Thursday, February 11, 2010

TV Show on the SEC Inspector General's 457 Page Report on the SEC's Malfeasance in the Madoff Matter.

February 11, 2010

Dear Colleagues:

To prepare for a television show with Erin Arvedlund on the SEC Inspector General’s 457 page Report on the SEC’s malfeasance in the Madoff matter, I have identified what I think the most important excerpts from the Report. The best excerpts comprise about eleven percent of the full Report. They are appended below and are also posted on my website (Velvelonnationalaffairs.com). Also appended below is a list of major topics (done in shorthand expressions), together with page numbers showing where given topics can be found in the excerpts.

The excerpts too give page numbers. But these numbers show where particular points can be found in the full 457 page Report. There is one complication here: near the beginning of the full Report, starting in the middle of page 20 and running through the end of page 41, is the Executive Summary. That Summary, however, was published by itself before the full Report came out. By itself, the Executive Summary’s pagination runs from 1 to 22. I read the Executive Summary when it came out by itself before the full Report, and the pages I give in the excerpts showing where points can be found in the Executive Summary are keyed to the Executive Summary as an independent document paginated 1-22 rather than to it as part of the subsequent full Report with page numbers running from pages 20-41. So . . . . whenever you see, in the excerpts, references to pages 1-22, those references are to the pages of the separate Executive Summary which came out prior to the full Report. Any references in the excerpts to pages 23 and higher are to the full Report.

For your convenience, I have appended below not just all the excerpts I have chosen, but also the separate Executive Summary which came out prior to the full Report (in which it was of course included).

I believe the excerpts from the Executive Summary and from the entire rest of the Report could prove helpful to persons who are litigating, talking to Congress, writing news stories, etc.

The television show with Erin Arvedlund is being taped on Friday, February 12th, and will be shown a few weeks later. It will also be posted on MSL’s website and, I believe, on YouTube. CDs of it will also be made available for those who would like them or have a use for them.


Larry Velvel



NOTES ON WHERE STUFF APPEARS IN
THE INSPECTOR GENERAL’S REPORT


1, 16, 17, 22, 29, 40, 41 SEC had more than enough info to uncover the Ponzi
scheme and should have as early as 1992. It never really investigated him for a Ponzi.

1 Red flags.

1, 2, 8, 31, 38, 39 Letters from an obvious insider.

2 Were told it’s a Ponzi scheme.

2, 21, 24, 26, 30, 31, 32,
33, 34, 38, 42 Teams knew he had lied to them, had made inconsistent statements.

2, 14 Teams were young and inexperienced, overawed.

3 In 1992 the SEC knew Madoff made all the decisions, yet hardly investigated him.

4, 29 2003 complaint from hedge fund manager: indicia of a Ponzi.

5, 15 SEC laziness -- didn’t want things to be too time consuming.

5, 16, 24 Hedge fund business making more money than brokerage.

5, 17, 18, 19, 20, 25, 26,
29, 30, 34 Red flag emails from Simon’s company. Not possible that he is doing options, questions re options, and questions re is he trading at all.

6, 14, 17, 20, 22, 26 One man auditor. Not independent. No real auditing.

6 Tips not from an insider.

6, 10, 22, 42, 43 Madoff being well connected.

6 Not resolving open questions.

7 Unprepared to take Madoff’s testimony.

9 A&B’s nonrecordkeeping and reasons.

9 Fake DTC records.

9, 10 Ira Sorkin and A&B.

9, 11 Only brief examination of Madoff in 1992.

10 Price Waterhouse can’t audit A&B.

11 Judge Sprizzo

11 3 to 7 billion in 2000.

12 Not allowing performance audits.

12 Ward apparently lied.

12 NERO refused to investigate in one day.

13 SEC did zip after Barron article.

13 The Hedge Fund Manager’s complaint with red flags, especially the lack of options, which SEC didn’t investigate.

15 Swanson’s lack of note taking.

16 Only concerned with front running.

18, 19 Renaissance (like ordinary people) took comfort from fact SEC gave him clean bill of health.

19 Again, is he actually trading?

21, 23, 27, 40 DTC’s business and what DTC would have told SEC.

21, 27, 31 Barclay’s.

22, 23 Madoff didn’t provide requested documents.

23, 33 The jig was up episode. Over the weekend didn’t contact DTC.

23, 27, 41 FINRA/NASD regarding is he trading.

24, 25 SEC superiors sometimes called a halt.

26 Should have contacted custodians.

28 Representing that he no longer uses options.

28, 29 Ignoring non insiders; not following tips.

31, 34, 35, 36, 37 Suh’s amazing failure to understand the necessary role of banks.

31, 32 Learning from NASD he had not held options on relevant days.

32 Many on Wall Street were dubious.

35 Commingling.





DAMAGING EXCERPTS FROM THE
SEC INSPECTOR GENERAL’S REPORT ON THE
SEC’S MALFEASANCE IN THE MADOFF AFFAIR


The OIG investigation did find, however, that the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six10 substantive complaints that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading. Finally, the SEC was also aware of two articles regarding Madoff’s investment operations that appeared in reputable publications in 2001 and questioned Madoff’s unusually consistent returns. (Page 1)

The SEC actually suspected the investment company was operating a Ponzi scheme and learned in their investigation that all of the investments were placed entirely through Madoff . . . . (Page 1)

[The complaint submitted in 2005 was entitled] “The World’s Largest Hedge Fund is a Fraud” and detailed approximately 30 red flags indicating that Madoff was operating a Ponzi scheme, a scenario it described as “highly likely.” (Page 2)

In May 2003, the SEC received a third complaint from a respected Hedge Fund Manager identifying numerous concerns about Madoff’s strategy and purported returns, questioning whether Madoff was actually trading options in the volume he claimed, noting that Madoff’s strategy and purported returns were not duplicable by anyone else, and stating Madoff’s strategy had no correlation to the overall equity markets in over 10 years. According to an SEC manager, the Hedge Fund Manager’s complaint laid out issues that were “indicia of a Ponzi scheme.” (Page 2)

The red flags identified included Madoff’s incredible and highly unusual fills for equity trades, his misrepresentation of his options trading and his unusually consistent, non-volatile returns over several years. One of the internal e-mails provided a step-by-step analysis of why Madoff must be misrepresenting his options trading. The e-mail clearly explained that Madoff could not be trading on an options exchange because of insufficient volume and could not be trading options over-the-counter because it was inconceivable that he could find a counterparty for the trading. The SEC examiners who initially discovered the e-mails viewed them as indicating “some suspicion as to whether Madoff is trading at all. (Page 2)

[A letter that appeared to come from an insider said] “Your attention is directed to a scandal of major proportion which was executed by the investment firm Bernard L. Madoff . . . . Assets well in excess of $10 Billion owned by the late [investor], an ultra-wealthy long time client of the Madoff firm have been ‘co-mingled’ with funds controlled by the Madoff company with gains thereon retained by Madoff.” (Page 2)

It may be of interest to you to that Mr. Bernard Madoff keeps two (2) sets of records. The most interesting of which is on his computer which is always on his person.” (Page 3)

The complaints all contained specific information and could not have been fully and adequately resolved without thoroughly examining and investigating Madoff for operating a Ponzi scheme. The journal articles should have reinforced the concerns about how Madoff could have been achieving his returns. (Page 3)

The OIG retained an expert in accordance with its investigation in order to both analyze the information the SEC received regarding Madoff and the examination work conducted. According to the OIG’s expert, the most critical step in examining or investigating a potential Ponzi scheme is to verify the subject’s trading through an independent third party. (Page 3)

The OIG investigation found the SEC conducted two investigations and three examinations related to Madoff’s investment advisory business based upon the detailed and credible complaints that raised the possibility that Madoff was misrepresenting his trading and could have been operating a Ponzi scheme. Yet, at no time did the SEC ever verify Madoff’s trading through an independent third-party, and in fact, never actually conducted a Ponzi scheme examination or investigation of Madoff. (Page 3)

In the first of the two OCIE examinations, the examiners drafted a letter to the National Association of Securities Dealers (NASD) (another independent third-party) seeking independent trade data, but they never sent the letter, claiming that it would have been too time-consuming to review the data they would have obtained. The OIG’s expert opined that had the letter to the NASD been sent, the data would have provided the information necessary to reveal the Ponzi scheme. In the second examination, the OCIE Assistant Director sent a document request to a financial institution that Madoff claimed he used to clear his trades, requesting trading done by or on behalf of particular Madoff feeder funds during a specific time period, and received a response that there was no transaction activity in Madoff’s account for that period. However, the Assistant Director did not determine that the response required any follow-up and the examiners testified that the response was not shared with them. (Page 4)

In 2004 and 2005, the SEC’s examination unit, OCIE, conducted two parallel cause examinations of Madoff based upon the Hedge Fund Manager’s complaint and the series of internal e-mails that the SEC discovered. The examinations were remarkably similar. There were initial significant delays in the commencement of the examinations, notwithstanding the urgency of the complaints. The teams assembled were relatively inexperienced, and there was insufficient planning for the examinations. The scopes of the examination were in both cases too narrowly focused on the possibility of front-running, with no significant attempts made to analyze the numerous red flags about Madoff’s trading and returns. (Page 4)
During the course of both these examinations, the examination teams discovered suspicious information and evidence and caught Madoff in contradictions and inconsistencies. However, they either disregarded these concerns or simply asked Madoff about them. Even when Madoff’s answers were seemingly implausible, the SEC examiners accepted them at face value. (Page 4)

In both examinations, the examiners made the surprising discovery that Madoff’s mysterious hedge fund business was making significantly more money than his well-known market-making operation. However, no one identified this revelation as a cause for concern. (Page 4)

In the first of the two OCIE examinations, the examiners drafted a letter to the National Association of Securities Dealers (NASD) (another independent third-party) seeking independent trade data, but they never sent the letter, claiming that it would have been too time-consuming to review the data they would have obtained. The OIG’s expert opined that had the letter to the NASD been sent, the data would have provided the information necessary to reveal the Ponzi scheme. In the second examination, the OCIE Assistant Director sent a document request to a financial institution that Madoff claimed he used to clear his trades, requesting trading done by or on behalf of particular Madoff feeder funds during a specific time period, and received a response that there was no transaction activity in Madoff’s account for that period. However, the Assistant Director did not determine that the response required any follow-up and the examiners testified that the response was not shared with them. (Pages 4-5)

Both examinations concluded with numerous unresolved questions and without any significant attempt to examine the possibility that Madoff was misrepresenting his trading and operating a Ponzi scheme. (Page 5)
The investigation that arose from the most detailed complaint provided to the SEC, which explicitly stated it was “highly likely” that “Madoff was operating a Ponzi scheme,” never really investigated the possibility of a Ponzi scheme. (Page 5)

As with the examinations, the Enforcement staff almost immediately caught Madoff in lies and misrepresentations, but failed to follow up on inconsistencies. They rebuffed offers of additional evidence from the complainant, and were confused about certain critical and fundamental aspects of Madoff’s operations. When Madoff provided evasive or contradictory answers to important questions in testimony, they simply accepted as plausible his explanations. (Page 5)

Although the Enforcement staff made attempts to seek information from independent third-parties, they failed to follow up on these requests. They reached out to the NASD and asked for information on whether Madoff had options positions on a certain date, but when they received a report that there were in fact no options positions on that date, they did not take any further steps. (Page 5)

The OIG also found that numerous private entities conducted basic due diligence of Madoff’s operations and, without regulatory authority to compel information, came to the conclusion that an investment with Madoff was unwise. Specifically, Madoff’s description of both his equity and options trading practices immediately led to suspicions about Madoff’s operations. With respect to his purported trading strategy, many simply did not believe that it was possible for Madoff to achieve his returns using a strategy described by some industry leaders as common and unsophisticated. In addition, there was a great deal of suspicion about Madoff’s purported options trading, with several entities not believing that Madoff could be trading options in such high volumes where there was no evidence that any counterparties had been trading options with Madoff. The private entities’ conclusions were drawn from the same “red flags” in Madoff’s operations that the SEC considered in its examinations and investigations, but ultimately dismissed. (Pages 5-6)

We also found that investors who may have been uncertain about whether to invest with Madoff were reassured by the fact that the SEC had investigated and/or examined Madoff, or entities that did business with Madoff, and found no evidence of fraud. Moreover, we found that Madoff proactively informed potential investors that the SEC had examined his operations. When potential investors expressed hesitation about investing with Madoff, he cited the prior SEC examinations to establish credibility and allay suspicions or investor doubts that may have arisen while due diligence was being conducted. Thus, the fact the SEC had conducted examinations and investigations and did not detect the fraud, lent credibility to Madoff’s operations and had the effect of encouraging additional individuals and entities to invest with him. (Page 6)

As the SEC began investigating the matter, they learned that Madoff had complete control over all of Avellino & Bienes’ customer funds and made all investment decisions for them, and, according to Avellino, Madoff had achieved these consistent returns for them for numerous years without a single loss. (Page 6)

The SEC suspected that Avellino & Bienes was operating a Ponzi scheme and took action to ensure that all of Avellino & Bienes’ investors were refunded their investments. Yet, the OIG found that the SEC never considered the possibility that Madoff could have taken the money that was used to pay back Avellino & Bienes’ customers from other clients as part of a larger Ponzi scheme. (Page 6)

The SEC actually conducted an examination of Madoff that was triggered by the investigation of Avellino & Bienes, but assembled an inexperienced examination team. The examination team conducted a brief and very limited examination of Madoff, but made no effort to trace where the money that was used to repay Avellino & Bienes’ investors came from. In addition, although the SEC examiners did review records from DTC, they obtained those DTC records from Madoff rather than going to DTC itself to verify if trading occurred. According to the lead SEC examiner, someone should have been aware of the fact that the money used to pay back Avellino & Bienes’ customers could have come from other investors, but there was no examination of where the money that was used to pay back the investors came from. Another examiner said such a basic examination of the source of the funds would have been “common sense.” In addition, although the SEC’s lead examiner indicated that the investment vehicle offered by Avellino & Bienes had numerous “red flags” and was “suspicious,” no effort was made to look at the investment strategy and returns. (Pages 6-7)

The SEC lawyers working on the matter were aware of the questionable returns and the fact that all the investment decisions were made by Madoff, but the focus of the investigation was limited to whether Avellino & Bienes was selling unregistered securities or operating an unregistered investment firm. A trustee and accounting firm were retained to ensure full distribution of the assets, but its jurisdiction was limited, and they did not take any action to independently verify account balances and transaction activity included in Madoff’s financial and accounting records. Even after the accounting firm was unable to audit Avellino & Bienes’ financial statements and uncovered additional red flags, such as Avellino & Bienes’ failure to produce financial statements or have the records one would have expected from such a large operation, no further efforts were made to delve more deeply into either Avellino & Bienes’ or Madoff’s operations. (Page 7)

The result was a missed opportunity to uncover Madoff’s Ponzi scheme 16 years before Madoff confessed. The SEC had sufficient information to inquire further and investigate Madoff for a Ponzi scheme back in 1992. (Page 7)

The SEC’s lead examiner said Madoff’s reputation as a broker-dealer may have influenced the inexperienced team not to inquire into Madoff’s operations. (Page 7)
Markopolos’ complaint stated that Madoff’s returns were unachievable using the trading strategy he claimed to employ, noting Madoff’s “perfect market-timing ability.” Markopolos also referenced the fact that Madoff did not allow outside performance audits. (Page 7)

Although this time the BDO did refer Markopolos’ complaint, NERO decided not to investigate the complaint only one day after receiving it. The matter was assigned to an Assistant Regional Director in Enforcement for initial inquiry, who reviewed the complaint, determined that Madoff was not registered as an investment adviser, and the next day, sent an e-mail stating, “I don’t think we should pursue this matter further.” The OIG could find no explanation for why Markopolos’ complaint, which the Enforcement attorney and the former head of NERO acknowledged was “more detailed than the average complaint,” was disregarded so quickly. (Page 8)

The OIG found that the SEC was aware of the Barron’s article when it was published in May 2001. On May 7, 2001, an Enforcement Branch Chief in the BDO followed up with NERO regarding Markopolos’ 2001 complaint and the Barron’s article, and asked the Director of NERO if he wanted a copy of the article. However, the decision not to commence an investigation was not reconsidered and there is no evidence the Barron’s article was ever even reviewed. (Page 9)

In May 2003, OCIE’s investment management group in Washington, D.C. received a detailed complaint from a reputable Hedge Fund Manager, in which he laid out the red flags that his hedge fund had identified about Madoff while performing due diligence on two Madoff feeder funds. (Page 9)

The complaint also described specific concerns about Madoff’s strategy and purported returns such as the fact that the strategy was not duplicable by anyone else; there was no correlation to the overall equity markets (in over 10 years); accounts were typically in cash at month end; the auditor of the firm was a related party to the principal; and Madoff’s firm never had to face redemption. (Page 9)

According to an SEC supervisor, the Hedge Fund Manager’s complaint implied that Madoff might be lying about its option trading and laid out issues that were “indicia of a Ponzi scheme.” One of the senior examiners on the team also acknowledged that the Hedge Fund Manager’s complaint could be interpreted as alleging that Madoff was running a Ponzi scheme. (Page 9)

The OIG’s expert concluded that based upon issues raised in the Hedge Fund Manager’s complaint, had the examination been staffed and conducted appropriately and basic steps taken to obtain third-party verifications, Madoff’s Ponzi scheme should and would have been uncovered. (Page 9)

A Planning Memorandum for the examination was prepared, but it failed to address several critical issues from the complaint, including the unusual fee structure; the inability to see the volume of options in the marketplace; the remarkable returns; the fact that Madoff’s trading strategy was not duplicable; the returns had no correlation to actual equity markets; the accounts were in cash at month’s end; there were no third party brokers; and the auditor of Madoff’s firm was a related party. (Page 10)

In addition, courses of action outlined in the Planning Memorandum that involved verification of trading with independent third parties should have been carried out, but were not. For example, the staff drafted a letter to the NASD (an independent third-party), which was critical to any adequate review of the complaint because the data and information from the NASD would have assisted in independently verifying trading activity conducted at Madoff’s firm. However, the letter was never sent, with the explanation given by staff that it would have been too time-consuming to review the information they would have obtained. According to the OIG’s expert, had the letter been sent out, the NASD would have provided order and execution data that would have indicated that Madoff did not execute the significant volume of trades for the discretionary brokerage accounts that he represented to the examiners, and the data would likely have provided the information necessary to reveal the Ponzi scheme. (Page 11)

The examiners also made the surprising discovery that Madoff’s mysterious hedge fund business was making significantly more money than his well-known market-making operation. (Page 11)

In a subsequent draft of a supplemental document request to Madoff, the examiners sought detailed audit trail data, including the date, time, and execution price for all of his trades in 2003. But the examiners removed the request for this critical data from the supplemental request before it was sent out. The reason given was that they were generally hesitant to get audit trail data “because it can be tremendously voluminous and difficult to deal with” and “takes a ton of time” to review. No requests were made from independent third-parties for any data, although an OCIE examiner acknowledged obtaining such data should not have been difficult. (Page 11)

In April 2004, a NERO investment management examiner had been conducting a routine examination of an unrelated registrant when it discovered internal e-mails from November and December 2003 that raised questions about whether Madoff was involved in illegal activity involving managed accounts. These internal e-mails described the red flags the registrant’s employees identified while performing due diligence using widely available information on their Madoff investment. The red flags the registrant had identified included Madoff’s: (1) incredible and highly unusual fills for equity trades; (2) misrepresentation of his options trading; (3) secrecy; (4) auditor; (5) unusually consistent and non-volatile returns over several years; and (6) fee structure. (Page 12)

Crucially, one of the internal e-mails provided a step-by-step analysis of why Madoff must be misrepresenting his options trading. The e-mail explained that Madoff could not be trading on an options exchange because of insufficient volume and could not be trading options over-the-counter because it was inconceivable he could find a counterparty for the trading. For example, the e-mail explained that because customer statements showed that the options trades were always profitable for Madoff, there was no incentive for a counterparty to continuously take the other side of those trades since it would always lose money. These findings raised significant doubts that Madoff could be implementing his trading strategy. The internal e-mails included the statement that the registrant had “totally independent evidence” that Madoff’s executions were “highly unusual.” (Page 12)

As with the examination, in Washington, D.C., there was a significant delay before the examination was commenced. Although the e-mails were discovered in April 2004 and immediately referred to the NERO broker-dealer examination program, a team was not assembled until December 2004. (Page 12)

Once again, although the e-mails raised significant issues about whether Madoff was engaging in trading at all, the decision was made to focus exclusively on front-running. (Page 13)

To the extent that the NERO examiners did examine issues outside of front-running, they conducted their examination by simply asking Madoff about their concerns and accepting his answers. With respect to the significant concerns about Madoff’s options trading, they asked Madoff about this issue, and when Madoff said he was no longer using options as part of his strategy, they stopped looking at the issue, despite the fact that Madoff’s representation was inconsistent with the internal e-mails, the two 2001 articles, and the investment strategy Madoff claimed to employ. As to why Madoff did not collect fees like all other hedge fund managers, they accepted his response that he was not “greedy” and was happy with just receiving commissions. (Page 13)

Several issues, including the allegation in the internal e-mails that Madoff’s auditor was a related party, were never examined at all. Yet, after Madoff confessed to operating a Ponzi scheme, a staff attorney in NERO’s Division of Enforcement was assigned to investigate Madoff’s accountant, David Friehling, and within a few hours of obtaining the work papers, he determined that no audit work had been done. (Page 13)

In addition, although one of the NERO examiners placed a “star” next to the statement in the internal e-mails about having “totally independent evidence” that Madoff’s executions were “highly unusual,” NERO never followed up with the registrant to inquire about or obtain this evidence. The NERO examiners explained that it was not their practice to seek information from third parties when they conducted examinations. (Page 13)

When the examiners began their on-site examination of Madoff, they learned Bernard Madoff would be their primary contact and Madoff carefully controlled to whom they spoke at the firm. (Page 33)

Madoff made efforts during the examination to impress and even intimidate the junior examiners from the SEC. Madoff emphasized his role in the securities industry during the examination. (Page 33)

Throughout the examination, the NERO examiners “had a real difficult time dealing with” Madoff as he was described as growing “increasingly agitated” during the examination, and attempting to dictate to the examiners what to focus on in the examination and what documents they could review. Yet, when the NERO examiners reported back to their Assistant Director about the pushback they received from Madoff, they received no support and were actively discouraged from forcing the issue. (Pages 33-34)

One effort was made to verify Madoff’s trading with an independent third-party, but even after they received a very suspicious response, there was no follow-up. The Assistant Director sent a document request to a financial institution that Madoff claimed he used to clear his trades, requesting records for trading done by or on behalf of particular Madoff feeder funds during a specific time period. Shortly thereafter, the financial institution responded, stating there was no transaction activity in Madoff’s account for that period. Yet, the response did not raise a red flag for the Assistant Director, who merely assumed that Madoff must have “executed trades through the foreign broker-dealer.” The examiners did not recall ever being shown the response from the financial institution, and no further follow-up actions were taken. (Page 34)

One of the few points that was made in a conference call between the offices was a comment by a senior-level Washington D.C. examiner reminding the junior NERO examiners that Madoff “was a very well-connected, powerful, person,” which one of the NERO examiners interpreted to raise a concern for them about pushing Madoff too hard without having substantial evidence. While the Washington, D.C. examination team decided not to resume their examination and sent their workpapers to NERO, the NERO examiners reported conducting only a cursory review of the workpapers and did not recall even reviewing the Hedge Fund Manager’s detailed complaint that precipitated the D.C. examination, appear to have never discussed the D.C. examiners’ open questions about Madoff’s representations and trading, and did not compare the list of clients Madoff produced to them with the list he produced to the D.C. team. (Page 34)

As had been the case with the Washington, D.C. examination, the NERO examiners learned that Madoff’s well-known market making business would be losing money without the secretive hedge fund execution business. Although they described this revelation as “a surprising discovery,” the issue was once again never pursued. (Page 35)

Although the NERO examiners determined Madoff was not engaged in front-running, they were concerned about issues relating to the operation of his hedge fund business, and sought permission to continue the examination and expand its scope. Their Assistant Regional Director denied their request, telling them to “keep their eyes on the prize,” referring to the front-running issue. When the examiners reported that they had caught Madoff in lies, the Assistant Director minimized their concerns, stating “it could [just] be a matter of semantics.” The examiners’ request to visit Madoff feeder funds was denied, and they were informed that the time for the Madoff examination had expired. The explanation given was that “field work cannot go on indefinitely because people have a hunch or they’re following things.” (Page 35)

Thus, the NERO cause examination of Madoff was concluded without the examination team ever understanding how Madoff was achieving his returns and with numerous open questions about Madoff’s operations. Many, if not most, of the issues raised in both the Hedge Fund Manager’s complaint that precipitated the Washington, D.C. examination and the internal e-mails that triggered the NERO examination had not been analyzed or resolved. In September 2005, NERO prepared a closing report for the examination that relied almost entirely on information verbally provided by Madoff to the examiners for resolution of numerous “red flags.” One of the two primary examiners on the NERO examination team was later promoted based on his work on the Madoff examination. (Page 35)

While the Madoff investigation was assigned within NERO Enforcement, it was assigned to a team with little to no experience conducting Ponzi scheme investigations. The majority of the investigatory work was conducted by a staff attorney who recently graduated from law school and only joined the SEC nineteen months before she was given the Madoff investigation. She had never previously been the lead staff attorney on any investigation, and had been involved in very few investigations overall. The Madoff assignment was also her first real exposure to broker-dealer issues. (Page 16)

The NERO Enforcement staff, unlike the BDO, failed to appreciate the significance of the evidence in the 2005 Markopolos complaint and almost immediately expressed skepticism and disbelief about the information contained in the complaint. The Enforcement staff claimed that Markopolos was not an insider or an investor, and thus, immediately discounted his evidence. (Page 17)

The NERO Enforcement staff also received a skeptical response to Markopolos’ complaint from the NERO examination team who had just concluded their examination. Even though the NERO examination had focused solely on front-running, NERO examination team downplayed the possibility that Madoff was conducting a Ponzi scheme, saying, “these are basically some of the same issues we investigated” and that Markopolos “doesn’t have the detailed understanding of Madoff’s operations that we do which refutes most of his allegations.” (Page 17)

Yet, the Enforcement staff almost immediately caught Madoff in lies and misrepresentations. An initial production of documents the Enforcement staff obtained from a Madoff feeder fund demonstrated Madoff had lied to the examiners in the NERO examination about a fundamental component of his claimed trading activity. Specifically, while Madoff told the examiners he had stopped using options as part of his strategy after they scrutinized his purported options trading, the Enforcement staff found evidence from the feeder funds that Madoff was telling his investors that he was still trading options during that same time period. Yet, the Enforcement staff never pressed Madoff on this inconsistency. After an interview with an executive from a Madoff feeder fund, the Enforcement staff noted several additional “discrepancies” between what Madoff told the examiners in the NERO examination and information they received in the interview. The Enforcement staff also discovered that the feeder fund executive’s testimony had been scripted and he had been prepped by Madoff. (Page 18)

As the investigation progressed, in December 2005, Markopolos approached the Enforcement staff to provide them additional contacts and information. However, the branch chief assigned to the Madoff Enforcement investigation took an instant dislike to Markopolos and declined to even pick up the “several inch thick file folder on Madoff” that Markopolos offered. (Page 18)

At a crucial point in their investigation, the Enforcement staff was informed by a senior-level official from the NASD that they were not sufficiently prepared to take Madoff’s testimony, but they ignored his advice. On May 17, 2006, two days before they were scheduled to take Madoff’s testimony, the Enforcement staff attorney contacted the Vice President and Deputy Director of the NASD Amex Regulation Division to discuss Madoff’s options trading. The NASD official told the OIG that he answered “extremely basic questions” from the Enforcement staff about options trading. He also testified that, by the end of the call, he felt the Enforcement staff did not understand enough about the subject matter to take Madoff’s testimony. The NASD official told the OIG that he answered “extremely basic questions” from the Enforcement staff about options trading. He also testified that, by the end of the call, he felt the Enforcement staff did not understand enough about the subject matter to take Madoff’s testimony. The NASD official also recalled telling the Enforcement staff that they “needed to do a little bit more homework before they were ready to talk to [Madoff],” but that they were intent on taking Madoff’s testimony as scheduled. (Page 19)

During Madoff’s testimony, he provided evasive answers to important questions, provided some answers that contradicted his previous representations, and provided some information that could have been used to discover that he was operating a Ponzi scheme. However, the Enforcement staff did not follow-up with respect to the critical information that was relevant to uncovering Madoff’s Ponzi scheme. (Page 19)

Each member of the Enforcement staff accepted as plausible Madoff’s claim that his returns were due to his perfect “gut feel” for when the market would go up or down. (Page 19-20)

During his testimony, Madoff also told the Enforcement investigators that the trades for all of his advisory accounts were cleared through his account at DTC. He testified further that his advisory account positions were segregated at DTC and gave the Enforcement staff his DTC account number. During an interview with the OIG, Madoff stated that he had thought he was caught after his testimony about the DTC account, noting that when they asked for the DTC account number, “I thought it was the end game, over. Monday morning they’ll call DTC and this will be over . . . and it never happened.” Madoff further said that when Enforcement did not follow up with DTC, he “was astonished.” (Page 20)

This was perhaps the most egregious failure in the Enforcement investigation of Madoff; that they never verified Madoff’s purported trading with any independent third parties. As a senior-level SEC examiner noted, “clearly if someone … has a Ponzi and, they’re stealing money, they’re not going to hesitate to lie or create records” and, consequently, the “only way to verify” whether the alleged Ponzi operator is actually trading would be to obtain “some independent third-party verification” like “DTC.” (Page 20)

A simple inquiry to one of several third parties could have immediately revealed the fact that Madoff was not trading in the volume he was claiming. The OIG made inquiries with DTC as part of our investigation. We reviewed a January 2005 statement for one Madoff feeder fund account, which alone indicated that it held approximately $2.5 billion of S&P 100 equities as of January 31, 2005. On the contrary, on January 31, 2005, DTC records show that Madoff held less than $18 million worth of S&P 100 equities in his DTC account. (Page 20)

When Madoff’s Ponzi scheme finally collapsed in 2008, an SEC Enforcement attorney testified that it took only “a few days” and “a phone call … to DTC” to confirm that Madoff had not placed any trades with his investors’ funds. (Page 20)

On May 16, 2006, three days before Madoff’s testimony, the Enforcement staff reached out to the Director of the Market Regulation Department at the NASD and asked her to check a certain date on which Madoff had purportedly held S&P 100 index option positions. She reported back that they had found no reports of such option positions for that day. Yet, the Enforcement staff failed to make any further inquiry regarding this remarkable finding. The Enforcement staff also failed to scrutinize information obtained in the NERO cause examination when the examination staff had attempted to verify Madoff’s claims of trading OTC options with a financial institution and found that “no relevant transaction activity occurred during the period” requested. Finally, although the Enforcement staff attorney attempted to obtain documentation from U.S. affiliates of European counterparties and one of Madoff’s purported counterparties was in the process of drafting a consent letter asking Madoff’s permission to send the Enforcement staff the documents from its European account, the inexplicable decision was made not to send the letter and to abandon this effort. Had any of these efforts been pursued by the Enforcement staff, they would have uncovered Madoff’s Ponzi scheme. (Pages 20-21)

[A letter to the SEC said] “Your attention is directed to a scandal of major proportion which was executed by the investment firm Bernard L. Madoff … Assets well in excess of $10 Billion owned by the late [investor], an ultra-wealthy long time client of the Madoff firm have been “co-mingled” with funds controlled by the Madoff company with gains thereon retained by Madoff.” (Page 21)

In investigating this complaint, the Enforcement staff simply asked Madoff’s counsel about it, and accepted the response that Madoff had never managed money for this investor. This turned out to be false. When news of Madoff’s Ponzi scheme broke, it became evident not only that Madoff managed this investor’s money, but also that he was actually one of Madoff’s largest individual investors. (Page 21)

Shortly after the Madoff Enforcement investigation was effectively concluded, the staff attorney on the investigation received the highest performance rating available at the SEC, in part, for her “ability to understand and analyze the complex issues of the Madoff investigation.” (Page 21)

[A second letter to the SEC from the same source said] “It may be of interest to you to that Mr. Bernard Madoff keeps two (2) sets of records.” The most interesting of which is on his computer which is always on his person. (Page 22)

As the foregoing demonstrates, despite numerous credible and detailed complaints, the SEC never properly examined or investigated Madoff’s trading and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme. Had these efforts been made with appropriate follow-up at any time beginning in June of 1992 until December 2008, the SEC could have uncovered the Ponzi scheme well before Madoff confessed. (Page 22)

Shortly after the investigation began, the former New York Enforcement Staff Attorney said he recalled, “Ike” Sorkin18 counsel for Avellino and Bienes, “calling up and saying, ‘I represent Avellino and Bienes’ and ‘nothing inappropriate is going on here.’” (Page 45)

Bienes described how at one time Avellino & Bienes had borrowed money from Chemical Bank for investing, but in 1988, they paid off the loan because they “didn’t want to have to explain what [their] investment strategies were … [and] didn’t want to submit detailed, annual, personal and business financial statements.” Id. at pgs. 53-58. Avellino also indicated that some investors were getting higher returns than others. (Page 45)

The FTI Engagement Team noted that the fact that some investors were getting higher returns than others could be indicative of a Ponzi scheme. (Page 45)

The FTI Engagement Team stated that such a long-standing relationship with no losses could raise the question as to whether Madoff may have been collaborating in a scheme with Avellino & Bienes.
(Page 46)

All the examination team members described the Madoff cause examination as brief and limited. Gentile stated it was a very brief examination and he did not recall if he ever went on site, although he believed he spoke with Bernard Madoff on the telephone. Gentile Interview Tr. at pgs. 12-13. Vasilakis stated the examination was very short, very limited . . . . (Page 47)

According to the examination team, they would have received DTC statements from Madoff himself, rather than seeking those records directly from DTC. (Page 48)

Gentile stated that if Madoff provided fake DTC records, “we would have relied on the fakes.” Gentile Interview Tr. at p. 18. He further acknowledged that if they were real DTC records, they would tell the story of whether there was trading going on. (Page 49)
The Examiners Were Aware of Madoff’s Stature. (Page 50)

The Complaint also did not charge the defendants with fraud or give any indication that they were suspected of running a Ponzi scheme. (Page 51)

Former New York Enforcement Staff Attorney #2 recalled that “there was a concern that Avellino and Bienes was operating a Ponzi scheme” that arose from “the returns that were being promised [by Avellino & Bienes] combined with a lack of transparency about how the monies were invested.” (Page 52)

Former New York Enforcement Staff Attorney #2 acknowledged that she was aware that Avellino and Bienes were stating that all the investment decisions were made by Madoff. (Page 52)

She also said she was not aware of any analysis undertaken to determine how Madoff was able to achieve the returns he was promising for Avellino & Bienes’ clients, although she acknowledged remembering that Avellino & Bienes had maintained that they never had a loss with their investments. (Page 53)

Lee Richards stated that he did not believe it was his role to look at whether Madoff could have misappropriated other customer funds in order to provide the capital needed to pay back the investors of Avellino & Bienes. Id. at pgs. 10-11. Lee Richards indicated that he was hired for the particular purpose of liquidating the accounts and ensuring that the investors were repaid. (Page 54)

In December 1992, Price Waterhouse reported back to Lee Richards and the SEC that they were unable to perform the function that they were directed to perform because of the lack of records maintained by Avellino & Bienes and their refusal to cooperate with the audit. (Page 55)

. . . Price Waterhouse reported that Frank Avellino “refus[ed] to prepare financial statements,” refused to provide requested documentation, and sent a letter to Price Waterhouse instructing them that they “should ‘not direct any further questions to a [representative of an outside computer service bureau],’” which had maintained the Avellino & Bienes’ noteholders’ ledger. Consequently, Price Waterhouse indicated that it would be unable to render an opinion or audit Avellino & Bienes’ financial statements even for the limited period of January 1, 1989 through November 1992. (Page 55)

Sorkin “vehemently oppose[d]” the request for additional time, noting that his clients have had their assets frozen during the period of Price Waterhouse’s audit. (Page 55)

On January 21, 1993, Price Waterhouse issued its final report to Lee Richards as Trustee, concluding that they were unable to render any opinion on Avellino & Bienes’ financial statements because of the lack of records and cooperation from Avellino & Bienes. Price Waterhouse Letter dated January 21, 1993, at p. 2, at Exhibit 127. Price Waterhouse’s report noted that even during the period from January 1989 until November 16, 1992, “records critical to the performance of an audit which one would expect a company that invested and borrowed over $400 million to have (such as security legers, security purchase and sales journals, monthly reconciliations of securities brokerage transactions and positions and investor/noteholder balances to Partnership records) were not maintained.” Id. Price Waterhouse’s report stated that when Frank Avellino was asked about the preparation of financial statements, he responded as follows: “My experience has taught me to not commit any figures to scrutiny when, as in this case, it can be construed as (bible) and subject to criticism.” (Page 56)

However, with respect to discovery, former New York Enforcement Staff Attorney #2 stated that “this was a fairly contentious litigation, that, you know, defense counsel [Sorkin?] was very aggressive.” (Page 58)

Judge Sprizzo also indicated in the same hearing that he did not believe Avellino’s testimony on the fee issues, stating, “I don’t believe your client. I heard his testimony, I saw his demeanor, I heard his inconsistencies on direct and cross. I noted the inconsistency in the position he took in the letter and the position he took on trial. I don’t believe him. (Page 58)

In connection with its investigation of Avellino & Bienes in 1992, according to FTI, there were several red flags that should have triggered a wide-ranging investigation of the existence of a Ponzi scheme on the part of Avellino & Bienes and potentially Bernard Madoff. For example, Avellino & Bienes was offering “100%” safe investments, which they characterized as loans, with high and extremely consistent rates of return over significant periods of time. (Pages 59-60)

While the SEC’s relatively inexperienced examination team conducted a brief and very limited examination of Madoff, they made no effort to trace where the money that was used to repay Avellino & Bienes’ investors came from, and relied upon DTC records from Madoff rather than going to DTC itself to verify if trading occurred. (Page 60)

The SEC lawyers working on the matter were aware of the questionable returns and the fact that all the investment decisions were made by Madoff, but the focus of the investigation was limited to whether Avellino & Bienes was selling unregistered securities or operating an unregistered investment firm. (Page 60)

Even after Price Waterhouse was unable to audit Avellino & Bienes’ financial statements and uncovered additional red flags, such as Avellino & Bienes’ failure to produce financial statements or have the records one would have expected from such a large operation, no further efforts were made to delve more deeply into either Avellino & Bienes’ or Madoff’s operations. (Page 60)

The 2000 submission also compared the amount of money Madoff was thought to manage at the time, $3 billion to $7 billion, with the open option positions on the Chicago Board Options Exchange (CBOE), and concluded that the “hedging cannot be taking place as described. … [I]f only $3 billion are allocated to this strategy, then there still aren’t enough options in open interest for this type of hedging to occur, since Madoff would be at least 1/3 of the open interest, and we know that’s not the case.” (Page 62)

[Markopolos’ red flags in 2000 included that ] “Madoff has perfect market-timing ability: One investor told me that Madoff went 100% to cash in July 1998 and December 1999, ahead of market declines.” (Page 63)

[Markopolos’ red flags in 2000 included that] “Madoff does not allow outside performance audits: One London based fund of funds representing Arab money, during the due diligence process, asked to send in a team of Big Six accountants to verify performance. They were told no, that only Madoff’s brother is allowed to audit performance for reasons of secrecy. Amazingly, this London based fund of funds invested over $200 million of their Arab client’s money anyway, because the low volatility of returns was so attractive.” (Page 63)

[Markopolos’ red flags in 2000 included that] “Having a broker/dealer subsidiary that is also an [Electronic Communication Network], which is then able to generate false trading tickets would also be a huge advantage. Not allowing external auditors in to verify performance would also be something a Ponzi Scheme operator would do.” (Page 63)

[Markopolos said] “[Ward] did not have an industry background that I was aware of. He had zero comprehension of topics being discussed. He seemed very ill-trained, uninformed about industry practices, did not understand financial instruments. Didn’t even have a basic understanding of finance.” (Page 64)

However, the OIG has found no documentary evidence that Ward referred the matter to NERO and, as discussed below, Marcelino’s understanding from speaking with Ward was that Ward had “decided not to pursue it.” (Page 65)

As part of its investigation, the OIG reviewed all e-mails produced by the Office of Internet Technology (OIT) from Ward’s files for the relevant time period and, in addition, reviewed all relevant e-mails from NERO’s files produced by OIT for the same period, and found no evidence that the 2000 submission was referred to NERO. (Page 65)

According to Adelman, Marcelino told him that he had spoken recently with Ward and Ward had told Marcelino: (1) that Ward remembered the Markopolos meeting in 2000;
(2) that Ward said he had “decided not to pursue” the matter in 2000; and (3) that Ward had said he was “perfectly comfortable with how he had handled it.” (Page 67)
Based on Marcelino’s testimony and Adelman’s corroborating statement, Ward’s testimony to the OIG was not credible regarding: (1) whether he recalled meeting with Markopolos or hearing concerns about Madoff’s hedge fund in 2000; and (2) the substance of his February 4, 2009 conversation with Marcelino. Accordingly, the OIG concludes that, based upon the preponderance of the evidence, Ward met with Markopolos in 2000 and told Manion that he had referred the complaint to NERO, but never actually did. (Page 67)

[Markopolos’ red flags in his 2001 submission included] “Only 3 down months vs. the market’s down 26 months during the same period, with a worst down month of only -1.44% (April 1993) vs. the market’s worst down month of -14.58% (August 1998).” (Page 67)

NERO Decided Not to Investigate Madoff Only One Day After Receiving the 2001 Submission. (Page 71)

Finally, Kazon also acknowledged that the 2001 submission should have been reviewed for more than one day before a decision was made regarding its disposition. (Page 73)

NERO Did Not Reconsider Its Decision Not to Investigate Madoff After Publication of the Articles. (Page 76)

The SEC did not commence an investigation of Madoff after the publication of the MARHedge and Barron’s articles. Schonfeld acknowledged that Barron’s is a “reputable publication” and that “the fact that in addition to a complaint being provided to you that there were two newspaper articles providing similar information as the complainant,” “would be [a] factor[] to consider in triaging, [which was the process utilized by NERO to determine if a complaint was worth pursuing.]” (Page 77)

Kelly signified in her notes that the following one piece of information the Hedge Fund Manager provided was of particular importance (by placing it in a box and drawing a star next to it): “For volume must see options on street yet never see them.” (Page 78)

On the following day, May 21, 2003, the Hedge Fund Manager sent Kelly a detailed complaint by e-mail, in which he laid out the red flags that his fund had identified about Madoff while performing due diligence on two Madoff feeder funds. (Page 78)

The CIO’s suspicions triggered, he called CBOE to find out how much daily volume traded on the exchange. He described his call to CBOE, as follows: “And the problem is … that the volume was never there for Madoff. So that was problem No. 1 for me. Problem No. 2 was … I called up buddies of mine around the street who were now running the equity derivatives departments of a number of firms, and I asked them all if they were trading with Madoff. And nobody was. Nobody was doing these OEX options. And in fact, the funny part about it was they all said, yeah. You know, I hear that he’s doing all these trades but, you know, we don’t see it anywhere … And so things just began to, you know, not match up. (Page 78)

The complaint also described the following specific concerns about Madoff’s strategy and purported returns:
according to [BMIS], the options are traded with a number of traders and crossed on CBOE. With a 8-10 billion size, you must see the volume, but unfortunately you don’t. We actually checked with some of the largest brokers (UBS, Merril [sic], etc) which told us they never traded with them OEX options. The question is do they really implement the full strategy.
(Page 79)

To Kelly, the complaint indicated “that there are areas that need to be answered, and we needed to look into them more.” Kelly Testimony Tr. at p. 37. She also understood that the Hedge Fund Manager was implying that BMIS might be lying about its option trading, and “some of the issues” that the [Hedge Fund Manager] laid out in the complaint were “indicia of a Ponzi scheme.” (Page 80)

Another examiner testified that in his experience it was unusual for Richards to personally call registrants at the start of an examination. (Page 87)

Walker’s “‘view’ of the team assigned to the Madoff investigation was that they did not have much experience in equity and options trading. Rather, their experience was in general litigation.” (Page 91)

Issues raised by the Hedge Fund Manager’s complaint and the two 2001 articles62 other than front-running – such as auditor independence, Madoff’s extraordinary returns, and lack of liquidity in the options market to support alleged trading – were not investigated at all in the examination. (Page 93)

McCarthy testified he did not make a mistake in focusing the examination on front-running “because that’s where my area, my team’s area of expertise led.” (Page 94)

The FTI Engagement Team opined that to focus an exam based upon the expertise of a team rather than on the complaint itself is nonsensical. As a result of the decision to not request assistance from the Investment Management Examination Group, the FTI Engagement Team concluded the project was not properly staffed with the expertise needed to address the allegations raised in the complaint. (Page 94)

According to the FTI Engagement Team, the allegation regarding BMIS’s auditor should have been investigated because the lack of an independent auditor raises concerns as to whether or not the auditor is unbiased, fair and impartial. (Page 95)

[After Madoff confessed] Within a few hours of obtaining the work papers, the New York Staff Attorney determined that no audit work had been done. New York Staff Attorney Testimony Tr. at p. 10. Immediately upon reviewing Friehling’s work papers, the New York Staff Attorney testified, there “were red flags for me as to the auditor. … I didn’t see anything that resembles kind of formal work papers, auditor work papers that would comply with generally accepted audit standards. (Page 95)

However, the OCIE examination team did not take any measures to verify whether or not Madoff was trading options on CBOE, and Donohue conceded that the examination did not engage in sufficient analysis or examination of options trading issues raised in the Hedge Fund Manager complaint. (Page 96)

As referenced in the Planning Memorandum, the staff prepared a draft letter to the NASD, dated December 17, 2003. Draft letter dated December 17, 2003 from Swanson to Luparello, at Exhibit 166. Examiners addressed the letter to Stephen Luparello of the NASD, and requested “Transaction data for all order executions effected by Madoff Securities” from “January 1, 2001 through December 15, 2003.” (Page 97)

Likewise, Swanson stated that “the NASD was oftentimes the best source to get accurate, timely sales data. So what we would have been doing is getting information about the market making trades that were reported to NASD from Madoff during that time period.” (Page 97)

However, the letter to the NASD was never sent. Nor did the staff request trade data from another independent third-party. Rather, the staff relied exclusively on trade data provided to them by Madoff. (Page 98)

If the staff had requested audit trail information from the correct third-party, the examiners could have uncovered Madoff was not making the trades he claimed to be making, according to Donohue who stated, “I think that we would have been able to uncover that he was not trading there.” (Page 98)

It appears that the letter to the NASD was not sent because it was less time-consuming for examiners to request and use data supplied by Madoff . . . . (Page 98)

Moreover, until Madoff’s confession to running a Ponzi scheme in December 2008, it was not unusual for OCIE to rely exclusively on records and data produced by the registrant, even in instances in which the registrant was being examined for possible fraud. (Page 98)

Madoff recalled that Donohue looked at the right things for front-running, but only would have discovered it was a Ponzi scheme if he had gone to an independent third-party. (Page 98)

Swanson recalled speaking with Madoff right before or soon after sending the initial document request. Swanson Testimony Tr. at p. 66. Swanson stated he does not believe he took notes of the conversation, as he did not typically take notes of telephone conversations with registrants. Id. Swanson recalled Madoff told him “there was a Chinese wall in place” and there was no basis for the Commission’s concerns he was running a hedge fund. (Page 100)

On January 16, 2004, Madoff personally responded to the document request. Madoff wrote in his response letter to Swanson, “Neither Madoff securities, nor any person or entity affiliated with Madoff Securities, manages or advises hedge funds,” and “we have no interest in becoming a manager or adviser to hedge funds.” Id. Instead, Madoff claimed BMIS only executed trades for institutional clients, stating, “As executing broker, Madoff Securities is compensated thru execution commissions derived from the Split Strike Conversion strategy transacted over our Institutional Department’s Execution Trading Platform.” (Page 100)

It was atypical for the CEO of an entity the size of BMIS to personally respond to an information and document request. Wood does not recall working on any other examination in which the CEO responded to an information and document request. Wood Testimony Tr. at p. 100. According to the FTI Engagement Team, examinations of small firms with few employees may necessarily involve significant participation from senior executives, but large firms (including Madoff) have compliance officers and other compliance staff that are typically involved in responding to SEC information requests. (Page 100)

Madoff’s response to the Document and Information Request contradicted the Hedge Fund Manager’s complaint and the two 2001 articles about Madoff which indicated Madoff was managing money for hedge funds. Michael Ocrant, Madoff Tops Charts; Skeptics Ask How, MARHedge, May 2001, at Exhibit 146; Swanson Testimony Tr. at p. 65; Donohue Testimony Tr. at p. 63. Swanson and Wood did not recall the team making any effort to determine whether statements Madoff made in his responses to their document requests were accurate “and that he wasn’t in fact managing money.” Wood Testimony Tr. at p. 59; Swanson Testimony Tr. at p. 65. As Swanson explained, “I didn’t test that. My concern was front-running.” (Page 101)

Notably, the examiners made the surprising discovery that BMIS’s mysterious institutional business was making significantly more money for BMIS than was BMIS’s well-known market making operation. Id. However, Wood and Walker did not identify this finding as a cause for concern in the memorandum:

The commission revenues generated from these four institutional clients account for the overwhelming majority of commission revenues generated for the firm since 2001.

(Page 103)

Donohue admitted the fact that the “overwhelming majority” of BMIS’s profits came from commission revenues from four hedge fund clients and not from market making activities “was a concern” and “[t]he size of his profits were of concern.” (Page 104)

Examination Team Failed to Request Data from Any Independent Third-Party. (Page 109)
The FTI Engagement Team concluded that obtaining data from an independent third-party such as NASD/FINRA, NSCC or DTC would have assisted in independently verifying trading activity conducted at Madoff. NASD/FINRA and NSCC data would have enabled the examination staff to verify trading volume whereas DTC data would have enabled the examination staff to verify overall position balances. (Page 111)

When he finally admitted to “executing trades” for billions of dollars in customers’ (hedge funds) money using specific proprietary trading algorithm, he said we should know about this as he told Lori Richards and John McCarthy about this 1.5 years ago. (Page 131)

Although the complaint was provided to the SEC in March 2003, after over two years had passed, the evidence shows that the OCIE never concluded the examination or resolved the many issues raised in the complaint. (Page 137)

The FTI Engagement Team concluded that multiple red flags were missed or were not pursued by the examination team. In addition, the FTI Engagement Team concluded that based upon issues raised in the complaint, had the examination been staffed and conducted appropriately, and basic steps taken to obtain third-party verifications, Madoff’s Ponzi scheme should and would have been uncovered. (Page 138)

Courses of action in the Planning Memorandum that involved going to third parties should have been followed through upon, but were not. For example, the staff drafted a letter to the NASD, which was critical to any adequate review of the complaint because the data and information from the NASD would have assisted in independently verifying trading activity conducted at BMIS. (Pages 142-143)

[A Renaissance email says] “In Nat’s note, I am most worried about the new information in the statement that “Madoff cherry-picks trades and ‘takes them for the hedge fund’.” We at Renaissance have totally independent evidence that Madoff’s executions are highly unusual.” (Page 147)

The secrecy of the floor coupled with the rumors about the lack of auditor independence was a red flag for Simons. Id. at p. 45. Similarly, the small size of Madoff’s auditor was an issue for Broder because Madoff was reportedly managing billions of dollars for investors. Broder Interview Tr. at p. 33. (Page 150)

Simons also found that “on its face,” Madoff’s fee structure was illogical. Simons Interview Tr. at p. 18. Simons did not understand why Madoff would allow feeder funds to take hundreds of millions of dollars in fees that Madoff could have kept for himself. (Page 150)

The most detailed reasoning for why Renaissance suspected Madoff was misrepresenting his trading came from Broder’s analysis of Madoff’s claimed options trades. In his November 21, 2003 e-mail, Broder concluded Madoff could not be trading on an exchange because of insufficient volume, and could not be trading options over the counter because it was inconceivable that Madoff could find counterparties for the trading. Memorandum dated April 22, 2004 from Eschwie to Sollazzo, at pgs. 5-6, at Exhibit 210; Broder Interview Tr. at p. 37. Laufer further explained, “[W]e made inquiries. We didn’t see anybody saying he did a lot of trading. We didn’t understand why anybody in the business of options would take the other side. … [Y]ou ask yourself, why would somebody do this? Because he’s going to lose money doing the trade, so far as we know.” (Page 153)

But if you’d read the e-mails … you would have thought the question would come to mind, hey, these guys are debating whether he could possibly be doing this volume. Let’s – the next step will be let’s try to verify that he did this volume. … And the first time you checked a trade, you would have found it’s not there. (Page 154)
Broder thought a regulator could have verified whether Madoff was trading by asking Madoff who his counterparty was and then verifying with the counterparty that the trade took place. (Page 154)

I mean this guy is trading – this is a cash account. So he’s turning over $10 billion of stocks each particular month. I mean, you’ve got to be [able to see it] in the marketplace. (Page 154)

Laufer also felt that a regulator conducting a thorough review of the e-mails would have had to have asked, “Who took the other side of the trade? You don’t have to deduce huge amounts. Just ask who took the other side of the trade, which of course we couldn’t find that [out].” Likewise, if Simons were investigating Madoff, he stated that he would have asked Madoff to “show me the other side of your trades” whether Madoff claimed to trade in the United States or Europe. Simons Interview Tr. at pgs. 36-37. As Simons explained, “I need to see the other side of those trades in Europe. If they’re in Europe, that’s fine, but you’re doing them with someone. There’s got to be somebody on the other side of the trade.” (Page 154)


Q: Do you think that someone from the SEC should be able to figure this out?
A: Much more elementary than that. Someone at the SEC could wander down, you know, to Goldman Sachs and wander over to their options department and ask them, how does somebody execute $10 billion of options, and find out it’s very difficult. This is not … proprietary Renaissance analysis here. … Paul Broder would not claim to be a mathematician, and he’s an expert of this, and he’s very smart.

(Page 155)

If your SEC person had a small amount of expertise, it’s clear you go to Madoff and you say, show me the – show me your volume. Show me the counter parties. And you see how he’s managing to do these extraordinary things. … [Y]ou don’t have to figure out if he’s front-running or if he’s doing something weird. You ask him to show you what he’s doing. (Page 157)

But one piece of information “helped to allay concerns” of other employees: “[W]e were aware that … [Madoff] had been investigated by the SEC.”98 Id. at pgs. 17, 28. Because of the competing viewpoints, Renaissance stated they initially reduced their investment by approximately one half and later got out of the investment entirely for unrelated reasons. (Page 157)

Simons cited their understanding that the SEC had looked at Madoff and given him a “clean bill of health” as a reason Renaissance did not initially divest itself of its Madoff-related investment. Id. at p. 28. Renaissance understood the SEC had examined “the whole business.” Id. at p. 17. Laufer agreed, “What was also on our minds … was that Madoff had been investigated – and cleared” by the SEC. Laufer Interview Tr. at pgs. 35-36. (Page 157)

Renaissance appears to have been referring to the 1992 examination of Madoff that arose from the SEC’s investigation of Avellino & Bienes. (Page 157)

Renaissance also doubted Madoff could be engaged in fraud because he operated through highly-regulated brokerage accounts:

[B]ecause of the nature of the fact that these were brokerage statements, and he had a big broker-dealer business and big market-maker and – you just assume that someone was paying attention to make sure that there was something on the other side of the trade. … I never, as the manager, entertained the thought that it was truly fraudulent. And it again was because … it would have been so easy to prove that it was fraud if it was just managed accounts that were set up. It would have been so
– again, forgive me here, but you know, it would have been pretty straightforward. We felt that he was sufficiently in the eye of the regulators that it was just hard for us to envision that that was the case.

(Page 158)


No one from the SEC contacted Simons, Laufer, or Broder about their e-mails until the OIG conducted its investigation in 2009. (Page 158)

Based on the Renaissance e-mails, one allegation that Eschwie would follow-up on was “whether Madoff was actually trading.” (Page 160)

According to the FTI Engagement Team, Madoff’s books and records were subject to examination whether or not he was registered as an investment adviser. As a registered broker-dealer, the Madoff firm’s books and records (including e-mails) related to that business are subject to compliance examinations and review by the SEC staff under Section 17 of the Exchange Act. If the firm had been registered as an investment adviser at that time, the firm’s books and records related to that business would have been subject to compliance examinations and review by the SEC staff under Section 204 of the Advisers Act. However, since Madoff was running the investment advisory business out of discretionary brokerage accounts at BMIS and it was a registered broker-dealer, those records were also subject to compliance examinations and review by the SEC staff under Section 17 of the Exchange Act. Therefore, OCIE examiners (whether in OCIE’s Broker-Dealer or Investment Management Groups) had access to all of BMIS’s books and records, including those relating to BMIS’s advisory accounts. (Pages 160-161)

. . . but we did know the firm was a fairly large firm, employed a lot of people, was a very big market-maker, had introduced the, sort of, third market issue to the market. So it didn't seem to be – it didn’t seem as if, you know, he was a fly-by-night operation that was out there to rip people off is I guess what I’m trying to get to. So that may have tempered our decision to wait until the proper personnel would have been available. (Page 165)

Lamore agreed that, in his November 21, 2003 e-mail, Renaissance’s Broder questioned whether Madoff was actually trading the options he represented he was trading. Id. at p. 40. However, Lamore did not recall the team focusing on the options issue: “I don’t recall focusing on the options. We were more focused on the equities.” Id. Likewise, Ostrow testified that he did not recall the examiners investigating the issue raised in the Renaissance e-mails about the unlikelihood that Madoff could find an options counterparty. (Page 171)

Although it was not a focus of the examination, the examination team stated that they looked into the general issue of Madoff’s options trading solely by asking Madoff about it. Lamore Testimony Tr. at p. 42; Ostrow Testimony Tr. at pgs. 38-39. However, when Madoff said he was no longer using options as part of his strategy, they stopped looking at the issue, despite the fact that Madoff’s representation was inconsistent with the Renaissance e-mails, the two 2001 articles, and the investment strategy Madoff claimed to employ. (Page 172)

Lamore explained he thought Renaissance was “questioning why Bernard Madoff would not set up his own fund and collect the 20 percent profits himself.” Lamore Testimony Tr. at p. 34. Lamore and Sollazzo stated that they were concerned about Madoff’s fee structure. (Page 172)

The FTI Engagement Team concluded that it was illogical to believe that Madoff was implementing the split-strike forward conversion strategy without trading options. According to the FTI Engagement Team, Madoff’s split-strike forward conversion strategy, as indicated in the Trading Authorization Directives, consisted of buying a basket of large capitalization stocks in the S&P 100 stock index (“OEX”), selling OEX call options and purchasing OEX put options. As a result, the options were a critical component of the strategy. (Page 172)

The examination team also did not contact Renaissance Technologies to follow up with them about the issues they raised in their e-mails. Memorandum dated April 22, 2004 from Eschwie to Sollazzo, at Exhibit 210; Sollazzo Testimony Tr. at p. 61; Nee Testimony Tr. at p. 41; Ostrow Testimony Tr. at p. 35; Lamore Testimony Tr. at p. 38. Laufer had stated in his November 14, 2003 e-mail, “We at Renaissance have totally independent evidence that Madoff’s executions are highly unusual.” E-mail dated April 20, 2004 from Thanasules to Rodriguez, at Exhibit 215. Nee explained that they did not follow up on the “entirely independent evidence . . . .” (Page 174)

A review by the examiners of the auditor’s engagement letter, reports and work papers would likely have raised serious doubts as to the scope of work actually performed. A closer look to determine whether or not the accountant verified, by actual examination, client funds and securities held by Madoff would have uncovered Madoff’s Ponzi scheme. In fact, after Madoff confessed to running a Ponzi scheme, a New York Staff Attorney was assigned to investigate Madoff’s accountant, David Friehling. Within a few hours of obtaining the work papers, he determined that no audit work had been done. New York Staff Attorney Testimony Tr. at p. 10. Immediately upon reviewing Friehling’s work papers, the New York Staff Attorney testified, there “were red flags for me as to the auditor. … I didn’t see anything that resembles kind of formal work papers, auditor work papers that would comply with generally accepted audit standards. So, there was almost nothing that indicated that any audit work had been done.” (Page 174)

The FTI Engagement team concluded that the examiners should have contacted Renaissance, especially since Renaissance had been an SEC-registered investment adviser since January 1998. (Page 175)

DTCC’s “subsidiaries provide the infrastructure for clearing, settlement, and custody of most US securities transactions. DTCC was established in 1999 when operating companies The Depository Trust Company (DTC) and the National Securities Clearing Company (NSCC) … were combined under a single holding structure. DTC is the world’s largest securities depository and a clearinghouse for trading settlement; NSCC processes most broker-to-broker equity, corporate, and municipal bond trades in the US.” 111 OCC is “the world’s largest equity derivatives clearinghouse. The OCC serves some 130 broker-dealers, futures commission merchants, and securities firms in the US and abroad. It is owned by options trading participants NYSE Alternext, Chicago Board Options Exchange, International Securities Exchange Holdings, and Nasdaq OMX PHLX.” (Page 176)

However, examiners did not identify the lack of an internal audit department at BMIS as a red flag. (Page 177)


The FTI Engagement Team concluded that the lack of an internal audit department at a relatively large and well-known firm as BMIS should generally have raised concerns with regard to the level and effectiveness of internal controls at the firm. (Page 177)

The examiners recognized that Madoff’s representations that he did not manage money and that he no longer traded option contradicted the news reports. (Page 187)

Other representations by Madoff also contradicted documents that Madoff produced to OCIE in 2004. For instance, Madoff provided the 2004 OCIE examination team with paper-based customer account statements for the month of January 2004 that included options and equities trading activity for 21 clients. (Page 187)

On May 16, 2005, Barclays responded to Nee’s information request, stating that
BMIS had recently opened an account at Barclays, but there was no transaction activity in the account. (page 189)

Examination Team Did Not Go To An Independent Source For Trading Data. (Page 191)

In the memorandum, the examiners described how Madoff had changed his story several times. Id. For example, Madoff had said he had no advisory clients, then he had claimed to have four, and then “closer to 15.” Id.; Lamore Testimony Tr. at p. 88. Lamore testified that he suspected Madoff may have been providing the examiners with a smaller number of clients than he actually had in order to stay below the threshold for registering.” (Page 193)

Initially, BMadoff stated there were four hedge funds using the model including Fairfield Sentry, Thema, Tremont, and Kingate Global. Subsequently, BMadoff stated there were approximately 15 entities including the four hedge funds and two corporate accounts using the model. (Page 193)

Nee also was “aware that the examiners on the Madoff cause exam felt that they were lied to by Mr. Madoff on numerous occasions.” Nee stated he was not “overly concerned with” the discrepancies as long as Madoff disclosed “the bulk” of his trading, and disclosed “some of the bigger ones” like Fairfield. (Page 194)

Sollazzo explained Madoff’s failure to provide “information on the underlying advisory clients” was “definitely a concern” as was Madoff’s frequently changing stories about the number of clients for which he executed trades. (Page 196)

During the conference call, Nee and the examiners recalled OCIE telling them Madoff was a powerful and well-connected individual:
I don’t know who said it, someone from OCIE basically, “He’s a very powerful person, Bernie, and you know, just remember that.’ … But basically just, “He is a very well-connected, powerful person.”
(Page 199)

Ostrow testified that this was an issue for the SEC generally, and that in past examinations unrelated to Madoff, supervisors at the SEC appear to have been reluctant to push issues against influential people: “Yes. I’ve seen it where, you know, maybe I’ve been told, ‘Don’t rock the boat so much there, because we have a good relationship with them,’ and when we – and not Madoff-related, but you know, ‘where we need to make a request for documents, they always gave it to us. So let’s try to go easy . . . .’” (Page 199)

According to the FTI Engagement Team, the Hedge Fund Manager’s complaint was detailed, insightful and considered to be from a credible source. The FTI Engagement Team concluded the complaint would have been particularly useful to the examination team because it included a number of serious allegations that needed further scrutiny, including. (Page 200)

This category included the Hedge Fund Manager’s Complaint investigated in the OCIE examination, which questioned whether Madoff was misrepresenting his trading to his investors, stated that Madoff’s returns were not correlated to the overall equity markets in over 10 years, and asserted that the auditor was a “related party to the principal.” (Page 200)

Madoff Failed to Produce Correspondence, E-mail and Other Documents Requested by the Examination Team. (Page 201)
Throughout the examination, Madoff failed to provide the team with requested documents. (Page 201)

BLACKED-OUT SECTION.

Madoff stated that he thought “the jig was up” during the on-site OCIE examination because he thought it was routine for the SEC to check with an independent third-party. Madoff Interview Memorandum, at p. 5. Madoff stated that Ostrow and Lamore “never really got into books and records as related to stock records or DTC records.” Id at p. 3. Madoff stated that “they never even looked at my stock records” or did a “box count.” Id. He said he was “astonished” that they didn’t ask for DTC records, and that only a regulator could get those records from DTC. (Page 206)

According to the FTI Engagement Team, examination staff could also have contacted FINRA/NASD, a SRO regulated by the Commission, in order to independently verify equities trading activity purportedly conducted by Madoff. (Page 206)

Madoff added that DTC does not have separate accounts for each customer, but rather, provides a global report, but stated that if they went to DTC, they would’ve seen his market making position, and that it “would’ve been easy for them to see” the Ponzi scheme. (Page 207)

During the Enforcement investigation of Madoff, Madoff told SEC Enforcement attorneys, in the presence of Lamore, that his trades cleared through DTC. See Section V. After Madoff confessed to running a Ponzi scheme, Friedman, a NERO Branch Chief in the Division of Enforcement, testified that it was his understanding that within a few days NERO confirmed through either a “DTC terminal” or a “a phone call … to DTC” that Madoff had not been placing trades for his clients. (Page 207)

Based on the volume (i.e., billions) of dollars that Madoff managed for the advisory clients, the FTI Engagement Team concluded that the SEC could have determined there was a problem if it had directly contacted DTC. If Madoff’s advisory account data was segregated from its market making data at DTC, those records should have shown significant positions coinciding with periods that Madoff reported holding significant positions in the split-strike forward conversion strategy. In addition, DTC’s affiliate, NSCC, could have also provided transactional volume data regarding the advisory account activity that should have been consistent with the transactional activity reported in the monthly account statements and customer confirmations. (Page 207)

Nee shared Lamore’s feeling that Madoff’s claim to be trading on “gut feel” was not credible. (Page 211)

Examiners Did Not Contact the Feeder Funds Madoff Disclosed. (Page 213)

The FTI Engagement Team concluded that it would have been useful for the examination team to contact the feeder funds in order to resolve a number of significant open issues including whether or not Madoff had full discretion over the accounts; how Madoff implemented the trading strategy; what the trading, clearing and settlement process was that was used and who was involved in that process; and the number of accounts Madoff had at each fund in order to confirm whether Madoff was accurately reporting those accounts to examination staff. (Page 213)

The finding that the well-known BMIS market making business would be losing money without the secretive hedge fund execution business was a surprising discovery for the entire team, one Sollazzo described as “a red flag.” Nee Testimony Tr. at p. 139; Sollazzo Testimony Tr. at p. 118; Lamore Testimony Tr. at pgs. 136-37. Ostrow was surprised by the discovery because “here was the large market making firm, and he hasn’t admitted to having any sort of accounts, but yet it makes up 80 or 90 percent, or … if anything, the investment adviser is smoothing out the earnings of the broker-dealer.” Ostrow Testimony Tr. at p. 158. The FTI Engagement Team concluded the examination staff should have recognized this discovery as a red flag and seriously considered investigating whether or not Madoff should have been registered as an investment adviser. However, Nee ultimately made the determination that the examination team should not pursue the issue of whether Madoff should be registered as an investment adviser. (Page 214)

Ostrow found Nee’s minimization of his concerns “frustrating,” stating in the following exchange:

A: It’s frustrating when you’re out there for three months, lied to every day, and you try relaying that, and you try to get it across that, you know, how can this be? Or, I mean, some of these are gray areas, some of them night not be. But, you know, I guess that’s the frustration, in terms of – you know, maybe he doesn’t see it as that.

Q: So did you feel that John was kind of [pawning] this off as semantics on some way?

A: Right, by asking, “How did you word the request?” You know, we worded it, or we asked him specifically, “Do you manage money?” Like, we asked it eight different ways and six different languages, and you know, got the same “No,” but yet the Barron’s article, the MarHedge article, you know, we didn’t know how to ask it. And this is already two or three months in, and we still can’t –

(Page 219)

As evidenced by the following e-mail from Ostrow, the examiners wanted to visit feeder funds, in part, because their research indicated that some of the Madoff feeder funds claimed to use a strategy that required options trading, yet Madoff had told examiners he no longer used options as part of his trading strategy. (Page 220)

Examiners were not allowed to visit feeder funds, in part due to fear of lawsuits. (Page 220)

Sollazzo explained that one of complications that arise when customers are contacted is that firms complain to top SEC officials. (Page 222)


Madoff’s claim not to use options as part of his strategy was Ostrow’s primary open question at the end of the examination. Id. at p. 75. Ostrow stated, “the biggest thing in my mind was … not using the options any more, when … 50 percent of the gist of it was having options as part of the strategy. … It wasn’t … according to John [Nee], the focus of the exam, and to just focus on, you know, proving these other points.” (Page 225)

Madoff viewed the three minor violations the examiners’ cited as “nitpicky” and “incorrect.” Madoff Interview Memorandum at p. 2. Madoff stated that two months after the examiners left, he received a letter citing him for “two ridiculous violations,” that were incorrect. Id. Madoff went on to state that when BMIS submitted their response to the SEC letter and copied it to FINRA, FINRA responded, “What the heck? Are you nuts with this nitpicking?” Id. Madoff stated, “After two months, they found 2-3 nitpicky things, and they were wrong about those things.” Id. Madoff asserted that “Everything the SEC did prior to 2006 [Enforcement Investigation] was a waste of time.” (Page 226)


In concluding the examination and writing the report, the examination team did not go back and examine the issues raised in the Renaissance e-mails to determine whether all of the issues identified in those e-mails had been resolved. Nee Testimony Tr. at p. 155. Neither did the report raise the numerous issues the examiners identified during the examination, including Madoff’s efforts to conceal the existence of his investment advisory business from examiners, the difficulties the examiners had in getting Madoff to produce documents and information, the inconsistencies examiners found in the information and documents produced, the issue of whether Madoff should be registered as an investment adviser, the issue of whether BMIS’s London office is an affiliate or a branch, and the inconsistencies between Madoff’s representations that he has stopped trading options and the representations made by the feeder funds. (Page 227)

Ostrow explained the lack of an independent custodian was not in the report because Bernie told the examiners that he did not have control over the money, and the examination team did not verify Madoff’s representation. (Page 228)

In addition, the FTI Engagement Team concluded that based upon issues raised in the Hedge Fund Manager’s complaint, had the examination been staffed and conducted appropriately, and basic steps taken to obtain third-party verifications, Madoff’s Ponzi scheme could have been uncovered. (Page 229)

Crucially, one of the Renaissance e-mails provided a step by step analysis of why Madoff must be misrepresenting his options trading. The e-mail explained that Madoff could not be trading on an options exchange because of insufficient volume and could not be trading options over-the-counter because it was inconceivable he could find a counterparty for the trading. For example, the e-mail explained that because customer statements showed that the options trades were always profitable for Madoff, there was no incentive for a counterparty to continuously take the other side of those trades since they would always lose money on the trades. These findings by Renaissance raised doubts that Madoff could be implementing his trading strategy. (Page 229)

In addition, Renaissance’s suspicions about Madoff’s options trading should have been a focus of the examination because Broder’s e-mail presented the staff with a thorough analysis of why Madoff must be misrepresenting his options trading. A basic step to investigating this allegation would have been to directly contact the counterparties in order to verify that the options trades took place. Moreover, the examiners should have been incredulous of Madoff’s claim to have stopped trading options since the strategy he claimed to be using required options trading. In addition, if the examiners had closely reviewed OCIE’s workpapers, they would have seen that the customer statements Madoff produced to OCIE included options trading during a month in which the customer statements Madoff had provided to NERO showed no options trading. (Page 230)

It was also a mistake for the examination team not to focus on the auditor. Renaissance suggested that Madoff utilized a non-independent auditor, which should have raised concerns for the auditors about whether or not the auditor was unbiased, fair, and impartial. Without an independent auditor, there can be no assurance that the BMIS’s audits were properly conducted. (Page 230)

It was an error for the supervisors of the examination team not to staff the examination with examiners experienced in investment adviser examinations. Investment Management expertise was necessary to the examination given the allegations in the Renaissance e-mails because many of the allegations involved analyzing returns and investment strategies, areas where the supervisor of the examination admitted broker-dealer examiners are not skilled. (Page 231)

The examiners’ document request to Madoff was flawed because much of the request was geared toward a standard broker-dealer examination and did not specifically address the allegations in the Renaissance e-mails. Madoff’s initial unwillingness to admit to managing money for hedge funds when the fact was widely-known suggested that he did not want to register as an investment adviser and be subjected to additional examinations. Madoff’s evasiveness should have raised suspicions that Madoff was involved in illegal activity. (Page 231)

Additional misgivings should have been raised by the numerous discrepancies in the information and documents Madoff provided to examiners. Almost the entire examination was based on documents provided by and assertions made by Madoff. The discrepancies and contradictions should have alerted the examination team of the need to independently verify Madoff’s representations. (Page 231)

The response from Barclays also should have raised significant suspicions because it did not verify any of Madoff’s transactional activity associated with the investment advisory business. The examination team should have contacted Barclay’s U.K. affiliate in order to verify whether Madoff had a trading relationship with Barclay’s and to seek records of trading activity associated with the advisory clients. (Page 231)

The NERO examination staff had difficulty understanding how Madoff executed and cleared his trades and, at times, believed that Madoff was deliberately misleading them. As a result, the FTI Engagement Team believes that the examination staff should have recognized the need to independently verify Madoff’s verbal representations as to how he executed and cleared his trades. (Page 231-232)

The questions raised by the examiners should have also caused them to contact purported custodians to directly verify the Madoff accounts held at the custodians, the account balances and any other arrangements that the custodians had with Madoff. The customer statements that Madoff produced to the examiners, in many instances, purported to show where the customer assets were custodied. For example, a customer statement for American Masters Broad Market Fund LP indicated that the custodian was Bank of America. Lamore acknowledged in testimony that Madoff never produced “any documentation of these custody of asset issues, supposedly from the bank that was custodying the assets” and no efforts were made to seek such documentation. Lamore Testimony Tr. at p. 114. In truth, the custody of assets issue was only a peripheral issue for the examiners who testified that they never nailed down how Madoff executed and cleared trades. (Page 232)

The DVP/RVP agreements adopted by Madoff also purportedly used Barclays in London as a clearing broker to clear the trades for Madoff’s U.K. affiliate. The examiners could have contacted Barclays in London in order to verify Madoff’s trading activity associated with the advisory clients. (Page 232)

Fourth, it is acknowledged that later in his testimony in connection with the Enforcement investigation, Madoff contradicted his assertion about a DVP/RVP arrangement by saying the trades for all his advisory accounts were cleared through his account at DTC. Madoff May 19, 2006 Testimony Tr. at p. 87, at Exhibit 267. Although Lamore was present when Madoff made this representation and identified contradictions in Madoff’s testimony, no effort was made to question Madoff about this contradiction and no inquiry was made with DTC at that time as well. (Pages 232-233)

The fact that the examination team did not go to an independent source for trading data and other information was a major mistake because the Renaissance information included an in-depth analysis that credibly questioned whether or not Madoff could have been executing the transactions needed to implement his split-strike forward conversion strategy. The key to uncovering the Ponzi scheme depended on directly contacting third parties in order to verify critical information. A sample comparison of Madoff’s purported trading activity in his account statements and customer confirmations against FINRA/NASD or DTC/NSCC data would have shown that Madoff did not execute the trades as he claimed. Similarly, if the examination staff had directly confirmed trading activity with those counterparties, they likely would have learned Madoff was not trading options. Third-party verification would have ultimately provided the information necessary to reveal the Ponzi scheme. (Page 233)

In addition, had NERO carefully reviewed OCIE’s work papers, the NERO team would have found that Madoff had provided customer trade confirmations showing options transactions to OCIE during a month he represented in documents to NERO that he no longer traded options. Moreover, if the OCIE work papers had been reviewed, NERO may have noticed the number of funds in OCIE work papers was different from the number of funds Madoff disclosed to NERO. These discrepancies should have raised suspicions and required further inquiry. (Page 233)

For example, had the examiners been allowed to visit the feeder funds, they may have discovered that Madoff had custody of investor assets, contrary to his representations to examiners. (Page 234)

The examination should never have been concluded without the staff understanding how Madoff was achieving his returns. The staff never answered the basic red flag raised in the Renaissance e-mails and the two 2001 articles, which was that trading experts did not believe that Madoff could be earning his returns legitimately. (Page 234)


The final report was flawed because it relied heavily on information verbally provided by Madoff. (Page 234)

[Markopolos’ 2005 submission included the following red flags]
“Madoff did not allow independent outside performance audits.”
(Page 238)

“Several equity derivatives professionals will all tell you that the split-strike conversion strategy that BM runs is an outright fraud and cannot possibly achieve 12% average annual returns with only 7 down months during a 14½ year time period.” (Page 238)

“It is mathematically impossible for a strategy using stock, individual stock call options and index put options to have such a low correlation to the market where its returns are supposedly being generated from.” Madoff experienced only seven “extremely small” losses in over 14 years.” (Page 239)

Suh also had never conducted a Ponzi scheme investigation when she was assigned the Madoff matter and “did not know at the time” the “particular steps that needed to be taken when you do a Ponzi scheme case investigation.” (Page 246)

Bachenheimer, Cheung and Suh all testified that they discounted the 2005 submission somewhat because Markopolos was neither a Madoff employee nor an investor. (Page 247)

BLACKED-OUT SECTION (Page 248)

The 2003 DC OCIE Examination was triggered by an April 2003 complaint about Madoff from a Hedge Fund Manager with the following concerns:
-according to BMS, the options are traded with a number of traders and crossed on the CBOE. With a 8-10 billion size, you must see the volume, but unfortunately you don’t;

-the strategy is not duplicable by anyone else as far as we know.
-there is no correlation to the overall equity markets (in over 10 years).
-accounts are typically in cash at month end.
-since the accounts are at BMS, the investors (i.e. the feeders that have discretionary accts) receive BMS brokerage statements. There are no third party brokers involved in the process. The auditor of the firm is a related party to the principal.
-finally, given the performance of the different accounts, BMS never had to face redemption. …
(Page 253)

Madoff did not have an independent auditor; and the volume of options Madoff would have had to trade exceeded the volume of all exchange-traded options. (Page 254)

[Renaissance said] “So we need an OTC counterparty (not necessarily a bank) who is willing to do the basket of the options plus the underlying with Madoff at prices unfavorable for the OTC counterparty – in 10-15bln!!! Any suggestions who that might be? None of it seems to add up.” (Page 254)

However, Lamore testified that in their examination, the examination staff didn’t “look at the Ponzi scheme issue at all.” (Page 258)

In her December 13, 2005 e-mail to Lamore and Cheung, Suh stated that she
noticed an “odd discrepancy” between Fairfield’s production and Madoff’s previous
representations to the examination staff, as follows:

While I have not yet completed the review of the general binder, one odd discrepancy did catch my eye. As you know, Madoff told [Lamore] that he stopped using options as part of his trading strategy in January 2004. Yet the account statements and trade confirmations produced by Fairfield Greenwich show trading in S&P 100 Index options all through 2004 and up to October 2005, the last month for which data was produced …

(Page 271)

The “odd discrepancy” Suh noted should have been recognized as a critical development in the investigation. The Enforcement staff’s first investigative step had revealed that Madoff had lied about a fundamental component of his claimed trading activity during the recent exam. (Page 273)

However, it is worth noting at this juncture that, despite having caught Madoff lying about his trading to the examination staff early in the investigation, the Enforcement staff did not reassess its investigative plan or expand the investigation’s limited focus to include the possibility that Madoff was operating a Ponzi scheme. (Page 274)

On December 16, 2005, Markopolos e-mailed Cheung that Michael Ocrant, the author of the 2001 MARHedge article, was willing to meet with the Enforcement staff and share his observations regarding Madoff’s operations. E-mail dated December 16, 2005 from Markopolos to Cheung, at Exhibit 310. He also suggested that the staff contact John Wilke, a Senior Investigative Reporter at the Wall Street Journal who Markopolos said “will soon start working on this story.” Id. In addition, Markopolos informed Cheung that he had “compiled several pages of contact information that might be useful to the SEC’s investigation” and offered Cheung a “several inch thick file folder on Madoff that I would be happy to let you copy if the SEC has any interest.” (Page 274)

Cheung did not pursue Markopolos’ suggestion to talk either with Ocrant or Wilke . . . . (Page 274)

Cheung also declined to obtain the materials Markopolos offered. (Page 275)

BLACKED-OUT SECTION (Pages 276-279)

On December 29, 2005, Bachenheimer e-mailed Sollazzo in reference to Madoff’s falsehoods, as follows:

The Madoff investigation took an interesting turn. Contrary to what Madoff told our exam team, he is trading options for at least one hedge fund.
(Page 280)

[Lamore] has been analyzing the Fairfield account statements and has found that, in fact, the number of S&P 100 index options traded by Madoff, purportedly over the counter, is an order of magnitude greater than the total exchange-traded volume for these options. This fact does not necessarily mean there is anything fishy going on, but it does, as [Lamore] pointed out, make it interesting to find out where and how these options are traded. (Page 280)

BLACKED-OUT SECTION (Page 284)

Perhaps the most notable aspect of Madoff’s document production to the Enforcement staff was what it did not include – OTC options contracts. (Page 284)

However, the Enforcement staff was not suspicious of Madoff’s claim to have had billions of dollars invested in undocumented OTC options contracts. (Page 285)

BLACKED-OUT SECTIONS (Pages 289-290)

As Branch Chief Caverly observed, “clearly if someone … has a Ponzi and they’re stealing money, they’re not going to hesitate to lie or create records. … And the only way to verify [whether the alleged Ponzi operator is actually trading] would be to – you know, some third party, some independent third party verification.” (Page 290)

BLACKED-OUT SECTION (Page 291)

On May 10, 2006, Suh e-mailed Cheung and asked, “Unless you disagree, we will hold off on making requests to Bank of New York and Barclays until Bernie’s testimony, when we should be able to talk to him in more detail about the function of those two accounts.” . . . .
The OIG found no evidence that either the Barclays or Bank of New York requests were ever sent and Suh testified that she believed they were not sent. (Page 304)

Barclays had informed the examination staff that it had account-opening documents for a Madoff account, but that “no relevant transaction activity occurred during the [requested] period.” (Pages 304-305)
Apparently, Suh did not understand that a bank must have been involved in the movement of funds, and that bank records would have existed that would have revealed Madoff’s Ponzi scheme. (Page 305)

Enforcement Staff Learned from NASD that Madoff Had Not Reported Holding Any Options Positions, but Failed to Pursue that Information. (Page 306)

Susan called back: they checked one of the dates Peter [Lamore] gave them and found no reports of S&P 100 index option position . . . . (Pages 307-308)
Tibbs had informed the Enforcement staff that there were “no reports” of Madoff holding any options positions “on one of the dates” the staff asked Tibbs to check. Id. Tibbs had also explained to the staff that, unless Madoff’s London affiliate held the contracts, Madoff either held no options positions or was in violation of the reporting requirement. (Page 308)

The Enforcement staff failed to appreciate the significance of this revelation that NASD had no records of Madoff holding any of the OTC options positions he claimed. (Pages 308-309)

However, that is exactly what the Enforcement staff learned from the May 16, 2006 call with Tibbs and Madoff’s May 19, 2006 testimony. Yet, after learning that Madoff either: (1) did not hold the OTC options positions he claimed; or (2) was in violation of the NASD rule requiring that he report those positions, the Enforcement staff did not contact NASD again or follow-up in any other manner. (Page 309)

During Madoff’s testimony, he provided evasive answers to important questions, provided some answers that contradicted his previous representations, and provided some information that could have been used to discover that he was operating a Ponzi scheme. However, the Enforcement staff did not follow-up with respect to any of the information that was relevant to Madoff’s Ponzi scheme. (Page 310)

As discussed above, the foundation of Markopolos’ 2005 submission was that it was impossible for Madoff to achieve his purported returns with the split-strike conversion strategy he claimed to use. That view was shared by several other industry professionals, as reported in the May 2001 Barron’s and MARHedge articles, as well as Garrity and many of Madoff’s own investors. (Page 310)

During his testimony, Madoff was asked how he achieved his consistently high returns. Madoff May 19, 2006 Testimony Tr. at p. 76, at Exhibit 267. Madoff never
answered the question with reference to his claimed trading strategy. Instead, he attacked those who questioned his returns, particularly the author of the Barron’s article. (Pages 310-311)

Cheung admitted that had the Enforcement staff obtained DTC records for Madoff’s account after his testimony, the Enforcement staff most likely would have discovered his Ponzi scheme. (Page 312)

Madoff said it was “amazing to me” that he didn’t get caught during the Enforcement investigation, because they specifically asked him, “Are these securities at DTC?” They further pressed, “What is your account number.” He replied, “646.” Madoff stated that it was “obvious they thought that something was amiss.” He went on to say that when they asked for the DTC account number, “I thought it was the end game, over. Monday morning they’ll call DTC and this will be over … and it never happened.” (Page 312)

According to the SEC’s Complaint against DiPascali, Madoff did not have the electronic, options-related documents that he claimed to have and which the Enforcement staff did not press him to produce. See SEC v. Frank DiPascali, Jr., No. 09 Civ. 7085 (LLS) (S.D.N.Y. filed August 11, 2009) at ¶ 60(d), at Exhibit 119 (alleging that, “The advisory account records on [Madoff’s computer] did not reflect any counterparty information (because none existed).”) (Page 314)

At different times, Madoff told the SEC staff different stories about where the equity trades for his investors were executed and cleared. Apparently, the staff did not recognize or appreciate the significance of these contradictory statements. (Page 315)

Contrary to his representations during the 2005 examination, in his testimony with
the Enforcement staff, Madoff specifically stated that the trades cleared at DTC, not Barclays Capital:

Q: The account, Depository Trust Clearing Corporation, what is the function of this account?

A: That’s the general clearance account for the firm that handles all the settlements of transactions for the firm.

Q: So this account handles the clearings of all –

A: -- all.

(Page 317)

The Enforcement staff did not ask Madoff to explain his prior, contradictory statements to the examination staff. (Page 317)
Madoff’s Denial that he had Lied to the Examination Staff about his Purported Options Trading Activity was not Credible. (Page 317)

As discussed above, Suh and Lamore believed that Madoff had lied during the 2005 NERO examination when he had claimed that, as of January 1, 2004, he no longer traded options for his investors. Madoff’s effort during his testimony to explain that his statements to the examination staff regarding this issue had been truthful was not credible. (Page 317)

When the Enforcement staff received statements from Fairfield, they learned that Madoff was representing to his investors that he did trade options in their accounts. Suh confronted Madoff during his testimony with that “odd discrepancy.” (Page 317)

During Madoff’s Testimony, Enforcement Staff Caught Madoff Lying about the Number and Identity of his Investors. (Page 319)

[W]e discovered that BLM’s principal, Bernard Madoff, mislead [sic] NERO examination staff earlier this year about the nature of his trading strategy. (Page 319)

Suh testified she had been “bothered” by the eleventh-hour discovery of these new accounts, “Well, it certainly bothered me, and it – I did think he was – had not been truthful in examination and in the testimony.” (Page 322)

Suh testified that at this point in the investigation, it was clear that Madoff “wasn’t truthful and I knew he was not giving us full information.” Suh Testimony Tr. at p. 223. Similarly, Lamore testified, “I just remember sitting there in the testimony thinking he’s lying during the testimony.” (Page 322)

So I’m sitting there thinking, “You got to be kidding me, I mean, this is huge. This guy just lied [in] on the record testimony to your face.” (Page 323)

Several SEC officials testified that verifying trading was a fundamental step in an investigation of an alleged Ponzi scheme. Garrity was asked how to conduct a Ponzi scheme investigation of Madoff. [Garrity said] (Page 323)

I think if there [were] no trades at all, I think it would be fairly self-evident.
(Pages 323-324)

I mean if they’re trading stocks, you can go to DTC or someplace like that … and see what they have there. You find out who the ultimate custodian is. (Page 325)
Kazon testified that obtaining “independent [trading] records” was required if a person was “seriously pursuing” a Ponzi scheme investigation. (Page 325)

Suh seemed to have ascribed no significance to the fact that she learned from DTC that Madoff had lied in his testimony about having segregated advisory positions at DTC. (Page 330)

Irrespective of the concern that should have been raised by Madoff having made such a “fundamental” misrepresentation, Garrity explained that the Enforcement staff should have been concerned about Madoff’s apparent commingling of assets. (Page 331)

In addition to not understanding that Madoff’s apparent commingling of assets was a serious red flag and a violation of the federal securities laws, Suh did not understand that DTC records would have quickly shown that Madoff was operating a Ponzi scheme. Specifically, DTC records would have shown that, on any particular day that Madoff’s records indicated that he held equities in his advisory accounts, Madoff did not hold billions of dollars of S&P 100 equities for his investors as he claimed. (Page 332)

For example, a January 2005 statement for one Fairfield account alone indicated that it held approximately $2.5 billion of S&P 100 equities as of January 31, 2005. See Account statement dated January 2005 for Fairfield Sentry account 1FN045, at Exhibit 366. In fact, on January 31, 2005, DTC records show that Madoff held less than $18 million worth of S&P 100 equities in his DTC account. Table of Madoff’s S&P 100 Positions. (Page 332)

When Madoff’s Ponzi scheme finally collapsed in 2008, Friedman testified that it took only “a few days” and “a phone call … to DTC” to confirm that Madoff had not placed any trades with his investors’ funds. (Page 333)
Finally, Suh did not understand that it was not necessary for Madoff’s claimed advisory account positions to be segregated at DTC in order to see that he was operating a Ponzi scheme. Similarly, Suh did not understand that it was not necessary to verify specific, individual trades in order to see that Madoff was not placing any trades at all. (Page 334)

As discussed above, Madoff claimed to have purchased billions of dollars of S&P 100 equities from certain European securities dealers. Had that been true, then Madoff would have wired billions of dollars from a bank account to those dealers. (Page 342)


Michael Kress, a Broker-Dealer Examinations Branch Chief in NYRO, testified that tracing the movement of the investors’ funds was a fundamental aspect of a Ponzi scheme investigation. (Page 343)

You would need custodial records from the custodian, you would need the bank accounts to see the movement of funds coming in and out … (Page 343)

BLACKED-OUT SECTION (Page 344)

Cheung and Suh apparently did not understand that a financial institution would have to be involved in the movement of funds to and from Madoff’s investors, securities dealers, and OTC option counterparties. (Page 345)

Suh Testimony Tr. at p. 117. Suh testified further:

Q: I mean, he has all this money that he’s trading, right?
A: Right.
Q: Where did he keep it?
A: My impression was that he kept it at the brokerage firm, but I don’t have – my impression was basically between when he sells and when he buys again it stayed within the brokerage firm.

Q: When they want to redeem monies it has to be wired out of an account, right?
A: Right.
Q: And that account has to be at a financial institution, a bank account, right?
A: I think that’s right. I don’t think I thought about it that –

(Page 347)

Suh acknowledged that the Enforcement staff would have discovered Madoff’s Ponzi scheme if they had examined the relevant bank records:

Q: If you had seen bank statements that showed that there was no money going to – independent of what the details of the trades, if you’d just seen bank statements that showed there was no money going to counterparties in Europe or dealers in Europe for equity trades, wouldn’t that have been a complete confirmation that he was running a Ponzi scheme?

A: Probably. I mean, I have to say the issue of getting bank records was never raised, never suggested, so–

(Page 347)

From the end of July 2006 until January 2007, Suh was out of the office on maternity leave. Suh testified that no active work was done on the case after Madoff agreed to register in August 2006. (Page 349)

Enforcement Staff Officially Closed the Investigation in January 2008, Characterizing it as a “Fishing Expedition.” (Page 350)

Despite Cheung’s testimony that having Madoff register as an investment adviser was a meaningful result of the Madoff investigation, as discussed in more detail below, the SEC’s investment adviser examination staff never conducted an examination of Madoff after he registered. (Page 350)

On January 16, 2007, Suh e-mailed Johnson a reminder about her request, adding, “Sorry to bother you again – I guess I can’t wait to lay this case to rest.” (Page 351)

The Enforcement Staff Ignored Additional, Troubling Information About Madoff While the Investigation Was Inactive for 18 Months. (Page 352)

The letter had been sent to Chairman Cox on December 6, 2006. Forwarded Letter dated December 6, 2006 to Cox, at Exhibit 381. The letter stated:
Your attention is directed to a scandal of major proportion which was executed by the investment firm Bernard L. Madoff … Assets well in excess of $10 Billion owned by the late Norman F. Levy, an ultra-wealthy long time client of the Madoff firm have been “co-mingled” with funds controlled by the Madoff company with gains thereon retained by Madoff.
(Page 352).

On January 9, 2007, Suh e-mailed Cheung, “Brandon Becker has called me to report that Bernie says he has not managed money for Norman F. Levy, the investor referenced in the anonymous letter.” E-mail dated January 9, 2007 from Suh to Cheung, at Exhibit 382. Cheung responded, “Then I think we are done and do not have to worry any further.” (Page 352)

It is extremely curious that when the staff received a tip that Madoff had stolen from Levy, they simply accepted Madoff’s claim that he had not managed money for Levy as an explanation for the tip. An accused fraudster’s unsubstantiated denial of wrongdoing is insufficient grounds for concluding that the accusation is without merit. In this instance, the staff also knew that Madoff had previously lied to them about several issues, including the number and identity of his clients. (Page 353)

Contrary to Madoff’s representations through his counsel, when news of Madoff’s Ponzi scheme broke, it became evident not only that Madoff managed Levy’s money, but also that Levy was actually one of Madoff’s largest investors. (Page 354)

The Madoff Investigation Officially Closed in January 2008, Although Enforcement Staff Recognized that Madoff Had Lied About His Advisory Business. (Page 356)

Suh began closing the Madoff investigation in January 2007, despite the fact, as discussed above, that the Enforcement staff knew Madoff had made numerous misrepresentations to the SEC during both the 2005 NERO examination and the 2006 Enforcement investigation. E-mail dated January 11, 2007 from Suh to Lamore, at Exhibit 380. Madoff had failed to fully disclose the number of clients he had and their identities; he had misrepresented to the examination staff that he no longer traded options (or at least represented to his investors that he did); and he had changed his story regarding where his purported trades were settling and clearing. (Page 356)

Enforcement staff not only closed the Madoff investigation without any enforcement action being taken, the investment adviser examination staff never conducted an examination of Madoff after he registered with the SEC as an investment adviser. (Page 357)

In March 2008, Enforcement Staff received a second tip regarding Norman Levy that may have come from a Madoff insider. (Page 358)

As discussed in detail above, the Enforcement staff received the following anonymous tip in December 2006 from a “concerned citizen,” advising the SEC to look into Madoff and his firm:
Your attention is directed to a scandal of major proportion which was executed by the investment firm Bernard L. Madoff….Assets well in excess of $10 Billion owned by the late Norman F. Levy, an ultra-wealthy long time client of the Madoff firm have been “co-mingled” with funds controlled by the Madoff company with gains thereon retained by Madoff.
(Page 358)

This tip was a copy of the previous tip sent in April 2006, with the addition of the following:

It may be of interest to you to that Mr. Bernard Madoff keeps two (2) sets of records. The most interesting of which is on his computer which is always on his person.

(Page 358)

Based on the substance of the tip (i.e. Madoff keeping two sets of books) and its place of origin (i.e. it was mailed from the New York Public Library in Manhattan), the anonymous tipper may have been an insider with personal knowledge of Madoff’s operations. As discussed in detail above, Bachenheimer, Cheung and Suh testified that they were skeptical of the allegation that Madoff was running a Ponzi scheme because Markopolos did not have any inside information to substantiate the allegation. However, Enforcement staff also ignored a serious tip that, on its face, appeared to come from an insider who was aware that Madoff was committing fraud. Moreover, if the tip was from an insider, it was understandable why the tipster would want to remain anonymous. (Page 359)

Cheung testified that forcing Madoff to register had been a “good result” because it would “expose [Madoff] to … to exams from the [investment adviser] examiners.” Cheung Testimony Tr. at p. 228. Yet, when the Enforcement staff received the tip that Madoff kept two sets of books, the matter was never referred to the examination staff. In fact, as discussed above, the investment adviser examination staff never conducted an exam of Madoff after he registered as an investment adviser. (Page 359)

BLACKED-OUT SECTION (Pages 359-360)

For the annual rating period ending April 30, 2007 (May 1, 2006 to April 30,
2007), Suh’s supervisors gave her the highest rating: “made contributions of the highest
quality.” (Page 360)

Q: Peter Lamore testified and there’s contemporaneous documentation to the effect that if he had made one or two phone calls, to either DTC or a counterparty, he would have discovered the Ponzi scheme. He believed that it would have been relatively easy to discover the Ponzi scheme had he made one or two phone calls. (Page 364)

The fact is that the SEC could have discovered Madoff’s Ponzi scheme with far fewer resources than were actually spent on the Enforcement staff’s Madoff investigation. As Cheung testified while explaining her comment that the Madoff investigation had been a “fishing expedition.” (Page 365)

When Madoff’s Ponzi scheme collapsed, Friedman testified that it took only “a few days” and “a phone call … to DTC” to confirm that Madoff had not placed any trades with his investors’ funds.” Friedman Testimony Tr. at pgs. 21-22. (Page 365)
[Suh testified that] the main question that, you know – as you can imagine I have been thinking a lot about what happened, and the main call that I am frustrated about is the call not to pursue further this getting Madoff’s consent for the counterparties to send trading records to us directly. And I do think that that was the wrong call and I wish it was a different call. (Page 367)

From the outset of its investigation, the NERO Enforcement staff, unlike the Boston District Office, failed to appreciate the significance of the evidence in the 2005 Markopolos submission. As a result of this initial failure, the Enforcement staff never really conducted an adequate and thorough investigation of Markopolos’ claim that Madoff was operating a Ponzi scheme. (Page 368)

Almost immediately after Markopolos’ submission was brought to the Enforcement staff’s attention, they expressed skepticism and disbelief toward the evidence contained in the submission. The Enforcement staff claimed that Markopolos was neither an insider nor an investor and, thus, immediately discounted his’ evidence. Bachenheimer testified that “often the only way [the SEC] can develop evidence … in a Ponzi scheme, is if we have somebody on the inside. …Yet, had the Enforcement staff simply sought documents from DTC, Madoff’s bank or his purported OTC option counterparties, they would have been able to uncover the fraud without any such inside information. (Page 368)

According to NASD Vice President Gene DeMaio, the Enforcement staff did not understand the basics about options and “some of those [options trading] strategies were over their heads.” DeMaio Testimony Tr. at p. 15. In addition, the Enforcement staff failed to recognize the significance of the issues they did not understand. They rejected DeMaio’s suggestion to postpone Madoff’s testimony “to do a little bit more homework,” and they did not accept his offer of further assistance. Id. at pgs. 14-15. Similarly, Cheung rejected offers from Markopolos to explain his observations and analyses regarding Madoff, or at least to provide additional information about Madoff. (Page 369)

If the Enforcement staff had simply sought assistance from OIA on matters within their area of expertise, they would have discovered that Madoff was not purchasing equities from foreign broker-dealers and that he did not have OTC options with European counterparties. (Page 370)

Moreover, the Enforcement staff’s failure to verify Madoff’s purported trading with any independent party is particularly troubling. (Page 370)

In addition, when the Enforcement staff began efforts to seek information from independent third parties, they failed to follow-up on those efforts even as they began to reveal that Madoff was not engaged in trading. On May 16, 2006, three days before Madoff’s testimony, Suh called Susan Tibbs, Director of the Market Regulation Department at the NASD (now FINRA) and asked her to check a certain date on which Madoff had purportedly held S&P 100 index option positions. Tibbs reported back that they had found no reports of such option positions for that day. Yet, the Enforcement staff failed to follow up on this remarkable finding. The Enforcement staff also failed to follow-up on information obtained in the 2005 NERO cause examination when the examination staff had attempted to verify Madoff’s claims of trading OTC options with Barclays and found that there was “no relevant transaction activity occurred during the period” requested. (Page 370)

Ironically, six days after Madoff’s Ponzi scheme collapsed, Pauline Calande, Counsel to the Director and Deputy Director of Enforcement, sent an e-mail to Linda Thomsen, former Director of Enforcement, and others in the context of discussing her concern about the thoroughness of the trustee’s work in the Avellino & Bienes investigation. The e-mail highlighted the trustee’s failure to confirm whether the investor funds were really “all there” in 1992, asking if the trustee went “to the street name custodian of the fund’s portfolio and inspected the securities,” or to the “banks or firms allegedly holding cash or sweep funds,” thus referencing the very steps that the NERO Enforcement staff should have, but failed to, take in their investigation. (Page 370)

Cheung Testimony Tr. at p. 256. When Madoff’s Ponzi scheme collapsed, Friedman testified that it took only “a few days” and “a phone call … to DTC” to confirm that Madoff had not placed any trades with his investors’ funds.” (Page 371)
Finally, the Enforcement staff failed to discover Madoff’s Ponzi scheme because they relied too heavily on Madoff’s representations and documents created by him. For example, Madoff lied several times about where the equity trades for his investors were executed and cleared. Madoff first told the examination staff that the trades were executed by his London affiliate and cleared through Barclays. During his investigative testimony, however, Madoff claimed that the London affiliate had nothing to do with either the equity or options trades for the advisory accounts and that those trades were executed by his New York office. He also later testified that the equity trades were cleared through DTC. (Page 372)

Madoff also told the examination staff that he had stopped placing options trades for investors in 2004. Yet, the account statements he was providing investors in 2005 and 2006 demonstrated that he was trading options on their behalf. The Enforcement staff caught Madoff in this contradiction and Suh and Lamore were convinced that Madoff had lied during the exam and that he continued to lie about the issue throughout the investigation. Yet, the Enforcement staff closed the investigation without ever scrutinizing this issue and what it meant in the context of the allegation that Madoff was operating a Ponzi scheme. (Page 372)

In connection with the 1992 investigation of Avellino & Bienes, an SEC examiner acknowledged that Madoff’s stature and reputation in the industry may have influenced their decision not to further examine Madoff’s operations while investigating Avellino & Bienes for a possible Ponzi scheme. (Page 383)

It was strictly -- when I walked out of there it was more along the lines of wow, this guy is a third market guy that does X percent of the volume on the exchange. This is where I actually learned about third market. I didn’t even know the so called term that that's what it was called [prior to the examination.] (Page 383)


Gentile stated that it was fair to say that because of Bernard Madoff’s reputation at that time as a large broker-dealer, there may not have been any thought to look into Madoff’s operation any further. Gentile Interview Tr. at p. 37. Gentile further acknowledged that in light of the evidence uncovered in the 1992 investigation, someone “should have been aware of” the fact that the money used to pay back Avellino and Bienes’ customers could have come from other investors, but there was no examination of where the money that was used to pay back the investors came from. Id. at pgs. 32-33. Gentile also admitted that Madoff could have taken the money that was used to pay back Avellino and Bienes’ investors from anybody, including other customers, stating that “absolutely could have been done,” but no effort was undertaken to verify if that occurred. (Page 383)

According to NERO examiner William Ostrow, during a conference call on May 31, 2005 with Swanson, McCarthy, and Donohue, he and fellow NERO examiner Peter Lamore were informed that Madoff was a powerful and well-connected individual, stating:
I don’t know who said it, someone from OCIE basically, “He’s a very powerful person, Bernie, and you know, just remember that.” … But basically just, “He is a very well-connected, powerful person.”
(Page 384)

Ostrow Testimony Tr. at pgs. 113-14. Ostrow interpreted the statement to raise a concern for them about pushing Madoff too hard without having substantial evidence. (Page 384)

The OIG investigation uncovered evidence that Ostrow and Lamore were well aware of Madoff’s stature in the industry, that Madoff attempted to intimidate and impress them with his perceived connections, and that the junior examiners were overmatched in their interactions with Madoff making them unable to aggressively conduct the 2005 NERO examination. (Pages 384-385)

Ostrow indicated that there were efforts made by Madoff to impress and even intimidate the examiners. Ostrow stated that “[a]ll throughout the examination, Bernard Madoff would drop the names of high-up people in the SEC.” (Page 385)

The Enforcement Assistant Regional Director stated Lamore’s reference to “hesitance towards rocking the boat” referred to the fact that “there’s a lot of players in the industry that are significant players and sometimes there’s a tendency to take at face value what industry people are saying.” (Page 387)

Lamore also acknowledged that at the senior levels of the SEC, the hesitancy towards rocking the boat may be even more pronounced with respect to someone like Bernie Madoff, who’s a well-known person in industry, although Lamore noted that “he’d like to say that … we’re sort of professional and treat everyone equally.” Lamore Testimony Tr. at p. 245. Lamore noted that it is easier to be more aggressive when you are examining a “penny-stock firm” rather than, for instance, Goldman Sachs, noting that it would be “very difficult” for someone in his position “to tell Bernie Madoff that he’s a liar.” (Page 387)

In light of the foregoing, the OIG concludes that Madoff’s stature played an ancillary role in the SEC’s failure to uncover the fraud in their examinations and investigations. In the 1992 investigation, we found evidence that in light of Madoff’s reputation, the examiners did not think it necessary to look into Madoff’s operation any further. In the 2005 NERO examination, Madoff was able to use his stature and perceived connections to push back successfully against the junior examiners, who did not feel sufficiently confident to be more aggressive in their examination and who were informed by senior officials in Washington, D.C., as they were conducting the examination, of Madoff’s reputation in the industry. In the 2005-2006 Enforcement investigation, Madoff’s prominence made it less likely for the SEC investigators to believe that he could be running a Ponzi scheme. (Page 389)

On May 31, 2005, a conference call took place with the NERO examiners, during which, one of Swanson, McCarthy or Donohue, stated to the NERO examiners that Madoff was a “very well-connected, powerful person.” E-mail dated May 31, 2005 from Nee to Swanson, at Exhibit 451; Ostrow Testimony Tr. at pgs. 113-14. One of the NERO examiners on the telephone call interpreted the statement to raise a concern for them about pushing Madoff too hard in their examination without having substantial evidence. (Page 396)

Many private sector firms conducted their own due diligence of Madoff’s operations while considering whether to invest with Madoff or Madoff feeder funds. While these firms did not have the authority that a regulator like the SEC has to compel the production of documents and information, in numerous cases their due diligence efforts were sufficient for the private entities to determine that investing with the Madoff firm was too risky, even with the limited information they were able to obtain. (Page 411)

As described in further detail below, many of the firms that conducted due diligence were already aware of suspicions in the industry about Madoff, even before they began their analyses of Madoff’s operations. Using ordinary due diligence methods, such as voluntarily requesting basic documents like financial statements, and asking pointed questions of Madoff or Madoff feeder funds, they determined that an investment would be unwise. Specifically, Madoff’s description of both his equity and options trading practices immediately led to suspicions about Madoff’s operations. With respect to his split-strike conversion strategy, many simply did not believe that it was possible for Madoff to achieve his returns using a strategy described by some industry leaders as common and unsophisticated. In addition, there was a great deal of suspicion about Madoff’s purported options trading, with several entities not believing that Madoff could be trading options in such high volumes where there was no evidence of any counterparties which had been trading options with Madoff. (Page 411)

In addition, these entities had suspicions concerning many of the same “red flags” that were discussed in the SEC examinations but which ultimately were not analyzed or were dismissed by the SEC, such as Madoff’s fee structure and the small size of Madoff’s auditor. Further, although some of these entities only had opportunities for a few brief conversations with Madoff or representatives of the feeder funds, they felt Madoff and his representatives simply did not provide satisfactory answers to their questions and left the meetings even more suspicious of Madoff’s operations. (Page 411)

There Were Rumors and Suspicion about Madoff in the Industry Even Before Due Diligence was Initiated. (Page 411)

The OIG investigation found that even before entities began performing due diligence, their efforts were influenced by the overall concerns and questions in the industry about Madoff’s operations and how he was able to achieve the returns he was claiming. James Hedges, IV, whose investment advisory firm was asked to approve investments with Madoff for a variety of clients, stated that “there was a preponderance of suspicion among hedge fund industry insiders that something was awry at Madoff Securities,” although not necessarily that Madoff was running a $50 billion Ponzi scheme. (Pages 411-412)

Nat Simons, the portfolio manager for Renaissance’s Meritage fund, a hedge fund of funds, whose e-mails triggered the 2005 NERO examination (as described in detail in Section IV above), stated that there were rumors from industry insiders that Madoff was cherry-picking trades and that a related party was his auditor. (Page 412)
Michael Ocrant, a financial journalist who authored the MarHedge article about Madoff in May 2001 entitled, “Madoff tops Charts; Skeptics Ask How,” stated that he spoke to a former senior executive at one of the futures exchanges, who, in referring to Madoff, told him, “everyone knows this isn’t real,” and “everybody knows he can’t possibly be producing these kinds of returns.” (Page 412)
The OIG investigation found that basic due diligence work by several private entities of Madoff or Madoff feeder funds revealed numerous and significant red flags and concerns that convinced these private entities not to invest with Madoff. The private entities that conducted an initial review of Madoff’s operations focused on basic documents which were voluntarily-produced, such as financial statements and trading records. In general, they did not use a checklist-type approach, but looked at larger issues such as independence and transparency, as well as conducted analyses of Madoff’s trading. In some cases, they met with Madoff and simply asked Madoff to explain his split-strike conversion strategy, while others were never able to even meet with him at all. (Page 412)

The investment professionals interviewed by the OIG, who conducted due diligence immediately had significant questions about Madoff’s trading strategy. ….
“The returns were impossible. Absolutely impossible in my opinion. No financial strategy could produce those sort of returns.” (Pages 413-414)


The CEO stated he found this “pattern which really seemed weird where the -- where the purchases were all at or close to the lows of the day and the sales were at or close to the highs of the day,” noting that “of course, nobody can do that.” (Page 414)

Laufer’s team found Madoff was reporting on his customer statements that he had purchased stocks at extremely low prices and sold stocks at extremely high prices. Id. at p. 17. Laufer explained, “this was statistically almost impossible to do if you were trading in an ordinary way.” (Page 415)

Broder stated, “I knew it wasn’t possible because of what we do.” (Page 415)

Ocrant stated that he followed up and remarked that he:
gave the terms and strategies [utilized by Madoff] to a guy who ran a quantitative analysis with a Japanese bank for a Fund to funds they ran and I said can you take this data and can you -- have you crunch it and let me know what you think and I didn’t give any further information and I said this is the strategy. He got back to me like a week to 10 days later and he said, “Well, the team came back and they said this could be done by a market-maker, probably have to use front money to do it,” and I said, “Oh, that’s interesting,” and I said, “What would you say if I told you this guy was managing maybe $5-6-7 billion?” He said, “Impossible. It has to be a Ponzi scheme.”
(Page 416)

The research firm was very suspicious about Madoff’s purported options trading, noting that the market for “[S&P] 100 options [was] nowhere near deep enough to trade $13 billion dollars, and that “[t]he liquidity of listed S&P 100 options could not handle 1/20th of that size.” CEO of Research Firm Interview Tr. at p. 35. Michael Ocrant’s source similarly commented on Madoff’s options trading that “[y]ou don’t see the volume,” or “market impact,” posing the question that even if options are traded over-the-counter, “you have counterparties, you know, where are they” and noting that the trading volume “just doesn’t exist.” (Page 417)
Renaissance suspected Madoff was misrepresenting his trading after conducting an analysis of Madoff’s claimed options trades. Renaissance concluded Madoff could not be trading on an exchange because of insufficient volume and could not be trading options over the counter because he would not be able to find a counterparty for the trading. (Page 417)


According to the CIO, Madoff replied that “none of the options were being traded over the counter … the options are traded through the Chicago Board of Options Exchange so that [they] have the clearinghouse of the options exchange as [their] counter party.” Id. at p. 6. The CIO stated that he found this answer “exceptionally odd” because in his experience, he knew that the Chicago Board of Options Exchange “was not a very deep market,” noting that it was “something that we would call a retail market.” Id. at p. 7. The CIO immediately determined that there simply was not “enough volume on the Chicago Board of Options Exchange … to get that sort of coverage for … 3 billion,” noting that “on any given day, there’s not enough volume.” (Pages 417-418)

The CIO said he also inquired with folks who were running equity derivatives departments at a few firms, and all of them reported to him that they “hear that [Madoff’s] doing all these trades” but they “don’t see it anywhere.” Id. The CIO found that “nobody did these options” and noted that he “could never find anybody who remotely even knew who was doing the options.” (Page 418)

Renaissance also found that “on its face” Madoff’s fee structure was illogical. Simons Interview Tr. at p. 18. Simons did not understand why Madoff would allow feeder funds to take hundreds of millions of dollars in fees that Madoff could have kept for himself, stating: “[W]hen you see a situation where it would appear that he’s only making money off of his … brokerage fees, why is he letting the Fairfield Greenwiches of the world take 2 points? I don’t know.” Id. at p. 18. Simons explained why he thought it was illogical for Madoff to not retain the fees for himself, as follows:

[Madoff] supposedly has excess demand for his product and – you know, normally you see third party marketers in situations where there is [not] enough demand for the product.…They need the third party marketer to help them raise money. …

(Page 418)


The CEO of the fund of funds firm also noticed on Madoff’s Securities balance sheet that Madoff was “audited by a firm in New City, NY,” which he had never heard of and thus, had to be “some suburban little shopping mall kind of accounting firm.” (Page 419)

Similarly, the research firm was suspicious when they found out that Madoff’s auditor was a firm named Friehling and Horowitz, who they had never heard of even though they had been in the industry for a long time. (Page 419)

Similarly, the small size of Madoff’s auditor was an issue for Renaissance, particularly because Madoff was reportedly managing billions of dollars for investors. (Page 419)

Several of the private entities conducting due diligence indicated that when they confronted Madoff or his feeder fund with their questions and suspicions, they did not get satisfactory answers and decided to forgo the investment entirely. (Page 420)


According to the CIO, Madoff replied that all of the options were being traded over the counter through the Chicago Board of Options Exchange. Id. at p. 6. The CIO stated that he found this answer “exceptionally odd” and after he called industry colleagues to check out Madoff’s answer, he became even more suspicious and declined to go forward with the investment. (Page 420)

Renaissance thought a regulator could have verified whether Madoff was trading by asking Madoff who his counterparty was and then verifying with the counterparty that the trade took place. Broder Interview Tr. at pgs. 21-22, 38. Broder would have performed the same verification process whether Madoff claimed his counterparty was in the United States or in Europe. (Pages 420-421)

[A Renaissance executive testified that] “Somewhere in the marketplace, either OTC or exchange-traded, those trades were taking place. And it seems to me a very simple set of steps to verify that those volumes [existed]. … I don’t see how that could have possibly been missed. I mean, this is a very simple verification. I mean this guy is trading – this is a cash account. So he’s turning over $10 billion of stocks each particular month. I mean, you’ve got to be [able to see it] in the marketplace.” (Page 421)

[When asked if the SEC should have figured things out, a Renaissance executive replied] “Much more elementary than that. Someone at the SEC could wander down, you know, to Goldman Sachs and wander over to their options department and ask them, how does somebody execute $10 billion of options, and find out it’s very difficult,” noting, “you don’t have to be as smart as Paul Broder” to figure this out.” (Page 421)

Numerous private entities conducted basic due diligence of Madoff’s operations and, without regulatory authority to compel information, came to the conclusion that an investment with Madoff was simply too risky. These decisions were made based upon the same “red flags” in Madoff’s operations that the SEC considered in its examinations and investigations, but ultimately dismissed. (Page 424)

THERE IS EVIDENCE THAT POTENTIAL INVESTORS RELIED UPON THE FACT THAT THE SEC HAD EXAMINED AND INVESTIGATED MADOFF IN MAKING DECISIONS TO INVEST WITH HIM. (Page 425)

During the course of the OIG investigation, we found that investors who may have been uncertain about whether to invest with Bernard Madoff were reassured by the fact that the SEC had investigated and/or examined Madoff, or entities that did business with Madoff, and found no evidence of fraud. (Page 425)

SEC Senior Associate Regional Administrator Martin Kuperberg was quoted in this December 1, 1992 Wall Street Journal article, stating that the returns appeared to have been generated legitimately and that “[r]ight now, there’s nothing to indicate fraud.” (Page 425)

It was later reported by the Wall Street Journal that the broker who managed the money and generated the high returns was “Bernard L. Madoff.” (Page 425)
The OIG obtained 25 affidavits from individuals who invested with Madoff who reported that they “knew of and relied upon the SEC’s 1992 public statement that there was nothing to indicate fraud” in deciding to invest with Madoff. 25 affidavits collectively, at Exhibit 484. Many of these investors, who had funds returned to them because of the SEC’s action against Avellino & Bienes, re-invested the funds with Bernard Madoff directly after the SEC action. (Page 425)

[A Madoff investor said] “We gave a big sigh of relief when we read & heard that a government agency called SEC said that there was no fraud. Since we were so sure that all was well if our government had checked we went directly into Madoff Investment Co. from Avellino & Bienes. … My generation (born 1922) was taught respect & trust for our government.” (Page 426)

[Another Madoff investor said] “My widowed mother had a small amount of money invested with Avellino and Bienes. When they were shut down by the SEC in 1992 she invested the proceeds from Avellino and Bienes with Madoff because of the SEC’s favorable report. She kept a copy of the Wall Street Journal article reporting the SEC’s giving Madoff a clean bill of health in her files. When I joined her Madoff account in 1994, my husband referred to that report as a key part of our research. The original WSJ article remains in our files.” (Page 426)

In addition, private entities who conducted due diligence stated that Madoff represented to them that the SEC had examined his operations when they raised issues with him about his strategy and returns. Nat Simons, the portfolio manager for Renaissance’s Meritage fund, a hedge fund of funds, who held a Madoff managed investment in 2003 and whose e-mails triggered the 2005 NERO examination (as described in detail in Section IV above), cited their understanding that the SEC had looked at Madoff and given him a clean bill of health as a reason they did not initially divest themselves of their Madoff-related investment. Simons Testimony Tr. at p. 28. Renaissance understood from Madoff that the SEC had examined “the whole business.” Id. at p. 17. Renaissance research scientist Henry Laufer agreed, “What was also on our minds … was that Madoff had been investigated – and cleared” by the SEC. Laufer Testimony Tr. at pgs. 35-36. Renaissance also doubted Madoff could be engaged in fraud because he operated through highly regulated brokerage accounts, stating:

[B]ecause of the nature of the fact that these were brokerage statements, and he had a big broker dealer business and big market-maker and – you just assume that someone was paying attention to make sure that there was something on the other side of the trade. … I never, as the manager, entertained the thought that it was truly fraudulent. And it again was because … it would have been so easy to prove that it was fraud if it was just managed accounts that were set up. It would have been so
– again, forgive me here, but you know, it would have been pretty straightforward. We felt that he was sufficiently in the eye of the regulators that it was just hard for us to envision that that was the case.
(Page 427)

Simons further explained that one reason they did not report their suspicions to the Commission directly was that they felt all of the information they were using in their analysis was readily available to the Commission. (Page 427)

An independent hedge fund research and advisory firm (research firm), who researched a Madoff feeder fund as an investment vehicle for two clients in the late 1990’s or early 2000’s and asked not to be identified in the OIG’s Report of Investigation, also confirmed that Madoff raised the SEC examinations while they were conducting due diligence. CEO of Research Firm Interview Tr. at pgs. 55-56. The Chief Executive Officer (CEO) of the research firm, described a meeting he had with Madoff where Madoff spoke about his split-strike conversion strategy and his business for about an hour. Id. at pgs. 2-3. The CEO reported that Madoff made a point of telling them that as a result of an SEC visit, Madoff registered as an investment adviser, in order to convey to them that he had been examined and got a clean bill of health. Id. at pgs. 55-56. The research firm also specifically recalled the Madoff feeder funds telling them “about [how] the SEC was just in there and they did not find anything.” (Page 428)

The CEO indicated that the research firm did not believe that Madoff was operating a Ponzi scheme because they found out that the SEC had received a copy of Harry Markopolos’s letter and “presumed” with the detailed information contained in Markopolos’s letter that “somebody at the SEC must have checked with DTCC.” Id. at p.
51. They stated that after reading Markopolos’s letter, “there [was] no way in hell the SEC did not take a hard look at this thing.” (Page 428)

Bernard Madoff himself acknowledged in his interview that he would inform potential investors about SEC examinations in order to provide them with a level of comfort, stating that “it lent to the credibility of his firm that he had passed examinations by the SEC.” (Page 429)

Accordingly, we found that not only was the SEC unable to uncover Madoff’s fraud in the several investigations and examinations it conducted over a period of years, the fact that they had conducted examinations and investigations and did not detect the fraud, lent credibility to Madoff’s operations and had the effect of encouraging additional individuals and entities to invest with him. (Page 429)

After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a modified public version of the ROI which redacted the identities of certain individuals because of privacy concerns as well as additional language at the request of the U.S. Department of Justice. (Page 432)

Concerned Citizen, at Exhibit 499. The letters were identical except for an additional paragraph added to the bottom of the second letter. Both letters stated the following:

Your attention is directed to a scandal of major proportion which was executed by the investment firm Bernard L. Madoff … Assets well in excess of $10 Billion owned by the late Norman F. Levy, an ultra-wealthy long time client of the Madoff firm have been “co-mingled” with funds controlled by the Madoff company with gains thereon retained by Madoff.

The action may have been taken with the knowledge and consent of the late Norman F. Levy in an effort to “take it with him” by avoiding the Federal and State estate taxes on these billions of dollars.
This is an extreme example of uncontrolable [sic] greed which should be investigated by the proper authorities. Letter dated December 6, 2006 and stamped December 11, 2006 from a Concerned Citizen to the Honorable Christopher Cox. The letter received in 2008 added the following paragraph to the letter above:

Dear Sir: It may be of interest to you to know that Mr. Bernard Madoff keeps two (2) sets of records. The most interesting of which is on his computer which is always on his person.

Letter dated December 6, 2006 and stamped March 31, 2008 from a Concerned Citizen

(Page 434)

NERO investigated the complaint by calling Brandon Becker, Madoff’s counsel, on January 8, 2007 and having Becker ask Madoff if he managed money for Norman F. Levy. Suh Telephone Log of Miscellaneous calls, at Exhibit 349. When Becker relayed that Madoff said he did not manage money for Levy, the complaint was not pursued further. (Page 435)

I received from you a referral concerning Madoff, the central character in the now closed investigation NY-7563. The referred letter appears to be a copy of a letter sent to us and reviewed by us in 2006. As in 2006, because the letter is anonymous and lacks detail, we will not be pursuing the allegations in it. (Page 435)
The FTI Engagement Team further noted that the oversight examination’s finding about BMIS’ ability to electronically disseminate account records contrasted sharply with the paper-based records associated with the investment advisory business at BMIS. While this was not a significant finding for examiners during this 1994-1995 oversight examination, it should have raised some questions during the later cause examinations at BMIS. (Page 439)

The OIG investigation found that the SEC received numerous substantive complaints since 1992 that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading and should have led to a thorough examination and/or investigation of the possibility that Madoff was operating a Ponzi scheme. However, the OIG found that although the SEC conducted five examinations and investigations of Madoff based upon these substantive complaints, they never took the necessary and basic steps to determine if Madoff was misrepresenting his trading. We also found that had these efforts been made with appropriate follow-up, the SEC could have uncovered the Ponzi scheme well before Madoff confessed. (Page 456)

The OIG found that the conduct of the examinations and investigations was similar in that they were generally conducted by inexperienced personnel, not planned adequately, and were too limited in scope. While examiners and investigators discovered suspicious information and evidence and caught Madoff in contradictions and inconsistencies, they either disregarded these concerns or relied inappropriately upon Madoff’s representations and documentation in dismissing them. Further, the SEC examiners and investigators failed to understand the complexities of Madoff’s trading and the importance of verifying his returns with independent third-parties. (Page 457)





REPORT OF INVESTIGATION
UNITED STATES SECURITIES AND EXCHANGE COMMISSION OFFICE OF INSPECTOR GENERAL
Case No. OIG-509
Investigation of Failure of the SEC To Uncover Bernard Madoff's Ponzi Scheme

Executive Summary

The OIG investigation did not find evidence that any SEC personnel who worked on an SEC examination or investigation of Bernard L. Madoff Investment Securities, LLC (BMIS) had any financial or other inappropriate connection with Bernard Madoff or the Madoff family that influenced the conduct of their examination or investigatory work. The OIG also did not find that former SEC Assistant Director Eric Swanson's romantic relationship with Bernard Madoffs niece, Shana Madoff, influenced the conduct of the SEC examinations of Madoff and his firm. We also did not find that senior officials at the SEC directly attempted to influence examinations or investigations of Madoff or the Madofffirm, nor was there evidence any senior SEC official interfered with the staffs ability to perform its work.

The OIG investigation did find, however, that the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six! substantive complaints that raised significant red flags concerning Madoffs hedge fund operations and should have led to questions about whether Madoffwas actually engaged in trading. Finally, the SEC was also aware oftwo articles regarding Madoffsinvestment operations that appeared in reputable publications in 2001 and questioned Madoffs unusually consistent returns.

The first complaint, brought to the SEC's attention in 1992, related to allegations that an unregistered investment company was offering "100%" safe investments with high and extremely consistent rates of return over significant periods of time to "special" customers. The SEC actually suspected the investment company was operating a Ponzi scheme and learned in their investigation that all of the investments were placed entirely

I There were arguably eight complaints, since as described in greater detail below, three versions of one of these six complaints were actually brought to the SEC's attention, with the first two versions being dismissed entirely, and an investigation not opened until the third version was submitted. SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

through Madoff and consistent returns were claimed to have been achieved for numerous years without a single loss. .

The second complaint was very specific and different versions were provided to the SEC in May 2000, March 2001 and October 2005. The complaint submitted in 2005 was entitled "The World's Largest Hedge Fund is a Fraud" and detailed approximately 30 red flags indicating that Madoffwas operating a Ponzi scheme, a scenario it described as "highly likely." The red flags included the impossibility of Madoffs returns, particularly the consistency of those returns and the unrealistic volume of options Madoff represented to have traded.

In May 2003, the SEC received a third complaint from a respected Hedge Fund Manager identifying numerous concerns about Madoffs strategy and purported returns, questioning whether Madoff was actually trading options in the volume he claimed, noting that Madoffs strategy and purported returns were not duplicable by anyone else, and stating Madoffs strategy had no correlation to the overall equity markets in oyer 10 years. According to an SEC manager, the Hedge Fund Manager's complaint laid out issues that were "indicia of a Ponzi scheme."

The fourth complaint was part of a series of internal e-mails of another registrant that the SEC discovered in April 2004. The e-mails described the red flags that a registrant's employees had identified while performing due diligence on their own Madoff investment using publicly-available information. The red flags identified included Madoffs incredible and highly unusual fills for equity trades, his misrepresentation of his options trading and his unusually consistent, non-volatile returns over several years. One of the internal e-mails provided a step-by-step analysis of why Madoff must be misrepresenting his options trading. The e-mail clearly explained that Madoff could not be trading on an options exchange because of insufficient volume and could not be trading options over-the-counter because it was inconceivable that he could find a counterparty for the trading. The SEC examiners who initially discovered the emails viewed them as indicating "some suspicion as to whether Madoff is trading at all."

The fifth complaint was received by the SEC in October 2005 from an anonymous informant and stated, "I know that Madoff [sic] company is very secretive about their operations and they refuse to disclose anything. If my suspicions are true, then they are running a highly sophisticated scheme on a massive scale. And they have been doing it for a long time." The informant also stated, "After a short period of time, I decided to withdraw all my money (over $5 million)."
The sixth complaint was sent to the SEC by a "concerned citizen" in December 2006, advising the SEC to look into Madoff and his firm as follows:

Your attention is directed to a scandal of major proportion which was executed by the investment firm Bernard L. Madoff.... Assets well in excess of$10 Billion owned by the late [investor], an ultra-wealthy long time client of the
2 SEC Office of Inspector General Report of Investigation - Case No. OIG-509

EXECUTIVE SUMMARY

Madoff firm have been "co-mingled" with funds controlled by the Madoff company with gains thereon retained by Madoff.

In March 2008, the SEC Chairman's office received a second copy of the previous complaint, with additional information from the same source regarding Madoff's involvement with the investor's money, as follows:

It may be of interest to you to that Mr. Bernard Madoff keeps two (2) sets of records. The most interesting of which is on his computer which is always on his person.

The two 2001 journal articles also raised significant questions about Madoff's unusually consistent returns. One of the articles noted his "astonishing ability to time the market and move to cash in the underlying securities before market conditions turn negative and the related ability to buy and sell the underlying stocks without noticeably affecting the market." This article also described that "experts ask why no one has been able to duplicate similar returns using [Madoff's] strategy." The second article quoted a former Madoffinvestor as saying, "Anybody who's a seasoned hedge-fund investor knows the split-strike conversion is not the whole story. To take it at face value is a bit nai've."
The complaints all contained specific information and could not have been fully and adequately resolved without thoroughly examining and investigating Madofffor operating a Ponzi scheme. The journal articles should have reinforced the concerns about how Madoff could have been achieving his returns.

The OIG retained an expert in accordance with its investigation in order to both analyze the information the SEC received regarding Madoff and the examination work conducted. According to the OIG's expert, the most critical step in examining or investigating a potential Ponzi scheme is to verify the subject's trading through an independent third party.

The OIG investigation found the SEC conducted two investigations and three examinations related to Madoff's investment advisory business based upon the detailed and credible complaints that raised the possibility that Madoff was misrepresenting his trading and could have been operating a Ponzi scheme. Yet, at no time did the SEC ever verify Madoff's trading through an independent third-party, and in fact, never actually conducted a Ponzi scheme examination or investigation of Madoff.

The first examination and first Enforcement investigation were conducted in 1992 after the SEC received information that led it to suspect that a Madoff associate had been conducting a Ponzi scheme. Yet, the SEC focused its efforts on Madoff's associate and never thoroughly scrutinized Madoff's operations even after learning that the investment decisions were made by Madoff and being apprised of the remarkably consistent returns over a period of numerous years that Madoffhad achieved with a basic trading strategy.

3 SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

While the SEC ensured that all of Madoffs associate's customers received their money back, they took no steps to investigate Madoff. The SEC focused its investigation too narrowly and seemed not to have considered the possibility that Madoff could have taken the money that was used to pay back his associate's customers from other clients for which Madoff may have had held discretionary brokerage accounts. In the examination of Madoff, the SEC did seek records from the Depository Trust Company (DTC) (an independent third-party), but sought copies of such records from Madoff himself. Had they sought records from DTC, there is an excellent chance that they would have uncovered Madoffs Ponzi scheme in 1992.2

In 2004 and 2005, the SEC's examination unit, OClE, conducted two parallel cause examinations of Madoffbased upon the Hedge Fund Manager's complaint and the series of internal e-mails that the SEC discovered. The examinations were remarkably similar. There were initial significant delays in the commencement of the examinations, notwithstanding the urgency of the complaints. The teams assembled were relatively inexperienced, and there was insufficient planning for the examinations. The scopes of the examination were in both cases too narrowly focused on the possibility of frontrunning, with no significant attempts made to analyze the numerous red flags about Madoffs trading and returns.

During the course of both these examinations, the examination teams discovered suspicious information and evidence and caught Madoff in contradictions and inconsistencies. However, they either disregarded these concerns or simply asked Madoff about them. Even when Madoffs answers were seemingly implausible, the SEC examiners accepted them at face value.

In both examinations, the examiners made the surprising discovery that Madoffs mysterious hedge fund business was making significantly more money than his wellknown market-making operation. However, no one identified this revelation as a cause for concern.

Astoundingly, both examinations were open at the same time in different offices without either knowing the other one was conducting an identical examination. In fact, it was Madoff himself who informed one of the examination teams that the other examination team had already received the information they were seeking from him.
In the first of the two aCIE examinations, the examiners drafted aletter to the National Association of Securities Dealers (NASD) (another independent third-party) seeking independent trade data, but they never sent the letter, claiming that it would have been too time-consuming to review the data they would have obtained. The OIG's expert opined that had the letter to the NASD been sent, the data would have provided the information necessary to reveal the Ponzi scheme. In the second examination, the OClE Assistant Director sent a document request to a financial institution that Madoff claimed he used to clear his trades, requesting trading done by or on behalf of particular Madoff

2 As discussed in the body of the Report ofInvestigation,this is premised upon the assumption that Madoff had been operating his Ponzi scheme in 1992, which most of the evidence seems to support.
4 SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

feeder funds during a specific time period, and received a response that there was no transaction activity in Madoff's account for that period. However, the Assistant Director did not determine that the response required any follow-up and the examiners testified that the response was not shared with them.

Both examinations concluded with numerous unresolved questions and without any significant attempt to examine the possibility that Madoff was misrepresenting his trading and operating a Ponzi scheme.

The investigation that arose from the most detailed complaint provided to the SEC, which explicitly stated it was "highly likely" that "Madoffwas operating a Ponzi scheme," never really investigated the possibility of a Ponzi scheme. The relatively inexperienced Enforcement staff failed to appreciate the significance ofthe analysis in the complaint, and almost immediately expressed skepticism and disbelief. Most of their investigation was directed at determining whether Madoff should register as an investment adviser or whether Madoff's hedge fund investors' disclosures were adequate.

As with the examinations, the Enforcement staff almost immediately caught Madoff in lies and misrepresentations, but failed to follow up on inconsistencies. They rebuffed offers of additional evidence from the complainant, and were confused about certain critical and fundamental aspects of Madoff's operations. When Madoffprovided evasive or contradictory answers to important questions in testimony, they simply accepted as plausible his explanations.

Although the Enforcement staff made attempts to seek information from independent third-parties, they failed to follow up On these requests. They reached out to the NASD and asked for information on whether Madoffhad options positions on a certain date, but when they received a report that there were in fact no options positions on that date, they did not take any further steps. An Enforcement staff attorney made several attempts to obtain documentation from European counterparties (another independent third-party), and although a letter was drafted, the Enforcement staff decided not to send it. Had any of these efforts been fully executed, they would have led to Madoff's Ponzi scheme being uncovered.

The GIG also found that numerous private entities conducted basic due diligence of Madoff's operations and, without regulatory authority to compel information, came to the conclusion that an investment with Madoffwas unwise. Specifically, Madoff's description of both his equity and options trading practices immediately led to suspicions about Madoff's operations. With respect to his purported trading strategy, many simply did not believe that it was possible for Madoff to achieve his returns using a strategy described by some industry leaders as common and unsophisticated. In addition, there was a great deal of suspicion about Madoff's purported options trading, with several entities not believing that Madoff could be trading options in such high volumes where there was no evidence that any counterparties had been trading options with Madoff.

5 SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

The private entities' conclusions were drawn from the same "red flags" in Madoff's operations that the SEC considered in its examinations and investigations, but ultimately dismissed.

We also found that investors who may have been uncertain about whether to invest with Madoff were reassured by the fact that the SEC had investigated and/or examined Madoff, or entities that did business with Madoff, and found no evidence of fraud. Moreover, we found that Madoff proactively informed potential investors that the SEC had examined his operations. When potential investors expressed hesitation about investing with Madoff, he cited the prior SEC examinations to establish credibility and allay suspicions or investor doubts that may have arisen while due diligence was being conducted. Thus, the fact the SEC had conducted examinations and investigations and did not detect the fraud, lent credibility to Madoffs operations and had the effect of encouraging additional individuals and entities to invest with him.

A more detailed description of the circumstances surrounding the five major investigations and examinations that the SEC conducted of Madoff and his firm is provided below. In June 1992, several customers of an investment firm known as Avellino & Bienes approached the SEC conveying concerns about investments they had made. The SEC was provided with several documents that Avellino & Bienes created that indicated that they were offering "100%" safe investments, which they characterized as loans, with high and extremely consistent rates of return over significant periods of time. Not everyone could invest with Avellino & Bienes, as this was a "special" and exclusive club, with some special investors getting higher returns than others.

As the SEC began investigating the matter, they learned that Madoffhad complete control over all of Avellino & Bienes' customer funds and made all investment decisions for them, and, according to Avellino, Madoffhad achieved these consistent returns for them for numerous years without a single loss. Avellino described Madoffs strategy for these extraordinarily consistent returns as very basic: investing in long-term Fortune 500 securities, with hedges ofthe Standard & Poor's (S&P) index.

The SEC suspected that Avellino & Bienes was operating a Ponzi scheme and took action to ensure that all of Avellino & Bienes' investors were refunded their investments. Yet, the OIG found that the SEC never considered the possibility that Madoff could have taken the money that was used to pay back Avellino & Bienes' customers from other clients as part of a larger Ponzi scheme.

The SEC actually conducted an examination of Madoff that was triggered by the investigation of Avellino & Bienes, but assembled an inexperienced examination team. The examination team conducted a brief and very limited examination of Madoff, but made no effort to trace where the money that was used to repay Avellino & Bienes' investors came from. In addition, although the SEC examiners did review records from DTC, they obtained those DTC records from Madoff rather than going to DTC itself to verify if trading occurred. According to the lead SEC examiner, someone should have been aware of the fact that the money used to pay back Avellino & Bienes' customers

6 SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

could have come from other investors, but there was no examination of where the money that was used to pay back the investors came from. Another examiner said such a basic examination of the source of the funds would have been "common sense." In addition, although the SEC's lead examiner indicated that the investment vehicle offered by Avellino & Bienes had numerous "red flags" and was "suspicious," no effort was made look at the investment strategy and returns.

Instead, the SEC investigative team, which was also inexperienced, brought a limited action against Avellino & Bienes for selling unregistered securities, not fraud, and did not take any further steps to inquire into Madoffs firm. The SEC lawyers working on the matter were aware of the questionable returns and the fact that all the investment decisions were made by Madoff, but the focus of the investigation was limited to whether Avellino & Bienes was selling unregistered securities or operating an unregistered investment firm. A trustee and accounting firm were retained to ensure full distribution of the assets, but its jurisdiction was limited, and they did not take any action to independently verify account balances and transaction activity included in Madoffs financial and accounting records. Even after the accounting firm was unable to audit Avellino & Bienes' financial statements and uncovered additional red flags, such as Avellino & Bienes' failure to produce financial statements or have the records one would have expected from such a large operation, no further efforts were made to delve more deeply into either Avellino & Bienes' or Madoffs operations.

The result was a missed opportunity to uncover Madoffs Ponzi scheme 16 years before Madoff confessed. The SEC had sufficient information to inquire further and investigate Madofffor a Ponzi scheme back in 1992. There was evidence of incredibly consistent returns over a significant period of time without any losses, purportedly achieved by Madoffusing a basic trading strategy of buying Fortune 500 stocks and hedging against the S&P index. Yet, the SEC seemed satisfied with closing Avellino & Bienes down, and never even considered investigating Madoff, despite knowing that Avellino & Bienes invested all of their clients' money exclusively with Madoff. The SEC's lead examiner said Madoffs reputation as a broker-dealer may have influenced the inexperienced team not to inquire into Madoffs operations.

In May 2000, Harry Markopolos provided the SEC's Boston District Office
..

(BDO) with an eight-page complaint questioning the legitimacy of Madoffs reported returns. The 2000 complaint posited the following two explanations for Madoffs unusually consistent returns: .(1) that "[t]he returns are real, but they are coming from some process other than the one being advertised, in which case an investigation is in order;" or (2) "[t]he entire fund is nothing more than a Ponzi Scheme." Markopolos' complaint stated that Madoffs returns were unachievable using the trading strategy he claimed to employ, noting Madoffs "perfect market-timing ability." Markopolos also referenced the fact that Madoff did not allow outside performance audits.

Markopolos explained his analysis presented in the 2000 complaint at a meeting at the SEC's Boston office and encouraged the SEC to investigate Madoff. After the meeting, both Markopolos and an SEC staff accountant testified that it was clear that the

7 SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

BDO's Assistant District Administrator did not understand the information presented.
Our investigation found that this was likely the reason that the BDO decided not to
pursue Markopolos' complaint or even refer it to the SEC's Northeast Regional Office
(NERO).

In March 2001, Markopolos provided the BDO with a second complaint, which supplemented his previous 2000 complaint with updated information and additional analysis. Markopolos' 2001 complaint included an analysis of Madoff's returns versus the S&P 500, showing that he had only three down months versus the market's 26 down months during the same period, with a worst down month of only -1.44% versus the market's worst down month of -14.58%. Markopolos concluded that Madoff's "numbers really are too good to be true." Markopolos' analysis was supported by the experience of two of his colleagues, Neil Chelo and Frank Casey, both of whom had substantial experience and knowledge of investment funds.

Although this time the BDO did refer Markopolos' complaint, NERO decided not to investigate the complaint only one day after receiving it. The matter was assigned to an Assistant Regional Director in Enforcement for initial inquiry, who reviewed the complaint, determined that Madoffwas not registered as an investment adviser, and the next day, sent an e-mail stating, "I don't think we should pursue this matter further." The OIG could find no explanation for why Markopolos' complaint, which the Enforcement attorney and the former head of NERO acknowledged was "more detailed than the average complaint," was disregarded so quickly.

Just one month after NERO decided not to pursue Markopolos' second submission to the SEC, in May 2001, MARHedge and Barron's both published articles questioning Madoff's unusually consistent returns and secretive operations. The MARHedge article, written by Michael Ocrant and entitled "Madoff tops charts; skeptics ask how," stated how many were "baffled by the way [Madoff's] firm has obtained such consistent, nonvolatile returns month after month and year after year," describing the fact Madoff"reported losses of no more than 55 basis points in just four of the past 139 consecutive months, while generating highly consistent gross returns of slightly more than 1.5% a month and net annual returns roughly in the range of 15.0%." The MARHedge article further discussed how industry professionals "marvel at [Madoff's] seemingly astonishing ability to time the market and move to cash in the underlying securities before market conditions turn negative and the related ability to buy and sell the underlying stocks without noticeably affecting the market." It further described how "experts ask why no one has been able to duplicate similar returns using [Madoff's] strategy."

The Barron's article, written by Erin Arvedlund and entitled "Don't Ask, Don't Tell: Bernie Madoff is so secretive, he even asks his investors to keep mum," discussed how Madoff's operation was among the three largest hedge funds, and has "produced compound average annual returns of 15% for more than a decade" with the largest fund "never [having] had a down year." The Barron's article further questioned whether Madoff's trading strategy could have been achieving those remarkably consistent returns.

8 SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

The OIG found that the SEC was aware of the Barron's article when it was published in May 2001. On May 7, 2001, an Enforcement Branch Chief in the BDO followed up with NERO regarding Markopolos' 2001 complaint and the Barron's article, and asked the Director ofNERO ifhe wanted a copy of the article. However, the decision not to commence an investigation was not reconsidered and there is no evidence the Barron's article was ever even reviewed. In addition, we found that former OCIE Director Lori Richards reviewed the Barron's article in May 2001 and sent a copy to an Associate Director in OCIE shortly thereafter, with a note on the top stating that Arvedlund is "very good" and that "This is a great exam for us!" However, OCIE did not open an examination, and there is no record of anyone else in OCIE reviewing the Barron's article until several years later.

In May 2003, OCIE's investment management group in Washington, D.C. received a detailed complaint from a reputable Hedge Fund Manager, in which he laid out the red flags that his hedge fund had identified about Madoff while performing due diligence on two Madoff feeder funds. The Hedge Fund Manager attached four documents to his complaint, including performance statistics for three Madoff feeder funds and the MARHedge article.

The Hedge Fund Manager's complaint identified numerous concerns about Madoffs strategy and purported returns. According to the Hedge Fund Manager's complaint, while Madoff purported to trade $8-$10 billion in options, he and his partner had checked with some of the largest brokers and did not see the volume in the market. Further, the Hedge Fund Manager explained in his complaint that Madoffs fee structure was suspicious because Madoff was foregoing the significant management and performance fees typically charged by asset managers. The complaint also described specific concerns about Madoffs strategy and purported returns such as the fact that the strategy was not duplicable by anyone else; there was no correlation to the overall equity markets (in over 10 years); accounts were typically in cash at month end; the auditor of the firm was a related party to the principal; and Madoffs firm never had to face redemption.

According to an SEC supervisor, the Hedge Fund Manager's complaint implied that Madoff might be lying about its option trading and laid out issues that were "indicia of a Ponzi scheme." One of the senior examiners on the team also acknowledged that the Hedge Fund Manager's complaint could be interpreted as alleging that Madoff was running a Ponzi scheme.
The OIG's expert concluded that based upon issues raised in the Hedge Fund Manager's complaint, had the examination been staffed and conducted appropriately and basic steps taken to obtain third-party verifications, Madoffs Ponzi scheme should and would have been uncovered.

However, we found that OCIE did not staff or conduct the examination

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adequately, and thus, missed another opportunity to uncover Madoffs fraud. The complaint was immediately referred to OClE's broker-dealer examination group even though the complaint mainly raised investment management issues. The broker-dealer group decided not to request investment adviser staff support for the examination even though the examiners testified that such support could have been arranged whether or not Madoffwas registered as an investment adviser. The OIG was informed that, at that time, the two OClE groups rarely collaborated on examinations.3
The broker-dealer examination team assigned to the examination was inexperienced. According to an examiner, at the time of the Madoff examination, OClE "didn't have many experienced people at all" noting that "we were expanding rapidly and had a lot of inexperienced people" conducting examinations. Another OClE examiner stated that "there was no training," that "this was a trial by fire kind ofjob" and there were a lot of examiners who "weren't familiar with securities laws." The team was composed entirely of attorneys, who according to one member, did "not have much experience in equity and options trading" but "rather, their experience was in general litigation." As noted above, the complaint included issues typically examined by investment adviser personnel, such as verification of purported investment returns and account balances, but the group assigned to the examination had no significant experience conducting examinations of these issues.

In addition, notwithstanding the serious issues raised in the Hedge Fund Manager's complaint, the start of the examination was delayed for seven months, until December 2003. No reason was given for this delay.

The OIG investigation also found that the complaint was poorly analyzed and the focus of the examination was much too limited. The examination focused solely on front-running, notwithstanding the numerous other "red flags" raised in the complaint, and failed to analyze how Madoff could have achieved his extraordinarily consistent returns, which had no correlation to the overall markets. When asked why the other issues in the Hedge Fund Manager's complaint and the two 2001 articles were not investigated, the Associate Director stated he focused on front-running because "that was the area of expertise for my crew."

A Planning Memorandum for the examination was prepared, but it failed to address several critical issues from the complaint, including the unusual fee structure; the inability to see the volume of options in the marketplace; the remarkable returns; the fact that Madoffs trading strategy was not duplicable; the returns had no correlation to actual equity markets; the accounts were in cash at month's end; there were no third party brokers; and the auditor of Madoffs firm was a related party.

3 It should be noted that the fact that Madoffs hedge fund business had not been registered at the time of the examinations would not have been an impediment to the examiners' ability to obtain information from Madoffas, at all relevant times, the SEC had authority to examine all ofMadoffs firm's books and records, whether they were related to market making or hedge fund clients.

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In addition, courses of action outlined in the Plarming Memorandum that involved verification oftrading with independent third parties should have been carried out, but were not. For example, the staff drafted a letter to the NASD (an independent thirdparty), which was critical to any adequate review of the complaint because the data and information from the NASD would have assisted in independently verifying trading activity conducted at Madoffs firm. However, the letter was never sent, with the explanation given by staff that it would have been too time-consuming to review the information they would have obtained. According to the DIG's expert, had the letter been sent out, the NASD would have provided order and execution data that would have indicated that Madoff did not execute the significant volume of trades for the discretionary brokerage accounts that he represented to the examiners, and the data would likely have provided the information necessary to reveal the Ponzi scheme.

During the course of the examination, the examination team discovered suspicious information and evidence, but failed to follow up on numerous "red flags." Responses by Madoffto the document requests contradicted the Hedge Fund Manager's complaint and the 2001 articles. For example, Madoffs claim that his firm did not manage or advise hedge funds was contradicted by the articles that reported Madoff was managing billions of dollars in assets. In addition, although known for advanced technology, Madoff claimed not to have e-mail communications with clients. However, the examiners did not follow up on these red flags.

We also found that Madoffs responses to the examiners' document requests should have raised suspicions because the information provided appeared incomplete and, at times, inconsistent when compared to other information provided. For example, Madoffs account statements only included average prices during each day without the actual prices for each transaction. According to the DIG's expert, based on the questions raised by the examination team with regard to differing trade patterns for certain clients, there should have been significant suspicions as to whether or not Madoff was implementing the strategy as claimed.

The examiners also made the surprising discovery that Madoffs mysterious hedge fund business was making significantly more money than his well-known marketmaking operation. However, this was not identified as a cause for concern. When the examination team contacted Madoff to discuss their open questions, his answers failed to clarify matters and he again claimed not to act as an investment adviser. In February 2004, the examination was expanded to analyze the question of whether Madoffwas acting as an investment adviser. Legal memoranda were drafted to seek guidance on this issue, but never sent. In a subsequent draft of a supplemental document request to Madoff, the examiners sought detailed audit trail data, including the date, time, and execution price for all of his trades in 2003. But the examiners removed the request for this critical data from the supplemental request before it was sent out. The reason given was that they were generally hesitant to get audit trail data "because it can be tremendously voluminous and difficult to deal with" and "takes a ton of time" to review. No requests were made from independent third-parties for any data, although an OClE examiner acknowledged obtaining such data should not have been difficult.

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Although there were numerous unresolved questions in the examination, in early April 2004, the examiners were abruptly instructed to shift their focus to "mutual funds" projects, placing the Madoff examination on the "backburner." We found that it was not unusual at that time to shift attention to high priority projects in OCIE and leave some projects incomplete

As the examination of Madoff in Washington, D.C. was shelved, in NERO, a nearly identical examination of Madoffwas just beginning. In April 2004, a NERO investment management examiner had been conducting a routine examination of an unrelated registrant when it discovered internal e-mails from November and December 2003 that raised questions about whether Madoff was involved in illegal activity involving managed accounts. These internal e-mails described the red flags the registrant's employees identified while performing due diligence using widely available information on their Madoff investment. The red flags the registrant had identified included Madoffs: (1) incredible and highly unusual fills for equity trades; (2) misrepresentation of his options trading; (3) secrecy; (4) auditor; (5) unusually consistent and non-volatile returns over several years; and (6) fee structure.
Crucially, one ofthe internal e-mails provided a step-by-step analysis of why Madoff must be misrepresenting his options trading. The e-mail explained that Madoff could not be trading on an options exchange because of insufficient volume and could not be trading options over-the-counter because it was inconceivable he could find a counterparty for the trading. For example, the e-mail explained that because customer statements showed that the options trades were always profitable for Madoff, there was no incentive for a counterparty to continuously take the other side of those trades since they would always lose money. These findings raised significant doubts that Madoff could be implementing his trading strategy. The internal e-mails included the statement that the registrant had "totally independent evidence" that Madoffs executions were "highly unusual."

The investment management examiner who initially discovered the e-mails and his supervisors viewed them as indicating the registrant's employees were clearly "trying to find out where exactly the trades were taking place" and the e-mails evidenced that "there's some suspicion as to whether Madoff is trading at all." They indicated they would have followed up on the allegation in the e-mails about "whether Madoffwas actually trading."

As with the examination, in Washington, D.C., there was a significant delay before the examination was commenced. Although the e-mails were discovered in April 2004 and immediately referred to the NERO broker-dealer examination program, a team was not assembled until December 2004.

The team assembled in NERO consisted of an Associate Director, an Assistant Director and two junior examiners in the broker-dealer examination program. A branch chief, whose role would be to oversee and assist the junior examiners, was not assigned to the examination. One of the junior examiners assigned to examination in 2004

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graduated from college in 1999 and joined the SEC as his first job out of school. The other examiner had worked as an equity trader for a few years before coming to the SEC. He had worked on approximately four examinations before being assigned to the Madoff examination.

Once again, no consideration was given to performing a joint examination with investment management examiners, despite the fact that the internal e-mails raised suspicions about Madoffs performance and returns. An examiner stated that each of the examination programs in NERO was a "silo" and they almost never worked together.
In late March 2005, approximately ten months after receiving the referral, the NERO broker-dealer examination team began performing background research in preparation for an on-site examination of Madoffto begin in April. Unlike the OClE examination team, the NERO examination team did not draft a planning memorandum laying out the scope of the examination. The examiners recalled that, at the time of the examination, NERO did not have a practice of writing planning memoranda.

Once again, although the e-mails raised significant issues about whether Madoff was engaging in trading at all, the decision was made to focus exclusively on frontrunning. The NERO Associate Director stated that despite identifying Madoffs returns as an issue, he did not necessarily have "an expectation" that the examiners would analyze Madoffs returns because portfolio analysis was not a strength of broker-dealer exammers.

To the extent that the NERO examiners did examine issues outside of frontrunning, they conducted their examination by simply asking Madoff about their concerns and accepting his answers. With respect to the significant concerns about Madoffs options trading, they asked Madoff about this issue, and when Madoff said he was no longer using options as part ofhis strategy, they stopped looking at the issue, despitethe fact that Madoffs representation was inconsistent with the internal e-mails, the two 2001 articles, and the investment strategy Madoff claimed to employ. As to why Madoff did not collect fees like all other hedge fund managers, they accepted his response that he was not "greedy" and was happy with just receiving commissions.

Several issues, including the allegation in the internal e-mails that Madoffs auditor was a related party, were never examined at all. Yet, after Madoff confessed to operating a Ponzi scheme, a staff attorney in NERO's Division of Enforcement was assigned to investigate Madoffs accountant, David Friehling, and within a few hours of obtaining the work papers, he determined that no audit work had been done.
In addition, although one ofthe NERO examiners placed a "star" next to the statement in the internal e-mails about having "totally independent evidence" that Madoffs executions were "highly unusual," NERO never followed up with the registrant to inquire about or obtain this evidence. The NERO examiners explained that it was not their practice to seek information from third parties when they conducted examinations.

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When the examiners began their on-site examination of Madoff, they learned Bernard Madoff would be their primary contact and Madoff carefully controlled to whom they spoke at the firm. On one occasion, when a Madoff employee was speaking to the NERO examiners at Madoffs firm, after a couple of minutes, another Madoff employee rushed in to escort her from the conversation, claiming she Was urgently needed. When the examiners later asked Madoffthe reason for the urgency, Madofftold them her lunch had just arrived, even though it was 3:00 o'clock in the afternoon.
Madoff made efforts during the examination to impress and even intimidate the junior examiners from the SEC. Madoff emphasized his role in the securities industry during the examination. One of the NERO examiners characterized Madoff as "a wonderful storyteller" and "very captivating speaker" and noted that he had "an incredible background of knowledge in the industry." The examiner said he found it "interesting" but also "distracting" because they were there "to conduct business."

The other NERO examiner noted that "[a]ll throughout the examination, Bernard Madoffwould drop the names of high-up people in the SEC." Madofftold them that Christopher Cox was going to be the next Chairman ofthe SEC a few weeks prior to Cox being officially named. He also told them that Madoff himself "was on the short list" to be the next Chairman of the SEC. When the NERO examiners would seek documents Madoff did not wish to provide, Madoffbecame very angry, with an examiner recalling that Madoffs "veins were popping out of his neck" and he was repeatedly saying, "What are you looking for? .... Front running. Aren't you looking for front running," and "his voice level got increasingly loud."
Throughout the examination, the NERO examiners "had a real difficult time dealing with" Madoff as he was described as growing "increasingly agitated" during the examination, and attempting to dictate to the examiners what to focus on in the examination and what documents they could review. Yet, when the NERO examiners reported back to their Assistant Director about the pushback they received from Madoff, they received no support and were actively discouraged from forcing the issue.

One effort was made to verify Madoffs trading with an independent third-party, but even after they received a very suspicious response, there was no follow-up. The Assistant Director sent a document request to a financial institution that Madoff claimed he used to clear his trades, requesting records for trading done by or on behalf of paliicular Madoff feeder funds during a specific time period. Shortly thereafter, the financial institution responded, stating there was no transaction activity in Madoffs account for that period. Yet, the response did not raise a red flag for the Assistant Director, who merely assumed that Madoff must have "executed trades through the foreign broker-dealer." The examiners did not recall ever being shown the response from the financial institution, and no further follow-up actions were taken.

At one point in the NERO examination, the examiners were planning to confront Madoff about the many contradictory positions he was taking, particularly as they related to Madoffs changing stories about how many advisory clients he had. However, when

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the NERO examiners pushed Madoff for documents and information about his advisory clients, he rebuffed them, pointing out that he had already provided the information to the Washington, D.C. staff in accordance with their examination. The NERO examiners were taken aback, since they were unaware that the D.C. office of OClE had been conducting a simultaneous examination of Madoff on the identical issues they were examining.

When the NERO examiners asked the Washington, D.C. examiners about Madoff's claim, they first learned about the Washington, D.C. examination, which by that time, had been dormant for months. There were a couple of brief conference calls between the two offices about their examinations, but relatively little sharing of information. One of the few points that was made in a conference call between the offices was a comment by a senior-level Washington D.C. examiner reminding the junior NERO examiners that Madoff"was a very well-connected, powerful, person," which one of the NERO examiners interpreted to raise a concern for them about pushing Madoff too hard without having substantial evidence. While the Washington, D.C. examination team decided not to resume their examination and sent their workpapers to NERO, the NERO examiners reported conducting only a cursory review ofthe workpapers and did not recall even reviewing the Hedge Fund Manager's detailed complaint that precipitated the D.C. examination, appearto have never discussed the D.C. examiners' open questions about Madoff's representations and trading, and did not compare the list of clients Madoff produced to them with the list he produced to the D.C. team.

Meanwhile, as the NERO examination continued, Madoff was failing to provide the NERO examiners with requested documents and the examiners continued to find discrepancies in the information Madoff did provide. As the examiners continued to review the documents Madoff produced, their confusion and skepticism grew. While the NERO examiners had significant questions about Madoff's trade executions and clearance, as well as Madoff's claim that he used his "gut feel" to time the market based on "his observations of the trading room," Madoffwas pushing them to finish the examination.

As had been the case with the Washington, D.C. examination, the NERO examiners learned that Madoff's well-known market making business would be losing money without the secretive hedge fund execution business. Although they described this revelation as "a surprising discovery," the issue was once again never pursued.
Although the NERO examiners determined Madoff was not engaged in frontrunning, they were concerned about issues relating to the operation of his hedge fund business, and sought permission to continue the examination and expand its scope. Their Assistant Regional Director denied their request, telling them to "keep their eyes on the prize," referring to the front-running issue. When the examiners reported that they had caught Madoff in lies, the Assistant Director minimized their concerns, stating "it could [just] be a matter of semantics." The examiners' request to visit Madofffeeder funds was denied, and they were informed that the time for the Madoff examination had expired.

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The explanation given was that "field work cannot go on indefinitely because people
have a hunch or they're following things."

Thus, the NERO cause examination of Madoff was concluded without the
examination team ever understanding how Madoff was achieving his returns and with numerous open questions about Madoffs operations. Many, if not most, of the issues raised in both the Hedge Fund Manager's complaint that precipitated the Washington, . D.C. examination and the internal e-mails that triggered the NERO examination had not been analyzed or resolved. In September 2005, NERO prepared a closing report for the examination that relied almost entirely on information verbally provided by Madoff to the examiners for resolution of numerous "red flags." One of the two primary examiners on the NERO examination team was later promoted based on his work on the Madoff examination.

Only a month after NERO closed its examination of Madoff, in October 2005, Markopolos provided the SEC's BDO with a third version ofhis complaint entitled "The World's Largest Hedge Fund is a Fraud." Markopolos' 2005 complaint detailed approximately 30 red flags indicating Madoffwas operating a Ponzi scheme, a scenario Markopolos described as "highly likely." Markopolos' 2005 complaint discussed an alternative possibility -that Madoff was front-running ~ but characterized that scenario as "unlikely." The red flags identified by Markopolos were similar to the ones previously raised in the Hedge Fund Manager's complaint and the internal e-mails that led to the two cause examinations of Madoff, although somewhat more detailed. They generally fell into one of three categories: (1) Madoffs obsessive secrecy; (2) the impossibility of Madoffs returns, particularly the consistency of those returns; and (3) the unrealistic volume of options Madoff was supposedly trading.

The BDO found Markopolos credible, having worked with him previously and took his 2005 complaint seriously. While senior officials with the BDO considered Markopolos' allegation that Madoffwas operating a Ponzi scheme worthy of serious investigation, they felt it made more sense for NERO to conduct the investigation because Madoffwas in New York and NERO had already conducted an examination of Madoff. The BDO made special efforts to ensure that NERO would "recognize the potential urgency of the situation" which was evidenced by the Director ofthe BDO emailing the complaint to the Director ofNERO personally, and by following up to ensure the matter was assigned within NERO.

While the Madoff investigation was assigned within NERO Enforcement, it was assigned to a team with little to no experience conducting Ponzi scheme investigations. The majority ofthe investigatory work was conducted by a staff attorney who recently graduated from law school and only joined the SEC nineteen months before she was given the Madoff investigation. She had never previously been the lead staff attorney on any investigation, and had been involved in very few investigations overall. The Madoff assignment was also her first real exposure to broker-dealer issues.

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The NERO Enforcement staff, unlike the BDO, failed to appreciate the significance ofthe evidence in the 2005 Markopolos complaint and almost immediately expressed skepticism and disbelief about the information contained in the complaint. The Enforcement staff claimed that Markopolos was not an insider or an investor, and thus, immediately discounted his evidence. The Enforcement staff also questioned Markopolos' motives, indicating concerns that "he was a competitor of Madoffs" who "was looking for a bounty." These concerns were particularly misplaced because in Markopolos' complaint, he described that it was "highly likely" that Madoffwas operating a "Ponzi scheme," and acknowledged that ifhe were correct, he would not be eligible for a bounty. Moreover, even after the branch chief assigned to the Madoff Enforcement investigation spoke with a senior official at the BDO, who vouched for Markopolos' credibility, she remained skeptical of him throughout the investigation.
The OIG investigation also found the Enforcement staff was skeptical about Markopolos' complaint because Madoff did not fit the "profile" of a Ponzi scheme operator, with the branch chief on the Madoff investigation noting that there was "an inherent bias towards [the] sort of people who are seen as reputable members of society."

The NERO Enforcement staff also received a skeptical response to Markopolos' complaint from the NERO examination team who had just concluded their examination. Even though the NERO.examination had focused solely on front-running, NERO examination team downplayed the possibility that Madoffwas conducting a Ponzi scheme, saying, "these are basically some of the same issues we investigated" and that Markopolos "doesn't have the detailed understanding of Madoffs operations that we do which refutes most of his allegations." In testimony before the OIG, the examiners acknowledged that their examination "did not refute Markopolos' allegations regarding a Ponzi scheme" and that the examiners' reaction may have given the impression their examination had a greater focus than it did. Indeed, since the NERO examination had ruled out front-running, the NERO examiners should have encouraged the Enforcement staff to analyze Markopolos' more likely scenario, the Ponzi scheme. Yet, that scenario was never truly analyzed.

The Enforcement staff delayed opening a matter under inquiry (MUI) for the Madoff investigation for two months, which was a necessary step at the beginning of an Enforcement investigation for the staff to be informed of other relevant information that the SEC received about the subject ofthe investigation. As a result ofthe delay in opening a MUI, the Enforcement staff never learned of another complaint sent to the SEC in October 2005 from an anonymous informant stating, "I know that Madoff [sic] company is very secretive about their operations and they refuse to disclose anything. If my suspicions are true, then they are running a highly sophisticated scheme on a massive scale. And they have been doing it for a long time." The informant also stated, "After a short period of time, I decided to withdraw all my money (over $5 million)." As a result, there was no review or analysis of this complaint.

In addition, as was the case with the SEC examinations of Madoff, the focus of the Enforcement staff's investigation was much too limited. Markopolos' 2005

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complaint primarily presented evidence that Madoff was operating a Ponzi scheme, calling that scenario "highly likely." However, most of the Enforcement staffs efforts during their investigation were directed at determining whether Madoff should register as an investmentadviser or whether Madoffs hedge fund investors' disclosures were adequate. In fact, the Enforcement staffs investigative plan primarily involved comparing documents and information that Madoff had provided to the examination staff (which he fabricated) with documents that Madoffhad sent his investors (which he also fabricated).

Yet, the Enforcement staff almost immediately caught Madoff in lies and misrepresentations. An initial production of documents the Enforcement staff obtained from a Madoff feeder fund demonstrated Madoff had lied to the examiners in the NERO examination about a fundamental component of his claimed trading activity. Specifically, while Madofftold the examiners he had stopped using options as part of his strategy after they scrutinized his purported options trading, the Enforcement staff found evidence from the feeder funds that Madoff was telling his investors that he was still trading options during that same time period. Yet, the Enforcement staff never pressed Madoff on this inconsistency. After an interview with an executive from a Madoff feeder fund, the Enforcement staff noted several additional "discrepancies" between what Madofftold the examiners in the NERO examination and information they received in the interview. The Enforcement staff also discovered that the feeder fund executive's testimony had been scripted and he had been prepped by Madoff.

As the investigation progressed; in December 2005, Markopolos approached the Enforcement staff to provide them additional contacts and information. However, the branch chief assigned to the Madoff Enforcement investigation took an instant dislike to Markopolos and declined to even pick up the "several inch thick file folder on Madoff' that Markopolos offered. One of the Enforcement staff described the relationship between Markopolos and the Branch Chief as "adversarial."
In February 2006, the Enforcement staff contacted the SEC's Office of Economic Analysis (OEA) seeking assistance in analyzing Madoffs trading. OEA failed to respond to the request for two and a half months. In April 2006, the Enforcement staff went back to OEA, but failed to provide OEA with a copy of Markopolos' 2005 complaint. An expert on options trading in OEA did review certain documents that OEA received from the Enforcement staff and, based upon a 20 minute review, concluded Madoffs split-strike conversion strategy "was not a strategy that would be expected to earn significant returns in excess of the market." However, this analysis was not conveyed to the Enforcement staff. In addition, the OEA options trading expert told the OIG that ifhe had been made aware ofthe amount of assets that Madoffhad been claiming to manage, he would have ruled out "front-running" as a possible explanation for Madoffs returns. In the end, the Enforcement staff never obtained any useful information or analysis from OEA.

Throughout the Enforcement staffs investigation, the Enforcement staff was confused about certain critical and fundamental aspects of Madoffs operations. They

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had trouble understanding Madoffs purported trading strategy, basic custody of assets issues arid, generally, how Madoffs operation worked. Despite the Enforcement staffs confusion, after their unsuccessful attempt to seek assistance from OEA, they never consulted the SEC's own experts on broker-dealer operations, the SEC's Division of Trading and Markets (formerly the Division of Market Regulation), who could have facilitated inquiries with independent third-parties such as the NASD and DTC. Similarly, after Madoff claimed his purported trading activity took place in Europe, the Enforcement staff did not seek help from the SEC's Office ofInternational Affairs (OIA). Had they simply sought assistance from OIA on matters within its area of expertise, the Enforcement staff should have discovered that Madoffwas not purchasing equities from foreign broker dealers and that he did not have Over-the-Counter (OTC) options with European counterparties.
At a crucial point in their investigation, the Enforcement staff was informed by a senior-level official from the NASD that they were not sufficiently prepared to take Madoffs testimony, but they ignored his advice. On May 17,2006, two days before they were scheduled to take Madoffs testimony, the Enforcement staff attorney contacted the Vice President and Deputy Director of the NASD Amex Regulation Division to discuss Madoffs options trading. The NASD official told the OIG that he answered "extremely basic questions" from the Enforcement staff about options trading. He also testified that, by the end of the call, he felt the Enforcement staff did not understand enough about the subject matter to take Madoffs testimony. The NASD official also recalled telling the Enforcement staff that they "needed to do a little bit more homework before they were ready to talk to [Madoff]," but that they were intent on taking Madoffs testimony as scheduled. He testified that when he and a colleague who was also on the call hung up, "we were both, sort of, shaking our heads, saying that, you know, it really seemed like some of these [options trading] strategies were over their heads." Notwithstanding the advice, the Enforcement staff did not postpone Madoffs testimony.

On May 19, 2006, Madofftestified voluntarily and without counsel in the SEC investigation. During Madoffs testimony, he provided evasive answers to important questions, provided some answers that contradicted his previous representations, and provided some information that could have been used to discover that he was operating a Ponzi scheme. However, the Enforcement staff did not follow-up with respect to the critical information that was relevant to uncovering Madoffs Ponzi scheme.

For example, when Enforcement staff asked the critical question of how he was able to achieve his consistently high returns, Madoff never really answered the question but, instead, attacked those who questioned his returns, particularly the author ofthe Barron's article. Essentially, Madoff claimed his remarkable returns were due to his personal "feel" for when to get in and out of the market, stating, "Some people feel the market. Some people just understand how to analyze the numbers that they're looking at." Because of the Enforcement staffs inexperience and lack of understanding of equity and options trading, they did not appreciate that Madoff was umible to provide a logical explanation for his incredibly consistent returns. Each member of the Enforcement staff

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accepted as plausible Madoffs claim that his returns were due to his perfect "gut feel" for when the market would go up or down.

During his testimony, Madoff also told the Enforcement investigators that the trades for all of his advisory accounts were cleared through his account at DTC. He testified further that his advisory account positions were segregated at DTC and gave the Enforcement staff his DTC account number. During an interview with the OIG, Madoff stated that he had thought he was caught after his testimony about the DTC account, noting that when they asked for the DTC account number, "I thought it was the end game, over. Monday morning they'll call DTC and this will be over ... and it never happened." Madofffurther said that when Enforcement did not follow up with DTC, he "was astonished."

This was perhaps the most egregious failure in the Enforcement investigation of Madoff; that they never verified Madoffs purported trading with any independent third pmiies. As a senior-level SEC examiner noted, "clearly if someone ... has a Ponzi and, they're stealing money, they're not going to hesitate to lie or create records" and, consequently, the "only way to verify" whether the alleged Ponzi operator is actually trading would be to obtain "some independent third-party verification" like "DTC."

A simple inquiry to one of several third parties could have immediately revealed the fact that Madoffwas not trading in the volume he was claiming. The OIG made inquiries with DTC as part of our investigation. We reviewed a January 2005 statement for one Madoff feeder fund account, which alone indicated that it held approximately $2.5 billion of S&P 100 equities as of January 31, 2005. On the contrary, on January 31, 2005, DTC records show that Madoffheld less than $18 million worth ofS&P 100 equities in his DTC account. Similarly, on May 19,2006, the day of Madoffs testimony with the Enforcement staff, DTC records show that Madoff held less than $24 million worth of S&P 100 equities in his DTC account and on August 10, 2006, the day Madoff agreed to register as an investment adviser and the Enforcement staff effectively ended the Madoff investigation, DTC records showed the Madoff account held less than $28 million worth of S&P 100 equities in his DTC account. Had the Enforcement staff learned this information during the course oftheir investigation, they would have immediately realized that Madoffwas not trading in anywhere near the volume that he was showing on the customer statements.4 WhenMadoffs Ponzi scheme finally collapsed in 2008, an SEC Enforcement attorney testified that it took only "a few days" and "a phone call ... to DTC" to confirm that Madoff had not placed any trades with his investors' funds.

Our investigation did find that the Enforcement staff made attempts to seek information from independent third-parties; however, they failed to follow up on these requests. On May 16,2006, three days before Madoffs testimony, the Enforcement staff reached out to the Director ofthe Market Regulation Department at the NASD and asked her to check a certain date on which Madoffhad purportedly held S&P 100 index option

4 The $18 to $24 million in positions were associated with the firm's own account.

20 SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

posItIons. She reported back that they had found no reports of such option positions for that day. Yet, the Enforcement staff failed to make any further inquiry regarding this remarkable finding. The Enforcement staff also failed to scrutinize information obtained in the NERO cause examination when the examination staff had attempted to verify Madoffs claims of trading OTC options with a financial institution and found that "no relevant transaction activity occurred during the period" requested. Finally, although the Enforcement staff attorney attempted to obtain documentation from U.S. affiliates of European counterparties and one of Madoffs purported counterparties was in the process of drafting a consent letter asking Madoffs permission to send the Enforcement staffthe docwnents from its European account, the inexplicable decision was made not to send the letter and to abandon this effort. Had any of these efforts been pursued by the Enforcement staff, they would have uncovered Madoff" s Ponzi scheme.

The Enforcement staff effectively closed the Madoff investigation in August 2006 after Madoff agreed to register as an investment adviser. They believed that this was a "beneficial result" as once he registered, "he would have to have a compliance program, and he would be subject to an examination by our [Investment Advisor] team." However, no examination was ever conducted of Madoff after he registered as an investment adviser.

A few months later, in December 2006, the Enforcement staff received another complaint from a "concerned citizen," advising the SEC to look into Madoff and his firm:

Your attention is directed to a scandal of major proportion which was executed by the investment firm Bernard L. Madoff .... Assets well in excess of $1 0 Billion owned by the late [investor], an ultra-wealthy long time client of the Madoff firm have been "co-mingled" with funds controlled by the Madoff company with gains thereon retained by Madoff.

In investigating this complaint, the Enforcement staff simply asked Madoff s counsel about it, and accepted the response that Madoff had never managed money for this investor. This turned out to be false. When news of Madoffs Ponzi scheme broke, it became evident not only that Madoffmanaged this investor's money, but also that he was actually one of Madoffs largest individual investors.

Shortly after the Madoff Enforcement investigation was effectively concluded, the staff attorney on the investigation received the highest performance rating available at the SEC, in part, for her "ability to understand and analyze the complex issues of the Madoff investigation."

Markopolos also tried again in June 2007, sending an e-mail to the Enforcement branch chief on the Madoff investigation attaching "some very troubling documents that show the Madoff fraud scheme is getting even more brazen" and noting ominously, "When Madofffinally does blow up, it's going to be spectacular, and lead to massive

21 SEC Office ofInspector General RepOlt ofInvestigation - Case No. OIG-509 EXECUTIVE SUMMARY

selling by hedge fund, fund of funds as they face investor redemptions." His e-mail was ignored.

After Madoffwas forced to register as an investment adviser, the Enforcement investigation was inactive for 18 months before being officially closed in January 2008. A couple of months later, in March 2008, the Chairman's office received additional information regarding Madoff's involvement with the investor's money from the same source. The previous complaint was re-sent, and included the following information:

It may be of interest to you to that Mr. Bernard Madoff keeps two (2) sets of records.5 The most interesting of which is on his computer which is always on his person.

This updated complaint was forwarded to the Enforcement staff who had worked on the Madoff investigation, but immediately sent back, with a note stating, in pertinent part, "[W]e will not be pursuing the allegations in it."

As the foregoing demonstrates, despite numerous credible and detailed complaints, the SEC never properly examined or investigated Madofi's trading and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme. Had these efforts been made with appropriate follow-up at any time beginning in June of 1992 until December 2008, the SEC could have uncovered the Ponzi scheme well before Madoff confessed.

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