Megan McArdle nails the real reason the SEC whiffed so badly on Madoff:
The brazenness of the fraud was, in some part, the reason it was easy to keep going. The SEC is looking for people pushing the envelope. It is not looking for people who have set fire to the envelope and substituted a piece of old newspaper recently used to wrap fish.
It’s actually easier for someone committing outright fraud to slide under the SEC wire, because when you’re making up financial statements out of whole cloth, it’s not hard to make them conform to SEC regulations. Similarly, Stephen Glass and Jayson Blair and Jack Kelley were able to get away with their frauds precisely because they fabricated things out of whole cloth.
If you’ve seen the excellent film Shattered Glass about the Stephen Glass fiasco, you’ll get it. The New Republic, where Glass was a reporter, had fact-checking mechanisms in place, but mainly it was about matching the story with the reporter’s own notebook. It just didn’t occur to them that the reporter would fabricate their notebook whole hog to back up a story. As was discussed this morning, the SEC was looking for specific behaviour patterns and trading techniques that it deemed to be dangerous. Had Madoff actually been front running, he probably would’ve been caught, as his trades would’ve fallen into a familiar pattern of fraud. But simply making it all up? That’s just too big and outlandish for anyone to take seriously.
And it’s for this reason that we’re sceptical about Mark Cuban’s latest suggestion: That the whole thing could’ve been avoided if only the SEC had implemented XBRL (a way of making filings machine-readable) sooner. That might work for forensic investigations that require subtlety, but it probably would’ve been useless for this.