Inexperienced Securities and Exchange Commission investigators bungled repeated opportunities over 16 years to expose Wall Street scam artist Bernard Madoff, the SEC's inspector general revealed in a devastating report released Wednesday.
"Despite numerous credible and detailed complaints, 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," Inspector General H. David Kotz concluded in a summary of his 450-page report. "Had these efforts been made with appropriate follow-up at any time beginning in June of 1992 … the SEC could have uncovered the Ponzi scheme well before Madoff confessed."
Madoff, a former Nasdaq chairman, was sentenced in June to 150 years in prison for swindling investors out of billions of dollars.
The SEC failed to end Madoff's scam despite conducting five probes and receiving "six substantive complaints that raised significant red flags" about his operations and investment claims. Moreover, two 2001 articles in financial journals conveyed skepticism about Madoff's eye-popping investment returns and obsessive secrecy.
The only good news for the SEC: Kotz found no evidence of "any financial or other inappropriate connection" between Madoff and SEC officials. And he found no evidence that a former SEC official's romance with Madoff's niece — the couple married — influenced the investigations.
Some highlights from Kotz's report:
• The SEC botched its first chance to stop Madoff in 1992. Investigating an investment firm controlled by Madoff that offered "100% safe" investments with high returns, the SEC suspected a Ponzi scheme and ordered the firm to repay investors. But SEC investigators never suspected that Madoff might have repaid them with money "from other clients as part of a larger Ponzi scheme."
• Investigators several times caught Madoff in lies and never pursued them. Another time, they accepted at face value his assertion that his "gut feel" for the markets were responsible for his incredible investment results.
• Madoff thought he'd been caught when investigators asked for the number of his account at the Depository Trust Corp., which kept a record of his trades. By checking with the firm, investigators would have learned that Madoff wasn't conducting enough trading volume to produce his impressive returns. "I thought it was the end — game over," Madoff said. But the investigators never followed up, leaving Madoff "astonished."
• SEC examiners drafted a letter to the National Association of Security Dealers requesting trade data that would exposed Madoff's deceptions but never sent it, "claiming that it would have been too time-consuming to review the data."
• Madoff, his veins popping, bullied investigators, dropped names of the influential people he knew and suggested that he might be on the short list to become SEC chairman. A senior-level SEC examiner reminded his younger colleagues that Madoff was a "very well-connected powerful person," leading them to conclude they should proceed cautiously.
Madoff oversaw SEC interviews with his employees. In the middle of one interview, an employee was suddenly called out of the room. "When the examiners later asked Madoff the reason for the urgency," Kotz wrote, "Madoff told them her lunch had just arrived, even though it was 3 o'clock in the afternoon."
• Two SEC teams investigating Madoff didn't know about each other — until Madoff told them.
•The SEC dismissed detailed complaints about Madoff's purported results from financial fraud investigator Harry Markopolos in 2000 and 2001 and never "truly analyzed" his suspicion, made in a 2005 complaint, that it was "highly likely" Madoff was running a Ponzi scheme.
• Investigators were discouraged by their bosses from expanding their probe beyond allegations of "front-running" — using advance information about clients' orders to profit in the market. "Keep your eyes on the prize," they were told.
SEC Chairwoman Mary Schapiro, who took office after Madoff's scams were exposed, expressed "regret" for the agency's performance and said the SEC has undertaken reforms — beefing up the enforcement division and improving the way it handles investor complaints and tips.
The inspector general's full 450-page report is expected to be released within days, Schapiro said.
Rep. Paul Kanjorsky, D-Pa., chairman of the House subcommittee on capital markets, called the SEC's performance "a colossal blunder" but "Chairman Schapiro has moved swiftly and vigorously to propose and adopt new safeguards. We must, however, still do more." He is pushing new investor protections.
"There were clearly human failures on the part of some at the SEC," says former SEC Chairman Harvey Pitt, who led the agency from 2001 until 2003. But he says the SEC was "righting the ship dramatically … investors should understand there is renewed vigor and competence at the SEC."
Neil Chelo, a member of the team assembled by Markopolos to probe Madoff and press for SEC action, said the team would not comment on the report because they are preparing a book about their Madoff investigation.
But some of Madoff's victims were not appeased.
"We can't just accept that the SEC messed up and say, 'Let's all move forward,' " says Ronnie Sue Ambrosino, coordinator of a support group for Madoff victims. "It was consistent negligence." She wants to see further investigation into the Financial Industry Regulatory Authority, the securities industry's self-regulatory body commonly known as FINRA, and how it treated Madoff.
Contributing: Kevin McCoy