The Commission’s New Chairwoman And The Madoff Scandal

Mary Schapiro was sworn in as the new SEC Chairwoman. Ms. Schapiro has previously served as the CEO of the Financial Industry Regulatory Authority, the Chairwoman of the CFTC and as an SEC Commissioner.

Ms. Schapiro assumes the position of Chairwoman at a pivotal time in the history of the agency. The market crisis which continues to transform Wall Street and the financial markets is on-going and seems to be never ending. Many have questioned whether the agency is an effective market regulator and up to the task of policing the securities markets, a key part of its historic mission. Others have suggested that the SEC should be merged with the CFTC and perhaps the Fed.

During confirmation hearing testimony, Ms. Schapiro stated that she would reinvigorate the Commission’s troubled enforcement program which many claim is ineffective and that has been the subject of adverse publicity in light of the Madoff scandal. Retooling the enforcement division and restoring the program and investor confidence in it will no doubt be a difficult task in the current environment.

While Ms. Schapiro was being sworn in Lori Richards, Director, Office of Compliance and Inspections and Examinations, and Linda Thomsen, Director Division of Enforcement, were on Capital Hill testifying before the Senate Committee on Banking, Housing and Urban Affairs. The focus of the testimony was the Madoff scandal and the Commission’s prior investigations.

Ms. Richards’ testimony consisted largely of a review of the Commission’s examination program. With respect to Mr. Madoff, Ms. Richards noted that he first registered his investment advisory business in 2006. That business was never inspected. In contrast, the Madoff broker-dealer operation was subject to routine examination oversight by the firm’s SRO and “was also subject to several limited-scope …” exams by the staff. No fraud was found. Ms. Richards noted however, that she was “not authorized to provide specific information about past regulatory oversight …” of Mr. Madoff.

Ms. Thomsen also did not discuss the allegations regarding the prior investigations of Mr. Madoff. After noting that there are on-going law enforcement investigations that might be compromised, Ms. Thomsen provided the Committee with an overview of three actions related to Mr. Madoff which have been brought by the Commission. The first is the current enforcement action, filed after the Ponzi scheme was revealed. SEC v. Madoff, Case No. 08 Civ. 10791 (S.D.N.Y. Dec. 11, 2008).

The second is a 1992 action captioned SEC v. Avellino & Bienes, Lit. Rel. No. 13443 (Nov. 27, 1992). The defendants there raised $441 million from 3,200 investors through unregistered securities offerings. The investors received notes with interest rates of between 13.5 and 20%. The funds were invested in discretionary brokerage accounts with Mr. Madoff’s broker-dealer firm. The case was settled with the return of investor funds, an accounting at Avellino & Bienes and the payment of penalties by the defendants.

A third case is SEC v. Telfran Associates, Ltd., Lit. Rel. No. 13463 (Dec. 9, 1992). This case involved the creation of a feeder fund to Avellino & Bienes. About $88 million was raised from 800 investors through unregistered securities offerings over a three-year period. Investors were promised a return of 15%. This action was settled on terms similar to the Avellino & Bienes case.

Ms. Thomsen’s only reference to the 2006 initial inquiry conducted by the New York Regional Office and discussed here noted that the matter was opened and closed: “As widely reported in the press, the SEC’s New York Regional Office commenced another investigation of Mr. Madoff in early 2006. Two years later, in January 2008, that investigation was closed without any recommendation of enforcement action.” In that inquiry, the Commission’s internal documents state that the investigation began based on allegations that Mr. Madoff was conducting a Ponzi scheme. At the time the case was opened, the Commission had received a detailed letter about the possible fraud from a source the staff found to be credible. Little was done in the two years the investigation was open and there is no indication the Ponzi scheme allegation was investigated.

The enforcement director went on to review how the division handles complaints, tips and referrals and the care with which this material is reviewed. Ms. Thomsen concluded her testimony with three suggestions to prevent future frauds: 1) certain regulatory reforms focused on “harmonizing the regulatory regimes that apply to these similar products and businesses …”; 2) more staff for the Commission; and 3) investor education. There was no mention of reforming the enforcement program.