updated 9/29/2009 2:31:25 PM ET 2009-09-29T18:31:25

The Securities and Exchange Commission has recommended a new system for handling the thousands of tips and complaints the agency receives to prevent another breakdown like the one that allowed Bernard Madoff's massive fraud to go undetected for 16 years.

The proposals from SEC Inspector General David Kotz for the agency's enforcement and inspections operations also include making it easier for junior-level enforcement attorneys to bring their concerns to top managers.

In a report late last month, Kotz detailed how the SEC bungled five investigations of Madoff's business between June 1992 and last December, when the financier confessed. Top SEC officials have pledged to fix the problems and say they already have made major changes.

"We found that enforcement staff lacked adequate guidance on how to appropriately analyze complaints," said one of the two reports Kotz issued Tuesday. "As a result, enforcement staff did not conduct a thorough review of a complaint brought to their attention in 2001 regarding Madoff."

The SEC receives an estimated 700,000 tips and outside complaints a year.

Kotz recommended that the SEC:

  • Establish formal guidance for evaluating various types of complaints and train staff on using the new guidelines.
  • Require tips and complaints to be reviewed by at least two people familiar with the subject matter before deciding not to take further action. Assign investigations to teams with at least one member who has specific knowledge of Ponzi schemes. In Ponzi, or pyramid, schemes, new investors' money is used to pay earlier investors, creating a high rate of return that cannot be sustained.
  • Require planning memos to be prepared during investigations that include details of the type of expertise that is needed from other people not involved in the investigation, both inside and outside the SEC.

Kotz's earlier review found that the enforcement attorneys and investigators assigned to probe Madoff were inexperienced and their work wasn't adequately supervised.

The 2001 complaint, made to the SEC by private fraud investigator Harry Markopolos, included some 30 red flags indicating that Madoff was running a Ponzi scheme, Kotz's report noted.

Madoff, who pleaded guilty in March, is serving a 150-year sentence in federal prison in North Carolina for what could be the biggest Ponzi scheme in history. It destroyed thousands of people's life savings, wrecked charities and gave the financial system another big jolt.

The legions of investors who lost money included Hollywood celebrities, ordinary people and famous names in business and sports — as well as big hedge funds, international banks and charitable foundations worldwide.

Federal prosecutors said earlier this month that a search of financial records, including microfilm records dating to 1979, show that investors suffered net losses exceeding $13 billion.

Kotz also is recommending "employee-by-employee" action to ensure the SEC fixes the deficiencies. No SEC employees have been fired specifically for the bungled investigations of Madoff, though the heads of the enforcement division and inspections office have left in recent months.

SEC Enforcement Director Robert Khuzami, who joined the agency in March, said recently that he has started the most extensive restructuring of his division in at least 30 years.

Copyright 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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