• Six substantive complaints made against Madoff between 1992 and 2008, resulting in two SEC investigations and three examinations
  • SEC did not follow up on inconsistencies; accepted Madoff's explanations at "face value"
  • New rules proposed by SEC will require investment advisors to have third-party review of client accounts

A US Securities and Exchange Commission (SEC) investigation has found that the agency missed multiple opportunities to uncover the Madoff Ponzi scheme. The investigation report, published last month by the SEC Office of Inspector General (OIG), concluded that if any of the "numerous and credible" complaints against Madoff had been followed up, the fraud would have been uncovered well before Madoff confessed to his $65 billion scam.

The OIG found that between 1992 and 2008, there were a total of six substantive complaints against Madoff that should have "raised red flags" about Madoff's hedge fund operations.

Although the SEC did conduct two investigations and three examinations into Madoff's investment firm during the 16-year period, crucially it did not at any time verify Madoff's trading through an independent third party. To sustain his fraud, Madoff fabricated backdated and fictitious trades to create the illusion of consistently high returns on the firm's investments. Ironically, the fact that the SEC had investigated Madoff meant that investors were reassured when deciding whether to invest in his firm.

Despite the investigations discovering suspicious information about Madoff's operations, the report says that the SEC did not follow up on inconsistencies. "Even when Madoff's answers were seemingly implausible, the SEC examiners accepted them at face value," said the report.

One complaint in 2003 from a hedge fund manager raised a series of concerns including the fact that Madoff's strategy had not been duplicated by anyone else, his returns had no correlation with the overall equity markets and that Madoff did not appear to be the trading the $8 to $10 billion in options he claimed to be part of his strategy. According to the report, the SEC investigation that followed this complaint was not staffed or conducted adequately and missed "another opportunity to uncover Madoff's fraud."

Responding to the OIG findings, SEC Chairman Mary Schapiro said that many of the shortcomings identified in the report were already being addressed, including putting more experienced staff on the "frontlines", revamping the way tip-offs are handled, and seeking more resources. In addition, new rules have been proposed by the SEC that will require investment advisors to have third-party reviews of client accounts to ensure the funds in their account exist.

Last month, the SEC charged Madoff's CFO Frank DiPascali with securities fraud for "overseeing the mechanics of Madoff's entirely fictitious investment strategy."

To view the full OIG report, click here: Investigation of the Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme.

To view the executive summary, click here.

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