Friday, December 12, 2008

Where was the SEC's due diligence on Madoff?

Here's what we know: The Securities and Exchange Commission was alerted to Bernard Madoff's suspicious returns several times during the past decade.

Here's what else we know: The S.E.C. failed to uncover what's being alleged as a massive Ponzi scheme at Madoff's firm.

Do we really need any more evidence that the agency charged with protecting investors needs massive overhaul and more oversight of hedge funds?

It's astonishing, really. Madoff was reporting consistent returns from an investment strategy that involved trading stock and options of S&P 100 companies. The returns weren't wildly huge, but they were reliably steady: up a little every month, up 10 percent per year. Madoff claimed to be up 5.6 percent this year through November, according to the Wall Street Journal. Meanwhile, the S&P 500 lost 38 percent during the same time frame.

In May 2001, Barron's ran a story that called Madoff's returns into question. Some wondered if Madoff was using information from his market-making business, which trades stocks for financial institutions, to front-run trades in his funds. It would be illegal if true, but investors seemed happier not to know. "Even knowledgeable people can't really tell you what he's doing," one "very satisfied" investor told Barron's.

Indeed, Henry Blodget at Clusterstock has heard from investors who knew Madoff had to have been doing something illegal in order to produce those returns, but that only gave them more reason to invest with him. That he was running a simple, old-fashioned Ponzi scheme never seemed to cross their minds.

A securities executive by the name of Harry Markopolos first started alerting the S.E.C. to Madoff's suspicious operations in 1999, and continued to press them for years. "Bernie Madoff's returns aren't real and if they are real, then they would almost certainly have been generated by front-running customer order flow from the broker-dealer arm of Madoff Investment Securities," Markopolos wrote to the S.E.C. in November 2005.

One very adept hedge fund investigator advised his clients not to invest with Madoff after he discovered his auditors operated out of a 13-by-18-foot office in Rockland County, according to Bloomberg. This was where books on the $17 billion under management by Madoff were "audited."

Anyone arguing against more regulation of hedge funds is going to have a hard time working around this story. It is impossible to see how the S.E.C. isn't culpable for allowing Madoff's scheme to go on as long as it did. The only reason we even know about it now is that he finally broke down and 'fessed up to his sons.

"We are moving quickly and decisively to stop the fraud and protect remaining assets for investors, and we are working closely with the criminal authorities to hold Mr. Madoff accountable," said S.E.C. enforcement director Linda Chatman Thomsen in a statement.

"We have 16 examiners on site all day and through the night poring over the records," S.E.C. associate director Andrew Calamari told the New York Times.

For Madoff's investors, it's a little late for the S.E.C.'s grandstanding.

Where was the "poring over records" in 1999, when the agency was told about Madoff's dubious returns? And in 2001, when Barron's raised more questions? What about in 2005, when the agency received even more inquiries about his mysterious trades?

The S.E.C. won't likely be forthcoming with these answers, but that shouldn't stop Madoff's investors from demanding them.

No comments: