Why SEC Stopped Investigating

It is a common notion that the U.S. Securities and Exchange Commission missed Bernard Madoff’s Ponzi scheme because its examiners were inexperienced and there weren’t enough resources. These claims do not hold up. From Ponzi Regulation

“…in fact some junior investigators realized there was something wrong and left to themselves would have almost certainly discovered the truth. They were prevented by a senior SEC manager.

A lot of resources were spent on Madoff and at least one team of examiners caught his lies—and left an email trail saying so. ….

One SEC examiner asked another in an email: ‘would you have time to take a look at the data to see if I am missing some obvious – and innocent – explanation for this?’ The obvious explanation was that Madoff was not telling the truth, and it is hard to imagine how that could be innocent.

This team of examiners was supervised by an SEC veteran with decades of experience. Therefore the claim that inexperience led to mistakes is nonsense: in fact it was the supervisor who told the examiners not to proceed further. He decided against the next step, which was to talk with the feeder fund operators—in effect, Madoff’s outside marketers.

The reason for the supervisor’s decision appears to be self protection. He mentioned that he was afraid of being sued by Madoff if the feeder funds turned around and pulled their assets, but this is not plausible. While any business manager in America fears being sued, a federal agency is largely protected from liability. It is extremely difficult, if not impossible, to succeed in suing a regulator…

And of all people, Madoff was the most unlikely to start a lawsuit. That would have meant being questioned. He was famous for his extreme secrecy, as the SEC staff knew. This was a man who did not want to take questions in private or give information to long-time associates; no way would he subject himself to hostile lawyers in a public courtroom…

There were other reasons for closing the case—SEC examiners had spent plenty of time on the Madoff examination; brokerage overseer NASD (later renamed FINRA) was the primary regulator of the firm and would be conducting additional exams. However, the examiners on the ground were not satisfied. ….

The SEC supervisor may have had reasons beyond what was stated for not pursuing the matter further. Madoff was aggressive in resisting investigations into the questionable parts of his story and not shy about raising hell—as long as it did not involve publicity. Had the examiners gone on, he might have privately complained to his high-level contacts that the SEC was harassing him.

From the supervisor’s point of view, the options were angering a powerful man versus saving himself the hassle. Put that way, it was an easy choice….”

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