Blogging the Senate’s Madoff Hearing

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Blogging the Senate’s Madoff Hearing
January 27, 2009, 12:53 pm
The Madoff ScandalIndustries Financial ServicesThe Senate Banking Committee held a hearing on Tuesday to look into the disgraced financier Bernard L. Madoff’s reputed $50 billion Ponzi scheme, how it escaped detection for years and what regulatory changes are needed to prevent a repeat.

The committee, led by Senator Christopher J. Dodd of Connecticut, heard from six witnesses: Professor John C. Coffee Jr. of Columbia University Law School; Dr. Henry A. Backe Jr., a Madoff investor and orthopedic surgeon from Fairfield, Conn.; Lori Richards, director of the office of compliance inspections and examinations at the Securities and Exchange Commission; Linda Thomsen, director of the S.E.C.’s enforcement division; Stephen Luparello, interim chief executive of the Financial Industry Regulatory Authority, or Finra; and Stephen P. Harbeck, president of the Securities Investor Protection Corporation.

DealBook live-blogged the hearing, with the most recent posts on top:

12:53 p.m. | It’s a wrap: Mr. Dodd concludes the hearing by saying that obvious errors were made regarding the Madoff case, but that should not stand in the way of discussions about what sort of regulatory reform is needed to prevent future frauds.

12:49 p.m. | Expanded jurisdiction: Mr. Coffee suggests Finra’s jurisdiction might have to be expanded to include investment advisers or have its own self-regulatory organization. He also suggests that Congress should consider whether S.I.P.C. should have a regulatory function much like the Federal Deposit Insurance Corporation.

12:34 p.m. | “A lot to answer for”: Mr. Coffee says Mr. Madoff’s brother Peter, the chief financial officer for the Madoff firm, has “a lot to answer for” because he failed to disclose to Finra that the investment advisory business actually existed within the firm.

12:29 p.m. | “Mr. Madoff was smarter than you”: Senator Robert Menendez, Democrat of New Jersey, assails Ms. Thomsen for not investigating Mr. Madoff further after he violated S.E.C. rules by not registering as an investment adviser before 2006. “So Mr. Madoff was smarter than you?” Mr. Menendez asks, and Ms. Thomsen responds again that she can’t comment on the specifics of the Madoff case.

12:25 p.m. | Feeder funds: Senator Jack Reed, Democrat of Rhode Island, asks Mr. Coffee about the role of feeder funds in sending money to Mr. Madoff’s firm. Mr. Coffee raises the possibility that Mr. Madoff could have paid feeder funds “under the table” to direct funds to the firm and he wouldn’t be surprised if this in fact happened, especially near the end of the Ponzi scheme.

12:15 p.m. | Support for independent custodians: Ms. Thomsen and Ms. Richards, who are only speaking for themselves and not the S.E.C., say they support requiring independent custodians for investment advisers.

12:02 p.m. | No customer complaints: Senator Bob Corker, Republican of Tennessee, asks Mr. Luparello if Finra digs further into the books and records of brokerage firms they examine. Mr. Luparello says the regulator does not just rely on the data firms provide, but in the case of Mr. Madoff’s broker-dealer operations, no red flags popped up and Finra received no customer complaints about the firm.

11:55 a.m. | Advisers’ performance data: Asked whether Mr. Madoff’s consistent investment returns raised any red flags, Ms. Richards said the S.E.C. doesn’t have access to a lot of investment advisers’ performance data because, in many cases, they aren’t required to provide them to regulators.

11:36 a.m. | Prior actions: Ms. Thomsen says some of the prior actions by the S.E.C. and others may have resulted in perjury and criminal action and the S.E.C.’s inspector general is pursuing the investigation.

11:28 a.m. | Red flags and tips: Mr. Dodd asks the S.E.C. how it avoided not reacting to all of the red flags, including Harry Markopolos’s analyses about Mr. Madoff’s firm. Ms. Thomsen says she can’t talk about the specifics of how the S.E.C. handled the tips about Mr. Madoff’s firm, but reiterated that the agency receives a substantial amount of tips, and that if there’s no evidence of fraud, the S.E.C. has to decide when to stop the investigation and focus its limited resources to another case.

11:23 a.m. | Independent custodians: Ms. Richards, responding to questions from Mr. Dodd, says the S.E.C. is strongly looking at taking up Mr. Coffee’s suggestion that all investment advisers have independent outside custodians, although it will increase the cost for investment advisers. Mr. Dodd said he wants to see immediate action on the matter.

11:15 a.m. | Claims and assets: Mr. Harbeck of S.I.P.C. said that more than 900 claims in the Madoff fraud case had been submitted so far and that further accounting work needed to be done before S.I.P.C. can start processing claims. The trustee overseeing the liquidation has taken possession of $100 million of assets and has identified about $830 million worth of liquid assets.

11:08 a.m. | No signs of trouble: - Mr. Luparello says Finra examined the broker-dealer operations of Mr. Madoff’s firm every other year and never saw any signs of trouble or received any tips about Madoff’s investment advisory business. During every inspection, Finra was told that 90 percent of the firm’s profits came from traditional market making operations and 10 percent came from proprietary trading.

11:04 a.m. | Thousands of tips: Ms. Thomsen echoes her colleague’s comments, saying they receive hundreds of thousands of tips every year and doesn’t have the resources to pursue every one of them. “Everyone at the S.E.C. wishes the Madoff fraud were detected earlier.”

10:58 a.m. | Oversight of advisers: Ms. Richards says the S.E.C. is examining several ways to improve oversight of investment advisers but notes that the nation’s top securities cop doesn’t have the resources to oversee the entire industry. “The S.E.C. cannot examine every investment adviser with frequency,” she said. About 10 percent of the 11,300 investment advisers in the United States are examined every three years by the S.E.C, Ms. Richards notes.

10:48 a.m. | Investing the pension plan: Dr. Backe says he engaged Mr. Madoff in the early 1990s to invest and administer his practice’s pension plan. His office invested its entire pension plan, with contributions from 15 doctors and over 100 staff members. The pension plan had contributions of $11.5 million and a paper balance of $33 million at the end of 2008. Dr. Backe says he spends $70,000 a month on legal fees and spends at least two hours a day dealing with the fallout from Mr. Madoff instead of seeing patients.

10:34 a.m. | Clearing and settling: Mr. Coffee highlights the problem of investment advisers who are self-clearing, or act as their own custodians, and suggests all advisers must have external clearing and custodial services. Mr. Madoff, of course, said he cleared and settled his own trades through his affiliated brokerage firm.

10:27 a.m. | Elephant in the room: Senator Charles E. Schumer calls the fraud “a punch in the gut” to the financial system and castigates the S.E.C. for its failure to uncover the scheme. He likens the actions to a giant elephant standing in a small room next to the S.E.C. for decades and “not only did they not see the elephant, they didn’t even smell the peanuts on his breath,” Mr. Schumer says.

10:18 a.m. | Where’s Markopolos?: The man who raised the red flag fails to show up again. Mr. Dodd says Harry Markopolos, who wrote a detailed analysis in 2000 of Mr. Madoff’s strategy and concluded it was a fraud, had the flu and couldn’t attend the hearing. Mr. Markopolos failed to show up at another hearing in the House of Representatives a few weeks ago.

10:05 a.m. | Opening statements: Mr. Dodd opens the meeting recapping the tragedy of Mr. Madoff’s $50 billion Ponzi scheme and asking how “regulators could miss so many warning signs.” “What’s most disturbing is that it went undetected” until Mr. Madoff himself confessed to the crime, Mr. Dodd says. Senator Richard C. Shelby, the ranking Republican member of the committee, also puts in his two cents, citing the “numerous red flags under their nose.”

Go to Hearing Statements and Details from the Senate Banking Committee