JEFFREY BROWN: It’s a blistering review of failure at the Securities and Exchange Commission. A newly released report by the agency’s inspector general details a series of missed opportunities and botched inquiries into Bernard Madoff’s investment schemes, concluding that, despite numerous credible and detailed complaints, the SEC never took the necessary but basic steps to determine if Madoff was operating a Ponzi scheme.
The report found no significant attempts made to analyze the numerous red flags about Madoff’s business, a team with little to no experience conducting Ponzi scheme investigations, and simultaneous investigations by different offices, without either knowing the other one was conducting an identical examination.
Bernard Madoff ended up bilking investors for billions of dollars. He was sentenced in June to 150 years in federal prison. We look at the details in the new report now with Kara Scannell, who covers the SEC for The Wall Street Journal, and John Coffee, professor of securities law at Columbia Law School. He has advised the SEC in the past, but was never consulting about this case.
Well, John Coffee, this report represents a tough very moment for the SEC.
JOHN COFFEE: This is more than a tough moment. This is probably the biggest embarrassment they have had in their 75-year history. Basically, it’s demoralized the agency and impacted on its reputation.
I would say that this was always the strongest of the federal independent agencies. But, right now, I think that the whole agency is under a cloud, and it’s struggling very diligently to get out from underneath that cloud.
JEFFREY BROWN: All right, let’s try to look at a little bit of this, Kara. The numerous opportunities for the SEC to do something, what does that mean? Give us some examples. What was there for the SEC to see?
KARA SCANNELL: Well, when they first got a look at Madoff in 1992, it was through two accountants who were selling unregistered securities, so basically selling the securities to the public, and no one knew.
When the SEC went to look behind it — they thought it was a Ponzi scheme — they found out that who was managing the money, but Bernard Madoff. At that point, they could have looked to have seen — they given the — they had returned the money to those investors, but they never looked to see where that money came from.
So, did it come from other investors, or was the money there, as it should have been? If they had kicked the door down a little bit more to see where the money was coming from, they might have concluded at that time that it was a Ponzi scheme.
And there were numerous tips since then over the years, from 2000, 2003, 2005, 2006, where people were raising questions about the viability of his trading strategy. Was it just even possible, the way that he was describing he was making money?
Previous investigations failed
JEFFREY BROWN: And, then, John Coffee, so, along those -- through those years, there were several investigations, in fact, and examinations. But what happened? I mean, among other things, as I said, some -- one shoe didn't seem to know -- one hand didn't seem to know what the other hand was doing.
JOHN COFFEE: Well, to generalize, a former chairman of the SEC told me a few months ago that, in his view, the SEC was like a group of vertical silos. Each silo knew a lot, but they never shared information with the other silo.
So, whether it's the New England regional office vs. the New York office, or the Office of Compliance and Inspections vs. the Enforcement Division, none knew what the other was doing. If you put it all together, they would have had enough information to begin to see a pattern.
But, instead, one division is investigating him for front-running. Well, they found he wasn't front-running because he wasn't trading. That should have sent off the really big alarm signals, because, if he wasn't trading, how was he making these returns? But it solved their problem that he wasn't engaged in this offense that they were investigating.
There wasn't an integrated view. They didn't have collective knowledge of what was going on.
JEFFREY BROWN: Some of the information was coming from what the report calls anonymous sources. There's one point where they quote a -- an e-mail from a concerned citizen. There is Harry Markopolos, the private investigator, who was sending up warning signals, correct? What -- what happened with his information?
KARA SCANNELL: Well, the summary of the report, which is coming out in its entirety on Friday, shows that, basically, the SEC staff looked at it and thought, well, he's a competitor. You know, he's looking for a reward.
So, they were discounting, to some extent, some of the things that he had said. And in -- there was another follow-up of a complaint in 2008 of March, which was just months before Bernard Madoff confessed. And, at that point, when it was brought back to the Enforcement Division's attention they said, well, we already looked at. They were wrong. We figured it out. And now he's a -- he's registered, and we will find out whatever else wrong with him.
JEFFREY BROWN: One of the things you see when you go through this is that, in some of these investigations, staffers were intimidated by Mr. Madoff, or -- or -- or he seemed to control the meetings.
A lot of the report blames it on incompetence, inexperience among staffers. Is that how you -- is that -- is that where you put the blame on the SEC?
SEC did not ask for trading records
JOHN COFFEE: Some of it is experience. Some of it is excessive deference to prominent people.
And that's happened in some other recent cases, in which the SEC dropped an investigation, only to find out later that there was real evidence of fraud. Another problem is logistical constraints.
If there was one recurring tragedy here, it's that they should have asked for the trading records. At several points, they almost did. And they basically didn't because they thought they were going to get truckloads of documents, so it would have taken them forever to analyze.
In truth, they would have found there were no records, and that would have revealed the fraud. But that's sort of the workload problem and the constraints of an overworked agency with too little resources.
JEFFREY BROWN: And, yet, I mean, some -- we're sitting here today, where it all looks so blatant. And the kinds of things you're saying, where one office didn't know, nobody put it all together, how could that be? How is that possible?
JOHN COFFEE: You know, that's a very fair question.
And the SEC has to reorganize itself. In part, I think -- and I was talking to Mary Schapiro this morning about this at a public hearing -- you have a number of people who are specialized in a very narrow task: Was there front-running occurring?
They need to get broader training in how do you recognize a fraud, and not focus just on your narrow sub-goal of what your division investigates, but, have we stumbled across the biggest fraud of all times? Because what you really want the SEC do -- to do is to find the major frauds, and not to catch all the minor regulatory violations.
But the way the internal culture works, you're promoted and rewarded for doing your division's job.
JEFFREY BROWN: And, Kara, ironically, in this case, the report cites Bernie Madoff citing the investigations by the SEC to potential investors to show -- to clear him, basically, to show he's on the up and up.
KARA SCANNELL: Right. Right.
And that's a -- that seems like that's a -- if -- he's basically using the fact that the SEC was in there as a selling point to investors, almost like a Good Housekeeping Seal of Approval.
So, if -- my understanding is that if -- any time anyone raised questions, that he would say, look, the SEC was just in here. Everything is fine.
JEFFREY BROWN: The one bit of good news here for the SEC, I guess, is that they are cleared of what -- what the report calls inappropriate connections. Explain...
No instances of favoritism
KARA SCANNELL: Well, the -- one of the senior investigators -- or examiners was married -- or got married to Shana Madoff, Bernard Madoff's niece, who was also a compliance official at the Madoff securities firm.
And the -- the report finds that there was no sort of favoritism given to Madoff's firm because of their relationship. And I think, in fact, he was taken off the case and recused himself from any examinations of it at the time that they were under review.
There were also a lot of rumors that just, you know, politicians, or there was kind of Madoff in touch with senior SEC officials was having some influence. And the report doesn't find that that's substantiated.
JEFFREY BROWN: John Coffee, you referred to Mary Schapiro, who just took over this year at the SEC. Today, she put out a statement saying: "The report makes clear the agency missed numerous opportunities to discover the fraud. It's a failure we continue to regret."
Now, fill that in a little bit more. What is their -- the response over there and as they're looking to change things?
JOHN COFFEE: I think she's trying to take significant steps. And she has done that. She's already brought in a new head of enforcement. And they have reorganized enforcement, so they will have a specialized division looking at Ponzi schemes.
So, you will have someone specifically focused on this kind of fraud, which is the kind of major fraud that we most want the SEC to be able to catch. More generally, I think there are going to be organizational reforms. I hope that they do go towards training all their staffers to recognize a fraud, not only the SEC.
All our federal regulatory agencies with responsibilities for the financial markets should have what I will call a fraud college, under which they get joint training on how you recognize a fraud. These steps, I think, will come. I think she understands the mood, and I think she's the right person in the right place.
But I do think that there were failures here that are more than just logistical. They involve an internal culture that often wants to settle cases too quickly, too cheaply, too easily. And that's continuing.
JEFFREY BROWN: And, briefly, what are you hearing from people over there in terms of the potential for change?
KARA SCANNELL: Well, I think what -- what John's saying. I mean, Mary Schapiro has taken a number of steps. You know, some of them are very specific in nature, proposing rules so that people actually can verify that money is in a place where the manager says it is.
You know, I think that a lot of it is rebuilding the morale, because morale is very low at the agency. And, you know, as the enforcement -- new enforcement director is specializing units, and I think there's a real effort to try to train people, recruit people, and, you know, reinvigorate the agency.
JEFFREY BROWN: All right, Kara Scannell and John Coffee, thank you both very much.
JOHN COFFEE: Thank you.
KARA SCANNELL: Thank you.