* SEC watchdog says agency fumbled five probes
* No evidence of improper SEC ties with Madoff
* Schapiro hopes to safeguard names of junior staffers
* Pitt: Madoff situation a tragedy of enormous proportions
(Adds Harvey Pitt statement)
By Ross Kerber and Jonathan Stempel
BOSTON/NEW YORK, Sept 2 U.S. securities
regulators missed "numerous" red flags that may have led to
Bernard Madoff's $65 billion Ponzi scheme and never did a
"thorough and competent" probe despite complaints dating to
1992, a federal watchdog has concluded.
The U.S. Securities and Exchange Commission's inspector
general said in a blistering report that despite five probes
and having caught Madoff in "lies and misrepresentations," the
SEC failed to follow up on inconsistencies.
"Despite numerous credible and detailed complaints, the SEC
never properly examined or investigated Madoff's trading and
never took the necessary, but basic, steps to determine if
Madoff was operating a Ponzi scheme," Inspector General David
Kotz said the SEC's "most egregious" lapse was its failure
to verify Madoff's purported trading with any independent third
parties, even after it took testimony from Madoff in May 2006.
Madoff later admitted that he thought it was "game over"
after testifying to having cleared his trades through the
Depository Trust Co, part of the U.S. Federal Reserve, and
provided his account number. He said he was "astonished" that
the SEC did not follow up.
Kotz quoted one senior-level SEC examiner as saying,
"Clearly, if someone ... has a Ponzi and they're stealing
money, they're not going to hesitate to lie to create records,"
and thus "some independent third-party verification" such as
through the DTC would be essential.
He said the SEC had made a "surprising discovery" earlier
this decade that Madoff's hedge fund business was making far
more money than his better known market-making business, but no
one thought this was a "cause for concern."
Madoff pleaded guilty in March to orchestrating the Ponzi
scheme, which used money from new investors to pay old ones, He
is serving a 150-year prison term.
Prosecutors have said that Madoff appeared to be rewarding
his customers with steady returns, but he was faking their
account statements and did not place trades on their behalf.
Kotz said SEC staffers were at times too inexperienced or
narrowly focused, and resisted whistle-blowers' efforts to
He said his investigation had not found evidence of
improper ties between the SEC and Madoff that interfered with
the SEC's examination or investigatory work.
And he said he had not found that former SEC Assistant
Director Eric Swanson's romantic relationship with Madoff's
niece, Shana Madoff, had influenced the SEC's conduct.
A 22-page summary of the report was released on Wednesday,
and posted on the SEC's website here. The full 450-page report is expected on Friday.
FAILURE LEADS TO REFORMS
The SEC's lapses in dealing with Madoff have prompted the
agency to implement reforms, including increased use of
Mary Schapiro, who became SEC chairman after Madoff's fraud
was uncovered in December 2008, said in a statement on
Wednesday that while the reforms should help, "the public
deserves a full accounting of why the agency did not detect the
There had been five SEC chairmen between 1992, when the
complaints to the SEC about Madoff started, and Madoff's
arrest: Richard Breeden, Arthur Levitt, Harvey Pitt, William
Donaldson and Christopher Cox.
"There were clearly lapses on the part of the SEC staff,
which accounted for the failure to uncover Madoff's Ponzi
scheme," Pitt said in an emailed statement.
"I had proposed, back in 2003, a better way to conduct
examinations and inspections, and Chairman Schapiro is now in
the process of implementing those ideas, which should avoid
some of the problems the SEC encountered.
"What happened in the Madoff situation was a tragedy of
enormous proportions," Pitt said, "and no one who cares about
the SEC can be anything but saddened by the missed
"But the true test of a regulatory agency is how it
responds to a crisis of this sort, and I think Chairman
Schapiro is doing an outstanding job of getting the SEC back on
the right track," Pitt said.
Linda Chatman Thomsen, the SEC enforcement chief when the
Ponzi scheme was uncovered in December 2008, is now a partner
at Davis Polk & Wardwell LLP in Washington, D.C. She did not
return a call seeking comment.
Harry Markopolos, who tried to warn the SEC about Madoff
and later testified before Congress about his efforts, was not
available for comment.
Rep. Paul Kanjorski, a Pennsylvania Democrat who heads a
House subcommittee on capital markets, said the scandal
"highlights the need to adopt new securities laws to reward
internal and external whistleblowers."
Schapiro observed in her statement that the SEC wanted a
way to reward some whistleblowers.
"We have sought legislation to enable us to compensate
whistleblowers for providing substantial evidence of
wrongdoing," she said.
Christopher Dodd, chairman of the Senate Banking Committee,
has scheduled a hearing for Sept. 10 on Kotz's findings. "We
will use this report to learn what went wrong and figure out
how best to get things right," the Connecticut Democrat said.
Sen. Charles Grassley, an Iowa Republican, called the
report evidence of the SEC's "culture of deference toward the
Wall Street elite," and said the SEC must be transformed so it
can be "the tough cop-on-the-beat that the public needs."
The SEC's Schapiro wrote in a letter to Grassley that
Kotz's report would be redacted only if it might harm an
ongoing law enforcement matter. "I do hope, however, to
safeguard the names of junior staffers who did not play a
central role in the examinations or investigations," she
See related Factbox: US SEC missteps in handling Madoff
fraud tips [ID:nN02549538]
(Reporting by Ross Kerber, Jonathan Stempel, Karey Wutkowski
and Rachelle Younglai; Editing by Toni Reinhold)