Regulators defend actions amid Madoff scandal
WASHINGTON (Reuters) - Top U.S. regulators defended their oversight of securities markets and said on Tuesday they had probed accused swindler Bernard Madoff's brokerage firm in the past, but found no evidence of a massive fraud.
The Securities and Exchange Commission is being heavily criticized for not thoroughly following up on tips from one of Madoff's competitors and missing red flags such as Madoff's ability to generate steady returns in all types of market environments.
The industry-funded Financial Industry Regulatory Authority (FINRA) has also been tainted by the Madoff scandal, as its main mission is to supervise nearly 5,000 U.S. brokerages.
At a congressional hearing, the SEC's head of enforcement, Linda Thomsen, said the agency started an investigation of Madoff's business in 2006 but closed it early in 2008 without recommending enforcement action.
Thomsen also said the SEC filed two enforcement actions in 1992 that involved Madoff's broker-dealer firm, but neither Madoff nor his firm was named as a defendant in either case.
Lori Richards, the SEC's director of compliance, inspections and examinations, said the SEC did examine Madoff's broker-dealer operation -- most recently in 2004 and 2005 -- but found no fraud.
The SEC did not examine Madoff's advisory operations despite the firm registering as an investment adviser in September 2006, Richards told the Senate Banking Committee in prepared testimony.
The banking committee hauled in top enforcement officials to press them over how and why they failed to uncover Madoff's alleged $50 billion fraud.
"The fact that the regulators were put on notice through direct tips, press articles and industry chatter raises serious questions about the state of our regulatory system," said the panel's top Republican, Richard Shelby of Alabama.
Senate Banking Committee Chairman Christopher Dodd said the Madoff fraud was a regulatory failure of historic proportions. "But what's more disturbing about it is that it went undetected until the perpetrator himself confessed," said Dodd, a Connecticut Democrat."
FINRA's interim chief executive, Stephen Luparello, said the watchdog conducted regular examinations of Madoff's broker-dealer operations during the last 20 years.
FINRA received and investigated 19 complaints against Madoff's broker-dealer, but the complaints generally related to trade execution quality and did not relate to the investment advisory issues where fraud is alleged, the watchdog has said.
Luparello said the watchdog never received any complaints alleging a Ponzi scheme, nor did the SEC share tips or concerns with FINRA.
The top securities regulators suggested ways to improve their oversight, including more coordination between the SEC and FINRA, third party custody of customer assets and aligning broker-dealer rules with investment adviser regulations.
Regulators also suggested that auditors for broker-dealers needed more oversight.
Dodd expressed disbelief that the SEC did not zero in on the fact that Madoff's auditor was a tiny, little-known auditor. "Isn't it often a preliminary question to ask, who is your auditor?" said Dodd.
Thomsen said consideration needed to be given to impose requirements about an auditor's qualifications.
Other experts have said broker-dealer auditors should be required to register with the audit supervisor, the Public Company Accounting Oversight Board.
SEC's Thomsen said resources for the agency have not kept pace with the growth in the securities industry and said the agency simply did not have the resources to fully investigate every tip.
Richards, the SEC's top compliance official, said the agency is considering how frequently it examines investment advisers and is determining whether advisers should disclose more risk-related information, such as the identity of their auditors and performance returns.
(Reporting by Karey Wutkowski, John Poirier and Rachelle Younglai; editing by John Wallace and Gerald E. McCormick)