On
September 4th, 2009, the Securities and Exchange Commission’s
Inspector General revealed that Wall Street’s watchdog
agency failed to adequately investigate six “detailed
and substantive complaints” that, if properly pursued,
could have exposed Bernard Madoff’s massive Ponzi
scheme. The real issue is why the SEC did not pursue these
leads?
Clearly Madoff had enormous influence at the SEC. Since
the 1980s, he had served on its advisory panels and was
constantly consulted by its top officials on issues such
as computerized trading. During one investigation of his
own firm, he confided to a SEC investigator that he was
on “the short list” to be the next SEC Commissioner,
which would make him his boss. While Madoff was not appointed
to the SEC, that investigation was, as the SEC inspector
general points out, prematurely terminated Madoff had become
so closely identified with the SEC by the early 2000s that
a controversial SEC short-selling exception that benefitted
Madoff became famously known on Wall Street as “The
Madoff Exception.”
Even as early as 1992, Madoff had become such a trusted
figure in the eyes of the SEC officials that he was able
to help them dispose of what appeared to be a possible Ponzi
scheme. The alarm bells were set off when SEC investigators
discovered that an unregistered investment company named
Avellino and Bienes was offering "100% safe investments”
. As noted in the Inspector General’s report, such
“high and extremely consistent rates of return over
significant periods of time to "special" customers”
were viewed by at least 4 SEC examiners as “red flags”
of a fraud involving over $441.9 million, which in the early
1990s was a sizable sum in the investment world. Indeed,
it was reminiscent of the now infamous Charles Ponzi in
the 1920s who paid the guaranteed “interest”
to old investors out of the funds of his new investors.
Neither Frank Avellino or his junior partner Michael Bienes
had been licensed to sell securities, yet they and their
associates had sold these guaranteed notes to 3100 investors
between 1962 and 1992. The different rates they offered
was yet another red flag. Larger investors got a guaranteed
annual return of a 20 percent– which in some years
was more than ten times the banks’ interest rate–
while smaller investors got between 13.5 and 15 percent.
Adding to the SEC’s concern, the firm was unable,
or unwilling, to produce financial records with Avellino
telling the court appointed auditors that he did not keep
detailed records because “My experience has taught
me not to commit any figures to scrutiny.” He insisted
that furnishing his own trading data was unnecessary since
“every single dollar, it is invested in long-term
Fortune 500 securities” with a single broker, who
makes every investment decision/ And that broker was Bernard
Madoff, with whom he had 5 accounts. To prove no money was
missing, Avellino provided the SEC examiners with the most
recent statements he received from Madoff. The New York
Enforcement Staff Attorney handling the case did not find
“Avellino and Bienes’ testimony altogether convincing.”
The next step was to verify the statements with Madoff.
When on November 16, 1992, SEC examiners conducted an examination
of Madoff’s firm “to verify certain security
positions carried for the accounts of Avellino & Bienes,”
Madoff was well prepared for their visit/ He provided them
with putative copies of records from the Depository Trust
Corporation (DTC) showing that he had made the trades listed
in the Avellino and Bienes accounts. Madoff’s stock
record exactly matched the DTC statement. The examiners
did not go any further. They concluded that there was no
Ponzi scheme, and merely fined Avellino and Bienes $500,000
for their illegal brokerage business, which they closed
down.
What the SEC did not do was to go to the DTC and verify
that the records Madoff gave them were authentic. If its
investigators had merely made a phone call to the DTC, they
would have discovered in 1992 that those records were hastily
forged and that the Avellino and Bienes accounts were only
a small part of Madoff’s much larger Ponzi scheme..
As we now know from the testimony of Frank DiPascali, Jr
, Madoff somehow knew the SEC examiners were about to descend
on his office and demand these records. In his 2009 debriefing
by the SEC, Dipascali specifically identified the SEC’s
Avellino & Bienes investigation as an occurrence when
“Madoff scrambled to ... fabricate credible account
records to corroborate the purported trading in the accounts.”
The rush to fake the records described by DiPascalini suggests
that Madoff might have had advance knowledge as to the SEC’s
actions.
In any case, the SEC’s failure to verify Madoff’s
records is difficult to explain in light of Madoff’s
long-term relationship with Avellino’s firm. Madoff
and Avellino had both worked together in the small accounting
office of Madoff’s father-in-law Sol Alpern, who was
deeply involved, if not the organizer, of the money-raising
operation. Alpern also helped set up Madoff’s brokerage
operation in 1960 by providing him with $50,000 to finance
it and then funneling into it the guaranteed investments
his firm sold. When Alpern retired, Avellino and his junior
partner, Michael Bienes, took over the business and changed
its name to Avellino and Bienes.
That Madoff’s name is not even mentioned by the SEC
actions against Avellino and Bienes, even though his records
were central to the quashing of the case, may be some indication
of the influence he had developed at the SEC. Such influence
would also explain why six subsequent complaints against
Madoff himself were not fully investigated and why the SEC
consistently neglected to verify Madoff’s accounts
against the readily-available DTC records. But how could
Madoff have such influence over his regulators? At the very
minimum, Madoff seemed had inside knowledge concerning SEC
investigations. Consider, for example, the heads-up he gave
executives at the Fairfield Greenwich Group in 2006, which
was then his main feeder fund. According to phone records
that came to light in a lawsuit filed by the state of Massachusetts,
Madoff called two of Fairfield Greenwich’s top executives
in Bermuda, and informed them of the questions that SEC
investigators would ask them. And he furnished the answers
that would satisfy them (while concealing Madoff’s
true role.) As for the SEC investigators themselves, he
pointed out, “They work for 5 years for the [SEC]
Commission and then become a compliance manager at a hedge
fund.” The implication here was that SEC officials
had a powerful incentive to be cooperative in this matter
since their future lay with hedge funds, not the SEC.
He clearly had one or more reliable sources. The SEC kept
to the Madoff script and, when it got the answered he provided,
it did not pursue the investigation. Such high-value feed-back,
which could have come from unwitting sources or from someone
cooperating with him. In either case, it would explain how
Madoff evaded SEC scrutiny. ***
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