Yesterday, the House Financial Services Committee held a hearing to assess the alleged $50 billion investment fraud engineered by Bernard L. Madoff and the possible need for regulatory reform. Witnesses included the following:

Panel 1:

Panel 2:

  • Allan Goldstein, a retiree and investor with Bernard L. Madoff Investment Securities
  • Tamar Frankel, Professor of Law and Michaels Faculty Research Scholar, Boston University School of Law
  • Leon Metzger, adjunct faculty member at Columbia University, Cornell University, New York University, and Yale University

Representative Kanjorski, the Chairman of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, set the tone of the hearing by suggesting that the regulatory system “failed miserably.” The panelists generally echoed those comments, noting that regulatory tools already in place had failed to detect the fraud and that due diligence by individual investors was unlikely to have warned the average Madoff investor.

The SEC came under particular scrutiny. SEC Inspector General Kotz noted that the Madoff investigation will include “an evaluation of broader issues regarding the overall operations of the Division of Enforcement.” Ultimately, Kotz will provide the SEC with “concrete and specific recommendations” to ensure the SEC responds “appropriately and effectively to complaints” in the future.

The Committee also explored to whether the Securities Investor Protection Corporation (SIPC) would be able to return any investor funds, and if so, how soon. There was a consensus that investor losses would likely exceed SIPC’s assets and available credit line with the Treasury. As Representative Sherman pointed out, SIPC’s net worth is “trivial” compared to the well over a trillion dollars it supposedly covers. This observation caused Harbeck to admit that SIPC may end up asking Congress, and the taxpayer, to help foot the bill if the investor losses from Madoff exceed its resources.

Lastly, Professor Frankel argued that disclosure and education do not do enough to protect investors, and that regulators should focus on verification instead. However, Frankel doubted the necessity for new rules to accomplish such verification. Instead, Frankel called for frequent examinations of broker-dealers, advisors and money managers, irrespective of registration, so long as they control a significant size of investors' money. She stated that such verification can be done within the existing securities regulation framework and implemented without drastic changes to current examination models. However, notwithstanding Professor Frankel's comments, the Madoff affair is likely to prompt significant regulatory changes.

This was the first of several public proceedings. Future hearings will include testimony from senior SEC officials, auditors and Harry Markopolous, the individual who may have alerted the SEC to Madoff’s alleged fraud as early as 1999.