Saturday, September 26, 2009

Inspector General Issues Madoff Report: SEC Criticized For Investigatory Failure

Recently, the Office of Inspector General (“OIG”) issued a Report of Investigation into the Securities and Exchange Commission (“SEC”) failure to investigate and uncover Bernard Madoff’s Ponzi scheme. The Report finds that no SEC personal had any financial or other inappropriate relationship that hindered their investigatory duties. However, the Report openly criticizes the SEC for failing to adequately investigate six (6) separate substantive complaints that should have raised red flags concerning Madoff’s operation. Additionally, the OIG’s Report indicates that the SEC further ignored two (2) published articles that should have called Madoff’s operations into question.

The Report notes:

“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.”

In face of all the red flags, the SEC clearly failed in its role as securities industry watchdog. The Madoff Report is interesting reading, and well worth the time and effort. At the end of the day, the OIG's Report chronicles how the SEC botched the investigation of Madoff, and postponed his day of atonement some sixteen (16) years.

Hopefully, the SEC has learned some valuable, albeit embarrassing lessons, that it won’t soon repeat. The lesson learned: Regulators don’t fall asleep on your watch the general public is relying upon you to do your job. To err is human. We all make mistakes. However, this has been one of the costliest mistakes resulting from a failure of oversight that we will hopefully see for some time to come.


  1. Professor Grant:

    I find it inexplicable that the SEC did any type of investigation into Bernie Madoff and came up empty. How is it possible that SEC staff could have conducted any semblance of an investigation and come up with nothing on Madoff who was NOT trading?

    I find this report dubious (haven't read it fully though) in its finding that SEC regulators were not "captured" by the industry or unconnected to Madoff in some way. Perhaps the report finds that they were unconnected to Madoff but does not say anything on regulatory capture.


  2. Although the report does not find impropriety in the form of regulatory capture, there is at least circumstantial evidence of regulatory capture here in that Bernard Madoff worked on SEC advisory committees over the years and was at the ground level in the development of the NASDAQ market. He was highly respected and his advice was sought out by the SEC over the years. With limited resources and many inquiries and investigations to pursue, the SEC may have (even inadvertently) chosen to fry other fish (so to speak) based in part on Mr. Madoff's reputation. Also, since Mr. Madoff knew the SEC's operations pretty well (from all his contacts over the years), he likely knew how to respond in a minimally satisfactory way to SEC questions. Others involved in SEC inquiries and investigations may not have been able to respond in similar fashion.

    This type of capture is, I fear, inevitable in a low-resource environment where there are many benefits (as well as detriments) to agency involvement with industry . . . .

  3. Anonymous and Professor Heminway:

    I think that Professor Heminway's comments are right on track. Madoff, unlike most, possessed a vast knowledge of the interworking of the SEC's investigatory and enforcement process. Honestly, I feel that Madoff knew the types of questions that SEC investigators would ask. Moreover, Madoff was skilled in providing the types of answers that would dispel suspicion. In other words, Madoff was adapt and skilled in knowing “what to say” to the SEC.

    I don’t think we have in the Madoff case an out-an-out example of regulatory capture. As Professor Heminway suggests, I think indirectly and circumstantially regulatory capture in the form of Madoff’s involvement with SEC advisory committees, and the NASDAQ are factors to be considered. At the end of the day, I think that SEC investigators found it shocking and laughable to believe that someone as powerful as Bernie Madoff would even ponder cheating the system. The horrible lesson that we all learn is that sometimes even “big fish” game and cheat the system. I think the SEC has learned a valuable lesson.

    Thank you Anonymous for your questions and comments. Again, thank you Professor Heminway for your valuable insights and comments.

  4. I agree with Professor Grant,

    I find it hard to believe that the SEC investigators failed to perform their duties. The duty of the SEC is to make sure everyone was compliant with SEC regulations and to increase public trust in the capital markets by requiring uniform disclosure of information about public securities offerings. It’s astonishing that these bureaucrats failed to look into Madoff's account with Wall Street's central stock-clearing office, and the deals he made with companies that handled all the trades.
    Even Bernard Madoff was astonished for not being caught sooner, in an online interview from TIME magazine; he stated he “was surprised his $65 billion Ponzi scheme was not uncovered sooner.” This brings up an interesting point on how did Madoff get away with the scheme for so long? Was it because the SEC had incompetent staff workers who ignored and neglected allegations of financial laws being broken?

  5. The SEC was put in place to prevent fraud such as what Madoff did. How is it that they investigated his business ventures and found nothing? This guy was taking money from everyone. It wasn't like he did it to a small sample of people, were talking an inordinate amount of people and a substantial sum of money. They should add a new category to those who deserve the death penalty and Madoff should be the case that sets the precedent!

  6. The situation involving Madoff is a classic example of someone pulling off a ponzie scheme using reputation, charity, and orchestrated fraud. The Rothstein case in south florida is another example. Well planned frauds are not easily detected; however, one does have to wonder how Mr. Madoff was able to avoid detection of oversight authorities for as long as he did. His case was a learning experience for everyone.