Today, the Senate Committee on Banking, Housing and Urban Affairs held a hearing entitled “Madoff Investment Securities Fraud: Regulatory and Oversight Concerns and the Need for Reform.” As Senator Dodd noted in his opening remarks, the purpose of the hearing was to discuss both how the “regulatory system failed to detect a fraud of this magnitude” and also to show the American people that the government is “committed to strengthening regulation [and] rebuilding confidence.”
Witnesses at the hearing included:
- Professor John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia University Law School
- Dr. Henry A. Backe, Jr., Orthopedic Surgeon, Fairfield, Connecticut
- Ms. Lori Richards, Director, Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission
- Ms. Linda Thomsen, Director, Division of Enforcement, U.S. Securities and Exchange Commission
- Mr. Stephen Luparello, Interim Chief Executive Officer, Financial Industry Regulatory Authority (FINRA)
- Mr. Stephen Harbeck, President and CEO, Securities Investor Protection Corporation (SIPC)
The SEC representatives came under fire from the Committee for the SEC Division of Enforcement’s apparent failures to pick-up on red flags and follow up on credible tips concerning Mr. Madoff. Ms. Thomsen acknowledged that the SEC began investigating Mr. Madoff's business in 2006 but closed it early in 2008 without recommending enforcement action. According to Ms. Richards, the SEC did examine Mr. Madoff's broker-dealer operations (but not his investment adviser operations) as recently as 2004 and 2005, but saw no evidence of fraud. Ms. Thomsen noted that the Division receives “hundreds of thousands of tips each year” and that they “do not have resources to fully investigate them all.” Overall, she outlined three areas in which the Division intends to make improvements: law enforcement, law and regulation, and resources.
Mr. Luparello stated that FINRA had conducted regular examinations of Mr. Madoff’s borker-dealer operations over the past 20 years and had investigated at least 19 complaints, most of which related to operational issues, like trade execution, and none alleged any Ponzi scheme or similar massive fraud. He also noted that the SEC never alerted FINRA to any complaints pertaining to Mr. Madoff. Mr. Luparello called for greater cooperation between regulators, including a more “formalized information sharing process.” Mr. Luparello also noted that FINRA regulates broker-dealers but not investment advisers, even though the services are “virtually indistinguishable.” He pointed out that this is just one example of a fractured regulatory system that is failing to adequately protect investors.
Other notable testimony came from SIPC CEO Stephen Harbeck, who explained that SIPC only advances up to $500,000 per customer on account of missing securities. At the very least, the Madoff brokerage firm owed customers $600 million worth of stock that it did not have on hand. So far, it cannot be determined if SIPC’s resources will be adequate to cover customer losses. What is certain, however, is that customers’ recovery will be capped at $500,000 and that customers will have to share pro rata in the corpus that the trustee collects. This will likely leave many very dissatisfied investors.