Corporate Governance

The SEC and the Madoff Investigation

By J. Robert Brown

Hearings were held on Monday before the House Committee on Financial Services concerning the failure of the SEC to uncover the Madoff Ponzi scheme sooner. It was a relatively staid affair, including testimony from academics, government officials and at least one investor.

The hearing involved testimony from the agency's Solicitor General, David Kotz, who has been charged by the chairman to look into the matter.  In addition to the specifics surrounding Madoff, Kotz indicated that he will look into a variet of structural issues, including:

1. The complaint handling procedures of the Division of Enforcement, including a review of how complaints are processed, internal incentives that may affect the decision whether to take action with respect to a complaint, an analysis of which complaints are brought to the Commissioners' and Chairman's attention, and whether tangible and specific complaints are being reviewed and followed-up on appropriately;

2. The OCIE examination and inspection procedures, including an analysis of what policies and procedures were then and are currently in place, whether these policies and procedures are being followed and/or whether there are gaps in these policies and procedures relating to operations involving voluntary private investment pools, such as hedge funds, because they are subject to limited oversight by the SEC, and whether any such gaps may lead to fraudulent activities not being detected; and

3. The relationships between different divisions and offices within the Commission and whether there is sufficient intra-agency collaboration and communication between the Agency components to ensure comprehensive oversight of regulated entities.

Consistent with this approach, Tamar Frankel, a professor at Boston University, testified on the need to strengthen the gate keeping function of examiners, including more frequent inspections and reliance on examiners who are "top notch experts". 

Reform at the SEC has been in the air for awhile.  Much of it has centered around a bureaucratic consolidation of the SEC and the CFTC.  The legacy of the Madoff scandal may be a shift in focus, with increased emphasis on internal reform, particularly to the Office of Compliance Inspections and Examinations.  It is a proactive office that can provide early warning of scandals and frauds.  That it requires greater resources and expertise is apparent.  That it will receive this support will likely be the result of the convincing case made by Bernard Madoff.   

Full post as published by The Race to the Bottom on January 06, 2009 (boomark / email).