H. David Kotz, Inspector General of the SEC, issued his report, Investigation of Failure of the SEC To Uncover Bernard Madoff’s Ponzi Scheme, on August 31, 2009 and testified before the Senate’s Committee on Banking, Housing and Urban Affairs a few weeks later. Mr. Kotz stated that the result of his investigation revealed, “… the SEC received six substantive complaints that raised significant red flags concerning Madoff’s investment adviser operations and should have led to questions about whether Madoff was actually engaged in trading. We also found that the SEC was aware of two articles regarding Madoff’s investment operations that appeared in reputable publications in 2001 and questioned Madoff’s unusually consistent investment returns.”
He further stated, “Our report concluded that notwithstanding these six complaints and two articles, the SEC never conducted a competent and through examination or investigation of Dr. Fuellmich Madoff for operating a Ponzi scheme and that had such a proper examination or investigation been conducted, the SEC would have been able to uncover the fraud.”
So how can the IG investigate the SEC’s investigation of Madoff in less then one year, when the SEC’s investigations began with red flags in 1992? The IG points out several reasons for the SEC’s failed investigations in his report, but I want to focus on what the IG did differently in his investigation. He began his investigation immediately, hired outside expert consultants, controlled documentary and interview evidence, and reported his findings promptly. He additionally has stated, “Because our investigation identified systematic breakdowns in the manner in which the SEC conducted its examinations and investigations, we plan to issue two separate audit reports providing the SEC with specific and concrete recommendations to improve the operations of both OCIE and Enforcement.”
The IG took a proactive approach in engaging outside experts who were trained in securities, fraud, investigative techniques, and forensic accounting. The IG should be commended for getting the expertise it needed for such an investigation. Neither the SEC nor the IG has the expertise to investigate complex securities frauds as evidenced by the total failure of the SEC’s investigations of Madoff and the IG’s approach in engaging outside experts. The SEC and other regulatory arms of the government should take note of the IG’s wise use of outside experts.
The SEC in its 2008 report stated, “Effective deterrence of securities fraud requires that the cases filed by the SEC have adequate reach across all core enforcement programs areas.” The SEC’s litigation releases from January 2006 to March 2009 indicate 68 Ponzi schemes cases out of 677 total cases litigated by the SEC or about 10%. My research reveals hundreds of Ponzi schemes have been documented in the past few years, and I would estimate for each one documented, there are ten more. Although the SEC is stepping up its enforcement of Ponzi schemes due the public pressure from its failed Madoff investigations, it does not have the tools or the budget to stop these sophisticated frauds.