SEC missed six clear opportunities to expose Madoff

While the Office of Inspector General of the SEC determined there was no evidence that SEC personnel had "any financial or other inappropriate connection with Bernard L. Madoff," the OIG did find that the "SEC received more than ample information in the form of detailed and substantive complaints over the years" that a "thorough and competent investigation or examination" should have been conducted. Oh, you think?

Let's take a look at the six substantive complaints the SEC received that should have raised red flags and started a "thorough and competent investigation or examination."
1. As far back as 1992, the OIG found there were allegations raised about an "unregistered investment company" that was offering "100%" safe investments with "high and extremely consistent rates of return over a significant periods of time to 'special' customers." The SEC suspected a Ponzi scheme and learned in their investigation that "all of the investments were placed entirely through Madoff and consistent returns were claimed to have been achieved for numerous years without a single loss." The unregistered investment company was Avellino & Bienes. The SEC shut them down but never investigated Madoff. The OIG report concludes, "The SEC's lead examiner said Madoff's reputation as a broker-dealer may have influenced the inexperienced team not to inquire into Madoff's operations."

2. SEC received three versions of a complaint in May 2000, March 2001 and October 2005 with details listing 30 red flags indicating Madoff was operating a Ponzi scheme. The 2005 report was called "The World's Largest Hedge Fund is a Fraud." The OIG summarizes the complaint saying, "The red flags included the impossibility of Madoff's returns, particularly the consistency of those returns and the unrealistic volume of options Madoff represented to have traded." There was no follow up directly to these complaints. In fact the report notes that Harry Markopolos explained his analysis to the SEC's Boston Office in May 2000. The report states, "After the meeting, both Markopolos and and SEC staff accountant testified that it was clear that the BDO's Assistant District Administrator did not understand the information presented."

3. May 2003 the SEC received a third complaint from a respected Hedge Fund Manager identifying numerous concerns about Madoff's strategy and purported returns, questioning whether he was actually trading options in the volume he claimed, noted that his returns could not be duplicated and stating the Madoff's strategy "had no correlations to the overall equity markets in over 10 years. Again the OIG report questioned the competence of the SEC investigators sent to investigate Madoff in response to the Hedge Fund Manager's complaint in 2004 and 2005, "The teams assembled were relatively inexperienced, and there was insufficient planning for the examinations. The scopes of the examination were in both cases too narrowly focused on the possibility of front-running, with no significant attempts made to analyze the numerous red flags about Madoff's trading and returns." The report further condemns the investigative teams by saying, "the examination teams discovered suspicious information and evidence and caught Madoff in contradictions and inconsistencies. However, they disregarded these concerns and simply asked Madoff about them."

4. There were a series of internal emails of another registrant that the SEC discovered in April 2004. The emails described red flags identified while performing due diligence using publicly available information. The emails questioned Madoff's "incredible and highly unusual fills for equity trades, his misrepresentation of his options trading and his unusually consistent, non-volatile returns over several years. The SEC examiners who initially discovered the emails thought they indicated "some suspicion as to whether Madoff is trading at all."

5. An anonymous informant in October 2005 stated, "I know that Madoff [sic] company is very secretive about their operations and they refuse to disclose anything. If my suspicions are true, then they are running a highly sophisticated scheme on a massive scale. And they have been doing it for a long time. After a short period of time, I decided to withdraw all my money (over $5 million)."

6. In December 2006 a "concerned citizen" recommended the SEC look into Madoff. One complaint stated, "Assets well in excess of $10 Billion owned by the late [investor], an ultra-wealthy long time client of the Madoff firm have been co-mingled with funds controlled by the Madoff company with gains thereon retained by Madoff." In a second complaint the complainer indicates there were two sets of records. Saying, "The most interesting of which is on his computer which is always on his person."

In addition to these complaints, there were two journal articles raising significant questions about Madoff's unusually consistent returns in 2001.

Clearly, incompetence reigned at the SEC if all these reports were made and the SEC never opened a thorough and comprehensive examination of Madoff. As a result, thousands of investors lost their life savings. The SEC is responsible for monitoring investment funds, especially large ones like Madoff's. It shirked that responsibility.

Lita Epstein has written over 25 books, including Reading Financial Reports for Dummies and Trading for Dummies.

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