SEC Officials Say the Agency Lacks Cash for Full Oversight

Date: Wednesday, January 28, 2009
Author: Zachary A. Goldfarb, Washington

Top Securities and Exchange Commission officials, under fire for failing to detect a $50 billion fraud allegedly orchestrated by Bernard L. Madoff, told Congress yesterday that they are taking new steps to identify abuses in the financial markets but warned that they lack the money and staff for comprehensive oversight.

Speaking publicly for the first time since the Madoff case surfaced, director of enforcement Linda Thomsen and director of inspections Lori Richards described how the SEC has not been able to keep up with the fast-increasing complexity of the financial markets. This challenge will be front and center for SEC chairman Mary Schapiro, the former head of Wall Street's self-regulator, who was sworn in yesterday.

"The amount of resources available to the SEC has not kept pace with the rapid expansion in the securities market over the past few years . . . either in terms of the number of firms or the explosion in the types of new and increasingly complex products . . . some of which were expressly designed to avoid SEC regulation and oversight," Thomsen said in prepared testimony at a hearing of the Senate Banking Committee.

Madoff faces accusations in criminal and civil cases that he ran what is likely history's largest Ponzi scheme, duping investors and regulators into thinking he could routinely yield unusually high profits.

Thomsen and Richards acknowledged that the SEC had looked into Madoff's firm several times, as recently as 2006 when the agency's New York office received a letter about a potential fraud at the firm. That tip prompted an investigation that closed two years later without any recommendation of enforcement.

The SEC ordered Madoff to register his investment management business in 2006 after it was found not be compliant with SEC rules. But the fraud allegedly taking place in that business eluded investigators.

Sen. Robert Menendez (D-N.J.) asked Thomsen yesterday whether "Mr. Madoff was smarter than all of you" because the SEC did not look closely enough at Madoff's business even after his failure to register. Thomsen declined to answer, saying she couldn't comment.

Some senators were skeptical that more resources were the answer to the SEC's troubles.

"The natural reaction of a regulatory agency confronting a failure of this magnitude is to cry lack of resources and lack of access," said Sen. Richard C. Shelby (R-Ala.), the top Republican on the banking committee. "Regulators were at the Madoff firm on multiple occasions over the years and, at times, they were armed with credible information suggesting that something was wrong."

Sen. Christopher J. Dodd (D-Conn.), the chairman of the banking committee, wondered whether the SEC has missed other frauds because the Madoff case was opened only after he confessed. "How many other 'Madoff schemes' are out there? Do we have any idea?" Dodd said.

Thomsen offered few new details about the 2006 investigation. The SEC's failure to spot irregularities at Madoff's firm is the subject of an investigation by the agency's inspector general.

Madoff ran separate brokerage and investment management businesses, though they were part of a single firm. Brokerages, which execute trades in addition to providing advice, are closely examined by the SEC and other regulators. But investment management firms, only in the business of offering advice, are more lightly regulated.

Attracted by the this lighter touch, the number of investment managers has ballooned to 11,300 from 7,547 in 2002. This trend has "outstripped the staff's ability to examine every firm on a regular basis," Richards said in prepared testimony. "Given the number of firms subject to examination oversight and the breadth of their operations, examinations are not audits and are not comprehensive in scope."

Richards said the agency is working to identify new steps to improve regulation and oversight, studying how best to conduct examinations and identify risks. Thomsen said new regulatory measures must be taken to protect investors, possibly toughening rules related to investment managers.

Stephen Luparello, the interim chief executive of the Financial Industry Regulatory Authority, told the committee that his organization was responsible for overseeing Madoff's brokerage business but didn't have the authority to look over his investment management unit.

"Mr. Madoff's alleged fraud highlights how our current fragmented regulatory system can allow bad actors to engage in misconduct outside the view and reach of some regulators," he said at the hearing.