Madoff Scam Reached Family of SEC Official Whose Unit Got tip

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Madoff Scam Reached Family of SEC Official Whose Unit Got Tip
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By David Scheer and Joshua Gallu


Sept. 7 (Bloomberg) -- Family members of a U.S. Securities and Exchange Commission enforcement official, whose unit got a tip in 2005 that Bernard Madoff may be running a Ponzi scheme, entrusted $2 million to the scam, the agency’s watchdog said.

The anonymous e-mailed tip to the Office of Internet Enforcement was among at least six “substantive complaints” the SEC didn’t fully investigate during 16 years, Inspector General H. David Kotz said Sept. 4 in a report released before he testifies before the Senate. Investments by two of the official’s relatives were disclosed as a footnote in the 457- page report, which doesn’t identify him or specify losses. He wasn’t part of any Madoff probe, Kotz noted.

Kotz’s eight-month inquiry offers the most exhaustive look yet at how the agency missed chances since 1992 to detect a $65 billion fraud that burned thousands of investors. The inspector faulted the agency for inadequately pursuing tips, assigning inexperienced staff to conduct reviews and failing to seek trading records that would have revealed the scam.

“It is a failure that we continue to regret, and one that has led us to reform in many ways how we regulate markets and protect investors,” SEC Chairman Mary Schapiro said in a statement. “In the coming weeks we will continue to closely review the full report and learn every lesson we can.”

Though the report describes dozens of contacts between Madoff and senior SEC officials, including former chairmen, it doesn’t find that managers improperly influenced or interfered with inquiries. Nor did Kotz find that an SEC employee’s romantic relationship with Madoff’s niece had any affect on the agency’s examinations.

Instead, Kotz said the SEC failed to scrutinize Madoff during a 1992 probe of a firm that funneled him money. Years later, employees failed to scrutinize his consistently strong profits, didn’t press harder when they caught him in lies and abruptly ended an examination to focus on mutual-fund abuses.

Exhibits Withheld

The SEC didn’t release more than 500 exhibits referenced in the report, including testimony from Madoff in June. The agency released the report after 5 p.m. on Sept. 4, the Friday before a three-day U.S. holiday weekend. A 22-page executive summary was issued Sept. 2

Kotz will testify on his findings before the Senate Banking Committee on Sept. 10. Other witnesses include SEC Enforcement Director Robert Khuzami and Harry Markopolos, a former money manager who repeatedly gave the agency details on Madoff’s scheme, according to the panel’s Web site.

The anonymous tip to the Internet unit, received in October 2005, claimed to be from a former client at Madoff’s New York- based investment advisory business.

‘Very Secretive’

“I know that Madoff company is very secretive about their operations and they refuse to disclose anything,” it said. “If my suspicions are true, then they are running a highly sophisticated scheme on a massive scale. And they have been doing it for a long time.”

The informant also added, “After a short period of time, I decided to withdraw all my money (over $5 million).”

The Internet enforcement official told Kotz he first became aware of the warning the day Madoff was arrested in December, after asking his staff to search the office’s archives for complaints relating to the scam, according to the report. The official said the tip should have been flagged for further investigation in 2005. An attorney working in the office testified she couldn’t remember whether she referred it. It apparently wasn’t passed along, Kotz concluded.

Kotz and SEC spokesman John Nester declined to comment beyond the report. John Reed Stark, who has led the SEC’s Internet program since 1995, couldn’t be reached after normal business hours on Sept. 4.

Renaissance Signals

Kotz also found that examiners failed to follow up on signs of fraud found during a routine examination of Renaissance Technologies LLC. An SEC compliance examiner informed his supervisor about internal e-mails at Renaissance, which indirectly invested in Madoff’s fund through a swap agreement with another firm, saying Madoff’s business may be a fraud, Kotz wrote. While the agency examined Madoff’s firm, it didn’t return to Renaissance to examine its information.

Renaissance e-mails said Madoff’s secrecy, auditor and fee structure were significant red flags, according to the report. Nathaniel Simons, portfolio manager for a Renaissance fund, said he didn’t understand how Madoff made money or why he used a fee structure that gave such a large percentage of profits to feeder funds.

“As we don’t know why he does what he does, we have no idea if there are conflicts in his business that could come to some regulator’s attention,” Simons said in an e-mail dated Nov. 13, 2003, according to the report. “Throw in that his brother-in-law is his auditor and his son is also high up in the organization and you have the risk of some nasty allegations.”

Prison Sentence

Madoff, 71, is serving a 150-year prison sentence after pleading guilty to a fraud that federal investigators said dated to at least the 1980s. The scam funneled funds from new clients to pay returns that were purportedly generated by a stock and options trading strategy known as a split-strike conversion.

SEC investigators have said Madoff and employees at his New York-based firm, Bernard L. Madoff Investment Securities LLC, used a variety of ruses, such as creating sham trading records, to avoid detection.

The criminal case against Madoff is U.S. v. Madoff, 09-cr- 213, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporters on this story: David Scheer in New York at dscheer@bloomberg.net; Joshua Gallu in Washington at jgallu@bloomberg.net.

Last Updated: September 7, 2009 00:01 EDT