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Madoff Investment Business Probed By SEC Eight Times, Yet No Fraud Found

Jan 5, 2009 | Parker Waichman LLP

Federal securities regulators investigated Bernard L. Madoff Investment Securities LLC a total of 8 times in the last 16 years.  But according to The Wall Street Journal, even though the Securities and Exchange Commission (SEC) conducted so many examinations, and interviewed Madoff at least twice, it failed to turn up evidence of  the $50 billion Ponzi scheme he allegedly ran for decades.

The 70-year-old Madoff was arrested on one count of securities fraud on December 11.  Madoff - once a chairman of the Nasdaq stock exchange - is the founder and primary owner of Bernard L. Madoff Investment Securities LLC. The firm is primarily known for its business in market-making, or serving as the middleman between buyers and sellers of shares. However, Madoff also oversaw an investment-advisory business that managed money for high-net-worth individuals, hedge funds and other institutions.

According to the FBI complaint against Madoff, that business was largely a Ponzi scheme.  The FBI said Madoff  “deceived investors by operating a securities business in which he traded and lost investor money, and then paid certain investors purported returns on investment with the principal received from other, different investors, which resulted in losses of approximately billions of dollars.” Madoff reportedly told employees that his fraud could cost investors as much as $50 billion.

According to The Wall Street Journal, the SEC received numerous tips about irregularities involving Madoff, and conducted more than half-dozen examinations of his investment advisory business.  The tips the SEC received included:

  • Emails from a New York hedge fund that described Madoff's business practices as "highly unusual."
  • Reports in 2001 by Barron's, and the hedge-fund trade publication MarHedge which suggested Madoff was front running for favored clients.
  • A 2007 report by the  Financial Industry Regulatory Authority that said parts of Madoff's  firm appeared to have no customers.


Yet, as the Journal reports, Madoff was able to keep regulators from discovering his alleged scheme.  Regulatory gaps appear to be part of the reason Madoff was able to evade the SEC.  For one thing, rather than telling regulators he ran an investment-advisory business, Madoff said he managed accounts for hedge funds.  This assertion allowed  Madoff was to avoid regular reviews of the advisory business, the Journal said.

When SEC examinations did turn up questions, Madoff always had ready answers.  For example, In 1999 and 2000,  SEC  examiners raised concerns that Madoff was violating a trading rule properly displaying orders to others in the market.  To put these questions to rest, Madoff outlined new procedures for the firm to follow, the Journal said.

In 2005, the SEC opened an enforcement investigation of Madoff's business, prompted in part by concerns brought to the agency by one Madoff critic.  According to a memo obtained by The Wall Street Journal, the agency was trying to determine if charges that Madoff "is operating a Ponzi scheme has any factual basis."

According to the Journal, that  SEC investigation did find some problems.  For one thing, it said that neither Madoff nor another firm that funneled money to him, had told investors that Madoff was the one  making investment decision .  The investigation also found that Madoff misled the SEC in 2005 about the strategy he used for customer accounts, withheld information about the accounts and violated SEC rules by operating as an unregistered investment adviser, the Journal said.  However, the investigation turned up no evidence of fraud.  In the end, Madoff agreed to register his business, and the findings of the SEC were never made public, the Journal said.

The SEC will have a chance today to explain its failure to detect Madoff's alleged fraud during a hearing of the House Financial Services Committee. As we reported last week, committee member Paul Kanjorski (D-PA) said in an email statement that the hearing will “help us to discern whether or not the Securities and Exchange Commission had the resources needed to get the job done, how such a sizable scheme could have evaded detection for so long, and what new safeguards we need to put in place to protect investors.”

According to Reuters, SEC Inspector General David Kotz, who is probing the agency’s oversight failures in the Madoff case, will be called to testify at the hearing.  Harry Markopolos, the former chief investment officer at Rampart Investment Management who said he repeatedly tried to get the SEC to investigate Madoff, will also appear, Reuters said.


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