The Securities and Exchange Commission (SEC) got its first tip about something fishy in Bernard Madoff's investment operations in 1992. The next, very detailed tip came in 2000, followed by four more reports before Madoff sons' accusations against their father in December 2008 finally got the agency to stop what appears to have been the largest Ponzi scheme in U.S. history.
The missed opportunities to stop a scheme that bilked investors out of $18 billion in cash — and higher amounts in claimed but nonexistent profits — are catalogued in a damning report issued in late August 2009 by the SEC's inspector general. SEC investigators repeatedly failed to grasp the significance of tipsters' information, according to the 450-page report, and never took some rudimentary steps that could have verified the suspicions.
Two years later, the agency confirmed on Nov. 11 that it had disciplined eight employees for mishandling the investigation, but fired no one. A ninth employee resigned before disciplinary action could be taken, according to The Washington Post's account. Victims of Madoff's fraud denounced the disciplinary steps as inadequate.
Madoff, now 73, is serving a 150-year sentence in a federal prison in North Carolina even as a court-appointed trustee seeks to recover and return to victims some of the misappropriated funds. As of December, an estimated $11 billion had been recovered.
The inspector general's report clears the SEC of any conflicts of interest or inappropriate interference in the investigations but ends with an understated critique of the agency's thoroughly botched response to tips it received.
“The SEC never properly examined or investigated Madoff's trading and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme,” the report states. “Had these efforts been made with appropriate follow-up at any time beginning in June 1992 until December 2008, the SEC could have uncovered the Ponzi scheme well before Madoff confessed.”
The report prompted sharp criticism of the agency from members of Congress from both parties. Sen. Charles E. Schumer, D-N.Y., said the report showed “a level of incompetence unseen since [the Federal Emergency Management Agency's] handling of Hurricane Katrina.” Sen. Charles Grassley, R-Iowa, said the agency's “utter failure” to follow up on the tips was “further evidence of a culture of deference toward the Wall Street elite.”
“The SEC was properly chastised,” says Thomas Gorman, a Washington lawyer who publishes a blog on SEC litigation. “They had multiple opportunities to find that case. They simply failed to analyze the information.”
Jennifer Arlen, a securities law professor at New York University, is more sympathetic to the agency's investigators' difficulties in dealing with what she calls “huge numbers of tips” of varying quality and credibility. “They're making tradeoffs between, ‘Here are these things that I know something wrong's going on,’ and ‘Here's something big but it could be something or it could be nothing.’”
The first of the tips against Madoff came in June 1992 from customers of an investment firm suspicious that the firm was claiming “100%” safe investments with “extremely high and consistent” rates of return. The firm's investments, it turned out, were managed exclusively by Madoff. “Inexperienced” investigators suspected a Ponzi scheme, the inspector general's report states, but failed to conduct a thorough investigation.
Bernard Madoff, once a prince of Wall Street, pleaded guilty to running a Ponzi scheme that bilked investors out of $18 billion. He is serving a 150-year prison sentence. (AFP/Getty Images/Timothy A. Clary)
Eight years later, the SEC received the first of three detailed complaints about Madoff from Harvey Markopolos, a securities executive-turned-independent financial fraud investigator in Boston. Markopolos' reports grew from an eight-page complaint in May 2000 to a longer version in October 2005 with the headline, “The World's Largest Hedge Fund Is a Fraud.”
In each report, Markopolos said he had attempted but failed to replicate Madoff's claimed returns based on Madoff's reports of his investment strategy. Markopolos has forcefully criticized the agency in interviews and in his first-person account, No One Would Listen, published in 2010.
By the third of his reports, Markopolos was being taken seriously by SEC investigators, according to the inspector general's report. They focused, however, more on the question of whether Madoff needed to register as an investment adviser than on whether he was operating a Ponzi scheme as Markopolos believed.
In addition, the report states, SEC investigators failed to take the basic step of attempting to verify through third parties whether Madoff actually was making the trades that he said he was making. “A simple inquiry … could have immediately revealed the fact that Madoff was not trading in the volume he was claiming,” the report states.
Other complaints came to the SEC from “a respected hedge fund manager,” an anonymous informant and a “concerned citizen,” who first contacted the agency in December 2006 and again in March 2008. The last communication included the damning detail — later confirmed — that Madoff kept two sets of records, “the most interesting of which is on his computer which is always on his person.”
Even when SEC investigators began probing his operations, Madoff, the one-time chairman of the NASDAQ stock exchange, fended them off in an interview, according to the report, by lording his credentials and knowledge over the less experienced agency personnel. Supervisors closed the investigation in January 2008 and declined to reopen it after receiving the report about double sets of books two months later.
Madoff's scheme finally unraveled when he confessed in December 2008 to his sons, Andrew and Mark, who reported him to federal authorities. Madoff was arrested on Dec. 10; he pleaded guilty on March 12, 2009, to 14 federal felonies, including securities fraud. In court, Madoff said he began his Ponzi scheme in 1991. Judge Denny Chin sentenced him three months later.
Madoff has apologized for his conduct, but his son Andrew has said he will never forgive his father. Mark Madoff committed suicide by hanging himself in his Manhattan apartment. He was found dead on Dec. 11, 2010, two years to the day after his father's arrest.
— Kenneth Jost