third party sources. Such evidence would have readily disclosed Madoff's Ponzi scheme.

In sum, the Inspector General's report paints a very disturbing picture of an agency with a mission to enforce securities fraud laws, essentially, acquiescing in the continuation of the largest fraud known to history. A combination of inexperienced investigators reporting to timid supervisors resulted in numerous missed opportunities for the SEC to uncover the Madoff Ponzi scheme and save countless investors from financial ruin. We are left to ponder the stupendous negligence and incompetence of the nation's securities regulators and wonder whether the SEC focuses its attention on small miscreants while ignoring the horrific harm caused by those con artists of higher professional reputation. Hopefully, the IG report will be a first step in the reform of the SEC to insure that it performs its mission to combat securities fraud in a more professional and competent manner.

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