SEC Madoff Report - Investigatory Shortcomings

Late on Friday evening the SEC Inspector General ("IG") released the full, 477-page version of his report on how the SEC missed the warning signs on Mr Madoff and his operation.

The report is the 'warts and all' version of an earlier executive summary and identifies some of the detailed actions (and inactions) of the SEC dating back to 1992. Although the IG has stated that he found no evidence of any financial or other inappropriate connection with the Madoff operation, he did find that ample information in the form of detailed and substantive complaints had been received to warrant a full and comprehensive investigation. The bottom line appears to be that despite the fact that investigations and examinations had been conducted, the investigators assigned were too inexperienced, had too narrow a remit or simply failed to verify basic facts - the phrase "auditing through discussion" springs to mind. Many of the complaints centre around the old adage "if it's too good to be true, then it probably is".  Unfortunately for those who were left standing when the music stopped such insights came too late.

The basic failures of not verifying Mr Madoff's trading through an independent third party and also in not pursuing a Ponzi scheme specific investigation were contributory factors to the failure to identify the scheme. Human nature is often such that the individual hearing or being provided with information which corroborates what one is being told, has a tendency to believe it unquestioningly.  Asking Mr Madoff for documentation and explanations which supported his claims falls in to that category.  However, one of the most surprising revelations in the report is that even when examination teams discovered suspicious information and evidence and caught out Mr Madoff in contradictions and inconsistencies they either disregarded these concerns or simply asked Madoff about them. Even when Mr Madoff’s answers were seemingly implausible, the SEC examiners accepted them at face value.

What also seems curious is that many private institutions had reached the conclusion that investing with Mr Madoff was unwise but conversely, the fact that the SEC had performed an investigation and found nothing untoward gave comfort to potential investors. The report is a tale of missed opportunities but contains many lessons for trustees and other who are considering investing clients' assets. The message seems to have remarkable similarities with the credit crunch - no-one took the time to step back, look at the situation and think the unthinkable. What makes this worse for the SEC is that the volume and specific nature of the complaints received should have been sufficient to ring the alarm bells.

http://www.sec.gov/news/studies/2009/oig-509.pdf

Ed Shorrock is the Director of Forensic & Regulatory Services at BakerPlatt, an offshore law firm specialising in litigation, financial crime, regulatory and insolvency matters.  Ed has been heavily involved in a variety of regulatory, criminal and civil actions with a focus on the restraint, custody, realisation and confiscation of assets. Having qualified as a chartered accountant in 1998, Ed has managed a range of projects involving asset seizures under drug trafficking and criminal legislation and been involved in regulatory investigations and complex liquidations. He delivers on training programmes focusing on financial crime and compliance issues and is a regular speaker at conferences on these topics and how they affect offshore financial centres.

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