Risk & Compliance

Madoff Case Triggers Wider Probe of SEC

"Many of us have lost confidence in the SEC," a Congresswoman declares.
David KatzJanuary 5, 2009

The attempt to determine whether the Securities and Exchange Commission failed to do its job in detecting the $50 billion Ponzi scheme put together by Bernard Madoff will be the launching pad for a wider-ranging investigation of the SEC’s operations, the commission’s inspector general told sometimes hostile members of the House Financial Service Committee today.

Besides investigating “the specific complaints that were allegedly brought to the SEC’s attention regarding Mr. Madoff and the reasons for the SEC’s apparent failure to act upon these complaints,” said SEC Inspector General H. David Kotz, the probe “must include an evaluation of broader issues regarding the overall operations” of SEC’s Division of Enforcement and Office of Compliance Inspections and Examinations.

The inspector general also expects “to provide overarching and comprehensive recommendations to ensure that the Commission fulfills its mission of protecting investors, facilitating capital formation and maintaining fair, orderly and efficient markets,” he said.

Perhaps anticipating the later pressure he received from some committee members to be quick about providing the details of the probe, Kotz said he was considering providing reports of his investigation on a “rolling basis” to provide some conclusions “very shortly.”

Later, Rep. Paul Kanjorski, a Pennsylvania Democrat, declaring that “my constituents are shocked about this and want action” and that “they don’t expect the cop on the beat to take the normal process,” pressed Kotz for an answer about when he could complete his investigations, which began on December 17, 2008.

At first hesitant to give a specific answer, Kotz indicated that he could provide some results in two weeks. Other members, perhaps employing them as stand-ins for what they saw as a broader regulatory failure in the Madoff case, took a more hostile tone with Kotz and with Stephen Harbeck, president, of the Securities Investor Protection Corporation, who also testified. (SIPC provides insurance protection to customers of failed broker-dealers).

Particularly acerbic was Rep. Gary Ackerman, a New York Democrat. Referring to Harbeck as the president of an organization that “hasn’t protected any of the security investors,” he called Kotz the inspector general who “didn’t watch out for anything” and “the Jacques Clouseau of the Keystone Cops.”

Ackerman, who said that many of his constituents on the North Shore of New York’s Long Island had lost great amounts of money in the scheme, declared that it had driven a “stake in the heart” of investor confidence.

Similarly, Rep. Carolyn Maloney, another New York Democrat, called the scheme “a serious blow to investors’ confidence at a critical time.” Asserting that “many of us have lost confidence in the SEC” because it had failed to investigate Madoff’s extraordinarily consistent success of his investment model, she asked Kotz, “for those of us who don’t trust the SEC anymore, what authority should go to other regulators?”

Kotz answered the understands “the concern about the credibility” of the SEC and suggested that his investigation would look into the matter of whether its authority might be better distributed among other rulemakers.

For his part, Madoff was awaiting a bail hearing in federal court in New York City on Monday, according to the Associated Press. A former Nasdaq chairman who was arrested Dec. 11 on securities fraud charges after the FBI said that he confessed, Madoff is reportedly under house arrest in his apartment. Besides individual investors, corporations, pension funds, and charities are said to be among those who have lost money as a result of the scheme.

In his prepared remarks, Kotz said he plans to investigate “the SEC’s response to all complaints it received regarding the activities of Bernard Madoff” and to trace their path through the commission from their beginnings. He will also probe conflict-of-interest charges concerning relationships between SEC officials and the Madoff family.

Further, Kotz said he would analyze whether “red flags” in the case were overlooked by SEC examiners and inspectors. During the hearing, a number of representatives mentioned that the fact that a three-person audit firm was the auditor of Madoff’s massive hedge fund operations should have set off loud alarms. Kanjorski, for example, said that it was a case of “an auditor the size of a mouse examining funds the size of an elephant.”