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It will be the end of the summer before we learn how the Securities and Exchange Commission could have conducted at least five inquiries into Bernie Madoff's activities over 16 years and never found a Ponzi scheme so huge that it robbed billionaires and bubbies of $13billion and won Madoff a 150-year, all-expenses-paid trip to prison.
That's when the commission's inspector general will issue his report on the Madoff screwup. By then, Mary Schapiro, the SEC's earnest and aggressive new chairman, will have done enough to restructure the agency, replace top management, expand the staff, step up enforcement and revive morale that she'll be able to declare, with sufficient credibility, that it won't happen again.
Make no mistake – the IG's report is likely to be a devastating rebuke of an agency once regarded with equal measure of fear and respect.
It would be comforting to learn that it was only a lack of resources and poor leadership at the top that explains why the SEC blew so many opportunities to uncover Madoff's larcenous scheme, along with Madoff's cunning and charm.
But the list of particulars against the SEC is also likely to include an insular culture that casts an overly skeptical eye on tips from jealous competitors, unhappy customers, disgruntled employees or publicity-seeking state regulators; a staff top-heavy with lawyers but woefully lacking in people who understand traders, markets and complex new financial instruments; and a mentality within the agency that discouraged cooperation and information-sharing among its divisions.
And, then, of course, there are the venal sins of timidity, gullibility and sheer incompetence, all of which play a role in the Madoff drama.
In the past month, more details have begun to dribble out about how Madoff created the illusion of a legitimate investment business while operating with only a handful of loyal lieutenants from a tiny office using an outdated IBM computer. The information is contained in civil suits against three firms that helped direct most of the money and investors into Madoff's net.
In one suit, the SEC alleges that Cohmad, the biggest of the so-called feeder firms, maintained its offices right next to Madoff's office in the Lipstick Building in Midtown Manhattan. At various times, Cohmad's two top executives, Maurice Cohn and his daughter Marcia, shared the same reception area, the same photocopier, the same bathrooms as Madoff. Madoff and his brother even owned a quarter of Cohmad's stock, giving rise to the company name, which combined Cohn and Madoff.
So imagine you are an SEC investigator and you show up at Madoff's office in 2006 to check out allegations that he may be running a Ponzi scheme and engaging in an illegal trading technique known as “front running” to inflate his investors' returns.
You are aware that, as far back as 1990, the SEC had uncovered evidence that Madoff was managing money for investors without properly disclosing this line of business with the SEC.
Your initial inquiry reveals that Madoff is once again acting as an investment adviser without proper disclosure. You also find that he is executing all his trades for those accounts not through his own brokerage firm, located on another floor in the same building, but through offshore companies.
There is no visible sign of any marketing efforts for these investment advisory services, but there is this other brokerage in the same office with a surprising number of clients who live in the same posh Florida resort as Madoff and belong to his country club.
Question: Do you (1) Close the investigation after requiring Madoff to register as an investment adviser? Or (2) Do a spot-check to see whether those offshore trades really happened and inquire further into the business relationship between the Cohns and Madoff?
If you answered (2), you may have a future at the SEC.
What you would have discovered is that Madoff had executed no overseas trades – or any trades – for his investment clients for at least a decade.
You would have discovered that Cohmad had 800 customers whose money was being managed by Madoff and that Madoff was the source of 64 to 91 percent of Cohmad's revenue, according to the SEC's recent complaint.
And if you had dug deep enough, you may have discovered, as the SEC now claims it has, that Cohmad's biggest fundraiser, Robert Jaffe, was paid not in fees but in inflated returns on a fictitious investment account that allowed Jaffe to withdraw millions of dollars each year in what was really other people's cash.
Before very long, you may have discovered that Madoff had other collaborators.
The SEC has now filed suit against Stanley Chais, a Beverly Hills money manager whose idea of money management, according to the complaint, was to turn all of his clients' money over to Madoff and then report that none of them had lost money on even a single trade from 1999 to 2008. The SEC alleges that Madoff rewarded Chais with $546 million in made-up “profits,” in addition to the hundreds of millions in fees he earned from his once-grateful, now-angry investors.
And the trustee overseeing the bankruptcy of Madoff's empire has filed suit against Jeffry Picower, a Palm Beach investor, alleging that Picower conspired with Madoff to generate phony losses in Picower's account when he needed them for tax losses, while at other times recording annual returns on his account of as high as 950 percent.
Like the Cohns and Jaffe, Picower and Chais claim they are victims of Madoff, not collaborators.
This story only gets more interesting.
Steven Pearlstein is a business columnist for the Washington Post.
