Four days after Bernard Madoff was arrested for allegedly running a "$50 billion ponzi scheme" disguised as an investment advisory business, attention is beginning to focus on what looks like a glaring failure of oversight by government regulators.
Let's step back for a second. Part of what may have helped Madoff escape scrutiny is that his company consisted of two separate arms -- a securities brokerage, which acted as a middleman between buyers and sellers of shares, and a straight investment business. According to the SEC complaint filed last week, Madoff ran the investment arm as a secretive business separate from the brokerage, and it was this arm that was used to perpetrate the alleged fraud.
Bloomberg reported yesterday that since Madoff registered the investment arm with the Securities and Exchange Commission in 2006, that agency hadn't got around to looking at the business's books. The SEC usually tries to go through the books of newly registered firms in their first year.
"If the SEC didn't come in and inspect (the Madoff hedge fund), then they have a hell of a lot to answer for," one expert told the Associated Press.
But the problem doesn't appear to have started in 2006.
As early as 1999, an executive in the securities industry had urged the SEC to probe Madoff, on the basis of the remarkably steady returns that his investment business seemed to provide. The executive, Harry Markopolos, argued that Madoff must be generating those returns by "front-running" -- that is, using the brokerage arm of his company to illegally provide information to the investment arm.
The SEC said in a statement that it had conducted two investigations into the brokerage arm -- not the investment arm -- of Madoff's company, in 2005 and 2007. The first, begun in response to allegations of front-running, found three violations of rules requiring brokers to obtain the best possible price for customer orders. That investigation appears to have led to Madoff agreeing to register with the SEC the following year, giving the agency access to far more information than it previously had. But the 2007 probe, conducted after Madoff registered, found no evidence of anything improper.
It's unclear why the probes focused on the brokerage arm when it was the investment arm that had generated complaints in the past -- and which apparently would have been the arm that improperly profited from any front-running activity.
So there are still far more questions than answers, including in regard to the performance of government regulators. But so far, the SEC doesn't appear to have covered itself in glory on this one.