Congress to probe SEC role in Madoff affair

WASHINGTON (Reuters) - A U.S. House of Representatives panel plans to convene an inquiry in January into the failure of regulators to unearth an alleged $50 billion securities fraud by financier Bernard Madoff, a key lawmaker said on Wednesday.

Madoff, a former Nasdaq Stock Market chairman, was arrested last week and charged with running a massive Ponzi scheme. He is accused of defrauding banks, investment funds, charities and wealthy individuals who invested in funds he controlled.

The U.S. Securities and Exchange Commission has come under fire for not uncovering the scandal until senior employees of Madoff went to authorities.

The agency, chaired by Christopher Cox, has been accused of missing a number of red flags about the way Madoff operated his investment business.

Rep. Paul Kanjorski, chairman of the House Financial Services subcommittee on capital markets, plans to examine the alleged scheme as soon as possible after Congress returns on January 6.

"Unfortunately, these events have only further weakened already battered investor confidence in our securities markets," Kanjorski, a Pennsylvania Democrat, said in a statement. "And they have raised even more troubling questions about the effectiveness of our regulatory system."

Kanjorski said the panel will look into why the U.S. markets watchdog as well as other regulators and market participants failed to detect "substantial evasions" that harmed innocent investors and charitable groups.

He said the inquiry will help the full committee, chaired by Massachusetts Democrat Barney Frank, to craft a strong, effective and modern regulatory system.

The committee's top Republican, Spencer Bachus, also wants hearings to investigate Madoff and the adequacy of the SEC, as well as supplemental oversight by the Financial Industry Regulatory Authority (FINRA).

"Obviously, there was a failure of regulatory oversight," said Bachus, who is from Alabama.

Sen. Chuck Grassley, the ranking Republican on the Senate Finance Committee who has repeatedly been critical of the SEC, drafted a letter on Wednesday to the SEC's inspector general, David Kotz, who is leading his own investigation into the agency's handling of the Madoff case.

Grassley said he is "extremely interested in learning how the massive frauds being described in the press could have been perpetrated despite SEC regulatory and investigative activity regarding Mr. Madoff."

MADOFF-SWANSON ROMANCE

Cox, a Republican, said he was gravely concerned about the SEC's failure to examine Madoff's activities, which were flagged going back to at least 1999 and repeatedly brought to the attention of SEC staff but never recommended for commission action.

In light of past credible allegations brought to the staff, Cox has asked the agency's inspector general to probe the agency's conduct in the case.

"We have thus far no evidence of any wrongdoing by any SEC personnel," Cox told reporters after an open meeting on Wednesday.

Madoff's niece, Shana Madoff, a compliance lawyer at his firm, is married to a former SEC lawyer, Eric Swanson, who was the agency's assistant director in the office of compliance inspections and examinations.

A spokesman for Swanson said his relationship with his wife began years after the compliance team he helped supervise inquired into Bernard Madoff's securities operations.

SEC compliance chief Lori Richards said Swanson was a member of an examination team that looked into Madoff's broker-dealer business in 1999 and 2004.

Richards said Swanson was not part of a 2005 examination of the broker-dealer firm by the SEC's New York office. She said there are very strict rules banning staff from engaging in matters involving companies and a personal interest.

"Subsequently, Mr. Swanson did not work on any other examination matters involving the Madoff firm before leaving the agency," she said.

Frank and Senate Banking Committee Chairman Christopher Dodd are likely to lead efforts in Congress to overhaul the regulation of the financial services industry after banking and securities regulators failed to rein in the creation of risky securities that led to the current financial crisis.

Dodd, concerned about the harm to investors, is seeking more information from the SEC. Dodd also may hold hearings, according to Senate aides.

A Senate subcommittee on securities, chaired by Jack Reed, a Rhode Island Democrat, may look into quickly pulling together a blue ribbon commission to make recommendations on regulatory changes.

(Additional reporting by Kevin Drawbaugh and Karey Wutkowski; Editing by Andre Grenon, John Wallace and Jeffrey Benkoe)