As many of you may know, former SEC Chairman Christopher Cox contacted the SEC’s Office of Inspector General (OIG) on or about December 16, 2008 requesting that the Office undertake a full investigation into: (i) the allegations made to the SEC regarding Bernard Madoff going back to at least 1999, (ii) the SEC’s internal policies that govern when allegations of fraudulent activity should be brought to the Commission, and (iii) if SEC Staff contacts with the Madoff family and firm had any impact on the Staff’s decisions regarding the firm. The results of the SEC’s Office of Inspector General’s extensive investigation were recently published in an over 450 page report. This report goes into great detail of how the SEC failed on numerous occasions to uncover Bernard Madoff’s jaw dropping Ponzi scheme. In reviewing the “public version” of the report, there are a number of items definitely worth highlighting (some of which are certainly not new, but still astonishing nonetheless).
For example, there were numerous big, red flags that went back to 1992 which, if common sense dictated, indicated that Madoff was a fraud (or at least warranted deeper questioning or investigation by regulators). In addition, the Division of Enforcement never verified the trading activity in Madoff’s account with any independent third parties, despite numerous substantive and credible complaints to the contrary.
Not surprising, in the wake of the Madoff scandal and while waiting for the OIG to release the foregoing report, the SEC has taken some steps to rebuild investor confidence and reduce the likelihood that frauds will occur or go by undetected in the future. As part of the Post-Madoff reforms, the SEC released, among other things, proposed rules that would encourage advisers to custody client assets with independent firms and undergo surprise examinations on an annual basis and instituted measures that are aimed at increasing the ability of examiners to detect fraud, such as third-party verification of client assets held during audits.
Based on our recent experiences with SEC audits, Staff examiners wasted no time in implementing the requirement of third-party verification of client assets. We have seen first hand, examiners reaching out directly to investors, prime brokers and custodians to ensure that the assets said to be held, actually do exist.
