More Congressional Testimony On The Madoff Scandal
For the SEC, the Madoff scandal must seem like the bad dream that will not go away. The House Financial Services Subcommittee on Capital Markets heard testimony from senior SEC staff officials and Harry Markopolos, a certified financial analyst and fraud examiner.
The Directors of Compliance and Inspections, Trading and Markets and Enforcement, and the Acting General Counsel, appeared before the Congressional Committee. Their testimony was largely confined to reviewing the operations of each of the staff divisions. It also briefly sketched the background to prior investigations relating to Mr. Madoff. That information had previously been furnished by the staff to Congress as noted here. The testimony did little to address the apparent failures of the SEC to discovery Mr. Madoff’s unprecedented Ponzi scheme.
In contrast, Mr. Markopolos did not hesitate to discuss the failures of the agency regarding the Madoff scandal. In his testimony, Mr. Markopolos detailed a nine year quest dating back to early 2000 to convince the agency that Barnard Madoff was committing securities fraud. While Mr. Markopolos noted that he failed to convince the agency that Mr. Madoff was running a Ponzi scheme, it clearly was not for lack of effort on his part.
In his testimony, Mr.Markopolos detailed the methodology he used to determined after four short hours of reviewing public materials in late 1999 and early 2000 that Mr. Madoff was engaged in securities fraud. Mr. Markopolos described in detail the reason the derivatives based strategy Mr. Madoff claimed to be using could not yield the claimed results. In sum he discovered that Mr. Madoff’s returns were not possible. As Mr. Markopolos noted in commenting on a Madoff offering brochure provided to investors at one point: “How can any capital market return over any length of time only go up and never down … How did the SEC’s staff miss this … this is picture said ‘FRAUD’ a thousand times over.”
Mr. Markopolos detailed contact after contact with the SEC over the years. In those contacts, he provided the SEC with lengthy written descriptions of the fraud. He also met with staff members at various times to amplify the written materials he furnished the agency. No action was ever brought.
Throughout this period investors continued to pour millions of dollars into Mr. Madoff’s hands for investment. Why? According to Mr. Markopolos: “Yes, BM [Madoff] was a ‘no-brainer’ investment but only in the sense that you had to have no brains whatsoever to invest into such an unbelievable performance record that bears no resemblance to any other investment managers’ track record throughout recorded human history.”
If the fraud was so obvious the question is how did the SEC miss it? According to Mr. Markopolos, the SEC suffers from “investigative ineptitude and financial illiteracy.” While this is harsh criticism, there is no doubt that the SEC had opportunities starting as early as 1992 to discover the Madoff fraud. The testimony given by the SEC staff demonstrates this point.
The SEC’s opportunities to discovery the Madoff fraud seem to have culminated in 2006 when the staff opened an inquiry apparently based on the information furnished by Mr. Markopolos. That inquiry terminated however, apparently without investigating the Ponzi scheme allegations as discussed here. The SEC staff testimony offered no explanation, citing on-going investigations. Perhaps there is none.
It is ironic that all of this testimony came on a day when the Washington Post reported that the new Chairman of the SEC, Mary Schapiro, plans to rejuvenate SEC enforcement. The article (available here, registration required) goes on to suggest that a new enforcement director may be appointed.
The congressional testimony today as well as other recent failures clearly suggests that the enforcement program needs to be revamped. Changes in the staff may or may not be required. What is clearly required however is a new tone at the top – that is, a change in tone from Ms. Schapiro and her fellow commissioners that clearly makes enforcement the top priority as discussed here. Only then will the enforcement division begin to return to being a highly effective cop on the beat.