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SEC Broadens Its Probe Of Failures in Madoff Case

By Zachary A. Goldfarb
Washington Post Staff Writer
Tuesday, January 6, 2009

The inspector general of the Securities and Exchange Commission said yesterday that he is broadening his investigation into the agency's failure to detect the alleged fraud committed by Bernard L. Madoff, examining whether the regulatory breakdown was isolated.

H. David Kotz, the SEC's inspector general, said he is looking to identify not only the officials who failed to uncover Madoff's activities, but also whether the agency is able to "to respond appropriately and effectively to complaints and detect fraud."

Kotz addressed outraged lawmakers on the House Financial Services Committee, who expressed bipartisan agreement that the Madoff scandal underscores the need to restructure the regulatory system.

Madoff, 70, ran a investment fund favored by wealthy investors, universities, charities and hedge funds. The SEC filed civil charges last month accusing him of securities fraud, claiming that Madoff confessed to stealing $50 billion of his clients' money through the world's biggest Ponzi scheme.

Since Madoff's arrest, the SEC itself has become the subject of inquiries. The SEC received multiple warnings over the years about Madoff's operations, and even examined his businesses, but failed to uncover the alleged fraud.

"We now know that our securities regulators have not only missed opportunities to protect investors against massive losses from the most complex financial instruments like derivatives, but they have also missed the chance to protect them against the simplest of scams, the Ponzi scheme," said Rep. Paul E. Kanjorski (D-Pa.).

Rep. Spencer Bachus of Alabama, the committee's top Republican, said the Madoff affair underscores the need for "a statutory and regulatory structure for the 21st century."

As lawmakers expressed anger at the SEC's failures in the case, Madoff, who is under house arrest in New York, was appearing in court for a bail hearing. Prosecutors argued that Madoff should be sent to jail for violating the terms of his bail by mailing about $1 million in jewelry and other assets to relatives. The court didn't make a ruling.

Meanwhile, efforts continued to recover Madoff's clients' money. Stephen P. Harbeck, the president of the Securities Investor Protection Corp., told lawmakers that the trustee appointed to liquidate Madoff's investment firm has found about $830 million that might be used to start paying back clients. SIPC, an organization that guarantees securities held with brokerages up to $500,000 per customer, also said 8,000 claim forms were sent to people who had accounts with Madoff.

It's unclear how much the SIPC will be able to cover in losses. It has $1.6 billion in assets, which come from fees charged to brokers, and a $1 billion credit line from the Treasury Department, as well as access to credit from an international group of banks. If that turns out to be insufficient, Harbeck said he'd ask Congress for more.

On Dec. 16, SEC Chairman Christopher Cox called for an internal investigation after acknowledging that his agency failed to act on "credible and specific allegations" about Madoff's activities dating to 1999.

Kotz said he is examining allegations of conflicts of interest between SEC officials and members of Madoff's family. On one occasion, Madoff reportedly boasted that his niece married a former SEC official.

Kotz is also looking at whether the SEC violated its own policies by not conducting timely reviews of Madoff's firm, and whether Madoff's membership on SEC advisory panels influenced the agency's decisions regarding his company.

Additionally, Kotz said he's expanding the probe to look more broadly at the SEC's Department of Enforcement and Office of Compliance Inspections and Examinations. He said he will study whether the agency's procedures to handle complaints are sufficient, whether there are gaps in policies and whether there is adequate internal collaboration.

Katz said he is asking for documents and e-mails related to Madoff by Jan. 16 and plans to interview agency officials as part of the investigation.

The SEC was warned on several occasions by Boston investment professional Harry Markopolos that Madoff's firm probably represented the world's largest Ponzi scheme. In such a scheme, some investors are paid with other investors' money. Allegedly using such a technique, Madoff was able to produce double-digit returns to investors year after year.

Markopolos was scheduled to testify yesterday before the House panel but asked to postpone his testimony, saying in a letter that he was ill and needed more time to prepare. Kotz said he plans to interview Markopolos in the near future.

Lawmakers yesterday were searching for people in the government to blame for the scandal.

"I want to know who is responsible for protecting the securities investor because I want to tell that person or those people whose job it is that they suck at it," said Rep. Gary L. Ackerman (D-N.Y.). "This is a spike in the heart of the investment community that makes America run."

Separately yesterday, the Senate Banking Committee announced that it is examining the Madoff case and has asked the SEC for documents relating to warnings the agency received.

"The Banking Committee is examining this case to determine how so many people could have been deceived and how such a massive fraud could have gone undetected for so long," Sen. Christopher J. Dodd (D-Conn.), chairman of the committee, said in statement. "American investors deserve an explanation and the responsible parties must be held accountable."

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