Madoff ‘Astonished’ SEC Failed to Stop Him After 2006 Interview

By Ian Katz

Sept. 3 (Bloomberg) -- Bernard Madoff thought regulators had caught him in 2006 and was “astonished” U.S. Securities and Exchange Commission investigators never followed up on information he gave them, the agency’s internal watchdog said.

Madoff, 71, told Inspector General H. David Kotz’s office this year that after being questioned in May 2006 and giving his account number at Depository Trust Co., an independent clearing agency, “I thought it was the end game, over. Monday morning they’ll call DTC and this will be over.” When that never happened, Madoff was “astonished,” according to a summary Kotz issued yesterday. The Ponzi scheme continued for 2 1/2 years.

“This was perhaps the most egregious failure in the enforcement investigation of Madoff,” Kotz’s report said. “They never verified Madoff’s purported trading with any independent third parties.” By checking with the clearing agency, the SEC would have “immediately realized that Madoff was not trading in anywhere near the volume that he was showing on the customer statements.”

The Kotz report detailed repeated missed opportunities by the agency after being alerted to Madoff’s Ponzi scheme activities at least six times dating back to 1992. The SEC assigned inexperienced lawyers to the investigation, supervisors denied requests of examiners to expand their review and staff withdrew a request for information from a third party on grounds a review of the data would be “too time-consuming,” Kotz said.

The inquiry is the most exhaustive look yet into the SEC’s failure to detect the world’s biggest Ponzi scheme, the $65 billion fraud that spanned decades and burned thousands of investors, including universities, charities and affluent clients. Lawmakers crafting a regulatory overhaul have awaited Kotz’s findings since agency officials rebuffed questions at hearings in January and February, citing the continuing inquiry.

‘Colossal Blunder’

“It is a failure that we continue to regret,” SEC Chairman Mary Schapiro said in a statement, adding that the agency is overhauling its enforcement and inspection units and reforming how it handles tips.

The SEC case is a “colossal blunder,” Representative Paul Kanjorski, a Pennsylvania Democrat and chairman of a subcommittee on capital markets, said in a statement yesterday. Representative Spencer Bachus of Alabama, ranking Republican on the House Financial Services Committee, said the report shows “institutional failure on a grand scale.”

SEC staff and supervisors “consistently demonstrated they were inexperienced, inept and easily duped,” said James Cox, a law professor at Duke University in Durham, North Carolina. “These were to a person, and there were many, individuals who seemed content to punch the clock but not push the investigation in any meaningful way.”

‘Never Answered Question’

While Kotz’s report portrays SEC enforcement staff as inexperienced and naïve, it doesn’t find that senior officials tried to improperly influence or interfere with inquiries.

SEC investigators had met Madoff in response to complaints, including a 2006 session where he was asked how he achieved his returns on investment. “Madoff never really answered the question,” Kotz wrote. “Madoff claimed his remarkable returns were due to his personal ‘feel’ for when to get in and out of the market.”

Because the staff lacked understanding of options trading, “they did not appreciate that Madoff was unable to provide a logical explanation for his incredibly consistent returns,” Kotz wrote. “Each member of the enforcement staff accepted as plausible Madoff’s claim that his returns were due to his perfect ‘gut feel.’”

Madoff also tried to impress and intimidate SEC examiners.

Name Dropper

Throughout an examination by the SEC’s Northeast regional office in New York of Madoff’s firm in April 2005, “Madoff would drop the names of high-up people in the SEC,” Kotz wrote. Madoff told examiners Christopher Cox was going to be chairman three weeks before Cox was named, and claimed he himself “was on the short list” to be chairman. When examiners sought documents he didn’t want to provide, Madoff became angry, and his “veins were popping out of his neck.”

Most work on the investigation by the Northeast office was led by a “staff attorney who recently graduated from law school and only joined the SEC 19 months before she was given the Madoff investigation,” Kotz wrote. “She had never previously been the lead staff attorney on any investigation, and had been involved in very few investigations overall. The assignment was also her first real exposure to broker-dealer issues.”

Enforcement officials failed to “appreciate the significance” of evidence from former money manager Harry Markopolos in 2005 and “almost immediately expressed skepticism and disbelief about the information,” Kotz write. “The enforcement staff claimed that Markopolos was not an insider or an investor, and thus, immediately discounted his evidence.”

1992 Complaint

The SEC might have discovered Madoff’s fraud in 1992. The agency received client complaints about Avellino & Bienes, a Fort Lauderdale, Florida-based firm that invested client money with Madoff, and suspected the firm was a Ponzi scheme. The SEC, learning that Madoff controlled the firm’s funds, assembled an “inexperienced” inspection team that conducted a “brief and very limited examination of Madoff,” without seeking to determine how Avellino & Bienes repaid customers, Kotz wrote.

“The result was a missed opportunity to uncover Madoff’s Ponzi scheme 16 years before Madoff confessed,” he said.

The criminal case against Madoff is U.S. v. Madoff, 09-cr- 213, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Ian Katz in Washington at ikatz2@bloomberg.net.