On December 11, 2008, the Securities and Exchange Commission (SEC) charged Bernard L. Madoff (Madoff) with securities fraud for a multi-billion dollar Ponzi scheme that he perpetrated on advisory clients of his firm. The complaint charged Madoff with violations of the anti-fraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.

In addition, the U.S. Attorney’s Office in the Southern District of New York also indicted Madoff for criminal offenses on the same date. On March 12, 2009, Madoff pled guilty to all charges and on June 29, 2009, federal District Judge Denny Chin sentenced Madoff to serve 150 years in prison, which was the maximum sentence allowed.

By mid-December 2008, the SEC learned that credible and specific allegations regarding Madoff’s financial wrongdoing were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action. As a result, on the late evening of December 16, 2008, former SEC Chairman Christopher Cox contacted the SEC Office of Inspector General (OIG) asking us to undertake an investigation into allegations made to the SEC regarding Madoff, going back to at least 1999, and the reasons that these allegations were found to be not credible.

Former Chairman Cox also asked that the OIG investigate the SEC’s internal policies that govern when allegations of fraudulent activity should be brought to the Commission. In addition, he requested that the OIG investigation include all staff contact and relationships with the Madoff family and firm, and any impact such relationships had on staff decisions regarding the firm.

The OIG’s investigation of the SEC’s failure to uncover Madoff’s Ponzi scheme analyzed the SEC’s response to all complaints it received regarding the activities of Madoff, and traced the path of these complaints through the Commission from inception, reviewing what investigative or examination work was conducted with respect to these allegations.

We have also investigated the allegations of conflicts of interest regarding relationships between any SEC officials or staff and members of the Madoff family, including examining the role that former SEC Assistant Director Eric Swanson (Swanson), who eventually married Madoff’s niece, Shana Madoff (Shana), may have played in the examination or other work conducted by the SEC with respect to Madoff or related entities, and whether such role or such relationship in any way affected the manner in which the SEC conducted its regulatory oversight of Madoff and any related entities.

Further, we have assessed the conduct of examinations and/or investigations of Madoff and/or Bernard Madoff Investment Securities, LLC (BMIS) by the SEC and conducted an analysis of whether there were “red flags” that were overlooked by SEC examiners or investigators (which may have been identified by other entities conducting due diligence), that could have led to a more comprehensive examination or investigation.

We have also considered the extent to which the reputation and status of Madoff and the fact that he served on SEC Advisory Committees, participated on securities industry boards and panels, and had social and professional relationships with SEC officials, may have affected Commission decisions regarding investigations, examinations and inspections of his firm.

The Report of Investigation (ROI) includes the following sections:

(a) the 1992 investigation of Avellino & Bienes and the related examination of Madoff (Section I);

(b) the circumstances surrounding the 2000 and 2001 complaints presented to the SEC by Harry Markopolos (Markopolos) (Section II);

(c) the Office of Compliance Inspections and Examinations (OCIE) Washington, D.C. examination of Madoff triggered by a May 2003 complaint from a Hedge Fund Manager (Section III);

(d) the Northeast Regional Office (NERO) examination of Madoff that arose out of an internal complaint found in April 2004 during a routine examination of an SEC registrant (Section IV);

(e) the Enforcement investigation of Madoff based upon Markopolos’ 2005 complaint (Section V);

(f) a discussion of whether there was any improper influence by senior-level officials at the SEC upon the examinations and investigations of Madoff and the effect that Madoff’s stature had on the SEC’s conduct of its examinations and investigations of Madoff (Section VI);

(g) an analysis of the allegation that former OCIE Assistant Director Eric Swanson’s relationship with Shana Madoff impacted the SEC’s examinations of Madoff (Section VII);

(h) a summary of the due diligence efforts undertaken by private parties who determined that Madoff was not a wise investment and a comparison with the methods utilized by the SEC in its examinations and investigations(Section VIII);

(i) the extent of reliance by potential investors with Madoff on the fact that the SEC conducted examinations and investigations of Madoff in making investment decisions; (Section IX);

(j) a summary of all the additional complaints that the SEC received regarding Madoff, or any of his firms or related entities (Section X); and

(k) a description of all the additional examinations that the SEC conducted of Madoff or his firms (Section XI).

Download Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme

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U.S. Securities and Exchange Commission
Office of Investigations

CONCLUSION
The OIG investigation found that the SEC received numerous substantive complaints since 1992 that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading and should have led to a thorough examination and/or investigation of the possibility that Madoff was operating a Ponzi scheme.

However, the OIG found that although the SEC conducted five examinations and investigations of Madoff based upon these substantive complaints, they never took the necessary and basic steps to determine if Madoff was misrepresenting his trading. We also found that had these efforts been made with appropriate follow-up, the SEC could have uncovered the Ponzi scheme well before Madoff confessed.

The OJG found that the conduct of the examinations and investigations was similar in that they were generally conducted by inexperienced personnel, not planned adequately, and were too limited in scope. While examiners and investigators discovered suspicious infonnation and evidence mid caught Madoffin contradictions and inconsistencies, they either disregarded these concerns or relied inappropriately upon Madoff's representations and documentation in dismissing them. Further, the SEC examiners and investigators failed to understand the complexities ofMadoff's trading and the importance ofverifying his returns with independent third-parties.

The OJG did not find that the failure ofthe SEC to uncover Madoff's Ponzi scheme was related to the misconduct of a particular individual or individuals, and found no inappropriate influence from senior-level officials. We also did not find that any improper professional, social or financial relationship on the part of any fonner or current SEC employee impacted the examinations or investigations.

Rather, there were systematic breakdowns in the manner in which the SEC conducted its examinations and investigations, and for that reason, the OJG is issuing under separate cover two audit reports providing the SEC with specific and concrete recommendations to improve the operations ofboth OCIE and Enforcement.

The OJG also recommends that the Chainnan carefully review this ROJ and share with OCIE and Enforcement management, the portions ofthis ROJ that relateto the perfonnance failures by those employees who still work at the SEC, so that appropriate action (which may include perfonnance-based action, as appropriate) is taken, on an employee-by-employee basis, to ensure that future examinations and investigations are conducted in a more appropriate manner and the mistakes and failures outlined in this ROJ are not repeated.

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