JEFFREY BROWN: Since the arrest last week of Wall Street financier Bernard Madoff, the financial web and pain have spread, and now the government itself is on the hot seat.
Christopher Cox, the chairman of the Securities and Exchange Commission, confirmed today he has launched an investigation to find out why the SEC had ignored tips and allegations about Madoff going back a decade.
For more on that, we’re joined by Diana Henriques, who’s covering the story for the New York Times, and John Coffee, professor of law at Columbia University Law School and director of its Center on Corporate Governance.
Diana, tell us more about what the SEC is now saying about its past experience with Mr. Madoff. What were those red flags?
DIANA HENRIQUES, The New York Times: Well, they aren’t saying, so I’m, of course, not privy to that, but they have given us some suggestions.
In that really remarkable statement that Chris Cox made last night, he suggested that credible evidence, credible tips had come in and had not been pursued.
Interestingly — and John can tell you more about this — they hadn’t been pursued because they were not pushed forward and turned into a formal investigation.
So the people who were looking into those tips were limited to whatever Bernie Madoff decided to tell them and whatever volunteer cooperation he gave them.
So, certainly, any sensible commission would want to know who made those decisions to not elevate this to a more serious level, where they’d have more weapons at their disposal to investigate it.
JEFFREY BROWN: It was described as an investigation in 2007 that ended in no action. Is that a fair even characterization, investigation, do we know?
DIANA HENRIQUES: No, not formally. I’m not a lawyer. You’ve got a great one here.
But there was no formal order of investigation voted by the commission in that case, and that was because the people who did the inquiry in 2007 did not seek a formal order. They did not refer anything to Washington, according to the SEC itself.
Regulators ignored red flags
JEFFREY BROWN: Well, John Coffee, help us clear up and understand one thing here. One issue is that Mr. Madoff clearly had different types of businesses. Now, how would that affect or impact the role of the SEC and what they should have been overseeing?
JOHN COFFEE, Columbia University: Well, the SEC, like most other governmental agencies, is a bureaucracy, and it has different divisions. One division investigates his broker-dealer operations, which were actually very high-tech and there are not any serious allegations about misperformance there.
But in 2006, Mr. Madoff finally registered as an investment adviser. Â And traditionally the SEC would conduct a thorough examination of the books and records of a new investment adviser during the first year after you register.
That didn't happen, despite all kinds of red flags, which include, most of all, the fact that he had $17 billion in investor assets under his personal management in a small, family-held firm, run by a family, with his brother as the chief compliance officer, with a fly-by-night accountant auditing the books, and without the use of any independent bank custodian to hold the money. All of that is a structure that should give some alarm.
And, finally, there is this point you've just been mentioning. There were credible allegations -- sent in perhaps by rival firms -- that his performance record was simply too consistent, unvarying, and too good to be true, and it looked like to them a Ponzi scheme. And the SEC stayed passive in the face of all that evidence.
JEFFREY BROWN: But the fraud, it sounds like, had been going on for even longer than that, a good ways back. Can you take...
JOHN COFFEE: We don't know how far back, really.
JEFFREY BROWN: Yes, can you pick up from any of the hints so far on -- on why nothing went forward?
JOHN COFFEE: Well, first of all, Ponzi schemes are usually acts of desperation. They're usually something done by a failing business that isn't meeting the performance it wants and you start stealing from the new investors to pay the former investors.
Now, why did the SEC defer? Remember that he was the former chairman of the NASD. He was a big man on Wall Street. And there had been other allegations recently -- some of them confirmed by the SEC's own inspector general -- that the SEC has not investigated at the staff level that intensively when they were dealing with major figures on Wall Street.
The SEC inspector general made that same conclusion recently about an investigation that didn't go very far of Morgan Stanley and its CEO, John Mack. And that's the pattern of a somewhat equivocal investigation and a somewhat incomplete pursuit of evidence that never got fully resolved.
Looking into personal relationships
JEFFREY BROWN: Well, Diana Henriques, there was a new sort of personal twist to all this that came out, a lawyer for the SEC who was married or married a few years back the niece of Mr. Madoff. What can you tell us about that?
DIANA HENRIQUES: Well, those are the facts. As John said, the Madoff firm is a family firm. Bernie's brother, Peter, is the general counsel and chief compliance officer. And his daughter, Shana, worked in the compliance office at the firm. I should say Bernie's two sons also worked at the firm on the trading proprietary desk that John was talking about.
Now, several years ago, Shana's now-husband, before they met, led a team in the compliance office that examined the Madoff firm. According to them -- and they put out a very unequivocal statement last night -- the relationship that led to their getting wed, their romantic relationship, did not begin at that time, did not begin until well after he had exited the Madoff inquiry and that, since that relationship began, he had not been involved in any of the Madoff cases.
But you've got to say, you know, of all the couples in all the world that could walk into a story, this is not good for the SEC.
JEFFREY BROWN: And, Diana, when Chairman Cox says that he's going to start an investigation, is it clear what the scope of that is at this point?
DIANA HENRIQUES: Well, we know one element of it, because he made that quite clear last night. He is going to be looking for personal relationships -- obviously, not wedding rings, but friendships there within the SEC that might have compromised their aggressiveness in looking at the Madoff firm.
He specifically said that he is going to require anyone who had more than just an inconsequential relationship with the Madoff firm and anybody at the firm to recuse themselves from this investigation.
Agency faces intense scrutiny
JEFFREY BROWN: And I suppose, John Coffee, a question would be whether -- to what extent the SEC is able to investigate itself at a point like this, if, in fact, it missed a lot of what was going on for quite a long time?
JOHN COFFEE: Well, the SEC does have an independent inspector general who has been quite critical in his recent review of the agency's performance, so I think they will give a very intensive scrutiny to these allegations, as will Congress.
I'm afraid the SEC is under the worst cloud in its history, and it's likely to be embarrassed for some time to come about these episodes, but I think it's more a problem of negligence than it is personal corruption by any SEC staffer.
JEFFREY BROWN: But you say it's under a cloud because this goes well beyond Madoff at this point. The SEC -- there have been a lot of questions throughout this whole financial crisis about what it's been doing, right?
JOHN COFFEE: You're correct. All of our major investment banks failed over the last year, and it seems to have had a good deal to do with the SEC relaxing its rules on capital adequacy and safety and soundness.
And in general, the SEC has given an awful lot of deference to self-regulation by the industry.
JEFFREY BROWN: And, Diana, briefly before we go, in the meantime, the investigation or I guess the understanding of the depths of this scandal continue to unfold, right?
DIANA HENRIQUES: They do. Chris Cox's statement indicated that there were credible tips going back at least a decade. Some officials working on the case right now say it's been going on for decades, plural.
We don't know yet how long it's been going on, but it is a remarkably durable Ponzi scheme, if that is the case. As John and I know, they usually blow up much faster than this.
JEFFREY BROWN: All right, Diana Henriques and John Coffee, thank you both very much.
JOHN COFFEE: Thank you.