SEC Ignored Warnings On $50 Billion Ponzi Scheme Since 1999
SEC's chief announced they had repeatedly received since 1999"credible and specific allegations" about Madoff’s $50 billion pyramid scheme...
...but for some reason were never acted on. That "some reason" is probably because their funding and resources were slashed to the core by agents of the anti-regulatory movement. Congrats, fellas, you got the government out of the marketplace and now the market is out of the marketplace as well.
S.E.C. Chief Says Staff Ignored Warnings on Madoff [Dealbook]
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Yes, the SEC was hurt by funding/staffing cuts, but there are also fairly substantive allegations of wrongdoing and cronyism.
You can give government agencies and regulators all the resources in the world, but you also have to make sure you aren't just providing for nicer back rooms that the old boy's network can work in. Regulation isn't a panacea, and throwing money at incompetence just creates more spectacular failures.
Keep in mind that lots of wealthy banks and superwealthy investors also got burned - all of which gave this guy a once-over with due diligence and didn't see the obvious problems. Isn't this a strong argument that more regulation and funding wouldn't have helped?
I didn't know it was possible to smile AND frown at the same time!
I've worked in a strictly-regulated bank and a loosely-regulated one (by the same governing body in the same region). The amount of variation in oversight from one to the next is astounding.
This doesn't surprise me one bit. Ultimately most financial regulation involves a degree of "gut feel" from the regulators in charge, regardless of what any quantitiative formulas might indicate (eg, capital ratios)
What about the responsibility of the investors to fully understand where they're putting their money? If they're going to be blindly throwing billions of dollars into this, you'd think they should the burden when it goes up in flames, right?
It shouldn't be the government's job to ensure everyone's investment decisions are wise -- otherwise it'll be the government's fault when those investments go awry.
No, but the government should have an active role in preventing fraud and establishing reasonable baselines. Basic regulation and oversight helps increase confidence in financial markets and ensures their efficient operation. Even dyed-in-the-wool capitalists believe in some level of regulation, though there is wide disagreement on how much is enough/too much.
It was just revealed that Madoff's compliance officer was married to one of the SEC investigators.
Unregulated Capitalism has destroyed the soul of our nation.
Congrats Wall Street and ever other slime out there, you did what Communism could not.
@The Name's Ash78, Housewares:
@ADismalScience:
Correct on both counts. In free market capitalism, the responsibility to investigate purchases should land squarely on the investor. Buyer beware.
However, rating the risk of an investment is impossible if the company is cooking the books. It is government's responsibility to insure that the company is following legal, honest forms of reporting the health of the company.
Everyone failed in this Madoff case; the government, the investors, the trusted fund manager. I agree with Ben, but only if we find that the SEC failed due to understaffing or underfunding. If it turns out to be fraud, or insider relationships, then it's government that's once again failed us due to corruption and greed.
What has astonished me is the number of hedge funds that put a vast majority of their moneys into this guy's fund. They obviously didn't do their own due diligence on the guy. They didn't diversify their investments. And they took huge fees for just picking up the phone and sending this guy check after check.
@ADismalScience: I think this is probably a case of hindsight being 20/20. Madoff is a smart guy. The only reason he was discovered is because everyone pulled out all at once and his sons tipped off the FBI. Other than the basic risk of Ponzi schemes failing, it sounds like he had a pretty bulletproof, transparent operation going. I bet the SEC gets tons of complaints and warnings on everybody and everything. But when you consider who Madoff is and how smart he probably had this all put together, they didn't find a thing. Or, knowing who Madoff is, they didn't investigate as deeply as they normally would have.
@Trotsky: LOL, unregulated. As if there aren't thousands of pages of US Code on market regulation, bankruptcy, and hundreds of other economic laws.
LOL, capitalism. As if our government didn't just socialize the failure of the banks and, soon, the car industry.
Point me to one time period where we had unregulated capitalism. Otherwise your comment is ignorant and empty.
@Bojangles: What I love is that you just leave Madoff out of it. Yes, it's all those customers' fault -- the crook should just get away! Because the alternative to the crook getting away is actually having a government that does something once in a while, and nobody wants THAT.
@Trotsky: You are kidding right? I really hope that is sarcasm.
Caveat emptor. People were fighting to invest in this scheme. However, they never took the time to understand it and were shortsighted. They only saw a big return. If anything, individual greed has as much to do with this as anything.
I like my capitalism like I like my coffee.
With no government.
Don't worry, we are migrating toward socialism. And as we know people (citizens) really flourish under socialism. When our new socialist steward replaces the old one, what will happen?
@picardia: It's not that we want a government that does nothing. We want a government that does something RIGHT. That just doesn't happen very often.
@TheFlamingoKing: I guess it was the tone of the comment, but I read your name as TheFlaming-O-King.
Flame on! :D
How was this a pyramid scheme?
@picardia: Oh, Madoff will get his as well. I'm not denying that. I wanted to point out, though, how everyone is pointing fingers and Madoff and the government, but very few at the actual people funding him.
And it's not just this case, either. Somehow it's the goverment's fault that people took out loans that they couldn't pay for. There's a distinct lack of blame being placed on the actual people making bad investment decisions, and I think that's a shame.
"The ultimate result of shielding men from the effects
of folly is to fill the world with fools."
@TheFlamingoKing: I do believe that all involved parties failed. It is easy to always blame someone else. If the SEC failed to do their job, then it is not just their fault.
The concern is that they did the latter. The SEC is being investigated pretty heavily on this matter from what I understand. It's like with anything else - some people know some other people and extend trust beyond the normal course of duty. People work in governments, not policy automatons, which is why I'm skeptical that any amount of regulation would have helped here.
The best analogy I can think of is having your friend that you've known forever come in to contract for you. You don't pay as much attention and then weeks later you find out some of your wife's jewelry is missing. Madoff has been on the Street since the 60's and had an impeccable reputation - which, I'm afraid, he appears to have used to achieve a unique abuse of the trust of both his investors and the SEC.
@ADismalScience: I get what you're saying. And I'm on board with that. At the same time though, I believe there is a big responsibility with investors to ask the tough questions. There have been lots of special interviews with analysts talking about this whole mess, and they all said the same things: These investors needed to ask the routine questions you ask when investing, and they needed to ask them often. Consistent 10-15% annual returns is unheard of, especially when returns are unaffected by other economic factors.
I guess basically I'm saying that it takes two to tango, if that's the right saying. Investors need to be cautious and investigate, SEC shouldn't have assumed his sterling reputation means he's not a thief on the inside.
@ADismalScience: Private entities can only take their marbles and go home if they don't get the access they need. A problem, if all the marbles are lost before the ills are exposed.
Lying to gov't regulators, FBI, etc., or using a legal demand to wipe with? Jail. Ruin. Perp walks.
There's a role for both, but both are needed in different ways.
Hiring a guy who says he hates gov't and it's always the problem to run things is like hiring an arsonist into your fire department.
"They obviously didn't do their own due diligence on the guy. They didn't diversify their investments "
Right - O , johnfrombrooklyn.
Everyone from wife bartering savages to Warren Buffett knows that you NEVER put all of your money in one investment. Period. Madoff may be a huge putz,but the money jockeys that put all of their eggs in his basket are at least as stupid as he is crooked.At bottom,this is a giant affinity fraud because I have been made to understand that the vast majority of Madoff's victims are Jewish and Jewish charities. But the hell of it is that even if this guy gets life with no possibility of parole,he might do 7-8 years before going Tango Uniform. Buyer beware,indeed...
All fair points, and failures in those areas are why so much money was lost and why many regulators will probably get canned or face jail time.
To my large point, though, the government's role is to provide a reasonable basis for all of this activity. Have they succeeded in providing enough control? I think they have. 50B lost is a big number and this scheme is unfortunate, but I think the size of the catastrophe is more a function of the failure of existing regulation than the absence of effective controls. If the SEC guys weren't corrupt or stupid they would have known that a 3-person audit team hovering over a product of that size wasn't legit. SEVERAL investment banks came out with press releases indicating that their due diligence teams concluded he was full of shit (and, of course, several disclosed losses).
The evidence was there, regulators were there, controls were in place - they simply failed, because governments infrequently hold up their end of the bargain when it comes to regs.
@Trai_Dep:
I'm not sure what you mean here, your post is a little jumbly. Are you suggesting that stronger fines and jail time are required in these cases? I'd respond that Madoff faces financial destruction and 20 years.
Out of the "seven deadly sins," Greed is the worst one there is. It leads to all the other ones and is the main cause of all the problems in the world. CEOs cheating people out of money left and right; investors like Madoff stealing people's money; companies cutting corners to make more money with lower quality products...the list goes on. Greed is a terrible, terrible thing.
@ADismalScience: He also violated a practice that, up until now, was always assumed* to be the norm. Normally, hedge funds have trading desks at other firms. It's a systemic reality check: if my books SAY I've bought 1m shares IBM, I have to actually give someone $ to effect that trade. And the two are easy to reconcile.
Madoff was also a market maker - he did his own trading. Hence no external entity was demanding real, hard, cash for all the transactions his books purported to have done. That's why it went so far and for so long.
It'd be a good thing to codify this informal norm into a law. One of many reforms, but a good start.
* Uh-huh. You know what they say...
@ADismalScience: What are you proposing as an alternative to regulation and government oversight? Jail time and fines may be ok after-the-fact, but the best results are obtained by ensuring the fraud and abuse doesn't happen to begin with. Lacking a better alternative, regulation is the only way to go.
@ADismalScience: Touche. Your argument is very compelling. Given the way the government has handled other recent messes, I think I'm falling more in line with what you're saying.
@ADismalScience: "Isn't this a strong argument that more regulation and funding wouldn't have helped?"
No, that's a straw argument. You're only talking about more funding, there hasn't been actual regulation, and actual CONSEQUENCES under this administration and the policies it enforces in all agencies.
@TheFlamingoKing: Unenforced laws = no laws. Which proves the point.
And, YOUR guy nationalized the US financial sector, not "the government". You achieved the near-impossible, so stand tall. The Republicans, thru ineptness and blind ideology forced the takeover of vast swaths of our private sector. While it's a stupider way to go about achieving Karl Marx's dream than the way he envisioned, it's still a signal accomplishment. Good job! Maybe take a well-deserved vacation in New Orleans?
You misunderstand. I'm saying regulation was there, and it simply failed.
I'd compare our willy-nilly cry for regulation after every scandal to the French response to the Great War. We suffer some horrible trauma, and the immediate response is "Regulate, regulate! Build a wall!" So we create the Maginot Line. Impressive! The Germans certainly can't go that way anymore. But there's always Belgium...
@Trai_Dep:
Any auditor other than the paid-off storefront firm Madoff used would have instantly complained that there was no possession and control over the fund's assets. The problem isn't the lack of oversight, it's that the oversight is corrupt. HF's will argue that they need to keep their positions and transactions secret, and I side with them against your suggestion of some sort of clearinghouse.
@ADismalScience: >gave this guy a once-over with due diligence and didn't see the obvious problems.
I'm going to have to take issue with this. On the NPR story about this guy yesterday they'd said that the ROI for this guy was far, far above what other investment firms were offering. Apparently people were practically begging him to take their money. Due diligence is one thing, but shouldn't common sense have reared its head and made people realize "Hey, this guy's ROI is insane compared to the other firms, can it be for real?"
It seems like time and time again in this crisis people that depend on goofy, esoteric market manipulation to get their money were the ones that got bit in the end, but the people that took a reasoned approach that invested in either tangible or highly conservative things win in the end. Warren Buffet knew this, why didn't everyone else?
SEC overlook something? C'mon, say it aint so...
His ROI wasn't insane, I have to correct you there - 10-12% is good but not unusual. It's relatively common for a fund to have market-beating returns, even over time - guys like Peter Lynch were able to beat the market for decades, and otheres pull off incredible years like Paulson did in 2007.
What was insane and hackle-raising for many prospective investors was his amazing results in the second-most important measure of asset manager performance: volatility. It is incredibly unusual for a fund to have so little variance from month to month from a performance perspective. His fund's performance volatility had so little correlation to the market that many due diligence teams concluded he was falsifying results. I would strongly suspect that commentary from several firms's due diligence teams regarding Madoff's lack of volatility were the "credible and specific allegations" that were being ignored as per the OP.
This guy will get less 10 years of actual time spent in prison, maybe less. The problem is that we still treat white collar crime like it isn't as bad.
Start applying RICO (and going after all the corporate officers) and sticking these idiots into a maximum security prison (23 hr a day lock downs) and you'll see a drop.
Ben, I am scratching my head trying to figure out what exactly "funding and resources were slashed to the core" means.
Total SEC budget has more than doubled under Bush 43 (see, for example, the first Google hit for "sec budget" -- [www.sec.gov])
Do you mean some sort of intra-agency resource allocation?
BULL. SHIT. That's what this excuse - and this post - are. The SEC looked the other way due to the sheer size of this guy's alleged assets. The SEC plays tough with the little guys and turns a blind eye to the largest thieves. Always has, always will. It has *NOTHING* to do with regulation. Or the budget.
@JimK: I don't think that's it, either. The SEC, like virtually all regulatory agencies, is designed to make sure people are following "the rules" -- that their i's are dotted and their t's are crossed. I think they do a good job of applying the rules fairly to people and organizations both big and small. (Of course, the bigger you are, the more people you can afford to hire to make sure you aren't breaking some silly rule.)
The problem with Madoff is that he followed all the silly rules. His paperwork was in order, so to speak. To detect that kind of fraud you have to go a little farther. Not saying that the SEC shouldn't have done that -- they definitely should have! But the reason they didn't is a lack of imagination, not of money. It only costs pennies to pick up the phone and call around about the supposed auditors and accountants Madoff's fund listed.
Here's more:
[meganmcardle.theatlantic.com]
The SEC turned a blind eye due to this guy's assets/reputation. They should be largely to blame in this mess, and they should be made to make it up to all the investors, or at least the nice ones.
heh heh heh
@Inglix_the_Mad: For real. 10 years (if that) at a country club isn't much of a sentence. That or wearing an ankle bracelet at home...
EXCUSE ME! I seem to recall having to modify lots of source code (not long ago) to raise the SEC FEE to some outrageous percentage. No one knew why the fees went up because they sure didn't add any more services. Where did all those new fees go?
Ponzi scheme, not pyramid scheme. Though, we may have seen pyramid schemes popping up sooner or later in an unregulated market.
However, it's foolish to blame this occurrence on deregulation. You know the Fed didn't act on this because I'm sure plenty of them had there hands in Madoff's cookie jar, or at least figured that they'd rather see some investments growing, at least ostensibly, instead of attacking them.
Like zigziggityzoo implies to kickstart the comments, over-regulation is like pumping cement into the market. While it creates very safe channels to ensure long-term growth at the expense of short-term success (not really a bad thing), the regulations themselves put a stranglehold on individual investors and investment groups. If you don't get the right balance, you end up strangling too much and you restrict growth. This happens in every industry when third-party intervention (government or involuntary regulatory bodies) gets ahead of itself, even for very good and apparently necessary reasons.
What you imply with this conclusion is that there's never really enough control to investigate every nook for loopholes, schemes, and scams. Besides bordering on fallacy, it's short-sighted. Don't just make it risky to attempt a Ponzi scheme, make it impossible or unnecessary. How about transparent investments up and down the chain? Requiring paper purchases, instead of just throwing money into the tumbler and watching more come out? Simpler control, not just more control.
While I agree that the market does need regulating, the unfortunate thing is the sheer amount we're throwing at the market. It's going to lead to stagflation, whether we like it or not.
btw, that guy's teeth are WAY photoshopped.