The SEC has seen better days. It underwent a very public flogging for missing the biggest Ponzi scheme in history, and the bandages have been ripped off again with Madoff's official banishment from investment advising. At first it seemed Bernie Madoff kept his multi-billion dollar scam stealthily under the radar of the SEC and Wall Street watchdogs, but it turns out that the SEC had multiple warnings to act upon, yet it did nothing. This has left investors and politicians wondering why.
There is no shortage of theories. One of the most likely is that, as a former Chairman of the Nasdaq stock market and politically connected businessman, Madoff was given considerable credit by the SEC. Another variation proposes that the size of the investments and the high-profile investors suggested to investigators that everyone had done their due diligence on Madoff and found nothing amiss, so why waste time double and triple checking?
There are even the fringe theories that have the SEC working with Madoff to keep the scheme going. The only thing missing is a truthful account by the SEC itself.
The fact is that Harry Markopolos and others knew something was fishy with Madoff's iron-clad returns. They filed multiple complaints and even ran mathematical models to prove that Madoff's returns were too good to be true. Considering how aggressively the SEC follows up on any insider-trading accusations, often taking the guilty-until-proven-innocent tactic, it's puzzling that Madoff slipped through the cracks for so long. Muriel Seibert, who is much more politically connected than Madoff, has found herself being investigated by the SEC for insider trading based on a single complaint by an employee that she'd fired. (Find out more in Uncovering Insider Trading.)
This case looks like it was all but handed to the SEC, and we can only hope that there is a proper accounting of what went wrong and what steps are being taken to fix it. Otherwise, what good is a policeman that hangs up the phone when you call to report a burglary?
Should Have Known Better
Not to let the SEC off the hook, but the investors should have also known something was up. The SEC is made up of lawyers, regulators and accountants, but it would be a stretch to call them the finest financial minds – all of those end up on Wall Street rather than in regulatory bodies. Therefore, both the managers of the feeder funds and the wealthy individuals who invested with Madoff had a serious lapse in their due diligence (or were complicit in the scheme).
If Markopolos figured out that Madoff was promising the impossible, then why didn't the others? Madoff's split strike strategy combined with the size of his fund should have noticeably moved the market with every trade, but investors ignored this incongruity as long as their money appeared to be growing at the promised rate. According to most accounts, investors, and even Madoff himself, had trouble explaining how the money was being "made."
Although we've come to associate an inability to communicate as a sign of true genius (bumbling professor, absent-minded inventor, socially awkward whiz kid, etc.), it is hard to believe so many people put so much money into an investment they didn't understand. If there is a lesson to be taken from the Madoff/SEC fiasco it's an old one: if you don't understand it, don't invest in it. This goes for new companies espousing new paradigms as well as old scams wearing new clothes.
Madoff holds the record for Ponzi schemes, but check out some other contenders in The Biggest Stock Scams of All Time and Tales From Wall Street's Crypt.