REPORT OF INVESTIGATION 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION 

OFFICE OF INSPECTOR GENERAL 

Case No. OIG-509
 

Investigation of Failure of the SEC
 

To Uncover Bernard Madoff's Ponzi Scheme
 

Executive Summary 

The OIG investigation did not find evidence that any SEC personnel who worked 

on an SEC examination or investigation of Bernard L. Madoff Investment Securities, 

LLC (BMIS) had any financial or other inappropriate connection with Bernard Madoff or 

the Madoff family that influenced the conduct of their examination or investigatory work. 

The OIG also did not find that former SEC Assistant Director Eric Swanson's romantic 

relationship with Bernard Madoffs niece, Shana Madoff, influenced the conduct of the 

SEC examinations of Madoff and his firm. We also did not find that senior officials at 

the SEC directly attempted to influence examinations or investigations of Madoff or the 

Madofffirm, nor was there evidence any senior SEC official interfered with the staffs 

ability to perform its work. 

The OIG investigation did find, however, that the SEC received more than ample 

information in the form of detailed and substantive complaints over the years to warrant a 

thorough and comprehensive examination and/or investigation of Bernard Madoff and 

BMIS for operating a Ponzi scheme, and that despite three examinations and two 

investigations being conducted, a thorough and competent investigation or examination 

was never performed. The OIG found that between June 1992 and December 2008 when 

Madoff confessed, the SEC received six! substantive complaints that raised significant 

red flags concerning Madoffs hedge fund operations and should have led to questions 

about whether Madoffwas actually engaged in trading. Finally, the SEC was also aware 

oftwo articles regarding Madoffsinvestment operations that appeared in reputable 

publications in 2001 and questioned Madoffs unusually consistent returns. 

The first complaint, brought to the SEC's attention in 1992, related to allegations 

that an unregistered investment company was offering "100%" safe investments with 

high and extremely consistent rates of return over significant periods of time to "special" 

customers. The SEC actually suspected the investment company was operating a Ponzi 

scheme and learned in their investigation that all of the investments were placed entirely 

I There were arguably eight complaints, since as described in greater detail below, three versions of one of 

these six complaints were actually brought to the SEC's attention, with the first two versions being 

dismissed entirely, and an investigation not opened until the third version was submitted. 
SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 

EXECUTIVE SUMMARY 

through Madoff and consistent returns were claimed to have been achieved for numerous 

years without a single loss. . 

The second complaint was very specific and different versions were provided to 

the SEC in May 2000, March 2001 and October 2005. The complaint submitted in 2005 

was entitled "The World's Largest Hedge Fund is a Fraud" and detailed approximately 

30 red flags indicating that Madoffwas operating a Ponzi scheme, a scenario it described 

as "highly likely." The red flags included the impossibility of Madoffs returns, 

particularly the consistency of those returns and the unrealistic volume of options Madoff 

represented to have traded. 

In May 2003, the SEC received a third complaint from a respected Hedge Fund 

Manager identifying numerous concerns about Madoffs strategy and purported returns, 

questioning whether Madoff was actually trading options in the volume he claimed, 

noting that Madoffs strategy and purported returns were not duplicable by anyone else, 

and stating Madoffs strategy had no correlation to the overall equity markets in oyer 10 

years. According to an SEC manager, the Hedge Fund Manager's complaint laid out 

issues that were "indicia of a Ponzi scheme." 

The fourth complaint was part of a series of internal e-mails of another registrant 

that the SEC discovered in April 2004. The e-mails described the red flags that a 

registrant's employees had identified while performing due diligence on their own 

Madoff investment using publicly-available information. The red flags identified 

included Madoffs incredible and highly unusual fills for equity trades, his 

misrepresentation of his options trading and his unusually consistent, non-volatile returns 

over several years. One of the internal e-mails provided a step-by-step analysis of why 

Madoff must be misrepresenting his options trading. The e-mail clearly explained that 

Madoff could not be trading on an options exchange because of insufficient volume and 

could not be trading options over-the-counter because it was inconceivable that he could 

find a counterparty for the trading. The SEC examiners who initially discovered the emails viewed them as indicating "some suspicion as to whether Madoff is trading at all." 

The fifth complaint was received by the SEC in October 2005 from an 

anonymous informant and stated, "I know that Madoff [sic] company is very secretive 

about their operations and they refuse to disclose anything. If my suspicions are true, 

then they are running a highly sophisticated scheme on a massive scale. And they have 

been doing it for a long time." The informant also stated, "After a short period of time, I 

decided to withdraw all my money (over $5 million)." 

The sixth complaint was sent to the SEC by a "concerned citizen" in December 

2006, advising the SEC to look into Madoff and his firm as follows: 

Your attention is directed to a scandal of major proportion 

which was executed by the investment firm Bernard L. 

Madoff .... Assets well in excess of $1 0 Billion owned by 

the late [investor], an ultra-wealthy long time client of the 

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Madoff firm have been "co-mingled" with funds controlled 

by the Madoff company with gains thereon retained by 

Madoff. 

In March 2008, the SEC Chairman's office received a second copy of the 

previous complaint, with additional information from the same source regarding 

Madoff's involvement with the investor's money, as follows: 

It may be of interest to you to that Mr. Bernard Madoff 

keeps two (2) sets of records. The most interesting of 

which is on his computer which is always on his person. 

The two 2001 journal articles also raised significant questions about Madoff's 

unusually consistent returns. One of the articles noted his "astonishing ability to time the 

market and move to cash in the underlying securities before market conditions turn 

negative and the related ability to buy and sell the underlying stocks without noticeably 

affecting the market." This article also described that "experts ask why no one has been 

able to duplicate similar returns using [Madoff's] strategy." The second article quoted a 

former Madoffinvestor as saying, "Anybody who's a seasoned hedge-fund investor 

knows the split-strike conversion is not the whole story. To take it at face value is a bit 

nai've." 

The complaints all contained specific information and could not have been fully 

and adequately resolved without thoroughly examining and investigating Madofffor 

operating a Ponzi scheme. The journal articles should have reinforced the concerns 

about how Madoff could have been achieving his returns. 

The OIG retained an expert in accordance with its investigation in order to both 

analyze the information the SEC received regarding Madoff and the examination work 

conducted. According to the OIG's expert, the most critical step in examining or 

investigating a potential Ponzi scheme is to verify the subject's trading through an 

independent third party. 

The OIG investigation found the SEC conducted two investigations and three 

examinations related to Madoff's investment advisory business based upon the detailed 

and credible complaints that raised the possibility that Madoff was misrepresenting his 

trading and could have been operating a Ponzi scheme. Yet, at no time did the SEC ever 

verify Madoff's trading through an independent third-party, and in fact, never actually 

conducted a Ponzi scheme examination or investigation of Madoff. 

The first examination and first Enforcement investigation were conducted in 1992 

after the SEC received information that led it to suspect that a Madoff associate had been 

conducting a Ponzi scheme. Yet, the SEC focused its efforts on Madoff's associate and 

never thoroughly scrutinized Madoff's operations even after learning that the investment 

decisions were made by Madoff and being apprised of the remarkably consistent returns 

over a period of numerous years that Madoffhad achieved with a basic trading strategy. 

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EXECUTIVE SUMMARY 

While the SEC ensured that all of Madoffs associate's customers received their money 

back, they took no steps to investigate Madoff. The SEC focused its investigation too 

narrowly and seemed not to have considered the possibility that Madoff could have taken 

the money that was used to pay back his associate's customers from other clients for 

which Madoff may have had held discretionary brokerage accounts. In the examination 

of Madoff, the SEC did seek records from the Depository Trust Company (DTC) (an 

independent third-party), but sought copies of such records from Madoff himself. Had 

they sought records from DTC, there is an excellent chance that they would have 

uncovered Madoffs Ponzi scheme in 1992.2 

In 2004 and 2005, the SEC's examination unit, OClE, conducted two parallel 

cause examinations of Madoffbased upon the Hedge Fund Manager's complaint and the 

series of internal e-mails that the SEC discovered. The examinations were remarkably 

similar. There were initial significant delays in the commencement of the examinations, 

notwithstanding the urgency of the complaints. The teams assembled were relatively 

inexperienced, and there was insufficient planning for the examinations. The scopes of 

the examination were in both cases too narrowly focused on the possibility of frontrunning, with no significant attempts made to analyze the numerous red flags about 

Madoffs trading and returns. 

During the course of both these examinations, the examination teams discovered 

suspicious information and evidence and caught Madoff in contradictions and 

inconsistencies. However, they either disregarded these concerns or simply asked 

Madoff about them. Even when Madoffs answers were seemingly implausible, the SEC 

examiners accepted them at face value. 

In both examinations, the examiners made the surprising discovery that Madoffs 

mysterious hedge fund business was making significantly more money than his wellknown market-making operation. However, no one identified this revelation as a cause 

for concern. 

Astoundingly, both examinations were open at the same time in different offices 

without either knowing the other one was conducting an identical examination. In fact, it 

was Madoff himself who informed one of the examination teams that the other 

examination team had already received the information they were seeking from him. 

In the first of the two aCIE examinations, the examiners drafted aletter to the 

National Association of Securities Dealers (NASD) (another independent third-party) 

seeking independent trade data, but they never sent the letter, claiming that it would have 

been too time-consuming to review the data they would have obtained. The OIG's expert 

opined that had the letter to the NASD been sent, the data would have provided the 

information necessary to reveal the Ponzi scheme. In the second examination, the OClE 

Assistant Director sent a document request to a financial institution that Madoff claimed 

he used to clear his trades, requesting trading done by or on behalf of particular Madoff 

2 As discussed in the body of the Report ofInvestigation,this is premised upon the assumption that Madoff 

had been operating his Ponzi scheme in 1992, which most of the evidence seems to support. 

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EXECUTIVE SUMMARY 

feeder funds during a specific time period, and received a response that there was no 

transaction activity in Madoff's account for that period. However, the Assistant Director 

did not determine that the response required any follow-up and the examiners testified 

that the response was not shared with them. 

Both examinations concluded with numerous unresolved questions and without 

any significant attempt to examine the possibility that Madoff was misrepresenting his 

trading and operating a Ponzi scheme. 

The investigation that arose from the most detailed complaint provided to the 

SEC, which explicitly stated it was "highly likely" that "Madoffwas operating a Ponzi 

scheme," never really investigated the possibility of a Ponzi scheme. The relatively 

inexperienced Enforcement staff failed to appreciate the significance ofthe analysis in 

the complaint, and almost immediately expressed skepticism and disbelief. Most of their 

investigation was directed at determining whether Madoff should register as an 

investment adviser or whether Madoff's hedge fund investors' disclosures were adequate. 

As with the examinations, the Enforcement staff almost immediately caught 

Madoff in lies and misrepresentations, but failed to follow up on inconsistencies. They 

rebuffed offers of additional evidence from the complainant, and were confused about 

certain critical and fundamental aspects of Madoff's operations. When Madoffprovided 

evasive or contradictory answers to important questions in testimony, they simply 

accepted as plausible his explanations. 

Although the Enforcement staff made attempts to seek information from 

independent third-parties, they failed to follow up On these requests. They reached out to 

the NASD and asked for information on whether Madoffhad options positions on a 

certain date, but when they received a report that there were in fact no options positions 

on that date, they did not take any further steps. An Enforcement staff attorney made 

several attempts to obtain documentation from European counterparties (another 

independent third-party), and although a letter was drafted, the Enforcement staff decided 

not to send it. Had any of these efforts been fully executed, they would have led to 

Madoff's Ponzi scheme being uncovered. 

The GIG also found that numerous private entities conducted basic due diligence 

of Madoff's operations and, without regulatory authority to compel information, came to 

the conclusion that an investment with Madoffwas unwise. Specifically, Madoff's 

description of both his equity and options trading practices immediately led to suspicions 

about Madoff's operations. With respect to his purported trading strategy, many simply 

did not believe that it was possible for Madoff to achieve his returns using a strategy 

described by some industry leaders as common and unsophisticated. In addition, there 

was a great deal of suspicion about Madoff's purported options trading, with several 

entities not believing that Madoff could be trading options in such high volumes where 

there was no evidence that any counterparties had been trading options with Madoff. 

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The private entities' conclusions were drawn from the same "red flags" in Madoff's 

operations that the SEC considered in its examinations and investigations, but ultimately 

dismissed. 

We also found that investors who may have been uncertain about whether to 

invest with Madoff were reassured by the fact that the SEC had investigated and/or 

examined Madoff, or entities that did business with Madoff, and found no evidence of 

fraud. Moreover, we found that Madoff proactively informed potential investors that the 

SEC had examined his operations. When potential investors expressed hesitation about 

investing with Madoff, he cited the prior SEC examinations to establish credibility and 

allay suspicions or investor doubts that may have arisen while due diligence was being 

conducted. Thus, the fact the SEC had conducted examinations and investigations and 

did not detect the fraud, lent credibility to Madoffs operations and had the effect of 

encouraging additional individuals and entities to invest with him. 

A more detailed description of the circumstances surrounding the five major 

investigations and examinations that the SEC conducted of Madoff and his firm is 

provided below. In June 1992, several customers of an investment firm known as 

Avellino & Bienes approached the SEC conveying concerns about investments they had 

made. The SEC was provided with several documents that Avellino & Bienes created 

that indicated that they were offering "100%" safe investments, which they characterized 

as loans, with high and extremely consistent rates of return over significant periods of 

time. Not everyone could invest with Avellino & Bienes, as this was a "special" and 

exclusive club, with some special investors getting higher returns than others. 

As the SEC began investigating the matter, they learned that Madoffhad 

complete control over all of Avellino & Bienes' customer funds and made all investment 

decisions for them, and, according to Avellino, Madoffhad achieved these consistent 

returns for them for numerous years without a single loss. Avellino described Madoffs 

strategy for these extraordinarily consistent returns as very basic: investing in long-term 

Fortune 500 securities, with hedges ofthe Standard & Poor's (S&P) index. 

The SEC suspected that Avellino & Bienes was operating a Ponzi scheme and 

took action to ensure that all of Avellino & Bienes' investors were refunded their 

investments. Yet, the OIG found that the SEC never considered the possibility that 

Madoff could have taken the money that was used to pay back Avellino & Bienes' 

customers from other clients as part of a larger Ponzi scheme. 

The SEC actually conducted an examination of Madoff that was triggered by the 

investigation of Avellino & Bienes, but assembled an inexperienced examination team. 

The examination team conducted a brief and very limited examination of Madoff, but 

made no effort to trace where the money that was used to repay Avellino & Bienes' 

investors came from. In addition, although the SEC examiners did review records from 

DTC, they obtained those DTC records from Madoff rather than going to DTC itself to 

verify if trading occurred. According to the lead SEC examiner, someone should have 

been aware of the fact that the money used to pay back Avellino & Bienes' customers 

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could have come from other investors, but there was no examination of where the money 

that was used to pay back the investors came from. Another examiner said such a basic 

examination of the source of the funds would have been "common sense." In addition, 

although the SEC's lead examiner indicated that the investment vehicle offered by 

Avellino & Bienes had numerous "red flags" and was "suspicious," no effort was made 

look at the investment strategy and returns. 

Instead, the SEC investigative team, which was also inexperienced, brought a 

limited action against Avellino & Bienes for selling unregistered securities, not fraud, and 

did not take any further steps to inquire into Madoffs firm. The SEC lawyers working 

on the matter were aware of the questionable returns and the fact that all the investment 

decisions were made by Madoff, but the focus of the investigation was limited to whether 

Avellino & Bienes was selling unregistered securities or operating an unregistered 

investment firm. A trustee and accounting firm were retained to ensure full distribution 

of the assets, but its jurisdiction was limited, and they did not take any action to 

independently verify account balances and transaction activity included in Madoffs 

financial and accounting records. Even after the accounting firm was unable to audit 

Avellino & Bienes' financial statements and uncovered additional red flags, such as 

Avellino & Bienes' failure to produce financial statements or have the records one would 

have expected from such a large operation, no further efforts were made to delve more 

deeply into either Avellino & Bienes' or Madoffs operations. 

The result was a missed opportunity to uncover Madoffs Ponzi scheme 16 years 

before Madoff confessed. The SEC had sufficient information to inquire further and 

investigate Madofffor a Ponzi scheme back in 1992. There was evidence of incredibly 

consistent returns over a significant period of time without any losses, purportedly 

achieved by Madoffusing a basic trading strategy of buying Fortune 500 stocks and 

hedging against the S&P index. Yet, the SEC seemed satisfied with closing Avellino & 

Bienes down, and never even considered investigating Madoff, despite knowing that 

Avellino & Bienes invested all of their clients' money exclusively with Madoff. The 

SEC's lead examiner said Madoffs reputation as a broker-dealer may have influenced 

the inexperienced team not to inquire into Madoffs operations. 

In May 2000, Harry Markopolos provided the SEC's Boston District Office . . 

(BDO) with an eight-page complaint questioning the legitimacy of Madoffs reported 

returns. The 2000 complaint posited the following two explanations for Madoffs 

unusually consistent returns: .(1) that "[t]he returns are real, but they are coming from 

some process other than the one being advertised, in which case an investigation is in 

order;" or (2) "[t]he entire fund is nothing more than a Ponzi Scheme." Markopolos' 

complaint stated that Madoffs returns were unachievable using the trading strategy he 

claimed to employ, noting Madoffs "perfect market-timing ability." Markopolos also 

referenced the fact that Madoff did not allow outside performance audits. 

Markopolos explained his analysis presented in the 2000 complaint at a meeting 

at the SEC's Boston office and encouraged the SEC to investigate Madoff. After the 

meeting, both Markopolos and an SEC staff accountant testified that it was clear that the 

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BDO's Assistant District Administrator did not understand the information presented. 

Our investigation found that this was likely the reason that the BDO decided not to 

pursue Markopolos' complaint or even refer it to the SEC's Northeast Regional Office 

(NERO). 

In March 2001, Markopolos provided the BDO with a second complaint, which 

supplemented his previous 2000 complaint with updated information and additional 

analysis. Markopolos' 2001 complaint included an analysis of Madoff's returns versus 

the S&P 500, showing that he had only three down months versus the market's 26 down 

months during the same period, with a worst down month of only -1.44% versus the 

market's worst down month of -14.58%. Markopolos concluded that Madoff's "numbers 

really are too good to be true." Markopolos' analysis was supported by the experience of 

two of his colleagues, Neil Chelo and Frank Casey, both of whom had substantial 

experience and knowledge of investment funds. 

Although this time the BDO did refer Markopolos' complaint, NERO decided not 

to investigate the complaint only one day after receiving it. The matter was assigned to 

an Assistant Regional Director in Enforcement for initial inquiry, who reviewed the 

complaint, determined that Madoffwas not registered as an investment adviser, and the 

next day, sent an e-mail stating, "I don't think we should pursue this matter further." The 

OIG could find no explanation for why Markopolos' complaint, which the Enforcement 

attorney and the former head of NERO acknowledged was "more detailed than the 

average complaint," was disregarded so quickly. 

Just one month after NERO decided not to pursue Markopolos' second 

submission to the SEC, in May 2001, MARHedge and Barron's both published articles 

questioning Madoff's unusually consistent returns and secretive operations. The 

MARHedge article, written by Michael Ocrant and entitled "Madoff tops charts; skeptics 

ask how," stated how many were "baffled by the way [Madoff's] firm has obtained such 

consistent, nonvolatile returns month after month and year after year," describing the fact 

Madoff"reported losses of no more than 55 basis points in just four of the past 139 

consecutive months, while generating highly consistent gross returns of slightly more 

than 1.5% a month and net annual returns roughly in the range of 15.0%." The 

MARHedge article further discussed how industry professionals "marvel at [Madoff's] 

seemingly astonishing ability to time the market and move to cash in the underlying 

securities before market conditions turn negative and the related ability to buy and sell 

the underlying stocks without noticeably affecting the market." It further described how 

"experts ask why no one has been able to duplicate similar returns using [Madoff's] 

strategy." 

The Barron's article, written by Erin Arvedlund and entitled "Don't Ask, Don't 

Tell: Bernie Madoff is so secretive, he even asks his investors to keep mum," discussed 

how Madoff's operation was among the three largest hedge funds, and has "produced 

compound average annual returns of 15% for more than a decade" with the largest fund 

"never [having] had a down year." The Barron's article further questioned whether 

Madoff's trading strategy could have been achieving those remarkably consistent returns. 

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The OIG found that the SEC was aware of the Barron's article when it was 

published in May 2001. On May 7, 2001, an Enforcement Branch Chief in the BDO 

followed up with NERO regarding Markopolos' 2001 complaint and the Barron's article, 

and asked the Director ofNERO ifhe wanted a copy of the article. However, the 

decision not to commence an investigation was not reconsidered and there is no evidence 

the Barron's article was ever even reviewed. In addition, we found that former OCIE 

Director Lori Richards reviewed the Barron's article in May 2001 and sent a copy to an 

Associate Director in OCIE shortly thereafter, with a note on the top stating that 

Arvedlund is "very good" and that "This is a great exam for us!" However, OCIE did not 

open an examination, and there is no record of anyone else in OCIE reviewing the 

Barron's article until several years later. 

In May 2003, OCIE's investment management group in Washington, D.C. 

received a detailed complaint from a reputable Hedge Fund Manager, in which he laid 

out the red flags that his hedge fund had identified about Madoff while performing due 

diligence on two Madoff feeder funds. The Hedge Fund Manager attached four 

documents to his complaint, including performance statistics for three Madoff feeder 

funds and the MARHedge article. 

The Hedge Fund Manager's complaint identified numerous concerns about 

Madoffs strategy and purported returns. According to the Hedge Fund Manager's 

complaint, while Madoff purported to trade $8-$10 billion in options, he and his partner 

had checked with some of the largest brokers and did not see the volume in the market. 

Further, the Hedge Fund Manager explained in his complaint that Madoffs fee structure 

was suspicious because Madoff was foregoing the significant management and 

performance fees typically charged by asset managers. The complaint also described 

specific concerns about Madoffs strategy and purported returns such as the fact that the 

strategy was not duplicable by anyone else; there was no correlation to the overall equity 

markets (in over 10 years); accounts were typically in cash at month end; the auditor of 

the firm was a related party to the principal; and Madoffs firm never had to face 

redemption. 

According to an SEC supervisor, the Hedge Fund Manager's complaint implied 

that Madoff might be lying about its option trading and laid out issues that were "indicia 

of a Ponzi scheme." One of the senior examiners on the team also acknowledged that the 

Hedge Fund Manager's complaint could be interpreted as alleging that Madoff was 

running a Ponzi scheme. 

The OIG's expert concluded that based upon issues raised in the Hedge Fund 

Manager's complaint, had the examination been staffed and conducted appropriately and 

basic steps taken to obtain third-party verifications, Madoffs Ponzi scheme should and 

would have been uncovered. 

However, we found that OCIE did not staff or conduct the examination 

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adequately, and thus, missed another opportunity to uncover Madoffs fraud. The 

complaint was immediately referred to OClE's broker-dealer examination group even 

though the complaint mainly raised investment management issues. The broker-dealer 

group decided not to request investment adviser staff support for the examination even 

though the examiners testified that such support could have been arranged whether or not 

Madoffwas registered as an investment adviser. The OIG was informed that, at that 

time, the two OClE groups rarely collaborated on examinations.3 

The broker-dealer examination team assigned to the examination was 

inexperienced. According to an examiner, at the time of the Madoff examination, OClE 

"didn't have many experienced people at all" noting that "we were expanding rapidly and 

had a lot of inexperienced people" conducting examinations. Another OClE examiner 

stated that "there was no training," that "this was a trial by fire kind ofjob" and there 

were a lot of examiners who "weren't familiar with securities laws." The team was 

composed entirely of attorneys, who according to one member, did "not have much 

experience in equity and options trading" but "rather, their experience was in general 

litigation." As noted above, the complaint included issues typically examined by 

investment adviser personnel, such as verification of purported investment returns and 

account balances, but the group assigned to the examination had no significant 

experience conducting examinations of these issues. 

In addition, notwithstanding the serious issues raised in the Hedge Fund 

Manager's complaint, the start of the examination was delayed for seven months, until 

December 2003. No reason was given for this delay. 

The OIG investigation also found that the complaint was poorly analyzed and the 

focus of the examination was much too limited. The examination focused solely on 

front-running, notwithstanding the numerous other "red flags" raised in the complaint, 

and failed to analyze how Madoff could have achieved his extraordinarily consistent 

returns, which had no correlation to the overall markets. When asked why the other 

issues in the Hedge Fund Manager's complaint and the two 2001 articles were not 

investigated, the Associate Director stated he focused on front-running because "that was 

the area of expertise for my crew." 

A Planning Memorandum for the examination was prepared, but it failed to 

address several critical issues from the complaint, including the unusual fee structure; the 

inability to see the volume of options in the marketplace; the remarkable returns; the fact 

that Madoffs trading strategy was not duplicable; the returns had no correlation to actual 

equity markets; the accounts were in cash at month's end; there were no third party 

brokers; and the auditor of Madoffs firm was a related party. 

3 It should be noted that the fact that Madoffs hedge fund business had not been registered at the time of 

the examinations would not have been an impediment to the examiners' ability to obtain information from 

Madoff as, at all relevant times, the SEC had authority to examine all ofMadoffs firm's books and 

records, whether they were related to market making or hedge fund clients. 

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In addition, courses of action outlined in the Plarming Memorandum that involved 

verification oftrading with independent third parties should have been carried out, but 

were not. For example, the staff drafted a letter to the NASD (an independent thirdparty), which was critical to any adequate review of the complaint because the data and 

information from the NASD would have assisted in independently verifying trading 

activity conducted at Madoffs firm. However, the letter was never sent, with the 

explanation given by staff that it would have been too time-consuming to review the 

information they would have obtained. According to the DIG's expert, had the letter 

been sent out, the NASD would have provided order and execution data that would have 

indicated that Madoff did not execute the significant volume of trades for the 

discretionary brokerage accounts that he represented to the examiners, and the data would 

likely have provided the information necessary to reveal the Ponzi scheme. 

During the course of the examination, the examination team discovered 

suspicious information and evidence, but failed to follow up on numerous "red flags." 

Responses by Madoffto the document requests contradicted the Hedge Fund Manager's 

complaint and the 2001 articles. For example, Madoffs claim that his firm did not 

manage or advise hedge funds was contradicted by the articles that reported Madoff was 

managing billions of dollars in assets. In addition, although known for advanced 

technology, Madoff claimed not to have e-mail communications with clients. However, 

the examiners did not follow up on these red flags. 

We also found that Madoffs responses to the examiners' document requests 

should have raised suspicions because the information provided appeared incomplete 

and, at times, inconsistent when compared to other information provided. For example, 

Madoffs account statements only included average prices during each day without the 

actual prices for each transaction. According to the DIG's expert, based on the questions 

raised by the examination team with regard to differing trade patterns for certain clients, 

there should have been significant suspicions as to whether or not Madoff was 

implementing the strategy as claimed. 

The examiners also made the surprising discovery that Madoffs mysterious 

hedge fund business was making significantly more money than his well-known marketmaking operation. However, this was not identified as a cause for concern. When the 

examination team contacted Madoff to discuss their open questions, his answers failed to 

clarify matters and he again claimed not to act as an investment adviser. In February 

2004, the examination was expanded to analyze the question of whether Madoffwas 

acting as an investment adviser. Legal memoranda were drafted to seek guidance on this 

issue, but never sent. In a subsequent draft of a supplemental document request to 

Madoff, the examiners sought detailed audit trail data, including the date, time, and 

execution price for all of his trades in 2003. But the examiners removed the request for 

this critical data from the supplemental request before it was sent out. The reason given 

was that they were generally hesitant to get audit trail data "because it can be 

tremendously voluminous and difficult to deal with" and "takes a ton of time" to review. 

No requests were made from independent third-parties for any data, although an OClE 

examiner acknowledged obtaining such data should not have been difficult. 

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Although there were numerous unresolved questions in the examination, in early 

April 2004, the examiners were abruptly instructed to shift their focus to "mutual funds" 

projects, placing the Madoff examination on the "backburner." We found that it was not 

unusual at that time to shift attention to high priority projects in OCIE and leave some 

projects incomplete 

As the examination of Madoff in Washington, D.C. was shelved, in NERO, a 

nearly identical examination of Madoffwas just beginning. In April 2004, a NERO 

investment management examiner had been conducting a routine examination of an 

unrelated registrant when it discovered internal e-mails from November and December 

2003 that raised questions about whether Madoff was involved in illegal activity 

involving managed accounts. These internal e-mails described the red flags the 

registrant's employees identified while performing due diligence using widely available 

information on their Madoff investment. The red flags the registrant had identified 

included Madoffs: (1) incredible and highly unusual fills for equity trades; (2) 

misrepresentation of his options trading; (3) secrecy; (4) auditor; (5) unusually consistent 

and non-volatile returns over several years; and (6) fee structure. 

Crucially, one ofthe internal e-mails provided a step-by-step analysis of why 

Madoff must be misrepresenting his options trading. The e-mail explained that Madoff 

could not be trading on an options exchange because of insufficient volume and could not 

be trading options over-the-counter because it was inconceivable he could find a 

counterparty for the trading. For example, the e-mail explained that because customer 

statements showed that the options trades were always profitable for Madoff, there was 

no incentive for a counterparty to continuously take the other side of those trades since 

they would always lose money. These findings raised significant doubts that Madoff 

could be implementing his trading strategy. The internal e-mails included the statement 

that the registrant had "totally independent evidence" that Madoffs executions were 

"highly unusual." 

The investment management examiner who initially discovered the e-mails and 

his supervisors viewed them as indicating the registrant's employees were clearly "trying 

to find out where exactly the trades were taking place" and the e-mails evidenced that 

"there's some suspicion as to whether Madoff is trading at all." They indicated they 

would have followed up on the allegation in the e-mails about "whether Madoffwas 

actually trading." 

As with the examination, in Washington, D.C., there was a significant delay 

before the examination was commenced. Although the e-mails were discovered in April 

2004 and immediately referred to the NERO broker-dealer examination program, a team 

was not assembled until December 2004. 

The team assembled in NERO consisted of an Associate Director, an Assistant 

Director and two junior examiners in the broker-dealer examination program. A branch 

chief, whose role would be to oversee and assist the junior examiners, was not assigned 

to the examination. One of the junior examiners assigned to examination in 2004 

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EXECUTIVE SUMMARY 

graduated from college in 1999 and joined the SEC as his first job out of school. The 

other examiner had worked as an equity trader for a few years before coming to the SEC. 

He had worked on approximately four examinations before being assigned to the Madoff 

examination. 

Once again, no consideration was given to performing a joint examination with 

investment management examiners, despite the fact that the internal e-mails raised 

suspicions about Madoffs performance and returns. An examiner stated that each of the 

examination programs in NERO was a "silo" and they almost never worked together. 

In late March 2005, approximately ten months after receiving the referral, the 

NERO broker-dealer examination team began performing background research in 

preparation for an on-site examination of Madoffto begin in April. Unlike the OClE 

examination team, the NERO examination team did not draft a planning memorandum 

laying out the scope of the examination. The examiners recalled that, at the time of the 

examination, NERO did not have a practice of writing planning memoranda. 

Once again, although the e-mails raised significant issues about whether Madoff 

was engaging in trading at all, the decision was made to focus exclusively on frontrunning. The NERO Associate Director stated that despite identifying Madoffs returns 

as an issue, he did not necessarily have "an expectation" that the examiners would 

analyze Madoffs returns because portfolio analysis was not a strength of broker-dealer 

exammers. 

To the extent that the NERO examiners did examine issues outside of frontrunning, they conducted their examination by simply asking Madoff about their concerns 

and accepting his answers. With respect to the significant concerns about Madoffs 

options trading, they asked Madoff about this issue, and when Madoff said he was no 

longer using options as part of his strategy, they stopped looking at the issue, despite the 

fact that Madoffs representation was inconsistent with the internal e-mails, the two 2001 

articles, and the investment strategy Madoff claimed to employ. As to why Madoff did 

not collect fees like all other hedge fund managers, they accepted his response that he 

was not "greedy" and was happy with just receiving commissions. 

Several issues, including the allegation in the internal e-mails that Madoffs 

auditor was a related party, were never examined at all. Yet, after Madoff confessed to 

operating a Ponzi scheme, a staff attorney in NERO's Division of Enforcement was 

assigned to investigate Madoffs accountant, David Friehling, and within a few hours of 

obtaining the work papers, he determined that no audit work had been done. 

In addition, although one ofthe NERO examiners placed a "star" next to the 

statement in the internal e-mails about having "totally independent evidence" that 

Madoffs executions were "highly unusual," NERO never followed up with the registrant 

to inquire about or obtain this evidence. The NERO examiners explained that it was not 

their practice to seek information from third parties when they conducted examinations. 

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EXECUTIVE SUMMARY 

When the examiners began their on-site examination of Madoff, they learned 

Bernard Madoff would be their primary contact and Madoff carefully controlled to whom 

they spoke at the firm. On one occasion, when a Madoff employee was speaking to the 

NERO examiners at Madoffs firm, after a couple of minutes, another Madoff employee 

rushed in to escort her from the conversation, claiming she Was urgently needed. When 

the examiners later asked Madoffthe reason for the urgency, Madofftold them her lunch 

had just arrived, even though it was 3:00 o'clock in the afternoon. 

Madoff made efforts during the examination to impress and even intimidate the 

junior examiners from the SEC. Madoff emphasized his role in the securities industry 

during the examination. One of the NERO examiners characterized Madoff as "a 

wonderful storyteller" and "very captivating speaker" and noted that he had "an 

incredible background of knowledge in the industry." The examiner said he found it 

"interesting" but also "distracting" because they were there "to conduct business." 

The other NERO examiner noted that "[a]ll throughout the examination, Bernard 

Madoffwould drop the names of high-up people in the SEC." Madofftold them that 

Christopher Cox was going to be the next Chairman ofthe SEC a few weeks prior to Cox 

being officially named. He also told them that Madoff himself "was on the short list" to 

be the next Chairman of the SEC. When the NERO examiners would seek documents 

Madoff did not wish to provide, Madoffbecame very angry, with an examiner recalling 

that Madoffs "veins were popping out of his neck" and he was repeatedly saying, "What 

are you looking for? .... Front running. Aren't you looking for front running," and "his 

voice level got increasingly loud." 

Throughout the examination, the NERO examiners "had a real difficult time 

dealing with" Madoff as he was described as growing "increasingly agitated" during the 

examination, and attempting to dictate to the examiners what to focus on in the 

examination and what documents they could review. Yet, when the NERO examiners 

reported back to their Assistant Director about the pushback they received from Madoff, 

they received no support and were actively discouraged from forcing the issue. 

One effort was made to verify Madoffs trading with an independent third-party, 

but even after they received a very suspicious response, there was no follow-up. The 

Assistant Director sent a document request to a financial institution that Madoff claimed 

he used to clear his trades, requesting records for trading done by or on behalf of 

paliicular Madoff feeder funds during a specific time period. Shortly thereafter, the 

financial institution responded, stating there was no transaction activity in Madoffs 

account for that period. Yet, the response did not raise a red flag for the Assistant 

Director, who merely assumed that Madoff must have "executed trades through the 

foreign broker-dealer." The examiners did not recall ever being shown the response from 

the financial institution, and no further follow-up actions were taken. 

At one point in the NERO examination, the examiners were planning to confront 

Madoff about the many contradictory positions he was taking, particularly as they related 

to Madoffs changing stories about how many advisory clients he had. However, when 

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EXECUTIVE SUMMARY 

the NERO examiners pushed Madoff for documents and information about his advisory 

clients, he rebuffed them, pointing out that he had already provided the information to the 

Washington, D.C. staff in accordance with their examination. The NERO examiners 

were taken aback, since they were unaware that the D.C. office of OClE had been 

conducting a simultaneous examination of Madoff on the identical issues they were 

examining. 

When the NERO examiners asked the Washington, D.C. examiners about 

Madoff's claim, they first learned about the Washington, D.C. examination, which by 

that time, had been dormant for months. There were a couple of brief conference calls 

between the two offices about their examinations, but relatively little sharing of 

information. One of the few points that was made in a conference call between the 

offices was a comment by a senior-level Washington D.C. examiner reminding the junior 

NERO examiners that Madoff"was a very well-connected, powerful, person," which one 

of the NERO examiners interpreted to raise a concern for them about pushing Madoff too 

hard without having substantial evidence. While the Washington, D.C. examination team 

decided not to resume their examination and sent their workpapers to NERO, the NERO 

examiners reported conducting only a cursory review ofthe workpapers and did not 

recall even reviewing the Hedge Fund Manager's detailed complaint that precipitated the 

D.C. examination, appearto have never discussed the D.C. examiners' open questions 

about Madoff's representations and trading, and did not compare the list of clients 

Madoff produced to them with the list he produced to the D.C. team. 

Meanwhile, as the NERO examination continued, Madoff was failing to provide 

the NERO examiners with requested documents and the examiners continued to find 

discrepancies in the information Madoff did provide. As the examiners continued to 

review the documents Madoff produced, their confusion and skepticism grew. While the 

NERO examiners had significant questions about Madoff's trade executions and 

clearance, as well as Madoff's claim that he used his "gut feel" to time the market based 

on "his observations of the trading room," Madoffwas pushing them to finish the 

examination. 

As had been the case with the Washington, D.C. examination, the NERO 

examiners learned that Madoff's well-known market making business would be losing 

money without the secretive hedge fund execution business. Although they described 

this revelation as "a surprising discovery," the issue was once again never pursued. 

Although the NERO examiners determined Madoff was not engaged in frontrunning, they were concerned about issues relating to the operation of his hedge fund 

business, and sought permission to continue the examination and expand its scope. Their 

Assistant Regional Director denied their request, telling them to "keep their eyes on the 

prize," referring to the front-running issue. When the examiners reported that they had 

caught Madoff in lies, the Assistant Director minimized their concerns, stating "it could 

[just] be a matter of semantics." The examiners' request to visit Madofffeeder funds was 

denied, and they were informed that the time for the Madoff examination had expired. 

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SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 

EXECUTIVE SUMMARY 

The explanation given was that "field work cannot go on indefinitely because people 

have a hunch or they're following things." 

Thus, the NERO cause examination of Madoff was concluded without the 

examination team ever understanding how Madoff was achieving his returns and with
 

numerous open questions about Madoffs operations. Many, if not most, of the issues
 

raised in both the Hedge Fund Manager's complaint that precipitated the Washington,
 

. D.C. examination and the internal e-mails that triggered the NERO examination had not
 

been analyzed or resolved. In September 2005, NERO prepared a closing report for the 

examination that relied almost entirely on information verbally provided by Madoff to the 

examiners for resolution of numerous "red flags." One of the two primary examiners on 

the NERO examination team was later promoted based on his work on the Madoff 

examination. 

Only a month after NERO closed its examination of Madoff, in October 2005, 

Markopolos provided the SEC's BDO with a third version of his complaint entitled "The 

World's Largest Hedge Fund is a Fraud." Markopolos' 2005 complaint detailed 

approximately 30 red flags indicating Madoffwas operating a Ponzi scheme, a scenario 

Markopolos described as "highly likely." Markopolos' 2005 complaint discussed an 

alternative possibility - that Madoff was front-running but characterized that scenario 

as "unlikely." The red flags identified by Markopolos were similar to the ones previously 

raised in the Hedge Fund Manager's complaint and the internal e-mails that led to the two 

cause examinations of Madoff, although somewhat more detailed. They generally fell 

into one of three categories: (1) Madoffs obsessive secrecy; (2) the impossibility of 

Madoffs returns, particularly the consistency of those returns; and (3) the unrealistic 

volume of options Madoff was supposedly trading. 

The BDO found Markopolos credible, having worked with him previously and 

took his 2005 complaint seriously. While senior officials with the BDO considered 

Markopolos' allegation that Madoffwas operating a Ponzi scheme worthy of serious 

investigation, they felt it made more sense for NERO to conduct the investigation 

because Madoffwas in New York and NERO had already conducted an examination of 

Madoff. The BDO made special efforts to ensure that NERO would "recognize the 

potential urgency of the situation" which was evidenced by the Director ofthe BDO emailing the complaint to the Director ofNERO personally, and by following up to ensure 

the matter was assigned within NERO. 

While the Madoff investigation was assigned within NERO Enforcement, it was 

assigned to a team with little to no experience conducting Ponzi scheme investigations. 

The majority ofthe investigatory work was conducted by a staff attorney who recently 

graduated from law school and only joined the SEC nineteen months before she was 

given the Madoff investigation. She had never previously been the lead staff attorney on 

any investigation, and had been involved in very few investigations overall. The Madoff 

assignment was also her first real exposure to broker-dealer issues. 

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SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 

EXECUTIVE SUMMARY 

The NERO Enforcement staff, unlike the BDO, failed to appreciate the 

significance ofthe evidence in the 2005 Markopolos complaint and almost immediately 

expressed skepticism and disbelief about the information contained in the complaint. The 

Enforcement staff claimed that Markopolos was not an insider or an investor, and thus, 

immediately discounted his evidence. The Enforcement staff also questioned 

Markopolos' motives, indicating concerns that "he was a competitor of Madoffs" who 

"was looking for a bounty." These concerns were particularly misplaced because in 

Markopolos' complaint, he described that it was "highly likely" that Madoffwas 

operating a "Ponzi scheme," and acknowledged that ifhe were correct, he would not be 

eligible for a bounty. Moreover, even after the branch chief assigned to the Madoff 

Enforcement investigation spoke with a senior official at the BDO, who vouched for 

Markopolos' credibility, she remained skeptical of him throughout the investigation. 

The OIG investigation also found the Enforcement staff was skeptical about 

Markopolos' complaint because Madoff did not fit the "profile" of a Ponzi scheme 

operator, with the branch chief on the Madoff investigation noting that there was "an 

inherent bias towards [the] sort of people who are seen as reputable members of society." 

The NERO Enforcement staff also received a skeptical response to Markopolos' 

complaint from the NERO examination team who had just concluded their examination. 

Even though the NERO.examination had focused solely on front-running, NERO 

examination team downplayed the possibility that Madoffwas conducting a Ponzi 

scheme, saying, "these are basically some of the same issues we investigated" and that 

Markopolos "doesn't have the detailed understanding of Madoffs operations that we do 

which refutes most of his allegations." In testimony before the OIG, the examiners 

acknowledged that their examination "did not refute Markopolos' allegations regarding a 

Ponzi scheme" and that the examiners' reaction may have given the impression their 

examination had a greater focus than it did. Indeed, since the NERO examination had 

ruled out front-running, the NERO examiners should have encouraged the Enforcement 

staff to analyze Markopolos' more likely scenario, the Ponzi scheme. Yet, that scenario 

was never truly analyzed. 

The Enforcement staff delayed opening a matter under inquiry (MUI) for the 

Madoff investigation for two months, which was a necessary step at the beginning of an 

Enforcement investigation for the staff to be informed of other relevant information that 

the SEC received about the subject ofthe investigation. As a result ofthe delay in 

opening a MUI, the Enforcement staff never learned of another complaint sent to the SEC 

in October 2005 from an anonymous informant stating, "I know that Madoff [sic] 

company is very secretive about their operations and they refuse to disclose anything. If 

my suspicions are true, then they are running a highly sophisticated scheme on a massive 

scale. And they have been doing it for a long time." The informant also stated, "After a 

short period of time, I decided to withdraw all my money (over $5 million)." As a result, 

there was no review or analysis of this complaint. 

In addition, as was the case with the SEC examinations of Madoff, the focus of 

the Enforcement staff's investigation was much too limited. Markopolos' 2005 

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EXECUTIVE SUMMARY 

complaint primarily presented evidence that Madoff was operating a Ponzi scheme, 

calling that scenario "highly likely." However, most of the Enforcement staffs efforts 

during their investigation were directed at determining whether Madoff should register as 

an investmentadviser or whether Madoffs hedge fund investors' disclosures were 

adequate. In fact, the Enforcement staffs investigative plan primarily involved 

comparing documents and information that Madoff had provided to the examination staff 

(which he fabricated) with documents that Madoffhad sent his investors (which he also 

fabricated). 

Yet, the Enforcement staff almost immediately caught Madoff in lies and 

misrepresentations. An initial production of documents the Enforcement staff obtained 

from a Madoff feeder fund demonstrated Madoff had lied to the examiners in the NERO 

examination about a fundamental component of his claimed trading activity. 

Specifically, while Madofftold the examiners he had stopped using options as part of his 

strategy after they scrutinized his purported options trading, the Enforcement staff found 

evidence from the feeder funds that Madoff was telling his investors that he was still 

trading options during that same time period. Yet, the Enforcement staff never pressed 

Madoff on this inconsistency. After an interview with an executive from a Madoff feeder 

fund, the Enforcement staff noted several additional "discrepancies" between what 

Madofftold the examiners in the NERO examination and information they received in 

the interview. The Enforcement staff also discovered that the feeder fund executive's 

testimony had been scripted and he had been prepped by Madoff. 

As the investigation progressed; in December 2005, Markopolos approached the 

Enforcement staff to provide them additional contacts and information. However, the 

branch chief assigned to the Madoff Enforcement investigation took an instant dislike to 

Markopolos and declined to even pick up the "several inch thick file folder on Madoff' 

that Markopolos offered. One of the Enforcement staff described the relationship 

between Markopolos and the Branch Chief as "adversarial." 

In February 2006, the Enforcement staff contacted the SEC's Office of Economic 

Analysis (OEA) seeking assistance in analyzing Madoffs trading. OEA failed to 

respond to the request for two and a half months. In April 2006, the Enforcement staff 

went back to OEA, but failed to provide OEA with a copy of Markopolos' 2005 

complaint. An expert on options trading in OEA did review certain documents that OEA 

received from the Enforcement staff and, based upon a 20 minute review, concluded 

Madoffs split-strike conversion strategy "was not a strategy that would be expected to 

earn significant returns in excess of the market." However, this analysis was not 

conveyed to the Enforcement staff. In addition, the OEA options trading expert told the 

OIG that ifhe had been made aware ofthe amount of assets that Madoffhad been 

claiming to manage, he would have ruled out "front-running" as a possible explanation 

for Madoffs returns. In the end, the Enforcement staff never obtained any useful 

information or analysis from OEA. 

Throughout the Enforcement staffs investigation, the Enforcement staff was 

confused about certain critical and fundamental aspects of Madoffs operations. They 

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EXECUTIVE SUMMARY 

had trouble understanding Madoffs purported trading strategy, basic custody of assets 

issues arid, generally, how Madoffs operation worked. Despite the Enforcement staffs 

confusion, after their unsuccessful attempt to seek assistance from OEA, they never 

consulted the SEC's own experts on broker-dealer operations, the SEC's Division of 

Trading and Markets (formerly the Division of Market Regulation), who could have 

facilitated inquiries with independent third-parties such as the NASD and DTC. 

Similarly, after Madoff claimed his purported trading activity took place in Europe, the 

Enforcement staff did not seek help from the SEC's Office ofInternational Affairs (OIA). 

Had they simply sought assistance from OIA on matters within its area of expertise, the 

Enforcement staff should have discovered that Madoffwas not purchasing equities from 

foreign broker dealers and that he did not have Over-the-Counter (OTC) options with 

European counterparties. 

At a crucial point in their investigation, the Enforcement staff was informed by a 

senior-level official from the NASD that they were not sufficiently prepared to take 

Madoffs testimony, but they ignored his advice. On May 17,2006, two days before they 

were scheduled to take Madoffs testimony, the Enforcement staff attorney contacted the 

Vice President and Deputy Director of the NASD Amex Regulation Division to discuss 

Madoffs options trading. The NASD official told the OIG that he answered "extremely 

basic questions" from the Enforcement staff about options trading. He also testified that, 

by the end of the call, he felt the Enforcement staff did not understand enough about the 

subject matter to take Madoffs testimony. The NASD official also recalled telling the 

Enforcement staff that they "needed to do a little bit more homework before they were 

ready to talk to [Madoff]," but that they were intent on taking Madoffs testimony as 

scheduled. He testified that when he and a colleague who was also on the call hung up, 

"we were both, sort of, shaking our heads, saying that, you know, it really seemed like 

some of these [options trading] strategies were over their heads." Notwithstanding the 

advice, the Enforcement staff did not postpone Madoffs testimony. 

On May 19, 2006, Madofftestified voluntarily and without counsel in the SEC 

investigation. During Madoffs testimony, he provided evasive answers to important 

questions, provided some answers that contradicted his previous representations, and 

provided some information that could have been used to discover that he was operating a 

Ponzi scheme. However, the Enforcement staff did not follow-up with respect to the 

critical information that was relevant to uncovering Madoffs Ponzi scheme. 

For example, when Enforcement staff asked the critical question of how he was 

able to achieve his consistently high returns, Madoff never really answered the question 

but, instead, attacked those who questioned his returns, particularly the author ofthe 

Barron's article. Essentially, Madoff claimed his remarkable returns were due to his 

personal "feel" for when to get in and out of the market, stating, "Some people feel the 

market. Some people just understand how to analyze the numbers that they're looking 

at." Because of the Enforcement staffs inexperience and lack of understanding of equity 

and options trading, they did not appreciate that Madoff was umible to provide a logical 

explanation for his incredibly consistent returns. Each member of the Enforcement staff 

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EXECUTIVE SUMMARY 

accepted as plausible Madoffs claim that his returns were due to his perfect "gut feel" 

for when the market would go up or down. 

During his testimony, Madoff also told the Enforcement investigators that the 

trades for all of his advisory accounts were cleared through his account at DTC. He 

testified further that his advisory account positions were segregated at DTC and gave the 

Enforcement staff his DTC account number. During an interview with the OIG, Madoff 

stated that he had thought he was caught after his testimony about the DTC account, 

noting that when they asked for the DTC account number, "I thought it was the end 

game, over. Monday morning they'll call DTC and this will be over ... and it never 

happened." Madofffurther said that when Enforcement did not follow up with DTC, he 

"was astonished." 

This was perhaps the most egregious failure in the Enforcement investigation of 

Madoff; that they never verified Madoffs purported trading with any independent third 

pmiies. As a senior-level SEC examiner noted, "clearly if someone ... has a Ponzi and, 

they're stealing money, they're not going to hesitate to lie or create records" and, 

consequently, the "only way to verify" whether the alleged Ponzi operator is actually 

trading would be to obtain "some independent third-party verification" like "DTC." 

A simple inquiry to one of several third parties could have immediately revealed 

the fact that Madoffwas not trading in the volume he was claiming. The OIG made 

inquiries with DTC as part of our investigation. We reviewed a January 2005 statement 

for one Madoff feeder fund account, which alone indicated that it held approximately 

$2.5 billion of S&P 100 equities as of January 31, 2005. On the contrary, on January 31, 

2005, DTC records show that Madoffheld less than $18 million worth ofS&P 100 

equities in his DTC account. Similarly, on May 19,2006, the day of Madoffs testimony 

with the Enforcement staff, DTC records show that Madoff held less than $24 million 

worth of S&P 100 equities in his DTC account and on August 10, 2006, the day Madoff 

agreed to register as an investment adviser and the Enforcement staff effectively ended 

the Madoff investigation, DTC records showed the Madoff account held less than $28 

million worth of S&P 100 equities in his DTC account. Had the Enforcement staff 

learned this information during the course oftheir investigation, they would have 

immediately realized that Madoffwas not trading in anywhere near the volume that he 

was showing on the customer statements.4 WhenMadoffs Ponzi scheme finally 

collapsed in 2008, an SEC Enforcement attorney testified that it took only "a few days" 

and "a phone call ... to DTC" to confirm that Madoff had not placed any trades with his 

investors' funds. 

Our investigation did find that the Enforcement staff made attempts to seek 

information from independent third-parties; however, they failed to follow up on these 

requests. On May 16,2006, three days before Madoffs testimony, the Enforcement staff 

reached out to the Director ofthe Market Regulation Department at the NASD and asked 

her to check a certain date on which Madoffhad purportedly held S&P 100 index option 

4 The $18 to $24 million in positions were associated with the firm's own account. 

20 
SEC Office ofInspector General Report ofInvestigation - Case No. OIG-509 

EXECUTIVE SUMMARY 

posItIons. She reported back that they had found no reports of such option positions for 

that day. Yet, the Enforcement staff failed to make any further inquiry regarding this 

remarkable finding. The Enforcement staff also failed to scrutinize information obtained 

in the NERO cause examination when the examination staff had attempted to verify 

Madoffs claims of trading OTC options with a financial institution and found that "no 

relevant transaction activity occurred during the period" requested. Finally, although the 

Enforcement staff attorney attempted to obtain documentation from U.S. affiliates of 

European counterparties and one of Madoffs purported counterparties was in the process 

of drafting a consent letter asking Madoffs permission to send the Enforcement staffthe 

docwnents from its European account, the inexplicable decision was made not to send the 

letter and to abandon this effort. Had any of these efforts been pursued by the 

Enforcement staff, they would have uncovered Madoff" s Ponzi scheme. 

The Enforcement staff effectively closed the Madoff investigation in August 2006 

after Madoff agreed to register as an investment adviser. They believed that this was a 

"beneficial result" as once he registered, "he would have to have a compliance program, 

and he would be subject to an examination by our [Investment Advisor] team." 

However, no examination was ever conducted of Madoff after he registered as an 

investment adviser. 

A few months later, in December 2006, the Enforcement staff received another 

complaint from a "concerned citizen," advising the SEC to look into Madoff and his firm: 

Your attention is directed to a scandal of major proportion 

which was executed by the investment firm Bernard L. 

Madoff .... Assets well in excess of $1 0 Billion owned by 

the late [investor], an ultra-wealthy long time client of the 

Madoff firm have been "co-mingled" with funds controlled 

by the Madoff company with gains thereon retained by 

Madoff. 

In investigating this complaint, the Enforcement staff simply asked Madoff s 

counsel about it, and accepted the response that Madoff had never managed money for 

this investor. This turned out to be false. When news of Madoffs Ponzi scheme broke, it 

became evident not only that Madoffmanaged this investor's money, but also that he was 

actually one of Madoffs largest individual investors. 

Shortly after the Madoff Enforcement investigation was effectively concluded, the 

staff attorney on the investigation received the highest performance rating available at the 

SEC, in part, for her "ability to understand and analyze the complex issues of the Madoff 

investigation." 

Markopolos also tried again in June 2007, sending an e-mail to the Enforcement 

branch chief on the Madoff investigation attaching "some very troubling documents that 

show the Madoff fraud scheme is getting even more brazen" and noting ominously, 

"When Madofffinally does blow up, it's going to be spectacular, and lead to massive 

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SEC Office ofInspector General RepOlt ofInvestigation - Case No. OIG-509 

EXECUTIVE SUMMARY 

selling by hedge fund, fund of funds as they face investor redemptions." His e-mail was 

ignored. 

After Madoffwas forced to register as an investment adviser, the Enforcement 

investigation was inactive for 18 months before being officially closed in January 2008. 

A couple of months later, in March 2008, the Chairman's office received additional 

information regarding Madoff's involvement with the investor's money from the same 

source. The previous complaint was re-sent, and included the following information: 

It may be of interest to you to that Mr. Bernard Madoff 

keeps two (2) sets of records. 5 The most interesting of 

which is on his computer which is always on his person. 

This updated complaint was forwarded to the Enforcement staff who had worked 

on the Madoff investigation, but immediately sent back, with a note stating, in pertinent 

part, "[W]e will not be pursuing the allegations in it." 

As the foregoing demonstrates, despite numerous credible and detailed 

complaints, the SEC never properly examined or investigated Madofi's trading and never 

took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme. 

Had these efforts been made with appropriate follow-up at any time beginning in June of 

1992 until December 2008, the SEC could have uncovered the Ponzi scheme well before 

Madoff confessed. 

·Submitted J(~ Date:

lfDavid K{}tJnspeeneral 

5 The allegation that Madoff kept two sets ofrecords also turned out to be true. 

22