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.

Theories
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."

Beyond Belief
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.

Related Articles
  1. Personal Finance

    How the Green Card Lottery Really Works

    Here's how the popular green card lottery, run by the U.S. State Department, operates, including some tips on improving your odds of winning.
  2. Fundamental Analysis

    HF Performance Report: Did Hedge Funds Earn Their Fee in 2015?

    Find out whether hedge funds, which have come under tremendous pressure to improve their performance, managed to earn their fee in 2015.
  3. Investing Basics

    Bill Ackman's 2 Best Investments (GGP, CP)

    Learn about the two best investments Ackman ever made. Ackman has demonstrated a consistent track record of success in all types of market environments.
  4. Investing

    George Soros: 3 Best Investments Ever

    Learn about some of the most successful trades famed investor George Soros has made during his career, including a billion dollar profit against the pound.
  5. Saving and Spending

    Where Does Bill Ackman Keep His Money?

    Learn about where prominent hedge fund manager Bill Ackman keeps his money. See how his short position in Herbalife has not been successful so far.
  6. Stock Analysis

    Elliott Management: An Activist Investor Analysis (HES, CTXS)

    Learn about the activist investor strategies used by Elliott Management. Read about the fund's positions in Hess Corp., Citrix and CDK Global.
  7. Entrepreneurship

    Multilevel Marketing Isn't Always A Scam, But It Often Is

    Nerium and Amway are popular direct sales companies that recruit new buyers and sellers to make a profit. Sadly, many direct sales firms are scams.
  8. Investing News

    Obama Wants to Double Wall Street Regulation

    President Obama wants to double the budgets of the SEC and the CFTC over the next five years.
  9. Taxes

    Why People Renounce Their U.S Citizenship

    This year, the highest number of Americans ever took the irrevocable step of giving up their citizenship. Here's why.
  10. Personal Finance

    What it Takes to Get a Green Card

    Grounds for getting a green card include having family members in the U.S., being a certain type of refugee or specialized worker, or winning a lottery.
RELATED FAQS
  1. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  2. What is the Writ of Mandamus?

    A writ of mandamus is a court order issued by a judge at a petitioner’s request compelling someone to execute a duty he is ... Read Full Answer >>
  3. Can hedge funds trade penny stocks?

    Hedge funds can trade penny stocks. In fact, hedge funds can trade in just about any type of security, including medium- ... Read Full Answer >>
  4. Are hedge funds regulated by FINRA?

    Alternative investment vehicles such as hedge funds offer investors a wider range of possibilities due to certain exceptions ... Read Full Answer >>
  5. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  6. Are UTMA accounts escheatable?

    Like most financial assets held by institutions such as banks and investment firms, UTMA accounts can be escheated by state ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center