Government and industry regulators were put sharply on the defensive Tuesday at a Senate hearing over their failure to uncover the more than a decade-long, multibillion-dollar fraud scheme allegedly carried out under their noses by Bernard Madoff.
With charities and residents in their states ruined by losses from Madoff, members of the Senate Banking Committee demanded answers and accountability. They were scarcely satisfied with explanations given by two high-ranking officials of the Securities and Exchange Commission and the interim CEO of the securities industry's self-policing organization.
And they said the Madoff affair clearly showed the need for an overhaul of the patchwork system governing regulation of the financial markets — something the new Congress appears to be moving toward.
"Madoff's fraud was so immense and obvious, and took place over such a long period of time, it is simply inexplicable how the SEC missed it," declared Sen. Charles Schumer, D-N.Y. "It's as if there was a giant elephant standing next to the SEC in a rather small room for 25 years, and the SEC never noticed the elephant or even the smell of peanuts on its breath."
Schumer wants the SEC to get more funding from Congress to hire 100 new enforcement staff members and to move its inspections office from Washington headquarters to Wall Street.
The Banking Committee chairman, Sen. Christopher Dodd, D-Conn., demanded of SEC Enforcement Director Linda Thomsen and the other regulators, "What's happened here?"
"We want some action very quickly in this area," Dodd told them, saying he spoke for the whole committee. He asked the regulators to report to the committee every three months on progress they were making in improving their processes for detecting fraud.
Thomsen said the SEC is committed to finding ways to bolster fraud detection after its breakdown in the Madoff case. While the agency needs to improve its internal processes for pursuing cases, she said the SEC also needs authority to regulate parts of the financial system that escape oversight and more funding to carry out more investigations.
"If we had more resources, we could clearly do more," Thomsen testified.
Thomsen faced grilling along with Lori Richards, who heads the SEC's inspections division, and Stephen Luparello, the interim chief executive of the Financial Industry Regulatory Authority. FINRA, the industry regulator, was headed until last month by Mary Schapiro, President Barack Obama's new SEC chairman.
Luparello was quick to say that Madoff carried out the scheme through his investment business and FINRA, the industry regulator, was empowered to inspect only the brokerage operation. He also said the SEC didn't share with FINRA the tips it received from outsiders on Madoff's operation.
The hearing provided a fresh volley of criticism of the SEC over its failure to discover the $50 billion Ponzi scheme allegedly run by Madoff, the prominent Wall Street figure and money manager now fallen into disgrace — despite credible allegations against him that were brought to the agency over the course of a decade. Against the backdrop of the worst financial crisis since the 1930s, the SEC also is accused of contributing to that disaster with lax oversight of Wall Street and the markets.
Shortly before senators began questioning the regulators on Capitol Hill, Schapiro was sworn in at SEC headquarters. She pledged commitment "to reinvigorating a financial regulatory system that must protect investors and vigorously enforce the rules."
"We will work to deepen the SEC's commitment to transparency, accountability and disclosure while always keeping the needs and concerns of investors front and center," Schapiro said.
Christopher Cox, then the SEC chairman, last month pinned the blame on the agency's career staff for the failure since at least 1999 to detect what Madoff was doing. He ordered the SEC's inspector general, H. David Kotz, to determine what went wrong. Kotz told a House hearing recently that he was expanding the inquiry to examine the operations of the divisions led by Thomsen, who has been the enforcement chief since mid-2005, and Richards, who has held that position since mid-1995.
Kotz has also been examining the relationship between a former SEC attorney, Eric Swanson, and Madoff's niece, Shana, who are now married. As an SEC attorney, Swanson was part of a team that examined Madoff's brokerage operation in 1999 and 2004. Neither review resulted in any action against Madoff, a former chairman of the Nasdaq Stock Market who was a member of SEC advisory committees.
Lawmakers say Madoff's alleged fraud, which caused massive damage to investors large and small around the world and may be the largest pyramid scam in history, reflects deep, systemic problems at the SEC.
Six weeks after Madoff's arrest in New York, thousands of victims who lost money investing with him have been identified — including ordinary people and Hollywood celebrities — as well as big hedge funds, international banks and charities in the U.S., Europe and Asia.