S.E.C. Accused of Failing to Act on Madoff Warnings
NYTIMES
By EDMUND L. ANDREWS and DAVID STOUT
January 6, 2009

WASHINGTON — Democratic lawmakers charged on Monday that the Securities and Exchange Commission had “failed miserably” in following up on warnings that could have uncovered several years ago possible wrongdoing by Bernard L. Madoff, who is accused of running a $50 billion Ponzi scheme.

“This elaborate Ponzi scheme fell through the cracks of our regulatory system,’” said Representative Paul E. Kanjorski, Democrat of Pennsylvania.

“We now know that our securities regulators have not only missed opportunities to protect investors against massive losses from the most complex financial instruments like derivatives, they have also missed the chance to protect them from the simplest of scams, the Ponzi scheme,” Mr. Kanjorski said.

But the financial examiner Harry Markopolos, the star witness who had warned the S.E.C. for nearly a decade about Mr. Madoff, begged off at the last minute for reasons that were not entirely clear.

In a letter sent by his lawyer, Mr. Markopolos said he was too ill to travel, that he needed more time to prepare and wanted “special dispensation” to have two lawyers, rather than one, with him at the witness table.

The S.E.C.’s inspector general, meanwhile, told lawmakers on Monday that his investigation into the agency’s failure to uncover Mr. Madoff’s apparent Ponzi scheme will go further than its chairman, Christopher Cox, has proposed.

“It is our opinion that the matters that must be analyzed regarding the S.E.C. and Bernard Madoff may go beyond the specific issues that S.E.C. chairman Cox has asked us to investigate,” H. David Kotz, the agency’s inspector general, told the House Financial Services Committee.

“Our efforts must include an evaluation of the broader issues regarding the overall issues” of the agency’s enforcement operations,” he continued.

Among the questions that Mr. Kotz said he would investigate were whether S.E.C. officials had “conflicts of interest” in their relationships with Mr. Madoff. Without naming names, he said he would look at the role of a former agency official who had “a personal relationship with a Madoff family member.” Mr. Kotz appeared to be referring to Eric Swanson, a former S.E.C. compliance lawyer who married Shana D. Madoff, Mr. Madoff’s niece.

Mr. Swanson acknowledged that he worked occasionally on some issues involving Mr. Madoff, though no evidence has yet surfaced of any work he did at the time he became romantically involved with Ms. Madoff in the spring of 2006.

Mr. Kotz said he would also be looking into whether enforcement officials might have been influenced by Mr. Madoff’s “reputation and status” as a result of participating on several advisory committees to the S.E.C.

Despite the dry, formal language of Mr. Kotz’s prepared remarks, it was clear as the afternoon hearing unfolded that the crimes that Mr. Madoff is accused of, and the human suffering he is said to have caused, will be a driving force in the 111th Congress, which begins on Tuesday.

Representative Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee, which received Mr. Kotz’s testimony, said “the country will not work” if everyone is afraid to invest, and that such a contagion of fear is not far-fetched, given the dimensions of the fraud that prosecutors say Mr. Madoff carried out over years.

The panel’s ranking Republican, Representative Spencer Bachus of Alabama, said the Madoff affair demonstrated the need for “a statutory and regulatory structure for the 21st century,” a subject whose details are likely to be intensively debated in the new Congress. Moreover, he said, “there’s every reason to believe” that other fraud schemes are lurking in the markets, waiting to ensnare other investors.

The question that dominated the hearing was the one that has been asked over and over in the weeks since, according to prosecutors, Mr. Madoff confided to his sons that his supposedly steady but safe investment operation was nothing more than a giant Ponzi scheme: How could the S.E.C. have missed all the warning signs, given that the supposedly huge Madoff investment operation was overseen by a tiny storefront accounting firm?

Perhaps, one lawmaker suggested, the term “Ponzi scheme,” named after the Italian immigrant who engineered the huge pyramid-investment scheme of the early 20th century, should be declared obsolete and replaced by “the Madoff scheme.”

It may be a while before the courts determine if Mr. Madoff deserves to be branded a criminal. But there were signs that his actions have already ignited a collective anger that the lawmakers will feel from their constituents.

“In the blink of any eye, savings that I had struggled my entire lifetime to earn have vanished,” one investor wrote the panel. He is 76 years old, and he and his wife had been living a retirement that was not only peaceful but seemingly prosperous — until Mr. Madoff’s empire collapsed, and with it the investor’s financial foundation.

Securities and Exchange Commission investigators discovered in 2006 that Bernard Madoff had misled the agency about how he managed customer money, according to documents, yet the SEC missed an opportunity to uncover an alleged Ponzi scheme.

The documents indicate the agency had Madoff in its sights amid multiple violations that, if pursued, could have blown open his alleged multibillion-dollar scam. Instead, his firm registered as an investment adviser, at the agency's request, and the public got no word of the violations.

Harry Markopolos - who once worked for a Madoff rival - sparked the probe with his nearly decadelong campaign to persuade the SEC that Madoff's returns were too good to be true. In recent days, The Wall Street Journal reviewed emails, letters and other documents that Markopolos shared with the SEC over the years.

When he first began studying Madoff's investment performance a decade ago, Markopolos told a colleague at the time, "It doesn't make any damn sense," he and the colleague recall. "This has to be a Ponzi scheme."

For Markopolos, the arrest last week of Madoff was something of a vindication after his long campaign. At a certain point, he says, "I was just the boy who cried wolf."

A lawyer for Madoff declined to comment on Markopolos's allegations.  On Jan. 4, 2006, the SEC's enforcement staff in New York opened an investigation, based on Markopolos's allegations, into whether Madoff was, in fact, running a Ponzi scheme.

The SEC staff received documents from Madoff and Fairfield Greenwich, a hedge fund that placed money with Madoff on behalf of its clients. The SEC also interviewed Madoff, his assistant, an official from Fairfield Greenwich and another employee.