Madoff documents reveal incredulous, unfocused SEC

By Jonathan Stempel and Rachelle Younglai

NEW YORK/WASHINGTON (Reuters) - U.S. securities investigators raised repeated concern over how Bernard Madoff could be running an honest business, but never followed through on the many red flags they uncovered.

Hundreds of documents released on Friday by U.S. Securities and Exchange Commission's portray an agency at times skeptical or dismissive of evidence that the now imprisoned mastermind of the world's largest Ponzi scheme was up to no good.

At other times, it appeared the agency knew that goings-on at Bernard L. Madoff Investment Securities LLC were improper but never followed through on their discoveries or on the allegations of chief whistleblower Harry Markopolos.

"I don't think we should worry about Bernie finding out to whom we speak .... we are not telling anybody that we have found anything improper (except for his lies to us, of course)," one SEC investigator wrote in a May 16, 2006 e-mail.

In September, SEC Inspector General David Kotz issued his full report on how the agency mishandled warnings and assigned inexperienced lawyers to examine Madoff.

He said this led to five botched probes starting in the early 1990s that might have unearthed Madoff's estimated $65 billion Ponzi scheme.

Madoff is serving a 150-year prison sentence after pleading guilty to the fraud. He told Kotz that if SEC lawyers had done some basic investigative work, it "would've been easy for them to see" he was a crook.

The documents could prove fodder for the lawyers suing the SEC for negligence on behalf of several Madoff victims.

This week, the court-appointed trustee liquidating Madoff's firm estimated the crime cost investors at least $21.2 billion, but only $534 million of payments have been authorized.

The SEC under current Chairman Mary Schapiro is implementing reforms designed to avoid a repeat, including more oversight by senior lawyers and greater use of subpoenas.

MARKOPOLOS

The new documents highlight the role of Markopolos who in 2001 began asking the SEC how Madoff could sustain high returns for investors in all sorts of market conditions.

He said at the time that Madoff was either "incredibly talented and/or lucky," or was using an unspecified process that needed investigation, or was running a Ponzi scheme.

Subsequent e-mails and handwritten notes sent during probes of Madoff's trading business show SEC staffers speculating or forwarding criticisms that it would be "impossible" for Madoff to perform as well he claimed.

In 2005, some at the SEC dismissed Markopolos when he presented the agency with a report on Madoff, titled "The World's Largest Hedge Fund is a Fraud."