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SEC Outlines Madoff Lessons
Inspector General Urges Policies to Make Most of Tips, Staff

By Zachary A. Goldfarb
Washington Post Staff Writer
Friday, September 11, 2009

The Securities and Exchange Commission's internal watchdog, fresh off issuing a blistering report on how the agency bungled its handling of the Bernard L. Madoff case, offered on Thursday a series of recommendations to fix the problems that contributed to the failure to stop the disgraced financier's infamous Ponzi scheme.

SEC Inspector General H. David Kotz, testifying before the Senate Banking Committee, urged the SEC to adopt a set of policies that sound like common sense but were not in place as the agency received warnings that Madoff was a fraud.

Kotz urged that the SEC set up a system to vet tips and complaints that come into the agency and catalog them under a timeline. The SEC received at least six warnings about Madoff's business over the years, including one that explicitly warned he was probably running a Ponzi scheme.

Kotz also recommended that SEC officials reviewing tips and complaints be experienced in the subject matter relevant to the tip or complaint. His review found that SEC officials often looked in the wrong places in the Madoff case because they were not trained in detecting Ponzi schemes.

And, among about 40 other suggestions, Kotz said it was important for the SEC to ensure that investigators know when to independently verify information provided by subjects of probes. Kotz's report said the SEC didn't take even basic steps to check on what Madoff told officials.

Kotz's 457-page report, issued last week, was the first detailed accounting of how, despite five reviews over 16 years, the SEC repeatedly failed to uncover anything but minor violations at Madoff's firm.

Madoff, a renowned money manager until he confessed to being a fraudster, told regulators and investors that he made double-digit returns year after year.

The exposure of the Madoff fraud was a deep embarrassment for the SEC, whose reputation was already taking a hit in the financial crisis. In a series of hearings, lawmakers have pilloried the agency and its top officials for the Madoff failure.

At Thursday's hearing, senior SEC officials said that they have already been working hard to fix problems exposed by the Madoff fraud.

John Walsh, acting director of the Office of Compliance Inspections and Examinations, said his office is focusing on fraud detection and ensuring that key staff is trained in detection, improving communication within the department and making clear to front-line investigators that they will have top management's support if they push hard.

Robert Khuzami, director of the Division of Enforcement, said he is creating specialized groups to probe potential wrongdoing, reducing the number of managers by 40 percent to focus more resources on investigators, working to better organize and analyze hundreds of thousands of tips and complaints, and eliminating other bureaucratic hurdles.

"We intend to learn every lesson we can" from the Madoff affair, Khuzami said.

Harry Markopolos, a whistleblower who wrote several letters to the SEC warning about Madoff, also testified Thursday and gave the agency high marks for working fast to try to right itself. In previous statements he had been sharply critical.

SEC Chairman Mary L. Schapiro "has been on fire lately," he said. "The pace of reforms has been rapid."

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