The Securities and Exchange Commission has released the executive summary of a report from its inspector general detailing the agency’s failures to stop Bernard Madoff from carrying out his Ponzi scheme.

The full report is expected to be released Friday, but SEC chair Mary Schapiro said she was releasing the executive summary early. In the report, the inspector general found that the SEC received “more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation” of Madoff and his investment firm for operating a Ponzi scheme.

Among the missed opportunities were allegations brought by Harry Markopolos, a certified fraud examiner, who posited that Madoff’s returns were either real but were coming from some process other than the one being advertised, or that Madoff’s entire fund was nothing more than a Ponzi scheme.

According to the report, Markopolos explained his analysis at a meeting in 2000 at the SEC’s Boston District Office and encouraged the SEC to investigate Madoff. After the meeting, however, both Markopolos and an SEC staff accountant testified that the assistant district administrator clearly did not understand the information presented, and that was probably the reason why the office decided not to pursue Markopolos’s complaint or even refer it to the SEC’s Northeast Regional Office. Markopolos produced a more detailed complaint in 2001, but an SEC official quickly rejected an investigation for reasons that remain unclear.

Even earlier than that, back in 1992, several customers of an investment firm known as Avellino & Bienes approached the SEC with concerns about some investments they had made. The SEC investigated and found that Madoff had complete control over the firm’s customer funds.

The SEC suspected that Avellino & Bienes was operating a Ponzi scheme and took action to ensure that all of its investors received refunds on their investments. Yet, the inspector general found that the SEC never considered the possibility that Madoff could have taken the money that was used to pay back Avellino & Bienes’ customers from other clients as part of a larger Ponzi scheme.

The SEC actually conducted an examination of Madoff that was triggered by the investigation of Avellino & Bienes, but assembled an inexperienced examination team. The examination team conducted a brief and very limited examination of Madoff, but made no effort to trace where the money that was used to repay Avellino & Bienes' investors came from. In addition, although the SEC examiners did review records from the Depository Trust Company, they obtained those records from Madoff rather than going to the DTC itself to verify that the trading had in fact occurred. According to the lead SEC examiner, someone should have been aware of the fact that the money used to pay back Avellino & Bienes’ customers could have come from other investors, but there was no examination of where the money came from.

The SEC also missed opportunities to catch Madoff after articles in Barron’s and MARHedge appeared questioning his investment methods. 

Despite the lapses, the report exonerates SEC officials from having too close a relationship with Madoff. The inspector general did not find that former SEC assistant director Eric Swanson's romantic relationship with Madoff’s niece, Shana Madoff, influenced the conduct of the SEC examinations of Madoff and his firm. The inspector general also did not find that “senior officials at the SEC directly attempted to influence examinations or investigations of Madoff or the Madoff firm, nor was there evidence any senior SEC official interfered with the staffs ability to perform its work.”

SEC chair Mary Schapiro noted that the agency has made changes in response to the Madoff case since she took over in January. “We have streamlined our enforcement procedures and are putting more experienced staff on the front lines,” she said in a statement. “We also have bolstered our inspection program, started to revamp the way we handle hundreds of thousands of tips received annually, begun to hire new skill sets, increased internal training, and sought more resources to keep pace with financial fraudsters.”

She noted that the SEC has also stepped up its filing of emergency temporary restraining orders related to Ponzi schemes and other frauds, filing more than twice as many this year compared to the same period last year. The agency has also proposed new industry rules to better protect clients of investment advisers by mandating independent reviews to assure that a client's account contains the funds that the investment adviser says it contains. The SEC has also sought legislation that would allow it to compensate whistleblowers for providing substantial evidence of wrongdoing.

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