(editorial) To Catch a ThiefDecember 18, 2008
Bernard Madoff’s alleged $50 billion fraud is giving politicians and investors who failed to diversify another excuse to blame too little enforcement in U.S. financial markets. Talk about compounding a case of misplaced trust. The real lesson is that financial enforcement nearly always fails to protect investors, and this Ponzi scheme is merely typical.
Since 2000 and especially after the fall of Enron, the SEC’s annual budget has ballooned to more than $900 million from $377 million. (See the nearby chart.) Its full-time examination and enforcement staff has increased by more than a third, or nearly 500 people. The percentage of full-time staff devoted to enforcement — 33.5% — appears to be a modern record, and it is certainly the SEC’s highest tooth-to-tail ratio since the 1980s. The press corps and Congress both were making stars of enforcers like Eliot Spitzer, so the SEC’s watchdogs had every incentive to ferret out fraud.
Yet they still failed to nail Bernard Madoff. Since at least 1992, when the SEC sued two accountants peddling Madoff investments while promising sky-high returns, the commission missed opportunities to dig deeper into his operations. In 1999, trader Harry Markopolos wrote that “Madoff Securities is the world’s largest Ponzi Scheme,” in a letter to the SEC. More recently, multiple SEC inquiries and exams in 2005 and 2007 found only minor infractions.
Under New York law, meanwhile, Mr. Madoff had to register as a broker with the Investor Protection Bureau of the office of the New York Attorney General. The New York AG is among the most powerful state securities regulators in the country, because the Martin Act allows him to pursue criminal convictions without having to prove criminal intent. Yet neither current AG Andrew Cuomo nor Mr. Spitzer appears to have had a clue about Mr. Madoff’s conduct.
Then there’s the Financial Industry Regulatory Authority (FINRA), a “self-regulatory organization” funded by industry. Its 3,000 employees ride herd on the brokerage industry, and these private cops are armed with an even bigger budget than the SEC. FINRA doesn’t disclose tips and complaints when they don’t result in enforcement action, so we can’t know for sure whether FINRA was contacted about the alleged Ponzi scheme.
What we can see are the Madoff files maintained by FINRA’s BrokerCheck database. Sons Andrew and Mark Madoff had clean records, while Bernard Madoff and his firm had infractions that probably appeared minor to regulators. An exception is the firm’s August 2008 failure to submit accurate “blue sheet” information, which might appear to be sloppy record-keeping, but might have suggested something worse to aggressive regulators.
Back at the SEC, even Chairman Chris Cox is blaming the enforcement staff, which as everyone knows may or may not pay attention to the five Commissioners. “The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action,” he says. We’ve also learned that Mr. Madoff’s niece married an SEC inspections official, but the complaints about the Madoff firm long preceded that romance.
Mr. Cox and Congress will undoubtedly look for other conflicts of interest, but the larger truth is that the SEC’s failure is business as usual. The real news would be a case when the SEC did prevent a fraud. Typically, its enforcers wait for a phone call and then pursue the tip, or in the case of Mr. Madoff pursue it without much energy.
The fact is that the only people who seem to have taken concrete action to protect investors from Mr. Madoff are private research shops like Aksia LLC. Its analysts did the real work of figuring out that Mr. Madoff’s claimed investment strategy couldn’t be happening at the volumes he claimed to be trading. Likewise, it was the short sellers who first blew the whistle on Enron, while the SEC was clueless and the firm’s auditors were asleep.
There’s a lesson here for investors and Congress. Instead of shoveling more money and power to the regulators who already had plenty of both, let’s take care not to overregulate the people who actually warned about Mr. Madoff’s miracle returns. Law enforcement is useful in punishing wrongdoers after the fact, which will deter some crooks. But expecting the SEC to prevent a determined and crafty con man from separating investors from their money is no more sensible than putting your life savings with a Bernard Madoff.