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OCIE Exam Process.doc

Review and Analysis of OCIE 

Examinations of Bernard L. Madoff 

Investment Securities, LLC 

September 29, 2009 

Report No. 468 

Review and Analysis of OCIE Examinations 

of Bernard L. Madoff Investment Securities, 

LLC

Executive Summary

Background. On June 25, 2009, the Securities and Exchange Commission’s 

(“SEC” or “Commission”) Office of Inspector General (“OIG”) retained the 

services of a team of experts at FTI Consulting, Inc. (“FTI Engagement Team”) to 

assess the adequacy of examinations conducted by the SEC’s Office of 

Compliance Inspections and Examinations (“OCIE”) in response to complaints 

regarding the activities of Bernard L. Madoff (“Madoff”) and his investment firm, 

Bernard L. Madoff Investment Securities, LLC (“BMIS”). 

Objectives. The FTI Engagement Team reviewed the OIG’s Report of 

Investigation dated August 31, 2009, including related findings, exhibits, witness 

testimony and supporting documentation, and analyzed the workpapers from 

OCIE’s examinations of Madoff, OCIE’s manuals, OCIE’s guidance documents 

and policies, and other governmental and private reports relating to examination 

programs. In addition, the FTI Engagement Team interviewed over a dozen key 

OCIE managers and staff to gain an understanding of the OCIE examination 

process. 

Results. The FTI Engagement Team found that OCIE examiners made critical 

mistakes in nearly every aspect of their examinations of Madoff and BMIS and 

missed significant opportunities to uncover Madoff’s Ponzi scheme. The FTI 

Engagement Team concluded that OCIE examiners did not properly plan or 

conduct their examinations of Madoff, and because of these failures, were unable 

to discover Madoff’s fraud. 

The following is a summary of many of the specific findings in this report. The 

FTI Engagement Team found that OCIE did not properly evaluate the information 

provided in 2001 news articles that raised significant red flags about Madoff’s 

operations. The FTI Engagement Team explained that information received 

relating to a potential violation must be properly vetted and opined that in the 

case of the 2001 articles about Madoff, there was sufficient detail in these articles 

to warrant additional scrutiny due to the red flags raised. 

The FTI Engagement Team further found that OCIE did not properly evaluate a 

complaint in 2003 and a referral in 2004 from highly credible sources that 

provided specific and concrete information about the possibility of Madoff not 

engaging in trading. The review found that given the credibility of the information 

triggering the examinations, the significant delays before the examinations 

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commenced were unreasonably long, there was insufficient review of the 

complaints, and the cause examinations failed to address critical issues raised in 

the complaints. The review found that, at the time, OCIE had no formal policies 

or procedures for handling tips and complaints in place which led to their 

mishandling of the information. 

The FTI Engagement Team also found that the planning memoranda for the 

OCIE examinations were either inadequate or not drafted at all. The review 

found that there were no formal policies or procedures at that time that required 

the preparation of a planning memorandum. The FTI Engagement Team 

concluded that had the scope of the examinations been adequately analyzed and 

related to the complaints, the cause examinations would have more closely 

focused on the possibility of a Ponzi scheme being conducted by Madoff. 

The FTI Engagement Team further found that there was inadequate 

communication and information sharing among OCIE personnel in connection 

with their examinations of Madoff. In addition, the pre-examination preparation 

was inadequate, the examination tracking system was not properly used to log 

the initiation of the cause examinations, and the examiners did not adequately 

close the examinations. The review found that while OCIE senior personnel had 

an initial conversation with Madoff concerning the cause examination, there were 

no policies or procedures in place requiring them to document substantive 

interviews, and as a result, no clear, contemporaneous record of this and other 

critical discussions was made. The review also found that OICIE did not have 

formal policies and procedures requiring the preparation of closing memoranda 

for examinations. 

The FTI Engagement Team found that OCIE did not form appropriate 

examination teams to conduct the examinations. The review found that one of 

the examinations lacked a Branch Chief and both teams lacked staff with the 

expertise necessary to effectively identify signs of fraud. The FTI Engagement 

Team concluded that the failure to form appropriate examination teams with 

sufficient expertise must be remedied in order for OCIE to uncover fraud in future 

cause examinations. 

The FTI Engagement Team found that OCIE failed to contact Madoff’s clients to 

corroborate his representations in the examinations even though several of these 

clients were SEC-registered investment funds who were subject to SEC books 

and records requirements. The review found that SEC examiners failed to 

follow-up on numerous contradictions discovered during the examinations and 

many discrepancies were left unresolved. 

The FTI Engagement Team found that OCIE failed to understand how BMIS 

executed, cleared and settled his purported trades, and these failures contributed 

to their inability to uncover Madoff’s Ponzi scheme. The review found that SEC 

examiners did not acquire and analyze trading data from an independent source 

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to verify the trading volume Madoff represented in client account statements, and 

had such an analysis been conducted, they would have likely discovered 

Madoff’s fictitious trades. The FTI Engagement Team replicated several aspects 

of the cause examinations of Madoff, and demonstrated how obtaining the 

pertinent information would have uncovered the fraud. 

The FTI Engagement Team also found that the examinations were improperly 

closed without resolving numerous issues, that one examination team actually 

believed they might be subjected to legal liability if they contacted Madoff’s 

feeder funds, and that the Madoff examination teams failed entirely to investigate 

the allegations in two complaints about the lack of independence of Madoff’s 

auditor. 

Summary of Recommendations. This report presents 37 specific and concrete 

recommendations designed to improve nearly every aspect of OCIE’s operations. 

Many of these recommendations are summarized as follows: The FTI 

Engagement Team recommends that examiners be provided access to industry 

publications and databases, and protocols be established for analyzing 

information from these outside sources. The report recommends that OCIE 

establish a specific protocol that explains how to identify red flags and potential 

violations of securities laws based on the information gleaned from these 

sources. 

The report further recommends the implementation of a collection system for 

capturing information in tips and complaints, a requirement that OCIE annually 

review and test the effectiveness of the new system, and that procedures be put 

in place to ensure that all OCIE-related tips and complaints are vetted within 30 

days of receipt and examinations commence within 60 days of receipt. 

The report prescribes specific procedures regarding scope and planning 

memoranda for cause examinations, including a requirement of concurring 

review by an unaffiliated senior-level official. The FTI Engagement Team also 

recommends that OCIE examiners be required to document all substantive 

interviews, prepare detailed workpapers, and log all examinations into a tracking 

system. There are also a number of concrete recommendations regarding the 

selection of the examination team. 

The report recommends the development of a formal plan to ensure that within a 

three-year period, 50% of OCIE staff become qualified by means of an industry 

certification to conduct thorough and comprehensive examinations. The report 

also recommends the development of interactive exercises prior to hiring new 

OCIE examiners to evaluate the relevant skills necessary to perform 

examinations. Moreover, the report makes recommendations for training of 

OCIE examiners in the mechanics of securities settlements, and in regulations of 

foreign and domestic exchanges. 

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The report also recommends that it be mandatory for the OCIE staff to verify a 

sample of transactions with an independent third party and that the staff be given 

direct access to databases maintained by self-regulatory organizations (“SROs”) 

to allow them to perform verifications of registrant information. 

The report further recommends requirements for all cause examinations to be 

tracked consistently and appropriately and for examinations to be concluded with 

a closing report. Finally, the report recommends that OCIE management make 

clear that it will support OCIE examiners in their pursuit of evidence in the course 

of an examination. 

We believe that implementation of all 37 recommendations contained in this 

report will significantly improve OCIE’s operations and its ability to uncover fraud 

in the future. 

A detailed list of our recommendations can be found in Appendix IV. 

OCIE concurred with all 37 of the report’s recommendations. Management’s 

responses to the report are included in its entirety in Appendix IV. The OIG’s 

response to Management’s comments is included in Appendix V. 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468

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TABLE OF CONTENTS 

Executive Summary...................................................................................................... ii 

Table of Contents ........................................................................................................ vi 

Background ..................................................................................................................1 

Objectives .....................................................................................................................2 

Findings and Recommendations...................................................................................3 

Finding1: OCIE Did Not Properly Evaluate in a Timely Manner Red Flags 

Provided in News Articles From 2001 That Raised Red Flags About 

Madoff...........................................................................................................3 

Recommendations 1.....................................................................4 

Recommendations 2.....................................................................4 

Recommendations 3.....................................................................5 

Finding 2: OCIE Did Not Properly Evaluate a Credible Complaint From an 

Industry Source During 2003 That Raised Red Flags About Madoff ............5 

Finding 3: NERO Did Not Properly Evaluate a Credible Complaint From 

An Industry Source During 2005 That Raised Red Flags About Madoff .......6 

Recommendation 4.......................................................................8 

Recommendation 5.......................................................................9 

Recommendation 6.......................................................................9 

Recommendation 7.......................................................................9 

Recommendation 8.......................................................................9 

Finding 4: NERO Did Not Prepare a Planning Memorandum For the 2005 

NERO Cause Examination of Madoff .........................................................10 

Finding 5: The OCIE Planning Memorandum Was Inadequate in its 

Scope and Execution..................................................................................10 

Recommendation 9.....................................................................12 

Recommendation 10...................................................................12 

Recommendation 11...................................................................13 

Recommendation 12...................................................................13 

Recommendation 13...................................................................13 

Finding 6: The Communication and Information Sharing Among OCIE 

Personnel Were Inadequate .......................................................................13 

Recommendation 14...................................................................15 

Recommendation 15...................................................................15 

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Recommendation 16...................................................................15 

Recommendation 17...................................................................16 

Finding 7: OCIE and NERO Did Not Form Appropriate Examination 

Teams Necessary to Conduct the Examinations ........................................16 

Recommendation 18...................................................................18 

Recommendation 19...................................................................18 

Recommendation 20...................................................................18 

Recommendation 21...................................................................18 

Recommendation 22...................................................................19 

Finding 8: The Examiners Did Not Contact Madoff’s Clients to Determine 

Whether He Provided Investment Advice ...................................................19 

Recommendation 23...................................................................20 

Finding 9: The NERO Examiners Did Not Follow-Up on Numerous 

Contradictions Discovered During the 2005 NERO Cause Examination ....21 

Recommendation 24...................................................................22 

Finding 10: The Examiners Did Not Understand How BMIS Executed, 

Cleared and Settled Trades ........................................................................22 

Recommendation 25...................................................................23 

Recommendation 26...................................................................23 

Recommendation 27...................................................................24 

Finding 11: Neither the OCIE Nor the NERO Examination Team 

Attempted to Acquire Trading Data from FINRA/NASD, DTC/NSCC or 

Other Independent Third Parties in Order to Verify the Trading Volume 

Purported by Madoff on Feeder Funds’ Account Statements .....................24 

Finding 12: Had the OCIE or the NERO Examination Team Conducted a 

Trading Volume Analysis Based on Third Parties’ Data, They Would 

Have Uncovered a Significant Red Flag That, With Further Inquiry, 

Would Likely Have Led to Discovery of the Ponzi Scheme or, At the 

Very Least, Madoff’s Fictitious Trades........................................................25 

Recommendation 28...................................................................31 

Recommendation 29...................................................................31 

Recommendation 30...................................................................32 

Finding 13: OCIE Did Not Adequately Track the Progress of its Cause 

Examination of BMIS ..................................................................................32 

Recommendation 31...................................................................33 

Recommendation 32...................................................................33 

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Review and An ysis of OCIE Examinations of Mado al ff Investment Securities, LLC September 29, 2009 

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Finding 14: OCIE Did Not Prepare a Closing Report That Resolved the 

Allegations from the Hedge Fund Manager’s Complaint and Identified 

Any Substantive Open Issues Discovered During the Examination............33 

Recommendation 33...................................................................34 

Finding 15: The NERO Examination Team Closed the Examination 

Despite A Number of Open Issues .............................................................35 

Recommendation 34...................................................................36 

Finding 16: The NERO Examination Team Believed They Might Be 

Subjected To Legal Liability If They Contacted The Feeder Funds ............36 

Recommendation 35...................................................................36 

Recommendation 36...................................................................37 

Finding 17: The Examinations Did Not Adequately Look Into the 

Allegations of the Auditor’s Lack of Independence or Refer Such 

Allegations To the Appropriate Agency.......................................................37 

Recommendation 37...................................................................38 

Appendices 

Appendix I: Acronyms. ................................................................................39 

Appendix II: Scope and Methodology ..........................................................41 

Appendix: III List of Recommendations.........................................................42 

Appendix IV: Management Comments..........................................................51 

Appendix V: OIG Response to Management’s Comments...........................64 

Appendix VI: A Detailed Trading Volume Analysis........................................66 

Tables 

Table 1: Selected Stocks from Kingate’s Account Statements, 

 March 10 – March 15, 2005 ........................................................................69 

Table 2: Kingate’s Volume Compared to BMIS’ Officially Cleared 

 and Settled Volume, March 10 – March 15, 2005.......................................71 

Table 3: Feeder Fund’s Equity Positions Compared to BMIS’ DTC 

 Positions, Selected S&P 100 Stocks – January 26, 2005...........................72 

Table 4: Kingate Funds Advised by Madoff – Selected Stocks, 

 March 10 – March 15, 2005 ........................................................................74 

Table 5: Madoff’s Trading Volume from OATS, Six Stocks: Microsoft, 

 Intel, Dell, Oracle, Amgen and Cisco, March 10 – March 15, 2005 ...........76 
Background and Objectives 

Background

On December 11, 2008, the Securities and Exchange Commission (“SEC” or 

“Commission”) charged Bernard L. Madoff (“Madoff”) and his investment firm, 

Bernard L. Madoff Investment Securities LLC (“BMIS”), with securities fraud for a 

multi-billion dollar Ponzi scheme that he perpetrated on advisory clients of his 

firm. The complaint charged the defendants with violations of the anti-fraud 

provisions of the Securities Act of 1933, the Securities Exchange Act of 1934 and 

the Investment Advisers Act of 1940. In addition, the U.S. Attorney’s Office in the 

Southern District of New York also indicted Madoff for criminal offenses on the 

same date. On March 12, 2009, Madoff plead guilty to all charges and on June 

29, 2009, federal District Judge Denny Chin sentenced Madoff to serve 150 

years in prison, which was the maximum sentence allowed. 

By mid-December 2008, the Commission learned that credible and specific 

allegations regarding Madoff’s financial wrongdoing, going back to at least 1999, 

were repeatedly brought to the attention of SEC staff, but were never 

recommended to the Commission for action. As a result, former Chairman Cox 

requested that the SEC's Office of Inspector General (“OIG”) conduct a full and 

immediate investigation of the past allegations regarding Madoff and his firm and 

the reasons they were not found credible. 

On June 25, 2009, FTI Consulting, Inc. (“FTI”) was retained1

 by the OIG to 

conduct a review to assess the adequacy of the SEC’s Office of Compliance 

Inspections and Examinations’ (“OCIE”) conduct, primarily with regard to two 

examinations. The first was the Washington, D.C. OCIE cause examination that 

was triggered by a submission from a hedge fund manager (hereinafter referred 

to as the “Hedge Fund Manager’s Complaint”) about Madoff and was conducted 

principally in 2004 (hereinafter, referred to as the “2004 OCIE Cause 

Examination”). The second was the examination conducted by the SEC’s 

Northeast Regional Office (“NERO”) as a result of internal emails they uncovered 

in connection with a routine examination of an SEC-registered firm, detailing 

concerns about Madoff’s operations, which was conducted mostly in 2005 

(hereinafter, referred to as the “2005 NERO Cause Examination”).2

 

 

1

 FTI had been previously retained by the SEC OIG in February 2009 to assist with the OIG’s 

investigation of OCIE’s examinations of Madoff and thus had the opportunity to review the 

documents and testimony in connection with the SEC examinations of BMIS and Madoff. 

Members of the FTI Engagement Team provided expert analysis to the OIG in the preparation of 

its Report of Investigation. 

2

 As discussed in the OIG Report of Investigation No. 509, OCIE also conducted the following 

examinations of BMIS since 1992: 1992 cause examination; 1994 special purpose examination; 

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For this engagement, OIG requested a team of FTI professionals from various 

disciplines, who are referred to, collectively, as the FTI Engagement Team. (The 

individual members of the FTI Engagement team are identified and biographies 

provided on pages 5 – 6 of the OIG’s Report of Investigation dated August 31, 

2009). The FTI Engagement Team reviewed the OIG’s Report of Investigation 

dated August 31, 2009 and also analyzed a number of other relevant sources in 

order to identify areas of improvement to OCIE’s examination program including, 

but not limited to, the following: GAO Report to Congress dated August 2007 

(“Steps Being Taken to Make Examination Program More Risk-Based and 

Transparent”); U.S. Chamber of Commerce Report dated February 2009 

(“Examining the Efficiency and Effectiveness of the U.S. Securities and 

Exchange Commission”); and recent submissions from Lori Richards, former 

Director of OCIE, and John Walsh, Chief Counsel and acting Director of OCIE, to 

David Kotz. As a result, some of the FTI Engagement Team’s recommendations 

may include a broader application than the 2004 OCIE Cause Examination and 

the 2005 NERO Cause Examination; however, such recommendations remain 

relevant to the goal of improving OCIE’s examination program. 

Objectives 

The OIG conducted a comprehensive investigation of the OCIE examinations of 

Madoff and BMIS that were triggered by credible and detailed complaints 

concerning Madoff’s operations. The OIG issued a 457-page Report of 

Investigation on August 31, 2009 entitled, “Investigation of Failure of the SEC to 

Uncover Bernard Madoff’s Ponzi Scheme.” 

In light of these investigative findings, the OIG retained the services of the FTI 

Engagement Team as experts in the areas of forensic accounting and regulatory 

examinations to examine and analyze the OCIE workpapers and reports in 

connection with the OCIE examinations of Madoff and BMIS and review OCIE 

modules, policies, procedures and guidance associated with the conduct of its 

examinations. The FTI Engagement Team was also tasked with providing 

specific and concrete recommendations designed to improve the operations of 

OCIE based upon its findings in the review. 

1995 oversight examination; 1998 inspection of third-market firms; 1999 special purpose 

examination; and the 2003 QQQ examination, and the FTI Engagement Team reviewed 

documents and information concerning those examinations as well. 
Findings and Recommendations 

Finding 1: OCIE Did Not Properly Evaluate in 

a Timely Manner Red Flags Provided in News 

Articles From 2001 That Raised Red Flags 

About Madoff 

Two articles published in 2001, one from Barron’s entitled 

“Don’t Ask, Don’t Tell: Bernie Madoff is so secretive, he even 

asks his investors to keep mum” and another from 

MAR/Hedge entitled “Madoff tops charts; skeptics ask how,” 

raised red flags concerning Madoff’s returns and trading 

strategy but were not adequately evaluated by OCIE. OCIE 

had no formal policy with regard to how it vetted news 

articles and other industry sources. Moreover, OCIE did not 

open the 2004 OCIE Cause Examination of BMIS until it 

received other tips and/or complaints two years later. 

The objective of a cause examination is to investigate a potential violation of 

securities laws. Potential violations come to the attention of OCIE through three 

principal means: 

1. Routine examinations – While conducting a routine examination for one 

broker-dealer (“BD”) or registered investment adviser (“IA”), an examiner 

may come across information that points to a potential violation at another 

BD or IA firm. 

2. News reports and articles – A journalist may have sources that are 

sufficiently well-informed, allowing for publication of potential securities 

law violations at specific firms. 

3. Outside Tips or Complaints – Complaints from investors, whistleblowers or 

market participants may come to the attention of OCIE through any of the 

SEC’s divisions or offices. 

Regardless of the source, the information relating to a potential violation (referred 

to generically as a “complaint,” or “tip”) must be properly vetted to determine if 

the information is sufficiently specific to establish the nature of the potential 

violation and whether the potential violation is severe enough to merit a cause 

examination. The MAR/Hedge and Barron’s articles quoted industry sources and 

discussed a number of issues, including Madoff’s highly unusual market-timing; 

his unusually consistent, non-volatile returns; and his ability to buy and sell 

securities without affecting the market. In our opinion, there was sufficient detail 

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in these articles to warrant additional scrutiny due to the red flags raised.3 

However, there is no evidence that OCIE personnel evaluated the merits of the 

issues raised until receiving additional complaints several years later. 

In order for articles and other industry sources to be properly vetted, examiners 

need access to these sources and also need to understand how to analyze the 

information contained in them. The FTI Engagement Team understands that 

OCIE’s Office of Risk Assessment currently monitors industry trends and 

developments, in part, by reviewing industry reports and news articles. OCIE 

staff also has access to news aggregator products (i.e., Factiva, Dow Jones 

Interactive), industry specific news services (Ignites, FundFire, etc.) and 

subscription services such Thomson Research, Bloomberg, Lexis and Westlaw. 

Notwithstanding the access, however, we found that OCIE did not conduct 

sufficient review and follow-up of the two articles raising concerns about Madoff’s 

operations. 

Recommendation 1: 

The Office of Compliance Inspections and Examinations (“OCIE”) should provide 

all examiners access to relevant industry publications (i.e., MAR/Hedge-type 

publications) and third-party database subscriptions sufficient to develop 

examination leads and stay current with industry trends. OCIE should regularly 

(i.e., quarterly) assess whether they have adequate access to relevant industry 

publications and other such sources (newsletters, independent subscription-type 

news alerts, etc.) and make reasonable attempts to gain such access. 

Recommendation 2: 

The Office of Compliance Inspections and Examinations should establish a 

protocol for searching and screening news articles and information from relevant 

industry sources that may indicate securities law violations at broker-dealers and 

investment-advisers. The protocol should include flexible searching capability to 

help identify specific areas of risk or concern and should include access to all 

relevant industry publications. The protocol should also include adequate 

screening criteria to eliminate unnecessary results and/or to more narrowly 

define a search in order to generate sufficient results. The screening criteria and 

any changes should be documented and the protocol should be re-assessed 

regularly (i.e., quarterly) in order to determine if any modifications are 

appropriate. 

3 As the OIG’s Report of Investigation dated August 31, 2009 discusses in detail, there is 

evidence that former Director of OCIE Lori Richards believed that the Barron’s article itself was a 

sufficient basis for an OCIE examination simply based upon her review of the article. 
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Recommendation 3: 

The Office of Compliance Inspections and Examinations (“OCIE”) should 

establish a protocol that explains how to identify red flags and potential violations 

of securities law based on an evaluation of information found in news reports and 

relevant industry sources. The protocol should also determine how decisions on 

whether to initiate cause examinations are made and by whom, set a reasonable 

time frame for evaluation (i.e., 90 days) of the search results and provide 

notification to OCIE management when such time has expired. 

Finding 2: OCIE Did Not Properly Evaluate a 

Credible Complaint From an Industry Source 

During 2003 That Raised Red Flags About 

Madoff 

A detailed complaint from a highly credible hedge fund 

manager employed at a SEC-registered fund of hedge funds 

was provided to OCIE during May 2003 (the “Hedge Fund 

Manager’s Complaint”). Although the 2004 OCIE cause 

examination was eventually opened to address alleged frontrunning activity at Madoff, the cause examination was not 

opened until six months after the complaint was received 

and did not address several significant issues and red flags 

raised in the tip. 

The Hedge Fund Manager’s Complaint was based on due diligence 

investigations it conducted into BMIS during 1998 and 2003. OCIE was familiar 

with the firm that provided the complaint and had recently conducted an 

examination of the firm. Testimony by OCIE personnel adjudged the hedge fund 

manager that provided the complaint to be a highly credible source of information 

and described his firm as very experienced and technically savvy. 

Given the credibility of the 2003 Hedge Fund Manager’s Complaint, the delay of 

over six months that occurred from the time the complaint was received until the 

start of the cause examination was an unreasonably long period of time due to 

the inherent nature of cause examinations. Cause examinations should be 

initiated as soon as possible based on their urgency and importance. Delays in 

starting a cause examination may prolong the effects of any illegal conduct, 

which may increase the potential harm to investors and capital markets. Despite 

this, the cause examination was not opened until another tip alleging front-
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running came to OCIE from the Division of Enforcement during December 2003 

(the “Enforcement Tip”).4

 

In addition, OCIE had no formal policies and procedures for handling tips and 

complaints. Such policies and procedures would have provided personnel with 

discrete guidelines to assist with the analysis and management of processing tips 

and complaints. Such a system would allow for appropriate personnel to monitor 

the status of the tips and complaints and could also alert personnel when 

additional action was needed. 

With regard to information from the hedge fund employee, OCIE did not monitor 

the status of the Hedge Fund Manager’s Complaint and it does not appear that 

anyone within OCIE management took ownership or responsibility for timely 

resolution of the tip. As a result, the Hedge Fund Manager’s Complaint was left 

inactive for months because there was no system to alert or remind staff that 

further action needed to be taken. 

Once the 2004 OCIE Cause Examination was opened, it did not address several 

significant issues and red flags raised in the Hedge Fund Manager’s Complaint 

but instead looked at the front running allegations in the Enforcement Tip. In 

mid-December 2003, OCIE prepared a Planning Memorandum that described 

the limited scope of its cause examination, which was primarily focused on frontrunning. Specific allegations and concerns were raised in the Hedge Fund 

Manager’s Complaint were not addressed in the Planning Memorandum.5

During January 2004, at least one OCIE manager contacted the hedge fund 

manager’s firm to discuss issues contained in the Hedge Fund Manager’s 

Complaint. OCIE did not have policies and procedures for documenting such 

conversations with registrants (see Finding 4), and as a result, the identity of all 

4 The pretext for the Enforcement Tip was likely that Madoff was using customer trading 

information from his market-making operations (another, presumably legitimate, part of BMIS) to 

front-run trades for his investment advisory clients and that front running would explain the 

consistent returns he reported to his investment advisory clients. Front running is an illegal 

attempt by a broker to insert one trade for the broker’s benefit in front of a large trade order 

received from the broker’s customer. The front-running broker hopes to profit from his knowledge 

that a large order is about to enter the market by taking a position in the stock before the large 

trade arrives. The front-runner’s trade, though, is usually much smaller than the customer order 

so as not to move stock prices until the larger order is being executed. After the larger order 

executes, the front-runner will likely liquidate its position immediately. 5

 Such issues and concerns included Madoff’s fee structure; whether or not there was enough 

market volume to support $8-10 billion of alleged trading by Madoff; whether or not the returns 

should have had a noticeable correlation to the overall equity markets; why the accounts held 

only cash at the end of the month; lack of a third-party broker; reports that the auditor was a 

related party; lack of independent custodian; and generally, whether or not the purported returns 

were feasible given the nature of the investment strategy and the large amount of assets 

purported to be under management. The complaint did not explicitly mention front-running as an 

issue. 
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participants and a clear, contemporaneous record of all substantive discussions 

during the call were not documented. Moreover, examination team members 

who did not participate in the call may not have been provided important 

information or details that could have been helpful during the examination. In 

addition, members of the examination staff indicated that they had not seen the 

Hedge Fund Manager’s Complaint or all of its supporting documentation. Due to 

the nature of the specific allegations, the cause examination team members were 

not provided critical information needed to adequately conduct the 2004 OCIE 

Cause Examination (see Finding 5). 

Finding 3: NERO Did Not Properly Evaluate a 

Credible Complaint From an Industry Source 

During 2005 That Raised Red Flags About 

Madoff 

A detailed analysis presented in a series of emails from a 

registered investment adviser came to the attention of NERO 

during 2004 (the “2004 Complaint”), which resulted in the 

NERO 2005 Cause Examination of front-running and cherrypicking activity at BMIS. The analysis performed by an 

employee at the investment adviser concluded that Madoff 

must have been misrepresenting his trading. However, the 

cause examination was not opened until eight months after 

the 2004 Complaint was received and it did not address 

several significant issues and red flags raised in the 

complaint. 

Similar issues raised in the Hedge Fund Manager’s Complaint preceding the 

2004 OCIE Cause Examination came to light with regard to the 2004 Complaint 

discovered by NERO during a SEC examination of a registered investment 

adviser in 2004. The 2004 Complaint was detailed, viewed as credible by NERO 

management and deemed worthy of a cause examination. The start of the 

examination, though, was delayed considerably in order to assign a particular 

NERO examiner who presumably had a sophisticated knowledge of options 

trading. However, no attempts were made by NERO to request such expertise 

from other offices or divisions of the SEC in order to begin the examination 

sooner. 

In addition, NERO examination staff never contacted the investment adviser that 

was the source of the 2004 Complaint in order to clarify or glean additional 

insight regarding the issues raised in the complaint. The 2004 Complaint raised 

a number of issues and concerns with regard to BMIS and its order routing for 
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trades, consistent returns, fee structure, and auditor independence. The 2004 

Complaint also raised additional concerns about Madoff’s representations 

concerning his options trading and his secrecy. Despite the specific concerns 

raised in the 2004 Complaint, NERO conducted only a narrowly focused 

examination of Madoff for front-running and cherry-picking activity.6

 NERO did 

not prepare a planning memorandum addressing the scope of the examination 

and the reasons for such a limited scope. 

OCIE contends that limited resources may affect examination activity. In the 

letter dated July 1, 2009 from OCIE to the OIG, Lori Richards explained that 

there are inherent limitations with regard to matters that can be worked on by 

examiners: “Given the large number of firms subject to examination oversight by 

the SEC and the relatively small number of SEC staff examiners, the SEC does 

not conduct comprehensive examinations, and it does not examine all firms that 

are registered with SEC. Examiners generally work on a number of examination 

matters simultaneously, and seek to prioritize the highest-risk firms and issues 

that most warrant examination.” OCIE claims staffing limitations may continue to 

have a significant impact on OCIE’s ability to conduct examinations in the future. 

It is the FTI Engagement Team’s understanding that the SEC has recently taken 

steps to improve its ability to handle tips and complaints. In February 2009, the 

SEC retained the Center for Enterprise Modernization to begin work on a 

comprehensive review of internal procedures to evaluate tips, complaints, and 

referrals. The FTI Engagement Team has learned that the project is intended to 

be significant in scope and has not yet been completed. On August 5, 2009, 

Robert Khuzami, Director of the Division of Enforcement, announced the creation 

of an Office of Market Intelligence. The Office of Market Intelligence will be 

responsible for the collection, analysis, risk-weighing, triage, referral and 

monitoring of the hundreds of thousands of tips, complaints and referrals that the 

Commission receives each year. 

While the SEC has begun the process of developing policies and procedures to 

improve the manner in which they evaluate tips and complaints, these 

procedures, when finalized, need to be tested to ensure that they operate 

effectively. 

Recommendation 4: 

In accordance with the findings of the Center for Enterprise Modernization project 

and prior to its completion, the Office of Compliance Inspections and 

Examinations (“OCIE”) should implement an OCIE-related collection system that 

adequately captures information relating to the nature and source of each tip or 

6

 Cherry-picking is the illegal practice of improperly allocating losing (or less profitable) trades to 

one account with winning trades allocated to another. 
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Report No. 468 

Page 9

complaint and also chronicles the vetting process to document why each tip or 

complaint was or was not acted upon and who made that determination. All 

OCIE examiners should be given access to the system in order to be able to 

timely view and monitor tips and complaints that may be relevant to examinations 

they are preparing to conduct or are actively conducting. In addition, OCIE 

examiners should be given adequate access to tips and complaints received by 

the newly-created Office of Market Intelligence and other relevant sources such 

as the Office of Investor Education and Advocacy. 

Recommendation 5: 

The Office of Compliance Inspections and Examinations (“OCIE”) should 

annually review and test the effectiveness of its policies and procedures with 

regard to its tip and complaint collection system. OCIE should also modify these 

policies and procedures, where needed. 

Recommendation 6: 

Tips and complaints reviewed by the Office of Compliance Inspections and 

Examinations that appear on the surface to be credible and compelling 

should be probed further by in-depth interviews with the sources to assess 

their validity and to determine if there are other issues that need to be 

investigated. Any apparent contradictions in tip or complaint information 

need to be resolved as early as possible in the examination process through 

interviews with appropriate sources or further independent research. 

Findings from such interviews should be adequately documented and should 

be required reading for examination team members. 

Recommendation 7: 

All Office of Compliance Inspections and Examinations (“OCIE”) related tips 

and/or complaints that are not vetted within 30 days of receipt should be brought 

to the attention of the OCIE Director with an explanation for the delay. All OCIErelated tips and/or complaints that merit a cause examination for which that 

examination does not begin within 60 days of receipt (a “Post-60 Day 

Examination”) must be reported to the OCIE Director with a monthly tally of yetto-be-opened Post-60 Day Examinations sent to the Securities and Exchange 

Commission Chairman. 

Recommendation 8: 

All potentially relevant information received by the Office of Compliance 

Inspections and Examinations from a tip or complaint source should be 

preserved as a complete unit and should be augmented with relevant information 
Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 10

that may have been provided in subsequent submissions by that source. Once 

an examination has been initiated, such information should be required reading 

for examination team members. 

Finding 4: NERO Did Not Prepare a Planning 

Memorandum For the 2005 NERO Cause 

Examination of Madoff

NERO Did Not Prepare a Planning Memorandum For the 

2005 NERO Cause Examination of Madoff. At the time, 

NERO had no policies and procedures that required the use 

of a Planning Memorandum. 

The 2004 Complaint that triggered the 2005 NERO Cause Examination included 

highly detailed e-mails discussing a number of issues and concerns with regard 

to BMIS and its order routing for trades, consistent returns, fee structure, and 

auditor independence. The 2004 Complaint also raised additional concerns 

about Madoff’s representations concerning his options trading and his secrecy. 

The examination staff had copies of the MAR/Hedge and Barron’s articles, both 

of which raised similar issues. However, these issues were not included in the 

apparent scope of the 2005 NERO Cause Examination. At the time, there were 

no formal policies in OCIE or NERO that required the preparation of a Planning 

Memorandum. As a result, a Planning Memorandum was never drafted by 

NERO that explained the focus or explicitly described the scope of its cause 

examination. 

Apparently, the issues raised in the 2004 Complaint were never fully vetted by 

the examination team and its supervisors. One NERO examiner testified that 

although they may have reviewed e-mails contained in the complaint, they were 

never discussed with their supervisors. Another examiner testified that he may 

have reviewed “snippets” of the emails contained in the 2004 Complaint, but 

really used the Barron’s article and the MAR/Hedge article as a starting point 

rather than the e-mails. Had the scope of the examination been adequately 

analyzed and documented, it likely would have resulted in a cause examination 

more closely focused on the issues raised in the 2004 Complaint. 

Finding 5: The OCIE Planning Memorandum 

Was Inadequate in its Scope and Execution 

The OCIE Planning Memorandum in connection with the 

2004 OCIE Cause Examination of BMIS was inadequate in 
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Report No. 468 

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its scope because it did not reflect an appropriate analysis of 

the Hedge Fund Manager’s Complaint that was received by 

OCIE. The execution of the OCIE Planning Memorandum 

was also inadequate because the OCIE examination team 

did not achieve the basic objectives of the memorandum. 

The basis for the determination of the focus of the 2004 OCIE Cause 

Examination lacked an appropriate analysis of the Hedge Fund Manager’s 

Complaint. OCIE management indicated that the Market Oversight/SRO group 

decided to focus on front-running during the cause examination because that 

was the group’s area of expertise. The decision to focus entirely on front-running 

was an improper one as the Hedge Fund Manager’s Complaint clearly identified 

other critical issues unrelated to front-running. The Planning Memorandum that 

was prepared by OCIE was evidence of this overly narrow focus. A review and 

comparison of the Hedge Fund Manager’s Complaint to the Planning 

Memorandum should have raised questions as to why such significant 

allegations were not included. In particular, management from OCIE’s IA group 

likely would have recognized issues that were not related to front-running that 

should have been considered during the cause examination, had they been given 

an opportunity to review the Planning Memorandum. 

Subsequent to the preparation of the Planning Memorandum, at least one OCIE 

manager had a phone conversation with the individual that provided the Hedge 

Fund Manager’s Complaint. The OCIE manager’s notes of that conversation 

indicate that during the call they discussed several of the concerns relating to 

BMIS raised in the tip (that were unrelated to front-running), including consistent 

returns, volume of options trading, whether the strategy is actually executed, and 

the operating structure of BMIS. Yet, no subsequent revision was made to the 

Planning Memorandum to address those concerns. 

The execution of the narrowly-focused Planning Memorandum was flawed 

because it included a request to NASD for trading data, but that request was 

never sent. Data provided by NASD would have allowed OCIE to examine 

whether or not BMIS was indeed front running its broker-dealer customers. 

Trading data from NASD, for instance, would have provided (presumed) 

execution times of trades for BMIS discretionary brokerage accounts, which 

would be needed to compare to the time of each customer order to determine if 

Madoff ran trades for his discretionary accounts in front of trades received from 

customers of the BMIS market making operations. In addition, if the Planning 

Memorandum had properly provided for investigation of the Hedge Fund 

Manager’s Complaint, the letter to NASD was critical to the review of the tip’s 

trading allegations because the data and information from NASD would have 

assisted in independently verifying trading activity conducted at BMIS (See 

Finding 9). 
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The FTI Engagement Team understands that scope memoranda are now 

regularly used throughout OCIE for routine and oversight examinations. An 

OCIE memorandum to all regional offices dated November 25, 2008 announced 

the implementation of a “...standard examination scope memorandum to be used 

by the broker-dealer, investment adviser/company, and transfer agent 

examination staff when conducting routine or oversight examinations.” The 

memorandum further states, “[u]nder this new guidance, a brief scope 

memorandum (i.e., typically no more than 2-4 pages) should be prepared for 

broker-dealer examinations, routine investment adviser and investment company 

examinations, and transfer agent examinations.” The procedures require 

documentation that management approved the selection and scope of each 

examination. The procedures also allow for a modification of the scope as new 

information is obtained during the examination and any significant modifications 

to the scope should be reflected in the examination report. 

While scope memoranda are now presumably being utilized in a more formalized 

manner, these memoranda must be carefully prepared and executed correctly in 

order to eliminate errors that we found in the 2004 OCIE Cause Examination and 

2005 NERO Cause Examination of BMIS. 

Recommendation 9: 

The Office of Compliance Inspections and Examinations (“OCIE”) should 

augment its policies and procedures related to the use of scope memoranda to 

better reflect particular consideration given to information collected as the result 

of tips and complaints that lead to cause examinations. When all potentially 

relevant tip and complaint source data, background information and research 

have been collected into one complete unit (see Recommendation 8), 

examination staff should identify all relevant potential securities law violations 

and other concerns and then prepare a planning memorandum that ties each and 

every potential violation and issue into the scoping discussion in the 

memorandum. The Planning Memorandum should include the basic steps that 

need to be taken in order to address the issues identified in the scope 

discussion. The Planning Memorandum should be reviewed, approved and 

signed (or initialed) by senior OCIE management (i.e., assistant director level or 

higher) and should include the names of the individuals who prepared and 

reviewed the document. 

Recommendation 10: 

The Office of Compliance Inspections and Examinations (“OCIE”) should timely 

modify or append the scope memorandum when significant new facts and issues 

emerge. The modified or supplemental scoping memorandum should be 

reviewed, approved and signed (or initialed) by senior OCIE management (i.e., 
Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 13

assistant director level or higher) and should include the names of the individuals 

who prepared and reviewed the document. 

Recommendation 11: 

After examination scoping provisions have been approved, along with all other 

elements of the Planning Memorandum, the Planning Memorandum should be 

subjected to concurring review by an unaffiliated OCIE associate or assistant 

director (“Concurring Director Review”), and the person performing the 

Concurring Director Review should also recommend additional concurring 

reviews from the Commission’s Office of Economic Analysis, Office of Chief 

Accountant or other offices or divisions of the Commission as needed. All 

concurring reviewers should sign off on the Planning Memorandum indicating 

their approval and add any comments on the proposed scope or other areas 

discussed in the memorandum. 

Recommendation 12: 

After the Planning Memorandum is first drafted, it should be circulated to all 

examination team members, and all team members should then meet, in person 

or electronically, to discuss the examination approach and methodology set out 

in the memorandum, as well as any other issues the team members wish to 

raise. 

Recommendation 13: 

The examination team leader should ensure that all steps of the examination 

methodology, as stated in the Planning Memorandum, are completed and either 

the team leader or the appropriate team member should sign off on each step as 

it is completed. 

Finding 6: The Communication and Information 

Sharing Among OCIE Personnel Were Inadequate 

The pre-examination preparation that was conducted for the 

2004 OCIE and 2005 NERO Cause Examinations was 

inadequate. The Super Tracking and Reporting System 

(“STARS”) was not properly used to log the initiation of the 

cause examinations. OCIE did not provide a closing 

memorandum or status report on the 2004 OCIE Cause 

Examination when it provided its examination workpapers to 

NERO. 
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Report No. 468 

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OCIE senior personnel held an initial conversation with Madoff concerning its 

upcoming 2004 OCIE Cause Examination. At the time of the examination, 

however, OCIE did not have policies and procedures requiring documentation of 

substantive interviews and pre-examination calls conducted by OCIE of 

registrants. As a result, the identity of all participants and a clear, 

contemporaneous record of all substantive discussions during the call were not 

documented. 

The 2004 OCIE Cause Examination team also did not enter its examination into 

STARS. Market Oversight staff and management at that time regularly did not 

log new examinations into STARS. As a result, other OCIE staff members, 

including personnel in the regional offices, were unaware of OCIE’s ongoing 

cause examination of BMIS. In fact, the 2005 NERO Cause Examination team 

learned of OCIE’s examination directly from Madoff during May 2005 and 

contacted OCIE, which until then, was unaware of the ongoing NERO 

examination of BMIS. The failure of one office to realize a duplicative 

examination was being conducted by another office resulted in embarrassment 

and a waste of Commission resources. 

Once the two teams became aware of their common objective, the exchange of 

documents and information was inadequate. The 2004 OCIE Cause 

Examination team sent their examination papers to NERO on June 9, 2005. The 

2005 NERO Cause Examination team noted that OCIE never documented their 

findings and did not provide a status report or closing memorandum that would 

identify any conclusions and open issues (See Finding 11). At the time, OCIE 

did not have formal policies and procedures that required closing memoranda for 

examinations. 

Presumably, OCIE now has new procedures for the use of STARS. An OCIE 

document titled, “Office of Market Oversight’s Document Policies and 

Procedures,” dated November 27, 2007, indicates that only non-SRO7

examinations (broker-dealers, investment advisers, investment companies and 

transfer agents) should be entered into STARS. However, on June 5, 2009, 

OCIE indicated to the OIG that it intends to ensure that SRO inspections will be 

included as well. 

As to documentation of findings, OCIE’s Examination Program Manual for 

Organization of Examination Workpapers dated July 8, 2008 now provides 

guidance with regard to a number of issues confronted by the examiners. For 

instance, the manual indicates that examiners should prepare and retain 

summaries of significant discussions with the registrant’s personnel or outside 

parties and the examiner should note any significant unresolved issues in the 

workpapers. The Program Manual states that a list of these unresolved issues 

7

 SRO stands for Self-Regulatory Organizations, such as FINRA and U.S. securities exchanges. 
Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

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should be prepared and given to the branch chief or team leader for review and 

disposition prior to closing the examination/inspection, that all discussions 

regarding document production should be documented (including use of a call 

log), and that the examiners should retain notes or emails as to why any 

documents were inexplicably or extraordinarily delayed or could not be produced. 

Documenting interviews of registrants and third-parties during examination 

activities is critical to the conduct of an effective examination. In addition, 

mandating and enforcing vigilant use of an examination tracking system 

(currently the STARS system) is necessary to ensure that SEC examination are 

conducted efficiently and appropriately and information is properly shared 

between offices. 

Recommendation 14: 

Substantive interviews conducted by the Office of Compliance Inspections and 

Examinations (“OCIE”) of registrants and third-parties during OCIE’s preexamination activities and during the course of an active examination should be 

documented with notes circulated to all team members. After each substantive 

interview during the examination, the team leader should re-evaluate the 

examination scope and methodology as set out in the Planning Memorandum to 

determine if the examination needs to be expanded and indicate by initialing the 

interview notes that the team leader has performed that evaluation. 

Recommendation 15:

The workpapers for a given examination should be in sufficient detail to provide a 

clear understanding of its purpose, source, and the conclusions reached. Also, 

the documentation should be appropriately organized to provide a clear link to 

the significant findings or issues.8

Recommendation 16:

When logging all Office of Compliance Inspections and Examinations 

examinations into an examination tracking system, the team leader should verify 

that the appropriate entry is made into the tracking system and, with a notation in 

the Planning Memorandum, indicate that such entry has been made with the 

team leader’s initials. 

8

 This requirement for work paper documentation is taken from the objectives of audit work paper 

documentation for public company audits adopted by the Public Company Accounting Oversight 

Board as expressed on paragraph 4 of Auditing Standard 3: 

Audit documentation should be prepared in sufficient detail to provide a clear 

understanding of its purpose, source, and the conclusions reached. Also, the 

documentation should be appropriately organized to provide a clear link to the 

significant findings or issues. [Footnote omitted.] 
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Report No. 468 

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Recommendation 17:

The Office of Compliance Inspections and Examinations should annually review 

and test the effectiveness of its policies and procedures with regard to 

conducting, documenting and concluding its examinations9

 and modify the 

policies and procedures, where needed. 

Finding 7: OCIE and NERO Did Not Form 

Appropriate Examination Teams Necessary to 

Conduct the Examinations 

OCIE’s SRO group and NERO did not form appropriate 

examination teams necessary to conduct their cause 

examinations of BMIS based on the allegations raised in the 

Hedge Fund Manager’s Complaint and 2004 Complaint, 

which included issues typically examined by investment 

adviser personnel including verification of purported 

investment returns and account balances. Although the 

SRO group and NERO had no significant experience 

conducting examinations related to verification of purported 

investment returns and account balances, the examination 

teams did not include individuals with such expertise. 

OCIE management acknowledged that its investment adviser personnel would 

have known to look specifically at the investment returns and verify custody of 

the assets, yet such personnel were not contacted for such assistance in 

connection with both the 2004 OCIE Cause Examination and 2005 NERO Cause 

Examination of BMIS. 

An appropriately thorough analysis of the Hedge Fund Manager’s Complaint 

and 2004 Complaint leading to the creation of the examination teams should 

have indicated to the individuals selecting the team that a collaboration 

between the BD and IA groups was necessary to fully understand certain 

issues raised, including, but not limited to, the BMIS fee structure, unusually 

consistent returns, purported trading strategy and accounts going to cash 

each month. Collaboration among the groups from BD and IA was critical in 

order to utilize IA’s expertise associated with fee structures, compensation 

9

 Similarly, investment firms are required to develop and implement policies and procedures 

designed to guide their securities activities and detect and prevent violative conduct. Broker 

Dealer policies and procedures must be reviewed for adequacy on an annual basis – see FINRA 

Rule 3130(b). Investment advisers must conduct an annual review of their policies and 

procedures – see Investment Advisers Act of 1940 Rule 206(4)-7(b). 
Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 17

arrangements, performance reporting, performance marketing materials, 

custodial arrangements and cherry-picking. 

Both examination teams lacked a Branch Chief during the examinations. A 

Branch Chief that was initially assigned to the 2004 OCIE Cause 

Examination was promoted to Assistant Director and was never replaced 

with another Branch Chief. During the 2005 NERO Cause Examination, a 

Branch Chief was never assigned. As a result, examiners were left 

unsupervised for significant portions of the onsite examination. There was 

also no clear designation as to who served as team leaders during both 

examinations. 

The examination teams also lacked expertise related to effectively identifying 

signs of fraud. The inconsistent and contradictory explanations of trading 

strategies that Madoff provided to both examination teams and Madoff’s 

suspicious behavior, which included, agitation, secrecy and anger when 

certain documents or information was sought during the 2005 NERO Cause 

Examination, should have been interpreted as indications that he was 

deliberately misleading staff in order to mask illegal activity. Training in 

understanding behavioral communication such as agitation, secrecy and 

anger would appear to be a missing component of the OCIE examiner’s 

repertoire. 

In a letter dated July 1, 2009 to OIG, OCIE indicated that it has made significant 

enhancements to the examination process since the Madoff fraud was revealed 

in December 2008 including, but not limited to: 

• Joint regulatory (SEC, Financial Industry Regulatory Authority (“FINRA”) 

and North American Securities Administrators Association (“NASAA”)) 

training for examiners on strategies to detect and investigate indications of 

fraud of various types, including Ponzi schemes, offering frauds, 

manipulations and other types of fraud. 

• Special OCIE training conducted in March 2009 with regard to strategies 

to identify and investigate Ponzi schemes, affinity frauds and other related 

schemes. 

• Training for more than 300 examination staff to become Certified Fraud 

Examiners. 

• Focused training in particular key areas such as options, derivatives, 

trading, anti-money laundering, financial/net capital issues and issues 

associated with firms that are registered as both broker-dealers and 

investment advisers. 

• Expanding examination activity of joint or dual registrants to assure that 

examiners have “eyes on” all activities, particularly advisers that use an 

affiliated broker-dealer for custody of advisory clients’ assets. 
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Report No. 468 

Page 18

The failure to form appropriate examination teams and the resulting 

inexperienced teams led to an inability to conduct the cause examinations of 

BMIS in an effective manner and must be remedied in order for OCIE to uncover 

fraud in future cause examinations.

Recommendation 18: 

The focus of an examination should drive the selection of the examination team 

and team members should be selected based upon their expertise related to 

such focus. There should also be a clearly defined examination team leader. 

Staffing decisions should be made by senior Office of Compliance Inspections 

and Examinations management (assistant director level or higher) after 

management has performed adequate pre-examination preparation so that 

management can make appropriate choices. The examination team should not 

be selected solely based on availability. 

Recommendation 19:

Senior Office of Compliance Inspections and Examinations (“OCIE”) 

management should ensure that personnel with the appropriate skills and 

expertise are assigned to cause examinations with unique or discrete needs (i.e., 

options expertise). OCIE should regularly seek out the appropriate expertise 

from other offices or divisions within the SEC and encourage intra-agency 

collaboration wherever possible. 

Recommendation 20:

The Office of Compliance Inspections and Examinations should assign a Branch 

Chief, or a similarly designated lead manager, on every substantive project 

including all cause examinations. The Branch Chief or designated lead manager 

must be onsite or in direct communication with the onsite staff daily during the 

onsite portion of the examinations. Lower lever or junior staff examiners must 

not be left unsupervised during substantive discussions with principals or senior 

executives at the registrant during the examination. 

Recommendation 21:

The Office of Compliance Inspections and Examinations (“OCIE”) should develop 

a formal plan with specific goals associated with achieving and maintaining 

professional designations and/or licenses by industry certification programs that 

are relevant to the examination activities conducted by OCIE. For instance, 

within the next three years, 50% of OCIE staff and management associated with 

examination activities should be qualified by means of a certification applicable to 

their profession such as the Association of Certified Fraud Examiners’ Certified 

Fraud Examiner designation, the American Institute of Certified Public 
Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 19

 

Accountants’ Certified in Financial Forensics designation and/or the FINRA 

General Securities Principal license required of investment professionals.10 

These should include an annual continuing education component for each of 

these licenses. 

Recommendation 22:

The Office of Compliance Inspections and Examinations (“OCIE”) should develop 

and implement interactive exercises to be administered by OCIE training staff or 

an independent third party and reviewed prior to hiring new OCIE employees in 

order to evaluate the relevant skills necessary to perform examinations. Similar 

exercises should be annually administered to all active examination staff and 

management in order to identify areas that need further development. 

Finding 8: The Examiners Did Not Contact 

Madoff’s Clients to Determine Whether He 

Provided Investment Advice 

The Examiners did not contact Madoff’s clients to 

corroborate his statement that he did not render investment 

advice. Although names and addresses of Madoff’s clients 

were obtained by examination staff, the examiners never 

contacted any of the clients during their cause examinations. 

During the course of the 2004 OCIE and 2005 NERO Cause Examinations, 

both examination teams considered whether or not BMIS should be 

registered as an investment adviser. One consideration, in particular, was 

whether or not BMIS exercised discretionary authority over the accounts or 

whether the firm acted strictly as an executing broker as Madoff often 

claimed. The written Trading Authorization Directives provided by BMIS 

indicted that Madoff had discretion over trading in the accounts of customers 

for which he implemented the split-strike conversion strategy. One approach 

to verify whether BMIS was exercising discretion and thus serving as an 

investment adviser would be to contact the firm’s clients and ask who 

authorizes trades. 

10 The investment firms that OCIE examines are required to have their professionals qualified by 

exam to perform securities investment activities. OCIE professionals should have a similar 

requirement in order to review and examine those activities. The FINRA General Securities 

license consists of the Series 7 and 24 courses covering the sales of securities and the 

supervision of such sales. The study materials are readily available from several providers. While 

OCIE examiners may not be able to sit for certain exams and obtain certain licenses due to their 

status as government employees, they are still able to obtain and study the course materials. 
Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 20

During the 2004 OCIE Cause Examination, examiners obtained a list of 

clients for which Madoff utilized the split-strike conversion strategy. 

However, the OCIE team did not contact the institutional clients Madoff 

identified, possibly due to concerns about disrupting BMIS’ business. During 

the 2005 NERO Cause Examination, examiners also obtained a list of clients 

for which BMIS utilized the split-strike conversion strategy, but the 

examination team did not contact any of the funds on the list. 

Had the examination team contacted BMIS’ clients, those funds could have 

confirmed that BMIS had full discretion over their accounts as well as the 

implementation of the trading strategy for those accounts. The funds could 

have also provided additional detail with regard to the trading, clearing and 

settlement process and who was involved in that process. Finally, each fund 

contacted could have verified the number of accounts they had with BMIS in 

order to confirm whether Madoff was accurately reporting the number of 

accounts for each fund to examination staff. A number of BMIS’ clients were 

SEC-registered investment advisers, which meant that the SEC had authority 

to request additional information under Section 204 of the Advisers Act. 

We understand that OCIE has procedures in place with regard to contacting 

registered and unregistered entities for information. SEC Form 1661 

“Supplemental Information for Regulated Entities Directed to Supply 

Information Other Than Pursuant to a Commission Subpoena” is supposed 

to accompany a document request sent by OCIE and provide the registrant 

information concerning the possible uses of such information. SEC Form 

1662, “Supplemental Information for Persons Requested to Supply 

Information Voluntarily or Directed to Supply Information Pursuant to a 

Commission Subpoena” is also supposed to be used when contacting a 

person or entity that is not registered with the SEC, such as a registrant's 

client or customer. 

Contacting clients to corroborate statements made by the registrant’s 

representative may be critical to uncovering fraud in a cause examination. 

Recommendation 23:

Subject to approval of the examination team leader, Office of Compliance 

Inspections and Examinations (“OCIE”) examiners should contact clients of a BD 

or IA when necessary to confirm statements made by BD or IA personnel. 

Examiners should be encouraged to verify representations of third parties by 

contacting such parties, and appropriate methods used to contact third parties 

should become a part of OCIE’s training of examiners. 
Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 21

Finding 9: The NERO Examiners Did Not 

Follow-Up on Numerous Contradictions 

Discovered During the 2005 NERO Cause 

Examination

The 2005 NERO Cause Examination team did not 

recognize that Madoff was either lying to the examiners 

and/or the feeder funds were making misrepresentations 

to their clients with regard to how the split-strike 

conversion strategy was being implemented. Madoff 

indicated to the examination staff that he no longer traded 

options for the strategy, which contradicted press reports 

and information contained in the 2004 Complaint with 

regard to implementation of the strategy. A number of 

other issues were never fully resolved including the 

number of clients, custody of the assets and verification 

of bank account numbers of various accounts 

Though the 2005 NERO Cause Examination was focused on front-running 

and cherry-picking, one examination team member picked up on the options 

trading volume issue raised in the 2004 Complaint. The examiner’s handwritten notes in the workpapers indicate that he recognized that there were 

questions as to “who is writing these OTC contracts.” The options issues 

were never examined however, apparently because the examiner was told 

by Madoff that he no longer utilized options trading in the split-strike 

conversion strategy after January 2004. The examination team was or 

should have been aware that this information was inconsistent with the 

MAR/Hedge and Barron’s articles as well as information contained in the 

2004 Complaint. Assuming that Madoff was telling the truth about his 

options activity, the examination team did not follow up with BMIS’ feeder 

funds as to whether those feeder funds may have intentionally or unwittingly 

misrepresented to their investors how the strategy was being implemented, 

or whether the strategy could be implemented without the use of options. 

Such misrepresentations to clients may violate securities laws. 

In a memorandum examiners wrote summarizing a meeting with Madoff, they 

described how Madoff had changed his story several times. For example, 

Madoff had said he had no advisory clients, then he had claimed to have four, 

and then “closer to 15.” At one point during the examination, an examiner didn’t 

believe the account numbers provided by Madoff were accurate and indicated 

that he would research record requirements for those accounts. 
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To the extent possible, all discrepancies should be resolved, no matter how 

small, as they frequently are indicators of a more serious problem. The 

preferable method to resolve a discrepancy is to contact the outside parties 

involved. 

Examination findings that lead to issues at other securities and investment 

firms must be followed up in order for thorough examinations to be 

conducted and fraud to be uncovered. 

Recommendation 24:

In the course of an examination, if an examiner becomes aware of a potential 

securities law violation at another firm, that examiner should consult with the 

team leader and the Office of Compliance Inspections and Examinations should 

make a referral to the appropriate personnel or agency. 

Finding 10: The Examiners Did Not 

Understand How BMIS Executed, Cleared and 

Settled Trades

Numerous questions were raised by both examination teams regarding BMIS’ 

trading. The OCIE staff could not understand why BMIS’ trade dates and 

settlement dates were inexplicably inconsistent and varied when compared to the 

securities industry standard of T+3 (trade date plus three days) and why certain 

option trades preceded the equity transactions when the examiner’s 

understanding of the split-strike conversion strategy would have indicated 

otherwise. 

The 2005 NERO Cause Examination staff also had questions about Madoff’s 

trading and settlement activity regarding the discretionary brokerage accounts for 

his investment advisory clients. The examination staff had been told by Madoff 

that Barclays Bank PLC “clears for the brokers in London,” and, in early May 

2005, a NERO document request was sent to Barclays asking for “[a]ll trading 

done by or on behalf of . . . Fairfield Sentry Ltd.,” “Kingate,” and “[a]ny account 

over which Bernard Madoff (or any entity known to the firm to be affiliated with 

Bernard Madoff or Madoff Securities) has any direct or indirect trading authority.” 

In mid-May, Barclays responded to NERO’s information request, stating that 

BMIS had recently opened an account at Barclays, but there was no recent 

transaction activity in the account. The response also stated, “[i]t should be 

noted that a prime brokerage and trading relationship with a Madoff-affiliated 

entity exists with our UK affiliate, Barclays Capital Securities Ltd., an FSAregulated institution.” NERO, however, never contacted Barclays Capital 
Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

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Securities Ltd. and, therefore, never verified Madoff’s purported European trading 

activity regarding the discretionary brokerage accounts for his investment 

advisory clients. 

During late May 2005, a NERO supervisor instructed the 2005 NERO Cause 

Examination team to confirm the details of how BMIS executed and cleared 

trades. The NERO examiners identified a number of unresolved issues 

regarding the potential role of a number of entities including the executing broker, 

prime broker, London Stock Exchange, Barclays and the BMIS U.K. affiliate. 

One NERO examiner indicated that these issues were discussed with Madoff 

and although Madoff was “somewhat vague regarding the actual execution and 

clearance of trades,” the examiners relied upon Madoff’s verbal representations. 

The NERO manager that supervised the examiners did not recall whether the 

examination team ever followed up on the details of BMIS’ trade executions. 

OCIE now has general “Guidance for Contacting Foreign-Based Entities and 

Individuals” provided by the SEC’s Office of International Affairs. OCIE has 

recently developed templates for contacting registered and unregistered 

custodians to assist in the verification of assets during examinations of 

broker-dealers and investment advisers. 

The failures by the OCIE examination teams to understand critical 

representations made by Madoff about his trading activity as well as the 

failures to appreciate information obtained during the course of the 

examinations concerning Madoff’s lack of trading contributed to OCIE’s 

inability to uncover Madoff’s Ponzi scheme. Training is necessary to ensure 

that OCIE examiners understand the issues they are examining. 

Recommendation 25:

The Office of Compliance Inspections and Examinations examiners should be 

trained in the mechanics of securities settlement, both in the U.S. and in major 

foreign markets. 

Recommendation 26:

The Office of Compliance Inspections and Examinations (“OCIE”) examiners 

should be trained by the Office of International Affairs (“OIA”) in methods to 

access the expertise of foreign regulators, such as the United Kingdom’s 

Financial Services Authority, as well as foreign securities exchanges and foreign 

clearing and settlement entities. OCIE examiners should also be trained by OIA 

in methods to request and receive information pursuant to SEC Memoranda of 

Understanding with those foreign regulators. OCIE in conjunction with OIA 

should develop templates for the most frequent types of requests (i.e., sample 
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trade data) from foreign regulators based on past experience in order to facilitate 

the process. OCIE in conjunction with OIA should develop and utilize contact 

lists with such regulators for use by appropriate examination staff. 

Recommendation 27:

For significant issues such as whether trades have been executed and who has 

custody of assets, in the absence of third party (counterparties, custodians, etc.) 

documentation, the Office of Compliance Inspections and Examinations (“OCIE”) 

examiners should not simply rely on representations of BD or IA personnel but 

should contact third parties directly. OCIE should provide guidance or training 

that clarifies for examiners circumstances that require such contact with third 

parties. 

Finding 11: Neither the OCIE Nor the NERO 

Examination Team Attempted to Acquire Trading 

Data from FINRA/NASD, DTC/NSCC or Other 

Independent Third Parties in Order to Verify the 

Trading Volume Purported by Madoff on Feeder 

Funds’ Account Statements 

The OCIE staff prepared a draft letter to the NASD, dated 

December 17, 2003 in connection with the 2004 OCIE 

Cause Examination of Madoff, but the staff never sent the 

letter. Nor did the OCIE staff ever request trading data (e.g., 

audit trail data) from another independent third party. The 

2005 NERO Cause Examination team did not make any 

attempt to reach out to an independent source for trading 

data in the course of their examination. Had the 2004 OCIE 

or the 2005 NERO Cause Examination teams approached 

independent third parties, they would have obtained detailed 

transaction data as well as securities position data for BMIS 

on a daily basis. 

The National Association of Securities Dealers (“NASD”, now “FINRA”) was, and 

still is, the largest independent regulator for all securities firms doing business in 

the United States, including its former subsidiary, the National Association of 

Securities Dealers Automated Quotations (“NASDAQ”) Stock Market,11 during 

the period of 2004 through 2006. Through NASDAQ, FINRA/NASD collects 

11 The NASDAQ Stock Market became an independent entity in January 2001 and registered as 

an exchange in August 2006. 
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detailed trading data from all market participants who are members of the NASD, 

including BMIS, on a daily basis.12 

Additionally, National Securities Clearing Corporation (“NSCC”), a subsidiary of 

the Depository Trust and Clearing Corporation (“DTCC”), provides clearing, 

settlement and central counterparty services for virtually all broker-to-broker 

trades involving equities, corporate and municipal debt and exchange-traded 

funds, etc. As a result, NSCC also provides a cleared and settled trade database 

on a daily basis. On the other hand, Depository Trust Corporation (“DTC”), 

another subsidiary of DTCC, maintains records that show, on any particular day, 

a market participant’s securities positions (equity, exchange-traded funds, 

corporate debt and municipal debt, etc.).13 

Finally, the Options Clearing Corporation (“OCC”) collects trading data for all 

cleared and settled option trades, including S&P 100 Stock Index (“OEX”) 

options, by its member firms, such as BMIS.

During the planning stage of the examination, the 2004 OCIE Cause Examination 

team had drafted a letter intended to request trading data related to BMIS directly 

from FINRA/NASD, but the letter was never sent. The NERO examination team 

did not make any effort to reach out to an independent source for trading data at 

all. During both examinations, it does not appear that the NASD or any other 

independent source, such as DTCC, was ever contacted in order to validate the 

transactions provided by BMIS. The FTI Engagement Team believes had either 

examination team approached FINRA/NASD, DTC/NSCC or OCC, detailed 

transaction data as well as securities overnight position data could have been 

obtained to challenge BMIS’ purported trading volume for both equities and 

options. 

12 Specifically, the NASDAQ Automated Confirmation of Transactions (“ACT”) database. 

Additionally, FINRA/NASD also established an Alternative Display Facility (“ADF”) for member 

firms who choose to report to ADF instead of ACT. 

13 DTC provides securities movements for NSCC's net settlements, as well as settlement for 

institutional trades, which typically involve money and securities transfers between custodian 

banks and broker-dealers. 
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Finding 12: Had the OCIE or the NERO 

Examination Team Conducted a Trading Volume 

Analysis Based on Third Parties’ Data, They 

Would Have Uncovered a Significant Red Flag 

That, With Further Inquiry, Would Likely Have Led 

to Discovery of the Ponzi Scheme or, At the Very 

Least, Madoff’s Fictitious Trades 

As a result of not requesting and obtaining data from third 

parties, validation of equity and options trading volume 

was never undertaken by either examination team during 

the 2004 OCIE Cause Examination or the 2005 NERO 

Cause Examination. Had the staff requested audit trail 

data and/or clearing and settlement information from third 

parties, it is likely that the examiners would have 

discovered that Madoff was not making the trades he 

claimed to be making. 

OIG’s Report of Investigation dated August 31, 2009 demonstrates that at no 

time did the two teams of the SEC examiners (2004 OCIE and 2005 NERO 

Cause Examination teams) initiate a comprehensive analysis to verify the 

trading volume of equity securities and OEX options as asserted by Madoff 

and reflected in the feeder funds’ statements, despite receiving several tips 

and complaints that raised suspicion about BMIS’ trading strategy and 

returns. The FTI Engagement Team believes that had either examination 

team conducted a detailed review of trading volume based on feeder fund 

account statements produced by BMIS compared to third-parties’ transaction 

data as well securities overnight position data, significant red flags would 

have been raised that should have prompted further inquiry, and the followup inquiry would likely have led to the discovery of the Ponzi scheme, or at 

the very least, Madoff’s fictitious trading. 

Summary of Received Tips in Regard to Trading Volume Issues 

2004 OCIE Cause Examination. In late 2003, when OCIE was assembling a 

team and preparing to conduct a cause exam of BMIS, the team possessed the 

following information in regard to anomalies of professed trading activities 

undertaken by BMIS: 
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• The Hedge Fund Manager’s Complaint received from a hedge fund 

manager indicated that the presumed OEX options volume done by 

Madoff could not be verified by the actual volume reported on the Chicago 

Board Options Exchange (“CBOE”) where, according to Madoff, those 

options should have traded; 

• A May 2001 MAR/Hedge article entitled “Madoff tops charts: Skeptics ask 

How” described Madoff’s “related ability to buy and sell the underlying 

stocks without noticeably affecting the market,” even though his trading 

volume of those stocks should have been in the billions of dollars on a 

daily basis; and 

• A Barron’s article entitled “Don’t Ask, Don’t Tell: Bernie Madoff is so 

secretive, he even asks his investors to keep mum,” published on May 5, 

2001, raised many of the same issues as in the MAR/Hedge article. 

As the OIG Report of Investigation describes, the 2004 OCIE Cause Examination 

team never requested trading and position data from a third-party source. 

Consequently, the OCIE team did not examine the market impact of Madoff’s 

alleged options trading, as specified in the Hedge Fund Manager’s Complaint 

from the investment adviser, and did not verify or reconcile the related equity 

trading volume. The examination team also did not take any measure to verify 

whether or not Madoff was trading options on CBOE or on other options trading 

venues including over the counter (“OTC”) market.

2005 NERO Cause Examination. In 2004, NERO possessed the following 

information in regard to alleged abnormal trading activities undertaken by BMIS: 

• The 2004 Complaint raised suspicion about Madoff’s equity trading stating 

the firm had “totally independent evidence that Madoff’s executions were 

highly unusual.”14

• The 2004 Complaint raised suspicion about Madoff’s options trading 

strategy and concluded that Madoff could not be trading on an exchange 

because of insufficient volume and could not be trading options over the 

counter because it was inconceivable he could find sufficient 

counterparties for the quantity of trading necessary to implement the splitstrike conversion strategy. 

• The Mar/Hedge article and the Barron’s article from May 2001 were also 

available for the 2005 NERO Cause Examination team at the start of the 

examination process. 

As the OIG’s Report of Investigation shows, the 2005 NERO Cause Examination 

team did not attempt to substantiate Madoff’s equity trading volume or the 

14 The firm that provided the 2004 Complaint had done an analysis of Madoff’s fills, or trade 

execution prices. The firm’s employees who analyzed the fills concluded that it was highly 

unlikely that Madoff’s executions could be legitimate.
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options trading volume. In fact, Madoff’s options trading was not a focus of the 

examination at all after Madoff told the team that he was no longer using options 

as part of his strategy. There is no evidence that the NERO team ever 

considered contacting the NASD or the DTCC for third-party trading data.

Trading Data and Markets 

The FTI Engagement Team replicated the 2004 OCIE Cause Examination data 

request to NASD (now FINRA) as if OCIE’s draft letter, which was never sent, 

had in fact gone to NASD; however, we limited the time period of the request to 

March 10 – 15, 2005 and the range of the request to selected securities to 

coincide with dates and securities shown on account statements provided to 

BMIS feeder funds found in OCIE workpapers. Furthermore, the FTI 

Engagement Team also obtained trading data from NSCC for the same time 

period of 2005 and securities position data from the Depository Trust Corporation 

(“DTC”). 

The FTI Engagement Team compared BMIS’ reported equity trading volumes 

from a sample of feeder fund account statements to BMIS’ trade reporting 

records submitted to the NASD, as well as BMIS’ trade clearing and settlement 

records provided by the NSCC.15 In addition, the FTI Engagement team 

compared BMIS’ securities position data provided by DTC for January 2005 to 

overnight securities holdings shown in BMIS account statements for its feeder 

fund client. 

The FTI Engagement Team’s analysis showed the following:16

• An analysis performed using data from the NASD/FINRA, NSCC and/or 

DTC would have likely resulted in uncovering during the examinations 

that Madoff was misrepresenting his trading. 

• The FTI Engagement Team’s analysis shows that, for one feeder fund 

manager alone, Kingate Management, Ltd. (“Kingate”), purported trading 

volume in U.S. markets for selected securities shown on BMIS statements 

significantly exceeded actual trading volume by BMIS in those securities, 

according to NASDAQ Automated Confirmation of Transactions (“ACT”) 

data provided by FINRA. In fact, the feeder fund’s volume surpassed the 

ACT volume for every single stock on every single trading day which the 

15 The FTI Engagement Team selected a sample of 14 stocks out of the total 44 stocks professed 

to be traded by Madoff for Kingate from March 10 through March 15, 2005. 

16 Appendix VI provides a more an in depth description of the FTI Engagement Team’s trading 

volume analysis, including databases, procedures, methodologies as well as a detailed 

breakdown of total volume calculated for each stock on each trading day during March 2005 

which is based on the records in Kingate and Fairfield’s account statements, NASDAQ ACT, 

FINRA OATS, NSCC and DTC databases. 
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FTI Engagement Team has investigated by a factor ranging from two to 

as much as 12.17 Moreover, Madoff eventually claimed to have executed 

trades for “closer to 15” feeder funds; therefore, the discrepancies of 

volume would have been even more significant had other feeder funds’ 

purported volume been factored into this analysis. The FTI Engagement 

Team concluded that had the examiners done a similar analysis, the 

disparity in US trading volume would have been uncovered during their 

examinations. 

• The FTI Engagement Team also compared the same trading volume as 

recorded in the feeders fund’s account statements to the volume cleared 

and settled by NSCC on behalf of Madoff during the same period. Similar 

to the results using the data from FINRA, purported trading volume for the 

feeder fund significantly exceeded actual trading volume by BMIS in those 

securities, as cleared by NSCC. Likewise, had the FTI Engagement 

Team included other feeder funds’ purported trading volume, as well as 

deducted BMIS’ actual market making volume from the NSCC cleared 

volume, the divergence of volume would be even more obvious and 

substantial.18

• Finally, the FTI Engagement Team also compared BMIS’ securities 

position holdings as reported by DTC to the overnight equity position of 

one of the feeder funds, Fairfield Sentry, Ltd. (“Fairfield”), based on a 

sample of trade confirmations issued by BMIS to the feeder fund. Based 

on the FTI Engagement Team’s research, BMIS did not hold billions of 

dollars of S&P 100 equities for Fairfield, as listed on the account 

statements. For example, on January 26, 2005, DTC records showed 

that the BMIS account held a total of 90,200 shares of 14 S&P 100 

equities in the DTC account.19 However, the trade confirmation 

statements produced by BMIS for the feeder fund show total holdings of 

35,682,300 shares for those same 14 stocks as of January 26, 2005, 

which exceeded the shares recorded in DTC by a factor of almost 400. 

17 For example, on March 14, 2005, Kingate’s two fund statements show a total buy and sell 

trading volume of 1,643,600 shares for Oracle Corporation (“ORCL”), while the reported volume 

submitted to ACT by BMIS was only about 136,850 shares. For that date, then, Kingate’s 

recorded volume was 12 times as large as the NASDAQ reported volume. 

18 Data relating to trades reported by BMIS to NASDAQ ACT or NSCC would be available only to 

the SEC, FINRA, NASDAQ and DTCC. Absent any specific legal authority, neither the BMIS 

feeder funds, nor their advisors and auditors, would have had access to the trade execution data 

needed to prepare an analysis similar to that which the FTI Engagement Team performed for this 

report. 

19 Most of the shares held by BMIS at DTC were likely related to BMIS market-making positions 

only. The FTI Engagement Team concluded that the DTC records would have included 

additional shares held by Madoff for its investors had Madoff conducted genuine trades in U.S. 

markets for those investors because Madoff was acting as their custodian. 
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• Even if Madoff represented to NERO examiners that BMIS executed 

trades for institutional clients in Europe before the U.S. markets were 

open, the examiners should have been prompted to pursue additional 

information on Madoff’s claimed European trade executions because, on 

its face, such a representation raised serious red flags. The after-hours 

markets for US stocks traded in both U.S. and Europe were viewed as 

illiquid.20 It was not likely that BMIS would transact several hundred 

thousand shares of volume for each individual stock on each day, as it 

purported to do for its investment adviser accounts, between 4:00 am and 

8:00 am on a European exchange when the market for this time period is 

viewed by the industry as illiquid. With the knowledge that the European 

market for U.S. equities was so limited, the examiners would have had a 

solid indicator to pursue information from European regulators, and, in 

turn, investigate other issues such as custody and existence of client 

securities. Had the examination team possessed a basic understanding 

of the interactions between the U.S. and European markets, they likely 

would have reached this conclusion. 

U.S. Treasury Holdings. In addition to equity positions, Fairfield’s trade 

confirmations also purported to carry large U.S. Treasury debt positions 

overnight. In fact, on some days, Fairfield’s entire portfolio was supposed to 

have been invested in US Treasury bills. US Treasury bills, though, could be 

held in both US and foreign depository institutions, making it difficult to obtain a 

definitive total of all holdings for a given broker-dealer such as BMIS. While 

OCIE examiners could have made inquires of US and foreign depository 

institutions, the examiners may have been dependent upon the cooperation of 

entities not under SEC supervision, lowering the likelihood of successfully 

reaching a conclusion. 

Options Trading. The FTI Engagement Team was not able to verify options 

trading volumes due to incomplete data. In fact, the 2005 account statements 

produced by BMIS to two of its feeder fund clients did not show any trading in 

S&P 100 stock index (“OEX”) options or other options.21 The FTI Engagement 

Team has verified that BMIS was a member of the Options Clearing Corporation 

(“OCC”)22 and also a member of Pacific Stock Exchange, which is known for its 

electronic options trading platform, during the period from 2004 – 2005.23 

Therefore, the SEC examination teams could have requested options trading 

data directly from OCC or the options exchanges in regard to BMIS’ purported 

20 See “After-Hours Trading: Understanding the Risks” 

http://www.sec.gov/investor/pubs/afterhours.htm. 21 However, we do have Fairfield trade confirmations that showed trading of OEX options in 2005. 22 Members of OCC would have to have reported all exchange-listed option trades (including 

OEX trades) to OCC for clearing and settlement purposes. 

23 See BMIS FOCUS Reports for 2004 and 2005, Schedule I, filed with FINRA. 
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trading activities in OEX options.24 As a result, it is likely that the OEX options’ 

trading volume fabricated by Madoff could have been exposed once an analysis 

of options’ trading volume was accomplished. 

As the above demonstrates, the FTI Engagement Team has concluded that there 

were several methods for the SEC examiners to verify BMIS purported trading 

volume with several different independent third-parties. Reaching out to any of 

these third-parties would have revealed discrepancies between Madoff’s 

representations concerning his trading volume and reality. Had the SEC 

examiners undertaken any of the volume or position analyses discussed above, 

they would have uncovered a significant red flag that, with further inquiry, would 

likely have led to discovery of the Ponzi scheme or, at the very least, Madoff’s 

fictitious trading volume.25

Recommendation 28: 

The Office of Compliance Inspections and Examinations examination staff should 

be required to verify a test sample of trading or balance data with counterparties 

and other independent third parties such as Financial Industry Regulatory 

Authority, Depository Trust Company, or National Securities Clearing Corporation 

whenever there are specific allegations of fraud involved in an examination. 

Recommendation 29: 

The Office of Compliance Inspections and Examinations (“OCIE”) examiners 

should be trained jointly with the Office of Economic Analysis economists by 

FINRA, other self-regulatory organizations and exchange staff in understanding 

the trading databases provided by the Financial Industry Regulatory Authority, 

The NASDAQ OMX Group, Inc., the New York Stock Exchange/Archipelago 

Holdings, Inc./American Stock Exchange, regional exchanges, Options Clearing 

24 A listed option such as OEX options could not have been traded solely over-the-counter and 

not reported to any regulated entities such as OCC or option exchanges. A broker-dealer could 

only trade a non-listed option over-the-counter. However, it is possible that a non-listed option 

that mimics OEX options with similar characteristics (e.g., a similar stock mix with volatility 

proximity) could be traded exclusively over-the-counter, although this scenario would be 

inconsistent with Madoff’s previous statements that he was trading OEX options only. 25 To minimize the resources required by OCIE to analyze trade data provided by FINRA 

(NASDAQ ACT and OATS databases), the FTI Engagement Team suggests that FINRA invest 

time and technical personnel to build the following two new databases based on the existing raw 

data: 1) a new database that would combine all OATS tables (order entry, routing, execution, 

cancellation, modification, etc.) into one “super” table so that examiners could easily understand 

the life cycle of a customer order submitted to a market participant; and 2) a “cleaned-up” version 

of a “super” ACT trade database that would eliminate the redundancies of tape-reported records 

and clearing records. FINRA should make the new databases available for request by the SEC 

(especially OCIE and OEA). Because this suggestion is directed at FINRA, not the SEC, the FTI 

Engagement Team is not including it as a formal recommendation, but wishes to bring it to the 

SEC’s attention. 
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Corporation, option exchanges, and Depository Trust Clearing 

Corporation/National Securities Clearing Corporation, etc. As trading and trading 

venues change over time, the OCIE training should be recurring and updated. 

Recommendation 30: 

The Office of Compliance Inspections and Examinations staff should be given 

direct access to certain databases maintained by self-regulatory organizations or 

other similar agencies in order to allow examiners to access necessary data for 

verification or analysis of registrant data. Such databases should include 

exchange trading execution data, Depository Trust Company / National 

Securities Clearing Corporation data, the Financial Industry Regulatory Authority 

(“FINRA”) Order Audit Trail System and the FINRA Central Registration 

Depository. 

Finding 13: OCIE Did Not Adequately Track the 

Progress of its Cause Examination of BMIS 

OCIE did not adequately track the progress of its 2004 

OCIE Cause Examination of BMIS. OCIE team members 

were pulled from the project and never returned to work 

on the cause examination even though it was never 

completed. 

The 2004 OCIE Cause Examination never reached a formal conclusion as 

the examination team was diverted to address another priority. The OCIE 

examiners were told by their supervisors to focus on a mutual fund revenue 

sharing sweep being conducted by OCIE. The examination team did not 

draft a closing report of the BMIS cause examination, and when the mutual 

fund revenue-sharing project was completed, the 2004 OCIE Cause 

Examination of Madoff did not resume. 

A senior OCIE manager indicated that one particular individual was 

responsible for keeping track of open examinations. However, this individual 

testified that although she maintained a spreadsheet that listed ongoing 

projects, she did not have the responsibility for monitoring whether 

examinations were completed and that the responsibility for ensuring that an 

examination was completed fell to the branch chief, the assistant director 

and the associate director in charge of the project. 

According to the letters dated June 5, 2009 and July 1, 2009 from OCIE to 

OIG, in late 2003 and 2004, Market Oversight was particularly busy with a 

number of high-profile sweep examinations that required significant staffing 
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resources. As a result, other projects, including the 2004 OCIE Cause 

Examination of BMIS, suffered considerable delays. 

As a result of the failure by OCIE to reach a formal conclusion and 

adequately trace the progress of the cause examination, the examination 

work conducted by the 2004 OCIE Cause Examination team was rendered 

useless. 

Recommendation 31: 

When an examination team is pulled off the examination for a project of 

higher priority, upon completion of that project, the examination team should 

return to their examination and bring the examination to a conclusion. 

Recommendation 32: 

One person in The Office of Compliance Inspections and Examinations 

(“OCIE”) should be responsible for tracking the progress of all cause 

examinations, and the tracking should include the number of cause 

examinations opened, the number on-going and the number closed for each 

month. Such data should be reported at least quarterly to the OCIE Director 

and to the Securities and Exchange Commission (“SEC”) Chairman. Any 

cause examinations open for more than 180 days should be reported to the 

OCIE Director and the SEC Chairman with an explanation as to why the 

examination requires more time. 

Finding 14: OCIE Did Not Prepare a Closing 

Report That Resolved the Allegations from the 

Hedge Fund Manager’s Complaint and Identified 

Any Substantive Open Issues Discovered During 

the Examination

The 2004 OCIE Cause Examination team did not prepare 

a closing report that resolved the allegations from the 

Hedge Fund Manager’s Complaint and identified any 

substantive open issues discovered during the 

examination. 

Had the 2004 OCIE Cause Examination been brought to a conclusion, 

presumably the examination team would have determined there was no 

front-running, but other issues remained. Senior OCIE managers have 
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Page 34

indicated that if they were doing the examination and did not find frontrunning, then they likely would have continued the examination, including a 

validation of investment performance and a review of the custody 

arrangements. 

Although OCIE had begun drafting a memorandum to the Division of Market 

Regulation (now the Division of Trading & Markets) addressing whether or 

not BMIS should had been registered as an investment adviser, that 

memorandum was never finalized. 

The failure to adequately address and resolve these issues can be linked to 

the overly narrow initial scope of the 2004 OCIE Cause Examination that 

focused on front-running. That scope was not modified to reflect the detailed 

Hedge Fund Manager’s Complaint received by OCIE, even though members 

of the examination team talked with the individual that provided the tip 

shortly after the Planning Memorandum was drafted, nor was the scope 

adjusted to include the issue of investment adviser registration. 

OCIE Office of Market Oversight’s Document Policies and Procedures dated 

November 27, 2007 suggested that a closing memorandum “should” be 

completed for every project. However, a letter dated June 5, 2009 from OCIE to 

the OIG stated, “[o]nce an examination is completed, the [Market Oversight] 

Guidelines require that each examination or inspection have a final closing report 

or memorandum.” Furthermore, OCIE’s Examination Program Manual for 

Organization of Examination Workpapers dated July 8, 2008 suggested that final 

examination/inspection reports may, but not necessarily must, be retained in 

examination files. OCIE’s Standard Report Format dated December 4, 2008 

described the minimum content and format for examination reports, when 

prepared.

The above demonstrates the conflicting policies and procedures in effect. In 

addition, the failure to document conclusions from the 2004 OCIE Cause 

Examination demonstrates the importance of clarifying that closing reports 

must be prepared at the conclusion of each examination. 

Recommendation 33: 

The Office of Compliance Inspections and Examinations’ policies and 

procedures should clearly indicate that at the conclusion of each 

examination, the examination team must prepare a closing report (“Closing 

Memorandum”) that begins with the scope discussion from the Planning 

Memorandum, as modified by new issues that arise during the course of the 

examination. For each and every issue discussed in the scoping discussion 

in the Planning Memorandum, the Closing Memorandum should provide 
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findings relevant to each issue and state the team’s conclusions. All 

members of the examination team should sign the Closing Memorandum. 

Finding 15: The NERO Examination Team Closed 

the Examination Despite A Number of Open 

Issues

The 2005 NERO Cause Examination team closed the 

cause examination of BMIS despite a number of open 

issues including whether BMIS should have been 

registered as an investment adviser, the role of the BMIS 

London affiliate and how Madoff was able to generate the 

returns once NERO determined he was not front-running. 

On June 2, 2005, a conclusion was reached by a NERO examiner that 

Madoff was not front-running his market-making customers in order to 

benefit his investment advisory clients. The examiner also noted that 

Madoff’s “purchase & subsequent sale timing was excellent (buy low & sell 

high).” Although no analysis had been conducted, the examiner suspected 

that Madoff was “extremely well connected to European order flow 

information through his brokers (and possibly the investors in his fund) and is 

timing the market based upon that information rather than his retail order 

flow information.” The examiners’ supervisor later stated that “we never 

found [out] why he was making those returns” and also indicated that he 

could not rule out the possibility that Madoff was doing something else 

illegally to achieve those returns. 

The 2005 NERO Cause Examination team spent several months reviewing 

documents and interviewing Madoff directly with regard to his split-strike 

conversion strategy but was still unable to understand how he was achieving 

his returns. Even though there were significant “red flags” outlined in both 

the 2004 Complaint that triggered the examination and the news articles, the 

2005 NERO Cause Examination team never reached a resolution on the 

many issues concerning Madoff’s returns. 

OCIE’s Examination Program Manual for Organization of Examination 

Workpapers dated July 8, 2008 indicates that workpapers should include a list of 

any unresolved issues that should be prepared and given to the branch chief or 

team leader for review and disposition prior to closing the 

examination/inspection. 
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Resolving issues provided in a complaint or uncovered during the course of a 

cause examination is critical to the conduct of a comprehensive examination. 

Recommendation 34: 

Examination staff should not leave open any substantive issue without 

providing a sufficient basis for such a determination or a plan to pursue that 

issue at an appropriate later time. In the event that issues are unresolved or 

cannot be pursued further, examination staff should formerly refer those 

issues to the appropriate Securities and Exchange Commission staff that 

may further investigate and resolve such issues. 

Finding 16: The NERO Examination Team 

Believed They Might Be Subjected To Legal 

Liability If They Contacted The Feeder Funds 

The 2004 NERO Cause Examination team believed they might be 

subjected to legal liability if they contacted the feeder funds. There was 

belief within the examination team that they might be sued if they 

contacted the feeder funds and those funds subsequently pulled their 

money out of BMIS. 

In mid-June 2005, the Northeast Regional Office examiners indicated to their 

supervisor that they were interested in visiting Madoff’s feeder funds in order to 

better gain an understanding of the strategy used by Madoff, to request 

marketing materials from the funds and to compare performance data of the 

funds. The supervisor told the examiners that they should not contact the funds, 

apparently due in part to his fear that they would be sued. One of the examiners 

believed that his supervisor was concerned about “potentially being liable if the 

hedge funds turned around and pulled their assets from Bernard Madoff.” 

Recommendation 35: 

The Office of Compliance Inspections and Examinations (“OCIE”) training 

should include instruction on personal liability, if any, assumed on the part of 

examiners for their actions in the course of performing their duties for OCIE. 
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Recommendation 36: 

Office of Compliance Inspections and Examinations (“OCIE”) management 

should make clear that it will support OCIE examiners in their pursuit of 

evidence in the course of an examination, even if pursuing that evidence 

requires contacting customers or clients of the target of that examination. 

Finding 17: The Examinations Did Not Adequately 

Look Into the Allegations of the Auditor’s Lack of 

Independence or Refer Such Allegations To the 

Appropriate Agency 

Both the 2004 OCIE and the 2005 NERO Cause Examinations did not 

adequately look into the allegations of the auditor’s lack of independence 

or refer such allegations to the appropriate agency. 

Despite concerns raised in the complaints, both the 2004 OCIE and the 2005 

NERO Cause Examinations did not look into the allegations of the auditor’s 

lack of independence to determine if there was a conflict of interest. The 

lack of an independent auditor raises potential concerns with regard to safety 

of custody of assets. Without an independent auditor, there can be no 

assurance that the audits of BMIS were properly conducted. Such potential 

conflicts should heighten awareness of, and the need for, verification that 

BMIS had internal controls in place that are designed to effectively prevent 

certain inappropriate activities, such as misrepresentation of trading activity 

and the misappropriation of client assets. The examination teams could 

have confirmed whether the accountant verified, by actual examination, 

client funds and securities held by BMIS, since BMIS did not utilize an 

independent custodian. Based on the information provided in the Hedge 

Fund Manager’s Complaint and the 2004 Complaint, such inquiries should 

have been considered as an area for review during the cause examinations. 

Lori Richards indicated in a June 17, 2009 speech at a SIFMA conference 

and in a letter dated July 1, 2009 to David Kotz that in the wake of Madoff 

and other frauds, OCIE is making changes to examination procedures. 

Among other things, these changes will include a more routine process with 

regard to contacting a firm’s independent auditor in order to understand the 

nature of its audit and determine whether the auditor confirmed or verified 

that assets held on behalf of customers actually exist. 

Procedures must be put into place to ensure that serious questions about an 

auditor’s independence are investigated and examined. 
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Recommendation 37: 

When an auditor’s independence is questioned in a tip or complaint, the Office of 

Compliance Inspections and Examinations should report the information, if 

deemed credible, to the appropriate state board of accountancy and to the Public 

Company Accounting Oversight Board, if applicable, in addition to considering a 

referral to the Securities and Exchange Commission’s Enforcement Division or 

other government agency. 

 
Appendix I 

Acronyms 

ACT Automated Confirmation of Transactions 

ADF Alternative Display Facility 

Adviser Act Investment Adviser Act of 1940 

AMEX American Stock Exchange 

ARCA Archipelago Holdings, Inc. 

BD Broker Dealer 

BMIS Bernard L. Madoff Investment Securities LLC 

CBOE Chicago Board Options Exchange 

Company Act Investment Company Act of 1940 

CRD Central Registration Depository 

DTC Depository Trust Company 

DTCC Depository Trust & Clearing Corporation 

ECN Electronic Communication Network 

Enforcement Division of Enforcement 

Exchange Act Securities Exchange Act of 1934 

Fairfield Fairfield Sentry 

FINRA Financial Industry Regulatory Authority (formerly NASD) 

FSA Financial Services Authority (United Kingdom) 

FTI FTI Consulting, Inc. 

IA Investment Adviser 

IC Investment Company 

IA/IC Investment Adviser/Investment Company 

Kingate Kingate Global Fund 

LSE London Stock Exchange 

Madoff Bernard L. Madoff 

Market Regulation Division of Market Regulation (now Trading & Markets) 

NASAA North American Securities Administrators Association 

NASD National Association of Securities Dealers (now FINRA) 

NASDAQ National Association of Securities Dealers Automated 

Quotations/ Nasdaq Stock Market 

NERO Northeast Regional Office (now NYRO) 

NSCC National Securities Clearing Corporation 

NYRO New York Regional Office (formerly NERO) 

NYSE New York Stock Exchange 

OATS Order Audit Trail System 

OCC Options Clearing Corporation 

OCIE Office of Compliance Inspections and Examinations 

OEA Office of Economic Analysis 

OEX S&P 100 Stock Index 

OIA Office of International Affairs 

OIEA Office of Investor Education and Advocacy 

OIG Office of Inspector General 

OMI Office of Market Intelligence 

OMX The NASDAQ OMX Group, Inc. 

ORA Office of Risk Assessment 

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Appendix I 

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OTC Over the Counter 

SEC/Commission U.S. Securities and Exchange Commission 

SIAC Securities Information Automation Corporation 

SRO Self-Regulatory Organization 

SRO/Market Oversight Office of Market Oversight 

STARS Super Tracking and Reporting System 

Trading & Markets Division of Trading & Markets (formerly Market Regulation) 
Appendix II

Scope and Methodology 

Scope. The FTI Engagement Team’s review of OCIE’s examinations of BMIS 

included the following areas:

• OCIE’s identification of red flags, improper conduct and illegal practices of 

BMIS and the ability of OCIE management to evaluate these issues and 

assign the appropriate SEC staff; 

• OCIE’s methodology, timeliness and effectiveness in initiating and 

performing “cause” examinations; 

• OCIE’s assessment of an entity’s internal controls and compliance with 

regulations and securities laws; 

• OCIE’s procedures for documentation of its workpapers; 

• OCIE’s confirmation or verification of an entity’s trading activity and 

customer account balances; 

• OCIE’s supervisory oversight of the examination staff; 

• OCIE’s coordination between the examination staff and other personnel in 

the various offices of SEC/OCIE; 

• Adequacy of staffing and resources at OCIE to support effective and 

efficient examinations; and 

• Other relevant aspects of the OCIE examinations of BMIS. 

Methodology. This review was not conducted in accordance with the 

government auditing standards. The FTI Engagement Team’s fieldwork in 

connection with this review began on July 6, 2009 during the in-person entrance 

interview of Lori Richards and John Walsh in Washington, D.C. The FTI 

Engagement Team reviewed the OIG’s August 31, 2009 Report of Investigation, 

including related findings, exhibits, witness testimony and other supporting 

documentation (i.e., OCIE examination staff workpapers), and the FTI 

Engagement Team also interviewed over a dozen key personnel representing 

OCIE’s broker-dealer, investment adviser and risk assessment programs. In 

addition, the FTI Engagement Team reviewed OCIE’s policies and procedures 

with regard to its examination processes and other third-party records including 

Financial Industry Regulatory Authority (“FINRA”) order and execution data, 

Depository Trust Corporation (“DTC”) records and National Securities Clearing 

Corporation (“NSCC”) records. The FTI Engagement Team also was granted 

access to OCIE’s various intranet sites, including the Broker-Dealer, Investment 

Advisor/Investment Company, Office of Market Oversight, and Training Branch 

sites, in order to view its examination policies and procedures. The FTI 

Engagement Team performed its findings and recommendations review from 

June 25, 2009 through August 28, 2009. 

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Appendix III

List of Recommendations 

Recommendation 1: 

The Office of Compliance Inspections and Examinations (“OCIE”) should provide 

all examiners access to relevant industry publications (i.e., MAR/Hedge-type 

publications) and third-party database subscriptions sufficient to develop 

examination leads and stay current with industry trends. OCIE should regularly 

(i.e., quarterly) assess whether they have adequate access to relevant industry 

publications and other such sources (newsletters, independent subscription-type 

news alerts, etc.) and make reasonable attempts to gain such access. 

Recommendation 2: 

The Office of Compliance Inspections and Examinations should establish a 

protocol for searching and screening news articles and information from relevant 

industry sources that may indicate securities law violations at broker-dealers and 

investment-advisers. The protocol should include flexible searching capability to 

help identify specific areas of risk or concern and should include access to all 

relevant industry publications. The protocol should also include adequate 

screening criteria to eliminate unnecessary results and/or to more narrowly 

define a search in order to generate sufficient results. The screening criteria and 

any changes should be documented and the protocol should be re-assessed 

regularly (i.e., quarterly) in order to determine if any modifications are 

appropriate. 

Recommendation 3: 

The Office of Compliance Inspections and Examinations (“OCIE”) should 

establish a protocol that explains how to identify red flags and potential violations 

of securities law based on an evaluation of information found in news reports and 

relevant industry sources. The protocol should also determine how decisions on 

whether to initiate cause examinations are made and by whom, set a reasonable 

time frame for evaluation (i.e., 90 days) of the search results and provide 

notification to OCIE management when such time has expired. 

Recommendation 4: 

In accordance with the findings of the Center for Enterprise Modernization project 

and prior to its completion, the Office of Compliance Inspections and 

Examinations (“OCIE”) should implement an OCIE-related collection system that 

adequately captures information relating to the nature and source of each tip or 

complaint and also chronicles the vetting process to document why each tip or 

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Appendix III

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complaint was or was not acted upon and who made that determination. All 

OCIE examiners should be given access to the system in order to be able to 

timely view and monitor tips and complaints that may be relevant to examinations 

they are preparing to conduct or are actively conducting. In addition, OCIE 

examiners should be given adequate access to tips and complaints received by 

the newly-created Office of Market Intelligence and other relevant sources such 

as the Office of Investor Education and Advocacy. 

Recommendation 5: 

The Office of Compliance Inspections and Examinations (“OCIE”) should 

annually review and test the effectiveness of its policies and procedures with 

regard to its tip and complaint collection system. OCIE should also modify these 

policies and procedures, where needed. 

Recommendation 6: 

Tips and complaints reviewed by the Office of Compliance Inspections and 

Examinations that appear on the surface to be credible and compelling 

should be probed further by in-depth interviews with the sources to assess 

their validity and to determine if there are other issues that need to be 

investigated. Any apparent contradictions in tip or complaint information 

need to be resolved as early as possible in the examination process through 

interviews with appropriate sources or further independent research. 

Findings from such interviews should be adequately documented and should 

be required reading for examination team members. 

Recommendation 7: 

All Office of Compliance Inspections and Examinations (“OCIE”)-related tips 

and/or complaints that are not vetted within 30 days of receipt should be brought 

to the attention of the OCIE Director with an explanation for the delay. All OCIErelated tips and/or complaints that merit a cause examination for which that 

examination does not begin within 60 days of receipt (a “Post-60 Day 

Examination”) must be reported to the OCIE Director with a monthly tally of yetto-be-opened Post-60 Day Examinations sent to the Securities and Exchange 

Commission Chairman. 

Recommendation 8: 

All potentially relevant information received by the Office of Compliance 

Inspections and Examinations from a tip or complaint source should be 

preserved as a complete unit and should be augmented with relevant information 

that may have been provided in subsequent submissions by that source. Once 
Appendix III

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an examination has been initiated, such information should be required reading 

for examination team members. 

Recommendation 9: 

The Office of Compliance Inspections and Examinations (“OCIE”) should 

augment its policies and procedures related to the use of scope memoranda to 

better reflect particular consideration given to information collected as the result 

of tips and complaints that lead to cause examinations. When all potentially 

relevant tip and complaint source data, background information and research 

have been collected into one complete unit (see Recommendation 8), 

examination staff should identify all relevant potential securities law violations 

and other concerns and then prepare a planning memorandum that ties each and 

every potential violation and issue into the scoping discussion in the 

memorandum. The Planning Memorandum should include the basic steps that 

need to be taken in order to address the issues identified in the scope 

discussion. The Planning Memorandum should be reviewed, approved and 

signed (or initialed) by senior OCIE management (i.e., assistant director level or 

higher) and should include the names of the individuals who prepared and 

reviewed the document. 

Recommendation 10: 

The Office of Compliance Inspections and Examinations (“OCIE”) should timely 

modify or append the scope memorandum when significant new facts and issues 

emerge. The modified or supplemental scoping memorandum should be 

reviewed, approved and signed (or initialed) by senior OCIE management (i.e., 

assistant director level or higher) and should include the names of the individuals 

who prepared and reviewed the document. 

Recommendation 11: 

After examination scoping provisions have been approved, along with all other 

elements of the Planning Memorandum, the Planning Memorandum should be 

subjected to concurring review by an unaffiliated Office of Compliance 

Inspections and Examinations (“OCIE”) associate or assistant director 

(“Concurring Director Review”), and the person performing the Concurring 

Director Review should also recommend additional concurring reviews from the 

Commission’s Office of Economic Analysis, Office of Chief Accountant or other 

offices or divisions of the Commission as needed. All concurring reviewers 

should sign off on the Planning Memorandum indicating their approval and add 

any comments on the proposed scope or other areas discussed in the 

memorandum. 
Appendix III

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Recommendation 12: 

After the Planning Memorandum is first drafted, it should be circulated to all 

examination team members, and all team members should then meet, in person 

or electronically, to discuss the examination approach and methodology set out 

in the memorandum, as well as any other issues the team members wish to 

raise. 

Recommendation 13: 

The examination team leader should ensure that all steps of the examination 

methodology, as stated in the Planning Memorandum, are completed and either 

the team leader or the appropriate team member should sign off on each step as 

it is completed. 

Recommendation 14: 

Substantive interviews conducted by the Office of Compliance Inspections and 

Examinations (“OCIE”) of registrants and third-parties during OCIE’s preexamination activities and during the course of an active examination should be 

documented with notes circulated to all team members. After each substantive 

interview during the examination, the team leader should re-evaluate the 

examination scope and methodology as set out in the Planning Memorandum to 

determine if the examination needs to be expanded and indicate by initialing the 

interview notes that the team leader has performed that evaluation. 

Recommendation 15:

The workpapers for a given examination should be in sufficient detail to provide a 

clear understanding of its purpose, source, and the conclusions reached. Also, 

the documentation should be appropriately organized to provide a clear link to 

the significant findings or issues.26

Recommendation 16:

When logging all Office of Compliance Inspections and Examinations 

examinations into an examination tracking system, the team leader should verify 

that the appropriate entry is made into the tracking system and, with a notation in 

26 This requirement for work paper documentation is taken from the objectives of audit work paper 

documentation for public company audits adopted by the Public Company Accounting Oversight 

Board as expressed on paragraph 4 of Auditing Standard 3: 

Audit documentation should be prepared in sufficient detail to provide a clear 

understanding of its purpose, source, and the conclusions reached. Also, the 

documentation should be appropriately organized to provide a clear link to the 

significant findings or issues. [Footnote omitted.] 
Appendix III

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the Planning Memorandum, indicate that such entry has been made with the 

team leader’s initials. 

Recommendation 17:

The Office of Compliance Inspections and Examinations should annually review 

and test the effectiveness of its policies and procedures with regard to 

conducting, documenting and concluding its examinations27 and modify the 

policies and procedures, where needed. 

Recommendation 18: 

The focus of an examination should drive the selection of the examination team 

and team members should be selected based upon their expertise related to 

such focus. There should also be a clearly defined examination team leader. 

Staffing decisions should be made by senior Office of Compliance Inspections 

and Examinations management (assistant director level or higher) after 

management has performed adequate pre-examination preparation so that 

management can make appropriate choices. The examination team should not 

be selected solely based on availability. 

Recommendation 19:

Senior Office of Compliance Inspections and Examinations (“OCIE”) 

management should ensure that personnel with the appropriate skills and 

expertise are assigned to cause examinations with unique or discrete needs (i.e., 

options expertise). OCIE should regularly seek out the appropriate expertise 

from other offices or divisions within the SEC and encourage intra-agency 

collaboration wherever possible. 

Recommendation 20:

The Office of Compliance Inspections and Examinations should assign a Branch 

Chief, or a similarly designated lead manager, on every substantive project 

including all cause examinations. The Branch Chief or designated lead manager 

must be onsite or in direct communication with the onsite staff daily during the 

onsite portion of the examinations. Lower lever or junior staff examiners must 

not be left unsupervised during substantive discussions with principals or senior 

executives at the registrant during the examination. 

27 Similarly, investment firms are required to develop and implement policies and procedures 

designed to guide their securities activities and detect and prevent violative conduct. Broker 

Dealer policies and procedures must be reviewed for adequacy on an annual basis – see FINRA 

Rule 3130(b). Investment advisers must conduct an annual review of their policies and 

procedures – see Investment Advisers Act of 1940 Rule 206(4)-7(b). 
Appendix III

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Recommendation 21:

The Office of Compliance Inspections and Examinations (“OCIE”) should develop 

a formal plan with specific goals associated with achieving and maintaining 

professional designations and/or licenses by industry certification programs that 

are relevant to the examination activities conducted by OCIE. For instance, 

within the next three years, 50% of OCIE staff and management associated with 

examination activities should be qualified by means of a certification applicable to 

their profession such as the Association of Certified Fraud Examiners’ Certified 

Fraud Examiner designation, the American Institute of Certified Public 

Accountants’ Certified in Financial Forensics designation and/or the FINRA 

General Securities Principal license required of investment professionals.28 

These should include an annual continuing education component for each of 

these licenses. 

Recommendation 22:

The Office of Compliance Inspections and Examinations (“OCIE”) should develop 

and implement interactive exercises to be administered by OCIE training staff or 

an independent third party and reviewed prior to hiring new OCIE employees in 

order to evaluate the relevant skills necessary to perform examinations. Similar 

exercises should be annually administered to all active examination staff and 

management in order to identify areas that need further development. 

Recommendation 23:

Subject to approval of the examination team leader, Office of Compliance 

Inspections and Examinations (“OCIE”) examiners should contact clients of a BD 

or IA when necessary to confirm statements made by BD or IA personnel. 

Examiners should be encouraged to verify representations of third parties by 

contacting such parties, and appropriate methods used to contact third parties 

should become a part of OCIE’s training of examiners. 

Recommendation 24:

In the course of an examination, if an examiner becomes aware of a potential 

securities law violation at another firm, that examiner should consult with the 

28 The investment firms that OCIE examines are required to have their professionals qualified by 

exam to perform securities investment activities. OCIE professionals should have a similar 

requirement in order to review and examine those activities. The FINRA General Securities 

license consists of the Series 7 and 24 courses covering the sales of securities and the 

supervision of such sales. The study materials are readily available from several providers. While 

OCIE examiners may not be able to sit for certain exams and obtain certain licenses due to their 

status as government employees, they are still able to obtain and study the course materials. 
Appendix III

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team leader and the Office of Compliance Inspections and Examinations should 

make a referral to the appropriate personnel or agency. 

Recommendation 25:

The Office of Compliance Inspections and Examinations examiners should be 

trained in the mechanics of securities settlement, both in the U.S. and in major 

foreign markets. 

Recommendation 26:

The Office of Compliance Inspections and Examinations (“OCIE”) examiners 

should be trained by the Office of International Affairs (“OIA”) in methods to 

access the expertise of foreign regulators, such as the United Kingdom’s 

Financial Services Authority, as well as foreign securities exchanges and foreign 

clearing and settlement entities. OCIE examiners should also be trained by OIA 

in methods to request and receive information pursuant to SEC Memoranda of 

Understanding with those foreign regulators. OCIE in conjunction with OIA 

should develop templates for the most frequent types of requests (i.e., sample 

trade data) from foreign regulators based on past experience in order to facilitate 

the process. OCIE in conjunction with OIA should develop and utilize contact 

lists with such regulators for use by appropriate examination staff. 

Recommendation 27:

For significant issues such as whether trades have been executed and who has 

custody of assets, in the absence of third party (counterparties, custodians, etc.) 

documentation, the Office of Compliance Inspections and Examinations (“OCIE”) 

examiners should not simply rely on representations of BD or IA personnel but 

should contact third parties directly. OCIE should provide guidance or training 

that clarifies for examiners circumstances that require such contact with third 

parties. 

Recommendation 28: 

The Office of Compliance Inspections and Examinations examination staff should 

be required to verify a test sample of trading or balance data with counterparties 

and other independent third parties such as Financial Industry Regulatory 

Authority, Depository Trust Company, or National Securities Clearing Corporation 

whenever there are specific allegations of fraud involved in an examination. 
Appendix III

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Recommendation 30: 

The Office of Compliance Inspections and Examinations staff should be given 

direct access to certain databases maintained by self-regulatory organizations or 

other similar agencies in order to allow examiners to access necessary data for 

verification or analysis of registrant data. Such databases should include 

exchange trading execution data, Depository Trust Company / National 

Securities Clearing Corporation data, the Financial Industry Regulatory Authority 

(“FINRA”) Order Audit Trail System and the FINRA Central Registration 

Depository. 

Recommendation 31: 

When an examination team is pulled off the examination for a project of 

higher priority, upon completion of that project, the examination team should 

return to their examination and bring the examination to a conclusion. 

Recommendation 32: 

One person in The Office of Compliance Inspections and Examinations 

(“OCIE”) should be responsible for tracking the progress of all cause 

examinations, and the tracking should include the number of cause 

examinations opened, the number on-going and the number closed for each 

month. Such data should be reported at least quarterly to the OCIE Director 

and to the Securities and Exchange Commission (“SEC”) Chairman. Any 

cause examinations open for more than 180 days should be reported to the 

OCIE Director and the SEC Chairman with an explanation as to why the 

examination requires more time. 

Recommendation 33: 

The Office of Compliance Inspections and Examinations’ policies and 

procedures should clearly indicate that at the conclusion of each 

examination, the examination team must prepare a closing report (“Closing 

Memorandum”) that begins with the scope discussion from the Planning 

Memorandum, as modified by new issues that arise during the course of the 

examination. For each and every issue discussed in the scoping discussion 

in the Planning Memorandum, the Closing Memorandum should provide 

findings relevant to each issue and state the team’s conclusions. All 

members of the examination team should sign the Closing Memorandum. 
Appendix III

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Recommendation 34: 

Examination staff should not leave open any substantive issue without 

providing a sufficient basis for such a determination or a plan to pursue that 

issue at an appropriate later time. In the event that issues are unresolved or 

cannot be pursued further, examination staff should formerly refer those 

issues to the appropriate Securities and Exchange Commission staff that 

may further investigate and resolve such issues. 

Recommendation 35: 

The Office of Compliance Inspections and Examinations (“OCIE”) training 

should include instruction on personal liability, if any, assumed on the part of 

examiners for their actions in the course of performing their duties for OCIE. 

Recommendation 36: 

Office of Compliance Inspections and Examinations (“OCIE”) management 

should make clear that it will support OCIE examiners in their pursuit of 

evidence in the course of an examination, even if pursuing that evidence 

requires contacting customers or clients of the target of that examination. 

Recommendation 37: 

When an auditor’s independence is questioned in a tip or complaint, the Office of 

Compliance Inspections and Examinations should report the information, if 

deemed credible, to the appropriate state board of accountancy and to the Public 

Company Accounting Oversight Board, if applicable, in addition to considering a 

referral to the Securities and Exchange Commission’s Enforcement Division or 

other government agency.
Appendix IV

Management Comments 

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Appendix V 

OIG Response to Management’s Comments 

The Office of Inspector General (“OIG”) is pleased that the Office of Compliance 

Inspections and Examinations (“OCIE”) concurred with all 37 recommendations 

in this report. We believe that these recommendations are crucial to ensuring 

that OCIE is able to conduct thorough and effective examinations in the future. 

As the OIG Report entitled “Investigation of Failure of the SEC to Uncover 

Bernard Madoff’s Ponzi Scheme” dated August 31, 2009 detailed, OCIE received 

substantive complaints that raised significant red flags concerning Bernard L. 

Madoff’s (“Madoff”) hedge fund operations and should have led to questions 

about whether Madoff was actually engaged in trading. Moreover, the 

examinations that OCIE conducted of Madoff based upon these detailed and 

credible complaints were poorly planned and executed and were concluded while 

numerous open and unresolved questions remained. 

We believe that the immediate implementation of these recommendations should 

be OCIE’s top priority. We are encouraged that OCIE is acknowledging that 

significant changes are necessary in its operations and that it intends to 

implement all of our recommendations. We have some concerns that OCIE’s 

responses to a few of the recommendations are vague or contain 

conditions, including some which are outside of OCIE’s control such as 

resources or policy issues. 

The strength of our capital markets relies on investor confidence, which in turn 

depends on vigorous regulatory oversight. The SEC oversees inspections and 

examinations of the key participants in the securities world, including securities 

exchanges, brokers, and investment advisers. Investors will only be confident in 

entrusting their savings with these entities when they have confidence that the 

SEC’s oversight is vigorous and competent. As the OIG’s Report of Investigation 

made clear, investors relied on SEC examinations in making investment 

decisions. Specifically, investors who were uncertain about whether to invest 

with Madoff were reassured by the fact that the SEC had conducted 

examinations of Madoff’s firm and not detected fraud. Moreover, Madoff himself 

cited these examinations as evidence that he was not engaged in fraud. Thus, it 

is critical that OCIE engage in competent and thorough examinations, which, in 

our view, can be accomplished only by quickly implementing in full the 

recommendations in this report. 

We believe that these recommendations would simply ensure a basic level of 

competence in OCIE examinations and can be fully implemented in short order. 

While we understand that OCIE believes that two of the 37 recommendations 

may require additional resources, we expect OCIE to immediately implement a 

substantial portion of the two recommendations and seek additional resources to 

assist in full compliance. 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC

Report No. 468 

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Appendix V 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

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The OIG plans to follow-up to ensure that all 37 recommendations are 

implemented in full and report back to the Congress on the status of these 

efforts. We also plan to conduct a follow-up audit to determine if the changes to 

OCIE’s operations are having the desired and appropriate effect. 
Appendix VI 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 66

A Detailed Trading Volume Analysis

The following is a more detailed description of the analysis performed by the FTI 

Engagement Team to verify BMIS’ reported equity trading volume based on a 

sample of account statements and trade confirmations issued by BMIS to its 

feeder fund clients Kingate Management Ltd. (“Kingate”) and Fairfield Sentry, 

Ltd. (“Fairfield”) in 2005, in comparison to BMIS’ trade reporting data submitted to 

the NASD, as well as its clearing and settlement records provided by NSCC, for 

U.S. executions. In addition, the FTI Engagement Team compared BMIS trade 

settlement records provided by DTC for January 2005 to overnight securities 

holdings shown in BMIS account statements. This exercise is meant to illustrate 

what the OCIE examination teams would have discovered had they conducted a 

similar analysis, which may also have, depending on its results, prompted the 

OCIE examination teams to pursue additional information on European trade 

executions. 

Feeder Fund Account Statements and Trade Confirmations

The FTI Engagement Team has a sample of trading activity records as captured 

in the monthly account statements for two Kingate funds (Kingate Global Fund 

and Kingate Euro Fund) produced by BMIS from 2005: Kingate Euro Fund – 

January 2005, Kingate Global Fund – February 2005, Kingate Euro Fund – 

March 2005 and Kingate Global Fund – March 2005. Additionally, The FTI 

Engagement Team also has trade confirmations produced by BMIS to Fairfield 

from January 2005. These account statements and trade confirmations were 

acquired by the 2005 NERO Cause Examination team from BMIS in 2005. 

The monthly account statements provide only basic information, i.e., they only 

include daily trading activities throughout the month without detailing either the 

investment position or the cash balance of the two fund portfolios at any given 

time. The trading activity records in the statements also do not show the 

execution time, the execution price or the trade date of each transaction. Only 

settlement dates and average daily prices of traded stocks are provided. 

Fairfield’s trade confirmations, on the other hand, contain month-end securities 

position information in addition to daily trading activities. 

For both Kingate funds, the account statements reveal that trading was centered 

on selected S&P 100 Index stocks with a daily buy and a daily (offsetting) sell for 

each of those stocks so that by the end of a trading day, all equity positions were 

closed out. For example, on March 10, 2005, BMIS executed buy and sell 

transactions for a total of 44 stocks selected from the S&P 100 Index list for each 

of the two Kingate funds (88 stock positions in total). For each stock, the monthly 

account statements show that BMIS first established either a long or a short 
Appendix VI 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 67

position on a given trading day, and then closed out the entire position by the end 

of the trading day so that no equity position was carried overnight. 

Equity Trading – FINRA/NASD Database Comparison

The FTI Engagement Team understood that the 2004 OCIE Cause Examination 

had prepared a data request letter to the NASD but the letter was never sent. 

Based on that draft letter, during the current OIG investigation process, the FTI 

Engagement Team drafted a data request letter to FINRA’s Market Regulation 

Department and asked for NASDAQ ACT (Automatic Confirmation of 

Transactions) data29 and OATS (Order Audit Trail System) data for the relevant 

time period of March 2005 in relation to BMIS account statements for the two 

Kingate funds. In addition, at the FTI Engagement Team’s request, OIG 

obtained data from NSCC for the same time period of 2005 and selected 

securities as the data provided by FINRA. The FTI Engagement Team has 

performed a review of trading volume based on the Kingate records provided by 

BMIS from March 2005, as well as actual relevant trading data provided by 

FINRA and NSCC for the same time period. 

The trading data that would have been provided by NASD during the 2004 OCIE 

examination, the NASDAQ ACT data, however, had limitations in that most but 

not all trading activity for a given broker-dealer would bear that broker-dealer’s 

name.30 Instead of relying solely on NASD data, a better approach to analyze 

volume for U.S. trading would have been to contact NSCC, 31 as data provided 

by NSCC is more comprehensive and should include most trades executed by 

broker-dealers. Regardless, the differences in reported volume between the 

NASDAQ ACT data and the NSCC data are insignificant when compared to the 

differences in total volume between those two databases and BMIS’ reported 

volume to its feeder funds, as the FTI Engagement Team’s charts below 

illustrate. An analysis performed on trading volume using either database would 

have likely resulted in uncovering a red flag during the examinations.32

For the volume analysis, the FTI Engagement Team selected a sample of 14 

stocks out of the total 44 stocks professed to be traded by BMIS from March 10 

through March 15, 2005 (with the corresponding settlement dates from March 15 

through March 18, 2005), a total of four trading days. Of the 14 stocks, 6 were 

 

29 Also known as the trade audit trail database. 

30 In the case of BMIS, some of the trades conducted through Electronic Communication 

Networks (“ECNs”) or other exchanges by BMIS where BMIS was not a member firm were likely 

not captured by the NASDAQ ACT system. 

31 FINRA, though, would still be the preferred source for data relating to front running, best 

execution and other trading issues. 

32 The results based upon the NSCC data will be presented in the following section. 
Appendix VI 

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Report No. 468 

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listed on NASDAQ, and 8 were listed on the NYSE.33 The other 30 stocks not 

included in this analysis were all listed on the NYSE. The FTI Engagement 

Team first calculated the total share volume traded based on Kingate’s account 

statements for each of the 14 stocks on each of the four trading days. The FTI 

Engagement Team then performed the same analysis using NASDAQ ACT and 

OATS data to sum up the total volume reported by BMIS for each stock on each 

trading day.34 

BMIS reported trades to the NASDAQ ACT system for both NASDAQ-listed and 

NYSE-listed issues. BMIS was a member firm of FINRA/NASD and NASDAQ; 

however, it was not a member firm of the NYSE. As a result, BMIS would trade 

NYSE-listed issues as a NASDAQ market maker and report trades to NASDAQ 

ACT, instead of to Securities Information Automation Corporation (“SIAC”), which 

handled NYSE member firms’ reported trades.35 In contrast, the NASDAQ’s 

OATS system is only required for NASDAQ-listed issues. Therefore, using 

OATS, the FTI Engagement Team could only perform the volume analysis for the 

six NASDAQ-listed stocks included in the sample account statements as part of 

the S&P 100 Index stocks. OATS is designed so that every member firm of 

FINRA/NASDAQ would report their customer orders’ final status, which includes 

execution, cancellation, replacement, expiration or being routed to another 

member firm for execution.36 

33 The FTI Engagement Team first selected all six stocks listed on NASDAQ, then randomly 

selected another 8 stocks from a pool of 38 NYSE-listed stocks. 

34 For NASDAQ-listed stocks, all execution volume in OATS should also be reflected in ACT, 

either as tape-reported volume, or in the case of odd-lot trades (less than 100 shares), as 

clearing and settlement volume. Therefore, OATS is serving as a second check on the total 

reported volume to FINRA/NASD by BMIS for the six NASDAQ-listed stocks. 

35 Any BMIS trades that were “laid off” to NYSE member brokers and executed through the NYSE 

trading system were not captured by the ACT data, though they would have been captured by the 

NSCC database. However, the layoff volume is part of a market maker’s proprietary volume; 

therefore, the layoff volume should not have explained the large discrepancy in volume between 

customers’ account statements and ACT, as volume shown in the account statements was all 

agency-based. The layoff volume is also relatively small when compared to the overall volume. 

For example, if BMIS, as a market maker, executes a 700-share customer buy order and then 

later a 1,000-share customer sell order, the net imbalance would only be 300 shares long. 

Typically, a market maker like BMIS would attempt to sell off the 300-share position at the end of 

the trading day without having to carry the open position overnight. For a NASDAQ-listed issue, 

BMIS would have sold the 300 shares to other market makers. On the other hand, for a NYSElisted issue, while it is still possible that BMIS could have sold the position to another NASDAQ 

market maker, due to the fact that the NYSE floor had most of the liquidity, it is more likely that 

BMIS would have liquidated the position using a NYSE order-routing system via a “sponsored” 

NYSE member firm (as a non-member firm of the NYSE, in order to access the NYSE floor, BMIS 

would have to route the order flow through a NYSE member firm). 36 Member firms’ principal volume is not reportable to OATS, as OATS only requires the reporting 

of member firms’ customer order flow information. However, if an order is routed from one 

member firm’s principal account to another member firm for execution, then both firms are 

required to report that order and its status to OATS, as that order is no longer considered 

“proprietary” once routed. 
Appendix VI 

The following table summarizes the results based on the reported volume to 

NASDAQ ACT and OATS system as well as the recorded volume in Kingate’s 

account statements.37 

Table 1: Selected Stocks from Kingate’s Account Statements, 

 March 10 – March 15, 2005 

The FTI Engagement Team’s analysis shows that, for that one feeder fund alone 

(Kingate), purported trading volume in selected securities shown on BMIS 

statements significantly exceeds actual trading volume by BMIS in those 

securities, according to NASDAQ ACT data (as well as OATS data) provided by 

FINRA.38 In fact, Kingate’s volume surpassed the ACT and OATS volume for 

every single stock on every single trading day which the FTI Engagement Team 

 

37 For the analysis of the OATS data, in addition to customer order execution volume reported by 

BMIS, the FTI Engagement Team also analyzed all BMIS customer orders routed to ECNs for 

execution (e.g., Instinet, BRUT, B*Trade and TRAC, etc.). While ECNs are registered member 

firms of FINRA/NASD, in effect, ECNs are simply computerized trading systems that facilitate 

trading by ECNs’ own customers, which include market makers, order-entry brokers, institutional 

traders, day traders and other professional traders. Nevertheless, once an order is routed to an 

ECN from BMIS, instead of BMIS, the ECN assumes the responsibility to report the order status 

to OATS as a member firm of FINRA. For our purpose, however, the executed trade should still 

be credited to BMIS since it involves a customer order from BMIS. 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

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38 There are some volume discrepancies between ACT and OATS databases, mainly due to the 

differences in reporting requirements by FINRA and NASDAQ. However, the differences in 

volume are trivial when compared to the differences in volume between those two databases and 

Kingate’s account statements. 
Appendix VI 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 70

has investigated, by a factor ranging from two to as much as 12.39 In contrast, 

under normal circumstances, account statement volume would be expected to be 

lower than the reported volume to NASDAQ since the reported volume should 

also include the BMIS market making volume that was in addition to Madoff’s 

purported trading on behalf of his discretionary accounts.40 Moreover, Madoff 

eventually claimed to have executed trades for “closer to 15” feeder funds; 

therefore, the discrepancies of volume would have been even more significant 

had other feeder funds’ purported volume been factored into this analysis.41 The 

FTI Engagement Team concluded that had the examiners done a similar 

analysis, the disparity in US trading volume would have been uncovered during 

their examinations; the only other operating theory at the time to explain that 

disparity was possible additional trading on the London Stock Exchange and 

possibly other European exchanges (see Finding 8). With this analysis, then, 

and with knowledge that the European market for U.S. equities was limited, the 

examiners would have had a solid indicator to pursue information from European 

regulators and, in turn, investigate other issues such as custody and existence of 

client securities.42

Equity Trading – NSCC Database Comparison

The FTI Engagement Team also compared the same trading volume as recorded 

in Kingate’s account statements to the volume cleared and settled by NSCC on 

behalf of Madoff during the same period in March 2005. 

 

39 For example, on March 14, 2005, Kingate’s two fund statements show a total buy and sell 

trading volume of 1,643,600 shares for Oracle Corporation (“ORCL”), while the reported volume 

submitted to ACT by BMIS was only about 136,850 shares. Kingate’s recorded volume is 12 

times as large as the NASDAQ reported volume. 

40 BMIS was a market maker for the securities listed above, executing trades for other brokers 

that were separate from any investment advisory accounts; one would expect that some, if not 

most, of the volume shown in ACT would be attributable to the market-making operations. 41 Data relating to trades reported by BMIS to NASDAQ ACT or NSCC would be available only to 

the SEC, FINRA, NASDAQ and DTCC. Absent any specific legal authority, neither the BMIS 

feeder funds, nor their advisors and auditors, would have had access to the trade execution data 

needed to prepare an analysis similar to that which the FTI Engagement Team performed for this 

report. 

42 Examiners would also have a strong case for following up with European regulators to obtain 

data on BMIS foreign trades. 
Appendix VI 

Table 2: Kingate’s Volume Compared to BMIS’ Officially Cleared 

 and Settled Volume, March 10 – March 15, 2005 

Similar to the results above, purported trading volume for the Kingate funds 

significantly exceeded actual trading volume by BMIS in those securities, as 

cleared by NSCC. Likewise, had the FTI Engagement Team included other 

feeder funds’ purported trading volume, as well as deducted Madoff’s actual 

market making volume from the NSCC cleared volume, the divergence of volume 

would be even more obvious and substantial. 

Equity Positions – DTC Database Comparison

Finally, the FTI Engagement Team also compared BMIS’ securities position 

holdings as reported by DTC to the overnight equity position of Fairfield, based 

on a sample of trade confirmations issued by BMIS to Fairfield in January 2005. 

Based on the FTI Engagement Team’s research, BMIS did not hold billions of 

dollars of S&P 100 equities for Fairfield, as listed on the account statements. For 

example, as the chart below illustrates, on January 26, 2005, DTC records 

showed that the BMIS account held a total of 90,200 shares of the aboveReview and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 71
Appendix VI 

mentioned 14 S&P 100 equities in the DTC account.43 On the contrary, the trade 

confirmation statements produced by BMIS for Fairfield show total holdings of 

35,682,300 shares for those same 14 stocks as of January 26, 2005, which 

exceeded the shares recorded in DTC by a factor of almost 400.44 This finding 

would likely have led SEC examiners to make further inquiries into positions held 

with any foreign custodians, such as Barclays.45

Table 3: Feeder Fund’s Equity Positions Compared to BMIS’ DTC 

Positions, Selected S&P 100 Stocks – January 26, 2005 

 

43 Most of the shares held by BMIS at DTC were likely related to BMIS market-making positions 

only. The FTI Engagement Team concluded that the DTC records would have included 

additional shares held by BMIS for its investors had Madoff conducted genuine trades in U.S. 

markets for those investors because BMIS was acting as their custodian. 44 The trade confirmations only provide the asset positions for Fairfield as of the month end date 

of January 31, 2005. The FTI Engagement Team netted out the trading activities between 

January 26 and January 31 to arrive at the asset positions as of January 26, 2005. 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

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45 OCIE’s IA/IC intranet currently includes an examination module titled “Account Statements 

Sent By Third Party” dated July 2008, which addresses issues associated with reconciling 

account statements sent by investment advisers with statements sent to customers from outside 

custodians, although it notes “If client does not receive an account statement from an 

independent third party, then they would not be able to detect problems or errors or fraud in their 

account.” 
Appendix VI 

Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC September 29, 2009 

Report No. 468 

Page 73

After Hour Trading

Both the FINRA/NASD data and DTC/NSCC data would omit any trading in 

European markets. During the 2005 NERO Cause Examination, according the 

OIG’s Report of Investigation, Madoff told the SEC onsite examiners that BMIS 

executed trades for institutional clients in Europe before the 9:30 opening of the 

U.S. equity markets. In order to verify BMIS’ trades on European markets, the 

OCIE examiners would likely have had to make follow-up requests to European 

entities and perform additional analyses to draw definitive conclusions as to the 

existence of fictitious trades or a Ponzi scheme. 

Nevertheless, ordinarily only a small percentage of volume for S&P 100 stocks 

was traded during after hours in Europe before the U.S. markets were open. 

After-hour markets for US stocks traded in both U.S. and Europe were viewed as 

illiquid.46 Additionally, even though a regular trading day on NASDAQ starts at 

9:30 am in the morning and ends at 4:00 pm in the afternoon, a market maker, 

such as BMIS, could continue to trade after hours on NASDAQ using NASDAQ 

trading systems or other proprietary trading systems and report trades to the 

ACT database. In fact, the NASDAQ ACT system accepted trade reporting from 

8:00 am in the morning until 6:30 pm in the afternoon during the early 2000s. 

Furthermore, even with the time differential, the normal trading session for the 

London Stock Exchange (“LSE”), for example, only ran from 4:00 am EST 

through 11:30 am EST, which only added an extra four hours from 4:00 am 

through 8:00 am before NASDAQ ACT and other proprietary trading systems 

opened. It was not likely that BMIS would transact several hundred thousand 

shares of volume for each individual stock on each day, as it purported to do for 

its investment adviser accounts, between 4:00 am and 8:00 am on a European 

exchange when the market for this time period is viewed by the industry as 

illiquid.47

 

46 See “After-Hours Trading: Understanding the Risks” 

http://www.sec.gov/investor/pubs/afterhours.htm. 47 The same conclusion applies to trading of OEX options during after hours. 
Table 4: Kingate Funds Advised by Madoff – Selected Stocks,  March 10 – March 15, 2005Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC 

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Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC 

Report No. 468 

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Review and Analysis of OCIE Examinations of Madoff Investment Securities, LLC Report No. 468 

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Table 5: Madoff’s Trading Volume from OATS, Six Stocks: Microsoft,  Intel, Dell, Oracle, Amgen and Cisco, March 10 – March 15, 2005 
Audit Requests and Ideas 

The Office of Inspector General welcomes your input. If you would like to 

request an audit in the future or have an audit idea, please contact us at: 

U.S. Securities and Exchange Commission 

Office of Inspector General 

Attn: Assistant Inspector General, Audits (Audit Request/Idea) 

100 F Street, N.E. 

Washington D.C. 20549-2736 

Tel. #: 202-551-6061 

Fax #: 202-772-9265 

Email: oig@sec.gov 

Hotline 

To report fraud, waste, abuse, and mismanagement at SEC, 

contact the Office of Inspector General at: 

Phone: 877.442.0854 

Web-Based Hotline Complaint Form: 

www.reportlineweb.com/sec_oig