SEC Inspector General David Kotz has turned over a 450-page report to the agency’s chairman Mary Schapiro, in which he details how the regulators screwed up with Bernie Madoff, failing to uncover the fraud.
The SEC released a portion of the report today and it’s pretty incriminating for the agency, corroborateiong what whistleblower Harry Markopolos told Congress in February. It also comes at a time when the administration is trying to reshape the financial regulatory system (uber regulator or no uber regulator?). This report might push Congress, which returns from its August recess next week, to act faster and in a more drastic way.
What’s pretty clear, is that–at least in the case of Madoff–the SEC was just clueless, gullible, incompetent and yes, plain stupid.
The report found that between June 1992 and December 2008 when Madoff confessed, the SEC received six substantive complaints that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions. The SEC did conduct two investigations and three examinations based upon the complaints, but never verified Madoff’s trading through an independent third-party.
The relatively inexperienced enforcement staff failed to appreciate the significance of the analysis in the complaint, and almost immediately expressed scepticism and disbelief. Most of their investigation was directed at determining whether Madoff should register as an investment adviser or whether Madoff’s hedge fund investors’ disclosures were adequate.
As with the examinations, the Enforcement staff almost immediately caught Madoff in lies and misrepresentations, but failed to follow up on inconsistencies. They rebuffed offers of additional evidence from the complainant, and were confused about certain critical and fundamental aspects of Madoff’s operations. When Madoff provided evasive or contradictory answers to important questions in testimony, they simply accepted as plausible his explanations.
The report also mentions Markopolos’ presentation of his complaint to the SEC, which the staff clearly didn’t understand.
When he testified before Congress in February, whistleblower Harry Markopolos who had been warning the SEC for a decade, made a point saying the agency was financially illiterate and way too chummy with many it was suppose to regulate.
From Markopolos’ testimony: When I pointed out that the SEC likely didn’t have any PH.D staff with derivatives trading experience who truly understood how these financial instruments worked, because a true derivatives expert couldn’t afford to work for SEC pay, she [SEC NY branch chief Meaghan Cheung] ignored me.
As it typical for the SEC, to many of the staff lawyers lack any financial industry expertise or training to conduct investigations.
The only question that remains is whether the regulators will be held accountable.