We are discussing the executive summary of the report ("Investigation of Failure of the SEC To Uncover Bernard Madoff's Ponzi Scheme") by the Inspector General on the failure of the SEC to uncover the Madoff ponzi scheme sooner. The Enforcement Division conducted two investigations (and probably should have conducted a third). We discussed these in an earlier post.
In addition, however, there were three "examinations" of Madoff's business. The first examination was conducted by the Office of Compliance Inspections and Examinations (OCIE) (a broker-dealer team) in 2003. The summary described the team as "inexperienced," including limited knowledge of the securities laws. Moreover, the complaint that triggered the examination involved issues "typically" handled by investment adviser personnel. The examination focused only on front running because, as one official described, it was "the area of expertise of my crew." In other words, they examined what they knew. Ultimately, the team was pulled off the matter to shift focus to "mutual funds."
A second examination occurred in 2004. This team operated out of the Northeast Regional Office (NERO) (aka the New York office). Once again, the examiners came out of the broker-dealer program, not investment management. Why? "An examiner stated that each of the examination programs in NERO was a 'silo' and they almost never worked together." The examiners often apparently asked perfunctory questions and accepted Madoff's responses.
The report chronicled intimidation by Madoff designed to throw off the examination. As the summary noted:
- Madoff made efforts during the examination to impress and even intimidate the junior examiners from the SEC. Madoff emphasized his role in the securities industry during the examination. One of the NERO examiners characterized Madoff as "a wonderful storyteller" and "very captivating speaker" and noted that he had "an incredible background of knowledge in the industry." The examiner said he found it "interesting" but also "distracting" because they were there "to conduct business."
- The other NERO examiner noted that "[a]ll throughout the examination, Bernard Madoff would drop the names of high-up people in the SEC." Madoff told them that Christopher Cox was going to be the next Chairman ofthe SEC a few weeks prior to Cox being officially named. He also told them that Madoff himself "was on the short list" to be the next Chairman of the SEC. When the NERO examiners would seek documents Madoff did not wish to provide, Madoff became very angry, with an examiner recalling that Madoffs "veins were popping out of his neck" and he was repeatedly saying, "What are you looking for? .... Front running. Aren't you looking for front running," and "his voice level got increasingly loud.
Ultimately, the examiners concluded that there was no front running and the examination was concluded. A simultaneous investigation undertaken by OCIE examiners was likewise terminated, with the workpapers sent to the NERO examiners.
In short, the examinations involved a silo mentality, a lack of coordination among offices, and a lack of sufficient expertise. In addition, the browbeating suggests a lack of support from higher ranked officials within the Commission. If there are structural changes that need to take place in the SEC as a result of the Maddoff fiasco, these are what need to be addressed.