WASHINGTON (Reuters) - The $50 billion fraud allegedly committed by broker Bernard Madoff is a major embarrassment for the U.S. Securities and Exchange Commission and adds to questions already being asked about the regulator’s competence.
The SEC’s inability to uncover the scandal until Madoff’s sons went to authorities last week comes at a particularly bad time for the SEC and its Chairman, Christopher Cox. They have already been accused by some lawmakers and market experts of being asleep at the wheel while the credit crisis exploded on Wall Street.
The agency’s future existence as a separate agency is already under threat as Washington looks at overhauling the regulation of the financial services industry.
“This will be profoundly embarrassing for the SEC,” said Columbia University law school professor John Coffee, who has been critical of the agency for failing to properly regulate the failed investments banks. “Congress will predictably give them little mercy.”
Madoff, a former Nasdaq Stock Market chairman, was arrested and charged last week with running a massive “Ponzi” scheme using his investment advisory firm.
A rapidly growing number of banks, investment funds, charities and wealthy individuals disclosed on Monday that they had invested in companies controlled by Madoff.
There had already been a number of red flags about the way Madoff operated his investment business going back many years, including an article in the financial newspaper Barron’s in 2001 that questioned how Madoff made stunning double-digit returns year after year.
The Wall Street Journal also reported on Friday that Harry Markopolos, who years ago worked for a rival firm, researched Madoff’s stock-options strategy and was convinced the results likely were not real. Markopolos pursued his accusations over the past nine years, dealing with both the New York and Boston offices of the SEC, according to documents he sent to the SEC, the newspaper said.
“I’m sure people will look closely at them (the SEC),” said Carl Loewenson, a partner in the New York law office of Morrison & Foerster, who warned against blaming the SEC too quickly.
He said the SEC may not completely be at fault for not catching Madoff’s activities sooner, even if some publications questioned his investment returns.
If Madoff was able to fool sophisticated hedge funds, institutions and individuals, he probably would have been able work around regulators too.
“Those people had every incentive to do the utmost due diligence and a lot of them did and a lot of them didn’t discover the fraud,” he said. “The victims here are not Moms and Pops.”
An SEC spokesman declined to comment on the criticism or give any details of inquiries into Madoff’s activities.
House Financial Services Committee Chairman Barney Frank is likely to examine how the SEC handled the matter, which also involves a criminal investigation.
Frank’s spokesman, Steven Adamske, said he would not comment on the matter until the criminal investigation was resolved, but said the committee will not ignore the matter either.
“In due time, however, we will look at what happened with the SEC and work with them to see if there was a failing of policy here,” Adamske said. “If so, there will be an appropriate course of action. But it is not something we will ignore.”
Frank, a Massachusetts Democrat, is a key lawmaker who could help determine how regulation of the financial services industry will be overhauled, given the failings by banking and securities regulators to reign in a bottomless appetite for risk.
He and Christopher Dodd, chairman of the Senate Banking Committee are likely to head the reform efforts in Congress.
Dodd is concerned about the people caught up in the scheme who may have been misled and also how such a massive fraud could have gone undetected, his spokeswoman, Kate Szostak, said.
“Senator Dodd is seeking more information from the SEC about this case and is determined to ensure that securities brokers and investment advisers are effectively regulated and supervised in order to protect investors and consumers,” she added.
In September, the SEC’s inspector general faulted the agency’s oversight of big investment bank Bear Stearns for failing to adequately supervise it and limit its risks.
Even after becoming aware of numerous potential red flags prior to Bear Stearns’ sale to JPMorgan Chase & Co in March, the SEC failed to limit the firm’s risks, including mortgage securities, the inspector general said.
Earlier this year, the Treasury Department issued a set of recommendations to streamline regulation of the financial services industry and entities that flew under the radar of U.S. authorities such as mortgage brokers and lenders, as well as credit default swaps.
The Treasury also recommended combining the SEC with the Commodity Futures Trading Commission and merging bank regulatory agencies the Office of Thrift Supervision and Office of the Comptroller of the Currency.
Some experts do not entirely blame the SEC and instead say Congress should have given the agency more power to regulate some institutions such as hedge funds.
“Congress needs to decide what it’s going to do with these gray area items like hedge funds and swaps,” said John Allan James, an adjunct professor of governance and regulatory issues at Pace University’s Lubin School of Business in New York.
Madoff’s attorney, Ira Sorkin, declined to comment on the case, other than to say a hearing was scheduled for Friday in the SEC case against his client in a federal court in New York.
Editing by Andre Grenon