U.S. Securities and Exchange Commission 

Office of Investigations 

Investigation of Failure 

of the SEC to Uncover 

Bernard Madoff’s Ponzi Scheme 

- Public Version -

August 31, 2009 

Report No. OIG-509 
Report of Investigation 

Case No. OIG-509 

- Public Version -

Table of Contents
 

Page 

Introduction....................................................................................................................1
 

Scope of the Investigation..............................................................................................3 

I. Document Preservation and Meetings with 

 Senior-Level Officials....................................................................................3 

II. E-mail Searches and Reviews of E-mails ......................................................3 

III.	 Document Requests and Review of Records.................................................4 

IV. Document and Information Requests to 

 Independent Third-Parties..............................................................................5 

V. Retention of Expert in Analyzing Examination 

and Investigatory Work..................................................................................5 

VI. Retention of Expert in Recovering E-mails...................................................6 

VII. Testimony and Interviews..............................................................................7 

Executive Summary.......................................................................................................20
 

Results of the Investigation ...........................................................................................42
 

I. SEC 1992 INVESTIGATION OF AVELLINO & BIENES.........................42 

A. Customers Complained about Avellino & Bienes’ 

 Investments ..............................................................................................42 

B. SEC Contacted Avellino and Suspected that Avellino & 

Bienes Was Selling Unregistered Securities and Running 

A Ponzi Scheme.......................................................................................44 

C. Counsel for Avellino & Bienes Contacted the SEC and 

Avellino and Bienes Came in for Voluntary Joint Testimony.................45 

D. The SEC Conducted a Brief, Limited Cause Examination of 

Madoff .....................................................................................................47 

1.	 The Examination was Conducted by a Relatively 

Inexperienced Team and Its Scope was Limited ........................47 

i 
2.	 A Net Capital Review was Performed and the SEC 

Examiners Sought DTC Records From Madoff, 

Not from DTC directly.................................................................48 

3.	 The Examiners Never Looked into Where the Money That 

Was Used to Pay Back Avellino & Bienes’ Investors 

Came From...................................................................................49 

4. The Examiners Were Aware of Madoff’s Stature .......................50 

E. The SEC Filed a Complaint against Avellino & Bienes for 

Selling Unregistered Securities, But the Complaint Did 

Not Allege Fraud and Did Not Assert Any Claims Against 

Madoff. ....................................................................................................50 

F. The Trustee Retained Price Waterhouse to Conduct an 

Audit of Avellino & Bienes’ Financial Statements and 

Conducted Discovery But Its Jurisdiction was Limited .........................53 

G. Price Waterhouse Experienced Great Difficulties in 

Conducting its Audit of Avellino & Bienes’ Financial 

Statements and a Request was made to the Presiding 

Judge for Additional Time .......................................................................55 

H. After the Request for Additional Time was Denied, Price 

Waterhouse Issued its Report But was Unable to Render an 

Opinion on Avellino & Bienes’ Financial Statements.............................56 

I. The SEC Conducted Limited Discovery About Madoff 

But Avellino & Bienes Objected Aggressively and it is 

Unclear if the SEC Obtained any Relevant Information ........................57 

J. A Final Judgment of Permanent Injunction was Entered on 

Consent Against the Defendants, Penalties were Assessed 

And the Investigation was Closed............................................................58 

K. Conclusion ...............................................................................................59 

II. SEC REVIEW OF 2000 AND 2001 MARKOPOLOS 

COMPLAINTS..............................................................................................61 

A. Markopolos Approached the SEC’s Boston Office in May 

2000 with Evidence that Madoff was Operating a Ponzi 

 Scheme.....................................................................................................61 

1. The 2000 Submission...................................................................61 

2. Markopolos Met with Grant Ward, a Senior SEC 

 Enforcement Official ...................................................................63 

3. Ward Decided Not to Pursue the 2000 Submission.....................64 

4. Ward’s Testimony Regarding the 2000 Submission 

is Suspect .....................................................................................65 

ii 
B. Markopolos Made a Second Submission to the 

Boston Office in March 2001 ..................................................................67 

1. The 2001 Submission...................................................................67 

2. Boston Forwarded the 2001 Submission to NERO .....................70 

3. NERO Decided Not to Investigate Madoff Only One 

Day After Receiving the 2001 Submission..................................71 

4. Two Articles Were Published in May 2001 

Questioning the Legitimacy of Madoff’s Returns .......................74 

5. NERO Did Not Reconsider Its Decision Not to 

Investigate Madoff After Publication of the Articles ..................76 

III.	 SEC 2004 OCIE WASHINGTON DC CAUSE 

EXAMINATION OF MADOFF ...................................................................77 

A. An Employee of a Registered Hedge Fund Provided 

The OCIE Investment Management Group With A 

Detailed Complaint About Madoff ..........................................................77 

1. During Due Diligence of Madoff Feeder Funds, 

Fund Managers Identified Red Flags in Madoff’s 

Representations ...........................................................................78 

2. MarHedge Article Raised Red Flags About 

Madoff’s Returns .........................................................................80 

3. Investment Management Examiners Would have 

Validated Madoff’s Returns.........................................................82 

4. Investment Management Examination Group 

Referred the Complaint to the Broker-Dealer/ 

Self-Regulatory Organization Examination Group .....................82 

5. SRO Group Received the Complaint No Later 

Than the Fall of 2003...................................................................84 

6. OCIE’s SRO Examination Group Had No Policies 

Or Procedures for Handling Tips or Complaints .........................85 

7. OCIE Received Another Tip About Madoff in 

 December 2003 ............................................................................85 

8. It Appears Richards First Sent McCarthy the 

Barron’s Article About Madoff in 2001 ......................................86 

9. Richards and McCarthy Called Madoff Prior to 

OCIE’s Examination....................................................................87 

B. SRO Group Began Planning Its Examination of Madoff in 

 December 2003 ........................................................................................89 

iii 
 

 

 

1. The Madoff Examination Team Consisted Entirely of 

Attorneys......................................................................................89 

2. OCIE Expanded Rapidly and Lacked Trained 

Examiners ....................................................................................90 

3. SRO Group Chose Not To Include Investment 

Management Examiners on Examination Team..........................91 

4. Examination Planning Memorandum Stated Trading 

Data Would be Sought From the NASD......................................92 

5. McCarthy Focused the Examination on Front-Running..............93 

6. Swanson Acknowledged in Testimony that If He Had 

Carefully Reviewed the Complaint, He Would Have 

Investigated Additional Red Flags That Were Raised ................95 

7. Donohue Acknowledged Issues Raised in the Hedge 

Fund Manager’s Complaint Other Than Front-running 

Should Have Been Investigated...................................................95 

8. The Examination Did Not Focus on Red Flags 

Raised in MarHedge Article About Madoff’s Trades 

Not Being Seen in the Market......................................................96 

9. Investment Management Examiners Did Not Read the 

Complaint’s Main Focus to be Front-running .............................96 

C. Conduct of the Examination ....................................................................97 

1. Examination Team Did Not Send Draft Letter to NASD............97 

2. OCIE Examiners Did Not Request Documents from
 

Madoff Feeder Funds...................................................................98 

3. Draft OCIE Document Request Referenced Madoff’s 

Call with Richards and McCarthy................................................99 

4. After Sending OCIE Document Request, Swanson 

Discussed Request with Madoff ..................................................99 

5. Documents and Information Madoff Produced 

Contradicted the 2001 Articles and the 2003 

Complaint, But OCIE Did Not Seek to Verify the
 

Accuracy of Madoff’s Representations ......................................100 

6. Exam Team Spoke to the Hedge Fund Manager Who 

Submitted the Complaint and Conveyed Concerns 

About Madoff, Including Inexplicable Returns and 

Options Trading ...........................................................................101 

7. Examination Team Analyzed Data and Detected 

Inconsistencies .............................................................................103 

iv 
8. Examiners Discovered Madoff was Making More 

Money from Hedge Funds than Through Market 

Making .........................................................................................103 

9. Examination Team Contacted Madoff About Open 

Issues............................................................................................104 

10. Examination was Expanded to Examine Whether 

Madoff was Acting as an Investment Adviser.............................105 

11. Examination Team Never Resolved Question of 

Whether Madoff Was Acting as an Investment 

Adviser ........................................................................................108 

12. Examiners Did Not Request Audit Trail Data from 

Madoff in Supplementary Document Request.............................108 

13. Examination Team Failed to Request Data from Any 

Independent Third-Party ..............................................................109 

14. Donohue was Promoted to Assistant Director and 

Took Over Primary Responsibility for the 

Examination .................................................................................111 

15. Madoff’s Responses to the Document Request Led 

To Additional Questions and Concerns .......................................112 

16. Follow-Up Call With Madoff Did Not Resolve 

Examination Teams Open Questions...........................................115 

17. Walker Raised Additional Questions About the 

Information Produced by Madoff ................................................117 

18. Hostility Arose Between Donohue and Walker...........................120 

19. After Donohue Reviewed the Data Madoff Produced, 

He Had Numerous Unanswered Questions..................................122 

20. After Reviewing the Data Madoff Provided, Walker 

Also Had Additional Unanswered Questions ..............................124 

D. The Madoff Examination was Halted......................................................125 

1. Examiners Stopped Working on Madoff Examination 

To Focus on Mutual Fund Project ...............................................125 

2. Not Unusual to Shift Attention to High Priority 

Projects in OCIE and Leave Some Projects Incomplete..............126 

3. OCIE Performed Only 11⁄2 More Days of Work on 

 Madoff Examination ...................................................................128 

4. Madoff Examination Put on the Backburner 

While Exam Team Still Had Unresolved 

Questions .....................................................................................128 

v 
5. Swanson Told Kelly the Examination Was 

Ongoing After the Team Had Stopped Working on the 

Examination .................................................................................129 

6. Eleven Months After the Examination Was Set Aside, 

Swanson Asked Donohue About the Examination 

After Seeing Shana Madoff at a Conference; 

Donohue Said Examination Was “Deady” .................................130 

7. OCIE Examination Was Still Inactive When NERO 

Told OCIE They Had Also Been Conducting A Cause 

Examination of Madoff ...............................................................131 

E. OCIE and NERO Learned of Their Parallel Examinations 

From Madoff............................................................................................132 

1. OCIE and NERO Had Been Unaware That Were 

Both Conducting Madoff Examinations ......................................132 

2. OCIE Had Conference Calls with NERO About 

Madoff..........................................................................................134 

3. NERO Examiners Recalled OCIE Warned them 

Madoff Was a Powerful and Influential Person...........................135 

4. When OCIE Sent Examination Documents to NERO 

In June 2005, the Examination Was Unresolved.........................135 

F. The OCIE Examination Concluded Without a Closing 

Report ......................................................................................................136 

G. Summary of FTI Engagement Team Expert Analysis.............................138 

1. OCIE’s Analysis of the Complaint Was Inadequate 

For a Number of Reasons ............................................................138 

2. The Team Assembled for Cause Examination was 

Inadequately Experienced in Investment 

Management Issues......................................................................141 

3. The Start of the Examination Should Not Have Been 

Delayed for Seven Months...........................................................142 

4. The Examination Should Have Been Logged Into the 

STARS System ............................................................................142 

5. The Planning Memorandum Was Too Narrowly 

Focused and Not All Courses of Action Were 

Followed Through Upon..............................................................142 

6. There Were Numerous Red Flags in the Course of 

The Examination that Were Not Pursued ....................................143 

7. SEC Offices Failed to Communicate...........................................144 

8. The Investment Adviser Issue Was Never Resolved ..................144 

vi 
 

9. FTI Engagement Team Conclusion .............................................145 

IV. SEC 2005 NERO EXAMINATION OF MADOFF .....................................145 

A.	 NERO Investment Adviser Examiner Discovered 

Renaissance Technologies E-mails Questioning Whether 

Madoff Was Involved in Illegal Activity.................................................145 

B.	 Renaissance Employees Suspected Madoff Was
 

Misrepresenting His Trading ...................................................................149 

1.	 Madoff’s Secrecy, Auditor, and Non-volatile 

Returns Were Significant Red Flags............................................149 

2.	 Madoff’s Fee Structure Was a Significant Red Flag ...................150 

3.	 Renaissance Examined Madoff’s Reported Equity 

And Options Trading Using Widely Available 

Information ..................................................................................151 

4.	 Madoff’s Stock Predictions Were Too Good to Be 

True ..............................................................................................151 

5.	 Cherry Picking Was an Unlikely Explanation for 

Madoff’s Incredible Fills .............................................................152 

6.	 Madoff Was Misrepresenting His Options Trading.....................153 

7.	 Renaissance Employees Felt the SEC Could Have 

Verified Whether Madoff Was Trading Options By 

Taking Elementary Steps .............................................................153 

8.	 The SEC Had the Expertise to Perform Broder’s 

Analysis .......................................................................................155 

9.	 Front-Running Would Not Have Answered All of 

The Questions in the Renaissance E-mails ..................................157 

10.	 Renaissance Relied on Prior SEC Examination in 

Making the Decision to Retain Part of Their Madoff 

Investment....................................................................................157 

C. Renaissance E-mails Raised Significant Red Flags For 

Investment Management Examiners .......................................................158 

D. NERO Investment Adviser Examination Group Referred 

E-mails Implying Madoff is Involved in Illegal Activity to 

NERO Broker-Dealer Examination Group..............................................160 

E. Examination of Madoff Was Commenced ..............................................161 

1. Examination Team of Non-Attorneys Was Chosen.....................161 

2. Joint Examination with Investment Management 

Examiners Was Not Considered ..................................................163 

vii 
3. Team Began Background Work in Preparation for 

On-site Examination Ten Months After Referral ........................164 

4. No Planning Memorandum Was Drafted Describing 

Focus and Scope of the Examination...........................................166 

5. Nee Determined the Renaissance E-mails Only Raised 

Issues Related to Front-Running and Cherry Picking..................167 

6. Madoff’s Unusually Consistent Returns Were Not 

Focused on In the Examination....................................................168 

7. Examiners Were Still Suspicious of Madoff’s 

Unusually Consistent Returns at the End of the 

Examination .................................................................................170 

8.	 Madoff’s Options Trading Was Not A Focus of the 

Examination .................................................................................171 

a. Examiners Investigated Madoff’s Options 

Trading Solely By Relying on Madoff’s 

Representation That He Stopped Trading 

Options.............................................................................172 

9.	 Madoff’s Fee Structure Was Not A Focus of the 

 Examination .................................................................................172 

a.	 The SEC Examined Madoff’s Fee Structure 

Solely by Asking Madoff About It and 

Relying on His Response.................................................172 

10.	 Madoff’s Auditor Was Not Looked Into During the 

Examination .................................................................................173 

11.	 The Examination Team Did Not Contact 

Renaissance..................................................................................174 

F. Examiners Performed Pre-examination Work.........................................175 

1. Examiners Reviewed Articles about Madoff’s 

Stature in the Industry..................................................................175 

2. NASD Reports of BMIS Did Not Mention Madoff’s 

 Advisory Accounts.......................................................................175 

3. Examiners Accepted Madoff’s Explanation for 

 Relationship With Cohmad Securities.........................................177 

4. Document Request Did Not Contain a Request for 

 Trade Data....................................................................................178 

G. NERO On-Site Examination Began Almost a Year After 

Referral was Made ...................................................................................179 

1. Bernard Madoff was the Examiners’ Exclusive 

Contact at BMIS ..........................................................................179 

viii 
 

 

2. Madoff Attempted To Intimidate and Impress 

 Examiners ....................................................................................180 

3. Despite the Evidence, Madoff Would Not Admit To 

Managing Money for Hedge Funds .............................................182 

4. Madoff Became Difficult for Examiners to Deal
 

With NERO Supervisors Did Not Push Back .............................183 

5. Examiners Noticed Madoff’s Representations Contradicted 

News Reports and Noted “Weird Descriptions” in Books 

and Records..................................................................................187 

6. Nee Sent Document Request to Barclays, and 

Barclays Responded There Was No Trading in 

Madoff’s Account ........................................................................188 

7. Madoff Continued to Press Examiners to Finish the 

Examination and Produced A Limited Amount of 

 Trading Data ................................................................................190 

8.	 Examination Team Did Not Go to an Independent 

Source for Trading Data...............................................................191 

9.	 Madoff Finally Confessed to Executing Trades for a Small 

Number of Institutional Clients ...................................................193 

H. Examiners Learned from Madoff that OCIE Had 

Been Conducting Its Own Examination of Madoff ...............................195 

I. 2003-2004 OCIE Examination Finished Without 

Conclusions..............................................................................................198 

1. OCIE and NERO Had a Conference Call ...................................198 

2. OCIE Told NERO that Madoff was Powerful and 

Well-Connected ...........................................................................199 

3. OCIE Sent Their Examination Papers to NERO .........................200 

J. NERO Examination Continued................................................................201 

1.	 Madoff Failed to Produce Correspondence, E-mail 

And Other Documents Requested by the 

 Examination Team ......................................................................201 

2.	 Questions About Trade Executions and Clearance 

 Were Never Resolved .................................................................203 

3.	 The Examiners Investigated How Madoff Executed 

And Cleared Trades by Asking Madoff and Relying 

On His Responses .......................................................................204 

4.	 According to Associate Director Sollazzo, The Key 

To Uncovering the Ponzi Scheme Would Have Been 

Going to Third Parties .................................................................206 

ix 
 

 

 

 

5.	 Examiners Identified Additional Discrepancies ..........................207 

6.	 Examiners Tested Madoff’s Truthfulness ...................................207 

7.	 The Account Numbers Madoff Produced Were 

 Suspicious to Examiners..............................................................209 

8.	 Examiners Were Skeptical of Madoff’s Claim to 

Time the Market Using His “Gut Feel” ......................................210 

9.	 Madoff’s Statement Were as “Clear as Mud” to 

 Examiners ....................................................................................211 

10.	 The Examiners Learned Madoff Was Required to 

Produce All Documents to the SEC.............................................211 

11.	 Examiners Preliminarily Determined Madoff Was 

 Not Front-Running.......................................................................212 

12.	 Examiners Did not Contact the Feeder Funds 

 Madoff Disclosed.........................................................................213 

13.	 The Examiners Learned that BMIS’s Market Maker 

Would be Losing Money Without the Hedge Fund 

Business .......................................................................................214 

14.	 Issues Regarding the Status of BMIS’s London 

Office and Whether Madoff Should Register as an 

Investment Adviser Were Not Resolved......................................215 

15.	 Examiners Were Told To Keep Their “Eyes On 

 The Prize” ...................................................................................215 

16.	 There was Pressure on the Examination Program to 

Complete a Large Number of Examinations Each 

Year..............................................................................................217 

17.	 Examiners Thought Madoff Had Lied to Them; Nee 

Played Down Madoff’s Misrepresentations.................................218
 

18.	 Nee Did Not Allow the Examiners to Visit Feeder

 Funds............................................................................................219 

19.	 Examiners Were Not Allowed to Visit Feeder Funds, 

In Part Due to Fear of Lawsuits ...................................................220 

20.	 Time for the Madoff Examination Had Expired..........................223 

K. The Examination was Concluded ...........................................................224 

1. The Examination Team Never Understood How 

 Madoff Was Acheiving His Returns............................................224 

2. When Examiners Finished the Examination, They 

Still Had Open Questions About Madoff.....................................225 

x 
 

3. Examination Report Recited Information Provided By 

Madoff..........................................................................................226 

4. Examination Report Did Not Describe Madoff’s 

Misrepresentations to Examiners or The Issues That 

 Remained Unresolved..................................................................227 

L. Lamore is Promoted, In Part, Based on The Madoff 

 Examination ............................................................................................228 

M. Summary of FTI Engagement Team Expert Analysis.............................229 

1. The Focus of the Exam Was Chosen In Error .............................229 

2. The Team Was Inadequately Staffed and 

Examination Should Not Have Been Delayed A 

Year..............................................................................................231 

3. The Conduct of the Examination Was Flawed ............................231 

4. There Was Little Communication Between Offices....................233 

5. Red Flags That Arose in the Examination Were Not 

Pursued.........................................................................................234 

6. The Examination Concluded with Unresolved Issues .................234 

7. FTI Engagement Team Conclusion .............................................235 

V. SEC 2006 INVESTIGATION OF MARKOPOLOS COMPLAINT ...........235 

A. Markopolos Made a Third Submission to the Boston Office 

In October 2005 .......................................................................................235 

1. Markopolos and His Team Continued to Gather 

Information About Madoff ..........................................................235 

2. The 2005 Submission...................................................................237 

3. The Boston and New York SEC Offices Reacted 

Very Differently to the 2005 Submission ....................................240 

a. The BDO Thought the 2005 Submission 

Warranted an Investigation ..................................................240 

b. The BDO Forwarded the 2005 Submission to 

NERO.....................................................................................242 

4. NERO was Skeptical About the 2005 Submission......................244 

a. The Matter was Assigned to a Relatively 

Inexperienced Team, Particularly with Respect to 

Conducting Ponzi Scheme Investigations..............................244 

xi 
 

 

 

 

b. The Enforcement Staff Assigned to the Matter 

Gave Little Weight to the 2005 Submission’s 

Evidence that Madoff was Operating a Ponzi 

Scheme...................................................................................247 

(1). The Enforcement Staff Considered the 

Evidence of Little Value Because Markopolos 

Was Not a Madoff Investor or Someone 

Personally Involved in the Alleged Ponzi 

 Scheme.............................................................................247 

(2). The Enforcement Staff Questioned 

Markopolos’ Credibility because of his 

 Perceived Self-Interest.....................................................249 

(3). Several Other Sources Raised Similar 

Concerns That Madoff Was Operating a 

 Ponzi Scheme...................................................................251 

(4). NERO’s Examination Staff Initially Misled 

Enforcement Staff Regarding the Scope of the 

 Recent Exam ....................................................................255 

(5). Enforcement Staff Knew that, Irrespective of 

Their Initial Representations, the Examination 

Staff Had Not Looked for Evidence that 

Madoff Was Operating a Ponzi Scheme..........................259 

(6). The Enforcement Staff Concluded that Madoff 

Did Not Fit the “Profile” of a Ponzi Scheme

 Operator ...........................................................................261 

5. The Enforcement Staff Delayed Opening a Matter 

Under Inquiry (MUI) 262 

a. The Madoff MUI was Not Opened Until January 

2006..............................................................................................262 

b. As a Result of the Delay in Opening a MUI, The 

Enforcement Staff Never Learned of a Tip From 

A Madoff Investor Who Suspected That Madoff 

Was Operating a Ponzi Scheme...................................................264 

6. The Enforcement Staff Investigated Madoff, But 

Focused on Issues Unrelated to a Ponzi Scheme

 Investigation.................................................................................266 

a. The Focus of the Investigation Was on Whether 

Madoff Should Register as an Investment Adviser 

And Whether His Hedge Fund Clients Were 

Adequately Disclosing Madoff’s Role to Investors.....................266 

xii 
 

b. The Investigation Focused on Reviewing Records 

Created by Madoff Without Verifying Those 

Records Through Independent Sources .......................................269 

(1). In December 2005, the Enforcement Staff 

Reviewed Documents Produced By Madoff’s 

Largest Hedge Fund Investor...........................................269 

(2). The Documents from Fairfield Demonstrated 

That Madoff Had Lied to the Examination 

 Staff..................................................................................271 

(3). In December 2005, Enforcement Staff Did 

Not Exhibit an Interest in Additional 

Information Offered by Markopolos................................274 

(4). In December 2005, the Enforcement Staff 

Interviewed an Executive from Fairfield and 

Became More Convinced that Madoff Had 

Lied to the Examination Staff ..........................................276 

(5). In January 2006, the Enforcement Staff 

Reviewed Documents Produced by Madoff ....................280 

(6). The Enforcement Staff Was Not Suspicious 

When Madoff Did Not Produce Documents 

Related to His Claimed OTC Options 

 Contracts ..........................................................................284 

(7). The MUI Was Converted to an Informal 

Investigation in January 2006 ..........................................286 

(8). Madoff’s “Right-Hand Man” and a Founding 

Partner of Fairfield Testified in January 2006, 

Raising More Questions That Were Never 

 Resolved...........................................................................289 

(9). In February 2006, Madoff Produced 

Documents Identifying Clearing Entities and 

Counterparties for His Purported Equities 

And Options Trades .........................................................294 

(10). In February 2006 and April 2006, 

Enforcement Staff Sought Assistance from 

The Office of Economic Analysis (OEA) .......................295 

(11). In April 2006, Enforcement Staff Decided 

That Madoff Should Register as an 

 Investment Adviser ..........................................................301 

(12). In May 2006, Enforcement Staff Considered 

Verifying Madoff’s Trades with Third Parties ................303 

xiii 
(13).	 Despite the Enforcement Staff’s Confusion 

About Madoff’s Operations, They Never 

Sought Information or Assistance from the 

SEC’s Division of Market Regulation .............................305 

(14).	 Enforcement Staff Learned from NASD that 

Madoff Had Not Reported Holding Any 

Options Positions, but Failed to Pursue that 

 Information ......................................................................306 

(15).	 Enforcement Staff Contacted an NASD 

Options Expert Who Advised them to 

Postpone Madoff’s Testimony because of 

Their Lack of Understanding about Options ...................309 

c. Madoff Testified on May 19, 2006..............................................310 

(1). Madoff Attributed His Consistently High 

Returns to His Personal “Feel” for Timing 

 The Market.......................................................................310 

(2). Madoff Testified That All Equity Trades for 

His Advisory Investors Were Settled in His 

 DTC Account...................................................................312 

(3).	 Contrary to His Previous Representations, 

Madoff Testified That He Had Documents 

Related to His OTC Option Contracts, but 

Enforcement Staff Did Not Insist That He 

Produce Those Documents ............................................313 

(4). Madoff Contradicted his Representations to 

The Examination Staff Regarding Where the 

Equity Trades were Executed and Cleared ......................315 

(5). Madoff’s Denial that he had Lied to the 

Examination Staff about his Purported Options 

Trading Activity was not Credible...................................317 

(6). During Madoff’s Testimony, Enforcement 

Staff Caught Madoff Lying about the Number 

And Identity of his Investors............................................319 

d. Enforcement Staff Contacted DTC but Decided to 

Not Request Any Records ...........................................................323 

e. Enforcement Staff Halted Efforts to Obtain Records 

From Madoff’s Purported Option Counter-parties .....................334 

f. Enforcement Staff Never Thought to Trace the 

Movement of the Investors’ Funds ..............................................342 

xiv 
g. The Investigation Effectively Stopped in August 

2006 After Madoff Agreed to Register as an 

 Investment Adviser ......................................................................348 

h. Enforcement Staff Officially Closed the 

Investigation in January 2008, Characterizing it as a 

 “Fishing Expedition” ..................................................................350 

(1). The Enforcement Staff Ignored Additional, 

Troubling Information About Madoff While 

the Investigation Was Inactive for 18 Months.................352 

(2). The Madoff Investigation Officially Closed in 

January 2008, Although Enforcement Staff 

 Recognized that Madoff Had Lied About His 

 Advisory Business ...........................................................356 

B. In March 2008, Enforcement Staff Received a Second Tip 

Regarding Norman Levy that may have Come From a Madoff 

Insider ......................................................................................................358 

1. Suh and Cheung’s Work on the Madoff 

Investigation Are Cited in their Evaluations................................360 

C. In April 2008, Markopolos Attempted to Send a Version of the 

2005 Submission to the SEC’s Office of Risk Assessment, but it 

Was Not Received....................................................................................361 

D. Enforcement Staff’s Reflections .............................................................363 

E. Factors in the SEC’s Failure to Discover Madoff’s Ponzi Scheme .........368 

VI. ALLEGATIONS OF IMPROPER INFLUENCE, 

 INTERACTIONS BETWEEN MADOFF AND THE SEC 

AND THE EFFECT OF MADOFF’S STATURE AND 

REPUTATION ON SEC EXAMINATIONS AND 

INVESTIGATIONS ......................................................................................373 

A.	 The OIG Investigation Found No Evidence of Improper 

Influence by Senior SEC Officials Based upon Their 

Relationships with Madoff.......................................................................373 

B.	 The OIG Found that Madoff Participated in SEC Panels and 

Events and Communicated with SEC Chairmen, and that 

SEC Officials Participated in Conferences Arranged by 

Shana Madoff ..........................................................................................377 

C.	 The OIG Investigation Found that the SEC Secured an 

Exemption from a Short Sale rule for Bernard Madoff’s firm ...............379 

D.	 The OIG Investigation Found that on Occasion Over the 

Years, the SEC Visited Madoff’s Firm’s Offices as Part of 

Official SEC Events.................................................................................381 

xv 
 

E.	 The OIG Investigation Found no Evidence of Inappropriate 

Financial or Other Relationships with Madoff, But Did Find 

That Madoff Used His Stature in the Industry to Try to 

Intimidate the SEC staffers and His Stature Played an 

Ancillary Role in the Conduct of Their Examination and 

 Investigatory Work. ................................................................................382 

1.	 No Evidence of Improper Financial or Other 

Connections Between Examiners and 

Investigators and Madoff .......................................................382 

2.	 Evidence of Awareness by Examiners and 

Investigators of Madoff’s Stature and Ancillary 

Role His Stature Played in their Work...................................382 

a.	 Introduction................................................................382 

b.	 1992 Investigation of Avellino & Bienes ..................383 

c.	 2003 DC OCIE Examination .....................................383 

d.	 2005 NERO Examination ..........................................384 

e.	 2005-2006 Enforcement Investigation.......................388 

f.	 Conclusion .................................................................389 

VII. ALLEGATIONS OF CONFLICT OF INTEREST OR 

IMPROPER INFLUENCE ARISING FROM THE 

RELATIONSHIP BETWEEN ERIC SWANSON AND 

SHANA MADOFF ........................................................................................389
 

A.	 Introduction..............................................................................................389 

B.	 Swanson’s Initial Contact with Shana Madoff .......................................390 

C.	 Swanson’s First in-Person Meeting with Shana Madoff .........................391 

D.	 Swanson’s Further Contacts with Shana Madoff at SIAB 

Conferences..............................................................................................393 

E.	 Swanson’s Romantic Relationships Between 2003 and 2005 ................397 

F. In February 2006, Swanson Learned About the Enforcement 

Investigation and Was Asked to “Put the Squeeze on Shana” ................399 

G. Swanson and Shana Madoff Became Romantically Involved 

In Early 2006 ..........................................................................................401 

H. Swanson’s Supervisor, John McCarthy, Opposed the 

Relationship and Swanson Kept it a Secret .............................................402 

I. Swanson’s Recusal from Madoff Matters................................................404 

J. McCarthy Cancelled April 2006 Greenwich SIAB 

Conference ...............................................................................................405 

xvi 
 

 

K. Swanson and Shana’s Relationship Continued and Swanson 

 Left the SEC.............................................................................................406 

L. Swanson’s Reaction to Learning Madoff Confessed to Ponzi 

Scheme.....................................................................................................408 

M.	 Conclusion ...............................................................................................408 

VIII. PRIVATE ENTITIES’ DUE DILIGENCE EFFORTS 

 REVEALED SUSPICIOUS ACTIVITY AND RED FLAGS 

 ABOUT MADOFF’S OPERATIONS...........................................................411 

A.	 Introduction..............................................................................................411 

B.	 There Were Rumors and Suspicion about Madoff in the 

Industry Even Before Due Diligence was Initiated .................................411 

C.	 Due Diligence Efforts of Private Entities Revealed Greater
 

Suspicions and Numerous Red Flags.......................................................412 

1.	 Basic Due Diligence Activities....................................................412 

2.	 There Were Immediate Questions about Madoff’s 

Trading Strategy ..........................................................................413 

3.	 There Were Immediate Questions about Madoff’s 

Trading Strategy ..........................................................................417 

4.	 There Were Also Questions About Madoff’s Fee 

Structure.......................................................................................418 

5.	 The Identity of Madoff’s Auditor Was Also a 

Concern........................................................................................419 

6.	 When They Met with Madoff, They Were not 

Impressed with his Answers to Their Questions..........................420 

D.	 Comments on the SEC’s Ability to Uncover Fraud and 

Inadequacy of SEC Examinations ...........................................................420 

E.	 Conclusion ...............................................................................................424 

IX. THERE IS EVIDENCE THAT POTENTIAL INVESTORS 

RELIED UPON THE FACT THAT THE SEC HAD 

EXAMINED AND INVESTIGATED MADOFF IN MAKING 

DECISIONS TO INVEST WITH HIM ........................................................425 

X. ADDITIONAL COMPLAINTS RECEIVED BY THE SEC

 REGARDING MADOFF .............................................................................429 

A. Introduction..............................................................................................429 

B. Complaints Identified as Relevant to the OIG’s Madoff 

Investigation.............................................................................................430 

xvii 
1.	 Anonymous Complaint about Manipulation of 

Securities, Prices or Markets .......................................................430 

2.	 Anonymous Complaint Unrelated to Madoff’s 

Investment Advisory Business Referred to the NASD................430 

3.	 Investor Complaint Unrelated to Madoff’s 

Investment Advisory Business Was Referred to 

NERO Examiners Conducting a Cause Examination 

At BMIS; Examiners Did Not Document Results of 

Complaint Investigation...............................................................430 

4.	 Anonymous, Generalized Complaint about Madoff’s 

Investment Advisory Business Was Not Referred to 

Enforcement.................................................................................431 

5. Anonymous Complaint About Madoff’s Investment 

Advisory Business Referred to Enforcement, Which 

Relied on Madoff’s Representation that the Complaint 

 Was False .....................................................................................433 

C. Conclusion ...............................................................................................435 

XI. ADDITIONAL EXAMINATIONS AND INSPECTIONS OF 

 BERNARD MADOFF’S FIRMS CONDUCTED BY THE SEC ................436 

A. 1993-1994 Special Purpose Inspection of Bernard Madoff 

Securities..................................................................................................436 

1.	 Summary of Inspection................................................................436 

2.	 Conclusion ...................................................................................437 

B. 1994-1995 Oversight Examination of NASD Examination 

Of Bernard Madoff Securities..................................................................438 

1.	 Summary of Examination ............................................................438 

2.	 Conclusion ...................................................................................439 

C. 1997-1998 Inspection of Third Market Firms .........................................439 

1.	 Summary of Inspection................................................................439 

2.	 Conclusion ...................................................................................440 

D. 1999 Special Purpose Examination Limit Order Display 

Rule..........................................................................................................440 

1.	 Summary of Examination ............................................................440 

2.	 Conclusion ...................................................................................443 

E. 2003 OCIE QQQ Examination ................................................................443 

1. Introduction..................................................................................443 

xviii 
2. March 3, 2003 Planning Memorandum .......................................444 

3. Staff Involvement in and Recollections of Madoff 

 QQQ Examination ......................................................................446 

4. Conduct of the OCIE QQQ Examination ....................................449 

5. Daugherty, the Lead Attorney on the Madoff QQQ 

Examination, Was Put on Another Project ..................................450 

6. September 12, 2003 Memorandum Finding Madoff 

Violated Duty of Best Execution .................................................451 

7. November 10, 2003 Memorandum Recommending 

That a Deficiency Letter be Issued to Madoff ............................452 

8. There is no Record of a Deficiency Letter being 

 Issued to Madoff .........................................................................453 

9. Conclusion ...................................................................................456 

Conclusion .....................................................................................................................456 

xix 
 

 

REPORT OF INVESTIGATION 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION 

OFFICE OF INSPECTOR GENERAL 

Case No. OIG-509 

Investigation of Failure of the SEC 

To Uncover Bernard Madoff’s Ponzi Scheme 

Introduction
 

On December 11, 2008, the Securities and Exchange Commission (SEC) charged 

Bernard L. Madoff (Madoff) with securities fraud for a multi-billion dollar Ponzi scheme 

that he perpetrated on advisory clients of his firm. The complaint charged Madoff 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 pled 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 SEC learned that credible and specific allegations 

regarding Madoff’s financial wrongdoing were repeatedly brought to the attention of 

SEC staff, but were never recommended to the Commission for action. As a result, on 

the late evening of December 16, 2008, former SEC Chairman Christopher Cox1 

contacted the SEC Office of Inspector General (OIG) asking us to undertake an 

investigation into allegations made to the SEC regarding Madoff, going back to at least 

1999, and the reasons that these allegations were found to be not credible. Former 

Chairman Cox also asked that the OIG investigate the SEC’s internal policies that govern 

when allegations of fraudulent activity should be brought to the Commission. In 

addition, he requested that the OIG investigation include all staff contact and 

relationships with the Madoff family and firm, and any impact such relationships had on 

staff decisions regarding the firm. 

The OIG’s investigation of the SEC’s failure to uncover Madoff’s Ponzi scheme 

analyzed the SEC’s response to all complaints it received regarding the activities of 

Madoff, and traced the path of these complaints through the Commission from inception, 

reviewing what investigative or examination work was conducted with respect to these 

allegations. We have also investigated the allegations of conflicts of interest regarding 

relationships between any SEC officials or staff and members of the Madoff family, 

1

 Chairman Cox resigned on January 20, 2009. Current SEC Chairman Mary Schapiro was appointed by 

President Barack Obama on January 20, 2009, and was sworn in on January 27, 2009. 
 

 

 

 

including examining the role that former SEC Assistant Director Eric Swanson 

(Swanson), who eventually married Madoff’s niece, Shana Madoff (Shana), may have 

played in the examination or other work conducted by the SEC with respect to Madoff or 

related entities, and whether such role or such relationship in any way affected the 

manner in which the SEC conducted its regulatory oversight of Madoff and any related 

entities. 

Further, we have assessed the conduct of examinations and/or investigations of 

Madoff and/or Bernard Madoff Investment Securities, LLC (BMIS) by the SEC and 

conducted an analysis of whether there were “red flags” that were overlooked by SEC 

examiners or investigators (which may have been identified by other entities conducting 

due diligence), that could have led to a more comprehensive examination or 

investigation. We have also considered the extent to which the reputation and status of 

Madoff and the fact that he served on SEC Advisory Committees, participated on 

securities industry boards and panels, and had social and professional relationships with 

SEC officials, may have affected Commission decisions regarding investigations, 

examinations and inspections of his firm.2 

The Report of Investigation (ROI) includes the following sections: (a) the 1992 

investigation of Avellino & Bienes and the related examination of Madoff (Section I); 

(b) the circumstances surrounding the 2000 and 2001 complaints presented to the SEC by 

Harry Markopolos (Markopolos) (Section II); (c) the Office of Compliance Inspections 

and Examinations (OCIE) Washington, D.C. examination of Madoff triggered by a May 

2003 complaint from a Hedge Fund Manager (Section III); (d) the Northeast Regional 

Office (NERO) examination of Madoff that arose out of an internal complaint found in 

April 2004 during a routine examination of an SEC registrant (Section IV); (e) the 

Enforcement investigation of Madoff based upon Markopolos’ 2005 complaint (Section 

V); (f) a discussion of whether there was any improper influence by senior-level officials 

at the SEC upon the examinations and investigations of Madoff and the effect that 

Madoff’s stature had on the SEC’s conduct of its examinations and investigations of 

Madoff (Section VI); (g) an analysis of the allegation that former OCIE Assistant 

Director Eric Swanson’s relationship with Shana Madoff impacted the SEC’s 

examinations of Madoff (Section VII); (h) a summary of the due diligence efforts 

undertaken by private parties who determined that Madoff was not a wise investment and 

a comparison with the methods utilized by the SEC in its examinations and 

investigations(Section VIII); (i) the extent of reliance by potential investors with Madoff 

on the fact that the SEC conducted examinations and investigations of Madoff in making 

investment decisions; (Section IX); (j) a summary of all the additional complaints that the 

SEC received regarding Madoff, or any of his firms or related entities (Section X); and 

(k) a description of all the additional examinations that the SEC conducted of Madoff or 

his firms (Section XI). 

2

 The OIG also intends to issue separate audit reports that analyze the findings of this ROI and make 

concrete and specific recommendations to both the Office of Compliance Inspection and Examinations 

(OCIE) and the Division of Enforcement for improvements in their operations based upon the findings in 

this ROI. We also intend to issue a third audit report analyzing why Madoff was not subjected to an OCIE 

Investment Adviser (IA) examination after he was forced to register as an investment adviser in 2007. 

2 
 

 

 

Scope of the Investigation 

I. DOCUMENT PRESERVATION AND MEETINGS WITH SENIOR-LEVEL 

OFFICIALS 

On December 18, 2008, we issued a document preservation notice to the entire 

Commission informing them that the Office of Inspector General has initiated an 

investigation regarding all Commission examinations, investigations or inquiries 

involving BMIS, and any related individuals or entities. We formally requested that each 

employee and contractor in the Commission preserve all electronically-stored 

information and paper records related to BMIS in their original format. 

In the next several days, the Inspector General (IG) H. David Kotz (Kotz) met 

with senior officials from the Commission’s Division of Enforcement (Enforcement) and 

the Office of Compliance Inspections and Examinations (OCIE), to ensure their 

cooperation in our investigation and our ability to gain access to their files and records. 

The IG also met with the Chairman’s office to seek information and documentation 

relevant to the investigation. 

II. E-MAIL SEARCHES AND REVIEWS OF E-MAILS 

On December 17, 2008, the OIG requested that the SEC’s Office of Information 

Technology (OIT) provide the OIG with (1) all e-mails of former OCIE employee Eric 

Swanson during his tenure with the Securities and Exchange Commission (SEC), i.e., 

from August 14, 1996 until September 15, 2006, to the extent those e-mails were 

available; and (2) the e-mails of six Northeast Regional Office (NERO) staff members 

who were involved in NERO’s investigation of the Madoff firm that was initiated in 2006 

(Case No. NY-07653) for the period from January 2006 through January 2008.3

 We 

requested that OIT provide these e-mails on an expedited basis.4 

On the following day, December 18, 2008, the OIG requested that OIT perform a 

search of all e-mails for SEC Headquarters, New York Regional Office (NYRO) and 

Boston Regional Office (BRO) staff members from January 1, 1999, through December 

11, 2008, or from the earliest available date if e-mails were not available going back to 

January 1, 1999. We also requested that this search be given priority and that the search 

results be provided to us on a rolling basis rather than waiting unit the entire search was 

completed. 

Subsequent to the initial OIG e-mail requests made on December 17 and 18, 

2008, the OIG made numerous requests to OIT for the e-mails of current and former SEC 

3 We requested the e-mails for this time period because, according to SEC case tracking records, the 

investigation was opened on January 4, 2006 and closed on January 3, 2008. 

4

 In February 2008, the OIG and OIT entered into a memorandum of understanding that provided that all
 

OIG requests for e-mails will receive the highest priority with e-mail requests responding to subpoenas, 

except in unusual circumstances where a subpoena request must be complied with first, and will be
 

processed before all other requests from SEC divisions or offices. 

3 
employees for various periods of time pertinent to the investigation. The e-mails were 

received, loaded onto computers with specialized search tools and searched on a 

continuous basis throughout the course of the investigation. 

In all, in addition to the e-mails received through the search of Headquarters, 

NYRO and BRO e-mails for the term “Madoff,” the OIG received from OIT e-mails for a 

total of approximately 68 current and former SEC employees for various time periods 

relevant to the investigation, ranging from 1999 to 2009. These included: 24 NYRO 

employees, 15 OCIE employees, ten BRO employees, six Los Angeles Regional Office 

employees, six Headquarters Division of Enforcement employees, four Office of 

Economic Analysis employees, and three employees from other SEC offices. The OIG 

estimates that it obtained and searched approximately 3.7 million e-mails during the 

course of its investigation. 

III. DOCUMENT REQUESTS AND REVIEW OF RECORDS 

On December 24, 2008, we sent comprehensive document requests to both the 

Enforcement Division and OCIE specifying the documents and records we required to be 

produced for the investigation. We followed up with memoranda to OCIE dated April 3, 

2009, May , 2009, and June 12, 2009. We also had follow-up communications with 

Enforcement on January 21, 2009 and July 22, 2009. We further had numerous e-mail 

and telephonic communications with both OCIE and Enforcement, regarding the scope 

and timing of the document requests and responses, as well as meetings to clarify and 

expand the document requests as necessary. 

We collected all the information we received as a result of our document 

production request and carefully reviewed and analyzed all investigative papers of all 

SEC investigations conducted relating to Madoff, Madoff’s firms, members of Madoff’s 

family, and Madoff’s associates between 1975 and the present. 

Through the course of the investigation, the OIG also reviewed the workpapers 

and examination files of nine SEC examinations of BMIS from 1990 to December 11, 

2008 as follows: 1990 BD NERO 0118 (routine examination), 1993 BD NERO 0015 

(routine examination), 1994 Special Purpose Inspections of BMIS and the Instinet 

Corporation, 1995 NERO 0027 (NASD Oversight Examination), 1998 Inspection of 

Eight Third Market Firms, 1999 Limit Order Display Review, 2003 QQQ Trading 

Review, 2004 OCIE Examination (Front-Running), and 2005 NERO Examination (FrontRunning). The examinations are described in Sections XI, II, and IV of this Report of 

Investigation. Where documents from the examination were not available, the OIG 

sought testimony and conducted interviews of current and former SEC personnel who 

had worked on the examinations. 

We also sought documents from the Department of Justice via an OIG request 

dated May 1, 2009, and communicated with DOJ frequently as part of our investigation. 

4 
 

 

IV. DOCUMENT AND INFORMATION REQUESTS TO INDEPENDENT 

THIRD-PARTIES 

In order to properly analyze how the SEC could have conducted examinations and 

investigations of Madoff that may have uncovered Madoff’s Ponzi scheme, the SEC 

sought information and documentation from third-parties in order to undertake our own 

analysis of Madoff’s trading records. During the course of the OIG investigation, the 

OIG requested and obtained from the Depository Trust Company (DTC) position reports 

for BMIS (account # 646) for the following dates: August 10, 2006; May 19, 2006; 

March 16, 2005; March 15, 2005; February 18, 2005; January 31, 2005; January 26, 

2005; January 25, 2005. 

We also requested and obtained from the National Securities Clearing 

Corporation (NSCC) all clearing data records for all executions effected by BMIS, 

whether BMIS was on the purchasing side or on the selling side of the securities, in 14 

specific equity securities, on a daily basis, in Excel format, by trade date for the trading 

time period of March 10 through March 18, 2005. 

We also received from the Financial Industry Regulatory Authority (FINRA): 

Order Audit Trail System data (OATS) submitted by BMIS for 6 National Association of 

Securities Dealers Automated Quotations (NASDAQ)-listed stocks (ticker symbol 

included) and NASDAQ Automated Confirmation of Transactions (ACT) database for 

the trading time period of March 10 through March 18, 2005. 

V. RETENTION OF EXPERT IN ANALYZING EXAMINATION AND 

INVESTIGATORY WORK 

In February 2009, the OIG retained several securities experts from FTI 

Consulting, Inc. (the FTI Engagement Team) to assist with the review of the examinations 

and investigations of Madoff and BMIS that were conducted by the SEC. Members of the 

FTI team engaged by the OIG were Charles R. Lundelis, Jr. (Lundelis), senior managing 

director, Forensic and Litigation Consulting, Simon Wu (Wu), managing director, 

Forensic and Litigation Consulting, John C. Crittenden III (Crittenden), managing 

director, Corporate Finance Group, and James Conversano (Conversano) director, 

Forensic and Litigation Consulting. 

Each individual member of the FTI Engagement team brought unique and 

specialized experience to the analysis contained in this ROI. Lundelis specializes in Rule 

10b-5 securities fraud, insider trading and manipulation cases, SEC, National Association 

of Securities Dealers (NASD, now FINRA), New York Stock Exchange (NYSE) market 

regulation investigations, securities valuation, financial accounting and reporting 

standards, share price modeling and commodities trading. He is also an expert in the 

areas of the underwriting process, securities market pricing, hedge fund operations, 

investment suitability, accounting fraud, compliance and due diligence practices. 

Lundelis is a CPA, Accredited in Business Valuation and Certified in Financial Forensics 

by the American Institute of Certified Public Accountants. 

5 
 

 

 

Wu was formerly a Senior Economist at the NASD and subsequently the 

NASDAQ Stock Market where he led a major study on the decimalization of securities 

quotations on NASDAQ. Dr. Wu has been qualified as an expert and testified before the 

SEC Administrative Law Judge, in Federal and State courts, and before the 

NASD/FINRA Arbitration Panels. Dr. Wu is an expert in SEC, NASD, Over-theCounter Bulletin Board (OTCBB), NYSE and American Stock Exchange (AMEX) 

market regulation rules (Rule 10b-5, Best Execution, Order Handling Rules, FrontRunning, etc.), as well as market structure issues. Dr. Wu received his Ph.D. in 

Economics from Vanderbilt University with a focus on finance and international finance. 

Crittenden advises insurance, retail and institutional broker-dealers and 

investment advisers, including hedge funds, regarding development of reasonable and 

adequate compliance policies and procedures, infrastructures and internal processes and 

controls. Mr. Crittenden also has been engaged as a regulatory compliance advisor, and 

was recently elected as Director for the failed Bear Stearns hedge funds to investigate and 

maximize recoveries. Mr. Crittenden holds the FINRA/WHARTON Certified Regulatory 

and Compliance Professional (CRCP) designation and is a FINRA registered General 

Securities Principal. 

Conversano has more than 15 years of regulatory, compliance and forensic 

investigation experience. Mr. Conversano has substantial experience in complex financial 

fraud investigations, securities related inspections and examinations, compliance 

assessments, antitrust matters, bankruptcy proceedings, restructurings, damages 

calculations, cash flow analysis, and valuations. 

At the direction of the OIG, the FTI Engagement Team conducted a thorough review 

of all of the relevant workpapers and documents associated with the OCIE examinations, 

and scrutinized the conduct of the SEC examinations and investigations, analyzing 

whether there were “red flags” that were overlooked by SEC examiners that could have 

led to the discovery of Madoff’s Ponzi scheme. The FTI Engagement Team also 

replicated aspects of the OCIE cause examinations of Madoff to determine whether the 

SEC sought the appropriate information in the examinations and analyzed such 

information correctly.5 

VI. RETENTION OF EXPERT IN RECOVERING E-MAILS 

During the course of the investigation, OIT informed the OIG that there were gaps 

in the e-mails that the OIG was seeking to review as part of its investigation because of 

failures to backup the tapes, hardware or software failures during the backup process, 

and/or lost, mislabeled or corrupted tapes. In order to ensure that the OIG was able to 

conduct a thorough and comprehensive investigation, in June, 2009, the OIG retained the 

services of First Advantage Litigation Consulting Services (First Advantage), to assist the 

5

 The OIG is issuing a separate audit report prepared by the FTI Engagement Team which will document 

the FTI Engagement Team’s analyses and provide recommendations to the SEC with respect to areas of 

improvements as a result of the FTI Engagement Team’s work. 

6 
 

 

 

OIG in the restoration and production of relevant electronic data. First Advantage’s team 

had significant experience in leading numerous large-scale electronic discovery 

consulting projects as well as assisting with highly sensitive and confidential 

investigations for corporations and the Federal Bureau of Investigation. 

In connection with its engagement, First Advantage provided consulting and 

technical support to understand how the SEC’s e-mail Exchange and file servers were 

configured and to understand the backup procedures relating to these systems for the 

relevant period. First Advantage also provided technical support to identify relevant 

electronic data from the SEC’s inventory of backup tapes and its online enterprise archive 

system that the SEC began using in 2008 to store copies of all e-mails sent to, from, or 

within the SEC. Based upon this work, First Advantage was able to successfully preserve 

and restore potentially responsive data from this universe of electronic data and 

coordinated the restoration of SEC electronic records identified by the OIG as relevant to 

our investigation. The OIG was therefore, able to review all e-mails that were pertinent 

to its investigation. 

VII. TESTIMONY AND INTERVIEWS 

The OIG conducted 140 testimonies and interviews of 122 individuals with 

knowledge of facts or circumstances surrounding the SEC’s examinations and/or 

investigations of Madoff and his firms. 

SEC IG Kotz personally led the questioning in the testimony and interviews of 

nearly all the witnesses in the investigation. Kotz also led the investigative team for this 

ROI, which included Noelle Frangipane, Deputy Inspector General, who worked on all 

aspects of the investigation; Assistant Inspector General for Investigations J. David 

Fielder and Senior Counsel David Witherspoon, who focused their efforts on Sections II 

and V of the ROI; Senior Counsel Heidi Steiber, who concentrated on Sections III, IV 

and X of the ROI; and Chris Wilson, Senior Counsel, who worked on Sections VII and 

XI of the ROI.6 

The OIG conducted testimony on-the-record and under oath of the following 

individuals: 

(1)	 Harry Markopolos, Chartered Financial Analyst and Certified Fraud 

Examiner, taken on February 5, 2009, at 9:42 a.m., excerpted portions of 

which are at Exhibit 1. 

(2)	 Alex Sadowski, Assistant General Counsel, Getco LLC, former Branch 

Chief, Office of Compliance Inspections and Examinations, Securities and 

Exchange Commission, taken on February 13, 2009, at 10:15 a.m., 

excerpted portions of which are at Exhibit 2. 

6

 Significant assistance in this investigation was also provided by Assistant to the Inspector General 

Roberta Raftovich, and OIG Summer Interns Kristina Katz and April Elliot. 

7 
________________________ 

 

(3)	 Redacted* name of Staff Accountant, Office of Compliance Inspections 

and Examinations, Securities and Exchange Commission, taken on 

February 19, 2009, at 2:20 p.m., referred to in the ROI as “OCIE Staff 

Accountant,” excerpted portions of which are at Exhibit 3. 

(4)	 Mavis Kelly, Branch Chief (now Assistant Director), Office of 

Compliance Inspections and Examinations, Securities and Exchange 

Commission, taken on February 23, 2009, at 10:35 a.m., excerpted 

portions of which are at Exhibit 4. 

(5)	 Walter Ricciardi, Partner, Paul Weiss Rifkind Wharton & Garrison LLP, 

former District Administrator, Boston District Office and former Deputy 

Director, Division of Enforcement, Securities and Exchange Commission, 

taken on February 26, 2009, at 10:48 a.m., excerpted portions of which are 

at Exhibit 5. 

(6)	 Redacted* name of Eric Swanson’s former fiancé, taken on March 2, 

2009, at 2:45 p.m., referred to in the ROI as “Jane Doe,” excerpted 

portions of which are at Exhibit 6. 

(7)	 Jacqueline Wood, Associate, Proskauer Rose LLP, former Staff Attorney 

Securities and Exchange Commission, taken on March 9, 2009, at 9:40 

a.m., excerpted portions of which are at Exhibit 7. 

(8)	 Redacted* name of Assistant Director, Office of Compliance Inspections 

and Examinations, Securities and Exchange Commission, taken on March 

13, 2009, at 9:29 a.m., referred to in the ROI as “OCIE Assistant 

Director,” excerpted portions of which are at Exhibit 8. 

(9)	 Gene Gohlke, Associate Director, Office of Compliance Inspections and 

Examinations, Securities and Exchange Commission, taken on March 16, 

2009, at 2:03 p.m., excerpted portions of which are at Exhibit 9. 

(10)	 Matthew Daugherty, Branch Chief (now Senior Special Counsel), Office 

of Compliance Inspections and Examinations, Securities and Exchange 

Commission, taken on March 23, 2009, at 2:06 p.m., excerpted portions of 

which are at Exhibit 10. 

(11)	 Redacted* name of Staff Attorney, Office of Compliance Inspections and 

Examinations (now Staff Attorney, Division of Trading and Markets), 

Securities and Exchange Commission, taken on March 25, 2009, at 11:02 

a.m., referred to in the ROI as “OCIE Staff Attorney,” excerpted portions 

of which are at Exhibit 11. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

8 
 

 

(12)	 Dorothy Eschwie, Assistant Regional Director, New York Regional 

Office,7

 Securities and Exchange Commission, taken on March 26, 2009, 

at 11:50 a.m., excerpted portions of which are at Exhibit 12. 

(13)	 Thomas Thanasules, Securities Compliance Examiner (now Staff 

Accountant), New York Regional Office, Securities and Exchange 

Commission, taken on March 26, 2009, at 1:32 p.m., excerpted portions of 

which are at Exhibit 13. 

(14)	 Michael Kress, Branch Chief, New York Regional Office, Securities and 

Exchange Commission, taken on March 26, 2009, at 2:04 p.m., excerpted 

portions of which are at Exhibit 14. 

(15)	 Neil Chelo, Director of Research, Benchmark Plus Management LLC, 

taken on March 31, 2009, at 11:45 a.m., excerpted portions of which are at 

Exhibit 15. 

(16)	 Frank Casey, President-USA, Fortune Asset Management, taken on March 

31, 2009, at 3:06 p.m., excerpted portions of which are at Exhibit 16. 

(17)	 Grant Ward, Senior Counsel, MetLife Group, former Assistant District 

Administrator, Boston District Office, Securities and Exchange 

Commission, taken on March 31, 2009, at 5:10 p.m., excerpted portions of 

which are at Exhibit 17. 

(18)	 Edward Manion, Staff Accountant, Boston Regional Office, Securities and 

Exchange Commission, taken on April 1, 2009, at 1:15 p.m., excerpted 

portions of which are at Exhibit 18. 

(19)	 Michael Garrity, Branch Chief (now Assistant Regional Director), Boston 

Regional Office,8

 Securities and Exchange Commission, taken on April 1, 

2009, at 10:30 am and April 2, 2009, at 2:30 p.m., excerpted portions of 

which are at Exhibit 19. 

(20)	 John Dugan, former Branch Chief and Assistant Regional Director, now 

Associate Regional Director, Boston Regional Office, Securities and 

Exchange Commission, taken on April 2, 2009, at 9:25 a.m. 

(21)	 Andrew Caverly, former Staff Attorney and Branch Chief (now Assistant 

Regional Director, Broker-Dealer Inspection Program, Boston Regional 

Office, Securities and Exchange Commission, taken on April 2, 2009, at 

1:15 p.m., excerpted portions of which are at Exhibit 20. 

(22)	 David Bergers, Assistant District Administrator (now Regional Director), 

Boston Regional Office, Securities and Exchange Commission, taken on 

April 2, 2009, at 3:12 p.m., excerpted portions of which are at Exhibit 21. 

(23)	 Eric Swanson, General Counsel, BATS Trading, former Assistant 

Director, Office of Compliance Inspections and Examinations, Securities 

7

 As of March 30, 2007, the Northeast Regional Office of the SEC (NERO), became known as the New 

York Regional Office (NYRO).

8

 The Boston office of the SEC was elevated from a District Office to a Regional Office on April 2, 2007. 

9 
 

 

 

and Exchange Commission, taken on April 15, 2009, at 9:25 a.m., 

excerpted portions of which are at Exhibit 22. 

(24)	 Lori Richards, former Director, Office of Compliance Inspections and 

Examinations, Securities and Exchange Commission, taken on April 17, 

2009, at 10:05 a.m., excerpted portions of which are at Exhibit 23. 

(25)	 Redacted* name former Branch Chief, Office of Investor Education and 

Advocacy, Securities and Exchange Commission, taken on April 20, 2009, 

at 2:05 p.m., referred to in the ROI as “former OIEA Branch Chief,” 

excerpted portions of which are at Exhibit 24. 

(26)	 Vance Anthony, Financial Economist, Office of Economic Analysis, 

Securities and Exchange Commission, taken on April 21, 2009, at 10:10 

am excerpted portions of which are at Exhibit 25. 

(27)	 Stewart Mayhew, Assistant Chief Economist (now Deputy Chief 

Economist), Office of Economic Analysis, Securities and Exchange 

Commission, taken on April 21, 2009, at 12:45 p.m., excerpted portions of 

which are at Exhibit 26. 

(28)	 Jonathan Sokobin, Deputy Chief Economist, (now Director, Office of Risk 

Assessment), Securities and Exchange Commission, taken on April 22, 

2009, at 3:20 p.m., excerpted portions of which are at Exhibit 27. 

(29)	 Mark Donohue, Branch Chief and Assistant Director, Office of 

Compliance Inspections and Examinations, Securities and Exchange 

Commission, taken on April 23, 2009, at 10:06 a.m., excerpted portions of 

which are at Exhibit 28. 

(30)	 John McCarthy, General Counsel, Getco LLC, former Staff Attorney, 

Division of Market Regulation,9

 and former Associate Director, Office of 

Compliance Inspections and Examinations, Securities and Exchange 

Commission, taken on April 27, 2009, at 9:45 a.m., excerpted portions of 

which are at Exhibit 29. 

(31)	 Juan Marcelino, Shareholder, Greenberg Traurig LLP, former Regional 

Administrator, Boston Regional Office, Securities and Exchange 

Commission, taken on April 27, 2009, at 1:30 p.m., excerpted portions of 

which are at Exhibit 30. 

(32)	 William Dale, former Assistant Chief Economist, Office of Economic 

Analysis, Securities and Exchange Commission, taken on April 28, 2009, 

at 2:43 p.m., excerpted portions of which are at Exhibit 31. 

9

 The Division of Market Regulation was renamed the Division of Trading and Markets on November 14, 

2007. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

10 
___________________________________ 

 

 

(33)	 George Curtis, Regional Director, Denver Regional Office (now Deputy 

Director, Division of Enforcement), Securities and Exchange Commission, 

taken on April 29, 2009, at 4:33 p.m. 

(34)	 Leslie Kazon, Assistant Regional Director, Division of Enforcement, New 

York Regional Office, Securities and Exchange Commission, taken on 

April 30, 2009, at 11:12 a.m., excerpted portions of which are at Exhibit 

32. 

(35)	 Andrew Calamari, Branch Chief (now Associate Regional Director), 

Division of Enforcement, New York Regional Office, Securities and 

Exchange Commission, taken on April 30, 2009, at 12:10 p.m. 

(36)	 Mark Schonfeld, Litigation Partner, Gibson Dunn & Crutcher, former 

Senior Counsel, Boston District Office and former Branch Chief, Assistant 

Director, Associate Director and Regional Director, Northeast Regional 

Office, Securities and Exchange Commission, taken on April 30, 2009, at 

2:55 p.m., excerpted portions of which are at Exhibit 33. 

(37)	 Redacted* name of Branch Chief, Office of Investor Education and 

Advocacy, Securities and Exchange Commission, taken on May 1, 2009, 

at 2:02 p.m., referred to in the ROI as “OIEA Branch Chief,” excerpted 

portions of which are at Exhibit 34. 

(38)	 Tina Barry, Branch Chief (now Assistant Director), Office of Compliance 

Inspections & Examinations, Securities and Exchange Commission, taken 

on May 1, 2009, at 3:29 p.m., excerpted portions of which are at Exhibit 

35. 

(39)	 William Ostrow, Senior Compliance Examiner (now Staff Accountant), 

New York Regional Office, Securities and Exchange Commission, taken 

on May 5, 2009, at 9:59 a.m. and August 19, 2009, at 10:08 a.m., 

excerpted portions of which are at Exhibit 36 and Exhibit 37, respectively. 

(40)	 John Nee, Assistant Regional Director, New York Regional Office, 

Securities and Exchange Commission, taken on May 6, 2009, at 10:50 

a.m., excerpted portions of which are at Exhibit 38. 

(41)	 Redacted* name of Staff Attorney, New York Regional Office, Securities 

and Exchange Commission, taken on May 11, 2009, at 11:00 a.m., 

referred to in the ROI as “New York Staff Attorney,” excerpted portions 

of which are at Exhibit 39. 

(42)	 Redacted* name of Senior Attorney, New York Regional Office, 

Securities and Exchange Commission, taken on May 11, 2009, at 1:54 

p.m., referred to in the ROI as “New York Staff Attorney,” excerpted 

portions of which are at Exhibit 40. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

11 
___________________________________ 

 

 

(43)	 Israel Friedman, Staff Attorney (now Branch Chief), New York Regional 

Office, Securities and Exchange Commission, taken on May 11, 2009, at 

12:00 p.m., excerpted portions of which are at Exhibit 41. 

(44)	 Alex Vasilescu, Supervisory Trial Counsel and Chief of the Trial Unit, 

New York Regional Office, Securities and Exchange Commission, taken 

on May 11, 2009, at 12:54 p.m. 

(45)	 Jason Gettinger, Regional Litigation Counselor, Division of Enforcement, 

New York Regional Office, Securities and Exchange Commission, taken 

on May 11, 2009, at 2:35 p.m., excerpted portions of which are at Exhibit 

42. 

(46)	 Linda Thomsen, Partner, Davis Polk & Wardwell, former Director, 

Division of Enforcement, Securities and Exchange Commission, taken on 

May 11, 2009, at 2:34 p.m., excerpted portions of which are at Exhibit 43. 

(47)	 Redacted* name of former Examiner, Office of Compliance Inspections 

and Examinations, Securities and Exchange Commission, taken on May 

11, 2009, at 3:19 p.m., referred to in the ROI as “former Examiner #1,” 

excerpted portions of which are at Exhibit 44. 

(48)	 Paul Pocress, Staff Accountant, New York Regional Office, Securities and 

Exchange Commission, taken on May 11, 2009, at 3:31 p.m., excerpted 

portions of which are at Exhibit 45. 

(49)	 Redacted* name of Staff Accountant (now Branch Chief), Division of 

Investment Management, New York Regional Office, Securities and 

Exchange Commission, taken on May 11, 2009, at 3:48 p.m., referred to in 

the ROI as “IM Staff Accountant,” excerpted portions of which are at 

Exhibit 46. 

(50)	 Robert Sollazzo, Associate Regional Director, New York Regional Office, 

Securities and Exchange Commission, taken on May 12, 2009, at 10:35 

a.m., excerpted portions of which are at Exhibit 47. 

(51)	 Peter Lamore, Securities Compliance Examiner (now Staff Accountant), 

New York Regional Office, Securities and Exchange Commission, taken 

on May 14, 2009, at 9:25 a.m. and August 19, 2009, at 10:30 a.m., 

excerpted portions of which are at Exhibit 48 and at Exhibit 49, 

respectively. 

(52)	 Stephen Johnson, Staff Accountant (now Branch Chief), Division of 

Enforcement, New York Regional Office, Securities and Exchange 

Commission, taken on May 21, 2009, at 10:38 a.m., excerpted portions of 

which are at Exhibit 50. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

12 
___________________________________ 

 

 

(53)	 Redacted* name of Staff Attorney, Division of Enforcement, Securities 

and Exchange Commission, taken on May 21, 2009, at 11:00 a.m., 

referred to in the ROI as “Enforcement Staff Attorney,” excerpted portions 

of which are at Exhibit 51. 

(54)	 Redacted* name of former Attorney Advisor, Office of Compliance 

Inspections and Examinations, Securities and Exchange Commission, 

taken on May 21, 2009, at 2:05 p.m., referred to in the ROI as “former 

OCIE Attorney Advisor,” excerpted portions of which are at Exhibit 52. 

(55)	 Simona Suh, Staff Attorney (now Branch Chief), Division of 

Enforcement, New York Regional Office, Securities and Exchange 

Commission, taken on May 27, 2009, at 9:35 a.m., excerpted portions of 

which are at Exhibit 53. 

(56)	 Peter Uhlmann, Chief of Staff to the Chairman (now Senior Advisor, 

Office of Executive Director), Securities and Exchange Commission, 

taken on May 28, 2009, at 10:00 a.m., excerpted portions of which are at 

Exhibit 54. 

(57)	 Doria Bachenheimer, former Assistant Director, Division of Enforcement, 

Northeast Regional Office, Securities and Exchange Commission, taken 

on June 3, 2009, at 12:10 p.m., excerpted portions of which are at Exhibit 

55. 

(58)	 Meaghan Cheung, former Branch Chief, Division of Enforcement, 

Northeast Regional Office, Securities and Exchange Commission, taken 

on June 4, 2009, at 10:40 a.m., excerpted portions of which are at Exhibit 

56. 

(59)	 Redacted* name of former Staff Attorney, Division of Enforcement, 

Northeast Regional Office, Securities and Exchange Commission, taken 

on June 10, 2009, at 1:55 p.m., referred to in the ROI as “former New 

York Enforcement Staff Attorney #2,” excerpted portions of which are at 

Exhibit 57. 

(60)	 Redacted* name of Assistant Regional Director, Division of Enforcement, 

New York Regional Office, Securities and Exchange Commission, taken 

on June 10, 2009, at 4:20 p.m., referred to in the ROI as “Enforcement 

Assistant Regional Director,” excerpted portions of which are at Exhibit 

58. 

(61)	 Susan Tibbs, Director, Market Regulation Department, formerly known as 

National Association of Securities Dealers (NASD), now known as 

Financial Industry Regulatory Authority (FINRA), taken on June 19, 

2009, at 3:20 p.m., excerpted portions of which are at Exhibit 59. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

13 
___________________________________ 

 

 

(62)	 Christopher Cox, former Chairman, Securities and Exchange Commission, 

taken on June 19, 2009, at 3:11 p.m., excerpted portions of which are at 

Exhibit 60. 

(63)	 Jordan Materna, Director, Chicago Board Options Exchange, taken on 

June 22, 2009, at 2:35 p.m., excerpted portions of which are at Exhibit 61. 

(64)	 Gene DeMaio, Senior Vice President, National Association of Securities 

Dealers, taken on June 25, 2009, at 2:07 p.m., excerpted portions of which 

are at Exhibit 62. 

(65)	 Susan Geigel, Director of Legal and Regulatory Compliance Depository 

Trust and Clearing Corporation, taken on June 26, 2009, at 11:30 a.m., 

excerpted portions of which are at Exhibit 63. 

(66)	 Annette Nazareth, former Commissioner, Securities and Exchange 

Commission, taken on July 9, 2009, at 10:34 a.m., excerpted portions of 

which are at Exhibit 64. 

(67)	 William Donaldson, Chairman, Donaldson Enterprises, former Chairman, 

Securities and Exchange Commission, taken on July 9, 2009, at 11:03 

a.m., excerpted portions of which are at Exhibit 65. 

(68)	 Redacted* name of Office of Internet Enforcement Official, Division of 

Enforcement, Securities and Exchange Commission, taken on July 30, 

2009, at 2:35 p.m., referred to in the ROI as “Office of Internet 

Enforcement Official,” excerpted portions of which are at Exhibit 66. 

(69)	 Redacted* name of Senior Counsel, Division of Enforcement, Securities 

and Exchange Commission, taken on July, 31. 2009, at 10:04 a.m., 

referred to in the ROI as “Enforcement Senior Counsel,” excerpted 

portions of which are at Exhibit 67. 

(70)	 Elisse Walter, Commissioner, Securities and Exchange Commission, taken 

on August 5, 2009, at 2:33 p.m., excerpted portions of which are at Exhibit 

68. 

(71)	 Unidentified Former SEC Examiner, New York Regional Office, 

Securities and Exchange Commission, taken on August 5, 2009, at 2:55 

p.m., excerpted portions of which are at Exhibit 69. 

(72)	 Elaine Solomon, former Secretary, Bernard L. Madoff Investment 

Securities, LLP, taken on August 17, 2009, at 11:08 a.m. excerpted 

portions of which are at Exhibit 70. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

14 
________________________ 

 

 

The OIG also conducted the following interviews of persons with knowledge of 

relevant facts in the investigation: 

(1)	 Unidentified Chief Executive Officer (CEO) of Research Firm, 

unidentified independent hedge fund research and advisory firm, 

conducted on January 6, 2009, at Exhibit 71. 

(2)	 Unidentified Investment Bank Due Diligence Team, unidentified 

investment bank, conducted on January 6, 2009, at Exhibit 72. 

(3)	 Unidentified Chief Executive Officer (CEO), unidentified fund of funds 

firm, taken on January 12, 2009, at 11:00 a.m., excerpted portions of 

which are at Exhibit 73. 

(4)	 Michael Ocrant, Journalist, Institutional Investor, former Managing 

Editor, MARHedge, taken on January 12, 2009, at 2:00 p.m., excerpted 

portions of which are at Exhibit 74. 

(5)	 James Hedges IV, President and Chief Investment Officer, LJH Global 

Investments, conducted on January 22, 2009, excerpted portions of which 

are at Exhibit 75. 

(6)	 Laura Goldman, Investment Advisor, LSG Capital, conducted on January 

23, 2009, excerpted portions of which are at Exhibit 76. 

(7)	 Ron Egalka, President and CEO, Rampart Investment Management, 

conducted on February 9, 2009. 

(8)	 Edward Perkins, former Examiner (now Staff Accountant), New York 

Regional Office, Securities and Exchange Commission, conducted on 

February 27, 2009. 

(9)	 William Dale, former Assistant Chief Economist, Office of Economic 

Analysis, Securities and Exchange Commission, Securities and Exchange 

Commission, conducted on February 27, 2009. 

(10)	 Thomas Thanasules, Securities Compliance Examiner (now Staff 

Accountant), New York Regional Office, Securities and Exchange 

Commission, conducted on March 3, 2009. 

(11)	 Redacted* name of Staff Attorney, Office of Compliance Inspections and 

Examinations (now Staff Attorney, Division of Trading and Markets), 

Securities and Exchange Commission, conducted on March 3, 2009, 

referred to in the ROI as “OCIE Staff Attorney.” 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

15 
________________________ 

 

 

(12)	 Dawn Libal, Examiner (now Staff Accountant), New York Regional 

Office, Securities and Exchange Commission, conducted on March 4, 

2009. 

(13)	 Harvey Westbrook Jr., former Financial Economist (now Senior 

Economist), Office of Risk Assessment, Securities and Exchange 

Commission, conducted on March 4, 2009. 

(14)	 Redacted* name of former Attorney Advisor, Office of Compliance 

Inspections and Examinations, Securities and Exchange Commission, 

conducted on March 4, 2009, referred to in the ROI as “former OCIE 

Attorney Advisor.” 

(15)	 Gregory Stahl, Chartered Financial Analyst, SEI Investments, conducted 

on March 6, 2009, excerpted portions of which are at Exhibit 77. 

(16)	 James Overdahl, Chief Economist, Office of Economic Analysis, 

Securities and Exchange Commission, conducted on March 11, 2009. 

(17)	 Paul Broder, Risk Manager, Renaissance Technologies Corporation, 

conducted on March 12, 2009, excerpted portions of which are at Exhibit 

78. 

(18)	 Henry Laufer, Chief Scientist, Renaissance Technologies Corporation, 

conducted on March 12, 2009, excerpted portions of which are at Exhibit 

79. 

(19)	 Nathaniel Simons, Portfolio Manager, the Meritage Fund, conducted on 

March 12, 2009, excerpted portions of which are at Exhibit 80 

(20)	 Joseph Cella, former Chief, Office of Market Surveillance, Division of 

Enforcement, Securities and Exchange Commission, conducted on March 

13, 2009. 

(21)	 Redacted* name of former Securities Compliance, Chicago Regional 

Office (formerly Midwest Regional Office), Securities and Exchange 

Commission, conducted on March 17, 2009, referred to in the ROI as 

“former Securities Compliance Examiner,” excerpted portions of which 

are at Exhibit 81. 

(22)	 John Ehinger, Chief Compliance Officer and General Counsel for 

Placemark Investments, former Staff Attorney, Division of Market 

Regulation, Securities and Exchange Commission, conducted on March 

17, 2009, excerpted portions of which are at Exhibit 82. 

(23)	 Redacted* name of Senior Counsel, Division of Enforcement, Securities 

and Exchange Commission, conducted on March 20, 2009, referred to in 

the ROI as “Enforcement Senior Counsel.” 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

16 
____________________________ 

 

 

(24)	 Redacted* name of Office of Internet Enforcement Official, Division of 

Enforcement, Securities and Exchange Commission, conducted on March 

20, 2009, referred to in the ROI as “Office of Internet Enforcement 

Official.” 

(25)	 Jim Adelman, General Counsel, Commonwealth Financial Network, 

former Associate District Administrator, Boston District Office, Securities 

and Exchange Commission, conducted on March 24, 2009 and April 30, 

2009, excerpted portions of which are at Exhibit 83. 

(26)	 Unidentified Hedge Fund Manager, taken on March 26, 2009, excerpted 

portions of which are at Exhibit 84. 

(27)	 Unidentified Chief Information Officer (CIO), unidentified fund of funds 

firm, conducted on April 7, 2009, excerpted portions of which are at 

Exhibit 85. 

(28)	 Silvestre Fontes, Branch Chief (now Senior Trial Counsel), Division of 

Enforcement, Boston Regional Office, Securities and Exchange 

Commission, conducted on April 7, 2009 and April 10, 2009, at Exhibit 86 

and Exhibit 87, respectively. 

(29)	 Grant Ward, Senior Counsel, MetLife Group, former Assistant District 

Administrator, Boston District Office, Securities and Exchange 

Commission, conducted on April 8, 2009, at Exhibit 88. 

(30)	 John Guthery, Vice President, LPL Financial, conducted on April 9, 2009, 

excerpted portions of which are at Exhibit 89. 

(31)	 Harry Markopolos, Chartered Financial Analyst and Certified Fraud 

Examiner, conducted on April 13, 2009. 

(32)	 Redacted* name of Staff Attorney, Division of Enforcement, Securities 

and Exchange Commission, conducted on April 13, 2009, referred to in 

the ROI as “Enforcement Staff Attorney.” 

(33)	 Juan Marcelino, Shareholder, Greenberg Traurig LLP, former Regional 

Administrator, Boston District Office, Securities and Exchange 

Commission, conducted on April 14, 2009. 

(34)	 Steve Luparello, Vice Chairman, Financial Industry Regulatory Authority, 

conducted on April 14, 2009. 

(35)	 Michael Garrity, Branch Chief (now Assistant Regional Director), Boston 

Regional Office, Securities and Exchange Commission, conducted on 

April 17, 2009. 

(36)	 Jim Fanslau, Criminal Investigator, Division of Enforcement, Securities 

and Exchange Commission, conducted on April 17, 2009. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

17 
____________________________ 

 

 

(37)	 Sonam Varghese, Branch Chief, Office of Compliance Inspections and 

Examinations, New York Regional Office, Securities and Exchange 

Commission, conducted on April 17, 2009, at Exhibit 90. 

(38)	 Sheryl Marcus, Staff Accountant, Office of Compliance Inspections and 

Examinations, New York Regional Office, Securities and Exchange 

Commission, conducted on April 22, 2009, at Exhibit 91. 

(39)	 David Marder, Partner, Robbins Kaplan Miller & Ciresi LLP, former 

Assistant District Administrator, Boston District Office, Securities and 

Exchange Commission, conducted on April 30, 2009, at Exhibit 92. 

(40)	 Azam Riaz, Staff Accountant, New York Regional Office, Securities and 

Exchange Commission, conducted on May 4, 2009. 

(41)	 Redacted* name of former Assistant Regional Administrator, New York 

Regional Office, Securities and Exchange Commission, conducted on May 

5, 2009, referred to in the ROI as “former Assistant Regional 

Administrator,” at Exhibit 93. 

(42)	 Redacted* name of former Assistant Regional Director, Division of 

Enforcement, New York Regional Office, Securities and Exchange 

Commission, conducted on May 6, 2009, referred to in the ROI as “former 

Assistant Regional Director,” at Exhibit 94. 

(43)	 Richard Walker, General Counsel, Deutsche Bank, former Regional 

Director of the New York Regional Office, conducted on May 8, 2009, 

excerpted portions of which are at Exhibit 95. 

(44)	 Redacted* name of former Staff Attorney, Division of Enforcement, New 

York Regional Office, Securities and Exchange Commission, conducted 

on May 18, 2009 and June 26, 2009, referred to in the ROI as “former 

New York Enforcement Staff Attorney,”at Exhibit 96 and Exhibit 97, 

respectivley. 

(45)	 Edwin Nordlinger, former Deputy Regional Administrator, Division of 

Enforcement, Northeast Regional Office, Securities and Exchange 

Commission, conducted on May 19, 2009, at Exhibit 98. 

(46)	 Redacted* name of former Examiner, Securities and Exchange 

Commission, conducted on May 27, 2009, at 6:27 p.m., referred to in the 

ROI as “former Examiner #2,” excerpted portions of which are at Exhibit 

99. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

18 
____________________________ 

 

 

(47)	 John Gentile, Partner, Ascendant Compliance, former Branch Chief, 

Division of Market Regulation, Securities and Exchange Commission, 

taken on June 10, 2009, at 11:20 a.m., excerpted portions of which are at 

Exhibit 100. 

(48)	 Demetrios Vasilakis, Chief Compliance Officer, Atticus Capital LLC, 

former Compliance Examiner and Branch Chief, Northeast Regional 

Office, Securities and Exchange Commission, conducted on June 10, 

2009, at 12:10 p.m. and August 17, 2009, excerpted portions of which are 

at Exhibit 101 and Exhibit 102, respectively. 

(49)	 Lee Richards, Partner, Richards Kibbe & Orbe LLP, taken on June 10, 

2009, excerpted portions of which are at Exhibit 103. 

(50)	 Bernard L. Madoff, former Chairman, Bernard L. Madoff Investment 

Securities LLP, conducted on June 17, 2009, excerpted portions of which 

are at Exhibit 104. 

(51)	 Arthur Levitt, former Chairman, Securities and Exchange Commission, 

taken on June 22, 2009, at Exhibit 105. 

(52)	 Brian Snively, Branch Chief, Office of Compliance Inspection and 

Examinations, Securities and Exchange Commission, taken on July, 23, 

2009, at 10:35 a.m., excerpted portions of which are at Exhibit 106. 

(53)	 Unidentified former girlfriend of Eric Swanson, conducted on August 4, 

2009, at Exhibit 107. 

(54)	 Kelly Bowers, Senior Assistant Regional Director, Division of 

Enforcement, Securities and Exchange Commission, conducted on August 

5, 2009. 

(55)	 Victoria Levin, Branch Chief, Division of Enforcement, Securities and 

Exchange Commission, conducted on August 5, 2009. 

(56)	 Annette Nazareth, former Commissioner, Securities and Exchange 

Commission, conducted on August 6, 2009, at Exhibit 108. 

(57)	 Redacted* name of former Staff Attorney, Division of Enforcement, 

Securities and Exchange Commission, conducted on August 7, 2009, 

referred to in the ROI as “former Enforcement Staff Attorney,” at Exhibit 

109. 

(58)	 Clifford Hyatt, former Deputy Assistant Regional Director, Division of 

Enforcement, Securities and Exchange Commission, conducted on August 

7, 2009 and August 12, 2009. 

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

19 
____________________________ 

 

 

(59)	 Redacted* name of Examiner, New York Regional Office, Securities and 

Exchange Commission, conducted on August 12, 2009, referred to in the 

ROI as “New York Examiner,” at Exhibit 110. 

(60)	 Redacted* name of Senior Counsel, Office of Investor Education and 

Advocacy, Securities and Exchange Commission, conducted on August 

13, 2009, referred to in the ROI as “OIEA Senior Counsel,” at Exhibit 

111. 

(61)	 Kenneth Liebl, Securities Compliance Examiner (now Branch Chief), 

New York Regional Office, Securities and Exchange Commission, 

conducted on August 17, 2009, at Exhibit 102. 

The OIG also reviewed the testimony of the Hearing Before the Committee on 

Financial Services, United States House of Representatives, 111th Congress, February 4, 

2009, Assessing the Madoff Ponzi Scheme and Regulatory Failures, which included 

testimony from Harry Markopolos, former Enforcement Director Linda Thomsen, 

Investment Management Director Andrew Donohue, former Trading and Markets 

Director Erik Sirri, then-acting General Counsel Andy Vollmer, former Office of 

Compliance Inspections and Examinations Director Lori Richards, and FINRA’s thenInterim Chief Executive Officer Stephen Luparello. 

We also reviewed various documents in connection with the current criminal 

investigation of Madoff, including the allocution transcripts of Bernard Madoff (March 

12, 2009 Allocution Testimony) and Frank DiPascali (August 11, 2009 Allocution 

Testimony). 

Executive Summary 

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

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

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

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

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

relationship with Bernard Madoff’s niece, Shana Madoff, influenced the conduct of the 

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

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

Madoff firm, nor was there evidence any senior SEC official interfered with the staff’s 

ability to perform its work. 

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

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

* After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

20 
 

 

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

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

investigations being conducted, a thorough and competent investigation or examination 

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

Madoff confessed, the SEC received six10 substantive complaints that raised significant 

red flags concerning Madoff’s hedge fund operations and should have led to questions 

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

of two articles regarding Madoff’s investment operations that appeared in reputable 

publications in 2001 and questioned Madoff’s unusually consistent returns. 

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

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

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

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

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

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

years without a single loss. 

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

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

was entitled “The World’s Largest Hedge Fund is a Fraud” and detailed approximately 

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

as “highly likely.” The red flags included the impossibility of Madoff’s returns, 

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

represented to have traded. 

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

Manager identifying numerous concerns about Madoff’s strategy and purported returns, 

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

noting that Madoff’s strategy and purported returns were not duplicable by anyone else, 

and stating Madoff’s strategy had no correlation to the overall equity markets in over 10 

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

issues that were “indicia of a Ponzi scheme.” 

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

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

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

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

included Madoff’s incredible and highly unusual fills for equity trades, his 

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

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

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

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

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

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

dismissed entirely, and an investigation not opened until the third version was submitted. 

21 
could not be trading options over-the-counter because it was inconceivable that he could 

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

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

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

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

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

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

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

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

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

Your attention is directed to a scandal of major proportion 

which was executed by the investment firm Bernard L. 

Madoff . . . . Assets well in excess of $10 Billion owned by 

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

Madoff firm have been “co-mingled” with funds controlled 

by the Madoff company with gains thereon retained by 

Madoff. 

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

previous complaint, with additional information from the same source regarding 

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

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

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

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

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

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

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

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

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

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

former Madoff investor as saying, “Anybody who’s a seasoned hedge-fund investor 

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

naïve.” 

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

and adequately resolved without thoroughly examining and investigating Madoff for 

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

how Madoff could have been achieving his returns. 

22 
 

 

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

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

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

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

independent third party. 

The OIG investigation found the SEC conducted two investigations and three 

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

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

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

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

conducted a Ponzi scheme examination or investigation of Madoff. 

The first examination and first Enforcement investigation were conducted in 1992 

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

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

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

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

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

While the SEC ensured that all of Madoff’s associate’s customers received their money 

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

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

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

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

of Madoff, the SEC did not seek Depository Trust Company (DTC) (an independent thirdparty) records, but sought copies of such records from Madoff himself. Had they sought 

records from DTC, there is an excellent chance that they would have uncovered Madoff’s 

Ponzi scheme in 1992.1 

In 2004 and 2005, the SEC’s examination unit, OCIE, conducted two parallel 

cause examinations of Madoff based upon the Hedge Fund Manager’s complaint and the 

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

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

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

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

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

Madoff’s trading and returns. 

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

suspicious information and evidence and caught Madoff in contradictions and 

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

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

examiners accepted them at face value. 

1

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

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

23 
 

In both examinations, the examiners made the surprising discovery that Madoff’s 

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

for concern. 

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

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

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

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

In the first of the two OCIE examinations, the examiners drafted a letter to the 

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

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

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

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

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

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

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

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

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

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

that the response was not shared with them. 

Both examinations concluded with numerous unresolved questions and without 

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

trading and operating a Ponzi scheme. 

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

SEC, which explicitly stated it was “highly likely” that “Madoff was operating a Ponzi 

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

inexperienced Enforcement staff failed to appreciate the significance of the analysis in 

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

investigation was directed at determining whether Madoff should register as an 

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

As with the examinations, the Enforcement staff almost immediately caught 

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

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

certain critical and fundamental aspects of Madoff’s operations. When Madoff provided 

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

accepted as plausible his explanations. 

Although the Enforcement staff made attempts to seek information from 

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

the NASD and asked for information on whether Madoff had options positions on a 

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

24 
on that date, they did not take any further steps. An Enforcement staff attorney made 

several attempts to obtain documentation from European counterparties (another 

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

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

Madoff’s Ponzi scheme being uncovered. 

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

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

the conclusion that an investment with Madoff was unwise. Specifically, Madoff’s 

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

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

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

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

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

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

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

The private entities’ conclusions were drawn from the same “red flags” in Madoff’s 

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

dismissed. 

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

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

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

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

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

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

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

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

did not detect the fraud, lent credibility to Madoff’s operations and had the effect of 

encouraging additional individuals and entities to invest with him. 

A more detailed description of the circumstances surrounding the five major 

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

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

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

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

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

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

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

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

As the SEC began investigating the matter, they learned that Madoff had 

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

decisions for them, and, according to Avellino, Madoff had achieved these consistent 

returns for them for numerous years without a single loss. Avellino described Madoff’s 

25 
strategy for these extraordinarily consistent returns as very basic: investing in long-term 

Fortune 500 securities, with hedges of the Standard & Poor’s (S&P) index. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

to look at the investment strategy and returns. 

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

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

did not take any further steps to inquire into Madoff’s firm. The SEC lawyers working 

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

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

Avellino & Bienes was selling unregistered securities or operating an unregistered 

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

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

independently verify account balances and transaction activity included in Madoff’s 

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

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

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

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

deeply into either Avellino & Bienes’ or Madoff’s operations. 

The result was a missed opportunity to uncover Madoff’s Ponzi scheme 16 years 

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

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

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

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

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

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

26 
Avellino & Bienes invested all of their clients’ money exclusively with Madoff. The 

SEC’s lead examiner said Madoff’s reputation as a broker-dealer may have influenced 

the inexperienced team not to inquire into Madoff’s operations. 

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

(BDO) with an eight-page complaint questioning the legitimacy of Madoff’s reported 

returns. The 2000 complaint posited the following two explanations for Madoff’s 

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

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

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

complaint stated that Madoff’s returns were unachievable using the trading strategy he 

claimed to employ, noting Madoff’s “perfect market-timing ability.” Markopolos also 

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

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

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

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

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

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

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

(NERO). 

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

supplemented his previous 2000 complaint with updated information and additional 

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

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

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

market’s worst down month of -14.58%. Markopolos concluded that Madoff’s “numbers 

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

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

experience and knowledge of investment funds. 

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

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

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

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

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

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

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

average complaint,” was disregarded so quickly. 

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

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

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

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

ask how,” stated how many were “baffled by the way [Madoff’s] firm has obtained such 

27 
consistent, nonvolatile returns month after month and year after year,” describing the fact 

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

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

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

MARHedge article further discussed how industry professionals “marvel at [Madoff’s] 

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

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

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

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

strategy.” 

The Barron’s article, written by Erin Arvedlund and entitled “Don’t Ask, Don’t 

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

how Madoff’s operation was among the three largest hedge funds, and has “produced 

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

“never [having] had a down year.” The Barron’s article further questioned whether 

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

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

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

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

and asked the Director of NERO if he wanted a copy of the article. However, the 

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

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

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

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

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

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

Barron’s article until several years later. 

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

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

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

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

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

funds and the MARHedge article. 

The Hedge Fund Manager’s complaint identified numerous concerns about 

Madoff’s strategy and purported returns. According to the Hedge Fund Manager’s 

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

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

Further, the Hedge Fund Manager explained in his complaint that Madoff’s fee structure 

was suspicious because Madoff was foregoing the significant management and 

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

specific concerns about Madoff’s strategy and purported returns such as the fact that the 

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

28 
 

 

 

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

the firm was a related party to the principal; and Madoff’s firm never had to face 

redemption. 

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

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

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

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

running a Ponzi scheme. 

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

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

basic steps taken to obtain third-party verifications, Madoff’s Ponzi scheme should and 

would have been uncovered. 

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

adequately, and thus, missed another opportunity to uncover Madoff’s fraud. The 

complaint was immediately referred to OCIE’s broker-dealer examination group even 

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

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

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

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

time, the two OCIE groups rarely collaborated on examinations.12 

The broker-dealer examination team assigned to the examination was 

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

“didn’t have many experienced people at all” noting that “we were expanding rapidly and 

had a lot of inexperienced people” conducting examinations. Another OCIE examiner 

stated that “there was no training,” that “this was a trial by fire kind of job” and there 

were a lot of examiners who “weren’t familiar with securities laws.” The team was 

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

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

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

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

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

experience conducting examinations of these issues. 

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

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

December 2003. No reason was given for this delay. 

12 It should be noted that the fact that Madoff’s hedge fund business had not been registered at the time of 

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

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

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

29 
The OIG investigation also found that the complaint was poorly analyzed and the 

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

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

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

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

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

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

the area of expertise for my crew.” 

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

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

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

that Madoff’s trading strategy was not duplicable; the returns had no correlation to actual 

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

brokers; and the auditor of Madoff’s firm was a related party. 

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

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

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

information from the NASD would have assisted in independently verifying trading 

activity conducted at Madoff’s firm. However, the letter was never sent, with the 

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

information they would have obtained. According to the OIG’s expert, had the letter 

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

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

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

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

During the course of the examination, the examination team discovered 

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

Responses by Madoff to the document requests contradicted the Hedge Fund Manager’s 

complaint and the 2001 articles. For example, Madoff’s claim that his firm did not 

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

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

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

the examiners did not follow up on these red flags. 

We also found that Madoff’s responses to the examiners’ document requests 

should have raised suspicions because the information provided appeared incomplete 

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

Madoff’s account statements only included average prices during each day without the 

actual prices for each transaction. According to the OIG’s expert, based on the questions 

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

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

implementing the strategy as claimed. 

30 
The examiners also made the surprising discovery that Madoff’s mysterious 

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

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

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

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

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

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

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

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

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

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

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

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

examiner acknowledged obtaining such data should not have been difficult. 

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

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

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

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

projects incomplete. 

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

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

investment management examiner had been conducting a routine examination of an 

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

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

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

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

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

included Madoff’s: (1) incredible and highly unusual fills for equity trades; (2) 

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

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

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

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

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

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

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

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

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

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

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

registrant had “totally independent evidence” that Madoff’s executions were “highly 

unusual.” 

31 
The investment management examiner who initially discovered the e-mails and 

his supervisors viewed them as indicating the registrant’s employees were clearly “trying 

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

“there’s some suspicion as to whether Madoff is trading at all.” They indicated they 

would have followed up on the allegation in the e-mails about “whether Madoff was 

actually trading.” 

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

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

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

was not assembled until December 2004. 

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

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

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

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

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

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

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

examination. 

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

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

suspicions about Madoff’s performance and returns. An examiner stated that each of the 

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

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

NERO broker-dealer examination team began performing background research in 

preparation for an on-site examination of Madoff to begin in April. Unlike the OCIE 

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

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

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

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

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

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

analyze Madoff’s returns because portfolio analysis was not a strength of broker-dealer 

examiners. 

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

and accepting his answers. With respect to the significant concerns about Madoff’s 

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

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

fact that Madoff’s representation was inconsistent with the internal e-mails, the two 2001 

32 
articles, and the investment strategy Madoff claimed to employ. As to why Madoff did 

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

was not “greedy” and was happy with just receiving commissions. 

 Several issues, including the allegation in the internal e-mails that Madoff’s 

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

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

assigned to investigate Madoff’s accountant, David Friehling, and within a few hours of 

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

In addition, although one of the NERO examiners placed a “star” next to the 

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

Madoff’s executions were “highly unusual,” NERO never followed up with the registrant 

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

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

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

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

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

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

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

the examiners later asked Madoff the reason for the urgency, Madoff told them her lunch 

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

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

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

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

wonderful storyteller” and “very captivating speaker” and noted that he had “an 

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

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

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

Madoff would drop the names of high-up people in the SEC.” Madoff told them that 

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

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

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

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

that Madoff’s “veins were popping out of his neck” and he was repeatedly saying, “What 

are you looking for? . . . . Front running. Aren’t you looking for front running,” and “his 

voice level got increasingly loud.” 

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

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

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

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

33 
reported back to their Assistant Director about the pushback they received from Madoff, 

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

One effort was made to verify Madoff’s trading with an independent third-party, 

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

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

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

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

financial institution responded, stating there was no transaction activity in Madoff’s 

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

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

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

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

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

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

to Madoff’s changing stories about how many advisory clients he had. However, when 

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

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

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

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

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

examining. 

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

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

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

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

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

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

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

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

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

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

examiners reported conducting only a cursory review of the workpapers and did not 

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

D.C. examination, appear to have never discussed the D.C. examiners’ open questions 

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

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

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

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

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

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

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

clearance, as well as Madoff’s claim that he used his “gut feel” to time the market based 

34 
 

on “his observations of the trading room,” Madoff was pushing them to finish the 

examination. 

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

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

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

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

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

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

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

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

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

[just] be a matter of semantics.” The examiners’ request to visit Madoff feeder funds was 

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

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

have a hunch or they’re following things.” 

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

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

numerous open questions about Madoff’s operations. Many, if not most, of the issues 

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

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

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

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

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

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

examination. 

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

Markopolos provided the SEC’s BDO with a third version of his complaint entitled “The 

World’s Largest Hedge Fund is a Fraud.” Markopolos’ 2005 complaint detailed 

approximately 30 red flags indicating Madoff was operating a Ponzi scheme, a scenario 

Markopolos described as “highly likely.” Markopolos’ 2005 complaint discussed an 

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

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

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

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

into one of three categories: (1) Madoff’s obsessive secrecy; (2) the impossibility of 

Madoff’s returns, particularly the consistency of those returns; and (3) the unrealistic 

volume of options Madoff was supposedly trading. 

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

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

Markopolos’ allegation that Madoff was operating a Ponzi scheme worthy of serious 

35 
investigation, they felt it made more sense for NERO to conduct the investigation 

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

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

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

the matter was assigned within NERO. 

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

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

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

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

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

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

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

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

significance of the evidence in the 2005 Markopolos complaint and almost immediately 

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

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

immediately discounted his evidence. The Enforcement staff also questioned 

Markopolos’ motives, indicating concerns that “he was a competitor of Madoff’s” who 

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

Markopolos’ complaint, he described that it was “highly likely” that Madoff was 

operating a “Ponzi scheme,” and acknowledged that if he were correct, he would not be 

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

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

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

The OIG investigation also found the Enforcement staff was skeptical about 

Markopolos’ complaint because Madoff did not fit the “profile” of a Ponzi scheme 

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

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

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

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

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

examination team downplayed the possibility that Madoff was conducting a Ponzi 

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

Markopolos “doesn’t have the detailed understanding of Madoff’s operations that we do 

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

acknowledged that their examination “did not refute Markopolos’ allegations regarding a 

Ponzi scheme” and that the examiners’ reaction may have given the impression their 

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

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

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

was never truly analyzed. 

36 
The Enforcement staff delayed opening a matter under inquiry (MUI) for the 

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

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

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

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

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

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

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

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

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

there was no review or analysis of this complaint. 

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

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

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

calling that scenario “highly likely.” However, most of the Enforcement staff’s efforts 

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

an investment adviser or whether Madoff’s hedge fund investors’ disclosures were 

adequate. In fact, the Enforcement staff’s investigative plan primarily involved 

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

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

fabricated). 

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

misrepresentations. An initial production of documents the Enforcement staff obtained 

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

examination about a fundamental component of his claimed trading activity. 

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

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

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

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

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

fund, the Enforcement staff noted several additional “discrepancies” between what 

Madoff told the examiners in the NERO examination and information they received in 

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

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

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

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

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

Markopolos and declined to even pick up the “several inch thick file folder on Madoff” 

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

between Markopolos and the Branch Chief as “adversarial.” 

37 
In February 2006, the Enforcement staff contacted the SEC’s Office of Economic 

Analysis (OEA) seeking assistance in analyzing Madoff’s trading. OEA failed to 

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

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

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

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

Madoff’s split-strike conversion strategy “was not a strategy that would be expected to 

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

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

OIG that if he had been made aware of the amount of assets that Madoff had been 

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

for Madoff’s returns. In the end, the Enforcement staff never obtained any useful 

information or analysis from OEA. 

Throughout the Enforcement staff’s investigation, the Enforcement staff was 

confused about certain critical and fundamental aspects of Madoff’s operations. They 

had trouble understanding Madoff’s purported trading strategy, basic custody of assets 

issues and, generally, how Madoff’s operation worked. Despite the Enforcement staff’s 

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

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

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

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

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

Enforcement staff did not seek help from the SEC’s Office of International Affairs (OIA). 

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

Enforcement staff should have discovered that Madoff was not purchasing equities from 

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

agreements with European counterparties. 

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

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

Madoff’s testimony, but they ignored his advice. On May 17, 2006, two days before they 

were scheduled to take Madoff’s testimony, the Enforcement staff attorney contacted the 

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

Madoff’s options trading. The NASD official told the OIG that he answered “extremely 

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

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

subject matter to take Madoff’s testimony. The NASD official also recalled telling the 

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

ready to talk to [Madoff],” but that they were intent on taking Madoff’s testimony as 

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

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

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

advice, the Enforcement staff did not postpone Madoff’s testimony. 

38 
 

 

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

investigation. During Madoff’s testimony, he provided evasive answers to important 

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

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

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

critical information that was relevant to uncovering Madoff’s Ponzi scheme. 

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

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

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

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

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

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

at.” Because of the Enforcement staff’s inexperience and lack of understanding of equity 

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

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

accepted as plausible Madoff’s claim that his returns were due to his perfect “gut feel” 

for when the market would go up or down. 

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

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

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

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

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

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

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

happened.” Madoff further said that when Enforcement did not follow up with DTC, he 

“was astonished.” 

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

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

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

they’re stealing money, they’re not going to hesitate to lie or create records” and, 

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

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

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

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

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

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

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

2005, DTC records show that Madoff held less than $18 million worth of S&P 100 

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

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

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

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

39 
 

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

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

learned this information during the course of their investigation, they would have 

immediately realized that Madoff was not trading in anywhere near the volume that he 

was showing on the customer statements.13 When Madoff’s Ponzi scheme finally 

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

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

investors’ funds. 

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

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

requests. On May 16, 2006, three days before Madoff’s testimony, the Enforcement staff 

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

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

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

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

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

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

Madoff’s claims of trading OTC options with a financial institution and found that “no 

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

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

European counterparties and one of Madoff’s purported counterparties was in the process 

of drafting a consent letter asking Madoff’s permission to send the Enforcement staff the 

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

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

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

The Enforcement staff effectively closed the Madoff investigation in August 2006 

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

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

and he would be subject to an examination by our [Investment Adviser] team.” However, 

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

adviser. 

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

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

Your attention is directed to a scandal of major proportion 

which was executed by the investment firm Bernard L. 

Madoff ... Assets well in excess of $10 Billion owned by 

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

Madoff firm have been “co-mingled” with funds controlled 

by the Madoff company with gains thereon retained by 

Madoff. 

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

40 
 

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

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

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

became evident not only that Madoff managed this investor’s money, but also that he was 

actually one of Madoff’s largest individual investors. 

Shortly after the Madoff Enforcement investigation was effectively concluded, the 

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

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

investigation.” 

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

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

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

“When Madoff finally does blow up, it’s going to be spectacular, and lead to massive 

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

ignored. 

After Madoff was forced to register as an investment adviser, the Enforcement 

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

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

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

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

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

keeps two (2) sets of records.14 The most interesting of 

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

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

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

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

As the foregoing demonstrates, despite numerous credible and detailed 

complaints, the SEC never properly examined or investigated Madoff’s trading and never 

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

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

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

Madoff confessed. 

14 The allegation that Madoff kept two sets of records also turned out to be true. 

41 
 

 

Results of the Investigation 

I. SEC 1992 INVESTIGATION OF AVELLINO & BIENES 

A. Customers Complained about Avellino & Bienes’ Investments 

In or before June 1992, the SEC was notified both verbally and in writing by two 

customers, Earl McClain and Sandra Bozarth, of investments that they had made with the 

firm of Avellino & Bienes. Memorandum dated June 24, 1992 from the former New 

York Enforcement Staff Attorney to File regarding the Matter of King Arthur MNY-1490 

(Former New York Enforcement Staff Attorney June 24, 1992 Memorandum) at p. 1, at 

Exhibit 1. The SEC determined that the transactions with Avellino & Bienes “were set 

up to give the appearance of a demand note.” Id. The SEC was also provided with an 

August 7, 1991 letter from Avellino & Bienes to a potential investor, which stated, in 

pertinent part, as follows: 

Avellino & Bienes invests with one particular Wall Street 

Broker (the same company since we first started doing 

business over 25 years ago) who buys and sells stocks and 

bonds in the name of Avellino & Bienes. The list of 

securities being traded are top corporations such as IBM, 

AT&T, etc. It’s the mechanics being used to protect the 

portfolio that makes our business successful, not just the 

top name securities being traded. 

... 

We do not encourage new accounts and therefore we do not 

solicit same. We do, however, like to accommodate those 

individuals, etc. that are recommended as you have been 

through Virginia Atherton.15 Summarily, this is a very 

private group and no financial statements, prospectuses or 

brochures have been printed or are available. 

Let me clarify one important thing. The money that is sent 

to A&B is a loan to A&B who in turns invests it on behalf 

of A&B for which our clients receive quarterly interest 

payments. 

... 

15 The SEC found that the fact that prospective investors had to be referred to Avellino & Bienes created 

an impression that the Avellino & Bienes’ investment program was “special” and exclusive. SEC 

Summary Memorandum dated November 13, 1992, at p. 7, at Exhibit 114. 

42 
 

 

The minimum deposit is $5,000.00. ... Interest rate is 

16.0% annually. Interest is computed quarterly. 

Letter dated August 7, 1991 from Avellino & Bienes to prospective investor, at p. 

1, at Exhibit 113. 

The SEC also obtained a “Fact Sheet” that described the structure of the 

investments with Avellino & Bienes. King Arthur Account Fact Sheet (undated) by 

Andrew Copperman,16 (The Fact Sheet), at p. 1, at Exhibit 115. The Fact Sheet, a twopage document resembling a brochure, was produced by Andrew Copperman, and 

answered a variety of questions about the Avellino & Bienes investment, such as the 

following: 

What does it pay? 13.5%. The interest income is paid 

quarterly. When the combined account 

size is $2 million, the rate will increase 

to 14%. If you reinvest, 13.5% 

compounded quarterly is 14.1% 

annually. 

Is it safe? Yes. 100%. At no time is a trade made 

that puts your money at risk. In over 20 

years there has never been a losing 

transaction. 

* * * 

How does it work? The funds you send to Avellino & 

Bienes are treated as a ‘loan’ by them. 

All of these funds are send [sic] to a 

New York broker who invests same on 

behalf of Avellino & Bienes. The 

underlying trades, made for the account 

of Avellino & Bienes are, in general, 

made as simultaneous purchases of 

convertible securities and its short sale 

of the common stock, locking in a profit. 

Other forms of riskless trading are also 

used. The brokerage firm that makes 

these trades is a wholesale dealer that 

16 Andrew Cooperman was an investment adviser who referred over 100 investors to Avellino & Bienes 

from 1989 to 1990, but after receiving a notice from the California Department of Corporations in October 

1990 that he may have been acting as an unregistered broker-dealer, he ceased his referrals to Avellino & 

Bienes and wrote a letter to each investor who he had referred to Avellino & Bienes indicating he would no 

longer recommend or render any advice with respect to Avellino & Bienes’ investments. SEC Summary 

Memorandum dated November 13, 1992, at p. 5, at Exhibit 114. 

43 
 

 

 

makes the market in Big Board 250 

highest volume trading stocks. In 

practice, the trades are handled by 

computer for speed and accuracy. 

Id. at pgs. 1-2. 

B.	 SEC Contacted Avellino and Suspected that Avellino & Bienes Was 

Selling Unregistered Securities and Running a Ponzi Scheme 

After receiving the information from the Avellino & Bienes’ customers, the thenActing Enforcement Branch Chief and former New York Enforcement Staff Attorney 

contacted Frank Avellino. Former New York Enforcement Staff Attorney June 24, 1992 

Memorandum, at p. 1, at Exhibit 1. Avellino stated that he borrowed “money from 

friends, relatives, referrals and past clients of his CPA firm,” “gave them ‘demand 

notes,’” and invested “the money in real estate and ‘some securities.’” Id. The former 

New York Enforcement Staff Attorney concluded that “it appears that Mr. Avellino and 

Mr. Bines [sic] and the firm A&B have been engaged in selling securities to the public, 

which are unregistered, in violation of Section 5(a) of the Securities Act of 1933.” Id. 

The former New York Enforcement Staff Attorney stated that the SEC 

investigators also initially believed that Avellino & Bienes was running a Ponzi scheme. 

Former New York Enforcement Staff Attorney Interview Memorandum (May 18, 2009). 

Others also recalled that the SEC was investigating Avellino & Bienes for a possible 

Ponzi scheme. Richard Walker, then-Regional Administrator of the SEC’s New York 

region, recalled a concern that Avellino & Bienes was engaged in a “Ponzi 

scheme/fraud.” Walker Interview Tr. at p. 11.17 Former New York Enforcement Staff 

Attorney #2, the Staff Attorney who eventually prepared the complaint brought against 

Avellino & Bienes, recalled that “there was a concern that Avellino & Bienes was 

operating a Ponzi scheme” that arose from “the returns that were being promised [by 

Avellino & Bienes] combined with a lack of transparency about how the monies were 

invested.” Former New York Enforcement Staff Attorney #2 Testimony Tr. at pgs. 11­

14. The former Assistant Regional Administrator in charge of Investment Management 

(IM) Inspection Branches in 1992, who consulted on the investigation, also recalled that 

the Enforcement attorneys working on the case were concerned that Avellino & Bienes 

was running a Ponzi scheme. Former Assistant Regional Administrator Interview 

Memorandum. 

Assistant Director Robert Sollazzo, who oversaw the examination team, also 

acknowledged concern “that there might have been a Ponzi scheme” in the Avellino & 

Bienes investigation. Sollazzo Testimony Tr. at p. 42. 

17 Richard Walker also told The Wall Street Journal at that time that “we went into this thinking it could be 

a major catastrophe.” Randall Smith, Wall Street Mystery Features a Big Board Rival, The Wall Street 

Journal, December 16, 1992, at Exhibit 116. 

44 
 

 

 

 

 

C.	 Counsel for Avellino & Bienes Contacted the SEC and Avellino and 

Bienes Came in for Voluntary Joint Testimony 

Shortly after the investigation began, the former New York Enforcement Staff 

Attorney said he recalled, “Ike” Sorkin18 counsel for Avellino and Bienes, “calling up 

and saying, ‘I represent Avellino and Bienes’ and ‘nothing inappropriate is going on here. 

They are former IRS agents and I’ll bring them in for testimony.’” Former New York 

Enforcement Staff Attorney Interview Memorandum (June 26, 2009) at p. 2. 

On July 7, 1992, Frank Avellino and Michael Bienes came in for joint voluntary 

testimony in which they answered the staff’s questions together. Transcript of Testimony 

of Frank Avellino and Michael Bienes on July 7, 1992 (Avellino and Bienes July 7, 1992 

Testimony Tr.), at Exhibit 117. The former New York Enforcement Staff Attorney 

reasoned that both Avellino and Bienes came in for testimony together because they were 

represented by the same counsel. Former New York Enforcement Staff Attorney 

Interview Memorandum (June 26, 2009) at p. 2. Ira Sorkin, Esq. and Dori Hanswirth, 

Esq. of Squadron, Ellenoff, Plesent, & Lehrer represented both Frank Avellino and 

Michael Bienes individually and the Avellino & Bienes partnership. Avellino and Bienes 

July 7, 1992 Testimony Tr. at p. 1, at Exhibit 117. 

In the testimony, Avellino described the investment process, which he 

characterized as “loans,” as follows: 

I borrow money from a Mr. Smith for which I pay interest, 

the proceeds of the loan are put into my checking account. 

I now write a check from my checking account, send it to 

Bernard L. Madoff on behalf of Avellino & Bienes. Like 

any other brokerage account, he takes the cash, gives me 

credit for it, goes out and executes whatever positions he 

has to. 

Id. at pgs. 47-48. 

Bienes described how at one time Avellino & Bienes had borrowed money from 

Chemical Bank for investing, but in 1988, they paid off the loan because they “didn’t 

want to have to explain what [their] investment strategies were ... [and] didn’t want to 

submit detailed, annual, personal and business financial statements.” Id. at pgs. 53-58. 

Avellino also indicated that some investors were getting higher returns than others. Id. at 

p. 73.19 

18 Ira “Ike” Sorkin currently represents Bernard L. Madoff in the criminal proceeding that arose out of
 

Madoff’s December 2008 confession. Madoff Interview Memorandum at p. 1.
 19 The FTI Engagement Team noted that the fact that some investors were getting higher returns than
 

others could be indicative of a Ponzi scheme. 

45 
 

 

Avellino testified that Avellino & Bienes invested through Bernard L. Madoff & 

Co., and primarily dealt with Bernard L. Madoff. Id. at pgs. 37-38. Avellino indicated 

that they had 5 accounts with Madoff’s firm. Id. at p. 38. Avellino stated that they solely 

invested money with Madoff’s firm, buying securities through them. Id. at p. 39. 

Avellino testified that Madoff determined how the monies would be invested. Id. When 

asked if he ever made a business decision on what securities to purchase, Avellino 

replied, “Never.” Id. at p. 40. 

Avellino stated “all of the $400 million plus [that was ‘loaned’ to Avellino & 

Bienes in investments] is with Bernard L. Madoff, every single dollar, it is invested in 

long-term Fortune 500 securities, it is, to use the word ‘protected’ with hedges of 

Standard & Poor’s index.” Id. at p. 77. 

Avellino also said the partnership of Avellino & Bienes had accounts with Madoff 

where Madoff makes all the investment decisions. Id. at pgs. 81-82. They acknowledged 

that in addition to the $400 million they had invested on behalf of investors, they were 

investing an additional $40 million of their personal partnership monies with Madoff. Id. 

at pgs. 82-85. 

Avellino described his understanding of Madoff’s strategy for buying securities 

for the Avellino & Bienes accounts, as follows: 

We sell short against the box, we use the hedges of the 

Standard & Poor’s 500, Fortune 500.... Madoff uses the 

hedges basically as S&P’s, puts and calls. Every security 

that we have in the long position has a hedge, every single 

one of them. We use what we call the hedge of the buying 

and selling, the buying of the convertible and the selling of 

the underlying common stock short, sometimes done the 

same two – sometimes done two days after the long 

position is bought, which we used to use years ago. 

Id. at pgs. 40-41. 

When asked if he had any input into how to employ the strategies, Avellino 

replied, “None at all.” Id. at p. 41. 

Avellino stated that Avellino & Bienes, [and its predecessor company] had 

invested with Madoff for 30 years, since 1962. Id. at p. 44.20 He also stated, “I could 

honestly say, and you could check any record that you want with me from 1962 to today, 

in thousands of transactions, of which I call arbitrage [referring to Madoff’s strategy], 

which is bona fide convertible buying and selling, there has never been a loss.” Id. at p. 

75. 

20 The FTI Engagement Team stated that such a long-standing relationship with no losses could raise the 

question as to whether Madoff may have been collaborating in a scheme with Avellino & Bienes. 

46 
 

 

 

The former New York Enforcement Staff Attorney stated that he did not find 

Avellino and Bienes’ testimony altogether convincing, stating that he “didn’t know if 

these guys were telling the truth or not,” and thus, the SEC “needed to do further things” 

to investigate the matter. Former New York Enforcement Staff Attorney Interview 

Memorandum (June 26, 2009) at p. 3. 

D.	 The SEC Conducted a Brief, Limited Cause Examination of Madoff 

1.	 The Examination was Conducted by a Relatively Inexperienced 

Team and Its Scope was Limited 

In the course of its investigation, the SEC sought and obtained documents from 

Avellino & Bienes, including their customer account statements for August, September 

and October of 1992. Memorandum dated November 16, 1992 regarding Madoff Cause 

Examination, (Madoff Cause Examination Report), at p. 2, at Exhibit 118. On November 

16, 1992, as a “direct result” of the investigation of Avellino & Bienes, the SEC 

conducted a cause examination of Bernard Madoff “to verify certain security positions 

carried for the accounts of Avellino & Bienes.” Id. at pgs. 1-2. The Madoff Cause 

Examination Report stated that the intent of the examination was “to verify [Madoff’s] 

proper segregation, of [Avellino & Bienes’] October 1992 month end securities positions, 

in [Madoff’s] segregated accounts at DTC.” Id. 

Branch Chief John Gentile, who had joined the SEC in 1987 as a securities 

compliance examiner and who had just been promoted to Branch Chief, assembled the 

examination team from the Broker-Dealer Enforcement group21 for the examination. 

Gentile Interview Tr. at pgs. 5-6; 12. The examination team was composed of Demetrios 

(Taki) Vasilakis and Former Examiner #2. Id. at pgs. 5-6; 11-12. Vasilakis had joined 

the SEC right out of college and had been working as a compliance examiner for 2 years 

when the Madoff cause examination began. Vasilakis Interview Tr. at pgs. 4-6. Former 

Examiner #2 joined the SEC in June of 1990 right out of college as well and had been 

working with the SEC as an examiner for approximately 2 years at the time of the Madoff 

cause examination. Former Examiner #2 Interview Tr. at pgs. 3-4. 

All the examination team members described the Madoff cause examination as 

brief and limited. Gentile stated it was a very brief examination and he did not recall if 

he ever went on site, although he believed he spoke with Bernard Madoff on the 

telephone. Gentile Interview Tr. at pgs. 12-13. Vasilakis stated the examination was 

very short, very limited and he did not believe it lasted more than two or three days. 

Vasilakis Interview Tr. at p. 11. Former Examiner #2 believed that it was a very limited 

exam and they were only at Madoff’s firm for a day. Id. at p. 6. 

Gentile did not recall being informed by the former New York Enforcement Staff 

Attorney that they were to look into the possibility of a Ponzi scheme, and had no 

21 Sollazzo explained that in the late 1980’s and early 1990’s, the Broker-Dealer group within the SEC had 

its own Enforcement group who worked closely with examiners on investigations. Sollazzo Testimony Tr. 

at pgs. 40-42. 

47 
recollection of working on a matter relating to a Ponzi scheme prior to that time period. 

Gentile Interview Tr. at pgs. 6, 15. Former Examiner #2 concurred that she did not 

believe they were supposed to be doing an examination relating to allegations of a Ponzi 

scheme. Former Examiner #2 Interview Tr. at pgs. 6-8. She also had never done a Ponzi 

scheme examination. Id. at p. 8. 

2.	 A Net Capital Review was Performed and the SEC Examiners 

Sought DTC Records From Madoff, not from DTC directly 

Vasilakis recalled conducting a net capital review to “check the financial stability 

of the broker-dealer” during the Madoff cause examination. Vasilakis Interview Tr. at p. 

10. Gentile agreed that they were attempting to confirm representations made by 

Avellino & Bienes about their trading positions at Madoff. Gentile Interview Tr. at p. 17. 

According to the Madoff Cause Examination Report, “Madoff informed the staff that 

there was no activity in any of the [Avellino & Bienes] accounts in question since 

October 31, 1992.” Madoff Cause Examination Report, at p. 2, at Exhibit 118. The 

Madoff Cause Examination Report further provided as follows: 

Madoff also furnished the staff with Madoff’s stock record 

and [Depository Trust Company] DTC participant 

statement as of the previous days’ close of business, 

November 12, 1992. The staff visited Madoff’s firm on 

November 13. The staff traced all of A&B’s positions to 

Madoff’s stock record. All of the securities in A&B’s 

accounts were listed on the November 12, 1992 stock 

record. The staff then traced all of Madoff’s stock record 

positions to the DTC participant statement for November 

12, 1992. The staff observed that Madoff’s stock record 

exactly matched the participant statement. It was also 

noted that and all positions were segregated at DTC and not 

in any type of loan account. 

Id. 

According to the examination team, they would have received DTC 

statements from Madoff himself, rather than seeking those records directly from DTC. 

Gentile stated that he had no recollection of going to DTC and believed that they would 

have received the DTC records directly from Madoff. Gentile Interview Tr. at pgs. 17­

18. Vasilakis recalled that when the SEC did examinations, it was common SEC practice 

to get the DTC statements from the firm, rather than directly from DTC, stating, “It 

would always be from the firm.” Vasilakis Interview Tr. at p. 12. Former Examiner #2 

noted that at that time when they would conduct a cause examination to determine 

whether a particular registrant’s positions matched up with DTC, they would not go to 

DTC itself to get those records, but “would get them from the registrant.” Former 

Examiner #2 Interview Tr. at p. 7. 

48 
 

 

 

Gentile stated that if Madoff provided fake DTC records,22 “we would have relied 

on the fakes.” Gentile Interview Tr. at p. 18. He further acknowledged that if they were 

real DTC records, they would tell the story of whether there was trading going on. Id. at 

pgs. 19-20. 

Gentile characterized Avellino and Bienes’ testimony that for a 30-yeard period 

there had never been a loss with respect to their investments with Madoff as “a red flag.” 

Id. at p. 29. However, Gentile said in the cause examination, the focus was on whether 

Avellino & Bienes’ positions were real, not on Bernard Madoff’s positions. Id. at p. 24. 

3.	 The Examiners Never Looked into Where the Money That 

was Used to Pay Back Avellino & Bienes’ Investors Came 

From 

Gentile acknowledged that Madoff could have taken the money that was used to 

pay back Avellino & Bienes’ investors as required by the SEC from anybody, including 

other customers, stating that “Absolutely could have been done.” Id. at p. 35. He further 

acknowledged that in light of the evidence, someone “should have been aware of” the 

fact that the money used to pay back Avellino & Bienes’ customers could have come 

from other investors, but there was no examination of where the money that was used to 

pay back the investors came from. Id. at pgs. 32-33. Gentile also did not recall the 

examiners attempting to independently verify Madoff's discretionary brokerage account 

balances for any clients other than Avellino & Bienes. Id. at p. 33. Therefore, Gentile 

stated that if Madoff had been liquidating other discretionary brokerage accounts in order 

to pay back Avellino & Bienes’ customers, checking all of Madoff’s discretionary 

brokerage account balances with DTC would have “showed positions being sold and 

cash[ed] out to a bank account that he controlled where he would then -- you can tie that 

into the millions of dollars paid back to the Avellino and Bienes’ customers.” Id. at p. 

35. Gentile, however, admitted that no such effort was undertaken. Id. at pgs. 35-36. 

Vasilakis also did not recall at any point in the Madoff cause examination any 

effort to trace where the money came from that was used to repay the investors of 

Avellino & Bienes. Vasilakis Interview Tr. at p. 19. Vasilakis noted that tracing the 

funds could have been done, and in fact, it would have been “common sense” to do that, 

given the allegations. Id. at pgs. 20-21. 

Gentile also indicated that the representation made by Avellino & Bienes that they 

were providing an investment vehicle with no risk as stated in the King Arthur fact sheet 

was “a red flag for sure.” Gentile Interview Tr. at p. 21. Gentile admitted the King 

Arthur fact sheet as a whole was “very suspicious.” Id. However, Gentile recalled the 

cause examination did not look at the investment strategy and the returns “because we 

22 According to the August 11, 2009 SEC complaint filed against Frank DiPascali, Jr., “To address due 

diligence custody audits, Madoff directed DiPascali and others to create fake DTC reports” and specifically 

identified the Avellino & Bienes investigation as an occurrence when “Madoff scrambled to ... fabricate 

credible account records to corroborate the purported trading in the accounts.” SEC v. Frank DiPascali, Jr., 

No. 09 Civ. 7085 (LLS) (S.D.N.Y. filed August 11, 2009) at ¶¶ 18-20, 60, at Exhibit 119. 

49 
were so focused on identifying the scope of the fraud, the investors, the dollars, where the 

assets custody” and the decision was made to “close this down and get the investors their 

money back.” Id. at p. 29. 

Vasilakis stated that other than this brief, limited examination of Madoff, he did 

not recall any other examination of Madoff or any other entity in connection with the 

Avellino & Bienes matter. Vasilakis Interview Tr. at p. 15. Vasilakis stated that he did 

not recall any discussion about the need to do a follow-up examination of Madoff that 

would focus on Madoff and not just his connection to Avellino & Bienes. Id. at p. 16. 

4. The Examiners Were Aware of Madoff’s Stature 

Gentile and Vasilakis became aware of Bernard Madoff’s stature in the securities 

industry during the examination. Gentile stated that he was aware that Madoff’s firm 

“was very prominent in developing third market particular automated trading.” Gentile 

Interview Tr. at p. 10. Vasilakis stated he was made aware that Bernard Madoff served 

on various industry committees, was a well respected individual and noted that the SEC 

examiners used an NASD manual with Bernard Madoff’s name in it. Vasilakis Interview 

Tr. at p. 27. In fact, when asked for his recollections of Bernard Madoff at that time, 

Vasilakis stated as follows: 

My personal conclusions [from the examination] were that 

[Bernard Madoff] was a pioneer in the industry, to use the 

term that’s been thrown around now, but that he really 

used, you know, technology to bring trading to the next 

level. It was strictly -- when I walked out of there it was 

more along the lines of wow, this guy is a third market guy 

that does X percent of the volume on the exchange. This is 

where I actually learned about third market. I didn’t even 

know the so called term that that’s what it was called [prior 

to the examination]. 

Id. at p. 17. 

Gentile stated that it was fair to say that because of Bernard Madoff’s reputation 

at that time as a large broker-dealer, there may not have been any thought to look into 

Madoff’s operation any further. Gentile Interview Tr. at p. 37. 

E.	 The SEC Filed a Complaint against Avellino & Bienes for Selling 

Unregistered Securities, But the Complaint Did Not Allege Fraud 

and Did Not Assert Any Claims Against Madoff. 

On November 17, 1992, the SEC filed a Complaint for Preliminary and 

Permanent Injunctive and other Equitable Relief against defendants Avellino & Bienes, 

Avellino and Bienes in the United States District for the Southern District of New York, 

alleging that from 1962 until at least July 1992, the defendants had accepted funds for 

50 
 

 

 

investments from customers, and guaranteed those customers rates of returns ranging 

from 13.5% to 20%. Complaint for Preliminary and Permanent Injunctive and Other 

Equitable Relief dated November 17, 1992 in Case no. 92 Civ. 8314, at ¶ 1, at Exhibit 

120. The Complaint further alleged that the defendants issued notes in return for the 

funds received by customers and invested those customer funds in securities. Id. The 

Complaint charged the defendants with operating Avellino & Bienes as an unregistered 

investment company and engaging in the unlawful sale of unregistered securities. Id.23 

The Complaint further specified that the defendants invested the customer funds 

in discretionary trading accounts at a registered broker-dealer and the broker-dealer 

managed the accounts, determining which securities to buy and sell, although the 

Complaint did not name the broker-dealer as Bernard Madoff’s firm and did not assert 

any allegations or claims against Madoff’s firm, as the broker-dealer. Id. at ¶ 4. The 

Complaint also did not charge the defendants with fraud or give any indication that they 

were suspected of running a Ponzi scheme. See generally id. 

The Complaint requested that the Court enter an order preliminarily and 

permanently enjoining the defendants from selling securities without a registration 

statement, making offers to sell or buy securities without a registration statement, and 

from acting as an investment adviser in violation of applicable law. Id. at pgs. 10-12. 

The Complaint also requested an order appointing a trustee to conduct an accounting of 

Avellino & Bienes’ assets and liabilities, to direct the dissolution of Avellino & Bienes, 

to dispose of Avellino & Bienes’ assets, return all investors’ funds to the investors as well 

as orders directing the defendants to disgorge all unjust enrichment, and pay civil 

penalties. Id. at pgs. 12-13. 

On November 18, 1992, upon submission by the SEC, the United States District 

Court for the Southern District of New York issued an Order of Preliminary Injunction 

and Other Equitable Relief on Consent which preliminarily enjoined the defendants from 

selling securities without a registration statement, making offers to sell or buy securities 

without a registration statement, and from acting as an investment adviser in violation of 

applicable law. Order of Preliminary Injunction and Other Equitable Relief on Consent 

dated November 18, 1992 in Case no. 92 Civ. 8314 (Preliminary Injunction Order), at 

pgs. I-III, at Exhibit 121. The Preliminary Injunction Order also ordered that Lee S. 

Richards, of the law firm of Richards Spears Kibbe & Orbe, be appointed Trustee for the 

purpose of taking control over the undistributed proceeds resulting from the liquidation of 

all brokerage accounts belonging to Avellino & Bienes, distributing the undistributed 

proceeds of the liquidation of Avellino & Bienes’ brokerage accounts, reviewing the 

entire distribution of the proceeds of the liquidation of Avellino & Bienes’ brokerage 

accounts in order to repay of all Avellino & Bienes’ noteholders, overseeing an audit of 

Avellino & Bienes’ financial statements from 1984 through November 1992, confirming 

the identity of Avellino & Bienes’ current noteholders and the amounts invested, and 

23 According to the SEC’s Summary Memorandum dated November 13, 1992, the SEC was alleging that 

Avellino & Bienes offered and sold securities to more than 1,000 individuals, raising in excess of $441 

million, none of which were registered with the Commission. SEC Summary Memorandum dated 

November 13, 1992, at pgs. 10-11, at Exhibit 114. 

51 
 

reporting back to the Court, the SEC, and counsel to Avellino & Bienes. Id. at pgs. 4-5. 

All three defendants, Avellino & Bienes, Frank Avellino, and Michael Bienes separately 

consented to the Order of Preliminary Injunction and waived any rights to challenge or 

appeal the Order. Consents of Avellino & Bienes, Frank Avellino, and Michael Bienes 

dated November 17, 1992, at Exhibit 122. 

Former New York Enforcement Staff Attorney #2 was assigned as the staff 

attorney for the Avellino & Bienes matter after the investigation had been concluded and 

the litigation was commenced. Former New York Enforcement Staff Attorney #2 

Testimony Tr. at pgs. 11-12. Former New York Enforcement Staff Attorney #2 had been 

with the Commission for only eight weeks when she was assigned to the Avellino & 

Bienes case and had no prior experience in investigating or litigating any matter 

involving a Ponzi scheme. Id. at pgs. 16-17. 

Former New York Enforcement Staff Attorney #2 recalled that “there was a 

concern that Avellino and Bienes was operating a Ponzi scheme” that arose from “the 

returns that were being promised [by Avellino & Bienes] combined with a lack of 

transparency about how the monies were invested.” Id. at pgs. 13-14. Former New York 

Enforcement Staff Attorney #2 stated that by the time she was brought into the Avellino 

& Bienes matter, it had been decided not to charge Avellino & Bienes with fraud, but 

merely to charge them for selling unregistered securities. Id. at p. 18. She noted that it 

was “unusual” that the SEC “would just be bringing a case solely on claims of not being 

registered and that there was not a corollary fraud component,” but she understood that 

her superiors “were of the view that they had not found any fraud.” Id. at p. 20. 

The former New York Enforcement Staff Attorney, who had joined the SEC right 

out of law school two years earlier and worked as a staff attorney until 1992,24 recalled 

that in the investigation, they found that there was more money at the broker-dealer than 

was owed to the investors. Former New York Enforcement Staff Attorney Interview 

Memorandum (June 26, 2009) at p. 2. He indicated that if it was the other way around, 

then they would have been more concerned that it was a Ponzi scheme. Id. at p. 2. The 

former New York Enforcement Staff Attorney said the focus of the action was to stop 

Avellino and Bienes from acting as unregistered investment advisers, but did not 

specifically recall why Avellino & Bienes was not charged with fraud. Id. at p. 3. 

Former New York Enforcement Staff Attorney #2 acknowledged that she was 

aware that Avellino and Bienes were stating that all the investment decisions were made 

by Madoff. Former New York Enforcement Staff Attorney #2 Testimony Tr. at p. 35. 

However, former New York Enforcement Staff Attorney #2 stated that given that Madoff 

was not “a defendant or a relief defendant” in the litigation, the particular focus in the 

case was on Avellino & Bienes, not Madoff. Id. at pgs. 36-37. Former New York 

24 Although the former Enforcement Assistant Regional Director was assigned to the Avellino and Bienes 

matter and the former New York Enforcement Staff Attorney recalled she was “heavily involved as his 

supervisor,” she had no recollection of any substantive involvement in the case. Former Enforcement 

Assistant Regional Director Interview Memorandum; Former New York Enforcement Staff Attorney 

Interview Memorandum (June 26, 2009) at p. 3. 

52 
 

 

Enforcement Staff Attorney #2 said “when Madoff was approached about liquidating the 

investments and returning the funds, that he was able to do so” and that “he was able 

indeed to liquidate the investments and get the cash available within a very short period 

of time ... which would suggest that the money was where we would expect it to be.” Id. 

at p. 39. Former New York Enforcement Staff Attorney #2 stated she did not recall any 

discussions at all that Madoff may have been running a Ponzi scheme. Id. at p. 39. She 

also said she was not aware of any analysis undertaken to determine how Madoff was 

able to achieve the returns he was promising for Avellino & Bienes’ clients, although she 

acknowledged remembering that Avellino & Bienes had maintained that they never had a 

loss with their investments. Id. at pgs. 40, 42. Former New York Enforcement Staff 

Attorney specifically recalled, “There was no focus on Madoff in this investigation at 

all.” Id. at p. 4. 

F.	 The Trustee Retained Price Waterhouse to Conduct an Audit of Avellino 

& Bienes’ Financial Statements and Conducted Discovery But Its 

Jurisdiction was Limited 

Immediately after the Preliminary Injunction Order, Lee Richards25 retained Price 

Waterhouse to conduct an audit of Avellino & Bienes’ financial statements from 1984 

until November 1992, and express an opinion confirming the identity of all noteholders in 

Avellino & Bienes’ notes and the amount of principal and accrued interest owed to each 

noteholder. Richards Interview Tr. at p. 11; Affidavit of Frederick M. Werblow, Partner 

at Price Waterhouse sworn to on January 15, 1993, at ¶ 1, at Exhibit 123. 

On November 20, 1992, Linda Imes, Esq., of Richards Spears Kibee & Orbe, 

attorneys for the Trustee, took the sworn deposition of Frank Avellino. Transcript of 

Deposition of Frank Avellino on November 20, 1992, at Exhibit 124. Avellino testified 

in the deposition that the business of Avellino & Bienes was to invest in marketable 

securities through a brokerage house in New York named Bernard L. Madoff. Id. at pgs. 

4-5. Avellino stated that a distribution was made from proceeds that were received from 

Bernard L. Madoff, upon liquidation of certain securities and earmarked for distribution 

in the amount of $113 million. Id. at pgs. 5-7. In the deposition, Imes stated that she 

obtained some documents from Madoff’s office which were purported to be current 

statements for the various accounts held there and Avellino indicated that those were all 

the accounts of Avellino & Bienes held at Madoff. Id. at pgs. 20-23. Avellino identified 

personal accounts he and Bienes’ wife had with Madoff, and Avellino confirmed that 

there were no other accounts at Madoff and that the funds in those accounts had been 

frozen. Id. at pgs. 23-24. In a continuation of Avellino’s deposition that was held on 

November 24, 1992, Avellino identified another entity called Telfran Associates, which 

took money from individuals and gave the funds to Avellino & Bienes, which then in turn 

invested those funds with Madoff. Transcript of Continued Deposition of Frank Avellino 

on November 24, 1992, at pgs. 67-68, at Exhibit 125. Avellino provided Imes with 

25 Lee Richards served as Receiver and Trustee in the liquidation of Bernard L. Madoff Investment 

Securities, LLC after the December 2008 confession of Madoff for a period of time. Richards Interview 

Tr. at p. 22. 

53 
 

 

 

 

specific information concerning the principals of Telfran Associates26 and their 

arrangement with Avellino & Bienes. Id. at pgs. 68-76. 

Although the trustee was conducting discovery and Price Waterhouse was 

examining Avellino & Bienes, their jurisdiction was limited. Lee Richards understood 

the concern in the Avellino & Bienes litigation to be that “they were acting as 

unregistered investment advisers” and stated that he did not recall being informed that 

there was a concern about Avellino & Bienes running a Ponzi scheme. Richards 

Interview Tr. at pgs. 5-6. Lee Richards said he understood that the firm of Avellino & 

Bienes was being liquidated because “they had operated as an investment adviser without 

the proper licensing.” Id. at p. 7. Lee Richards recalled that Avellino & Bienes “were 

achieving a fairly high rate of return for their investors,” but he did not “recall anyone 

expressing concerns that they were fraudulent returns.” Id. at pgs. 7-8. Lee Richards 

stated that he did not believe it was his role to look at whether Madoff could have 

misappropriated other customer funds in order to provide the capital needed to pay back 

the investors of Avellino & Bienes. Id. at pgs. 10-11. Lee Richards indicated that he was 

hired for the particular purpose of liquidating the accounts and ensuring that the investors 

were repaid. Id. at p. 11. He stated that he did not remember at any point in time anyone 

from the SEC suggesting that there was going to be an investigation of Bernard Madoff, 

and he did not remember ever talking with anyone at Price Waterhouse about the 

possibility of fraud at Madoff Securities. Id. at pgs. 20-21. 

Lee Richards noted that: 

[The trustee’s] responsibility would be to independently 

verify account balances on the records of Madoff, but not 

to independently verify that the securities that Madoff were 

reporting actually existed. In other words, we’d go as far 

as Madoff records, and as long as they were consistent with 

what we thought investors of Avellino and Bienes were 

owed and indeed we got the money and securities, then I 

think it would be my judgment and Price Waterhouse’s 

judgment that we had done our job. 

Id. at pgs. 17-18. He reiterated as follows: “I don’t recall that we investigated Madoff 

Securities in any way.” Id. at p. 9. 

26 After obtaining this information, on November 25, 1992, the SEC brought a second, nearly identical 

action to the one brought against Avellino & Bienes, against Telfran Associates and its principals, Steven 

Mendelow and Edward Glantz, obtaining injunctive relief upon consent, and having a trustee appointed to 

oversee the liquidation of Telfran Associates’s assets as well. Complaint for Preliminary and Permanent 

Injunctive Relief and Other Equitable Relief; Order of Preliminary Injunction and Other Equitable Relief 

on Consent both dated November 25, 1992 in Case no. 92 Civ. 8564, at Exhibit 126. 

54 
 

 

G.	 Price Waterhouse Experienced Great Difficulties in Conducting its Audit 

of Avellino & Bienes’ Financial Statements and a Request was made to 

the Presiding Judge for Additional Time 

In December 1992, Price Waterhouse reported back to Lee Richards and the SEC 

that they were unable to perform the function that they were directed to perform because 

of the lack of records maintained by Avellino & Bienes and their refusal to cooperate 

with the audit. Letter dated January 21, 1993 from Price Waterhouse to Lee Richards, 

Trustee (Price Waterhouse Letter dated January 21, 1993), at p. 2, at Exhibit 127. 

Although Price Waterhouse was directed in the Preliminary Injunction Order to audit 

Avellino & Bienes’ financial statements from the period of 1984 through November 

1992, Price Waterhouse found that Avellino & Bienes had not prepared financial 

statements for the period of 1984 through December 31, 1988, and the underlying 

accounting records of Avellino & Bienes for that period of time were not available. Id. 

Because of this finding, it was agreed by the SEC, the Trustee and Price Waterhouse that 

Price Waterhouse would limit its audit of Avellino & Bienes’ financial statements to the 

period of January 1, 1989 through November 16, 1992. Id. 

However, after Price Waterhouse performed substantial work to attempt to obtain 

the information to conduct an audit of Avellino & Bienes’ financial statements for that 

limited period, including making requests for additional documentation from Frank 

Avellino, Price Waterhouse reported that Frank Avellino “refus[ed] to prepare financial 

statements,” refused to provide requested documentation, and sent a letter to Price 

Waterhouse instructing them that they “should ‘not direct any further questions to a 

[representative of an outside computer service bureau],’” which had maintained the 

Avellino & Bienes’ noteholders’ ledger. Id. at Exhibit A to Price Waterhouse Letter 

dated January 21, 1993 at p. 10, at Exhibit 127. Consequently, Price Waterhouse 

indicated that it would be unable to render an opinion or audit Avellino & Bienes’ 

financial statements even for the limited period of January 1, 1989 through November 

1992. Price Waterhouse Letter dated January 21, 1993 at pgs. 2,5, at Exhibit 127. 

On January 19, 1993, Lee Richards appeared before the Presiding Judge in the 

Avellino & Bienes matter, the Honorable John E. Sprizzo, together with representatives 

of the SEC and Ike Sorkin on behalf of Avellino & Bienes, requesting an additional 

month for Price Waterhouse to complete its audit of Avellino & Bienes’ financial 

statements because of the absence of records necessary to render an opinion. Transcript 

of Court Conference in SEC v. Avellino & Bienes, Avellino and Bienes, 92 Civ. 8314 

(January 19, 1993) at pgs. 2-3, 11-12, at Exhibit 128. Sorkin “vehemently oppose[d]” the 

request for additional time, noting that his clients have had their assets frozen during the 

period of Price Waterhouse’s audit. Id. at p. 4. Lee Richards and the former 

Enforcement Assistant Regional Director, on behalf of the SEC, explained that the delay 

was caused by the absence of documents that should have been provided by Avellino & 

Bienes and that without those documents and the extension of time, Price Waterhouse 

would not be able to render an opinion. Id. at pgs. 13, 16-17. Judge Sprizzo denied the 

request for additional time, granting an extension of only 5 days, until January 24, 1993 

for Price Waterhouse to complete the audit, and indicated that he would reconsider the 

55 
 

 

request if they could show evidence that Avellino & Bienes willfully obstructed Price 

Waterhouse’s audit. Id. at p. 17.27 

H.	 After the Request for Additional Time was Denied, Price Waterhouse 

Issued its Report But was Unable to Render an Opinion on Avellino & 

Bienes’ Financial Statements 

On January 21, 1993, Price Waterhouse issued its final report to Lee Richards as 

Trustee, concluding that they were unable to render any opinion on Avellino & Bienes’ 

financial statements because of the lack of records and cooperation from Avellino & 

Bienes. Price Waterhouse Letter dated January 21, 1993, at p. 2, at Exhibit 127. Price 

Waterhouse’s report noted that even during the period from January 1989 until November 

16, 1992, “records critical to the performance of an audit which one would expect a 

company that invested and borrowed over $400 million to have (such as security legers, 

security purchase and sales journals, monthly reconciliations of securities brokerage 

transactions and positions and investor/noteholder balances to Partnership records) were 

not maintained.” Id. Price Waterhouse’s report stated that when Frank Avellino was 

asked about the preparation of financial statements, he responded as follows: “My 

experience has taught me to not commit any figures to scrutiny when, as in this case, it 

can be construed as (bible) and subject to criticism.” Id. at Exhibit A to Price 

Waterhouse Letter dated January 21, 1993 at p. 10 at Exhibit 127. Ira Sorkin, counsel for 

Avellino & Bienes, admitted later in an April 21, 1993 hearing on an objection to Price 

Waterhouse’s fees, that Price Waterhouse “were auditing phantom books.” Transcript of 

Hearing Before Hon. John E. Sprizzo in SEC v. Avellino & Bienes, Avellino and Bienes, 

92 Civ. 8314 (April 21, 1993), at p. 7, at Exhibit 129. 

Price Waterhouse’s report did detail the distribution of over $329 million to 

Avellino & Bienes’ noteholders, which included the review of noteholders’ files, the 

confirmation of noteholders’ addresses, and the arrangements for distribution of funds by 

federal express and wire transfer. Price Waterhouse Letter dated January 21, 1993, at 

Exhibit A at pgs. 1-6, at Exhibit 127. 

Lee Richards recalled that he and Price Waterhouse “were frustrated by some lack 

of recordkeeping” and remembered generally that Price Waterhouse had difficulties 

during the audit with respect to books and records being missing and Avellino & Bienes 

not having financial statements. Richards Interview Tr. at pgs. 12-13. Lee Richards 

stated “not only were [Avellino & Bienes] not properly licensed, but they were not 

running the kind of operation that they should have been, notwithstanding the fact that 

the money seemed to be there and the securities seemed to be there.” Id. at p. 16. 

The former New York Enforcement Staff Attorney recalled that Price Waterhouse 

could not complete the audit and they “requested going back and doing the procedures or 

doing the books and records.” Former New York Enforcement Staff Attorney Interview 

Memorandum (June 26, 2009) at p. 3. However, the former New York Enforcement 

27 The OIG has located no evidence that any such request to reconsider Judge Sprizzo’s opinion was ever 

made. 

56 
 

 

 

 

Staff Attorney stated that “the Receiver/Trustee told us he got all the money, there was 

money left over,” and he believed there were “no unresolved issues” in the case. Id. at p. 

4. 

Former New York Enforcement Staff Attorney #2 also recalled that Price 

Waterhouse was “unable to render an opinion as to certain parts of what they were 

looking at” in their role as trustee. Former New York Enforcement Staff Attorney #2 

Testimony Tr. at p. 27. She said she remembered that those involved in the litigation 

“did think it was odd or curious that [Avellino and Bienes] had a lack of records, 

particularly for an accounting firm.” Id. at. p. 28. When asked if given the difficulties 

that Price Waterhouse had with respect to rendering an opinion and in light of the lack of 

records on the part of Avellino & Bienes, whether there was any discussion about 

conducting further investigation, former New York Enforcement Staff Attorney #2 

indicated that there was no such discussion since the focus of the action against Avellino 

& Bienes was to prevent them from continuing to sell unregistered securities or operating 

an unregistered investment company, and to have a comfort level that monies were 

returned to the investors who invested it with Avellino & Bienes. Id. 

I.	 The SEC Conducted Limited Discovery About Madoff But Avellino & 

Bienes Objected Aggressively and it is Unclear if the SEC Obtained any 

Relevant Information 

In or before April 1993, the SEC conducted limited discovery in the Avellino & 

Bienes action, submitting a first set of interrogatories and requests for documents.28 In 

the SEC’s Interrogatories, interrogatory no. 3 requested as follows: 

The name and address of the registered broker dealer who 

managed the discretionary trading account, the name and 

account number of each discretionary account, the name of 

the account in which each investors’ monies were held, and 

the individual at the broker-dealer who managed or directed 

the trading or investment of the monies in those accounts. 

Defendants’ Response to Plaintiff’s First Set of Interrogatories and Request for 

Documents dated May 3, 1993, at p. 4, at Exhibit 131. 

In the defendants’ response to the SEC’s interrogatory no. 3, submitted on May 4, 

1993, defendants objected to the interrogatory on the grounds that it was “unduly 

burdensome, inconvenient and expensive to answer,” and that the documentation needed 

to answer the interrogatory had already been made available to the SEC and the SEC had 

ample opportunity to obtain it. Id. Defendants’ response did indicate that the 

documentation would be made available to the SEC. Id. 

28 Defendants also submitted a first set of interrogatories and first request for the production of documents 

to the SEC on March 15, 1993 seeking responses by April 19, 1993. Defendant’s First Request for the 

Production of Documents dated March 15, 1993 and Plaintiff’s Response to Defendants’ First Set of 

Interrogatories dated April 19, 1993, collectively at Exhibit 130. 

57 
 

 

 

 

 

 

 

 

In the SEC’s request for documents, document request no. 5 sought “[a]ll 

documents relating to the broker-dealer,” and document request no. 14 sought “[a]ll 

documents provided to [Avellino & Bienes] from the broker-dealer for the years 1962 to 

the present, inclusive.” Id. at pgs. 13, 16. In defendants’ responses to both of these 

requests for documents, defendants stated “[T]he documents responsive to the request 

currently within the custody and control of defendants are available for copying and 

inspection in Fort Lauderdale, Florida.” Id. 

None of the attorneys interviewed by the OIG recalled whether the SEC 

eventually received the information and documents concerning Bernard Madoff that it 

requested in discovery. However, with respect to discovery, former New York 

Enforcement Staff Attorney #2 stated that “this was a fairly contentious litigation, that, 

you know, defense counsel was very aggressive.” Former New York Enforcement Staff 

Attorney #2 Testimony Tr. at p. 34. She did not recall if she “ultimately got the 

information [she] needed,” but indicated that there were lots of objections to discovery 

requests and these many objections were “indicative of the tone in this litigation which 

was, you know, contentious.” Id. 

In an April 21, 1993 hearing before Judge Sprizzo relating to an objection from 

Avellino & Bienes to Price Waterhouse’s fees, Ira Sorkin, counsel for Avellino & Bienes, 

acknowledged to Judge Sprizzo that Avellino & Bienes was able to avoid other remedies 

that would have resulted in additional discovery had they not consented to the audit. 

Transcript of Hearing Before Hon. John E. Sprizzo in SEC v. Avellino & Bienes, April 

21, 1993, at p. 139, at Exhibit 129.29 

J.	 A Final Judgment of Permanent Injunction was Entered on Consent 

Against the Defendants, Penalties were Assessed and the Investigation 

was Closed 

On June 4, 1993, defendants Frank Avellino and Michael Bienes consented to the 

Terms of a Final Judgment of Permanent Injunction and Other Equitable Relief, and on 

September 7, 1993, the Final Judgment was filed with the United States District Court for 

the Southern District of New York. Final Judgment of Permanent Injunction and Other 

Equitable Relief by Consent Against Avellino & Bienes, Frank J. Avellino, and Michael 

S. Bienes filed on September 7, 1993 in Case no. 92 Civ. 8314 (Final Judgment), at 

Exhibit 132. The Final Judgment ordered that the defendants be permanently enjoined 

from selling any securities without a registration statement, making offers to sell or buy 

securities without a registration statement, and acting as an investment company in 

violation of the Investment Company Act of 1940. Id. at pgs. 2-5. The Final Judgment 

29 Judge Sprizzo also indicated in the same hearing that he did not believe Avellino’s testimony on the fee 

issues, stating, “I don’t believe your client. I heard his testimony, I saw his demeanor, I heard his 

inconsistencies on direct and cross. I noted the inconsistency in the position he took in the letter and the 

position he took on trial. I don’t believe him. So, to the extent there are credibility issues to resolve, I 

resolve them against your client.” Transcript of Hearing Before Hon. John E. Sprizzo in SEC v. Avellino 

& Bienes, April 21, 1993, at p. 147, at Exhibit 129. 

58 
also ordered the defendants to pay a civil penalty in the amount of $250,000 for Avellino 

& Bienes, and $50,000 each for Frank Avellino and Michael Bienes within 10 business 

days of the entry of the Final Judgment. Id. 

Because the Trustee arranged for Avellino & Bienes’ customers to be refunded 

the funds they invested and penalties were assessed against the defendants, the SEC 

considered the result of the litigation to be a satisfactory one. The former New York 

Enforcement Staff Attorney stated that after the permanent injunction, everybody got 

their money back and “we were quite satisfied this was a very good result.” Former New 

York Enforcement Staff Attorney Interview Memorandum (June 26, 2009) at p. 4. He 

stated that the Receiver/Trustee told us he got all the money, that there was money left 

over, and he believed there were “no unresolved issues” in the case. Id. at p. 4. The 

former New York Enforcement Staff Attorney recalled that the civil penalties imposed on 

Avellino & Bienes “were the highest penalties” ever imposed by the SEC at that time. Id. 

at p. 4. 

Former New York Enforcement Staff Attorney #2 understood that the Avellino & 

Bienes litigation ended when “both defendants in the firm were permanently enjoined 

from the sale of unregistered securities and acting as an unregistered investment company 

and they had to pay fines” as well as the money having been returned through the trustee 

to the investors. Former New York Enforcement Staff Attorney #2 Testimony Tr. at p. 

49. 

On March 23, 1994, the former New York Enforcement Staff Attorney completed 

an SEC form to formally close the Avellino & Bienes investigation and it was approved 

by his supervisors on March 30, 1994. SEC Form 19A for Enforcement File Number 

NY-6066, “In the Matter of King Arthur” dated March 30, 1994 (closing report), at 

Exhibit 133. The closing report stated that the SEC alleged that Avellino & Bienes, 

Frank Avellino, and Michael Bienes operated as an unregistered investment company by 

selling unregistered securities in the form of demand notes. Id. at p. 3. The closing 

report further stated that on November 17, 1992, the U.S. District Court, SDNY, issued 

an Order of Preliminary Injunction and Other Equitable Relief on Consent which 

preliminarily enjoined the Defendants from engaging in further violations of the above 

provisions of the federal securities laws. Id. The closing report provided that the 

appointed Trustee redeemed all of the notes held by A&B and the appointed auditors 

uncovered no fraud. Id. The closing report indicated that, on September 7, 1993, the 

Defendants were permanently enjoined, by consent, from further securities law violations 

and ordered to pay $50,000 each individually and $250,000 from their partnership and 

confirmed that these penalties were paid. Id. 

K. Conclusion 

In connection with its investigation of Avellino & Bienes in 1992, according to 

FTI, there were several red flags that should have triggered a wide-ranging investigation 

of the existence of a Ponzi scheme on the part of Avellino & Bienes and potentially 

Bernard Madoff. For example, Avellino & Bienes was offering “100%” safe 

59 
 

investments, which they characterized as loans, with high and extremely consistent rates 

of return over significant periods of time. Not everyone could invest with Avellino & 

Bienes, as this was a “special” and exclusive club and some even more special investors 

were getting higher returns than others. 

As the SEC began investigating the matter, they learned that all of Avellino & 

Bienes’ investments were conducted entirely through Madoff and according to Avellino, 

Madoff had achieved these consistent returns for them for numerous years without a 

single loss. According to FTI, such a long-standing relationship with no losses could 

raise the question as to whether or not Madoff might be collaborating in a scheme with 

Avellino & Bienes. Although the SEC suspected and purported to investigate Avellino & 

Bienes for running a Ponzi scheme, they seemed not to have considered the possibility 

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

customers from other clients for which Madoff may have had held discretionary 

brokerage accounts. While the SEC’s relatively inexperienced examination team 

conducted a brief and very limited examination of Madoff, they made no effort to trace 

where the money that was used to repay Avellino & Bienes’ investors came from, and 

relied upon DTC records from Madoff rather than going to DTC itself to verify if trading 

occurred. The Branch Chief on the examination team acknowledged that this was an area 

that was missed and should have been followed-up on. There is evidence that the 

examination team was well aware of Madoff’s reputation and that this may have factored 

into their decision not to scrutinize Madoff’s operation more carefully. 

The SEC’s investigative team, which was also relatively inexperienced, brought 

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

not take further steps to inquire into Madoff’s firm. The SEC lawyers working on the 

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

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

Avellino & Bienes was selling unregistered securities or operating an unregistered 

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

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

independently verify account balances and transaction activity included on the financial 

and accounting records of Madoff. Even after Price Waterhouse was unable to audit 

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

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

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

deeply into either Avellino & Bienes’ or Madoff’s operations. 

The former SEC Regional Administrator in 1992 for Northeast Region, Edward 

Nordlinger, acknowledged that given the circumstances, he did not believe that merely 

locating the funds would be sufficient to determining whether a Ponzi scheme had 

occurred, and that more evidence would have been necessary to investigate that matter. 

Nordlinger Interview Memorandum. 

The FTI Engagement Team concluded that while the SEC did take appropriate 

steps to ensure that the funds were repaid and that Avellino & Bienes were barred from 

60 
 

 

 

 

 

further selling of unregistered securities and assessed significant penalties, no 

investigative actions were taken to determine if the funds that Avellino & Bienes 

arranged to have repaid were taken from other customers as part of a larger Ponzi scheme 

engineered by Bernard Madoff. Thus, assuming that Bernard Madoff was running his 

Ponzi scheme in 1992,30 the SEC missed an excellent opportunity to uncover this scheme 

by not undertaking a more thorough and comprehensive investigation. 

II. SEC REVIEW OF 2000 AND 2001 MARKOPOLOS COMPLAINTS 

A. Markopolos Approached the SEC’s Boston Office in May 2000 with 

Evidence that Madoff was Operating a Ponzi Scheme 

1. The 2000 Submission 

In May 2000, Harry Markopolos made an eight-page submission (the “2000 

submission”) to the Boston District Office (BDO)31 questioning the legitimacy of 

Madoff’s reported returns. 2000 submission, at Exhibit 134. The 2000 submission 

posited the following two explanations for Madoff’s unusually consistent returns: (1) 

that “[t]he returns are real, but they are coming from some process other than the one 

being advertised, in which case an investigation is in order;” or (2) “[t]he entire fund is 

nothing more than a Ponzi Scheme.” Id. at p. MARK 0005. See also Markopolos 

Testimony Tr. at pgs. 16-17. At that time, Markopolos considered either scenario equally 

likely, but in either case he was certain that “something illegal was going on there.” Id. at 

p. 17. 

The 2000 submission explained that the magnitude and consistency of Madoff’s 

returns, as well as the secrecy of Madoff’s operations, suggested that Madoff was not 

operating legally. 2000 submission, at Exhibit 134. Specifically, the submission stated 

that Madoff’s returns were unachievable using the trading strategy he claimed to 

30 In his sworn allocution given on March 12, 2009 as part of his guilty plea, Madoff stated that his fraud 

began in the early 1990’s. Transcript of March 12, 2009 Allocution in the Matter entitled U.S. v. Madoff, 

Case No. 09 CR 213, U.S. District Court for the Southern District of New York (March 12, 2009 

Allocution Testimony Tr.), at p. 25, at Exhibit 375. In an interview Madoff gave to the OIG, he denied that 

he had been operating a Ponzi scheme in 1992. Madoff Interview Memorandum at pgs. 7-8. However, 

according to the August 11, 2009 SEC complaint filed against Frank DiPascali, Jr., Madoff and DiPascali 

“fabricate[d] credible account records to corroborate the purported trading in the [Avellino & Bienes] 

accounts.” SEC v. Frank DiPascali, Jr., No. 09 Civ. 7085 (LLS) (S.D.N.Y. filed August 11, 2009) at ¶¶ 18­

20, at Exhibit 119.

31 The Boston office of the SEC was elevated to a Regional Office on April 2, 2007. Since then, the 

Boston office has reported directly to the SEC’s Home Office in Washington, DC. In 2000, the Boston 

office was a District Office that reported to the SEC Northeast Regional Office (NERO) in New York. 

61 
 

 

 

 

 

 

employ.32 Id. at p. MARK 0009; Markopolos Testimony Tr. at p. 16. As Markopolos 

explained: 

Madoff claim[ed] to provide 80% of the market’s return 

with only 1/3rd of the risk. Madoff’s number of losing 

months seems beyond the bounds of what is reasonable for 

such a strategy. 

2000 submission at p. MARK 0007, at Exhibit 134. 

In his testimony, Markopolos explained that if Madoff was using the trading 

strategy he claimed, Madoff’s returns compared to the performance of the S&P 500 

should have had “a correlation coefficient between 30 percent similarity and 60 percent 

similarity ... hover[ing] around 50 percent similarity ...” Markopolos Testimony Tr. at 

p. 20. However, Markopolos noted that there was only a six percent correlation between 

Madoff’s returns and the S&P 500, which Markopolos considered “outside the bounds of 

rationality.” Id.; 2000 submission at p. MARK 0006, at Exhibit 134. Markopolos 

elaborated on the reasons Madoff’s claimed returns could not be real as follows: 

Only 3 down months vs. the market’s down 26 months 

during the 87 month time period presented.... The Madoff 

hedge fund returns are inconsistent with a publicly traded 

mutual fund using a similar stated return methodology. 

2000 submission at p. MARK 0007, at Exhibit 134. 

The 2000 submission also compared the amount of money Madoff was thought to 

manage at the time, $3 billion to $7 billion, with the open option positions on the Chicago 

Board Options Exchange (CBOE), and concluded that the “hedging cannot be taking 

place as described. ... [I]f only $3 billion are allocated to this strategy, then there still 

aren’t enough options in open interest for this type of hedging to occur, since Madoff 

would be at least 1/3 of the open interest, and we know that’s not the case.” Id. at p. 

MARK 0006. 

32 Madoff’s purported split-strike conversion investment strategy was described in a May 2001 Barron’s 

article as follows: 

Madoff invests primarily in the largest stocks in the S&P 100 index – 

names like General Electric, Intel and Coca-Cola. At the same time, he 

buys and sells options against those stocks. For example, Madoff 

might purchase shares of GE and sell a call option on a comparable 

number of shares – that is, an option to buy the shares at a fixed price at 

a future date. At the same time, he would buy a put option on the 

stock, which gives him the right to sell shares at a fixed price at a future 

date. 

Erin Arvedlund, Don’t Ask, Don’t Tell, Barron’s, May 7, 2001, at p. 2, at Exhibit 135. 

62 
 

 

 

 

Markopolos also identified in his 2000 submission other troubling indications that 

Madoff was operating a Ponzi scheme such as the following: 

Madoff has perfect market-timing ability: One investor 

told me that Madoff went 100% to cash in July 1998 and 

December 1999, ahead of market declines. He told me that 

he knows this because Madoff faxes his trade tickets to his 

firm and the custodial bank. However, Madoff also owns 

the [broker-dealer] that generates the trade tickets, so that 

collusion between Madoff’s [broker-dealer] and Madoff’s 

hedge fund could take place. 

Madoff does not allow outside performance audits: One 

London based fund of funds representing Arab money, 

during the due diligence process, asked to send in a team of 

Big Six accountants to verify performance. They were told 

no, that only Madoff’s brother is allowed to audit 

performance for reasons of secrecy. Amazingly, this 

London based fund of funds invested over $200 million of 

their Arab client’s money anyway, because the low 

volatility of returns was so attractive.

 ... 

Combining the discrepancies I’ve noted in Exhibit 1, with 

the hearsay I’ve heard, seems to fit in with the patterns 

commonly found in Ponzi Schemes. Having a 

broker/dealer subsidiary that is also an [Electronic 

Communication Network], which is then able to generate 

false trading tickets would also be a huge advantage. Not 

allowing external auditors in to verify performance would 

also be something a Ponzi Scheme operator would do. 

Id. at p. MARK 0009 (emphasis in original). 

2. Markopolos Met with Grant Ward, a Senior SEC Enforcement 

Official 

Sometime shortly after Markopolos sent the 2000 submission to the SEC, he met 

with Ed Manion, Staff Accountant, and Grant Ward, BDO Assistant District 

Administrator, to discuss his concerns about Madoff.33 See Markopolos Testimony Tr. at 

33 There are no clear records indicating the date of the meeting; however, SEC NRSI records indicate that 

someone in BDO searched “Madoff” on May 4, 2000, presumably in connection with the 2000 submission. 

Excerpt from the NRSI list of SEC employees who searched for “Madoff” at Exhibit 136. In addition, the 

2000 submission included data from April 2000 and Ward left the SEC in early July 2000; supporting an 

63 
 

 

pgs. 13-14; Manion Testimony Tr. at p. 15; Ward Testimony Tr. at p. 9. Ward reported 

to Juan Marcelino, District Administrator, and to Jim Adelman, the Associate District 

Administrator. See Ward Testimony Tr. at pgs. 14, 16. Ed Manion was Markopolos’ 

initial contact at BDO; Manion and Markopolos were acquaintances through their work 

with the Boston Security Analyst Society. Markopolos Testimony Tr. at p. 12. 

At the meeting, Markopolos explained the analysis presented in the 2000 

submission and encouraged the SEC to investigate Madoff. Markopolos Testimony Tr. at 

pgs. 14-17, 22. Markopolos testified that since SEC staff “lacked industry expertise” 

and “were only lawyers,” he “tried to make it as simple as possible to understand for the 

SEC staff.” Id. at pgs. 18-19. 

Despite Markopolos’ efforts to present the 2000 submission in a clear and 

straightforward manner, he left the meeting with the impression that Ward did not 

understand his concerns about Madoff, stating: 

[Ward] did not have an industry background that I was 

aware of. He had zero comprehension of topics being 

discussed. He seemed very ill-trained, uninformed about 

industry practices, did not understand financial instruments. 

Didn’t even have a basic understanding of finance. 

Id. at pgs. 15-16. Markopolos testified that he “walked out of the meeting feeling very 

dejected” and “didn’t think [that Ward] had a clue.” Id. at p. 23. Manion left the meeting 

with a similar impression, stating, “When we walked out of the meeting ... with Grant 

Ward, [Harry and I] looked at each other and we both said, ‘He didn’t understand a damn 

thing we said.’” Manion Testimony Tr. at p. 23. See also Markopolos Testimony Tr. at 

pgs. 23-24. 

3. Ward Decided Not to Pursue the 2000 Submission 

Manion testified that based upon Markopolos’ analysis, he was hoping that the 

May 2000 meeting with Ward would result in an investigation of Madoff’s hedge fund 

operation. Manion Testimony Tr. at p. 23. Although Ward testified that he did not recall 

the meeting, he stated that if he had participated in such a meeting, “there should have 

been some post-meeting follow-up... [e]ven if we decided that there was nothing there 

...” Ward Testimony Tr. at p. 33. 

Manion testified that Ward told him in 2000 that he had referred Markopolos’ 

2000 submission to the SEC’s Northeast Regional Office (NERO), stating: “...Ward 

said, well, Madoff is headquartered in New York. It’s not our jurisdiction. So I’m going 

inference that the meeting occurred in May or June 2000. 2000 submission, at Exhibit 134; Ward 

Testimony Tr. at p. 8. 

64 
 

 

to refer it to New York.” Manion Testimony Tr. at p. 25. Manion further stated that he 

recalled following up with Ward as follows: 

I went in there a few times afterwards to say, Grant, you 

know, how – how’s New York doing with this thing, you 

know what I mean, and I think he – I think he did refer it to 

New York but I think once it left Boston, you know, he 

didn’t care. 

Id. at p. 26. See also Id. (Manion testified, “...[Ward] told me he did [refer it to New 

York].”). Ward stated in his interview with the OIG that he might have referred the 

matter to New York, but did not recall whether, in fact, he had done so. Ward Interview 

Memorandum. 

However, the OIG has found no documentary evidence that Ward referred the 

matter to NERO34 and, as discussed below, Marcelino’s understanding from speaking 

with Ward was that Ward had “decided not to pursue it.” April 30, 2009 Adelman 

Interview Memorandum. In any event, neither Manion nor Markopolos was contacted by 

NERO regarding the 2000 submission and no action was taken by the SEC with regard to 

the allegations contained therein. Manion Testimony Tr. at p. 27; Markopolos Testimony 

Tr. at p. 24. 

4. Ward’s Testimony Regarding the 2000 Submission is Suspect 

As part of the OIG’s investigation in this matter, on March 31, 2009, Ward 

testified under oath that he did not recall ever meeting with Markopolos, stating: 

A: I have no memory of that [meeting with 

Markopolos]. 

Q: At all? 

A: None. 

Q: Do you have any memory of Harry Markopolos, 

period, ever meeting him, ever talking to him, ever 

being in his presence? 

A: No. 

Q: At all? 

34 As part of its investigation, the OIG reviewed all e-mails produced by the Office of Internet Technology 

(OIT) from Ward’s files for the relevant time period and, in addition, reviewed all relevant e-mails from 

NERO’s files produced by OIT for the same period, and found no evidence that the 2000 submission was 

referred to NERO. 

65 
 

 

A: At all. 

Q: You don’t remember him as a person at all? 

A: When I saw his [testimony before Congress in 

2009], I still didn’t recall. His face did not jog a 

memory. 

... 

Q: Do you recall in the time – well, any time while you 

were at the SEC in Boston of looking at or 

discussing [a] referral about Bernie Madoff? 

A: No, no memory of that at all. 

Q: No memory of discussions with Ed Manion about 

that? 

A: No. No. I've been trying to wrack [sic] my brain to 

remember and I don't. 

Ward Testimony Tr. at pgs. 25-26. 

Ward and Marcelino each testified that they spoke with each other on February 4, 

2009, following Markopolos’ Congressional testimony.35 Id. at pgs. 48-49; Marcelino 

Testimony Tr. at p. 8. However, their testimony about what Ward said during that 

conversation differs markedly. Ward testified that Marcelino called to “lend his support” 

and stated that Ward “indicated to [Marcelino] at that time that I don’t remember 

[meeting with Markopolos] and wish I had.” Ward Testimony Tr. at p. 49. Ward was 

unequivocal during his testimony, stating: “I volunteered that I didn’t remember” and “I 

recall telling [Marcelino] I don’t remember anything.” Id. at pgs. 49, 53. 

Marcelino directly contradicted Ward’s testimony. Marcelino testified that during 

their February 4, 2009 conversation, “Ward indicated that he had met with Harry 

Markopolos [and] that [Ward] didn’t think he did anything wrong.” Marcelino 

Testimony Tr. at p. 8. Marcelino reiterated in his testimony that “[Ward] remembered 

meeting with Markopolos but that he didn’t feel he did anything wrong.” Id. at p. 9. 

Marcelino’s recollection of his February 4, 2009 conversation with Ward was 

corroborated to some extent by Adelman. Adelman told the OIG that he saw Marcelino 

at the SEC Speaks Conference held on February 6-7, 2009, two or three days after 

Marcelino’s conversation with Ward. April 30, 2009 Adelman Interview Memorandum. 

35 Markopolos testified about his frustration with the SEC before Congress on February 4, 2009. During 

that testimony, Ward was described in unflattering terms. See February 4, 2009 Testimony of Harry 

Markopolos Before the U.S. House of Representatives, Committee on Financial Services Tr. at pgs. 11-12, 

at Exhibit 269. 

66 
 

 

According to Adelman, Marcelino told him that he had spoken recently with Ward and 

Ward had told Marcelino: (1) that Ward remembered the Markopolos meeting in 2000; 

(2) that Ward said he had “decided not to pursue” the matter in 2000; and (3) that Ward 

had said he was “perfectly comfortable with how he had handled it.” Id. 

Based on Marcelino’s testimony and Adelman’s corroborating statement, Ward’s 

testimony to the OIG was not credible regarding: (1) whether he recalled meeting with 

Markopolos or hearing concerns about Madoff’s hedge fund in 2000; and (2) the 

substance of his February 4, 2009 conversation with Marcelino. Accordingly, the OIG 

concludes that, based upon the preponderance of the evidence, Ward met with 

Markopolos in 2000 and told Manion that he had referred the complaint to NERO, but 

never actually did. 

B. Markopolos Made a Second Submission to the Boston Office in March 

2001 

1. The 2001 Submission 

Markopolos e-mailed a second submission to Manion in the Boston office about 

Madoff on March 1, 2001 (the “2001 submission”). E-mail dated March 1, 2001 from 

Markopolos to Manion, with attachments, at Exhibit 137. The 2001 submission 

supplemented the 2000 submission with updated information and additional analysis. Id. 

At the time of the 2001 submission, Markopolos “put [Madoff’s] assets under 

management in the $12 to $20 billion range.” Markopolos Testimony Tr. at p. 26. 

Markopolos’ 2001 submission added, inter alia, the following observations: 

[Madoff purportedly] [e]arned over 151⁄2% a year for over 

seven years with extremely low standard deviation of 4.3% 

versus the S&P 500 which earned over 191⁄2% but with 

12.9% annual standard deviation over the same period. 

This program earned 80% of the market’s return with only 

one third of the risk. Think about it! Is this really possible, 

or is it too good to be true? (I have attached an excel 

spreadsheet comparing and contrasting Madoff’s 

program to the S&P 500 index.) 

Only 3 down months vs. the market’s down 26 months 

during the same period, with a worst down month of only 

-1.44% (April 1993) vs. the market’s worst down month of 

-14.58% (August 1998). 

... 

These numbers really are too good to be true. And every 

time I’ve thought a company’s or a manager’s numbers 

were “too good to be true,” there has been fraud involved. 

67 
Yes, access to order flow is worth something but this worth 

can be measured in pennies per share. 

... 

Yes, Madoff can make more intelligent short-term bets via 

their access to order flow. However, short-term 

forecastability does not lead to long-term knowledge of 

where the stocks that he buys are headed. Short-term he 

may know there are a lot of IBM shares to buy, but that 

doesn’t lead to knowledge of where IBM will be trading 

next month. 

Madoff’s out-of-the-money OEX index puts do offer 

protection against systemic market declines. However, his 

30-35 stock portfolio has individual company risk in it and 

should experience more frequent and more sizeable losses 

than what his performance record indicates. 

E-mail dated March 1, 2001 from Markopolos to Manion, with attachments, at p. MARK 

0024 (emphasis in original), at Exhibit 137. 

Markopolos’ analysis was supported by the experience of two of his colleagues, 

Neil Chelo and Frank Casey. Markopolos Testimony Tr. at pgs. 26-27; Chelo Testimony 

Tr. at p. 10. Chelo was a chartered financial analyst, chartered investment analyst, and a 

financial risk manager with substantial experience researching hedge funds. Chelo 

Testimony Tr. at p. 7. Casey was a registered investment adviser with an options 

specialization. Casey Testimony Tr. at p. 9. Chelo’s research into Madoff convinced 

him that Madoff’s hedge fund was a fraud. Chelo Testimony Tr. at p. 24. Chelo 

testified: 

A key part of kind of my experience ... was to go out and 

find what I believe are the most talented investment or 

hedge fund managers in the world. And ... I’ve met, you 

know, probably a couple thousand hedge fund managers. 

So I have a very good idea of when someone is frankly 

trying to bull[****] me or the story doesn’t make sense, 

because after you see and research a few thousand stories, 

you have a good idea of what smells fishy and what is 

really good. 

Id. at pgs. 11-12. Chelo described some of the investigative work he and Markopolos 

performed as follows: 

[W]e called pretty much every broker we knew on the 

streets ... and we asked like everyone: Do you do business 

with Bernie Madoff? Have you ever heard of Bernie 

68 
 

 

Madoff? And for the most part, people would be like: I've 

heard of him. I heard he’s a big player in the options 

market, but we’ve never done a trade with him. 

Id. at p. 18. 

Chelo believed that Madoff’s claimed returns were impossible to achieve using 

Madoff’s claimed split-strike conversion strategy, stating: 

I just don’t know how you can produce these types of 

returns given the strategy that was outlined in the 

marketing material. It was just, in my mind, impossible ... 

Mainly the consistency because you’d have to have 

basically like perfect market timing every month or every 

year, depending on how he structures his split strike 

conversions. It’s like impossible. No one has that ability 

to forecast market direction for such a long period and so 

consistently. 

... 

And if you did have that ability, you would do another 

strategy besides split strike conversion. You would do like 

a levered future strategy. You’d make way more money, 

and it just didn’t make sense. It just didn’t make sense, 

period. 

Id. at p. 16. 

We got pretty quantitative, not to sound geeky, but I 

remember putting together, you know, spreadsheets of, you 

know, literally trying to replicate the strategy of: Hey, if I 

buy [sic] replicated basket of the OEX, what’s my tracking 

error? How much will it cost me to get, you know, into 

these stocks, like, big offer spread, commissions, what 

options can I write, looking at different strikes and figuring 

out, you know, quantitatively, hey, like, is there something 

we’re missing? Is – you know, is there a way that this can 

be done? ... And, you know, the more I, you know, tried to 

put together something that would duplicate Madoff’s 

returns, the more convinced I was that it was impossible. 

Id. at p. 24. 

69 
Chelo was also suspicious of Madoff’s reliance on feeder funds to raise money, 

stating: 

Another one that – another huge red flag in our mind was 

we heard that, you know, [Madoff] was raising all his 

money through these feeder funds. So my logical question 

was: Why would he give up the ability to charge 1 and 20 

or 2 and 20 to clients and let all the feeder funds earn the 

bulk of the returns? That just made no sense to me at all. I 

mean, any legitimate businessman would have said: Hey, 

I’m going to cut out the middleman and do it myself. 

Id. at p. 29. 

Considering all of the red flags, Chelo believed that “common sense” indicated 

Madoff was a fraud, stating: 

So Harry and I, obviously, have a better background to 

understand this. We’ve been in the equity derivatives 

business and that was what we did at Rampart ... Having 

said that, I think you could have just taken someone out of 

business school with some real common sense, and they 

would have looked at the picture and came [sic] to the 

conclusion that something – something is at least fishy and 

that you should stay away ... You know, maybe not be able 

to prove or come to the analytical reasons of why it was 

fishy but, you know, there was [sic] a couple big red flags 

that were just common sense. 

Id. at p. 44. 

2. Boston Forwarded the 2001 Submission to NERO 

Manion discussed the 2001 submission with Silvestre Fontes, an Enforcement 

Branch Chief in the BDO. E-mail dated March 12, 2001 from Fontes to Manion, at 

Exhibit 138. On March 12, 2001, Fontes e-mailed Manion, subject line “Madoff”: 

“Talked to Grant about this; I’ll look for you and we can discuss.” Id. Fontes explained 

that “Grant” most likely referred to Grant Ward, who the OIG found had met with 

Markopolos and Manion regarding Madoff the previous year. April 7, 2009 Fontes 

Interview Memo. 

On April 2, 2001, Fontes e-mailed David Marder, BDO Assistant District 

Administrator, subject line “Madoff,” stating: 

I’d like to talk to you at some point about this case. This is 

the one where you’ve got a Boston money manager 

70 
 

 

basically squealing on a New York money manager – 

alleging that given the trading strategies that they each use, 

there is no way the New York money manager could be 

putting up the numbers that he’s reporting (for certain 

hedge funds). 

E-mail dated April 2, 2001 from Fontes to Marder, at Exhibit 139; Marder Interview 

Memorandum. 

At the suggestion of Marder, Fontes forwarded the 2001 submission to Mark 

Schonfeld, NERO Regional Director for Enforcement. E-mail dated April 3, 2001 from 

Fontes to Schonfeld, at Exhibit 140. On April 3, 2001, Fontes e-mailed Schonfeld, 

subject line “Madoff”: “I overnighted to you some documents on the case you, Marder 

and I discussed over the phone yesterday.” Id. 

When interviewed in April 2009 by the OIG, Fontes recalled neither receiving the 

submission from Markopolos nor talking to Manion, Ward or Schonfeld about Madoff. 

April 7, 2009 Fontes Interview Memorandum; April 10, 2009 Fontes Interview 

Memorandum. Similarly, Marder did not recall discussing Madoff or the 2001 

submission with Fontes or Schonfeld. Marder Interview Memorandum. However, after 

reviewing his e-mails to Manion, Marder and Schonfeld, Fontes did recall referring a 

matter to Schonfeld around the time of the 2001 submission, but did not recall the subject 

of that referral or whether it involved Madoff. April 10, 2009 Fontes Interview 

Memorandum. 

Additionally, Fontes recalled that Manion had been unhappy about the way things 

were being handled with respect to a particular matter, and also recalled that Manion had 

mentioned a friend of his in the industry that had been pursuing the matter. Id. Fontes 

did not recall, however, whether the matter was Madoff or whether Manion’s friend was 

Markopolos. Id. 

Schonfeld testified that he did not recall the referral from Boston regarding 

Madoff, receiving Fontes’ e-mails or the documents he overnighted regarding Madoff, or 

even seeing the 2001 submission prior to testimony. Schonfeld Testimony Tr. at p. 15. 

Thus, while the individuals involved had difficulty recollecting these events, the 

e-mails demonstrate that Fontes forwarded Markopolos’ 2001 submission to Schonfeld. 

3. NERO Decided Not to Investigate Madoff Only One Day After Receiving 

the 2001 Submission 

Upon receiving the 2001 submission from BDO, Schonfeld assigned the matter to 

Leslie Kazon, Assistant Regional Director of Enforcement in NERO, for initial inquiry. 

E-mail dated April 3, 2001 from Schonfeld to Neuschaefer, at Exhibit 141. See also 

71 
 

 

 

 

 

Schonfeld Testimony Tr. at p. 20; Kazon Testimony Tr. at p. 16. On April 4, 2001, 

Kazon e-mailed Sandy Sadwin, a broker-dealer examiner in NERO, stating: 

The [Investment Adviser] people have been checking and 

Madoff does not appear to be registered as an [Investment 

Adviser] or [Investment Company]. So I would like to take 

a look at a copy of the most recent exam report for the 

[Broker-Dealer], Bernard L. Madoff Investment Securities, 

LLC, when you get the chance.36 

E-mail dated April 4, 2001 from Kazon to Sadwin, at Exhibit 142; Kazon Testimony Tr. 

at p. 15. Kazon subsequently e-mailed Sadwin, “The registrants I am aware of with 

whom Madoff might be associated are Broyhill Management and BMC Fund, Inc.”37 

E-mail (undated) from Kazon to Sadwin, at Exhibit 143. After reviewing the 2001 

submission for only one day, Kazon sent an April 5, 2001 e-mail to Schonfeld, saying: 

As we discussed, after reviewing the complaint received 

(via the BDO) from Harry Markopol[o]s of Rampart 

Investments about purported performance claims for funds 

managed by Bernard Madoff, and some information about 

Madoff and others identified in the complaint, I don’t think 

we should pursue this matter further. 

E-mail dated April 5, 2001 from Kazon to Schonfeld, at Exhibit 144. 

Kazon testified that she did not “remember having received a referral in or around 

April 2001 involving Madoff.” Kazon Testimony Tr. at p. 15. She also did not recall 

sending the April 5, 2001 e-mail to Schonfeld stating her opinion that, “I don’t think we 

should pursue this matter further.” Id. at p. 16. In fact, Kazon stated that she did not 

recall ever seeing the 2001 submission and did not recall hearing the name “Markopolos” 

until December 2008. Id. at pgs. 15-18.38 While Kazon did not recall the 2001 

submission, she testified that: 

[I]n general, you know, when we get a complaint we would 

read it, we would try to figure out whether within the four 

36 With respect to her April 4, 2001 request to see the most recent broker-dealer exam report on Madoff, 

Kazon explained that the 2001 submission discussed “the way he executes trades or how much money he’s 

making or whether he’s doing something improper about trading. So, that would have been something that 

might have been discussed or illuminated by the examining board.” Id. at p. 23. 37 A Broyhill Management document describing the returns Broyhill earned with Madoff was included in 

the 2001 submission. E-mail dated March 1, 2001 from Markopolos to Manion, with attachments, at 

Exhibit 137. The same document was included in the 2000 submission. 2000 submission, at Exhibit 134. 

38 On April 4, 2001, Sheryl Marcus, an examiner in NERO, conducted a search of the SEC’s Name 

Relationship Search Index (NRSI) for “Madoff” in order to determine whether there were open 

investigations involving Madoff. See Excerpt from the NRSI list of SEC employees who searched for 

“Madoff” at Exhibit 145. Marcus stated that she did not recall performing the search. Marcus Interview 

Memorandum. 

72 
corners of it[,] it stated a possible violation of securities 

laws as opposed to a violation of something else. And then 

talk to – and usually I would talk to a supervisor about, you 

know, whether we should pursue it or how we should 

pursue it. 

Id. at pgs. 18-19. Kazon described the 2001 submission as “more detailed than the 

average complaint in those days that came through.” Id. at p. 25. Similarly, after 

reviewing the 2001 submission during his testimony, Schonfeld described it as “more 

detailed than the average [referral].” Schonfeld Testimony Tr. at p. 18. 

Kazon testified further: 

My impressions are that this is a document that I probably 

would have needed to consult somebody about, I hope I 

consulted somebody. I honestly don’t remember. I also 

would have thought that the author of this document was 

odd, to say the least, but I hope that would not have led me 

to dismiss this, but I just don’t recall. 

Kazon Testimony Tr. at pgs. 20-21. 

Kazon acknowledged that she “would have needed to consult with somebody with 

greater [options] expertise to figure out the full extent to which [the 2001 submission] 

could be followed up on.” Id. at p. 21. Kazon testified that, “probably the people I 

would have consulted with would have been in the [Investment Adviser] exam program 

or ... Mark [Schonfeld]. Not because he’s an expert in options, but just because he’s a 

really smart guy.” Id. at pgs. 21-22. Kazon stated that she did not know if she had ever 

investigated a Ponzi scheme at that point in her career. Id. at p. 24. 

Finally, Kazon also acknowledged that the 2001 submission should have been 

reviewed for more than one day before a decision was made regarding its disposition: 

Q: Putting that aside, putting aside the fact that Bernie 

Madoff confessed to running a Ponzi scheme in 

December of 2008. Just based on the [2001 

submission], would it be fair to say that given the 

complexity, there were some details in the 

documents, that it would take some period of time, 

weeks perhaps, at least, to mark [sic] a 

determination as to whether the matter was 

appropriate for investigation? 

A: It should have in the hindsight. Again, I don’t know 

whether it was that I asked someone in the exam 

program to review it, and just based on whatever 

73 
that person told me or whether it was based on 

resources or priority, I just don’t recall. 

Id. at p. 29. 

4. Two Articles Were Published in May 2001 Questioning the Legitimacy of 

Madoff’s Returns 

In the month following NERO’s decision not to investigate the claims raised by 

Markopolos, MARHedge and Barron’s both published articles questioning Madoff’s 

unusually consistent returns and secretive operations. The MARHedge article written by 

Michael Ocrant was entitled “Madoff Tops Charts; Skeptics Ask How,” and published on 

May 1, 2001. It included the following: 

[M]ost of those who are aware of Madoff’s status in the 

hedge fund world are baffled by the way the firm has 

obtained such consistent, nonvolatile returns month after 

month and year after year. 

... 

Throughout the entire period Madoff has managed the 

assets, the strategy, which claims to use [Over the Counter] 

OTC options almost entirely, has appeared to work with 

remarkable results. Again, take the Fairfield Sentry fund as 

the example. It has reported losses of no more than 55 

basis points in just four of the past 139 consecutive months, 

while generating highly consistent gross returns of slightly 

more than 1.5% a month and net annual returns roughly in 

the range of 15.0%. 

... 

The best known entity using a similar strategy, a publicly 

traded mutual fund dating from 1978 called Gateway, has 

experienced far greater volatility and lower returns during 

the same period. 

... 

Skeptics who express a mixture of amazement, fascination 

and curiosity about the program wonder, first, about the 

relative complete lack of volatility in the reported monthly 

returns. But among other things, they also marvel at the 

seemingly astonishing ability to time the market and move 

to cash in the underlying securities before market 

conditions turn negative; and the related ability to buy and 

sell the underlying stocks without noticeably affecting the 

market. 

74 
In addition, experts ask why no one has been able to 

duplicate similar returns using the strategy and why other 

firms on Wall Street haven’t become aware of the fund and 

its strategy and traded against it, as has happened so often 

in other cases. ... 

Michael Ocrant, Madoff Tops Charts; Skeptics Ask How, MARHedge, May 2001, at pgs. 

1, 16, at Exhibit 146. 

The Barron’s article, written by Erin Arvedlund was entitled “Don’t Ask, Don’t 

Tell,” and was published on May 7, 2001. It included the following: 

“Don’t Ask, Don’t Tell” 

Bernie Madoff might as well hang that sign on his 

secretive hedge-fund empire. Even adoring investors 

can’t explain his enviably steady gains. 

... 

[W]hat few on the Street know is that Bernie Madoff also 

manages $6 billion-to-$7 billion for wealthy individuals. 

That’s enough to rank Madoff's operation among the 

world’s three largest hedge funds, according to a May 2001 

report in MARHedge, a trade publication. 

What’s more, these private accounts, have produced 

compound average annual returns of 15% for more than a 

decade. Remarkably, some of the larger, billion-dollar 

Madoff-run funds have never had a down year. 

... 

Using this split-strike conversion strategy, Fairfield Sentry 

Limited has had only four down months since inception in 

1989. In 1990, Fairfield Sentry was up 27%. In the 

ensuing decade, it returned no less than 11% in any year, 

and sometimes as high as 18%. Last year, Fairfield Sentry 

returned 11.55% and so far in 2001, the fund is up 3.52%. 

... 

[S]ome on Wall Street remain skeptical about how Madoff 

achieves such stunning double-digit returns using options 

alone. The recent MARHedge report, for example, cited 

more than a dozen hedge fund professionals, including 

current and former Madoff traders, who questioned why no 

one had been able to duplicate Madoff's returns using this 

strategy. Likewise, three option strategists at major 

75 
investment banks told Barron’s they couldn’t understand 

how Madoff churns out such numbers. Adds a former 

Madoff investor: “Anybody who’s a seasoned hedge-fund 

investor knows the split-strike conversion is not the whole 

story. To take it at face value is a bit naïve.” 

... 

The lessons of Long-Term Capital Management’s collapse 

are that investors need, or should want, transparency in 

their money manager’s investment strategy. But Madoff’s 

investors rave about his performance – even though they 

don’t understand how he does it. “Even knowledgeable 

people can’t really tell you what he’s doing,” one very 

satisfied investor told Barron’s. “People who have all the 

trade confirmations and statements still can't define it very 

well. The only thing I know is that he’s often in cash” 

when volatility levels get extreme. This investor declined 

to be quoted by name. Why? Because Madoff politely 

requests that his investors not reveal that he runs their 

money. 

“What Madoff told us was, ‘If you invest with me, you 

must never tell anyone that you’re invested with me. It’s 

no one’s business what goes on here,’” says an investment 

manager who took over a pool of assets that included an 

investment in a Madoff fund. “When he couldn’t explain 

how they were up or down in a particular month,” he 

added, “I pulled the money out.” 

Erin Arvedlund, Don’t Ask, Don’t Tell, Barron’s, May 7, 2001, at pgs. 1-3, at Exhibit 

135. 

5. NERO Did Not Reconsider Its Decision Not to Investigate Madoff After 

Publication of the Articles 

On May 7, 2001, Fontes followed up with NERO regarding the 2001 submission 

and the Barron’s article with an e-mail to Schonfeld, stating: 

There is a Barron’s article dated today, 5/7, on this guy; 

this is the referral we made to you a few weeks ago. The 

article discusses his trading strategy, which he says is 

“proprietary” in nature and refuses to discuss with the 

reporter. Let me know if you can’t immediately get a copy 

of [the] article so that I can send a copy to you. 

E-mail dated May 7, 2001 from Fontes to Schonfeld, at Exhibit 147. The OIG found no 

76 
 

 

 

 

 

record of a response to this e-mail from Schonfeld. Schonfeld testified that he did not 

recall receiving the e-mail or seeing the article. Schonfeld Testimony Tr. at pgs. 24-25. 

The SEC did not commence an investigation of Madoff after the publication of 

the MARHedge and Barron’s articles. Schonfeld acknowledged that Barron’s is a 

“reputable publication”39 and that “the fact that in addition to a complaint being provided 

to you that there were two newspaper articles providing similar information as the 

complainant,” “would be [a] factor[] to consider in triaging, [which was the process 

utilized by NERO to determine if a complaint was worth pursuing.]” Id. at pgs. 27-28. 

However, Schonfeld testified that Kazon’s decision “not to pursue it” was apparently not 

revisited after publication of the Barron’s article, “[a]nd the article ... came out later and, 

you know, arguably nobody went back and then reevaluated the original decision.” Id. at 

p. 30. In fact, the OIG found no indication that any of the NERO Enforcement staff who 

considered opening up an investigation about Madoff even read the Barron’s article until 

late 2005, after Markopolos made a third submission. 

III.	 SEC 2004 OCIE WASHINGTON DC CAUSE EXAMINATION OF 

MADOFF 

A. An Employee of a Registered Hedge Fund Provided the OCIE Investment 

Management Group With A Detailed Complaint About Madoff 

During a 2002 examination sweep of hedge funds registered with the 

Commission, OCIE examiners from the Investment Management Group40 requested that 

employees at the examined funds alert them to fraudulent or suspicious activity. Kelly 

Testimony Tr. at p. 14; Hedge Fund Manager Testimony Tr. at pgs. 16-17. In response to 

this request, a Managing Director and Chief Investment Officer (Hedge Fund Manager)41 

at a Commission registered fund of hedge funds contacted Edward Perkins, one of the 

sweep examiners. E-mail dated May 13, 2003 from Perkins to Kelly, at Exhibit 149. 

Perkins referred the Hedge Fund Manager to Mavis Kelly, who was then an OCIE 

Branch Chief in the Investment Management Group at the Commission’s Washington, 

D.C. headquarters.42 Id. 

Kelly had worked with the Hedge Fund Manager during the Commission’s 

examination of his fund and adjudged him to be a “highly” credible source of information 

39 Several other SEC officials acknowledged that Barron’s, a Dow Jones publication, is reputable. See, 

e.g., Richards Testimony Tr. at p. 34; McCarthy Testimony Tr. at p. 43; Swanson Testimony Tr. at p. 46. 

Richards opined further that the author of the Barron’s article, Erin Arvedlund, “is very good” and has 

“written great articles.” Richards Testimony Tr. at p. 34. 

40 For purposes of this report, the terms Investment Management Group or Investment Management
 

Examination Group are used to describe the Investment Adviser/Investment Company Examination 

program within OCIE. 

41 When he submitted his complaint and attachments, the Hedge Fund Manager requested that his identity 

be kept confidential. E-mail dated May 21, 2003, from the Hedge Fund Manager to Kelly, with
 

attachments, at Exhibits 148.

42 Kelly was promoted to Assistant Director on May 2, 2004. 

77 
 

 

 

 

 

 

 

 

 

 

 

and his firm to be “a very thorough ... very analytical, very experienced, very technically 

savvy firm.” Kelly Testimony Tr. at pgs. 16-17, 49. 

1. During Due Diligence of Madoff Feeder Funds, Fund Managers 

Identified Red Flags in Madoff’s Representations 

On May 20, 2003, Kelly and Snively, an OCIE Investment Management 

examiner, had a conference call with the Hedge Fund Manager who expressed concerns 

that “he couldn’t understand how [Madoff] was maintaining his performance” and “he 

couldn’t figure out how he was ... earning returns.” Kelly notes dated May 20, 2003 on 

conference call with Hedge Fund Manager, at Exhibit 150; Kelly Testimony Tr. at pgs. 

16-17; Snively notes dated May 20, 2003 on conference call with Hedge Fund Manager, 

at Exhibit 151. In notes of the conversation, both Kelly and Snively commented that the 

Hedge Fund Manager’s firm was “[n]ever able to understand nature of return.” Kelly 

notes dated May 20, 2003 on conference call with Hedge Fund Manager, at Exhibit 150; 

see also Snively notes dated May 20, 2003 on conference call with Hedge Fund Manager, 

at Exhibit 151. Kelly signified in her notes that the following one piece of information 

the Hedge Fund Manager provided was of particular importance (by placing it in a box 

and drawing a star next to it): “For volume must see options on street yet never see 

them.” Kelly notes dated May 20, 2003 on conference call with Hedge Fund Manager, at 

Exhibit 150; Kelly Testimony Tr. at p. 23. 

On the following day, May 21, 2003, the Hedge Fund Manager sent Kelly a 

detailed complaint by e-mail, in which he laid out the red flags that his fund had 

identified about Madoff while performing due diligence on two Madoff feeder funds.43 

43 The registered fund of funds evaluated potential investments with Madoff feeder funds in 1998 and 2003. 

Hedge Fund Manager Testimony Tr. at pgs. 5-9. It considered an investment with Fairfield in 1998. Id. at 

pgs. 5-6. As part of their standard due diligence process, the Hedge Fund Manager and his unidentified 

CIO met with Madoff. Id. at 3. The CIO former options trader, pressed Madoff for information about his 

options trading. CIO of Fund of Funds Interview Tr. at pgs. 3-7. To the CIO’s surprise, Madoff claimed to 

trade options through the Chicago Board of Options Exchange (CBOE). Id. at 7. The CIO stated: “Well I 

found something exceptionally odd about that .... [I]mmediately what I asked Madoff was: How are you 

doing that? Because I don’t think there’s enough volume on the Chicago Board of Options Exchange for 

you to get that sort of coverage for the amount that you’re managing.” Id. at 7. 

The CIO’s suspicions triggered, he called CBOE to find out how much daily volume traded on the 

exchange. He described his call to CBOE, as follows: “And the problem is ... that the volume was never 

there for Madoff. So that was problem No. 1 for me. Problem No. 2 was ... I called up buddies of mine 

around the street who were now running the equity derivatives departments of a number of firms, and I 

asked them all if they were trading with Madoff. And nobody was. Nobody was doing these OEX options. 

And in fact, the funny part about it was they all said, yeah. You know, I hear that he’s doing all these 

trades but, you know, we don’t see it anywhere ... And so things just began to, you know, not match up. 

And so for me, the biggest issue was – the biggest issue was the fact that I couldn’t reconcile a big part of 

that strategy. And the information that was being told to me on the surface seemed to be false.” CIO of 

Fund of Funds Interview Tr. at pgs. 11-12. Because of the unanswered questions, they passed on the 

investment. Hedge Fund Manager Testimony Tr. at pgs. 8-9. 

In 2003, the two managers again evaluated an investment with a Madoff feeder fund. By adding up 

feeder funds and Madoff clients they were aware of in the United States and Europe, they estimated Madoff 

was managing between 8 and 10 billion dollars. Hedge Fund Manager Testimony Tr. at pgs. 10, 39-40. 

78 
 

 

 

 

 

 

 

 

 

E-mail dated May 21, 2003 from the Hedge Fund Manager to Kelly, with attachements, 

at Exhibit 148; Hedge Fund Manager Testimony Tr. at pgs. 10-13, 17; OCIE Assistant 

Director Testimony Tr. at p. 27 (agreeing that the Hedge Fund Manager’s complaint 

“Yes, absolutely” was a substantive, detailed complaint). The Hedge Fund Manager 

attached four documents to his complaint, including performance statistics for three 

Madoff feeder funds and a May 2001 article published in MARHedge entitled “Madoff 

Tops Charts; Skeptics Ask How.”44 E-mail dated May 21, 2003 from the Hedge Fund 

Manager to Kelly, with attachements, at Exhibit 148. 

The Hedge Fund Manager estimated Madoff managed $8-10 billion in 

discretionary brokerage accounts at the Madoff firm using a split-strike conversion 

strategy,45 which consisted of buying a basket of large cap stocks in the S&P 100 stock 

index (OEX), selling OEX call options and purchasing OEX put options.46 E-mail dated 

May 21, 2003 from the Hedge Fund Manager to Kelly, with attachements, at Exhibit 148. 

The complaint stated BMIS charged only brokerage commissions as compensation. Id. 

BMIS’s fee structure was notable because Madoff was foregoing the significant 

management and performance fees typically charged by asset managers.47 The complaint 

also described the following specific concerns about Madoff’s strategy and purported 

returns: 

- according to [BMIS], the options are traded with a number of 

traders and crossed on CBOE. With a 8-10 billion size, you must 

see the volume, but unfortunately you don’t. We actually checked 

with some of the largest brokers (UBS, Merril [sic], etc) which told 

us they never traded with them OEX options. The question is do 

they really implement the full strategy. 

This time, the feeder fund did not allow them access to Madoff during their due diligence process. Hedge 

Fund Manager Testimony Tr. at p. 9. Regardless, they quickly made several unsettling findings, including 

a potential conflict of interest with the auditor and the fact that Madoff’s returns seemed to have continued 

unaffected by the bust of the dot-com bubble. Id. at pgs. 10-13. After a “week or two” of due diligence, 

the Hedge Fund Managers again rejected an investment with Madoff because “[t]here were too many 

holes.” Hedge Fund Manager Testimony Tr. at p. 31. 

44 MARHedge provided a semi-monthly publication that delivered news on global hedge fund markets. 

45 According to the FTI Engagement Team, a split-strike conversion strategy is normally considered a 

limited-risk, limited-reward strategy because downside risk and upside potential are somewhat limited by 

the call and put option contracts. For the strategy to be particularly effective, the manager must be able to 

successfully time the purchase and sale of the securities, relative to movements in the market for such 

securities, on a consistent basis over an extended period of time. The manager would also have to 

demonstrate excellent stock-selection skills over an extended period of time, since the split-strike 

conversion strategy utilized by the Madoff firm requires a subset of OEX stocks that will maintain a high 

correlation to that overall index. 

46 A call option is an agreement that gives an investor the right, but not the obligation, to buy a specified 

amount of an underlying security at a specified price within a specific time period. 

http://www.investopedia.com/terms/c/calloption.asp. A put option is an agreement that gives the owner the 

right, but not the obligation, to sell a specified amount of an underlying security at a specified price within 

a specified time period. Id. 47 According to the FTI Engagement Team, a typical management fee of 2% and a performance fee of 20% 

would have likely yielded the Madoff firm tens of millions, if not hundreds of millions in dollars of 

additional profits compared to the commissions Madoff was purportedly earning. 

79 
- the strategy is not duplicable by anyone else as far as we know. 

- there is no correlation to the overall equity markets (in over 10 

years). 

- accounts are typically in cash at month end. 

- since the accounts are at [BMIS], the investors (i.e. the feeders 

that have discretionary accts) receive [BMIS] brokerage 

statements. There are no third party brokers involved in the 

process. The auditor of the firm is a related party to the principal. 

- finally, given the performance of the different accounts, [BMIS] 

never had to face redemption. In fact given the fact that the 

different feeders are closed for new investments, there is always 

replacement capital (1/5 ration [sic] according to some people). 

E-mail dated May 21, 2003 from the Hedge Fund Manager to Kelly, at Exhibit 148. 

To Kelly, the complaint indicated “that there are areas that need to be answered, 

and we needed to look into them more.” Kelly Testimony Tr. at p. 37. She also 

understood that the Hedge Fund Manager was implying that BMIS might be lying about 

its option trading, and “some of the issues” that the [Hedge Fund Manager] laid out in the 

complaint were “indicia of a Ponzi scheme.” Id. at pgs. 32, 36, 94-95. 

The three attachments containing Madoff feeder fund performance results 

provided “backup for why [the Hedge Fund Manager] was questioning” Madoff’s 

remarkable returns. Kelly Testimony Tr. at p. 60. The attached MARHedge article 

“Madoff Tops Charts; Skeptics Ask How” also raised concerns similar to and in support 

of those in Hedge Fund Manager’s complaint. Kelly Testimony Tr. at pgs. 46-47. Kelly 

was familiar with MARHedge and found it to be a credible “long standing” publication, 

but not one that she believed the Commission usually received. Id. at 46. 

2. MarHedge Article Raised Red Flags About Madoff’s Returns 

In addition to describing concerns similar to those provided by the Hedge Fund 

Manager’s complaint, the MARHedge article, written by Michael Ocrant and entitled, 

“Madoff Tops Charts; Skeptics Ask How,” contained the following additional red flags 

about the lack of volatility in Madoff’s returns, his unbelievable ability to time the 

80 
 

 

 

 

 

 

market, the fact that his trading was not seen or felt in the market, and his unusual fee 

structure:48 

Skeptics who express a mixture of amazement, fascination 

and curiosity about the program wonder, first, about the 

relative complete lack of volatility in the reported monthly 

returns. 

But among other things, they also marvel at the seemingly 

astonishing ability to time the market and move to cash in 

the underlying securities before market conditions turn 

negative; and the related ability to buy and sell the 

underlying stocks without noticeably affecting the market. 

In addition, experts ask why no one has been able to 

duplicate similar returns using the strategy and why other 

firms on Wall Street haven’t become aware of the fund and 

traded against it, as has happened so often in other cases; 

why Madoff Securities is willing to earn commissions off 

the trades but not set up a separate asset management 

division to offer hedge funds directly to investors and keep 

all the incentive fees for itself, or conversely, why it 

doesn’t borrow money from creditors, who are generally 

willing to provide leverage to a fully hedged portfolio of up 

to seven to one against capital at an interest rate of Liborplus, and manage the funds on a proprietary basis. 

Michael Ocrant, Madoff Tops Charts; Skeptics Ask How, MARHedge, May 2001, at 

Exhibit 146. 

48 Ocrant, the author of the MARHedge article, stated that he intentionally did not accuse Madoff of 

falsifying customer returns or running a Ponzi scheme in his article because Ocrant “thought in the story it 

was more powerful, [to] just la[y] out ... concerns people had about why whatever he said he was doing 

couldn’t be what he’s doing.” Ocrant Interview Tr. at p. 26. The article posits that one possible 

explanation for Madoff’s extraordinary purported performance could be his use of order flow information 

from the Madoff firm’s market making business to benefit the discretionary brokerage accounts (such as by 

front-running). Michael Ocrant, Madoff Tops Charts; Skeptics Ask How, MARHedge, May 2001, at 

Exhibit 146. Others, including the Commission’s Deputy Chief Economist, have testified that “frontrunning or other types of abuse of broker-dealer information could [not] generate returns on an asset base 

this large.” Mayhew Testimony Tr. at pgs. 27-28, 36 (“If you are [front-running] with a huge base of 

billions and billions of dollars that would have an insignificant impact on your returns so you could not 

generate real returns that way”); Ocrant Testimony Tr. at p. 13 (stating that a quantitative analyst that 

analyzed Madoff’s returns opined to him that if Madoff was managing between $7-9 million, then it would 

be impossible for Madoff to be front-running, and he would have to be running a Ponzi scheme). 

81 
3. Investment Management Examiners Would have Validated 

Madoff’s Returns 

According to Kelly, were Investment Management examiners to investigate the 

allegations in the Hedge Fund Manager’s complaint and attachments, “one of the things 

we would look to validate is the performance returns.” Kelly Testimony Tr. at p. 53. 

Kelly stated that to validate returns, Investment Management examiners would use a 

number of methods: 

I would look for the misrepresentation of performance to see 

if he was just falsifying the performance; I would look for 

the individual accounts to see, is he using ... a specific set of 

clients, and only those highly profitable accounts; ... we do 

a client account review, we do a performance review. And 

in doing the client account review, I would notice if the 

trades were there, any activities reported, who was the 

custodian ... 

Kelly Testimony Tr. at pgs. 52-54. Moreover, the OCIE Assistant Director stated that the 

complaint “appears to be dealing with performance ... and that’s something that is 

checked on [in] every examination that I know of.” OCIE Assistant Director Testimony 

Tr. at p. 28. 

4. Investment Management Examination Group Referred the 

Complaint to the Broker-Dealer/Self-Regulatory Organization 

Examination Group 

Despite their expertise in this area, the Investment Management examiners never 

investigated the Hedge Fund Manager’s complaint or the allegations in the MARHedge 

article. Through at least February 2009, OCIE did not have formal policies and 

procedures for handling complaints. Gohlke Testimony Tr. at pgs. 10, 19. In OCIE’s 

Investment Management Program, the informal uniform practice was to provide the 

complaints to the OCIE Assistant Director, Kelly’s supervisor in 2003. Kelly Testimony 

Tr. at pgs. 69, 71; OCIE Assistant Director Testimony Tr. at p. 10; Gohlke Testimony Tr. 

at p. 11. The OCIE Assistant Director typically logged the complaints into a spreadsheet 

and distributed them to the appropriate regional office. Kelly Testimony Tr. at p. 69; 

OCIE Assistant Director Testimony Tr. at pgs. 10-11, 15. The practice of OCIE’s 

Investment Management Group was to refer complaints about registered broker-dealers 

to OCIE’s Broker-Dealer/Self-Regulatory Organization Group (SRO Group) for 

investigation even where the complaint raised Investment Management issues, such as 

questions about hedge fund performance. Gohlke Testimony Tr. at pgs. 28, 32; Kelly 

Testimony Tr. at pgs. 62-63, 76-77; Snively Interview Tr., at pgs. 17-18. If there was no 

registered entity, then they would typically refer the complaint to the Division of 

Enforcement. Gohlke Testimony Tr. at p. 14; Snively Interview Tr. at p. 18. 

82 
 

 

 

 

 

 

 

According to Kelly, the OCIE Investment Management Group determined that, 

according to their group’s procedure, they should refer the complaint to the OCIE SRO 

Group because BMIS was a registered broker-dealer, but Kelly also noted that the 

Investment Management Group could have provided assistance:49 

Since it says that they were discretionary accounts [in the 

complaint], we felt that they [SRO Group] could look at the trading 

activities in the brokerage accounts, and could validate the 

information from a brokerage level. ... So I don’t know that they 

needed to go to [the] management side, but if they weren’t 

understanding how the returns were achieved, we are used to doing 

that. That is something we could have done, because I don’t know 

that on the broker-dealer side that they’re really worried about 

performance. That is a routine part of what we’re doing. 

Kelly Testimony Tr. at pgs. 83, 90; see also Gohlke Testimony Tr. at pgs. 18, 43 

(Investment Management expertise probably would have been helpful to the SRO staff in 

investigating the Hedge Fund Manager’s complaint).50 

Kelly believes she likely spoke to Gene Gohlke about the complaint and 

researched some of the issues it raised before distributing it. Kelly Testimony Tr. at pgs. 

62-64. Gohlke emphasized that it appears his group appropriately referred the matter to 

the SRO Group based on the nature of the accounts: 

...[J]ust observe that the trustee in Madoff right now is the SIPC 

trustee, and SIPC only pays for losses on broker dealer customer 

accounts, so SIPC must be of the opinion that these are broker 

dealer customer accounts, not advisory customer accounts. 

Gohlke Testimony Tr. at p.42. 

49 “When OCIE was initially formed, it had one group devoted to conducting inspections of SelfRegulatory Organizations (SROs). However, in 2000, recognizing the need for greater specialization, 

OCIE reorganized and divided its SRO inspection staff into two groups: “SRO 1” and “SRO 2.” The SRO 

1 Group focuses on inspecting the SROs’ programs for providing trading facilities and overseeing 

members’ trading activities. This specialization permits the group to develop and retain expertise in trading 

facilities and activities. The SRO 2 Group, on the other hand, focuses on inspecting the SROs’ programs 

for overseeing members’ activities away from the trading markets. This specialization permits the group to 

develop and retain expertise in member regulation, listings, arbitration, and the other areas subject to its 

review. The SRO 1 Group is now known as OCIE’s Office of Market Oversight (Market Oversight). 

Market Oversight’s primary focus remains on the SROs. However, to assess the quality of SRO programs 

relating to trading activity, Market Oversight also conducts examinations of broker-dealers’ trading 

activity.” Letter dated June 5, 2009 from Walsh to Kotz, at Exhibit 152. 

50 The FTI Engagement Team concluded that the SRO Group should have, at a minimum, sought 

Investment Management advice in investigating the Hedge Fund Manager’s complaint because it included 

issues typically examined by investment adviser personnel, including verification of purported investment 

returns and account balances. The SRO Group had no significant experience in these areas. OCIE 

management acknowledged that its Investment Management Examination Group personnel would have 

known to look specifically at the investment returns and verify custody of the assets. However, such 

personnel were not contacted for assistance. 

83 
 

 

 

 

 

The OCIE Assistant Director did not recall discussing the complaint, nor do his 

records show he logged the complaint into his spreadsheet. OCIE Assistant Director 

Testimony Tr. at pgs. 13-14, 42. However, the OCIE Assistant Director stated that if the 

determination was made to refer it to OCIE’s SRO Group, he “would probably just 

forward it over to our broker-dealer people” without logging it in. OCIE Assistant 

Director Testimony Tr. at p. 23. 

5. SRO Group Received the Complaint No Later Than the Fall of 

2003 

No later than the fall of 2003, Kelly provided the complaint to the OCIE SRO 1 

Group (SRO Group).51 E-mail dated December 17, 2003 from Donohue to Walker, at 

Exhibit 153; Kelly Testimony Tr. at pgs. 63-64; Wood Testimony Tr. at p. 22; Donohue 

Testimony Tr. at p. 32. In 2003, OCIE’s SRO Inspection Program was headed by 

Associate Director John McCarthy and Assistant Director Eric Swanson. McCarthy 

Testimony Tr. at p. 16; Sadowski Testimony Tr. at p. 48. Kelly circulated the complaint 

and attachments to the SRO Group in paper rather than by e-mail due to the Hedge Fund 

Manager’s confidentiality concerns. Kelly Testimony Tr. at p. 97. 

Kelly expected the SRO Group “would look into the trading volume question, ... 

would get the information about the accounts, he would get the information necessary to 

understand whether the performance was falsified[,]” and would look at whether Madoff 

should be registered as an investment adviser. Kelly Testimony Tr. at p. 67. She 

understood that since all of the questionable activity was taking place in brokerage 

accounts, the Commission would have access to all books and records related to those 

accounts. Id. at pgs. 68, 76. Kelly’s view was supported by other OCIE examiners. 

Matthew Daugherty, Senior Special Counsel in OCIE who had limited involvement in the 

Madoff examination, opined, “If it was all through the broker-dealer then you could get 

everything ....” Daugherty Testimony Tr. at p. 93. Similarly, former OCIE examiner 

Wood stated, “We always ask for proprietary information whenever we did any exam and 

[] we received it.”52 Wood Testimony Tr. at p. 34. 

51 While Snively does not have a specific recollection of when the complaint was referred to the SRO 

Group, he believes that according to the standard practice of the Investment Management Examination 

Group, it was provided prior to the fall of 2003. Snively Interview Tr. at p. 21. Snively stated that his 

group typically researched and referred complaints “within a matter of a day or so ... And I think the 

typical situation would be to send it along within a matter of days at the most.” Id. The OIG has found no 

records indicating the exact date the complaint was referred. 

52 According to the FTI Engagement Team, Madoff’s books and records were subject to examination 

whether or not he was registered as an investment adviser. As a registered broker-dealer, the Madoff firm’s 

books and records (including e-mails) related to that business are subject to compliance examinations and 

review by the SEC staff under Section 17 of the Exchange Act. If the firm had been registered as an 

investment adviser at that time, the firm’s books and records related to that business would have been 

subject to compliance examinations and review by the SEC staff under Section 204 of the Advisers Act. 

However, since Madoff was running the investment advisory business out of discretionary brokerage 

accounts at BMIS and it was a registered broker-dealer, those records were also subject to compliance 

examinations and review by the SEC staff under Section 17 of the Exchange Act. 

84 
 

 

6. OCIE’s SRO Examination Group Had No Policies or Procedures 

for Handling Tips or Complaints 

The OCIE SRO Group did not log tips or complaints, had no policies or 

procedures for handling tips or complaints, nor did it have uniform informal procedures 

of which Richards, McCarthy or other examiners were aware. McCarthy Testimony Tr. 

at pgs. 20-21; Daugherty Testimony Tr. at pgs. 39-40; Richards Testimony Tr. at p.10. 

OCIE then-Director Lori Richards testified that “cause examinations are a 

priority” and that she would expect the staff to begin a cause examination within “days, 

hours, weeks perhaps” of receiving a complaint containing serious allegations. Richards 

Testimony Tr. at pgs. 15-16. In other testimony given by Richards to the United States 

Senate Committee on Banking, Housing and Urban Affairs on January 27, 2009, 

Richards stated, “[Cause examinations] give the staff the ability to respond very quickly 

to fast-breaking problems, once an indication of the possible problem becomes known.” 

Richards Testimony Before the United States Senate Committee on Banking, Housing 

and Urban Affairs, Madoff Investment Securities Fraud: Regulatory and Oversight 

Concerns and the Need for Reform, January 27, 2009, at p. 8, at Exhibit 154. However, a 

cause examination53 of Madoff was not opened by OCIE’s SRO Group until December 

2003, approximately six months after OCIE received the Hedge Fund Manager’s 

complaint. 

7. OCIE Received Another Tip About Madoff in December 2003 

It appears the SRO Group did not begin to examine the allegations in the Hedge 

Fund Manager’s complaint until another tip about Madoff was provided to Richards by 

Steve Cutler, then-Director of the Division of Enforcement.54 McCarthy Testimony Tr. 

at p. 67. On December 10, 2003, Richards e-mailed John McCarthy about the tip and 

asked him to follow-up: 

Steve talked to the informant on canary . ... She said that there is bad behavior at 

madoff, they’re making a lot of money by front-running in their hedge fund, or 

front-running trades by their hedge fund. Can we send them a letter? 

53 Lori Richards explained the different between “cause” and “routine” examinations: “A cause 

examination is conducted when the staff have ‘cause’ to believe there may be a problem or a violation. A 

cause exam is conducted when the staff learns of information from a press article, for example, a complaint 

or a tip. Other information comes to our attention that indicates there’s a possible problem or violation and 

the staff will go in and really focus discreetly on that issue. Routine examination, we conduct routine 

examinations of investment advisers and investment companies on a cycle. And in those examinations 

we’re looking at the firm’s compliance with the law in generally a specified number of areas. They’re 

conducted based on the passage of time rather than based on a particular incident or complaint.” Richards 

Testimony Tr. at 9-10. 

54 The date of the initiation of the cause examination cannot be pinpointed because the OCIE SRO Group 

did not log the examination into the Super Tracking and Reporting System (“STARS”). Richards testified 

that all examinations should be logged into the STARS system, but she was aware the SRO Group 

routinely did not log their examinations into the system. Richards Testimony Tr. at 21. 

85 
 

E-mail dated December 10, 2003 from Richards to McCarthy, at Exhibit 155; McCarthy 

Testimony Tr. at p. 16. 

The next day, at McCarthy’s request, Tina Barry sent McCarthy and Richards a 

May 7, 2001 article from Barron’s entitled, “Don’t Ask, Don’t Tell.” Barry Testimony 

Tr. at p. 26; E-mail dated December 11, 2003 from Barry to McCarthy and Richards, at 

Exhibit 156. The Barron’s article, written by Erin Arvedlund, was first published in the 

same month Ocrant’s MARHedge article was published – and raised concerns similar to 

those presented in MARHedge. Ocrant Interview Tr. at p. 23. 

8. It Appears Richards First Sent McCarthy the Barron’s Article 

About Madoff in 2001 

This was not the first time McCarthy had been given a copy of the Barron’s 

article. It appears Lori Richards sent a hard copy of the Barron’s article to McCarthy in 

2001, approximately two years before OCIE received the Hedge Fund Manager’s 

complaint. Erin Arvedlund, Don’t Ask, Don’t Tell, Barron’s, May 7, 2001, at Exhibit 

135. Across the top of the Barron’s article Richards gave to McCarthy previously, she 

wrote: 

John, she [referring to Arvedlund] is very good. This is a 

great exam for us! Lori. 

Richards’ copy of Erin Arvedlund, Don’t Ask, Don’t Tell, Barron’s, May 7, 2001, at 

Exhibit 157; Richards Testimony Tr. at pgs. 24-35. Although Richards and McCarthy 

cannot recall the date Richards sent the hard copy article to McCarthy, the article appears 

from the footer to have been retrieved from Dow Jones Interactive and printed on May 

15, 2001. Richards Testimony Tr. at p. 35; McCarthy Testimony Tr. at p. 43; Richards’ 

copy of Erin Arvedlund, Don’t Ask, Don’t Tell, Barron’s, May 7, 2001, at Exhibit 157. 

McCarthy did not open an examination of Madoff in response to the article, and testified 

that he may not have read the article at the time Richards provided it to him. McCarthy 

Testimony Tr. at pgs. 43-45, 48. 

On December 18, 2003, McCarthy sent an e-mail to Richards, with a copy to Eric 

Swanson,55 informing her that a compliance officer had told Kelly he was concerned 

about Madoff’s “impossible” returns. E-mail dated December 18, 2003 from McCarthy 

to Richards, at Exhibit 158. In the e-mail, McCarthy did not reveal that the Hedge Fund 

Manager had submitted the complaint to OCIE approximately seven months earlier and 

55 The December 18, 2003 e-mail from McCarthy came from McCarthy’s e-mail account but was signed 

“Eric,” presumably for Eric Swanson, the OCIE Assistant Director who worked closely with McCarthy. 

McCarthy thought it was possible he and Swanson worked on the e-mail together and then McCarthy sent it 

to Richards. McCarthy Testimony Tr. at pgs. 51-52. 

86 
 

 

that the complaint had been sitting idle with the SRO Group for months, but stated as 

follows: 

A compliance officer at an investment adviser notified Mavis 

[Kelly] that he was concerned about the returns Fairfield was 

posting. He said that he was aware that Madoff was running 

Fairfield using a strategy called a split strike conversion or option 

something or other, that he was very familiar with that strategy, 

and that from his perspective, it would have been impossible for 

Madoff/Fairfield to post the returns they have using this strategy. 

We would like to contact this compliance officer and get a better 

understanding of how this strategy is supposed to work. 

E-mail dated December 18, 2003 from McCarthy to Richards, at Exhibit 158. Richards 

provided her permission for the examiners to contact the Hedge Fund Manager, but 

testified she was unaware that the Hedge Fund Manager had sent OCIE a detailed 

complaint with attachments. Richards Testimony Tr. at pgs. 45-46. 

9. Richards and McCarthy Called Madoff Prior to OCIE’s 

Examination 

Later that day, McCarthy and Richards placed a phone call to Madoff. E-mail 

dated December 18, 2003 from Richards to McCarthy, at Exhibit 159; E-mail dated 

December 19, 2003 from Donohue to Daugherty, at Exhibit 160. Richards “recall[ed] 

telephoning him in advance of an exam that we were going to perform to tell him that we 

expected full cooperation of the firm.” Richards Testimony Tr. at p. 26. Richards stated 

that it was not atypical for her to call registrants prior to an examination and that “in 

situations where it’s important, where we want their cooperation and expect it promptly;” 

she does “many of those calls.” Richards Testimony Tr. at p. 68. McCarthy testified, 

“It’s not normal for Lori to be on a call with me ... [b]ut ... I’m sure it’s happened many 

times in the past.” McCarthy Testimony Tr. at p. 75. Daugherty testified Richards has 

“been involved in conversations with the registrants, particularly the heads of registrants, 

on multiple occasions that I’ve been a part[y] to.” Daugherty Testimony Tr. at p. 65. 

Another examiner testified that in his experience it was unusual for Richards to 

personally call registrants at the start of an examination. Donohue Testimony Tr. at p. 

55. 

Richards testified she did not recall having a substantive discussion with Madoff 

on the December 18, 2003 call, stating, “I don’t recall specifically. I recall generally 

saying what we would be looking at. ... I don’t recall specifically but it would likely have 

been we’re looking at allegations of front-running.”56 Richards Testimony Tr. at p. 66. 

56 Madoff recalled that two years before NERO examiners performed an examination at BMIS, he received 

a phone call from Lori Richards, which he characterized as an inquiry for a hedge fund sweep. Madoff 

Interview Memorandum at p. 2. He stated that while in the lobby of his building, his personal cell phone 

rang and he had the following conversation with Richards: 

87 
 

 

 

 

McCarthy recalled they called Madoff “basically to verify that he had a hedge 

fund[,] ... what that looked like, where the trades were executed, things like that. And to 

basically make sure that we could ... then start conducting the exam.” McCarthy 

Testimony Tr. at p. 73. Other documents from the examination indicate Richards and 

McCarthy had a substantive conversation with Madoff, and Madoff told them he was 

executing trades for four hedge funds using a split-strike conversion strategy. Draft letter 

dated December 2003 from Swanson to Madoff, at Exhibit 161; E-mails dated May 26, 

2005 between Swanson, Donohue, and Nee, at Exhibit 162; Donohue Testimony Tr. at p. 

60. 

According to undated notes from the examination papers, it appears that 

McCarthy took notes of at least one conversation with Madoff.57 Swanson notes, 

undated, on conversation with Madoff, at 4, at Exhibit 163; Swanson Testimony Tr. at p. 

70. The notes reflect Madoff telling McCarthy about his operations and investment 

strategy. Id. The notes state, “Black Box Drives Model”; “4 Funds [are] offshore 

Funds”58; “no discretion = 10% return.” Swanson notes, undated, on conversation with 

Madoff, at 4, at Exhibit 163. 

LR: “Bernie, its Lori.” 

BM: “Hi Lori.” 

LR: “I need you to help me out. Can you tell me about your hedge funds?” 

BM: “I don’t have a hedge fund.” 

LR: “I didn’t think so.” 

BM: “I execute trades for hedge funds.” 

Id. Madoff recollected the call lasting about 15 minutes, and stated that John McCarthy may have been on 

the call, but could not remember for sure. Id. He remembered Richards telling him that he’d probably get 

a call from McCarthy and that they may need more information from him. Id. Shortly thereafter, Madoff 

received a call from McCarthy, during which McCarthy told him, “You’ll get a letter after the first of the 

year.” Id. Madoff stated that when he got the letter, it was readily apparent to him that they were focused 

on front-running and thought it was part of a sweep that the SEC was doing on front-running. Id. He 

recalled the letter was seeking the names of hedge funds he did business with, a description of his splitstrike conversion strategy, copies of “maybe” two years of statements from large hedge funds, and his P&L 

trading profit in those securities. Id. 57 Alex Sadowski, an OCIE Branch Chief at the time, testified McCarthy told him that he had spoken to 

Madoff during the examination. Sadowski Testimony Tr. at p. 32. 

58 McCarthy testified Madoff told him he did his trading in London. McCarthy Testimony Tr. at pgs. 101­

102. There is no evidence in the examination papers or from examiner testimony that Madoff told the 

OCIE examiners that he was executing trades in London. According to notes that have been identified as 

McCarthy’s, Madoff may have told him the feeder funds (not the trade executions) were off shore. 

Swanson notes, undated, on conversation with Madoff, at 4, at Exhibit 163; Swanson Testimony Tr. at p. 

70. McCarthy may also have developed his belief Madoff told him that he was trading off shore from news 

reports of what Madoff told NERO examiners in 2005. 

88 
 

 

 

B. SRO Group Began Planning Its Examination of Madoff in December 2003 

1. The Madoff Examination Team Consisted Entirely of Attorneys 

In December 2003, McCarthy, Swanson, and Donohue assembled a team from the 

SRO Group to work on the cause examination of Madoff. The examination team 

included the following members, all of whom where attorneys: John McCarthy, 

Associate Director; Eric Swanson, Assistant Director; Mark Donohue, Branch Chief and 

later Assistant Director; Jaqueline Wood, Staff Attorney; and Genevievette Walker, Staff 

Attorney.59 Draft Planning Memorandum dated December 16, 2003 from Donohue, 

Walker, and Wood to Swanson, at Exhibit 165. Two other attorneys – Matthew 

Daugherty and a former OCIE Attorney Advisor – had limited involvement in the 

examination. Former OCIE Attorney Advisor Testimony Tr. at p. 29; Daugherty 

Testimony Tr. at p. 57; Donohue Testimony Tr. at p. 24. Donohue stated that his role 

was to “run the examination.” Donohue Testimony Tr. at pgs. 21-22. 

At the time of the Madoff examination, McCarthy had worked at the Commission 

for almost a decade. McCarthy Testimony Tr. at p. 11. He worked in the Division of 

Market Regulation until OCIE was established in 1995. McCarthy Testimony Tr. at p. 

11. In OCIE, McCarthy worked on and supervised inspections of SROs until 1999, when 

he briefly left the Commission to work at Knight Securities. McCarthy Testimony Tr. at 

pgs. 12-13. After his return to the Commission, Richards promoted McCarthy to 

Associate Director. McCarthy Testimony Tr. at pgs. 13-15. As the Associate Director, 

he was responsible for “running the SRO Inspection Program” and supervised 10-25 

people. McCarthy Testimony Tr. at p. 16. 

McCarthy worked closely with Swanson, his second-in-command. Swanson 

Testimony Tr. at pgs. 12-13, 141. Swanson graduated from law school in 1993 and 

practiced non-securities related law until he came to the Commission in August 1996. 

Swanson Testimony Tr. at 10. After working in the SRO Group for approximately two 

years, he was promoted to Branch Chief. Swanson Testimony Tr. at p. 11. In 2000, he 

was promoted to Senior Counsel. Swanson Testimony Tr. at pgs. 11-12. Within a few 

months of becoming Senior Counsel, Swanson was promoted again to Assistant Director 

in a “completely different” SRO Group (now known as “Market Oversight”), where he 

supervised approximately 8-18 employees. Swanson Testimony Tr. at pgs. 11-12. 

59 Walker claimed that at the beginning of the examination, she was designated the lead examiner and that 

Donohue later removed her from that role. Letter dated June 12, 2009 from Walker to Kotz, with 

attachments, at p. 2, at Exhibit 164. While Wood testified that she did not act as lead on the examination, 

she did not testify that Walker was designated as the lead or that Donohue removed Walker from that role. 

Wood Testimony Tr. at p. 112. Donohue did not recall whether the Madoff examination had a lead 

examiner, and the examination papers do not indicate that the examination had a lead examiner. Donohue 

Testimony Tr. at p. 28. 

89 
 

2. OCIE Expanded Rapidly and Lacked Trained Examiners 

It does not appear the Branch Chief and examiners were chosen to work on the 

Madoff examination due to any particular expertise or experience. At the time of the 

Madoff examination, OCIE “didn’t have many experienced people at all. ... we were 

expanding rapidly and had a lot of inexperienced people at the time. ... I guess you could 

say we were all effectively inexperienced.” Daugherty Testimony Tr. at p. 69. Wood 

had a similar recollection, stating that many OCIE examiners were relatively 

inexperienced in 2003. Wood Testimony Tr. at p. 129. 

Donohue came to the Commission in 2000 after practicing general litigation for 

approximately five years. Donohue Testimony Tr. at pgs. 9-11. He began at the 

Commission as a staff attorney in SRO 1 Group (now known as Market Oversight). 

Donohue Testimony Tr. at pgs. 12-13. After approximately a year and a half, he was 

promoted to Branch Chief reporting to Eric Swanson, the position he held when the 

Madoff cause examination began. Donohue Testimony Tr. at p. 13. In February 2004, 

approximately a year after he became a Branch Chief, he was promoted to Assistant 

Director. Donohue Testimony Tr. at p. 14. After his promotion to Assistant Director, 

Donohue took Swanson’s place as the Assistant Director on the Madoff examination. 

Swanson Testimony Tr. at p. 99; Donohue Testimony Tr. at pgs. 26-27. 

Wood arrived at the Commission in September 2003 after practicing litigation at a 

law firm for almost five years. Wood Testimony Tr. at pgs. 10, 13. Wood explained, as 

follows, that she did not have formal securities training when she came to the 

Commission and had no training in identifying fraud: 

It’s really on-the-job training. I mean, that was something that 

myself along with other individuals in the group wanted to have 

more formalized training. We thought it was very important to 

bring people on and do some type of formal training, but it just 

didn’t happen for some reason. ... I think back in 2003 when I 

came, it was a very young group and a group of people who 

wanted to be trained more and more and probably there should 

have been better training. And I think that for me, that was one of 

the issues that I had with the group. I think that could be part of 

the problem.
 

Wood Testimony Tr. at pgs. 91, 129. 

Another OCIE examiner who joined the Commission in 2003 provided a similar 

description of OCIE training, stating as follows: 

Oh, there was no training. ... And I was told that when I came in 

that this was a trial by fire kind of job that you get trained as you 

come in; and, frankly, I don’t know how you trained somebody to 

do this side of the job. And I feel over time, luckily I had a 

90 
 

background in some trading activity, so I understood basic trading, 

how it works, what the terminology is and that sort of thing, but ... 

there’s a lot of people that weren’t familiar with securities laws. 

OCIE Staff Attorney Testimony Tr. at p. 49. 

Walker, the other examiner on the team, also commented on the lack of 

experience and training in OCIE. She said she “observed many people who appeared to 

be hired by the SEC more for their personal connections to other SEC employees than for 

any substantive experience or knowledge they possessed. It appeared that these 

employees were supposed to learn on the job, which was difficult to do given the nature 

of the SEC’s work.” Letter dated June 12, 2009 from Walker to Kotz, with attachments, 

at 8, at Exhibit 164. 

Walker had approximately two years of securities experience before joining the 

Commission in April 2001. Letter dated June 12, 2009 from Walker to Kotz, with 

attachments, at p. 9, at Exhibit 164. Following her law school graduation in 1999, she 

worked for approximately a year and eight months at the American Stock Exchange as a 

Market Investigations Department Liaison. Id. At the American Stock Exchange, she 

“[r]eviewed trading in AMEX equities and options for violations of exchange rules and 

federal securities laws” and “[c]onducted numerous insider trading investigations and 

other reviews of violative trading violations.” Id. In law school, she spent three months 

as a legal extern at the NASD Office of Dispute Resolution, where she assisted with 

arbitration hearings and in the preparation of arbitration awards. Id. 

Walker’s “‘view’ of the team assigned to the Madoff investigation was that they 

did not have much experience in equity and options trading. Rather, their experience was 

in general litigation.” Letter dated June 12, 2009 from Walker to Kotz, with attachments, 

at p. 8, at Exhibit 164. Similarly, Wood expressed that the SEC “need[s] to make sure 

you have people in the office who have industry experience who have been in the 

industry and can spot these issues based on experience.” Wood Testimony Tr. at p. 128. 

3. SRO Group Chose Not To Include Investment Management 

Examiners on Examination Team 

The SRO Group did not request investment adviser staff support for the 

examination. Wood Testimony Tr. at p. 39. McCarthy testified that he could have 

created an examination team that had examiners with Investment Management expertise 

or could have separated the issues and had the OCIE Investment Management Group 

examine the issues associated with the verification of certain trading activity. McCarthy 

Testimony Tr. at p. 62. Swanson stated that if he were handling the complaint, he thinks 

“there would have been some joint effort between the two disciplines within OCIE to – to 

review it.” Swanson Testimony Tr. at pgs. 41-42. Associate Director Gene Gohlke 

explained that they could have had a combined SRO/Investment Management 

examination team whether or not Madoff was registered as an investment adviser. 

Gohlke Testimony Tr. at pgs. 46-48 (stating, “in this case, yet, if it is a registered broker91 
 

 

 

dealer, and he had, what in retrospect appeared to be discretionary accounts, yes, those 

would be fair game for examination.”). 

Both examiners and examination supervisors testified that until recently, the two 

OCIE groups rarely collaborated on examinations. Sollazzo Testimony Tr. at pgs. 67-68 

(stating “we rarely did joint exams” until recently); Nee Testimony Tr. at p. 48 (stating “I 

don’t think we have ever, until maybe this year, sent examiners out together”); Ostrow 

Testimony Tr. at p. 57 (stating each of the examination programs was a “silo”); Snively 

Interview Tr. at p. 28 (testifying he cannot recall working on any joint examination in the 

ten years he has worked at the SEC); IM Staff Accountant Testimony Tr. at p. 13 (stating 

he cannot recall ever “doing a 100 [%] coordinated examination with the BD staff”). 

4. Examination Planning Memorandum Stated Trading Data Would 

be Sought From the NASD 

In mid-December 2003, Wood and Walker drafted a “Planning Memorandum” for 

the Madoff cause examination. Draft Planning Memorandum dated December 16, 2003 

from Donohue, Walker, and Wood to Swanson, at Exhibit 165. The Planning 

Memorandum was divided into four parts: (1) Background; (2) Scope of the Inspection; 

(3) Course of Action; (4) and Potential Issues, and it had one attachment – an “NASD 

Document Request Letter.” Id. 

The Background section of the Planning Memorandum stated that an “outside 

source” has provided information that Madoff “has been committing front-running 

violations” and “is allegedly effecting either equity or option security transactions via 

Madoff-managed hedge fund accounts based on inside market moving information 

regarding equity block trades effected through Madoff Securities and possibly other 

unknown broker-dealers.” Id. 

The “Scope of the Examination” section stated, “The staff intends to examine 

customer orders received by Madoff Securities for the time period of January 1, 2001 

through December 31, 2002 in order to determine whether Madoff is front-running 

impending Madoff Securities block transactions through his Madoff-managed fund 

accounts.” Id. 

Under “Course of Action” subsection A, the Planning Memorandum indicated, 

“The Staff intends to send a letter to NASD requesting execution data for Madoff 

Securities for the time period of January 1, 2001 through December 31, 2002. The Staff 

will review and analyze the execution data produced by NASD to identify which trades 

or series of trades may have been utilized to commit the alleged front-running 

violations.” Id. 

Subsections B and C stated the staff intends to send a document request to BMIS 

requesting that he produce order execution data, a list of prime brokerage firms utilized in 

connection with Madoff’s hedge fund accounts, and account opening documentation for 

proprietary accounts. Id. Subsection D stated as follows: “The Staff intends to send a 

92 
 

 

 

 

 

letter to those investment adviser firms that market Madoff-managed hedge funds. The 

Staff will request that each firm produce, among other things, a list of Madoff-managed 

hedge funds that the firm markets to its customers.” Id. The examination team did not 

reference an intention to go on-site to review trading records at BMIS. Id. 

In the final section of the Planning Memorandum, the Staff identified the 

following potential issues: 

A. Inability to obtain execution data from hedge funds[;] B. 

Inability to identify which securities comprise the hedge 

fund portfolios[;] C. Inability to identify the investors in the 

hedge funds[; and] D. Inability to determine the identity of 

both sides of the front-running strategy due to the inability 

to obtain the execution data from the hedge funds. 

Id. There was no reference in the Planning Memorandum to any trade executions 

occurring in Europe or anticipated difficulties in obtaining trade data. Id. 

5. McCarthy Focused the Examination on Front-Running 

The determination that the “Scope of the Examination” focus exclusively on 

front-running was made by McCarthy, in consultation with Swanson and Donohue.60 

McCarthy Testimony Tr. at pgs. 25, 56; Swanson Testimony Tr. at p. 49; Donohue 

Testimony Tr. at pgs. 22-24.61 When determining the focus of the examination, it does 

not appear that McCarthy or Swanson closely reviewed or analyzed the allegations in the 

Hedge Fund Manager’s complaint. McCarthy Testimony Tr. at pgs. 56-57; Swanson 

Testimony Tr. at p. 55-56. Although McCarthy and Swanson referenced the Hedge Fund 

Manager’s complaint in an e-mail to Richards, neither recalled reviewing the complaint. 

Swanson Testimony Tr. at pgs. 34, 50-51; McCarthy Testimony Tr. at pgs. 56-60. 

Issues raised by the Hedge Fund Manager’s complaint and the two 2001 articles62 

other than front-running – such as auditor independence, Madoff’s extraordinary returns, 

and lack of liquidity in the options market to support alleged trading – were not 

investigated at all in the examination. Id. at pgs. 57-61; Donohue Testimony Tr. at pgs. 

43-44. When asked why the other issues in the Hedge Fund Manager’s complaint and the 

two 2001 articles were not investigated, McCarthy stated he did not recall the allegations 

in the Hedge Fund Manager’s complaint and focused on front-running because “my 

60 Generally, front-running is the illegal practice of a broker executing orders on a security for its own 

account while taking advantage of advance knowledge of pending orders from its customers. 61 The staff examiners performed work as directed by Donohue, but asserted they were unaware of what 

had instigated the examination. Wood Testimony Tr at pgs. 24-26; Former OCIE Attorney Advisor 

Testimony Tr. at p. 15; Letter dated June 12, 2009 from Walker to Kotz, with attachments, at p. 6, at 

Exhibit 164. 

62 Madoff stated that when the MARHedge and Barron’s articles came out, he expected the SEC to come 

follow up with him, and he was surprised the SEC did not. He also mentioned that Arvedlund did not 

know what she was talking about, and that it was obvious she was not familiar with the industry. Madoff 

Interview Memorandum at p. 8. 

93 
 

 

group was responsible for trading exams, so we focused on, in essence, the trading aspect 

of the allegation. ... it could be mainly because that was the area of expertise for my 

crew.” McCarthy Testimony Tr. at pgs. 54, 56. McCarthy stated he recalled telling “Lori 

[Richards] that there’s allegations of front-running so I said that ... would be an area that 

we could do an exam.” Id. at p. 56. 

McCarthy testified he did not make a mistake in focusing the examination on 

front-running “because that’s where my area, my team’s area of expertise led.” Id. at p. 

88. McCarthy stated his responsibility was only “to take information that’s consistent 

with my program and to follow up on those complaints.” Id. at p. 89.63 He stated he 

would have expected OCIE’s Investment Management Group “to follow up on those 

complaints that were consistent with their program.” Id. at pgs. 89-90. McCarthy 

testified that he now believes that “the other allegations should have been brought to 

other people’s attention.” Id. at p. 88. In contrast to McCarthy’s narrow view of the 

SRO Examination Program, Donohue stated the SRO Group worked on a wide variety of 

issues: “Our office focused on SROs, but we do broker-dealer work, investment adviser 

work. We focus on trading issues. Anything that I was directed to do or came in the 

door from our standpoint we would work on. It was a wide variety of information.” 

Donohue Testimony Tr. at p. 14. 

Swanson explained he was, 

focused predominantly on whether or not there was frontrunning going on [because] [i]t was just a theory that 

seemed to make sense to me, you know. ... [M]y theory 

was, and I think I’ve since learned or come to understand 

that it’s not a very good theory ...[was that] it did seem 

likely to me that having access to that type of retail order 

flow could be valuable and that you could profitably trade 

ahead of it and make money. 

Swanson Testimony Tr. at pgs. 48-49. Swanson further stated, “I can tell you that the 

idea of front-running seemed very plausible, based on information that I knew in the past, 

plus it was within my – much more in my rubric of what I understood about the securities 

world ...” Id. at p. 45. He said, “I do recall in my mind settling on the issue, if there’s 

something here, it’s most likely front-running.” Id. at p. 74. He did not recall ever 

speaking with the Hedge Fund Manager. Id. at p. 74. 

63 The FTI Engagement Team opined that to focus an exam based upon the expertise of a team rather than 

on the complaint itself is nonsensical. As a result of the decision to not request assistance from the 

Investment Management Examination Group, the FTI Engagement Team concluded the project was not 

properly staffed with the expertise needed to address the allegations raised in the complaint. 

94 
 

 

 

 

 

6. Swanson Acknowledged in Testimony that If He Had Carefully 

Reviewed the Complaint, He Would Have Investigated Additional 

Red Flags That Were Raised 

Swanson stated the Hedge Fund Manager’s complaint and the 2001 articles mean 

something different to him today than they did at the time of the examination in 2003­

2004, noting, “I didn’t know anything, very little anyway, about hedge funds and mutual 

funds and how they operated.” Id. at p. 39. Swanson admitted that to someone who 

understood the hedge fund world, Madoff’s failure to charge money management fees 

“would probably be a little surprising.” Id. at p. 37. Swanson now reads the Hedge Fund 

Manager’s complaint to “indicate to me ... [BMIS] may be not trading as much in 

options as they’re saying they’re doing,” and the red flag about the auditor to “signal 

some level of a lack of independence with respect to the auditor.” Id. at pgs. 37-38. 

Swanson testified that if he had reviewed the complaint, he would have wanted to 

look into the auditor issue. Swanson Testimony Tr. at p. 50. McCarthy and Donohue 

also thought that the allegation that the auditor was a related party to the principal was 

noteworthy and something that should have been followed up upon. Donohue Testimony 

Tr. at p. 42; McCarthy Testimony Tr. at p. 58. As Donohue explained, “His statement 

that the auditor of the firm is a related party to the principal would indicate that there are 

potential conflicts with the firm and the auditor.” Donohue Testimony Tr. at p. 42. 

However, during the course of the examination, the exam team did not examine whether 

the auditor of the firm was a related party to the principal.64 Id. 

7. Donohue Acknowledged Issues Raised in the Hedge Fund 

Manager’s Complaint Other Than Front-running Should Have 

Been Investigated 

Unlike McCarthy and Swanson, Donohue recalled reviewing the Hedge Fund 

Manager’s complaint and attachments during the course of the examination. Id. at pgs. 

32, 48; E-mail dated December 17, 2003 from Donohue to Walker, at Exhibit 153. 

Donohue testified “[t]he whole document is a red flag of a problem. He is asserting a 

problem. Every piece of information in here is his support of the problem.” Donohue 

64 According to the FTI Engagement Team, the allegation regarding BMIS’s auditor should have been 

investigated because the lack of an independent auditor raises concerns as to whether or not the auditor is 

unbiased, fair and impartial. Without an independent auditor, there can be no assurance that the BMIS’s 

audits were properly conducted. Such potential conflicts should heighten awareness of, and the need for, 

verification that Madoff had internal controls in place that were designed to effectively prevent certain 

inappropriate activities, such as misrepresentation of performance results and the safety of client assets 

from misappropriation. Typically, in conducting basic due diligence of the auditor, an examiner will 

review the auditor’s engagement letter, reports, and work papers. After Madoff confessed to running a 

Ponzi scheme, the New York Staff Attorney in the Division of Enforcement was assigned to investigate 

Madoff’s accountant, David Friehling. Within a few hours of obtaining the work papers, the New York 

Staff Attorney determined that no audit work had been done. New York Staff Attorney Testimony Tr. at p. 

10. Immediately upon reviewing Friehling’s work papers, the New York Staff Attorney testified, there 

“were red flags for me as to the auditor. ... I didn’t see anything that resembles kind of formal work papers, 

auditor work papers that would comply with generally accepted audit standards. So, there was almost 

nothing that indicated that any audit work had been done.” Id. at 9-10. 

95 
Testimony Tr. at p. 41. Donohue admitted, “I certainly wish I would have followed up 

on more stuff after the fact.” Id. at p. 38. 

The structure of Madoff’s operation was also something Donohue said he would 

have expected OCIE to follow up on at the time of the examination. Id. at pgs. 34-35. 

The allegation that Madoff was managing $8-10 billion in discretionary broker-dealer 

accounts and not charging management fees “was not normal” and “something we would 

look at.” Id. 

Donohue agreed the Hedge Fund Manager’s complaint implied that Madoff was 

misrepresenting his options trading. Id. at p. 37. However, the OCIE examination team 

did not take any measures to verify whether or not Madoff was trading options on CBOE, 

and Donohue conceded that the examination did not engage in sufficient analysis or 

examination of options trading issues raised in the Hedge Fund Manager complaint. Id. 

at pgs. 39-40. Donohue could not explain why the examination did not focus on the 

options trading issues. Id. at p. 38. 

8. The Examination Did Not Focus on Red Flags Raised in 

MarHedge Article About Madoff’s Trades Not Being Seen in the 

Market 

In addition, the team did not examine the market impact of Madoff’s alleged 

equity trading. The MARHedge article raised the issue of Madoff’s “related ability to buy 

and sell the underlying stocks without noticeably affecting the market.” Michael Ocrant, 

Madoff Tops Charts; Skeptics Ask How, MARHedge, May 2001, at Exhibit 146. 

Donohue stated that one would expect $7-12 billion of buying and selling S&P 100 

stocks to be noticed in the market, but “I do not remember us looking at the market 

impact of the trading strategy.” Donohue Testimony Tr. at p. 47. With hindsight, 

Donohue agreed that the article implies that Madoff might not actually be trading. Id. at 

pgs. 47-48. 

Moreover, Donohue agreed that the Hedge Fund Manager’s complaint could be 

interpreted as alleging that BMIS was running a Ponzi scheme. Id. at p. 44. In fact, in 

reaction to reading the Hedge Fund Manager’s statement that “BMIS never had to face 

redemption ... [and] given the fact that the different feeders are closed for new 

investments, there is always replacement capital,” Donohue stated, “I think he is 

providing allegations of what he is alleging that could be interpreted as a Ponzi scheme.” 

Id. at p. 44. 

9. Investment Management Examiners Did Not Read the Complaint’s 

Main Focus to be Front-Running 

Kelly did not understand why the SRO Group focused its examination on frontrunning, since she did not believe that the crux of the Hedge Fund Manager’s complaint 

was front-running. Kelly Testimony Tr. at pgs. 72, 74. Likewise, OCIE Associate 

96 
Director Gohlke opined that front-running did not appear to be the focus of the 

complaint, stating: 

[T]his more or less doesn’t say front-running in it. This ... says that trades are 

done, but apparently information in the market didn’t support the fact that those 

trades were being done. And so that doesn’t necessarily mean front-running at 

all. ... It means something else. 

Gohlke Testimony Tr. at p. 49. 

Swanson asserted that the OCIE Investment Management Group had more 

expertise than his group did to investigate the performance issues raised in the complaint, 

stating, “the Investment Adviser, Investment Company Examination group within OCIE 

... I think that would have been their area of expertise, certainly much more than the 

[M]arket [O]versight [Group].” Swanson Testimony Tr. at p. 41. Swanson testified that 

if the complaint was “deemed to be a high priority, I’m guessing that they [the 

Investment Management Group] would have looked at it.” Id. at p. 42. However, the 

Investment Management examiners never had any involvement in the examination after 

referring it to the SRO Group. 

C. Conduct of the Examination 

1. Examination Team Did Not Send Draft Letter to NASD 

As referenced in the Planning Memorandum, the staff prepared a draft letter to the 

NASD, dated December 17, 2003. Draft letter dated December 17, 2003 from Swanson 

to Luparello, at Exhibit 166. Examiners addressed the letter to Stephen Luparello of the 

NASD, and requested “Transaction data for all order executions effected by Madoff 

Securities” from “January 1, 2001 through December 15, 2003.” Id. The letter was 

likely drafted because, as McCarthy testified, it would be good practice for the staff to 

request trade data from the NASD, in part because “it has a certain level of reliability” 

and was “easy to get.” McCarthy Testimony Tr. at pgs. 64-65, 107. 

Likewise, Swanson stated that “the NASD was oftentimes the best source to get 

accurate, timely sales data. So what we would have been doing is getting information 

about the market making trades that were reported to NASD from Madoff during that 

time period.” Swanson Testimony Tr. at p. 53. Wood explained, “we wanted to see the 

data from a third-party, an outside source. ... Just to make sure, compare it with what we 

received from the actual firm.” Wood Testimony Tr. at p. 45. Daugherty testified, as 

follows, that given the type of allegations the team was looking at in this cause 

examination, it would not be out of the ordinary to seek data from a third-party: “well, it 

depends what stocks you thought he was disadvantaging. Because if it was New York 

listed stocks, you would go to New York [Stock Exchange]. If it was third market stocks 

like the Qs, or NASDAQ listed stocks like Microsoft, you would go to the NASD, or 

FINRA....” Daugherty Testimony Tr. at pgs. 78-79. 

97 
 

However, the letter to the NASD was never sent. Nor did the staff request trade 

data from another independent third-party.65 Rather, the staff relied exclusively on trade 

data provided to them by Madoff. Swanson testified that he was “perplexed” by the team 

not requesting data from the NASD because “I’m not sure how we would have done the 

review of – for front-running if we didn’t have that.” Swanson Testimony Tr. at p. 62. 

Wood also stated she did not “know why this letter would not have gone out and I don’t 

have a reason as to why it wouldn’t go out because this would be data that we would ask 

for.” Wood Tr. at p. 47. Donohue stated that the “execution data would certainly [have] 

been helpful,” and he did not know why the letter to the NASD was never sent “other 

than we got information from the firm itself.” Donohue Testimony Tr. at p. 50. Donohue 

explained, “I wish I would have gone to a bunch of different sources to get information.” 

Id. at p. 50. If the staff had requested audit trail information from the correct third-party, 

the examiners could have uncovered Madoff was not making the trades he claimed to be 

making, according to Donohue who stated, “I think that we would have been able to 

uncover that he was not trading there.” Id. at pgs. 51-52. 

It appears that the letter to the NASD was not sent because it was less timeconsuming for examiners to request and use data supplied by Madoff and because OCIE 

routinely relied on data provided by the subjects of examinations. Donohue explained 

that detailed audit trail data can be “tremendously voluminous and difficult to deal with 

and is a huge resource issue for us.” Id. at p. 83. Moreover, until Madoff’s confession to 

running a Ponzi scheme in December 2008, it was not unusual for OCIE to rely 

exclusively on records and data produced by the registrant, even in instances in which the 

registrant was being examined for possible fraud. McCarthy Testimony Tr. at pgs. 69-70, 

72; Swanson Testimony Tr. at pgs. 54-55, 86; Wood Testimony Tr. at p. 53. As Swanson 

stated, “We ... routinely requested trading information from registrants directly.” 

Swanson Testimony Tr. at p. 54. Richards testified that she did not know if 

“confirm[ing] the accuracy of particular trades” with third parties was a routine part of 

examinations, but asserted that “Going forward it’s clearly going to be a part of 

examination protocol and already it is for investment adviser and broker-dealer exams.” 

Richards Testimony Tr. at p. 58. 

2. OCIE Examiners Did Not Request Documents from Madoff 

Feeder Funds 

In addition to the staff not requesting and reviewing trade data from the NASD as 

they had outlined in the Planning Memorandum under “Course of Action” subsection A, 

the staff did not pursue “Course of Action” subsection D, which stated, “The Staff 

intends to send a letter to those investment adviser firms that market Madoff-managed 

hedge funds... . [to] request that each firm produce, among other things, a list of Madoffmanaged hedge funds that the firm markets to its customers.” Draft Planning 

Memorandum dated December 16, 2003 from Donohue, Walker, and Wood to Swanson, 

at Exhibit 165; Donohue Testimony Tr. at p. 53. Donohue explained that he did not 

65 Madoff recalled that Donohue looked at the right things for front-running, but only would have 

discovered it was a Ponzi scheme if he had gone to an independent third-party. Madoff Interview 

Memorandum at p. 7. 

98 
know why the staff never sought the documents from the feeder funds, “other than the 

general decision – resources ... I was likely involved in the drafting of it [Planning 

Memo], but I do not remember thinking about sending things out.” Donohue Testimony 

Tr. at p. 53. 

3. Draft OCIE Document Request Referenced Madoff’s Call with 

Richards and McCarthy 

After completing the Planning Memorandum, the exam staff drafted a document 

and information request to Madoff. Madoff Document Request dated January 6, 2004, at 

Exhibit 167. A December 24, 2003 version of the request referenced Madoff’s phone 

conversation with Richards and McCarthy. Id. Request 2 stated, “Describe in detail the 

hedging model or investment strategy identified as ‘split-strike forward conversion’ in 

the telephone conversation between Lori Richards, John McCarthy, and Bernie Madoff 

on December 19, 2003??.” Id. (emphasis in original). Similarly, Request 3 directed 

Madoff to, “Identify the four hedge funds discussed in the telephone conversion [sic] 

between Lori Richards, John McCarthy and Bernard Madoff on December 19, 2003?? 

....” Id (emphasis in original). Swanson, McCarthy, and Donohue provided revisions to 

the request. Id.; McCarthy Testimony Tr. at pgs. 80-81; Swanson Testimony Tr. at pgs. 

59-60. The final version of the request did not reference Madoff’s phone conversation 

with Richards and McCarthy. Madoff Document Request dated January 6, 2004, at 

Exhibit 167. Although no one could recall specifically, members of the examination 

team believe the references to the telephone call were taken out because they were not 

relevant to the document request. Donohue Testimony Tr. at p. 59; Swanson Testimony 

Tr. at pgs. 60-61. As Donohue explained, “I do not have any specific recollection of it. 

In drafting document requests we try to make them more generic than specific, therefore 

[] they can get more response.” Donohue Testimony Tr. at p. 59. 

4. After Sending OCIE Document Request, Swanson Discussed 

Request with Madoff 

The final version of the document and information request was dated January 6, 

2004, addressed to Peter Madoff, and signed by Eric Swanson. Madoff Document 

Request dated January 6, 2004, at Exhibit 167. The request directed BMIS to provide 

information about its money management activities, such as “monthly profit and loss 

statements by security,” “monthly commission revenues segregated by customer and by 

security,” and “the identity of all institutional customers of Madoff Securities.” Id. The 

request also directed BMIS to identify each private equity investment held by Madoff 

Securities, “to describe “the ‘split-strike conversion’ strategy used by some customers of 

Madoff securities, list the customers using that strategy, list all securities traded as part of 

that strategy, and explain how Madoff Securities is compensated for executing that 

strategy.” Id. 

In addition, the staff asked Madoff for “copies of all communications and 

disclosures from the customers using the strategy ... since January 1, 2001.” Id. Finally, 

the document request directed BMIS to “[i]dentify all hedge funds managed or advised 

99 
 

 

 

by any person or entity affiliated with Madoff securities, ... [and] the investment 

objective and strategy of each fund since January 1, 2001.” Id. No request for audit trail 

data was in the initial information and document request. McCarthy Testimony Tr. at p. 

82; Donohue Testimony Tr. at p. 61. 

Swanson recalled speaking with Madoff right before or soon after sending the 

initial document request. Swanson Testimony Tr. at p. 66. Swanson stated he does not 

believe he took notes of the conversation, as he did not typically take notes of telephone 

conversations with registrants. Id. Swanson recalled Madoff told him “there was a 

Chinese wall in place” and there was no basis for the Commission’s concerns he was 

running a hedge fund. Id. at p. 57. Madoff explained to Swanson that BMIS only 

executed trades for hedge funds using a particular strategy and did not actually have a 

hedge fund. Id. Swanson recalled telling Madoff to send the Commission the data that 

they requested. Id. 

Swanson also recalled a subsequent call with Madoff and Lori Richards, but he 

did not recall any details about the conversation. Id. at p. 58. Richards only recalled 

having two conversations with Madoff: a phone call at the outset of the examination and 

one brief conversation at a public industry conference. Richards Tr. at pgs. 26-27. 

5. Documents and Information Madoff Produced Contradicted the 

2001 Articles and the 2003 Complaint, But OCIE Did Not Seek to 

Verify the Accuracy of Madoff’s Representations 

On January 16, 2004, Madoff personally responded to the document request. 

Letter dated January 16, 2004 from Madoff to Swanson, at Exhibit 168.66 Madoff wrote 

in his response letter to Swanson, “Neither Madoff securities, nor any person or entity 

affiliated with Madoff Securities, manages or advises hedge funds,” and “we have no 

interest in becoming a manager or adviser to hedge funds.” Id. Instead, Madoff claimed 

BMIS only executed trades for institutional clients, stating, “As executing broker, Madoff 

Securities is compensated thru execution commissions derived from the Split Strike 

Conversion strategy transacted over our Institutional Department’s Execution Trading 

Platform.” Id. 

Madoff also claimed BMIS had “no communications or disclosures from 

customers using this strategy ....” Id. Madoff attached several documents to his 

response, including a description of the split-strike forward conversion strategy; a 

66 It is notable Madoff, rather than a compliance officer, responded to the staff’s document requests. 

Although the staff’s document requests were addressed to BMIS’s Chief Compliance Officer, Peter 

Madoff, all BMIS responses in the examination came from Madoff. It was atypical for the CEO of an 

entity the size of BMIS to personally respond to an information and document request. Wood does not 

recall working on any other examination in which the CEO responded to an information and document 

request. Wood Testimony Tr. at p. 100. According to the FTI Engagement Team, examinations of small 

firms with few employees may necessarily involve significant participation from senior executives, but 

large firms (including Madoff) have compliance officers and other compliance staff that are typically 

involved in responding to SEC information requests. The FTI Engagement Team believes that it was 

unusual for Madoff to serve as the primary contact during the examination. 

100 
 

 

 

 

description of “time slicing,” which Madoff wrote was an automated methodology for 

delivering average price executions; a list of 29 institutional customers, 16 of which he 

claimed were executing trades through the Institutional Department for 4¢ per share on 

equities and $1 per option contract; a list of securities he claimed were “Executed as Part 

of Split Strike Conversion”; an index of excel files he provided, which purported to list 

commissions BMIS earned by client; and an organization chart. Id. 

On the organization chart, Madoff labeled one side of the chart “Institutional” and 

designated only himself as an officer.67 Id. On the other side of the chart, he designated 

“Broker-Dealer/Wholesale,” under which he listed his brother, Peter Madoff, and his 

sons, Andrew and Mark. Id. 

Madoff’s response to the Document and Information Request contradicted the 

Hedge Fund Manager’s complaint and the two 2001 articles about Madoff which 

indicated Madoff was managing money for hedge funds. Michael Ocrant, Madoff Tops 

Charts; Skeptics Ask How, MARHedge, May 2001, at Exhibit 146; Swanson Testimony 

Tr. at p. 65; Donohue Testimony Tr. at p. 63. Swanson and Wood did not recall the team 

making any effort to determine whether statements Madoff made in his responses to their 

document requests were accurate “and that he wasn’t in fact managing money.” Wood 

Testimony Tr. at p. 59; Swanson Testimony Tr. at p. 65. As Swanson explained, “I 

didn’t test that. My concern was front-running.” Swanson Testimony Tr. at p. 65. 

Although Donohue could not recall whether Madoff’s responses to the document 

request raised questions and concerns for him at the time of the examination, he testified 

that the responses, such as Madoff’s claim to have no communications or disclosures 

from customers, do in fact raise concerns. Donohue Testimony Tr. at 63. In contrast, 

Swanson testified that learning that Madoff would not produce e-mail or other 

documentation of communications with clients did not raise concerns for him, stating, 

“given what I understood about what the firm was doing, I don’t think I would have 

expected direct communication between the executing broker and the clients of the hedge 

funds.” Swanson Testimony Tr. at p. 89. Wood did not recall Madoff’s responses 

raising concerns. Wood Testimony Tr. at p. 59. McCarthy testified he did not recall 

Donohue or Swanson “highlighting concerns” about the documents Madoff produced or 

the answers he provided to the staff. McCarthy Testimony Tr. at 83. 

6. Exam Team Spoke to the Hedge Fund Manager Who Submitted 

the Complaint and Conveyed Concerns About Madoff, Including 

Inexplicable Returns and Options Trading 

On December 18, 2003, Richards gave McCarthy and Swanson permission to call 

the Hedge Fund Manager who had submitted the detailed complaint about Madoff. 

E-mail dated December 18, 2003 from Richards to McCarthy, at Exhibit 159. On 

January 29, 2004, at least one senior member of the examination staff had a conference 

67 As discussed previously, the FTI Engagement Team opined that the Commission had authority to 

examine all of the BMIS’s books and records, whether they were related to market making or hedge fund 

clients. See supra fn. 11. 

101 
call with the Hedge Fund Manager. McCarthy notes undated, on call with Hedge Fund 

Manager, at Exhibit 169. Donohue recalled speaking with the Hedge Fund Manager and 

took notes of the conversation. Donohue notes dated January 29, 2004, on conference 

call with Hedge Fund Manager, at Exhibit 170; Donohue Testimony Tr. at pgs. 67-68. It 

is unclear whether Swanson and McCarthy were also on the call; neither recalled 

speaking with the Hedge Fund Manager. Swanson Testimony Tr. at pgs. 70-71; 

McCarthy Testimony Tr. at p. 87; Donohue Testimony Tr. at p. 68. 

Donohue’s notes of the conversation indicated that the Hedge Fund Manager 

discussed several of the following concerns he raised in his complaint, including 

Madoff’s anomalous returns, inexplicable options trading, and unusual structure of 

operation: 

-Returns are too consistently high for this strategy. 

-Funds use brokerage accts – concern 

-Speculate about the use of Market Making 

Not doing that strategy b/c option trading is not is [sic] high 

-entry and exit points of stocks 

-how does he trade the options 

-He [Hedge Fund Manager] doesn’t understand how he 

consistently makes money off this strategy. 

-Perhaps he doesn’t really use the strategy 

-he uses info from his mkt making 

He must have some knowledge about when to get in & out 

of positions 

-The vol. of options trading doesn’t seem to be enough to 

protect the size of the equity trading.
 

-Perhaps he trades options differently. 

Donohue notes dated January 29, 2004, on conference call with Hedge Fund Manager, at 

Exhibit 170; Donohue Testimony Tr. at pgs. 67-71. 

After the call with the Hedge Fund Manager, however, the team did not look at 

the market impact of Madoff’s options or equity trading. Donohue Testimony Tr. at p. 

102 
 

 

71. The exam team continued to focus the examination exclusively on front-running. Id. 

at p. 72. 

7. Examination Team Analyzed Data and Detected Inconsistencies 

In late January and early February 2004, the examination staff worked on trying 

to understand the trading strategy Madoff claimed to be using and how Madoff was able 

to generate his claimed returns. Wood Testimony Tr. at pgs. 61-62. Staff examiner 

Walker raised the issue of Madoff’s returns not appearing to fit his claimed strategy, 

stating, “it has always been my understanding that ‘collars’ – (Madoff’s strategy is a 

variation of this) ... is a more protective type of position (meaning protective of 

underlying profits on the stock). So, I don’t think this should go in the short memo, but 

perhaps we should explore it later???” E-mail dated January 29, 2004 from Walker to 

Donohue, at Exhibit 171; Donohue Testimony Tr. at p. 69. 

Based on the documents and commission data provided by Madoff, Walker and 

Wood drafted a summary memorandum. E-mail dated January 29, 2004 from Walker to 

Donohue, at Exhibit 171. On February 3, 2004, Wood e-mailed Donohue (with a copy to 

Walker) the final version of the memorandum, which summarized BMIS’s purported 

trading strategy, the commission revenues BMIS generated from its “institutional” 

business, profits made from executing trades for the institutional business, and questions 

the staff had after reviewing the documents produced by Madoff. Id. 

8. Examiners Discovered Madoff was Making More Money from 

Hedge Funds than Through Market Making 

The memorandum described BMIS’s compensation and states in the following 

excerpt that Madoff made most of his revenue from only four clients: 

Madoff is compensated 4 cents per share ‘commission equivalent’ 

on equities and $1.00 per option contract. Although 16 of 

Madoff’s institutional clients utilize this trading strategy, since 

2001, the vast majority of Madoff’s commission revenues is 

derived from only four of its clients [identified as Kingate Global 

Fund, Thema Ltd, Fairfield Sentry Ltd, and Tremont – Broad 

Market Fund]. 

Id. 

Notably, the examiners made the surprising discovery that BMIS’s mysterious 

institutional business was making significantly more money for BMIS than was BMIS’s 

well-known market making operation. Id. However, Wood and Walker did not identify 

this finding as a cause for concern in the memorandum: 

The commission revenues generated from these four institutional 

clients account for the overwhelming majority of commission 

103 
 

 

revenues generated for the firm since 2001. Obviously, this 

trading strategy has yielded Madoff unbelievable profits, which 

would explain why this strategy is well-guarded by Madoff. ... 

Moreover, the profits from Madoff’s market making trades are 

nominal compared to the commissions generated from those clients 

utilizing the split-strike forward conversion strategy. 

Id. 

Donohue admitted the fact that the “overwhelming majority” of BMIS’s profits 

came from commission revenues from four hedge fund clients and not from market 

making activities “was a concern” and “[t]he size of his profits were of concern.” 

Donohue Testimony Tr. at p. 73. Wood testified none of the senior members of the 

examination team (McCarthy, Swanson, and Donohue) told her the size of Madoff’s 

commissions from hedge funds was of concern. 68 Wood Testimony Tr. at p. 71. 

9. Examination Team Contacted Madoff About Open Issues 

Donohue recalled at this point in the examination, the team had significant 

follow-up questions and stated, “We had concerns about what was happening and what 

he was doing.” Donohue Testimony Tr. at p. 74. Wood also recalled at that point in the 

examination, there were numerous open questions. Wood Testimony Tr. at pgs. 69-71. 

The examination staff included in their memorandum a page and a half of additional 

documents to request of Madoff, as well as questions to ask in a second document and 

information request to BMIS. Memorandum dated February 3, 2004 from Walker and 

Wood to Donohue, at Exhibit 172. The staff’s questions included confirming Madoff had 

only the 29 institutional clients he identified in his response to the staff’s first request, 

identifying the investment adviser for each of Madoff’s clients, requesting detailed trade 

execution information, and seeking all correspondence and e-mail between BMIS and its 

clients relating to the split-strike conversion strategy. Id. 

The next day, on February 4, 2004, the examination team contacted Madoff to 

discuss their open questions.69 Wood notes dated February 4, 2004, on conference call 

with Madoff, at Exhibit 173. Wood recalled, and her notes reflect, that the team focused 

the call on understanding how his purported “black box” worked. Wood Testimony Tr. 

at pgs. 72-75; Wood notes dated February 4, 2004, on conference call with Madoff, at 

Exhibit 173. According to the following notes from Wood, Madoff once again claimed 

68 The FTI Engagement Team believes that if a manager has specific concerns about an issue that arises 

during an examination, it is the manager’s responsibility to adequately resolve those concerns. In this case, 

the first logical step toward such a resolution would have included sharing any such concerns with the 

examination staff. Based on the disproportionately large amount of revenue and income derived from 

Madoff’s investment advisory clients, the examination staff should have recognized this as a red flag and 

seriously considered investigating whether or not Madoff should have been registered as an investment 

adviser. 

69 Madoff recalled that during the examination, he called Dohonue and asked him if there was “something 

going on here I should know about?” Madoff Interview Memorandum at p. 7. Madoff stated that Donohue 

replied, “No, we’re just trying to understand the business. Sunlight is the best disinfectant.” Id. 

104 
not to act as an investment adviser: “no discretion on the part of Madoff – everything is 

determined by the black box.” Id. 

10. Examination was Expanded to Examine Whether Madoff was 

Acting as an Investment Adviser 

Also on February 4, 2004, Walker sent Donohue and Wood an e-mail with the 

subject line, “Food for Thought re Madoff as an Investment Adviser.” E-mail dated 

February 4, 2004 from Walker to Donohue and Wood, at Exhibit 174. Walker analyzed 

whether Madoff fell within the statutory definition of “Investment Adviser.” Id. Walker 

noted that if he did fall within the definition and did not meet an exception from 

registration, Madoff would have to register with the Commission as an investment 

adviser and would be subject to investment adviser examinations. Id. Walker concluded, 

in the following e-mail, that Madoff may well have fallen within the definition of 

investment adviser: 

Bernie Madoff claims that he neither manages nor advises 

hedge funds. However, pursuant to the Investment 

Advisers Act, he may fall under the definition of 

investment adviser. Madoff’s trading, on behalf of his 

hedge fund clients, is composed of two parts, the trading 

and the strategy. According to the above-referenced 

definition, although the trading may not be considered 

advice, the strategy could be considered either advice or 

analyses of securities constituting advice, if it involves 

more than just executing the split-strike forward conversion 

stock and option combinations pursuant to the hedge fund’s 

instructions. For example, Madoff stated in his response to 

our request that he executes trades according to clientdefined conditions. Madoff has described these conditions 

in his response, however, it would be important to know 

who defines these conditions and is his description 

complete regarding the conditions. (NOTE: Does “client 

defined” mean that the fund specifies all of the conditions 

or does it mean that conditions for trading on behalf of 

clients, using the split-strike conversion strategy, are 

further specified, by client. I would think that any advice 

provided by Madoff, in addition to the split-strike forward 

conversion strategy, would constitute advice and/or 

analyses of securities under the definition of an investment 

adviser, especially if he considers that information to be 

proprietary in nature. Additionally, the fact that Madoff 

may have discretionary trading authority on behalf of the 

fund accounts may help to further determine whether or not 

he is acting as an adviser to the hedge funds. Lastly, if 

Madoff is in fact acting as an adviser, he may be receiving 

105 
 

 

 

compensation for his services in the form of “commission 

equivalent revenue”, if we can show that the revenue 

includes something in addition to commissions for the 

actual trades. 

Furthermore, the definition of an investment adviser 

excludes Madoff’s activities if he is performing services for 

the hedge fund clients, via Madoff Securities, that are 

solely incidental to Madoff’s brokerage function and he is 

not receiving special compensation. Therefore, even if 

Madoff can prove that his trading on behalf of the hedge 

funds is solely incidental to Madoff’s brokerage function, if 

he is receiving special compensation, pursuant to his 

receipt of “commission equivalent revenue”, Madoff’s 

activities would not fall under the exception for brokerdealer services. (This is assuming that we can show that 

the “commission equivalent revenue” is not solely 

attributable commissions for the actual trading effected on 

behalf of the hedge funds.) 

E-mail dated February 4, 2004 from Walker to Donohue and Wood, at Exhibit 175. 

Wood recalled the investment adviser issue “was something that Gen [Walker] was 

running with.” Wood Testimony Tr. at p. 81. 

The Madoff cause examination was expanded to look at whether Madoff was 

acting as an investment adviser. McCarthy Testimony Tr. at p. 94; Donohue Testimony 

Tr. at pgs. 64-66, 79. It appeared to Donohue that Madoff was trying to avoid 

registration as an investment adviser. Donohue Testimony Tr. at p. 79. Although the 

investment adviser issues were outside the scope of the examination’s original focus, as 

Donohue explained, “[t]he focus of an examination is an evolving topic. We try to go 

whether the exam leads us.”70 Donohue Testimony Tr. at p. 25. 

On February 4, 2004, Walker responded to a question from Donohue by 

explaining in an e-mail, “Madoff needn’t register as an IA [investment adviser] as long as 

“... during the course of the preceding 12 months [he] has had fewer than 15 clients and 

... [doesn’t] hold[] himself out generally to the public as an investment adviser ....” Email dated February 4, 2004 from Walker to Donohue and Wood, at Exhibit 175. Walker 

explained that Madoff had represented to the staff that he had 16 customers in 2003, 14 

customers in 2002, and 13 customers in 2001. Id. She reasoned it was unlikely that all of 

70 The FTI Engagement Team agrees that the scope of an examination may not, and at times should not, 

remain static. Newly discovered relevant information may necessitate a modification to the original scope 

of an examination. For instance, in addition to the investment adviser registration issue discovered during 

the examination, several other issues that were raised in the Tip and reiterated in a subsequent call with 

OCIE should have been but were not included in the scope of the cause examination. Such issues included 

the unusual fee structure; doubts expressed about replicating Madoff’s strategy; concerns with regard to the 

lack of transparency in the options volume; and questions as to how Madoff was able to achieve his returns. 

106 
his institutional customers were hedge funds and that she was “sure he is well aware of 

the 15 client limitation on the exemption from registration.” Id. Walker suggested, as 

follows, however, that they consider verifying Madoff’s customer relationships: 

Nevertheless, we don’t know the classification of all clients, when 

these entities became clients and when clients were dropped/added 

... we could verify the nature and duration of the customer 

relationships via their prime brokerage agreements with Madoff, if 

we felt that was necessary. 

E-mail dated February 4, 2004 from Walker to Donohue and Wood, at Exhibit 175. 

In addition to Walker’s research on investment adviser registration, on February 

27, 2004, Donohue asked Matthew Daugherty to research and write a memorandum for 

Dan Gray in the Division of Market Regulation about both broker-dealer and investment 

adviser issues related to Madoff. E-mail dated February 27, 2004 from Donohue to 

Daugherty, with attachment, at Exhibit 176. Daugherty described his involvement in the 

examination in the following testimony: 

My involvement in this cause exam I think was related to 

some research or maybe a memo I drafted on whether his 

investment advisory business should be registered with the 

Commission. ... But I think Mark had asked me to do some 

research for him, particularly since I was kind of interested 

in that area, since at the time, I think the Commission was 

considering whether to have hedge funds register, so I had 

kind of been – kind of just doing a little research in that 

area for my own edification, and just Mark had asked me to 

give him some – a memo on it. 

Tr. Daugherty at 57. 

In March, Daugherty drafted two memoranda to Dan Gray from Lori Richards, 

John McCarthy, Eric Swanson, Mark Donohue and Matt Daugherty. Memorandum dated 

March 4, 2004 from Richards to Gray, at Exhibit 177; Memorandum dated March 11, 

2004 from Richards to Gray, at Exhibit 178. McCarthy explained that “typically we’d 

send memos if we had questions of securities laws or interpretation or guidance, things 

like that.” McCarthy Testimony Tr. at p. 94. 

The first memorandum was dated March 4, 2004 and stated, “the Staff finds that 

Madoff may be misappropriating material nonpublic information relating to customer 

orders, and allowing the funds to profit from this order flow data in violation of various 

anti-fraud provisions of the Exchange Act as well as NASD rules.” Memorandum dated 

March 4, 2004 from Richards to Gray, at Exhibit 177. The second memorandum, dated 

March 11, 2004, analyzed whether BMIS is a statutory investment adviser required to 

register with the Commission. Memorandum dated March 11, 2004 from Richards to 

107 
 

 

Gray, at Exhibit 178. The memorandum concluded that while it appeared that BMIS may 

fit the definition of investment adviser, the staff could not make a definitive conclusion as 

to whether BMIS fit an exception to registration “[u]ntil the Staff receives more 

information concerning the shareholders or clients to the funds.” Id. 

11. Examination Team Never Resolved Question of Whether Madoff 

Was Acting as an Investment Adviser 

Although the issue was raised and the examination expanded, neither 

memorandum was ever sent to Dan Gray, and the examination team never resolved the 

issue of whether Madoff should register as an investment adviser. Memorandum dated 

March 4, 2004 from Richards to Gray, at Exhibit 177; Memorandum dated March 11, 

2004 from Richards to Gray, at Exhibit 178.; Donohue Testimony Tr. at pgs. 79-80; 

Daugherty Testimony Tr. at pgs. 91-92. 

12. Examiners Did Not Request Audit Trail Data from Madoff in 

Supplementary Document Request 

On February 6, 2004, staff examiners Walker and Wood began to send drafts of a 

supplemental document request to Donohue for review. Memorandum dated March 11, 

2004 from Richards to Gray, at Exhibit 178. By February 11, 2004, the staff had 

exchanged at least six drafts of the document request. Draft Supplemental Madoff 

Document Requests dated February 6, 2004, at Exhibit 179. Each of the six draft 

requests sought detailed audit trail data, including the date, time, and execution price for 

all of BMIS’s trades in 2003. Id. The drafts also stated that Madoff should produce all of 

BMIS’s communications with clients utilizing the split-strike forward conversion strategy 

and all agreements, new account opening documents and trading authorizations for 

Madoff clients using the trading strategy. Id. 

On February 12, 2004, Donohue sent a draft of the document request to Swanson 

for final review. Memorandum dated March 11, 2004 from Richards to Gray, at Exhibit 

178. The final version of the request letter, which was addressed to Peter Madoff, signed 

by Swanson and faxed to Madoff on February 18, 2004, did not contain a request for 

detailed audit trail data. Request letter dated February 18, 2004 from Swanson to 

Madoff, at Exhibit 180; McCarthy Testimony Tr. at pgs. 96-97. A draft of the document 

request in the examination work-papers showed the request for trade data crossed out 

with the phrase “save for next letter” written beside it.71 In addition, the words “SEC 

Speaker” were written at the top of the letter near the recipient’s name and address. 

Request letter draft, undated, from Swanson to Madoff, at Exhibit 181. Donohue testified 

the handwriting on the document appeared to be his. Donohue Testimony Tr. pgs. 81-82. 

Donohue testified that although he believes he made the change eliminating the 

request for detailed audit trail data, he did not specifically recall why he decided not to 

request audit trail data. Donohue Testimony Tr. at p. 83. Donohue explained that one 

71 The OIG has found no evidence in the examination papers that the team sent any further letters to 

Madoff requesting documents or information. 

108 
 

reason why he might have decided not to request the audit trail data was because 

reviewing the data requires substantial resources, stating, “I can tell you we were always 

hesitant to get audit trail data because it can be tremendously voluminous and difficult to 

deal with and is a huge resource issue for us. It takes us a ton of time.” Id. at pgs. 83-84. 

Donohue did not recall why he wrote “SEC Speaker” on the document request. Id. at p. 

82. 

Swanson had no explanation for why the request for detailed audit trail data 

would be eliminated, stating, “I can’t account for this, but it would have been, frankly, 

asinine for us to not get the audit trail. I don’t understand that.” Swanson Testimony Tr. 

at p. 87. McCarthy testified that he may have instructed Donohue to focus on preopening orders, but did not believe he told Donohue not to obtain the audit trail data, 

stating: 

... I do remember asking Mark to concentrate on the preopen where you most likely would have market-moving 

information, the intraday trading. The intraday trading I 

think was much more difficult to – much more difficult for 

that information to be front-ran. So back to your question 

if you’re looking at – if you have account statements which 

show you bought 10,000 shares on a certain day, I think 

that’s, to me, enough information to know that that’s 

unlikely to have front-ran retail customer orders because 

it’s simply – there’s no information in retail order flow to 

determine – to take advantage of that to get a better price 

for Exxon or Home Depot.... I mean, I definitely – like I 

said, the front-running – should have included trading data 

from retail side and from the proprietary side. I don’t recall 

and would certainly be surprised if I ever said, “Don’t get 

the proprietary trading data.” 

McCarthy Testimony Tr. at pgs. 100-101.72 

13. Examination Team Failed to Request Data from Any Independent 

Third-Party 

According to Donohue’s undated notes from the examination, Donohue appears 

to have considered going to the NASD/FINRA for detailed audit trail data. Donohue 

Examination Notes, undated, at Exhibit 182. In his notes, Donohue wrote, “Mavis” and 

placed a box around it. Id. Beneath “Mavis,” he wrote the following: 

72 The FTI Engagement Team believes that detailed order and execution data would have provided the 

information necessary to examine whether or not Madoff was front-running its broker-dealer customers. 

OATS data for instance, would have provided the time of each customer order from Madoff’s market 

making business, which the examiners should have compared to the execution times of trades for the 

discretionary brokerage accounts. 

109 
 

Few stocks on a few days w/ critical 

Get Oats from NASD & Act 

all Madoff orders. 

Id. 

Donohue stated that although he did not recall a specific conversation, the only 

“Mavis” he knew was Mavis Kelly73 and that the notes seemed to refer to the question of 

whether to request audit trail data from the NASD/FINRA. Donohue Testimony Tr. at p. 

77. Swanson explained, as follows, why data from NASD/FINRA should have been 

sought: 

I think the A[CT] data would have been the most important 

data... . There is a reason why you’d want OATS. It’s 

because it would show the time that the order arrived at 

Madoff, and ... I don’t believe the A[CT] data would have 

shown that. So that is why we would have wanted to see 

the OATS data. 

Swanson Testimony Tr. at p. 82. 

Daugherty explained why one would request OATS and ACT data and stated that 

obtaining the data from the NASD/FINRA should not have been difficult: 

One reason would be to review the order entry information 

and the execution information from – that the NASD had 

stored regarding certain trades. ... generally speaking, if 

you wanted to look at a limited sample of orders, it 

shouldn’t even be a problem at all. And even if it’s a lot 

[of orders], we can always get it. ... But if I wanted some 

reasonable set from them of OATS and ACT data, it 

shouldn’t be a problem at all. 

Daugherty Testimony Tr. at p. 86-87. 

Although requesting trade data from the NASD was considered and a draft letter 

to the NASD was written, the exam team neither requested OATS or ACT trade data 

73 Donohue’s notes may have been in reference to a call Mavis Kelly testified that she made to Donohue. 

Kelly Testimony Tr. at pgs. 72-73. Mavis stated, “I called Mark at the time ... after market timing, and ... I 

was trying to impress upon them the importance of following up on this, because I found this to be a very 

credible source. And, he said, you know, especially in light of what was happening at the time ... they 

would take it very seriously.” Id. 

110 
 

 

 

 

 

from the NASD, nor requested trade data from any other independent source.74 Donohue 

Testimony Tr. at p. 77. 

14. Donohue was Promoted to Assistant Director and Took Over 

Primary Responsibility for the Examination 

On February 22, 2004, Donohue was promoted to Assistant Director, reporting 

directly to McCarthy.75 Donohue Testimony Tr. at pgs. 14-16, 27. When he was 

promoted to Assistant Director, Donohue took over the “day to day responsibility” for the 

Madoff examination. Swanson Testimony Tr. at pgs. 71, 84. As an Assistant Director, 

Donohue said his role on the Madoff examination did not change a great deal since a new 

Branch Chief was not assigned, but he had a larger number of examinations and less time 

to devote to the Madoff examination. Donohue Testimony Tr. at pgs. 26-28. Donohue 

stated that he believes that Swanson “stay[ed] in the loop” on the Madoff examination. 

Donohue Testimony Tr. at 27. Swanson testified that “sometime in the spring of 2004 

[he] was no longer in the chain of command on the inquiry and had very limited, if any, 

involvement in the conduct of the inquiry or its resolution.” Letter dated June 19, 2009 

from Michael Wolk, Counsel to Swanson, to IG Kotz, at p. 2, at Exhibit 183. 

Donohue’s testimony that Swanson remained “in the loop” on the Madoff 

examination is supported by correspondence, such as a March 11, 2004 e-mail from 

Swanson to Donohue regarding “Madoff.” See E-mail dated March 11, 2004 from 

Swanson to Donohue, at Exhibit 184. In the following e-mail Swanson asked Donohue a 

question about Madoff’s strategy and stated that he had suspicions about Madoff’s 

trading: 

Just a thought – do we know what the standard is for this 

strategy in terms of long, med, or short term. Given that it 

is supposedly a fairly conservative strategy I would expect 

that it is designed to make money off of broad, med to long 

term mkt trends, which is clearly much diff tha[n] what 

[B]ernie is doing. Doesn’t prove anything, but it makes me 

more suspicious. 

Id. 

74 The FTI Engagement Team concluded that obtaining data from an independent third-party such as 

NASD/FINRA, NSCC or DTC would have assisted in independently verifying trading activity conducted 

at Madoff. NASD/FINRA and NSCC data would have enabled the examination staff to verify trading 

volume whereas DTC data would have enabled the examination staff to verify overall position balances. 

75 When Donohue was promoted to Assistant Director, he had worked at the Commission for 

approximately three years and had five years of general litigation experience. Donohue Testimony Tr. at 

pgs. 9-14. Swanson thought Donohue was capable but “no expert,” while another examiner felt “that 

[Donohue’s] level of expertise was not where it should be, given his – what position he was at the time, 

ultimately.” Swanson Testimony Tr. at p. 72; Former OCIE Attorney Advisor Testimony Tr. at p. 28. In 

contrast, Wood found Donohue “very personable and knowledgeable, and [she] would work with him again 

today.” Wood Testimony Tr. at pgs. 84-85. 

111 
 

 

15. Madoff’s Responses to the Document Request Led to Additional 

Questions and Concerns 

On March 1, 2004, Madoff responded in writing to the staff’s second document 

request. Letter dated March 1, 2004 from Madoff to Swanson, at Exhibit 185. Madoff 

stated BMIS had no communications or other correspondence with clients using the splitstrike forward conversion trading strategy and stated BMIS did not communicate with its 

clients’ investors. Id. Madoff included account opening documents, trading 

authorizations, and client account statements for the clients he had disclosed. Letter 

dated March 1, 2004 from Madoff to Swanson, at Exhibit 185; BMIS account documents 

for the period ending December 31, 2001, at Exhibit 186. The client account statements 

did not contain detailed audit trail information. Donohue Testimony Tr. at pgs. 85-86; 

McCarthy Testimony Tr. at p. 98. They contained the date of the purported securities 

transaction, the number of shares purchased or sold, the name of the security, the average 

price of the security, and the amount debited or credited to a customer account. BMIS 

account documents for the period ending December 31, 2001, at Exhibit 186. Although 

the account statements included the date of each transaction, they did not contain the 

execution times of those transactions. Id. The actual language of Madoff’s response was 

as follows: 

In response to your letter of February 18, 2004, we are 

providing copies of client account statements reflecting all 

the transaction data related to the accounts of those clients 

utilizing the split strike conversion strategy. We have also 

enclosed copies of opening account documents, Trading 

Authorizations, Trading Authorization Directives (which 

also contain compensation disclosure relating to client 

commission and commission equivalents.) We do not 

charge expenses or fees to clients, nor do we prepare any 

reports of client profit and loss or any other related 

information. We do not issue or prepare reports or 

memorandum relating to trading strategies, investment 

strategies or research. Bernard L. Madoff Investment 

Securities LLC (Madoff Securities) does not provide prime 

brokerage or full service brokerage to its clients. We 

provide execution only services to a limited number of 

clients applying a technologically enhanced approach to a 

traditional trading strategy known as a split strike forward 

conversion. 

The enclosed Trading Authorizations and Trading Directive 

Agreements define the specific[] terms, conditions and 

obligations between Madoff Securities and those clients 

utilizing the strategy.76 Because of the limited scope of 

76 The Trading Directive Agreement for Kingate Global Fund Limited had a BMIS header and stated that 

the trades will be executed by BMIS. See Undated “Trading Authorization Directive” for Kingate Global 

112 
 

brokerage execution service we provide and the fully 

automated and electronic nature of our business, there are 

no other communications or correspondence between 

Madoff Securities and their clients utilizing the split strike 

forward conversion. Madoff Securities does not 

communicate or correspond with the investors or owners of 

its clients. 

Letter dated March 1, 2004 from Madoff to Swanson, at Exhibit 185. 

Madoff’s response to the second document request raised concerns with the staff. 

Donohue Testimony Tr. at p. 87. As Donohue recalled, the exam staff was “concerned 

about [Madoff’s] communications.” Id. When asked whether the team thought it was 

odd that BMIS, a company known for its advanced technology, was claiming not to have 

e-mail communications with clients, Donohue agreed he had never seen anyone operate 

the way Madoff did, stating: 

What was going on was different than what I was used to. 

It was all a concern. I do not mean to over generalize, but 

it was a concern. We were trying to figure out what was 

going on. 

Id. 

McCarthy and Swanson did not recall reviewing Madoff’s response to the second 

document request. McCarthy Testimony Tr. at p. 97; Swanson Testimony Tr. at p. 88. 

However, on March 9, 2004, Wood sent Swanson (with a copy to Donohue) an e-mail 

entitled “List of Madoff’s Institutional Clients (hedge funds) Utilizing the Split-Strike 

Conversion Strategy.” E-mail dated March 9, 2004 from Wood to Swanson, at Exhibit 

188. It appears that the e-mail was provided in response to a request from Swanson for a 

list of Madoff’s clients. Id. In the e-mail, Wood listed the 16 institutional clients Madoff 

identified as using the split-strike conversion trading strategy. Id. Wood also noted that 

Madoff had identified “13 institutional clients who are NOT utilizing the Split-Strike 

Conversion Strategy” and stated, “Please let me know if you would like the names of 

those clients as well.” Id. (emphasis in original). 

Fund Limited signed by Bernard Madoff, at Exhibit 187. The footer of the trade directive stated, 

“Affiliated with: Madoff Securities International Limited” and provided its London address. Id. 

113 
 

 

 

The team did not contact the institutional clients Madoff identified, possibly due 

to concerns about disrupting Madoff’s business. Wood Testimony Tr. at p. 103. Wood 

explained: 

You have to be really careful when you contact other 

people you don’t want to scare clients... . So once you go 

outside to the clients of the entity that you’re examining, 

that could scare their clients, and that could cause business 

issues. 

Id.77 

After reviewing the information and documents provided by Madoff, the 

examination team had numerous unresolved questions. On March 10, 2004, Walker sent 

Donohue a list of the following questions she had about the documents Madoff produced: 

Here are my questions... 

1.	 Are the dates settlement or trade dates? 

2.	 If they are settlement dates, are they regular way, cash, 

etc.? 

3.	 Can we obtain the actual trade dates? 

4.	 Are the prices average prices? (This would affect 

finding the trades on the audit trail.) 

5.	 Do you hold any other form of brokerage account 

statements or accounting documents for these accounts? 

6.	 Are these DVP/RVP accounts? 

7.	 If so, do you have the prime brokerage or custodial 

banking agreements for these accounts? 

8.	 What does “Assign” mean in the options portion of the 

statements? 

9.	 How do assignments by OCC fit into the split strike 

conversion strategy? 

77 Similar concerns about contacting customers were expressed by the Assistant Director and the Associate 

Director responsible for NERO’s 2005 examination of Madoff. Nee Testimony Tr. at pgs. 149-51 (stating 

that one has to be careful about contacting customers because it raises suspicions about the firm); Sollazzo 

Testimony Tr. at p. 124 (stating that when customers are contacted they become agitated and the calls may 

be reported to top SEC officials). According to the FTI Engagement Team, there was no formal OCIE 

policy that prevented examiners from contacting customers in order to follow up on leads or to verify 

information during an examination. In addition, a number of Madoff’s clients were SEC-registered 

investment advisers, from which the SEC had authority to request additional information under Section 204 

of the Advisers Act. 

114 
E-mail dated March 10, 2004 from Walker to Donohue, at Exhibit 189. Walker asserted 

it was her “belief that the SEC did not have enough information to conduct the 

investigation.” Letter dated June 12, 2009 from Walker to Kotz, with attachments, at p. 

2, at Exhibit 164. 

16. Follow-Up Call With Madoff Did Not Resolve Examination 

Teams Open Questions 

On March 18, 2004, Wood e-mailed Donohue with a list of the open questions she 

had after reviewing Madoff’s responses to the staff’s document and information requests. 

E-mail dated March 18, 2004 from Wood to Donohue, at Exhibit 190. In her first 

question, Wood appeared to have been skeptical about Madoff’s assertion he had no email or other correspondence with his hedge fund clients. Wood’ s questions were as 

follows: 

1. Does Madoff provide anything to the hedge funds re: 

what they pay Madoff in commissions? I find it hard to 

believe that the hedge funds would be in the dark about 

what they pay Madoff. 

2. Confirm that he has no e-mail communications 

whatsoever re: any of the requests. 

3. How does Madoff determine the time to execute the 

orders? We know that the black box actually does the 

legwork in executing the orders, but it doesn’t do anything 

until Madoff decides when. 

4. Madoff needs to give us more of an explanation as to the 

account statements. 

Id. 

Donohue also had open questions about Madoff’s responses to the supplemental 

document request and drafted the following notes of his unresolved questions: 

Follow-up w/ Madoff re: inputs to Black Box. ... 

Questions
 

-Communications 

- Who do you communicate with (Acct 

holders[arrow] feeder funds) 

-What about “client defined conditions” 

-e-mails 

-all electronic nature of business, means no communication 

115 
Reports of P/C 

-Non[e] prepared; Nothing internal? No tracking
 

documents? 

Who sells the stuff? How do you get investors? 

-Feeder funds (how do they get paid) ... 

Statements
 

-Execution date/settlement date/trade date?
 

-Can we get them electronically (scan them in) 

-Individual trades? (just avg price per day?) 

-Direct tech line to funds?
 

-Do you have any other statements or acct docs 

-Are they DVP/RVP accounts (delievery vs 

payment/receipt v. payment) 

-“Assign” options?
 

-Wash trades? 

-Prime Broker 

-Net price or reflect commissions 

Black Box
 

-Feed from Mkt mkg desk? (order flow) 

-All sources of info 

Donohue Examination Notes, undated, at Exhibit 182; Donohue Testimony Tr. at pgs. 

76-78. 

On March 18, 2004, the examination team had a conference call with Madoff to 

follow up on open questions. E-mail dated March 18, 2004 from Wood to Donohue, at 

Exhibit 190. It appears that Donohue, Wood, Walker, and Daugherty were on the call. 

Id. According to the following notes taken by Wood of the conversation, the staff asked 

Madoff about his communications with clients and information on the account 

statements: 

Authorized agent of client calls Madoff re: amt of $ to 

invest. Acct statement -sent to the fund itself – only 

communication b/c based on trading directive, Madoff 

[indecipherable word] the criteria & enters into the box. 

No profit/loss calculated by Madoff
 

settlement date on acct statements 

-prices – average price stock trades 

116 
-average price at the end of the day. 

-dvp [delivery versus payment] 

Wood notes dated March 18, 2004 on conference call with Madoff, at Exhibit 191; Wood 

Testimony Tr. at p. 106. Wood stated that the conference call with Madoff answered 

some questions and created further questions requiring clarification. Wood Testimony 

Tr. at p. 107. 

17. Walker Raised Additional Questions About the Information 

Produced by Madoff 

As Walker reviewed and analyzed the documents provided by Madoff, she had a 

number of questions about the data and information that Madoff had provided. Letter 

dated June 12, 2009 from Walker to Kotz, with attachments, at pgs. 1-4, 7, at Exhibit 

164. On the evening of March 23, 2004, she sent Donohue (with a copy to Wood) the 

following e-mail highlighting the initial discrepancies she noticed between the data that 

Madoff provided and what he had told the examination team: 

In my review of the documents we have for Tremont (a 

large fund) and Sway (a smaller fund), I noticed some basic 

differences. Madoff stated to us that “The specific model 

used to execute the split strike conversion orders 

of...clients has client defined conditions that must exist at 

the time of execution. These conditions dictate which 

securities are executed and the quantity of each order.[“] 

However, if it is a given that each client is utilizing the 

strategy in the same manner, as specified by Madoff, there 

are significant differences between the Tremont and Sway 

account transactions: 

1.	 The trade dates vary. For example, the initial May 2002 

transaction for Sway is settlement date May 3, 2002, but for 

Sway it is May 10, 2002. If these were T+3 transactions, 

the variation in transaction dates, April 30 and May 7, 

2002, for a strategy that “activates” when the “Madoffspecific” conditions occur, does not make sense. 

Moreover, Tremont’s settlement dates of May 3, May 6, 

May 9, May 10, May 20, May 21, and May 22 vary greatly 

from Sway’s settlement dates of May 10, May 23 and May 

24. (These are dates for the equity transactions only.) 

2.	 Also, I noted that Tremont traded on 7 days versus Sway 

which traded on only 3 days. Shouldn't the trading be 

almost identical if trading in the accounts “activates” via 

the strategy conditions aligning? 

117 
 

 

3.	 Why don’t we see the corresponding equity activity/or 

hedge restructuring when the options trades are assigned? 

E-mails dated March 24, 2004 between Walker and Donohue, at p. 3, at Exhibit 192. 

(emphasis in original.) 

According to Walker, she, 

[T]old Donohue and Swanson that if the specific conditions 

mentioned by Madoff were a prerequisite for the ‘splitstrike conversion’ strategy to activate, the trade and or 

settlement dates should not have varied for those accounts 

per her review of trading account documentation provided 

by Madoff. Moreover, the trade dates versus settlement 

dates were inexplicably inconsistent and varied when 

compared to the securities industry standard of T+3 (trade 

date plus 3 days). This led [her] to believe that either the 

strategy did not work as stated and/or the account 

statements and other documentation provided to the SEC 

were inaccurate. 

Letter dated June 12, 2009 from Walker to Kotz, with attachments, at p. 2, at Exhibit 164. 

Walker claimed to have “communicated her concerns to Donohue and Swanson directly” 

and in e-mail.78 

The following morning, Walker sent another e-mail to Donohue (with a copy to 

Wood) further explaining why she found the documentation Madoff provided to be 

atypical. E-mails dated March 24, 2004 between Walker and Donohue, at Exhibit 192. 

As follows, Walker recommended they perform independent analysis in addition to 

asking Madoff additional questions: 

Based on what we discussed, I’m going to compare the 

largest feeder fund, by commission equivalent revenue, that 

uses the split-strike forward conversion strategy and the 

largest non-feeder fund, by commission equivalent revenue, 

that uses the strategy, for the months of May and June 

2002. Those funds are Fairfield Sentry (totaling 

$4,696,278) and Yeshaya (totaling $63,597), respectively. 

Also, just to follow-up about #3 in my e-mail from 

yesterday, in my experience, when securities are transferred 

from the executing brokerage account to another account of 

78 While there is some correspondence supporting Walker’s rendition of the facts, it is difficult to assess 

her credibility because she was the only person involved in the OCIE Madoff examination to refuse to 

testify. Instead, she had her attorney submit a letter containing her recollection of events. 

118 
 

 

 

the same accountholder, for example the account holder’s 

prime brokerage account, the notation is usually “Journal” 

or “Transfer” and not “Assign”. I interpret “assign” to 

mean that the option was assigned by OCC and “Expire” to 

mean that the option expired (hence my reference to the 3rd 

Friday). Also, when securities are journalled or transferred, 

the account to which the securities have been journalled is 

also noted, for example, “Journal 7555”, which would 

mean that the securities were journalled to account 7555, 

another account of the same account holder. Because the 

account statement is used by the executing broker, prime 

broker or custodial bank, account holder and regulatory 

authorities to determine the account's position, accurately 

reflect trading activity and commissions charged, etc., in 

the case of securities being transferred/journalled from one 

account to another, indication of where the securities have 

been journalled or transferred is a recordkeeping/regulatory necessity. 

Lastly, in my below-referenced trading activity 

comparison, I focused on Tremont sub-acct #1-FR010-3-0 

and Sway sub-account #1-FN043-3-0. However, as noted 

by Madoff, some accounts have multiple (sub)-accounts 

that are part of the fund management group. So, for 

example, Tremont Broad Market Group has 8 sub-accounts 

that comprise the Tremont fund (Madoff) client account 

and Sway Pension Fund has 2 sub-accounts that comprise 

the Sway fund (Madoff) client account. But, it is unclear 

whether the strategy is executed individually in each of 

these accounts or across the entire account, via the subaccounts, in some sort of weighted fashion?? I think we 

need to determine that by either examining the trading in 

each sub-account and then conducting an intra-fund trade 

pattern comparison OR by just asking Madoff. I think it’s 

probably a good idea to do our own independent analysis, 

as well as ask Madoff how the strategy is executed/how 

trades executed using the strategy are apportioned among 

the sub-accounts of each individual fund client. 

Id. at p. 2. Donohue responded to Walker, “Gen, let’s chat about this when you get a 

chance.”79 Id. 

79 According to the FTI Engagement Team, the examiner noted some apparent inconsistencies in the 

trading data and raised credible questions as to how Madoff executed his strategy. Although the examiner 

suggested conducting an independent analysis to determine if the strategy was implemented for each subaccount individually or universally across an entire account, the examiner did not suggest independent 

119 
 

 

 

18. Hostility Arose Between Donohue and Walker 

Walker asserted that “[a]t the same time that [she] was leading the Madoff 

investigation and providing her findings to Donohue and Swanson, she was meeting with 

resistance from them.” Letter dated June 12, 2009 from Walker to Kotz, with 

attachments, at p. 3, at Exhibit 164. From her perspective, Donohue demoted her from 

lead examiner on the Madoff examination and “excluded [her] from meetings related to 

the Madoff investigation.”80 Id. Donohue and Walker’s troubled working relationship 

culminated in Walker filing an EEOC complaint against the Commission, “alleging that 

Mark Donohue and a former OCIE Branch Chief, who was supervised by Donohue, were 

creating a hostile work environment for her.” Id. at pgs. 1, 3. 

According to Walker, “In April 2004, [she] was removed from her position as the 

lead investigator” in the Madoff examination “shortly after she raised questions about the 

veracity and completeness of documents and explanations provided by Madoff regarding 

his trading activities.” Id. at 2. Walker asserted that the first person to whom she 

“complained about this treatment was Eric Swanson, who did nothing to relieve her 

situation.” The Commission ultimately settled the EEOC suit with Walker. Id. at p. 3. 

Donohue stated he was unaware of the tension with Walker, he was surprised by 

the complaint she filed, and believed the complaint was without merit, stating: 

I thought the complaint had no merit. It was a complaint 

alleging discrimination... . I was utterly surprised when I 

heard about it. Certainly I never felt that was something I 

would take into account or would ever do. ... No. I must 

say I was very surprised by the complaint. I think she felt 

there were things going on and friction that I did not see. ... 

I do not recall whether there was a lead, so to make coleads I just do not know. These are indications of her 

frustrations that I was not aware of. 

Donohue Testimony Tr. at pgs. 104-106. 

As for her work, Donohue felt that Walker’s work was stronger on the technical 

side than the work ethic side, stating, “I think she could have strong abilities. I think they 

did not always come through.” Id. at 104. 

verification of activity from a third-party such as the NASD, NSCC or DTC. The FTI Engagement Team 

concluded that independent verification of activity from the NASD, NSCC or DTC would have likely led to 

the discovery of the Ponzi scheme, or at the very least, the fictitious trades. 

80 The OIG has found no evidence that Walker was demoted or received any other adverse employment 

action as a result of raising questions about Madoff. 

120 
McCarthy recalled that Walker had issues with Donohue but attributed them to 

Walker’s inadequacy as an employee, stating: 

I do recall Genevievette [Walker], issues with Genevievette 

...we had trouble with documents that she was responsible 

for keeping. ... Like sloppiness, things like that. I think 

[the] doors were locked and it was hard to get to them 

sometimes, just vague recollections. ... I would say she 

was one of the weaker employees I’ve had in my career. 

McCarthy Testimony Tr. at pgs. 114-115. In contrast, McCarthy recalled Wood as 

“probably one of the best [employees] I’ve ever had.” Id. at 115. McCarthy did not 

believe that the difficulties between Donohue and Walker should have impacted the 

examination, asserting: 

I don’t think it should have. I mean, it’s unfortunate she 

was a weak member, but the data analysis could have done 

– been done by Jackie [Wood] at a high level, so – but it’s 

certainly, you know, probably didn’t help, obviously. 

Id. at p. 116. 

In the following exchange, Swanson recalled Donohue had problems with 

Walker’s work effort and, possibly, with the competence of her work, but felt Donohue 

dealt with Walker too aggressively: 

A: ... I do recall there were some issues, yeah. ... I think 

Mark was dissatisfied with her performance and I 

think, if I recall correctly, he had confronted her at 

some point in a somewhat aggressive way, but I don’t 

recall the specifics or the timing of that. ... I don’t 

remember exactly what was in the complaint. 

However, I -- I do recall that there were some 

performance issues with Genevievette and I also 

recall that Mark was definitely too aggressive, in my 

opinion, was too aggressive in dealing with her. 

Q: And the performance issues with Genevievette, were 

they more in terms of work effort or competence of 

work? 

A: I believe predominantly the former, although there 

may have been some of the latter, but I think it was 

mainly work effort. 

Swanson Testimony Tr. at p. 69. 

121 
Other OCIE employees working on the OCIE examination were aware of the 

difficulties between Donohue and Walker. Wood testified, “I just don’t think she was 

very happy working with Mark. ... I love working with Mark. ... But some people just 

don’t get along, and I think that was just one instance.” Wood Testimony Tr. at pgs. 84­

85. The former OCIE Attorney Advisor stated, “at least my impression was there was a 

source of maybe tension, in the sense that there appeared to be some type of, some sort of 

– and this is just an observation, some type of favoritism with certain individuals within 

the group, within the department. And I think that there may – that may have created 

some tension.” Former OCIE Attorney Advisor Testimony Tr. at p. 28. 

The OCIE Staff Attorney, another OCIE examiner, also felt some OCIE hiring 

and promotion decisions were based on relationships, stating, 

There [were] definitely cliques. There were definitely like 

some sort of social hierarchy. ... Probably, the primary 

inner circle was the circle around John [McCarthy], and 

that would be John [McCarthy], Eric [Swanson], and Alex 

[Sadowski], and sometimes maybe a few other people: 

Matt [Daugherty], in a way; and, there were certain people 

not in the circle but were trusted by the circle. 

OCIE Staff Attorney Testimony Tr. at p. 37. The OCIE Staff Attorney also noted, 

“There is a bit of kind of self-replicating problems here wherein, you know, they promote 

people that are more because of personal relationships than because of any sort of 

professional background or anything like that.” Id. at p. 52. The OCIE Staff Attorney 

stated, “It’s just crazy stuff that goes on in this office. It was weird. It was like a sitcom 

or something. It didn’t exist in the real world and it’s hard to explain. It really is.” Id. at 

57. 

19. After Donohue Reviewed the Data Madoff Produced, He Had 

Numerous Unanswered Questions 

Also on March 24, 2004, in response to a request made during the March 18, 2004 

conference call, Donohue received eight floppy discs from Madoff, which contained the 

monthly customer statements in electronic format. Letter dated March 23, 2004 from 

Madoff to Donohue, at Exhibit 193; see also E-mail dated March 24, 2004 from Donohue 

to Walker, at p. 4, at Exhibit 192 (stating, “We received the electronic versions of 

Madoff’s 2003 account statements. I crudely converted them from text to excel and they 

now reside on the J drive”). 

The data Madoff produced left Donohue with unresolved questions. E-mails 

dated March 24, 2004 between Walker and Donohue, at pgs. 1-2, at Exhibit 192. On 

March 24, 2004, Donohue e-mailed himself the following draft analysis of the data, 

which indicates that Donohue was finding that the data did not add up: 

122 
 

Just a follow-up. The split-strike strategy, as I understand 

it, entails selling a covered call and buying an index put. 

Selling the call should be reflected by an inflow or credit to 

the client fund account, as well as the commission charged 

by Madoff for the trade itself, an outflow or debit from the 

account. 

From Sway 1-FN043-3-0 and 1-FN043-4-0: 

Leg 1 of the Collar: 

5/8/02, (trade date 5/7), transaction 6006, -- Bought 

Received 13 S&P 100 Index May 520 Calls @ 23.3 and 

Madoff debited $30,290 from the account 

5/8/02, (trade date 5/7) transaction 6006, --Sold Delivered 

13 S&P 100 Index May 520 Calls @ ASSIGN and Madoff 

credited $30,290 to the account 

Leg 2 of the Collar: 

5/8/02, (trade date 5/7), transaction 17182, --Bought 

Received 13 S&P 100 Index May 520 Puts @ 8.5 and 

Madoff debited $11,063 from the account 

5/8/02. (trade date 5/7), transaction 17182, Sold Delivered 

13 S&P 100 Index May 520 Puts @ ASSIGN and Madoff 

credited $11,063 to the account 

Leg 3 of the Collar: 

There should be a purchase on 5/8/02, trade date 5/3/02, for 

1300 shares of the S&P 100 Index or some composition 

thereof of the individual components, that totals 1300 

shares. Again, I am assuming that the collar is completely 

put on the same trade date. However, a total of 18,551 

shares were bought/received, way more than a 1:1 hedge. 

Madoff stated in his letter that he charges $1 commission 

equivalent per option contract. 

Just looking at the call leg of the collar transaction... 

Selling Open 13 S&P 100 May 520 Calls @ 23.3=$30,290 

credited to the fund client account. (So, I guess we can 

assume that the true average price is $22.3/contract + $1, 

totaling $23.3/contract.) But, I’m confused because, 

although Madoff should charge $1 for each contract 

purchased, a debit of $1300, the premium received from the 

123 
selling open of 13 S&P 100 May 520 calls, $28,990, should 

be a credit to the client account. 

But, we see a debit and a credit for $30,290 for trades “in 

and out” of the S&P 100 May 520 Call position established 

on trade date 5/3/02 and settled on 5/8/02, instead of a 

$28,990 credit and a $1300 debit and then the same 

amounts again for a transfer of the position (and the 

premium received from the sell open) out of the 

account...why? Alternatively, an assignment of the 

position would mean that the fund client must sell 1300 

shares of the S&P 100 @ 22.3, plus commission costs of 

$.04/share, which at $22.34/share equals $29,042, a credit 

to the account. So, we should see another credit to the fund 

client account for $29,042. 

I think we should see a credit for $28,990 and a debit for 

$1300, for the opening transaction of the call, and then, in 

the case of a transfer of the position, a debit from the 

account of the premium received, $28,990, as well as a 

transfer fee, which could be $1 per option contract, which 

would be $1300. So, maybe we should clarify what the 

commission equivalent is for transferring equity/option 

positions out of the fund accounts. 

Although Madoff executes the strategy, does that mean he 

also executes any assignments that may occur?? Would he 

consider these types of transactions part of his strategy?? I 

think we can assume in some instances that an option trade 

can be assigned after the position is transferred to the 

custodial bank account, right? (The trades in teh [sic] fund 

accounts seem to reflect [sic] that all executions are 

transferred to the custodial bank on settlement date. What 

broker would handle that assignment? 

Id. (emphasis in original). 

20. After Reviewing the Data Madoff Provided, Walker Also Had 

Additional Unanswered Questions 

Just as Donohue had unanswered questions after reviewing the data Madoff 

produced, Walker’s review of the electronic data left her with additional questions as 

well. E-mail dated March 24, 2004 from Walker to Donohue, at Exhibit 195; E-mail 

dated March 25, 2004 from Walker to Donohue, at Exhibit 196. It appeared from the 

data that Madoff was purchasing options on equity trades he had not yet executed, but 

124 
 

 

 

Walker found this illogical. E-mail dated March 24, 2004 from Walker to Donohue, at 

Exhibit 195. On March 24, 2004, Walker stated the following in an e-mail to Donohue:81 

It appears that Madoff does execute the strategy “equally” 

among the accounts, treating the sub-accounts of each fund 

as a separate account for purposes of executing the strategy. 

According to the strategy, he needs to sell an index call, 

buy an index put and buy components of the underlying 

index. However, I’m unclear about how the “collar” works 

with this strategy because most of the option trades appear 

to precede the equity transactions. Based on the dates, it 

looks like he’s front-running the equities by executing the 

option portion of the collar prior to the equity trades. 

Logically speaking, if a trader wanted to put on a “collar” 

position, would he execute the option portion 2-4 days prior 

to the equity portion of the transaction? Given the 

volatility factor of the trading involved, I would think not. 

Id. (emphasis in original) 

On March 26, 2004, Donohue e-mailed Walker (with a copy to Wood) about an 

additional potential issue with the data from Madoff. E-mails dated March 26, 2004 

between Donohue and Walker, at Exhibit 197. Donohue indicated that one of the hedge 

funds appeared to use a different trading strategy from another fund, stating, “Ginco 

trades differently (at least in March), but it could be simply that the size of the fund only 

requires one day (instead of three) to buy and sell a position. Look to see if that situation 

is similar for other funds?” Id. On March 31, 2004, Walker told Donohue that she would 

“look more closely at that account.” Id. 

D. The Madoff Examination was Halted 

1. Examiners Stopped Working on Madoff Examination to Focus on 

Mutual Fund Project 

Despite their open questions, it does not appear Walker had an opportunity to 

“look more closely at that account” or that the team resolved the other issues they had 

identified in the data. Work on the Madoff examination came to a halt as OCIE shifted 

its focus to other priorities. Walker and Wood were directed by their supervisors to focus 

on a mutual fund revenue sharing sweep being conducted by OCIE. Donohue Testimony 

Tr. at p. 93. Richards stated in a letter submitted to the OIG that, “In early 2004, OCIE 

made it a priority to examine mutual funds’ undisclosed payments to broker-dealers.” 

Letter dated July 1, 2009 from Richards to Kotz, at p. 4, at Exhibit 198. 

81 According to the FTI Engagement Team, Madoff’s Trading Authorization Directives indicate that his 

split-strike forward conversion strategy will attempt to utilize broad-based index option positions “upon 

establishment of equity positions.” As a result, it appears illogical that the option positions would be taken 

prior to establishing the equity positions for any given account. 

125 
 

 

On April 6, 2004, Walker e-mailed Sadowski, an OCIE Branch Chief, about how 

to focus her priorities, stating, “I believe that those who are participating in the mutual 

fund project are supposed to make that project a priority. ... But, I’m not sure where the 

hedge fund [Madoff] project falls on our list of priorities right now.” Sadowski 

responded, “Get the mutual fund work completed first.” E-mail dated April 6, 2004 from 

Sadowski to Walker, at Exhibit 199. 

On the same day, Walker also e-mailed Donohue (with a copy to Wood) asking 

which project to prioritize, stating as follows: 

I’m not sure what you want Jackie and I to do concerning 

Madoff, but I’m focusing on the mutual fund project, as 

requested. 

Should we just focus on mutual funds and return to Madoff 

when we’re done?? 

E-mails dated April 6, 2004 between Walker and Donohue, at Exhibit 200. The 

following morning, Donohue responded, “Concentrate on mutual funds for the time 

being.” Id. 

2. Not Unusual to Shift Attention to High Priority Projects in OCIE 

and Leave Some Projects Incomplete 

At the time, mutual fund work was a “very high priority” in OCIE.82 Swanson 

Testimony Tr. at pgs. 96-97. Swanson was not surprised that the Madoff examination 

82 Lori Richards provided a letter to the OIG dated July 1, 2009 to supplement her testimony. In the letter, 

she explained as follows that the examination of mutual funds’ undisclosed payments to broker-dealers was 

a priority for OCIE: 

As background, in this time period, OCIE’s Office of Market 

Oversight, a group of about 20 staff, were juggling many examination 

matters (including the Madoff exam). In early 2004, OCIE made it a 

priority to examine mutual funds’ undisclosed payments to brokerdealers. This priority status followed an examination sweep concluded 

in late 2003 that had revealed that 15 broker-dealer firms had received 

payments from mutual fund companies in exchange for recommending 

those funds to their retail customers. Those examinations found that 

the broker-dealers had not disclosed these payments, and that the 

payments may have violated antifraud provisions of the securities laws. 

As a result, in early 2004, working collaboratively with Enforcement 

and other agency staff, the Office of Market Oversight initiated an 

examination sweep of mutual fund companies to determine how the 

payments were made, whether they diminished shareholder returns, and 

whether they were disclosed to the funds’ shareholders and to their 

boards of directors. This was a large exam sweep (45 mutual fund 

companies) and approximately 16 examination staff, including the two 

staff examiners on the Madoff exam, were assigned from other 

126 
 

 

would be set aside for higher priority projects. Id. at p. 98. As another OCIE examiner 

explained, stopping work on incomplete projects in order to work on higher priority 

matters was not an unusual occurrence: 

John [McCarthy] had kind of a tendency to kind of go from 

project to project very quickly without really circling back. 

... [F]rankly, there was a lot of projects at the time that 

would just kind of die off. I mean, you know, you do some 

initial review and you go up the chain. And I think the 

superiors had determined, well, I got other things to worry 

about. Those old projects just kind of languished; and I had 

a lot of projects like that....I mean, we do our fact-finding, 

whatever, and say like okay, what do we do next. And 

there just was never any further direction; or, we’d write a 

memo summarizing whatever we thought we had found 

[and we wouldn’t get] further input. So that was a pretty 

common occurrence. 

OCIE Staff Attorney Testimony Tr. at p. 25. 

Swanson agreed with the OCIE Staff Attorney’s assessment, stating, “there were 

situations where we opened inquiries and, you know, to my knowledge, they may never 

have gotten completely resolved because we were busy with other more high-priority 

matters...” Swanson Testimony Tr. at p. 33. Daugherty also recalled there were times 

when examinations were worked on but then the work was stopped as OCIE moved on to 

other priorities. Daugherty Testimony Tr. at pgs. 117-118. While he acknowledged 

some OCIE examinations could be put on the sidelines for several months while 

examiners worked on other projects, he found eleven months to be a particularly long 

time for an examination to be left inactive. Id. 

OCIE projects may have fallen through the cracks because examiners typically 

handled several open projects at any one time. Wood estimated that she had 5-10 open 

matters at the time she worked on the Madoff examination and recalled some of the 

mutual fund work was given priority over other projects. Wood Testimony Tr. at pgs. 42, 

90. Richards, offered a similar assessment, asserting that “Examiners generally work on 

a number of examination matters simultaneously, and seek to prioritize the highest-risk 

firms and issues that most warrant examination.” Letter dated July 1, 2009 from 

Richards to Kotz, at p. 2, at Exhibit 198. She explained that given “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 the SEC.” Id. 

examinations or asked to prioritize the mutual fund examinations in 

order to complete the examination sweep in a timely way. 

Letter dated July 1, 2009 from Richards to Kotz, at p. 4, at Exhibit 198, 

127 
 

Tina Barry, a Branch Chief and later Assistant Director who reported to 

McCarthy, also recalled that from 2003-2005 “we did have a lot of projects going on” 

and it did happen from time to time where there were kind of old projects and things were 

not followed up with.” Barry Testimony Tr. at pgs. 18-19. McCarthy disagreed that 

some examinations under his supervision were left unresolved, stating that if an examiner 

“felt things died there might have been reasons why they died and maybe he wasn’t 

aware of.” McCarthy Testimony Tr. at p. 41. He stated, “Tina Barry was for the – most 

of the years, responsible for keeping track of our open inspections” and that she should 

have a record of the inspections undertaken under McCarthy and their resolutions. Id. at 

p. 42. 

Barry contradicted McCarthy’s statement, testifying she did not have the 

responsibility for monitoring whether examinations were completed. Barry Testimony 

Tr. at p. 21. Although Barry maintained a “spreadsheet [that] listed out all the projects 

that were going on” and that she provided it to McCarthy “from time to time,” 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. Id. at 20-23. 

3. OCIE Performed Only 11⁄2 More Days of Work on Madoff 

 Examination 

After Walker and Wood set aside the Madoff examination to work on the mutual 

fund project, the only examiner to perform any further work on the Madoff examination 

was the former OCIE Attorney Advisor, who joined OCIE in March 2004. Former OCIE 

Attorney Advisor Testimony Tr. at pgs. 7,9; Donohue Testimony Tr. at pgs. 95-96. Soon 

after the former OCIE Attorney Advisor joined the Commission, he spent one and a half 

days calculating Madoff’s commissions on the securities and options trades Madoff 

claimed to have executed. Former OCIE Attorney Advisor Testimony Tr. at pgs. 15-16, 

21; E-mail dated June 1, 2005 from the former OCIE Attorney Advisor to Donohue, with 

attachments, at Exhibit 201. After the former OCIE Attorney Advisor provided the 

spreadsheet of his calculations to Donohue, he performed no further work on the Madoff 

examination. Former OCIE Attorney Advisor Testimony Tr. at pgs. 16, 21. Donohue 

explained no further work was done on the Madoff examination because “At this time it 

was refocusing priorities... people were concentrating on mutual funds.” Donohue 

Testimony Tr. at p. 95. 

4. Madoff Examination Put on the Backburner While Exam 

Team Still Had Unresolved Questions 

Although the examination team may not have had found any evidence that 

Madoff was running a Ponzi scheme at the time the Madoff project was set aside, they 

did have many “lingering questions” about Madoff and his representations about his 

hedge fund business. Id. at 92. When these open questions were not easily resolved, 

there was no evidence that the answers to the questions were ever pursued.83 Wood 

83 Madoff recalled that communications from Donohue “just dropped off.” Madoff Interview 

Memorandum at p. 7. 

128 
stated that the fact that Madoff was a well-known figure may have played a role in the 

decision to put it on the back burner because the exam supervisors may have thought it 

was unlikely he was engaging in fraud. Wood Testimony Tr. at p. 127. 

5. Swanson Told Kelly the Examination Was Ongoing After 

the Team Had Stopped Working on the Examination 

On April 16, 2004, after the Madoff project had become inactive, Mavis 

followed-up with Eric Swanson about the examination. “FYI – Bernie Madoff is 

speaking at 10:30. I received my file back. What ever happened with this?” E-mails 

dated April 16, 2004 between Kelly and Swanson, at Exhibit 202. In the following 

e-mail, Swanson responded to Kelly that the examination was “ongoing,” despite the fact 

that the team had stopped working on the examination: 

The examination is ongoing, we are in the process of 

reviewing trading on the MM desk and comparing it 

against trades in the hedge funds. Premarily [sic], we are 

fairly suspicious that something is going on simply 

because, although he is known in the industry as a MM, it 

is clear he makes the vast majority of his money form 

commissions earned on executing trades on behalf of the 

hedge funds. We have reviewed the trading in the hedge 

funds, and we think he may be using info gleaned from 

order flow on the MM desk to predict broad market 

movements and then trigger investments by the hedge 

funds in certain S and P stocks. We won’t know for a few 

more weeks, however. I’ll keep you posted. 

Id. 

Swanson explained an examination would be considered “ongoing” even it were 

put on hold. Swanson Testimony Tr. at p. 101. Swanson stated in his testimony that he 

was not closely involved in the examination after Donohue became an Assistant Director, 

and in the e-mail to Kelly, he may have been exaggerating the SRO Group’s progress: 

... I was somewhat out of the loop at this point because 

Mark was working on it, that I may not have known the 

exact status and probably didn’t know the exact status of 

where things were going on the examination, and I would 

add that I very likely gave Madoff – Mavis a response that 

would please her a little bit, to let her know that, you know, 

it was still being looked at and – might have overstated my 

case a little bit. 

Id. at pgs. 84, 103-104. 

129 
 

6. Eleven Months After the Examination Was Set Aside, Swanson 

Asked Donohue About the Examination After Seeing Shana 

Madoff at a Conference; Donohue Said Examination Was “Deady” 

No one on the team heard anything further about the Madoff examination until 

approximately eleven months after they had stopped working on it. Wood Testimony Tr. 

at pgs. 121-22. On March 16, 2005, Swanson and McCarthy attended a securities 

conference in St. Louis. E-mails dated March 16, 2005 between Swanson and Donohue, 

at Exhibit 203. The morning of the conference, they waited for Shana Madoff at the 

Hyatt in order to travel to the conference with her. Id. Later that day, Swanson e-mailed 

Donohue about the Madoff examination: 

[Swanson] What is the status of the madoff hedge fund 

thingy?”[sic] 

[Donohue] Deady. We never found any real problems. 

Does it need to be revised? 

E-mails dated March 16, 2005 between Swanson and S. Madoff, at Exhibit 204. 

Swanson testified that “[i]t’s likely” that seeing Shana Madoff at the conference 

triggered Swanson to check on the status of the examination; however, he stated “Shana 

never once asked [him] about the status of an exam,” and he “Never talked to her about 

the status of the exam.” Swanson Testimony Tr. at pgs. 109-110. 

Donohue explained he called the exam “Deady” because “I think we did not know 

what to do next. ... I imagine what this means is there was not much work being done on 

it right then.” Donohue Testimony Tr. at p. 96. Donohue explained the phrase he used – 

“Does it need to be revised,” – as meaning he was asking Swanson if the examination 

needed to be “revived [and] .... Do we need to concentrate on Madoff.” Id. at pgs. 96-97. 

At the time Donohue sent the e-mail to Swanson, Donohue recalled the 

examination team had unresolved questions but that they had not identified violations of 

the law: 

I think there were open questions and I do not think we 

found problems. There were questions that needed to be – 

that we could focus more time on to get answer to. I do not 

think at that point we had said there were violations. 

Id. at p. 97.84 

84 According to the FTI Engagement Team, significant questions or concerns raised during a cause 

examination should not be left unresolved due to the seriousness and urgency associated with such cause 

examinations. Significant delays or inactivity may allow for illegal activity to continue unimpaired for 

longer periods of time, resulting in potentially greater harm to consumers and investors. 

130 
 

 

7. OCIE Examination Was Still Inactive When NERO Told OCIE 

They Had Also Been Conducting A Cause Examination of Madoff 

The subject of the Madoff examination came up again two and a half months after 

Swanson attended the conference with Shana Madoff and learned from Donohue that the 

examination was “Deady.” Nee, an Assistant Director in the NERO85 examination 

program, e-mailed McCarthy on May 26, 2005, and told him that they had been 

conducting a cause examination of Madoff with regard to basically the same activity as 

OCIE’s examination. E-mails dated May 26, 2005 between Nee, McCarthy, Swanson, 

and Donohue, at p. 2, at Exhibit 205. The NERO examination team learned of OCIE’s 

examination from Madoff, as is evidenced by the following e-mail from Nee to 

McCarthy: 

We are currently conducting an exam at Madoff. Our 

major focus has been the possibility that Madoff is using 

his vast amounts of customer order flow to benefit the $6 

billion in hedge fund money that we believe he manages. 

In initial inquiries about managing outside money and 

supplying black box models (algorithms, etc.) to outside 

accounts he either denied it or was evasive. 

When he finally admitted to “executing trades” for billions 

of dollars in customers’ (hedge funds) money using specific 

proprietary trading algorithm, he said we should know 

about this as he told Lori Richards and John McCarthy 

about this 1.5 years ago. We are hoping that if what he is 

saying has any truth at all to it that you might have some 

info related to his hedge fund related activities that you 

could send us. 

Thanks, 

John Nee 

P.S. See the attached article for our concerns. We also 

received some intelligence on a recent IA [NERO 

Investment Management Examination Group] exam 

questioning his hedge fund involvement and trading 

practices. 

Id. 

Soon after receiving the e-mail from Nee, McCarthy forwarded it to Swanson. Id. 

Swanson then responded to Nee (copying McCarthy and Donohue), stating, “John – we 

85 The SEC changed the name of the Northeast Regional Office (“NERO”) to the New York Regional 

Office (“NYRO”) on March 30, 2007. See http://www.sec.gov/news/press/2007/2007-59.htm. 

131 
should discuss. Ocie [sic] has an open exam of madoff on this issue. I’m on road today, 

but am available tomorrow AM.” Id. 

Swanson then e-mailed Donohue and asked him about the examination team’s 

findings, in the following exchange: 

[Swanson] Can you refresh my recollection abt [sic] what 

we did with this exam? I know we talked abt [sic] it the 

other month, but I forget.” 

[Donohue] Nothing’s happened since we last spoke. I’ll 

gather the stuff, and figure out what we have. The article is 

from 2001, so they probably have the same intel we have.” 

[Swanson] I thought we had formed some conclusions abt 

[sic] this? 

Id. When asked what the conclusions were that he thought he and Donohue had formed, 

Swanson stated, “I don’t remember, but I’m guessing ... that I’m referring back to the 

“deadie” e-mail. ... So I’m guessing in this e-mail, I’m referring back to, you know, 

Mark having told me that they didn’t – they had completed their review or some of the 

review and hadn’t found anything.” Swanson Testimony Tr. at pgs. 115-116. 

E. OCIE and NERO Learned of Their Parallel Examinations From Madoff 

1. OCIE and NERO Had Been Unaware That Were Both Conducting 

Madoff Examinations 

NERO was unaware that OCIE had been conducting a cause examination of 

Madoff of almost identical issues. OCIE’s BD/SRO Group did not enter their 

examinations into the examination tracking system, and McCarthy “remember[ed] being 

mildly upset” to find out that the SEC’s New York office had been conducting an 

examination of Madoff at the same time their examination of Madoff was open 

“[b]ecause it meant that we probably didn’t put our information into the tracking system 

like we’re supposed to do.” McCarthy Testimony Tr. at p. 113. 

Swanson agreed that “the group that I was in that John and I were running” did 

not log examinations into the STARS system, stating, “I never used STARS ... – we did 

not log things into STARS.” Swanson Testimony Tr. at p. 114. Richards explained that 

there should never be two examinations of the same entity being conducted at the same 

time without both teams being aware of the other’s examination. Richards Testimony Tr. 

at pgs. 23-24. Richards explained the following process examiners should use before 

beginning an examination: 

A: The STAR[S] System. They would log into the 

STARS System and identify past examination 

132 
history. First they would identify whether it was a 

registered entity and then identify past examination 

history. In addition, there’s a geographical 

assumption that firms located in a particular region 

of the country are subject to examination by that 

regional office so that staff would likely call the 

exam leaders in the particular regional office and 

ask about any examination history. 

Q: So, there shouldn't be two cause exams that are 

going on at the same the same entity at the same 

time without two people – the two groups who are 

doing the exams talking to each other? 

A: Without knowledge – there should certainly be 

knowledge. 

Richards Testimony Tr. at pgs. 23-24. 

Richards was aware that the BD/SRO group did not log their examinations into 

the STARS system. Id. at p. 21. She believed the group did not log examinations into 

the system because “[w]hen they then shifted and began to do more broker-dealer exams, 

I think there was a lack of understanding of the STARS System.” Id. When asked 

whether the group now logs their examinations into the system, Richards stated, “I don’t 

know. I hope so.” Id. 

Swanson recalled, in the following testimony, that communication between 

Commission offices could be hindered due to competition among offices: 

Again, there was no rule or policy about it, but I think the 

information-sharing at that level between offices was not 

always great. ... I sometimes sensed at the SEC that there 

was a bit of eat what you kill kind of – a bit of 

competitiveness between the offices. I’m sure we were that 

way and I know some of the regional offices were that way. 

So it felt a little bit like Corporate coming in when 

Washington would come in and do something without 

telling the regional offices, and I think, you know, I think 

on some level rightfully so, they didn’t like it. So should 

they have known? I assume, but after this process you’re 

going through, there may be a more formalized way that 

that information flows, but there wasn’t back then. 

Swanson Testimony Tr. at p. 113. 

133 
 2. OCIE Had Conference Calls with NERO About Madoff 

After receiving the e-mail, McCarthy believed he asked Swanson and Donohue to 

speak with Nee in NERO and “deal with the fact that we have two ongoing exams of the 

same firm at the same time or in near terms.” McCarthy Testimony Tr. at p. 113. 

McCarthy recalled that OCIE discussed the OCIE examination with NERO, stating, “I 

remember John Nee contacting us or me, but I don’t recall me discussing it clearly. I’m 

sure it was discussed with them.” Id. Sadowski, who currently reports to McCarthy in 

private practice, testified McCarthy told him he had a conversation with Nee, as follows: 

John did mention [] this conversation he had with Nee 

about this. ... Yes, yes, he is like, ‘I remember talking with 

Nee about it, that they were doing an examination of 

Madoff,’ and he was like that, ‘We talked to him’ because 

it is funny because he said that at first that Madoff didn’t 

even admit or something because when he [Nee] says here, 

‘When he finally admitted to executing trades for billions 

of dollars in customers,’ he kind of said that – John 

McCarthy told me that, ‘I thought that was a red flag’ in 

talking about it kind of now in the sense of why wouldn’t 

Madoff admit, because apparently it took him – when John 

Nee spoke to him, it took him [Madoff] a long time to kind 

of I guess admit that he was executing trades for hedge 

funds. 

Sadowski Testimony Tr. at pgs. 33-34. 

Swanson recalled “having a couple of calls” with the NERO examination team to 

explain what the OCIE examination team had done and to let NERO know that OCIE 

was shipping their examination documents to them, stating: 

Well, I don’t know if it was prompted by this particular email or if John Nee was the person that I spoke to, but I do 

know that at some point around this time period I had a 

conversation with NERO, it could have been John Nee, at 

which point, you know, I told him about the review that we 

had – that we had done and that was open, and he told me 

that they were doing a review that touched on the same 

issues. I – again, I don’t remember if it was John Nee that I 

spoke to, but it – it could have been, and I remember – I 

remember having a discussion about whether he was a 

hedge fund or wasn’t a hedge fund and, you know, what 

Bernie had told me way back when I had first spoken with 

him about how he was – had this black box and was an 

executing broker for these other hedge funds. But I recall 

at some point, and whether it was this conversation or a 

134 
subsequent one, but I recall, you know, telling him we’ll 

send him all of our files, the ones that they haven’t. 

... 

I remember having a couple of calls and, you know, one 

was – I think one was just to tell them what we have done 

or explain it a little bit and what we had or hadn’t found, 

and then the next one, if there was another one, and I think 

there may have been, was just to tell them we were 

shipping all the documents up to New York. It’s possible 

even that I had Mark make that call, but I – I don’t recall. 

Swanson Testimony Tr. at pgs. 111, 117. 

While Donohue recalled in the following testimony that there were 

communications with NERO about OCIE’s examination, he did not recall any specifics: 

I do not remember the specific communications 

themselves. I remember we forwarded everything to 

N[E]RO. I just do not remember. I do not remember 

verbal communications. 

... 

I know there was communication with N[E]RO regarding 

the examination. I do not remember the sequence of the 

communication and quite frankly whether I was involved in 

the communication other than the information in the 

documents. 

Donohue Testimony Tr. at pgs. 100-101, 103. 

3. NERO Examiners Recalled OCIE Warned them Madoff Was a 

Powerful and Influential Person 

The NERO examination team had a more specific recollection of the phone call 

with OCIE. As described in more detail in Section IV of this Report of Investigation, 

Nee and the examiners recalled that during the conference call, McCarthy, Swanson, or 

Donohue told them that Madoff was a powerful and well-connected individual. One of 

the NERO examiners interpreted the statement to raise a concern for OCIE about pushing 

too hard without having substantial evidence, while Nee interpreted the phone call to 

indicate that they might receive a phone call “from someone” influential, something that 

never occurred. Ostrow Testimony Tr. at pgs. 145-46; Nee Testimonmy Tr. at p. 104. 

135 
4. When OCIE Sent Examination Documents to NERO in June 2005, 

the Examination Was Unresolved 

On May 31, 2005, Donohue contacted the Madoff examination team and asked 

them to gather the documents to send to the New York Office. Former OCIE Attorney 

Advisor Testimony Tr. at p. 21; E-mail dated May 31, 2005 from Donohue to the Former 

OCIE Attorney Advisor, Walker, and Daugherty, at Exhibit 206. Donohue recalled it 

was difficult to locate the Madoff documents to send them to NERO. Donohue 

Testimony Tr. at pgs. 97-98. In an attempt to locate the documents, Wood e-mailed 

Walker the following: 

Mark is looking for the Madoff junk and I remember giving 

them to you so that we could have all the Madoff stuff in 

one central location. ... NERO needs to see some things on 

what we previously did. 

E-mail dated June 1, 2005 from Wood to Walker, at Exhibit 207. 

Walker told Donohue she “saw some boxes marked Madoff in the hallway last 

with some other items to be archived/stored.” E-mail dated June 2, 2005 from Walker to 

Davis and Donohue, at Exhibit 208. Walker implied she was surprised the examination 

papers were going to storage without the examination reaching a resolution, stating: 

It was the top box/my eye level, which is why I noticed it. 

But they were boxes, not file folders. I remember seeing 

them because I thought to myself, hmmm, ‘I never heard 

anything more about that case, but it’s going to storage.’ 

E-mail dated June 1, 2005 from Wood to Walker, at Exhibit 207. 

Donohue was not surprised Walker could not recall what happened to the Madoff 

examination because it was dormant for a significant period of time. Donohue Testimony 

Tr. at p. 100. Like Walker, Wood also recalled the examination was unfinished when 

they sent their examination materials to the New York office. Wood Testimony Tr. at p. 

62. McCarthy opined that, “It’s concerning” and “shows a certain level of inadequacy” if 

the Madoff examination operating under his supervision sat dormant for almost a year 

prior to the New York office contacting OCIE. McCarthy Testimony Tr. at pgs. 112-114. 

F. The OCIE Examination Concluded Without a Closing Report 

The examination team did not draft a closing report of the Madoff examination. 

Swanson Testimony Tr. at p. 117; McCarthy Testimony Tr. at p. 84. Swanson stated 

drafting a closing report at the conclusion of an examination is “good practice.” Swanson 

Testimony Tr. at p. 117. McCarthy concurred, stating, “Typically, staff is supposed to – 

when they finish an exam they’re supposed to close it out and I think there should have 

been a close-out memo is my understanding.” McCarthy Testimony Tr. at pgs. 84-85. 

136 
 

 

Swanson testified there may have been no report because no conclusions may have been 

formed in connection with the examination. Swanson Testimony Tr. at p. 119. 

Although the complaint was provided to the SEC in March 2003, after over two 

years had passed, the evidence shows that the OCIE never concluded the examination or 

resolved the many issues raised in the complaint. The lack of a closing report and 

Swanson’s e-mail to Nee copying McCarthy that “Ocie [sic] has an open exam of madoff 

on this issue” corroborate the fact that the examination was never concluded and 

contradict McCarthy’s testimony that he believed the examination was concluded when 

“Mark said they did not find any indicia of front-running.” McCarthy Testimony Tr. at p. 

84. 

Moreover, even if examiners had concluded there was no front-running, the other 

issues raised in the Hedge Fund Manager’s complaint had not been resolved. Gohlke 

stated if he were doing the examination and did not find front-running, then likely he 

would have continued the examination. Gohlke Testimony Tr. at p. 49. Similarly, Kelly 

stated if front-running was looked for and not found, she “might try a different angle”: 

... What we do from the investment adviser program is we 

follow the trades. We look at the transactions, we follow 

the assets, custodial arrangements, we look at it from a 

portfolio manager perspective. ... I would validate the 

performance – is this actually the performance derived. ... 

I would recreate the performance to see if it made sense, 

because at that point you would know, you know, were the 

trades real, would he have the ability to pay back cash. 

Kelly Testimony Tr. at pgs. 78-79. 

Donohue explained that there was no closing report because “from my mind, our 

exam was not closed. ...We never completed the work.” Donohue Testimony Tr. at p. 

101. Although he thought it was unusual for an examination to lay dormant for as long as 

it did, Donohue stated that “I think it is usual for the staff to be refocused on different 

priorities all the time. We had many things to do and not enough resources to do them 

all.” Id. 

On June 9, 2005, OCIE sent two boxes of examination documents, including the 

complaint and attachments from the Hedge Fund Manager, to NERO. Letter dated June 

9, 2005 from Wood to Nee, at Exhibit 209. The examination team did not recall OCIE 

drawing their attention to the complaint, which OCIE listed last in its list of enclosed 

documents. Ostrow Testimony Tr. at pgs. 119-122; Lamore Testimony Tr. at pgs. 109­

110. Neither did NERO recall OCIE providing them with any substantive information, 

such as telling them of the open questions they had from their examination or the 

inconsistencies the examination team identified. Lamore Testimony Tr. at pgs. 107-108; 

Ostrow Testimony Tr. at p. 122. After the documents were sent to NERO, there is no 

137 
evidence of any further telephone calls or collaboration between OCIE and NERO on the 

Madoff examination. 

G. Summary of FTI Engagement Team Expert Analysis 

The OIG retained the FTI Engagement Team to analyze the information that the 

OIG uncovered about the OCIE examination of Bernard Madoff’s firm and express an 

expert opinion on the overall adequacy of the examination and the question of whether 

OCIE should have uncovered the Ponzi scheme based upon the complaint and other 

information provided to them and the appropriate steps that should have been undertaken 

in an examination. The FTI Engagement Team concluded that multiple red flags were 

missed or were not pursued by the examination team. In addition, the FTI Engagement 

Team concluded that based upon issues raised in the complaint, had the examination been 

staffed and conducted appropriately, and basic steps taken to obtain third-party 

verifications, Madoff’s Ponzi scheme should and would have been uncovered. 

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 policies 

and procedures also would have allowed for appropriate personnel to monitor the status 

of the tips and could also have alerted personnel that additional action needed to be taken. 

The lack of these formal policies and procedures at least partially led to significant 

mistakes made by OCIE in its initial handling of the complaint. 

1. OCIE’s Analysis of the Complaint Was Inadequate For a Number 

of Reasons 

First, the content of the complaint directed that the SRO and Investment 

Management Groups should have collaborated on the analysis of the complaint and the 

conduct of the examination. The fact that the two examination programs operated as 

silos was an initial and critical mistake in the conduct of the examination. 

Second, despite that the complaint came from a credible source and that the 

Investment Management Group had emphasized that it should be taken seriously, the 

complaint was inadequately analyzed and the focus of the examination was chosen in 

error. The Associate Director and the Assistant Director on the examination did not even 

recall reviewing the complaint and believed they never spoke to the Hedge Fund 

Manager who submitted the complaint. These supervisors stated that they had chosen to 

focus on front-running, not because it was the subject of the complaint, but because it 

was the SRO Group’s area of expertise. In order to conduct an effective examination, the 

focus of the examination should be based on the allegations raised in the complaint rather 

than the expertise of a team. 

138 
 

 

 

 

 

Third, the complaint raised numerous issues outside of front-running that should 

have been considered significant red flags for the examiners to investigate, including the 

following: 

(1) BMIS’s unusual fee structure, in which it did not charge 

typical management and performance fees, leaving 

hundreds of millions of dollars of fees for his feeder funds 

that Madoff could have taken; 

(2) the volume of Madoff’s options trading was undetected 

in the market. Madoff had represented to the Hedge Fund 

Manager that he transacted options on CBOE, yet the daily 

option volume published by CBOE did not appear to reflect 

the options volume necessary to execute Madoff’s strategy 

and options traders stated they did not see Madoff’s 

volume; 

(3) BMIS’s returns were remarkable for the lack of 

negative returns and their consistency. Performance results 

provided for Kingate Global Fund, Ltd. and Fairfield 

Sentry Limited indicated consistently high returns over the 

past 12-15 years with unusually low volatility compared to 

the overall market. The extraordinary risk-adjusted returns 

and apparent superb market timing skills should have 

warranted further scrutiny by examiners and should have 

been included as an area of review during the 

examination;86 

(4) BMIS’s trading strategy was not duplicable by anyone 

the Hedge Fund Manager was aware of, which suggested 

that the examiners needed to determine whether the 

86 One widely recognized industry metric used to measure risk-adjusted performance is the Sharpe Ratio. 

It is calculated by subtracting the risk-free rate (i.e., 10-year U.S. Treasury bond) from the rate of return for 

a portfolio and dividing the result by the standard deviation of the portfolio returns. Sharpe Ratio statistics 

associated with the performance returns of a Madoff client were contained in the supporting documentation 

included in the Hedge Fund Manager’s complaint. The Sharpe Ratios provided show extraordinarily high 

risk-adjusted returns for two Madoff client funds when compared to the overall market, as indicated by the 

S&P 500 index. For an investment manager to so drastically and consistently outperform the overall 

market on a risk-adjusted basis, the manager would have to possess unusually superb stock picking and 

market timing skills over a consistently long period of time. For the time period covered by the 

performance statistics, this would include periods of economic recession (1990-1991, 2001) including 

numerous disruptions to the market caused by the collapse of the dot-com bubble, the September 11th 

attacks and massive accounting scandals involving Enron, WorldCom, etc. Even so, a fund marketing 

presentation provided with the Hedge Fund Manager’s complaint describes how the underlying manager 

[Madoff] ranks in the “top 1% of all US securities firms,” with “90% of months profitable,” and “largest 

losing month [of only] -0.72%.” Additional fund marketing materials further describes the manager’s 

“edge” to include among other things, “An exquisite sense of timing, as to when to initiate and de-activate 

the strategy.” 

139 
 

 

strategy was legitimate and therefore should have been 

included as an area of review during the cause examination; 

(5) BMIS’s long-term returns did not correlate to the 

overall equity market. Per the Trading Authorization 

Directive agreements between BMIS and its clients, the 

split strike conversion strategy explicitly requires a basket 

of stocks that have a very high correlation (95%) with the 

S&P 100 index (OEX). Stocks included in the OEX are 

generally among the largest and most established 

companies in the S&P 500 index. As such, the OEX 

generally provides a good measure of the market’s overall 

performance. Based on the broad index utilized as the 

basis for BMIS’s strategy, certain industry observers 

believed that BMIS’s returns over time should generally be 

correlated to the overall equities market; however, they 

were not. The discrepancy between BMIS’s returns and the 

returns of the overall equity markets is an issue that should 

have been included for consideration in the scope of the 

examination; 

(6) BMIS accounts were typically in cash at month end. 

An examiner might reasonably suspect “churning”87 of 

customer accounts. At the very least, accounts that are 

typically in cash at month end should raise the question as 

to why systematically converting assets under management 

of $10 billion into cash every month would be appropriate 

for the split-strike strategy. Therefore, the examination 

should have included a review to determine whether BMIS 

was churning its accounts and also should have determine 

if going to cash at month’s end was appropriate for the 

split-strike strategy; 

(7) BMIS used no independent brokers and generated its 

own account statements. These particular concerns 

identified serious conflicts of interest that put clients’ assets 

at risk. Without an independent broker or custodian, there 

would be no independent “gatekeeper” in place to 

safeguard the clients’ assets. These issues should have 

been investigated thoroughly by examiners and certainly 

87 “Churning” generally refers to the excessive buying and selling of securities in an account by a broker, 

for the purpose of generating commissions and without regard to the client’s investment objectives. 

Churning can be a violation of SEC Rule 15c1-7 and other securities laws. For churning to occur, a broker 

must exercise control over the investment decisions in the account, either through a formal written 

discretionary agreement or otherwise. Madoff had such discretion in its discretionary brokerage accounts. 

140 
should have been included in the Planning Memorandum; 

and 

(8) The auditor of BMIS was a related party. The lack of 

an independent auditor further exacerbated the potential 

concerns with regard to the safety of clients’ assets. 

Without an independent auditor, there could be no 

assurance that the audits of Madoff were properly 

conducted. Such potential conflicts should have heightened 

the 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 performance results and the safety of 

client assets from misappropriation. Based on the 

information provided in the complaint, such a review 

should have been included as an area for review during the 

cause examinations. 

Fourth, the complaint should have been deemed especially credible because the 

MARHedge and Barron’s articles substantiated many issues raised in the complaint. For 

example, the articles discussed that the options volume needed to implement the splitstrike conversion strategy for $8-$10 billion in assets under management should have 

been seen by industry professionals who attempted to identify it but it was not; there was 

doubt as to whether or not BMIS really was implementing the full strategy; no one had 

been able to duplicate BMIS’ purported split-strike conversion strategy; there was no 

correlation to the overall equity markets (i.e., lack of volatility); the accounts were 

typically “in cash at month end”; and there were questions as to why Madoff was willing 

to forego management or incentive fees. The substantiated nature of the Hedge Fund 

Manager’s concerns deserved thorough scrutiny by Commission examiners. 

Overall, an adequate analysis of the complaint should have led to the cause 

examination focusing on the many other issues raised in the complaint in addition to 

front-running. While there was no specific mention of a Ponzi scheme per se in the 

complaint, an examination based upon that complaint should have analyzed how Madoff 

could have achieved these types of returns, including the possibility that he did not 

actually conduct any trading. 

2. The Team Assembled for Cause Examination was Inadequately 

Experienced in Investment Management Issues 

Another failing in the OCIE examination was in the inexperience of the team 

assembled for the examination. The complaint included issues typically examined by 

investment adviser personnel including verification of purported investment returns and 

account balances. The SRO Group had no significant experience conducting 

examinations of these issues. OCIE management acknowledged that its investment 

adviser personnel would have known to look specifically at the investment returns and 

141 
 

 

verify custody of the assets; yet such personnel were not contacted for assistance. 

Personnel should have been assigned with a strong background in Investment 

Management regulation and derivatives/options trading strategies, something no one on 

the team possessed. In addition, personnel should have been assigned with a strong 

understanding of discretionary brokerage accounts and proper custodial procedures for 

such accounts. Without properly skilled examiners, many of the issues that were raised 

in the complaint and the Barron’s and MARHedge articles remained unresolved. 

3. The Start of the Examination Should Not Have Been Delayed for 

Seven Months 

In addition, given the severity of the allegations in the complaint, a cause 

examination should have started soon after the complaint was received. A seven month 

delay from the time the complaint was received until the start of the examination was an 

unreasonably long period of time due to the urgent nature of the examination. OCIE did 

not monitor the status of the complaint and no one within management took ownership or 

responsibility for timely resolution of the complaint. As a result, the complaint was left 

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

action needed to be taken. 

4. The Examination Should Have Been Logged Into the STARS 

System 

The examination should have been logged into the Super Tracking and Reporting 

System (STARS), which is used to monitor the status of all examinations being 

conducted by OCIE. However, OCIE’s SRO Group failed to log their examination 

information into STARS and regularly did not log examination information into the 

system. Because the examination was not logged into STARS, the NERO office would 

not have known that OCIE had been conducting an almost identical examination to the 

one NERO initiated. The failure to properly track the examination and coordinate among 

offices resulted in embarrassment and a waste of Commission resources as two 

examination teams from two different offices essentially conducted the same 

examination. 

5. The Planning Memorandum Was Too Narrowly Focused and Not 

All Courses of Action Were Followed Through Upon 

The Planning Memorandum was further evidence that the examination was too 

narrowly focused. The Planning Memorandum failed to address several critical issues 

from the complaint, including the unusual fee structure; not seeing the volume of options; 

remarkable returns; trading strategy not duplicable; no correlation to actual equity 

markets; accounts in cash at months end; no third-party brokers; and that the auditor of 

firm is a related party. 

Courses of action in the Planning Memorandum that involved going to third 

parties should have been followed through upon, but were not. For example, the staff 

142 
drafted a letter to the NASD, which was critical to any adequate review of the complaint 

because the data and information from the NASD would have assisted in independently 

verifying trading activity conducted at BMIS. It would also have allowed for the specific 

data necessary to examine whether or not BMIS was front-running its broker-dealer 

customers. OATS data for instance, would have provided the time of each customer 

order, which was needed to compare to the execution times of trades for the discretionary 

brokerage accounts. Had the letter been sent out and information received, the NASD 

would have provided order and execution data that would have indicated BMIS did not 

execute the significant volume of trades for the discretionary brokerage accounts that 

Madoff represented to the examiners that he executed and would have provided the 

information necessary to reveal the Ponzi scheme. 

It was also a mistake not to send the letter to the hedge funds as outlined in the 

Planning Memorandum. The Hedge Funds could have confirmed that BMIS had full 

discretion over their accounts as well as details regarding the implementation of the 

trading strategy for those accounts. They could also have confirmed the number of 

accounts they had with BMIS in order to confirm whether Madoff was accurately 

reporting those accounts to OCIE staff. 

6. There Were Numerous Red Flags in the Course of the Examination 

that Were Not Pursued 

During the course of the examination, the examination team obtained suspicious 

information and evidence, but failed to follow up on numerous “red flags.” The 

responses by Madoff to the document requests were suspicious and contradicted the 

complaint and the 2001 articles. BMIS’s response claimed “... Neither Madoff 

Securities, nor any person or entity affiliated with Madoff Securities, manages or advises 

hedge funds,” yet the articles reported that Madoff was managing billions of dollars in 

assets. BMIS further claimed, “Because of the limited scope of brokerage execution 

service we provide and the fully automated and electronic nature of our business, there 

are no other communications or other correspondence between Madoff Securities and 

their clients utilizing the split strike forward conversion. Madoff Securities does not 

communicate or correspond with the investors or owners of its clients.” OCIE examiners 

were suspicious about Madoff’s response regarding such communications, especially 

since BMIS, a company known for its advanced technology, was claiming not to have email communications with clients. However, they did not follow up on these red flags. 

In addition, the examination team spoke with the Hedge Fund Manger but did not 

follow up on issues raised in the call that were outside of front-running. During the call, 

doubts were expressed about replicating BMIS’s strategy and there were concerns with 

regard to the lack of transparency in the options volume, even though BMIS was 

reportedly managing $7-12 billion in assets under management. Furthermore, the Hedge 

Fund Manager indicated that he was never able to understand the nature of the returns, a 

point that was also raised in the MARHedge and Barron’s articles. Such issues were not 

pursued. 

143 
Further, inconsistencies detected by the examiners during the examination raised 

even more suspicions. BMIS’s claim to neither manage nor advise hedge funds was not 

believable because the accounts had the hallmarks of advisory accounts – the trading 

authorization directives for BMIS’ discretionary accounts were not temporary and not 

limited to price, time or other parameters. 

BMIS’s responses to the second document request also should have raised 

suspicions because the information provided appeared incomplete and at times, 

inconsistent when compared to other information provided. For example, Madoff’s 

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

for each transaction. As a result, the information could not have allowed the examination 

team to thoroughly conduct a front-running examination. Based on the numerous 

questions raised by the examination team with regard to differing trade patterns for 

certain clients, there should have been significant suspicions as to whether or not Madoff 

was implementing the strategy as claimed. 

Notwithstanding these red flags and unresolved issues, the examination was 

allowed to “fall through the cracks.” Given the serious allegations in the complaint, and 

the suspicions that should have been aroused during then exam, this matter should have 

been given priority and not pushed aside in favor of other projects. Where there are 

significant unresolved questions, examinations should not be pushed aside for long 

periods of time and left unresolved. 

7. SEC Offices Failed to Communicate 

The examination process was also hindered by a lack of communication between 

SEC offices. Two examinations were conducted by different offices simultaneously and 

independently without any sharing of resources and expertise. Moreover, when the two 

offices finally communicated with each other about their respective examinations, OCIE 

had only a few conversations with NERO about its examination, and should have 

provided significantly more information to NERO about the complaint that precipitated 

their examination, the work they did, the findings and inconsistencies. 

In addition, the lack of a closing report or an understanding of what OCIE had 

concluded was a critical error because significant resources (time and personnel) were 

necessary in order to conduct the cause examinations. The lack of a closing report results 

in ambiguity and confusion when it is necessary at a later time to recall all activity 

conducted during an examination months or years later. 

8. The Investment Adviser Issue Was Never Resolved 

Although the examination was expanded to consider whether Madoff was 

required to register as an investment adviser and examiner resources were spent 

researching the issue and drafting a memorandum, the issue was never fully pursued and 

never resolved. Madoff registered as an investment adviser in 2006, at least two years 

after the team considered the issue. If Madoff had been forced to register in 2004, it is 

144 
 

 

 

possible he would have been examined by investment adviser examiners and his Ponzi 

scheme discovered prior to December 2008. 

9. FTI Engagement Team Conclusion 

A compelling and credible complaint was provided with several significant red 

flags. However, the exam was not staffed appropriately, delayed in outset, focused too 

narrowly, conducted without obtaining critical independent data and undertaking basic 

steps needed to address obvious suspicions, not given adequate priority, closed with 

unresolved issues remaining, and conveyed to NERO without full information. Because 

of these mistakes, an opportunity to uncover Madoff’s Ponzi scheme was missed. 

IV. SEC 2005 NERO EXAMINATION OF MADOFF 

A.	 NERO Investment Adviser Examiner Discovered Renaissance 

Technologies E-mails Questioning Whether Madoff Was Involved in 

Illegal Activity 

In April 2004, Thomas Thanasules, a securities compliance examiner in the 

Investment Management Examination Group88 of the Northeast Regional Office 

(NERO),89 conducted a routine examination of Renaissance Technologies LLC 

(Renaissance). While reviewing internal Renaissance correspondence, he discovered emails from November and December 2003 that “rais[ed] questions” about whether 

Madoff was involved in illegal activity involving managed accounts. Memorandum 

dated April 22, 2004 from Eschwie to Sollazzo, at Exhibit 210. 

Thanasules e-mailed his Branch Chief, Diane Rodriguez,90 about his findings, 

explaining that Renaissance had an indirect investment with Madoff through a “total 

return swap agreement with another entity (‘HCH’91).” Id. at p. 3. The underlying 

investment held by HCH was managed by Madoff. Id. Thanasules also sent Rodriguez 

the text of three of the Renaissance e-mails. Id. 

The first e-mail, dated November 13, 2003, was from Nat Simons, the portfolio 

manager for Renaissance’s Meritage fund, a hedge fund of funds. Meritage held the 

indirect investment with Madoff through a swap agreement with HCH. Simons Interview 

Tr. at p. 5. Simons expressed concern that they did not understand how Madoff was 

making money or why he used a fee structure that gave such a large percentage of profits 

88 NERO Assistant Regional Director Dorothy Eschwie explained that although the NERO examination 

program is part of OCIE, “We don’t call ourselves OCIE because ... we are used to calling the Washington
 

office OCIE. But I think the whole examination inspection program is under the direction of L[ori] 

Richards, so we would all be part of that program. It’s just that in the regions we’re separated [into]
 

investment management and broker-dealer.” Eschwie Testimony Tr. at 8.
 89 The SEC changed the name of the Northeast Regional Office (NERO) to the New York Regional Office 

(NYRO) on March 30, 2007. See http://www.sec.gov/news/press/2007/2007-59.htm. 

90 Ms. Rodriguez is deceased. Eschwie Testimony Tr. at p. 37. 

91 HCH appears to be a reference to HCH Capital Ltd., an affiliate of Khronos, LLC. Simons Interview Tr. 

at p. 9. 

145 
 

to feeder funds. E-mail dated November 13, 2003 from Nat Simons to Jim Simons et al, 

at Exhibit 211. Simons also stated in the following e-mail that there were rumors from 

industry insiders that Madoff was cherry-picking trades and that a related party was his 

auditor: 

Committee members, 

We at Meritage are concerned about our HCH investment 

[Renaissance’s indirect investment with Madoff]. First of 

all, we spoke to an ex-Madoff trader (who was applying for 

a position at Meritage) and he said that Madoff cherrypicks trades92 and “takes them for the hedge fund.” He said 

that Madoff is pretty tight-lipped and therefore he didn’t 

know much about it, but he didn’t really know how they 

made money. [A colleague] heard a similar story from a 

large hedge fund consultant who also interviewed an extrader. The head of this well-respected group told us in 

confidence that he believes that Madoff will have a serious 

problem within a year. We are going to be speaking to him 

in 11 days to see if we can get more specifics. 

Another point to make here is that not only are we unsure 

as to how HCH makes money for us, we are even more 

unsure as to how HCH makes money from us; i.e. why 

does [Madoff] let us make so much money? Why doesn’t 

he capture that for himself? There could well be a 

legitimate reason, but I haven’t heard any explanation we 

can be sure of. Additionally, there is a $4 billion Madoff 

pass-through fund (Fairfield Sentry) that charges 0 and 

20% and it’s not clear why Madoff allows an outside group 

to make $100 million per year in fees for doing absolutely 

nothing (unless he gets a piece of that). The point is that as 

we don’t know why he does what he does we have no idea 

if there are conflicts in his business that could come to 

some regulator’s attention. Throw in that his brother-in-law 

is his auditor and his son is also high up in the organization 

and you have the risk of some nasty allegations, the 

freezing of accounts, etc. To put things in perspective, if 

HCH went to zero it would take out 80% of this year’s 

profits. 

92 According to the FTI Engagement Team, cherry-picking is generally a scheme in which trades, once 

they are determined to be favorable, are allocated by a trader to a favored account at the expense of other 

accounts. Former OCIE Director Lori Richards defined cherry-picking as “trading and then deciding which 

account to allocate the trade to after it’s done. After you know whether it’s profitable then you decide 

which account gets it. So, you cherry pick the profitable trades and put them in a favored account and 

leave other accounts with losing trades. It’s a violation of the law if it’s not disclosed as such.” Richards 

Testimony Tr. at 96. 

146 
Perhaps the best reason to get out is that we really don’t 

expect to make an outsized return on this investment. Sure 

it’s the best risk-adjusted fund in the portfolio, but on an 

absolute return basis it’s not that compelling (12.16% 

average return over [the] last three years). If one assumes 

that there’s more risk than the standard deviation would 

indicate, the investment loses it[]s luster in a hurry. 

It’s high season on money managers, and Madoff’s head 

would look pretty good above Elliot Spitzer’s mantle. I 

propose that unless we can figure out a way to get 

comfortable with the regulatory tail risk in a hurry, we get 

out. The risk-reward on this bet is not in our favor. 

Please keep this confidential. 

Nat [Simons] 

Id. 

The following day, Henry Laufer, a research scientist at Renaissance, responded 

to Simons’ e-mail. Laufer stated that Renaissance had “independent evidence” that 

Madoff’s executions were “highly unusual” and agreed with Simons’ conclusion that if 

they could resolve their concerns, they should divest themselves of their Madoff-related 

investment: 

I share the concern at Meritage about the HCH investment. 

In Nat’s note, I am most worried about the new information 

in the statement that “Madoff cherry-picks trades and ‘takes 

them for the hedge fund’.” We at Renaissance have totally 

independent evidence that Madoff’s executions are highly 

unusual. 

I do not know what to make of the consultant saying 

“Madoff will have a serious problem within a year.” 

In all, I very much agree with the sentiment[,] “It’s high 

season on money managers, and Madoff’s head would look 

pretty good above Elliott Spitzer’s mantle. I propose that 

unless we can figure out a way to get comfortable with the 

regulatory tail risk in a hurry, we get out. The risk-reward 

on this bet is not in our favor.” 

147 
A last quote, from Jim, I believe: “If you are going to 

panic, panic early.” 

Henry [Laufer] 

E-mail dated November 14, 2003 from Laufer to Simons, at Exhibit 212. 

In the final e-mail on November 21, 2003, Paul Broder, the risk manager at 

Renaissance, provided a step by step analysis of why he did not think that Madoff was 

actually trading options as indicated by Madoff’s customer statements: 

I have kept this note to a restricted circulation: 

I had some further conversations with MRB on the Madoff 

data. I also looked at some daily volume data on and 

around the OEX option transaction dates as indicated by 

Madoff’s statements. 

I was specifically trying to address the question of how big 

a fund base can [M]adoff trade with this strategy by 

focusing on the option volume numbers. 

1.	 Recall that Madoff’s strategy involves a collar, that is a put 

and a call. The volume numbers provide total calls 

executed on the OEX and total puts. In the two 

independent set of statements which MRB analyzed the 

strikes were always the same for both accounts. Make the 

generous assumption that 50% of the volume was in the 

most liquid strike (it seems to average 25-25%) 

By this measure Madoff could only do $750m. That is with 

him doing 100% of the option volume in his chosen strike 

(with the generous 50% assumption). Let’s assume that he 

spreads it over 3 days – so we get to 2.1bln – still far short 

of the target numbers. 

2.	 Another important point: In every case that MRB 

examined the options strike (call) is the one closest to the 

close in the underlying market. Of course the market is not 

known until the close!! Does this mean that all the options 

are done almost at the close? 

3.	 The volume does seem to spike on the days that Madoff is 

executing by a factor of 3-4. This must produce a 

deterioration in execution prices – and for 15bln! 

148 
4.	 When we examined the issue before, we concluded that 

maybe he does the options in the OTC market. We have 

spoken to several market makers in OTC equity options. 

Recall that Raf stated that Madoff had said it was necessary 

to spread trades over several days – why if you are doing 

OTC? 

5.	 Recall point 2. This would indicate that the OTC options 

would also have to be done at the end of the day (to get a 

strike near the close). Are we to believe that the market 

makers would take on $15bln of market risk at the close? 

Of course they might (might!!!) be willing to take the 

options risk if Madoff provided the market hedge in the 

underlying (ie they did the whole package with Madoff) but 

we already know that the trades in the underlying, 

compared with the closing prices, would leave the OTC 

counterparty showing losses (as our account always shows 

gains). 

6.	 Of course ALL of our trades are with Madoff as the 

principal – so our option positions are OTC with Madoff so 

he can choose to use any strike, and any total volume he 

chooses, but the risk must be covered somewhere if he is 

doing the trades at all? 

So we need an OTC counterparty (not necessarily a bank) 

who is willing to do the basket of the options plus the 

underlying with Madoff at prices unfavorable for the OTC 

counterparty – in 10-15bln!!! 

Any suggestions who that might be? 

None of it seems to add up. 

Paul [Broder] 

E-mail dated November 21, 2003 from Broder to Simons, at Exhibit 213. 

B.	 Renaissance Employees Suspected Madoff Was Misrepresenting His 

Trading 

1.	 Madoff’s Secrecy, Auditor, and Non-volatile Returns Were 

 Significant Red Flags 

At the outset, the rumors and mystery surrounding Madoff made some 

Renaissance employees uneasy. Simons had heard Madoff kept a restricted floor at 

149 
 

 

BMIS. Simons Interview Tr. at pgs. 44-45. The secrecy of the floor coupled with the 

rumors about the lack of auditor independence was a red flag for Simons. Id. at p. 45. 

Similarly, the small size of Madoff’s auditor was an issue for Broder because Madoff was 

reportedly managing billions of dollars for investors. Broder Interview Tr. at p. 33. But 

it was Madoff’s steady, non-volatile returns that initially made Broder “suspicious.” Id. 

at p. 9. As Broder explicated, “He should have more volatility in his returns than he 

actually stated. ... It was just too steady.” Id. at pgs. 9-10. Broder noted that no matter 

what happened in the market, no matter what crisis occurred, Madoff’s returns remained 

almost the same. Id. at p. 9. 

2. Madoff’s Fee Structure Was a Significant Red Flag 

Simons also found that “on its face,” Madoff’s fee structure was illogical. Simons 

Interview Tr. at p. 18. Simons did not understand why Madoff would allow feeder funds 

to take hundreds of millions of dollars in fees that Madoff could have kept for himself: 

“[W]hen you see a situation where it would appear that he’s only making money off of 

his ... brokerage fees, why is he letting the Fairfield Greenwiches of the world take 2 

points? I don’t know.” Id. at pgs. 17-18. Simons explained why he thought it was 

illogical for Madoff not to retain the fees for himself: 

[Madoff] supposedly has excess demand for his product 

and – you know, normally you see third party marketers in 

situations where there is [not] enough demand for the 

product. ...They need the third party marketer to help them 

raise money. ... In Madoff’s situation, when there ... was 

plenty of pent-up demand for his product, which would 

mean that you just kind of hire a couple of guys and set 

them up in offices, and you could raise money all day. And 

so why not just capture that for yourself, build your own ... 

sales and marketing team in-house? Why continue to 

outsource it to Fairfield. 

Id. at pgs. 20-21. Laufer estimated that Madoff could be foregoing $200 million a year in 

fees, something he and Broder found unusual. Broder remarked, “[R]emember at the 

time he had a fantastic system but he didn’t charge anybody any fees. That seemed a 

little bit strange.” Laufer Interview Tr. at pgs. 42-43; Broder Interview Tr. at p. 10. 

Simons’ only possible explanation for Madoff’s fee structure was to speculate that there 

might be “some underlying agreement between Fairfield and Madoff, and maybe some of 

that [fees] could come back to him. ... Maybe he had an interest in Fairfield.” Simons 

Interview Tr. at p. 23. 

150 
 

 

 

 

3.	 Renaissance Examined Madoff’s Reported Equity and Options 

Trading Using Widely Available Information 

The unresolved questions about their Madoff-related investment led Renaissance 

to take a closer look. Because they did not hold a direct investment with Madoff,93 they 

had to perform due diligence using only publicly available information and customer 

statements provided to them by two other Madoff clients. Laufer Interview Tr. at pgs. 

15-16; Broder Interview Tr. at pgs. 13-14. They had no communications with Madoff or 

BMIS. Broder Interview Tr. at p. 14. 

Simons explained that one reason they did not report their suspicions to the SEC 

directly was that they felt all of the information they were using in their analysis was 

readily available to the SEC: 

We did feel that despite the fact that we’re kind of smart 

people, we were just looking at matters of public record. I 

mean, you know, it wasn’t hard to get these statements. 

These statements, you know, hundreds of – lots and lots 

and lots of people had Madoff statements. So we didn’t 

really feel that we were dealing with something which is 

proprietary, and therefore the conclusions that we came to 

were something that was – you know, other people were 

unlikely to come to. And it’s not like we needed a PhD in 

mathematics to do the ... study on the OEX.94 Right? I 

mean, this is just – just looking at the size of the market. 

Simons Interview Tr. at p. 48. 

4. Madoff’s Stock Predictions Were Too Good to Be True 

As part of Renaissance’s due diligence, they analyzed Madoff’s reported trading 

and returns. Madoff claimed to be using a split-strike forward conversion strategy, which 

was described in a 2001 article in MarHedge as consisting of “buying a basket of stocks 

closely correlated to an index, while concurrently selling out-of-the-money call options 

on the index and buying out-of the money put options on the index.” Michael Ocrant, 

Madoff Tops Charts; Skeptics Ask How, MARHedge, May 2001, at Exhibit 146. Madoff 

93 Renaissance invested with Madoff indirectly because Madoff would not accept a direct investment from 

them. Broder Interview Tr. at pgs. 6-7. Broder speculated that the reason for Madoff’s refusal was that 

Renaissance employees “were too smart.” Id. at p. 6. 

94 The OEX is “[t]he ticker symbol for the Standard & Poor's 100 Index.” See 

http://www.investopedia.com/terms/o/oex.asp. “The S&P 100 is a market-capitalization weighted index of 

100 stocks from a broad range of industries.” Id. According to the FTI Engagement Team, “stocks 

included in the OEX are generally among the largest and most established companies in the S&P 500 

index. As such, the OEX generally provides a good measure of the U.S. equity market’s overall 

performance.” 

151 
 

further claimed to trade baskets of stock “made up of 30-35 stocks most correlated to the 

S&P 100 index.” Id. 

To examine whether Madoff’s stated investment strategy could be producing his 

reported results, Laufer, who specialized in equity trading, supervised an analysis of 

Madoff’s purported stock trading while Broder analyzed the options trading. Laufer 

Interview Tr. at pgs. 13, 51. Laufer’s team found Madoff was reporting on his customer 

statements that he had purchased stocks at extremely low prices and sold stocks at 

extremely high prices. Id. at p. 17. Laufer explained, “this was statistically almost 

impossible to do if you were trading in an ordinary way.” Id. “[I]f you looked at those 

monthly statements and looked at the executions of the stock side, that the prices were 

just too good from any mode of execution that we were aware of that was legitimate.” Id. 

at p. 44. “And we would have loved to figure out how he did it so we could do it 

ourselves. And so that was very suspicious.” Id. at p. 28. 

Simons and Broder shared Laufer’s view of Madoff’s claimed executions, stating, 

“[W]e observed that he got extraordinarily good fills95,” and if the fills were legitimate, 

then Madoff’s predictions for when to buy and sell stocks would have been much better 

than anyone else that Broder had ever seen. Simons Interview Tr. at p. 34; Broder 

Interview Tr. at pgs. 15-16. Broder stated, “Well, I knew it wasn’t possible because of 

what we do.” Id. at 16. 

Renaissance also noticed that Madoff’s predictions for when to stay out of the 

stock market were extraordinary. The customer statements showed that at certain points 

“his position would go to zero [go to cash]. It seemed to us that the quarters that he’d 

decide to go to zero were exceptionally good quarters to have no position. ... It seemed to 

us that those quarters in which he decided to go into zero cash were quarters in which, if 

you blindly tried to do what he was doing, you would have lost money, it seemed to us. 

... We had no idea ... how he managed to do that. ... We didn’t understand what he was 

doing. We didn’t understand how he was doing what he was doing.” Laufer Interview 

Tr. at pgs. 22-23. 

5.	 Cherry Picking Was an Unlikely Explanation for Madoff’s 

Incredible Fills 

Renaissance determined it was unlikely Madoff’s incredible fills were the result 

of cherry picking the best trades for his institutional clients because of the large number 

of customers they estimated Madoff had. Renaissance made “estimates ... about how 

large [Madoff] might be ... based on some attempts to aggregate information that we had 

in terms of Fairfield and other feeder funds that we were aware of.” Simons Interview 

Tr. at p. 29. “So for a small account, you could somehow manage to imagine that he has 

this whole big operation, and he picks off a few trades and he puts them in, and he could 

95 A “fill” is “the action of completing or satisfying an order for a security or commodity. It is the 

basic act in transacting stocks, bonds or any other type of security.” See 

http://www.investopedia.com/terms/f/fill.asp. According to the FTI Engagement Team, “good fills” refer 

to favorable execution prices. 

152 
 

physically do it. But you have to wonder whether he could do it for a large” operation. 

Laufer Interview Tr. at p. 29. “So it’s a question of scale, of how many customers you 

have versus how many you want to cherry-pick.” Id. at p. 31; see also E-mail dated 

November 14, 2003 from Broder to Brown, at Exhibit 214 (e-mail questioning the 

possibility of cherry picking). 

6. Madoff Was Misrepresenting His Options Trading 

The most detailed reasoning for why Renaissance suspected Madoff was 

misrepresenting his trading came from Broder’s analysis of Madoff’s claimed options 

trades. In his November 21, 2003 e-mail, Broder concluded 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 that Madoff could find counterparties for the 

trading. Memorandum dated April 22, 2004 from Eschwie to Sollazzo, at pgs. 5-6, at 

Exhibit 210; Broder Interview Tr. at p. 37. Laufer further explained, “[W]e made 

inquiries. We didn’t see anybody saying he did a lot of trading. We didn’t understand 

why anybody in the business of options would take the other side. ... [Y]ou ask yourself, 

why would somebody do this? Because he’s going to lose money doing the trade, so far 

as we know.” Laufer Interview Tr. at pgs. 25, 49.96 

After concluding Madoff was not trading options, Renaissance had no reason to 

come to a final conclusion that he was engaged in fraud. The unanswered questions were 

enough reason to begin divesting themselves of their investment with Madoff. Simons 

Interview Tr. at pgs. 37-38; Broder Interview Tr. at pgs. 34-35. Broder explained their 

reasoning, as follows: 

I came to the conclusion that we didn’t understand what he 

was doing. We had no idea how he was making his money. 

The numbers, the volume numbers that he suggested he 

was doing was not supported by any evidence we could 

find. And, you know, that in itself should just mean we get 

out. 

Broder Interview Tr. at p. 35. 

7.	 Renaissance Employees Felt the SEC Could Have Verified 

Whether Madoff Was Trading Options By Taking Elementary 

Steps 

While Renaissance did not have the authority to force Madoff to reveal his trading 

counterparties, Renaissance employees believed that regulators, such as the SEC, could 

have verified whether Madoff was executing his purported options trades. Broder 

96 According to the FTI Engagement Team, a counterparty is a party to a contract that essentially serves as 

the trading participant on one particular side of a trade. If Madoff’s options trades were always profitable 

for Madoff, as indicated in the Renaissance e-mails, there is little or no incentive for a counterparty to 

continuously take the other (i.e., unfavorable) side of those trades since they would lose money. 

153 
thought the first step a regulator reading the e-mails would have taken was to verify that 

Madoff was actually trading: 

But if you’d read the e-mails ... you would have thought 

the question would come to mind, hey, these guys are 

debating whether he could possibly be doing this volume. 

Let’s – the next step will be let’s try to verify that he did 

this volume. ... And the first time you checked a trade, you 

would have found it’s not there. 

Id. at pgs. 25-26. 

Broder thought a regulator could have verified whether Madoff was trading by 

asking Madoff who his counterparty was and then verifying with the counterparty that the 

trade took place. Id. at pgs. 21-22, 38. Broder stated he would have performed the same 

verification process whether Madoff claimed his counterparty was in the United States or 

in Europe. Id. at p. 23. Broder explained, as follows, why he thought going to Madoff’s 

alleged counterparties would have been a simple step for a regulator: 

[S]omewhere in the marketplace, either in an exchangetraded marketplace or an OTC marketplace, exactly those 

trades which were on the client account statement should 

exist on someone else’s books, you know. ... Somewhere 

in the marketplace, either OTC or exchange-traded, those 

trades were taking place. And it seems to me a very simple 

set of steps to verify that those volumes [existed]. ... I 

don’t see how that could have possibly been missed. I 

mean, this is a very simple verification. I mean this guy is 

trading – this is a cash account. So he’s turning over $10 

billion of stocks each particular month. I mean, you’ve got 

to be [able to see it] in the marketplace. 

Id. at pgs. 25-26. 

Laufer also felt that a regulator conducting a thorough review of the e-mails 

would have had to have asked, “Who took the other side of the trade? You don’t have to 

deduce huge amounts. Just ask who took the other side of the trade, which of course we 

couldn’t find that [out].” Laufer Interview Tr. at pgs. 27-28. Likewise, if Simons were 

investigating Madoff, he stated that he would have asked Madoff to “show me the other 

side of your trades” whether Madoff claimed to trade in the United States or Europe. 

Simons Interview Tr. at pgs. 36-37. As Simons explained, “I need to see the other side of 

those trades in Europe. If they’re in Europe, that’s fine, but you’re doing them with 

someone. There’s got to be somebody on the other side of the trade.” Id. 

154 
 

 

 

Laufer asserted that someone at the SEC should have been able to do the same 

analysis and draw the same conclusions Broder did without determining whether or not 

Madoff was front-running: 

A: ...This is not rocket scientists. This is not rocket 

science. 

Q: Do you think that someone from the SEC should be 

able to figure this out? 

A: Much more elementary than that. Someone at the 

SEC could wander down, you know, to Goldman 

Sachs and wander over to their options department 

and ask them, how does somebody execute $10 

billion of options, and find out it’s very difficult. 

This is not ... proprietary Renaissance analysis 

here. ... Paul Broder would not claim to be a 

mathematician, and he’s an expert of this, and he’s 

very smart. But you don’t have to be as smart as 

Paul Broder is to do what he says here. 

Laufer Interview Tr. at pgs. 49-50. 

8. The SEC Had the Expertise to Perform Broder’s Analysis 

Stewart Mayhew, the SEC’s current Deputy Chief Economist,97 reviewed 

Broder’s options analysis and felt the SEC’s Office of Economic Analysis (OEA) was 

capable of providing a similar analysis. Mayhew provided a summary of Broder’s 

analysis: 

This e-mail describes trading volume in the S&P 100 

options, which are traded on the CBOE. The document is 

indicating that the trading volume in that market is not high 

enough to be consistent with a claim that a market 

participant is following a split strike conversion strategy 

using S&P 100 options on a huge scale. 

Mayhew Testimony Tr. at p. 37. 

97 Mayhew first came to the SEC in 2002 as a Visiting Academic Scholar in the Office of Economic 

Analysis (OEA). Mayhew Testimony Tr. at 7. In 2004, he took a permanent position with the SEC as 

Assistant Chief Economist. He was appointed Deputy Chief Economist in July 2008. Id. at 7-8. 

155 
 

Mayhew could not confirm the accuracy of the analysis without verifying the numbers, 

but stated Broder’s approach to his analysis appeared to be logical: 

I do agree it is something that makes sense to look at. If 

somebody is saying they are doing a certain strategy it 

would make sense to go out and look at the trading volume. 

If the scale of the strategy they are claiming to follow is 

significantly larger than the available liquidity of volume in 

that market, then that would be a red flag that they were not 

telling the truth. 

Id. at pgs. 37-38. 

When asked if this was a difficult analysis to perform, Mayhew indicated that it 

was not, and stated he could do it easily: 

No. It looks to me like all they are doing is looking at 

trading volumes on certain days. If I had specific 

information about what Madoff’s purported strategy was, 

then I could have easily looked up the volume data to do 

this similar type of analysis. 

Id. at p. 38. 

Mayhew took Broder’s analysis one step further. Mayhew asserted he did not 

believe Madoff could be making money following Madoff’s stated strategy. Id. at p. 39. 

Mayhew further stated that if somehow Madoff did make money, then Mayhew agreed 

with Broder’s analysis of the unlikelihood of finding an options counterparty, stating as 

follows: 

It presupposes the fact pattern that I do not think is likely to 

be possible. I do not think the strategy that he said he was 

following actually would make money. If somehow 

Madoff or some other trader was able stumble upon some 

really extremely profitable strategy and execute over the 

counter, then one of two things would happen as a result. 

Either the counter-party would lose money or the counterparty would have to be hedging. If the counter-party was 

not hedging, then I would suspect that they would be losing 

money and they would not want to continue doing those 

types of trades. I do not know enough about the specific 

business of these [counterparties] to know how much risk 

they are willing to bear. My intuition is they would prefer 

to hedge if possible and not bear the risk themselves. 

Id. 

156 
 

 

9.	 Front-Running Would Not Have Answered All of the 

Questions in the Renaissance E-mails 

Renaissance employees stated that in 2002 or 2003, “the most common rumor that 

was out there [about BMIS] was somehow the notion that they were actively frontrunning their institutional clients on the brokerage side.” Simons Interview Tr. at p. 14; 

Laufer Interview Tr. at pgs. 11, 23. However, to Laufer, the questions raised in the 

Renaissance e-mails about Madoff’s options trading could not be explained by frontrunning. Id. at p. 34. He felt the SEC did not need to determine whether or not he was 

front-running to answer the open questions: 

If your SEC person had a small amount of expertise, it’s 

clear you go to Madoff and you say, show me the – show 

me your volume. Show me the counter parties. And you 

see how he’s managing to do these extraordinary things. 

... [Y]ou don’t have to figure out if he’s front-running or if 

he’s doing something weird. You ask him to show you 

what he’s doing. 

Id. at p. 51. Moreover, if examiners ruled out the possibility of front-running, Simons 

thought there were still unanswered questions in the Renaissance e-mails that needed to 

be pursued, such as Madoff’s purported “OEX option position” that Broder had called 

into question. Simons Interview Tr. at pgs. 43-44. 

10.	 Renaissance Relied on Prior SEC Examination in Making the 

Decision to Retain Part of Their Madoff Investment 

After performing their due diligence, Laufer stated that “we were very worried” 

about the investment with Madoff. Laufer Interview Tr. at p. 33. However, opinions 

diverged at Renaissance about whether to entirely divest itself of the investment. Simons 

Interview Tr. at p. 28. Broder and Simons wanted to get out of the investment. Broder 

Interview Tr. at p. 35; Simons Interview Tr. at p. 27. But one piece of information 

“helped to allay concerns” of other employees: “[W]e were aware that ... [Madoff] had 

been investigated by the SEC.”98 Id. at pgs. 17, 28. Because of the competing 

viewpoints, Renaissance stated they initially reduced their investment by approximately 

one half and later got out of the investment entirely for unrelated reasons. Id. at p. 28. 

Simons cited their understanding that the SEC had looked at Madoff and given 

him a “clean bill of health” as a reason Renaissance did not initially divest itself of its 

Madoff-related investment. Id. at p. 28. Renaissance understood the SEC had examined 

“the whole business.” Id. at p. 17. Laufer agreed, “What was also on our minds ... was 

that Madoff had been investigated – and cleared” by the SEC. Laufer Interview Tr. at 

pgs. 35-36. 

98 Renaissance appears to have been referring to the 1992 examination of Madoff that arose from the 

SEC’s investigation of Avellino & Bienes. 

157 
 

 

 

 

 

Renaissance also doubted Madoff could be engaged in fraud because he operated 

through highly-regulated brokerage accounts: 

[B]ecause of the nature of the fact that these were 

brokerage statements, and he had a big broker-dealer 

business and big market-maker and – you just assume that 

someone was paying attention to make sure that there was 

something on the other side of the trade. ... I never, as the 

manager, entertained the thought that it was truly 

fraudulent. And it again was because ... it would have 

been so easy to prove that it was fraud if it was just 

managed accounts that were set up. It would have been so 

– again, forgive me here, but you know, it would have been 

pretty straightforward. We felt that he was sufficiently in 

the eye of the regulators that it was just hard for us to 

envision that that was the case. 

Simons Interview Tr. at pgs. 28, 39-40. 

No one from the SEC contacted Simons, Laufer, or Broder about their e-mails 

until the OIG conducted its investigation in 2009. Id. at p. 27; Laufer Interview Tr. at p. 

46; Broder Interview Tr. at p. 38. 

C.	 Renaissance E-mails Raised Significant Red Flags For Investment 

Management Examiners 

Thanasules reviewed the substance of the e-mails and stated that “all the [e]-mails 

raised red flags at that time. ... [T]he [e]-mails raised questions on our end and that’s 

why I told my manager about them.” Thanasules Testimony Tr. at pgs. 8, 16-17. 

Thanasules testified the e-mail from Broder “raises a red flag as to whether Madoff is 

doing these trades at all.” Id. at p. 17. After providing the e-mails that raised suspicions 

about Madoff’s trading activity to Rodriguez, his Branch Chief, Thanasules had no 

further involvement investigating the content of the e-mails, and he did not recall ever 

being contacted to discuss his findings.99 Id. at pgs. 17-18. 

Rodriguez then provided the e-mails to her supervisor, NERO Assistant Regional 

Director Dorothy Eschwie, and provided Eschwie with an oral briefing. Eschwie 

Testimony Tr. at pgs. 11-12. Eschwie recalled that Rodriguez told her the e-mails raised 

questions about Madoff being engaged in illegal activity, but Eschwie did not review the 

e-mails herself at the time Rodriguez provided them to her. Id. at pgs. 11-12. 

99 When Thanasules sent the suspicious e-mail to Rodriguez, he told her that he “spoke to the compliance 

officer [at Renaissance] that informed me that they have reduced their investment in this vehicle but not 

due to anything referenced in the aforementioned e-mails. At this point, I do not have any further details 

....” E-mail dated April 20, 2004 from Thanasules to Rodriguez, at Exhibit 215. 

158 
After reviewing the Renaissance e-mails during her testimony, Eschwie testified 

that Simons’ statement contained therein – “not only are we unsure as to how HCH 

makes money for us, we are even more unsure as to how HCH makes money from us, 

why does [Madoff] let us make so much money?” – was questioning “the fee structure or 

it sounds like the performance of the account.” Id. at pgs. 16-17. She stated that if the 

investment management examiners were investigating the allegations in the e-mails, they 

would investigate the allegation of possible “conflicts in his business” and “that his 

brother-in-law is his auditor.” Id. at pgs. 19-20. Eschwie agreed, as follows, that 

“whether it was a brother-in-law or not, the independence of the auditor would be 

something that would be important to look at” in the examination: 

Yes, I believe we would ask some additional questions as 

to why this particular person is the auditor and how long 

and what their, you know, what their expertise is or – I 

believe we would ask some additional questions if it was 

brought to our attention that somebody is somebody’s 

brother-in-law. The same way we do with any other 

conflicts of interests. We ask additional questions in 

particular with relatives, that is a common question... . But 

as far as on the investment adviser side, we would 

definitely question whether somebody would be deemed 

independent. 

Id. at pgs. 19-21. Eschwie stated the Investment Management Examination Group was 

well aware of auditor independence as a potential issue: 

And in particular on the investment adviser side over the 

years, the issue of custody of client accounts, assets, client 

assets, over the years before they amended the custody rule 

we had – there were areas where if an investment advisory 

firm had control or had custody of client assets, they could 

follow no action letters, so that they would not be deemed 

to have custody. And one of the things that they did, and 

this is numerous times we saw this, they would have an 

accountant view the disbursement from the account, and 

that accountant did have to be independent. So, we are, 

you know, aware of the independence issues with regard to 

an accountant. 

Id. at pgs. 21-22. 

If she were investigating the allegations in the e-mails, Eschwie stated she “would 

want to talk to the person who wrote the e-mail and ask them what are they referring to.” 

Id. at p. 25. She did not think there would have been any reason that broker-dealer 

examiners could not have contacted the employees at Renaissance. Id. 

159 
 

 

Eschwie viewed the e-mails as indicating that employees at Renaissance were 

clearly “trying to find out where exactly the trades were taking place” and that the emails evidenced that “there’s some suspicion as to whether Madoff is trading at all.” 

Eschwie Testimony Tr. at pgs. 29-30. She also believed that the e-mails showed Broder 

was “questioning whether anybody would want to be an OTC counterparty in this 

situation.” Id. at p. 31. 

If the Investment Management Examination Group were to examine Madoff 

based on the Renaissance e-mails, Eschwie believed they would focus their cause 

examination on the allegations in the complaint: “We would follow-up on whatever 

allegations were made. We get complaints all the time. And that’s the focus on the cause 

exam, is the complaint or if there’s suspicion of questionable activity, that’s what the 

focus of the exam would be.” Id. at p. 36. Based on the Renaissance e-mails, one 

allegation that Eschwie would follow-up on was “whether Madoff was actually trading.” 

Id. at p. 37. 

Eschwie also thought examiners could do what Renaissance did -- contact market 

makers [in] OTC options and find out if they were seeing the type of volume that Madoff 

claimed to be trading. Id. at p. 33-34. Eschwie noted, “I would think that firms probably 

have better resources th[a]n I would to know who to call to see what you see.” Id. at p. 

34. Eschwie explained that although they usually sought documentation from the firm 

rather than from third parties, they also followed up on that information: “what we 

really do, we talk to people at the firms and we would follow-up and ask, where did you 

get that information, do you have documentation to show us, who did you speak to.” Id. 

at p. 35. 

D. NERO Investment Adviser Examination Group Referred E-mails 

Implying Madoff is Involved in Illegal Activity to NERO Broker-Dealer 

Examination Group 

Based on NERO’s investment adviser examination of Renaissance, Thanasules 

and Eschwie viewed Renaissance as a “very sophisticated place” and a credible source of 

information. Eschwie Testimony Tr. at p. 13; Thanasules Testimony Tr. at pgs. 9-10. 

Eschwie determined the allegations in the e-mails should be referred for investigation. 

Eschwie Testimony Tr. at p. 12. Eschwie then referred the Renaissance e-mails to the 

NERO Broker-Dealer Examination Group for investigation for the same reason that the 

OCIE Investment Management Examination Group referred the 2003 Hedge Fund 

Manager’s Complaint about Madoff to the OCIE Broker-Dealer Examination Group. Id.; 

see Section IV of this Report of Investigation. Eschwie explained that she referred the emails to the Broker-Dealer Examination Group -- despite that they included investment 

adviser issues -- because BMIS was registered as a broker-dealer and not as an 

investment adviser.100 Eschwie Testimony Tr. at p. 12. 

100 According to the FTI Engagement Team, Madoff’s books and records were subject to examination 

whether or not he was registered as an investment adviser. As a registered broker-dealer, the Madoff firm’s 

books and records (including e-mails) related to that business are subject to compliance examinations and 

review by the SEC staff under Section 17 of the Exchange Act. If the firm had been registered as an 

160 
 

 

 

On April 22, 2004, Eschwie sent a cover letter with the three Renaissance e-mails 

described above101 to the two Associate Regional Directors responsible for NERO’s 

Broker-Dealer Examination Program, Robert (Bob) Sollazzo and Richard Lee. Id. at pgs. 

4, 12, 14; E-mail dated April 20, 2004 from Thanasules to Rodriguez, at Exhibit 215. 

On May 11, 2004, Sollazzo responded to Eschwie. E-mail dated May 11, 2004 

from Sollazzo to Eschwie, at Exhibit 217. Sollazzo stated the alleged conduct should be 

examined and that the NERO Broker-Dealer Examination Group would conduct a cause 

examination as soon as they had the resources, which included finding an examiner 

knowledgeable about options trading. Id. Sollazzo took note in his e-mail to Eschwie 

that Madoff’s returns were suspicious: 

We believe this matter is worthy of an examination when 

resources permit. Since the trading appears somewhat 

complex, we will have to assign an experienced examiner 

who has a sophisticated knowledge of options. When the 

time is right we will strike. 

The story, especially the consistent high returns earned 

over an extended period, makes you wonder. 

E-mail dated May 11, 2004 from Sollazzo to Eschwie, at Exhibit 217. 

E. Examination of Madoff Was Commenced 

1. Examination Team of Non-Attorneys Was Chosen 

Eight months after Eschwie’s April 22, 2004 referral to the NERO Broker-Dealer 

Examination Group and almost seven and a half months after Sollazzo’s May 11, 2004 

e-mail to Eschwie that “this matter was worthy of an examination when resources 

investment adviser at that time, the firm’s books and records related to that business would have been 

subject to compliance examinations and review by the SEC staff under Section 204 of the Advisers Act. 

However, since Madoff was running the investment advisory business out of discretionary brokerage 

accounts at BMIS and it was a registered broker-dealer, those records were also subject to compliance 

examinations and review by the SEC staff under Section 17 of the Exchange Act. Therefore, OCIE 

examiners (whether in OCIE’s Broker-Dealer or Investment Management Groups) had access to all of 

BMIS’s books and records, including those relating to BMIS’s advisory accounts. 

101 There were additional e-mails referring to Madoff from the Renaissance examination that were not 

provided to the broker-dealer examiners with the referral. Eschwie Testimony Tr. at pgs. 50-51. The emails reiterated the concerns about Madoff expressed in the three e-mails provided to the broker-dealer 

examiners. E-mails produced by Renaissance Technologies to the OIG, at Exhibit 216. One e-mail of note 

questioned whether cherry-picking was the reason for Madoff’s performance. On November 14, 2003 

Broder wrote the following in an e-mail, “Like background radiation my concern about Madoff has never 

really gone away. ... But if cherry picking is the reason for the highly-favorable fills – who is taking the hit 

on the other side?” E-mail dated November 14, 2003 from Broder to Brown, at Exhibit 214. Ostrow 

testified that knowing about the additional Renaissance e-mails would have been helpful to the 

examination. Ostrow Testimony Tr. at pgs. 47-48. 

161 
 

permit,” Assistant Director John Nee e-mailed Eschwie to let her know the Broker-Dealer 

Examination Group would start an examination of Madoff in 2005. E-mail dated April 

20, 2004 from Thanasules to Rodriguez, at Exhibit 215; E-mail dated May 11, 2004 from 

Sollazzo to Eschwie, at Exhibit 217. By late December 2004, Sollazzo and Nee had 

assembled a team for the examination. Sollazzo Testimony Tr. at p. 58; Nee Testimony 

Tr. at pgs. 26-27; E-mail dated December 22, 2004 from Nee to Ostrow and Lamore, at 

Exhibit 218. The team consisted of Sollazzo, Nee, and two examiners in the brokerdealer examination program – William Ostrow, a staff accountant, and Peter Lamore, a 

compliance examiner. 

Nee did not assign a Branch Chief to the examination. Nee Testimony Tr. at p. 

27. For the Madoff examination, Nee assigned the examination “directly to [him]self,” 

and served in both Assistant Director and Branch Chief roles. Id. at p. 26. Nee 

acknowledged it was “unusual” to conduct an examination without a Branch Chief. Id. at 

pgs. 27-28. Ostrow and Lamore were able to recall only one other examination in which 

they did not have a Branch Chief. Ostrow Testimony Tr. at p. 27; Lamore Testimony Tr. 

at p. 27. Paul Pocress, a NERO examiner for over twenty years, stated that he has never 

done an examination without a branch chief. Pocress Testimony Tr. at pgs. 5, 11. 

Unlike the OCIE examination team, all of the NERO team members had a 

background in accounting or finance, and none of the members was an attorney. Sollazzo 

graduated from college with a bachelor’s degree in Accounting in 1978. Sollazzo 

Testimony Tr. at p. 8. He joined the SEC in 1981 after spending three years working as 

an auditor. Id. at p. 9. He has spent the rest of his career at the SEC, except for 

approximately two years when he worked as a public accountant and earned his CPA. Id. 

at p. 10. Sollazzo was promoted to Associate Director in approximately 1992. Id. at pgs. 

10-11. 

Nee received a bachelor’s degree in Accounting in 1986, and a master’s degree in 

Finance in 2003. Nee Testimony Tr. at pgs. 8-9. After college, he worked at Drexel 

Burnham Lambert as a mutual fund accountant for approximately three years, as an 

accounting supervisor for Fairchild for a year, and as an auditor in the Inspector 

General’s Office at the U.S. Department of Housing and Urban Development for one 

year. Id. at pgs. 9-10. He began working at the SEC as an examiner in 1991 and was 

promoted to Assistant Director in approximately 1996. Id. at pgs. 10-11. 

William Ostrow earned a bachelor’s degree in Finance from New York Institute 

of Technology in 1999. Id. at p. 11. His first job after college was at the SEC as a Junior 

Compliance Examiner. Id. Ostrow was promoted to Staff Accountant in 2002. See 

Standard Form 52, “Request for Personnel Action,” U.S. Office of Personnel 

Management (7/14/02), at Exhibit 219. Prior to the Madoff examination, Ostrow had 

over five years of examination experience. Id. at pgs. 11-12. 

Peter Lamore graduated from the United States Coast Guard Academy with a 

degree in Management in 1993. Lamore Testimony Tr. at p. 12. For the following five 

years, he served in the U.S. Coast Guard and went to business school part-time, 

162 
 

 

graduating in 1999 from New York University with a master’s degree in Business 

Administration. Id. In 1998, he became an Assistant Equity Trader at First New York 

Securities. Id. at p. 12-13. After a year, he became an Equity Trader where he “traded 

[his] own book for two years, and then the last two years, [at New York Securities, he] 

worked for a hedge fund ... called Millennium Partners.” Id. After leaving First New 

York Securities in 2003, he took trading positions at three other firms for brief periods of 

time before joining the SEC in November 2003. Id. at p. 14-15. While he was a trader, 

Lamore had some experience trading equity options. Id. at p. 15. 

Lamore had worked on approximately four examinations before being assigned to 

the Madoff examination. Lamore Testimony Tr. at pgs. 19-20. Nee thought Lamore was 

qualified to work on the examination despite his lack of experience: “I think ... Peter 

Lamore, based on his equity trading experience as a trader, probably would have been 

among one of the best choices of anyone in the broker-dealer program to work on this 

examination, in spite of the fact that he had not been an examiner for that long.” Nee 

Testimony Tr. at pgs. 49, 50-51. 

2. Joint Examination with Investment Management Examiners Was 

 Not Considered 

In creating an examination team, Sollazzo and Nee did not consider performing a 

joint examination with investment management examiners, despite the fact that the 

Renaissance e-mails raised suspicions about Madoff’s performance. Sollazzo was asked 

why he did not assign a joint examination team, in the following exchange during his 

testimony: 

Q: Did you think of assigning someone from the 

investment adviser exam team to this exam since 

you have these hedge fund issues and these return 

issues that they specialize in? 

A: Never did. Never did. ... Never considered it. ... 

Well, part of the reason is we didn’t work that many 

joint exams, we rarely did joint exams at that time. 

... We’re a bit better now, and I’ve – frankly, I felt 

also that if it related to broker-dealer trading 

practices that we could figure it out. ... We rarely 

did joint exams at that time. 

Sollazzo Testimony Tr. at pgs. 67-68. Similarly, in the following testimony, Nee stated 

that he did not recall the two examination programs jointly performing an examination 

until recently: 

That program [investment management examination 

program] is completely distinct. There are two separate – 

it’s not organized the same way that it’s organized in some 

163 
 

 

other offices. There are two associates or distinct 

associates, one on the investment advisor side, one on the 

broker-dealer side, and I don’t think we have ever, until 

maybe this past year, sent examiners out together. And, 

again, they are two separate examinations, so it just wasn’t 

done. 

Nee Testimony Tr. at p. 48. 

Ostrow provided a description similar to Nee’s, stating that each of the 

examination programs in NERO was a “silo” and estimated that he had worked on only 

one joint BD/IM examination in his ten years at the SEC. Ostrow Testimony Tr. at p. 57. 

Brian Snively, a Branch Chief in OCIE’s Investment Management Group testified that he 

could not recall working on any joint examinations in the ten years he has worked at the 

SEC. Snively Interview Tr. at p. 28. Similarly, the IM Staff Accountant, a NERO 

Branch Chief in the Investment Management Examination Group with nine years of SEC 

examination experience, stated that he could not recall ever “doing a 100 [%] coordinated 

examination with the BD staff.”102 IM Staff Accountant Testimony Tr. at p. 13. 

3. Team Began Background Work in Preparation for On-site 

Examination Ten Months After Referral 

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

NERO Investment Management Examination Group, the NERO Broker-Dealer 

Examination Team began performing background research in preparation for an on-site 

examination of Madoff to begin in April. Sollazzo acknowledged that beginning the 

examination almost a year after the referral was a long delay, stating, “I agree, I think that 

is a pretty long period of time.” Sollazzo Testimony Tr. at p. 72. He explained that he 

“had trouble staffing the exam.” Id. at pgs. 71-72. In part, they had been waiting for 

Lamore, who Sollazzo chose for the examination team because he “had been a[n] equities 

trader for hedge funds.” Nee Testimony Tr. at pgs. 26-27; Sollazzo Testimony Tr. at p. 

58. 

Nee stated the long delay was not necessarily unusual, especially where there was 

no particular urgency to begin the examination. Nee Testimony Tr. at p. 45. In this case, 

notwithstanding the red flags contained in the Renaissance e-mails, Nee stated, in the 

following exchange, that he did not believe there was a particular urgency because he felt 

it unlikely that a firm of BMIS’s size and legitimacy would “rip people off”: 

Q: Was it unusual for an exam to start so long after a 

referral came in? 

102 Lamore appears to have had access to assistance from the IM Staff Accountant during the Madoff 

examination, but did not request his assistance in conducting the examination. IM Staff Accountant 

Testimony Tr. at pgs. 12-13. 

164 
 

A: Not – I would say not necessarily. Although a year, 

that – a year may seem long, it depends on, again, I 

would think if there’s some sort of immediate need 

where we had direct evidence or a customer 

complaint that their funds were somehow being 

converted against their will or something along that 

– along those lines. So – 

Q: So there was – there wasn’t a particular urgency in 

connection with the Eschwie referral in April 2004? 

A: I don’t think – well, I don’t think there was a 

particular urgency. ...Which is not to say we did not 

appreciate the severity of the charges or of the 

allegation. Again, in – but – and also keep in mind 

that we did know that Bernie Madoff was a – I’m 

talking about the firm because I don’t know 

anything – I didn’t know, at that time I don’t think I 

knew anything about the individual – but we did 

know the firm was a fairly large firm, employed a 

lot of people, was a very big market-maker, had 

introduced the, sort of, third market issue to the 

market. So it didn't seem to be – it didn’t seem as 

if, you know, he was a fly-by-night operation that 

was out there to rip people off is I guess what I’m 

trying to get to. So that may have tempered our 

decision to wait until the proper personnel would 

have been available. ...I believe at that time we had 

a lot of exams going on, especially in my org code 

... So, [Sollazzo] may have been talking about 

waiting until I ... got involved. I don’t know if he 

had anyone ... specific in mind but I think he 

wanted to, you know, make sure that whoever was 

involved was a good examiner because we have 

different strata of examiners, some who we would 

send on a cause examination and some who we 

wouldn’t. 

Id. at pgs. 45-47.103 

103 Similarly, in the 2004 OCIE cause examination of Madoff, there was an almost seven month delay 

between the receipt of the complaint and the initiation of the cause examination. See Section III. 

165 
4. No Planning Memorandum Was Drafted Describing Focus and 

Scope of the Examination 

Unlike the OCIE examination team, the NERO examination team did not draft a 

planning memorandum laying out the scope of the examination. Lamore Testimony Tr. 

at p. 161. Lamore recalled that at the time of the examination, NERO might not have had 

a practice of writing planning memoranda. Id. Ostrow agreed, explaining as follows, 

that a formalized process was not in place for determining the focus of an examination: 

“Only for the last year or so have I sent scope memos and had them reviewed and have 

comments made. Prior to a few years ago, it was really ... just sort of as the exam 

progressed, notes were taken and e-mails were exchanged.” Ostrow Testimony Tr. at p. 

17. 

Members of the examination team agreed the “cause” of the examination was the 

Renaissance e-mails, and Sollazzo recalled he instructed Nee to perform “a cause exam 

based on the information” in the Renaissance e-mails. Lamore Testimony Tr. at pgs. 31­

32; Sollazzo Testimony Tr. at p. 58. In addition to the e-mails, the examination team had 

two articles about Madoff’s operations from 2001. E-mail dated April 25, 2005 from 

Ostrow to Lamore, attaching Barron’s article, at Exhibit 220; Lamore’s copy of 

MARHedge article with comments, at Exhibit 221. One of the articles was published in 

MarHedge and entitled, “Madoff tops Charts; Skeptics Ask How.” Michael Ocrant, 

Madoff Tops Charts; Skeptics Ask How, MARHedge, May 2001, at Exhibit 146. The 

second article was from Barron’s – “Don’t Ask, Don’t Tell”; Erin Arvedlund, Don’t Ask, 

Don’t Tell, Barron’s, May 7, 2001, at Exhibit 135. 

It is unclear how much guidance examiners were given by Nee and Sollazzo at the 

start of the examination. Lamore testified the focus of the examination “was determined 

for” him, and stated the following about the focus of the examination: 

Q: Okay. How did you understand what the focus 

was? 

A: Well, we had been given – I believe we had been 

given a report or some e-mails that sort of alleged 

suspicious activities at the firm. 

Lamore Testimony Tr. at pgs. 30-31. 

Upon receiving the e-mails, Lamore recalled that he “definitely reviewed” them, 

but did not recall discussing the e-mails with Nee or any other supervisor, stating, “I 

think we sort of worked on our own.” Id. at pgs. 31-32, 42. Ostrow stated he did not 

focus on the Renaissance e-mails, and testified he was “not sure if [he] had read” all of 

the Renaissance e-mails and may have just read “snippets” of them. He recalled that in 

developing the focus of the examination, the examination team “really used the Barron’s 

article and the MarHedge article as a starting point,” rather than the e-mails. Ostrow 

Testimony Tr. at pgs. 28-29, 34. Ostrow explained he did not focus on the e-mails 

166 
 

 

because he viewed tips skeptically, noting, although when you receive a tip “from an IA 

examiner,” one should “take it serious[ly], but still [you] ha[ve] to take it with a grain of 

salt what the people are writing back and forth to each other.” Id. at p. 38.104 

5. Nee Determined the Renaissance E-mails Only Raised Issues 

Related to Front-Running and Cherry Picking 

When asked who chose the focus of the examination, Nee stated that the focus 

was a “foregone conclusion” he disseminated to the staff examiners: 

Well, I think it was a foregone conclusion that we would 

focus on the referral that was – that had been forwarded to 

me as something to conduct a cause examination. So, I 

don’t know exactly where you can say who made that 

decision. I was given a referral to look into, so that was 

sort of, as I said a foregone conclusion. If I’m given a 

referral to look into a specific matter, that specific matter 

was the focus of the examination. I would have been the 

one to, I guess, disseminate it to the examination staff. 

Nee Testimony Tr. at p. 28. 

Unlike the Renaissance employees who drafted the e-mails and the SEC 

Investment Management examiners who initially reviewed them, Nee testified he did not 

see anything in the Renaissance e-mails upon which to focus an examination except for 

cherry picking and front-running. Id. at p. 40. Nee stated, in the following testimony, 

that the “foregone conclusion” of the e-mails was to focus exclusively on whether 

Madoff was using his market making capability to cherry pick trades or to front run 

market making trades for the benefit of his hedge fund clients: 

Yeah, our focus was strictly to look at the trading to see ... 

if there was any correlation between his trading for the 

hedge funds, if there was, in fact, trading for hedge funds 

being done, if he had hedge fund clients in some way, and 

compare that to, again, his market-making and his 

proprietary business. ... I think the overriding issue that’s, 

you know, central to this whole thing is he – is he somehow 

using his order flow business and [] that’s the inference that 

I had gotten from all the research. I think that’s sort of 

104 The FTI Engagement Team concluded that in determining the focus of the examination, the 

examination team’s analysis of the Renaissance e-mails was insufficient. According to the FTI 

Engagement Team, all relevant information contained in tips and complaints from a credible source must 

be sufficiently vetted. It may be the case, after a thorough review, that certain information is not entirely 

accurate or may even be biased to a certain extent, depending on the circumstances and context of the 

allegations. However, the examiner must still review all of the allegations before any conclusions can be 

made with regard to the legitimacy of such allegations. 

167 
 

 

 

what the widely held belief from the referral from Dorothy 

Eschwie. 

Id. at pgs. 37-39. 

6. Madoff’s Unusually Consistent Returns Were Not Focused on 

In the Examination 

Sollazzo’s testified he was concerned with Madoff’s high consistent returns, 

stating, “Consistency every month, I agree, is very, very unusual.” Sollazzo Testimony 

Tr. at p. 109. However, he testified his “first read of these documents when we looked at 

it, it just appeared more that there were execution issues and potential abuses in that 

regard.” Id. at p. 64. He explained he focused on abusive trading practices rather than 

the other issues raised in the e-mail, in part, because order leakage was a prominent issue 

at the time of the examination: 

In terms of the focus ... the allegations here were 

something we were going to focus on ... [T]his seemed to 

be abusive trading practices. And at the time I knew we 

had a lot of focus on order leakage, you know, leakage of 

information, customer order information, front-running, it 

was just a big issue that was – and it’s still an issue in the 

marketplace now. 

Id. at pgs. 57-58. 

Sollazzo stated that from the e-mails “it looked like there was a possibility of 

some sort of manipulation, fraud [] because of the high returns, consistent high returns” 

and that he “was concerned about the returns.” Id. at pgs. 65, 82. Sollazzo expressed his 

concern about Madoff’s returns in an e-mail to Eschwie in which he stated that Madoff’s 

“consistent high returns earned over an extended period, makes you wonder.” E-mail 

dated May 11, 2004 from Sollazzo to Eschwie, at Exhibit 217. 

However, despite identifying Madoff’s returns as an issue, Sollazzo testified he 

did not necessarily have “an expectation” that the examiners would analyze Madoff’s 

returns because portfolio analysis was not a strength of broker-dealer examiners:105 

See, we do broker-dealer exams, you know, and outside – 

we’re not expert in sort of portfolio trends and returns over 

time, you know, it’s not something that we spend a huge 

105 The FTI Engagement Team examined Sollazzo’s statement that he was concerned about Madoff’s 

returns and his acknowledgement that the examiners from the broker-dealer group likely were not wellsuited to determine if those returns were legitimate. The FTI Engagement Team noted that instead of 

requesting support from OCIE’s investment advisory group, which was experienced and skilled at such 

reviews, Sollazzo limited the composition of the examination team to include only broker-dealer staff. The 

FTI Engagement Team concluded that as a result, the project was not properly staffed with the expertise 

needed to address the allegations raised in the tip. 

168 
amount of time doing. ... But, you know, what I’m getting 

at is we don’t necessarily have the, you know, that sort of 

discipline in terms of doing comparatives to other 

portfolios. It’s not something that is ordinarily done in our 

exams.” 

Sollazzo Testimony Tr. at pgs. 65-66. 

Although Sollazzo testified he did not expect the examination team to analyze 

Madoff’s returns, he also stated he did expect them to determine the reason for the returns 

and to “[d]ig in and try to figure out what’s happening.” Id. at p. 67. Nee, however, did 

not believe the examination team needed to determine how Madoff was generating his 

returns, other than to determine if they were the result of cherry picking or front-running. 

Nee Testimony Tr. at pgs. 43-44. Nee stated they had “no evidence ... other than 

anecdotal evidence” and the two 2001 articles “of what the returns are or were.” Id. at p. 

44. Nee explained, in the following exchange, that he read Sollazzo’s e-mail to Eschwie 

stating Madoff’s “consistent high returns earned over an extended period, makes you 

wonder,” to contain “the assumption ... that those high returns are contingent upon the 

cherry picking” or front-running: 

Q: Okay, but doesn’t it seem as though Bob Sollazzo’s 

e-mail actually is a broader question? 

A: No. I think he’s saying, this story, if, you know, 

and the story would be we – someone thinks that 

Bernie Madoff is achieving high returns by cherry 

picking, obviously those high returns are – would 

be – the assumption would be that those high 

returns are contingent upon the cherry picking. So 

first we would have to look for the cherry 

picking/front-running to determine if it exists, and if 

not then – 

Q: And would you ever get to the question of how he 

was able to obtain the consistent high returns earned 

over an extended period? 

A: Again, the focus was trading, you know, ahead of 

customers. There are many people who would say, 

you know, “Bill Miller from Legg Mason beat the 

S&P market for 15 or 20 years,” whatever he beat 

it, []How could he possibly do that?? You know, 

many learned people assume or are, you know, 

convinced you can’t do that. But – so the high 

returns – and then again, the high returns, we did – 

we had no evidence of – other than anecdotal 

169 
evidence, of what the returns are or were. 

According to – supposed high returns – according to 

articles we read, he achieved outside returns. But 

that was not the focus of the examination. The 

examination was very focused and that’s what I 

understood our role to be. 

Id. at pgs. 44-45. 

Nee acknowledged Madoff’s timing was beyond exceptional, but stated his team 

did not focus on the incredible timing because, “We went in there to look at – specifically 

at the trading, it was sort of a front end review, we weren’t there to really try to see if the 

returns he was reporting were correct.” Id. at p. 132. 

7. Examiners Were Still Suspicious of Madoff’s Unusually 

Consistent Returns at the End of the Examination 

In contrast, Lamore and Ostrow recalled one of the issues looked at in the Madoff 

cause exam was how Madoff was able to generate his highly consistent returns. Lamore 

Testimony Tr. at pgs. 43-44; Ostrow Testimony Tr. at pgs. 43-44. The examiners were 

aware from the 2001 MarHedge article that questions had been raised about how Madoff 

could possibly achieve his stated returns using the split-strike conversion strategy. 

Ostrow Testimony Tr. at pgs. 64-65. Lamore had never seen such consistent returns over 

such a long period of time and thought the lack of volatility in the returns was something 

suspicious that should have been looked into. Lamore Testimony Tr. at pgs. 44. 

Lamore and Ostrow recalled that they pursued the issue of Madoff’s unusual 

returns only by looking at Madoff’s trading to determine if the returns were the result of 

front-running. Id. at pgs. 36-37, Ostrow Testimony Tr. at p. 43. Ostrow recalled the 

examiners analyzed Madoff’s trading and found “there were a lot of inconsistencies.” 

Ostrow Testimony Tr. at p. 44. The examiners then asked Madoff about the 

inconsistencies they found. Id. at pgs. 44, 65. When asked if by the end of the 

examination, the examiners were satisfied that they had an explanation as to how Madoff 

was able to obtain these consistent high returns over an extended period of time, Ostrow 

explained, in the following testimony, that although by the end of the examination they 

were satisfied Madoff was not front-running, they were still suspicious about how he was 

earning his returns: 

We satisfied ourselves at the end of the exam knowing that 

he hadn’t – wasn’t front-running individual customers and 

order flow. We still knew and felt that it was highly 

suspicious and just odd and the whole story, there were 

inconsistencies, so, you know, that were unsettling, but, 

you know, there’s only so much you can stress the point to 

your supervisors and, you know, before you [are] put on the 

next exam ... 

Id. at p. 45. 

170 
 

 

8. Madoff’s Options Trading Was Not A Focus of the Examination 

The issue Broder raised regarding the unlikelihood that Madoff could be trading 

options was not a focus or even part of the initial scope of the examination. Nee stated 

the issue of who would write the OTC contract was not pursued because, “I don’t think it 

was an issue that was the overriding theme of the examination.” Nee Testimony Tr. at p. 

65. However, according to the following testimony from Sollazzo, Broder’s conclusion 

that Madoff could not find a counterparty with which to trade OTC options raised a red 

flag: 

Essentially, what they’re saying is you need some sort of a 

counterparty who’s willing to take on substantial risk at 

what would appear to be unfavorable OTC options prices. 

...It seems to be a red flag, yeah.” 

Sollazzo Testimony Tr. at p. 63. 

In addition, looking at the Renaissance e-mails in hindsight, Sollazzo agreed the 

Broder e-mail implied that Madoff may not be executing trades at all. Id. at p. 64. 

However, Sollazzo did not know what if anything was done in the cause examination to 

look at this issue. Id. at p. 63. 

At the time of the examination, Lamore appears to have recognized the options 

issue Broder raised. On a copy of the MarHedge article, Lamore made handwritten notes 

stating, “OTC Options – Who is writing these OTC contracts.” Lamore’s copy of 

MARHedge article with comments, at Exhibit 221. Lamore’s notes seem to be a direct 

reference to the question Broder raised in his e-mail. Id. Lamore explained his 

interpretation of the Broder e-mail, as follows: 

He’s saying that if somebody’s going to take the opposite 

side, the counterparty to the options trading would either 

have to, you know, be exposed or have to hedge 

themselves, and he’s saying that it’s a lot of money to 

hedge. 

Lamore Testimony Tr. at p. 41. 

Lamore agreed that, in his November 21, 2003 e-mail, Renaissance’s Broder 

questioned whether Madoff was actually trading the options he represented he was 

trading. Id. at p. 40. However, Lamore did not recall the team focusing on the options 

issue: “I don’t recall focusing on the options. We were more focused on the equities.” 

Id. Likewise, Ostrow testified that he did not recall the examiners investigating the issue 

raised in the Renaissance e-mails about the unlikelihood that Madoff could find an 

options counterparty. Ostrow Testimony Tr. at pgs. 41-42. 

171 
 

 

 

 

a. Examiners Investigated Madoff’s Options Trading Solely 

By Relying on Madoff’s Representation That He Stopped 

Trading Options 

Although it was not a focus of the examination, the examination team stated that 

they looked into the general issue of Madoff’s options trading solely by asking Madoff 

about it. Lamore Testimony Tr. at p. 42; Ostrow Testimony Tr. at pgs. 38-39. However, 

when Madoff said he was no longer using options as part of his strategy, they stopped 

looking at the issue, despite the fact that Madoff’s representation was inconsistent with 

the Renaissance e-mails, the two 2001 articles, and the investment strategy Madoff 

claimed to employ.106 Nee Testimony Tr. at p. 37; Ostrow Testimony Tr. at p. 39. 

Ostrow stated as follows: 

Options in general we looked at and ... we were told by 

Bernard Madoff during the exam that, I believe in January 

of ’04, the firm stopped using options. So once he tells us 

that, it made me at least think do the outside funds, like 

Kingate and FEMA, know that he’s no longer using 

options, but it sort of removed the question of could he do 

this on an exchange where they don’t trade that many 

options. 

Ostrow Testimony Tr. at pgs. 38-39. 

9.	 Madoff’s Fee Structure Was Not A Focus of the Examination 

In his November 13, 2003 e-mail, Simons from Renaissance raised the issue of 

Madoff’s fee structure as a red flag. E-mail dated November 13, 2003 from Nat Simons 

to Jim Simons et al, at Exhibit 211. Lamore explained he thought Renaissance was 

“questioning why Bernard Madoff would not set up his own fund and collect the 20 

percent profits himself.” Lamore Testimony Tr. at p. 34. Lamore and Sollazzo stated 

that they were concerned about Madoff’s fee structure. Sollazzo Testimony Tr. at p. 59; 

Lamore Testimony Tr. at pgs. 34-35. 

a.	 The SEC Examined Madoff’s Fee Structure Solely by 

Asking Madoff About It and Relying on His Response 

Nee stated the examination team looked into the issue of Madoff’s fee structure 

by asking Madoff about it, stating, “I believe it was looked into and the answer from 

106 The FTI Engagement Team concluded that it was illogical to believe that Madoff was implementing the 

split-strike forward conversion strategy without trading options. According to the FTI Engagement Team, 

Madoff’s split-strike forward conversion strategy, as indicated in the Trading Authorization Directives, 

consisted of buying a basket of large capitalization stocks in the S&P 100 stock index (“OEX”), selling 

OEX call options and purchasing OEX put options. As a result, the options were a critical component of 

the strategy. 

172 
Bernie Madoff [was] that he was happy getting commission income on the trades.” Nee 

Testimony Tr. at p. 34. 

The examiners explained they asked Madoff for an explanation and did not feel 

they could do anything other than accept what he told them. Lamore Testimony Tr. at 

pgs. 34-35; Ostrow Testimony Tr. at p. 112. In the following exchange, Lamore 

described his conversation with Madoff about the fee structure: 

Q: Okay. So were there actions that were taken in the 

cause exam to look into this issue? 

A: Yes. ... I asked Bernard Madoff directly why he 

would do this, why doesn’t he want to set up a fund 

and collect the fees himself. ... His response was 

essentially, “A lot of people ask me that question. 

I’m not a marketing person. I don’t want to deal 

with customers. I have no interest in doing that. 

I’m perfectly happy making my commission 

equivalent 4 cents per share.” 

Q: Okay. And did you find his answer suspicious at 

all? 

A: Most people on Wall Street are extremely greedy, 

so yeah. I mean people don’t typically – I mean – 

but, you know, it’s hard to – to sort of rebut that. 

You know, at that point I wasn’t sure what else I 

could say to him. 

Q: Okay. So there wasn’t anything further on that 

point that was done? 

A: Correct. 

Lamore Testimony Tr. at pgs. 34-35. 

10. Madoff’s Auditor Was Not Looked Into During the Examination 

In his November 13, 2003 e-mail, Simons from Renaissance asserted there were 

rumors that Madoff’s auditor was a related party. E-mail dated November 13, 2003 from 

Nat Simons to Jim Simons et al, at Exhibit 211. Sollazzo testified this allegation was 

“certainly” something to be seriously considered, stating: 

Obviously the conflicts issue, you know, is a big 

consideration. You have a brother-in-law who’s an auditor, 

173 
 

 

 

 

 

that’s obviously an issue. It’s a family-run firm. You 

know, there are red flags here. 

Sollazzo Testimony Tr. at p. 60. Nee agreed that if Madoff’s brother-in-law was in fact 

the auditor, “It seems to be, on its face, a conflict.” Nee Testimony Tr. at p. 31. 

However, the examination team did not look into the auditor issue to determine if 

there was a conflict of interest. Sollazzo Testimony Tr. at pgs. 34, 60, 167; Nee 

Testimony Tr. at p. 31; Lamore Testimony Tr. at pgs. 36-37. Ostrow explained, “I don’t 

believe we looked into that. I know we had a copy of the annual audit of the brokerdealer, I believe, in my files. That’s it.”107 Ostrow Testimony Tr. at p. 34. 

11. The Examination Team Did Not Contact Renaissance 

The examination team also did not contact Renaissance Technologies to follow up 

with them about the issues they raised in their e-mails. Memorandum dated April 22, 

2004 from Eschwie to Sollazzo, at Exhibit 210; Sollazzo Testimony Tr. at p. 61; Nee 

Testimony Tr. at p. 41; Ostrow Testimony Tr. at p. 35; Lamore Testimony Tr. at p. 38. 

Laufer had stated in his November 14, 2003 e-mail, “We at Renaissance have totally 

independent evidence that Madoff’s executions are highly unusual.” E-mail dated April 

20, 2004 from Thanasules to Rodriguez, at Exhibit 215. Nee explained that they did not 

follow up on the “entirely independent evidence” because it was just “a vague statement.” 

Nee Testimony Tr. at p. 42. Nee and Ostrow stated that instead of asking Renaissance 

for its evidence, they would just go through Madoff’s books and records on their own 

because “we were there to see if the executions were highly unusual ourselves.” Id. at 

pgs. 42, 51; Ostrow Testimony Tr. at p. 38. 

Lamore, however, appears to have taken notice of Laufer’s comment. On his 

copy of the Renaissance e-mails, Lamore had starred Laufer’s statement about their 

“totally independent evidence.” E-mail dated April 20, 2004 from Thanasules to 

Rodriguez, at Exhibit 215. Lamore explained they did not follow-up with Renaissance 

because he understood they were not supposed to go to third parties: 

107 The FTI Engagement Team concluded that if the examiners look into the auditor, they likely would 

have recognized significant red flags. For instance, it is likely that the examiners would have had difficulty 

reconciling how such a small, unknown auditing firm located in a New York suburb was responsible for 

auditing such an established, well-known firm as BMIS, which generated $80 million in annual 

commission revenues from its discretionary brokerage accounts alone. A review by the examiners of the 

auditor’s engagement letter, reports and work papers would likely have raised serious doubts as to the 

scope of work actually performed. A closer look to determine whether or not the accountant verified, by 

actual examination, client funds and securities held by Madoff would have uncovered Madoff’s Ponzi 

scheme. In fact, after Madoff confessed to running a Ponzi scheme, a New York Staff Attorney was 

assigned to investigate Madoff’s accountant, David Friehling. Within a few hours of obtaining the work 

papers, he determined that no audit work had been done. New York Staff Attorney Testimony Tr. at p. 10. 

Immediately upon reviewing Friehling’s work papers, the New York Staff Attorney testified, there “were 

red flags for me as to the auditor. ... I didn’t see anything that resembles kind of formal work papers, 

auditor work papers that would comply with generally accepted audit standards. So, there was almost 

nothing that indicated that any audit work had been done.” Id. at pgs. 9-10. 

174 
 

 

 

My understanding is that we really, as an agency don’t do 

that and I mean it wasn’t my call. I didn’t ask to, nor was I 

directed, but it’s just an understanding that we sort of do 

our examinations and investigations without going to sort 

of third parties.108 

Lamore Testimony Tr. at p. 38. 

F.	 Examiners Performed Pre-examination Work 

1. Examiners Reviewed Articles about Madoff’s Stature in the 

Industry 

In late March 2005, Ostrow and Lamore performed background research on 

Madoff and his firm. Id. at pgs. 48-49. The examiners exchanged articles describing 

Madoff’s significant achievements, including “serv[ing] as chairman of the board of 

directors of the Nasdaq Stock Market as well as a member of the board of governors of 

the NASD ... [and] of the Securities Industry Association. ... [and] a founding member 

of the board of directors of the International Securities Clearing Corporation in London.” 

E-mail dated March 28, 2005 from Ostrow to Lamore, at Exhibit 222. Another article 

exchanged by the examiners was entitled, “The Madoff Dynasty.” E-mail dated March 

30, 2005 from Lamore to Ostrow, at Exhibit 223. The article described Madoff’s family 

members working at BMIS, including his brother Peter, Peter’s daughter Shana, and 

Madoff’s two sons, Mark and Andrew. Id. The article also described how the Madoffs 

“embrace[d] technology early on.” Id. 

By the time the examination began, Ostrow and Lamore were aware that Madoff 

was an important figure in the industry. Ostrow Testimony Tr. at p. 19; Lamore 

Testimony Tr. at p. 50. However, Ostrow stated he did not think his knowledge of 

Madoff’s stature had much relevance to the examination. Ostrow Testimony Tr. at p. 21. 

2. NASD Reports of BMIS Did Not Mention Madoff’s Advisory 

Accounts 

As another part of their pre-examination work, examiners reviewed BMIS’s most 

recent NASD Exam Report and Focus Reports.109 E-mail dated December 22, 2004 from 

108 The FTI Engagement team concluded that the examiners should have contacted Renaissance, especially 

since Renaissance had been an SEC-registered investment adviser since January 1998 (IARD # 106661). 

As a registered investment adviser, the firm’s books and records (including e-mails) are subject to 

compliance examinations and review by the SEC staff under Section 204 of the Advisers Act. According 

to the FTI Engagement Team, the record shows that the examiners needed third-party assistance in 

conducting the examination.

109 According to the FTI Engagement Team, SEC Form X-17A-5, the Financial and Operational Combined 

Uniform Single Report Form or “FOCUS” Report, includes information required of brokers and dealers 

pursuant to SEC Rule 17a-5 pertaining to books and records. Madoff’s Trading Authorization Directive 

states that BMIS charges a “commission equivalent” of four cents ($.04) per share on equity transactions 

and a commission of one dollar ($1.00) per contract for option transactions in order to execute the split175 
 

 

 

 

 

 

 

Nee to Ostrow and Lamore, at Exhibit 218. The NASD Exam Report indicated BMIS 

was a member of the NASD (now FINRA) and several clearing corporations, including 

the Depository Trust & Clearing Corporation (DTC), the National Securities Clearing 

Company (NSCC),110 and the Options Clearing Corporation (OCC).111 Id. The Exam 

Report also stated BMIS did not have an internal audit department. Id. 

Although reviewing recent NASD/FINRA Exam Reports was a standard part of 

an examination,112 members of the exam team stated they generally found NASD/FINRA 

Exam Reports to be “not very helpful.” Sollazzo Testimony Tr. at p. 52; Lamore 

Testimony Tr. at p. 52. Ostrow stated, “...I don’t think [the Report] had any reference to 

the hedge fund account. So we also take, you know, these reports with a grain of salt.” 

Ostrow Testimony Tr. at p. 49. Ostrow explained that when he performed oversight 

examinations of NASD/FINRA examinations, he had found there were issues that “were 

completely missed.” Ostrow Testimony Tr. at p. 51. He thought it was possible that the 

weaknesses in the NASD/FINRA Exam Reports were attributable to FINRA’s 

connections to industry or examiner incompetence, but more likely the result of FINRA’s 

examination procedures, which he described as “a check box system and they don’t think 

outside the box.” Id. at p. 50. Lamore had a similar view of the weaknesses of 

NASD/FINRA Exam Reports, stating, “Well, I think – in general I think the NASD 

exams are a little less in-depth. It’s more ... checklist-type reviews that they conduct. So 

they don’t go into great detail about specific areas.” Lamore Testimony Tr. at p. 161.113 

strike forward conversion strategy. The practice of using a mark-up captured in the stock price (i.e., 

commission equivalent) instead of charging a commission is not unusual among market-makers such as 

BMIS. However, BMIS’ annual, quarterly and monthly FOCUS Reports during 2004 do not include any 

reported commissions, even for the purported options trades, which are clearly commission-based. The 

FTI Engagement Team concluded that the lack of any commissions in BMIS’ 2004 FOCUS reports should 

have raised questions within the examination team with regard to BMIS’ fee structure and possibly it’s 

trading activity.

110 DTCC’s “subsidiaries provide the infrastructure for clearing, settlement, and custody of most US 

securities transactions. DTCC was established in 1999 when operating companies The Depository Trust 

Company (DTC) and the National Securities Clearing Company (NSCC) ... were combined under a single 

holding structure. DTC is the world’s largest securities depository and a clearinghouse for trading 

settlement; NSCC processes most broker-to-broker equity, corporate, and municipal bond trades in the 

US.” http://www.Hoovers.com /dtcc/--ID__104975--/free-cofactsheet.xhtml?cm_ven=Biz_Dev&cm_cat= 

Google&cm_pla=Free&cm_ite=Factsheet. 

111 OCC is “the world’s largest equity derivatives clearinghouse. The OCC serves some 130 brokerdealers, futures commission merchants, and securities firms in the US and abroad. It is owned by options 

trading participants NYSE Alternext, Chicago Board Options Exchange, International Securities Exchange 

Holdings, and Nasdaq OMX PHLX.” http://www.hoovers.com/options-clearing-corporation/-­

ID__118343--/free-cofactsheet.xhtml?cm_ven=Biz_Dev&cm cat=Google&cm_pla=Free&cm_ite 

=Factsheet. 

112 Paul Pocress, a staff accountant in the NERO examination program with over twenty years of 

experience, stated that prior to an examination he typically would contact FINRA to get “any thoughts 

about the firm that I can possibly have prior to going into a firm.” Pocress Testimony Tr. at pgs. 15-16. 

113 As discussed in detail in Section VIII of this Report of Investigation, several witnesses criticized SEC 

examinations for using the same checklist approach Ostrow and Lamore critiqued in FINRA examinations. 

For example, one former examiner described what he viewed as the weaknesses in the examination 

program, by stating, “Typically when people come in, it is difficult if they are really not up to par to get rid 

of them. And there is a mentality sometimes ... we have this checklist, right, so we need to go by this 

176 
 

 

 

 

The “Internal Audit” section of the NASD/FINRA report on BMIS stated that, 

“The firm does not have an Internal Audit Department.” E-mail dated December 22, 

2004 from Nee to Ostrow and Lamore, at p.13, at Exhibit 218. However, examiners did 

not identify the lack of an internal audit department at BMIS as a red flag. Ostrow 

Testimony Tr. at pgs. 48-49; Nee Testimony Tr. at p. 54.114 Nee explained, as follows, 

that they relied on FINRA as the front line regulator of BMIS to identify concerns with 

BMIS’s audit department (something that FINRA had not done that in this case) and that 

internal audit processes were not the focus of NERO’s examination of Madoff: 

[T]he way the SEC exam program is structured, we rely 

[on] the SRO [FINRA], on our front line. It didn’t seem to 

have been a concern for them, they had more experience 

with Bernard Madoff Securities, it didn’t seem to have been 

a concern with them, I believe. So I would say in hindsight 

the answer may have been different, but it’s not unusual for 

a firm not to have an internal audit department, they may 

just have a compliance function. ... It was not our focus to 

do an examination of the internal audit function to see if 

they were in compliance with all regulatory provisions. 

Nee Testimony Tr. at p. 54. 

After the examination was completed, NERO did not share the information that 

they learned about Madoff with FINRA. Id. at p. 71. 

3. Examiners Accepted Madoff’s Explanation for Relationship 

With Cohmad Securities 

Cohmad Securities Corporation (Cohmad), a SEC-registered broker-dealer 

(CRD# 16307), was minority owned by Bernard Madoff. See SEC v. Cohmad Securities 

Corp., No. 09 Civ. 5680, Complaint, ¶ 14 (S.D.N.Y. filed June 22, 2009), at Exhibit 224. 

The annual audited report contained in Cohmad’s June 30, 2005 FOCUS Report (Form 

X-17A-5 Part III) identified the existence of a related-party entity, owned by a minority 

shareholder that provided 90% of Cohmad’s revenues, and that the entities shared office 

checklist and if everything happens on this checklist, it is okay. There was not a lot of outside the box 

thinking. ... The analogy that we use is that a typical SEC examiner walks into a room where there are a 

bunch of dead bodies lying around and they notice that the clocks are 10 minutes fast. And it really is. 

And, again, it is not meaning to be disparaging but it becomes difficult but you also have to factor in the 

restraints that you have.” Sadowski Testimony Tr. at pgs. 102-103. Moreover, one fund adviser explained 

he did not think the SEC examinations he had been involved with were thorough, because “there is a lot of 

minutia, detail-oriented work that is done. I am not sure that the auditors actually relate that detail to the 

big picture of what is going on, what the firm does for a living, their strategy. You know, the bigger things 

in terms of the investment strategy, for hedge funds especially. But that actually requires a certain level of, 

I guess, technical knowledge of, you know, the different hedge fund strategies.” Hedge Fund Manager 

Testimony Tr. at 35-36. 

114 The FTI Engagement Team concluded that the lack of an internal audit department at a relatively large 

and well-known firm as BMIS should generally have raised concerns with regard to the level and 

effectiveness of internal controls at the firm. 

177 
 

 

 

space, equipment and administrative support. See Cohmad Form X-17A-5 Part III (June 

30, 2005), at Exhibit 225. Cohmad’s FOCUS Report filings and BMIS’ FOCUS Report 

filings indicated that both entities were located at 885 Third Avenue, NY New York 

10022. Id.; See 2004 and 2005 BMIS Form X-17A-5 Part III, at Exhibit 226. However, 

the annual audited report, which contained BMIS’ October 31, 2004 and October 31, 

2005 FOCUS Reports (Form X-17A-5 Part III), failed to identify the related party 

relationship with Cohmad.115 Id. 

Examiners saw substantial monthly checks going to Cohmad Securities, but 

Madoff was able to explain away the examiners’ suspicions. Ostrow Testimony Tr. at 

pgs. 54-55. Ostrow explained, “I’m sure we brought it to John [Nee’s] attention, the 

Cohmad relationship, but after we got the story that he’s just helping them manage their 

bonds, you know, how much more can you, you know, keep going?” Id. at p. 55. 

Ostrow said that Madoff’s explanation for why BMIS was paying Cohmad “seemed odd 

... but he gave us an answer. ... You know, you try to take people’s words for it, and ... 

we thought it might be a good idea to do a follow-up exam one day.” Id. at p. 111. 

Ostrow believes that in the past the examination program has taken the word of 

registrants too often without verifying it with an outside source. Id. Ostrow believes that 

the examination program is “going to start going to outside sources.” Id. 

4. Document Request Did Not Contain a Request for Trade Data 

At the end of their pre-examination work, the examiners drafted a document 

request to send to BMIS. E-mail dated March 24, 2005 from Ostrow to Nee, at Exhibit 

227. The staff requested general information about the organization, including BMIS’s 

organizational charts and annual audited reports; documents relating to BMIS’s net 

capital and financial reporting; documents related to BMIS’s sales practices, including all 

sales and promotions literature for the firm and a list of all institutional and broker-dealer 

accounts; information related to internal audit procedures; information related to the 

firms contingency planning in the case of a disaster; and documents related to BMIS’s 

Anti-Money Laundering Program. Id. The document request, however contained no 

request for trade data. Id. 

Ostrow explained they used a template to determine what documents and 

information to request: “I basically work off a template for each of my firms’ request list 

and tweak it accordingly to the type of firm.” Ostrow Testimony Tr. at p. 59. Similarly, 

Lamore stated, “we have standard information that we request, and then based on the 

exam, you somewhat tailor it.” Lamore Testimony Tr. at pgs. 55-56. 

Lamore did not know why there was no request for trade data in the document 

request. Id. at p. 56. He explained that in cause examinations they sometimes did not 

want to tip their hand about what they are looking at and “intentionally may[] not put 

115 According to the FTI Engagement Team, lack of disclosure regarding related-party relationships may 

provide a signal that the examiner needs to closely review and discuss the relationship and any other 

related-party relationships with the firm and its auditor. This is especially true when one party (i.e., BMIS) 

accounts for virtually all of the revenue of the other party (i.e., Cohmad). 

178 
 

 

 

 

things in.” Id. Ostrow had a similar recollection, stating, “We do not ask for “the 

specific customer transactions, that we usually get into later. ... very rarely do we in the 

initial document request come out with exactly what we know we’re looking for, trying 

to find, trying to figure it out as we go along.” Ostrow Testimony Tr. at p. 59. 

The document request was dated April 1, 2005 and requested the documents by 

Monday April 4, 2005 because “[w]e plan to begin our examination on that date.” E-mail 

dated March 24, 2005 from Ostrow to Nee, at Exhibit 227. 

G.	 NERO On-Site Examination Began Almost a Year After Referral was 

Made 

1. Bernard Madoff was the Examiners’ Exclusive Contact at BMIS 

When the examiners began their on-site examination of Madoff, on or around 

April 11, 2005,116 they learned Bernard Madoff would be their primary contact.117 

Lamore Testimony Tr. at p. 28. As Lamore noted, “He was our primary – really 

exclusive contact for the firm.” Id. at p. 28. Ostrow added that “we really didn’t deal 

with anyone else at the firm, other than Bernie, and we tried to, you know, have 

conversations with Peter [Madoff] or have conversations with Shana [Madoff] and, you 

know, usually were thwarted or once in a blue moon were able to send an e-mail to Shana 

to request an e-mail or something.” Ostrow Testimony Tr. at p. 33. 

Ostrow described that they had contact with Bernard Madoff “almost every day” 

for the “two and a half months or so that I was onsite” at BMIS. Id. at pgs. 21-22. Both 

Lamore and Ostrow found their extensive contact with Bernard Madoff “odd” and 

unusual. Lamore Testimony Tr. at p. 28; Ostrow Testimony Tr. at p. 22. In his prior 

examinations, Ostrow had never had such extensive contact with the CEO of a firm the 

size of BMIS: “I usually have a contact person in the firm, like a compliance examiner. 

He [Bernie Madoff] was the contact person for myself and Peter [Lamore] throughout [] 

95 percent of the exam.” Ostrow Testimony Tr. at p. 22. Lamore felt similarly: “It just 

seemed odd to me that someone of his stature ... would be dealing with us directly.”118 

Lamore Testimony Tr. at p. 30. 

Sollazzo also found their extensive contact with Bernard Madoff to be out of the 

ordinary, stating, “You know, it’s unusual that he was dealing directly with the 

examiners. I don’t know if I fully understood that he was the only one they were dealing 

116 Lamore recalled that that the examination began on April 1, 2005, but an e-mail indicates that they may 

not have started their on-site examination until April 11. E-mail dated April 11, 2005 from Ostrow to Nee, 

at Exhibit 228.
 117 Madoff recalled that with respect to the 2006 OCIE exam, “two young fellows,” [Lamore and Ostrow] 

came in “under the guise of doing a routine exam.” Madoff Interview Memorandum at p. 1. Madoff said
 

that during that time period, sweeps were being done of hedge funds that focused on front-running, and that
 

was why he believed Ostrow and Lamore were at BMIS. Id.
 118 Former Examiner #1, testified that in approximately three years of conducting examinations, he only 

dealt directly with a CEO during one examination and that was at a “small firm” with “only five people in
 

the firm.” Former Examiner #1 Testimony Tr. at pgs. 12-13. 

179 
 

 

 

with.” Sollazzo Testimony Tr. at p. 89. Nee thought it was odd that all the contact for 

the examination was with Bernard Madoff as well, and could not think of another 

instance in which an entity of BMIS’s size had the CEO as the primary contact for an 

examination. Nee Testimony Tr. at pgs. 86-87. However, he did not identify Bernard 

Madoff being the point of contact as an issue or raising any concerns, stating, “it did 

seem odd, but again, on its face it seemed off but there was nothing inherently wrong 

with it ... .” Id. 

2. Madoff Attempted To Intimidate and Impress Examiners 

From the beginning of the examination, Madoff told the examiners about 

influential people he knew inside and outside of the SEC. Ostrow recalled the following: 

All throughout the examination, Bernard Madoff would 

drop the names of high-up people in the SEC ... he would 

always reference people in OCIE and Broker-Dealers 

sometimes. So he knew a lot of people. He even came in 

and told myself and Peter who the next chairman of the 

SEC was going to be a few weeks prior to us actually 

getting an e-mail at the SEC. So we were just pretty 

amazed by that .... We just first thought he was throwing 

out a lot of names and then came to realize he did know 

these people. [H]e had already pretty much well 

established that he knew everyone in OCIE, and named 

everyone, and already mentioned Lori Richards .... 

Ostrow Testimony Tr. at pgs. 24-25, 142. Lamore had a similar recollection: 

Yes. I remember him throwing in a couple of names, 

actually, SEC employees. One was – one was the 

commissioner, Commissioner Annette Nazareth. He’d 

throw in – at one point, I believe an individual named 

Henry Kaufman who was formerly Salomon and Smith 

Brothers – Salomon Chief Economist. I think he was there 

one day. And I think he actually – at the time we 

conducted the exam was the time when Chairman Cox took 

over, and he seemed to have – he thought he had some 

insight as to who was going to get named. And I think he 

actually even named at one point in the past he was in the 

running to become commissioner of the SEC. 

Lamore Testimony Tr. at p. 89. Sollazzo and Nee recalled that the examiners told them 

that Madoff said that in the past he was on the short list to be the next chairman of the 

SEC119 and later told them who was chosen to be the new Chairman prior to the 

119 On June 1, 2005, Lamore e-mailed Nee, “Bernie told us that he was on the ‘short list’ when Chairman 

Donaldson was selected. Maybe this time...” E-mail dated June 1, 2005 from Nee to Lamore, at Exhibit 

180 
 

 

 

 

 

information being made public. Sollazzo Testimony Tr. at p. 102; Nee Testimony Tr. at 

p. 125; Lamore Testimony Tr. at pgs. 89, 23; E-mail dated June 1, 2005 from Nee to 

Lamore, at Exhibit 229. Nee thought it was possible the examiners told him Madoff 

knew who the new Chairman of the SEC was before he was appointed, but Nee did not 

have a specific recollection. Nee Testimony Tr. at p. 125. 

Ostrow described Madoff as “charismatic” and “charming,” “[e]xcept when he 

was angry with us.” Ostrow Testimony Tr. at p. 148. Lamore recalled that while 

Madoff’s stories were interesting, they tended to distract from work on the examination, 

stating as follows: 

[D]uring the course of the exam, [Madoff] made a point to 

tell us ... and emphasize that his family had a dramatic 

influence on the securities industry. ... I think ... clearly 

he’s a wonderful storyteller, very captivating speaker, and 

he has an incredible or had an incredible background of 

knowledge in the industry. So for me that was very 

interesting. I mean it became a little frustrating at times, 

though, because, you know, we obviously were there to 

conduct business, and so [he] can be sort of distracting. 

Lamore Testimony Tr. at pgs. 50-51. 

Examiners had the impression Madoff referenced his influential connections at 

the SEC and on Capitol Hill in an effort to both impress and intimidate them. Ostrow 

Testimony Tr. at pgs. 24-25; Nee Testimony Tr. at pgs. 123; Lamore Testimony Tr. at p. 

90. Elaine Solomon, who worked as Peter Madoff’s secretary from March 1997 until 

December 2008, stated that the SEC examiners who met with Madoff looked like they 

were “in awe” of him. Solomon Testimony Tr. at p. 14.120 

Nee believed Madoff’s efforts to impress the examiners was unsuccessful and that 

the examiners just found Madoff to be a “bit of a blowhard.” Nee Testimony Tr. at p. 

124. Ostrow testified that Madoff’s name dropping “didn’t really impress us.” Ostrow 

Testimony Tr. at pgs. 24-25. 

Sollazzo reflected that although the examiners were not highly experienced and 

may have been “overwhelmed by Bernie,” they were a good fit for the examination, 

229. Nee responded, “Maybe you and William can be his aides.” Id. Nee stated he was “trying to be 

facetious” in the e-mail. Nee Testimony Tr. at p. 196. 120 Solomon also stated that over the years, people from the SEC would ask about working at Madoff’s firm 

and inquire whether they could drop off resumes, although she never actually saw any resumes provided. 

Solomon Testimony Tr. at pgs. 14-15. However, when asked specifically about the examiners who were at 

Madoff’s firm during the 2005 examination, she stated she did not believe those examiners (likely Lamore 

and Ostrow) ever asked about jobs or a resume. Id. at p. 14. Both Ostrow and Lamore adamantly denied 

ever inquiring about employment at BMIS in any way. Ostrow August 19, 2009 Testimony Tr. at pgs. 7-8; 

Lamore August 19, 2009 Testimony Tr. at pgs 6-7. The OIG has discovered no evidence that Ostrow or 

Lamore sought employment with BMIS. 

181 
 

 

adding that they had Nee, who had substantial experience, to help them with the 

examination. Sollazzo stated the following: 

[S]omeone, you know, with that reputation and supposed 

world of knowledge could he overcome, stonewall 

examiners? It’s a possibility, you know, it is a possibility. 

Obviously, you know, John was also – had some 

involvement with the exam. I know he attended at least 

some meetings and he was – you know, John was pretty – 

he is a pretty sophisticated guy, so we did have that 

knowledge as well, you know, working on the exam. ... 

The examiners ... didn’t have a huge amount of experience, 

but someone – and Ostrow is a very skeptical guy, and I 

know he sort of thinks a little bit differently, it’s outside the 

box and he’s very good with analyzing e-mails. And 

Lamore was one of our strongest people in terms of 

knowledge of trading. ... I think for the exam they were a 

reasonably good fit, they may have been outmatched a bit, 

you know, they probably were as it turns out, but we did 

have ... someone like John [Nee] involved with the process 

also. 

Sollazzo Testimony Tr. at pgs. 90-91. 

Although Sollazzo stated the examiners had Nee upon which to rely, the 

examiners recalled that during the two and a half months of the examination, Nee was onsite at BMIS for only one afternoon. In addition, they did not recall Sollazzo coming onsite at all. Lamore Testimony Tr. at p. 28; Ostrow Testimony Tr. at p. 15. Nee 

acknowledged being on-site “no more than two to three times.” Nee Testimony Tr. at p. 

19. 

3. Despite the Evidence, Madoff Would Not Admit To Managing 

Money for Hedge Funds 

On April 13, 2005, the examiners and Nee met with Madoff. Madoff would not 

admit he had hedge fund clients for which he was managing money. Lamore Testimony 

Tr. at p. 71; Ostrow Testimony Tr. at p. 63. Ostrow explained that “According to Bernie 

there was no investment advisory business.”121 Ostrow Testimony Tr. at p. 70. Lamore 

commented that in the meeting, Madoff “has a story about everything,” which caused the 

meeting to go on for hours. E-mail dated April 14, 2005 from Lamore to Libal, at Exhibit 

230. Sollazzo recalled the examination team “having difficulty getting information on 

the underlying advisory clients” and Madoff not being “forthcoming with the client list or 

the number of clients.” Sollazzo Testimony Tr. at p. 93. Sollazzo stated that Madoff’s 

failure to provide the information “was definitely a concern.” Id. 

121 Madoff stated that he told Ostrow and Lamore, “I don’t manage money.” Madoff explained that, “At 

this time, I was trying to conceal.” Madoff Interview Memorandum at p. 2. 

182 
 

 

 

 

 

 

 

 

 

 

The examiners were unaware that Madoff was using the 17th Floor of the Lipstick 

building for his investment advisory business. Ostrow Testimony Tr. at pgs. 69-70. 

Ostrow explained that although they were aware that Madoff had offices on the 17th 

Floor, “We didn’t know that there were any customer accounts or anything, you know, 

being done there or anything like that, just that there was a back office, a few people 

sitting there, not related to an investment advisory business, because, according to Bernie, 

there was no investment advisory business.”122 Id. at p. 70. 

Because “the exam team was having a hard time getting Madoff to admit that he 

had any involvement with hedge funds,” the day after the meeting, Nee asked the 

examiners to send him a list of the Madoff feeder funds they had been identified in news 

articles. Nee Testimony Tr. at p. 76; E-mail dated April 14, 2005 from Nee to Ostrow 

and Lamore, at Exhibit 231. Nee explained in an e-mail to Ostrow and Lamore that he 

“was thinking that it might be beneficial to us to send an info[rmation] request to some of 

the larger prime brokers to see if they deal with the hedge funds that some suppose are 

connected to Madoff.” Id. Later that day, Lamore e-mailed Nee the list of funds that Nee 

had requested. Id. 

By April 20, 2005, the examiners had looked at BMIS’s Profit and Loss (P&L) 

statements from the prior period and had a “walk through of the firm’s e-mail system.” 

E-mail dated April 20, 2005 from Ostrow to Nee and Lamore, at Exhibit 232. Ostrow 

noted Madoff had told them BMIS had started saving instant messages only since the 

beginning of the year. Id.123 They had also received some limited trading information 

from Madoff, but it was not in a usable format and they had requested it be converted to 

Microsoft Excel. Id. 

4. Madoff Became Difficult for Examiners to Deal With NERO 

Supervisors Did Not Push Back 

Ostrow explained that the examiners “had a real difficult time dealing with” 

Madoff.124 Ostrow Testimony Tr. at p. 28. In his testimony, Ostrow described Madoff 

growing “increasingly upset” during the examination, and attempting to dictate to the 

examiners what to focus on in the examination and what documents they could review:125 

122 After Madoff admitted to the NERO examiners that he had close to 15 advisory clients, the examiners 

never requested to see Madoff’s 17th Floor or inspect the trading or back-office areas associated with 

Madoff’s advisory business. Ostrow Testimony Tr. at p. 70. The examiners also did not request to speak 

with any other personnel that had primary responsibilities associated with the advisory business. Id. As a 

result, the FTI Engagement Team concluded the examiners missed an opportunity to corroborate Madoff’s 

representations about his advisory business with other personnel.

123 The FTI Engagement Team concluded that typically, such verbal statements by a respondent should be 

vetted by examination staff in order to determine whether a potential violation of the books and records 

requirements had occurred and whether staff needed to pursue the issue further. 

124 Madoff viewed Ostrow, who he found “so cryptic,” with disdain. Madoff Interview Memorandum at p. 

1. He stated he “really got annoyed” with Ostrow for repeatedly asking BMIS to generate “computer runs” 

which required Madoff’s computer programmer to reformat the material. Id. 125 Madoff asserted that he thought the examiners were asking for irrelevant documents. Madoff Interview 

Memorandum at p. 1. Madoff stated he did not understand what Lamore and Ostrow were looking for 

because they looked through bank reconciliations, expense accounts, canceled checks, and phone bills. Id. 

183 
 

 

 

Bernard Madoff grew increasingly upset with the Exam 

staff or the Exam Program and I know multiple times Peter 

would e-mail back saying, you know, just talk to me, 

saying we shouldn’t be looking at e-mails126, we shouldn’t 

be doing this, and you guys show know what time splicing 

is or slicing and what – that we’re talking with OCIE .... 

Id. at pgs. 28, 60. 

On the afternoon of April 20, 2005, Ostrow e-mailed Nee about Madoff’s 

attempts to dictate the examination, informing Nee of the following: 

Just to make you aware of the current situation. Bernard 

Madoff is getting increasingly agitated regarding our 

examination. He keeps on insisting in knowing exactly 

what we are looking for. He repeatedly mentions frontrunning as something we should be looking for. He thinks 

our request for order and execution data in three securities 

is outrageous. We keep informing Bernard that this is an 

examination of his book and records and we are only 

requesting information that would apply to SEC and NASD 

Rules and Regulations. 

E-mail dated April 20, 2005 from Ostrow to Nee, at Exhibit 233. 

Lamore described, in the following testimony, Madoff’s extreme anger, which 

precipitated Ostrow’s e-mail to Nee: 

[W]e were asking for documents or something and he got – 

I mean I think this e-mail was sent because it was actually – 

it was sort of disconcerting how angry he became. I mean 

his veins were popping out of his neck, and during that – it 

was a – I think his brother Peter might’ve been there, and 

he just repeatedly said, you know, “What are you looking 

for?” And his voice level got increasingly loud and the 

veins were popping out, and one of us – I may have said 

something, you know, “What do you want us to look for? 

Madoff stated he had “tons of capital,” so he “didn’t understand why they were looking at that stuff.” Id. 

Madoff commented Ostrow spent a “huge amount of time looking at invoices for expenses.” Id. Because 

of the documents that the examiners were focused upon, Madoff thought that Lamore and Ostrow were 

doing an examination sweep and were looking for wrongdoing pertaining to an industry issue concerning 

how firms paid independent contractors. Id. 126 Madoff recalled that Ostrow and Lamore were at BMIS for two months, and that they “spent 90% of 

their time looking through e-mails.” Madoff Interview Memorandum at p. 1. Madoff opined that this is 

“routine for the SEC now, they feel that’s the way they find things.” Id. 

184 
 

What do you think we’re looking for?” And then he – 

that’s when he said something like, you know, “Frontrunning. Aren’t you looking for front-running,” or 

something – something to that effect. ... I think he was 

frustrated because he couldn’t figure out exactly why we 

were there, and I think at this point, we had asked him 

about all of his businesses and he had not revealed his 

investment advisory business. So I think we were hinting 

around things, trying to get him to admit or acknowledge 

he was conducting this business, and I think that frustrated 

him. 

Lamore Testimony Tr. at p. 71. 

Lamore testified that Madoff attempted to take charge of the examination before 

the examiners had even gone on-site at BMIS. Id. at p. 68. Lamore explained that the 

examination team had broken with NERO’s typical examination protocol for a firm of 

BMIS’s size and told BMIS ahead of time that they would be conducting an examination. 

Id. at pgs. 68-69. According to Lamore, this advance notice gave Madoff time to prepare 

an offense against the examiners: 

[P]rior to doing – our normal course of business in New 

York is to not make the registrant aware of an exam before 

we go out and do it. We show up unannounced. In this 

case, for the larger firms, we typically announce ahead of 

times that we’re going. Mr. Nee typically focuses on the 

larger firm exams. For this examination of Bernard 

Madoff, he called, I believe, Peter Madoff, the compliance 

officer, to let him know that we would be conducting an 

exam of Bernie Madoff and within, I believe – I believe I 

recall within five minutes or, you know, shortly thereafter, 

Bernard Madoff called Mr. Nee back and wanted to know 

essentially, “What’s this about? Why you doing an exam,” 

et cetera. So I think, you know, from the very beginning 

that we informed him that we were doing the exam, he was, 

you know, sort of agitated or just not easy to deal with. He 

was difficult. ... [H]e got pretty agitated and, you know, he 

was pretty upset. 

Id. Lamore explained they typically did not give a registrant notice they would be 

conducting a cause examination so that the registrant could not “[c]reate documents or 

destroy documents, things like that.” Id. at p. 69. 

185 
 

After Ostrow informed Nee127 that Madoff was angry with them and pushing back 

against their requests, the examiners did not recall Nee stepping in to keep Madoff in 

check, as evidenced by the following exchange during Lamore’s testimony: 

Q: Okay. And so when Ostrow would report back to 

Nee that Madoff was getting agitated, do you know 

what the response was from Nee? 

A: I don’t think we got any response. 

... 

Q: All right. And did -- were there ever any times 

where got Nee [got] involved because of the 

pushback or because he was getting agitated? 

A: I don’t recall any. 

Id. at pgs. 72-73. Ostrow had a similar recollection, as follows: 

Q: When you received this pushback from Madoff, did 

you feel that, you know, need to push right back at 

– at Madoff? 

A: Sort of that we were stuck in the middle and just 

being squeezed... We would go back and tell John 

what [had happened] and ask to push further and 

just told to, you know, relax or not and, you know, 

time to get out or, you know, you’ve been out there 

long enough or things like that. 

Q: So John Nee discouraged you from pushing it 

further when Bernie Madoff would pushback? 

A: Sometimes him, sometimes even Pete would say 

let’s – let’s wait and ask him this in the big meeting 

or I would say let’s hold off and not put it in writing 

yet because he would get somewhat inflamed about 

it .... 

Ostrow Testimony Tr. at pgs. 61-62. 

127 Sollazzo also recalled being aware that Madoff was uncooperative during the examination. Sollazzo 

Testimony Tr. at pgs. 87-88. 

186 
 

 

5. Examiners Noticed Madoff’s Representations Contradicted News 

Reports and Noted “Weird Descriptions” in Books and Records 

On April 27, 2005, the examiners requested documents from Madoff relating to 

the compensation of several BMIS employees and trading data for certain employee and 

customer accounts, unrelated to Madoff’s institutional accounts. Document Request 

dated April 27, 2005 from SEC to Madoff, at Exhibit 234; Lamore Testimony Tr. at p. 

75. The following day, examiners met with Madoff and other members of the 

compliance department, including Peter Madoff. E-mail dated April 28, 2005 from 

Ostrow to Nee and Lamore, at Exhibit 235. 

Ostrow e-mailed Nee about the April 27 meeting, explaining they had asked if 

anyone at the firm had ever “managed money for an outsider [and] Bernie said, “Never.” 

Id. The examiners recognized that Madoff’s representations that he did not manage 

money and that he no longer traded options128 contradicted the news reports. Ostrow 

Testimony Tr. at p. 88; Michael Ocrant, Madoff Tops Charts; Skeptics Ask How, 

MARHedge, May 2001, at Exhibit 146; Erin Arvedlund, Don’t Ask, Don’t Tell, Barron’s, 

May 7, 2001, at pgs. 1-3, at Exhibit 135. Nee was unaware of whether or not Madoff was 

ever asked how he could execute the split-strike forward conversion strategy without 

trading options. Nee Testimony Tr. at pgs. 151-152. 

On May 3, 2005, Lamore e-mailed Nee, as follows, to let him know Barclays may 

be acting as a prime broker for some of the feeder funds, to alert Nee to some strange 

entries in BMIS’s operating accounts, and to inform him that Madoff denied that BMIS’s 

London office managed money. The e-mail stated the following: 

I know that you mentioned that Barclays may be 

conducting prime brokerage services for some of the funds 

and I think that you may be correct. I came across multiple 

transactions in the firm’s operating account with large 

dollar amounts that involved Barclays and I asked Bernie 

about them [there were no transactions with Lehman, 

Goldman, Merrill etc.] After going to “consult with his 

staff,” he stated that Barclays “clears for the brokers in 

London” delivery in the U.S. and paying them. [sic] 

Additionally, in the same operating account, I came across 

some weird descriptions that I asked Bernie to explain O/B 

128 Other representations by Madoff also contradicted documents that Madoff produced to OCIE in 2004. 

For instance, Madoff provided the 2004 OCIE examination team with paper-based customer account 

statements for the month of January 2004 that included options and equities trading activity for 21 clients. 

See, e.g. Tremont Customer Account Statement dated January 1, 2004 (showing option and equities trades), 

at Exhibit 236. In contrast, Madoff provided the 2005 examination team electronic customer account 

statements for the same month that included only equities trading activity for 17 clients. See, e.g. Tremont 

Trade Data produced to NERO Examination Team dated January 2004 (showing only equities trades), at 

Exhibit 237. OCIE provided the customer account statements showing the options trading to NERO in 

June 2005. Letter dated June 9, 2005 from Wood to Nee, at Exhibit 209. 

187 
 

Mellon Pit/ ($8.459M credit to the account), O/B Mellon 

Pit/ ($10.775M credit), O/B No Name Given ($5.548M 

credit). He stated that these transactions were also related 

to the Barclays clearing. 

Another weird description for some very large transactions 

is John/LDN. After consulting with his staff again, Bernie 

stated that this is John Bonventre who works in the cage 

deals with clearing and settlement issues. [John B is 

actually listed as operations on the directory that we were 

given.] As William mentioned yesterday, the LDN 

description leads me to believe that he is connected with 

the London office and Barclays... 

I specifically asked Bernie if the London office manages 

money for outside investors. Bernie said “it is my money.” 

E-mail dated May 3, 2005 from Lamore to Nee and Ostrow, at Exhibit 238. Lamore 

thought Madoff was able to explain away many of the discrepancies the examiners had 

identified. Lamore Testimony Tr. at pgs. 77-78. 

6. Nee Sent Document Request to Barclays, and Barclays Responded 

There Was No Trading in Madoff’s Account 

Nee sent a document request to Barclays on the same day he received Lamore’s email, requesting, “All 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.”129 Letter dated May 3, 2005 from Nee to Barclays Capital, at Exhibit 

239. 

Also on May 3, 2005, Lamore and Nee had the following e-mail exchange in 

which Lamore told Nee that he wanted to wait to confront Madoff until they received the 

trading data they requested from BMIS and a response from Barclays: 

[Lamore] I’m ready to call his bluff on his refusal to admit 

the money-management side of the business, so your 

document request is perfect timing. 

[Nee] If you guys think the timing is right, question him 

about it whenever you want. 

[Lamore] Ok. I’d like to get the e-mail and trading data 

that we’ve requested (in addition to the Barclays 

129 Ostrow testified that the examiners “probably pushed hard to write a letter to Barclays, and [Nee] did 

send the letter.” Ostrow Testimony Tr. at p. 86. 

188 
 

 

information from your request) before we confront him. 

Also, I think that it would be a good idea to be ready to 

speak with the funds as soon as possible after he denies 

involvement with them. I suggest we shoot for Monday, 

May 24, 2005 to confront him as well as be ready to speak 

to all the funds.” 

E-mail dated May 3, 2005 from Lamore to Nee, at Exhibit 240. 

On May 16, 2005, Barclays responded to Nee’s information request, stating that 

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

in the account. Letter dated May 16, 2005 from Barclays Capital to Nee, at Exhibit 241. 

The letter from Barclays stated as follows: 

The enclosed responsive documents are limited to Know 

Your Customer and related account opening documentation 

for Bernard L. Madoff Investment Securities LLC. This 

relationship was established on February 16, 2005; no 

relevant transaction activity occurred during the period 

March 1, 2005-March 31, 2005. There were no other 

customer relationships identified at Barclays Capital Inc. 

for the other names provided in your inquiry letter. It 

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. 

Id. 

The response from Barclays stating there was “no relevant transaction activity” 

for Madoff did not raise a red flag for Nee.130 Nee inferred from the letter that Madoff 

must have “executed trades through the foreign broker-dealer.” Nee Testimony Tr. at p. 

78. The examiners did not recall ever seeing a copy of the letter or Nee ever sharing it 

with them. Lamore Testimony Tr. at p. 81; Ostrow Testimony Tr. at p. 82. Nee stated 

that he did not follow-up with Barclays U.K affiliate because not long after he received 

the response from Barclays, Madoff admitted to executing trades for hedge funds. Nee 

Testimony Tr. at pgs. 78-81. Once Madoff admitted to having the clients, Nee planned to 

have Madoff produce the trading data rather than seek the data from an independent 

source, stating: 

Again, our whole goal was to just find trading where it was 

or to get – at this point I don’t think he had admitted to us 

130 The FTI Engagement Team concluded that the examination staff should have realized that the response 

from Barclays did not verify Madoff’s purported trading activity, and thus, was a major red flag that should 

have raised concerns and led the staff to contact the U.K. affiliate of Barclays to further verify Madoff’s 

purported trading activity. 

189 
 

 

 

that he was executing trades, and that seemed to be, you 

know, part of the battle. ... once ... he admitted that he had 

these clients, you know, then it became moot and we would 

get the trading directly from him. 

Id. at pgs. 79-81. 

Sollazzo concluded that the examination team did not reach out to U.K. affiliates 

of Barclays “because of the difficulty at times reaching outside of the U.S. It’s not as 

easy as going to a U.S. broker-dealer where, you know, we have open channels of 

communication.” Sollazzo Testimony Tr. at p. 86. 

7. Madoff Continued to Press Examiners to Finish the Examination 

and Produced A Limited Amount of Trading Data 

On May 24, 2005, the day before the meeting in which Madoff finally admitted to 

executing trades for institutional clients, Madoff pressed Lamore to finish the 

examination. E-mail dated May 24, 2005 from Lamore to Ostrow, at Exhibit 242. 

Lamore e-mailed Ostrow about his conversation with Madoff: 

He wants an idea of when we are going to finish the exam. 

He is getting more aggressive about trying to find out. I 

told him that we would speak to him tomorrow and based 

upon our questions and requests he should have a better 

idea. ... Again, be ready for his badgering about us leaving. 

Id. 

Also on May 24, 2005, BMIS produced 10 days of trading data for Madoff’s 

“market making business” in electronic format. E-mail dated May 24, 2005 from Ostrow 

to Lamore, at Exhibit 243; Lamore Testimony Tr. at pgs. 86, 88. Lamore recalled that 

they never received trading data in electronic format for Madoff’s advisory accounts and 

that data for the advisory accounts was produced in paper, stating, “My recollection is 

that it was a huge document. It was like a paper-based document for the trade blotter.” 

Id. at p. 87. Lamore believes that they did receive the customer account statements for 

the advisory clients in electronic format.131 Id. 

131 The FTI Engagement Team reviewed various data found in the NERO examination team’s work files 

including electronic and paper-based customer account statements and paper-based Order Entry Execution 

History reports related to Madoff’s investment advisory business, as well as paper-based equity trade 

execution data related to Madoff’s market making business. More specifically, the FTI Engagement Team 

reviewed electronic monthly account statements for each month during January 2004 - April 2005 for 17 

accounts that were found in the 2005 examinations team’s work files. There was no options information 

included in those statements. Madoff had also produced electronic customer statements for each month 

during January 2003 - March 2003 and May 2003 – December 2003 for 21 accounts in OCIE’s 2004 

examination of Madoff. These statements provided to the 2004 examination staff generally reflected 

options trading. OCIE sent NERO the 2003 electronic statements in June 2005. Letter dated June 9, 2005 

190 
 

 

 

 

 

 

 

8.	 Examination Team Did Not Go to an Independent Source for 

 Trading Data 

The examination team did not go to an independent source for trading data. 

Sollazzo and Nee stated the NERO examination program’s standard procedure is to 

obtain trading data from the subject firm and not from an independent source, such as 

FINRA, unless there is a particular reason to do so. Nee Testimony Tr. at pgs. 52-53; 

Sollazzo Testimony Tr. at p. 74. Nee explained that “we get the trading data – unless we 

have reason to get it directly from NSCC it’s sort of standard procedure to get it directly 

from a clearing firm – from the firm.” Nee Testimony Tr. at pgs. 52-53. Sollazzo 

agreed, stating, “We generally don’t go to these entities for trading data” because “it’s not 

the front-end trading data, it’s a lot of clearance settlement records.” Sollazzo Testimony 

Tr. at p. 74. 

Sollazzo clarified that if an examiner was “doing a Ponzi review,” then “you 

would go to DTC” and “very well may” go to OCC if “options were implicated.” Id. at 

75. Lamore also testified that it was not normal practice in the exam program to reach 

out to entities like DTC, OCC, and NSCC, stating, “I haven’t experienced ever reaching 

out to I don’t think any of these entities.” Lamore Testimony Tr. at pgs. 52-53. 

from Wood to Nee, at Exhibit 209. The FTI Engagement Team also reviewed various paper-based monthly 

account statements during January 2001 - January 2004 for 21 accounts that were found in the 2004 

examination team’s work files. 

The 2005 examination team’s work papers also included paper-based Order Entry Execution History 

reports related to Madoff’s split-strike forward conversion strategy, purportedly representing equity orders 

(shares, CUSIP, symbol, price, time) for January 20, 2005 during non-standard trading hours (i.e., not 

9:00am -4:00pm EST). There was no options information included in these reports. 

Additional information was provided in the 2005 examination team’s work papers that was not directly 

related to the split-strike forward conversion strategy. The 2005 examination team’s work papers included 

paper-based equity trade execution blotter data (trade date, settlement date, shares, CUSIP, price, net) 

primarily for shares of Exxon Mobil Corp. for trade dates January 20, 21, 24 and 25, 2005. The 2005 

examination team’s work files also included electronic records representing a sample of 10 days of trading 

data during February and March 2005 and trading data for 4 particular stocks (Dynamic Materials 

Corporation; 8x8, Inc.; Ionatron, Inc.; Time Warner, Inc.) during March 2005. In addition, the 2005 

examination team’s work papers included security position reports (symbol, market price, security, 

position, value) as of settlement date December 31, 2004, which were used by the NERO examiners to 

review the market making-business’ net capital position. 

191 
 

 

 

 

 

 

 

 

Sollazzo stated that examiners go to FINRA to obtain an audit trail.132 Sollazzo 

Testimony Tr. at p. 96. Nee, however, was unaware whether obtaining the audit trail 

from FINRA or the stock exchanges was standard practice in a front-running 

examination. Nee Testimony Tr. at pgs. 126-127. Sollazzo recalled that Madoff told 

examiners that he executed his trades in London after hours. Sollazzo Testimony Tr. at p. 

83. Thus, Sollazzo did not think FINRA would have an audit trail for trades executed 

outside the United States, 133 stating as follows: 

We were going to try to get the trade information from his 

internal records to see what existed. We wouldn’t be going 

to FINRA to get the trade information. ... To get an audit 

trail you would go to FINRA. If they are not executed in 

the U.S. I don’t think it’s going to [be] part of the FINRA 

audit trail.” 

Id. at pgs. 96-97.134 

132 The FTI Engagement Team opined that FINRA execution and order audit trail data is extremely useful 

in conducting a front-running examination. Such data includes pertinent information regarding the order 

and execution of a trade including: order date; order time; trade date; security symbol; time of execution; 

size of the execution; price of the execution; executing firm; executing contra firm; executing firm 

capacity; reporting firm; reporting contra firm; executing contra-firm capacity; and transaction type (i.e., 

buy, sell, sell short, etc.). This data would have assisted in independently verifying trading activity 

conducted at Madoff and would have included specific data necessary to examine whether or not Madoff 

was front-running its broker-dealer customers. Order Audit Trail System (OATS) data for instance, would 

have provided the time of each customer order, which the examiners should have compared to the 

execution times of trades for the discretionary brokerage accounts. 133 The examination team never established where the trades were executed. The FTI Engagement Team 

believes that if Madoff had used an after-hours electronic communication network in the U.S., such activity 

likely would have been reported to FINRA and cleared and settled through DTC/NSCC. Even if Madoff 

somehow executed the trades through his U.K. affiliate but not the U.S. broker-dealer, those trades likely 

would have been reported to the London Stock Exchange (“LSE”), since Madoff’s U.K. affiliate was a 

member firm. Further, if Madoff’s U.K. affiliate cleared its trades through Barclays in London as was 

suggested, then that institution or its affiliated clearing house (likely the London Clearing House) would 

have records of such activity. The FTI Engagement Team concluded that independent third-party audit 

trail data should have existed for Madoff’s trading whether or not he claimed to execute trades outside of 

the United States and that audit trail data should have been requested and obtained. 

134Unlike retail investors, a market maker like Madoff has access to after-hour trading facilities in the U.S. 

such as Electronic Communication Networks (“ECNs”) or other proprietary trading systems. In fact, 

NASDAQ accepts trade reporting from member firms from 8:00 a.m. in the morning, one-and-half hour 

before the market opens, through 6:30 p.m. in the evening, two-and-half hours after the market closes. 

Regardless of the venues, the after-hour markets are known to be illiquid when compared to regular hour 

markets; most high-volume traders would avoid after-hour trading except when a company is releasing 

material news that could impact the stock price. Also, even with the time differential, the LSE is only 

operating starting from 4:00 a.m. EST. A U.S.-based market maker would be much more likely to use 

ECNs or other proprietary systems to trade a large volume of U.S. listed securities after-hour (or trade 

during the regular hours for that matter). It is highly unlikely that a market maker would choose to move 

significant positions on the LSE at 4:00 a.m. in the morning on an almost daily basis. The FTI Engagement 

Team concluded that Madoff’s representations about executing his large-sized trades overseas and after 

hours was not credible and should have alerted the examiners to dig deeper into their investigation of 

Madoff’s claimed oversea trading volume. 

192 
 

 

 

9.	 Madoff Finally Confessed to Executing Trades for a Small 

Number of Institutional Clients 

Lamore and Ostrow planned to confront Madoff about managing money for 

hedge funds. On the morning of May 25, 2005, Lamore e-mailed Nee and Ostrow, 

stating, “I look forward to speaking to him regarding the hedge fund issue which he has 

opportunistically failed to mention to us.” E-mail dated May 25, 2005 from Lamore to 

Nee and Ostrow, at Exhibit 244. Lamore also explained that Madoff “started to bash the 

SEC exam program for not having a full understanding of” the firm’s technology and for 

“spending time reviewing e-mails.” Id. 

Later that day Ostrow and Lamore had the meeting with Madoff that they had 

been anticipating. Madoff Interview conducted by Ostrow and Lamore on May 25, 2005 

Memorandum, at Exhibit 245. After raising the issue of the 2001 MarHedge and 

Barron’s articles, Madoff finally admitted to executing trades for a small number of 

clients. Id. In a memorandum examiners provided to Nee on May 26, 2005, they 

summarized their meeting with Madoff. Id. 

In the memorandum, the examiners described how Madoff had changed his story 

several times. Id. For example, Madoff had said he had no advisory clients, then he had 

claimed to have four, and then “closer to 15.” Id.; Lamore Testimony Tr. at p. 88. 

Lamore testified that he suspected Madoff may have been providing the examiners with a 

smaller number of clients than he actually had in order to stay below the threshold for 

registering.” Id. According to the examiner’s memorandum, Madoff told the examiners 

all of the clients were foreign investors and that the trading directive agreements were the 

only correspondence he had with the clients. Madoff Interview conducted by Ostrow and 

Lamore on May 25, 2005 Memorandum, at Exhibit 245. The memorandum stated the 

following: 

When the staff mentioned the Mar[H]edge and Barrons 

articles, BMadoff stated “we do execute trades on behalf of 

brokerage firms and institutions which include a number of 

hedge funds. They use a model (algorithm) that we 

developed.” Initially, BMadoff stated there were four 

hedge funds using the model including Fairfield Sentry, 

Thema, Tremont, and Kingate Global.135 Subsequently, 

BMadoff stated there were approximately 15 entities 

including the four hedge funds and two corporate accounts 

using the model. The Trading Directive agreements 

between Madoff and these entities will be provided by the 

firm.136 BMadoff stated that all investors are foreign 

135 “According to BMadoff, Fairfield Sentry is affiliated with Citco, Tremont is affiliated with Bank of
 

America, and Thema and Kingate Global are affiliated with HSBC.” [Actual footnote from the examiners’ 

memorandum.] 

136 “BMadoff stated these agreements were the only written correspondence between Madoff and these 

entities.” [Actual footnote from the examiners’ memorandum.] 

193 
 

 

investors and the accounts are all DVP/RVP.137 Madoff 

provides these entities with trade confirmations and monthend account statements which include all trading activity. 

The staff will select a timeperiod and review the account 

statements generated during this timeperiod. According to 

BMadoff, he is not an investor in any of these entities and 

he does not use the model to trade the firm’s capital. 

Id. (emphasis in original). 

Madoff told the examiners he alone executed trades on behalf of the entities using 

a computer model. Id. According to the examiners’ memorandum, Madoff stated the 

model suggested when to enter and exit the market, but he “was adamant he also uses his 

‘gut feel’ to make these decisions.” Id. “According to Madoff, the shares are executed in 

Europe before the 9:30 opening of the U.S. equity markets using various brokerage firm’s 

who bid or offer on the securities in the basket in an ‘auction system’ format.” Id. The 

memorandum also contained the following passage, stating that Madoff told examiners 

he did not consider himself an investment adviser because he only charged brokerage 

commissions: 

According to BMadoff, there was approximately six to 

seven billion dollars allocated to the model by the 15 

entities in April, 2005. The firm’s compensation for 

conducting this business is four cents per share, which is 

incorporated in the execution price.138 The revenue 

generated from this business is reflected in the “Other 

Trading” line item of the firm’s FOCUS Report. BMadoff 

explained that due to the compensation structure of this 

business, he does not consider himself an Investment 

Advisor. Therefore, he did not state that the firm managed 

outside money when previously questioned by the staff. 

Id. 

Nee recalled that the news reports at the time that discussed the number of Madoff 

feeder funds and the number of dollars invested with Madoff may not have reconciled 

with what Madoff told examiners. Nee Testimony Tr. at pgs. 90-91. Nee also was 

“aware that the examiners on the Madoff cause exam felt that they were lied to by Mr. 

Madoff on numerous occasions.” Id. at p. 85. Nee stated he was not “overly concerned 

with” the discrepancies as long as Madoff disclosed “the bulk” of his trading, and 

disclosed “some of the bigger ones” like Fairfield. Id. at pgs. 90-91. Nee explained, as 

137 DVP/RVP refers to delivery-versus-payment/receive-versus-payment. Delivery-versus-payment, in 

relation to a purchase or sale of a security, means a service available to the buyer which allows him, her or 

it to pay for the security when the security is delivered at settlement. Receive-versus-payment, in relation 

to a purchase or sale of a security, means a service available to the seller which allows him, her or it to 

deliver the security when payment is received at settlement. 138 “BMadoff stated that all entities are charged four cents per share.” [Footnote from the examiners’ 

memorandum.] 

194 
 

 

 

 

follows, why Madoff’s initial lie to the examination team about not having investment 

advisory clients “was suspicious” to him but not pursued: 

Oh, it was suspicious, but you know, it’s hard to get inside 

someone’s head about why they’re saying what they’re 

saying. But yes, it was suspicious but we knew that 

ultimately it was a books and records review. If we could 

get – if we could walk out of there, get the trading, look at 

it, compare it to the other side of his business, then we will 

have done what we were sent in to do. 

Id. at 82-83. 

H.	 Examiners Learned from Madoff that OCIE Had Been Conducting Its 

Own Examination of Madoff 

In the last line of the examiners’ May 26, 2005 memorandum, the examiners 

noted that the existence of the hedge fund relationships, which had taken the examiners 

more than six weeks on-site to get Madoff to acknowledge, had already been revealed to 

OCIE a year and a half before during an examination conducted by OCIE.139 The last 

line of the memorandum stated the following: 

BMadoff was surprised that the staff was unaware that 

Madoff conducted this type of business since he had 

discussions regarding the firm’s hedge fund relationships 

with SEC officials approximately one and one-half years 

earlier. 

Madoff Interview conducted by Ostrow and Lamore on May 25, 2005 Memorandum, at 

Exhibit 245. 

139 Madoff confirmed that NERO appeared unaware that OCIE had been conducting an examination of 

BMIS until he told them. Madoff Interview Memorandum at p. 2. Madoff explained that the NERO staff 

insisted it was a routine exam, and that “We haven’t been here in ten years,” to which Madoff replied, 

“You [DC OCIE staff] were just here.” Id. Madoff recounted a conversation with Ostrow: 

Ostrow: “So tell me about this article.” (Madoff said Ostrow was referring to the MAR/Hedge 

article, leaning back with his hands behind his head “like Lieutenant Colombo.”) 

BM: “What about it?” (Madoff stated that Ostrow was “acting as if I didn’t do this business.”) 

BM: “Lori Richards has a whole file I sent her with this info. They have it.” 

WO: “Well, it’s a big organization; we don’t talk to each other.” 

Id. Madoff stated that he thought Ostrow was acting “as if the left hand didn’t know what the right hand 

was doing.” Id. 

195 
On May 26, 2005, the day after meeting with Madoff, Lamore and Ostrow sent 

Nee their summary memorandum. Id. Nee forwarded the memorandum to Sollazzo, who 

responded with the following comment on Madoff’s fee structure: 

Bernie’s fessing up. I could only access part of the memo, 

but it sounds like we may have something to review 

(directed executions). You wonder what is his benefit 

beyond commissions. 

E-mail dated May 26, 2005 from Sollazzo to Nee, at Exhibit 246. Sollazzo explained 

Madoff’s failure to provide “information on the underlying advisory clients” was 

“definitely a concern” as was Madoff’s frequently changing stories about the number of 

clients for which he executed trades. Sollazzo Testimony Tr. at pgs. 93, 95. 

Later that day, Nee sent the following e-mail to McCarthy, with a copy to 

Sollazzo and the examiners, asking him if Madoff was correct and McCarthy and 

Richards were already aware that Madoff managed money for hedge funds: 

We are currently conducting an exam at Madoff. Our 

major focus has been the possibility that Madoff is using 

his vast amounts of customer order flow to benefit the $6 

billion in hedge fund money that we believe he manages. 

In initial inquiries about managing outside money and 

supplying black box models (algorithms, etc.) to outside 

accounts he either denied it or was evasive. 

When he finally admitted to “executing trades” for billions 

in customers’ (hedge funds) money using specific 

proprietary trading algorithm, he said we should know 

about this as he told Lori Richards and John McCarthy 

about this 1.5 years ago. We are hoping that if what he is 

saying has any truth at all to it that you might have some 

info related to his hedge fund related activities that you 

could send us. 

E-mail dated May 26, 2005 from Nee to McCarthy, at Exhibit 247. McCarthy forwarded 

the e-mail to Swanson who responded that OCIE was already looking at the same issue: 

John – we should discuss. Ocie [sic] has an open exam of 

madoff on this issue. I’m on road today, but am available 

tomorrow AM. 

Id. 

NERO may not have known OCIE was conducting an examination of Madoff 

because OCIE had not entered the examination into the STARS tracking system. 

196 
McCarthy Testimony Tr. at p. 113; Swanson Testimony Tr. at p. 114. However, even if 

the examination had been entered, it is not clear that NERO would have known OCIE 

was examining Madoff because examiners did not check the system when they started the 

examination. Ostrow Testimony Tr. at pgs. 115-116. 

The examination team found it embarrassing to learn from Madoff that another 

examination group at the SEC was conducting an examination of the same issue at the 

same entity without either group having any idea about the other. Lamore Testimony Tr. 

at pgs. 102-103; Ostrow Testimony Tr. at p. 115; Nee Testimony Tr. at p. 108. Sollazzo 

explained: 

It is embarrassing to find out that there’s an open exam for 

a registrant, we should have full awareness of that. You 

know, it – first going in and asking that question [whether 

another office of the SEC is also examining you] doesn’t 

make any sense, that[] shows, like, you know, the right 

hand doesn’t know what the left hand is doing. Generally, 

I think we’re much better than that. 

Sollazzo Testimony Tr. at p. 158. Lamore stated that Madoff used the opportunity to 

condescend to examiners: 

... I was sort of shocked that Washington had looked at this 

issue and also, it was – once he finally acknowledged it, he 

became – it was pretty condescending, I think, and because 

we didn’t – weren’t even aware of it, I think that was sort 

of the tone he took like when I didn't understand 

algorithmic trading. So I think that’s kind of what my 

thinking was at that point. And then we asked, I think, who 

– you know, who did you deal with or speak with so we 

could follow up with them. 

Lamore Testimony Tr. at p. 103. 

Unlike Lamore and Sollazzo, Nee did not find the discovery of the OCIE 

examination to be surprising: “Well, it’s not unusual for people in OCIE to do their own 

examinations or inquiries. I don’t, you know, sometimes they might not even call them – 

you know, there might not even be a report issued.” Nee Testimony Tr. at p. 97. 

Eric Swanson, an OCIE Assistant Director, recalled in the following testimony 

that communication between Commission offices could be hindered due to competition 

among offices: 

A: Bob Sollazzo was particularly protective of, you 

know, his territory and – and was – was very 

political about how he would approach this if he 

197 
 

 

found out that we had some into New York and 

done a trading exam, but he really did want to know 

in advance when we had done it and we were not 

always good about – about telling him. ... Again, 

there was no rule or policy about it, but I think the 

information-sharing at that level between offices 

was not always great. ... I sometimes sensed at the 

SEC that there was a bit of eat what you kill kind of 

– a bit of competitiveness between the offices. I’m 

sure we were that way and I know some of the 

regional offices were that way. So it felt a little bit 

like Corporate coming in when Washington would 

come in and do something without telling the 

regional offices, and I think, you know, I think on 

some level rightfully so, they didn’t like it. So 

should they have known? I assume, but after this 

process you’re going through, there may be a more 

formalized way that that information flows, but 

there wasn’t back then. 

Q: So given the culture at that time, you’re not 

surprised that the New York office wouldn’t know 

that you guys were doing the same exam as them? 

A: No, I’m not surprised. 

Q: Okay. And in fact, given the competitiveness, that 

information might not have been shared with the 

New York office? 

A: It wasn’t – you know, my recollection, it – we 

wouldn’t have just – we just wouldn’t have even 

thought to call them, which is, I think, bad. I think 

they probably should have been made aware. 

Swanson Testimony Tr. at pgs. 112-114. 

I.	 2003-2004 OCIE Examination Finished Without Conclusions 

1. OCIE and NERO Had a Conference Call 

On May 31, 2005, Nee and the examiners had a conference call with OCIE. Email dated May 26, 2005 from Nee to McCarthy, at Exhibit 247. Examiners could not 

identify for certain who from OCIE was on the telephone call, but believed meeting 

participants included McCarthy, Swanson, and Donohue. Ostrow Testimony Tr. at pgs. 

113-114 (recalled McCarthy, Swanson and possibly Donohue on the call); Nee 

198 
 

 

 

Testimony Tr. at p. 102 (recalled Swanson being on the call); Lamore Testimony Tr. at p. 

105 (recalled Swanson and Donohue on the call). 

From the conversation, Nee understood that although the OCIE examination had 

not concluded, “for all intents and purposes it was finished,” stating, “[I]t was my 

understanding at the time that they were not actively working on the issue, it just so 

happened that it looked like they were working on the same issue that we were.” Nee 

Testimony Tr. at pgs. 98-99. Despite the fact that the 2003-2004 OCIE examination had 

been open for a year and a half, Nee recalled that OCIE did not provide NERO with its 

conclusions or an examination report. Id. at 110-111. Lamore thought it was “strange” 

that OCIE had not written an examination report. Lamore Testimony Tr. at p. 107. Nee 

opined that in his group it would not be acceptable to have an examination that was not 

being actively worked on to remain open without conclusions or a final report being 

issued. Nee Testimony Tr. at p. 111. 

2. OCIE Told NERO that Madoff was Powerful and Well-Connected 

During the conference call, Nee and the examiners recalled OCIE telling them 

Madoff was a powerful and well-connected individual: 

I don’t know who said it, someone from OCIE basically, 

“He’s a very powerful person, Bernie, and you know, just 

remember that.’ ... But basically just, “He is a very wellconnected, powerful person.” 

Ostrow Testimony Tr. at pgs. 113-114. Ostrow interpreted the statement to raise a 

concern for them about pushing Madoff too hard without having substantial evidence. Id. 

at 145-146. Lamore had a similar recollection: 

I’m not sure if those were the exact words, but it struck me 

as odd at the time. It’s what I remember from that call was 

– you know, we’re always professional, of course, when we 

go do our exams, but that kind of elevates your sense of 

your need to be professional. 

Lamore Testimony Tr. at pgs. 105-106. Lamore could not recall who from OCIE made 

the statement. Id. Tr. at 106. 

Nee also recalled the statement, but did not interpret it to mean they should “tread 

lightly.” Nee Testimony Tr. at p. 103. He thought the comment indicated “they might 

get a phone call from someone but we never did.” Id. at p. 104.140 

140 Ostrow testified that this was an issue for the SEC generally, and that in past examinations unrelated to 

Madoff, supervisors at the SEC appear to have been reluctant to push issues against influential people: 

“Yes. I’ve seen it where, you know, maybe I’ve been told, ‘Don’t rock the boat so much there, because we 

199 
 

 

 

 

 

3. OCIE Sent Their Examination Papers to NERO 

On June 9, 2005 OCIE sent their examination papers to NERO. Letter dated June 

9, 2005 from Wood to Nee, at Exhibit 209. Nine categories of documents were listed on 

the cover letter to the OCIE work papers, and the final category was described as “Work 

papers received from Mavis Kelly (IA/IC).” Id. This category included the Hedge Fund 

Manager’s Complaint investigated in the OCIE examination, which questioned whether 

Madoff was misrepresenting his trading to his investors, stated that Madoff’s returns 

were not correlated to the overall equity markets in over 10 years, and asserted that the 

auditor was a “related party to the principal.” Lamore Testimony Tr. at p. 109; E-mail 

dated May 21, 2003, from the Hedge Fund Manager to Kelly, at Exhibit 148. OCIE also 

provided NERO with access to the BMIS customer account statements that Madoff had 

produced in electronic format. See E-mail dated June 9, 2005 from Fentress to Slains, at 

Exhibit 248 (stating examination team had been given access to OCIE’s Madoff folders). 

Ostrow did not recall seeing the Hedge Fund Manager’s Complaint at the time of 

the examination, and neither Ostrow nor Lamore recalled OCIE drawing any attention to 

it. Ostrow Testimony Tr. at pgs. 119-121; Lamore Testimony Tr. at pgs. 109-110. 

Lamore acknowledged he “may have glanced at it” and described his recollection as 

follows: 

I had conducted some sort of like cursory review of the 

documents, but it seemed so similar to what we were 

receiving in real time, that I didn’t spend a lot of focus and 

I just – this didn’t stick out to me at the time. 

Lamore Testimony Tr. at p. 110. Ostrow had a similar recollection. He explained that by 

the time the OCIE documents arrived in NERO, they had already returned “from the 

field” and he did not “really remember doing much with OCIE’s work papers.” Ostrow 

Testimony Tr. at pgs. 118-121. 

Nee and Sollazzo did not recall seeing the Hedge Fund Manager’s complaint 

during the examination. Nee Testimony Tr. at pgs. 107-108; Sollazzo Testimony Tr. at 

101. Although it was not reviewed during NERO’s examination, Sollazzo thought the 

examination team would have found the Hedge Fund Manager’s complaint to be a 

relevant document.141 Sollazzo Testimony Tr. at p. 101. 

have a good relationship with them,’ and when we – and not Madoff-related, but you know, ‘where we 

need to make a request for documents, they always gave it to us. So let’s try to go easy.’ You know, and I 

don’t go easy, and I push hard, and I get pushback from staff members. But, you know, at the end of the 

day it turns out, yes, it is an issue, or it should be an issue.” Ostrow Testimony Tr. at pgs. 163-164. 

141 According to the FTI Engagement Team, the Hedge Fund Manager’s complaint was detailed, insightful 

and considered to be from a credible source. The FTI Engagement Team concluded the complaint would 

have been particularly useful to the examination team because it included a number of serious allegations 

that needed further scrutiny, including: 

1. the unusual fee structure; 

200 
 

 

 

 

 

 

 

 

 J. NERO Examination Continued 

1.	 Madoff Failed to Produce Correspondence, E-mail and Other 

Documents Requested by the Examination Team 

Throughout the examination, Madoff failed to provide the team with requested 

documents. Ostrow Testimony Tr. at p. 126. 

2.	 whether or not there was enough market volume to support Madoff’s trading strategy for $8-$10 

billion of trading; 

3.	 whether or not the returns should have correlated to the overall equity markets; 

4.	 whether or not it was appropriate or feasible for accounts to move to cash at months end given the 

strategy; 

5.	 whether or not the auditor was a related party; 

6.	 whether or not there was no independent custodian; and 

7.	 whether or not the purported returns were feasible given the strategy and amount of assets 

purported to be under management. 

201 
 

 

 

Id. at p. 106. 

Sollazzo was not aware that examiners had trouble obtaining e-mail, but “was 

aware they were having some difficulty getting some records ... I had some awareness 

that they were having some difficulty getting some of the trading records and things of 

that nature.” Sollazzo Testimony Tr. at p. 91. 

202 
 

2.	 Questions About Trade Executions and Clearance Were Never 

Resolved 

On the afternoon of May 26, 2005, Nee e-mailed Lamore and Ostrow in response 

to the examiners’ memorandum of their meeting with Madoff. E-mail dated May 26, 

2005 from Lamore to Nee, at Exhibit 251. Nee e-mailed Lamore that he had told Ostrow 

to nail down the details of how Madoff executed and cleared trades. Id. Lamore 

responded, in the following e-mail exchange, that Madoff had been vague about trade 

execution and clearance, and he would find out the information by the following week: 

[Nee] In talking to William I asked him to find out more 

about the actual execution and clearance of the trades - 

executing brokers? London exchange? Prime broker used (I 

think they use Barclays) show him the article; role of UK 

affiliate (in e-mails they seem to be involved with 

Barclay’s.) And what are the parameters, or at least the 

factors that his model uses? 

[Lamore] Ok. He just graced me with his presence for an 

hour plus and I was able to get a better understanding. 

However, he was somewhat vague regarding the actual 

execution and clearance of trades other than the basket is 

advertised and as equities in the basket are traded, the 

model adjusts how much capital can be put to work and 

still stay within the parameters of client agreement. I’ll 

find out this information by the time you come back on 

Tuesday. Enjoy the super long weekend. 

Id. 

Nee did not “recall specifically” whether the details of Madoff’s trade execution 

were ever followed up on, stating, “I asked William to follow up, I don’t know if he 

followed up with more questions, but I don’t think there was – I don’t recall specifically.” 

Nee Testimony Tr. at p. 93. Sollazzo admitted that that details of how Madoff executed 

and cleared trades may never have been nailed down.” 142 Sollazzo Testimony Tr. at p. 

98. 

There is evidence that the examiners intended to draft a written request for 

information in order to follow up on the trade execution and clearance issues. Their 

intention in submitting a written request was to have Madoff “acknowledge in writing 

142 The FTI Engagement Team concluded that the staff should have recognized the need to independently 

verify Madoff’s verbal representations pertaining to how he executed, cleared and settled his trades. The 

FTI Engagement Team further concluded that Madoff’s informing the NERO examiners that BMIS 

functioned as an executing broker on a DVP/RVP basis by his U.K. affiliate should not have hindered their 

ability to uncover the Ponzi scheme or at the very least, the fictitious trades. See Section IV(M) for the FTI 

Engagement Team’s extended analysis. 

203 
 

 

 

that certain things didn’t apply to him, rather than him just giving us a verbal response.” 

Lamore Testimony Tr. at p. 115; Ostrow Testimony Tr. at p. 127. On the morning of 

May 27, 2005, Ostrow and Lamore outlined questions to add to such a request, and 

included the following: 

1. Customer statements and confirmations in an electronic 

format for all 14/15 entities from January 2004 through 

April 2005. (once we eyeball the statements we can 

than [sic] select specific accounts to request the trading 

activity for specific days) 

2. All correspondence (i.e. Facsimiles, e-mail, instant 

messages) between the firm and any of the 14/15 

entities for the period of January 2004 through April 

2005. 

3. What markets in London is Bernie using? How does 

the security settle? (It would not be DTC or NSCC) 

4. Provide a description of the algorithm used for the 

14/15 entities. What are the underlying assumptions? 

What factors feed into the model? Do any order entry 

systems feed into the model? 

5. What is Barclays role in facilitating the transactions of 

the 14/15 entities? Any other roles? 

6. What role does the UK office play in the 14/15 entities? 

E-mail dated May 27, 2005 from Lamore to Ostrow, Re Meeting with Berine [sic], at 

Exhibit 249. Lamore added that he would draft the request after he completed his review 

of the documents Madoff had produced, which appeared to Lamore to be incomplete. Id. 

Lamore stated that he did not recall putting together the request and did not 

“recall receiving anything in writing” from Madoff at all. Lamore Testimony Tr. at p. 

115. Ostrow was uncertain whether they submitted the request, and the OIG found no 

evidence that such request was ever submitted. Ostrow Testimony Tr. at p. 127. 

3.	 The Examiners Investigated How Madoff Executed and Cleared 

Trades by Asking Madoff and Relying on His Responses 

The examiners believed that the issue of how Madoff executed and cleared trades 

was discussed with Madoff and that examiners relied upon Madoff’s verbal 

representations. Ostrow recalled they likely received “a vague answer” from Madoff. 

Ostrow Testimony Tr. at pgs. 109-110. Ostrow stated that Madoff had a habit of 

providing answers that were “[v]ague or misleading, extremely misleading.” Id. at p. 

110. Lamore recalled asking Madoff about trade execution and clearance, but stated the 

examiners did not confirm the information provided with any third parties: 

A: We asked – we asked Bernard about this. My – my 

recollection is that Barclays – Barclays London 

204 
 

served as the clearance and settlement for the 

account that conducted this business. His – his 

London MSIO, his London affiliate served as a 

settlement agent. Bernard said that in order to 

conduct securities trades in Europe, you had to have 

a settlement agent, and that’s how it went. 

Q: Did you do anything further beyond talking to 

Bernie Madoff to resolve this issue? 

A: No. 

Lamore Testimony Tr. at p. 104; See also E-mail dated May 27, 2005 from Lamore to 

Ostrow, Re Meeting with Berine [sic], at Exhibit 249. 

After Lamore discussed the questions about trade execution and clearance with 

Madoff, on May 27, 2005, Lamore e-mailed Ostrow, “Regarding the settlement and 

clearance process, he [Madoff] stated that Barclays clears the trades and then delivers the 

fund/shares to the customers. There is no prime broker, Barclays clears the trades for 

Madoff.” E-mail dated May 27, 2005 from Lamore to Ostrow, at Exhibit 252. Ostrow 

responded to Lamore’s e-mail by raising the following additional questions that Madoff 

had not answered: 

We also want to know how that basket of trades is 

submitted to the 50 brokers in London. Maybe he just logs 

onto Barclays website and has an interface through them. 

How is the basket represented to these 50 brokers? Is it 

shown as Madoff being the customer? Is Barclays 

considered the customer? Is the whole size shown at once? 

Does it get shown piecemeal if it is done over three days? 

Why does he use Barclays as opposed to his London 

affiliate? What does Barclays charge per share? 

Id. Lamore responded to Ostrow, “I suggest we hold off on those questions until we 

receive the statements and other information.” Id. 

When asked if the examiners ever obtained answers to the questions Ostrow 

raised in his e-mail, Ostrow responded, “we probably just verbally asked him, and it 

came back to, again, that Barclays was being used as the clearing agent, clearing the 

trades for London on behalf of these 16 hedge funds, and that’s how it all worked.” 

Ostrow Testimony Tr. at p. 131. Lamore also recalled that they only sought answers to 

the questions Ostrow raised by “getting an explanation of how sort of the transaction 

205 
 

 

 

 

process worked” from Madoff “verbally.”143 Lamore Testimony Tr. at p. 118. Madoff 

never produced any documentation regarding custody of client assets. Id. at p. 114. 

4.	 According to Associate Director Sollazzo, The Key to Uncovering 

the Ponzi Scheme Would Have Been Going to Third Parties 

Sollazzo stated that he felt that the key to uncovering the Ponzi scheme was to 

reach out to third parties, such as the supposed options counterparties and the custodial 

agents.144 Sollazzo Testimony Tr. at p. 163. 

Nee stated that if the investment adviser examination team had performed the 

examination, he believes that they would have looked at custody of assets and safety of 

client assets. Nee Testimony Tr. at p. 56. Sollazzo explained the SEC is currently 

attempting to improve its ability to obtain independent verification in examinations: 

I’m on a committee now actually, with the OCIE level 

coordinated with FINRA as well, trying to work through, 

raise some of the limitations here and have better policies 

for verification. Because [] in the exam world, most of the 

time we do not send out confirmations and do asset 

verification, but clearly there has to be times where we do 

that and it’d have to be more effective. So you know, that’s 

some of [] what we’re working on. 

Sollazzo Testimony Tr. at p. 160. 

Madoff stated that he thought “the jig was up” during the on-site OCIE 

examination because he thought it was routine for the SEC to check with an independent 

third-party. Madoff Interview Memorandum, at p. 5. Madoff stated that Ostrow and 

Lamore “never really got into books and records as related to stock records or DTC 

records.” Id at p. 3. Madoff stated that “they never even looked at my stock records” or 

did a “box count.” Id. He said he was “astonished” that they didn’t ask for DTC records, 

and that only a regulator could get those records from DTC.145 Id. Madoff emphasized, 

143 According to the FTI Engagement Team, significant issues that are raised with registrants are typically 

done so in writing in order to memorialize the requests and responses. As a result, the examination team 

will have a record of such correspondence, which may be used to further develop and resolve any 

outstanding issues. Relying solely on verbal answers from the subject of a cause examination is not an 

appropriate method of examination. 

144 According to the FTI Engagement Team, examination staff could also have contacted FINRA/NASD, a 

SRO regulated by the Commission, in order to independently verify equities trading activity purportedly 

conducted by Madoff.

145 Sollazzo and Nee testified that it was reasonable for the examination team not to go to DTC because 

they believe that Madoff had provided documents to the examiners that led them to believe the securities 

were delivered directly to the customers. Sollazzo Testimony Tr. at p. 159; Nee Testimony Tr. at p. 153. 

The FTI Engagement Team concluded that the lack of clarity the examiners had about how Madoff 

executed and cleared trades and the inconsistencies the examiners identified in Madoff’s documents and 

representations should have caused the examination team to independently verify Madoff’s verbal 

206 
 

 

 

 

 

 

 

the SEC would “have to go to DTC.”146 Id. Madoff added that DTC does not have 

separate accounts for each customer, but rather, provides a global report, but stated that if 

they went to DTC, they would’ve seen his market making position, and that it “would’ve 

been easy for them to see” the Ponzi scheme. 147 Id. 

5. Examiners Identified Additional Discrepancies 

As the examination progressed, the examiners continued to find discrepancies in 

the information Madoff provided. For example, Ostrow recalled that the examiners 

identified, contrary to Madoff’s representation, the documents that Madoff produced in 

fact showed some options trading: 

And I think in a few instances, I think we did see some 

options trading. It might have fallen into some of our 

review period, and it was odd that in one instance, I think 

the options were put on before the basket or something 

which seemed to be in ... contradiction ... with the trading 

authorization directive. 

Ostrow Testimony Tr. at p. 65. Ostrow recalled that “there were a lot of inconsistencies 

in terms of data provided to us, why don’t we see a trade on this day” and Madoff would 

explain the inconsistencies away. Id. at p. 44. 

6. Examiners Tested Madoff’s Truthfulness 

In addition to other information he was to provide to the examiners, Madoff was 

supposed to provide the names of the “14 or so companies” for which he admitted to 

representations pertaining to how he executed and cleared trades. See Section IV(M) for FTI’s full 

analysis.

146 During the Enforcement investigation of Madoff, Madoff told SEC Enforcement attorneys, in the 

presence of Lamore, that his trades cleared through DTC. See Section V. After Madoff confessed to 

running a Ponzi scheme, Friedman, a NERO Branch Chief in the Division of Enforcement, testified that it 

was his understanding that within a few days NERO confirmed through either a “DTC terminal” or a “a 

phone call ... to DTC” that Madoff had not been placing trades for his clients. Friedman Testimony Tr. at 

pgs. 19-22.

147 Based on the volume (i.e., billions) of dollars that Madoff managed for the advisory clients, the FTI 

Engagement Team concluded that the SEC could have determined there was a problem if it had directly 

contacted DTC. If Madoff’s advisory account data was segregated from its market making data at DTC, 

those records should have shown significant positions coinciding with periods that Madoff reported holding 

significant positions in the split-strike forward conversion strategy. In addition, DTC’s affiliate, NSCC, 

could have also provided transactional volume data regarding the advisory account activity that should 

have been consistent with the transactional activity reported in the monthly account statements and 

customer confirmations. If the advisory data was not segregated from the market making data reported to 

DTC/NSCC, the examiners could have still reviewed the DTC/NSCC information to see if it reasonably 

could have accounted for the combined activity from both the market making business and the advisory 

business. The FTI Engagement Team concluded that the examination staff should have contacted 

DTC/NSCC in order to verify what records may have been available to verify Madoff’s purported trading 

activity, especially in light of the confusion among staff members with regard to how such trades were 

cleared and settled. 

207 
 

 

executing trades. E-mail dated June 6, 2005 from Lamore to Nee, at Exhibit 253. 

Ostrow determined, from research he conducted on Bloomberg, that Auriga International 

Euro Limited (Auriga) was a Madoff feeder fund. E-mail dated May 26, 2005 from 

Ostrow to Lamore, at Exhibit 250. Ostrow decided they should test the information 

provided by Madoff by not telling Madoff they knew about Auriga to see if Madoff 

would produce related documents. Id. When Madoff failed to produce the documents, 

Ostrow told Lamore to ask Madoff about Auriga. E-mail dated May 27, 2005 from 

Ostrow to Lamore, at Exhibit 254. On May 27, 2005, Lamore and Ostrow had the 

following e-mail exchange about Madoff’s puzzling response and then attempted to 

explain away the discrepancy: 

[Lamore] He [Madoff] said that he is not familiar with 

Auriga International although they could be an investor 

through one of the feeder funds. 

[Ostrow] That’s weird because Bloomberg reports Auriga 

has discretionary accounts with B. Madoff. Maybe it was a 

few years ago or it could be a feeder fund. 

Id. 

In testimony, Ostrow recalled the Auriga discrepancy. Lamore Testimony Tr. at 

p. 135. Nee did not have a specific recollection of this issue, but had a general 

recollection that Madoff “was playing a semantics game” with the examiners, and “the 

intent was sort of to deceive.” Nee Testimony Tr. at pgs. 120-122. 

Also on May 27, 2005, examiners discussed, in the following e-mail exchange, 

Madoff’s failure to produce all of the requested documents, and identified additional 

discrepancies in the documents he had produced: 

[Lamore] Bernie failed to give me the account information 

for Thema US Equity Fund which I noted in yellow on the 

attached spreadsheet. 

[Ostrow] Did he get you the RVP/DVP instruction sheet? 

Also we would like a list of corresponding contacts at each 

account. Or who is the investment manager who is 

authorized to call on behalf of the fund and increase the 

trading limits?” 

[Lamore] I’ll ask him to provide the information. I asked 

him to provide us with a copy of the information that he 

previously sent to the SEC. He said the information 

included account statements and P&L information in paper 

format. In our request today, we asked for a copy of all 

confirmations. He stated that all confirmation information 

was contained in the account statements. He asked if he 

208 
 

 

could provide a sample of confirmations to show that the 

information is contained in the account statements. I said 

that would be ok for now. 

[Ostrow] Try to get a month or two of a big account like 

Fairfield Sentry, Kingate or Tremont printed out today and 

put in a geek bag just so we get a feel for what the rest 

should look [like]. Otherwise he has three days to come up 

with a sample. 

E-mail dated May 27, 2005 from Lamore to Ostrow, Re Correction For Accounts Using 

Bernie’s Model, at Exhibit 255. Nee had a “general recollection throughout the course of 

the exam” that the examiners told him that Madoff was failing to provide requested 

information. Nee Testimony Tr. at p. 11. However, Nee believed “ultimately we got the 

bulk of what we requested in order to, you know, determine whether he was frontrunning.” Id. at p. 122. 

Ostrow testified that in his e-mail to Lamore he suggested locking up documents 

by putting them “in a geek bag” because he was suspicious Madoff was giving them only 

select documents.148 E-mail dated May 27, 2005 from Lamore to Ostrow, Re Correction 

For Accounts Using Bernie’s Model, at Exhibit 255; Ostrow Testimony Tr. at p. 70. 

Ostrow asked Lamore to request documents for same day production and then lock up the 

documents “before the weekend because we didn’t want to give Bernie a chance to ... 

cherry-pick or get us the best statement. We want just a raw statement right off the press 

and take it.” Id. The OIG has found no evidence that documents were locked up, and 

Lamore did not recall discussing with Ostrow the possibility Madoff could be 

“fabricating statements.” Lamore Testimony Tr. at p. 119. 

7.	 The Account Numbers Madoff Produced Were Suspicious to 

Examiners 

Also on May 27, 2005, Ostrow noted another discrepancy with the information 

Madoff provided to the SEC examiners. Lamore stated Madoff told him BMIS had 

provided a DVP/RVP instruction sheet listing “the custodian bank along with the 

accounts number that I listed on the spreadsheet.” E-mail dated May 27, 2005 from 

Lamore to Ostrow, Re Correction For Accounts Using Bernie’s Model, at Exhibit 255. 

Ostrow did not believe the account numbers provided were accurate, and stated, as 

follows, that he would research record requirements for the accounts: 

Wouldn’t those account numbers you listed in the 

spreadsheet correspond to the account at Barclays or the 

Madoff Account number? I can’t believe that is the bank 

account information for each of the 15 accounts. I can’t 

148 Madoff stated that the examiners “never asked for DTC records” or other records that needed to be 

prepared. Madoff Interview Memorandum, at p. 2. Thus, Madoff contends he did not provide false DTC 

records to the SEC. Id. 

209 
 

believe that Bank of America and HSBC both have account 

ranges that start with 1FR. I’ll need to do a little research 

and see what kind of record requirements if any are 

required for DVP/RVP accounts. 

Id. Ostrow explained in testimony that the account numbers looked suspicious to him: 

Sure, it was strange. .... You know, so we had suspicions 

about pretty much everything there, everything he said we 

wanted to try to figure out if it existed or it didn’t exist. 

Ostrow Testimony Tr. at p. 137. To find our more information about these accounts, 

Lamore reviewed BMIS’s required Anti-Money Laundering submissions. E-mail dated 

May 27, 2005 from Lamore to Ostrow, Re Correction For Accounts Using Bernie’s 

Model, at Exhibit 255. However, he did not find the submissions helpful because they 

not list a contact person or state who the beneficial owners was of the foreign accounts at 

issue. Id. The issue does not appear to have been resolved by examiners, as Ostrow 

explained: 

I know we didn’t send a letter to Bank of America and say, 

“Would you have an account 1FR.” ... Well, we did what 

we would do on a normal exam if they provided us a 

spreadsheet and we asked for the outside statements, which 

were statements he printed up, and we looked at it and 

compared it, and then if we had stuff received by OCIE, we 

usually wouldn’t go the next step the same way an outside 

auditor doing the annual audit would maybe send a request 

letter, even though – we thought everything was weird, so 

we would have been sending letters out everywhere. 

Ostrow Testimony Tr. at pgs. 137-138.149 

8.	 Examiners Were Skeptical of Madoff’s Claim to Time the Market 

Using His “Gut Feel” 

As the examiners continued to review the documents Madoff produced, their 

confusion grew. On June 1, 2005, Lamore e-mailed Nee and Ostrow a summary of the 

meeting he had with Madoff that morning. E-mail dated June 1, 2005 from Lamore to 

Ostrow, at Exhibit 256. Madoff reiterated to Lamore that “Bernie’s gut feel tells him 

when to enter the market and exit the market. His gut feel includes his observations of 

the trading room here in NY, what his European contacts are telling him, [and] what he 

reads in industry papers and publications.” Id. According to Lamore’s e-mail, Madoff 

stated that he did not “track monthly performance data of his model,” something Lamore 

“highly doubt[ed].” Id. Lamore also informed Nee and Ostrow that he “did receive the 

149 In testimony, Lamore stated he could not recall the issue of the suspicious account numbers. Lamore 

Testimony Tr. at p. 121. 

210 
 

list of brokers who execute for his model and 2005 monthly statements in paper format 

for Kingate Global and Kingate Euro.” Id. 

Lamore testified that he was suspicious of Madoff’s claim to enter and exit the 

market for billions of dollars of trades using his “gut feel,” stating as follows: 

I asked him repeatedly, you know. I thought his gut feel 

was, you know, strange, suspicious. You know, I kept 

trying to press him. I thought there was something else. 

You know, I thought, you know, he was getting some sort 

of insight into the overall broad market that other people 

weren’t getting. So I repeatedly sort of pressed him on 

that. I asked Bernie repeatedly over and over again, and at 

some point, I mean, I’m not sure what else to do. 

Lamore Testimony Tr. at pgs. 126-127. Nee shared Lamore’s feeling that Madoff’s 

claim to be trading on “gut feel” was not credible. Nee Testimony Tr. at pgs. 128-129. 

Sollazzo recalled the examiners being “skeptical” of how Madoff was earning his returns. 

Sollazzo Testimony Tr. at pgs. 111-112. However, Sollazzo did not find that Madoff’s 

claim to be trading on “gut feel” was “necessarily ... ridiculous.” Id. at pgs. 104-105. 

Nee testified that despite the two 2001 articles raising the issue of Madoff’s 

incredible timing and the examiners finding Madoff’s timing to be “exceptional,” he did 

not focus on Madoff’s incredible timing because, “We went in there to look at – 

specifically at the trading, it was sort of a front end review, we weren’t there to really try 

to see if the returns he was reporting were correct.” Nee Testimony Tr. at p. 132. As 

discussed below, notwithstanding these suspicions, no efforts were taken in the NERO 

examination to analyze this issue. 

9. Madoff’s Statement Were as “Clear as Mud” to Examiners 

The monthly statements Madoff provided appear to have raised more questions 

for examiners than they answered. Lamore e-mailed Ostrow on June 1, 2005, stating, 

“I’m not quite sure what’s going on with these statements. I’ll show you later but it 

seems clear as mud to me.” Ostrow responded, “That’s a funny way but I’m sure 

appropriate way to put it.” E-mail dated June 1, 2005 from Lamore to Ostrow, at Exhibit 

256. Examiners noted that Madoff appeared to have “‘timed’ the market pretty well.” Id. 

10.	 The Examiners Learned Madoff Was Required to Produce All 

Documents to the SEC 

Because Madoff had been refusing the produce documents associated with his 

trade execution model, Nee had contacted Michael Macchiaroli from the Division of 

Trading and Markets, to ask him if the documents were subject to the books and records 

requirements. Lamore Testimony Tr. at pgs. 132-133; Ostrow Testimony Tr. at pgs. 67­

68. Nee told the examiners that Macchiaroli agreed Madoff had to produce the 

211 
 

 

 

documents. E-mail dated June 2, 2005 from Nee to Ostrow, at Exhibit 257. Sollazzo was 

aware that Macchiaroli’s general determination was that BMIS was a registered brokerdealer; and therefore, the SEC was entitled to all of Madoff’s books and records, 

including information related to Madoff’s trading strategy and institutional clients.150 

Sollazzo Testimony Tr. at pgs. 116. 

However, the examiners never obtained documents about Madoff’s “black box” 

model. Ostrow Testimony Tr. at pgs. 152-153. Ostrow explained that by this time, they 

were scheduled to end the on-site portion of their examination and they needed to tie up 

their conclusions, stating as follows: 

And this is in June already, so we’re probably two or three 

days shy of coming back from the field. And in terms of 

when you said did we follow up on those Barclay questions 

and the other questions, we were still trying to just still get 

to the black box, three months later, and only one week 

after finally officially being told that he was running money 

for six or seven customers. So, you can see how our hands 

were tied from the whole – beginning, and we’re trying to 

gather the information ... 

We have to sort of tie our ends together and come up with 

the – you know, we had the violations of the market 

making side, which we were able to work on in the two or 

three-week – or the two-month downtime that we were 

waiting for Bernie to confess that he had these accounts 

under his control. 

Id. 

11.	 Examiners Preliminarily Determined Madoff Was Not FrontRunning 

Once Lamore had a portion of the trading data from one of Madoff’s largest 

hedge fund clients, he was finally able to determine whether or not he believed Madoff 

was front-running. E-mail dated June 2, 2005 from Nee to Ostrow, at Exhibit 257. On 

June 2, 2005, Lamore told Nee that they had made a preliminary determination that 

Madoff was not front-running. Id. Lamore noted that Madoff’s timing for his purchases 

and sales “was excellent.” Id. Lamore hypothesized in his e-mail to Nee and Ostrow that 

Madoff’s incredible timing could be a result of his European connections. Lamore 

Testimony Tr. at pgs. 134-135. 

We [the examiners] are still waiting for some documents 

from our last request. After reviewing the Kingate account 

150 The FTI Engagement Team found that since Madoff’s advisory business consisted of discretionary 

brokerage accounts at a Commission-registered broker-dealer, the SEC was entitled to inspect such records 

under Section 17 of the Exchange Act. 

212 
 

 

 

statements for January through April 2005 (paper version), 

I don’t believe the retail customer order flow information 

from Madoff's market-making business has anything to do 

with his hedge fund model. Essentially, he got long the 

S&P 100 for the hedge funds January 20 through January 

24, 2005 and sold the S&P 100 (flattened out) March 10 

through March 15, 2005. There was no activity in April 

2005. Granted, his purchase & subsequent sale timing was 

excellent (buy low & sell high), but he held the basket for 

approximately six weeks. Therefore, I don’t believe that he 

is using any short-term signals that would come from his 

retail order flow. I suspect that he is 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. 

E-mail dated June 2, 2005 from Nee to Ostrow, at Exhibit 257. Nee forwarded Lamore’s 

analysis to Sollazzo. Id. 

12. Examiners Did not Contact the Feeder Funds Madoff Disclosed 

On June 5, 2005, Ostrow e-mailed Lamore and Nee, indicating that BMIS had 

given the examiners a disc of text files containing fifteen months of customer statements. 

E-mail dated June 6, 2005 from Lamore to Nee, at Exhibit 253. Lamore then e-mailed 

Nee that although they received the statements, they “still have not received the hedge 

fund contact list nor do the statements contain the address of the 15 entities.” Id. 

Sollazzo testified that he was aware from either Nee or the examiners that they were 

having trouble getting a hedge fund contact list from Madoff. Sollazzo Testimony Tr. at 

p. 115. 

When the examination team finally received the hedge fund contact list from 

Madoff, Ostrow recalled that it contained names of funds and their foreign addresses. 

Ostrow Testimony Tr. at pgs. 156-157. The list that appears to the OIG to be the one 

Madoff produced, also contained telephone numbers for the funds. List of Madoff’s 

hedge fund contacts, at Exhibit 258. The examination team did not contact any of the 

funds on the list.151 Id. 

151 The FTI Engagement Team concluded that it would have been useful for the examination team to 

contact the feeder funds in order to resolve a number of significant open issues including whether or not 

Madoff had full discretion over the accounts; how Madoff implemented the trading strategy; what the 

trading, clearing and settlement process was that was used and who was involved in that process; and the 

number of accounts Madoff had at each fund in order to confirm whether Madoff was accurately reporting 

those accounts to examination staff. 

213 
 

13.	 The Examiners Learned that BMIS’s Market Maker Would be 

Losing Money Without the Hedge Fund Business 

On June 07, 2005, Ostrow sent the following e-mail to Nee with a copy to 

Lamore, stating that they had reviewed Madoff’s trading for hedge funds and that they 

discovered that without the hedge fund execution business, BMIS would be losing 

millions of dollars a year: 

We have been reviewing all of the basket trades conducted 

by the fifteen or so entities using Bernie’s proprietary 

model. For all of 2004, Madoff executed close to 2 billion 

shares of stock, which represents a commission equivalent 

of approximately $82 million (.04 cents a share). It appears 

that without this commission equivalent business derived 

from the hedge funds, we estimate the firm would lose $10 

to $20 million per year. We intend to obtain an expense 

breakdown for October 2004 December 2004 to get a better 

understanding of the commission equivalent business. 

E-mail dated June 7, 2005 from Nee to Ostrow, at Exhibit 259. 

The finding that the well-known BMIS market making business would be losing 

money without the secretive hedge fund execution business was a surprising discovery152 

for the entire team, one Sollazzo described as “a red flag.” Nee Testimony Tr. at p. 139; 

Sollazzo Testimony Tr. at p. 118; Lamore Testimony Tr. at pgs. 136-37. Ostrow was 

surprised by the discovery because “here was the large market making firm, and he hasn’t 

admitted to having any sort of accounts, but yet it makes up 80 or 90 percent, or ... if 

anything, the investment adviser is smoothing out the earnings of the broker-dealer.” 

Ostrow Testimony Tr. at p. 158. The FTI Engagement Team concluded the examination 

staff should have recognized this discovery as a red flag and seriously considered 

investigating whether or not Madoff should have been registered as an investment 

adviser.153 However, Nee ultimately made the determination that the examination team 

should not pursue the issue of whether Madoff should be registered as an investment 

adviser. 

152 OCIE DC had also made the discovery regarding the profitability of Madoff’s hedge fund-related 

business during its examination. Memorandum dated February 3, 2004 from Walker and Wood to 

Donohue, at Exhibit 172. 

153 According to the FTI Engagement Team, broker-dealers offering certain types of accounts and services 

may also be subject to regulation under the Investment Advisers Act. Generally, a broker-dealer whose 

performance of advisory services is “solely incidental” to the conduct of its business as a broker-dealer and 

that receives no “special compensation” is excepted from the definition of investment adviser. However, 

based on the disproportionately large amount of revenue and income derived from Madoff’s investment 

advisory clients, the FTI Engagement Team concluded the examination staff should have recognized this as 

a red flag and seriously considered investigating whether or not Madoff should have been registered as an 

investment adviser. 

214 
14.	 Issues Regarding the Status of BMIS’s London Office and 

Whether Madoff Should Register as an Investment Adviser Were 

Not Resolved 

In the same e-mail to Nee, Ostrow explained, as follows, that although Madoff’s 

trading did not appear to be unusual, the examiners were researching two additional 

issues: (1) whether Madoff should be registered as an investment adviser due to his 

discretion over the hedge fund accounts; and (2) whether BMIS’s London office should 

be deemed a branch or affiliate in order to determine whether or not its books and records 

were subject to examination by SEC staff: 

There does not appear to be anything unusual with the 

basket trading strategies employed. The trading appears to 

be in line with the trading directive. We are researching 

whether or not Bernie should be registered as an investment 

manager / advisor due to his entire discretion in trading 

these accounts. 

Another issue we have is with the London affiliated office 

of Madoff. Since the London Affiliate of Madoff serves as 

the settlement agent for the US office through Barclays, we 

will be researching whether the London office should be 

deemed a branch vs. an affiliate. 

E-mail dated June 7, 2005 from Nee to Ostrow, at Exhibit 259. 

Ostrow explained that he wanted a determination that BMIS’s London office was 

a branch office for purposes of SEC examinations because his impression was that OCIE 

examiners had limited ability to investigate foreign affiliates. Ostrow Testimony Tr. at 

pgs. 85, 224. Ostrow explained, “I mean even making a long distance call or something 

is something that might be frowned upon or you need all these documents and stuff to say 

you’re calling customers. You know, it’s a lot of red tape to sometimes get stuff done.” 

Id. at pgs. 85, 224; E-mail dated May 23, 2005 from Lamore to Nee, at Exhibit 260. 

15. Examiners Were Told To Keep Their “Eyes On The Prize” 

The two issues the examiners raised about investment adviser registration and the 

status of Madoff’s London office were not pursued or resolved. In response to the 

examiners’ e-mail raising these issues, Nee told them to keep their focus on the frontrunning issue and to push aside the investment adviser registration issue and the foreign 

office status issue. E-mail dated June 7, 2005 from Nee to Ostrow, at Exhibit 259. On 

June 7, 2005, Nee sent the examiners the following e-mail: 

Be sure to keep your eyes on the prize. The branch vs. 

affiliate issue is a secondary (terciary ?) issue at best. I also 

don’t think we’d get far with the IA issue as broker-dealers 

215 
can, as you know, act in an advisory capacity (eg. 

Discretionary accounts, advice. Etc.) Have you given him 

the written requests re: the model logic and IT feeds yet? 

Id. Ostrow was disappointed by Nee’s response. Ostrow Testimony Tr. at p. 159. 

Ostrow stated, “I don’t know what the prize what. But yes, [Nee wanted us] to basically 

just stay focused on verifying that the – the front-running issue, that it wasn’t happening.” 

Id. at p. 159. 

Nee explained that when he told examiners to “keep your eyes on the prize,” he 

was telling them “[t]o focus on the issue of front-running.” Nee Testimony Tr. at p. 140. 

Nee thought Ostrow was trying to expand the examination, and Nee viewed the other 

issues Ostrow raised as secondary and “not nearly as important as the front-running.” Id. 

at pgs. 139-140, 143. In the following testimony, Nee explained that he did not want 

examiners to spend time pursing the investment adviser registration issue because the 

examiners had already spent almost three months on the examination: 

Well, we don’t have unlimited time to – and if there was a 

legitimate reason to think we would have if we found out, 

for instance, you know, he was stealing customer money 

and we had evidence of that, obviously we would have 

moved in that direction. But the registration of his 

investment adviser, you know, that was more an issue for 

the IA side. ... No, in my mind it wasn’t an issue because 

I assumed – I was of the opinion that there’s a good chance 

... he would probably be subject to the broker-dealer 

exemption. And, you know, as I said before, our 

examinations cannot go on forever. We, you know, this – 

by now it’s already into – well into the exam timeframe. 

So I – my message to William was, you know, we’re here 

to look specifically at this issue. To – in my mind this, him 

registering as an investment adviser, was not nearly as 

important as the front-running. ... Well, because it was 

focused on front-running, you know, we really didn’t have 

the luxury to look at any conceivable area which might 

have a securities violation. ... by now we’re into July and, 

you know, we don’t have an unlimited amount of time. 

...And, you know, for an examination that’s been going on 

three months I don’t know that that was, you know, 

something that we wanted to spend time on. 

Id. at pgs. 140-43, 158-59. 

The determination as to the status of Madoff’s London office remained 

unresolved, as did the issue of whether or not Madoff needed to register as an investment 

216 
 

 

 

 

 

adviser.154 Ostrow Testimony Tr. at pgs. 98-99, 223-24; Nee Testimony Tr. at pgs. 141­

143. Moreover, the examination team did not refer the investment adviser registration 

issue to “the IA side.” Nee Testimony Tr. at p. 141. Nee testified he did not refer the 

issue because “in my mind it wasn’t an issue because I assumed – I was of the opinion 

that there’s a good chance that [Madoff] ... would probably be subject to the brokerdealer exemption” and not be required to register.155 Id. at p. 143. 

16.	 There was Pressure on the Examination Program to Complete a 

Large Number of Examinations Each Year 

Sollazzo defended Nee’s decision to focus on front-running and not to pursue the 

other red flags raised because of the pressure on Nee to complete examinations,156 stating 

the following: 

In all fairness to ... John, ... someone like ... me, is also 

looking at the exams, how long they’re taking, all that. So, 

you know, I think in the back of John’s mind is, you know, 

how long we [have] been out here, you know, this is an 

important exam and all these issues, but we have an[] exam 

program we’re running and, you know, that may be 

something in the back of someone’s mind who’s 

supervising this exam. 

Sollazzo Testimony Tr. at p. 118-119. Similarly, former OCIE Director Richards 

explained that the Assistant and Associate Directors of the examination program “are 

responsible for managing all examinations underway at any one time within the program 

and responsible for making sure that they’re conducted appropriately and in a timely 

way.” Richards Testimony Tr. at p. 22. 

154 Nee was aware that Madoff ultimately registered as an investment adviser in 2006 as a result of an 

Enforcement Investigation. Nee Testimony Tr. at p. 143

155Nee also testified that he may have not referred the registration issue to the Investment Management 

Group because he may have believed that the OCIE Investment Management Group was already aware of 

the issue, since Mavis Kelly’s name appeared on some of the documents OCIE sent to NERO. Nee 

Testimony Tr. at p. 141. However, Nee was uncertain if he knew of Kelly’s involvement at the time of the 

NERO examination. Id. at pgs. 141-142. It does not appear likely from Nee’s other testimony that he was 

aware of Kelly’s involvement at the time of the NERO examination because Nee also testified that he had 

“no recollection” of reviewing the documents from OCIE, which included the complaint from the Hedge 

Fund Manager to Kelly. Id. at p. 108. Nee also testified that he had no recollection of OCIE telling NERO 

what precipitated OCIE’s examination of Madoff. Id. at p. 108. 156 According to a current SEC employee who asked not to be identified, when he worked as an examiner 

for Bob Sollazzo, he found that Sollazzo was reluctant to even look for fraud in an examination. 

Unidentified SEC Examiner Testimony Tr. at pgs. 19, 28. This current SEC examiner recounted that one 

time in the course of an examination, he went to Sollazzo to inquire about following up on possible fraud 

and Sollazzo replied, “That’s not us, that’s not our job.” Id. at p. 10. 

217 
 

 

17.	 Examiners Thought Madoff Had Lied to Them; Nee Played Down 

Madoff’s Misrepresentations 

A few hours after Nee told the examiners to keep their focus on front-running, 

Ostrow e-mailed Nee about believing he caught Madoff in yet another lie. E-mail dated 

June 7, 2005 from Ostrow to Nee, at Exhibit 261. Nee’s response to Ostrow appears to 

have played down Ostrow’s concerns. Id. In the following exchange, Ostrow responded 

to Nee by highlighting other instances in which Madoff made misrepresentations: 

[Ostrow] On one of the days that we requested trades, 

Bernie was closing a basket. I asked why we did not have 

these trades on the CD with all trades entered between 

2/28/05 and 3/11/05. Bernie stated that because the basket 

was originally entered into in January, there were not 

orders entered in March, only executions of orders placed 

previously. How can this be if a specific price is not 

known and you are relying on the fluctuation of 50 stocks 

in a basket? Lamore views it as a standing limit order 

(good till cancel). What is your take? 

[Nee] What was the actual language we used in the 

request? It could be a matter of semantics. 

[Ostrow] A large portion of this exam has come down to 

semantics. On April 27th, we asked for all orders received 

by the firm February 28, 2005 through March 11, 2005. On 

trade date March 11, 2005, Bernie begins selling shares 

from his basket. He basically said it was due to the order 

coming in two months earlier. We noticed that the trading 

directive states, “If the correlation variance still exceeds 

stated tolerance, the model’s predetermined orders to 

reverse positions will be exposed.” We requested an 

explanation for this on the request we submitted regarding 

all documents related to MA2.06 and MISS.....Bernie also 

signed off on May 30, 2005 that there is NO 

correspondence including facsimiles, e-mails, instant 

messages, etc. between the firm and any client associated 

with Model MA2.06 for the time period between January 

2004 and April 2005. Semantics maybe? 

E-mail dated June 7, 2005 from Ostrow to Nee, at Exhibit 261. Ostrow explained that he 

“had never seen something like that, where a trade can be entered, not executed until two 

months later because of a black box whether a trade is just sitting, and it just – it didn’t 

seem right,157 and we relayed those concerns.” Ostrow Testimony Tr. at p. 84. 

157 The FTI Engagement Team concluded that the confusion that resulted from these apparent incoherent 

explanations provided by Madoff when reviewing the order and trade data raised questions as to how 

218 
 

 

Ostrow found Nee’s minimization of his concerns “frustrating,” stating in the 

following exchange: 

A: It’s frustrating when you’re out there for three 

months, lied to every day, and you try relaying that, 

and you try to get it across that, you know, how can 

this be? Or, I mean, some of these are gray areas, 

some of them night not be. But, you know, I guess 

that’s the frustration, in terms of – you know, 

maybe he doesn’t see it as that. 

Q: So did you feel that John was kind of [pawning] this 

off as semantics on some way? 

A: Right, by asking, “How did you word the request?” 

You know, we worded it, or we asked him 

specifically, “Do you manage money?” Like, we 

asked it eight different ways and six different 

languages, and you know, got the same “No,” but 

yet the Barron’s article, the MarHedge article, you 

know, we didn’t know how to ask it. And this is 

already two or three months in, and we still can’t -- 

.... 

E-mail dated June 7, 2005 from Ostrow to Nee, at Exhibit 261. 

Nee had a “general recollection” that Ostrow “expressed a lot of frustration about 

Madoff’s responses.” Nee Testimony Tr. at p. 145. In response to Ostrow’s e-mail about 

Madoff’s use of “semantics” throughout the examination, on June 7, 2005, Nee told the 

examiners to consider requesting e-mail from other BMIS employees who might have 

correspondence regarding Madoff’s hedge fund customers. E-mail dated June 7, 2005 

from Ostrow to Nee, at Exhibit 261. Ostrow responded the next morning that they would 

consider requesting the e-mail after they received from Madoff other documents they had 

requested, including a list of individuals and entities that interacted with Madoff’s 

proprietary trading model. Id. 

18. Nee Did Not Allow the Examiners to Visit Feeder Funds 

On June 15, 2005, Ostrow informed Nee that Madoff had produced the documents 

requested, and the following day they would ask for a limited amount of e-mail from a 

Madoff actually implemented the strategy, which was a red flag. First, unlike retail orders, large 

institutional orders are unlikely to be designated as “limit” with a firm price. Instead, they are generally 

marked as “worked” or “not-held,” which means that the price attached is only a suggestive price and the 

broker has the discretion to execute the orders. Therefore, it is implausible that large institutional orders 

would just “stand in line” for two months without ever being executed, canceled or modified. Second, even 

if those orders were strict limit orders, it is almost impossible that among a basket of 50 stocks, none of the 

50 stocks’ limit prices were ever traded through during a two-month time frame. 

219 
 

 

few employees. E-mail dated June 15, 2005 from Ostrow to Nee, at Exhibit 262. Ostrow 

then told Nee that although the on-site portion of their examination was complete, they 

still wanted to visit Madoff feeder funds to resolve open questions they had about 

Madoff’s hedge fund trading. Id. As evidenced by the following e-mail from Ostrow, 

the examiners wanted to visit feeder funds, in part, because their research indicated that 

some of the Madoff feeder funds claimed to use a strategy that required options trading, 

yet Madoff had told examiners he no longer used options as part of his trading strategy: 

We would still like to visit some of the hedge funds (ex. 

Tremont in Rye, NY and Fairfield in CT or NY). We want 

to gain an understanding from the hedge funds from their 

prospective of the strategy used by Madoff. In addition to 

requesting marketing material from the hedge funds, we 

would also like to compare performance data of the funds. 

Recent Internet documents indicate a split strike conversion 

strategy being employed by some of the funds, specifically 

Tremont Broad Market Fund. Option collars are no longer 

part of the strategy here at Madoff. The hedge fund itself 

would have to put on the collar. We hope to have a draft 

request list for the hedge funds by mid next week. We will 

most likely be in the office full time starting Monday unless 

something else arises. 

E-mail dated June 15, 2005 from Ostrow to Nee, at Exhibit 262. Nee responded to 

examiners that they should meet on June 16 to discuss the plan going forward. Id. 

19.	 Examiners Were Not Allowed to Visit Feeder Funds, In Part Due 

to Fear of Lawsuits 

At the meeting on June 16, 2005, the examiners learned they would not be visiting 

the hedge funds. Ostrow Testimony Tr. at p. 39. Nee expressed that it was time for the 

examination to end and time for the examiners to write the examination report and move 

on to their next examination. Id. at p. 172. The examiners explained that the primary 

reasons Nee did not want them to contact the hedge funds was Nee’s fear that they would 

be sued158 and his feeling that enough time had been spent on the Madoff examination. 

158 Former examiner #1 recalled that fear of “being sued” also kept NERO from collecting documents from 

Madoff customers. Former Examiner #1 Testimony Tr. at pgs. 5-6, 9. Prior to coming to the SEC, former 

Examiner #1 worked for a private wealth management company that had an investment with Madoff. Id. at 

pgs. 7-8. However, because of a confidentiality agreement former Examiner #1 had signed, Nee and 

Lamore decided not to request customer statements from his former employer. Id. at p. 8-10. Former 

Examiner #1 implied, in the following testimony, that part of the fear of a lawsuit came from knowing his 

former employer adhered to Madoff’s demands for secrecy out of a fear that Madoff would terminate their 

relationship: 

Because Madoff from my experience with him it was always a good 

source of cash flow. If we needed a million dollars for operations we 

220 
 

 

 

Lamore Testimony Tr. at pgs. 142-143; Ostrow Testimony Tr. at p. 165. Lamore 

explained what he recalled from the June 16 meeting with Nee in the following exchange: 

A: When we went back to the office, we spoke to Mr. 

Nee. We had a discussion about visiting the hedge 

funds and Mr. Nee said essentially no, we could not 

do that. He was concerned about potentially being 

liable if the hedge funds turned around and pulled 

their assets from Bernard Madoff. 

Q: Do you remember if he specifically said the SEC 

could get sued if you did that? 

A: I don’t recall specifically the SEC. He may have 

even thought personally he could be sued. 

Q: Okay. Personally, meaning him, John Nee? 

A: Yes. 

Q: So he indicated that he might be sued personally if 

you went through this? 

A: I think he said us, individually rather than the 

agency. 

Q: Okay. And so basically, he made the determination 

not to go and he was the boss, so you didn’t go? 

A: Right. 

Lamore Testimony Tr. at pgs. 142-143. Ostrow had a similar recollection “that meeting 

the next morning sort of put a kibosh to” the examiners’ plans to visit the feeder funds. 

Ostrow Testimony Tr. at p. 165. Ostrow explained as follows: 

So, once we got back [to the office], then we wanted to 

continue on, at least in the sense of going to Fairfield 

Greenwich and following up and seeing where it would go 

from there. ...“[W]e wanted to go to Fairfield Greenwich, 

would be able to pull out money, but he always had a rule. Don’t pull 

out too much money, you know, he started saying to use, you know, 

I’m not going to let you back in if you keep taking out money. And 

also, if you tell anybody on the outside that you’re invested with me, 

you’re going to be out. 

Id. 

221 
to see if the glossy material they’re sending to investors 

reflects the same 1.5 percent [monthly returns]. ... We 

wanted to verify outside. ... We sent an e-mail to John Nee, 

I guess, informing him we were about to come back form 

the field, that we thought it would be good to go there to 

look at their marketing material, to look at their returns 

they were seeing, to make sure it was correlating with the 

returns that Bernie was earning, and also to point out to 

them because Bernie told us that it would be up to the fund 

to funds to put on the options trades themselves, but we 

were just trying to figure out how they know [what option 

collar to put on] if all of his information was proprietary 

and he doesn’t release any of that information when he 

buys and sells, how could these funds know? So we made 

that point and during a meeting, we were sort of told that 

this is a $7 billion customer [Fairfield] and if you go and 

raise red flags there and they go ahead and pull all of their 

money from Bernie and we’re wrong, then we’ll be sued 

personally or the SEC itself. 

Id. at pgs. 39-40, 104, 139. 

Nee did not recall fear of a lawsuit being a reason that he did not want the 

examiners to contact the hedge funds, stating: 

I imagine I probably would have said that, you know, you 

can’t just go to customers of a firm, you know, lightly 

without raising suspicions of the firm. ... I don’t think I 

would ever say the SEC could be sued. I may have said 

something along the lines that we have to be sensitive to 

going to customers. And this is an issue with many exams, 

you know, you make a call to a customer about his broker, 

you can never get that call back. ... [W]hat I’m trying to 

say is that absent any specific evidence of wrongdoing 

we’d have to be very careful about going to a hedge fund 

client. 

Nee Testimony Tr. at pgs. 149-151. Sollazzo explained that one of complications that 

arise when customers are contacted is that firms complain to top SEC officials: 

If we have – if we believe there’s some sort of a fraud here 

we have to contact who we have to contact. ... You know, 

we don’t – you know, one of the challenges you have with 

contacting customers is that they become very agitated and 

disturbed. And what happens is they call the firm right 

away and everyone’s up in arms and then we get calls, the 

222 
regional director gets calls. And it doesn’t happen every 

time, but it happens a fair amount of time. But, you know, 

when it should be done, it should be done. 

Sollazzo Testimony Tr. at p. 124. 

20. Time for the Madoff Examination Had Expired 

According to the examiners, the other reason the examination was closed before 

all of the questions about Madoff’s advisory business were answered was because the 

examiners had spent several months on the Madoff examination, and it was time to move 

on. Ostrow Testimony Tr. at p. 104. Nee explained, “There’s no hard and fast rule about 

field work but, you know, field work cannot go on indefinitely because people have a 

hunch or they’re following things.” Nee Testimony Tr. at p. 147. Nee stated, “[O]ne of 

my primary responsibilities” is “to make sure that the exams are moved on, work is 

completed, reports are issued and they move on to the next exam.” Id. at p. 148. Ostrow 

viewed the examination program as sometimes coming down to the number of 

examinations completed, stating: 

[U]nfortunately it comes down to, sometimes, numbers, 

and quantity, not quality, and ... I guess your supervisor 

gets pressure from his supervisor who gets pressure from 

their supervisor, which is Bob, and then, ultimately, maybe 

he is getting pressure from OCIE to churn out certain 

numbers. 

Ostrow Testimony Tr. at p. 103. 

Ostrow recalled other situations, unrelated to Madoff, in which examiners pushed 

issues in examinations that their supervisors did not want them to pursue. Id. at p. 175. 

He recalled that “usually those exams get either shipped off to FINRA, to follow up on, 

or those exams sit and go nowhere.” Id. Ostrow’s view was that it would be better to 

fully investigate all issues the examiners identify rather than running to the next 

examination, explaining as follows: 

And a lot of times the supervisor will say, “Well, okay, find 

two examples of this.” So you find two examples, and you 

think you got something worthwhile. But then you’re told, 

“All right. Find this now.” Like, they send you on these 

goose chases and by the time you've found every piece of 

the puzzle, it’s like, “Okay, wrap it up, we’re done, let’s 

stop.” 

Id. at p. 177. 

223 
 

 

K. The Examination was Concluded 

1. The Examination Team Never Understood How Madoff Was

 Achieving His Returns 

When the examination was closed, the examination team had determined that 

Madoff was not front-running, but they still did not understand how he was achieving his 

remarkable returns. Sollazzo Testimony Tr. at pgs. 107-108, 110. Sollazzo explained as 

follows: 

... I felt that – we did an exam, we found what we could, 

which was some slight errors, slight problems, you know, 

with the best execution in the market-making desk, but we 

didn’t find the solution to those returns. We never found 

[out] why he was making those returns. ... But we didn’t 

find any evidence of wrong-doing either, other than the 

FINRA, the NASD violation. ... We never figured out how 

he was able to get those consistently high returns. 

Id. at p. 132. 

Nee did not believe it was necessary to understand how Madoff was achieving his 

returns in order to close the examination, stating that at the end of the exam “I didn’t 

know how he was achieving his gains, but I did, based on the examination work that was 

done, have a feeling of comfort that he was [not] using individual customer information.” 

Nee Testimony Tr. at p. 135. Nee testified that at the time the examination was closed, 

he had not foreclosed the possibility Madoff was engaged in another illegal activity to 

achieve the returns: 

Well, at the end of any cause exam I don’t know whether 

the registrant is doing something else illegally. I just – if 

it’s a cause exam and I’m looking at a specific allegation 

and I get comfort in that then I think I’ve done my job. ... 

At the end of our examination I could not definitively say 

that he wasn’t doing anything otherwise illegal to achieve 

his outside returns. ... We deal with black and white. 

Id. at pgs. 136, 138. 

Nee explained he did not feel it would be practical to continuously expand cause 

examinations to determine whether other illegal activity was taking place and he thought 

that identifying other issues at BMIS was the NASD’s/FINRA’s responsibility, stating as 

follows: 

The general feeling was that if this firm was doing 

something outside of the law it had to do with this sort of 

224 
 

 

 

trading ahead and front-running. And I can say that there is 

some, at least, comfort in knowing that there have been 

other exams of this firm by the NASD over the years, that 

they are the primary regulator. So it wouldn’t be practical 

for us every time we go in to do a cause exam to keep 

expanding out and concentric circles indefinitely, again, 

because we’d never finish an examination. 

Id. at p. 70. 

2. When Examiners Finished the Examination, They Still Had Open 

Questions About Madoff 

Although the examiners were satisfied that Madoff was not front-running, they 

still had many suspicions about Madoff at the end of the examination, as Ostrow 

explained in his testimony: 

We still knew and felt that it was highly suspicious and just 

odd and the whole story, there were inconsistencies ... that 

were unsettling, but, you know, before you put on the next 

exam .... I think throughout the exam we wanted to do 

more, but there was a lot of questionable things in terms of 

– and just semantics in terms of the London office. Is it a 

branch, is it an affiliate? You know, Bernard Madoff liked 

to play with words. ... So you know, there was frustration 

throughout the whole exam. 

Ostrow Testimony Tr. at pgs. 45-46. 

Madoff’s claim not to use options as part of his strategy was Ostrow’s primary 

open question at the end of the examination. Id. at p. 75. Ostrow stated, “the biggest 

thing in my mind was ... not using the options any more, when ... 50 percent of the gist 

of it was having options as part of the strategy. ... It wasn’t ... according to John [Nee], 

the focus of the exam, and to just focus on, you know, proving these other points.” Id. 

Ostrow explained that while the examination team had “some other ideas” related 

to insider trading for how Madoff was achieving his returns, there was no discussion of 

continuing the examination because the time period scheduled for the examination had 

elapsed: “By then we had already been there two-and-a-half months, and that’s the time 

we’re given, and that’s it. You know, do me and Pete pass each other in the hall the 

month after, three months later, and still shaking our heads about Madoff? Sure, of 

course.”159 Id. at p. 172. 

159 Former examiner #1 also confirmed there was “a great focus when you did the examinations previously 

on timelines, getting them done in a specific period of time.” Former Examiner #1 Testimony Tr. at pgs. 

11-12. 

225 
 

 

Sollazzo explained that one reason he believes the examination ended without a 

resolution or understanding of how Madoff was earning his returns was because Madoff 

claimed to trade in Europe:160 

Well, part of it is how far do you take an exam. Now the 

finger’s pointing to Europe and, you know, where are we 

going to get the information? You know, where – what are 

the sources of the information? How do we find this out? I 

don’t really have an idea even as we sit now know this is 

fictitious, but if it wasn’t I’m not too sure how we’d figure 

that piece out. 

Sollazzo Testimony Tr. at p. 114. 

3. Examination Report Recited Information Provided By Madoff 

From approximately June 20 to August 8, 2005, Lamore and Ostrow drafted a 

report of their Madoff examination. The report, which was finalized on September 2, 

2005, identified three minor violations of NASD/FINRA Rule 2320 for BMIS’s failure to 

obtain best execution on customer limit order in one stock.161 Examination Report dated 

September 2, 2005, at Exhibit 263. The report was twelve pages and divided into seven 

sections. Id. The first section of the report summarized the findings and disposition of 

the examination. Id. at p. 1. The second section contained background information about 

the firm. Id. at pgs. 2-3. The third section, entitled “Examination Purpose and Scope” 

briefly summarized two of the Renaissance e-mails and the two 2001 articles from 

Barron’s and MarHedge. Id. at pgs. 3-4. The third section contained no analysis of the 

e-mails or the articles. Id. The fourth section consisted of one paragraph and stated 

simply, “The staff was concerned that BMIS might be using customer order flow 

information to improve the returns of its IA and/or proprietary business by front-running 

customer orders or otherwise using customer’s order flow information.” Id. at p. 3. 

The fifth section, entitled “Examination Findings,” was eight pages and divided 

into two parts and several subsections. Examination Report dated September 2, 2005, at 

pgs. 3-5, at Exhibit 263. The first part of the fifth section concerned “BMIS’s IA/‘Hedge 

Fund’ Business.” Id. The first subsection contained extended summaries (without 

analysis) of the two 2001 articles. Id. The second and third subsections described 

Madoff’s “IA Business Structure,” and trading strategy. Id. at pgs.5-8. The information 

160 The FTI Engagement Team opined that in situations where the counterparty is not located in the United 

States, the examination staff should contact other SEC Offices, such as the SEC’s Office of International 

Affairs, for additional assistance rather than not pursuing verification of trade activity. 

161 Madoff viewed the three minor violations the examiners’ cited as “nitpicky” and “incorrect.” Madoff 

Interview Memorandum at p. 2. Madoff stated that two months after the examiners left, he received a letter 

citing him for “two ridiculous violations,” that were incorrect. Id. Madoff went on to state that when 

BMIS submitted their response to the SEC letter and copied it to FINRA, FINRA responded, “What the 

heck? Are you nuts with this nitpicking?” Id. Madoff stated, “After two months, they found 2-3 nitpicky 

things, and they were wrong about those things.” Id. Madoff asserted that “Everything the SEC did prior 

to 2006 [Enforcement Investigation] was a waste of time.” Id. 

226 
 

in the two sections appeared to come entirely from Madoff because it was replete with 

sentences beginning with, “According to BMadoff.” Id. at pgs. 6-7. 

The fourth subsection of part one of section five consisted of one paragraph in 

which examiners described the customer statements they reviewed and their 

determination that Madoff was not front-running. Id. at p. 8. Part two of the fifth section 

concerned “Firm Trading and Marketing.” Id. at pgs. 9-10. The first subsection of part 

two of section five contained background about BMIS’s market making business and 

descriptions of its advanced technology. Id. According to the report, the majority of the 

information in the subsection was supplied by Madoff and BMIS. Id. The second 

subsection of part two of section five described the testing examiners performed to locate 

the Rule 2320 violations. Id. at pgs. 10-11. The sixth section consisted of two 

paragraphs describing the e-mail the examiners reviewed, and the seventh section stated 

that a violation letter would be sent to BMIS. Id. at pgs. 11-12. 

Over half of the report is a recitation of information Madoff provided the 

examiners verbally and a summary of the 2001 Barron’s and MarHedge articles. Id. 

Lamore explained that the report was primarily based on information and data from 

Madoff because “[h]e was our primary contact.” Lamore Testimony Tr. at p. 158. Nee 

was untroubled that the information in the report was supplied by Madoff, stating, “but 

that’s a usual thing, you know, for – to get trade data from – when you come down to it, 

all our examinations are books and records examinations. We rely on the firm to supply 

us with the required information and they do so under penalty of law if they don’t.” Nee 

Testimony Tr. at pgs. 162-63, 167. 

4. Examination Report Did Not Describe Madoff’s 

Misrepresentations to Examiners or The Issues That Remained 

Unresolved 

In concluding the examination and writing the report, the examination team did 

not go back and examine the issues raised in the Renaissance e-mails to determine 

whether all of the issues identified in those e-mails had been resolved. Nee Testimony 

Tr. at p. 155. Neither did the report raise the numerous issues the examiners identified 

during the examination, including Madoff’s efforts to conceal the existence of his 

investment advisory business from examiners, the difficulties the examiners had in 

getting Madoff to produce documents and information, the inconsistencies examiners 

found in the information and documents produced, the issue of whether Madoff should be 

registered as an investment adviser, the issue of whether BMIS’s London office is an 

affiliate or a branch, and the inconsistencies between Madoff’s representations that he has 

stopped trading options and the representations made by the feeder funds. Examination 

Report dated September 2, 2005, at Exhibit 263. 

Concerning specific open questions, Lamore testified that he did not know why 

the issue of Madoff’s highly consistent returns was not raised in the report. Lamore 

Testimony Tr. at p. 159. He explained that issues such as potential conflicts of interest at 

BMIS, lack of an independent custodian, and Shana Madoff’s discretion to delete e-mail 

227 
may not have been included in the report because his supervisors did not feel these issues 

were a problem or because he have lacked the experience to determine whether or not 

these issues should be included in the report. Id. at pgs. 150-153. Ostrow explained the 

lack of an independent custodian was not in the report because Bernie told the examiners 

that he did not have control over the money, and the examination team did not verify 

Madoff’s representation. Ostrow Testimony Tr. at pgs. 169-170. 

Sollazzo felt that the report was well-written and did not find it unusual that the 

report did not contain the examiners’ open questions, stating, “I don’t know if we 

necessarily put every, you know, open item in the report, if it would go in there as a 

featured item.” Sollazzo Testimony Tr. at pgs. 126, 130-131. 

L. Lamore is Promoted, In Part, Based on The Madoff Examination 

On September 13, 2006, the New York Branch Chief (Lamore’s Branch Chief) 

recommended in a letter to Jeffrey Risinger, Associate Executive Director of the 

Commission’s Office of Human Resources, that Lamore be promoted based, in part, on 

his 2005 examination of Madoff. See Memorandum dated September 13, 2006 from 

New York Branch Chief to Risinger, at Exhibit 264. The letter stated: 

Mr. Lamore conducted an examination of Bernard L. 

Madoff Investments [sic] Securities LLC (Madoff), 

wherein he examined financial records for accuracy and 

compliance to generally accepted accounting standards. 

The existence of all material assets and liabilities, and the 

proper treatment of such items in the broker-dealer’s net 

capital were verified. In addition to comparing income and 

expense items for significant fluctuations form comparative 

periods, Mr. Lamore conducted a detailed review of 

Madoff’s Annual Audit. This Annual Audit review 

revealed a large source of the firm’s revenues was being 

generated from a business division of the firm that was not 

disclosed to the staff at the outset of the examination. Mr. 

Lamore’s finding led the staff to focus the examination on 

this business division. 

Id. Also on September 13, 2006, the OCIE Assistant Regional Director recommended in 

a letter to Risinger that Lamore be promoted in part because of his work on the Madoff 

examination. The OCIE Assistant Regional Director’s letter stated as follows: 

During his examination of Bernard L. Madoff Investment 

Securities (Madoff), Mr. Lamore reviewed all aspects of 

Madoff’s unregistered institutional trading business. Two 

months after completing the examination, NERO’s 

Division of Enforcement received a tip suggesting 

wrongdoing in Madoff’s institutional trading business. 

228 
Two months after completing the examination, NERO’s 

Division of Enforcement received a tip suggesting 

wrongdoing in Madoff’s institutional trading business. As 

a result of this collaboration, significant differences were 

uncovered between what was communicated by Madoff 

during the examination versus the Enforcement staff’s 

findings. 

Memorandum dated September 13, 2006 from OCIE Assistant Regional Director to 

Risinger, at Exhibit 265. Lamore received the promotion to Staff Accountant effective 

November 12, 2006. Standard Form 52, “Request for Personnel Action,” U.S. Office of 

Personnel Management (11/12/06), at Exhibit 266. 

M. Summary of FTI Engagement Team Expert Analysis 

The FTI Engagement Team analyzed the information that the OIG uncovered 

about the NERO examination of Bernard Madoff’s firm and concluded that multiple red 

flags were missed or were not pursued by the examination team. In addition, the FTI 

Engagement Team concluded that based upon issues raised in the Hedge Fund Manager’s 

complaint, had the examination been staffed and conducted appropriately, and basic steps 

taken to obtain third-party verifications, Madoff’s Ponzi scheme could have been 

uncovered. 

1. The Focus of the Exam Was Chosen In Error 

The initial error the examination team made was in its analysis of the Renaissance 

e-mails that triggered the examination. The Renaissance e-mails described the red flags 

that Renaissance employees identified while performing due diligence (using widely 

available information) on their Madoff investment. The red flags Renaissance employees 

identified included (1) Madoff’s incredible and highly unusual fills for equity trades; (2) 

Madoff’s misrepresentation of his options trading; (3) Madoff’s secrecy; (4) Madoff’s 

auditor; (5) Madoff’s unusually consistent non-volatile returns over several years; and (6) 

Madoff’s fee structure. 

Crucially, one of the Renaissance e-mails provided a step by step analysis of why 

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

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

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

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

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

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

they would always lose money on the trades. These findings by Renaissance raised 

doubts that Madoff could be implementing his trading strategy. 

Despite the numerous red flags raised in the Renaissance e-mails and the in-depth 

analysis of why Madoff must be misrepresenting his options trading, the examination was 

229 
limited to front-running and cherry picking. The focus of the examination was 

inadequate and did not reflect all of the issues in the Renaissance e-mails. In determining 

the focus of the examination, the examination team’s analysis of the Renaissance e-mails 

was insufficient. All relevant information contained in tips and complaints from a 

credible source should have been sufficiently vetted. 

The decision to focus exclusively on cherry picking and front-running was also 

erroneous because both of those activities were unlikely explanations for Madoff’s 

purported returns. Madoff was alleged to be managing at least $10 billion in client assets 

at the time of the examination. BMIS’s market making clients did not generate enough 

“winning” trades to allow Madoff to consistently cherry pick winning trades for all of his 

advisory clients. Moreover, front-running was an unlikely explanation for Madoff’s 

purported returns because of the extraordinary volume of trading that Madoff needed in 

order to execute his split-strike forward conversion strategy. 

Even if front-running and cherry picking had been an appropriate focus of the 

examination, it was a mistake for the team not to also focus on Madoff’s unusually 

consistent returns because until the team had figured out how he was earning his returns, 

they could not rule out that Madoff was either achieving his returns illegally or 

misrepresenting his returns to investors. In addition, Renaissance’s suspicions about 

Madoff’s options trading should have been a focus of the examination because Broder’s 

e-mail presented the staff with a thorough analysis of why Madoff must be 

misrepresenting his options trading. A basic step to investigating this allegation would 

have been to directly contact the counterparties in order to verify that the options trades 

took place. Moreover, the examiners should have been incredulous of Madoff’s claim to 

have stopped trading options since the strategy he claimed to be using required options 

trading. In addition, if the examiners had closely reviewed OCIE’s workpapers, they 

would have seen that the customer statements Madoff produced to OCIE included options 

trading during a month in which the customer statements Madoff had provided to NERO 

showed no options trading. 

It was also a mistake for the examination team not to focus on the auditor. 

Renaissance suggested that Madoff utilized a non-independent auditor, which should 

have raised concerns for the auditors about whether or not the auditor was unbiased, fair, 

and impartial. Without an independent auditor, there can be no assurance that the 

BMIS’s audits were properly conducted. Such potential conflicts should heighten 

awareness of, and the need for, verification that Madoff had internal controls in place that 

were designed to effectively prevent certain inappropriate activities, such as 

misrepresentation of performance results and misappropriation of client assets. 

Typically, in conducting basic due diligence of the auditor, an examiner will review the 

auditor’s engagement letter, reports and work papers. This basic due diligence was not 

performed despite Renaissance’s allegation. 

230 
2. The Team Was Inadequately Staffed and Examination Should Not 

Have Been Delayed A Year 

It was an error for the supervisors of the examination team not to staff the 

examination with examiners experienced in investment adviser examinations. Investment 

Management expertise was necessary to the examination given the allegations in the 

Renaissance e-mails because many of the allegations involved analyzing returns and 

investment strategies, areas where the supervisor of the examination admitted brokerdealer examiners are not skilled. In addition, a Branch Chief should have been assigned 

to the examination to provide supervision and support for the relatively inexperienced 

examiners. If a Branch Chief was not available, the Assistant Director should have come 

on-site regularly to provide support to the examiners, especially after the examiners 

communicated that they were not receiving cooperation from Madoff. 

The Renaissance e-mails contained significant and specific concerns. The e-mails 

were written in 2003, referred to the broker-dealer examination program in 2004, but not 

addressed until 2005. Such a significant delay to begin a cause examination increases the 

potential risk of harm to investors. 

3. The Conduct of the Examination Was Flawed 

The examiners’ document request to Madoff was flawed because much of the 

request was geared toward a standard broker-dealer examination and did not specifically 

address the allegations in the Renaissance e-mails. Madoff’s initial unwillingness to 

admit to managing money for hedge funds when the fact was widely-known suggested 

that he did not want to register as an investment adviser and be subjected to additional 

examinations. Madoff’s evasiveness should have raised suspicions that Madoff was 

involved in illegal activity. 

Additional misgivings should have been raised by the numerous discrepancies in 

the information and documents Madoff provided to examiners. Almost the entire 

examination was based on documents provided by and assertions made by Madoff. The 

discrepancies and contradictions should have alerted the examination team of the need to 

independently verify Madoff’s representations. 

The response from Barclays also should have raised significant suspicions 

because it did not verify any of Madoff’s transactional activity associated with the 

investment advisory business. The examination team should have contacted Barclay’s 

U.K. affiliate in order to verify whether Madoff had a trading relationship with Barclay’s 

and to seek records of trading activity associated with the advisory clients. If the 

examination team did not understand how to request documents from a non-U.S. entity, 

then they should have requested assistance with the SEC’s Office of International Affairs. 

The NERO examination staff had difficulty understanding how Madoff executed 

and cleared his trades and, at times, believed that Madoff was deliberately misleading 

them. As a result, the FTI Engagement Team believes that the examination staff should 

231 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

have recognized the need to independently verify Madoff’s verbal representations as to 

how he executed and cleared his trades. The FTI Engagement Team further believes that 

Madoff’s informing the NERO examiners that BMIS functioned as an executing broker 

on a DVP/RVP basis by his U.K. affiliate should not have hindered their ability to 

uncover the Ponzi scheme, or at the very least, the fictitious trades.162 

162 There are several reasons why the examination staff should have verified Madoff’s execution, clearing 

and settlement. First, even had there been a DVP/RVP arrangement with several European custodians, the 

examination staff could have contacted an independent source to verify the trading activity. Madoff’s U.K. 

affiliate was an FSA-registered entity and a member of the London Stock Exchange (LSE), which would 

have cleared its trades through the LCH Clearnet Group (LCH). As a result, any trades conducted by 

Madoff’s U.K. affiliate would have been reported to those institutions. The SEC examiners could have, but 

did not, contact the FSA, the LSE or the LCH in order to verify any of the purported trading activity of 

Madoff associated with his advisory clients. 

The questions raised by the examiners should have also caused them to contact purported 

custodians to directly verify the Madoff accounts held at the custodians, the account balances and any other 

arrangements that the custodians had with Madoff. The customer statements that Madoff produced to the 

examiners, in many instances, purported to show where the customer assets were custodied. For example, 

a customer statement for American Masters Broad Market Fund LP indicated that the custodian was Bank 

of America. Lamore acknowledged in testimony that Madoff never produced “any documentation of these 

custody of asset issues, supposedly from the bank that was custodying the assets” and no efforts were made 

to seek such documentation. Lamore Testimony Tr. at p. 114. In truth, the custody of assets issue was only 

a peripheral issue for the examiners who testified that they never nailed down how Madoff executed and 

cleared trades. 

The DVP/RVP agreements adopted by Madoff also purportedly used Barclays in London as a 

clearing broker to clear the trades for Madoff’s U.K. affiliate. The examiners could have contacted 

Barclays in London in order to verify Madoff’s trading activity associated with the advisory clients. 

Similarly, the examiners could have also contacted the European counterparties in order to verify Madoff’s 

trading activity associated with his advisory clients. If the examiners needed assistance contacting any of 

these European entities, they could have contacted the SEC’s Office of International Affairs, which often 

provides guidance to OCIE and other offices with regard to contacting and obtaining information from 

foreign entities. 

Second, Madoff’s purported use of his U.K. affiliate to execute his strategy should have triggered 

additional suspicions and red flags about Madoff’s trading. The Trading Authorization Directives state that 

Bernard L. Madoff, as an agent, will implement the strategy on behalf of Bernard L. Madoff Investment 

Securities LLC, which was a member of NASD/FINRA. This appears inconsistent with what Madoff told 

the examiners, which was that the strategy was executed solely by his U.K. affiliate. This should have 

raised doubt as to how the strategy could have been transacted solely by Madoff’s U.K. affiliate. 

Third, the account statements and trade confirmations should have raised a suspicion by the 

examiners as to whether Madoff was merely a self-professed executing broker. The information contained 

in the account statements and trade confirmations reviewed by the examiners included detail regarding 

securities positions, which is not normally captured by executing brokers. In contrast, when an executing 

broker also manages or maintains custody of the assets in its discretionary brokerage accounts, that broker 

would typically provide trade activity as well as securities positions and cash balances to its customers. 

The examination team did not fully resolve either of these issues. 

Fourth, it is acknowledged that later in his testimony in connection with the Enforcement 

investigation, Madoff contradicted his assertion about a DVP/RVP arrangement by saying the trades for all 

his advisory accounts were cleared through his account at DTC. Madoff May 19, 2006 Testimony Tr. at p. 

87, at Exhibit 267. Although Lamore was present when Madoff made this representation and identified 

232 
 

 

 

 

The fact that the examination team did not go to an independent source for trading 

data and other information was a major mistake because the Renaissance information 

included an in-depth analysis that credibly questioned whether or not Madoff could have 

been executing the transactions needed to implement his split-strike forward conversion 

strategy. The key to uncovering the Ponzi scheme depended on directly contacting third 

parties in order to verify critical information. A sample comparison of Madoff’s 

purported trading activity in his account statements and customer confirmations against 

FINRA/NASD or DTC/NSCC data would have shown that Madoff did not execute the 

trades as he claimed. Similarly, if the examination staff had directly confirmed trading 

activity with those counterparties, they likely would have learned Madoff was not trading 

options. Third-party verification would have ultimately provided the information 

necessary to reveal the Ponzi scheme. 

4. There Was Little Communication Between Offices 

Although OCIE sent its examination work papers to NERO, the fact that there 

was little communication between the two groups and little review by NERO of OCIE’s 

work papers was problematic because a comparison of work papers and preliminary 

findings could have eliminated duplicative efforts and potentially identified 

inconsistencies in information provided separately to the examination teams. For 

instance, both examination teams spent considerable time concluding that Madoff 

managed billions of dollars for 17-21 funds, which suggested that Madoff should have 

been registered as an investment adviser. In addition, had NERO carefully reviewed 

OCIE’s work papers, the NERO team would have found that Madoff had provided 

customer trade confirmations showing options transactions to OCIE during a month he 

represented in documents to NERO that he no longer traded options. Moreover, if the 

OCIE work papers had been reviewed, NERO may have noticed the number of funds in 

OCIE work papers was different from the number of funds Madoff disclosed to NERO. 

These discrepancies should have raised suspicions and required further inquiry. 

Finally, the fact that OCIE did not bring the Hedge Fund Manager’s complaint to 

NERO’s attention and that NERO did not review or consider the complaint was a concern 

because the complaint was from a credible source and would have provided additional 

support for Renaissance’s analysis. The FTI Engagement Team concluded the complaint 

would have been particularly useful to the examination team because it included a 

number of serious allegations that needed further scrutiny. 

contradictions in Madoff’s testimony, no effort was made to question Madoff about this contradiction and 

no inquiry was made with DTC at that time as well. 

Fifth and finally, it should be noted that in the NERO examination, there is no evidence from the 

documents and testimony of examiners that NERO intended to go to DTC but determined not to take this 

step because of any representation by Madoff about a DVP/RVP arrangement. The examiners and their 

supervisors testified that it would have been an unusual step for OCIE to verify a registrant’s 

representations with a third-party even in a cause examination. 

233 
5. Red Flags That Arose in the Examination Were Not Pursued 

The fact that several red flags that arose during the examination were simply not 

pursued was improper because these were significant issues related to the potential 

detection of Madoff’s Ponzi scheme. For example, Madoff’s actions and statements 

suggested to examiners that Madoff was trying to avoid investment adviser registration. 

If examiners had been allowed to pursue the issue, the examiners may have learned that 

Madoff had thousands of clients who he had not disclosed to the SEC. In addition, 

examiners wanted to pursue the issue related to the status of BLM’s London office. 

Madoff’s misrepresentation that the split-strike forward conversion strategy was traded or 

cleared through his London office may have been discovered by examiners if they had 

been allowed by their supervisors to pursue this open issue. 

The instruction from Nee to the examiners to keep their “eyes on the prize” (e.g., 

front-running) in response from the examiners’ request to pursue legitimate unanswered 

questions was in error. The lack of flexibility in expanding the focus of the examination 

may have prevented the staff from discovering the Ponzi scheme. For example, had the 

examiners been allowed to visit the feeder funds, they may have discovered that Madoff 

had custody of investor assets, contrary to his representations to examiners. 

6. The Examination Concluded with Unresolved Issues 

The examination should never have been concluded without the staff 

understanding how Madoff was achieving his returns. The staff never answered the basic 

red flag raised in the Renaissance e-mails and the two 2001 articles, which was that 

trading experts did not believe that Madoff could be earning his returns legitimately. 

Although the staff had concluded that Madoff was not front-running, they had not 

determined that he was earning his returns legitimately. The examination should not 

have been concluded with significant unanswered questions left open because of the 

gravity of such allegations and the potential harm to investors. Moreover, the 

examination should not have concluded without examiners understanding and verifying 

Madoff’s execution, clearing and settlement process, something they never were able to 

accomplish. 

The final report was flawed because it relied heavily on information verbally 

provided by Madoff. The examiners were conducting a cause examination based on 

allegations that BMIS was engaged in fraud, yet conducted their examination by relying 

exclusively on documents and information Madoff provided. There was inadequate 

diligence with regard to testing and verifying statements and representations made by 

Madoff during the examination. 

In addition, the final report should have included the open questions and other 

issues that arose with Madoff during the examination because such information would 

have accurately conveyed the scope of issues investigated, whether all of the issues were 

234 
resolved, how such issues were resolved and identification of any issues that were not 

resolved. 

7. FTI Engagement Team Conclusion 

A compelling and credible complaint was provided with several significant red 

flags. However, the examination was not staffed appropriately, delayed in outset, 

focused in error, conducted without obtaining critical independent data, examiners were 

not allowed to follow up on their suspicions, and it concluded with unresolved issues 

remaining and with a closing report that relied too heavily on the representations of 

Madoff. Because of these mistakes, an opportunity to uncover Madoff’s Ponzi scheme 

was missed. 

V. SEC 2006 INVESTIGATION OF MARKOPOLOS COMPLAINT 

A. Markopolos Made a Third Submission to the Boston Office in October 

2005 

As discussed above, in May 2000, Markopolos made an eight-page submission to 

the SEC’s Boston District Office questioning the legitimacy of Madoff’s reported returns. 

He subsequently met with Grant Ward from BDO, but Ward took no action with respect 

to the 2000 submission. In March 2001, Markopolos made a second, similar submission 

to the BDO that was forwarded to the SEC’s New York office. In April 2001, after a 

one-day review of the 2001 submission, NERO decided to not investigate Madoff. That 

decision was not revisited when MARHedge and Barron’s published articles in May 2001 

raising some of the same questions regarding Madoff’s claimed returns as the 2001 

submission. 

1. Markopolos and His Team Continued to Gather Information 

About Madoff 

Markopolos and his team were incredulous when the SEC did not pursue the 2001 

submission after the MARHedge and Barron’s articles were published. Markopolos 

testified, “[O]nce those articles hit in May, my team was convinced that Bernie Madoff 

would be shut down within days, that an SEC investigation team would be in there and 

shut him down.” Markopolos Testimony Tr. at p. 30. See also Chelo Testimony Tr. at 

pgs. 47-48 (I would have sworn that after that article and especially after Harry’s SEC 

submissions to that point, that something was going to happen.); Casey Testimony Tr. at 

p. 56 (We surely felt after the Barron’s article [the SEC was] coming in.). 

Although the SEC had shown little interest in Markopolos’ information regarding 

Madoff, he and his team continued to gather information about Madoff’s operations. In 

June 2002, Markopolos travelled to England, France, and Switzerland on a business trip. 

Markopolos Testimony Tr. at pgs. 42, 46. During that trip, Markopolos met several 

investors that “bragged about their Madoff exposure, that Mr. Madoff was their best 

235 
manager.” Id. at p. 47. Markopolos testified that what he heard about Madoff on this trip 

“increased the probability that Madoff was running a Ponzi [scheme],” stating: 

I was hearing information from these 14 managers that ... 

Madoff was closed to new investors, he was not taking new 

money in, but that each of those 14 had a very special 

relationship and that Madoff would take their money and 

their money only... . And when you hear the same thing 

once, you take it at face value. When you hear it twice, you 

become suspicious. After you have heard it 14 times, you 

become deeply suspicious... . And that fit with the Ponzi 

theory and it increased the probability that it was a Ponzi 

many fold... . If you are a Ponzi, you have a ferocious 

appetite for new cash because you have to pay off old 

investors. 

... . 

So you need ever increasing amounts of new money and 

new victims to come into your fund. And that was fitting 

with the Ponzi scenario. And you also have to have a series 

of lies. And it was clearly a lie that Mr. Madoff was telling 

people that he was closed publicly, but in private, was 

telling these 14 managers that they had special access 

when, in fact, there was nothing special about their access. 

He would take new money from anybody. 

Id. at pgs. 47-48. 

Markopolos also testified that the investors he met with in Europe did not believe 

Madoff could achieve his returns using the claimed split-strike conversion strategy. Id. at 

p. 50. These investors believed Madoff was illegally using his broker-dealer operation to 

generate returns for the hedge fund, as Markopolos noted: 

When I heard these people ... [had] funds that were 

invested in Madoff, they would, like, wink and – it was 

almost like a wink and a nod. “Well, of course, we don’t 

believe he really is using split-strike conversion.” A few of 

them said that. “We think he has access to order flow,” ... 

And that is how they justified it. They thought the [returns] 

were real, but they were generated through an illegal 

activity known as front-running. 

Id. 

In 2005, Casey learned of indications that Madoff was running short of cash as 

Markopolos testified: 

236 
 

 

Frank Casey ... had a meeting where it was clear that Mr. 

Madoff was trying to borrow funds from French and other 

European banks. And that was the first warning sign – and 

this is what we were looking for – that he was running short 

of cash to keep the operation going ... And we took that as 

a clear warning sign that he was in trouble and in danger of 

folding, but we had no inside information to that. 

Id. at pgs. 53-54. 

2. The 2005 Submission 

In October 2005, Markopolos made his third submission to the BDO entitled “The 

World’s Largest Hedge Fund is a Fraud” (the “2005 submission”). 2005 submission, at 

Exhibit 268. The 2005 submission discussed numerous red flags concerning Madoff’s 

operations. See Id. At that time, Walter Ricciardi was the District Administrator for 

BDO, and David Bergers was the Associate District Administrator for Enforcement. 

Ricciardi Testimony Tr. at p. 7; Bergers Testimony Tr. at p. 8. Bergers testified that the 

BDO considered Markopolos credible, stating: 

I think when we talked to him, we felt like he was 

connected to the industry, that he may be making guesses 

about certain things, but that it was – it was worthwhile to 

take a look at or try to think it through. 

Id. at p. 19.163 Michael Garrity, Branch Chief, Investment Adviser and Investment 

Company Examinations, also testified to Markopolos’ credibility with BDO, stating: 

[C]learly other people in the – above me thought Harry 

[Markopolos] was credible, and I – if someone said “Harry 

is coming in to talk about something,” then we’re all ears 

because we wanted to hear what Harry had to say. 

Garrity Testimony Tr. at p. 34. Garrity also testified that: “the more I talked with 

[Markopolos], the more I thought he was, you know, knowledgeable and so it increased 

his credibility overall ... the more I worked with him, the more credible he was.” Id. at p. 

28. 

Markopolos explained in his Congressional testimony why he made a third 

attempt to interest someone at the SEC in investigating Madoff: 

[Manion] felt that Mr. Garrity was a conscientious, hardworking Branch Chief who would give me a fair and 

163 BDO had experience with Markopolos from other matters he had referred, including “market timing 

[at] several different [mutual] fund companies.” Bergers Testimony Tr. at p. 13. 

237 
 

impartial hearing that might be what was needed to get this 

case re-submitted to the SEC’s New York Office. Ed 

Manion scheduled an appointment for me with Mr. Garrity 

and I thought that perhaps the third time submitting this 

case would turn out to be the charm. 

February 4, 2009 Testimony of Harry Markopolos Before the U.S. House of 

Representatives, Committee on Financial Services Tr. at p. 14, at Exhibit 269. 

On October 20 and 21, 2005, Garrity and Bergers arranged for Markopolos to 

meet with Garrity; John Dugan, Assistant Director for Enforcement; and Andrew 

Caverly, Branch Chief, Broker-Dealer Examinations. E-mail dated October 20, 2005 

from Garrity to Bergers, at Exhibit 270. On October 25, 2005, Markopolos met with 

these SEC representatives to discuss the 2005 submission. Markopolos Testimony Tr. at 

p. 54; Garrity Testimony Tr. at pgs. 23, 35. See also E-mail dated October 20, 2005 from 

Garrity to Bergers, at Exhibit 270. 

The 2005 submission detailed approximately 30 red flags indicating that Madoff 

was operating a Ponzi scheme, a scenario it described as “highly likely,” or committing 

some other violation of the federal securities laws. 2005 submission, at Exhibit 268. The 

2005 submission discussed an alternative possibility – that Madoff was front-running – 

but characterized that scenario as “unlikely.” 2005 submission at pgs. MARK 0051-52, 

at Exhibit 268. The red flags identified by Markopolos generally fell into one of three 

categories: (1) Madoff’s obsessive secrecy; (2) the impossibility of Madoff’s returns, 

particularly the consistency of those returns; and (3) the unrealistic volume of options 

Madoff was supposedly trading. The following are examples of the red flags identified in 

the 2005 submission: 

•		 “Third party hedge funds and fund of funds that 

market this hedge fund strategy that invests in 

[Bernard Madoff] don’t name and aren’t allowed to 

name Bernie Madoff as the actual manager in their 

performance summaries or marketing literature.” 

Id. at p. MARK 0054. 

•		 Madoff did not allow independent outside 

performance audits. Id. at p. MARK 0059. 

•		 “BM goes to 100% cash for every December 31st 

year-end.” Id. at p. MARK 0061. 

•		 “Several equity derivatives professionals will all tell 

you that the split-strike conversion strategy that BM 

runs is an outright fraud and cannot possibly 

achieve 12% average annual returns with only 7 

down months during a 141⁄2 year time period.” 

238 
Markopolos listed three individuals the SEC could 

contact who would support this contention. Id. 

•		 Madoff experienced very few down months: “only 

one monthly loss of 6 basis points during 1997’s 

Asian Currency Crises, the 1998 Russian & LTCM 

Crises and the market blood bath of 2000-2002.” 

Id. at p. MARK 0055. 

•		 “It is mathematically impossible for a strategy using 

stock, individual stock call options and index put 

options to have such a low correlation to the market 

where its returns are supposedly being generated 

from.” Madoff experienced only seven “extremely 

small” losses in over 14 years. Id. at p. MARK 

0056. 

•		 “Madoff has perfect market-timing ability” in that 

he went to 100% cash right before market declines 

in 1998 and 1999. Id. at p. MARK 0059. 

•		 Markopolos compared Madoff’s return to the 

Gateway Option Income Fund (GATEX), “the one 

publicly traded option income fund with a history as 

long as Madoff’s” and found that “[d]uring the 87 

month span analyzed, Madoff was down only 3 

months versus GATEX being down 26 months.” 

Id. 

•		 Madoff “would have to be over 100% of the total 

OEX put option contract open interest in order to 

hedge his stock holdings as depicted in the third 

party hedge funds marketing literature” based on 

Markopolos’ estimate of the amount of assets 

Madoff managed. Id. at p. MARK 0056. 

•		 Madoff reportedly was relying on “over-the-counter 

options and trades exclusively through UBS and 

Merrill Lynch ... [but] it seems implausible that a 

BD would trade $20-$50 billion worth of index put 

options per month over-the-counter through only 2 

firms... . The counter-party credit exposures for 

UBS and Merrill would be too large for these firms’ 

credit departments to approve.” 

Id. 

239 
 

 

 

 

Shortly after the October 25, 2005 meeting, Markopolos e-mailed Manion the 

2001 Barron’s article on Madoff and observed, “there are plenty of red flags in light of 

the many hedge funds that have blown up in the past 41⁄2 years. The similarities between 

Bernie Madoff and Bayou, Manhattan Fund, Wind River, the Blue Water Funds164, and 

others is startling.” E-mail dated October 29, 2005 from Markopolos to Manion, at 

Exhibit 271. 

3. The Boston and New York SEC Offices Reacted Very Differently to the 

2005 Submission 

a. The BDO Thought the 2005 Submission Warranted an 

Investigation 

The BDO took the 2005 submission very seriously. Ricciardi testified it was 

“much more detailed than your average tip. It would clearly call for a follow up.” 

Ricciardi Testimony Tr. at p. 27. Garrity testified that the 2005 submission was notable 

in that it: “is unusual [] to have something of this breadth this detailed. That is rare.” 

Garrity Testimony Tr. at p. 69. Caverly testified: 

[T]he detail that he had I thought was somewhat unusual. 

You know, because quite often you’ll have people in and 

they’ll have one nugget or one fact that they’re, you know, 

throwing at you and you might have some questions about. 

But I think clearly, I mean he had spent a lot of work – you 

know, spent a lot of time on this, and it was a series of 

things that it wasn’t somebody just happening to hear 

something and coming in and passing it along. 

Caverly Testimony Tr. at p. 24.165 

Garrity testified further that the allegations “seemed credible” and that “in the 

aggregate [the red flags] troubled me.” Garrity Testimony Tr. at pgs. 38, 42-43. Garrity 

understood that the premise of Markopolos’ referral – that Madoff’s reported returns 

164 These are examples of significant hedge fund fraud cases from 2000 through 2005.
 165 Additional SEC officials acknowledged that the 2005 submission was unusually detailed. McCarthy
 

characterized it as “exhaustive.” McCarthy Testimony Tr. at p. 137. Sadowski described the 2005
 

submission as follows:
 

It was detailed. It was very – in my judgment, very methodical. It just 

gave you a road map. It just gave you so many ways to – because that 

is what you need as an examiner, you need to say all right, I now have 

this so I can go ask this person for this piece of information. And it is, 

it is a connecting of the dots. That is what these types of things are and 

that was certainly something that led you to at least start connecting. 

Sadowski Testimony Tr. at pgs. 101-102. 

240 
were impossible to achieve with his purported trading strategy – was incontrovertible, 

stating: 

[T]he thing that bugged me is when I came to understand, 

in a sort of primitive way, the split-strike conversion 

strategy, I couldn’t imagine, and it goes back to what I 

spent time on after the meeting, this Fairfield document, I 

couldn’t understand how if you were selling calls, how you 

could have a big upside. 

Id. at p. 43. 

Madoff’s claim to have so few down months also concerned Garrity, as he noted: 

“It was just highly improbable, you know, unless you’re in a CD, I don’t know how you 

can do this over this period of time.” Id. at p. 47. Reflecting on his 2005 meeting with 

the BDO, Markopolos said Garrity “understood it” and “saw the threat.” Markopolos 

Testimony Tr. at p. 58. In his Congressional testimony, Markopolos described the 

October 25, 2005 meeting as follows: 

I met with Mr. Garrity for several hours and found him to 

be very patient and eager to master the details of the case. 

Unlike my disastrous May 2000 meeting with that office’s 

Director of Enforcement, Attorney Grant Ward, I found 

Mr. Garrity to be interested and fully engaged in my telling 

of the scheme. Some of the derivatives math was difficult 

for him to understand, so I went to the white board and 

diagrammed out Madoff’s purported strategy and its 

obvious failings until he understood it. A few of the more 

difficult concepts required repeated trips up to the white 

board but at the end of our meeting, it was clear that Mr. 

Garrity understood the scheme, it’s size, and it’s threat to 

the capital markets. 

Mr. Garrity promised to follow up and he was true to his 

word. About a week or so later, Mike Garrity called me 

back telling me that he did some investigating and found 

some irregularities but that he couldn’t tell me what they 

were, only that he was in contact with the New York 

Regional Office and wanted to put me in touch with a 

Branch Chief there for follow on investigation. 

February 4, 2009 Testimony of Harry Markopolos Before the U.S. House of 

Representatives, Committee on Financial Services Tr. at pgs. 14-15, at Exhibit 269. 

241 
b. The BDO Forwarded the 2005 Submission to NERO 

While the BDO considered Markopolos’ allegation that Madoff was operating a 

Ponzi scheme worthy of serious investigation, Ricciardi felt that it made more sense for 

the NERO office to conduct the investigation, stating: 

I wanted to send it to the office that was the most 

appropriate office to investigate this. [NERO] had already 

begun an exam, and [Madoff] was in New York. It did not 

make sense for our people to be using taxpayer money to 

be taking trains back and forth to New York to investigate 

something in New York. 

Ricciardi Testimony Tr. at p. 59. 

After deciding that NERO was the more appropriate office to conduct the 

investigation, Ricciardi e-mailed Dugan, Bergers, Garrity, and Caverly: “Let’s try to 

make sure that NERO recognizes the potential urgency of the situation.” E-mail dated 

October 25, 2005 from Dugan to Ricciardi, at Exhibit 272. The day after the BDO met 

with Markopolos, Ricciardi e-mailed Schonfeld as follows: 

Mark, as outlined below, we met yesterday with an 

informant that raised some significant concerns about 

Bernard Madoff and his broker-dealer, Madoff Investment 

Securities. Since Madoff is in New York, and NERO 

recently conducted an examination, we thought you might 

want to follow up on this. Additional details are available 

from John Dugan. 

E-mail dated October 26, 2005 from Ricciardi to Schonfeld, at Exhibit 273. Ricciardi 

forwarded Schonfeld an e-mail from Dugan summarizing the meeting with Markopolos 

as follows: 

We met this morning with an informant who passed on 

information about Bernard L. Madoff and the registered 

broker-dealer entity that he operates, New York-based 

Madoff Investment Securities, LLC. 

In a nutshell, the informant believes that although Madoff 

holds himself out as a [broker-dealer], he actually manages 

money for hedge funds. Various hedge funds apparently 

raise money from investors and hand it over to Madoff to 

manage, and they don’t disclose this to the investors in 

writing (because Madoff does not want them to reveal that 

he is managing the money). The hedge funds apparently 

want Madoff to manage the money because he purportedly 

242 
 

has some system that is extremely successful. In fact, the 

informant believes that Madoff cannot possible [sic] be 

achieving the returns that the hedge funds claim he is 

getting. The informant believes that Madoff may be 

running one giant Ponzi scheme, and there are signs that it 

may be close to crashing down on him. According to the 

informant, if that happens, it would have widespread 

ramifications, as a lot of people have placed a lot of money 

with Madoff (including some Swiss banks and a lot of 

Europeans). A few of the hedge funds that have apparently 

placed money with Madoff are Fairfield Sentry, Ltd.; 

Access International Advisors; and Broyhill All-Weather 

Fund, L.P. 

... . 

The informant passed along a lot of other information about 

this situation... . As an alternative to the Ponzi scheme 

theory, the informant believes that Madoff may actually be 

achieving the claimed returns, but is doing so by frontrunning. Also, Madoff apparently will not allow any hedge 

fund to have an independent auditor look at his books... . 

There are no open investigations of Madoff or the hedge 

fund entities I mentioned above that may have placed their 

money with him. NERO apparently recently (in September 

2005) conducted an exam of Madoff’s broker-dealer entity, 

and the exam report that Andy [Caverly] obtained touches 

on some of the same issues that the informant was 

discussing. 

Because Madoff is in New York and NERO may already be 

interested in this as a result of its exam, I recommend that 

we refer this to NERO for investigation. 

Id. 

According to Ricciardi, it was unusual that he e-mailed Schonfeld regarding the 

2005 submission and he explained that he did so to ensure that NERO gave the 2005 

submission serious attention: 

I didn’t want New York to think this was something that 

we just didn’t think needed attention. I wanted to make 

sure it was a high level, not just the standard referral 

243 
 

 

 

process, but a high-level referral, so that it would be taken 

more seriously ... . 

Ricciardi Testimony Tr. at pgs. 21-22. Garrity agreed that it was not standard practice for 

the head of one office to contact the head of another office about a tip, and that 

Ricciardi’s actions in this instance signaled an “urgency to conduct an exam or conduct 

an investigation.” Garrity Testimony Tr. at p. 53. 

Following Ricciardi’s direction to “make sure that NERO recognizes the potential 

urgency of the situation,” Dugan sent an e-mail on November 3, 2005 to all of the 

Associate Directors for Enforcement at NERO (Helene Glotzer, David Rosenfeld and 

Andrew Calamari), stating: 

I don’t know if Mark [Schonfeld] forwarded [Ricciardi’s email to Schonfeld and Dugan’s e-mail summarizing the 

meeting] to any of you, or if NERO is interested in 

investigating this, but the informant who brought this to us 

wants to come in and talk about it some more. If NERO 

plans to investigate this, I would prefer to just hook the 

informant up with someone in your office. Could you let 

me know either way? 

E-mail dated October 26, 2005 from Ricciardi to Schonfeld, at Exhibit 273. Calamari 

responded to Dugan and referred the matter to Doria Bachenheimer, Assistant Director, 

and Meaghan Cheung, Branch Chief. Id.; E-mail dated November 3, 2005 from Garrity 

to Dugan, at Exhibit 274. After the matter was referred to NERO, BDO staff gave 

Cheung’s contact information to Markopolos. Id.; E-mail dated November 4, 2005 from 

Markopolos to Garrity, at Exhibit 275; Ricciardi Testimony Tr. at p. 50. On November 4, 

2005, Markopolos sent Cheung a copy of his 2005 submission.166 E-mail dated 

November 4, 2005 from Markopolos to Cheung, at Exhibit 276; Cheung Testimony Tr. at 

p. 31. 

4. NERO was Skeptical About the 2005 Submission 

a. The Matter was Assigned to a Relatively Inexperienced 

Team, Particularly with Respect to Conducting Ponzi 

Scheme Investigations 

As discussed above, the 2005 submission was viewed by the BDO as significant 

and credible. It did not get the same reception from NERO.167 On November 3, 2005, 

166 On November 7, 2005, Markopolos sent Cheung a second, slightly revised version of the 2005 

submission. November 7, 2005 Submission, at Exhibit 285. 

167 One factor in NERO’s reaction to the 2005 submission may have been a general attitude towards Ponzi 

investigations that was expressed by Jason Gettinger, NERO Regional Litigation Counsel, in the context of 

another matter. In a January 14, 2004 e-mail discussing a different SEC Regional Office’s action against a 

Ponzi scheme, Gettinger opined, “[O]f course we should get out of the business of burning resources to 

chase ponzi schemes ....” E-mail dated January 14, 2004 from Gettinger, at Exhibit 278. Gettinger, 

244 
 

 

 

 

 

 

Calamari forwarded Dugan’s October 25, 2005 e-mail to Doria Bachenheimer, Assistant 

Director of Enforcement. E-mail dated November 3, 2005 from Calamari to 

Bachenheimer, at Exhibit 277. At that time, Bachenheimer had never conducted a Ponzi 

scheme investigation. Bachenheimer Testimony Tr. at p. 26. 

Although Bachenheimer testified that she had been “concerned” about one 

significant indicia of a Ponzi scheme in the Madoff matter – the consistency of Madoff’s 

returns – she had viewed this red flag through the lens of financial fraud cases with which 

she did have experience, stating: 

I thought he was – at this point, I was not thinking a Ponzi 

scheme. I was thinking he’s doing something to smooth 

earnings. I was trying to come up with a theory of what he 

was doing, so I was thinking was this like an accounting 

case, is this like cookie cutter reserves, does he have some 

money somewhere else. When he said he had these other 

accounts, I just thought let’s get the records and see if there 

is some way he’s smoothing earnings. I don’t even know if 

you can do that. I was wondering. 

Id. at p. 114. 

On November 3, 2005, Bachenheimer sent an e-mail to Meaghan Cheung, an 

Enforcement Branch Chief, and Simona Suh, an Enforcement Staff Attorney, stating: 

“Here’s a new case for Simona. Do you want to come by and we’ll call John Dugan to 

see what he can tell us?” E-mail dated November 3, 2005 from Bachenheimer to 

Cheung, at Exhibit 279.168 At this time, Cheung also had never conducted a Ponzi 

scheme investigation. Cheung Testimony Tr. at p. 22. Cheung acknowledged that, 

during the Madoff investigation, “I don’t think anybody ever said to me here’s how you 

investigate a Ponzi scheme and here is what you should do here.” Id. at p. 59. Cheung 

testified further that she did have experience with “boiler-room-type [cases]” and “some 

fair number of [those cases] could arguably be called Ponzi schemes.” Id. at p. 22.169 

however, testified that he believed his view about using SEC resources to investigate Ponzi schemes was 

the “minority view” within the SEC’s Division of Enforcement. Gettinger Testimony Tr. at pgs. 26-27.
 168 It appears that Calamari was primarily responsible for assigning the Madoff referral to Suh. On
 

November 3, 2005, Calamari forwarded Dugan’s October 25, 2005 e-mail that described BDO’s meeting 

with Markopolos to Bachenheimer and asked, “What do you think of this as a case for Simona?”
 

Bachenheimer responded to Calamari, “Looks good – should I tell her and Meaghan?” E-mail dated 

November 3, 2005 from Calamari to Bachenheimer, at Exhibit 277. 

169 Boiler room cases generally involve: 

•		 lying about the firm's reputation and expertise, claiming it had a 

“research department” that analyzed stocks when it didn’t, 

•		 refusing to say anything negative about the stocks they pushed, 

including the “risk factors” discussed in the prospectus, 

•		 making baseless price predictions, promising that certain stocks would 

double in price within a short time period, 

•		 impersonating other salespeople at the firm, and 

245 
 

 

 

 

 

Suh also had never conducted a Ponzi scheme investigation when she was 

assigned the Madoff matter and “did not know at the time” the “particular steps that 

needed to be taken when you do a Ponzi scheme case investigation.” Suh Testimony Tr. 

at p. 31.170 Moreover, Suh was a relatively inexperienced staff attorney. Suh graduated 

from Fordham Law School in 2001 and clerked for two years before joining the law firm 

of Cravath, Swaine & Moore LLP in New York as an associate. Id. at pgs. 11-12. Suh 

described her experience at Cravath as follows: 

I did not stay there long. I was assigned to the Enron 

matter and being the most junior associate on the Enron 

matter was not very rewarding because I was tasked with 

basically – primarily even secretarial, not even paralegal 

tasks. And so I soon decided that I wanted to leave. 

Id. Suh joined NERO in April 2004 as a staff attorney. Id. at p. 13. During her nineteen 

months at NERO before being assigned the Madoff case, Suh had not been the lead staff 

attorney on any investigation, and had been involved in very few investigations overall. 

Id. at p. 23. The Madoff assignment was also Suh’s first real exposure to broker-dealer 

issues. Id. at pgs. 67-68. As she explained: 

You know, I had worked on Bear Stearns even – it was 

technically a broker-dealer case but it was really about [a] 

very idiosyncratic part of the operations and did not really 

deal with the mechanics of trading. The AIG matter was an 

accounting fraud case so that certainly did not involve 

trading. And I had never been inside a broker-dealer and a 

broker-dealer’s office, so it’s true, I was pretty unfamiliar 

with the trading aspects. 

Id. at p. 68. However, in her nineteen months at NERO, Suh had established a reputation 

for being smart and hard-working. Bachenheimer Testimony Tr. at p. 29. Bachenheimer 

testified as to why Suh was assigned to the Madoff investigation, stating: 

The main reason she was given this case was because she 

was a superstar. She was one of the smartest lawyers I had 

•		 discouraging customers from selling the stocks they recommended 

without regard to the customers’ best interests. 

See http://www.sec.gov/investor/links/toptips.htm, at Exhibit 280 (emphasis in original). Cheung explained 

that “a lot of [her] boiler room cases involved paying back earlier investors with proceeds from later 

investments.” Cheung Testimony Tr. at p. 22. Cheung did not testify as to whether, or how, Ponzi 

schemes and boiler room cases should be investigated in a similar fashion. 

170 Suh testified that she did not seek guidance during the Madoff investigation from anyone at the SEC 

who had conducted Ponzi scheme investigations. Suh Testimony Tr. at pgs. 68-69. Suh testified she has 

since learned to seek such guidance, “[T]his is what I now do whenever I have a new type of case, I – the 

first thing I do is I go to the people who have done this type of case and ask exactly the question, ‘What 

evidence do you need to gather.’” Id. at p. 255. 

246 
 

 

 

ever seen right out of the box. This looked like – with the 

options trading strategy, quite frankly, Meaghan and I 

thought if there’s anybody who is going to be able to 

understand this, it’s going to be Simona. 

Id. Suh’s immediate supervisor, Cheung, echoed Bachenheimer’s sentiments, stating: “I 

think that Simona is a terrific lawyer, and I think that Simona had worked on complicated 

cases. She had worked on the Bear Stearns case, and I think she had a good 

understanding of complicated financial products.” Cheung Testimony Tr. at pgs. 24-25. 

b. The Enforcement Staff171 Assigned to the Matter Gave 

Little Weight to the Evidence in the 2005 Submission that 

Madoff was Operating a Ponzi Scheme 

(1) The Enforcement Staff Considered the Evidence of 

Little Value Because Markopolos Was Not a Madoff 

Investor or an Individual Personally Involved in the 

Alleged Ponzi Scheme 

Bachenheimer, Cheung and Suh all testified that they discounted the 2005 

submission somewhat because Markopolos was neither a Madoff employee nor an 

investor. Bachenheimer testified that: 

[Markopolos] was not working– he had no inside 

information – those are the wrong words to use – he was 

not an employee, and as far as I knew, received no 

information from Madoff directly. I would have no way of 

knowing, and I actually would assume – I guess you might 

think it was a comprehensive and thorough statement of 

what he knew, but not what was going on with Madoff. 

Bachenheimer Testimony Tr. at p. 40. Bachenheimer also testified that she viewed the 

circumstantial evidence presented in the 2005 submission as only “theories,” stating, 

“[the 2005 submission] wasn’t evidence. You know, it wasn’t something we could take 

and bring a lawsuit with. We had to substantiate it. We had to test it and substantiate it. 

It’s theoretical.” Id. at p. 65. Bachenheimer opined that in her view, “[i]t’s very 

challenging to develop evidence [about a Ponzi scheme] until the thing actually falls 

apart,” stating: 

It is very difficult to develop evidence, and the best way 

and often the only way we can develop evidence, 

particularly in a Ponzi scheme, is if we have somebody on 

the inside or if we have better documents than we had in 

171 As used herein, “Enforcement staff” refers to the four NERO employees (Bachenheimer, Cheung, Suh 

and Lamore) who were assigned to work on the Division of Enforcement’s 2005-2006 investigation of 

Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC. 

247 
 

 

 

this case. I can give you an example 

I’m not saying that you have to have that in every case, but 

a very challenging part of Ponzi schemes, especially where 

the investors are being paid, is they’re happy and they’re 

not going to talk to you and they’re telling you to go away, 

and that happened not only here but it happened in any 

number of cases that I worked on. It’s very challenging to 

develop evidence that something is going wrong until the 

thing actually falls apart. 

Id. at pgs. 65-66. See also id. at p. 162 (Bachenheimer stated, “I still come back to we 

needed a search warrant. ”).172 

Cheung was also skeptical of the 2005 submission because she did not consider 

Markopolos a “whistleblower,” stating: 

I remember thinking that after I spoke to him that he wasn’t 

technically a whistleblower because it wasn’t inside 

information so that was, I think, a distinction that I’m sure I 

made, because I think – I think that, you know, when you 

hear “whistleblower” or “informant,” there’s an assumption 

that it’s somebody who’s inside an operation and has – and 

has nonpublic information to give you. And I remember 

realizing that he was not. 

Cheung Testimony Tr. at pgs. 29-30. In a written submission made by Cheung’s attorney 

after her testimony, Cheung opined that “[c]onstraints on the operations of the SEC 

[E]nforcement staff ... may make it difficult for it to identify Ponzi schemes when there 

are no investor complaints (or the inspections division does not raise a flag).” 

Submission on Behalf of Meaghan Cheung dated July 24, 2009, at p. 4, at Exhibit 281. 

Suh echoed Cheung’s view that Markopolos’ 2005 submission was of limited 

value in the following exchange: 

172 It should be noted that although Bachenheimer had strong opinions on what was needed to bring a Ponzi 

scheme case, she acknowledged at that time, having had no prior experience conducting Ponzi scheme 

investigations. 

248 
 

 

Q: But you didn’t believe that Markopolos’s complaint 

contains specific facts about the alleged Ponzi 

scheme? 

A: I – well, in the sense that it was an allegation that it 

was a Ponzi but there was no detail in terms of what 

exactly he does. 

Q: What specific facts would you have liked to have 

seen that weren’t in Harry Markopolos’s complaint? 

A: If – I think what was – what I was referring to 

mostly – what I was referring to was that he did not 

have first-hand personal knowledge of the fraud that 

he was alleging. 

Suh Testimony Tr. at p. 118. 

(2) The Enforcement Staff Questioned Markopolos’ 

Credibility because of his Perceived Self-Interest 

Bachenheimer, Cheung and Suh were also skeptical of the 2005 submission 

because they were concerned about Markopolos’ motives for approaching the SEC. 

Bachenheimer testified that she “had concerns that he was a competitor of Madoff’s who 

had been criticized for not being able to meet Madoff’s returns, and that he was looking 

for a bounty.” Bachenheimer Testimony Tr. at p. 45. She further stated, “If the first 

thing I hear from someone is what’s in it for me, then it raises my antenna a little bit.” Id. 

at p. 47. However, Markopolos himself noted in the 2005 submission that he would not 

be eligible for a bounty in the event the SEC discovered Madoff was operating a Ponzi 

scheme, the scenario Markopolos described as “highly likely.” 2005 Submission at p. 

MARK 0052, at Exhibit 268. See also Section 21A(e) of the Securities Exchange Act of 

1934, 15 U.S.C. § 78u-l(e), at Exhibit 282. 

Cheung expressed a similar opinion in a November 4, 2005 e-mail exchange 

between her and Suh. Suh e-mailed Cheung as follows: 

Some prior statements from Harry Markopolos: From 

Bloomberg, 8/16/04, article re: Bush’s prospects: “If Iraqi 

cities go up in flames, so do Bush’s re-election hopes,” said 

Harry Markopolos, who oversees $900 million as chief 

investment officer at Rampart Investment Management in 

Boston. “And if oil prices keep rising, so do Kerry’s 

chances of winning.”173 

173 Suh admitted that Markopolos’s political views and comments should not have been relevant to the 

matter, stating: 

249 
 

 

E-mail dated November 4, 2005 from Suh to Cheung, attached hereto, at Exhibit 283. 

Cheung responded, “I have some qualms about a self-identified independent fraud 

analyst, but who knows.” Id. Cheung elaborated on this e-mail in her testimony as 

follows: 

I meant that I was concerned that – that he might have an 

agenda, that – that identifying himself as a fraud analyst, 

although he also appeared to have worked at at least one 

investment advisory firm and one investment firm, I was 

concerned what his personal motivations might be, and I 

thought that was something – that was just a reaction that I 

had at the time. 

Cheung Testimony Tr. at p. 35. 

Cheung’s initial concerns about an “independent fraud analyst” were not 

alleviated even when Bergers vouched for Markopolos’ credibility. On December 5, 

2005, Cheung called Bergers to find out more information about Markopolos. E-mail 

dated December 5, 2005 from Cheung to Bachenheimer, at Exhibit 284. After the call, 

she sent an e-mail to Bachenheimer and Suh summarizing the conversation, stating: 

I spoke to David Bergers in the Boston office about Harry 

Markopolus [sic] (the “informant”). They’ve worked with 

him before, as Markopolus [sic] keeps telling me, and find 

him to be generally reliable. Their past experience with 

him has been that Markopolus[sic] has very good sources, 

but he can be credulous and immediately believes what his 

sources tell him, even when they have biases. Some of his 

tips have panned out and have been very good cases, others 

have turned out to be nothing. 

Id. According to Suh, Cheung remained skeptical of Markopolos throughout the 

investigation. Suh Testimony Tr. at pgs. 72-73. Suh suggested that Cheung’s skepticism 

may have been more about a personal dislike for Markopolos than his credentials, as 

evidenced by the following exchange: 

Q: Do you have any – do you know why it seems as 

though from the e-mails Harry Markopolos was 

kind of trying to meet with Meaghan but she didn’t 

seem interested in meeting with him? 

No. That aspect was not really relevant. We were just trying find out 

who exactly he is and what he does and so on, just to get his 

background. And I remember not being able to find much and it looks 

like I just cut and pasted some things I found on the internet. 

Suh Testimony Tr. at p. 33. 

250 
 

 

 

 

 

 

A: I don’t know what her reasons were. I know her 

general impression of him was – she was skeptical 

of him, but I don’t know what her reasons for not 

meeting with him were. 

Q: In what way was she skeptical of him? 

A: ... I remember hearing that she thought he was kind 

of condescending to the SEC in terms of SEC 

expertise and knowledge ... 

Id. at p. 72.174 According to Bachenheimer, the relationship between Markopolos and 

Cheung became “adversarial.” Bachenheimer Testimony Tr. at p. 64. 

(3) Several Other Sources Raised Similar Concerns That 

Madoff Was Operating a Ponzi Scheme 

Setting aside their skepticism about Markopolos, the Enforcement staff knew of 

several other sources that had raised the same or similar allegations about Madoff. The 

May 2001 MARHedge and Barron’s articles discussed several of the red flags mentioned 

in the 2005 submission. However, Cheung testified that she did not believe these articles 

bolstered the credibility of the 2005 submission, stating: 

Q: Did you find that significant at all that there was 

someone who wrote an article that seemed to 

provide the same viewpoint that Markopolos did? 

A: I think that that – that the Ocrant article and the 

Barron’s article both raised concerns that were 

similar to Mr. Markopolos’s concerns. 

Q: Okay. But then the question is: Did that add 

credibility to Markopolos’s complaint? I know that 

they raised the same concern. My question to you 

was: You have Markopolos coming in, he raises 

concerns. Then you have two other people 

independently also raising that same concern. 

Would that add to the credibility of the concerns or 

would it have no effect? 

174 A major reason behind Cheung’s skepticism toward, and possible dislike for, Markopolos may have 

been telephone exchanges between the two where Markopolos inquired about Cheung’s understanding of 

his 2005 submission, derivatives, and Madoff’s fraud. Specifically, Markopolos recalled asking Cheung 

whether she understood derivatives, to which she responded, “Well, I did the Adelphia case.” Markopolos 

Testimony Tr. at p. 64. Markopolos responded: “Well, that was just an accounting fraud. That is much 

easier to understand than a complex derivatives fraud, and it is a much smaller case. [Madoff] is several 

times the size of the Adelphia case.” Id. According to Markopolos, “she seemed offended by that...” Id. 

Markopolos had the impression that Cheung “wanted to get [him] off the phone.” Id. at p. 66. 

251 
 

 

 

A: That’s kind of hard to answer because they actually 

predate – you know, they’re 2001 articles, so, you 

know, one way of looking at it could be that they 

said it and then Mr. Markopolos got some of his 

information from them and – and rewrote it. I know 

that – so I think it probably just was another thing 

that I looked at again when I got it. 

Cheung Testimony Tr. at pgs. 101-102. In addition to Cheung not fully explaining why 

the two articles raising similar issues to Markopolos’ failed to enhance his credibility, 

contrary to Cheung’s testimony that Markopolos may have “got[ten] some of his 

information from [the articles]” and “rewrote” them, the first sentence of the 2005 

submission that Markopolos e-mailed Cheung on November 7, 2005, stated, “I am the 

original source for the information presented herein having first presented my rationale, 

both verbally and in writing, to the SEC’s Boston office in May, 1999 before any public 

information doubting Madoff Investment Securities, LLC appeared in the press.”175 

November 7, 2005 Submission, at p. SUHS 011991, at Exhibit 285. 

In contrast with Cheung, Suh acknowledged that the articles made Markopolos’ 

concerns about Madoff “more likely to be true,” stating: 

Q: Okay. And so would that lend some credibility to 

Harry Markopolos’s allegations in that these other 

publications had raised the same questions? 

A: Well, I guess in the sense that other people – he was 

not alone in his thinking. So to the extent that 

multiple people have the same view, and maybe that 

does make that view more likely to be true. 

Q: But in terms of, you know, the returns itself, the 

time period of which Madoff had the consistent 

returns and kind of industry professionals 

understanding that that was extremely unlikely that 

anyone could achieve those kinds of returns using 

the strategy that Madoff said; wouldn’t that fact that 

the Barron’s article and the MARHedge article 

made the same points, wouldn’t that add credibility 

to that part of Markopolos’s claim? 

A: Yes. And the question was a question. You know, 

this is the question that we were asked to 

investigate. 

Suh Testimony Tr. at p. 75. 

175 As discussed above, Markopolos made his first submission to the SEC in May 2000; not May 1999. 

252 
The Enforcement staff was also in possession of another tip that raised some of 

the issues presented in Markopolos’ 2005 submission and should have added credibility 

to the 2005 submission. See id. (Suh testified, “So to the extent that multiple people have 

the same view, and maybe that does make that view more likely to be true.”). As 

discussed in greater detail in section III of this Report of Investigation, the 2003 DC 

OCIE Examination was triggered by an April 2003 complaint about Madoff from a 

Hedge Fund Manager with the following concerns: 

-according to BMS, the options are traded with a number of 

traders and crossed on the CBOE. With a 8-10 billion size, 

you must see the volume, but unfortunately you don’t; 

-the strategy is not duplicable by anyone else as far as we 

know. 

-there is no correlation to the overall equity markets (in 

over 10 years). 

-accounts are typically in cash at month end. 

-since the accounts are at BMS, the investors (i.e. the 

feeders that have discretionary accts) receive BMS 

brokerage statements. There are no third party brokers 

involved in the process. The auditor of the firm is a related 

party to the principal. 

-finally, given the performance of the different accounts, 

BMS never had to face redemption. ... 

E-mail dated May 21, 2003 from the Hedge Fund Manager to Kelly, at Exhibit 148. The 

Hedge Fund Manager’s complaint was provided to the New York examination staff 

(including Peter Lamore) when the records of the DC OCIE examination were shipped to 

the New York examination staff on June 9, 2005. Letter dated June 9, 2005 from Wood 

to Nee, at Exhibit 209. Although the Hedge Fund Manager’s complaint had information 

consistent with Markopolos’ 2005 submission, Lamore was the only member of the New 

York examination staff to recall seeing the Hedge Fund Manager’s complaint, and he 

testified that he only “glanced at it” but did not “focus” on it or “analyze” it. Lamore 

Testimony Tr. at pgs. 109-110. See also Nee Testimony Tr. at p. 108 (“no recollection” 

of the tip); Ostrow Testimony Tr. at p. 119 (“[I] don’t believe I ever saw” the tip); 

Sollazzo Testimony Tr. at pgs. 100-101 (“I don’t recall seeing” the tip). 

Suh obtained the examination records from the DC OCIE Madoff examination, 

which included the Hedge Fund Manager’s complaint, at the outset of the Enforcement 

investigation. E-mail dated November 4, 2005 from Sollazzo to Bachenheimer, at 

253 
 

Exhibit 286; Suh Testimony Tr. at pgs. 46-47.176 However, Suh never reviewed the 

complaint. Suh Testimony Tr. at p. 250. Suh acknowledged that the complaint would 

have been relevant for her investigation. Id. at pgs. 48-49. 

In addition, as discussed above, the 2005 NERO examination had been 

precipitated by the SEC’s discovery of internal e-mails at Renaissance, a hedge fund with 

an indirect investment with Madoff, that candidly discussed several reasons why 

Madoff’s purported trading and returns did not “add up.” E-mail dated November 21, 

2003 from Broder to Simons, at Exhibit 213. Among the issues that concerned the 

Renaissance officers were: (1) they did not understand how Madoff’s trading strategy 

generated the reported returns; (2) they did not understand why Madoff allowed the 

feeder funds to take such large fees; (3) Madoff did not have an independent auditor; and 

(4) the volume of options Madoff would have had to trade exceeded the volume of all 

exchange-traded options. Id.; E-mail dated November 13, 2003 from Nat Simons to Jim 

Simons et al, at Exhibit 211. Regarding the latter issue, a Renaissance officer stated: 

[M]aybe he does the options in the OTC market... . [B]ut 

we already know that the trades ... would leave the OTC 

counterparty showing losses (as our account always shows 

gains). 

... 

[T]he risk must be covered somewhere if he is doing the 

trades at all? 

So we need an OTC counterparty (not necessarily a bank) 

who is willing to do the basket of the options plus the 

underlying with Madoff at prices unfavorable for the OTC 

counterparty – in 10-15bln!!! Any suggestions who that 

might be? None of it seems to add up. 

E-mail dated November 21, 2003 from Broder to Simons, at Exhibit 213. 

Suh testified that she was aware of the Renaissance e-mails, but did not attribute 

much significance to them: 

A: I did see the e-mails that came out of [the 

Renaissance] exam that led to the exam of Madoff. 

Q: Okay and did you have any impression of those emails? Did the[y] seem consistent with what Harry 

Markopolos was saying? 

176 The Hedge Fund Manager’s original e-mail complaint with attachments were produced to the OIG as 

part of Suh’s investigative file. 

254 
 

 

A: Yes. And I asked the examiners who worked on the 

Renaissance exam about, you know, what did they 

find out about those e-mails and they said that the 

author has basically backed away and said it was 

nothing specific, it was just rumors, and – 

Q: Really? 

A: Yeah. 

Q: Did you ever talk to anybody at Renaissance 

Technologies? 

A: I did not. 

Suh Testimony Tr. at pgs. 47-48. 

Thus, while the Enforcement staff thought they had reasons to be skeptical of 

Markopolos, that skepticism should have been overcome by the fact that a Hedge Fund 

Manager and several officers of another hedge fund had independently expressed the 

same concerns. 

(4)	 NERO’s Examination Staff Initially Misled 

Enforcement Staff Regarding the Scope of the Recent 

Exam 

As discussed in detail in section IV of this Report of Investigation, NERO had 

submitted an examination report on Madoff in September 2005. The OIG investigation 

found that the results of that exam and the examination staff’s reaction to Markopolos’ 

referral contributed to the Enforcement staff’s skepticism regarding the 2005 submission. 

On November 3, 2005, Bachenheimer sent an e-mail to Bob Sollazzo, Associate Regional 

Director, Broker-Dealer Operations, NERO, attaching the referral and asking who had 

been involved in the 2005 exam. E-mail dated November 3, 2005 from Bachenheimer to 

Sollazzo, at Exhibit 287. Sollazzo responded to Bachenheimer and copied Assistant 

Director John Nee: 

These are basically some of the same issues we investigated 

and I recognize at least one of the hedge funds ... Some of 

these comments are not new, I remember looking into a [sic] 

similar allegations back in the 90’s at Madoff. John Nee 

supervised the exam (he is not in on Friday), but I can get 

you a copy of the report. You should definitely speak to John 

and the exam team before you move forward.177 

Id. 

177 Sollazzo testified that his statement that he had “look[ed] into similar allegations back in the ‘90s at 

Madoff” was a reference to the 1992 investigation of Avellino & Bienes. Sollazzo Testimony Tr. at p. 138. 

However, as discussed in greater detail in Section I of this Report of Investigation, in the 1992 investigation 

of Avellino & Bienes, the SEC did not investigate the possibility that Madoff was operating a Ponzi 

scheme. 

255 
Nee forwarded Bachenheimer and Sollazzo’s e-mail exchange about the Enforcement 

staff looking at the allegations against Madoff to Lamore with the comment, “Oh no!” Email dated November 3, 2005 from Nee to Lamore, at Exhibit 288 (emphasis added). 

Lamore responded to Nee: 

Ironically, I thought of Madoff as I went to sleep last night. 

I would be more than happy to sit down with anyone to 

provide them with an understanding of Madoff’s strategy 

and our findings. Also, our files are still in my cube. I 

don’t believe that we missed anything. 

Id (emphasis added). 

On November 10, 2005, Cheung forwarded the 2005 submission to 

Lamore and Lamore forwarded it to Nee and Ostrow, explaining: 

I’m going to meet with Meaghan and Simona on Monday 

@ 3:00 to provide my input regarding these allegations. In 

short, these are basically the same allegations we have 

heard before. The author’s motives are to make money by 

uncovering the alleged fraud. I think he is on a fishing 

expedition and doesn’t have the detailed understanding of 

Madoff’s operations that we do which refutes most of his 

allegations....Any thoughts? 

E-mail dated November 10, 2005 from Lamore to Nee, at Exhibit 290. 

Nee responded: 

No, Pete, I don’t have anything to add. I think the report 

speaks for itself. There is still a little mystery as to what 

Madoff does but a Ponzi scheme or directly trading on 

immediate customer order flow doesn’t [appear] likely 

from what we’ve seen. 

E-mail dated November 7, 2005 from Markopolos to Cheung, at Exhibit 289. 

Lamore responded, acknowledging: 

I must admit that [I] was a bit spooked when you first 

forwarded me the string of e-mails between the Boston and 

New York SEC offices (Ponzi scheme getting ready to 

crash), but after having just read the “informant’s” analysis 

I feel much better that he is incorrect. 

Id. 

256 
 

 

Nee and Lamore’s reactions when they first learned that Enforcement was looking 

at allegations that Madoff was operating a Ponzi scheme shortly after the 2005 exam was 

completed, suggest that their concern may have been at least partially for their own 

reputations if Enforcement discovered a fraud that they had missed. 

Alex Sadowski, former OCIE branch chief, testified that their reaction was 

probably a reflection of what, in his view, is a cultural problem at the SEC in the 

following exchange: 

Q: But do you think that it is possible that there might 

have been examiners who were working on an 

examination, had suspicions but didn’t find 

anything and then Enforcement is picking 

something up and so they were potentially worried 

that Enforcement would find something that would 

make them look [bad]? 

A: I think that is a very valid theory in the sense that, 

and I think that potentially is one of the cultural 

problems with the SEC is that there is the culture 

[of] fear ... . 

Q: The culture being? 

A: Of “I don’t want to be proven to be incompetent and 

so we are going to kind of – not slide this under the 

rug but it is just if I have already looked at 

something and it is not there, it is not there because 

I am competent and you don’t need to go and look 

and question my judgment.” 

Q: Right, so you might want to convince Enforcement 

that there isn’t something there to prove that you 

were right in the first place? 

A: I could certainly see people doing that because it is 

obviously poor but people worry about reputations, 

and I think that is probably one of the – again, from 

a cultural standpoint of the agency, that is probably 

a weakness in my judgment. 

Sadowski Testimony Tr. at pgs. 104-105.178 Ostrow testified that Nee’s “Oh no!” 

reaction indicated that Nee was “not so happy” “that Enforcement was looking at [the 

178 Sadowski also testified about problems with the “mentality” of the “typical SEC examiner” who “walks 

into a room where there are a bunch of dead bodies lying around and [notices] that the clocks are 10 

minutes fast.” Sadowski Testimony Tr. at pgs. 102-103. 

257 
Madoff] matter further.” Ostrow Testimony Tr. at p. 188. Ostrow also acknowledged 

that “it could make [OCIE] look bad” if “[t]here was a Ponzi and we missed it.” Id. at p. 

189. 

Subsequently, Lamore e-mailed Cheung and Suh on November 14, 2005, 

regarding the 2005 submission, stating: 

In general, the informant raises some valid questions, but I 

believe most of his allegations can be refuted based upon 

the examination that we conducted this year. However, in 

order to refute all of his allegations, we may need to request 

some documentation from one or more of the Fund of 

Funds (FOF). 

E-mail dated November 14, 2005 from Lamore to Cheung, at Exhibit 291. 

On November 22, 2005, Bachenheimer e-mailed Calamari about the Madoff 

matter, stating: “The exam team doesn’t think that there’s anything here.” E-mail dated 

November 3, 2005 from Bachenheimer to Sollazzo, at Exhibit 287. Bachenheimer 

explained, “My recollection is the exam team was saying generally they don’t think 

there’s anything there with respect to [Markopolos’] allegations of false performance.” 

Bachenheimer Testimony Tr. at p. 59. 

Cheung testified that she also believed that because the SEC had conducted a 

recent examination of Madoff and had found only “technical violations,” Madoff could 

not have been operating a Ponzi scheme, stating: 

[Madoff’s firm] had certain technical violations. But yes, 

my overall – my overall impression was that the most scary 

of the potential things that could be wrong at Madoff 

Investment Securities [a Ponzi scheme] couldn’t have been 

wrong if an exam team had been there and checked all the 

things that it appeared from the report were checked. 

Cheung Testimony Tr. at p. 67. See also id. at p. 68. Similarly, Suh testified: “Certainly 

the fact that multiple exam teams had gone into the firm made the – made the Ponzi 

allegation less likely. It seemed like they were there, they’re onsite, they see their 

operation, they are supposed to be industry experts.” Suh Testimony Tr. at pgs. 54-55. 

However, Lamore testified that in their examination, the examination staff didn’t 

“look at the Ponzi scheme issue at all.” Lamore Testimony Tr. at p. 164. Ostrow 

concurred that the examination team focused on front-running, not the possible existence 

of a Ponzi scheme in the examination. Ostrow Testimony Tr. at p. 187. See also id. at p. 

188 (Ostrow testified that the allegations the examination staff had explored were not 

similar to the allegations in the Markopolos complaint). Sollazzo also acknowledged that 

the 2005 exam “did not refute” Markopolos’ allegations regarding a possible Ponzi 

258 
 

 

scheme. Sollazzo Testimony Tr. at pgs. 140-141. Sollazzo admitted that, “The primary 

issue [during the 2005 exam] was the front-running and the trading issues, that was – 

those were the issues... . The Ponzi scheme aspect, it was not part – it was not the scope 

of the examination.” Id. at pgs. 142-143. In addition, contrary to the statements in his 

response to Lamore, Nee acknowledged in his OIG testimony that the description of the 

2005 submission as making “the same allegations we have heard before” was not true 

because the 2005 exam had not looked for evidence of a Ponzi scheme. Nee Testimony 

Tr. at pgs. 171-172. See also id. (Nee testified that the examination staff had not 

reviewed information that could have refuted Markopolos’ allegations). 

Even though the examiners agreed that the 2004-2005 NERO examination had 

not looked at the possibility that Madoff was operating a Ponzi scheme, Ostrow 

acknowledged that Sollazzo’s November 3, 2005 response to Bachenheimer gave the 

impression that the examination staff had already analyzed the Ponzi scheme issue. 

Ostrow Testimony Tr. at p. 188. Similarly, Sollazzo acknowledged that it was “possible” 

that Enforcement lawyers would get the impression from Lamore’s November 14, 2005 

e-mail that the 2005 NERO examination had a greater focus than it did. Sollazzo 

Testimony Tr. at p. 141. Indeed, since the 2005 NERO examination had ruled out frontrunning, the NERO examiners should have encouraged the Enforcement staff to analyze 

Markopolos’ more likely of the two scenarios, the Ponzi scheme. 

(5) Enforcement Staff Knew that, Irrespective of Their 

Initial Representations, the Examination Staff Had Not 

Looked for Evidence that Madoff Was Operating a 

Ponzi Scheme 

However the examination staff characterized the scope of its recent examination 

to the Enforcement staff, the examination report itself, which was attached to Sollazzo’s 

e-mail to Bachenheimer, stated, “The staff’s examination consisted primarily of 

analyzing and comparing BLM’s proprietary trading and IA trading to its customer order 

flow business for the purpose of identifying instances of front-running ... .” Examination 

Report dated September 2, 2005, at p. 3, at Exhibit 292.179 

Suh acknowledged that: 

[A]fter talking to Peter [I learned] that the focus of their 

exam was the front-running allegation, which was listed as 

the second allegation in the Markopolos report. I knew that 

179 Bachenheimer testified that she did not remember whether she read the exam report. Bachenheimer 

Testimony Tr. at p. 63. Cheung and Suh testified that they remembered reading the report. Cheung 

Testimony Tr. at p. 64; Suh Testimony Tr. at p. 51. 

259 
 

 

their primary focus was front-running... . I did not believe 

that they focused on a Ponzi scheme allegation. 

Suh Testimony Tr. at p. 27. In fact, as discussed below, Suh believed the exam had 

eliminated the possibility that Madoff was front-running, but that the possibility Madoff 

was operating a Ponzi scheme still needed to be investigated. 

In contrast to Suh, Bachenheimer and Cheung may have relied upon their 

mistaken belief, that the SEC examination had looked for evidence that Madoff was 

operating a Ponzi scheme to dismiss that possibility at the outset of the Enforcement 

investigation. Yet, as discussed below, they instead decided that front-running should be 

a principal focus of the Enforcement investigation even though they also believed that the 

exam had looked for, and not found, evidence of front-running.180 Cheung Testimony Tr. 

at p. 65 (acknowledging that the examination staff investigated front-running allegations). 

In addition, the Enforcement staff should have known that the examination staff’s 

work could not have eliminated the possibility that Madoff was operating a Ponzi 

scheme, because the examiners had only reviewed evidence created by or represented by 

Madoff.181 Suh acknowledged during testimony that she knew the examination staff had 

relied solely on Madoff’s representations: 

Q: Did you ever read the exam report that Lamore did? 

A: Yes. 

Q: Did you notice that in the exam report nearly the 

entire report recites what Bernie Madoff says? 

A: I knew that, yes. 

Q: Okay. So a lot of the information that Lamore was 

getting that he was telling you was just based on 

what – something Bernie Madoff told him. 

A: Yes. 

Q: Okay and given that you were investigating Bernie 

Madoff for essentially being a liar and a fraud, 

180 The 2005 submission included the statement, “Fund of funds with whom I have spoken to that have BM 

in their stable of funds continually brag about their returns and how they are generated thanks to BM’s 

access to his broker-dealer’s access to order flow.” 2005 submission at p. MARK 0057, at Exhibit 268. In 

Lamore’s copy of the 2005 submission, he wrote “wrong” in the margin adjacent to that statement and 

underlined “his broker-dealer’s access to order flow.” Lamore’s copy of the 2005 submission at p. 8, at 

Exhibit 293. 

181 In his allocution, Madoff acknowledged that the trading confirmations and account statements that he 

provided to clients and the SEC had been fabricated. Madoff Allocution Testimony Tr. at pgs. 27-28, at 

Exhibit 375. 

260 
wouldn’t you be very skeptical that any of this stuff 

was true? 

A: That’s true and that makes sense to me now. At the 

same time, I was told that Peter was an industry 

expert and I thought that if there were things that 

jumped out at him as things that didn’t make sense, 

I deferred to his judgment on that point. 

Suh Testimony Tr. at p. 51. 

Finally, regardless of how dismissive the examination staff was when they first 

heard that Enforcement was planning on investigating the 2005 submission, once Lamore 

began working with the Enforcement staff, the OIG found that he accurately conveyed to 

Enforcement the limited scope of the 2005 exam and expressed serious concern about 

Madoff. As Ostrow explained: 

Q: ... . [D]o you think that perhaps John [Nee] or Bob 

Sollazzo sort of downplayed the allegations in 

Harry Markopolos’s complaint to enforcement? 

A: It appears that way, but even then when 

enforcement took the next step and started bringing 

people in and Peter [Lamore] heard Bernie 

[Madoff] or Frank [DiPascali] or whoever blatantly 

lying again, there’s only so much jumping up and 

down he can do and even with me confirming what 

he’s saying it didn’t help any. 

Ostrow Testimony Tr. at pgs. 199-200. See also Suh Testimony Tr. at p. 27 (Suh 

testified that “after talking to Peter ... I did not believe that [the examination staff had] 

focused on a Ponzi scheme allegation”); E-mail dated December 28, 2005 from Lamore 

to Suh, at Exhibit 294 (describing his “major concern” as relating to where “the securities 

and money [are] held”). 

(6) The Enforcement Staff Concluded that Madoff Did Not 

Fit the “Profile” of a Ponzi Scheme Operator 

Another factor in the Enforcement staff’s skepticism of Markopolos’ allegation 

that Madoff was operating a Ponzi scheme was their view that Madoff did not fit the 

profile of a Ponzi scheme operator. As Suh explained during testimony, “It’s certainly 

true that [Madoff] didn’t fit the profile of a Ponzi schemer, at least as we – in the world 

that we knew then.” Suh Testimony Tr. at pgs. 44-45. 

While Cheung acknowledged that she “embarrassingly” had not heard of Madoff 

prior to the 2005 submission, she soon learned of his background and ties throughout the 

securities industry. Cheung Testimony Tr. at p. 23. Cheung testified: 

261 
 

I don’t think there was ever a conscious desire to make 

something go away or to ignore an allegation about Bernie 

Madoff. Do I think that there’s an inherent bias towards 

[the] sort of people who are seen as reputable members of 

society, there may be an inherent bias in that way. 

Id. at p. 264. Cheung was adamant, however, that Madoff’s stature in the securities 

industry did not affect the Enforcement staff’s investigation, stating: 

I think that we did not forego investigative steps because of 

who he was, and I don’t think we were easier on him. I 

have personally interviewed, requested documents, gotten 

tolling agreements, pushed from people who I view as – as 

sort of more powerful than Bernie Madoff without, I think, 

pulling a punch. 

Id. Suh expressed the same belief: 

And – but also, I never had a concern in terms of, you 

know, stepping on the wrong toe or anything like that, and I 

had no impression that anybody else did. 

Suh Testimony Tr. at pgs. 44-45.182 

5. The Enforcement Staff Delayed Opening a Matter Under 

Inquiry (MUI) 

a. The Madoff MUI was Not Opened Until January 2006 

As discussed above, on November 3, 2005, Calamari forwarded the 2005 

submission to Bachenheimer, suggesting that it would be a good case for Suh. E-mail 

dated November 3, 2005 from Calamari to Bachenheimer, at Exhibit 277. Bachenheimer 

replied and asked whether she should inform Suh and Cheung. Id. Calamari immediately 

182 In fact, Cheung claimed that because of her doubts about Markopolos and the 2005 submission, she 

believed the Enforcement staff conducted a thorough investigation: 

Everything factored – everything factors into your overall sense of a 

person, but I actually think that in a lot of ways because of our concerns 

[about Markopolos], I think we looked awfully hard and awfully close. 

And I think we were – I was certainly conscious of making sure or 

trying to make sure that we didn’t miss something that would come out 

in The Wall Street Journal. 

Cheung Testimony Tr. at p. 36. 

262 
 

 

 

 

 

 

 

replied: “Sure, they should open a MUI.” Id.

183 However, the staff did not initiate the 

process of opening a MUI until December 27, 2005, approximately 8 weeks later.184 The 

MUI was officially opened on January 4, 2006. E-mail dated January 4, 2006 from Case 

Management System to Suh, at Exhibit 295. 

Bachenheimer acknowledged that it was important to open a MUI so that staff is 

informed of other relevant information that the SEC receives: 

Q: Is one of the reasons why you would open a MUI is 

if a complaint comes in separately that the person or 

entity that gets the complaint could look up on 

NRSI [the SEC’s Name Relationship Search Index] 

to see whether there’s an open investigation or a 

MUI? 

A: Yes. 

Bachenheimer Testimony Tr. at p. 82. Bachenheimer acknowledged that the Madoff 

MUI “should have been opened sooner.” Id. With respect to opening a MUI generally, 

Suh acknowledged learning shortly after she joined the SEC that sometimes a MUI was 

not opened if “it was clear so quickly that we did not – it wouldn’t be something we 

pursued.” Suh Testimony Tr. at pgs. 95-96. Suh testified that: 

[N]ow, with the benefit of more experience and sort of 

being more aware of the various information sources that 

we have with in the Commission, I do, myself, make a 

practice and I also talk to my branch members to make sure 

that the related names get loaded up as soon as we become 

aware of them for that very reason, so that if anybody else 

is looking at that person we learn about it right away. I 

have to say at the time, I was – it was not an issue that was 

on my personal radar. 

Id. 

183 According to the SEC’s Enforcement Manual, “Complaints that appear to be serious and substantial are 

usually forwarded to staff in the home office or the appropriate regional office for more detailed review, 

and may result in the opening of a MUI.” 2008 SEC Enforcement Manual, at p. 8, at Exhibit 296. 

184 Apparently, Suh believed she had requested the opening of a MUI in mid-December 2005. E-mail 

dated December 27, 2005 from Cheung to Calamari, at Exhibit 297. On December 27, 2005, Cheung emailed Calamari asking him to review Suh’s MUI request. Id. Calamari responded, “I don’t have the email, which means either that I approved it or never got it. If I had not approved it for some reason, I 

would have spoken to her. Are you sure it’s not open?” Id. Cheung speculated that there was a “glitch” 

with the first attempt since NERO was “transitioning to [a] new system at that point...” Cheung Testimony 

Tr. at p. 131. In any event, Suh then submitted a MUI request on December 27, 2005. E-mail dated 

December 28, 2005 from Suh to Cheung, at Exhibit 298. 

263 
 

b. As a Result of the Delay in Opening a MUI, The Enforcement 

Staff Never Learned of a Tip From a Madoff Investor Who 

Suspected That Madoff was Operating a Ponzi Scheme 

Because of the two-month delay in opening the Madoff MUI, the NERO 

Enforcement staff never received a tip from a former Madoff investor who alleged 

Madoff was operating a Ponzi scheme. The SEC Office of Internet Enforcement (OIE) 

(within the Enforcement Division) received an October 1, 2005 e-mail from an 

anonymous informant who stated he had invested with Madoff in 1999 and was “deeply 

concerned that Madoff is running a very sophisticated fraudulent pyramid scheme” (the 

“October 2005 tip”). E-mail dated October 1, 2005 from Nomen Nescio to 

ENFORCEMENT, at Exhibit 299. The informant stated, “I know that Madoff [sic] 

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

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

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

“After a short period of time, I decided to withdraw all my money (over $5 million).” Id. 

On October 28, 2005, after reviewing the October 2005 tip, an Enforcement Staff 

Attorney, in OIE searched NRSI [the SEC’s Name Relationship Search Index]185 for 

“Madoff” and found no record of the 2005 Markopolos submission or of an active 

Madoff investigation. Enforcement Staff Attorney Testimony Tr. at p. 31; Excerpt from 

the NRSI list of SEC employees who searched for “Madoff,” at Exhibit 300. On 

November 18, 2005, the Enforcement Staff Attorney in OIE forwarded the tip to the 

Enforcement Senior Counsel in OIE, for her review, stating, “I did a little research on this 

one but I couldn’t find anything on Madoff Financial.” E-mail dated October 1, 2005 

from Nomen Nescio to ENFORCEMENT, at Exhibit 299. On November 21, 2005, the 

Enforcement Senior Counsel searched NRSI for “Madoff” and also found no record of 

the 2005 submission or of a Madoff investigation in NERO. Enforcement Senior 

Counsel Testimony Tr. at pgs. 20-21; Excerpt from the NRSI list of SEC employees who 

searched for “Madoff,” at Exhibit 300. 

NERO had received the 2005 submission more than two weeks before the 

Enforcement Senior Counsel searched NRSI. The Enforcement Senior Counsel found no 

record of a Madoff investigation because NERO had not opened a MUI. The 

Enforcement Senior Counsel testified that the October 2005 tip would have been 

forwarded to NERO had her NRSI search revealed that NERO was investigating Madoff. 

Id. at pgs. 15-16, 22.186 If she had forwarded the October 2005 tip to NERO, the 

Enforcement Senior Counsel testified that she would have forwarded it to Jason 

Gettinger. Id. at pgs. 12-13. 

185 NRSI is used by the SEC’s Enforcement staff to research whether a person or entity is involved in an
 

open investigation. Bachenheimer Testimony Tr. at p. 82. 

186 As discussed in the Enforcement Manual, “Complaints that relate to an existing MUI or investigation 

are generally forwarded to the staff assigned to the existing matter.” 2008 SEC Enforcement Manual, at p.
 

8, at Exhibit 296. 

264 
OIE did not investigate the October 2005 tip and apparently it was not referred to 

NERO or anywhere else within Enforcement. Id. at pgs. 22-23; Enforcement Staff 

Attorney Testimony Tr. at p. 43. The OIG found no evidence in the SEC’s e-mail 

records for the Enforcement Senior Counsel and the Enforcement Staff Attorney that 

either one referred the October 2005 tip or discussed it with anyone other than each other 

before December 11, 2008, and the Enforcement Senior Counsel testified that she did not 

discuss the October 2005 tip with anyone other than the Enforcement Staff Attorney prior 

to December 11, 2008. Enforcement Senior Counsel Testimony Tr. at p. 23. 

On December 11, 2008, the day it was reported that Madoff had confessed to the 

Ponzi scheme, an Office of Internet Enforcement Official asked his staff to search OIE’s 

archived records to determine whether OIE had ever received any complaints about 

Madoff. Office of Internet Enforcement Official Testimony Tr. at p. 33. That search 

revealed the October 2005 tip. Id. The Office of Internet Enforcement Official testified 

that he had not been aware of the October 2005 tip before that day. Id. at pgs. 32-33. 

On December 11, 2008, the Enforcement Senior Counsel initially told the Office 

of Internet Enforcement Official that she thought she may have referred the October 2005 

tip to someone else within Enforcement. Id. at p. 37. However, the Enforcement Senior 

Counsel testified that she had no recollection of referring the matter and, as noted, the 

OIG found that the October 2005 was not referred to anyone outside of OIE for possible 

investigation. Enforcement Senior Counsel Testimony Tr. at p. 22. 

Both the Enforcement Senior Counsel and the Office of Internet Enforcement 

Official testified that the October 2005 tip should have been referred by OIE for 

investigation. Enforcement Senior Counsel Testimony Tr. at p. 25; Office of Internet 

Enforcement Official Testimony Tr. at p. 32. Bachenheimer and Cheung each testified 

that the October 2005 tip would have been relevant to the Madoff investigation. Cheung 

Testimony Tr. at pgs. 261-262; Bachenheimer Testimony Tr. at pgs. 158-159. In 

addition, as discussed above, Suh, Bachenheimer and Cheung all testified that a tip from 

a Madoff investor would have been more credible than the 2005 submission. Suh 

Testimony Tr. at p. 118; Cheung Testimony Tr. at pgs. 29-30; Bachenheimer Testimony 

Tr. at p. 40. 

Had the MUI been opened when Calamari requested it, on November 3, 2005, the 

Enforcement Senior Counsel’s NRSI search on November 21, 2005, would have resulted 

in the October 2005 tip being referred to the Enforcement staff. Enforcement Senior 

Counsel Testimony Tr. at p. 22. As a result of their delay in opening the MUI, the 

Enforcement staff was not aware of the October 2005 tip. However, it is unclear whether 

the tip would have made any difference in the conduct or the result of the 2006 

investigation because, as discussed in detail below, when Suh later received another 

anonymous tip regarding Madoff, she dismissed it without any investigation because of 

her view that anonymous tips, “on [their] face” were not credible. Suh Testimony Tr. at 

p. 233. 

265 
6. The Enforcement Staff Investigated Madoff, but Focused on Issues 

Unrelated to a Ponzi Scheme Investigation 

a. The Focus of the Investigation Was on Whether Madoff 

Should Register as an Investment Adviser and Disclosure 

Issues 

As discussed above, the 2005 submission primarily presented evidence that 

Madoff was operating a Ponzi scheme; calling that scenario “highly likely.” However, 

most of the Enforcement staff’s efforts during the 2006 investigation were directed at 

determining whether Madoff was front-running, whether Madoff should register as an 

investment adviser, or whether Madoff’s hedge fund investors’ disclosures were 

adequate. 

Regarding her understanding of the Madoff investigation’s focus, Bachenheimer 

testified: 

My recollection of the investigation was we did start with 

whether it was a Ponzi scheme ... we knew how much 

money Fairfield had given to Madoff, and it was accounted 

for, and given the size and the fact that it was accounted 

for, I remember thinking it was unlikely it was a Ponzi 

scheme. Then I think we did focus on front running. 

Bachenheimer Testimony Tr. at p. 36. Bachenheimer later reiterated her understanding 

of the investigation’s focus: 

Q: Why at that point were you not thinking Ponzi 

scheme? 

A: Going back to what I testified to earlier about the 

Fairfield Century thing, that the money had been 

accounted for, and it was too big. I thought it was 

more about performance. 

Id. at p. 114. 

Cheung testified that she did not believe the Ponzi scheme scenario was the 

primary issue presented in the 2005 submission, despite Markopolos’ characterization of 

that scenario as “highly likely,” stating: 

Q: Okay. Was there one particular aspect that you felt 

was kind of the primary focus? ... Did you also get 

the sense from Markopolos’ complaint or 

presentation that the primary issue that he was 

266 
 

 

 

 

 

bringing to your attention was an allegation that 

Madoff Securities was a Ponzi scheme? 

A: I don’t know if – I don’t know if that’s what I 

thought was primary. I thought that was a real 

concern, but I thought the disclosure issues were 

also a real concern. And I think also – I think also 

the front-running issue seemed like a real concern. 

I mean, I think – I think there was a lot in this for us 

to investigate. 

Cheung Testimony Tr. at pgs. 32-33. 

Stephen Johnson, a Branch Chief for broker-dealer examinations, also provided 

some insight regarding the focus of the Enforcement staff’s Madoff investigation. 

Johnson Testimony Tr. at pgs. 18-19. As discussed in greater detail below, Johnson was 

asked in May 2006 to assist with some of the preparation for Madoff’s testimony and to 

attend that testimony because of his experience with market maker activity and frontrunning investigations. Id. at pgs. 7-8, 10, and 17-18. Johnson testified that the 

Enforcement staff had explained to him they were investigating Madoff for “operating as 

an investment adviser and he wasn’t registered” and that “someone discuss[ed] the 

possibility of frontrunning customer orders.” Id. at p. 18. After Madoff’s testimony, 

Johnson understood that the Enforcement staff ruled out the possibility that Madoff was 

front-running and focused exclusively on the investment adviser registration issue. Id. at 

pgs. 55-56. Johnson was never told that the Enforcement staff’s Madoff investigation 

also involved the possibility of Madoff operating a Ponzi scheme. Id. at pgs. 19 and 55­

58. 

Another indication of the focus of the Enforcement staff’s Madoff investigation 

was the description of the investigation that Cheung gave Israel Friedman, a, SEC New 

York Regional Office Branch Chief, after Madoff confessed. Friedman called Cheung 

only a “few hours” after opening the SEC’s current Madoff investigation on December 

11, 2008, the day after Madoff had confessed to the Ponzi scheme. Friedman Testimony 

Tr. at p. 29. Friedman called Cheung after learning that there had been a previous 

Enforcement investigation about Madoff. Id. Friedman testified that Cheung told him 

the Enforcement staff had “worked pretty hard and looked very hard for in particular 

front running type issues.” Id. Friedman testified that Cheung did not mention anything 

about looking for a Ponzi scheme. Id. at p. 30.187 

187 However, in a written submission made by Cheung’s attorney after her testimony, Cheung claimed that 

she had “recognized the seriousness of the Ponzi scheme allegation made by Mr. Markopolos [and had] 

developed a plan to investigate those allegations by initially obtaining documents and testimony from 

Fairfield Greenwich – the main feeder fund to BLM – and from BLM and Madoff. And that plan was 

implemented and followed. It would be wrong and unfair to conclude that Ms. Cheung and her colleagues 

did not seriously investigate the Ponzi scheme allegations.” Submission on Behalf of Meaghan Cheung 

dated July 24, 2009, at pgs. 9-10, at Exhibit 281. 

267 
 

The OIG investigation found that there was significant confusion among the 

members of the Enforcement staff as to what the focus of the investigation was, or should 

have been in 2005. Bachenheimer and Cheung believed that the Ponzi scheme scenario 

had been eliminated as a possibility by the examination staff. See Bachenheimer 

Testimony Tr. at p. 59; Cheung Testimony Tr. at pgs. 66-68. 

While Bachenheimer and Cheung believed that Suh was focused on the frontrunning scenario, Suh believed that “the front-running issue had kind of already been 

looked at [during the examination] so ... [the] focus was ... whether [Madoff] was 

operating a Ponzi scheme.” Suh Testimony Tr. at p. 37. See also id. at p. 27 (Suh 

testified that “after [she talked] to Peter [she learned] that the focus of the[] exam [had 

been] the front-running allegation ... and that [the examination staff had not] focused on 

a Ponzi scheme allegation.”) In a December 28, 2005 e-mail, Lamore described his and 

Suh’s “major concern” as relating to where “the securities and money [are] held,” which 

indicates that front-running was not Suh’s and Lamore’s “major concern.” E-mail dated 

December 27, 2005 from Suh to Cheung, at Exhibit 294. 

However, on January 27, 2006, Suh remarked in an e-mail to Lamore that she did 

not think there was “any real reason to suspect some kind of wrongdoing ...” (emphasis 

in original) and indicated that “all we suspect is disclosure problems.” E-mail dated 

January 27, 2006 from Lamore to Suh, at Exhibit 301. Suh testified regarding this email, “At that time I think the view was that there’s probably nothing there and that this 

would be primarily a registration and disclosure case.” Suh Testimony Tr. at p. 130. 

As discussed in greater detail below, the OIG investigation found that it was not 

until near the end of the investigation that the Enforcement staff made any effort to obtain 

documents that would have indicated whether or not Madoff was actually placing any 

trades with his investors’ funds, and those efforts were halted before any of those 

documents were obtained. Suh explained that the decision not to obtain those documents 

was made “very close to the end of the investigation, it was in July, and the focus at that 

time was on the registration issue.” Id. at p. 61 (emphasis added). 

On August 10, 2006, Suh received an e-mail from Cheung stating that Madoff had 

agreed to register as an investment adviser. She testified that “once I got that e-mail I 

kind of assumed we were done” because “registration was the goal at that point.” Id. at p. 

231. 

268 
 

 

 

 

 

 

b. The Investigation Focused on Reviewing Records Created by 

Madoff Without Verifying Those Records Through 

Independent Sources 

1. In December 2005, the Enforcement Staff Reviewed 

Documents Produced By Madoff’s Largest Hedge Fund 

Investor 

The Enforcement staff’s investigative plan primarily involved comparing 

documents and information that Madoff had provided to the examination staff (which he 

fabricated) with documents that Madoff had sent his investors (which he also fabricated). 

Suh began the investigation by sending a document request to Fairfield Greenwich Group 

(Fairfield) on November 18, 2005.188 See Document Request dated November 18, 2005 

from Suh to Fairfield, at Exhibit 302.189 

Suh acknowledged in testimony that this plan was not helpful for ascertaining 

whether Madoff was operating a Ponzi scheme: 

Q: What is the point of trying to verify that the 

information that ... Madoff provided to Fairfield 

matches the information that Madoff gave to [the 

examination staff]? 

A: Well, if it didn’t match it certainly would be a 

huge red flag. 

... 

188 The November 18, 2005 document request to Fairfield sought, inter alia: (1) documents describing the 

investment strategies employed by all Fairfield hedge funds and the returns generated through those 

strategies and (2) account statements and trade confirmations for the hedge funds. See Document Request 

dated November 18, 2005 from Suh to Fairfield, at Exhibit 302. The Enforcement staff subsequently 

limited the request to include only the Fairfield hedge funds with assets managed by Madoff. See 

Supplemental Document Request dated November 18, 2005 from Suh to Fairfield, at Exhibit 303. On 

December 8, 2005, Fairfield produced documents responsive to the November 18, 2005 requests. See 

Fairfield Production Letter dated December 8, 2005, at Exhibit 307. 

189 In February 2006, the Enforcement staff sent Tremont Partners, Inc. (Tremont) a request for documents 

similar to the November 2005 Fairfield request. Letter dated February 1, 2006 from Suh to Tremont, at 

Exhibit 304. Tremont produced documents in response to that request initially on February 22, 2006, and 

throughout the month of March. Tremont Production Index, at Exhibit 305. 

In April 2006, the Enforcement staff requested similar documents from Tremont relating to 

Kingate’s accounts with Madoff. See Letter dated May 5, 2006 from Tremont to Suh, at Exhibit 306. 

Those documents were produced on May 5, 2006. Id. 

269 
 

 

Q: But it wouldn’t really go to the Ponzi scheme 

issue, right? 

A: That’s right. 

Suh Testimony Tr. at pgs. 65-66.190 

On November 22, 2005, Bachenheimer explained the investigative plan in an email to Calamari, as follows: 

The exam team doesn’t think that there’s anything here. 

Simona is going to seek information from some of the 

hedge funds on a voluntary basis to test some of the 

explanations that Madoff gave to the exam team. If they 

work out we won’t do anything. 

E-mail dated November 3, 2005 from Bachenheimer to Sollazzo, at Exhibit 287. 

On December 13, 2005, Suh e-mailed Cheung and Lamore to inform them of the 

contents of Fairfield’s document production and her plan going forward, as follows: 

Fairfield Greenwich produced 11 binders of documents last 

Thursday. Ten of those binders contain account statements 

and trade confirmations, one – general fund documents 

such as subscription materials, private placement 

memoranda, etc. Fairfield Greenwich did not produce the 

monthly statements with performance data that the 

administrators of the two relevant funds (Citco Fund 

Services (Europe) B.V. for Fairfield Sentry Limited and 

GlobeOp Financial Services, LLC for Greenwich Sentry, 

L.P.) send directly to investors, but offered to request and 

produce them, if we ask. Fairfield Greenwich did produce 

account statements and trade confirmations that it receives 

from Madoff. 

... 

Thus, with the data produced so far, it looks like we should 

be able to verify whether the information Madoff provided 

to Fairfield Greenwich matches the data Madoff gave to 

[Lamore] and his team, but we will need to make an 

additional request if we decide to try matching this data 

190 However, in a written submission made by Cheung’s attorney after her testimony, Cheung claimed that 

the Enforcement staff’s investigative plan had been designed to investigate Madoff for a Ponzi scheme. 

Submission on Behalf of Meaghan Cheung dated July 24, 2009, at p. 9, at Exhibit 281 (Cheung “developed 

a plan to investigate [the Ponzi scheme] allegations by initially obtaining documents and testimony from 

Fairfield Greenwich – the main feeder fund to BLM – and from BLM and Madoff. And that plan was 

implemented and followed.”) 

270 
 

 

 

with the information that Fairfield Greenwich provides to 

its investors. 

E-mail dated December 13, 2005 from Suh to Lamore, at Exhibit 308 (emphasis 

in original). 

2. The Documents from Fairfield Demonstrated that Madoff 

Had Lied to the Examination Staff 

In her December 13, 2005 e-mail to Lamore and Cheung, Suh stated that she 

noticed an “odd discrepancy” between Fairfield’s production and Madoff’s previous 

representations to the examination staff, as follows: 

While I have not yet completed the review of the general 

binder, one odd discrepancy did catch my eye. As you 

know, Madoff told [Lamore] that he stopped using options 

as part of his trading strategy in January 2004. Yet the 

account statements and trade confirmations produced by 

Fairfield Greenwich show trading in S&P 100 Index 

options all through 2004 and up to October 2005, the last 

month for which data was produced ... Moreover, the CD 

with account statements that Madoff produced to [Lamore] 

and his team does not include statements for three accounts 

and one sub-account in the Fairfield Greenwich production 

... Peter [Lamore], would you have time to take a look at 

the data to see if I am missing some obvious – and innocent 

– explanation for this? 

Id.191 

191 Suh also raised a “conflict of interest” issue with Lamore while she reviewed Fairfield’s documents: 

Fairfield Sentry’s private placement memorandum discloses the 

following “potential conflict of interest”: 

The broker-dealer through which the Fund conducts its SSC Investment 

activities, in its role as a market-maker, may effect transactions in 

equity securities with the Fund as principal. This may provide such 

broker-dealer with the ability to use the Fund’s assets to enhance its 

equities market making function. 

What is this about? (I am sure this is basic stuff, but I am still pretty 

new to all things b-d.) Thanks!” 

E-mail dated December 14, 2005 from Suh to Lamore, at Exhibit 353. 

271 
On December 15, 2005, Cheung raised this “odd discrepancy” in an e-mail to 

Bachenheimer: 

Do you have a few minutes to talk about Madoff? It may 

actually be something of concern since Madoff failed to 

produce a whole set of accounts to the examiners. In those 

accounts he’s using the option strategy that he told our 

examiners that he was no longer using. He seems to have 

failed to disclose to the examiners several billion dollars 

worth of options accounts. 

E-mail dated December 15, 2005 from Cheung to Bachenheimer, at Exhibit 309. 

Bachenheimer testified that she had a vague recollection of the discrepancy and “was 

concerned that [Madoff] had lied,” stating: 

Q: Do you remember this particular issue that 

Meaghan references here in this e-mail on Exhibit 

14 that Madoff failed to produce a whole set of 

accounts to the examiners, and in those accounts, 

he's using the options strategy that he told our 

examiners he was no longer using? 

A: You know, I just have a very vague sense of this, of 

learning this, but I really can’t remember the 

specifics of it. 

Q: Do you remember generally that Madoff had lied to 

the examiners on numerous occasions in the 

examination, that was the conclusion of the exam 

staff? 

A: As I remember it, I don’t think my thought was that 

he had lied numerous times. I think he had lied. I 

was concerned that he had lied. 

Bachenheimer Testimony Tr. at p. 72. 

Cheung testified that the discrepancy was “serious” and precipitated a phone call 

from Bachenheimer to Madoff “to impress on him the importance” of the issue, stating: 

Q: Does this [December 15, 2005 e-mail from you to 

Bachenheimer] refresh your recollection about that 

options issue at all? 

A: A little bit. I still don’t – I think that this – what it 

seems to be refreshing is that this is what kind of 

272 
came out of – that this came out of Simona’s initial 

e-mail to Peter about a discrepancy and then she 

and Peter met and then they met with me. And then 

I thought it was significant enough that we should 

be bringing it to Doria right away. That’s what I 

remember. 

Q: Okay. And do you remember what was decided 

about this issue or? 

A: I – I remember we went back to Mr. Madoff for 

documents again. I believe at that point because we 

were disturbed about not – that things not being 

produced to the exam staff, that I believe that Doria 

was on the call to impress on him the importance of 

what we were – how serious this was to us. 

Cheung Testimony Tr. at pgs. 98-99. 

The “odd discrepancy” Suh noted should have been recognized as a critical 

development in the investigation. The Enforcement staff’s first investigative step had 

revealed that Madoff had lied about a fundamental component of his claimed trading 

activity during the recent exam. Suh testified that she was still bothered by this 

discrepancy when the investigation was closed, stating: 

Q: Okay. And this discrepancy, was that resolved by 

the end of the investigation? 

A: We did confront Madoff with the discovery during 

his testimony. He attempted to portray this as a 

misunderstanding. It did bother me. I did not think 

it was resolved. I did believe that he was not 

forthright. 

Q: So the explanation that Madoff gave in his 

testimony didn’t convince you? 

A: That’s correct. 

Suh Testimony Tr. at p. 67. See also id. at p. 223 (Suh testified, “I knew [Madoff] wasn’t 

truthful and I knew he was not giving us full information.”). 

The fact that the Enforcement staff knew or suspected that Madoff was lying 

about this and other significant issues during the investigation is discussed in more detail 

below. Cheung acknowledged that “the issue of Madoff’s honesty was relevant in terms 

of the investigation of him running a Ponzi scheme.” Cheung Testimony Tr. at p. 222. 

273 
 

 

However, it is worth noting at this juncture that, despite having caught Madoff lying 

about his trading to the examination staff early in the investigation, the Enforcement staff 

did not reassess its investigative plan or expand the investigation’s limited focus to 

include the possibility that Madoff was operating a Ponzi scheme. 

(3).	 In December 2005, Enforcement Staff Did Not 

Demonstrate an Interest in Additional Information Offered 

by Markopolos 

On December 16, 2005, Markopolos e-mailed Cheung that Michael Ocrant, the 

author of the 2001 MARHedge article, was willing to meet with the Enforcement staff 

and share his observations regarding Madoff’s operations. E-mail dated December 16, 

2005 from Markopolos to Cheung, at Exhibit 310. He also suggested that the staff 

contact John Wilke, a Senior Investigative Reporter at the Wall Street Journal who 

Markopolos said “will soon start working on this story.” Id. In addition, Markopolos 

informed Cheung that he had “compiled several pages of contact information that might 

be useful to the SEC’s investigation” and offered Cheung a “several inch thick file folder 

on Madoff that I would be happy to let you copy if the SEC has any interest.” Id. 

Cheung did not pursue Markopolos’ suggestion to talk either with Ocrant or 

Wilke and testified that Markopolos’ suggestion to do so made her “nervous” because, as 

she explained: 

A: [O]ne of the very last things that I would want to 

happen would be the beginnings of an investigation 

end up in the newspaper before we had even gotten 

anywhere on it. That’s something I was very 

sensitive to because it had happened in the past. 

Q: What would be the – why would you be concerned 

about that? 

A: One of the things that had happened that was 

happening in this time frame and a little bit before, 

there had been some number of instances that the 

staff were aware of and some that I experienced 

where short sellers or people who would use the 

news of an investigation to depress a stock price 

and that was – was something that people were 

conscious of. I had gotten – I had gotten a referral 

about accounting fraud that turned out to have come 

through short sellers. We had – somebody had – 

there had been an investigation, a very short 

investigation into cookie jar accounting at a 

company, and luckily, we closed it very quickly 

because the next – very soon afterwards there was 

274 
 

 

 

 

 

an article in the press about it. So that was certainly 

something that I was – I was thinking about and was 

worried about. 

Cheung Testimony Tr. at pgs. 34-35.192 

Cheung also declined to obtain the materials Markopolos offered. Cheung 

testified that, “If [Markopolos] offered information, I would take it. I don’t know that I 

ran him down and said ‘wait a minute, is there more stuff.’” Id. at p. 103. However, 

when Markopolos offered a list of contact names193 and a “several inch thick file folder 

on Madoff,” Cheung apparently did not accept his offer to provide those materials. On 

December 19, 2005, Cheung forwarded Markopolos’ e-mail offer to Suh without 

comment.194 E-mail dated December 16, 2005 from Markopolos to Cheung, at Exhibit 

310. Suh testified that she never saw the file (Suh Testimony Tr. at pgs. 71-72) and 

Cheung acknowledged that she “would not have [received it and not given it to Simona].” 

Cheung Testimony Tr. at pgs. 103-104. 

In her testimony, Suh offered a possible explanation for why Cheung did not 

accept Markopolos’ offer of additional information, stating: 

Q: Do you have any – do you know why it seems as 

though from the e-mails Harry Markopolos was 

kind of trying to meet with Meaghan but she didn’t 

seem interested in meeting with him? 

A: I don’t know what her reasons were. I know her 

general impression of him was – she was skeptical 

of him, but I don’t know what her reasons for not 

meeting with him were. 

192 While Cheung may have been legitimately concerned about contacting reporters, her comparison of 

Markopolos’s motives to those of “short sellers or people who would use the news of an investigation to 

depress a stock price” is misplaced. There was no stock at issue whose price could be affected by the 

SEC’s investigation. Furthermore, Markopolos himself correctly noted in his 2005 submission that he 

would not be eligible for a bounty in the event the SEC discovered Madoff was operating a Ponzi scheme, 

the scenario Markopolos described as “highly likely.” 2005 submission at p. MARK 0052, at Exhibit 268. 

193 Bergers had previously vouched for Markopolos’s credibility, telling Cheung in 2005 that Markopolos 

had “very good sources.” E-mail dated December 5, 2005 from Cheung to Bachenheimer, at Exhibit 284. 

194 Suh started to draft an e-mail response to Cheung. Suh’s draft, which was apparently never completed 

or sent, stated: 

Do you think it makes sense to agree to meet with him and to look at 

his “inch thick file folder?” I am not sure whether [sentence ends] 

Should we (and can we) do anything about the purported upcoming 

press interest? It does not sound like anything will be published very 

soon [sentence ends without punctuation]. 

Draft e-mail dated December 19, 2005 from Suh to Cheung, at Exhibit 311. 

275 
Q: In what way was she skeptical of him? 

A: ... I remember hearing that she thought he was kind 

of condescending to the SEC in terms of SEC 

expertise and knowledge ... 

Suh Testimony Tr. at p. 72. 

(4).	 In December 2005, the Enforcement Staff Interviewed an 

Executive from Fairfield and Became More Convinced that 

Madoff Had Lied to the Examination Staff 

The Enforcement staff continued executing its investigative plan of comparing 

Madoff’s representations to the examination staff with Madoff’s representations to 

Fairfield by interviewing a Fairfield officer. On December 21, 2005, Cheung, Suh, and 

Lamore interviewed Amit Vijayvergiya, then-Managing Director and Head of Risk 

Management of Fairfield. E-mail dated December 22, 2005 from Suh to Lamore, at 

Exhibit 312. In a December 22, 2005 e-mail to the OCIE Assistant Regional Director, 

Lamore referenced the fact that the interview with Vijayvergiya and Fairfield’s document 

production had revealed that Madoff had lied to the examination staff: 

I’ll be writing up my notes from the Madoff / [Fairfield] 

conference call that I participated in yesterday. Also, I’m 

going to provide the attorneys with a list of differences 

(lies) from what we were told and provided during the 

Madoff exam vs. what we learned about Madoff’s 

operation from various documents provided by [Fairfield] 

and during the conference call yesterday. 

E-mail dated December 22, 2005 from OCIE Assistant Regional Director to Lamore, at 

Exhibit 313 (emphasis added). 

Later that day, Lamore e-mailed Cheung and Suh as follows: 

276 
 

 

 

 

 

.

277 
 

 

 

 

E-mail dated December 22, 2005 from Lamore to Cheung, at Exhibit 314 (emphasis 

added). Suh responded to Lamore and Cheung as follows: 

Id. (emphasis added). Lamore’s response to Suh also indicated that he did not understand 

“the back-office operations and trade execution process questions,” and he wrote, “[I] 

will try to find out more about these areas from my colleagues in [the Broker-Dealer 

examination group].” Id. 

278 
 

 

E-mail dated December 22, 2005 from Suh to Lamore, at Exhibit 312. Suh testified that 

she “knew that ... whatever answers we were getting [from Vijayvergiya] had been 

vetted by [Madoff]” and “Madoff had prepped Vijayvergiya.” Suh Testimony Tr. at pgs. 

78, 88. 

The day after the Vijayvergiya interview, December 22, 2005, McKeefry called 

Suh and was “mostly concerned” about Madoff. E-mail dated December 22, 2005 from 

Suh to Lamore, at Exhibit 315. On the same day, Suh e-mailed Lamore a memorandum 

summarizing her call with McKeefry. Id. 

For your reading pleasure. He sounded very somber and 

concerned – and it sounded like he was mostly concerned 

about your friend Bernie. I talked to Meaghan about this, 

and, while she found this annoying, she too agreed that 

there is not much else we can do about this. 

Suh’s e-mail stated: 

Id. The memorandum attached to Suh’s e-mail stated: 

Id. 

Lamore responded on December 23, 2005, “Bernie can be very intimidating. Do 

you know what McKeefry meant when he said ‘our inquiry may have serious 

consequences for Madoff?’ If there is no problem with his activity, then why would there 

be serious consequences?” Id. Suh responded, “Well, I guess even if the fact that we are 

looking at Bernie gets out, it’s a big deal for his reputation etc. I wouldn’t worry about 

this call too much ...”195 

195 On April 1, 2009, the Massachusetts Secretary of State filed a lawsuit against Fairfield for colluding 

with Madoff to “funnel[] billions of dollars into Bernard Madoff’s Ponzi scheme.” The Massachusetts 

279 
 

 

 

On December 29, 2005, Bachenheimer e-mailed Sollazzo in reference to 

Madoff’s falsehoods, as follows: 

The Madoff investigation took an interesting turn. 

Contrary to what Madoff told our exam team, he is trading 

options for at least one hedge fund. 

E-mail dated December 29, 2005 from Bachenheimer to Sollazzo, at Exhibit 316. 

(5). In January 2006, the Enforcement Staff Reviewed 

Documents Produced by Madoff 

On December 27, 2005, Suh e-mailed Cheung and Lamore a draft voluntary 

document request to Madoff. E-mail dated December 27, 2005 from Suh to Cheung, at 

Exhibit 294. In her e-mail, Suh explained that she “picked the three customers 

specifically named in the draft – [Fairfield], Kingate and Tremont – because, according 

to the data provided by Madoff, these customers’ accounts contain approximately 88% of 

all assets managed by Madoff.” Id. (emphasis added). Suh also noted: 

[Lamore] has been analyzing the Fairfield account 

statements and has found that, in fact, the number of S&P 

100 index options traded by Madoff, purportedly over the 

counter, is an order of magnitude greater than the total 

exchange-traded volume for these options. This fact does 

not necessarily mean there is anything fishy going on, but it 

does, as [Lamore] pointed out, make it interesting to find 

out where and how these options are traded. 

Id. (emphasis in original). 

Lamore suggested that Suh also request, inter alia, (1) “[c]opies of the OTC 

Option Agreements with counterparties,” and (2) “a written explanation of the entire 

trading process (including the clearing and settlement of securities and funds).” E-mail 

dated December 27, 2005 from Suh to Cheung, at Exhibit 294. Suh revised the document 

request incorporating Lamore’s comments, and forwarded it to Cheung that same day. 

Id. 

lawsuit referenced a transcript of a phone call between Madoff, Vijayvergiya, and McKeefry during which 

Madoff coached Vijayvergiya for his upcoming SEC telephone interview. See Svea Herbst-Baylis, 

“Massachusetts regulator sues Madoff feeder fund,” Reuters, April 1, 2009, at Exhibit 317. 

While the SEC did not have that transcript during the 2006 investigation, Suh’s memoranda 

regarding the December 21, 2005 interview of Vijayvergiya and her December 22, 2005 call with 

McKeefry show that the Enforcement staff was fully aware in 2005 that Fairfield was “cooperating with 

Madoff” in connection with the 2006 investigation and that, as Suh testified, “Madoff had prepped 

Vijayvergiya.” E-mail dated December 22, 2005 from Suh to Lamore, at Exhibit 315; Suh Testimony Tr. 

at p. 88. 

280 
 

 

On December 28, 2005, Lamore e-mailed Suh additional comments regarding the 

document request, stating: 

I’m not certain how to phrase it, but I suggest that we ask 

[Madoff] directly about the money and securities issue. 

That is, are the securities and money held at BLM or Citco? 

We need to know the answer to this question to alleviate 

our major concern. 

Id.196 Suh forwarded Lamore’s e-mail to Cheung. Id. Cheung testified regarding the 

“major concern” referenced by Lamore, as follows: 

A: Well, I think that is the concern about whether or 

not it was a Ponzi scheme, you know, so that we 

could see where the securities and money – I think 

that was something that would factor into the 

securities – where the securities were held and who 

had custody. 

... 

Q: And so did you know that if you got information 

responsive that alleviated that major concern? 

A: I don’t remember now. 

Cheung Testimony Tr. at pgs. 137-138. 

After Suh and Cheung agreed to “add a request for documents sufficient to 

identify all persons who had custody of the assets in ... all accounts covered by the 

request,” Lamore responded as follows: 

Sounds good. I’d sleep better with the answer to this 

question. 

On a side note, if Bernie calls me regarding the request list, 

I don’t intend to speak to him about it. I’ll refer him to 

you. 

E-mail dated December 27, 2005 from Suh to Cheung, at Exhibit 294. Suh responded to 

Lamore’s “side note” as follows: 

196 Citco Fund Services B.V. (part of The Citco Group of Companies) was the fund administrator for some 

of the Fairfield’s hedge funds. See E-mail dated December 13, 2005 from Suh to Lamore, at Exhibit 308. 

281 
 

 

 

 

 

 

I agree – at this point, he should deal with Enforcement 

(especially since, technically, you could be a witness to his 

lying – whatever we end [sic] making of it in the end). 

Id. (emphasis added). 

After learning that Madoff was trading options for his investors, Bachenheimer 

asked Sollazzo to have someone “particularly knowledgeable about options trading” 

assigned to the Madoff investigation, but Sollazzo offered no additional support. E-mail 

dated December 29, 2005 from Bachenheimer to Sollazzo, at Exhibit 316. Bachenheimer 

e-mailed Sollazzo on December 29, 2005 as follows: 

Contrary to what Madoff told our exam team, he is trading 

options for at least one hedge fund. Peter is looking at the 

trading records for us (he’s been very helpful) but I was 

wondering if you can direct us to someone in the office 

who is particularly knowledgeable about options trading. 

Thanks. 

Id. Sollazzo responded: 

Peter is one of our most knowledgeable staffers in respect 

to trading practices. We don’t have anyone in the [BrokerDealer group] who is particularly knowledgeable in options 

trading. I would think that Peter should be able to work 

through and understand much of the activity. 

Id.197 

197 After receiving Sollazzo’s e-mail, Bachenheimer e-mailed Cheung and Suh on December 29, 2005, and 

suggested contacting the Office of Economic Analysis (OEA) for assistance: 

When [Lamore] has finished his review of the trading, let’s 

call Bill Dale in OEA – he may be able to give us general 

advice and he may also be able to help us find something 

by analyzing the trading. 

E-mail dated December 29, 2005 from Bachenheimer to Sollazzo, at Exhibit 316. 

However, while Bachenheimer’s very suggestion to contact OEA was prompted by her 

recognition that Lamore and Suh lacked the requisite knowledge about options trading, apparently no one 

gave Lamore or Suh any guidance regarding what questions to ask OEA. E-mail dated January 13, 2006 

from Suh to Lamore, at Exhibit 322. On January 13, 2006, Suh e-mailed Lamore: 

Doria has suggested that we talk to somebody in the Office of 

Economic Analysis about Bernie’s trading. To be honest, I am not 

entirely sure what questions we would want to ask them – so if you 

have any thoughts on what they can do for us, let me know. 

Id. 

282 
 

 

 

 

On December 29, 2005, the Enforcement staff faxed a voluntary request to 

Bernard L. Madoff Investment Securities LLC (BMIS) for certain documents related to 

three of BMIS’s hedge fund clients – Fairfield, Kingate, and Tremont – and for any other 

accounts that “were traded ... pursuant to the [split strike conversion strategy].” 

Document Request dated December 29, 2005 from Suh to BLM, at Exhibit 318. 

Specifically, the staff requested, inter alia, account opening documents, trading 

authorizations, account statements, trade confirmations, trade tickets, agreements 

(including options agreements), correspondence, audio records of telephone 

conversations, and documents sufficient to identify all persons who had custody of the 

assets in the accounts identified in response to the request.198 Id. 

That same day, Madoff called Suh to discuss the request. E-mail dated December 

29, 2005 from Suh to Cheung, at Exhibit 319. Suh summarized the call for Lamore and 

Cheung in an e-mail as follows: 

Bernie Madoff called me back to speak about the faxed 

request. Surprisingly to me, he was very friendly and 

cooperative. He did, of course, try the usual “what is this 

all about” question – to which I gave the usual “non-public 

inquiry/can’t tell you more than what’s in the document 

request” answer. (He also mentioned that he knows that we 

spoke to Fairfield and that they also could not say what this 

is all about.) ... 

Id. Suh testified that she had been surprised that Madoff was “very friendly and 

cooperative” “[b]ecause of [Lamore’s] experiences that it was very hard to get anything 

out of him and because of the impression of him that [Lamore] conveyed to me.” Suh 

Testimony Tr. at p. 106. 

Although Suh noted Madoff had been friendly and cooperative in the previous 

communication, she also expressed frustration in her December 29, 2005 e-mail that 

Madoff did not have counsel, “Ugh ... I wish he’d just get a lawyer – but he did make it 

sound as though he was planning to handle the whole thing himself. Bad idea for him 

and a lot more hassle for us.” E-mail dated December 29, 2005 from Suh to Cheung, at 

Exhibit 319. Lamore responded, “Yes. He will handle EVERYTHING himself – which 

always seemed strange to us.” Id. (emphasis in original). 

Suh contacted OEA in February 2006 and provided certain documents for OEA to analyze. Email dated February 6, 2006 from Suh to Anthony, at Exhibit 335. As discussed below, after not receiving 

a response for two months, Suh followed up with OEA, but did not obtain any helpful information or 

analysis.

198 On the same day that Suh sent Madoff the request for documents, Suh predicted, “I don’t think we can 

expect to be done with this case at least for another 2-3 months, even though I do not think that it will 

require 100% of our time.” E-mail dated December 29, 2005 from Suh to Cheung, at Exhibit 319. 

283 
 

 

Lamore subsequently related the following experience with Madoff during the 

2005 NERO examination: 

E-mail dated January 27, 2006 from Lamore to Suh, at Exhibit 301. Suh responded to 

Lamore’s anecdote, “Ugh... what a pain he is.” Id. While Suh expressed annoyance at 

Madoff’s behavior, she did not seem to appreciate that his behavior may also have been 

suspicious. 

(6).	 The Enforcement Staff Was Not Suspicious When Madoff 

Did Not Produce Documents Related to His Claimed OTC 

Options Contracts 

On January 13, 2006, the Enforcement staff received Madoff’s document 

production from the December 29, 2005 voluntary request. Letter dated January 13, 2006 

from Madoff to Suh, at Exhibit 320. The production included documents related to 

seventeen clients with twenty corresponding account numbers and a description of the 

split-strike conversion strategy. Suh Production Log, at Exhibit 321. Perhaps the most 

notable aspect of Madoff’s document production to the Enforcement staff was what it did 

not include – OTC options contracts. As she reviewed Madoff’s production, Suh 

prepared notes itemizing what Madoff had produced in response to the Enforcement 

staff’s specific requests. Id. Regarding request 1(f) – “[a]ll documents concerning 

trading activity in all accounts of [Fairfield] at [Bernard L. Madoff] BLM ... including ... 

agreements (including options agreements)” – Suh noted: 

[Madoff’s] Cover letter refers to documents responsive to 

1(a) and 1(b)199 

199 Requests 1(a) and 1(b) asked for “account opening documents” and “trading authorizations.” 

Document Request dated December 29, 2005 from Suh to BLM, at Exhibit 318. 

284 
1/23/06 call to BMadoff: BMadoff says BLM has no 

documentation of option contracts other than what was 

produced; e.g., no written contract between purchaser and 

counter-party. 

Id. (emphasis added.) 

However, the Enforcement staff was not suspicious of Madoff’s claim to have had 

billions of dollars invested in undocumented OTC options contracts. Suh testified: 

Q: But do you remember a specific request about the 

options agreements – 

A: Yes. 

Q: – as part of the overall request? 

A: Right. And I definitely know that there was a 

request for options agreements and that what he 

produced he claimed that that was all he has. 

Q: Okay. So he, literally, claimed he didn’t have 

copies of the master derivatives contracts that he 

was trading with these counterparties on? 

A: I think he said he has electronic versions and he did 

not produce them. So I actually do think that I 

probably – I mean I overlooked that. 

Q: Was there any – do you recall any discussion on 

whether to push him on that or – 

A: No, I don’t think that was discussed. 

Suh Testimony Tr. at p. 149. As Markopolos noted in the 2005 submission, “[e]xtensive 

and voluminous paperwork would be required to keep track of and clear each OTC 

trade.” 2005 submission at p. MARK 0056, at Exhibit 268. 

After her initial review of the documents, Suh e-mailed Lamore as follows: 

[I]t looks like [Madoff] is telling us now that he is, in fact, 

trading options. The write-ups on the strategy and the list 

of customers look very similar to the ones he gave you, but 

I need to take a closer look at them to know for sure if there 

are any discrepancies. What’s annoying is that he clearly 

created special write-ups in response to our request, instead 

285 
 

 

of producing existing documents. The write-ups are 

helpful, but he should also be producing everything 

existing ... Oh well – we’ll see if we need to pursue this 

issue. 

... . 

[C]ould you go over your notes from the exam and find 

places where you made you made notes of conversations 

about Bernie no longer trading options? ... [W]e just want 

to nail this down as specifically as we can at some point 

before we talk to Bernie himself. 

E-mail dated January 13, 2006 from Suh to Lamore, at Exhibit 322. Suh testified that “at 

this point” in the investigation she believed “that [Madoff] had lied to Lamore [during the 

exam].” Suh Testimony Tr. at p. 112. 

On January 19, 2006, Suh e-mailed Lamore as follows: 

... I have been having trouble figuring out how to tell from 

the produced account statements the balances of assets 

managed for each customer ... If you can take a look at the 

statements and try to figure out what these different 

numbers mean, that would be very helpful. 

E-mail dated January 19, 2006 from Suh to Lamore, at Exhibit 323. Lamore responded 

to Suh on January 20, 2006: 

Unfortunately, after reviewing the accounts and speaking 

with my supervisor, I don’t have clean answers to your 

questions. However, I do believe your questions go back to 

the custody of assets issue. Where are the assets held and 

how does [Bernard L. Madoff] BLM settle the trades 

(wiring instructions ...). 

Id. Suh responded: “Thank you – I am glad I am not the only one confused. :-)” Id. 

Lamore then responded: “Ha. No problem. It’s very confusing to me as well.” Id. The 

Enforcement staff’s confusion about Madoff’s operations generally, and the custody of 

assets specifically, adversely impacted the investigation until it was closed. 

(7). The MUI Was Converted to an Informal Investigation in 

January 2006 

At approximately the same time that Suh and Lamore were discussing their 

confusion about “the custody of assets issue,” Suh drafted a summary of the matter in 

286 
 

 

order to convert the MUI to an informal investigation.200 E-mail dated January 23, 2006 

from Suh to Amy Lam, at Exhibit 324. Suh described the investigation’s status as of 

January 23, 2006 as follows: 

The staff received a complaint alleging that Bernard L. 

Madoff Investment Securities LLC, a registered brokerdealer in New York (“BLM”), operates an undisclosed 

multi-billion dollar investment advisory business, and that 

BLM operates this business as a Ponzi scheme. The 

complaint did not contain specific facts about the alleged 

Ponzi scheme, and the complainant was neither a BLM 

insider nor an aggrieved investor. Nevertheless, because of 

the substantial amounts at issue, the staff, in the abundance 

of caution, requested voluntary production of certain 

documents from BLM and two of its hedge fund customers 

... . 

The staff found, first, that neither BLM nor [the hedge 

funds] disclose to investors that the investment decisions 

for [the hedge funds] are made by BLM ... and that, in 

substance, BLM acts as an undisclosed investment adviser 

to [the hedge funds]. 

Second, the staff found that, during an SEC examination of 

BLM that was conducted earlier this year, BLM – and more 

specifically, its principal Bernard L. Madoff, – mislead 

[sic] the examination staff about the nature of the strategy 

implemented ... and also withheld from the examination 

staff information about certain of these customers’ accounts 

at BLM ... . 

The staff is now seeking additional evidence, in the form of 

documents and witness testimony from BLM and its hedge 

fund customers, on the issues of BLM’s role in those hedge 

funds’ investment activities and the adequacy of related 

disclosures. Additionally, the staff is trying to ascertain 

whether the complainant’s allegation that BLM is operating 

a Ponzi scheme has any factual basis. 

Id. 

200 According to the 2008 Enforcement Manual, “The evaluation for whether to convert a MUI to an 

investigation...turns on whether, and to what extent, the investigation has the potential to address violative 

conduct.” 2008 SEC Enforcement Manual, at pgs. 16-17, at Exhibit 296. Converting a MUI to an 

investigation requires the assigned staff attorney to, among other things: (1) consult with the Associate 

Director assigned to the matter; and (2) fill out an investigation opening form and forward it, along with an 

Opening Narrative Form, to the Associate Director for approval. Id. at p. 19. 

287 
 

 

 

It is noteworthy that, on the one hand, Suh’s narrative describes the investigation 

as taking seriously the allegation that Madoff was “operat[ing] an undisclosed multibillion dollar investment advisory business,” stating: 

The staff found, first, that neither BLM nor [the hedge 

funds] disclose to investors that the investment decisions 

for [the hedge funds] are made by BLM ... and that, in 

substance, BLM acts as an undisclosed investment adviser 

to [the hedge funds]. 

Id. (emphasis added). On the other hand, the narrative expresses skepticism about the 

allegation that Madoff was operating a Ponzi scheme as follows: 

The complaint did not contain specific facts about the 

alleged Ponzi scheme, and the complainant was neither a 

BLM insider nor an aggrieved investor. Nevertheless, 

because of the substantial amounts at issue, the staff, in the 

abundance of caution, requested voluntary production of 

certain documents from BLM and two of its hedge fund 

customers.... 

Id. 

Suh acknowledged in her testimony that she “could see how one reading [the case 

narrative]” could think “there was some skepticism of [the Ponzi scheme allegations].” 

Suh Testimony Tr. at p. 121. Suh also acknowledged that “Markopolos’s complaint 

contained a lot of detailed facts,” contrary to the statement in the case narrative stating 

that, “[t]he complaint did not contain specific facts about the alleged Ponzi scheme.” Id. 

at p. 118; January 4, 2006 Case Opening Report for NY-07563, at Exhibit 325. In sum, 

Suh’s January 24, 2006 case narrative further demonstrates that the Enforcement staff 

was more focused on determining whether Madoff should be registered as an investment 

adviser than in pursuing the evidence that he was operating a Ponzi scheme. 

The Enforcement staff’s interest in the registration issue also is evidenced in the 

following January 25, 2006 e-mail in which Suh asked Lamore: 

When you have time, could you check if we have 

information on commission rates that BLM charges other, 

non-[Investment Adviser] IA customers? Are the rates as 

uniform as in the IA business – same rate for everybody? 

Are they lower, higher than the IA business rates? (No 

rush – we don't need to know this before the testimony 

tomorrow; my thought was that if the other customers’ 

288 
 

 

 

 

rates are markedly lower, we could say that the increment 

is a hidden advisory fee ... .).201 

E-mail dated January 25, 2006 from Suh to Lamore, at Exhibit 326. Lamore responded 

to this e-mail as follows: 

Good thought, but BLM’s market-making (Non-IA 

business) is different. Non-IA BLM customers are not 

charged any commissions. The firm makes money by 

making a market (the spread between the bid and offer – 

buys at the bid and sells at the offer). 

Id. Suh responded, “Shows how much I know about the business ... Thanks!” Id. 

Lamore then e-mailed Suh, “It’s no reflection on you – don’t feel bad. Until I conducted 

Id. 

the [Madoff] exam, I also thought that they received commissions from [market making]. 

In her testimony, Suh explained why she had raised the issue of Madoff’s 

commissions: 

I think the reason I asked this particular question was, the 

Fairfield Testified in January 2006, Raising More 

Questions That Were Never Resolved 

question on our radar was is this an advisory business and 

so one indicator could have been that he’s charging more 

than he would charge for just execution services. 

Suh Testimony Tr. at p. 122. After approximately two months of investigating Madoff, 

the Enforcement staff was predominantly pursuing the issue of whether Madoff should 

register as an investment adviser instead of conducting a Ponzi scheme investigation. 

(8). Madoff’s “Right-Hand Man” and a Founding Partner of 

201 As discussed in an April 10, 2006 memorandum that Suh prepared for the SEC’s Division of 

Investment Management (IM) in order for IM to opine on whether Madoff should have registered as an 

investment adviser, the nature of Madoff’s compensation was relevant for whether he was eligible for the 

broker-dealer exemption from the registration requirement. E-mail dated April 10, 2006 from Suh to 

Chretien-Dar, at Exhibit 344. 

289 
 

 

 

 

 

 

 

 

 

 

Id. 

The day after DiPascali’s testimony, Lamore e-mailed Suh some “rambling 

thoughts regarding Madoff:” 

I meant to ask Frank [DiPascali] why the strategy is 

implemented only in Europe and during European trading 

hours and not New York time? What if there is breaking 

news having a huge impact on the market such as 9/11? 

... . 

I am still puzzled that Bernie is able to always ... find 

counterparties willing to trade options in the size that he 

202 On August 11, 2009, the U.S. Attorney for the Southern District of New York filed a criminal 

information charging, inter alia, that DiPascali conspired with Madoff and others to mislead and deceive 

the Enforcement staff regarding Madoff’s “relationship with the hedge fund industry.” U.S. v. Frank 

DiPascali, Jr., No. 09 Cr. 764 (RJS) (S.D.N.Y. filed August 11, 2009) at ¶ 27, at Exhibit 329. With respect 

to the Enforcement staff’s Madoff investigation, the charges against DiPascali are, in total, that he 

“oversaw the production by other co-conspirators of false trade blotters in anticipation of inquiries from the 

SEC” and lied in his SEC testimony “about the [split-strike conversion] strategy, the purported trades that 

resulted from the execution of that strategy, and the size of the IA business.” Id. at ¶¶ 27-28. 

Also on August 11, 2009, the SEC filed a civil complaint in the U.S. District Court for the 

Southern District of New York against DiPascali asserting claims based on his role in Madoff’s fraud. 

With respect to the Enforcement staff’s Madoff investigation, the SEC alleges that DiPascali “gave 

testimony that was fraught with false and misleading statements. He lied about the number of client 

accounts and about the extent of assets under management. He also testified that the trading was real and 

that he personally received and reviewed trade confirmations for the options trades, none of which was 

true.” SEC v. Frank DiPascali, Jr., No. 09 Civ. 7085 (LLS) (S.D.N.Y. filed August 11, 2009) at ¶ 61(f), at 

Exhibit 119. 

As Branch Chief Caverly observed, “clearly if someone ... has a Ponzi and they’re stealing 

money, they’re not going to hesitate to lie or create records. ... And the only way to verify [whether the 

alleged Ponzi operator is actually trading] would be to – you know, some third party, some independent 

third party verification.” Caverly Testimony Tr. at pgs. 36-37. 

290 
 

 

 

 

 

 

 

 

needs to for the strategy without freaking out the market. 

Talk about having difficulty finding liquidity – try calling a 

large broker-dealer in the U.S. with such a huge options 

order. I am confident that you would move (scare) the 

market. Maybe the counterparties are able to hedge 

themselves somehow, but I don’t see how. 

E-mail dated January 27, 2006 from Lamore to Suh, at Exhibit 301. Later in the day, 

Lamore was still puzzled by Madoff’s claimed OTC option counterparties: 

Options issue – I don’t know what I’m thinking, but it 

seems ... weird to me that the counterparties aren’t the [big 

investment banks] (Goldman, Merrill, Lehman ...)[.] 

Instead, they are smaller/more obscure investment banks. 

Id. 

203 

Suh responded to some of Lamore’s concerns as follows: 

Excellent points. We can pursue them with Bernie, when 

we take his testimony. 

... 

On the options trading issue, we probably will not be able 

to get any help from the dealers, since they are all overseas. 

... 

203 Other issues that puzzled Lamore included: 

The [Wall Street] Journal’s latest update on the state of the Madoff 

investigation added another name to the FBI’s list of persons of 

interest: Joann “Jodi” Crupi. Like Frank DiPascali, Crupi, it appears, 

also had a hand in the creation of client reports, which were utterly 

fictitious. 

Joe Wiesenthal, Why Did Madoff’s Assistant Have Two Nevada LLCs?, The Business Insider, January 24, 

2009, at p. 1, at Exhibit 330 (citing Kara Scannell and Amir Efrati, Probers Work Backward on Madoff –­

Chief’s Alleged Confession Forces Investigators to Go From Top Down, The Wall Street Journal, January 

23, 2009, at p. 1, at Exhibit 331 (“Ms. Crupi and a more senior employee, Frank DiPascali, were part of a 

group that dealt with clients who deposited and redeemed funds from the firm. ... The group also helped 

generate monthly and quarterly client statements that are now believed to be fraudulent.”)). 

291 
On the momentum tools issue, if we had any real 

(emphasis in original) reason to suspect some kind of 

wrongdoing in Bernie’s market timing decisions, I would 

send a document request on the issue, but I am not sure 

how much stress we want to put on him if all we suspect is 

disclosure problems (emphasis added). I will talk to 

Meaghan about it. We can definitely question him about it. 

Id. When asked whether she had understood Lamore’s puzzlement “that Bernie is able to 

always find counterparties willing to trade options in the size that he needs to for the 

strategy,” Suh testified: 

A: ... I think now I have greater reaction to it in terms 

of what it means as a suspicious – as a reason to be 

suspicious than I did then. I understood what he 

was saying. I did think that the only way to really 

dispel or answer that question would be to get the 

independent verification. 

Q: Right. So is it fair to say you never got to the 

bottom of this point? 

A: Yes. 

Suh Testimony Tr. at pgs. 129-130. 

When asked what she meant by “how much stress we want to put on [Madoff],” 

Suh testified: 

Well, I think – in retrospect, that’s certainly not the best 

way to describe the situation. At that time I think the view 

was that there's probably nothing there and that this would 

be primarily a registration and disclosure case. 

Id. at p. 130 (emphasis added). In the following exchange in testimony, Suh discussed 

her view that she had no “real reason to suspect” Madoff: 

Q: You find out that he was lying to the examiners 

about the options issue, for example. The secrecy. 

You hadn’t gotten to a point where you talked to 

Bernie, so he hadn’t allayed your concerns. You 

hadn’t gotten to a point where you talked to NASD 

and CBOE and try to make those efforts, DTC, et 

cetera. And yet is seems, based on what you have 

so far, is you don’t think there’s much – you know, 

I – “if we had any real reason to suspect some kind 

292 
 

 

 

 

of wrongdoing.” It seems as though you don’t think 

there’s much chance of actual wrongdoing. And 

that’s what I don’t understand, how at that point in 

time, given the red flags, given that some of these 

red flags were validated, before you talk to Bernie 

even for him to explain it, how is it that you didn’t 

feel there was likely [any] chance of wrongdoing? 

A: I don’t remember why I wrote what I wrote, but I do 

know that we did not stop at this point and we kept 

going and we did take his testimony and we 

continued the investigation. So whatever – it’s 

possible that there was skepticism that I was 

perceiving about the allegations and it did seem that 

ultimately it was unlikely that it was a Ponzi, but we 

did continue. 

Q: Did you think some of that skepticism was, you 

know, from above you? 

A: Well, I do know that at least Meaghan did not think 

that this was likely to lead to an enforcement action 

or this was likely to lead to anything. 

Q: Through the entire investigation? 

A: Unfortunately, I can’t time it very precisely. I know 

that was definitely her view by the time of Bernard 

Madoff’s testimony. 

Q: But it may have been earlier? 

A: It may have been earlier. 

Id. at pgs. 131-32. 

On January 30, 2006, the Enforcement staff took the testimony of Jeffrey Tucker, 

a founding partner of Fairfield. During testimony, the Enforcement staff focused 

primarily on Madoff’s trading authority and commissions with respect to Fairfield 

accounts,204 and on Fairfield’s own disclosures.205 

204 As discussed below, these issues were relevant for whether Madoff was eligible for the broker-dealer 

exemption from the registration requirement. 

205 Tucker Testimony Tr. at p. 43 (limits on trading created by Madoff); pgs. 44-45 (terms and conditions 

for options trading); pgs. 45-46 (determination of commission rate); pgs. 46-50 (comparison of Madoff’s 

rates to those of other managers); pgs. 63-64 (preparation of Fairfield offering materials); pgs. 68-72 

(modification of Fairfield offering material description of Madoff’s role); pgs. 73-76 (description of 

Madoff’s role and strategy to new investors); pgs. 78-80 (disclosures to prospective investors regarding 

293 
 

 

 

(9). In February 2006, Madoff Produced Documents Identifying 

Clearing Entities and Counterparties for His Purported 

Equities and Options Trades 

On February 10, 2006, Suh sent a second voluntary request to BMIS [or BLM] for 

the following documents: 

1. Documents sufficient to identify all accounts 

through which BLM executed, cleared or settled 

any trades, including any option trades, for BLM 

Institutional Trading Accounts [defined as all 

accounts originally identified in response to NERO 

staff’s December 29, 2005 voluntary document 

request, including those of [Fairfield], Kingate, and 

Tremont – and any other accounts traded pursuant 

to the split-strike conversion strategy ] during the 

Relevant Period [defined as January 1, 2005 

through the date of the request]. 

... 

2. Documents sufficient to identify all brokers or 

dealers through which BLM executed any trades, 

including any option trades, for BLM Institutional 

Trading Accounts during the Relevant Period. 

Voluntary Document Request dated February 10, 2006 from Suh to BLM, at p. SUHS 

011807, at Exhibit 333. In response to this request, Madoff produced a six-page list of 

entities on February 23, 2006. Letter dated February 23, 2006 from Madoff to Suh, at 

Exhibit 334. Madoff listed the following four entities as ones through which BMIS 

purportedly executed, cleared or settled trades for the Institutional Trading Accounts: 

•		 BLM itself; 

•		 DTCC; 

•		 the Bank of New York; and 

•		 Barclays Capital of London. 

Id.206 

Madoff’s role and strategy); pgs. 81-87 (sentence by sentence analysis of accuracy of Fairfield offering 

materials); and pgs. 88-99 (removal of explicit references to Madoff in Fairfield offering materials), at 

Exhibit 332. 

206 During testimony, Madoff explained to the Enforcement staff the purported roles of each entity. With 

respect to BMIS, Madoff stated, “That’s the account that the executions go through for the clients.” 

Madoff May 19, 2006 Testimony Tr. at p. 87, at Exhibit 267. Madoff claimed that DTCC was “the general 

294 
 

 

 

 

 

Madoff’s response also listed forty-two overseas broker-dealers through which 

BMIS purportedly executed equity transactions for the Institutional Trading Accounts. 

Id. Thirty-six of these broker-dealers were in the United Kingdom; two were in Ireland; 

and one each in Belgium, Germany, the Netherlands, and Spain. Id. 

Finally, Madoff’s response listed twelve overseas entities through which BMIS 

purportedly executed options trades for the Institutional Trading Accounts. Id. These 

entities included UBS in Switzerland, the Royal Bank of Scotland (RBS), and the Bank 

of Bermuda in London. Id. The other nine entities were located in Germany (4), 

Switzerland (1), Austria (1), France (1), the Netherlands (1), and Spain (1). Id. 

(10). In February 2006 and April 2006, Enforcement Staff 

Sought Assistance from the Office of Economic Analysis 

(OEA) 

On February 6, 2006, Suh contacted William (Bill) Dale, OEA’s Enforcement 

Liaison, regarding the 2006 investigation. E-mail dated February 6, 2006 from Suh to 

Anthony, at Exhibit 335. Suh contacted OEA at Bachenheimer’s suggestion in the 

following e-mail: 

When [Lamore] has finished his review of the trading, let’s 

call Bill Dale in OEA – he may be able to give us general 

advice and he may also be able to help us find something 

by analyzing the trading. 

E-mail dated December 29, 2005 from Bachenheimer to Sollazzo, at Exhibit 316. 

However, apparently no one gave Lamore or Suh any guidance regarding what 

questions to pose to OEA. E-mail dated January 13, 2006 from Suh to Lamore, at 

Exhibit 322. Two weeks after Bachenheimer suggested that OEA might “be able to give 

us general advice and ... help us find something by analyzing the trading,” Suh e-mailed 

Lamore: 

Doria has suggested that we talk to somebody in the Office 

of Economic Analysis about Bernie’s trading. To be 

honest, I am not entirely sure what questions we would 

want to ask them – so if you have any thoughts on what 

they can do for us, let me know. 

Id. 

clearance account for the firm that handles all the settlements of transactions for the firm.” Id. Madoff 

testified further that his Bank of New York account “work[ed] in conjunction with DTC” and that it was “a 

settlement account, where we settle our trades....” Id. at p. 89. Finally, Madoff described the function of 

his Barclays account as “clear[ing] and sell[ing] trades for Madoff London....” Id. at p. 90. 

295 
On February 6, 2006, after speaking with Dale and Vance Anthony, a Financial 

Economist in OEA, Suh e-mailed Anthony: 

As we discussed earlier today, attached are the 2004-2005 

account statements for the four accounts of Fairfield Sentry 

Limited, a hedge fund, at Bernard L. Madoff Investment 

Securities LLC (“BLM”), a registered broker-dealer in New 

York. The first two accounts, 1FN012 and 1FN045, are 

equities trading accounts; the other two accounts, 1FN069 

and 1FN070, are options trading accounts. We would like 

to confirm, on a sample basis, that the trading reflected in 

these account statements generates the returns that Fairfield 

Sentry reports to its investors. 

Fairfield Sentry allocates at least 95% of its assets to the 

trading accounts at BLM. In these accounts, BLM executes 

a trading strategy known as split strike conversion. An 

“independent fraud investigator” contacted our office in 

November, claiming that Fairfield Sentry’s reported returns 

were too good to be true and could not have been generated 

by this strategy. Similar allegations had also been made in 

the financial press – specifically, in an article in Barron’s 

in 2001, which is attached. Although neither the 

“informant” nor the Barron’s article provided any specific 

evidence of fraud, due to the high amounts at issue, we 

undertook a preliminary inquiry into BLM. As a result, we 

discovered that BLM’s principal, Bernard Madoff, mislead 

[sic] NERO examination staff earlier this year about the 

nature of his trading strategy. Specifically, he told the 

examination staff that BLM no longer traded options as 

part of the strategy. The attached account statements show 

that that is not the case. Additionally, Madoff did not 

disclose to the examination staff some of the accounts in 

which he implemented this trading strategy. Because of 

these misrepresentations, and also because of the high 

amounts at issue, we would like to obtain some 

independent verification of the reported returns. 

In addition to the account statements and the Barron’s 

article, I am attaching to this e-mail Fairfield Sentry’s 

reports on returns generated during the first half of 2005, 

the most recent time period for which we have complete 

data. 

We would greatly appreciate an opportunity to discuss with 

you and/or your colleagues what calculations, if any, from 

296 
 

 

 

the data in the account statements can help advance our 

inquiry. 

E-mail dated February 6, 2006 from Suh to Anthony, at Exhibit 335.207 On February 8, 

2006, Suh spoke to Dale and Anthony at length “to discuss ... what calculations, if any, 

from the data in the account statements can help advance [the Enforcement staff’s] 

inquiry.” See E-mail dated February 6, 2006 from Suh to Anthony, at Exhibit 335; 

February 8, 2006 and May 3, 2006 notes typed by Vance Anthony of phone calls with 

Suh, Cheung and Lamore (Anthony Notes), at Exhibit 336; Anthony Testimony Tr. at p. 

15. However, Anthony never reviewed the statements he received from Suh. Id. at pgs. 

16-17. 

After not hearing back from OEA for two months, Suh e-mailed Anthony on 

April 12, 2006, asking for a status report: 

Van, Meaghan Cheung, Peter Lamore and I spoke to you 

and Bill Dale about this case in February. Have you had a 

chance to take a closer look at it? Thank you and best 

regards. 

E-mail dated April 12, 2006 from Suh to Anthony, at Exhibit 337. 

Anthony called Suh in late April 2006, in response to her e-mail. E-mail dated 

April 28, 2006 from Suh to Lamore, at Exhibit 338. Suh summarized the call for 

Lamore, “OEA finally responded that they want to talk next week. Are you available? ... 

From talking to Van Anthony last week, my impression is that they have not done any 

analysis yet, but have only found us an expert on options trading, Stuart [sic] Mayhew.” 

Id. Lamore replied: “OK, hilarious. I wonder where they had to go to find this ‘options 

expert’ since it took them 3+ months? :-)” Id. Suh replied: “I suspect that they had to 

go to the office next door. ...” Id. 

On May 3, 2006, Suh, Cheung and Lamore held a conference call with Dale and 

Anthony. E-mail dated April 28, 2006 from Suh to Anthony, at Exhibit 339. During this 

call, the Enforcement staff told OEA they thought Madoff was “running $9 billion to $15 

billion” for his investors using the split-strike conversion strategy. Anthony Notes, at 

Exhibit 336.208 On May 4, 2006, Suh responded by e-mail to certain questions OEA 

raised on the call and attached additional documents, stating: 

Thank you for speaking with us yesterday about Madoff. 

Unfortunately, we do not have the actual options contracts 

and thus cannot determine the settlement terms or the 

207 The Enforcement staff never sent OEA a copy of Markopolos’ 2005 submission. Suh Testimony Tr. at 

p. 139. 208 Anthony’s notes indicate that on the February 8, 2006 call, the Enforcement staff had indicated that 

Madoff had “about $15 billion under management.” Anthony Notes, at Exhibit 336. 

297 
 

 

options type.209 (Bernie Madoff has represented to us that 

he does not have any such contracts.) We will get back to 

you shortly with a list of dates on which Madoff executed 

the strategy in 2004-2005. 

Attached are several descriptions of the strategy and the 

trade execution process that Madoff produced to us. Also 

attached are the two key contracts between Madoff and its 

institutional customers, the trading authorization directive 

covering the equities trading and the terms and conditions 

for the options trading. These two documents are standard 

for all Madoff customers in the institutional trading 

program. 

E-mail dated May 4, 2006 from Suh to Anthony, at Exhibit 342. Dale responded to Suh 

on May 4, 2006 as follows: “Simona – Thanks very much for getting back to us. We’ll 

see what we can tell from this.” E-mail dated May 4, 2006 from Suh to Anthony, at 

Exhibit 342. 

On May 9, 2006, Suh sent OEA additional information and stated: 

Following up on our discussion last week, attached is a 

spreadsheet that Peter Lamore prepared based on the 

account statements Madoff provided to Fairfield Sentry 

Limited (FSL). The spreadsheet indicates the dates when 

Madoff purchased and sold equities and options for the 

split strike conversion strategy as well as movements in 

[the] S&P100 on those days. Also attached are FSL’s 

monthly strategy reviews, which contain narratives 

describing the trading for each month. 

E-mail dated May 9, 2006 from Suh to Anthony, at Exhibit 341. 

Anthony testified that he never performed the analysis the Enforcement staff 

requested: 

Q: Okay. But do you remember whether there was 

some independent verification [of reported returns] 

that was done by your office? 

209 Although Madoff never produced “the actual options contracts” to the Enforcement staff, the Fairfield 

statements that Suh had sent Anthony on February 6, 2006, contained the information regarding settlement 

terms that OEA was apparently requesting, See, e.g., Account statement January 2004 for Fairfield Sentry 

account 1FN069, at Exhibit 340. However, Anthony never reviewed the statements he received from Suh. 

Anthony Testimony Tr. at pgs. 16-17. 

298 
A: I did not. I can tell you that I did not do any 

verification. 

... 

Q: Okay. Do you remember whether you reviewed 

these attachments that Ms. Suh sent [with the 

February 6, 2006 e-mail]? 

A: I did not. I know I – I’m sure that I clicked on them 

to look and see – saw what they were, but I didn’t 

do anything else. Didn’t input them into any, you 

know, there are no [Statistical Analysis Software] 

programs in my Madoff file, so I did not analyze 

them in any way, no Excel files used to analyze 

them. 

Q: Okay. So you recall there was [sic] these 

communications but you don’t remember what 

happened after that? 

A: It’s not so much [I] don’t remember what happened 

after [that], I don’t think I did anything after that. 

Anthony Testimony Tr. at pgs. 16-17. Anthony testified that he believed “Bill Dale had 

the lead on this” and that he did not “know whether Bill gave [the Madoff matter] to 

someone else.” Id. at p. 15. 

However, a February 27, 2006 e-mail between Dale and Anthony with the subject 

line “hedge fund imagination” indicates that Anthony was responsible for assisting the 

Enforcement staff with its Madoff investigation. E-mail dated February 27, 2006 from 

Dale to Anthony, at Exhibit 343. Dale e-mailed, “Vance, Nonchu forget Madoff. Bill.” 

Id. Dale testified that his e-mail was “slang for don’t forget Madoff.” Dale Testimony 

Tr. at p. 21. 

Mayhew testified that he spoke to Dale and Anthony at some point about Madoff, 

but that he did not participate in the May 3, 2006 call. Mayhew Testimony Tr. at p. 14. 

Mayhew testified that he spent approximately 20 minutes reviewing certain documents 

that OEA received from the Enforcement staff. Id. at p. 19. On the basis of that review, 

he concluded that the split-strike conversion strategy “was not a strategy that would be 

expected to earn significant returns in excess of the market.” Id. at p. 15. Mayhew 

testified that he thought Madoff might have been doing something illegal “involving his 

broker-dealer business”: 

... I thought that there was a chance that if Madoff was 

earning extremely high returns, that perhaps it was due to 

some other type of clever activity he may be doing 

299 
involving his broker-dealer business. Perhaps illegal, but I 

did not have any specific ideas about what Madoff may be 

doing other than he may be doing something illegal or 

abusive that would channel money away from brokerage 

clients to investment clients. 

Id. at p. 17. 

However, Mayhew also testified that he had not known that Madoff managed 

approximately $15 billion. Id. at p. 27. Although the Enforcement staff had informed 

Dale and Anthony that Madoff was “running $9 billion to $15 billion” using the splitstrike conversion strategy, apparently neither Dale nor Anthony passed that information 

on to Mayhew. Anthony Notes, at Exhibit 336. Mayhew testified that had he known that 

Madoff was managing that many assets, he would have realized that there was no way he 

could be using his broker-dealer to generate his claimed returns: 

If I had known [that Madoff was managing so many assets] 

then I would not have believed it possible to generate high 

returns on such a large asset base by pilfering assets away 

from the brokerage customers. I had presumed that it was a 

relatively small portfolio. If you have a really large brokerdealer operation and you abuse your customers and pilfer 

money away from them to benefit your asset clients, you 

could enhance your returns. 

If you are doing it with a huge base of billions and billions 

of dollars that would have an insignificant impact on your 

returns so you could not generate real returns that way. 

Mayhew Testimony Tr. at p. 27. Mayhew testified that he informed Dale of his 

conclusions and “assume[d] that [Dale] passed on that opinion.” Id. at pgs. 16-20. 

In fact, there is no evidence that Dale ever passed along Mayhew’s opinion to the 

Enforcement staff. Suh testified: 

Q: Did OEA ever give you a sense of whether or not 

they had an opinion about whether the type of 

returns Bernie was reporting was theoretically 

possible, there could be a way he was legitimately 

achieving those returns? 

A: They did not express a view. 

Suh Testimony Tr. at p. 146. Dale did not recall hearing or conveying to the 

Enforcement staff Mayhew’s assessment that Madoff could not have been using the split300 
 

strike conversion strategy to generate his claimed returns. Dale Testimony Tr. at pgs. 43­

44. 

After reviewing the e-mails the Enforcement staff and OEA had exchanged about 

the Madoff matter, Dale was surprised that Enforcement staff had expected OEA to 

perform an analysis: 

Q: Do you know why enforcement may have had the 

impression that you were going to – your office or 

your group was going to do an analysis? 

A: No. 

Q: Okay. You’re surprised to see from these e-mails 

that they might have expected something? 

A: Yes. 

Dale Testimony Tr. at p. 34.210 Ultimately, the Enforcement staff’s effort to obtain useful 

insight from OEA proved to be completely unsuccessful. 

(11). In April 2006, Enforcement Staff Decided That Madoff 

Should Register as an Investment Adviser 

On April 10, 2006, Suh sent an e-mail to Barbara Chretien-Dar of the IM seeking 

advice on whether Madoff should register as an investment adviser. E-mail dated April 

10, 2006 from Suh to Chretien-Dar, at Exhibit 344. The e-mail attached a memorandum 

summarizing Suh’s analysis of the registration issue. Id. Suh’s e-mail stated: 

I would like to consult with your Division staff on another 

matter involving a broker-dealer functioning as an 

investment adviser with respect to discretionary accounts. 

Id. 

Suh’s e-mail described the Enforcement staff’s Madoff investigation as follows: 

We initially began looking at BLM’s institutional trading 

business because of suggestions in the press that the returns 

reported by BLM’s customers were too good to be true and 

210 On February 20, 2009, Dale sent the OIG an e-mail regarding the SEC’s 2005 Enforcement 

investigation of Madoff. Dale stated, “Given the discussion we had with NERO, I was surprised that the 

case was closed.” E-mail dated February 20, 2009 from Dale to Kotz, at Exhibit 345. When Dale testified 

on April 28, 2009, he did not elaborate on or explain the basis for his claimed surprise other than “the 

[Enforcement] staff seemed to have suspicions about the trading that was going on at the firm and they said 

there might be a problem getting records” and, therefore, he “thought it was the kind of thing they would 

stick with.” Dale Testimony Tr. at pgs. 13-14. 

301 
that BLM could be engaging in some improper conduct, 

such as front-running or false reporting of returns. So far, 

we have not found evidence of any such wrongdoing. It 

does appear to us, however, that BLM’s institutional 

trading business is actually [an] investment advisory 

business and that BLM should be registered with the 

Commission as an investment adviser. 

Id. (emphasis added). 

Suh’s e-mail concluded: 

Based on the Advisers Act Rule 202(a)(11)-1, it appears to 

us that Madoff’s position [that he is not an investment 

adviser] is without merit and, because none of the 

exemptions from registration apply, BLM is violating 

Section 203 of the Advisers Act by failing to register as an 

investment adviser.... We would like to hear your thoughts 

on these issues. 

Id. 

The e-mail to IM described the origin of the investigation as “suggestions in the 

press,” and made no mention of Markopolos or his 2005 submission. Id. The e-mail also 

made no reference to the possibility that Madoff was operating a Ponzi scheme. Id. On 

August 2, 2006, in preparation for a call with IM, Suh sent Bachenheimer the same 

description of the Madoff matter that she had sent IM on April 10, 2006. E-mail dated 

August 2, 2006 from Suh to Bachenheimer, at Exhibit 346. Bachenheimer testified 

regarding that description and its omissions as follows: 

Q: I’m a little struck by the fact that I thought you 

initially began looking at it because of Harry 

Markopolos’ complaint about a Ponzi scheme, not 

because of suggestions in the press that the returns 

were too good to be true or that BLM was engaging 

in improper conduct. 

A: I think that’s right. 

Q: Is there any reason why Simona would have said 

something different in this outline? 

A: No, I don’t think it was really relevant to our 

discussion, you know, where the case came from 

was not really relevant to the discussion of why he 

302 
 

should register. It wasn’t a significant point to 

focus on. 

Q: What about the fact that the allegation initially 

was a Ponzi scheme? 

A: Again, we were going to be talking to IM about 

whether or not he needed to register as an adviser, 

so it would not have been relevant to IM. That 

would have no relevance to the issue of whether or 

not he should register as an adviser. 

Q: Wouldn’t you nevertheless accurately portray why 

you began looking at the – initiating the 

investigation and what were the allegations? 

A: Sure. I would always want to be accurate and I 

guess I made a mistake. I don’t know why. 

Bachenheimer Testimony Tr. at pgs. 147-148. The failure to mention Markopolos’ 

allegations that Madoff was operating a Ponzi scheme may have been due to the 

Enforcement staff’s focus on the registration issue at this stage of the investigation. 

(12). In May 2006, Enforcement Staff Considered Verifying 

Madoff’s Trades with Third Parties 

On May 8, 2006, Suh sent an e-mail to Cheung and Lamore regarding scheduling 

Madoff’s voluntary testimony for either May 18 or May 19, 2006. E-mail dated May 8, 

2006 from Suh to Cheung, at Exhibit 347. In her e-mail, Suh queried whether it would be 

better to wait and schedule Madoff’s testimony for after the Enforcement staff received 

additional information from certain third parties: 

What is your view on trying to schedule [Madoff’s] 

testimony for the second half of next week – Thursday 5/18 

or Friday 5/19? The downside is that we will not yet have 

the account statements from The Bank of New York, 

Barclays or DTC, and there will probably still be 

unreviewed portions of the Tremont productions. On the 

other hand, if we wait to get and analyze those statements 

and to complete the document review, that could delay the 

testimony until mid-June. 

Id. (emphasis added). Cheung responded to Suh the same day, “At this point I would 

lean towards getting him in sooner rather than later. We could always ask him to come 

back if anything shocking comes up in the documents.” Id. 

303 
 

According to her notes, Suh called Madoff on May 9, 2006, regarding: 

Questions re accounts produced in Feb: DTC/NSCC, Bank 

of New York and Barclays – all three accounts are not 

solely for the institutional trading but for all BLM business. 

Requested [Madoff] to produce account statements for 

BLM account 290003 (per BMadoff, this one is solely for 

the institutional trading), Jan-Dec 2005. 

Suh’s Phone Log, at Exhibit 349. 

On May 9, 2006, Suh drafted voluntary document requests to the Bank of New 

York and Barclays Capital Inc. (Barclays) in order to “verify either the trading or the 

assets.” Suh Testimony Tr. at pgs. 153-154. See Draft Voluntary Document Request 

dated May 9, 2006 to Bank of New York, at Exhibit 348 and Draft Voluntary Document 

Request dated May 9, 2006 from Suh to Barclays, at Exhibit 350. The Bank of New 

York draft request asked for voluntary production of “all account statements for all Bank 

of New York accounts of Bernard L. Madoff Investment Securities LLC or Madoff 

Securities International Limited, including account number 8661126621” for the time 

period January 1, 2005 through the date of the request. Draft Voluntary Document 

Request dated May 9, 2006 from Suh to Bank of New York at p. SUHS 012959, at 

Exhibit 348. The Enforcement staff also requested “all account opening documents” and 

“any documents evidencing the transfer of funds into or out of” the referenced accounts, 

“including, without limitation, wire transfer instructions, instructions to transfer securities 

and cancelled checks (front and back).” Id. The Enforcement staff’s draft request to 

Barclays was similar to the Bank of New York request. Draft Voluntary Document 

Request dated May 9, 2006 from Suh to Barclays, at Exhibit 350. 

On May 10, 2006, Suh e-mailed Cheung and asked, “Unless you disagree, we 

will hold off on making requests to Bank of New York and Barclays until Bernie’s 

testimony, when we should be able to talk to him in more detail about the function of 

those two accounts.” E-mail dated May 10, 2006 from Suh to Cheung, at Exhibit 351. 

Cheung responded, “This is terrific. Thank you. I think [holding off on the Bank of 

New York and Barclays requests] makes sense.” Id. 

The OIG found no evidence that either the Barclays or Bank of New York 

requests were ever sent and Suh testified that she believed they were not sent. Suh 

Testimony Tr. at p. 153. The failure to send the requests before or after Madoff’s 

testimony may have been due to the fact, according to Suh, that Cheung had decided “by 

the time of Madoff's testimony ... that there would be nothing there,” Id. at pgs. 110­

111. 

One year before the Enforcement staff drafted a request for documents to 

Barclays, the examination staff actually sent a similar request to Barclays. E-mail dated 

May 3, 2005 from Nee to Mansfield, at Exhibit 352. Barclays had informed the 

examination staff that it had account-opening documents for a Madoff account, but that 

304 
 

 

“no relevant transaction activity occurred during the [requested] period.” Letter dated 

May 16, 2005 from Mansfield to Nee, at Exhibit 241 (emphasis added). 

Suh testified that she had not known that the examination staff had previously 

sent a request to Barclays for Madoff account information. Suh Testimony Tr. at p. 155. 

Suh also testified that had she known about the previous request and the response that no 

records of actual trades were found, she would have followed up on the issue. Id. at p. 

156.211 Similarly, Cheung testified that she did not remember knowing about the 2005 

Barclays request and its response to the examination staff and that it was something that 

should have been pursued. Cheung Testimony Tr. at pgs. 189-190. Bachenheimer also 

testified that she did not recall being aware of the 2005 Barclays request and its response 

and that it “would have been of concern to me.” Bachenheimer Testimony Tr. at p. 109. 

(13). Despite the Enforcement Staff’s Confusion About Madoff’s 

Operations, They Never Sought Information or Assistance 

from the SEC’s Division of Market Regulation 

Throughout the Enforcement staff’s Madoff investigation, the Enforcement staff 

was confused about certain critical and fundamental aspects of Madoff’s operations. For 

example, Lamore testified: 

Q: What was the particular expertise that you felt you 

and Simona didn’t have? 

A: Well I think an understanding [of] the actual 

strategy that he was – that he had claimed to do, not 

just the split-strike conversion strategy but the 

actual – the execution of the orders overseas, you 

know, was that feasible, was that possible. I think 

that was a question that we didn’t get answered that, 

you know, would have been helpful. 

Lamore Testimony Tr. at pgs. 195-196. At various points in the investigation, Suh 

expressed confusion about the custody of assets issue, see E-mail dated January 19, 2006 

from Suh to Lamore, at Exhibit 323, and acknowledged that she was “new to all things” 

broker-dealer related. See E-mail dated December 14, 2005 from Suh to Lamore, at 

Exhibit 353. Suh also testified that during the Enforcement staff’s Madoff investigation, 

she did not understand “how the operation works in terms of the flow of the cash” and 

thought that Madoff kept his investors’ cash at his brokerage firm. Suh Testimony Tr. at 

pgs. 193-194. Apparently, Suh did not understand that a bank must have been involved 

in the movement of funds, and that bank records would have existed that would have 

revealed Madoff’s Ponzi scheme. Id. 

211 There were indications that Suh had access to Lamore’s workpapers, and Lamore testified he was aware 

of the previous request made to Barclays and Barclay’s response. Lamore Testimony Tr. at pgs. 78-79. 

305 
 

Despite the Enforcement staff’s confusion about Madoff’s operations, they never 

consulted with the SEC’s own experts on broker-dealer operations. The SEC’s Division 

of Trading and Markets (formerly the Division of Market Regulation) “assists the 

Commission in executing its responsibility for maintaining fair, orderly, and efficient 

markets. The staff of the Division provide day-to-day oversight of the major securities 

market participants: the securities exchanges; securities firms; self-regulatory 

organizations (SROs) including the FINRA ... [and] clearing agencies that help facilitate 

trade settlement ....” The Investor’s Advocate: How the SEC Protects Investors, 

Maintains Market Integrity, and Facilitates Capital Formation (Dec. 17, 2008) 

http://www.sec.gov/about/whatwedo.shtml, at Exhibit 356. 

On May 16, 2006, three days before Madoff’s testimony, Lamore sent Suh an email asking, “Do you know if Rob [DeLeonardis, Assistant Regional Director, NERO] 

spoke to someone in Market Regulation (SEC)?” E-mail dated May 12, 2006 from Suh 

to Johnson, at Exhibit 355. Suh responded later that day, “I don’t think Rob 

[DeLeonardis] spoke to Market Reg., and, to be honest, considering how unhelpful they 

usually are, I doubt it’s worth the effort.” Id. Suh testified that she did not contact 

anyone in the SEC’s Division of Market Regulation because “by then I had some 

frustrating interactions with them.” Suh Testimony Tr. at p. 165. 

(14).	 Enforcement Staff Learned from NASD that Madoff Had 

Not Reported Holding Any Options Positions, but Failed to 

Pursue that Information 

More than six months after the Enforcement staff received Markopolos’ 2005 

submission but just two weeks before Madoff’s testimony, Cheung suggested that Suh 

and Lamore meet with Robert DeLeonardis, because he had a lot of industry contacts and 

could help the Enforcement staff decide what information they needed to get from 

outside institutions. See E-mail dated May 10, 2006 from Suh to Lamore, at Exhibit 354; 

Suh Testimony Tr. at p. 150. Suh summarized the meeting with DeLeonardis in a May 

10, 2006 e-mail to Cheung: 

Peter and I spent about an hour talking to Rob DeLeonardis 

and Stephen Johnson, also a former trader in our office ... 

Rob thinks both Peter and Steve should attend Bernie’s 

testimony because of their trading experience212 ... Rob 

suggested that we talk to his contact at [Chicago Board 

Options Exchange] CBOE about the volume of Bernie’s 

options trading ... Peter will find out who examines 

[Depository Trust Company] DTC; hopefully, they will be 

able to give us more information about what data to ask for 

212 Prior to joining the SEC, Stephen Johnson had worked as a market maker on the trading desk of 

Herzog, Heine, Geduld. Johnson Testimony Tr. at pgs. 7-8. Based on that experience and his 

understanding of front-running issues, Johnson was asked to attend Madoff’s testimony. Id. at pgs. 17-18. 

After attending Madoff’s testimony, Johnson had no role in the Enforcement staff’s Madoff investigation. 

Id. at pgs. 56-57. 

306 
 

 

and in what format. Rob will also talk to Joseph Cella, the 

head of Market Surveillance in DC ... 

E-mail dated May 10, 2006 from Suh to Cheung, at Exhibit 351.213 

After talking with DeLeonardis, Suh called Jordan Materna, a Director at the 

Chicago Board Options Exchange (CBOE) in the Insider Trading Group and one of the 

SEC contacts there. Materna Testimony Tr. at p. 9, 22. However, Suh learned that 

CBOE did not have records for OTC options, which she relayed in a May 12, 2006 e-mail 

to Johnson, Lamore, and Cheung: “Jordan called back to say that he does not know 

anything about OTC options trading and suggested that we talk to somebody at NASD.” 

E-mail dated May 12, 2006 from Suh to Johnson, at Exhibit 355.214 

Lamore responded to the suggestion to call the National Association of Securities 

Dealers (NASD), “I know that it is irrelevant, but keep in mind that the more people that 

we speak to, the more likely it gets back to Bernie. He is very well connected, especially 

to the NASD.” Id. Suh addressed Lamore’s concern as follows: “I don’t think we 

should worry about Bernie finding out to whom we speak: (1) he already knows we are 

looking at his trading; and (2) we are not telling anybody that we have found anything 

improper (except for his lies to us, of course).” Id. (emphasis added). When asked about 

this e-mail from Lamore, Suh testified: 

I think he was basically referring to the fact that Madoff 

had – let me see, this is before the testimony –Madoff 

definitely spoke about having served on committees and so 

on, during his testimony. I probably knew about that 

before the testimony as well because I’m sure I had looked 

him up in, sort of, public sources; but I didn’t give it much 

thought because at that time we had already contacted 

[Fairfield], Madoff knew that we were investigating him, so 

there was no concern about him finding out that we were 

investigating him. 

Suh Testimony Tr. at pgs. 165-166. 

On May 16, 2006, three days before Madoff’s testimony, Suh called Susan Tibbs, 

Director, Market Regulation Department, FINRA (formerly NASD). E-mail dated May 

16, 2006 from Suh to Johnson, at Exhibit 357. Suh summarized her call with Tibbs in a 

May 16, 2006 e-mail to Lamore and Johnson, copying Cheung: 

Susan called back: they checked one of the dates Peter 

[Lamore] gave them and found no reports of S&P 100 

213 As discussed below, the Enforcement staff did not contact DTC until after taking Madoff’s testimony. 214 Materna testified that he did not recall a phone call with Suh, but confirmed that CBOE did not have 

records of OTC options in 2006 and that he would have referred the SEC to NASDAQ for such records. 

Materna Testimony Tr. at pgs. 20, 30. 

307 
 

 

 

 

index option positions; the electronic search on the other 

dates will take about 24 hours – they will let us know what 

they find out. Susan said that this is not necessarily a 

reporting violation – if the London affiliate is writing the 

contracts and holding the positions, then there is no 

violation. I don’t think that is the case, but we definitely 

will have to ask Bernie about that. Susan suggested that, 

before talking to Bernie on Friday, we talk to Gene 

DeMaio, an NASD VP who runs the AmEx surveillance. 

She said he is a former options trader and also has 

previously consulted [the] SEC on options issues. 

Id. (emphasis added).215 

Tibbs had informed the Enforcement staff that there were “no reports” of Madoff 

holding any options positions “on one of the dates” the staff asked Tibbs to check. Id. 

Tibbs had also explained to the staff that, unless Madoff’s London affiliate held the 

contracts, Madoff either held no options positions or was in violation of the reporting 

requirement. Id. 

Madoff testified three days after the call with Tibbs that his London affiliate was 

not involved with the OTC option contracts: 

Q: And actually to be clear, the DTC accounts are in 

the name of the New York office. 

A: Right. 

Q: Just to go back to the options issue, the options 

positions, are they also in the name of the New 

York – 

A: Correct. 

Madoff May 19, 2006 Testimony Tr. at p. 90, at Exhibit 267. 

The Enforcement staff failed to appreciate the significance of this revelation that 

NASD had no records of Madoff holding any of the OTC options positions he claimed. 

In her testimony, Cheung stated that if the Enforcement staff had learned that the options 

positions were purportedly held by Madoff’s New York entity, an NASD member, and 

215 During her testimony, Tibbs did not recall talking to Suh. Tibbs Testimony Tr. at p. 13. Tibbs testified 

that in 2006, NASD Rule 2860 required NASD members to report options positions of 200 contracts or 

more, including OTC contracts. Id. at pgs. 7-8. 

308 
that there were no records of the positions at NASD, the Enforcement staff should have 

been suspicious and followed up with that information: 

Well, it could have indicated that he – it could indicate that 

he didn’t have the options contracts or that he was not 

complying with NASD rules which would have been his 

own problem and would have been a separate SEC issue. 

Cheung Testimony Tr. at p. 188. 

However, that is exactly what the Enforcement staff learned from the May 16, 

2006 call with Tibbs and Madoff’s May 19, 2006 testimony. Yet, after learning that 

Madoff either: (1) did not hold the OTC options positions he claimed; or (2) was in 

violation of the NASD rule requiring that he report those positions, the Enforcement staff 

did not contact NASD again or follow-up in any other manner. Suh testified: 

Q: Okay. So after his testimony was there any effort to 

follow up with the information Ms. Tibbs had given 

to determine whether or not he was, at a minimum, 

in violation of some NASD reporting requirement 

for his options? 

A: There was not. 

Q: Any discussion of doing that? 

A: No. I do think the focus became on – after his 

testimony the focus was on one side on the 

registration issue and then the second to – to the 

counterparties, and we did not follow up on this. 

Suh Testimony Tr. at pgs. 171-172. 

(15).	 Enforcement Staff Contacted an NASD Options Expert 

Who Advised them to Postpone Madoff’s Testimony 

because of their Lack of Understanding about Options 

Following Tibbs’s suggestion, Suh contacted Gene DeMaio, Vice President and 

Deputy Director of the NASD Amex Regulation Division, on May 17, 2006, just two 

days before Madoff’s testimony. E-mail dated May 17, 2006 from Suh to Cheung, at 

Exhibit 358. Suh testified that she did not remember the phone call (Suh Testimony Tr. 

at p. 173), but a May 17, 2006 e-mail from Suh to Cheung described the phone call as 

“surprisingly productive.” E-mail dated May 17, 2006 from Suh to Cheung, at Exhibit 

358. 

309 
 

 

 

DeMaio testified that he remembered the phone call with the Enforcement staff 

regarding Madoff’s options. DeMaio Testimony Tr. at p. 10. DeMaio testified that he 

answered “extremely basic questions” from the Enforcement staff about options trading. 

Id. at pgs. 11, 14. DeMaio also testified that, by the end of the call, he felt the 

Enforcement staff did not understand enough to take Madoff’s testimony. Id. at p. 13. 

DeMaio recalled telling the Enforcement staff that they “needed to do a little bit 

more homework before they were ready to talk to [Madoff],” but that they said they were 

going to take Madoff’s testimony as scheduled. Id. at p. 14. DeMaio testified that his 

colleague, Daniel Malito, was also on the call and that “when we hung up, we were both, 

sort of, shaking our heads, saying that, you know, it really seemed like some of these 

[options trading] strategies were over their heads.” Id. at p. 15. 

Finally, DeMaio testified that he offered further assistance to the Enforcement 

staff but was never contacted again. Id. at p. 16. Notwithstanding DeMaio’s advice, the 

Enforcement staff did not postpone Madoff’s testimony. 

c. Madoff Testified on May 19, 2006 

Madoff testified voluntarily and without counsel in the SEC investigation on 

Friday, May 19, 2006. Madoff May 19, 2006 Testimony Tr. at p. 4, at Exhibit 267.216 At 

9:03 a.m. the day of Madoff’s testimony, Suh e-mailed Bachenheimer, “I have a couple 

of questions about the approach to his prior disclosures to the exam staff.” E-mail dated 

May 19, 2006 from Suh to Bachenheimer, at Exhibit 359. Suh testified that the questions 

she posed to Bachenheimer approximately one hour before Madoff’s testimony related to 

“how to confront him with the fact that he lied.” Suh Testimony Tr. at p. 178. 

During Madoff’s testimony, he provided evasive answers to important questions, 

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

information that could have been used to discover that he was operating a Ponzi scheme. 

However, the Enforcement staff did not follow-up with respect to any of the information 

that was relevant to Madoff’s Ponzi scheme. 

(1).	 Madoff Attributed His Consistently High Returns to His 

Personal “Feel” for Timing the Market 

As discussed above, the foundation of Markopolos’ 2005 submission was that it 

was impossible for Madoff to achieve his purported returns with the split-strike 

conversion strategy he claimed to use. That view was shared by several other industry 

professionals, as reported in the May 2001 Barron’s and MARHedge articles, as well as 

Garrity and many of Madoff’s own investors. 

During his testimony, Madoff was asked how he achieved his consistently high 

returns. Madoff May 19, 2006 Testimony Tr. at p. 76, at Exhibit 267. Madoff never 

216 Bachenheimer, Cheung, Suh, Lamore, and Johnson attended Madoff’s testimony. Madoff May 19, 

2006 Testimony Tr., at p. 2, at Exhibit 267. 

310 
 

 

 

 

answered the question with reference to his claimed trading strategy. Id. at pgs. 76-79. 

Instead, he attacked those who questioned his returns, particularly the author of the 

Barron’s article. Id. at p. 77.217 Essentially, Madoff claimed his remarkable returns were 

due to his personal “feel” for when to get in and out of the market, stating: “Some people 

feel the market. Some people just understand how to analyze the numbers that they’re 

looking at.” Id. at p. 47. 

When Suh reviewed Madoff’s explanation for his returns during her OIG 

testimony, she acknowledged Madoff’s response “doesn’t answer the question.” Suh 

Testimony Tr. at p. 185. Suh testified that, prior to Madoff’s testimony, she “didn’t know 

what to think” about the magnitude of Madoff’s claimed returns and she “did not know 

enough about this industry to place that number.” Id. at p. 41. Suh also testified that she 

“did not have a view about how likely or unlikely” “it was that one person could achieve 

such consistent returns over 14-and-a-half years with only seven down months.” Id. at p. 

42. Suh testified that, after Madoff’s testimony, she “didn’t know what to make of” 

Madoff’s explanation for his returns. Id. at pgs. 127-129. 

Bachenheimer and Cheung both took Madoff’s explanation at face value. Cheung 

testified: 

Well, as I – as I read it and as I think I under – to me, it 

sounded like by not – by not reaching for astronomically 

high returns, he was reducing – part of it, he was reducing 

his risk of – of any particularly low down months and also 

that the variations in inter-day trading were things that he 

was able to take advantage of in his market – in his time 

when he put things on. 

Cheung Testimony Tr. at pgs. 194-195. Bachenheimer testified, “I mean, what I 

understood him to be saying here is because he was hedged in both directions, you would 

not expect there to be a lot of volatility, and I think that is while not 100 percent 

responsive, not a perfect answer, it does answer the question.” Bachenheimer Testimony 

Tr. at p. 115. 

The Enforcement staff’s inexperience and unfamiliarity with equity and options 

trading may have contributed to their belief that Madoff’s explanation for his remarkable 

returns was satisfactory. In contrast, Garrity understood that the premise of Markopolos’ 

referral – that Madoff’s reported returns were impossible to achieve with his purported 

trading strategy – was incontrovertible. Garrity Testimony Tr. at pgs. 43, 47. That 

premise had also been the thesis of two industry publications. As a former Madoff 

investor quoted in the May 2001 Barron’s article explained, “Anybody who’s a seasoned 

hedge-fund investor knows the split-strike conversion is not the whole story. To take it at 

217 Madoff testified, “There was an article written years ago about this strategy. I remember the lady that 

wrote it ... [s]he did a number of stupid articles.” Madoff May 19, 2006 Testimony Tr. at p. 77, at Exhibit 

267. 

311 
 

face value is a bit naïve.” Erin Arvedlund, Don’t Ask, Don’t Tell, Barron’s, May 7, 2001 

at p. 2., at Exhibit 135. 

(2). Madoff Testified That All Equity Trades for His Advisory 

Investors Were Settled in His DTC Account 

Madoff testified that the trades for all of his advisory accounts were cleared 

through his account at DTC. Madoff May 19, 2006 Testimony Tr. at p. 87, at Exhibit 

267. Madoff testified further that his advisory account positions were segregated at DTC: 

“The institutional accounts are separate from the firm’s accounts... . There are codes [at 

DTC] that are attached to the activity that say whether it’s, whether it’s held for the firm 

or whether it’s held in seg.” Id. at p. 88. Madoff insisted that, “in the DTC account, the 

activity that’s in the segregated account, that’s solely institutional trading business and 

solely what’s perceived as the strategy we’ve been discussing.” Id. at p. 89. 

As discussed below, when Suh subsequently spoke to a representative at DTC, 

she learned that Madoff’s claimed advisory positions were not segregated in his DTC 

account. However, Suh does not appear to have recognized that Madoff had lied during 

his testimony by claiming to have segregated positions at DTC and, more importantly, 

concluded incorrectly that the lack of segregation in Madoff’s DTC account made it 

impractical to use DTC records to verify whether Madoff was placing any trades for his 

investors. Suh Testimony Tr. at pgs. 58-59. Cheung admitted that had the Enforcement 

staff obtained DTC records for Madoff’s account after his testimony, the Enforcement 

staff most likely would have discovered his Ponzi scheme. Cheung Testimony Tr. at pgs. 

202-203. 

During a recent interview with the OIG, Madoff stated that he had thought he was 

caught after his testimony about the DTC account: 

Madoff said it was “amazing to me” that he didn’t get 

caught during the Enforcement investigation, because they 

specifically asked him, “Are these securities at DTC?” 

They further pressed, “What is your account number.” He 

replied, “646.” Madoff stated that it was “obvious they 

thought that something was amiss.” He went on to say that 

when they asked for the DTC account number, “I thought it 

was the end game, over. Monday morning they’ll call DTC 

and this will be over ... and it never happened.” Madoff 

stated that when nothing happened, he thought, “After all 

this, I got away lucky.” But he said he thought it was just 

“a matter of time,” saying “that was the nightmare I lived 

with.” When Enforcement did not follow up with DTC, “I 

was astonished.” 

312 
 

 

 

 

 

 

 

 

Madoff Interview Memorandum at pgs. 3-4. Madoff’s narrow escape, due to the 

Enforcement staff’s failure to appreciate the significance of DTC verification, allowed 

the Ponzi scheme to continue for an additional 2 1/2 years.218 

(3).	 Contrary to His Previous Representations, Madoff Testified 

That He Had Documents Related to His OTC Option 

Contracts, but Enforcement Staff Did Not Insist That He 

Produce Those Documents 

As discussed above, on December 29, 2005, the Enforcement staff requested, 

inter alia, copies of Madoff’s claimed OTC options contracts. When Madoff produced 

documents, he represented that he did not have supporting documentation for his OTC 

options contracts. Suh’s Phone Log, at p. 1, at Exhibit 349; See also E-mail dated May 4, 

2006 from Suh to Anthony, at Exhibit 342. 

During testimony, the Enforcement staff asked Madoff if “there [was] any 

documentation generated” for his OTC option trades. Madoff claimed: 

A: Yes, there’s an affirmation that’s generated 

electronically, and there’s a master option 

agreement that’s attached to that that’s also 

electronic. 

Q: And the electronic affirmation stores data for each 

trade with each particular dealer. 

A: Correct. 

Q: So if you wanted to find out with whom you bought 

these contracts on a particular day, that’s where you 

would go. 

218 On July 28, 2009, Joseph Cotchett, an attorney for certain of Madoff victims, interviewed Madoff. 

According to Cotchett, Madoff also admitted to him that he thought the SEC would discover his Ponzi 

scheme immediately after his SEC testimony. Cotchett stated in an interview with CNN: 

In [2006], the SEC sat down with him for a full day and grilled him. 

And he told me that when he left that meeting, late in the afternoon, 

four, five, whatever it was, he thought the following morning he would 

– excuse me, the following Monday he would be closed down. That 

was in [2006]. I asked him, I said Bernie, how much money did you 

have essentially in your fund at that time? I said, was it about $16 

billion or $18 billion by our calculation? No. He said no, it was 

probably closer to 20. So in ... 2006, when he sat down with the SEC, 

he thought on Monday, he would be closed down. Had he been closed 

down, $20 billion would have been saved of investors’ money. 

Transcript of July 29, 2009 CNN Interview with Joseph Cotchett at p. 16; available at: 

http://transcripts.cnn.com/TRANSCRIPTS/0907/29/ec.01.html., at Exhibit 360. 

313 
 

A: Right. 

Madoff May 19, 2006 Testimony Tr. at p. 67, at Exhibit 267. 

The Enforcement staff did not ask Madoff why these option-related documents 

had not been produced in response to the SEC’s December 29, 2005 document request or 

why he had not mentioned them to Suh when she called him on January 13, 2006, to ask 

why he had not produced any option-related documents. More importantly, the 

Enforcement staff did not request that Madoff produce the documents he referenced in 

his testimony. Suh testified that the Enforcement staff never discussed pushing Madoff 

to produce those documents: 

Q: Okay. But do you remember a specific request 

about the options agreements – 

A: Yes. 

Q: – as part of the overall request? 

A: Right. And I definitely know that there was a 

request for options agreements and that what he 

produced he claimed that that was all he has. 

Q: Okay. So he, literally, claimed he didn’t have 

copies of the master derivatives contracts that he 

was trading with these counterparties on? 

A: I think he said he has electronic versions and he did 

not produce them. So I actually do think that I 

probably – I mean I overlooked that. 

Q: Was there any – do you recall any discussion on 

whether to push him on that or – 

A: No, I don’t think that was discussed. 

Suh Testimony Tr. at p. 149. 

According to the SEC’s Complaint against DiPascali, Madoff did not have the 

electronic, options-related documents that he claimed to have and which the Enforcement 

staff did not press him to produce. See SEC v. Frank DiPascali, Jr., No. 09 Civ. 7085 

(LLS) (S.D.N.Y. filed August 11, 2009) at ¶ 60(d), at Exhibit 119 (alleging that, “The 

advisory account records on [Madoff’s computer] did not reflect any counterparty 

information (because none existed).”), at Exhibit 361.219 

219 In his interview with the OIG, Madoff stated that he did not have fake options trading records prepared 

for the SEC and explained that “[y]ou can’t replicate options records.” Madoff Interview Memorandum at 

314 
 

 

 

 

 

 

 

(4).	 Madoff Contradicted his Representations to the 

Examination Staff Regarding Where the Equity Trades 

were Executed and Cleared 

At different times, Madoff told the SEC staff different stories about where the 

equity trades for his investors were executed and cleared. Apparently, the staff did not 

recognize or appreciate the significance of these contradictory statements. During the 

2005 NERO examination, Madoff informed the examination staff that his London 

affiliate, Madoff Securities International Limited (MSIL), was settling the orders and 

Barclays Capital in London was clearing the equity trades. Examination Report dated 

September 2, 2005, at p. 8, at Exhibit 263. This representation was not verified by the 

examination staff220 but was presented in the final report: 

According to BMadoff, MSIL acts as the settlement agent 

for the orders and Barclays Capital serves as the clearing 

firm. In addition, each of the 16 entities are provided with 

trade confirmations and end-of-month statements noting 

shares bought or sold, prices, and amount debited or 

credited to their account. 

Id. Lamore had relayed this information to Suh in a December 22, 2005 e-mail, “[A]ll 

equity transactions occur in Europe (which we verified during the exam by reviewing the 

trading blotters) and clear through Barclays Capital.” E-mail dated December 22, 2005 

from Lamore to Cheung, at Exhibit 314. Three days before Madoff’s testimony, on May 

16, 2006, Lamore e-mailed Suh and reiterated his understanding that MSIL was involved 

in “the IA business trades”: 

Hi Simona, I spoke to our DTC contact person in BD 

regarding our DTC questions. However, I didn’t get any 

clear answers. The only piece of advice was to find out if 

MSIL (which I believe clears the IA business trades) 

participates in DTC. 

E-mail dated May 16, 2006 from Lamore to Suh, at Exhibit 361 (emphasis added). 

During Madoff’s testimony, Suh asked: 

p. 4. Madoff also stated that he was surprised that the Enforcement staff never pressed for records of his 

purported OTC options trades. Id. 220 On May 3, 2005, Nee sent a document request to Barclays Capital, Inc. requesting, inter alia, 

information on all trading done by or on behalf of “any 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” for the period March 1 through March 31, 2005. E-mail dated May 3, 2005 from Nee to 

Mansfield, at Exhibit 352. On May 16, 2005, Barclays Capital, Inc. responded that the only documents 

responsive to Nee’s request were account-opening documents for a BLM account that was opened “on 

February 16, 2005,” and that “no relevant transaction activity occurred during the period March 1, 2005 – 

March 31, 2005. ... It should be noted that a prime brokerage and trading relationship with a Madoffaffiliated entity exists with our UK affiliate, Barclays Capital Securities Ltd., an FSA-regulated institution.” 

Letter dated from May 16, 2005 from Mansfield to Nee (emphasis added). As discussed above in Section 

IV, the examination staff did not follow-up on the information provided by Barclays Capital, Inc. 

315 
Q: Now you said the firm has an affiliate firm in 

London – 

A: Yes. 

Q: Madoff Securities International Limited. Correct? 

A: Correct. 

Q: What role does it play in the trading for the 

institutional – 

A: None. 

Q: None whatsoever? 

A: In the execution side? No, because first of all they 

only trade foreign securities over there. They only 

trade a couple of USA DRs, but basically they’re 

trading foreign securities. 

Madoff May 19, 2006 Testimony Tr. at p. 59, at Exhibit 267. Lamore then asked: 

Q: From an administrative perspective, are they 

involved with the equities at all? 

A: They’re the liaison on the selling side but not on the 

trading side, no. 

Q: And how are the equities’ trades cleared? 

A: The equity trades are all cleared through us because 

they’re U.S. securities. 

Q: So the firm – 

A: Right. 

Id. at p. 59. 

316 
Contrary to his representations during the 2005 examination, in his testimony with 

the Enforcement staff, Madoff specifically stated that the trades cleared at DTC, not 

Barclays Capital: 

Q: The account, Depository Trust Clearing 

Corporation, what is the function of this account? 

A.: That’s the general clearance account for the firm 

that handles all the settlements of transactions for 

the firm. 

Q: So this account handles the clearings of all – 

A: –all. 

Id. at p. 87. The Enforcement staff did not ask Madoff to explain his prior, contradictory 

statements to the examination staff. 

(5). Madoff’s Denial that he had Lied to the Examination Staff 

about his Purported Options Trading Activity was not 

Credible 

As discussed above, Suh and Lamore believed that Madoff had lied during the 

2005 NERO examination when he had claimed that, as of January 1, 2004, he no longer 

traded options for his investors. Madoff’s effort during his testimony to explain that his 

statements to the examination staff regarding this issue had been truthful was not 

credible. 

When the Enforcement staff received statements from Fairfield, they learned that 

Madoff was representing to his investors that he did trade options in their accounts. Suh 

confronted Madoff during his testimony with that “odd discrepancy.” Madoff May 19, 

2006 Testimony Tr. at p. 103, at Exhibit 267. Madoff denied having told the examination 

staff that he had ever stopped trading options for the advisory accounts, claiming that 

there must have been a miscommunication: 

Q: Do you recall telling [Lamore] that as of January 1, 

2004 you no longer incorporated options into the 

strategy for the institutional trading business? 

A: I said [options are] not part of the model. The 

options are not deemed to be part of the model. I 

did not say, my recollection certainly is not that I 

said that the accounts don't use options any more to 

trade. I said the options, that the options were taken 

317 
out of the model, and they’re not part of the model 

any longer. 

Id. Suh asked Madoff about his statement to the examination staff that, since the change 

in January 2004, his investors may have been hedging themselves but did not receive 

guidance from him. Id. at pgs. 104-105. Madoff testified that he did not represent that to 

Lamore: 

Q: Do you recall telling Mr. Lamore in substance that 

since that change, as of January 1, 2004, the clients 

may hedge the strategy themselves but that you did 

not discuss or provide any guidance to clients for 

hedging the strategy? 

A: No. 

Q: You do not recall making that statement? 

A: I recall saying what I just said, that they were part 

of the model, that they were no longer part of the 

model, but I remember specifically saying that the 

options are still used to hedge the transactions. 

Id. 

Cheung testified that she accepted Madoff’s explanation for his prior statements 

to the examination staff regarding whether he traded options for his investors, stating: 

Q: Did you ever get a resolution to why Bernie Madoff 

previously said he wasn’t using the options strategy 

and you found documents showing that he was? 

A: I don’t remember – I don’t remember clearly what 

the answer was. I remember that there was an 

answer, and I think that it was an answer that he – 

he was saying that the examiners asked it in a way 

that was different from the way that we had asked 

it. 

Q: And you found that answer satisfactory? 

A: I think we did. 

Cheung Testimony Tr. at p. 100. 

318 
 

Suh, however, testified that she did not believe Madoff when he tried to portray 

the “odd discrepancy” she had pointed out in her December 13, 2005 e-mail221

 as a 

miscommunication: 

We did confront Madoff with the discovery during his 

testimony. He attempted to portray this as a 

misunderstanding. It did bother me. I did not think it was 

resolved. I did believe that he was not forthright. 

Suh Testimony Tr. at p. 67. Suh testified further that, after testimony, it was clear 

Madoff had lied during the examination as well as the investigation: “I did credit 

[Lamore’s] recollection and I did continue to think that Madoff was dishonest in that he 

was just basically trying to get out of being called a liar.” Id. at pgs. 205-206. Lamore 

testified that he was “furious” during Madoff’s testimony at Madoff’s attempt to explain 

his prior statements to the examination staff about whether he traded options for his 

advisory clients. Lamore Testimony Tr. at p. 182. 

(6). During Madoff’s Testimony, Enforcement Staff Caught 

Madoff Lying about the Number and Identity of his 

Investors 

Early in the investigation, the Enforcement staff learned that Madoff had withheld 

account information from the examination staff. On December 13, 2005, Suh e-mailed 

Cheung and Lamore, stating, “[T]he CD with account statements that Madoff produced to 

[the examination staff] does not include a statement for three accounts and one subaccount in the [Fairfield] production.” E-mail dated December 13, 2005 from Suh to 

Lamore, at Exhibit 308. On February 6, 2006, Suh e-mailed Anthony several Fairfield 

account statements and explained: 

[W]e discovered that BLM’s principal, Bernard Madoff, 

mislead [sic] NERO examination staff earlier this year 

about the nature of his trading strategy. The attached 

account statements show that is not the case. Additionally, 

Madoff did not disclose to the examination staff some of 

the accounts in which he implemented this trading strategy. 

Because of these misrepresentations, and also because of 

the high amounts at issue, we would like to obtain some 

independent verification of the reported returns. 

E-mail dated February 6, 2006 from Suh to Anthony, at Exhibit 335. 

221 E-mail dated December 13, 2005 from Suh to Lamore, at Exhibit 308. 

319 
During his testimony, Madoff was asked repeatedly if he had disclosed all of his 

accounts: 

Q: And I just want to go back to the list of accounts 

that’s on the second page of Exhibit 19 [and] 

Exhibit 20, are there any other accounts in the 

institutional trading business? 

A: No. 

Q: Are there any other accounts for which you trade 

the split strike conversion strategy that we’ve been 

discussing? 

A: No. 

Q: Are there any other accounts in addition to the ones 

listed in Exhibit 19 and the one pointed out in 

Exhibit 20 where you trade customers’ funds 

pursuant to some trading strategy? 

A: I’m sorry, what? 

Q: Are there any other accounts, basically where the 

firm trades for that customer pursuant to that 

strategy? 

A: No. 

Q: Mr. Madoff, do you personally trade money for 

anybody else? 

A: What do you mean trade money for anybody else? 

Q: Is there anybody else who provides you capital to 

invest and you trade on their behalf, whether it be 

an individual, an entity, a partnership, a corporation, 

your neighbor, anything or anyone? 

A: We trade, as part of our market making strategy, we 

get non-held orders. That we trade. We have — 

there are some individual accounts, family accounts 

and friends that we trade as well. Is that what you 

mean? 

320 
 

Q: Yes. I don’t mean — putting aside the market 

making business and putting aside the proprietary 

trading, but family, any kind of money that you 

trade pursuant to any strategy? 

A: Yes. Not institutional funds. 

Madoff May 19, 2006 Testimony Tr. at pgs. 101-102, at Exhibit 267. 

During testimony, the Enforcement staff requested that Madoff produce a letter 

with the names of all individuals or entities that Madoff or his firm traded on behalf of 

that were not a part of his market making or proprietary business. Id. at p. 102. On June 

7, 2006, Suh e-mailed Cheung, Lamore and Johnson, informing them that Madoff had 

produced a list of 86 “previously undisclosed” accounts: 

On Monday, Madoff produced the attached explanation for 

the trades that Peter had pointed out during his review of 

the account statements, as well as the attached list of 

previously undisclosed accounts that Madoff trades 

pursuant to the split strike conversion strategy. In all, the 

list includes 86 accounts, with total value as of 4/30/06 of 

approximately $336.5M. Most of the accounts are in the 

names of various trusts and seem to belong to 

approximately 10 families. 

... 

Also, because Madoff stated during his testimony that the 

newly disclosed accounts are traded pursuant to the same 

strategy as the accounts in the institutional trading program, 

I was thinking of calling him and telling him that, in our 

view, documents concerning these accounts are responsive 

to our earlier document requests, and that he should 

produce them. Let me know if you disagree. 

E-mail dated June 7, 2006 from Suh to Cheung, at Exhibit 362. Suh testified she had 

been “bothered” by the eleventh-hour discovery of these new accounts, “Well, it certainly 

bothered me, and it – I did think he was – had not been truthful in examination and in the 

testimony. So it bothered me.” Suh Testimony Tr. at p. 220. 

On June 8, 2006, Suh called Madoff to discuss the new disclosures. E-mail dated 

June 8, 2006 from Suh to Cheung, at Exhibit 363. Suh summarized the phone call in an 

e-mail to Cheung, Lamore and Johnson as follows: 

I called Bernie to tell him that, in our view, the accounts he 

produced on Monday were covered by our previous 

document requests because, from what he told us in 

testimony, we understand them to be traded pursuant to the 

321 
 

same strategy as the institutional accounts. His response 

was: 1. Only 5 of those 86 accounts are in fact traded 

pursuant to the same strategy. (This seems to be correct: 

The options trading data shows allocations of options 

positions to only 5 of the newly disclosed accounts.) 2. He 

did not provide us with information about these 5 accounts 

earlier because Madoff does not view these accounts as 

discretionary... 

E-mail dated June 8, 2006 from Suh to Cheung, at Exhibit 363. With respect to her June 

8, 2006 call with Madoff, Suh testified that Madoff’s story regarding his investors’ 

accounts kept “changing” and “shifting.” Suh Testimony Tr. at p. 221. 

After Madoff produced some documents related to the five accounts he had 

referenced in the June 8, 2006 call, Suh summarized his production in a June 26, 2006 

e-mail to Cheung, copying Lamore: 

On Friday, I received from Madoff documents concerning the 

mysterious “other accounts” that came up during Bernie’s 

testimony. ...On the other hand, when we ultimately do talk to 

Bernie about registration, it may be helpful to know if we 

should consider these accounts to be advisory accounts. For 

now, we can see what IM says on this issue. 

E-mail dated June 26, 2006 from Suh to Cheung, at Exhibit 364. Cheung responded, “He 

has a Clintonian definition of discretionary.” Id. Suh added, “Or of anything ... it still is 

not clear to me on what grounds he did not disclose these accounts when we had that ‘is 

there anything else’ exchange of letters.” Id. On June 26, 2006, Lamore drafted a 

response to Suh’s e-mail regarding Madoff’s production, stating, “I don’t understand why 

these accounts were excluded during our exam when we asked for a list of all 

customers?” E-mail dated June 26, 2006 from Suh to Cheung, at Exhibit 364. 

Suh testified that at this point in the investigation, it was clear that Madoff 

“wasn’t truthful and I knew he was not giving us full information.” Suh Testimony Tr. at 

p. 223. Similarly, Lamore testified, “I just remember sitting there in the testimony 

thinking he’s lying during the testimony. It was just remarkable to me.” Lamore 

Testimony Tr. at p. 250. Lamore explained also: 

I’m not sure why but I’m pretty sure that they emphasized 

that they needed to ask about additional accounts, because 

there’s additional accounts. I don’t remember how I knew, 

why I knew, but I said, “You need to ask that question.” So 

in the testimony there was, “Are there additional 

accounts?” “No.” “Are you sure there are [no] additional 

accounts?” “No.” “Are you positively sure there are [no] 

322 
additional accounts?” “Well, there might be a few 

additional accounts.” 

So I’m sitting there thinking, “You got to be kidding me, I 

mean, this is huge. This guy just lied [in] on the record 

testimony to your face.” 

Id. at p. 249. 

However, Lamore testified that he was unaware of any “consideration [by the 

Enforcement staff] in charging Madoff with perjury.” Id. Lamore also testified that he 

was not substantively involved in the investigation after Madoff’s testimony. Id. 

Ostrow verified that Lamore was very agitated by Madoff’s lies 

during testimony: 

Q: Do you know if Peter told the enforcement 

attorneys that he heard the testimony of Bernie 

Madoff and it conflicted with what Bernie had told 

him and you in the exam? 

A: I don’t know, but I believe he did because I think he 

told me, “I was jumping up and down at the 

attorneys and letting them know about all of the 

discrepancies.” 

Ostrow Testimony Tr. at pgs. 212-213. According to Ostrow, Lamore was “extremely 

upset that [the Enforcement attorneys] weren’t taking seriously the fact that everything 

was a lie. [T]here were so many contradictions to what Bernie said in testimony or 

[DiPascali] said to what we were told on our exam.” Id. at p. 203. Yet, there was no 

evidence of effective follow-up by the Enforcement staff on these contradictions. 

d. Enforcement Staff Contacted DTC but Decided to Not Request 

Any Records 

Several SEC officials testified that verifying trading was a fundamental step in an 

investigation of an alleged Ponzi scheme. Garrity was asked how to conduct a Ponzi 

scheme investigation of Madoff. Garrity explained: 

Q: With respect to the Ponzi scheme allegations that 

Mr. Markopolos was making in this case, I think 

you probably know from either at the time or 

sources now that Mr. Madoff was a significant 

market maker in a lot of equities and that he also 

self-cleared. 

323 
A: Yes, I know that now. I didn’t at the time. 

... 

Q: [H]ow would you address probing the allegations 

that Mr. Markopolos made in light of those two 

facts. And let’s first start with the Ponzi scheme 

scenario. 

A: Yes. 

Q: If he’s not executing any trades at all for the money 

that he’s managing, purportedly managing, but is 

executing trades in the broker/dealers market maker 

function, et cetera – 

A: Yes. 

Q: – he’s self-clearing, so there’s no clearing broker 

you can go to, what would be one of your first 

fundamental steps to take to go about confirming 

that he actually is executing trades on behalf of the 

money that he's managing? 

A: My goal would be to keep working my way back 

through the food chain to get to an independent 

source that could verify the existence of the assets. 

So that would be my objective. So I would – 

presumably the next step up the food chain would 

be Depository Trust Company and its entity. 

... 

Q: If it turned out to be the case that with respect to the 

money that he was purportedly managing for hedge 

funds, he was executing no trades, how easy or 

difficult do you think it would have been to 

ascertain that fact from the DTC records? 

A: I think if there [were] no trades at all, I think it 

would be fairly self-evident. 

Garrity Testimony Tr. at pgs. 90-93 (emphasis added). 

324 
Caverly observed that “clearly if someone ... has a Ponzi and they’re stealing 

money, they’re not going to hesitate to lie or create records.” Caverly Testimony Tr. at 

pgs. 36-37. Consequently, Caverly explained: 

And the only way to verify [whether the alleged Ponzi 

operator is actually trading] would be to obtain – you 

know, some third party, some independent third party 

verification... . I mean if they’re trading stocks, you can go 

to DTC or someplace like that ... and see what they have 

there. You find out who the ultimate custodian is. 

Id. 

Kazon testified that obtaining “independent [trading] records” was required if a 

person was “seriously pursuing” a Ponzi scheme investigation: 

Q: How would you go about investigating a Ponzi 

scheme case? 

A: Typically you try to find out where is the trading 

that’s supposedly being conducted, where is it going 

on, and you get records to confirm that ... it is in 

fact going on. 

Q: Would you try to get independent records other than 

from the entity that you’re investigating? 

A: Generally, ideally if I was seriously pursuing it, yes. 

Kazon Testimony Tr. at p. 26. Sollazzo also testified that, “if [he] were investigating ... 

whether Madoff was running a Ponzi scheme, [he] would go to DTC.” Sollazzo 

Testimony Tr. at p. 45. 

Bachenheimer, however, testified that, in her opinion, verifying trading activity 

from an independent source was not an “essential” part of a Ponzi scheme investigation, 

stating: 

Q: ... Generally, if one were to do an investigation 

involving a Ponzi scheme to determine whether 

there is trading going on, would any of the steps 

include going to any independent outside entities to 

confirm that there were trades? 

A: That is certainly one thing you could do; absolutely. 

325 
 

Q: Would that be an essential part of what one were to 

do to investigate of a Ponzi scheme? 

A: I don’t think you can say it’s essential. I think it 

would be a good thing to do but I don't think you 

can say it's essential. 

Bachenheimer Testimony Tr. at p. 32. 

On February 23, 2006, Madoff produced a document to the Enforcement staff 

representing that his trades cleared through, among other financial institutions, DTC, and 

identifying his DTC account number as “0646.” Letter dated February 23, 2006 from 

Madoff to Suh, at Exhibit 334. Madoff confirmed his DTC account number during his 

testimony. Madoff May 19, 2006 Testimony Tr. at p. 88, at Exhibit 267. 

On May 10, 2006, nine days before taking Madoff’s testimony, the Enforcement 

staff discussed obtaining records for Madoff’s account at DTC to verify his claimed 

trading activity. E-mail dated May 10, 2006 from Suh to Lamore, at Exhibit 354. 

Specifically, Suh e-mailed Lamore, “Meaghan suggested that you and I talk to Rob 

DeLeonardis about the best way to get the information we want from DTC and possibly 

the other financial institutions.” Id. Suh and Lamore then spent approximately one hour 

talking to DeLeonardis and Stephen Johnson about the best way to obtain the desired 

information. E-mail dated May 10, 2006 from Suh to Cheung, at Exhibit 351. During 

the meeting, it was decided that “[Lamore] will find out who examines DTC; hopefully, 

they will be able to give us more information about what data to ask for and in what 

format.” Id. Lamore then e-mailed Suh on May 12, 2006, “Hi Simona, I've spoken to 

Ellen Hersh in our office regarding DTC. She suggested that I speak to Sonam Varghese, 

a branch chief familiar with DTC. I've left a message for Sonam to call me back.” Email dated May 10, 2006 from Suh to Cheung, at Exhibit 351.222 

On May 16, 2006, Lamore e-mailed Suh: 

Hi Simona, I spoke to our DTC contact person in [the 

Broker-Dealer group] regarding our DTC questions. 

However, I didn’t get any clear answers. The only piece of 

advice was to find out if MSIL (which I believe clears the 

IA business trades) participates in DTC. If you have a 

contact person in DTC, I will call them to find out the 

answers to our questions. Also, we could ask Bernie to 

explain the processing of the IA business trades during 

222 Lamore and Suh testified that they did not recall whether Lamore spoke to Varghese about DTC. 

Lamore Testimony Tr. at p. 238; Suh Testimony Tr. at p. 160. Similarly, Varghese did not recall such a 

conversation. Varghese Interview Memorandum. 

326 
 

 

 

 

testimony and then go to DTC after the testimony. Any 

thoughts? 

E-mail dated May 16, 2006 from Lamore to Suh, at Exhibit 361 (emphasis added). 

Suh described the “DTC questions” referenced in Lamore’s e-mail as follows: 

I think these were basic questions about what kind of 

records they keep and can those records help verify the 

trading that Madoff was reporting to the hedge funds ... I 

think this was shortly before Madoff's testimony, so I think 

at the time I probably thought that it would be helpful to 

ask Madoff about how the firm keeps its accounts in DTC 

and then pursue further with DTC. 

Suh Testimony Tr. at p. 161. 

As Lamore suggested, the Enforcement staff waited to contact DTC until after 

taking Madoff’s testimony on May 19, 2006. Id. at p. 162. Sometime after testimony, 

Simona contacted Susan Geigel, Director of Legal and Regulatory Compliance at DTC. 

Id. at p. 159.223 Suh recalled: 

[T]he bottom line that came out of that conversation or 

those conversations, there may have been more than one, 

was that we concluded there was no feasible – it wasn’t 

feasible to confirm the trading through DTC because there 

was no way to segregate the trading for the advisory 

223 During her testimony, Suh did not initially recall the name of the person with whom she spoke at DTC. 

Suh had produced to the OIG staff a list of contact names and telephone numbers from her investigative 

file, and Geigel’s name was the only one listed under “DTC.” After her recollection was refreshed with 

that information, Suh testified that she had spoken to Geigel: 

A: I knew that ultimately I may not have had the name at that 

time, I know ultimately I did, and then we had a call with that 

person. 

Q: Is that Susan Geigel? 

A: That’s – I think that’s right. I mean, that name definitely is 

one of the people – she’s among the people we talked to 

between DTC, NASD, and CBOE. I don’t – it sounds right 

that it would be a DTC person. 

Q: And this call was after Madoff's testimony? 

A: Yes. 

Suh Testimony Tr. at p. 162. 

327 
 

business into separate – the trading in any account from the 

trading of the Madoff firm. 

Id. at p. 59.224 Suh testified that she probably had asked Geigel for information verifying 

specific, individual trades, which DTC did not have, but which was actually not 

necessary to see that Madoff was operating a Ponzi scheme: 

Q: Let me ask a couple more questions about the DTC 

phone call, ... everything we’ve seen up to now 

seems to be the focus was confirming audit trail 

type data for the reported trades, confirming that a 

trade occurred and it’s at a stated time and stated 

price, et cetera. 

A: Right. 

Q: Is that a fair – 

A: Right, right. 

Q: – sort of what you guys were trying to confirm? 

A: Right. 

Q: It may be, and I don’t know for sure, but it may be 

that DTC told you they couldn’t give you that 

specific information, but they could have told you 

whether or not trades were actually occurring at all. 

Is that possible that your question to them was do 

they have data on specific trades, audit trail type 

data? 

A: It’s possible because I know that I was thinking in 

those terms. 

Q: Okay. But if you’re investigating a Ponzi scheme 

there’s no trades, right? 

A: That’s right. 

Q: So you don’t need that level of detail to determine 

whether it’s a Ponzi scheme, you just need to know 

where any – as an initial matter, whether any trades 

are occurring, right? 

224 Geigel does not recall the phone conversation with Suh. Geigel Testimony Tr. at p. 12. 

328 
A: That’s right. 

Q: Do you think that wasn’t what you asked DTC, 

whether they could confirm that any trades were 

occurring? 

A: I’m pretty sure I didn’t ask it in those terms, but I – 

since I, unfortunately, I don’t remember what the 

conversation was, so I’m speculating about it based 

on sort of what I think my thinking was and what 

the discussions were. But I can’t say. 

Id. at pgs. 203-204. 

Suh’s recollection of the call is troubling. Madoff had testified that his 

institutional accounts were segregated from his firm’s accounts at DTC: 

Q: Is there any segregation of that account into subaccounts or some other segregation where you 

separate the institutional trading transactions from 

other firm transactions? 

A: Yes. The institutional accounts are separate from 

the firm’s accounts. 

Q: So DTC, how is that segregated? Under subaccounts within 0646? 

A: No, it’s just the one account for [the] benefit of 

clients. 

Q: I guess I’m having trouble understanding because 

my understanding is there is one account at DTC in 

the name of your firm. 

A: Right. 

Q: And it’s Account 0646. 

A: Right. 

Q: And all kinds of transactions go through it. 

... 

329 
A: There are codes that are attached to the activity that 

say whether it’s, whether it’s held for the firm or 

whether it’s held in seg. 

Q: What do you mean when you say in seg? You 

mean in segregated? 

A: Segregated.
 

... 

Q: Do you remember what these codes are? 

A: No. 

Q: But DTC would know. 

A: Yes. 

Madoff May 19, 2006 Testimony Tr. at pgs. 87-89 at Exhibit 267. Suh seemed to have 

ascribed no significance to the fact that she learned from DTC that Madoff had lied in his 

testimony about having segregated advisory positions at DTC: 

Q: So following Madoff telling you in the testimony 

that he had segregated accounts – 

A: Right. 

Q: – institutional accounts separate from the firms 

accounts, you didn't verify this with DTC? 

A: I don’t know. I don’t know if we did. I mean, I 

knew that there was a – to see after his testimony. 

Q: But did you seek any records from DTC after 

Madoff's testimony to verify this? 

A: No. 

Suh Testimony Tr. at pgs. 199-200. 

Garrity explained that learning from DTC that Madoff had lied about having 

segregated accounts at DTC was an important red flag: 

Q: [I]f it turns out that [Madoff has] represented to you 

that he does have two accounts at DTC or that he 

has a separate money management account, and it 

330 
turns out not to be the case, would that concern you 

or be a red flag? 

A: Clearly. Clearly. Because that’s a very 

fundamental misrepresentation, and it would 

concern me greatly, and I’d move pretty quickly. 

Garrity Testimony Tr. at p. 95. 

Irrespective of the concern that should have been raised by Madoff having made 

such a “fundamental” misrepresentation, Garrity explained that the Enforcement staff 

should have been concerned about Madoff’s apparent commingling of assets: 

Q: If you find out that [Madoff has] just got one 

account ... And [Madoff] says, “Well, I just – I 

never set up two accounts; I just commingle them.” 

What would be your concern about that response, 

independent of the fact that he might have earlier 

misrepresented the facts to you? 

A: Trying to divine out what accounts are for the 

broker/dealer and the money manager would be – 

would be opaque, and I’d also have – there’s a 

couple of other concerns I’d have. One is if it was 

an account in the name of the broker/dealer, my fear 

would be somehow the broker/dealer itself would 

become involved in litigation or some other action, 

someone could reach and apply and in effect attach 

that account where the beneficial interest was really 

held for the money management clients, and it 

would look like the firm’s account, especially for a 

market maker. So I would be afraid that the money 

management clients, even if all their money was in 

there, was at risk. 

... 

Because it could get effectively attached. And 

that’s why you segregate accounts, and that’s why 

it’s for the benefit of the clients rather than for the 

firm. So it insulates them from litigation. So that 

would be my first concern. My second concern 

would be about the accuracy of it, that money was 

getting siphoned off or, at a minimum, there's a 

greater chance for negligence in the accounting of 

who owns what, what does Harry, Fred, and Jane 

own as part of that account. 

331 
 

 

Q: If the assets were commingled in that manner, ... 

would that be a violation of any kind of regulatory 

requirement for broker/dealers that you know of? 

A: I don’t know about the broker/dealer regulator 

requirement, but it would be for investment 

advisers, if it was commingled like that, yes, it 

would be a problem for the custody [rule]. 

Id. at pgs. 95-97. 

Suh’s only reaction upon learning about Madoff’s apparent commingling of his 

investors’ assets was to conclude that DTC records were of no use: 

[T]he bottom line that came out of that conversation or 

those conversations [with DTC], there may have been more 

than one, was that we concluded there was no feasible – it 

wasn't feasible to confirm the trading through DTC because 

there was no way to segregate the trading for the advisory 

business into separate – the trading in any account from 

the trading of the Madoff firm. 

Suh Testimony Tr. at p. 59. (emphasis added). 

In addition to not understanding that Madoff’s apparent commingling of assets 

was a serious red flag and a violation of the federal securities laws, Suh did not 

understand that DTC records would have quickly shown that Madoff was operating a 

Ponzi scheme. Specifically, DTC records would have shown that, on any particular day 

that Madoff’s records indicated that he held equities in his advisory accounts, Madoff did 

not hold billions of dollars of S&P 100 equities for his investors as he claimed. Geigel 

Testimony Tr. at pgs. 23-24. 

For example, a January 2005 statement for one Fairfield account alone indicated 

that it held approximately $2.5 billion of S&P 100 equities as of January 31, 2005. See 

Account statement dated January 2005 for Fairfield Sentry account 1FN045, at Exhibit 

366. In fact, on January 31, 2005, DTC records show that Madoff held less than $18 

million worth of S&P 100 equities in his DTC account. Table of Madoff’s S&P 100 

Positions, at Exhibit 365. 

On May 19, 2006, the day of Madoff’s testimony with the Enforcement staff, 

DTC records show that he held less than $24 million worth of S&P 100 equities in his 

DTC account.225 Id. Similarly, on August 10, 2006, the day Madoff agreed to register as 

an investment adviser and the Enforcement staff effectively ended the Madoff 

225 These positions were associated with the firm’s own account. Geigel Testimony Tr. at pgs. 43-44. 

332 
 

 

 

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

of S&P 100 equities in his DTC account. Id. 

When Madoff’s Ponzi scheme finally collapsed in 2008, Friedman testified that it 

took only “a few days” and “a phone call ... to DTC” to confirm that Madoff had not 

placed any trades with his investors’ funds. Friedman Testimony Tr. at pgs. 21-22. 

Friedman explained: 

Well, there was no – if a trade is purportedly being 

executed, then there would be some kind of back office 

function that would true up to the trade, and there was [sic] 

no such records to reflect that anywhere. We have not been 

able to identify any records at DTC or elsewhere that would 

substantiate that any of those trades existed.... So, for 

example, when everything collapsed on December 11th, if 

all the 4,000 plus accounts had held all the assets that they 

purportedly held, then that would presumably be reflected 

in DTC that Madoff’s security firm held all these records. 

But it’s our understanding that there was no such record at 

DTC indicating, you know, very large positions in, you 

know, these pretty liquid securities that were purportedly 

being held according to the Madoff stock records. 

Id. at pgs. 19-20.226 

A combination of factors resulted in Enforcement staff’s failure to examine DTC 

records and uncover Madoff’s Ponzi scheme relatively quickly. Bachenheimer, who 

testified that obtaining third-party verification was not an “essential” part of a Ponzi 

scheme investigation, acknowledged that Enforcement staff could have pursued the 2005 

submission by contacting DTC, but explained that they had “chose[n] to pursue a 

different path”: 

Q: What I’m asking is based on the information that 

Harry Markopolos provided in the Madoff case, 

based on the abilities of the Enforcement Division, 

without that inside information or more concrete 

information, wouldn’t it have been possible for 

Enforcement to simply go to DTC and check the 

records? 

226 In his interview with the OIG, Madoff stated that reconciling records with DTC was something the 

Enforcement staff “should’ve done in ‘06.” Madoff Interview Memorandum at p. 7. Madoff stated further 

that the SEC would have discovered his Ponzi scheme if it had gone to DTC. Id. 

333 
A: I suppose it would have been possible for us to do 

that. We chose to pursue a different path, and that 

was to reach out to some of his investors. 

Bachenheimer Testimony Tr. at p. 69. 

Cheung testified that she understood that DTC records were “a way of verifying 

whether or not trades were made” but, apparently, was unaware either that Suh had 

contacted DTC, or that Suh mistakenly believed after the DTC call that DTC records 

could not verify whether trading was occurring. Cheung Testimony Tr. at p. 181. 

Finally, Suh did not understand that it was not necessary for Madoff’s claimed advisory 

account positions to be segregated at DTC in order to see that he was operating a Ponzi 

scheme. Similarly, Suh did not understand that it was not necessary to verify specific, 

individual trades in order to see that Madoff was not placing any trades at all. 

e. Enforcement Staff Halted Efforts to Obtain Records From 

Madoff’s Purported Option Counter-parties 

As discussed above, Madoff represented to the Enforcement staff that the options 

component of his split-strike conversion strategy was implemented with OTC options 

contracts and that the counterparties to those contracts were various entities in Europe 

including, inter alia, UBS of Switzerland (UBS) and the Royal Bank of Scotland (RBS). 

Madoff May 19, 2006 Testimony Tr. at pgs. 64-65, at Exhibit 267; Letter dated February 

23, 2006 from Madoff to Suh, at Exhibit 334. In its Complaint filed on August 11, 2009, 

against DiPascali, the SEC discussed Madoff’s misrepresentations regarding his 

purported options trades, alleging: 

(d) Shifting Counterparties. The advisory account records on 

[Madoff’s computer] did not reflect any counterparty 

information (because none existed). To respond to inquiries 

from regulators and auditors, however, DiPascali had to 

create credible trade blotters for the [Madoff] advisory 

business that included counterparty information. Including 

counterparties, however, created a risk of detection because 

the regulator or auditor might approach the counterparty for 

its corresponding records and compare the two. This risk 

was particularly acute for options trades because Madoff and 

DiPascali, when pressed about the volume or pricing of 

option positions, would explain that the option trading was 

not done on any exchange but directly with counterparties 

over-the-counter. To alleviate this risk, DiPascali, at 

Madoffs direction, created a list of counterparties that were 

unlikely to be approached for verification. ...[W]hen 

334 
 

 

 

 

 

regulators and auditors in the U.S. asked for the information, 

DiPascali provided a list of European financial institutions. 

SEC v. Frank DiPascali, Jr., No. 09 Civ. 7085 (LLS) (S.D.N.Y. filed August 11, 2009) at 

¶ 60 (d) (emphasis added), at Exhibit 119. 

Early in the Enforcement investigation, on December 22, 2005, Lamore suggested 

to Suh and Cheung that “we should find out more about the counterparties to these option 

transactions and the agreements/arrangements between Madoff and the counterparties.” 

E-mail dated December 22, 2005 from Lamore to Cheung, at Exhibit 314. However, it 

was not until relatively late in the Enforcement investigation, after taking Madoff’s 

testimony, that Enforcement staff made an effort to verify some of Madoff’s purported 

options trading with European counterparties.227 

In order to verify trading activity directly with the entities that Madoff claimed 

were his European OTC option counterparties, the Enforcement staff needed to involve 

the SEC’s Office of International Affairs (OIA), which the Enforcement staff was 

strongly opposed to doing. Consequently, the staff considered requesting documents for 

two of those entities through their domestic affiliates. E-mail dated June 16, 2006 from 

Suh to Cheung, at Exhibit 368. 

On June 16, 2006, Suh e-mailed Cheung a draft document request to UBS. 

June 16, 2006 Document Request to UBS Financial Services, Inc., at Exhibit 367. The 

draft UBS document request sought, in relevant part, Madoff’s account statements, 

account opening documents, and “any documents evidencing the transfer of funds or 

securities into or out of” Madoff’s account from January 1, 2005 through the date of the 

request. Id. 

After Cheung approved the draft, Suh asked, “We don’t have to go through OIA 

when we are sending the request to the domestic subsidiary, even if the account is with 

the foreign subsidiary, correct?” E-mail dated June 16, 2006 from Suh to Cheung, at 

Exhibit 368. Cheung answered, “No OIA for domestic subs. Luckily enough for us.” Id. 

Suh replied, “Great. I will send a similar request to RBS Greenwich Capital – one of two 

domestic [broker-dealer] subsidiaries of RBS.” Id. 

Suh sent the document requests to UBS and RBS on June 16, 2006. On June 20, 

2006, Suh e-mailed Cheung regarding the UBS request: 

I suspect that we may run into a problem with this request. 

A guy from UBS called me this morning to get Madoff's 

tax [ID] number. He asked if we believe Madoff has 

accounts at UBS; when I told him that we believe so, but 

the account may have been opened with a foreign affiliate, 

227 Lamore was unaware that Suh had ever made any effort to obtain documents from the counterparties. 

Lamore Testimony Tr. at p. 42. Lamore testified that he was not “involved in the investigation postMadoff testimony.” Id. at pgs. 249-250. 

335 
 

he said that they do not have access to that data from here 

and that we would have to approach the foreign affiliate 

directly. Of course, our request, as usual, defined UBS to 

include foreign affiliates, but I did not want to get into a big 

discussion with him without getting a clearer idea of what 

our ground rules are for this situation. Do you think this is 

something that warrants a consultation with OIA? Thanks. 

E-mail dated June 20, 2006 from Suh to Cheung, at Exhibit 369. 

Cheung forwarded Suh’s e-mail to Jill Slansky, another Enforcement staff 

attorney Cheung supervised, for her thoughts on the issue. Slansky responded: 

I would call OIA but it seems to me that if it’s a UBS 

affiliate they are required to produce it. The burden should 

be on them to get the info. Otherwise you are going to 

have to go through all of the OIA crap and it will take you 

forever to get the documents. 

Id. Cheung replied, “I hate OIA – they are probably the slowest part of our bureaucracy, 

and that is saying a lot.” Id. 

Suh followed up on the document requests with several phone calls to UBS and 

RBS representatives. Suh summarized these conversations in a contemporaneous phone 

log. Suh’s Phone Log, at Exhibit 349. Suh testified that UBS was able to provide 

documents involving a Madoff account, but the information was “completely different 

from what we were looking for, like [a] different account number ... It seemed to be 

unrelated to the money-management business.” Suh Testimony Tr. at p. 213. See also 

Letter dated June 28, 2006 from Zawacki to Suh, at Exhibit 370; letter dated June 30, 

2006 from Rizzo to Suh, at Exhibit 371; Suh’s UBS Production notes, at Exhibit 372. 

Suh was also in contact with the domestic entities at RBS and RBS Greenwich Capital. 

Both institutions informed Suh that they did not have any records for Madoff. Suh 

Testimony Tr. at pgs. 213-214. 

Suh explained the difficulty she had encountered while attempting to obtain 

relevant documents from the European counterparties without involving OIA: 

We were trying to – RBS and UBS were, according to 

Madoff, counterparties of his options trade actions, so we 

were trying to go to the domestic subsidiaries to get records 

of those trades to confirm those trades. And they 

responded that because the accounts that we were interested 

in were with the foreign affiliates that are separate legal 

entities they can’t help us and we have to go to those 

separate – to those entities directly. 

Suh Testimony Tr. at p. 209. 

336 
 

 

 

 

During the OIG investigation, Bachenheimer, Cheung and Suh defended the 

decision not to involve OIA and seek verification of Madoff’s options trades directly with 

the European counterparties that he identified. Bachenheimer testified that: 

I don’t know that we would have ever been able to get the 

documents out of Europe because I always had great 

difficulty getting documents out of Europe and was only 

successful when I was working with the U.S. Attorneys 

Office. I don’t know that we would have ultimately gotten 

the documents. I think it’s not unreasonable for you to 

draw that conclusion, but I can’t say with certainty that’s 

right. 

Bachenheimer Testimony Tr. at p. 162. 

Cheung testified, “I found that OIA was very, very slow and that if we could find 

ways to – if we could find ways to get documents without involving OIA, we were better 

off.” Cheung Testimony Tr. at p. 211. Suh testified, “I guess the reputation of – or the 

impression [I had was] that trying to get records from overseas going through OIA is 

always very lengthy and often unfruitful.” Suh Testimony Tr. at p. 207.228 

Notwithstanding the difficulties Suh encountered in trying to obtain relevant 

records without OIA’s involvement, RBS did offer to provide its overseas account 

information if Madoff signed a consent form. Suh’s Phone Log at pgs. 4-5, at Exhibit 

349. RBS even drafted the consent letter for the SEC staff. Id. at p. 7; E-mail dated July 

26, 2006 from RBS to Suh, at Exhibit 374. However, the staff decided to withdraw the 

request. Suh’s Phone Log at p. 7, at Exhibit 349. 

Suh’s phone log indicates that on July 13, 2006, David Meisels, Senior Counsel of 

RBS, was in the process of drafting the consent letter asking Madoff’s permission to send 

the Enforcement staff the documents from RBS’s Edinburgh branch: 

228 At the OIG’s request, OIA prepared a memorandum discussing the assistance that OIA could have 

provided the Enforcement staff during the Madoff investigation. July 20, 2009 Memorandum from OIA to 

the OIG Re: “Framework for Cooperation with United Kingdom Financial Services Authority,” at Exhibit 

373. As discussed above, most of the foreign broker-dealers and options counterparties that Madoff 

claimed to execute trades with for his investors were located in the United Kingdom. The 1991 Bilateral 

Memorandum of Understanding (1991 MOU) among the SEC, the United Kingdom’s Department of Trade 

and Industry and the United Kingdom’s Securities and Investments Board, provides that the SEC can 

request and obtain information about, inter alia: “[t]he conduct of investment businesses or securities 

processing businesses.” Id. at p. 1. The SEC can, through OIA, request the United Kingdom’s Financial 

Services Authority to provide, inter alia: “specified information and documents from persons in the UK.” 

Id. at p. 2. Furthermore, through OIA and pursuant to the 1991 MOU, the SEC has requested in the past 

documentation that would have been key to establishing whether Madoff was trading with European 

counterparties, including trading instructions, trading authorizations, option agreements, and electronic 

trade runs indicating purchases, sales, and short sales of securities. Id. at pgs. 2-3. 

337 
 

[Meisels] will send me [a] draft of their letter to Bernie 

asking for the permission to send us the documents from 

the Edinburgh branch. I told him that at that point, we 

might call Bernie as a courtesy to let him know that he’ll be 

getting the request. 

Id. at p. 6. The phone log also indicates that on July 27, 2006, Suh left a message for 

Meisels, informing him that the Enforcement staff had decided not to pursue the request 

at that time: 

Thank[ed] him for sending us [a] draft of [the] letter to 

Madoff, asking release of information; told him that we 

decided not to pursue the request at the moment and asked 

him not to send the letter to Madoff unless he hears from us 

again. 

Id. at p. 7 (emphasis added). The consent letter was never sent to Madoff, and Suh 

testified that Cheung made the decision to not send it: 

And I spoke to Meaghan about it and asked whether we 

would pursue this and she said no. And that was very close 

to the end of the investigation, it was in July, and the focus 

at that time was on the registration issue. In retrospect I do 

think that that’s an avenue we should have pursued. 

Suh Testimony Tr. at p. 61. 

Cheung testified, however, that she likely would not have made a decision 

not to pursue getting Madoff’s consent without consulting with Bachenheimer first: 

Q: Now, just to be fair to you, if you had made this 

decision not to pursue getting Madoff's consent 

for the counterparties to send trading records to 

you, would you have made that decision without 

checking with Doria? 

A: I don’t think so. 

Cheung Testimony Tr. at p. 217. Cheung also testified that she did not “believe that I 

unilaterally said ‘stop it, we’re done, that’s enough.’” Id. at p. 218. Cheung did 

acknowledge, however, that if the Enforcement staff had sent the consent letter and 

received Madoff’s permission to obtain his account information, she believed “we would 

have” uncovered the Ponzi scheme. Id. at pgs. 216-217. Bachenheimer testified that she 

had no recollection of Cheung raising the issue with her and said she could not think of 

any reason not to follow up with the consent letter. Bachenheimer Testimony Tr. at pgs. 

135-136. 

338 
 

 

 

 

In a written submission made by Cheung’s attorney after her testimony, Cheung 

asserted: 

We cannot be certain why the effort to obtain the foreign 

records was not pursued. One possible reason is that given 

the scarcity of resources and the difficulty of obtaining 

such records, it made more sense at the time to reach a 

settlement requiring Madoff to register as an Investment 

Adviser subject to additional exams rather than to persist in 

an investigation which thus far had not uncovered evidence 

of a Ponzi scheme. 

July 24, 2009 Submission on Behalf of Meaghan Cheung at p. 15. 

Suh reflected on the decision not to send Madoff the consent letter, and believed 

that had the letter been sent, “[Madoff ] may not have given a consent, but certainly if he 

– had he refused it would have raised the suspicion level much higher.” Suh Testimony 

Tr. at pgs. 86-87 (emphasis added). Suh also testified that if Madoff had withheld his 

consent, the Enforcement staff might have pursued obtaining a formal order from the 

Commission. 

229 Id. at pgs. 217-218. 

However, as Cheung acknowledged in testimony, as long as the Enforcement 

staff’s investigative efforts were spent comparing documents Madoff produced to the 

229 The SEC’s Enforcement Manual describes the purpose of a formal order of investigation and the 

process by which the staff requests that the Commission issue a formal order: 

The staff cannot issue investigative subpoenas to compel testimony or 

the production of documents unless the Commission issues a formal 

order of private investigation. ... [The formal order] designates specific 

staff members as officers for the purposes of the investigation and 

empowers them to administer oaths and affirmations, subpoena 

witnesses, compel their attendance, take evidence, and require the 

production of documents and other materials. 

... 

The staff may recommend that the Commission issue a formal order by 

presenting an action memorandum to the Commission: 

... 

[The staff should] keep the following considerations in mind when 

deciding whether to seek a formal order: 

... 

[I]s a subpoena needed to obtain bank or telephone records? Are there 

persons who will not agree to testify under oath or to provide 

documents unless subpoenaed? 

2008 SEC Enforcement Manual, at pgs. 20-21, at Exhibit 296. 

339 
 

SEC with documents that Madoff had created for his investors, a formal order would not 

have been helpful: 

I think in every investigation there’s a discussion about 

whether we need a formal order, but at this point in time, I 

think there were sort of two important answers here. And 

the first is that because Madoff Investment Securities was a 

registered broker-dealer, any written request from the 

enforcement staff or from anyone at the SEC has the same 

force of law as a subpoena. You know, registered – 

registered entities have to respond to written document 

requests and produce them. So a subpoena wouldn’t be any 

stronger with Mr. Madoff than an enforcement document 

request is. 

Cheung Testimony Tr. at p. 157. See also July 24, 2009 Submission on Behalf of 

Meaghan Cheung at p. 13 (stating that the Enforcement staff had “believed that they 

could obtain the documents and testimony needed to conduct the investigation without 

having the authority to issue a subpoena”). 

Ricciardi explained why having a formal order would not have helped the 

Enforcement staff obtain any more, or different, documents from Madoff, “If someone is 

going to lie to you about ‘These are all of my books,’ and not give you the second set in 

the drawer, I don’t know that having the subpoena [would help].” Ricciardi Testimony 

Tr. at p. 48. 

A formal order might have been helpful at this point in the investigation had the 

Enforcement staff wanted to pursue obtaining documents from Madoff’s purported OTC 

option counterparties. Ricciardi testified regarding the value of a formal order in a Ponzi 

scheme investigation: “[T]he main reason for the subpoena is that there are some honest 

people who may be a counterparty, who can then give you information, and on an 

informal basis they really cannot give it necessarily.” Id. 

Cheung testified that obtaining a formal order at the time of the 2006 Madoff 

investigation was somewhat difficult, stating: 

[T]o get a formal order at that point in time with the 

Commission as it was constituted at that point, the 

threshold question was what have you asked for that you 

haven't gotten. And that’s something that you’ll see on the 

short form, formal order memorandum for insider trading. 

In particular, it means what document have you asked [for] 

that you have – what is the staff’s need for a formal order 

here? 

Cheung Testimony Tr. at p. 157. See also July 24, 2009 Submission on Behalf of 

Meaghan Cheung at p. 13 (stating that “the Commission as then constituted had made 

340 
 

clear to the Staff that it would not approve formal orders unless the Staff could 

demonstrate that they had been deprived of documents because they were not able to 

issue a subpoena”). 

Bachenheimer also referenced the Commission’s resistance to issuing formal 

orders at that time when she testified that, in her view, seeking confirmation of the OTC 

options contracts with counterparties was “not something [she] would have done.” 

Bachenheimer Testimony Tr. at pgs. 31-32: 

At this period of time, actually, that’s something that 

probably would have been frowned upon by the 

Commission. It’s not something that we did routinely and 

it’s not something I would have done during this period of 

time....We certainly didn’t have enough here to go to a 

counterparty to suggest that Mr. Madoff was doing 

anything wrong, and to raise that suggestion in this 

Commission in 2005 would have been viewed as the wrong 

way to go about this. 

Id.230 

Regardless of the Enforcement staff’s perception of the difficulties in obtaining a 

formal order from the Commission, the OIG found no evidence that the staff’s perception 

was a factor in its conduct of the 2006 Madoff investigation. A formal order was not 

necessary for the Enforcement staff to obtain documents from DTC or other independent 

third parties. Nor was one necessary for Enforcement staff to ask Madoff for his consent 

to have RBS produce account records. Suh testified that the decision not to pursue 

“Madoff's consent for the counterparties to send trading records to us directly ... was the 

wrong call” and “the main call that I am frustrated about”: 

A: I do question some of the choices that were made 

and I particularly – it seems like the question of 

verifying the transactions with – from independent 

sources, it was on the radar throughout but it seems 

like it could have been made more central and we 

could have just focused on that question as opposed 

to spending more time trying to figure out how 

Madoff portrayed his trading to others. And the 

main question that, you know – as you can imagine 

I have been thinking a lot about what happened, and 

the main call that I am frustrated about is the call 

230 Bachenheimer’s testimony that seeking confirmation of the OTC options contracts with counterparties 

was “not something [she] would have done” because the Commission would not have approved that course 

of action is belied by the fact that the Enforcement staff did approach the counterparties about Madoff’s 

trades; they just failed to follow through. Moreover, Bachenheimer contradicted her testimony on this 

point when she testified that she could not think of any reason not to send Madoff the RBS consent letter. 

Bachenheimer Testimony Tr. at pgs. 135-136. 

341 
 

 

 

 

not to pursue further this getting Madoff’s consent 

for the counterparties to send trading records to us 

directly. And I do think that that was the wrong call 

and I wish it was a different call. 

... 

Q: I just want to be clear, who in your mind or – made 

that call? 

A: Meaghan. 

Suh Testimony Tr. at pgs. 86-87.231 

If the Enforcement staff had pursued RBS’s offer to provide documents subject to 

Madoff’s consent, and Madoff had consented, the staff would have learned that Madoff 

had no OTC contracts with RBS, which would have been a significant red flag that 

Madoff was operating a Ponzi scheme. If Madoff had refused to consent to the 

production of documents from RBS, a formal order would have likely been pursued and 

the information obtained through subpoena. 

f. Enforcement Staff Never Thought to Trace the Movement of 

the Investors’ Funds 

As discussed above, Madoff claimed to have purchased billions of dollars of S&P 

100 equities from certain European securities dealers. Had that been true, then Madoff 

would have wired billions of dollars from a bank account to those dealers. In his 

allocution, Madoff explained how his investors’ funds were actually handled: 

I never invested the[] funds in the securities, as I had 

promised. Instead, those funds were deposited in a bank 

account at Chase Manhattan Bank. When clients wished to 

receive the profits they believed they had earned with me or 

to redeem their principal, I used the money in the Chase 

Manhattan bank account that belonged to them or other 

clients to pay the requested funds. ... Among other means, 

I obtained their funds through interstate wire transfers they 

231 See also Suh Testimony Tr. at p. 61: 

I believe it was UBS, one of the two suggested that we get Madoff’s 

consent to get the records from the foreign affiliate and even provided 

the consent letter – or the draft consent letter. And I spoke to Meaghan 

about it and asked whether we would pursue this and she said no. And 

that was very close to the end of the investigation, it was in July, and 

the focus at that time was on the registration issue. In retrospect I do 

think that that’s an avenue we should have pursued. 

342 
sent from [other] financial institutions ... to the bank 

account of my investment advisory business.... 

March 12, 2009 Allocution Testimony Tr. at pgs. 24-25. 

Michael Kress, a Broker-Dealer Examinations Branch Chief in NYRO, testified 

that tracing the movement of the investors’ funds was a fundamental aspect of a Ponzi 

scheme investigation, stating: 

Q: If I were doing a Ponzi review, what steps would I 

take and what records would I seek? 

A: You would need custodial records from the 

custodian, you would need the bank accounts to see 

the movement of funds coming in and out ... 

Kress Testimony Tr. at p. 25. 

Bachenheimer acknowledged that verifying assets was something “you would 

normally look at in connection with investigating a Ponzi scheme.” Bachenheimer 

Testimony Tr. at pgs. 123-124. However, she apparently did not consider it necessary to 

obtain bank records to verify the proper movement of funds, as evidenced by the 

following exchange in her testimony: 

Q: Was there any request at any point made to Bernie 

Madoff to show where the bank accounts were for 

this very, very large investment adviser business, 

show where the money was? 

A: I thought Peter and Simona had looked at that, and I 

thought they had seen where the money was, when 

it went into cash in particular. I thought they had 

seen that and knew where that was and it was all 

there and accounted for. 

Q: And Madoff had given them bank account 

information? 

A: I don’t know. 

Q: Is it possible that based on your understanding that 

you had just seen internal records that Madoff kept 

that reflected say at year end he was all in cash? 

A: That is possible; yes. 

343 
 

 

Q: That would be consistent with what your 

understanding was at the time, that they – 

A: I don’t know. I’m sorry to cut you off. I don’t 

remember what my understanding was at the time, 

but that is entirely possible that’s what they saw. 

Id. at pgs. 124-125. 

In fact, the Enforcement staff never asked Madoff to produce any bank records 

that evidenced the use of his investors’ funds to purchase equities or OTC option 

contracts. Suh testified: 

Q: So, it looks like no one ever asked in his testimony, 

“Where do you maintain your bank account or 

accounts that handles [sic] this money?” Is that 

correct? 

A: I think that’s right as to the testimony. 

Q: And no one ever asked to see bank statements – 

A: Yes, that’s right. 

Suh Testimony Tr. at pgs. 195-196.232 Suh testified further that “the issue of getting bank 

records was never raised, never suggested”: 

Q: ... That is different than the issue of custody as it 

relates to a Ponzi scheme investigation where 

232 

344 
you’re wanting to literally trace the money. 

Where’s the money coming from? Where’s it going 

to? For example, if he’d been placing trades with 

these counterparties in Europe, then wherever the 

bank account was the money would be being wired 

out to them, right? 

A: Right. 

... 

Q: And no one ever asked to see bank statements – 

A: Yes, that’s right. 

... 

Q: And that was never discussed with Doria – 

A: Bank records, no, not at all. 

... 

A: ... I have to say the issue of getting bank records 

was never raised, never suggested... 

Id. at pgs. 195-197. 

Cheung and Suh apparently did not understand that a financial institution would 

have to be involved in the movement of funds to and from Madoff’s investors, securities 

dealers, and OTC option counterparties. Cheung testified: 

Q: I mean, this is a real critical issue in a Ponzi scheme 

case ... where the money is. ... Then the question 

is: Did anyone ever go to that financial institution 

to determine what the activity was? 

A: Well, I do think that Fairfield was asked. I do not 

know – I do not know whether the financial 

institutional – and I don’t know whether there was a 

financial institution or it could go straight into the 

broker-dealer. 

Q: You think the broker-dealer could be set up with the 

Federal Reserve so that money could be wired 

directly to it and out of it? 

345 
 

A: No, I don’t. I’m not sure. I’m not sure how money 

got to the broker-dealer. I don’t remember at this 

point what I knew then. 

... 

Q: Did you think about following up beyond Fairfield 

with some financial institution to see if there was 

money there? 

A: I don’t know. I thought that the money was at the 

broker-dealer. 

Q: The broker-dealer was like a bank? 

A: No. That the broker-dealer was – was holding the 

money that it was using to purchase – to purchase 

securities. 

Cheung Testimony Tr. at pgs. 151-153. Suh testified: 

Q: Well the actual money, even if it’s – even if he’s his 

own custodian, has to be held at a financial 

institution, correct? I mean, I assume your 

impression wasn’t that he kept billions of dollars in 

a safe? 

A: Right. I – actually, I don’t know the answer to that. 

Suh Testimony Tr. at p. 117. Suh testified further: 

A: I can’t say that I understood how the operation 

works in terms of the flow of the cash. .... 

... 

Q: I mean, he has all this money that he’s trading, 

right? 

A: Right. 

Q: Where did he keep it? 

A: My impression was that he kept it at the brokerage 

firm, but I don’t have – my impression was 

basically between when he sells and when he buys 

again it stayed within the brokerage firm. 

... 

346 
Q: But the brokerage firm has to have an account, 

right? I mean, when customers want to invest with 

him they have to be able to wire money somewhere, 

right? 

A: Right. 

Q: When they want to redeem monies it has to be 

wired out of an account, right? 

A: Right. 

Q: And that account has to be at a financial institution, 

a bank account, right? 

A: I think that’s right. I don’t think I thought about it 

that – 

Id. at pgs. 193-194. 

Suh acknowledged that the Enforcement staff would have discovered Madoff’s 

Ponzi scheme if they had examined the relevant bank records: 

Q: If you had seen bank statements that showed that 

there was no money going to – independent of what 

the details of the trades, if you’d just seen bank 

statements that showed there was no money going 

to counterparties in Europe or dealers in Europe for 

equity trades, wouldn’t that have been a complete 

confirmation that he was running a Ponzi scheme? 

A: Probably. I mean, I have to say the issue of getting 

bank records was never raised, never suggested, so– 

Q: I’m just asking you if it had been and if the bank 

records had shown no monies going to 

counterparties for options trades or dealers for 

equity trades, in your opinion would that have been 

just absolute evidence that he must be running a 

Ponzi scheme? ... 

... 

A: I mean, of course. 

Id. at pgs. 197-198. 

347 
 

 

On March 10, 2009, the U.S. Attorney for the Southern District of New York filed 

a criminal information charging, inter alia, that between 2002 and 2008, “[Madoff] 

caused more than $250 million of [his] investment advisory clients’ funds to be directed, 

through a series of wire transfers ... to accounts held by [his affiliate] in London, United 

Kingdom....” March 10, 2009 Madoff Criminal Information at ¶ 11, at Exhibit 376. 

According to the criminal information, “Madoff directed these funds transfers, in part, to 

give the appearance that he was conducting securities transactions in Europe ... when, in 

fact, he was not conducting such transactions.” Id. 

In his allocution, Madoff admitted that, in an effort to conceal his fraud, he “wired 

money between the United States and the United Kingdom to make it appear as though 

there were actual securities transactions executed on behalf of [his] investment advisory 

clients.” March 12, 2009 Allocution Testimony Tr. at p. 28. He admitted further that 

“...I caused money from the bank account of my fraudulent advisory business [in the 

U.S.] to be wire transferred to the London bank account of [affiliate] Madoff Securities 

International Limited.” Id. at p. 29. 

Madoff’s efforts to conceal his fraudulent activities, however, would not have 

withstood any real scrutiny. A complete tracing of the investors’ funds would not have 

ended at the London affiliate. Unless Madoff could have demonstrated that the funds 

were transferred from the London affiliate to the securities dealers he had identified, his 

Ponzi scheme would have been revealed. In fact, a complete tracing of the funds would 

have shown that after transferring funds to his London affiliate, Madoff transferred those 

funds back to his account in New York. March 10, 2009 Madoff Criminal Information at 

¶ 11, at Exhibit 376; March 12, 2009 Allocution Testimony Tr. at pgs. 28-29. 

g. The Investigation Effectively Stopped in August 2006 After 

Madoff Agreed to Register as an Investment Adviser 

As discussed above, the primary issue on which the Enforcement staff focused 

throughout 2006 was whether Madoff was required to register as an investment adviser. 

The Enforcement staff decided that Madoff was not eligible for the broker-dealer 

exemption of the Investment Advisers Act of 1940, because he managed more than 

fifteen discretionary accounts.233 Cheung Testimony Tr. at p. 226. Madoff informed the 

Enforcement staff on July 21, 2006 that he had retained Brandon Becker from the law 

firm of WilmerHale to refute the SEC’s interpretation of the rule. E-mail dated July 21, 

2006 from Suh to Cheung, at Exhibit 377. Upon hearing the news, Suh e-mailed Cheung: 

233 Although, IM assisted Enforcement with this issue, Suh expressed frustration with IM: 

Well, with IM, I have to say I had a very difficult time getting a 

response from them, myself, on this matter and also a matter that I had 

earlier, which, you know, the commission overcharge case. So their 

answers ultimately were helpful and correct, but getting the answers 

was very difficult and took many phone calls and e-mails. 

Suh Testimony Tr. at p. 228. 

348 
 

 

 

Well, Bernie is one step ahead of us: He just called me to 

say that he and his counsel do not agree with our 

interpretation of the rule and do not believe the accounts 

are advisory accounts. 

Id. Suh forwarded the news to Lamore on the same day, prompting him to respond on 

July 24, “Thanks for the update. I suppose that if he has finally obtained counsel, then he 

believes there is an issue.” Id. 

Two weeks later, on August 7, 2006, the Enforcement staff (along with “a whole 

bunch of people from IM”) had a phone call with Madoff and Becker, who “fought hard” 

to keep Madoff from registering. Suh Testimony Tr. at p. 231. However, Becker called 

Cheung on August 10, 2006, and informed her that Madoff would register as an 

investment adviser. E-mail dated August 10, 2006 from Cheung to Bachenheimer, at 

Exhibit 378. Cheung e-mailed Bachenheimer, Suh and Lamore, “Brandon Becker ... just 

called to say that Bernie has decided to register as an investment adviser.” Id. Cheung 

added in a subsequent e-mail, “Purely, I think, from Simona’s persuasiveness on 

Monday’s call.” Id. 

Suh testified that after she received Cheung’s August 10, 2006 e-mail, she 

considered the Madoff investigation finished: 

And a couple of days after [the August 7] call Meaghan emailed me saying that she heard from Becker and that 

Madoff will register. In the weeks leading up to that call, 

you know, the instruction that I understood was registration 

was the goal at that point and so once I got that e-mail I 

kind of assumed we were done. 

Suh Testimony Tr. at p. 231 (emphasis added).234

 Bachenheimer testified that she had believed forcing Madoff to register as an 

investment adviser “would help the situation.” Bachenheimer Testimony Tr. at p. 37. 

She explained: 

[M]y thoughts on the investment adviser piece of this was it 

would help the situation – he was doing this without being 

– he was conducting this activity without being registered. 

Without being registered, he had no books and records’ 

requirement as an investment adviser. If we could get him 

to register, he would have to keep all the books and records 

that are required under Section 204 of the Advisers Act. 

234 From the end of July 2006 until January 2007, Suh was out of the office on maternity leave. Suh 

testified that no active work was done on the case after Madoff agreed to register in August 2006. Suh 

Testimony Tr. at pgs. 230-232. 

349 
 

 

 

He would have to have a compliance program, and he 

would be subject to an examination by our IA team. 

Id. 

Cheung testified that forcing Madoff to register as an investment adviser was a 

“good result” from the investigation: 

A: ... I think it was a good result. I thought it would – 

I think it’s also a way to expose him to more – to 

exams from the other set of examiners. 

Q: More exams? 

A: But – at the time that seemed like a beneficial 

result. I think – I think it seemed very obvious that 

he needed at a minimum to register. 

Cheung Testimony Tr. at p. 228. Cheung added, “[O]ne of the reasons that registration 

felt really important to us was to – keep opening him to extra regulatory scrutiny, you 

know, in case there was something that we just weren't able to find. Id. at p. 257 

(emphasis added).235 See also July 24, 2009 Submission on Behalf of Meaghan Cheung 

at p. 8, at Exhibit 281 (stating that Madoff’s agreement to register as an investment 

adviser had been viewed by the Enforcement staff as “a positive development for law 

enforcement” because, inter alia, Madoff would “be subject to continued on-site 

inspections”). 

h. Enforcement Staff Officially Closed the Investigation in 

January 2008, Characterizing it as a “Fishing Expedition” 

On January 3, 2008, more than two years after the Enforcement staff had received 

the 2005 submission, the Enforcement staff officially closed the Madoff investigation. 

Case Closing Report dated January 3, 2008, at Exhibit 379. Between August 2006, when 

Madoff agreed to register as an investment adviser, and January 3, 2008, when the matter 

was officially closed, the investigation was inactive: 

A: ...And a couple of days after that call Meaghan emailed me saying that she heard from Becker ... 

that Madoff will register. In the weeks leading up 

to that call, you know, the instruction that I 

understood was registration was the goal at that 

point and so once I got that e-mail I kind of 

assumed we were done. 

235 Despite Cheung’s testimony that having Madoff register as an investment adviser was a meaningful 

result of the Madoff investigation, as discussed in more detail below, the SEC’s investment adviser 

examination staff never conducted an examination of Madoff after he registered. 

350 
 

Q: So it was just kind of wrapping it up? 

A: Right. 

Q: And then you were out on maternity leave so you 

waited to wrap it up until after you came back? 

A: Right. 

Q: Okay. So there was no active work that you're 

aware of on the case while you were on maternity 

leave? 

A: That’s right. 

Suh Testimony Tr. at pgs. 231-232. Suh also explained that the decision to close the 

investigation was made much earlier than January 2008: 

A: ...Well, I should clarify that there often is and there 

was in this case, a substantial lag between when the 

decision to close and when actual closing happens. 

Q: How come? 

A: Because [officially closing an investigation is] not a 

high-priority task and people know that they're 

supposed to do it but it also requires organizing a lot 

of paper and it’s unpleasant and not [a] high-priority 

task, so there is often [a] substantial lag. So the 

decision to close was made much earlier than the 

closing happened. 

Id. at p. 237. 

In fact, on January 11, 2007, three days after Suh had returned from maternity 

leave, Suh e-mailed Lamore and Johnson asking them to bring her their files related to 

the Madoff investigation because she was “preparing [the] case for closing.” E-mail 

dated January 11, 2007 from Suh to Lamore, at Exhibit 380. On January 16, 2007, Suh 

e-mailed Johnson a reminder about her request, adding, “Sorry to bother you again – I 

guess I can’t wait to lay this case to rest.” Id. (emphasis added). 

351 
 

 

 

 

 

(1). The Enforcement Staff Ignored Additional, Troubling 

Information About Madoff While the Investigation Was 

Inactive for 18 Months 

During the 18 months that the investigation was inactive, the Enforcement staff 

received additional information regarding Madoff. On December 14, 2006, the SEC’s 

Office of Investor Education and Advocacy (OIEA) forwarded to Suh a letter regarding 

Madoff from an anonymous “concerned citizen.” The letter had been sent to Chairman 

Cox on December 6, 2006.236 Forwarded Letter dated December 6, 2006 to Cox, at 

Exhibit 381. The letter stated: 

Your attention is directed to a scandal of major proportion 

which was executed by the investment firm Bernard L. 

Madoff ... Assets well in excess of $10 Billion owned by 

the late Norman F. Levy, an ultra-wealthy long time client 

of the Madoff firm have been “co-mingled” with funds 

controlled by the Madoff company with gains thereon 

retained by Madoff. 

Id. 

The letter was sitting in Suh’s office when she returned from maternity leave in 

January 2007. Suh Testimony Tr. at p. 232. Suh “checked the account list that [she] had 

for Madoff and ... didn’t see [the name Levy] among the accounts that [Madoff had 

provided].” Id. at p. 232. According to Suh’s phone log, she called Brandon Becker on 

January 8, 2007, “to find out from Bernie whether he ever managed money for Norman 

F. Levy,” the investor referenced in the anonymous letter. Suh’s Phone Log, at p. 7, at 

Exhibit 349.237 

On January 9, 2007, Suh e-mailed Cheung, “Brandon Becker has called me to 

report that Bernie says he has not managed money for Norman F. Levy, the investor 

referenced in the anonymous letter.” E-mail dated January 9, 2007 from Suh to Cheung, 

at Exhibit 382. Cheung responded, “Then I think we are done and do not have to worry 

any further.” Id. (emphasis added). Exactly one week later, on January 16, 2007, the 

Enforcement staff began closing the investigation. See E-mail dated January 11, 2007 

from Suh to Lamore, at Exhibit 380. 

236 Chairman Cox testified that he never saw this letter. Cox Testimony Tr. at p. 12. Cox explained letters 

such as this one were reviewed by the Chairman’s Correspondence Unit within his office and assigned to 

various SEC staff persons for the appropriate action. Id. at p. 13. The letter was sent to Chairman Cox’s 

office on December 6, 2006, but the letter indicated that the sender had addressed the letter to Cox once 

before, on April 26, 2006. Letter dated December 6, 2006 to Cox attached hereto as Exhibit 381. 

However, the OIG found no evidence that Cox’s office, or any other part of the SEC, received the letter in 

April 2006. 

237 Suh’s phone log also indicates that on July 24, 2006, she spoke with Becker and “[c]onfirmed that 

Wilmer Hale’s representation of Madoff is limited to application of Rule 202(a)(11)-1 [dealing with the 

registration of investment advisers] and that we will continue to talk to Madoff directly on other issues; 

agreed to get a letter from Madoff confirming the scope.” Suh’s Phone Log at p. 7, at Exhibit 349. 

352 
When asked why the Enforcement staff dismissed the tip solely on the basis of 

Madoff’s denial, which was communicated through counsel, Bachenheimer testified: 

Yeah, I think you have to look at the context of this, and 

that is once Mr. Madoff, I guess – Simona now viewed 

Brandon Becker to be representing Madoff. We would, of 

course, reach out to Madoff's counsel, you know, send him 

a document request, do whatever we would have to do. As 

a member of a top firm, as a member of the Bar, we would 

expect him to investigate and report back to us and rely on 

the answer. 

Bachenheimer Testimony Tr. at p. 150. Likewise, Cheung explained why she had 

thought Becker’s response was sufficient: 

A: I can – I can at least say that coming through – it 

coming through – it coming through Brandon 

Becker gave it more weight in my mind and coming 

through a reputable counsel gave it more weight in 

my mind. And Mr. Madoff involving reputable 

counsel actually gave me some more comfort about 

answers. 

Q: But don’t you think Brandon Becker would have 

just gone to Bernie Madoff and asked him and taken 

his word for it? I mean, Brandon Becker certainly 

isn’t responsible to go beyond talking to his client. 

That's something the SEC should do. 

A: At the time, I took more comfort from the fact that 

there was a lawyer involved. I – I’m not disputing 

anything you guys are saying about wishing we had 

done things differently. 

Cheung Testimony Tr. at p. 246. Suh testified that accepting Becker’s representation 

without question was justified because, “the letter was anonymous and did not just – on 

its face it would not have been credible.” Suh Testimony Tr. at p. 233. 

It is extremely curious that when the staff received a tip that Madoff had stolen 

from Levy, they simply accepted Madoff’s claim that he had not managed money for 

Levy as an explanation for the tip. An accused fraudster’s unsubstantiated denial of 

wrongdoing is insufficient grounds for concluding that the accusation is without merit. In 

this instance, the staff also knew that Madoff had previously lied to them about several 

issues, including the number and identity of his clients. 

353 
 

 

 

 

Contrary to Madoff’s representations through his counsel, when news of Madoff’s 

Ponzi scheme broke, it became evident not only that Madoff managed Levy’s money, but 

also that Levy was actually one of Madoff’s largest investors. Levy’s foundation JEHT – 

which stood for “Justice, Equality, Human Dignity and Tolerance” – was forced to close 

in January 2009 due to the millions of dollars it lost in Madoff’s Ponzi scheme. See 

Philip Boroff, “Madoff Fraud Case Leads to Collapse of Justice-Reform Advocate,” 

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aj3r8k36.3Y8 (December 

16, 2008), at Exhibit 384. Levy was not only an important investor, but also considered 

Madoff one of his closest confidants.238 

On June 29, 2007, approximately six months after the Enforcement staff 

dismissed the Levy tip, Markopolos e-mailed Cheung: 

Hello Meaghan, Attached are some very troubling 

documents that show the Madoff fraud scheme is getting 

even more brazen.... Madoff couldn’t possibly be 

managing the billions in this strategy unlevered, much less 

levered. I thought you would want to see these Wickford 

documents. When Madoff finally does blow up, It’s going 

to be spectacular, and lead to massive selling by hedge 

fund, fund of funds as they face investor redemptions. 

E-mail dated June 29, 2007 from Markopolos to Cheung, at Exhibit 383 (emphasis 

added). 

Cheung acknowledged that when she received this e-mail from Markopolos, the 

Madoff investigation was “for all intents and purposes closed without the formalities.” 

Cheung Testimony Tr. at pgs. 254-255. Cheung did not know whether Markopolos’ 

e-mail and attachments were given “significant analysis.” Id. at p. 255. On June 29, 

2007, Cheung forwarded Markopolos’ e-mail to Suh, but Suh did not recall receiving the 

e-mail. E-mail dated June 29, 2007 from Markopolos to Cheung, at Exhibit 383; Suh 

Testimony Tr. at p. 236. Suh explained that, “when I came back [to the SEC] in January 

[2007] I understood that we were done and [the Madoff investigation] would be closed 

without further steps.”239 Id. at p. 237. 

Approximately four months after receiving and ignoring Markopolos’ last e-mail, 

Cheung and Suh discussed an unrelated matter originating from a tip from someone with 

no first-hand knowledge of the misconduct they alleged. On October 24, 2007, Suh 

e-mailed Cheung regarding this other matter, “I have to say, I am a bit concerned that 

this may be another fishing expedition a la Madoff... .” E-mail dated October 24, 2007 

238 In a 2009 Vanity Fair article, the late Levy’s girlfriend, Carmen Dell’Orefice, gave an interview about 

the Levy-Madoff friendship. The article described the relationship as follows: “‘Norman said, 

innumerable times, ‘He is my son,’ she told me, meaning that Levy considered Madoff his surrogate son, a 

member of his family.’” Mark Seal, Madoff’s World, Vanity Fair, April 2009, at 3, available at 

http://www.vanityfair.com/politics/features/2009/04/madoff200904, at Exhibit 385. 

239 When she reviewed Markopolos’ June 29, 2007 e-mail during her OIG testimony, Suh opined that it did 

not provide any new information. Suh Testimony Tr. at pgs. 236-237. 

354 
 

 

from Suh to Cheung, at Exhibit 386 (emphasis added). Cheung responded, “I too have no 

interest in another Madoff.” Id. (emphasis added). During testimony, Suh explained her 

characterization of the Madoff investigation as a “fishing expedition:” 

Well, I think I meant that it didn’t go anywhere in terms of 

bringing [an] enforcement action for fraud. And the 

parallel that I saw between the tip about [the other matter] 

and [the] Markopolos report was that it was from a person 

who –without inside information and a person – well, in the 

[other matter] it was a person reporting only rumors, in 

Markopolos reported – information as well. 

Suh Testimony Tr. at pgs. 238-239. Cheung explained similarly: 

[W]e had spent a long time investigating the Madoff 

[matter] and not found anything of significance. And that's 

– we – and it had taken up an extraordinary amount of staff 

resources and not found anything, and that's what I mean – 

meant. I think Simona and I both meant about spending a 

lot of time investigating something and not finding 

anything. 

Cheung Testimony Tr. at p. 256. Bachenheimer also shared Suh’s view of the Madoff 

investigation: “[W]e all thought we had done a thorough investigation and there was 

nothing there and Markopolos was wrong, and this person who was calling us was 

another Markopolos.” Bachenheimer Testimony Tr. at p. 153. 

On November 20, 2007, the Enforcement staff sent Madoff a letter indicating that 

the investigation was being closed without an enforcement action. Termination Letter 

dated November 20, 2007 from Doria Bachenheimer to Brandon Becker, at Exhibit 387. 

However, there was some last-minute concern expressed by the Enforcement staff 

regarding sending Madoff the letter. On November 20, 2007, Suh e-mailed Cheung: 

Do you think it makes more sense to ask [Calamari’s] 

permission NOT to send a termination letter to [Madoff]? 

Given [Madoff’s] capacity for “finessing” the reality, I am 

a bit concerned about giving him anything in writing. 

E-mail dated November 20, 2007 from Suh to Cheung Re: re-closing Madoff, at Exhibit 

388 (emphasis added). During testimony, Suh explained her concern about sending the 

termination letter to Madoff: 

Well, Madoff had been splitting hairs over language and 

not – was not – we knew he was not truthful, and so I – my 

thought was, you know, will he sort of make a big deal 

about getting a termination letter and basically use it as a 

355 
 

seal of approval or, you know, just make more of it than it 

is, which basically is we're not recommending enforcement 

action against you at this time. You know, so use it as a, 

like, claim that he got almost like an audit opinion or 

something like that. 

Suh Testimony Tr. at pgs. 240-241. 

(2). The Madoff Investigation Officially Closed in January 

2008, Although Enforcement Staff Recognized that Madoff 

Had Lied About His Advisory Business 

Suh began closing the Madoff investigation in January 2007, despite the fact, as 

discussed above, that the Enforcement staff knew Madoff had made numerous 

misrepresentations to the SEC during both the 2005 NERO examination and the 2006 

Enforcement investigation. E-mail dated January 11, 2007 from Suh to Lamore, at 

Exhibit 380. Madoff had failed to fully disclose the number of clients he had and their 

identities; he had misrepresented to the examination staff that he no longer traded options 

(or at least represented to his investors that he did); and he had changed his story 

regarding where his purported trades were settling and clearing. 

Suh e-mailed a two-page draft of a revised closing memorandum to Cheung on 

November 20, 2007.240 E-mail dated November 20, 2007 from Suh to Cheung, at Exhibit 

389. In that draft, Suh wrote: 

Second, in the course of a preliminary inquiry into these 

allegations, the staff learned that, during a recent 

examination of BLM by NERO’s broker-dealer 

examination staff, Bernard Madoff, the sole owner of BLM, 

misrepresented to the examination staff both the nature of 

the trading conducted in the hedge fund accounts and also 

the number of such accounts at BLM. 

Id. (emphasis added). Cheung responded, “I would say that Bernie did not fully disclose 

to the exam staff rather than misrepresented to the exam staff.” Id. 

Cheung testified that she “believed at the time that ‘did not fully disclose’ was 

more accurate than ‘misrepresented.’” Cheung Testimony Tr. at pgs. 260-261. Suh, 

however, testified that she “would [have] prefer[red] to go with ‘misrepresented’ because 

[Madoff] did affirmatively state that he did not trade options.” Suh Testimony Tr. at p. 

244. 

240 The closing memorandum is referred to as the “closing recommendation” in the SEC Enforcement 

Manual: “The closing recommendation is a short memorandum and serves as the basic historical record 

summarizing what the staff did in the investigation and action.” 2008 SEC Enforcement Manual, at p. 34, 

at Exhibit 296. 

356 
 

 

On November 21, 2007, Suh submitted the closing memorandum for review, with 

Cheung’s changes. Case Closing Memorandum, at Exhibit 390. The Enforcement staff’s 

closing of the Madoff investigation was approved on January 3, 2008 by Mark Schonfeld, 

Director of NERO.241 Case Closing Report dated January 3, 2008, at Exhibit 379. 

While Suh testified that when the investigation closed, she did not suspect Madoff 

was operating a Ponzi scheme, Suh Testimony Tr. at p. 235, she acknowledged that she 

knew Madoff had lied to the Enforcement staff during the investigation and the exam, Id. 

at pgs. 205-206, and that the Enforcement staff had not verified that Madoff was placing 

any trades: 

I knew what we did and what we didn’t do, so I knew that 

we ultimately did not get the confirmations with – from the 

counterparties. I relied on the judgment of my supervisors 

that we were done. 

Id. at p. 235. 

Enforcement staff not only closed the Madoff investigation without any 

enforcement action being taken, the investment adviser examination staff never 

conducted an examination of Madoff after he registered with the SEC as an investment 

adviser. See File Memorandum from John Walsh, currently OCIE Acting Director at p. 5 

(identifying all SEC examination activity regarding Madoff since 1997), at Exhibit 391; 

Snively Interview Tr. at pgs. 23-24. 

Brian Snively, a Branch Chief for investment adviser examinations, testified that 

when Madoff registered, he was classified as “medium risk.” Snively Interview Tr. at 

pgs. 7, 24. Snively explained that a medium risk classification does not trigger an 

immediate exam. Id. at p. 24. However, Snively also testified that Madoff might have 

been subject to a “cause exam” immediately after he registered had the investment 

adviser examination staff been informed that Madoff had lied to the Enforcement staff or 

the broker-dealer examination staff. Id. at pgs. 26-27. 

Despite the Enforcement staff’s focus during the 2006 investigation on forcing 

Madoff to register as an investment adviser, and their stated belief that this was a “good 

result” because it would expose Madoff to “extra regulatory scrutiny” (see Cheung 

Testimony Tr. at pgs. 227-228), there is no indication that anyone on the Enforcement 

staff ever suggested that the investment adviser examination staff conduct an examination 

of Madoff. 

241 Bachenheimer testified that the decision to close the Madoff investigation “was a joint decision, but I 

think it comes to me and based on the facts that the staff had presented to me, it didn't seem like there was 

anything else we could do.” Bachenheimer Testimony Tr. at p. 151. Cheung described the decision as 

“collaborative.” “Everybody agreed, but yes, it had to be approved at least [at the Bachenheimer] level and 

probably the [Calamari] level.” Cheung Testimony Tr. at p. 248. When asked who decided to close the 

investigation, Suh testified, “Well, I asked – I mean, I got that direction from my supervisors. I – Meaghan 

and/or Doria both, they – I mean, I understood that after registration we're done, so – and that meant we're 

done.” Suh Testimony Tr. at p. 235. 

357 
 

 

 

The SEC’s failure to conduct an exam of Madoff’s advisory accounts is 

particularly troubling given the fact that, as discussed in greater detail above, the 

Enforcement staff had learned from DTC that the billions of dollars of equities in his 

investment advisory accounts were commingled with each other and commingled with 

his broker-dealer proprietary account. Suh Testimony Tr. at pgs. 199-200. That apparent 

commingling should have been of serious concern to the SEC and would have been a 

violation of the custody rule for investment advisers. Garrity Testimony Tr. at pgs. 95­

97. 

B. In March 2008, Enforcement Staff Received a Second Tip Regarding 

Norman Levy that may have Come From a Madoff Insider 

As discussed in detail above, the Enforcement staff received the following 

anonymous tip in December 2006 from a “concerned citizen,” advising the SEC to look 

into Madoff and his firm: 

Your attention is directed to a scandal of major proportion 

which was executed by the investment firm Bernard L. 

Madoff....Assets well in excess of $10 Billion owned by 

the late Norman F. Levy, an ultra-wealthy long time client 

of the Madoff firm have been “co-mingled” with funds 

controlled by the Madoff company with gains thereon 

retained by Madoff. 

Letter dated December 6, 2006 to Cox, at p. 2, at Exhibit 381. The Enforcement staff 

dismissed this tip after Madoff falsely represented, through his counsel, that he had never 

managed money for Norman F. Levy. Suh’s Phone Log, at p. 7, at Exhibit 349.; see also 

E-mail dated January 9, 2007 from Suh to Cheung, at Exhibit 382. 

On March 31, 2008, almost three months after the Madoff investigation had been 

officially closed, the Chairman’s office received another anonymous tip regarding 

Madoff’s involvement with Levy’s money from the same source. Anonymous Tip dated 

March 31, 2008 Regarding Norman F. Levy, at Exhibit 392. This tip was a copy of the 

previous tip sent in April 2006, with the addition of the following: 

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

keeps two (2) sets of records.242 The most interesting of 

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

242 On December 17, 2008, just days after Madoff confessed to the Ponzi scheme, the Securities Investor 

Protection Corporation told The Associated Press that “there are different sets of books that investigators 

are sorting through. One set keeps track of the losses at Bernard L. Madoff Investment Securities LLC’s 

investment advisory arm, while the other is what investors were shown.” Associated Press, Madoff 

falsified books to hide losses, investigators say, USA Today (Dec. 19, 2008), at Exhibit 394. 

358 
 

 

Id. The updated tip was forwarded to Suh by John McCreery, a Senior Counsel in OIEA, 

on April 7, 2008. See OIEA Referral Memorandum, at Exhibit 395. On the Referral 

Memorandum to Suh, McCreery noted, “Anonymous letter. The return address on the 

envelope appears to be for the New York public library.” Id. On September 16, 2008, 

Suh informed McCreery that she was returning the referral without taking any action. 

E-mail dated September 16, 2008 from Suh to McCreery, at Exhibit 393. Suh explained 

in her e-mail: 

I received from you a referral concerning Madoff, the 

central character in the now closed investigation NY-7563. 

The referred letter appears to be a copy of a letter sent to us 

and reviewed by us in 2006. As in 2006, because the letter 

is anonymous and lacks detail, we will not be pursuing the 

allegations in it. 

Id. (emphasis added). 

Based on the substance of the tip (i.e. Madoff keeping two sets of books) and its 

place of origin (i.e. it was mailed from the New York Public Library in Manhattan),243 

the anonymous tipper may have been an insider with personal knowledge of Madoff’s 

operations. As discussed in detail above, Bachenheimer, Cheung and Suh testified that 

they were skeptical of the allegation that Madoff was running a Ponzi scheme because 

Markopolos did not have any inside information to substantiate the allegation. However, 

Enforcement staff also ignored a serious tip that, on its face, appeared to come from an 

insider who was aware that Madoff was committing fraud. Moreover, if the tip was from 

an insider, it was understandable why the tipster would want to remain anonymous. 

.

Short of re-opening its investigation of Madoff, the Enforcement staff could have 

suggested that the investment adviser examination staff conduct an examination to 

explore these new allegations. Snively Interview Tr. at pgs. 26-27. Cheung testified that 

forcing Madoff to register had been a “good result” because it would “expose [Madoff] to 

... to exams from the [investment adviser] examiners.” Cheung Testimony Tr. at p. 228. 

Yet, when the Enforcement staff received the tip that Madoff kept two sets of books, the 

matter was never referred to the examination staff. In fact, as discussed above, the 

investment adviser examination staff never conducted an exam of Madoff after he 

registered as an investment adviser. 

That failure is also puzzling in light of Bachenheimer’s testimony regarding the 

 of a model Ponzi scheme 

investigation. According to Bachenheimer, this model investigation involved: (1) an 

examination being conducted; (2) 

243 The return address was 455 Fifth Avenue, New York, NY 10016. See OIEA Referral Memorandum, at 

p.2, at Exhibit 395. 

359 
 

that “the exam staff was in;” and (3) that 

: 

I can give you an example 

1. Suh and Cheung’s Work on the Madoff Investigation Are Cited in their 

Evaluations 

For the annual rating period ending April 30, 2007 (May 1, 2006 to April 30, 

2007), Suh’s supervisors gave her the highest rating: “made contributions of the highest 

quality.” Cheung’s statement in support of that rating included the following: 

Simona’s ability to understand and analyze the complex 

issues of the Madoff investigation is particularly 

impressive. Madoff refused to register as an investment 

adviser, despite providing what appeared to be advisory 

services to certain hedge fund clients. Madoff retained 

prominent counsel, including a former director of the 

Investment Management division. Simona’s command of 

the laws, regulations, and staff guidance was such that she 

was able to convince Madoff and his counsel that he 

needed to register. 

Supervisor Contribution Statement for Simona Suh for the Period of May 1, 2006 – April 

30, 2007 and Supervisory Transmittal Form, collectively at Exhibit 396. 

360 
 

 

 

 

 

 

 

Cheung’s self-evaluation for the same rating period included the following: 

I have worked closely with my branch members on their 

investigations. I have attempted to participate and assist in 

their investigations without taking over and have tailored 

my involvement to the needs of the particular case and the 

strengths of the individual attorney involved. 

... 

In Madoff, we investigated the asset management services 

provided by a broker-dealer specializing in hedge funds 

who was not registered as an investment adviser. After our 

investigation, we conducted discussions among the staff, 

the Division of Investment Management, and Madoff‘s 

counsel. We also held separate discussions with Madoff’s 

largest hedge fund client. As a result of those discussions, 

Madoff’s firm registered with the Commission as an 

investment adviser, and his hedge fund client corrected its 

disclosure. 

Contribution Statement of Meaghan Cheung, Rating Period May 1, 2006 – 

April 30, 2007, at Exhibit 397. 

C. In April 2008, Markopolos Attempted to Send a Version of the 2005 

Submission to the SEC’s Office of Risk Assessment, but it was Not 

Received 

On April 2, 2008, Markopolos attempted to send his 2005 submission to Jonathan 

Sokobin, Director of the SEC’s Office of Risk Assessment, but inadvertently sent the email to a non-existent address.244 The e-mail composed and sent by Markopolos was 

244 Markopolos’ contact with Sokobin had been initiated by Sokobin a few days earlier. Sokobin was 

appointed Director of the SEC’s Office of Risk Assessment on February 28, 2008. Sokobin Testimony Tr. 

at p. 9. Shortly thereafter, Sokobin contacted Rudi Schadt, Director of Risk Management, Oppenheimer 

Funds, to discuss “what were emergent risks, what were things that the Commission wasn’t focusing on 

that they should have.” Id. at p. 21. Schadt recommended that Sokobin contact Markopolos. Id. at p. 22. 

On March 31, 2008, Sokobin e-mailed Markopolos, “Harry, Our mutual friend, Rudi Schadt has 

suggested that I contact you. Rudi tells me that he has great respect for you and that I would do well to 

listen. Please let me know when you might have some time to chat. Thanks in advance.” E-mails between 

Sokobin and Markopolos, at Exhibit 399. Markopolos responded the next day and suggested a call the 

following morning. Id. 

On April 2, 2008, Sokobin and Markopolos spoke by phone. Sokobin Testimony Tr. at p. 23; 

June 4, 2009 Testimony of Harry Markopolos Before the U.S. House of Representatives, Committee on 

Financial Services Tr. at p. 22, at Exhibit 269. Sokobin testified that he and Markopolos spoke for 

approximately 20 to 40 minutes. Sokobin Testimony Tr. at p. 24. Sokobin recalled Markopolos discussing 

361 
 

 

 

addressed to “sokobin@sec.gov”, not to Sokobin’s actual e-mail address, 

“sokobinj@sec.gov.” E-mail dated April 2, 2008 from Markopolos to Sokobin@sec.gov, 

at Exhibit 398. 

Markopolos assumed that Sokobin received his April 2, 2008 e-mail, and, in his 

Congressional testimony, discussed his frustration that Sokobin had not responded. 

February 4, 2009 Testimony of Harry Markopolos, Before the U.S. House of 

Representatives, Committee on Financial Services Tr. at pgs. 22-23. (Markopolos 

testified, “At this point I truly had given up on the [SEC’s Madoff] investigation.”). The 

Wall Street Journal reported on December 18, 2008, that: 

Early this year, Mr. Markopolos made one last major effort 

after receiving an e-mail from Jonathan Sokobin, an official 

in the SEC’s Washington, D.C., office whose job was to 

search for big market risks. Mr. Sokobin had heard about 

Mr. Markopolos and asked him to give him a call, 

according to an e-mail exchange between them. 

With low expectations, Mr. Markopolos got in touch. “The 

way I figured it,” he says, “if they didn’t believe you at $5 

billion, and not at $10 billion, they didn’t believe you at 

$30 billion, then why would they believe you at $50 

billion?” 

Mr. Markopolos also sent Mr. Sokobin an e-mail – with the 

stark subject line “$30 billion Equity Derivative Hedge 

Fund Fraud in New York” – saying an unnamed Wall 

Street pro recently pulled money from Mr. Madoff’s firm 

after trying to confirm trades supposedly done in his 

account, but discovering that no such trades had been 

made. 

It was his last try. He never heard back about his 

allegations regarding Mr. Madoff. 

Gregory Zuckerman and Kara Scannell, Madoff Misled SEC in ’06, Got Off, The Wall 

Street Journal, December 18, 2008, at pgs. 3-4, at Exhibit 400. 

“general concerns he had in the market” and “concerns he had with separately managed accounts” but did 

not recall any discussion regarding Madoff. Id. 

Following the April 2, 2008 phone call, Markopolos composed his e-mail to Sokobin regarding 

Madoff. June 4, 2009 Testimony of Harry Markopolos Before the U.S. House of Representatives, 

Committee on Financial Services Tr. at pgs. 22-23, at Exhibit 269. As Markopolos explained, “After our 

call, I felt that I had established my bona fides as a risk expert and felt comfortable enough to send him my 

updated, 32-page, [2005 submission] along with a short 4 paragraph e-mail.” Id. 

362 
 

 

 

 

However, Sokobin testified that he did not recall ever seeing Markopolos’ April 2, 

2008 e-mail or the attached version of the 2005 submission. Sokobin Testimony Tr. at p. 

27. While Sokobin and Markopolos did exchange a few e-mails245 and had at least one 

phone conversation, none of the e-mails that Sokobin received mentioned Madoff, and 

Sokobin testified that he did not recall Madoff being discussed during his phone 

conversation with Markopolos. Id. at p. 24. 

As discussed above, Markopolos’ April 2, 2008 e-mail to Sokobin was 

accidentally sent to a non-existent e-mail address. Moreover, OIT’s e-mail tracking 

system shows no record of the e-mail having been received by the SEC. Consequently, 

the OIG found that Sokobin did not receive any information from Markopolos regarding 

Madoff. 

D. Enforcement Staff’s Reflections 

Bachenheimer, Cheung, and Suh all testified that when news of Madoff’s Ponzi 

scheme broke on December 11, 2008, they were shocked. Suh testified, “Well, we had 

the allegation so I guess – I was shocked that the allegation turned out to be so true and 

that the scope was so much vaster than what we had thought.” Suh Testimony Tr. at p. 

251. Bachenheimer testified, “I was shocked. In fact, when I first heard the news that 

Madoff had been arrested, I didn’t think it was in relation to this. I thought he had done 

something different, and it wasn’t until the next day that I realized it was this.” 

Bachenheimer Testimony Tr. at p. 163. Cheung testified that she “was more shocked 

[than someone who wasn’t aware of the allegations] because I had investigated it. 

Cheung Testimony Tr. at p. 262. 

Even Lamore, who had conducted the 2005 examination and aided the 

Enforcement staff with the investigation in 2006, was “just utterly shocked” that the 

allegations had turned out to be true. Lamore Testimony Tr. at pgs. 243-244. An e-mail 

sent to Michelle Trillhaase, a member of Enforcement in the New York Regional Office, 

just days after Madoff confessed, shows Lamore evaluating the SEC’s performance: “It’s 

been a tough couple of days for me. Although I gave the exam and follow-up 

investigation 110% we just didn’t uncover it. I think we were very close, -- probably 

only 1 or2 phone calls away from blowing it open...” E-mail dated December 12, 2008 

from Trillhaase to Lamore, at Exhibit 401 (emphasis added). 

During testimony, Lamore explained what he meant by being “only 1 or 2 phone 

calls away,” saying: 

You know, I think had we been able to contact the 

counterparties to the – equities or the options, I think that 

would have, you know, that would have been the call that 

245 See E-mails between Sokobin and Markopolos, at Exhibit 399. 

363 
 

would have revealed the entire Ponzi scheme because there 

would have been no executions. 

Lamore Testimony Tr. at pgs. 247-248 (emphasis added). 

Bachenheimer testified that she and the other members of the Enforcement staff 

thought they had conducted a thorough investigation and that “there was nothing there 

and Markopolos was wrong....” Bachenheimer Testimony Tr. at p. 153. To some extent, 

Bachenheimer even blamed Lamore for not taking initiative when he supposedly knew 

what steps to take: 

Q: Peter Lamore testified and there’s contemporaneous 

documentation to the effect that if he had made one 

or two phone calls, to either DTC or a counterparty, 

he would have discovered the Ponzi scheme. He 

believed that it would have been relatively easy to 

discover the Ponzi scheme had he made one or two 

phone calls. 

A: I don’t know why Peter didn’t do that. I mean, 

Peter sat in my office and told me that he had a 

command of this and that he was pursuing it and he 

wasn’t finding anything. I felt entitled to rely on 

Peter. 

Id. at p. 98. 

Bachenheimer also attributed the SEC’s failure to uncover Madoff’s Ponzi 

scheme to a lack of resources: 

The resource issues and the challenges that we were facing, 

everything. Everything in that [GAO] report, I think I 

agree with. We had to buy our own legal pads. We had to 

buy our own pens. It got to the point where we didn’t have 

paper for the printers. There is a lot of metrics that were put 

into place that were very good metrics but the problem was 

you only had one person to be doing the same jobs. We had 

cases that had remained open for years. 

Id. at p. 170. Bachenheimer testified that “given the resources that we had available ... 

[the Enforcement staff’s 2006 investigation of Madoff] was the best we could do”: 

Q: Looking back now after all the documents we’ve 

shown you today, do you think there were sufficient 

actions taken by the Enforcement staff to uncover 

364 
[Madoff’s] Ponzi scheme, to investigate the Ponzi 

scheme issue? 

A:	 I think given the resources that we had available to 

us and given what else we all had to do at the time, 

this was the best we could do. 

Id. at pgs. 162-163. In a written submission made by Cheung’s attorney after her 

testimony, Cheung also claimed that the Enforcement staff had been “hamstrung by a 

lack of resources and personnel and the lack of responsiveness of other offices within the 

SEC that could have assisted in the [Madoff] investigation.” July 24, 2009 Submission 

on Behalf of Meaghan Cheung, at p. 4, at Exhibit 281. 

The fact is that the SEC could have discovered Madoff’s Ponzi scheme with far 

fewer resources than were actually spent on the Enforcement staff’s Madoff 

investigation. As Cheung testified while explaining her comment that the Madoff 

investigation had been a “fishing expedition”: 

[W]e had spent a long time investigating the Madoff 

[matter] and not found anything of significance. And that's 

– we – and it had taken up an extraordinary amount of staff 

resources and not found anything, and that’s what I mean – 

meant. 

Cheung Testimony Tr. at p. 256. When Madoff’s Ponzi scheme collapsed, Friedman 

testified that it took only “a few days” and “a phone call ... to DTC” to confirm that 

Madoff had not placed any trades with his investors’ funds.” Friedman Testimony Tr. at 

pgs. 21-22. 

Bachenheimer also connected the SEC’s failure to discover Madoff’s Ponzi 

scheme to a lack of adequate training: 

The other point that I want to make that I think is really 

important is they stopped – when I got to the Commission, 

it was great, you actually had money for training, because I 

came from the Department of Justice, the U.S. Trustee’s 

Office, we had no money for training. When I got to the 

Commission, I thought this was the greatest thing in the 

world. In 2005, and maybe before 2005, they shut down 

our money for training. 

Bachenheimer Testimony Tr. at p. 171. Bachenheimer also testified: 

I don’t think it’s a function of inexperience for Simona. I 

think it’s a function of inexperience at an agency with some 

issues and a lack of resources. I think we are lawyers and 

365 
we have a fair amount of securities experience, and you 

tend to learn. You know, you have a background in 

securities, and you have a fair amount of knowledge, and 

then as you work in an area, you tend to get more and more 

– develop greater and greater knowledge in that area. I 

think the fact that Simona didn’t know more, that any of us 

didn’t know more, related more to a lack of training and 

that no training is available for us on these issues, that we 

didn’t have broker-dealer resources that we could go to, 

you know. We asked for additional options help, and it 

wasn’t there to be had. I don’t think it’s her lack of 

experience. I think it’s a knowledge gap, absolutely. 

Id. at pgs. 161-162. 

Finally, Bachenheimer also identified administrative burdens that occupied much 

of Cheung’s time: 

You had to have people writing closing memos, which is of 

course, you should be shutting down your old cases, but 

that’s what Meaghan spent a lot of her time doing, writing 

closing memos because she had inherited a branch where 

everybody had left and left these old cases in shambles, and 

you had to go back to the court records, pulling all these 

court files, and recreating files to close them. Meaghan had 

tons of this stuff, much more than [the other Branch Chief 

in Bachenheimer’s group]. It was crazy. Then you had to 

have six month memos on cases, whether or not you should 

keep them open, memos to write. The joke that we had in 

the office was that you had to write a memorandum to get 

permission to write a memo. You know, a lot of this was to 

make the performance measurable, which is great, and it 

should be measurable, but you have to provide people the 

resources to do it. 

Id. at pgs. 170-171. 

Cheung and Suh were more introspective about the SEC’s failure to uncover 

Madoff’s Ponzi scheme. Cheung testified: 

At the time, I thought it was a good investigation. At this 

point, I see where there were flaws and there are things that 

I would like to have done differently. And I see specific 

366 
ones that came out today that I – if I could go back in time 

would do differently. 

Cheung Testimony Tr. at p. 252. 

Specifically, Cheung acknowledged that the Enforcement staff should have gone 

to third parties to verify that Madoff was placing trades with the investors’ funds: 

I think that in retrospect we should have gone to third – to 

more third party – to third parties. At the time that we did 

the investigation, I thought it was reasonable to rely on the 

fact that there had been an exam team in place to put aside 

the idea that trading wasn’t happening. I – I put too much – 

I think – I think that I was sure – I put comfort too early on 

in the idea that there was trading and that it was less likely 

to be a Ponzi scheme because there had been an exam, that 

it was to be another problem, another type of problems. 

Id. at p. 253. 

In the final analysis, Suh provided the most revealing explanation for the failure 

of the Enforcement investigation: 

[H]aving had more experience myself, I do question some 

of the choices that were made and I particularly – it seems 

like the question of verifying the transactions with – from 

independent sources, it was on the radar throughout but it 

seems like it could have been made more central and we 

could have just focused on that question as opposed to 

spending more time trying to figure out how Madoff 

portrayed his trading to others. And the main question 

that, you know – as you can imagine I have been thinking a 

lot about what happened, and the main call that I am 

frustrated about is the call not to pursue further this getting 

Madoff’s consent for the counterparties to send trading 

records to us directly. And I do think that that was the 

wrong call and I wish it was a different call. 

Suh Testimony Tr. at p. 86. Suh continued: 

A: I don’t know. I – looking back at it I, you know, 

it’s hard to speculate what, sort of, my instincts 

would have been had I had more experience. For 

example, I know that had I had more experience I 

may have taken more steps or different steps. 

367 
Q: You think that if you had more experience or maybe 

had more support you would have had a better sense 

of just how unusual Madoff's returns were, not just, 

you know, that he does a good job picking or he has 

a – he's an experienced guy, but that, you know, 

what he was achieving wasn't able really to be 

replicated by anybody. 

A: That’s probably true. Certainly had I – certainly 

had I had Ponzi – had worked on Ponzi scheme 

cases I also probably would have been able to cut to 

the right steps. 

Id. at pgs. 128-129. 

E. Factors in the SEC’s Failure to Discover Madoff’s Ponzi Scheme 

From the outset of its investigation, the NERO Enforcement staff, unlike the 

Boston District Office, failed to appreciate the significance of the evidence in the 2005 

Markopolos submission. As a result of this initial failure, the Enforcement staff never 

really conducted an adequate and thorough investigation of Markopolos’ claim that 

Madoff was operating a Ponzi scheme. 

Almost immediately after Markopolos’ submission was brought to the 

Enforcement staff’s attention, they expressed skepticism and disbelief toward the 

evidence contained in the submission. The Enforcement staff claimed that Markopolos 

was neither an insider nor an investor and, thus, immediately discounted his’ evidence. 

Bachenheimer testified that “often the only way [the SEC] can develop evidence ... in a 

Ponzi scheme, is if we have somebody on the inside ... It’s very challenging to develop 

evidence [about a Ponzi scheme] until the thing actually falls apart.” Bachenheimer 

Testimony Tr. at pgs. 65-66. Yet, had the Enforcement staff simply sought documents 

from DTC, Madoff’s bank or his purported OTC option counterparties, they would have 

been able to uncover the fraud without any such inside information. 

The Enforcement staff also questioned Markopolos’ motives, indicating concerns 

that “he was a competitor of Madoff’s” who “was looking for a bounty.” Id. at p. 45. 

Bachenheimer further stated about Markopolos, “If the first thing I hear from someone is 

what’s in it for me, then it raises my antenna a little bit.” Id. at p. 47. These concerns 

were particularly curious because in the scenario Markopolos described as “highly likely” 

in his 2005 submission, the “Ponzi scheme,” he acknowledged that would not have been 

eligible for a bounty. 2005 Submission at p. 2, at Exhibit 268. Moreover, even after 

Meaghan Cheung spoke with David Bergers, the Associate District Administrator for 

Enforcement in Boston, who vouched for Markopolos’ credibility, she remained skeptical 

of him throughout the investigation. 

368 
Another factor that contributed to the Enforcement staff’s failure to appreciate the 

“red flags” contained in Markopolos’ 2005 submission was a lack of experience 

necessary for a fundamental understanding of equity and options trading. Unlike Garrity 

and others in the Boston office, the NERO Enforcement staff did not appreciate 

Markopolos’ observation that Madoff’s “numbers really [were] too good to be true.” 

E-mail dated March 1, 2001 from Markopolos to Manion, with attachments, at Exhibit 

137. As a former Madoff investor who was quoted in the 2001 Barron’s article observed, 

“To take [Madoff’s explanation for his returns] at face value is a bit naïve.” Erin 

Arvedlund, Don’t Ask, Don’t Tell, Barron’s, May 7, 2001, at p. 2, at Exhibit 135. 

However, each member of the Enforcement staff accepted as plausible Madoff’s 

claim that his returns were due to his perfect “gut feel” for when the market would go up 

or down. Suh testified that she “didn’t know what to think at that time about [Madoff’s 

claimed returns]. I did not know enough about this industry to place that number” and 

that she “did not have a view about how likely or unlikely” “it was that one person could 

achieve such consistent returns over 14-and-a-half years with only seven down months.” 

Suh Testimony Tr. at pgs. 41-42. Bachenheimer and Cheung both took Madoff’s 

explanation at face value that “by not reaching for astronomically high returns,” he could 

achieve such remarkable consistency, with Bachenheimer, noting that Madoff’s 

explanation, “while not 100 percent responsive, not a perfect answer, it d[id] answer the 

question.” Cheung Testimony Tr. at pgs. 194-195; Bachenheimer Testimony Tr. at p. 

115. 

The Enforcement staff’s lack of experience not only contributed to their failure to 

understand that Madoff’s returns could not be real, it also was a factor in their failure to 

conduct an effective investigation regarding how Madoff was creating those returns. 

According to NASD Vice President Gene DeMaio, the Enforcement staff did not 

understand the basics about options and “some of those [options trading] strategies were 

over their heads.” DeMaio Testimony Tr. at p. 15. In addition, the Enforcement staff 

failed to recognize the significance of the issues they did not understand. They rejected 

DeMaio’s suggestion to postpone Madoff’s testimony “to do a little bit more homework,” 

and they did not accept his offer of further assistance. Id. at pgs. 14-15. Similarly, 

Cheung rejected offers from Markopolos to explain his observations and analyses 

regarding Madoff, or at least to provide additional information about Madoff. 

Garrity met with Markopolos for several hours during which Markopolos made 

“repeated trips up to the white board” to explain the “derivatives math” and “a few of the 

more difficult concepts.” Division Exhibit 18 at pgs. 14-15. As a result, Garrity 

“understood the scheme, its size, and its threat to the capital markets.” Id. In contrast, 

Cheung was offended when Markopolos questioned whether she understood derivatives 

enough to understand some of the red flags in the 2005 submission. Cheung rebuffed 

Markopolos’ offer to help the Enforcement staff understand the 2005 submission as he 

had done in his meeting with the Boston office. 

The Enforcement staff also did not understand critical aspects of Madoff’s brokerdealer operations, but did not consult the SEC’s Division of Market Regulation for 

369 
 

 

 

 

assistance in understanding those issues. Similarly, the staff did not seek help from the 

SEC’s Office of International Affairs (OIA) regarding Madoff’s purported trading 

activity in Europe. OIA may have been able to provide the “particular expertise” that 

Lamore acknowledged would have been “helpful”: 

[T]he execution of the orders overseas, you know, was that 

feasible, was that possible. I think that was a question that 

we didn’t get answered that, you know, would have been 

helpful. 

Lamore Testimony Tr. at pgs. 195-196. If the Enforcement staff had simply sought 

assistance from OIA on matters within their area of expertise, they would have 

discovered that Madoff was not purchasing equities from foreign broker-dealers and that 

he did not have OTC options with European counterparties. 

Moreover, the Enforcement staff’s failure to verify Madoff’s purported trading 

with any independent party is particularly troubling. This was due, in part, to a lack of 

experience with Ponzi scheme investigations. Despite that inexperience, the staff did not 

reach out to any of their SEC colleagues who had investigated Ponzi schemes for 

guidance on the proper investigative steps to follow. All of the SEC employees with such 

experience who testified during the OIG’s investigation disagreed with Bachenheimer’s 

view that independent verification of trading was not an “essential” part of a Ponzi 

scheme investigation.246 

In addition, when the Enforcement staff began efforts to seek information from 

independent third parties, they failed to follow-up on those efforts even as they began to 

reveal that Madoff was not engaged in trading. On May 16, 2006, three days before 

Madoff’s testimony, Suh called Susan Tibbs, Director of the Market Regulation 

Department at the NASD (now FINRA) and asked her to check a certain date on which 

Madoff had purportedly held S&P 100 index option positions. Tibbs reported back that 

they had found no reports of such option positions for that day. Yet, the Enforcement 

staff failed to follow up on this remarkable finding. The Enforcement staff also failed to 

follow-up on information obtained in the 2005 NERO cause examination when the 

examination staff had attempted to verify Madoff’s claims of trading OTC options with 

Barclays and found that there was “no relevant transaction activity occurred during the 

period” requested. Letter dated May 16, 2005 from Mansfield to Nee, at Exhibit 241 

(emphasis added). Finally, although Suh made several attempts to obtain documentation 

from European counterparties, and one of Madoff’s purported counterparties was in the 

process of drafting a consent letter asking Madoff’s permission to send the Enforcement 

246 Ironically, six days after Madoff’s Ponzi scheme collapsed, Pauline Calande, Counsel to the Director 

and Deputy Director of Enforcement, sent an e-mail to Linda Thomsen, former Director of Enforcement, 

and others in the context of discussing her concern about the thoroughness of the trustee’s work in the 

Avellino & Bienes investigation. The e-mail highlighted the trustee’s failure to confirm whether the 

investor funds were really “all there” in 1992, asking if the trustee went “to the street name custodian of the 

fund’s portfolio and inspected the securities,” or to the “banks or firms allegedly holding cash or sweep 

funds,” thus referencing the very steps that the NERO Enforcement staff should have, but failed to, take in 

their investigation. E-mail dated December 17, 2008 from Calande to Thomsen et al, at Exhibit 402. 

370 
staff the documents from its European account, the inexplicable decision was made not to 

send the letter and to abandon this effort. 

In addition to a lack of experience, the investigation suffered from a lack of 

supervision. Suh certainly worked hard enough on the investigation to discover Madoff’s 

Ponzi scheme, but her efforts were wasted on futile tasks (e.g., comparing Madoffgenerated client statements to documents Madoff created for the SEC) or chasing red 

herrings (e.g., whether Madoff should register as an investment adviser). 

Bachenheimer attributed the SEC’s failure to discover Madoff’s Ponzi scheme to 

a lack of resources, as evidenced by the following exchange: 

Q: Looking back now after all the documents we’ve 

shown you today, do you think there were sufficient 

actions taken by the Enforcement staff to uncover 

[Madoff’s] Ponzi scheme, to investigate the Ponzi 

scheme issue? 

A: I think given the resources that we had available to 

us and given what else we all had to do at the time, 

this was the best we could do. 

Bachenheimer Testimony Tr. at pgs. 162-163. The fact is, as Cheung testified while 

explaining her comment that the Madoff investigation had been a “fishing expedition”: 

[W]e had spent a long time investigating the Madoff 

[matter] and not found anything of significance. And that’s 

– we – and it had taken up an extraordinary amount of staff 

resources and not found anything, and that’s what I mean – 

meant. 

Cheung Testimony Tr. at p. 256. When Madoff’s Ponzi scheme collapsed, Friedman 

testified that it took only “a few days” and “a phone call ... to DTC” to confirm that 

Madoff had not placed any trades with his investors’ funds.” Friedman Testimony Tr. at 

pgs. 20-22. 

Suh repeatedly lamented the lack of competent supervision when she reflected on 

the SEC’s failure to discover Madoff’s Ponzi scheme: 

Well, Peter was very helpful, and to the extent that I asked 

for his help he never shied away from it. But the help that 

– I did not – this was not a situation where there was an 

issue of volume of documents where you just needed an 

extra set of hands to go through things, it was more a 

371 
 

situation where I needed guidance about what to do and 

what steps to pursue. 

Suh Testimony Tr. at p. 83. Suh continued: 

[Cheung] answered questions that I posed to her. At the 

time I had no reason to doubt her answers, subsequently, 

after I – in subsequent years I did become frustrated with 

sort of [a] lack of involvement from her part. But I did not 

form that view or get that impression until later when I had 

had more opportunities to work with her. 

Id. at p. 84. Suh stated further: 

I guess my frustration was that I did not get sort of value 

added from her being my supervisor. ... She did know the 

Commission processes so she was very helpful in terms of 

... who would be the right person in Washington to call 

...but in terms of daily activity I did not feel like I was 

getting much out of having her as a supervisor. 

Id. at p. 85. 

Finally, the Enforcement staff failed to discover Madoff’s Ponzi scheme because 

they relied too heavily on Madoff’s representations and documents created by him. For 

example, Madoff lied several times about where the equity trades for his investors were 

executed and cleared. Madoff first told the examination staff that the trades were 

executed by his London affiliate and cleared through Barclays. During his investigative 

testimony, however, Madoff claimed that the London affiliate had nothing to do with 

either the equity or options trades for the advisory accounts and that those trades were 

executed by his New York office. He also later testified that the equity trades were 

cleared through DTC. 

Madoff also told the examination staff that he had stopped placing options trades 

for investors in 2004. Yet, the account statements he was providing investors in 2005 

and 2006 demonstrated that he was trading options on their behalf. The Enforcement 

staff caught Madoff in this contradiction and Suh and Lamore were convinced that 

Madoff had lied during the exam and that he continued to lie about the issue throughout 

the investigation. Yet, the Enforcement staff closed the investigation without ever 

scrutinizing this issue and what it meant in the context of the allegation that Madoff was 

operating a Ponzi scheme. 

372 
 

 

An SEC attorney currently working on the Madoff matter touched on that failure 

when she opined: 

I think people were too trusting. I don’t mean this in a bad 

way. I think, you know, very often you hear these stories 

and the guy, you know, I didn’t know his reputation, but he 

apparently did have a tremendous reputation. And I think 

people were trusting. I mean he gave testimony that was 

clearly, you know, a complete and utter fabrication. ... I 

mean why didn’t they talk to the European options, you 

know, the people on the other side of the option trade, I 

don’t know. 

New York Staff Attorney #2 Testimony Tr. at p. 28. 

VI. ALLEGATIONS OF IMPROPER INFLUENCE, INTERACTIONS 

BETWEEN MADOFF AND THE SEC AND THE EFFECT OF MADOFF’S 

STATURE AND REPUTATION ON SEC EXAMINATIONS AND 

INVESTIGATIONS 

A.	 The OIG Investigation Found No Evidence of Improper Influence 

by Senior SEC Officials Based upon Their Relationships with 

Madoff 

The OIG investigation did not find any evidence that senior officials at the SEC 

directly attempted to influence examinations or investigations of Bernard Madoff and the 

Madoff firm, nor was there evidence that any senior SEC official interfered with the 

staff’s ability to perform its work. During the course of the OIG investigation, the OIG 

reviewed millions of e-mails and took testimony of the SEC personnel who conducted the 

examinations and investigations of Madoff and found no evidence that the work of any 

SEC staffers involved in Madoff examinations or investigations was influenced by any 

senior SEC official. 

We also took the testimony of or interviewed former Chairmen Christopher Cox, 

William Donaldson and Arthur Levitt, former Commissioner Annette Nazareth, current 

Commissioner Elisse Walter, former Chief of Staff Peter Uhlmann, former Director of 

Enforcement Linda Thomsen, and former Director of OCIE Lori Richards.247 We found 

that none of these senior officials played any inappropriate role in the SEC’s 

examinations and investigations of Madoff. We further found that while several of these 

SEC officials knew Bernard Madoff and met with him on occasion, these officials were 

generally unaware of the SEC’s examinations and investigations of Madoff until he was 

arrested in December 2008. 

247 The OIG took the testimony of or interviewed the current or former senior-level SEC officials who we 

determined based upon the evidence were or could have been in a position to influence the examinations 

and investigations of Madoff that could have uncovered the Ponzi scheme. 

373 
 

 

 

 

 

Christopher Cox, who served as Chairman of the SEC from August 2005 until 

January 2009, stated that prior to December 2008, he had not been familiar with the name 

Bernie Madoff or his firm. Cox Testimony Tr. at pgs. 7-8. Cox also testified that he has 

never met any member of the Madoff family. Id. at p. 8.248 Cox stated that he was not 

aware that there had been either an Enforcement investigation or OCIE examination of 

Bernard Madoff or his firm prior to December 2008. Id. at pgs. 8-9. 

When asked about a complaint letter addressed to him in December 2006 that 

conveyed concerns about Madoff’s firm, Cox testified that he had never seen the letter 

and noted that all letters addressed to him would first go the Chairman’s Correspondence 

unit, at which point a determination would be made as to where at the SEC the letter 

should be referred for appropriate response and handling. Id. at pgs. 12-13.249 

William Donaldson, who served as Chairman of the SEC from February 2003 

until June 2005, stated that he met Bernie Madoff when Donaldson was Chairman of the 

New York Stock Exchange between 1991 and 1995. Donaldson Testimony Tr. at pgs. 6­

7. Donaldson recalled that on one occasion, Bernie Madoff visited the SEC when he was 

Chairman and asked if he could stop by Donaldson’s office, and he came in and said 

“hello.” Id. at p. 9. Donaldson stated he never invested with Madoff, and never met with 

any other member of Madoff’s family. Id. at p. 10. Donaldson said he was not aware 

that Madoff had a separate investment management business. Id. at p. 11. He also said 

he was not aware of any examinations or investigations of Madoff while he was 

Chairman, nor any complaints about Madoff or Congressional interest in Madoff. Id. at 

pgs. 10-11. 

Arthur Levitt, who served as the Chairman of the SEC from 1993 until 2001, 

stated that he met Bernard Madoff “on an infrequent basis” while he was Chairman of the 

SEC, mostly at seminars or outside functions. Levitt Interview Memorandum at p. 1. 

Levitt approximated that he saw Madoff once a year while he was the Chairman of the 

SEC. Id. Although Bernard Madoff, in his interview with the OIG, stated that he knew 

Levitt “very well,” Levitt stated he did not have a personal friendship with Madoff, had 

never socialized with him, and did not know his family, other than having met Bernard 

Madoff’s brother. Madoff Interview Memorandum at p. 9; Levitt Interview 

Memorandum. Levitt stated that while he was Chairman of the SEC, he was not aware of 

any examinations or investigations that the SEC was conducting of Madoff. Id. 

Levitt further stated that during his tenure as Chairman of the SEC, he was not 

aware that Madoff had been managing money for outsiders, and was only aware of 

Madoff’s broker-dealer operation. Id. Levitt also said he didn’t recall knowing anything 

248 Bernie Madoff confirmed in his interview with the OIG that he had never met Christopher Cox. Madoff 

Interview Memorandum at p. 9. 

249 At the request of the OIG, former Chief of Staff Peter Ulhmann conducted a search of the Chairman’s 

correspondence system between 1992 and 2009 for any correspondence relating to any member of the 

Madoff family and identified only two versions of the December 2006 anonymous complaints that came in 

relating to Madoff's firm and no records of congressional correspondence relating to any examination or 

investigation of Madoff. Uhlmann Testimony Tr. at pgs. 8, 15, 23-24. 

374 
 

 

 

 

about Madoff managing money for investors at any time before the story broke and 

Madoff turned himself in on December 11, 2008. Id. 

Annette Nazareth served for brief periods as Senior Counsel to Chairman Arthur 

Levitt and Interim Director of the Division of Investment Management beginning in 

August of 1998 and then as Director of the Division of Market Regulation from 

December 1999 until she was nominated as a Commissioner, a role she served in from 

August 2005 until January 2008. Nazareth Testimony Tr. at p. 6. 

Nazareth stated she first met Madoff in her capacity as Senior Counsel to former 

Chairman Levitt. Id. at p. 7. Bernard Madoff stated that he knew Nazareth “very well,” 

and Nazareth acknowledged that she has had “in excess of ten” meetings with Madoff, 

but she did not believe she ever met with him one-on-one. Madoff Interview 

Memorandum at p. 9; Nazareth Testomony Tr. at p. 7. Nazareth stated she never 

invested with Madoff and was not even aware that Madoff’s firm invested funds for 

individuals. Id. at pgs. 12; 14. Nazareth stated that she was not aware of any 

Enforcement investigations of Madoff and had not seen any complaints that were filed 

with the SEC about Madoff. Id. at pgs. 14-15. She stated that “she may have been aware 

of sweep efforts by the SEC examination unit of market participants that may have 

involved Madoff and others,” but was clear that she “was not aware of any routine or 

cause examinations of Madoff in particular.” Nazareth Interview Memorandum.250 

Elisse Walter served in various positions in the SEC Office of General Counsel 

and as Deputy Director of the SEC’s Division of Corporation Finance between 1977 and 

1994. Walter Testimony Tr. at pgs. 6-7. Then, after working for both the Commodity 

Futures Trading Commission (CFTC) and the National Association of Securities Dealers 

(NASD), she became an SEC Commissioner on July 9, 2008. Id. Walter testified that 

she was aware of Bernard Madoff’s broker-dealer firm from her time at the NASD. Id. at 

p. 7. 

Walter stated she met Bernard Madoff approximately 10 times, but never had any 

one-on-one meetings with him, nor met with him on any social occasions. Id. at p. 8. 

Walter stated she also met Peter Madoff, Shana Madoff, and Mark Madoff at industry 

events or market regulation committees while she was at the NASD. Id. at pgs. 8-9. 

Walter stated she did not recall participating in any industry events with Madoff while 

she was with the SEC. Id. at p. 9. The OIG investigation did locate two pieces of 

correspondence from Madoff family members to Walter.251 The first was an undated 

handwritten letter from Bernie Madoff to Walter congratulating her on her appointment 

as a commissioner, stating, “Your knowledge and experience is so important in these 

complex times and your unique style of always listening to both sides of opposing 

250 Nazareth was asked about a December 16, 2003 e-mail from Lori Richards in which Richards stated, 

“Remind me to tell you what we’re looking at too with Madoff” and stated that she did not recall speaking
 

with Richards about Madoff. Nazareth Interview Memorandum. Richards testified that she also could not
 

recall any such conversation with Nazareth about Madoff. Richards Testimony Tr. at pgs. 63-64. 251 The OIG also inquired of the records of current SEC Commissioners Paredes, Aguilar, Casey and 

Chairman Schapiro and found no documents in their correspondence files relating to Madoff. 

375 
 

 

arguments has served us so well. We are lucky to have you.” Letter (undated) from 

Bernie Madoff to Walter, at Exhibit 403. The second was a typed July 15, 2009 letter 

from Peter B. Madoff “[o]n behalf of the entire Madoff family” asking that she “accept 

[their] congratulations and best wishes” on her appointment as an SEC Commissioner. 

Letter dated July 15, 2009 from Peter Madoff to Walter at Exhibit 404. Walter testified 

she was not aware of any additional correspondence between her and Madoff family 

members and stated that she did not have phone or other conversations with either Peter 

or Bernard Madoff after she received the letters. Walter Testimony Tr. at p. 11. Walter 

stated she received numerous letters of congratulations when she was nominated to be an 

SEC Commissioner in April 2009. Id. at p. 12. 

Walter also stated she never invested with Madoff and was not aware that Madoff 

had a separate investment business prior to December 2008. Id. at p. 9. Walter testified 

that she was not aware of any SEC’s examinations or investigations of Madoff or any 

complaints made with the SEC about Madoff before he was arrested in December 2008. 

Id. at p. 10. 

Peter Uhlmann, who served as Senior Advisor to the Chairman and Chief of Staff 

to Chairman Cox from August 2005 until early 2009, testified that he had also not heard 

of Bernard Madoff or his firm prior to December 2008. Uhlmann Testimony Tr. at pgs. 

6-7. 

Linda Thomsen, who served as the Director of the Enforcement Division from 

2005 until February 2009 and served in other capacities in the Enforcement Division 

from 1995 until 2005, testified that she was generally aware of Madoff’s firm but did not 

recall being aware that the Enforcement Division had received any tips or complaints 

about Bernard Madoff or Madoff’s firm prior to December 2008. Thomsen Testimony 

Tr. at pgs. 4-5. Thomsen stated that she did not remember knowing Bernie Madoff and 

stated she has never had any social interactions with Madoff family members outside of 

an industry conference. Id.252 

Lori Richards, who began working for the SEC in 1985 and served as the Director 

of OCIE from 1995 until August 2009, stated that after Bernard Madoff was arrested in 

December 2008, she recused herself from all OCIE or other matters concerning Madoff 

because she had attended the wedding of Eric Swanson and Shana Madoff, and because 

Swanson had been in her chain of command. Richards Testimony Tr. at pgs. 8, 116-117. 

Richards stated there was no other reason for her recusal. Id. at pgs. 116-117. 

Richards, whom Madoff stated he “does not know very well,” said she recalled 

speaking to Bernie Madoff on only two occasions, once in connection with the 2003 

OCIE examination and the second at an industry conference in which she had a brief 

conversation with him that lasted no more than 5 minutes. Madoff Interview 

Memorandum at p. 9; Richards Testimony Tr. at pgs. 26-27. Richards also stated she 

spoke on two occasions with Peter Madoff, once at an SEC Chief Compliance Officer 

(CCO) Outreach program and once at the wedding of Shana Madoff and Eric Swanson. 

252 Bernie Madoff confirmed that he did not know Thomsen well. Madoff Interview Memorandum at p. 9. 

376 
 

Id. at pgs. 27-28. Richards recalled speaking with Shana Madoff on approximately 5 or 6 

occasions, at the same CCO Outreach program where she spoke to Peter Madoff, an SEC 

speaks event, a Securities Industry Association (SIA) committee meeting, a meeting of 

compliance officers at the SEC, and at Eric Swanson’s wedding and going-away party. 

Id. at p. 29. Richards stated she did not speak to either Peter or Shana Madoff about SEC 

examinations or investigations. Id. at pgs. 28-29. She also stated that she never 

communicated to any examiner to back off of an examination relating to Madoff, and 

denied that Bernie Madoff received any special treatment because he was a well-known 

entity. Id. at pgs. 117-118. Richards noted that she had sent a hard copy of the Barron’s 

article written by Erin Arvedlund, entitled “Don’t Ask, Don’t Tell” to OCIE Associate 

Director John McCarthy with a note that stated: 

John, she [referring to Arvedlund] is very good. This is a great exam for us! Lori. 

Id. at pgs. 32-35; Richards’ copy of Erin Arvedlund, Don’t Ask, Don’t Tell, 

Barron’s, May 7, 2001, at Exhibit 157. 

B.	 The OIG Found that Madoff Participated in SEC Panels and 

Events and Communicated with SEC Chairmen, and that SEC 

Officials Participated in Conferences Arranged by Shana Madoff 

The OIG investigation found that Bernard Madoff participated on an SEC 

advisory committee and in public hearings. We also found that Madoff communicated 

numerous times over the years with SEC Chairmen on a variety of matters. We further 

found that SEC officials participated in industry events and conferences set up by Shana 

Madoff regarding SEC compliance issues. 

On September 27, 2000, the SEC announced the members of an Advisory 

Committee on Market Information, which it was establishing to assist the SEC in 

evaluating issues relating to the public availability of market information in the equities 

and options markets. SEC Announcement, 2000-140 dated September 27, 2000, at 

Exhibit 405. Bernard Madoff of Bernard L. Madoff Investment Securities was listed as a 

member of the newly formed Advisory Committee. Id. This committee met on several 

occasions at the SEC Office with Bernard Madoff in attendance, including on October 

10, 2000, December 14, 2000, March 1, 2001, April 12, 2001, May 14, 2001 and July 19, 

2001. Minutes of October, 10, 2000, December 14, 2000, March 1, 2001, April 12, 2001, 

May 14, 2001 and July 19, 2001 Meeting of Advisory Committee on Market Information 

collectively, at Exhibit 406. Reviewing the meeting minutes of this advisory committee, 

we found Madoff to be an active participant, and he was also listed on the final report 

provided by the committee to the SEC. Id.; Report of the Advisory Committee on 

Market Information: A Blueprint for Responsible Change dated September 14, 2001, at 

Exhibit 407. 

We also found that the Commission invited Madoff to provide opinions on 

matters that were the subject of public hearings. On October 15, 2002, the SEC 

announced hearings to discuss issues relating to the structure of the U.S. equity securities 

377 
 

 

markets and invited Madoff as Principal in Bernard L. Madoff Investment Securities to 

participate as a panelist. 2002 SEC News LEXIS 2305 (October 15, 2002), at Exhibit 

408. Madoff also participated in an October 29, 2002 session after remarks by several 

senior-level SEC officials. SEC News Digest, Issue 2002-208 (October 28, 2002), at 

Exhibit 409. In addition, on April 21, 2004, the SEC announced an agenda for a public 

hearing on proposed regulation NMS which was intended to enhance and modernize the 

regulatory structure of the U.S. equity markets. SEC Press Release 2004-52 (April 15, 

2004), at Exhibit 410. William Donaldson, then-Chairman of the SEC, and Annette 

Nazareth, then-Director of the Division of Market Regulation, both gave remarks at the 

hearing and Bernard Madoff served as a participant on two panels – one panel regarding 

trade-through proposal and another panel regarding market access proposal (linkage). Id. 

SEC officials also regularly participated in events that were set up by Bernie 

Madoff’s niece and Madoff’s firm’s compliance officer, Shana Madoff. Ms. Madoff 

served on the Executive Committee of the SIA’s Compliance and Legal Division, and 

routinely invited SEC officials such as OCIE Associate Director John McCarthy and 

Assistant Director Eric Swanson to participate in SIA Breakfasts (SIABs). For example, 

Swanson participated in at least 17 SIABs during the period from October 2, 2003 until 

November 1, 2006. Swanson Testimony Tr. at pgs 165-169. 

Shana Madoff also invited and arranged for the participation of SEC officials in 

other events, including the Washington, D.C. Compliance & Regulatory Forum, and 

various events sponsored by The Securities Industry and Financial Markets Association 

(SIFMA), such as the Washington, D.C. Regional Conference. E-mail dated October 18, 

2007 from Iris Delgado to Thomas Biolsi at Exhibit 411; E-mail dated October 10, 2007 

from Iris Delgado to Mary Ann Gadziala, Thomas Biolsi at Exhibit 412; E-mail dated 

September 20, 2007 from Iris Delgado to Thomas Biolsi at Exhibit 413. 

The OIG investigation also identified 27 records of correspondence sent between 

1994 and 2005 by Bernard Madoff or members of his family to the Chairman and/or 

other SEC officials. There were no records of any such correspondence between 2005 

and 2009 or between 1992 and 1994. Uhlmann Testimony Tr. at pgs. 15-20. The 

correspondence that could be located included the following: 

(1)	 January 5, 1995 letter from Bernard and Peter Madoff to then-Chairman 

Arthur Levitt, enclosing a copy of an announcement regarding Madoff’s 

Nasdaq initiative. 

(2)	 November 14, 1995 letter from Bernie Madoff to then-Chairman Arthur 

Levitt, complimenting Chairman Levitt’s speech regarding Madoff’s 

recent efforts in price improvement and limit order exposure. 

(3)	 January 22, 1997 letter from Bernard Madoff on behalf of the SIA to thenDirector of Market Regulation Richard Lindsey, with a copy to thenChairman Arthur Levitt, regarding the SEC’s approval of changes by the 

NASD relating to implementation of the SEC’s order handling rules. 

378 
 

 

(4)	 January 30, 1997 letter from Bernard Madoff to then-Director of Market 

Regulation Richard Lindsey, with a copy to then-Chairman Arthur Levitt, 

regarding the SIA’s Trading Committee’s monitoring of the SEC order 

handling rules. 

(5)	 April 28, 1997 letter from Bernard and Peter Madoff to then-Chairman 

Arthur Levitt, asking the Commission for the opportunity to compete for 

National Market System business. 

(6)	 March 20, 1998 letter from Bernie Madoff to then-Chairman Arthur 

Levitt, attaching a comment letter dealing with an NASD filing on its limit 

order book. 

(7)	 May 4, 1998 letter from Bernard Madoff to then-SEC Secretary Jonathan 

Katz, providing comments on behalf of the SIA Trading Committee to 

SEC rules regarding NASD proposed Integrated Order Delivery and 

Execution System. 

(8)	 May 26, 1999 letter from Peter Madoff to then-Chairman Arthur Levitt, 

informing him of a new enhancement to Madoff’s order execution and 

price improvement services. 

(9)	 August 23, 2000 letter from Bernie and Peter Madoff to then-Chairman 

Arthur Levitt, providing information about Madoff’s procedures for the 

handling of orders in the decimal environment. 

(10)	 November 1, 2002 letter from Bernard Madoff to then-Chairman Harvey 

Pitt, thanking him for giving him the opportunity to participate at a an 

SEC Roundtable. See copies of letters collectively at Exhibit 414. 

We also located an August 14, 2002 letter from former Chairman Harvey Pitt to 

Bernard and Peter Madoff, thanking them for their letter regarding SuperMontage and 

Nasdaq’s exchange registration, and a January 29, 1996 letter from former Chairman 

Arthur Levitt to Peter Madoff, thanking him for the copy of Madoff’s comment letter 

regarding the SEC’s Order Execution Obligations Proposal. See copies of letters 

collectively at Exhibit 414. 

C.	 The OIG Investigation Found that the SEC Secured an Exemption 

from a Short Sale rule for Bernard Madoff’s firm 

On February 9, 2001, Bernard L. Madoff sent the SEC’s Division of Market 

Regulation a letter requesting an exemption for Madoff Securities from the short sale 

rule, Rule 10a-1, under the Securities Exchange Act of 1934 (Exchange Act). Letter 

dated February 9, 2001 from Madoff to James Brigagliano, Assistant Director, Division 

379 
 

 

 

 

 

 

 

of Market Regulation, at Exhibit 415.253 Madoff’s firm requested a limited exemption 

pursuant to paragraph (f) of Rule 10a-1 for short sales effected in its capacity as a market 

maker in New York Stock Exchange (NYSE) listed securities that are executed at the 

National Best Offer price. Id. 

Madoff’s firm represented in its letter that the advent of trading in decimal prices 

had caused an increase “in the incidence of rapidly fluctuating quotation changes.” Id. 

Madoff asserted that this increase had caused the number of proprietary short sales 

prohibited by its automated system’s programmed short sale rule protections to increase 

from about 10-15 to about 400 orders per day. Id. Madoff requested that Madoff 

Securities be exempted from the short sale rule when, “acting in its capacity as a market 

maker, the broker-dealer effected proprietary short sales in order to passively provide 

liquidity to customer orders at the current National Best Offer.” Id. Madoff reasoned 

that the requested exemption would allow the broker-dealer to satisfy its “best execution” 

obligations, and asserted that “the executions effected pursuant to this limited exemption 

would not be subject to the types of abuses underlying the intent of Rule 10a-1 [i.e. the 

downward manipulation of the price of a security] and would facilitate market makers’ 

compliance with ‘best execution.’” Id. 

In a no-action letter dated February 9, 2001, the SEC Division of Market 

Regulation granted Madoff Securities’ request for the limited exemption from Rule 10a1. 2001 SEC No-Act LEXIS 190, at Exhibit 417. As the Market Regulation staff 

described in its letter to Madoff, the so-called “tick” test of Rule 10a-1(a) prohibits the 

short sale of a reportable security “at a price either: (1) below the last reported price of a 

transaction reported in the consolidated transaction reporting system (minus tick); or 

(2) at the last reported price if that price is lower than the last reported different price 

(zero-minus tick).” Id. 

Without necessarily concurring in Madoff Securities’ analysis, the Market 

Regulation staff granted the exemption from the short sale rule allowing “registered 

market makers and specialists that are publishing two-sided quotes in the security... to 

sell short to facilitate customer market and marketable limit buy orders at the national 

best offer.” Id. The Market Regulation letter instructed that the market maker or 

specialist must report all such sales as “sell short exempt.” Id.254 

Nazareth recalled Madoff’s firm’s exemption request during her interview with 

the OIG, and specifically recalled the fact that Commission granted Madoff’s firm the 

exemption it sought. Nazareth Testimony Tr. at pgs. 9-11. She also indicated she did not 

253 Rule 10a-1(a)(1) provides that, subject to certain exceptions, a listed security may be sold short (A) at a 

price above the price at which the immediately preceding sale was effected (plus tick), or (B) at the last sale 

price if it is higher than the last different price (zero-plus tick.) 2006 SEC LEXIS 2850, * 18, at Exhibit 

416. Short sales are not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions. Id.
 

The operation of these provisions is commonly described as the “tick test.” Id.
 254 We found that the exemption was commonly referred to as the “Madoff exemption.” Division of
 

Market Regulation: Responses to Frequently Asked Questions Concerning Rule 612 (Minimum Pricing
 

Increment) of Regulation NMS dated October 21, 2005, at Exhibit 418. 

380 
 

recall any other similar requests for exemptions made by any member of the Madoff 

family. Id. at p. 9. 

D.	 The OIG Investigation Found that on Occasion Over the Years, the 

SEC Visited Madoff’s Firm’s Offices as Part of Official SEC 

Events 

The OIG investigation uncovered several instances in which the SEC staff visited 

the Bernard Madoff’s offices in New York City as part of official SEC activities. John 

Ehinger, who worked for the SEC in the Division of Market Regulation from 1999-2003, 

stated that on his first day at the SEC in 1999, he was informed that he would be joining 

other junior SEC attorneys on a “tour of all the various facilities” in New York. Ehinger 

Testimony Tr. at pgs. 58, 60. Ehinger noted that on the second day of the tour, the SEC 

junior attorneys went to visit Madoff Securities. Id. at pgs. 60-61. Ehinger said that 

during the tour, there “was definitely a sense that the -- that Madoff Securities was doing 

a favor for the staff, to let the junior attorneys come in and have a look at all the stuff on 

the trading screens and so on.” Id. at p. 63. Ehinger stated that he thought “there was a 

general sense by the more senior staff that brought us, that they were appreciative of the 

efforts of the Madoff team in general.” Id. at p. 65. 

The OIG also discovered that in June 2000, the SEC scheduled and paid for a trip 

for all students in the SEC Summer Honors Program to New York, NY that included 

tours of the New York Mercantile Exchange and the New York Stock Exchange and trips 

to the offices of Bernard L. Madoff Investment Securities and Merrill Lynch. SEC 

Summer Honors Program Schedule of Events (June 22, 2000), at Exhibit 419; E-mail 

dated June 8, 2000 from Candyce Pare to Ahmad et al, at Exhibit 420. Pursuant to the 

schedule of events, Mark Madoff was to provide the SEC Summer Honors Program 

students with an 11⁄2 hour presentation at the firm’s Third Avenue office on the 18th Floor 

regarding Bernard Madoff Investment Securities. Id. 

Former Chairman Arthur Levitt also stated that he had met Bernard Madoff’s 

brother when he visited Madoff’s offices with members of his staff (5 or 6 people from 

the Division of Market Regulation). Levitt Interview Memorandum at p. 1. He further 

stated that Madoff’s firm was one of many that he had visited and that he routinely 

visited broker-dealers and exchanges while he was Chairman of the SEC. Id. 

Edward Nordlinger, who served as Deputy Regional Director for the Northeast 

region of the SEC from 1988 through 2005, recalled that when a new Commissioner 

(which he believed was Norman Johnson) first began as a Commissioner, Nordlinger 

accompanied the new Commissioner to Bernie Madoff’s office so that Johnson could 

learn about the “over the counter market.” Nordlinger Interview Memorandum at p. 1. 

He recalled the head of the New York office also accompanying him and the new 

Commissioner to meet with Bernard Madoff. Id. 

381 
 

E.	 The OIG Investigation Found no Evidence of Inappropriate 

Financial or Other Relationships with Madoff, But Did Find that 

Madoff Used His Stature in the Industry to Try to Intimidate the 

SEC staffers and His Stature Played an Ancillary Role in the 

Conduct of Their Examination and Investigatory Work. 

1.	 No Evidence of Improper Financial or Other Connections 

Between Examiners and Investigators and Madoff 

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

who worked on an SEC examination or investigation of Bernard L. Madoff Investment 

Securities had any financial or other inappropriate connection with Bernard Madoff or 

Bernard Madoff’s family that influenced the conduct of their examination or 

investigatory work.255 During the course of the OIG investigation, the OIG reviewed 

millions of e-mails and took testimony of the SEC personnel who conducted the 

examinations and investigations of the Madoff firm and found no evidence that any SEC 

personnel who participated in Madoff examinations or investigations invested with 

Madoff, or had any financial or other tie to Madoff or his family.256 

2.	 Evidence of Awareness by Examiners and Investigators of 

Madoff’s Stature and Ancillary Role His Stature Played in their 

Work 

a.	 Introduction 

The OIG investigation did find that the examiners and investigators who worked 

on Madoff-related matters were aware, or became aware, of Madoff’s prominence in the 

industry, and that Madoff used his stature and perceived connections to try to influence 

examinations and investigations. We also found that the examiners’ and investigators’ 

awareness of Madoff’s stature played an ancillary role in the conduct of their 

examination and investigatory work. 

255 Allegations that former OCIE Assistant Director Eric Swanson’s relationship with Bernard Madoff’s 

niece, Shana Madoff, influenced the OCIE examinations in which Swanson participated are discussed in 

detail in Section VII of this Report of Investigation. 

256 Two of the SEC Office of Internet Enforcement Official’s family members invested $1.5 million and 

$500,000 respectively with Madoff, but we have found no evidence that the Office of Internet Enforcement 

Official played any role in any Madoff examination or investigation. Office of Internet Enforcement 

Official Testimony Tr. at pgs. 25-27. As discussed in greater detail in Section X of this Report of 

Investigation, the Office of Internet Enforcement Official’s office received a complaint about Madoff that 

was not referred for investigation, but the OIG found no evidence that the Office of Internet Enforcement 

Official himself saw the complaint prior to December 2008. Id. at pgs. 20-22; Enforcement Senior Counsel 

Testimony Tr. at p. 23. 

382 
b. 1992 Investigation of Avellino & Bienes 

In connection with the 1992 investigation of Avellino & Bienes, an SEC examiner 

acknowledged that Madoff’s stature and reputation in the industry may have influenced 

their decision not to further examine Madoff’s operations while investigating Avellino & 

Bienes for a possible Ponzi scheme. SEC Branch Chief John Gentile stated that he was 

aware that Madoff’s firm “was very prominent in developing third market particular 

automated trading.” Gentile Interview Tr. at p. 10. Similarly, SEC examiner Demetrios 

Vasilakis stated that during the 1992 examination, he was “made aware” by Bernard 

Madoff himself that Madoff served in various industry committees, was a well respected 

individual and noted that the SEC examiners used an NASD manual with Bernard 

Madoff’s name on it. Vasilakis Interview Tr. at pgs. 24, 27. In fact, when asked for his 

recollections of Bernard Madoff at the time of the examination, Vasilakis stated as 

follows: 

My personal conclusions [from the examination] were that 

[Bernard Madoff] was a pioneer in the industry, to use the 

term that’s been thrown around now, but that he really 

used, you know, technology to bring trading to the next 

level. It was strictly -- when I walked out of there it was 

more along the lines of wow, this guy is a third market guy 

that does X percent of the volume on the exchange. This is 

where I actually learned about third market. I didn’t even 

know the so called term that that's what 

it was called [prior to the examination.] Id. at p. 17. 

Gentile stated that it was fair to say that because of Bernard Madoff’s reputation 

at that time as a large broker-dealer, there may not have been any thought to look into 

Madoff’s operation any further. Gentile Interview Tr. at p. 37. Gentile further 

acknowledged that in light of the evidence uncovered in the 1992 investigation, someone 

“should have been aware of” the fact that the money used to pay back Avellino and 

Bienes’ customers could have come from other investors, but there was no examination 

of where the money that was used to pay back the investors came from. Id. at pgs. 32-33. 

Gentile also admitted that Madoff could have taken the money that was used to pay back 

Avellino and Bienes’ investors from anybody, including other customers, stating that 

“absolutely could have been done,” but no effort was undertaken to verify if that 

occurred. Id. at pgs. 35-36. 

c. 2003 DC OCIE Examination 

With respect to the 2003 OCIE examination in Washington, D.C, Associate 

Director John McCarthy stated he became aware of Madoff when he conducted an 

examination in the mid-90s. McCarthy Testimony Tr. at p. 18. McCarthy said he 

subsequently learned that Madoff’s firm was one of the largest third market maker firms 

and that they had a very good reputation in terms of their execution quality of retail 

customer orders. Id. Assistant Director Eric Swanson also stated that in the later 1990’s 

383 
he became aware of Madoff Securities as a large market maker in over-the-counter space. 

Swanson Testimony Tr. at pgs. 15-16. Then-Branch Chief Mark Donohue stated that he 

was also aware of Madoff’s firm as a market maker prior to the 2003 examination. 

Donohue Testimony Tr. at p. 18. 

Although McCarthy, Swanson, and Donohue were aware of Madoff’s stature, 

there is no evidence that Madoff’s prominence impacted their examination, and they 

denied that their examination was influenced by Madoff’s reputation. McCarthy 

Testimony Tr. at p. 140; Donohue Testimony Tr. at pgs. 82-83. However, there is 

evidence that when McCarthy, Swanson, and Donohue discussed their examination with 

the NERO examiners, they made a point to inform the NERO examiners of Madoff’s 

stature in the industry. 

According to NERO examiner William Ostrow, during a conference call on May 

31, 2005 with Swanson, McCarthy, and Donohue, he and fellow NERO examiner Peter 

Lamore were informed that Madoff was a powerful and well-connected individual, 

stating: 

I don’t know who said it, someone from OCIE basically, 

“He’s a very powerful person, Bernie, and you know, just 

remember that.” ... But basically just, “He is a very wellconnected, powerful person.” 

Ostrow Testimony Tr. at pgs. 113-14. Ostrow interpreted the statement to raise a concern 

for them about pushing Madoff too hard without having substantial evidence. Id. at 145­

146. Lamore had a similar recollection as follows: 

I’m not sure if those were the exact words, but it struck me 

as odd at the time. It’s what I remember from that call was 

-- you know, we’re always professional, of course, when 

we go do our exams, but that kind of elevates your sense of 

your need to be professional. 

Lamore Testimony Tr. at pgs. 105-106. 

Assistant Director on the NERO examination John Nee also recalled the 

statement, although he did not interpret it to mean they should “tread lightly.” Nee 

Testimony Tr. at p. 103. He thought the comment indicated “they might get a phone call 

from someone but we never did.” Id. at 104. 

d. 2005 NERO Examination 

The OIG investigation uncovered evidence that Ostrow and Lamore were well 

aware of Madoff’s stature in the industry, that Madoff attempted to intimidate and 

impress them with his perceived connections, and that the junior examiners were 

384 
overmatched in their interactions with Madoff making them unable to aggressively 

conduct the 2005 NERO examination. 

Prior to beginning the examination, Ostrow stated he knew the name Bernie 

Madoff because Madoff was “a large market maker.” Ostrow Testimony Tr. at p. 18. 

We also found that around the time of the examination, Ostrow and Lamore exchanged 

articles describing Madoff’s significant achievements, including “serv[ing] as chairman 

of the board of directors of the Nasdaq Stock Market as well as a member of the board of 

governors of the NASD ... [and] of the Securities Industry Association. ... [and] a 

founding member of the board of directors of the International Securities Clearing 

Corporation in London.” E-mail dated March 28, 2005 from Ostrow to Lamore, at 

Exhibit 222. Another article exchanged by the examiners was entitled, “The Madoff 

Dynasty” and described Madoff’s family members. Id. 

Lamore also testified that the name Madoff was familiar to him when he began 

the examination, stating he was aware that Madoff was “a pretty prominent maker.” 

Lamore Testimony Tr. at p. 23. Lamore acknowledged that after researching Madoff 

prior to the examination, he concluded that Madoff was an impressive and influential 

figure in the industry. Id. at p. 50. Nee and Associate Director Sollazzo also recalled 

being aware of Madoff as a big market-maker when they began the cause examination. 

Sollazzo Testimony Tr. at p. 35; Nee Testimony Tr. at p. 18. 

Lamore said Madoff made efforts to emphasize his role in the securities industry 

during the examination. Lamore Testimony Tr. at p. 50. Lamore characterized Madoff 

as “a wonderful storyteller” and “very captivating speaker” and noted that he had “an 

incredible background of knowledge in the industry.” Id. at p. 51. Lamore said he found 

it “interesting” but also “distracting” because they were there “to conduct business.” Id. 

Ostrow indicated that there were efforts made by Madoff to impress and even 

intimidate the examiners. Ostrow stated that “[a]ll throughout the examination, Bernard 

Madoff would drop the names of high-up people in the SEC.” Ostrow Testimony Tr. at 

p. 24. Ostrow reported that Madoff told him and Peter Lamore that Christopher Cox was 

going to be the next Chairman of the SEC a few weeks prior to Cox being officially 

named. Id. at pgs. 24; 141. Ostrow stated they “were pretty amazed” that Madoff knew 

this information and he felt that Madoff’s intention was to both impress and intimidate 

them. Id. at p. 24. Ostrow said Madoff made clear that “he knew everybody in OCIE,” 

and referenced his relationship with Lori Richards, Director of OCIE. Id. at pgs. 141­

142. 

Ostrow also reported that Madoff told them that Madoff himself “was on the short 

list” to be the next Chairman of the SEC. Id. at p. 142. Ostrow said they believed it was 

a possibility since he was very well known in the industry. Id. at p. 143. Ostrow also 

said because he was aware of Madoff’s connections with NASDAQ during the 

examination, he did not feel comfortable calling an official at NASDAQ because “it was 

too clubby of a system.” Id. at p. 144. However, Ostrow also stated that Madoff’s namedropping “didn’t really impress us.” Id. at pgs. 24-25. 

385 
 

 

 

 

 

 

Lamore also recalled that Madoff would drop the names of senior SEC officials, 

including referencing a meeting or rulemaking relating to Commissioner Annette 

Nazareth. Lamore Testimony Tr. at pgs. 89-90. Lamore stated that Madoff was trying to 

impress him with all his connections, and noted that dropping the name of a 

Commissioner of the SEC, “was a pretty big name ... to mention.” Id. at p. 90. Lamore 

also recalled Madoff saying that he was on the short list to be the next Chairman of the 

SEC. Id. at p. 123. In fact after the examiners received an e-mail from the Director of 

the SEC’s New York office announcing that Chairman William Donaldson would be 

resigning, Lamore sent an e-mail to John Nee stating, “Bernie told us he was on the short 

list when Chairman Donaldson was selected. Maybe this time.” E-mail dated June 1, 

2005 between Lamore and Nee, at Exhibit 229. Nee responded to Lamore’s e-mail, 

stating, “Maybe you and William can be his aides.” Id. Nee stated that in his response 

on the e-mail about Lamore and Ostrow being Madoff’s aides, he “was trying to be 

facetious.” Nee Testimony Tr. at p. 196. 

Lamore recalled one incident when he was asking Madoff for documents and 

Madoff became very angry, recalling that Madoff’s “veins were popping out of his neck” 

and he was repeatedly saying, “What are you looking for?” and “his voice level got 

increasingly loud.” Lamore Testimony Tr. at p. 71. Lamore responded to Madoff, 

“What do you want us to look for?” and “What do you think we’re looking for?” and 

Madoff replied, “Front running. Aren’t you looking for front running.” Id.257 Ostrow 

similarly described Madoff during the examination as being charming and charismatic at 

times, but that he got “angry” at the examiners when they asked him to produce certain 

documents or information. Ostrow Testimony Tr. at pgs. 148-150. 

While Nee stated he did not believe that Ostrow was “star struck” when meeting 

Madoff, he did note that he later found out that Ostrow had his wife take pictures of 

Madoff when he was being arraigned. Nee Testimony Tr. at pgs. 197-198. Nee 

acknowledged that Madoff’s intent was to impress and intimidate the examiners, but he 

thought these efforts were unsuccessful and the examiners found Madoff to be a “bit of a 

blowhard.” Id. at pgs. 123-124. Sollazzo also acknowledged that given the frequent 

interaction between Madoff and the examiners, there was a possibility that Madoff’s 

“reputation and supposed world of knowledge” that he could “overcome” or “stonewall 

examiners.” Sollazzo Testimony Tr. at p. 89. He stated that they may have been 

“overwhelmed” by Madoff and “outmatched a bit.” Id. at p. 90. Elaine Solomon, who 

worked as Peter Madoff’s secretary from March 1997 until December 2008, stated that 

the SEC examiners who met with Madoff looked like they were “in awe” of him. 

Solomon Testimony Tr. at p. 16.258 

257 Lamore stated that when angry, Madoff “could belittle you to the point, where, you know, you feel 

pretty low.” Lamore Testimony Tr. at p. 210. 

258 Solomon also stated that over the years, people from the SEC would ask about working at Madoff’s 

firm and even if they could drop off resumes, although she never actually saw any resumes provided. 

Solomon Testimony Tr. at pgs. 14-15. However, when asked specifically about the examiners who were at 

Madoff’s firm during the 2005 examination, she stated she did not believe those examiners (likely Lamore 

and Ostrow) ever asked about jobs or a resume. Id. at p. 14. Both Ostrow and Lamore adamantly denied 

ever making any comments about seeking jobs with Madoff, or dropping off any resumes. Ostrow 

Testimony Tr. (8/19/2009) at pgs. 7-8; Lamore Testimony Tr. (8/19/2009) at pgs. 6-7. 

386 
 

After Madoff confessed, Lamore reflected in an e-mail with an office colleague, 

an Enforcement Assistant Regional Director, about why they were unable to uncover the 

fraud, noting “that additional authority access would have possibly enabled us to detect 

it” and stated, “Our hesitancy toward rocking the boat also is something that should be 

reconsidered.” Lamore Testimony Tr. at p. 244; E-mail dated December 13, 2008 from 

Lamore to Enforcement Assistant Regional Director at Exhibit 421. Lamore stated he 

was referring to the fact that the examiners do not reach out to industry or to third parties 

and that “sometimes the exam program ... can sort of not be taken seriously at times.” 

Lamore Testimony Tr. at p. 244. Lamore stated that in every exam, he feels like he is 

trying to “find some information out” and he is “really kind of at the behest of the 

registrant as to ... whatever they tell” him. Id. at p. 245. Lamore stated that in his 

opinion, the exam program is not aggressive or assertive enough. Id. The Enforcement 

Assistant Regional Director stated Lamore’s reference to “hesitance towards rocking the 

boat” referred to the fact that “there’s a lot of players in the industry that are significant 

players and sometimes there’s a tendency to take at face value what industry people are 

saying.” Enforcement Assistant Regional Director Testimony Tr. at p. 12. 

Lamore also acknowledged that at the senior levels of the SEC, the hesitancy 

towards rocking the boat may be even more pronounced with respect to someone like 

Bernie Madoff, who’s a well-known person in industry, although Lamore noted that 

“he’d like to say that ... we’re sort of professional and treat everyone equally.” Lamore 

Testimony Tr. at p. 245. Lamore noted that it is easier to be more aggressive when you 

are examining a “penny-stock firm” rather than, for instance, Goldman Sachs, noting that 

it would be “very difficult” for someone in his position “to tell Bernie Madoff that he’s a 

liar.” Id. at pgs. 245-246. 

Ostrow also recalled that in past examinations unrelated to Madoff, supervisors at 

the Commission appear to have been reluctant to push issues against influential people, 

stating: 

Yes. I’ve seen it where, you know, maybe I’ve been told, 

“Don’t rock the boat so much there, because we have a 

good relationship with them,” and when we -- and not 

Madoff-related, but you know, “where we need to make a 

request for documents, they always gave it to us. So let’s 

try to go easy.” You know, and I don’t go easy, and I push 

hard, and I get pushback from staff members. But, you 

know, at the end of the day it turns out, yes, it is an issue, 

or it should be an issue. 

Ostrow Testimony Tr. at pgs. 163-164. 

387 
 

 

 

 

 

e. 2005-2006 Enforcement Investigation 

In connection with the 2005-2006 Enforcement investigation, the OIG found that 

the Enforcement investigators were not aware of Madoff’s stature before they began the 

investigation. Assistant Director Doria Bachenheimer stated that when she first learned 

of Markopolos’ complaint, she had not heard the name Bernie Madoff or Madoff 

Securities. Bachenheimer Testimony Tr. at p. 52. Branch Chief Meaghan Cheung stated 

that she had “embarrassingly” not heard of Madoff or his firm before the Madoff case. 

Cheung Testimony Tr. at p. 23. Staff attorney Simona Suh similarly stated that prior to 

being assigned the case, she had never heard of Madoff or his firm. Suh Testimony Tr. at 

p. 25. 

In addition, while the Enforcement investigators acknowledged becoming aware 

of Madoff’s stature during the investigation, they denied that his prominence impacted 

the investigation, except to the extent that they were less likely to believe that Bernie 

Madoff had engaged in a Ponzi scheme. Cheung acknowledged that during the 

investigation, she learned that Madoff was an influential figure in the securities industry, 

and had a high-level position with the NASDAQ. Cheung Testimony Tr. at p. 263.259 

Moreover, when asked if once she learned of Madoff’s reputation, she thought that the 

staff treated him differently, Cheung stated as follows: 

I don’t think there was ever a conscious desire to make 

something go away or to ignore an allegation about Bernie 

Madoff. Do I think that there’s an inherent bias towards 

the sort of people who are seen as reputable members of 

society, there may be an inherent bias in that way. I think 

that we did not forego investigative steps because of who 

he was, and I don’t think we were easier on him. I have 

personally interviewed, requested documents, gotten tolling 

agreements, pushed from people who I view as -- as sort of 

more powerful than Bernie Madoff without, I think, pulling 

a punch. 

Id. at p. 264. 

Suh stated in testimony, “Madoff [did] sort of try to play up his prominence to 

some degree. He talked about, you know, being on panels of, I believe, NASD or 

something like that.” Suh Testimony Tr. at p. 93. However, Suh stated, “It did not really 

matter much to me.” Id. Suh, did, however, acknowledge, “It’s certainly true that he 

didn’t fit the profile of a Ponzi schemer, at least as we -- in the world that we knew then,” 

however, “I never had a concern in terms of, you know, stepping on the wrong toe or 

anything like that, and I had no impression that anybody else did.” Id. at pgs. 44-45. 

259 Bachenheimer stated that shortly after she began the investigation, she “learned that people had been 

making allegations about Madoff for years and they hadn’t stuck, and that’s what I knew as far as his 

reputation.” Bachenheimer Testimony Tr. at p. 52. 

388 
 

Cheung, however, denied that in her mind, it was “just inconceivable” that 

someone like Bernie Madoff would have run a Ponzi scheme, stating that the 

investigators significantly looked at and considered the issue of a potential Ponzi scheme 

even though he was Bernie Madoff. Cheung Testimony Tr. at p. 264. 

f.	 Conclusion 

In light of the foregoing, the OIG concludes that Madoff’s stature played an 

ancillary role in the SEC’s failure to uncover the fraud in their examinations and 

investigations. In the 1992 investigation, we found evidence that in light of Madoff’s 

reputation, the examiners did not think it necessary to look into Madoff’s operation any 

further. In the 2005 NERO examination, Madoff was able to use his stature and 

perceived connections to push back successfully against the junior examiners, who did 

not feel sufficiently confident to be more aggressive in their examination and who were 

informed by senior officials in Washington, D.C., as they were conducting the 

examination, of Madoff’s reputation in the industry. In the 2005-2006 Enforcement 

investigation, Madoff’s prominence made it less likely for the SEC investigators to 

believe that he could be running a Ponzi scheme. 

VII. ALLEGATIONS OF CONFLICT OF INTEREST OR IMPROPER 

INFLUENCE ARISING FROM RELATIONSHIP BETWEEN ERIC 

SWANSON AND SHANA MADOFF 

A.	 Introduction 

The OIG thoroughly investigated allegations that the relationship between OCIE 

Assistant Director Eric Swanson and Bernard Madoff’s niece, Shana Madoff (Shana), 

constituted an improper conflict of interest and impacted the SEC examinations of 

Bernard Madoff, in which Swanson was involved. 

The OIG took Swanson’s testimony under oath, reviewed thousands of e-mails 

relating to Swanson’s relationship with Shana, and took the testimony of or interviewed 

numerous other individuals in Swanson’s life during the pertinent time period, including 

his former girlfriends and close friends.260 Because of the seriousness of the allegations, 

the OIG provides in detail the information it learned about Swanson’s relationship with 

Shana, his other relationships while he was involved in the OCIE examination of Madoff, 

and the events that occurred after Swanson and Shana’s relationship became public. 

260 Through her counsel and Eric Swanson, the OIG made numerous requests to speak to Shana Madoff, 

but she declined to be interviewed. 

389 
 

 

 

B. Swanson’s Initial Contact with Shana Madoff 

The OIG investigation found that Eric Swanson’s initial contact with Shana 

occurred in April 2003, in connection with OCIE’s Madoff QQQ examination.261 

Swanson Testimony Tr. at pgs. 23-24. On April 8, 2003, Swanson sent out document 

requests for the QQQ examination, including a document request to Bernard Madoff 

Investment Securities (BMIS). Letter dated April 8, 2003 from Swanson to Peter 

Madoff, at p. 1-2, at Exhibit 422. On April 15, 2003, Swanson e-mailed Shana, in her 

role as compliance attorney at BMIS, regarding the OCIE document request for BMIS’ 

trades in the QQQ examination. E-mail dated April 15, 2003 from Swanson to Shana, at 

Exhibit 423; Swanson Testimony Tr. at p. 23. Swanson’s e-mail stated as follows: 

Shauna [sic]: 

These are the adjustments we have made to the information 

requested: 

1. Please disregard any limitation on size. We would like 

the information for all orders. 

2. For the dates listed, we intend for you to include the 

requested audit trail all orders in the QQQ that were routed 

out to any other venue for execution, including proprietary 

trades (this may not have been clear from the request). 

I apologize you did not receive a phone call before now. 

Call with any questions. 

E-mail dated April 15, 2003 from Swanson to Shana, at Exhibit 423. 

This is the first written record the OIG has located of any contact between 

Swanson and Shana. While Swanson did not specifically recall this first contact with 

Shana, he acknowledged he sent the e-mail to Shana clarifying the document request, and 

believed that it was the probably the first time he ever had any contact with Shana. Id.; 

Swanson Testimony Tr. at p. 23. Swanson described his recollections of this e-mail and 

his first contact with Shana in the following exchange: 

A: I don’t recall specifically having contact, but it seems 

likely, based on this e-mail, that there must have been 

something, a phone call or something, with the firm. 

Q: Okay. Do you think this e-mail, Exhibit 4, might 

have been the first contact you had with Shana 

Madoff? 

261 A more detailed discussion of the Madoff QQQ examination is found in Section XI of this Report of 

Investigation. 

390 
 

A: I’m reasonably certain, given the fact that I’ve 

misspelled her first name, and I -- I -- I didn’t recall 

having had any contact with her prior to when I 

actually met her later that year. So, yeah, this is 

probably it. 

Q: Okay. So this would have been just an e-mail 

communication, not a meeting in person? 

A: Oh, no. I know I didn’t have a meeting in person. It’s 

possible that this was preceded by a telephone call. 

The contacts, if this all there is by e-mail, it seems to 

suggest that there was some telephone contact. 

Id. at pgs. 23-24. 

On May 2, 2003, Shana e-mailed Swanson, stating that BMIS’ response to the 

document request would be sent via Federal Express to the SEC the following week. 

E-mail dated May 2, 2003 from Shana to Swanson, at Exhibit 424. The OIG 

investigation did not uncover evidence of any further contact between Swanson and 

Shana regarding this examination. We found that on June 5, 2003, BMIS’ Liz Weintrab 

sent an e-mail to Swanson containing BMIS’ QQQ trading excel spreadsheets, and the 

BMIS spreadsheets were then forwarded to the lead attorney on the QQQ examination, 

Matt Daugherty. E-mail dated June 5, 2003 from Weintraub to Swanson, at Exhibit 425; 

E-mail dated June 5, 2003 from Swanson to Daugherty, at Exhibit 426. 

C. Swanson’s First in-Person Meeting with Shana Madoff 

In August 2003, Shana contacted Swanson about whether OCIE Associate 

Director John McCarthy would be able to speak at a Securities Industry Association 

Breakfast (SIAB) conference in St. Louis for the Securities Industry Association’s (SIA) 

Compliance and Legal Division.262 E-mail dated August 13, 2003 from Swanson to 

McCarthy, at Exhibit 427. McCarthy asked Swanson to contact Shana on his behalf and 

inform her that he would like to speak at the meeting. E-mail dated August 14, 2003 

from McCarthy to Swanson, at Exhibit 428. 

262 Shana Madoff served on the executive committee of the Securities Industry Association’s Compliance 

and Legal Division. In November, 2006, the Securities Industry Association (SIA) merged with the Bond 

Market Association to form the Securities Industry and Financial Markets Association (SIFMA). See 

http://www.sifma.org/regulatory/litigation/utah_lawsuit/index.html. Securities Industry Association 

Topical Breakfasts were seminars where regulators and industry met to discuss current areas of interest in 

the securities industry. The SIA Compliance & Legal Division sponsored the breakfasts. Shana Madoff, 

who was active on the Executive Committee of SIA's Compliance & Legal Division, planned the SIABs 

from August 2003 to October 2006. 

SIA’s invitations promoted that leading regulators from the SEC, NASD and NYSE will be 

discussing the examination agendas and current industry regulatory issues. Regulators such as FINRA’s 

Steve Luparello and Tom Gira, and NYSE’s Mike Rufino, Grace Vogel and Susan Axelrod also 

participated as speakers for the seminars. 

391 
On August 18, 2003, Swanson e-mailed Shana, stating that “I can’t seem to get 

through on your tele number, but wanted to let you know that John McCarthy would be 

willing to attend/speak at your breakfast mtg [sic] in St. Louis ... I may come as well.” 

E-mail dated August 18, 2003 from Swanson to Shana, at Exhibit 429. Shana responded, 

indicating they were having problems with their phones, and thanked Swanson and 

McCarthy for agreeing to speak at the SIAB meeting in St. Louis. E-mail dated August 

18, 2003 from Shana to Swanson, at Exhibit 430. Swanson forwarded Shana’s e-mail to 

McCarthy. E-mail dated August 18, 2003 from Swanson to McCarthy, at Exhibit 431. 

Swanson recalled the breakfast meeting in St. Louis as the first time he met Shana 

in person in the following exchange with the OIG: 

Q: Okay. Do you recall if this e-mail referenced this 

breakfast meeting which was the first time that you 

met Shana Madoff? 

A: Well, I don’t -- I don’t recall the e-mail, but it 

absolutely does reference that breakfast meeting. 

Q: Okay. And that breakfast meeting would have been 

when? 

A: I have no independent recollection of exactly when 

it is, but I did have an opportunity to look at some 

of the documents that I think [my attorney] has sent 

over to you --

Q: Okay. 

A: -- in the aftermath of when all this happened, and I 

want to know when that was. So I believe it was in 

October of 2003. 

Q: Okay. So you -- you had e-mail communication 

with Shana Madoff prior to that and perhaps phone 

calls, but you hadn’t met her in person? 

A: That’s correct. 

Swanson Testimony Tr. at pgs. 25-26. 

Later in his testimony, Swanson confirmed for a second time that he believed that 

the first time that he met Shana in person was “in October of 2003.” Id. at pgs. 125-126. 

There was no evidence of any further interaction between Swanson and Shana at the St. 

Louis breakfast after this initial meeting. 

392 
 

D. Swanson’s Further Contacts with Shana Madoff at SIAB Conferences 

The OIG found that over the next couple of years, Swanson continued to 

communicate with Shana and attend the SIAB conferences she arranged even as he 

worked on an OCIE cause examination of Madoff that was initiated in late 2003. On 

November 12, 2003, a month after Swanson first met Shana in person, Swanson saw 

Shana again at the Minneapolis SIAB conference. Swanson Testimony Tr. at p. 166. 

Approximately one month after the Minneapolis SIAB conference, on December 18, 

2003, Swanson’s supervisor, John McCarthy sent an e-mail to OCIE Director Lori 

Richards, with a copy to Swanson, informing her about the complaint from the Hedge 

Fund Manager that triggered the OCIE Madoff cause examination.263 E-mail dated 

December 18, 2003 from McCarthy to Richards, at Exhibit 158. 

Later that day, Richards and McCarthy contacted Madoff to inform him that they 

were beginning an examination. E-mail dated December 18, 2003 from Richards to 

McCarthy, at Exhibit 159; Richards Testimony Tr. at p. 26. Shortly thereafter, an 

examination team was assembled and McCarthy, in consultation with Swanson and 

Branch Chief Mark Donohue, decided to limit the focus of the examination to frontrunning. McCarthy Testimony Tr. at pgs. 25, 56; Swanson Testimony Tr. at pgs. 48-49; 

Donohue Testimony Tr. at pgs. 22-26. On January 6, 2004, Swanson signed and sent a 

formal document request to Peter Madoff (Shana’s father) on behalf of the SEC in 

connection with the OCIE cause examination. Letter dated January 6, 2004 from 

Swanson to Peter Madoff, at Exhibit 432. 

On January 13, 2004, Swanson communicated via e-mail with Shana regarding a 

potential upcoming SIAB conference in Boston. E-mail dated January 13, 2004 from 

Shana to Swanson, at Exhibit 433. Swanson, however, did not attend the SIAB in 

Boston. Swanson Testimony Tr. at pgs. 165-168. On February 18, 2004, Swanson 

signed and sent a second document request to Peter Madoff in connection with the OCIE 

cause examination. Letter dated February 18, 2004 from Swanson to Peter Madoff, at 

Exhibit 434. On February 22, 2004, Donohue was promoted to Assistant Director 

reporting directly to McCarthy and Donohue took over the “day to day responsibility” for 

the OCIE cause examination. Swanson Testimony Tr. at pgs. 71, 84; Donohue 

Testimony Tr. at p. 14. 

On April 7, 2004, the staff-level examiners on the OCIE cause examination of 

Madoff were told by Donohue to focus their priorities on a mutual fund project, and the 

Madoff cause examination was put on the backburner, even though there were unresolved 

questions. E-mail dated April 7, 2004 from Donohue to Walker (with copy to Wood), at 

Exhibit 435; Donohue Testimony Tr. at p. 94. 

On April 29, 2004, Swanson attended another SIAB conference organized by 

Shana in Atlanta. Swanson testimony Tr. at p. 166. After another SIAB conference in 

Seattle originally scheduled for June 2004 had been postponed, on August 12, 2004, 

263 A more detailed discussion of the OCIE Madoff cause examination is found in Section III of this Report 

of Investigation. 

393 
Swanson e-mailed Shana about a possible SIAB in Dallas for October, stating to her, 

“We’re in. Its been too long – I’m starting to miss it.” E-mail dated August 12, 2004 

from Swanson to Shana, at Exhibit 436. Swanson also e-mailed Shana on August 12, 

2004 asking for her assistance in preparing comments for a presentation he was giving on 

the role of the compliance professional in the regulatory environment. E-mail dated 

August 12, 2004 from Swanson to Shana, at Exhibit 437. In this August 12, 2004 e-mail, 

Swanson described how the compliance industry tended to gravitate toward industry 

standards, which he expressed concerns were too low, and noted that a compliance 

officer may face resistance to going beyond these low standards. Id. Swanson then 

stated in the e-mail, “The question is, and acknowledging that Madoff is the exception to 

the above [concern about compliance officers gravitating toward a low standard], do you 

think this theory is plausible?” Id. Shana responded the next day and scheduled a time 

for them “to chat about” the subject. E-mail dated August 13, 2004 from Shana to 

Swanson, at Exhibit 438. 

In October 2004, Swanson arranged for Donohue and OCIE Senior Special 

Counsel Tom Eidt to speak at Shana’s SIAB conference in Dallas because Swanson had a 

conflict. E-mail dated October 7, 2004 from Swanson to Shana, at Exhibit 439. Shana 

thanked Swanson for arranging for Donohue and Eidt, and stated, “Eric, you are so great 

and no matter what you and John will always be my A-team players.” E-mail dated 

October 7, 2004 from Shana to Swanson, at Exhibit 440. 

In December 2004, McCarthy asked Swanson to follow up on a best execution 

problem at Madoff’s firm regarding a delay in the opening of a particular stock on the 

New York Stock Exchange. E-mail dated December 17, 2004 from McCarthy to 

Swanson, at Exhibit 441. There is no evidence that this concern led to any further 

examination of Madoff. 

In January 2005, Swanson, Eidt, McCarthy and Steve Luparello from NASD, 

spoke at an SIAB conference in Seattle and had dinner with Shana. E-mail dated January 

25, 2005 from Shana to McCarthy, Swanson, Eidt, and Luparello, at Exhibit 442; E-mail 

dated January 26, 2005 from Luparello to Shana, McCarthy, Swanson, and Eidt, at 

Exhibit 443. 

In March 2005, Swanson attended an SIAB conference in St. Louis. Swanson 

Testimony Tr. at pgs. 107-108, 167. On March 16, 2005, Swanson and Shana 

communicated via e-mail in an attempt to locate each other at the Hyatt Hotel. Id. at p. 

107-108; E-mail dated March 16, 2005 from Swanson to Shana Re: At Starbucks, at 

Exhibit 444. Shana e-mailed Swanson that she was “in the mall.” E-mail dated March 

16, 2005 from Shana to Swanson Re: At Starbucks, at Exhibit 445. Swanson replied, 

“John [McCarthy] and I are in the lobby.” E-mail dated March 16, 2005 from Swanson 

to Shana, at Exhibit 446. After several more e-mail exchanges, Swanson and Shana met 

in the Hyatt Hotel and went to the SIAB conference together. E-mails dated March 16, 

2005 from Shana to Swanson, at Exhibit 447. Swanson Testimony Tr. at pgs. 107-109. 

394 
 

Several hours after meeting Shana in the hotel lobby, Swanson sent Donohue an 

e-mail asking, “What is the status of the MADF hedge fund thingy?” E-mail dated 

March 16, 2005 from Swanson to Donohue, at Exhibit 448; Swanson Testimony Tr. at 

pgs. 104-105. Donohue responded, “Deady. We never found any real problems. Does it 

need to be revised?” E-mail dated March 16, 2005 from Donohue to Swanson, at Exhibit 

449; Swanson Testimony Tr. at p.104-105. 

Swanson admitted in his testimony that seeing Shana at the St. Louis SIAB 

conference likely triggered his recollection of the Madoff examination and accordingly, 

he followed up with Donohue. Swanson Testimony Tr. at pgs. 106-109. However, 

Swanson denied ever speaking to Shana about the status of the Madoff examination and 

stated that he did not believe that Shana was ever aware of the Madoff examination, as 

demonstrated by the following exchange: 

A: I will tell you definitively right now I never once 

had a conversation with Shana Madoff about this 

review that was going on. 

* * * 

Q: Okay. So did Shana ever ask you about the status 

of an examination? 

A: No. In fact, I don’t believe she ever knew about 

this examination. 

* * * 

Q: Okay. But it’s possible that because you had just 

been with Shana Madoff at this conference, that 

triggered in your mind whatever happened with the 

Madoff hedge fund? 

A: It’s likely. 

Q: Okay. But again, Shana never asked you about the 

status of the exam? 

A: Shana never once asked me about the status of an 

exam. 

Q: And you never talked to her about the status of the 

exam? 

395 
 

 

 

 

 

 

A: Never talked to her about the status of the exam, 

and I will add that I don’t believe she even knew 

about this particular examination.264 

Id. at pgs. 107-110.265 

Less than two months after seeing Shana in St. Louis, Swanson learned on May 

26, 2005, that NERO examiners were conducting their own examination of Madoff. 

E-mail dated May 26, 2005 from McCarthy to Swanson, at Exhibit 450. On May 31, 

2005, a conference call took place with the NERO examiners, during which, one of 

Swanson, McCarthy or Donohue, stated to the NERO examiners that Madoff was a “very 

well-connected, powerful person.” E-mail dated May 31, 2005 from Nee to Swanson, at 

Exhibit 451; Ostrow Testimony Tr. at pgs. 113-14. One of the NERO examiners on the 

telephone call interpreted the statement to raise a concern for them about pushing Madoff 

too hard in their examination without having substantial evidence. Id. at pgs. 145-146. 

On June 9, 2005, the OCIE examination team packed up their examination workpapers 

and sent them to NERO. Letter dated June 9, 2005 from Wood to Nee, at Exhibit 209.266 

After his sworn testimony on June 19, 2009, Swanson provided supplemental 

information to the Office of the Inspector General, stating that he had a vague 

recollection that, “prior to 2005, he and Mr. McCarthy discussed the appropriateness of 

working on matters involving Madoff in light of their participation in the compliance 

breakfasts, and that neither he nor McCarthy determined that they should be recused.” 

Letter dated June 19, 2009 from Michael Wolk, Counsel to Swanson, to IG Kotz, at p. 2, 

at Exhibit 183. Swanson also stated that he “took comfort in the fact that Lori Richards, 

Director, Office of Compliance Inspections and Examinations, was aware that the 

breakfasts were sponsored by the Securities Industry Association (SIA).” Id. 

In addition, McCarthy testified OCIE Director Lori Richards encouraged her staff 

to participate in these SIAB conferences. McCarthy Testimony Tr. at p. 119. Richards 

confirmed that her staff spoke at these events and she encouraged their participation. 

Richards Testimony Tr. at p. 110. It is noteworthy that Swanson’s résumé under “Public 

Speaking” stated as the first entry: “Frequent speaker at Securities Industry Association 

meetings around the country.” Résumé of Eric J. Swanson, at Exhibit 452. 

264 While there is no specific evidence that Shana knew about the OCIE examination supervised by 

Swanson, it is likely given her role as a Compliance Officer that she was aware at least generally about the 

SEC examination. 

265 In later testimony, Swanson stated he did tell Shana Madoff about the front-running examination of 

Madoff, but only after he left the SEC, stating, “I think she made a comment but you’ve never done an 

exam of us and I said, ‘no I did. I sent the letter on the front-running thing.’” Swanson Testimony Tr. at p. 

157. He denied he ever shared with her anything he learned during the Madoff examination at any time. 

Id. 

266 Eric Swanson also attended additional SIAB conferences in Charlotte on September 29, 2005, in 

Richmond on November 2, 2005, in Miami on January 30, 2006, in St. Louis on March 10, 2006, in New 

Orleans on May 18, 2006, in Greenwich on June 8, 2006, and again in Minneapolis on July 21, 2006. 

Swanson Testimony Tr. at pgs. 165-168. 

396 
 

 

E. Swanson’s Romantic Relationships Between 2003 and 2005 

Between December 2003 and May 2005, as discussed above, Swanson worked in 

various capacities on the OCIE cause examination of Madoff. While as the above 

describes, there was a professional relationship between Swanson and Shana during this 

time period, the OIG investigation has found no evidence that Swanson had or developed 

a romantic relationship with Shana in 2003, 2004 or 2005. 

In fact, the OIG confirmed the existence and extent of Swanson’s romantic 

relationships with other women during this time period. Swanson confirmed that 

between 2003 and 2004, he had an “on-again/off-again relationship” with an attorney in 

Washington, D.C., who asked not to be identified in our Report of Investigation. 

Swanson Testimony Tr. at p. 131. The OIG contacted this attorney who we will refer to 

as “Swanson’s former girlfriend” and she confirmed the relationship. Unidentified 

former girlfriend of Eric Swanson Interview Memorandum, at p. 1. Swanson’s former 

girlfriend stated she met Swanson when they both lived in Richmond, Virginia. Id. 

According to Swanson’s former girlfriend, they started dating in October 1996 and 

continued to date during that time period until January 2005 when Swanson became 

involved with another woman, referred to as “Jane Doe” in this ROI. Id. She also 

recalled Swanson dating a third woman during that time period and did not believe that 

Swanson was involved with any women other than her and the third woman from 

October 1996 to January 2005. Id. 

The OIG investigation further found that in late 2004 or early 2005, Swanson 

began “a very serious relationship” with Jane Doe. Swanson Testimony Tr. at p. 131­

132. Swanson recalled the relationship beginning in “late ’04,” while Jane Doe stated she 

met Swanson in January 2005 and they “immediately” developed a romantic relationship. 

Id. at p. 132; Jane Doe Testimony Tr. at p. 6. Jane Doe also confirmed that Swanson had 

a serious relationship before her with a former girlfriend whom she identified in 

testimony. Id. at pgs. 9-10. 

Jane Doe testified that “maybe about two months” after beginning her relationship 

with Swanson, by March or April 2005, she moved in with him and they became engaged 

to be married. Id. at p. 6. These facts were also confirmed by an OCIE Staff Accountant 

who lived in Swanson’s basement from 2001 to August 2006. OCIE Staff Accountant 

Testimony Tr. at pgs. 17-18. The OCIE Staff Accountant stated Swanson confided in 

him about his relationships. Id. at p. 17. According to the OCIE Staff Accountant, 

Swanson was in a serious relationship with Jane Doe “for about a year before things 

dissolved. But after four or five months, she did move in ... She was living upstairs.” Id. 

Swanson and Jane Doe set their wedding date for October 2005 and planned to 

marry in Florida. Swanson Testimony Tr. at p. 132; Jane Doe Testimony Tr. at p. 7. 

However, Swanson and Jane Doe’s wedding never took place. Id. According to several 

sources including Alex Sadowski, who worked for and developed a “good personal 

relationship” with Swanson at that time, the weekend of their wedding, Hurricane Wilma 

397 
 

 

 

hit Florida and caused the wedding to be cancelled.267 Id. at p. 7; Sadowski Testimony 

Tr. at p. 46; OCIE Staff Accountant Testimony Tr. at pgs. 17-18. 

In early November 2005, the couple’s relationship ended, and Jane Doe moved 

out of Swanson’s home. Swanson Testimony Tr. at pgs. 132; Jane Doe Testimony Tr. at 

p. 7; Sadowski Testimony Tr. at p. 46; OCIE Staff Accountant Testimony Tr. at pgs. 17­

18. Jane Doe stated they were both devastated after their break-up. Jane Doe Testimony 

Tr. at p. 14. Sadowski confirmed that Swanson was “pretty distraught” about his 

relationship with Jane Doe ending. Sadowski Testimony Tr. at p. 46. 

Jane Doe testified she moved to Florida shortly thereafter, and she and Swanson 

did not keep in contact. Jane Doe Testimony Tr. at p. 7. Swanson testified that although 

he had friendly communications with Shana during that time, he did not have any 

romantic interest in her in 2004 or 2005, as he was involved with other women. Swanson 

Testimony Tr. at pgs. 131-132. Swanson also testified that the end of his engagement to 

Jane Doe had nothing to do with Shana. Id. at p. 133. This assertion was confirmed by 

Jane Doe herself, as well as by the OCIE Staff Accountant. OCIE Staff Accountant 

Testimony Tr. at pgs. 17-19; Jane Doe Testimony Tr. at pgs. 9, 14. Jane Doe also stated 

she would have known if Swanson was interested in someone else while they were 

involved because they spent all their time together. Jane Doe Testimony Tr. at p. 9. Jane 

Doe was asked specifically in testimony if Swanson could have been involved with 

Shana when they were together, and stated as follows: 

Absolutely not. I knew exactly where he was and we spent 

all of our time together except for his trips here and there. 

And even then I knew where he was. I don’t think he was 

doing anything shady. I think a woman probably knows 

when someone she’s seeing is seeing someone else. And 

especially because our relationship was so new and really 

didn’t have any issues until the latter part of the 

relationship. 

Jane Doe Testimony Tr. at p. 14. 

The OCIE Staff Accountant testified he was not aware of Swanson dating anyone 

else while he was involved with Jane Doe or immediately after his break-up with her, 

stating, “Swanson is a – he’s not the type of guy that plays the field. He’s a relationship 

guy. When he gets in a relationship, you know, he kind of -- just kind of sets the tone. 

But he also gets very involved very quickly, you know.” OCIE Staff Accountant 

Testimony Tr. at pgs. 22-23. Swanson’s former girlfriend, who kept in touch with 

Swanson after they broke up, also stated she did not believe Swanson dated anyone from 

the end of his engagement to Jane Doe to when he started his relationship with Shana in 

April 2006. Swanson’s former girlfriend Interview Memorandum. 

267 Swanson and Jane Doe were to be married in Naples, Florida. Hurricane Wilma hit Southern Florida 

on October 23-24, 2005. See http://www.nws.noaa.gov/storms/wilma. 

398 
 

 

 

The OCIE Staff Accountant also stated that although he was aware Swanson and 

McCarthy were participating in various SIAB conferences, Swanson had never 

mentioned Shana’s name until he started dating her in the Spring of 2006. OCIE Staff 

Accountant Testimony Tr. at p. 19. The OCIE Staff Accountant recalled that after the 

break-up with Jane Doe, Swanson went “through a mourning period” for several months, 

stating that Swanson “kind of bemoaned his relationship with [Jane Doe] for a period of 

time, to the point to where I was almost kind of like, hey, Eric, you know, you’ve been 

broken up with her almost as long as you were with her....” Id. at p. 22. The OCIE Staff 

Accountant stated that Swanson had confided to him that he and Shana “had known each 

other through the [industry events], but that it was never anything more than a working 

relationship for most of that time.” Id. at p. 20. The OCIE Staff Accountant stated he 

“absolutely” would have known, given his relationship with Swanson, if Swanson had 

feelings for Shana previously, in the 2004 and 2005 time frame. Id. 

F. In February 2006, Swanson Learned About the Enforcement Investigation 

and Was Asked to “Put the Squeeze on Shana” 

On February 28, 2006, Swanson learned in an e-mail from Assistant Director John 

Nee that the SEC’s New York Regional Office was investigating Harry Markopolos’ 

complaint that Bernard Madoff may be running “the biggest Ponzi scheme ever.” E-mail 

dated February 28, 2006 from Swanson to McCarthy, at Exhibit 453. Swanson then 

forwarded Nee’s e-mail to John McCarthy. Id. Swanson stated that he did not recall 

receiving the February 28, 2006 e-mail from Nee, and that he “[a]bsolutely [didn’t] recall 

being aware that there was this complaint” alleging Madoff was running a Ponzi scheme. 

Swanson Testimony Tr. at pgs. 120-121. However, the next day after receiving Nee’s 

e-mail telling him Madoff was being investigated for running a Ponzi scheme, McCarthy 

e-mailed Swanson to “put the squeeze on” Shana, as follows: 

2 things. 

1. put the squeeze on shana 

2. Cutler gave lori a tip we shld [sic] follow up on.268 

E-mail dated March 1, 2006 from McCarthy to Swanson, at Exhibit 454. Swanson 

informed McCarthy he would call her the next day and asked, “What’s the tip?” E-mail 

dated March 1, 2006 from Swanson to McCarthy, at Exhibit 455. 

McCarthy testified the reference to putting “the squeeze on Shana” had nothing to 

do with learning about Enforcement’s investigation of a possible Ponzi scheme and the 

tip referred to in the e-mail had nothing to do with Madoff. McCarthy Testimony Tr. at 

p. 119. McCarthy explained, in the following testimony, that the e-mail was a reference 

268 McCarthy was not sure, but thought the tip was about Cutler “want[ing] us to look into possible – 

possibility of insider trading in CDs and that’s about the right period of time.” McCarthy Testimony Tr. at 

p. 119. The OIG did not find evidence that the tip referred to in this e-mail related to Madoff. 

399 
to him wanting Swanson to put pressure on Shana to get him on a panel at a securities 

conference: 

I think it has to do with the conference that was coming up, 

if I recall correctly ... a big annual conference, I think I 

was getting pressure at that time. You know, [OCIE 

Director] Lori [Richards] was really encouraging senior 

staff to participate in conferences and [Shana] was -- if I 

recall correctly, like, you know, the emcee of the 

conference in Florida so I wanted -- you know, I asked 

[Shana] previously, and this is a follow up to that, whether 

she could get me on a panel. ... Probably just asking Eric to 

because he communicated with her more than I did so I 

just, you know, when you’re talking to her, you know, 

remind her if she’s had any luck with getting me on a 

panel. 

Id. at pgs. 118-119. 

Swanson’s recollection of why he was “to put the squeeze on Shana” was 

consistent with McCarthy’s, as follows: 

John -- John wanted me to get him on a panel ... and I 

don’t know if I had reached out to Shana prior to this or 

not, but Shana was the avenue to get him on that panel. ... 

* * * 

You know, John had asked me to help him get on the panel 

and I was trying to be helpful to him. So I don’t recall, you 

know, the timing of this. I don’t recall being -- having a 

heightened concern about a Ponzi scheme at Bernie 

Madoff. It just doesn’t -- I just don’t recall it. 

Swanson Testimony Tr. at pgs. 122,124. 

Swanson further testified as follows: “I swear to you, I mean I know I’m already 

under oath, but I’ll swear it under oath again, there is no way that that put the squeeze on 

Shana and the tip comment are connected. The ‘put the squeeze’ on was to get John on a 

panel.” Id. at p. 135. 

The OIG investigation found that Swanson did e-mail Shana about getting “John 

on the equity institutional panel” on February 28, 2006, the same day he received the 

e-mail from Nee about the Enforcement investigation. E-mail dated February 28, 2006 

from Shana to Swanson, at Exhibit 456. On March 3, 2006, two days after McCarthy 

sent the “put the squeeze on Shana e-mail,” Swanson followed-up with Shana about 

400 
 

 

 

 

 

getting McCarthy on the panel. E-mail dated March 3, 2006 from Shana to Swanson, at 

Exhibit 457. Shana looked into it and informed Swanson that she got McCarthy on the 

panel. Id. Further, the OIG found no evidence to contradict Swanson and McCarthy’s 

accounts of the e-mail or that Swanson was providing any information about the 

Enforcement investigation to Shana. 

G. Swanson and Shana Madoff Became Romantically Involved in Early 2006 

The OIG investigation found that Swanson and Shana’s relationship did not 

became romantic until March 2006. On March 3-4, 2006, the 2006 SEC Speaks program, 

a conference during which SEC officials discussed their initiatives and priorities for the 

year ahead, was held in Washington, DC. SEC Speaks 2006 Program Brochure, at 

Exhibit 458; Swanson Testimony Tr. at pgs. 133-136. On March 3, 2006, Shana 

e-mailed Swanson to ask him if he was going to attend. E-mail dated March 3, 2006 

from Swanson to Shana, at Exhibit 459. She stated she would be taking the New York 

shuttle to Washington, DC and that she hoped to see him. Id. Swanson replied, he would 

see her “at Speaks – at least for the reception.” Id. 

At the end of the program, several SEC Speaks attendees went to a bar, including 

Swanson and Shana. Swanson Testimony Tr. at p. 134. Swanson described SEC Speaks 

as “a fairly social event in terms of ... shaking hands and small talk with people, and 

Shana and I continued to talk throughout the evening.” Id. 

Swanson further stated: 

I had a sense from that night that – and I was having a good 

time hanging out with her. I found her to be a lot funnier 

than I had – than I thought she was and we were out with a 

big group of people and we went from SEC Speaks to a bar 

across the street to yet another bar ... and I got the distinct 

sense that she was kind of flirting with me that night. But, 

you know, I also felt like if I had wanted to take it further 

that night, I could have, but I didn’t. 

Id. 

The e-mails sent between Swanson and Shana during the 2006 SEC Speaks 

confirmed that they were becoming more friendly. On March 4, 2006, at 2:00 a.m., 

Shana e-mailed Swanson, stating, “Made it home ... hope u r having fun. Thanks again, 

S.” E-mail dated March 4, 2006 from Swanson to Shana, at Exhibit 460. At 2:45 a.m. 

Swanson responded, “Home now - long night for me! But, had a great time. See you 

thursday.” Id. 

On March 4, 2006 at 10:00 a.m., Swanson e-mailed Sadowski, asking him how he 

was feeling. E-mail dated March 4, 2006 from Swanson to Sadowski, at Exhibit 461. 

Sadowski responded via e-mail, “Whoo boy. Shana madoff just leave?” Id. Swanson 

401 
e-mailed back, “I understand why you wouldn’t remember, but let me refresh your brain 

– she left on her own well before we did. There was an option- I took a pass. Caught an 

earful from MS last night re: Madoff- apparently I’m a sycophant.” Id. Swanson 

explained that the “MS” referred to in his e-mail was an OCIE Branch Chief, who 

Swanson said was giving him a hard time because he “was being maybe a little too nice 

to Shana.” Swanson Testimony Tr. at p. 134. 

One month later, on or about April 4, 2006, Swanson’s romantic relationship with 

Shana progressed. Swanson Testimony Tr. at p. 146-147. While Swanson was in New 

York, Shana e-mailed him to come meet her out. E-mail dated April 4, 2006 from 

Swanson to Shana, at Exhibit 462. Swanson informed her he couldn’t, stating, “We’re 

having margaritas at some place called Zarella. Next time.” Id. Shana then e-mailed 

Swanson asking him to come to where she was. Id. Swanson responded, “You’re 

dangerous. Let me see what we’re doing here.” Id. Shana replied, “You are leaving” to 

meet us. Id. Swanson replied he would “be there in 5 [minutes].” Id. Swanson met up 

with Shana and stated that he believed his romantic relationship with Shana began that 

night on April 4, 2006. Swanson Testimony Tr. at pgs. 146-147. 

The OCIE Staff Accountant stated that he “had a front-row seat with [Swanson] 

and Shana as their relationship grew” and confirmed that he first starting hearing about 

Shana in the late spring of 2006. OCIE Staff Accountant Testimony Tr. at pgs. 19-20. 

Sadowski also concurred that he believed Shana and Swanson became romantically 

involved in March or April of 2006, and remembered seeing Swanson and Shana 

spending time talking together during the 2006 SEC Speaks. Sadowski Testimony Tr. at 

pgs. 56-57. Sadowski specifically recalled Swanson telling him that Shana was “an easy 

person to talk to” and “got the sense ... maybe something [was] going to happen here.” 

Id. at p. 56. 

H. Swanson’s Supervisor, John McCarthy, Opposed the Relationship and 

Swanson Kept it a Secret 

Swanson’s supervisor, McCarthy, became aware of Swanson’s night with Shana 

and did not approve of the relationship. McCarthy Testimony Tr. at p. 124. On April 6, 

2006, McCarthy asked Sadowski to send Swanson an e-mail stating, “I guess we won’t 

be inspecting Madoff anytime soon.” E-mail dated April 6, 2006 from McCarthy to 

Sadowski, at Exhibit 463. McCarthy testified that he was upset about the relationship 

when he sent this e-mail, and that a more accurate description would probably be that 

Swanson would not be inspecting Madoff anytime soon because of Swanson’s personal 

relationship with Shana. McCarthy Testimony Tr. at pgs. 128-129. As discussed in 

greater detail below, however, McCarthy’s objection was not related to the fact that 

Shana worked for a registrant. 

On April 7, 2006, Swanson e-mailed Shana that “John [McCarthy’]s upset. Very” 

about the relationship. E-mail dated April 7, 2006 from Swanson to Shana Madoff, at 

Exhibit 464. Shortly thereafter, according to Swanson, McCarthy “indicat[ed] some 

402 
 

fairly extreme displeasure with me dating Shana ... and he explain[ed] to me that he’s 

worried about me.” Swanson Testimony Tr. at p. 138. 

According to Swanson, McCarthy told him he did not believe Shana was “a good 

person on some level” and confided in Swanson a story about a woman from a past 

relationship he likened to Shana who broke his heart. Id. Swanson thought McCarthy 

was being “fairly paternalistic” towards him, which was not an unusual aspect of their 

relationship. Id. Swanson believed he and McCarthy were very close and, in some ways, 

Swanson sometimes felt it was like a father-and-son relationship. Id. at pgs. 138-139. 

Swanson said McCarthy did not want Swanson dating Shana. Id. at pgs. 141, 149. 

Swanson “got fairly upset about it because ... I found somebody that I really liked and I 

wanted her to be accepted by John [McCarthy].” Id. at p. 139. Swanson described his 

working relationship with McCarthy as “intense,” which “carried over into [their] 

personal lives” and testified that McCarthy was fairly protective of him. Id. at p. 141. 

Swanson felt his relationship with McCarthy became strained because he got involved 

with Shana and also because he was getting ready to leave the SEC and McCarthy “was 

not happy about that.” Id. 

McCarthy made clear that his opposition to Swanson’s relationship with Shana 

was not related to the fact that Shana worked for a registered broker-dealer. McCarthy 

Testimony Tr. at pgs. 124-125. At the time, he did not view BMIS as “a company that 

was doing illegal things,” despite the fact that there were still open questions about 

Madoff’s returns and he had received an e-mail stating that the New York Office of the 

SEC was investigating a complaint that Madoff may have been engaged in a Ponzi 

scheme. Id. at pgs. 125-126. McCarthy stated that the fact that Swanson might be 

regulating the entity Shana worked for was “irrelevant or would have played a minor 

role” in his thinking. Id. at p. 125. According to McCarthy, the reason he did not want 

Swanson dating Shana “was more personal than kind of the fact that she worked at a 

broker-dealer”; it was just that he did not like her. Id. at p. 124, 126. 

Swanson testified that, in his capacity as his boss, McCarthy never directly raised 

a concern that he was dating somebody who was involved in the industry. Swanson 

Testimony Tr. at p. 142. Swanson did not recall any conversation where McCarthy 

expressed concerns about Shana in terms of the company she worked for had been 

examined, there was an open investigation, or about being involved with someone whose 

company may be involved in doing illegal things. Id. at p. 144. Swanson testified that 

what McCarthy expressed to him was “all very much of a personal nature.” Id. at p. 142. 

Swanson continued to see Shana, although he kept the relationship a secret from 

McCarthy. Id. at pgs. 142-143. Swanson made a conscious decision not to talk about the 

relationship with McCarthy, stating: 

I made the decision that ... the day to day around the office 

was tense and if John -- John had this reputation ... if he 

didn’t like you, it was like you didn’t exist and for someone 

like me who ... had worked so hard to gain his approval 

403 
 

 

 

and ... wanted that, and knowing that I was going to be 

leaving the SEC in a few months, I wanted to continue and 

have a peaceful exit from the SEC. 

Id. 

While he stated he did not explicitly hide the relationship, Swanson stated he was 

not “completely forthright” with McCarthy for some time while seeing Shana. Id. at p. 

140. He explained that McCarthy never asked him about the relationship and, had 

McCarthy asked him, he would have told him: “I mean, he -- he -- he didn’t need to know 

all the details. It was personal and it clearly was upsetting him.” Id. at p. 143. 

McCarthy acknowledged that he “was very much against him having a 

relationship with her and [he] made it clear early on and ... at some point...[Swanson] 

saw [Shana] without ... telling him.” McCarthy Testimony Tr. at p. 124. McCarthy 

recalled an incident when he saw Shana at Swanson’s apartment when Swanson’s 

roommate, the OCIE Staff Accountant, was there. Id. at pgs. 126-127. He was surprised 

and upset that Swanson was still seeing Shana. Id. at p. 127. 

After McCarthy learned that Swanson was still seeing Shana, the record shows 

that McCarthy became so opposed to Swanson’s and Shana’s relationship that Swanson 

felt that if he did not end the relationship, he would lose McCarthy as a friend. Swanson 

Testimony Tr. at p. 149. Swanson e-mailed Sadowski about his conversation with 

McCarthy: “I came clean ... He went nuts. He came over abt [sic] 10 and we had a 

really bad night. Bottom line, I need to cut it off or lose my relationship with john, which 

I may have done already.” E-mail dated April 22, 2006 from Swanson to Sadowski, at 

Exhibit 465. McCarthy testified that Swanson’s description was consistent with the way 

he felt. McCarthy Testimony Tr. at p. 127. Sadowski confirmed Swanson’s relationship 

with Shana caused a strain on Swanson’s friendship with McCarthy. Sadowski 

Testimony Tr. at p. 77. 

I. Swanson’s Recusal from Madoff Matters 

According to Swanson, his relationship with Shana was entirely appropriate 

because he was not working on anything related to Madoff and, if he had been, he would 

have recused himself. Swanson Testimony Tr. at p. 145. Swanson was not aware of the 

SEC’s formal recusal process, but he considered himself recused from all Madoff-related 

matters. Id. Swanson testified that if somebody asked him to work on anything related to 

Madoff, he would have said he could not. Id. 

McCarthy testified that in his typical experience people in romantic relationships 

did not proactively recuse themselves, stating that if a matter came up certainly one 

should be recused. McCarthy Testimony Tr. at p. 130. McCarthy testified that he was 

not that familiar with the process, but acknowledged that if Swanson was interviewing for 

a position with Madoff’s firm, he was supposed to alert somebody, but there were no 

404 
 

 

 

 

 

 

 

 

 

rules he was aware of regarding an SEC employee who got involved in a romantic 

relationship with someone who worked for a registrant. Id. 

McCarthy testified that if “an inspection of Madoff was in the offing,” Swanson 

would not have been a part of it, but Swanson’s relationship with Shana would not have 

factored into his group’s decisions whether it would be involved in a Madoff inspection. 

Id. at p. 129. McCarthy felt the group could have conducted a Madoff inspection without 

Swanson. Id. 

McCarthy testified that there was a point at which a relationship between SEC 

examiners and registrants could cross a line, such as when an examiner was married to a 

person at a broker-dealer and that it was simply a matter of judgment where that line was. 

Id. at pgs. 132-133. McCarthy stated that it certainly could create an appearance problem 

when there was too much fraternization or interaction between examiners and registrants 

at social functions. Id. at p. 133. 

Former OCIE Director Richards stated there are ethics policies regarding 

relationships between SEC employees and registrants and noted, “Generally, if there 

could be an appearance of impropriety or bias we would encourage employees to 

communicate with the ethics office about whether they should recuse themselves from 

any ongoing examination.” Richards Testimony Transcript at pgs. 112. 

Richards stated if an examiner became romantically involved with an employee of 

a registrant, “you would communicate with the ethics office and get specific guidance 

about the situation.” Id. at p. 113. She thought there was “no general disclosure 

obligation to disclose people you’re dating to your supervisor. But, certainly, if it was a 

firm that the examiner was going to examine or was examining, that would be very clear 

that in that situation you could -- you should not have a personal relationship with 

someone you’re examining.” Id. 

J. McCarthy Cancelled April 2006 Greenwich SIAB Conference 

Despite the strain on his friendship with McCarthy, Swanson did not end his 

relationship with Shana. While McCarthy and Swanson were on a trip to New York, 

Swanson asked McCarthy to go with him to a karaoke bar and meet Shana. Id. at p. 123. 

According to McCarthy, “the karaoke bar turned out to be a ... high-end strip club, and I 

was extremely upset. But they were kind of having – looked like they were having fun at 

my expense, so I think it became a big deal between Eric and myself.” Id. 

After that night, McCarthy told Swanson to cancel their participation in the 

Greenwich SIAB conference scheduled for April 27, 2006.269 Id. at 131. McCarthy 

269 The Greenwich SIAB conference appears to have been about a new rule the SEC had recently issued 

requiring hedge funds to register with the SEC by February 1, 2006. See http://www.sec.gov/rules/final/ia2333.htm. The SIA wanted guidance from the SEC regarding the requirements under the rule. In June 

2006, the United States Court of Appeals for the District of Columbia Circuit vacated the SEC’s hedge 

fund rule. Goldstein v. SEC, 451 F.3d 873 (DC Cir. 2006), at Exhibit 466. 

405 
 

 

 

 

wanted to limit his interactions with Shana, and he felt that Swanson was comporting 

himself in a way that he never did in the past. McCarthy Testimony Tr. at p. 131. 

McCarthy stated: 

I’m not sure on the dates but I think after the karaoke thing 

I made the decision I don’t -- you know, want to basically 

limit my interactions with Shana, so I was asking her to -- I 

told Eric to cancel the breakfast. 

Id. 

On April 22, 2006, McCarthy e-mailed Shana that the SEC contingent was going 

to have to back out of the Greenwich SIAB conference. E-mail dated April 22, 2006 

from McCarthy to Swanson, at Exhibit 467. McCarthy stated in the e-mail, “Obviously 

you all can proceed without us but, given the unique aspects of this breakfast, I 

understand that it creates difficulties without SEC involvement.” Id. After the 

conference was cancelled, McCarthy changed his mind and decided to participate in the 

conference, stating, “The hedge fund one I felt was actually relatively important, the one 

up in Greenwich, so I think we -- Eric was kind -- I put him in probably an awkward 

situation of canceling it then kind of rescheduling it is my recollection.” McCarthy 

Testimony Tr. at p. 134. On April 27, 2006, Swanson e-mailed Shana apologizing for the 

cancelation of their participation in the Greenwich SIAB conference and asked her about 

having the conference rescheduled. E-mail dated April 27, 2006 from Swanson to Shana, 

at Exhibit 468. 

Swanson stated he did not believe McCarthy cancelled their participation in the 

Greenwich SIAB conference because of his relationship with Shana. Swanson 

Testimony Tr. at pgs. 150-151. He acknowledged McCarthy “might have been a little 

less comfortable going to do them, but we still did them. I think we did two or three after 

-- after all this.” Id. at p. 151. Swanson and McCarthy did attend the New Orleans, the 

rescheduled Greenwich, and the Minneapolis SIAB conferences.270 Id. at pgs. 150-151, 

166, 168. 

K. Swanson and Shana’s Relationship Continued and Swanson Left the SEC 

Partly because of the tension with McCarthy, Swanson decided to leave the SEC. 

Swanson testified that he started thinking about leaving the SEC in 2005, and that his 

decision was a personal one; however, he added that “tension” in his relationship with 

McCarthy played a role as well. Id. at pgs. 155-156. Swanson claimed he was 

“frustrated and restless” at the SEC, and wanted to “sell [his] house, leave D.C. and do 

something completely different.” Id. at p. 156. By June 2006, Swanson was actively 

looking to leave the SEC. Id. at p. 152; E-mail dated June 6, 2006 from Swanson to 

Pinetumpartners, at Exhibit 470. On June 6, 2006, Swanson contacted a headhunter 

270 The April 2006 Greenwich SIAB conference, after being initially cancelled by McCarthy, was 

eventually rescheduled to June 8, 2009. E-mail dated June 6, 2006 from Buchmueller to Rufino, Swanson, 

McCarthy, Luparello and Malitzis, at Exhibit 469. 

406 
Shana referred him to about his plans to leave the SEC. Swanson Testimony Tr. at p. 

152; E-mail dated June 6, 2006 from Pinetumpartners to Swanson, at Exhibit 470. The 

headhunter arranged an interview for Swanson with Bridgewater Associates, Inc., a 

hedge fund, on June 15, 2006. E-mail dated June 13, 2006 from Pinetumpartners to 

Swanson, at Exhibit 471. 

In July 2006, Swanson informed former OCIE Director Lori Richards that he 

planned to leave the SEC, stating in an e-mail to Shana: “I just had a long talk with Lori 

[Richards] abt [sic] everything. She is not happy abt [sic] me leaving and is trying to 

give me incentives to stay. She is v[e]ry happy about us, however.” E-mail dated July 

17, 2006 from Swanson to Shana, at Exhibit 472. 

On July 18, 2006, Swanson received a job offer from Bridgewater Associates. 

E-mail dated July 18, 2006 from Woodhouse (Bridgewater) to Swanson, at Exhibit 473; 

E-mail dated July 18, 2006 from Pinetumpartners to Swanson, at Exhibit 474; Swanson 

Testimony Tr. at 152. On July 21, 2006, Swanson and Shana attended a Minneapolis 

SIAB, and Swanson had an initial interview with Ameriprise Financial, a broker-dealer 

and financial services company. E-mail dated July 24, 2006 from Swanson to Kokinda, 

at Exhibit 475; E-mail dated July 7, 2006 from Buchmueller to Rufino, Swanson, 

McCarthy and Luparello, at Exhibit 476. Over the next two weeks, Swanson had 

additional interviews with Ameriprise in Minneapolis and in New York. Swanson 

Itinerary dated July 25, 2006 to July 26, 2006, at Exhibit 477; E-mail dated July 28, 2006 

from Junek (Ameriprise) to Swanson, at Exhibit 478. On August 1, 2006, Ameriprise 

offered Swanson a position, and the next day, he accepted the offer, as he stated in an 

e-mail to Shana, “Call me when you can babe - I have accepted the Ameriprise offer.” 

E-mail dated August 1, 2006 from Junek (Ameriprise) to Swanson, at Exhibit 479; 

E-mail dated August 2, 2006 from Swanson to Shana, at Exhibit 480; Swanson 

Testimony Tr. at p. 155. 

McCarthy testified that over time, he was “getting mellower” about the 

relationship and in September 2006, actually hosted a going away party for Swanson that 

Shana attended. McCarthy Testimony Tr. at pgs. 134-135. Shana and several former and 

present SEC employees attended the party. Id. September 15, 2006 was Swanson’s 

official last day at the SEC. Standard Form (SF) 50, Notification of Personnel Action, at 

Exhibit 481. 

In December 2006, Swanson and Shana became engaged and were married on 

September 29, 2007. Swanson Testimony Tr. at p. 151. Wedding guests included 

Bernard Madoff, John McCarthy, Lori Richards, Alex Sadowski and an OCIE Staff 

Accountant. McCarthy Testimony Tr. at pgs. 20, 140; Richards Testimony Tr. at p. 28; 

Sadowski Testimony Tr. at p. 95; OCIE Staff Accountant Testimony Tr. at pgs. 41, 46. 

407 
 

 

 

 

L. Swanson’s Reaction to Learning Madoff Confessed to Ponzi Scheme 

Swanson described his initial reaction to hearing that Bernard Madoff had 

confessed to running a Ponzi scheme: 

Well, my -- my initial reaction and really reaction that has 

stuck with me is that, you know, I knew that we had looked 

at some aspect of this in terms of front-running but not at 

whether or not it was a Ponzi scheme and then it was only 

after I, you know, started getting access to documents that 

had been leaked to the Wall Street Journal in the days and 

weeks after Bernie was arrested that I saw the full scope of 

what NERO had done and I thought it’s a major problem 

here. 

Swanson Testimony Tr. at pgs. 157-158. 

Swanson was surprised that NERO did so much looking into Madoff’s operations, 

but never found the Ponzi scheme. Id. at p. 158. He further stated he did not learn 

anything by virtue of marrying into the family that would have provided any information 

about how the SEC missed this Ponzi scheme “beyond sort of what I’ve read in the paper. 

I mean, I kind of have a better understanding of who Bernie is and the way he kind of 

manipulates people and information, but I didn’t learn that by virtue of being married into 

the family.” Id. at p. 164. 

M. Conclusion 

After conducting a thorough investigation, the OIG did not find evidence that 

Swanson’s romantic relationship with Shana influenced the conduct of the SEC 

examinations of Bernard Madoff and his firms. We found that during the period of time 

that Swanson was conducting the OCIE cause examination of Madoff, Swanson was 

involved with other women, including a very serious relationship with a woman he 

almost married. We did not uncover any evidence that Swanson had any romantic 

involvement with Shana during this time frame and found that Swanson and Shana’s 

romantic relationship did not begin until March of 2006, nearly a year after the OCIE 

examination he had conducted had been completed in June of 2005.271 We also found no 

evidence that Swanson shared information regarding SEC examinations or investigations 

of Madoff with Shana while Swanson was at the SEC. 

We did, however, find that Swanson’s initial contact with Shana occurred as a 

result of an OCIE QQQ examination of Madoff, and that he communicated with her and 

attended SIAB conferences she arranged, even as he worked on a second OCIE 

271 Moreover, as discussed above, the record shows that Donohue had taken over Swanson’s day-to-day 

monitoring of the OCIE cause examination of Madoff as of February 2004, and the cause examination was 

put on the “backburner” in April 2004 and thus, the romantic relationship did not begin until more than two 

years after Swanson’s active involvement in the cause examination. 

408 
 

examination of Madoff, creating the appearance of a potential improper conflict of 

interest. The sequence of events is as follows. In November 2003, Swanson saw Shana 

at the Minneapolis SIAB conference. In December 2003, Swanson was involved in 

reviewing a complaint from a Hedge Fund Manager about Madoff that triggered the 

OCIE Madoff cause examination. Shortly thereafter, an examination team for the Madoff 

cause examination was assembled and Swanson participated in the decision to limit the 

focus of the Madoff examination to front-running. In early January 2004, Swanson 

signed and sent a formal document request to Peter Madoff (Shana’s father) on behalf of 

the SEC in connection with the OCIE cause examination. One week after Swanson sent 

the formal document request to Peter Madoff, Swanson communicated with Shana via 

e-mail regarding a potential upcoming SIAB conference in Boston, although he did not 

attend the Boston SIAB conference. 

Swanson continued to have primary responsibility for the OCIE cause 

examination, until late February 2004, when Donohue took over the “day to day 

responsibility” for the examination. In early April 2004, the OCIE cause examination of 

Madoff was put on the backburner even though there were unresolved questions. In late 

April 2004, Swanson attended another SIAB conference organized by Shana in Atlanta. 

Swanson continued to communicate with Shana and in August 2004, he asked for her 

assistance in preparing comments for a presentation he was giving on the role of the 

compliance professional in the regulatory environment. In December 2004, McCarthy 

asked Swanson to follow up on a best execution problem at Madoff’s firm regarding a 

delay in the opening of a particular stock on the New York Stock Exchange. In January 

2005, Swanson and other SEC officials spoke at an SIAB conference in Seattle and had 

dinner with Shana. 

In March 2005, Swanson’s attendance at an SIAB conference in St. Louis 

triggered his recollection about the dormant OCIE cause examination of Madoff and he 

followed up with Donohue about its status. In May 2005, Swanson learned that NERO 

examiners were conducting their own examination of Madoff and shortly before OCIE’s 

documents were shipped to NERO, he participated in a conference call where one of 

three OCIE officials on that call (which included him) stated that Madoff was a “very 

well-connected, powerful person.” One of the NERO examiners on the telephone call, 

interpreted the statement to raise a concern for OCIE about pushing Madoff too hard in 

their examination without having substantial evidence. 

In late February 2006, Swanson learned in an e-mail that the SEC’s Enforcement 

Division was investigating Harry Markopolos’ tip that Bernard Madoff may be running 

“the biggest Ponzi scheme ever” and after forwarding the e-mail to McCarthy, the next 

day, McCarthy e-mailed Swanson to “put the squeeze on” Shana. While the OIG found 

that the reference to putting the “squeeze” on Shana was related to an industry conference 

and not the investigation of Madoff, the timing of this e-mail as well as the sequence of 

events described above created an appearance concern. 

We conclude that Swanson’s communication with and attendance at events 

sponsored by Shana during the period of time he was engaged in a cause examination of 

409 
 

 

 

 

 

her uncle and father’s firm, created the appearance of a potential conflict of interest. 

While there is no evidence that any information about the examination was imparted to 

Shana during these communications, the level of interaction with a registrant while 

Swanson was supervising a cause examination of the firm could have created the 

appearance that the examination was impacted by their personal relationship. 

We also found that although Swanson did not participate in any Madoff-related 

matters after his relationship with Shana began, he did not take any proactive steps to 

inform anyone, including the Ethics office, about his relationship with Shana, and for 

other reasons, kept the fact that he was continuing to see Shana a secret from his 

supervisor, John McCarthy, who disapproved of the relationship for “personal reasons.” 

When McCarthy found out that Swanson was still involved with Shana, McCarthy 

cancelled the SEC’s participation at an industry breakfast sponsored by Shana, although 

the breakfast was eventually rescheduled. 

The OIG did not find that Swanson violated any ethics rules during the period of 

time that Swanson was romantically involved with Shana and hiding it from McCarthy. 

Indeed, there was no obligation for Swanson to recuse himself before a matter involving 

the Madoff family was brought to his attention. However, McCarthy’s reaction to his 

learning about Swanson’s continued relationship with Shana in cancelling the SEC’s 

participation in the industry event, demonstrates the potential predicaments and dilemmas 

that may ensue from this type of relationship. The decision for SEC officials to attend or 

not attend an industry breakfast should be made based upon the business interests of 

OCIE, not because of personal matters involving a relationship between an SEC official 

and a representative of a registrant. There are also questions about the level of 

fraternization that is appropriate at these industry events between SEC officials and 

representatives of companies that the SEC regulates. We found that SEC officials and 

representatives of registrants went out on more than one occasion drinking the night 

before the conference day ended. As OCIE’s Ethics Rules for the Exam Program state, 

“staff must avoid situations involving not only a conflict of interest, but also the 

appearance of a conflict,” and as John McCarthy acknowledged, an increased level of 

fraternization between SEC officials and registrants, could create an “appearance” 

problem.272 

OCIE should look carefully at these industry events and determine what 

guidelines should be put in place to ensure that even the appearance of a conflict is 

avoided and establish clear rules concerning attendance at events sponsored by registrants 

while examinations are ongoing.273 

272 Memorandum dated September 8, 1997 from Lori Richards, Director, John Walsh, Senior Advisor and 

Susan Walters, Special Counsel, re: “The Commission’s Ethics Rules and The Exam Program: Frequently 

Asked Questions,” at p. 1, at Exhibit 482. 

273 The OIG is also issuing a separate report containing recommendations to improve OCIE’s examination 

program as a result of findings made in the OIG’s Madoff investigation. 

410 
 

 

 

VIII. PRIVATE ENTITIES’ DUE DILIGENCE EFFORTS REVEALED 

SUSPICIOUS ACTIVITY AND RED FLAGS ABOUT MADOFF’S 

OPERATIONS 

A.	 Introduction 

Many private sector firms conducted their own due diligence of Madoff’s 

operations while considering whether to invest with Madoff or Madoff feeder funds. 

While these firms did not have the authority that a regulator like the SEC has to compel 

the production of documents and information, in numerous cases their due diligence 

efforts were sufficient for the private entities to determine that investing with the Madoff 

firm was too risky, even with the limited information they were able to obtain.274 

As described in further detail below, many of the firms that conducted due 

diligence were already aware of suspicions in the industry about Madoff, even before 

they began their analyses of Madoff’s operations. Using ordinary due diligence methods, 

such as voluntarily requesting basic documents like financial statements, and asking 

pointed questions of Madoff or Madoff feeder funds, they determined that an investment 

would be unwise. Specifically, Madoff’s description of both his equity and options 

trading practices immediately led to suspicions about Madoff’s operations. With respect 

to his split-strike conversion strategy, many simply did not believe that it was possible for 

Madoff to achieve his returns using a strategy described by some industry leaders as 

common and unsophisticated. In addition, there was a great deal of suspicion about 

Madoff’s purported options trading, with several entities not believing that Madoff could 

be trading options in such high volumes where there was no evidence of any 

counterparties which had been trading options with Madoff. 

In addition, these entities had suspicions concerning many of the same “red flags” 

that were discussed in the SEC examinations but which ultimately were not analyzed or 

were dismissed by the SEC, such as Madoff’s fee structure and the small size of Madoff’s 

auditor. Further, although some of these entities only had opportunities for a few brief 

conversations with Madoff or representatives of the feeder funds, they felt Madoff and 

his representatives simply did not provide satisfactory answers to their questions and left 

the meetings even more suspicious of Madoff’s operations. 

B.	 There Were Rumors and Suspicion about Madoff in the Industry Even 

Before Due Diligence was Initiated 

The OIG investigation found that even before entities began performing due 

diligence, their efforts were influenced by the overall concerns and questions in the 

industry about Madoff’s operations and how he was able to achieve the returns he was 

274 The OIG did not conduct a comprehensive analysis of all private entity due diligence efforts made with 

respect to Madoff or Madoff feeder funds, and acknowledges that many sophisticated investors gave 

significant funds to Madoff. However, it is instructive to analyze the due diligence methods utilized by the 

private entities that decided to pass on a Madoff-related investment and compare those efforts with the 

steps taken by the SEC in its examinations and investigations. 

411 
 

claiming. James Hedges, IV, whose investment advisory firm was asked to approve 

investments with Madoff for a variety of clients, stated that “there was a preponderance 

of suspicion among hedge fund industry insiders that something was awry at Madoff 

Securities,” although not necessarily that Madoff was running a $50 billion Ponzi 

scheme. Hedges Interview Tr. at pgs. 19-21. 

Nat Simons, the portfolio manager for Renaissance’s Meritage fund, a hedge fund 

of funds, whose e-mails triggered the 2005 NERO examination (as described in detail in 

Section IV above), stated that there were rumors from industry insiders that Madoff was 

cherry-picking trades and that a related party was his auditor. E-mail dated November 

13, 2003 from Simons at Exhibit 211 

Michael Ocrant, a financial journalist who authored the MarHedge article 

about Madoff in May 2001 entitled, “Madoff tops Charts; Skeptics Ask How,” stated that 

he spoke to a former senior executive at one of the futures exchanges, who, in referring to 

Madoff, told him, “everyone knows this isn’t real,” and “everybody knows he can’t 

possibly be producing these kinds of returns.” Ocrant Interview Tr. at p. 15. 

C.	 Due Diligence Efforts of Private Entities Revealed Greater Suspicions 

and Numerous Red Flags 

1.	 Basic Due Diligence Activities 

The OIG investigation found that basic due diligence work by several private 

entities of Madoff or Madoff feeder funds revealed numerous and significant red flags 

and concerns that convinced these private entities not to invest with Madoff. The private 

entities that conducted an initial review of Madoff’s operations focused on basic 

documents which were voluntarily-produced, such as financial statements and trading 

records. In general, they did not use a checklist-type approach, but looked at larger issues 

such as independence and transparency, as well as conducted analyses of Madoff’s 

trading. In some cases, they met with Madoff and simply asked Madoff to explain his 

split-strike conversion strategy, while others were never able to even meet with him at all. 

Hedges stated he utilized a due diligence questionnaire, which 

sought basic information about the firm, the principals and the assets under management 

that the firm had. Hedges Interview Tr. at p. 5. Hedges explained that he looked at the 

inception of the business, the product lines, the different types of funds or separate 

accounts or other investment vehicles that were offered, the stated investment philosophy 

as well as the peer group and competition. Id. at p. 6. Hedges also stated that he looked 

at the business strategy, not just the investment strategy, including associated entities, and 

the various directors, officers, staff, their respective backgrounds, tenures and 

responsibilities. Id. Hedges stressed that his due diligence was “an iterative multiphased process” to be contrasted with what he termed “a box-checking consultant” that 

asks “question 1, 2, 3, down to question 653, and then get all the answers and then have a 

yes or no answer on making an investment.” Id. at pgs. 15-16. Hedges also explained 

the necessity of speaking with “people throughout all aspects of the organization,” noting 

412 
 

that “meeting CFOs, back office people, traders, analysts, et. cetera [are important], 

because they give you perspective on the business that you don’t get from just meeting 

the boss.” Id. at pgs. 17-18. 

An independent hedge fund research and advisory firm (the research firm), who 

asked not to be identified in the OIG Report of Investigation, researched a Madoff feeder 

fund as an investment vehicle for a client in the late 1990’s or early 2000’s. CEO of 

Research Firm Interview Tr. at p. 5. The CEO of the research firm stated that they started 

the process by requesting that the Madoff feeder fund voluntarily produce basic 

documents such as financial statements. Id. at pgs. 7-8. The research firm then requested 

a meeting to have a explanation of Madoff’s split-strike strategy. Id. at p. 20. The 

research firm also asked about the counterparties for Madoff’s options trading and 

requested trading records. Id. at pgs. 20-21. 

Because of the structure of the investment, Renaissance’s Meritage fund had to 

perform due diligence using only publicly available information and customer statements 

provided to them by other Madoff clients. Laufer Interview Tr. at pgs. 15-16. They had 

no communications with Madoff or Madoff’s firm. Broder Interview Tr. at p. 14. As 

part of their due diligence, the Renaissance team analyzed Madoff’s reported trading and 

returns. Laufer Interview Tr. at pgs. 13, 51. To examine whether Madoff’s stated 

investment strategy could be producing his reported results, Laufer, who specialized in 

equity trading, supervised an analysis of Madoff’s purported stock trading while Broder 

analyzed the options trading. Id. at p. 14. 

A large investment bank, who asked not to be identified in the OIG Report of 

Investigation and who was considering an investment with Madoff, indicated that they 

did not use a specific checklist when performing due diligence, but did look at certain 

basic items, such as independence criteria and transparency. Investment Bank Due 

Diligence Team Interview Memorandum at pgs. 2-3. Specifically, “they want to see what 

the [trade] positions are and want to have an independent custodian holding the assets so 

they can see how much money is under management.” Id. at p. 3. The due diligence 

team then attempted to elicit Madoff’s trading strategy by obtaining Madoff’s trade 

records from a Madoff feeder fund. Id. 

2.	 There Were Immediate Questions about Madoff’s Trading 

Strategy 

The investment professionals interviewed by the OIG, who conducted due 

diligence immediately had significant questions about Madoff’s trading strategy. Hedges 

stated that a “substantial red flag” was the “consistency of [Madoff’s] returns that was not 

in keeping with the type of strategy that we understood him to be implementing because 

we felt that there were -- that the track record did not correlate to what we saw as either 

market factors, volatility factors, or other exogenous factors that would have otherwise 

affected the track record one way or another.” Hedges Interview Tr. at p. 10. The CEO 

of the research firm stated immediately he was “cynical” because, “The returns were 

413 
 

 

 

 

 

 

impossible. Absolutely impossible in my opinion. No financial strategy could produce 

those sort of returns.” CEO of Research Firm Interview Tr. at p. 3.275 

The Chief Executive Officer of a company with a fund of funds business, who 

asked not to be identified in the OIG’s Report of Investigation, stated that the first thing 

he noted “was that the description of what [Madoff] was doing seemed to be [was] 

inconsistent with what he knew about what you could achieve in a strategy like that.” 

CEO of Fund of Funds Firm Interview Tr. at p. 4. 

The CEO explained that Madoff’s strategy was: 

 ... described as being long a bucket of -- of pretty common 

variety listed stocks and writing options and trading options 

around that kind of bucket and that’s a strategy that will 

make money most of the time, but it’s going to lose money 

if there’s exposure and volatility. It’s going to lose money 

if there’s big market moves. It won’t produce the kind of 

pattern of returns that was the -- was the Madoff pattern. 

Id. at pgs. 4-5. 

The CEO explained that with options “you can lose money,” and “his track record 

at that point was a very, very long track record.” Id. at pgs. 5-6. The CEO noted when it 

came to Madoff, “[m]arket’s down, markets didn’t really matter,” explaining that “[y]ou 

can construct a strategy like that where you’ll make money most of the time but you 

cannot construct a strategy where you make money all the time.” Id. at p. 6. The CEO 

said he had seen consistent strategies before, but “every once in a while, they trip up, 

while Madoff “didn’t have that every once in a while.” Id. 

The CEO was suspicious and obtained copies of an investor’s last few account 

statements from Madoff Securities, and compared a sample of trades on the statements 

with what was actually going on in the markets on the day Madoff was trading. Id. at p. 

8. The CEO stated he found this “pattern which really seemed weird where the -- where 

the purchases were all at or close to the lows of the day and the sales were at or close to 

the highs of the day,” noting that “of course, nobody can do that.” Id. His “suspicion 

was that the fact pattern that [he] had seen seemed consistent with a Ponzi scheme.” Id. 

at p. 14. The CEO said he “didn’t conclude that that was the case, but [he] certainly 

thought there was enough of a risk that that was the case that, you know, [he] certainly 

wouldn’t touch it with a 10-foot pole.” Id. 

275 The CEO of the research firm also was suspicious when the research firm asked to see Madoff’s trading 

records and although they expected to see a computer screen, they were given a “binder about this thick 

that had just zillions of [hard copy] trade tickets in this binder, noting that he had “never in his life seen 

[hard copy] ticker trade tickets in this industry.” CEO of Research Firm Interview Tr. at p. 21. The 

research firm said this “was highly unusual” as usually you can see trade confirmations electronically as it 

happens. Id. at p. 22. 

414 
 

Renaissance’s risk manager, Paul Broder, found Madoff’s steady, non-volatile 

returns initially to be “suspicious,” as Broder stated, “He should have more volatility in 

his returns than he actually stated.... It was just too steady.” Broder Interview Tr. at pgs. 

9-10. Broder noted that no matter what happened in the market, no matter what crisis 

occurred, Madoff’s returns remained almost the same. Id. at p. 9. 

The Renaissance team then analyzed Madoff’s reported trading and returns. 

Laufer Interview Tr. at pgs. 13, 51. Laufer’s team found Madoff was reporting on his 

customer statements that he had purchased stocks at extremely low prices and sold stocks 

at extremely high prices. Id. at p. 17. Laufer explained, “this was statistically almost 

impossible to do if you were trading in an ordinary way.” Id. Laufer stated, “if you 

looked at those monthly statements and looked at the executions of the stock side, that the 

prices were just too good from any mode of execution that we were aware of that was 

legitimate.” Id. at p. 44. He noted that “we would have loved to figure out how he did it 

so we could do it ourselves ... [a]nd so that was very suspicious.” Id. at p. 28. 

Simons and Broder shared Laufer’s view of Madoff’s claimed executions, stating, 

“we observed that he got extraordinarily good fills,” and if the fills were legitimate, then 

Madoff’s predictions for when to buy and sell stocks would have been much better than 

anyone else that Broder had ever seen. Simons Interview Tr. at p. 34; Broder Interview 

Tr. at pgs. 15-16. Broder stated, “I knew it wasn’t possible because of what we do.” Id. 

at p. 16. 

Renaissance also noticed that Madoff’s predictions for when to stay out of the 

stock market were extraordinary. Laufer explained that the customer statements showed 

that at certain points: 

[Madoff’]s position would go to zero [go to cash]. It 

seemed to us that the quarters that he’d decide to go to zero 

were exceptionally good quarters to have no position. ... It 

seemed to us that those quarters in which he decided to go 

into zero cash were quarters in which, if you blindly tried to 

do what he was doing, you would have lost money, it 

seemed to us ... We had no idea ... how he managed to do 

that ... We didn’t understand what he was doing. We 

didn’t understand how he was doing what he was doing. 

Laufer Interview Tr. at pgs. 21-23. 

The investment bank who conducted due diligence also analyzed Madoff’s returns 

and concluded the returns were impossible, especially considering that the technology 

bubble burst during this time. Investment Bank Due Diligence Team Interview 

Memorandum at p. 3. They determined that particularly in the years 2000, 2001 and 

2002, there was no way Madoff’s performance could be that good, saying it was “readily 

apparent” that the returns were not possible (noting that Madoff’s returns in the years 

415 
 

 

2000-2003 were in the neighborhood of 8% which was not conceivable in that type of 

down market.) Id. 

Ocrant was also suspicious about Madoff’s strategy, stating that to “be that 

successful at managing that kind of capital, and in doing what he was doing, also, you 

know, you would have had to be right on picking the stocks themselves about, you know, 

90-95 percent of the time. Again, people said it’s not possible. You can’t be that good.” 

Ocrant Interview Tr. at p. 12. Ocrant’s source was particularly suspicious of Madoff’s 

returns, saying it was “impossible” and “you could be the greatest computer genius in the 

world and have access to all the super computers in the world and the market just won’t 

let you perform like that.” Id. at p. 11. 

Ocrant stated that he followed up and remarked that he: 

gave the terms and strategies [utilized by Madoff] to a guy 

who ran a quantitative analysis with a Japanese bank for a 

Fund to funds they ran and I said can you take this data and 

can you -- have you crunch it and let me know what you 

think and I didn’t give any further information and I said 

this is the strategy. He got back to me like a week to 10 

days later and he said, “Well, the team came back and they 

said this could be done by a market-maker, probably have 

to use front money to do it,” and I said, “Oh, that’s 

interesting,” and I said, “What would you say if I told you 

this guy was managing maybe $5-6-7 billion?” He said, 

“Impossible. It has to be a Ponzi scheme.” 

Id. at p. 13. 

Ocrant also noted that the fact that no one was able to duplicate Madoff’s strategy 

was suspicious, saying “if he’s figured something out, others don’t even have to look at 

the black box, a lot of smart people will look at -- figure out, especially these things -- 

they would have figured out.” Id. He discovered that “other big financial services firms 

who knew about this [strategy] have tried to duplicate it because they were curious 

themselves and they wanted to see, you know, can this work and they just couldn’t do it.” 

Id. 

Gregory Stahl, a fund of funds manager whose firm considered a Madoff feeder 

fund in 2005 for a possible investment, stated that he found it odd that the strategy that 

the Madoff feeder fund described “was a relatively common strategy.” Stahl Interview 

Tr. at p. 8. According to Stahl, the split-strike conversion strategy Madoff purportedly 

was using “usually produces a pretty consistent return,” but in Madoff’s case, the “level 

of consistency exhibited by [Madoff’s] strategy relative to other strategies we knew that 

did similar things was much, much better.” Id. Stahl said that strategy worked well for 

several years, but in 2004 and 2005, because the “volatility levels in the market had fallen 

off so dramatically” the returns from that strategy fell off. Id. at pgs. 8-9. Stahl said 

416 
 

 

Madoff’s “strategy has been around forever” and he knew of a mutual fund that adopted 

the same strategy, but while that mutual fund’s returns got weaker as the overall market 

got weaker, Madoff’s returns “remained very high.” Id. at p. 9. 

A Hedge Fund Manager, who eventually informed the SEC about his suspicions, 

triggering the 2003 OCIE examination (described in detail in section III above) but who 

asked not to be identified in the OIG’s Report of Investigation, also analyzed Madoff’s 

purported equity-based strategy and noted that this type of strategy “get[s] hurt when 

there is a severe dislocation, which we saw actually in ‘02.” Hedge Fund Manager 

Interview Tr. at p. 11. But the hedge fund manager discovered that Madoff’s strategy 

was not affected at all. Id. at pgs. 10-11. 

3.	 There Were also Significant Suspicions About the Levels of 

Madoff’s Purported Options Trading 

The research firm was very suspicious about Madoff’s purported options trading, 

noting that the market for “[S&P] 100 options [was] nowhere near deep enough to trade 

$13 billion dollars, and that “[t]he liquidity of listed S&P 100 options could not handle 

1/20th of that size.” CEO of Research Firm Interview Tr. at p. 35. Michael Ocrant’s 

source similarly commented on Madoff’s options trading that “[y]ou don’t see the 

volume,” or “market impact,” posing the question that even if options are traded overthe-counter, “you have counterparties, you know, where are they” and noting that the 

trading volume “just doesn’t exist.” Ocrant Interview Tr. at p. 11. 

Renaissance suspected Madoff was misrepresenting his trading after conducting 

an analysis of Madoff’s claimed options trades. Renaissance concluded Madoff could 

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

options over the counter because he would not be able to find a counterparty for the 

trading. Broder Interview Tr. at pgs. 35-37. Laufer explained their reasoning: “[W]e 

made inquiries. We didn’t see anybody saying he did a lot of trading. We didn’t 

understand why anybody in the business of options would take the other side.... [Y]ou 

ask yourself, why would somebody do this? Because he’s going to lose money doing the 

trade, so far as we know.” Laufer Interview Tr. at pgs. 25, 49. 

A former co-chief Information Officer (CIO) for a fund of hedge fund who 

considered an investment with Madoff in late 1997 or early 1998 and who asked not to be 

identified in the OIG’s Report of Investigation, reported that Madoff described his 

options strategy in a meeting with him, and that Madoff stated the assets under 

management with Madoff Securities in this strategy were about $3 billion. CIO of Fund 

of Funds Interview Tr. at pgs. 4-5. The CIO stated that he asked Madoff “who [was he] 

trading these options with?” Id. According to the CIO, Madoff replied that “none of the 

options were being traded over the counter ... the options are traded through the Chicago 

Board of Options Exchange so that [they] have the clearinghouse of the options exchange 

as [their] counter party.” Id. at p. 6. The CIO stated that he found this answer 

“exceptionally odd” because in his experience, he knew that the Chicago Board of 

Options Exchange “was not a very deep market,” noting that it was “something that we 

417 
 

 

 

would call a retail market.” Id. at p. 7. The CIO immediately determined that there 

simply was not “enough volume on the Chicago Board of Options Exchange ... to get 

that sort of coverage for ... 3 billion,” noting that “on any given day, there’s not enough 

volume.” Id. The CIO explained that you can look at a Bloomberg terminal and “in a 

heartbeat” know the volume trading on CBOE for a particular day and there were not 

enough options for Madoff to conducting his trading. Id. at p. 8. 

The CIO stated after his meeting with Madoff, he called people he knew at CBOE 

asking them to help him get a feel for how much volume trades on a daily basis. Id. at p. 

10. The CIO explained that you could download off of Boomberg or the CBOE website 

the daily call and put volume for the OEX picks. Id. at p. 11. The CIO found that “the 

volume was never there for Madoff.” Id. The CIO said he also inquired with folks who 

were running equity derivatives departments at a few firms, and all of them reported to 

him that they “hear that [Madoff’s] doing all these trades” but they “don’t see it 

anywhere.” Id. The CIO found that “nobody did these options” and noted that he “could 

never find anybody who remotely even knew who was doing the options.” Id. at p. 13. 

4. There Were Also Questions About Madoff’s Fee Structure 

The CEO of the fund of funds firm who conducted due diligence of Madoff, 

thought it was “very unusual for somebody who could generate those kind of returns to 

not create their own hedge funds.” CEO of Fund of Funds Firm Interview Tr. at p. 16. 

He noted that if Madoff’s firm “created their own hedge fund, then their auditor would be 

looking at individual positions.” Id. at pgs. 16-17. The CEO also said the fee structure 

“was extremely unusual,” explaining that he could not “think of anybody else really 

who’s running a large fund account, large hedge fund money in managed account 

format.” Id. at p. 17. 

Similarly, the research firm was suspicious about Madoff’s fee structure because 

they could not understand why Madoff only charged commissions. CEO of Research 

Firm Interview Tr. at p. 36. If he had collected hedge fund fees, he could have earned $1 

billion a year, instead of the $200 million he collected from commissions. Id. 

Renaissance also found that “on its face” Madoff’s fee structure was illogical. 

Simons Interview Tr. at p. 18. Simons did not understand why Madoff would allow 

feeder funds to take hundreds of millions of dollars in fees that Madoff could have kept 

for himself, stating: “[W]hen you see a situation where it would appear that he’s only 

making money off of his ... brokerage fees, why is he letting the Fairfield Greenwiches 

of the world take 2 points? I don’t know.” Id. at p. 18. Simons explained why he 

thought it was illogical for Madoff to not retain the fees for himself, as follows: 

[Madoff] supposedly has excess demand for his product 

and – you know, normally you see third party marketers in 

situations where there is [not] enough demand for the 

product....They need the third party marketer to help them 

raise money. ... In Madoff’s situation, when there ... was 

418 
 

plenty of pent-up demand for his product, which would 

mean that you just kind of hire a couple of guys and set 

them up in offices, and you could raise money all day. And 

so why not just capture that for yourself, build your own ... 

sales and marketing team in-house? Why continue to 

outsource it to Fairfield. 

Id. at pgs. 19, 21. 

Broder estimated that Madoff could be foregoing as much as $200 million a year 

in fees, something he and Broder found unusual, stating: “[R]emember at the time he had 

a fantastic system but he didn’t charge anybody any fees. That seemed a little bit 

strange.” Broder Interview Tr. at p. 10; Laufer Interview Tr. at pgs. 42-43; 

Ocrant’s source also could not understand why Madoff would “structure himself 

in this weird way and give up tens of millions in fees? Why would you possibly do 

that?” Ocrant Interview Tr. at p. 12. 

5. The Identity of Madoff’s Auditor Was Also a Concern 

The CEO of the fund of funds firm also noticed on Madoff’s Securities balance 

sheet that Madoff was “audited by a firm in New City, NY,” which he had never heard of 

and thus, had to be “some suburban little shopping mall kind of accounting firm.” CEO 

of Fund of Funds Firm Interview Tr. at pgs. 10-11. 

Similarly, the research firm was suspicious when they found out that Madoff’s 

auditor was a firm named Friehling and Horowitz, who they had never heard of even 

though they had been in the industry for a long time. CEO of Research Firm Interview 

Tr. at p. 44. The research firm said that they “had never seen them before in [their] entire 

existence and it [was] very, very, very rare that [they would] run across an accountant 

that [they had] never seen in [their] years.” Id. They asked around and “googled” the 

accounting firm and no one had heard of them and they found very little information 

about them. Id. at pgs. 44-45. The research firm then hired a private investigator to find 

out more about the auditor and discovered that the firm had three employees, Friehling, 

Horowitz, and a secretary, and that Jerome Horowitz was 78 years old and lived in 

Florida. Id. at p. 47. 

Similarly, the small size of Madoff’s auditor was an issue for Renaissance, 

particularly because Madoff was reportedly managing billions of dollars for investors. 

Broder Interview Tr. at p. 33. 

419 
 

 

 

 

 

6.	 When They Met with Madoff, They Were not Impressed with 

his Answers to Their Questions 

Several of the private entities conducting due diligence indicated that when they 

confronted Madoff or his feeder fund with their questions and suspicions, they did not get 

satisfactory answers and decided to forgo the investment entirely. According to Hedges, 

after the initial meeting with Madoff, he realized that the investment was too risky, 

stating that his meeting with Madoff “led to [his] hitting a roadblock in so many instances 

that [he] had no interest in continuing to ask about this business strategy or ... whatever 

other issues might have come up later.” Hedges Interview Tr. at p. 16. Hedges stated 

Madoff’s explanation of how made money simply did not make sense to him. Id. at p. 

17. 

The research firm also described a meeting with Madoff where they asked him 

about his split-strike conversion strategy and Madoff explained that “he has got this 

wonderful feel for when to enter the market, when to get out, and which subset of the 

S&P 100 stocks to trade,” which they simply did not believe. CEO of Research Firm 

Interview Tr. at p. 20. 

The CIO of the fund of funds met with Bernard Madoff in late 1997 or early 

1998, and asked Madoff about his options strategy, specifically, “who [was he] trading 

these options with?” CIO of Fund of Funds Interview Tr. at pgs. 4-6. According to the 

CIO, Madoff replied that all of the options were being traded over the counter through the 

Chicago Board of Options Exchange. Id. at p. 6. The CIO stated that he found this 

answer “exceptionally odd” and after he called industry colleagues to check out Madoff’s 

answer, he became even more suspicious and declined to go forward with the investment. 

Id. at p. 13.276 

Gregory Stahl stated that when he asked the Madoff feeder fund for an 

explanation and more information about their strategy, the feeder fund replied that the 

information was proprietary and they would not answer Stahl’s questions. Stahl 

Interview Tr. at p. 10. 

D.	 Comments on the SEC’s Ability to Uncover Fraud and Inadequacy of SEC 

Examinations 

Many of the private entities that conducted due diligence of Madoff and declined 

to invest with him because of significant red flags that arose during the routine review of 

his operations felt that the SEC could have uncovered the fraud. Renaissance thought a 

regulator could have verified whether Madoff was trading by asking Madoff who his 

counterparty was and then verifying with the counterparty that the trade took place. 

Broder Interview Tr. at pgs. 21-22, 38. Broder would have performed the same 

276 Another potential investor, Laura Goldman, noted that when she met with Madoff and began asking him 

questions, “he started shuffling” and “didn’t really answer questions.” Laura Goldman Interview Tr. at p. 

14. 

420 
 

 

verification process whether Madoff claimed his counterparty was in the United States or 

in Europe. Id. at p. 23. 

Broder explained his reasoning as follows: 

[S]omewhere in the marketplace, either in an exchangetraded marketplace or an OTC marketplace, exactly those 

trades which were on the client account statement should 

exist on someone else’s books, you know... Somewhere in 

the marketplace, either OTC or exchange-traded, those 

trades were taking place. And it seems to me a very simple 

set of steps to verify that those volumes [existed]. ... I 

don’t see how that could have possibly been missed. I 

mean, this is a very simple verification. I mean this guy is 

trading – this is a cash account. So he’s turning over $10 

billion of stocks each particular month. I mean, you’ve got 

to be [able to see it] in the marketplace. 

Id. at pgs. 25-26. 

Laufer also felt that a regulator conducting a thorough review of the Renaissance 

e-mails that led to the 2005 NERO cause examination would have had to have asked, 

“Who took the other side of the trade? You don’t have to deduce huge amounts. Just ask 

who took the other side of the trade, which of course we couldn’t find that [out].” Laufer 

Interview Tr. at pgs. 27-28. Likewise, if Simons were investigating Madoff, he stated 

that he would have asked Madoff to show me the other side of your trades whether he 

claimed to trade in the United States or Europe: “I need to see the other side of those 

trades in Europe. If they’re in Europe, that’s fine, but you’re doing them with someone. 

There’s got to be somebody on the other side of the trade.” Simons Interview Tr. at pgs. 

36-37. 

Laufer asserted that someone at the SEC should have been able to do the same 

analysis and draw the same conclusions Broder did without determining whether or not 

Madoff was front-running, stating, “This is not rocket science.” Laufer Interview Tr. at 

p. 49. When asked if he thought someone from the SEC should have been able to figure 

it out, Laufer replied, “Much more elementary than that. Someone at the SEC could 

wander down, you know, to Goldman Sachs and wander over to their options department 

and ask them, how does somebody execute $10 billion of options, and find out it’s very 

difficult,” noting, “you don’t have to be as smart as Paul Broder” to figure this out. Id. at 

pgs 49-50. 

James Hedges stated that it was “fair to say that there [were] enough red flags that 

I came across that would even alert the lay person to the potential for the Madoff track 

record being too good to be true.” Hedges Interview Tr. at p. 12. 

421 
When asked why the SEC was unable to uncover Madoff’s fraud or even 

appreciate the suspicions and “red flags” that the private entities focused on, the reasons 

provided were that SEC examinations were conducted by less experienced personnel and 

the examinations were too formulaic and “checklist-oriented.” Hedges noted that “the 

SEC and the self-regulating organizations are, by and large, staffed with traditionally 

junior people conducting investigations,” and “a certain degree of -- of education and 

credentialing and breadth of understanding of strategies would be helpful.” Id. at pgs. 

23-24. His experience with examiners was they were “working off of a rote formulaic 

process that [they] did not understand because if [they] had understood the process, [they 

would not have asked the questions they asked].” Id. at p. 24. 

The research firm also stated that SEC examinations lacked the ability to be “able 

to look at the forest and not the trees,” noting that “these guys come in with a checklist 

and they are trying to get through this checklist and it is all about the checklist.” CEO of 

Research Firm Interview Tr. at pgs. 76-77. 

Ocrant described what he called “an open secret on Wall Street” about the 

inspections and examinations that the SEC and other regulatory agencies conduct: 

Those who do inspections usually are relatively young 

attorneys who come with an attorney mindset which means 

they have a rule book and a checklist. They look at the rule 

book. They look at the checklist. They say, well, I have 

Rule A and I have Checklist A. Okay. They’re complying 

with Rule A, so I can check that box off, and they go 

through and they check off the boxes and they may find a 

violation, say okay, here’s a violation, you have to do this 

or you have to pay a fine, something like that, but they 

don’t come in with a mindset of, you know, guys I talk to, 

you know, capital markets experience, with financial 

trading experience, with a real understanding of what’s 

possible and not possible in any given market or any given 

strategy. They don’t really know to ask those questions 

even if they somehow came upon it or thought they had 

something because they don’t have the experience to do so. 

Ocrant Interview Tr. at pgs. 46-47. 

The hedge fund manager explained, based upon his direct experience with 

examinations, that he did not think the Commission examinations were thorough, stating: 

[T]here is a lot of minutia, detail-oriented work that is 

done. I am not sure that the auditors actually relate that 

detail to the big picture of what is going on, what the firm 

does for a living, their strategy. You know, the bigger 

things in terms of the investment strategy, for hedge funds 

especially. But that actually requires a certain level of, I 

422 
 

guess, technical knowledge of, you know, the different 

hedge fund strategies. 

Hedge Fund Manager Interview Tr. at pgs. 35-36. 

Two former SEC examiners stated that they became frustrated with the 

“checklist-oriented” approach that was utilized while they were at the SEC. A former 

securities compliance examiner with the SEC who worked on investment adviser 

examinations stated that he became frustrated in performing SEC examinations because 

“the focus was kind of lost off of the initial, I guess, what as I saw as the mission, which 

was protecting investors and watching out for money, and that sort of stuff, And it 

became more of checking the box and it was just writing reports, and more administrative 

aspects of it, as opposed to, you know, the field work aspect in really protecting the 

investors.” Former Securities Compliance Examiner Interview Tr. at p. 5. 

The former Securities Compliance Examiner also stated that he did not think that 

examiners at the SEC “had the competency level, the education, and the knowledge to 

follow up on a question. Like if you asked them, I don’t know what the question was, 

something about the guy’s investment strategy, and he answered the question, I felt like 

half the people didn’t really understand what his answer to the question was, and they 

couldn’t really follow up that question because they didn’t really understand what he was 

saying.” Id. at p. 29. The former Securities Compliance Examiner also indicated that 

examiners “were so focused on the checklist” that they would often “miss the forest for 

the trees.” Id. 

The former Securities Compliance Examiner was also frustrated by working with 

the Enforcement Division, stating that the “big problem with enforcement” was that 

although “they know the procedures of law and how it works, motions and all that sort of 

stuff,” they “have to get trained on what each particular case is about” and can get 

“swamped.” Id. at pgs. 10-11. The former Securities Compliance Examiner recalled that 

in one large matter, the Enforcement staff “didn’t really understand fully the topic that we 

were dealing with, and they just had ... too much on their plate, and didn’t have enough 

assistance from people who did really understand, you know, the case, and the investment 

side of it, if you will” and the case, which the former Securities Compliance Examiner 

thought was strong, was never made. Id. at pgs. 11-12. The former Securities 

Compliance Examiner said in general, he felt that the Enforcement attorneys were not 

well-versed enough in investment adviser issues, stating “they do not really grasp 

investment” theories and “how the investment system works.” Id. at p. 15. 

Former OCIE examiner Alex Sadowski described what he viewed as the 

weaknesses in the examination program: 

And there is a mentality sometimes ... we have this 

checklist, right, so we need to go by this checklist and if 

everything happens on this checklist, it is okay. There was 

not a lot of outside the box thinking. ... The analogy that 

423 
 

 

we use is that a typical SEC examiner walks into a room 

where there are a bunch of dead bodies lying around and 

they notice that the clocks are 10 minutes fast. And it 

really is. And, again, it is not meaning to be disparaging 

but it becomes difficult but you also have to factor in the 

restraints that you have. 

Sadowski Testimony Tr. at pg. 102-103. 

E. Conclusion 

Numerous private entities conducted basic due diligence of Madoff’s operations 

and, without regulatory authority to compel information, came to the conclusion that an 

investment with Madoff was simply too risky. These decisions were made based upon 

the same “red flags” in Madoff’s operations that the SEC considered in its examinations 

and investigations, but ultimately dismissed. 

An explanation of why these private entities were able to understand and 

appreciate the suspicious aspects of Madoff’s strategies and operations may be related to 

the differing approaches utilized by these private sector individuals conducting the 

analysis as compared to SEC examinations. The private entities generally described an 

“iterative” approach to due diligence, focusing on basic items, such as independence and 

transparency, while many faulted the SEC examinations for being too “checklistoriented.” Through this “iterative” approach, the private entities were able to better 

understand the matters they were analyzing, such as the improbability of Madoff 

achieving his returns using his split-strike conversion strategy and the fact that Madoff 

could not be trading options in such high volumes without affecting the market or having 

counterparties that could be located. In addition, private entities who conducted due 

diligence appreciated the “red flags” that the SEC personnel dismissed because they had 

a greater experience and knowledge base in the industry than many SEC examiners have. 

The SEC examination program should analyze the approaches utilized by private 

entities who conducted due diligence of Madoff’s operations and apply these methods to 

strengthen their program. They should also seek to learn from these private entities 

through training mechanisms and in fact, several private entities informed the OIG that 

they would be willing to conduct training of SEC examiners in their due diligence 

approaches. Learning from private sector efforts would improve the SEC’s ability to 

conduct meaningful and comprehensive examinations and detect potential fraud.277 

277 The OIG is also issuing a separate report containing recommendations to improve OCIE’s examination 

program as a result of findings made in the OIG’s Madoff investigation. 

424 
 

IX. THERE IS EVIDENCE THAT POTENTIAL INVESTORS RELIED UPON 

THE FACT THAT THE SEC HAD EXAMINED AND INVESTIGATED 

MADOFF IN MAKING DECISIONS TO INVEST WITH HIM 

During the course of the OIG investigation, we found that investors who may 

have been uncertain about whether to invest with Bernard Madoff were reassured by the 

fact that the SEC had investigated and/or examined Madoff, or entities that did business 

with Madoff, and found no evidence of fraud. Moreover, we found that Bernard Madoff 

proactively informed potential investors that the SEC had examined his operations as a 

method to establish credibility and allay suspicions or investor doubts that may have 

arisen while due diligence was being conducted. 

After the SEC brought its action against Avellino & Bienes in 1992, the Wall 

Street Journal reported that the SEC had charged Avellino & Bienes with operating an 

unregistered investment company, as they had failed to register promissory notes given to 

their investors, which purported to deliver annual returns of 13.5% to 20.0%. Randall 

Smith, SEC Breaks up Investment Company that Paid Off But Didn’t Register, The Wall 

Street Journal, December 1, 1992, at Exhibit 483. The Wall Street Journal article further 

stated that Avellino and Bienes had returned $441 million to investors as a result of the 

SEC complaint. Id. SEC Senior Associate Regional Administrator Martin Kuperberg 

was quoted in this December 1, 1992 Wall Street Journal article, stating that the returns 

appeared to have been generated legitimately and that “[r]ight now, there’s nothing to 

indicate fraud.” Id. 

It was later reported by the Wall Street Journal that the broker who managed the 

money and generated the high returns was “Bernard L. Madoff.” Randall Smith, Wall 

Street Mystery Features a Big Board Rival, The Wall Street Journal, December 16, 1992, 

at Exhibit 116. 

The OIG obtained 25 affidavits from individuals who invested with Madoff who 

reported that they “knew of and relied upon the SEC’s 1992 public statement that there 

was nothing to indicate fraud” in deciding to invest with Madoff. 25 affidavits 

collectively, at Exhibit 484. Many of these investors, who had funds returned to them 

because of the SEC’s action against Avellino & Bienes, re-invested the funds with 

Bernard Madoff directly after the SEC action. One investor, Angelina Sandolo, stated in 

her sworn affidavit that: 

My initial investment was with Avellino & Bienes until 

they were forced by the SEC to shut down. I then moved 

my investment directly to Bernard L. Madoff Investment 

Securities relying on the SEC’s 1992 statement that there 

was no indication of fraud. 

Affidavit of Angelina Sandolo, sworn to on July 2, 2009, at Exhibit 484. 

425 
Another Madoff investor, Shirley K. Stone, stated similarly as follows: 

We gave a big sigh of relief when we read & heard that a 

government agency called SEC said that there was no 

fraud. Since we were so sure that all was well if our 

government had checked we went directly into Madoff 

Investment Co. from Avellino & Bienes. ... My generation 

(born 1922) was taught respect & trust for our 

government.” 

Affidavit of Shirley K. Stone (undated), at Exhibit 484. 

Judith Welling, another Madoff investor, relied upon the representation in 

the Wall Street Journal article, stating: 

My widowed mother had a small amount of money 

invested with Avellino and Bienes. When they were shut 

down by the SEC in 1992 she invested the proceeds from 

Avellino and Bienes with Madoff because of the SEC’s 

favorable report. She kept a copy of the Wall Street Journal 

article reporting the SEC’s giving Madoff a clean bill of 

health in her files. When I joined her Madoff account in 

1994, my husband referred to that report as a key part of 

our research. The original WSJ article remains in our files. 

Affidavit of Judith Welling, sworn to on July 1, 2009, at Exhibit 484. 

Susanne Marshall, who also invested with Madoff, relied upon a letter she 

received from the SEC after the SEC forced Avellino & Bienes to close its 

operations, stating: 

I began my account with A&B in or about 1990. I received 

a letter in 1992 stating A&B was closing and returning my 

money with the gains I had made. The letter explained that 

the SEC had found A&B & their firm [sic] of no wrong 

doing, but they were being fined for an error in registration. 

I remember discussing this with my parents as an article 

also came out in a newspaper about the situation. A few 

months later I reinvested with Mr. Madoff as did all of my 

family. Mr. Madoff called my parents & we knew he had 

worked with A&B, so we considered it to be safe since the 

SEC investigated A&B. 

Affidavit of Susanne Marshall, sworn to on July 10, 2009, at Exhibit 484 

426 
 

 

 

 

A Certified Public Accounting firm, Abelson & Company analyzed statistics 

relating to the losses suffered by 16 of the above affiants who suffered losses after relying 

upon SEC’s statements regarding Madoff. Abelson & Company reported total losses of 

$70,105,580.62, with an average loss of $4,381,598.79. Abelson & Company report at 

Exhibit 485.278 

In addition, private entities who conducted due diligence stated that Madoff 

represented to them that the SEC had examined his operations when they raised issues 

with him about his strategy and returns. Nat Simons, the portfolio manager for 

Renaissance’s Meritage fund, a hedge fund of funds, who held a Madoff managed 

investment in 2003 and whose e-mails triggered the 2005 NERO examination (as 

described in detail in Section IV above), cited their understanding that the SEC had 

looked at Madoff and given him a clean bill of health as a reason they did not initially 

divest themselves of their Madoff-related investment. Simons Testimony Tr. at p. 28. 

Renaissance understood from Madoff that the SEC had examined “the whole business.” 

Id. at p. 17. Renaissance research scientist Henry Laufer agreed, “What was also on our 

minds ... was that Madoff had been investigated – and cleared” by the SEC. Laufer 

Testimony Tr. at pgs. 35-36. 

Renaissance also doubted Madoff could be engaged in fraud because he operated 

through highly regulated brokerage accounts, stating: 

[B]ecause of the nature of the fact that these were 

brokerage statements, and he had a big broker dealer 

business and big market-maker and – you just assume that 

someone was paying attention to make sure that there was 

something on the other side of the trade. ... I never, as the 

manager, entertained the thought that it was truly 

fraudulent. And it again was because ... it would have 

been so easy to prove that it was fraud if it was just 

managed accounts that were set up. It would have been so 

– again, forgive me here, but you know, it would have been 

pretty straightforward. We felt that he was sufficiently in 

the eye of the regulators that it was just hard for us to 

envision that that was the case. 

Simons Testimony Tr. at pgs. 28, 39-40. 

Simons further explained that one reason they did not report their suspicions to 

the Commission directly was that they felt all of the information they were using in their 

analysis was readily available to the Commission: 

278 The Ableson & Company report and the 25 affidavits were provided to the OIG in their investigation by 

Gaytri Kachroo, Esq., counsel for Harry Markopoulos, and compiled by Lawrence R. Velvel, Dean, 

Massachusetts School of Law. 

427 
 

We did feel that despite the fact that we’re kind of smart 

people, we were just looking at matters of public record. I 

mean, you know, it wasn’t hard to get these statements. 

These statements, you know, hundreds of – lots and lots 

and lots of people had Madoff statements. So we didn’t 

really feel that we were dealing with something which is 

proprietary, and therefore the conclusion that we came to 

were something that was – you know, other people were 

unlikely to come to. And it’s not like we needed a PhD in 

mathematics to do the ... study on the OEX. Right? I 

mean, this is just – just looking at the size of the market. 

Id. at p. 48. 

An independent hedge fund research and advisory firm (research firm), who 

researched a Madoff feeder fund as an investment vehicle for two clients in the late 

1990’s or early 2000’s and asked not to be identified in the OIG’s Report of 

Investigation, also confirmed that Madoff raised the SEC examinations while they were 

conducting due diligence. CEO of Research Firm Interview Tr. at pgs. 55-56. The Chief 

Executive Officer (CEO) of the research firm, described a meeting he had with Madoff 

where Madoff spoke about his split-strike conversion strategy and his business for about 

an hour. Id. at pgs. 2-3. The CEO reported that Madoff made a point of telling them that 

as a result of an SEC visit, Madoff registered as an investment adviser, in order to convey 

to them that he had been examined and got a clean bill of health. Id. at pgs. 55-56. The 

research firm also specifically recalled the Madoff feeder funds telling them “about [how] 

the SEC was just in there and they did not find anything.” Id. at p. 58. 

The CEO indicated that the research firm did not believe that Madoff was 

operating a Ponzi scheme because they found out that the SEC had received a copy of 

Harry Markopolos’s letter and “presumed” with the detailed information contained in 

Markopolos’s letter that “somebody at the SEC must have checked with DTCC.” Id. at p. 

51. They stated that after reading Markopolos’s letter, “there [was] no way in hell the 

SEC did not take a hard look at this thing.” Id. at p. 55. 

The research firm agreed that they had another potential investor become aware 

“that the SEC was there in 2005 and found only minor things and the fact that there was 

the Markopolos complaint out there and it seemed liked the SEC must have looked at it,” 

it would have “provide[d] some assurances to people.” Id. at pgs. 57-58. However, the 

research firm decided in the end not to invest with Madoff because of the numerous red 

flags that they had uncovered during the course of their own due diligence. Id. at p. 4. 

428 
 

 

 

 

 

Bernard Madoff himself acknowledged in his interview that he would inform 

potential investors about SEC examinations in order to provide them with a level of 

comfort, stating that “it lent to the credibility of his firm that he had passed examinations 

by the SEC.” Madoff Interview Memorandum at p. 6. 

Accordingly, we found that not only was the SEC unable to uncover Madoff’s 

fraud in the several investigations and examinations it conducted over a period of years, 

the fact that they had conducted examinations and investigations and did not detect the 

fraud, lent credibility to Madoff’s operations and had the effect of encouraging additional 

individuals and entities to invest with him. 

X. ADDITIONAL COMPLAINTS RECEIVED BY THE SEC REGARDING 

MADOFF 

A. Introduction 

In addition to the complaints previously discussed at length in Sections I, II, III, 

IV and V of this Report of Investigation, the SEC received additional tips and complaints 

about Bernard Madoff and/or his firm, Bernard L. Madoff Investment Securities LLC 

over the years. Many of those tips and complaints were directly provided to or internally 

referred to the SEC’s Office of Investor Education and Advocacy (OIEA). OIEA serves 

individual investors who complain to the SEC about investment fraud or the mishandling 

of their investments by securities professionals. See http://intranet.sec.gov/divisions_ 

offices/hqo/oiea/OIEAHome.html, at Exhibit 486. OIEA routinely refers tips and 

complaints to other offices and divisions with the SEC as well as to other regulatory 

agencies. 

OIEA retains paper records of customer complaints for four years before they are 

destroyed. Letter dated December 19, 2008 from Kristin Kaepplein, Director OIEA, to 

Kotz, at Exhibit 487. OIEA’s ACTS+ database includes approximately the last six years 

of electronic records. Id. Through requests made to OIEA and a search of OIEA’s 

ACTS+ complaint database and its archives, the OIG identified six complaints that were 

handled by OIEA prior to Madoff’s December 11, 2008 arrest determined to be 

“Relevant to [the OIG’s] Madoff Investigation.” Table 1, “Investor Complaints Received 

by OIEA through 12/15/2008,” at Exhibit 488.279 

279 OIEA also identified eight complaints related to Madoff or BMIS that were determined to be “Not 

Relevant to Madoff Investigation.” Table 2, “Investor Complaints Received by OIEA Prior to 

12/11/2008,” at Exhibit 490. These complaints appear to be unrelated to Madoff’s investment advisory 

business. 

429 
 

 

B. Complaints Identified as Relevant to the OIG’s Madoff Investigation 

1. Anonymous Complaint about Manipulation of Securities, Prices or 

Markets 

The first complaint that OIG identified as relevant to the Madoff investigation 

was a letter submitted anonymously to the SEC’s Washington, DC headquarters on 

August 8, 2002. OIEA File HO372641, at p. 1, at Exhibit 489. The actual letter 

submitted was destroyed as per OIEA’s customary record retention practice. Table 1, 

“Investor Complaints Received by OIEA through 12/15/2008” at p. 1, at Exhibit 488; 

OIEA Branch Chief Testimony Tr. at pgs. 27-28. OIEA records from the ACTS+ 

database show that the complaint concerned Madoff Securities and described Madoff 

Securities as “Mutual fund—general.” OIEA File HO372641, at p. 1, at Exhibit 489. 

The OIEA code used to describe the letter was “081-Manipulation of securities, prices or 

markets.” Id. No other information about the substance of the complaint was contained 

in OIEA records. Id. The complaint was closed on August 9, 2002 without being 

referred to any other SEC Division or Office or elsewhere. Id. 

2. Anonymous Complaint Unrelated to Madoff’s Investment 

Advisory Business Referred to the NASD 

A second complaint identified by the OIG was sent by an anonymous investor to 

the SEC’s Northeast Regional Office (NERO) on February 16, 2005. OIEA ACTS+ 

database records show that the complaint consisted of a letter alleging that “Pilla directed 

customer order flow ... to specific firms in return for gifts in excess of $100.” BMIS is 

among three firms that are listed as possibly involved in the practice. OIEA File 

NERO1066, at p. 1, at Exhibit 491. The complaint did not appear to concern allegations 

related to Madoff’s investment advisory business. OIEA referred the complaint to the 

NASD. Id. 

3. Investor Complaint Unrelated to Madoff’s Investment Advisory 

Business Was Referred to NERO Examiners Conducting a Cause 

Examination at BMIS; Examiners Did Not Document Results of 

Complaint Investigation 

A third complaint was also received by NERO. On April 13, 2005, a letter was 

submitted by James Tucker, an investor who stated that he had executed trades through 

Fidelity that were then routed through BMIS. OIEA File NERO1072975, at p. 1, at 

Exhibit 492. Tucker claimed that he did not receive the correct price on his trades. Id. 

The complaint did not concern allegations related to Madoff’s investment advisory 

business. 

Because NERO examiners William Ostrow and Peter Lamore were on-site at 

BMIS performing an examination during the time period this complaint was received by 

OIEA, the complaint was referred to them on May 18, 2005. Id.; E-mail dated May 18, 

2005 from Ostrow to Lamore, at Exhibit 493. However, Lamore did not recall receiving 

430 
 

 

the complaint or investigating it. Lamore Testimony Tr. at pgs. 84-85. Ostrow recalled 

reviewing the customer complaint and acting on the complaint immediately by either 

requesting trade data or following up on the complaint with BMIS. Ostrow Testimony 

Tr. at pgs. 94-95. However, Ostrow could not recall how the complaint was resolved 

and did not recall documenting the results of the investigation of the complaint. Id. 

When asked if he went back to the Investor Assistance Specialist who had referred the 

complaint to inform her of the results of their investigation of the complaint, Ostrow 

stated that he did not, in the following exchange: 

Q: Would you have gone back to [the Investor 

Assistance Specialist] to let her know how this 

complaint was resolved, or your findings? 

A: No, that’s probably a weakness of the SEC, in 

general, just in terms of -- you know, sometimes 

tips or complaints come in, but what is the way to 

handle it afterwards? You know, it was great that 

we got it while we were there on site. But, I mean, 

it wasn’t something to the point where we thought 

we needed to contact the customer who was writing 

in, or it was something that – you know, the nature 

of it was not as severe, or just – I don’t recall. ... I 

don’t know what exactly happened to resolve that. 

Id. at pgs. 94-97. 

On July 25, 2005, Tucker sent a second letter to NERO, stating that he had not 

received an acceptable explanation from Fidelity Group about why his trades were routed 

through BMIS and asking the SEC to look again at Fidelity’s trading practices. Letter 

dated July 25, 2005 from James H. Tucker to Donna Smith, Investor Assistance 

Specialist in NERO, at Exhibit 494. On September 9, 2005, the SEC Investor Assistance 

Specialist who had previously handled Tucker’s complaint sent him a response. Letter 

dated September 9, 2005 letter from Smith to Tucker, at Exhibit 495. The letter informed 

Tucker that his complaint had been referred but that the SEC “cannot provide you with 

updates on the status of your complaint or of any pending SEC investigation.” Id. 

4. Anonymous, Generalized Complaint about Madoff’s Investment 

Advisory Business Was Not Referred to Enforcement 

The fourth complaint was submitted anonymously on November 24, 2006 to 

OIEA in the SEC’s Washington, DC headquarters. The complaint was an anonymous 

letter, stating the following: 

While I have no specific information/evidence of 

wrongdoing, I would be interested if I were you in 

investigating the combined activities of Bernard L. Madoff 

431 
 

 

 

Investment Securities LLC (money manager and market 

maker) and the hedge funds managed by Fairfield 

Greenwich Group. No down months and low volatility all 

the time just doesn’t add up. 

OIEA File HO1190190, at p. 3, at Exhibit 496. 

The OIEA Acts+ database shows that the complaint was assigned to an OIEA 

Senior Counsel280 and was not referred for investigation. Id. at p. 1. Under “Comment,” 

the OIEA Senior Counsel wrote, “complaint that hedge funds have not have [sic] losses 

and low volatility. No other information.” Id. The decision to not refer the complaint 

was approved by the OIEA Senior Counsel’s supervisor, a former OIEA Branch Chief. 

Id.; Former OIEA Branch Chief Testimony Tr. at p. 39. Although the former OIEA 

Branch Chief did not have a specific recollection of the complaint, he explained that the 

complaint was likely not referred because it was “general” and “the broadest of 

allegations,” making it difficult to know how to conduct the investigation and requiring a 

great deal of resources.” Id. at pgs. 34, 38-39; OIEA Branch Chief Testimony Tr. at p. 

31. The former OIEA Branch Chief stated that prior to Madoff’s confession in December 

2008, he did not believe resources were devoted to cases dealing with generalized 

allegations about unusual investment returns. Former OIEA Branch Chief Testimony Tr. 

at pgs. 34-35. Moreover, the former OIEA Branch Chief stated that because the 

complaint was anonymous, the staff could not follow up with the complainant to seek out 

more specific information. Id. at p. 32. 

An additional reason the former OIEA Branch Chief and a fellow OIEA Branch 

Chief testified that an OIEA staff member might be reluctant to refer a generalized, 

anonymous complaint to NERO was because Regional Litigation Counsel, Jason 

Gettinger, who was the “main person” responsible for handling tips or complaints 

provided to NERO, was known to often reject “general allegations.” Id. at pgs. 20-23; 

OIEA Branch Chief Testimony Tr. at pgs. 42-44; Gettinger Testimony Tr. at pgs. 7-8. 

According to the former OIEA Branch Chief and the OIEA Branch Chief, Gettinger 

repeatedly sent “harsh” e-mails back to the OIEA staff members, rejecting their 

complaints and copying their supervisors. Former OIEA Branch Chief Testimony Tr. at 

pgs. 20-23; OIEA Branch Chief Testimony Tr. at pgs. 42-44. The former OIEA Branch 

Chief described Gettinger “as the highest hurdle we ever had in the time I was with 

OIEA” and stated that the November 28, 2006 complaint would be the type of allegation 

that Gettinger would disfavor. Former OIEA Branch Chief Testimony Tr. at pgs. 20, 32. 

When asked how specific he required a complaint to be in order for it to be 

investigated, Gettinger indicated, in the following testimony, that generalized, 

anonymous complaints were unlikely to meet his criteria: “If the complaint cannot tell us 

that there’s more than one victim, if the complaint can’t tell us who, what, when, where, 

280 After the OIG issued the ROI to the Chairman of the SEC, at the SEC’s request, the OIG prepared a 

modified public version of the ROI which redacted the identities of certain individuals because of privacy 

concerns as well as additional language at the request of the U.S. Department of Justice. 

432 
 

 

 

particularly if it’s anonymous, it’s probably not enough for us [to] go on.” Gettinger 

Testimony Tr. at pgs.15-16. 

Gettinger was of the opinion that the SEC was not the appropriate agency to 

pursue Ponzi schemes that did not involve entities registered with the SEC because they 

were resource intensive and “were essentially criminal matters” that “should be chased by 

the FBI, local prosecutors.” Id. at pgs. 25-26, 33-34. Gettinger stated that within the 

Enforcement Division he “was in a minority of thinking that we would be hurting our 

overall effort if we spent too much resources on localized Ponzi schemes that weren’t 

connected to what’s now called off market Ponzi schemes.” Id. at p. 26. 

As part of the standard OIEA process, when an employee is assigned a complaint 

to handle, he is supposed to search the NRSI database to find out if an investigation is 

being conducted of the person or entity that is the subject of the complaint. Former 

OIEA Branch Chief Testimony Tr. at p. 37. If there is an investigation, then the 

complaint is supposed to be referred regardless of whether the complaint would normally 

meet the criteria for referral. Id. At the time the November 28, 2006 complaint was 

received, the Enforcement Division of NERO had an open investigation of Madoff, 

which meant that the complaint should have been referred despite its general nature. Id. 

It does not appear from NRSI records that the OIEA Senior Counsel checked the NRSI 

system.281 NRSI Search List on Madoff, Bernard, at Exhibit 497; Former OIEA Branch 

Chief Testimony Tr. at p. 38. 

The OIEA Senior Counsel did not recall whether he checked the NRSI system, 

but recalled that he checked to see if BMIS was registered as a hedge fund, and it was 

not. OIEA Senior Counsel Interview Memorandum. The OIEA Senior Counsel stated 

that he believes he did not refer the complaint because there were no specific allegations, 

it was anonymous, and BMIS was not a registered investment adviser. Id. He stated that 

in his experience, the Enforcement Division would not do anything with anonymous, 

general allegations. Id. 

5. Anonymous Complaint About Madoff’s Investment Advisory 

Business Referred to Enforcement, Which Relied on Madoff’s 

Representation that the Complaint Was False 

The fifth and sixth complaints were from an anonymous “concerned citizen” who 

sent two letters to Chairman Christopher Cox – one received by Chairman’s 

Correspondence Unit on December 11, 2006 and one on March 20, 2008. Letter dated 

December 6, 2006 and stamped December 11, 2006 from a Concerned Citizen to the 

Honorable Christopher Cox, at Exhibit 498; Letter dated December 6, 2006 and stamped 

March 31, 2008 from a Concerned Citizen to the Honorable Christopher Cox from a 

281 The NRSI records do not appear to record every search. The name of another OIEA employee who 

referred a complaint about Madoff after checking the NRSI system was not contained in the NRSI record of 

employees who checked the NRSI system that was produced to the OIG by OIEA. Former OIEA Branch 

Chief Exh. 3; Former OIEA Branch Chief Testimony Tr. at pgs. 41-43; OIEA Branch Chief Testimony Tr. 

at pgs. 44-45. 

433 
 

 

Concerned Citizen, at Exhibit 499. The letters were identical except for an additional 

paragraph added to the bottom of the second letter. Both letters stated the following: 

Your attention is directed to a scandal of major proportion 

which was executed by the investment firm Bernard L. 

Madoff ... Assets well in excess of $10 Billion owned by 

the late Norman F. Levy, an ultra-wealthy long time client 

of the Madoff firm have been “co-mingled” with funds 

controlled by the Madoff company with gains thereon 

retained by Madoff. 

The action may have been taken with the knowledge and 

consent of the late Norman F. Levy in an effort to “take it 

with him” by avoiding the Federal and State estate taxes on 

these billions of dollars. 

This is an extreme example of uncontrolable [sic] greed 

which should be investigated by the proper authorities. 

Letter dated December 6, 2006 and stamped December 11, 2006 from a Concerned 

Citizen to the Honorable Christopher Cox. The letter received in 2008 added the 

following paragraph to the letter above: 

Dear Sir: 

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

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

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

Letter dated December 6, 2006 and stamped March 31, 2008 from a Concerned Citizen to 

the Honorable Christopher Cox from a Concerned Citizen. 

Both letters were referred by the Chairman’s Correspondence Unit to OIEA.282 

Table 1, “Investor Complaints Received by OIEA through 12/15/2008,” at pgs. 3-4. 

David Powers of OIEA handled the complaint. Powers searched NRSI and found that 

NERO had an “active” investigation of BMIS. NRSI Printout for Enforcement 

Investigation NY-07563-A dated December 14, 2006, at Exhibit 500. On December 14, 

2006, Powers referred the complaint to Simona Suh, the staff attorney responsible for the 

investigation. OIEA Referral dated December 14, 2006 from David Powers to Suh dated 

December 14, 2006, at Exhibit 501. 

282 Chairman Cox testified that he has never seen any version of the Levy letter and that his 

Correspondence Unit handled the initial review of his correspondence. Cox Testimony Tr. at pgs. 12-13. 

Peter Uhlmann, Chief of Staff to Chairman Cox from 2006 to 2009, corroborated Cox’s testimony, stating 

that Chairman Cox did not personally review most of the correspondence addressed to him. Uhlmann 

Testimony Tr. at pgs. 18-19. 

434 
 

 

NERO investigated the complaint by calling Brandon Becker, Madoff’s counsel, 

on January 8, 2007 and having Becker ask Madoff if he managed money for Norman F. 

Levy. Suh Telephone Log of Miscellaneous calls, at Exhibit 349. When Becker relayed 

that Madoff said he did not manage money for Levy, the complaint was not pursued 

further.283 E-mail dated January 9, 2007 from Cheung to Suh, at Exhibit 382. 

On April 7, 2008, OIEA referred the second letter regarding Levy to Suh. 

Because the Enforcement Investigation had been closed, John McCreery of OIEA sent 

the letter to Suh as an “FYI referral.” OIEA File H01270413, at pg. 1, at Exhibit 502. In 

an e-mail dated September 16, 2008, Suh explained to McCreery that Enforcement would 

not pursue the allegations in the tip: 

I received from you a referral concerning Madoff, the 

central character in the now closed investigation NY-7563. 

The referred letter appears to be a copy of a letter sent to us 

and reviewed by us in 2006. As in 2006, because the letter 

is anonymous and lacks detail, we will not be pursuing the 

allegations in it. 

E-mail dated September 16, 2008 from Suh to McCreery (emphasis added), at Exhibit 

393. 

C. Conclusion 

In all but one instance, tips or complaints that were received by OIEA appear to 

have been referred appropriately for investigation. In the one instance in which a 

generalized complaint should have been referred to NERO according to OIEA 

procedures, it does not appear that NERO would have followed up on the complaint 

because of the non-specific and anonymous nature of the complaint. 

However, procedures should be considered for documenting the investigations of 

complaints following referral from OIEA. When an investor complaint was referred to 

NERO examiners, they did not appear to have documented their investigation of the 

complaint. Moreover, Enforcement guidelines for investigating complaints should be 

strengthened. When two specific complaints were referred to NERO Enforcement, they 

were not adequately investigated. As discussed at greater length in Section V of this 

Report of Investigation, accepting the word of a registrant who is alleged to be engaged 

in a specific instance of fraud is an inadequate investigation. 

283 A detailed discussion of the Enforcement’s handling of the Levy complaints can be found in Section V 

of the Report of Investigation. 

435 
 

 

 

 

 

 

 

XI. ADDITIONAL EXAMINATIONS AND INSPECTIONS OF BERNARD 

MADOFF’S FIRMS CONDUCTED BY THE SEC 

A. 1993-1994 Special Purpose Inspection of Bernard Madoff Securities284 

1.	 Summary of Inspection 

In July 1993, the Division of Market Regulation285 conducted a special purpose 

inspection of Bernard Madoff Investment Securities (BMIS) and the Instinet Corporation 

(Instinet). Special Purpose Inspections Memorandum dated July 19, 1994 at Exhibit 505. 

The purpose of the inspection was to address areas of market performance that may not 

have been covered in the National Association of Securities Dealers, Inc.’s (NASD’s) 

examination process of third market makers, because these entities were regulated 

primarily as broker-dealers. Id. at p. 1. During the inspection, SEC staff requested 

BMIS’ trading data for 22 securities for trade dates from June 21, 1993 to July 2, 1993. 

Special Purpose Inspection of BMIS Report (undated), at p. 1, at Exhibit 506. The SEC 

Division of Market Regulation staff also spent one week onsite at BMIS to review and 

better understand the firm’s automated systems, procedures and trading practices. Id. 

On July 19, 1994, Division of Market Regulation Associate Director Mark 

Fitterman and Senior Adviser Mary Ann Gadziala issued a memorandum to the 

Division’s Director, Brandon Becker, and Deputy Director, Bob Colby, that summarized 

the special purpose inspection. Special Purpose Inspections Memorandum dated July 19, 

1994 at Exhibit 505. According to the memorandum, the SEC reviewed several areas of 

BMIS and Instinet’s businesses, including their payment for order flow, order execution 

procedures, market order price improvement procedures, market maker performance, 

surveillance of automated execution systems, Intermarket Trading System (ITS)286 

trading procedures, and audit trail of broker-dealer trading systems. Id. at p. 1. 

284 The OIG identified two other OCIE examinations of BMIS conducted in 1990 and 1993, respectively. 

In interviews with the SEC examination staff, the OIG learned that they were likely routine broker-dealer 

examinations, which would have involved checking BMIS’ sales practices and books and records. New 

York Examiner Interview Memo. Moreover, one examiner believed that these examinations were part of 

the normal three-year examination cycle for broker-dealers. Id. No one could recall any particular findings 

of either examination. Id.; Liebl Interview Memorandum; Vasilakis Interview Memorandum. The OIG 

found that the workpapers for the 1990 examination were destroyed in accordance with the 13-year records 

retention schedule maintained by the SEC Records Management Office, and the workpapers for the 1993 

examination were destroyed during the September 11, 2001 terrorist attack. Memorandum dated June 4, 

2009 from John Walsh to H. David Kotz, Inspector General, at pgs. 2-3 at Exhibit 503. There is no 

evidence that these examinations should or could have uncovered Madoff’s fraudulent activity since they 

related solely to Madoff’s broker-dealer operations. 

285 In 1995, the Division of Market Regulation and the Division of Investment Management’s examination 

functions were transferred to a newly created Office of Compliance Inspections and Examinations. 1995 

SEC Annual Report at p. v, at Exhibit 504 . 

286 ITS links all exchange specialists and third market makers for the purpose of assuring a fair and orderly 

national market system. Special Purpose Inspection of BMIS Report (undated), at Exhibit 506 at p. 2. As a 

member of the Cincinnati Stock Exchange (CSE), BMIS was able to participate in ITS via the CSE’s 

linkage to ITS. Id. As an NASD registered market maker, BMIS was also able to utilize the NASD’s 

Computer Assisted Execution System (CAES) as a linkage to ITS. Id. Trades executed through CAES, the 

436 
 

The memorandum’s overall findings indicated that SEC staff found BMIS’ 

automated execution systems were functioning as represented. Id. at p. 2; Special 

Purpose Inspection of BMIS Report (undated), at p. 19, at Exhibit 506. The staff, 

however, did identify certain deficiencies that may have existed in BMIS’ market order 

price improvement sub-systems. Id. In addition, while the inspection found that the 

NASD’s oversight examinations were adequate for surveillance of a typical market 

maker on the NASDAQ, it also concluded that BMIS operated more as an integrated 

market center and that NASD oversight examinations should be revised to include certain 

market structure issues not included in the routine broker-dealer examination conducted 

by NASD. Id. The memorandum suggested that NASD oversight examinations be 

revised to include automated trading or execution systems, ITS trading and quotation 

activities and payment for order flow. Id. 

The Special Purpose Inspection of BMIS Report further noted: 

[BMIS] manages the risk of its business in a firm-wide and 

security specific basis. The firm-wide risk management is 

the direct responsibility of Bernard Madoff. 

* * * 

None of the firm’s periodic risk management evaluations 

are documented. 

Id. at p. 16. 

As a result of the inspection, the SEC proposed Rule 17a-23, which sought to 

establish a uniform comprehensive recordkeeping and reporting structure for brokerdealers sponsors of “broker-dealer trading systems.”287 Special Purpose Inspections 

Memorandum dated July 19, 1994 at pgs. 2-3, at Exhibit 505. In addition, the SEC 

recommended that the NASD develop a comprehensive program for examining third 

market activity and submit it to the Commission. Id. at p. 3. 

2. Conclusion 

The 1993-1994 Special Inspection of BMIS was limited in scope and unrelated to 

the investment advisory business of Bernard Madoff’s firm. Thus, there is no evidence 

that this examination should or could have uncovered Madoff’s fraudulent activity since 

account data and trading records of discretionary brokerage accounts and investment 

advisory accounts were not the subject of the review. 

However, the FTI Engagement Team noted that the inspection did find that none 

of the firm’s periodic risk management evaluations were documented, and although the 

CSE, or BMIS’ system are reported automatically to the Securities Industry Automatic Corporation (SIAC) 

or NASDAQ and the respective parties’ clearing corporations. Id.
 287 Release No. 34-33605 (February 18, 1994), 59 FR 8368, at Exhibit 507. 

437 
 

 

 

 

failure to maintain risk management evaluation documentation does not necessarily 

indicate evidence of wrongdoing or fraud, it typically would be considered a deficiency 

that required remediation or improvement. 

B. 1994-1995 Oversight Examination of NASD Examination of Bernard 

Madoff Securities 

1.	 Summary of Examination 

In 1994-1995, the SEC’s Northeast Regional Office (NERO)288 conducted an 

oversight examination of the NASD’s most recent examination on BMIS, which had been 

conducted in February 1993. The oversight examination was conducted for the purpose 

of reviewing BMIS’ financial condition, books and records and sales practice activities. 

BMIS Examination Report dated January 26, 1995, at p. 1, at Exhibit 509. In addition, 

the SEC’s oversight examination served as a “training vehicle” for a NERO broker-dealer 

examiner. Id. NERO assigned two examiners to the BMIS oversight examination. 

OCIE Appendix A: List of Examinations and Staff, at p. 2, at Exhibit 510. 

On January 26, 1995, NERO Broker-Dealer Examination staff issued an oversight 

examination report that included background information of BMIS, prior oversight 

findings and comments, current period findings, and a discussion regarding the sales 

practice review that was conducted during the oversight examination. Id. The oversight 

examination report concluded that BMIS was in substantial compliance and did not 

disclose any relevant findings. Id. at p. 4. As a result, the staff concluded that no further 

action would be taken. Id. 

The January 26, 1995 BMIS Examination Report included the following 

information regarding BMIS’ required annual audit: 

A review of [BMIS’] certified annual audit report, dated 

October 31, 1993, indicated that the report has been filed in 

a complete and timely manner, in accordance with Rule 

17a-5(d), and that it disclosed no material deficiencies in 

the registrant’s system of internal control. 

Id. at p. 4. 

The report also specifically noted the following: 

[BMIS] has eliminated the need to produce physical order 

tickets, through its modernized computer system. The 

system enables the firm to readily retrieve trade data. The 

Trade Reconciliation Report includes information, such as 

cusip, symbol, broker-dealer, type trade, sell order, but 

288 NYRO was referred to as the Northeast Regional Office (“NERO”) until March 30, 2007. SEC Press 

Release 2007-59 (http://www.sec.gov/news/press/2007/2007-59.htm), at Exhibit 508. 

438 
 

 

order, price, limit price, agency fee, principal fee, 

commission, and time. The staff requested to see a Trade 

Reconciliation Report for a specific date, and the report 

was generated immediately by the firm employees. 

Id. at p. 3. 

2. Conclusion 

The 1994-1995 oversight examination of BMIS was limited in scope and focused 

solely on the market making activities at BMIS. The oversight examination was 

unrelated to the investment advisory business of Bernard Madoff’s firm and thus, there is 

no evidence that this examination should or could have uncovered Madoff’s fraudulent 

activity. 

However, the FTI Engagement Team noted that there was no indication that any 

due diligence was performed by the examiners with regard to a review of BMIS’ 

auditor’s work performed during its audit. Such due diligence could have included a 

review of BMIS’ auditor’s engagement letter, reports and work papers and may have 

uncovered information that would have verified whether the auditor was truly 

independent and was providing the services that it purportedly performed. 

The FTI Engagement Team further noted that the oversight examination’s finding 

about BMIS’ ability to electronically disseminate account records contrasted sharply with 

the paper-based records associated with the investment advisory business at BMIS. 

While this was not a significant finding for examiners during this 1994-1995 oversight 

examination, it should have raised some questions during the later cause examinations at 

BMIS. 

C. 1997-1998 Inspection of Third Market Firms 

1. Summary of Inspection 

In 1997-1998, OCIE conducted an inspection of eight third market firms “to 

evaluate the execution quality of retail orders in the third market” as a result of the 

Commission’s recently issued “order handling rules emphasizing the duty of best 

execution.”289 Information Memorandum dated February 9, 1998, at Exhibit 512. The 

SEC primarily reviewed the third market firms BMIS, Hull Liquidity Fund L.P., 

Tradetech Securities L.P., Phoenix Third Market Corp., The Third Market Corp., 

Westfalia Investments, Inc. and Peters Securities Co.290 Id. at p. 1. The review focused 

289 Securities Exchange Act Release No. 37619 (August 29, 1996), 61 FR 48290 (September 12, 1996) 

(“Order Handling Rules Release”), at Exhibit 511. 

290 “Third market firms are NASD member firms that execute exchange-listed securities orders for brokerdealers’ retail order flow (“order-routing firms”).” Information Memorandum dated February 9, 1998, at p. 

1, at Exhibit 512. The Staff reviewed limited information from Trimark Securities, Inc., but did not 

examine the firm because the Division of Enforcement had a pending matter under investigation related to 

certain third market activities conducted by the firm. Id. at p. 1. 

439 
 

 

 

 

 

on these firms’ execution quality, including price improvement, executions inferior to the 

national best bid or offer (NBBO), trading ahead of customer market orders and trade 

reporting practices. Id. On February 9, 1998, OCIE issued to the Commission an 

inspection memorandum that summarized the inspection of the eight third market firms 

and provided findings on the execution quality of retail-sized orders in the third market. 

Id. 

The inspection found that BMIS was deficient in its obligations under the order 

handling rules. Id. On February 6, 1998, the SEC issued a deficiency letter to BMIS 

concluding that BMIS executed “six orders (less than 0.5% of the orders reviewed) at 

prices inferior to the national best bid or offer [NBBO] at order entry time” and BMIS 

executed “110 market orders (2.0% of the orders reviewed) at prices inferior to NBBO at 

order execution time.” Letter dated February 6, 1998 from Richards to BMIS, at p. 1, at 

Exhibit 513. The deficiency letter further stated, “This usually occurred at your firm 

because an order was manually executed. Id. In addition, the SEC concluded that 

because manually executed orders at BMIS were priced at the NBBO at order entry and 

not execution time, BMIS should “explicitly inform [its] broker-dealer customers that 

orders are executed at prices that reference the NBBO at receipt time, notwithstanding the 

fact that the NBBO may be superior at order execution time.” Id. 

2. Conclusion 

The 1997-1998 Inspection of Third Markets was limited in scope and unrelated to 

the investment advisory business of Bernard Madoff’s firm. Thus, there is no evidence 

that this examination should or could have uncovered Madoff’s fraudulent activity since 

account data and trading records for discretionary brokerage accounts and investment 

advisory accounts were not the subject of the review. 

D. 1999 Special Purpose Examination Limit Order Display Rule 

1. Summary of Examination 

In 1999, after conducting examinations of several Self-Regulatory Organizations 

(SRO’s) compliance with the Display Rule, OCIE determined it was necessary to 

examine a third market making firm291 to evaluate third market makers’ compliance with 

the Display Rule, “as well as to complete an industry-wide evaluation of the Display Rule 

compliance and oversight.” Planning Memorandum dated October 20, 1999 from Barry 

to Gadziala, McCarthy and Moore, at p. 1, at Exhibit 514. According to the Planning 

Memorandum, OCIE selected BMIS because it was “one of the largest and most wellknown third market makers.” Id. 

In October 1999, OCIE-DC initiated a “narrowly focused inspection of BMIS 

compliance with SEC Rule 11Ac1-4 (Display Rule).” Inspection Scope Memorandum 

dated October 20, 1999 from McCarthy, Moore and Barry to Gadziala, at p. 1, at Exhibit 

291 Third market makers make markets and trade listed securities over-the-counter. Planning Memorandum 

dated October 20, 1999 from Barry to Gadziala, McCarthy and Moore, at p. 1, at Exhibit 514. 

440 
515. The inspection was to examine the systems, policies and procedures that BMIS has 

implemented in order to comply with the Display Rule. Id. The Display Rule generally 

requires Over-the-Counter (OTC) market makers and exchange specialists to display the 

price and full size of customer limit orders when these orders are priced better than the 

OTC market maker’s or specialist’s quote. BMIS Examination Report dated August 3, 

2000, at p. 1, attached at Exhibit 516. 

During the examination, OCIE reviewed 643 Madoff customer limit orders for 

trade dates October 11, 12 and 25, 1999. Id. at p. 2; Letter dated January 4, 2000 from 

Barry to BMIS, at Exhibit 517. The staff found that 169 customer orders appeared to 

have not been displayed in accordance with the Display Rule and requested BMIS 

provide a written explanation why the trades were not in compliance. Id. 

On August 3, 2000, OCIE issued an examination report of BMIS’ compliance 

with the Display Rule. BMIS Examination Report dated August 3, 2000, at Exhibit 516. 

The report concluded that BMIS did not fully comply with the Display Rule. Id. at p. 2. 

Specifically, the staff found that BMIS “designed its internal control order routing, 

display, and execution system with certain parameters that result[ed] in non-compliance 

with the Display Rule.” Id. In addition, the staff found BMIS “had notice that some 

parameters would prevent certain customer limit orders from being displayed in 

compliance with the rule,” but “nevertheless failed to take further action to improve the 

compliance of its system.” Id. Based on the examination findings, the staff 

recommended referring the violations to the Division of Enforcement for further action. 

Id. 

As a result, OCIE Director Lori Richards and Associate Director John McCarthy 

sent an enforcement referral to the Division of Enforcement’s Director Richard Walker 

and Deputy Director Stephen Cutler outlining BMIS’ violations of the Display Rule. The 

staff stated they believed BMIS warranted enforcement action for the following reasons: 

•		 The Staff’s review of a sample of eligible customer limit 

orders revealed that approximately 18% [119 of the 643] 

of the orders were not displayed in compliance with the 

Display Rule. 

•		 [BMIS] designed its internal order handling system with 

certain parameters that result in noncompliance with the 

Display Rule. 

•		 In June 1999, [BMIS] represented to NASD Regulation, 

Inc., in response to violations of the Display Rule, that it 

made the appropriate curative systems modifications. 

However, the staff found similar violations in October 

1999, indicating that the systems modifications were not 

effective. 

OCIE Enforcement Referral Memorandum dated August 3, 2000, at p. 1, at Exhibit 518. 

In addition, Richards included two other firms, Schwab Capital Markets (Schwab) and 

441 
 

 

J.B. Oxford & Company (J.B. Oxford), in the enforcement referral for similar violations 

of the Display Rule. Id. at p. 2. 

On December 20, 2000, Lori Richards sent a deficiency letter to BMIS stating the 

staff found 119 (approximately 18%) of the 643 orders reviewed were improperly 

displayed for 30 seconds or longer when required by the Display Rule. Letter dated 

December 20, 2000 letter from Richards to BMIS, at p. 1, at Exhibit 519. The letter 

requested BMIS to respond in writing as to the specific procedures that BMIS had or 

would put into effect to prevent further violations of the law. Id. Richards also sent 

deficiency letters to Schwab Capital Markets and J.B. Oxford & Company and asked 

them to respond in writing to the questions presented in the letters. Memorandum dated 

March 8, 2001 from McCarthy to Richardson, at Exhibit 520. 

In January 2001, BMIS responded to the deficiency letter, stating it had corrected 

a number of issues that caused non-compliance and that it continued to improve its 

systems and procedures to detect and prevent problems in the future. Letter dated 

January 19, 2001 from BMIS to Richards, at Exhibit 521. Two months later, John 

McCarthy forwarded BMIS, Schwab, and J.B. Oxford’s responses to the deficiency 

letters to the Division of Enforcement. Memorandum dated March 8, 2001 from 

McCarthy to Richardson, at Exhibit 520. 

On April 4, 2001, the Division of Enforcement opened a Matter Under Inquiry 

(MUI) regarding the three firms Display Rule violations.292 NRSI Enforcement MUI 

MLA-02469, at Exhibit 522. However, the Enforcement staff decided not to pursue the 

referral on BMIS and Schwab because BMIS and Schwab “provided detailed responses 

about their problems and the steps they were taking to correct them.” E-mail dated 

August 7, 2001 from Former Enforcement Staff Attorney #2 to Bowers and Hyatt, at 

Exhibit 523. 

The Enforcement staff did, however, conduct a second examination of J.B. 

Oxford because its Display Rule violations “appeared the most egregious.” Id. The 

Enforcement staff’s second examination of J.B. Oxford found “that J.B. Oxford is 

currently complying with the Display Rule and has adequately revised its Display Rule 

policies.” Memorandum dated July 19, 2001 from frmer Enforcement Staff Attorney #2 

to Cutler, at p. 2, at Exhibit 524. In July 2001, the frmer Enforcement Staff Attorney #2 

sent a memorandum to Steve Cutler stating: “Given that [J.B. Oxford’s] systems 

problems that caused the January 2000 violations of the Display Rule appeared to be 

resolved, the staff did not believe the violations would be appropriate for enforcement 

action.” Id. The frmer Enforcement Staff Attorney #2 concurred in her interview with 

292 MUIs are preliminary in nature and typically involve incomplete information. The threshold 

determination for opening a MUI is low because the purpose of a MUI is to gather additional facts to help 

evaluate whether an investigation would be an appropriate use of resources. 2008 SEC Enforcement 

Manual, at p. 13, at Exhibit 296. 

442 
 

the OIG that she believed that the greater concern was with J.B. Oxford’s violations. 

Former Enforcement Staff Attorney #2 Interview Memo.293 

The next month, Associate Regional Director Sandra Harris sent Steve Cutler an 

e-mail stating, “the focus of the investigation has been J.B. Oxford ... Because we are not 

recommending action against Oxford, it does not seem appropriate to do so against 

Schwab and Madoff, both of whom were taking steps to correct systems problems 

discovered during the exam.” E-mail dated August 7, 2001 from Harris to Cutler, at 

Exhibit 525. In November 2001, the staff closed the MUI as being inappropriate for 

enforcement action because “the systems problems that resulted in [the three firms] 

Display Rule violations appear resolved.” November 15, 2001 CATS 2000 Data Entry 

Form Matter Under Inquiry, at Exhibit 526. 

2. Conclusion 

The 1999 Special Purpose Examination of BMIS was limited to the market 

making function of its broker-dealer business and unrelated to the investment advisory 

business of Madoff’s firm. Thus, there is no evidence that this examination should or 

could have uncovered Madoff’s fraudulent activity, since account data and trading 

records for discretionary brokerage accounts and investment advisory accounts were not 

the subject of the review. While the results of the examination demonstrated violations 

on the part of BMIS, and the violations were referred to the Enforcement Division, the 

Enforcement staff determined that the BMIS violations were inappropriate for 

Enforcement action because the systems problems that resulted in BMIS’ October 1999 

Display Rule violations appeared to be resolved. 

E. 2003 OCIE QQQ Examination 

1. Introduction 

In March 2003, the Office of Compliance Inspections and Examinations (OCIE) 

initiated examinations of certain SROs and market-makers, including BMIS, regarding 

“policies and procedures with respect to order handling and execution in the Nasdaq 100 

Index Exchange Traded Fund, or “QQQ”, during periods of abnormal market conditions, 

i.e., when the market is locked or crossed.”294 Planning Memorandum dated March 3, 

2003 from McCarthy, Swanson, and Daugherty to Richards, at p. 1, at Exhibit 527. The 

staff was concerned that “when the market is locked or crossed, Market Makers and 

Exchange Specialists may be handling customer orders in violation of their fiduciary best 

execution obligations.” Id. The QQQ is an exchange traded fund, which allows investors 

293 The OIG also interviewed former Deputy Assistant Regional Director Clifford Hyatt, although he could 

not recall specifics about the investigation. Hyatt Interview Memo. 

294 Organizations selected for review by OCIE-DC included the Chicago Stock Exchange (“CHX”), the 

American Stock Exchange (“AMEX”), the Boston Stock Exchange (“BSE”), Knight Securities, L.P. 

(“Knight”) and BMIS. Planning Memorandum dated March 3, 2003, at Exhibit 527. 

443 
 

 

 

 

to essentially invest in all of the stocks that make up the Nasdaq 100 in a single 

security.295 

2. March 3, 2003 Planning Memorandum 

On March 3, 2003, OCIE Associate Director John McCarthy, Assistant Director 

Eric Swanson and Branch Chief Matt Daugherty drafted a Planning Memorandum to 

OCIE Director Lori Richards for the “Inspection of Self Regulatory Organizations and 

Market Makers with Respect to Trading in the Nasdaq 100 Exchange Traded Index Fund 

in the Nasdaq Intermarket During Periods of Abnormal Market Conditions.” Planning 

Memorandum dated March 3, 2003, at Exhibit 527. 

The March 3, 2005 Planning Memorandum was divided into four sections: 

Introduction, Inspection Scope, Background and Inspection Issues. Id. 

The Introduction stated as follows: 

Staff from the Office of Compliance Inspections and 

Examinations (“Staff”) will conduct inspections of certain 

Self Regulatory Organizations (“SROs”) and Market 

Makers. ... The purpose of these inspections is to examine 

the aforementioned [entities] regarding policies and 

procedures with respect to order handling and execution in 

the Nasdaq 100 Index Exchange Traded Fund, or “QQQ”, 

during periods of abnormal market conditions, i.e, when the 

market is locked or crossed. The staff is concerned that 

when the market is locked or crossed, Market Makers and 

Exchange Specialists may be handling customer orders in 

violation of their fiduciary best execution obligations. The 

staff selected the QQQ security for their review because it 

is the most actively traded security and is frequently locked 

or crossed. 

Id. at p. 1.296 

295 Barron’s Finance & Investment Handbook at p. 720 (6th ed. 2003); http://financial-dictionary.thefree 

dictionary.com/QQQ, at Exhibit 528. 

296 OCIE also generally reviewed whether each organization executed orders in compliance with their own 

order handling procedures and whether organizations traded ahead of customer orders. Planning 

Memorandum dated March 3, 2003, at Exhibit 527. Trading ahead of a customer order generally occurs 

when an exchange specialist or market maker fills a customer order at an inferior price through the firm's 

proprietary account while a matchable customer order was present on the opposite side of the market. As a 

result, the executed customer order receives an inferior price compared to the price it would have received 

if it was matched with the order on the opposite side of the market. SEC Press Release 2009-42, at p. 2, at 

Exhibit 529 ; Planning Memorandum dated March 3, 2003, at Exhibit 527. 

444 
 

The Inspection Scope stated that the inspection would “examine the following 

aspects of Exchange and Market Maker operations:” 

•		 Order executions in the QQQ during periods of locked 

or crossed markets. 

•		 Exchange and Market Maker procedures for order 

handling and execution when the market is locked or 

crossed. 

•		 The status, use, and procedures for Exchange and 

Market Maker automatic execution systems, 

specifically at time when the market is locked or 

crossed. 

•		 Exchange and Market Maker internal controls and 

compliance procedures relation to best execution 

obligations. 

•		 Exchange and Market Maker internal controls and 

compliance procedures relating to the display of limit 

orders that would lock or cross the market. 

Id. 

The Background section was divided into two sections: Best Execution and 

Locked/Crossed Markets. Id. at p. 2. The section provided descriptions of a brokerdealer’s duty of Best Execution and Locked and Crossed Markets, as follows: 

The duty of best execution requires that a broker-dealer 

seek to obtain for its customer orders the most favorable 

terms reasonably available under the circumstances. In 

addition to price, other terms are also relevant to best 

execution, and must be taken into consideration by the 

broker dealer. These include order size, the trading 

characteristics of the security, execution speed, clearing 

costs, and the cost and difficulty of factors including: 

abnormal market conditions; common industry practices 

such as internalization of order flow; and the automatic 

execution of customer orders – coupled with potentially 

inadequate order handling systems and guidelines for 

Market Makers and Exchanges – is causing best execution 

violations. [Footnotes omitted] 

A locked market occurs when a market participant’s bid 

equals the lowest offer of another market participant. A 

crossed market occurs when a market participant’s bid 

exceeds the lowest offer of another market participant. 

Market Makers and Exchanges consider instances when the 

market is locked or crossed as “non-normal” or “abnormal” 

445 
market conditions. During these times, Market Makers and 

Exchanges often deviate from their routine order handling 

procedures. As explained below, Market Makers and 

Exchanges will “turnoff” their automatic execution systems 

during these periods. [Footnotes omitted]. 

Id. at p. 2. 

The Inspection Issues section, stated, in pertinent part, as follows: 

The Staff is concerned that Market Makers and Exchange 

Specialists may not be honoring their quoted market during 

a locked or crossed market, and may not be fulfilling 

fiduciary obligations to obtain best execution for customer 

orders. Further retail customers and order entry firms may 

not be aware that a majority of the trades in the most 

frequently traded security will not be aware that a majority 

of the of the trades in the most frequently traded security 

will not be automatically executed at the current NBBO as 

per their agreements, but instead manually handled and 

possibly executed outside the current NBBO on a delayed 

basis by the Market Maker or Specialist. 

Id. at pgs. 2-3. 

3. Staff Involvement in and Recollections of Madoff QQQ 

Examination 

According to testimony, Swanson, Daugherty, and the OCIE Staff Attorney were 

involved in the review of BMIS’ trading in the QQQ examination. Swanson Testimony 

Tr. at pgs. 22, 29; Daugherty Testimony Tr. at p. 35; OCIE Staff Attorney Testimony Tr. 

at p. 10. Daugherty testified that three other OCIE attorneys, Chris Chase, Shauna 

Sappington, and Tom Stickley, may have also reviewed some trading data related to the 

overall QQQ examination, although their involvement appeared to have been minor. 

Daugherty Testimony Tr. at pgs. 31, 37-38. 

OCIE Associate Director John McCarthy did not recall much about the 2003 

Madoff QQQ examination. McCarthy stated he had a “vague recollection” of the 

examination, but did not recall that he had a role. McCarthy Testimony Tr. at pgs. 31, 

34. When asked if he recalled that OCIE decided to investigate trading in the security 

based on the fact that the market for QQQ was often locked or crossed and that marketmakers and specialists were violating their duty at best execution on customer trades, 

McCarthy stated, “Yes, that’s a fair sentence.” Id. at pgs. 33-34. McCarthy also said he 

“was apprised that, that, if I recall, that -- I often encouraged my staff to come up with 

ideas, I think [the OCIE Staff Attorney] came up with this, I’m not sure. And so my role 

would have simply said, “Sure, go ahead and do that.” Id. at p. 34. 

446 
McCarthy stated that he would “[r]ely on Eric [Swanson] and Mark [Donohue] to 

basically manage the day-to-day part of the exams.” Id. When asked if he would follow 

up to make sure that they were being worked on, he stated, “I mean, where I felt – I 

would ask questions and see how things were going, sure.” Id. at p. 35. He did not recall 

that he was on any phone calls with anyone from Madoff’s firm during this examination. 

Id. at pgs. 35-36. 

Swanson recalled working on the QQQ examination, but stated in his role, “I 

likely wouldn’t have been involved in the day to day review of any files related to this, 

just getting updates on the status from -- probably from Matt or maybe directly from [the 

Staff Attorney], if he was the staff attorney that was working it.” Swanson Testimony Tr. 

at p. 23. Although he did not specifically recall being involved in the drafting of the 

Madoff QQQ planning memorandum, he stated, “I’m sure I would have been.” Planning 

Memorandum dated March 3, 2003, at Exhibit 527; Tr. Swanson Testimony at p. 20. He 

also did not recall being involved in the drafting of the April 8, 2003 document request to 

Peter Madoff, even though he was the signatory, but stated that “it makes sense that I 

would have been, and I believe this was part of the sweep of more than one firm, but I 

don’t know that for certain.” Id.; letter dated April 8, 2003 from Swanson to BMIS at 

Exhibit 422. While he did not recall why OCIE was conducting an examination of the 

QQQ, he stated, “I do know generally what we would have been concerned about here” 

and further explained as follows: 

A lot of the exchanges and the firms that conducted marketmaking would have auto execution guarantees that would 

trade at the NBB[O] or perhaps at a price slightly improved 

over the NBB[O]. Those auto-ex systems would tend to 

shut down if a market was locked or crossed. So if the bid 

crossed the ask, they wouldn’t auto-ex because they 

wouldn’t know exactly what price to give it and so they 

would manually handle the order for execution. 

And I think what we were concerned about, and this goes 

back to a time period where we were generally concerned, 

and this is pre-Regulation NMS, we were generally 

concerned about the frequency of locked and crossed 

markets and -- and trades that would trade through a better 

price on an away market. 

The Qs was, if not the most actively-traded security, one of 

the most actively-traded security. So that’s probably why 

we focused on the Qs and I think what we were concerned 

about is, okay, there’s – it’s not obvious from the way the 

systems are programmed and what they would generally 

guarantee to their customers how they would trade during a 

locked and crossed market, so let’s find out in fact what 

they are doing because there are ways that someone who is 

447 
trading proprietarily against customer order flow could gain 

the scenario when a locked and crossed market occurred to 

do an arbitrage and profit which, you know, would not be 

considered in my view giving best execution to a client. 

So -- but I – I’m going – I’m not going off my specific 

recollection of what we were doing here, but that just 

makes sense to me, given the time frame and what we were 

asking for. 

Id. at pgs. 21-22. 

Swanson testified that he did not specifically recall having contact with anyone at 

Madoff Securities. Id. at p. 23. However, he acknowledged sending an April 15, 2003 

e-mail to Shana Madoff, a Madoff compliance attorney. E-mail dated April 15, 2003 

from Swanson to Shana, at Exhibit 423; Swanson Testimony Tr. at p. 23. Swanson 

further testified that “it seems likely, based on this e-mail, that there must have been 

something, a phone call or something, with the firm” prior to sending the document 

request. Swanson Testimony Tr. at pgs. 23-24; E-mail dated April 15, 2003 from 

Swanson to Shana Madoff at Exhibit 423. He did not recall being on any other calls with 

anyone at the Madoff firm regarding this examination. Swanson Testimony Tr. at pgs. 

24-25. 

Matt Daugherty was the lead attorney on the 2003 Madoff QQQ examination 

when it began, and worked directly for Eric Swanson and John McCarthy on the 

examination. Daugherty Testimony Tr. at pgs. 30-31. Daugherty said his role as lead 

attorney “was to sort of lead the inspection and the examinations, so just conduct the day 

to day activities of examining them, to go on site, to review the documents after the staff 

had had a chance to evaluate them, that type of thing.” Id. at p. 31. 

Daugherty characterized the 2003 Madoff QQQ examination as a cause 

examination, which he described as an examination where, “you have an idea of 

something that may be occurring, and you’re going in to look for that specific thing. So 

you got a tip from somebody or, you know, you read a newspaper article in the Wall 

Street Journal, or you would go look for something on a cause basis by focusing on that 

specific thing at the registrant.” Id. at pgs. 19, 26. Daugherty recalled OCIE conducted 

this cause examination of Madoff because: 

[A]t the time the market in -- for the Qs, as they call them, 

QQQ, was very fragmented and hectic, and that there were 

potential, I guess, thoughts or concerns. I'm not sure 

exactly what the genesis of them were, whether it was, sort 

of, known in the industry, or thought in the industry, or 

there was a tip in the Wall Street Journal, or whatever. I 

can't remember exactly, sort of, if there was a tipping point 

or a specific impetus for looking at this, other than the sort 

448 
of general concerns that I knew about, that there was 

potential for illicit trading, if you will, in the triple Qs, 

particularly during periods where the market in the 

securities quote unquote locked or crossed. 

So I believe what we determined to do was to initiate what 

I guess now would be referred to as a sweep inspection -- 

I'm not even sure if we used the term back then -- of some 

market makers and exchanges, to look at their trading in the 

Qs, and see if we could ascertain whether there may or may 

not be any, sort of, illicit trading, sort of, best execution 

trading or trading ahead, or any of those potentialities...” 

Daugherty Testimony Tr. at pgs. 26-27 

4. Conduct of the OCIE QQQ Examination 

As part of the QQQ examination, OCIE sent document requests to two market 

makers and three SROs to look at trading in the triple Qs. Id. at p. 28. Daugherty stated 

that the intent was “to obtain trading data, to review it in order to determine whether we 

could identify instances in which they failed to properly execute customer orders for -- in 

sum.” Id. at pgs. 28-29. The two market makers were Bernard Madoff Investment 

Securities and Knight Securities. Id. at p. 29. Daugherty stated, at the time, these two 

firms were the biggest market makers in exchange listed securities over the counter. Id. 

at pgs. 29-30. They looked at these two firms because they were the two most likely to 

have potentially committed these violations. Id. at p. 30. Daugherty added, “I don’t 

believe that there was any evidence that we had that they were committing violations. It 

was more we wanted to look at the big players, because we figured that's the best place to 

start with this type of thing.” Id. 

Daugherty drafted the planning memorandum, sent the document request, and had 

some conversations with the registrants, including Shana Madoff about obtaining 

documents. Id. at pgs. 33-34. Daugherty recalled that BMIS was “one of the firms, or 

maybe one of the only firms that sent the information in in paper, so I think we had talked 

to them about getting it electronically....” Id. at p. 34. When asked if this was odd, 

Daugherty stated as follows: 

So at the time it -- some people had the ability to put stuff 

in electronic format, and some didn’t. So I wouldn't say at 

that time it was unusual that it was only paper, and I’m not 

even sure we didn’t get it electronically. So it wasn’t like 

shocking that I got it that way. But obviously now it would 

be a little different, than again, only six years -- five or six 

years ago. 

Id. at p. 35. 

449 
Daugherty stated that he was never on-site for the Madoff examination and he did 

not know if any of the staff was ever on site. Id. at p. 36. 

5. Daugherty, the Lead Attorney on the Madoff QQQ Examination, 

Was Put on Another Project 

Daugherty stated he was lead attorney on the Madoff examination until a cause 

examination of the New York Stock Exchange was initiated in May or June 2003 at 

which point he was taken off the Madoff examination. Id. at p. 32. Daugherty explained: 

If you note the date on here, March 3, 2003, this was 

probably two months before the Wall Street Journal picked 

up the story about Dick Grasso and trading, and [inter]­

positioning and trading ahead on the New York Stock 

Exchange. 

When -- when you talk about prioritizing -- when that hit, I 

was one of the only people in the office that really had any, 

sort of, trade devaluation experience because of my time at 

the NASD, so I was actually taking -- taken off this project 

and put onto the New York Stock Exchange project as the 

lead of that inspection. 

Id. 

Daugherty noted that at that time, “there [were] a lot of projects that I was -- that 

were sort of taken off my plate, and eventually, in, like, May or June -- obviously there 

was some sort of transition period -- I was taken off this [Madoff] project to work almost 

exclusively on New York.” Id. 

Daugherty believed staff attorneys Chris Chase and Shauna Sappington initially 

replaced him on the Madoff examination when he was reassigned to the New York Stock 

Exchange. Id. at p. 35. However, he was “not sure that they, were even the staffers that 

continued on this project. I think they got staffed up on other things.” Id. He recalled 

Tom Stickley started working on the Chicago Stock Exchange examination, “if not on 

more than them, and had done some work, and identified some potential trades by the 

specialist, where I believe he might have been trading ahead.” Id. He also thought the 

OCIE Staff Attorney may have been involved in the exam. Id. at p. 36. Daugherty noted 

that he was not the only busy one at that time in the office, and that they “literally were 

swamped.” Id. at p. 35. Daugherty testified he did not know what happened to the 

Madoff QQQ exam. Id. at p. 37. 

The OCIE Staff Attorney testified he did not remember anyone else working on 

the 2003 QQQ Madoff exam after Daugherty left. OCIE Staff Attorney Testimony Tr. at 

p. 12. The OCIE Staff Attorney recalled that he had two phone calls with BMIS during 

the examination. Id. at pgs. 11-13, 17; E-mail dated August 27, 2003 from the OCIE 

450 
 

 

 

 

Staff Attorney to Daugherty and Eidt, at Exhibit 530. He stated the calls were with Shana 

Madoff, a Madoff “compliance person.” Id. at p. 11. He did not recall if anyone else was 

on the call with him and Shana Madoff. Id. at p. 12. He never went on-site at BMIS and 

did not think anyone from OCIE did either. Id. at pgs. 39-40.297 

6. September 12, 2003 Memorandum Finding Madoff Violated Duty 

of Best Execution 

After conducting an analysis of the Madoff QQQ trading data, the OCIE Staff 

Attorney drafted a September 12, 2003 memorandum to Senior Special Counsel Tom 

Eidt on Madoff trading activity in the QQQ. Memorandum dated September 12, 2003 

from the OCIE Staff Attorney to Eidt, at Exhibit 532. In the memorandum, the OCIE 

Staff Attorney stated, “I have investigated the trading activity of he Nasdaq market maker 

Bernard L. Madoff Investment Securities, LLC (MADF) in the Nasdaq 100 Exchange 

Traded Fund (QQQ) for the days of January 6, 2003 to January 10, 2003.... [and] I have 

come to the conclusion that MADF specifically has violated their duty of best execution 

for a number of trades although perhaps not with the frequency that was expected.” Id. at 

p. 1. The memorandum included a description of the firm’s order handling policies and a 

description of 29 specific trades that appeared to be problematic. Id. at pgs. 1-8. 

On October 20, 2003, the OCIE Staff Attorney e-mailed Swanson his September 

12, 2004 memorandum. E-mail dated October 20, 2003 from the OCIE Staff Attorney to 

Swanson, at Exhibit 533. On October 31, 2003, the OCIE Staff Attorney e-mailed 

Swanson and asked him if he had a chance to review the September 12, 2003 

memorandum he wrote and whether he should “look again at Madoff concentrating on 

best [ex].” E-mail dated October 31, 2003 from the OCIE Staff Attorney to Swanson, at 

Exhibit 534. The OCIE Staff Attorney explained, “BestEx is generally the obligation of a 

broker to provide the Best Execution for his client.” OCIE Staff Attorney Testimony Tr. 

at p. 27. Swanson responded, “I assume what you’re asking is whether to look at 

Madoff's trades against the quotes? The answer is yes.” E-mail dated October 31, 2003 

from the OCIE Staff Attorney to Swanson, at Exhibit 534. The OCIE Staff Attorney 

explained: 

When I first looked at Madoff, I was just looking at did the 

clients send in their order and did Madoff front-run that 

order or trade ahead of that order. And probably what was 

happening was that [with the Philadelphia Stock Exchange 

(PHLX)] I was noticing a lot of orders where PHLX was 

executing at one price, but really the market was saying it 

297 On May 29, 2003, Matt Daugherty sent Tina Barry an e-mail, which copied Chris Chase and Shauna 

Sappington and attached the March 3, 2003 planning memorandum and Madoff document request. E-mail 

dated May 29, 2003 Daugherty to Barry, at Exhibit 531. Barry thought the reason Daugherty sent the 

documents to her was because “being a branch chief in the office...a lot of times you’re just consulted 

generally on hey, can you take a look at this. Let me know what you think. Barry Testimony Tr. at p. 16. 

Branch Chief Tina Barry testified she was aware of the Madoff QQQ examination, although she was not 

involved in the examination. Barry Testimony Tr. at pgs. 15-16. 

451 
 

 

was a much better price; and they weren’t price improving 

those clients. 

So probably in the course of doing that was like wow, you 

know what? I never did this with Madoff. I should 

probably ask Eric if he wants that sort of analysis done too. 

I did. He said [yes].... 

OCIE Staff Attorney Testimony Tr. at p. 28. 

The OCIE Staff Attorney did not remember whether Swanson gave him 

additional feedback on this memorandum. Id. at p. 25. 

7. November 10, 2003 Memorandum Recommending that a 

Deficiency Letter be Issued to Madoff 

In November 2003, the OCIE Staff Attorney drafted another Madoff QQQ 

examination memorandum, which provided the following additional examination 

conclusions: “the Staff has found numerous and consistent instances of bad executions by 

[Madoff], resulting in some loss to the customers involved.” Memorandum dated 

November 10, 2003 from the OCIE Staff Attorney to Swanson, at Exhibit 535 

The memorandum concluded as follows: 

[T]he Staff believes that there is a best execution problem 

with MADF. The staff further believes that MADF and its 

broker customers have thus far failed to adequately monitor 

this behavior. Based on these conclusions, the Staff 

recommends a deficiency letter be sent outlining the 

problem areas as well as recommending that MADF 

execute customer orders at ECNs when it is able to do so 

rather than proprietarily taking that price while executing 

the customer at a worse ITS price. 

Id. 

The memorandum included a description of the firm’s order handling policies, a 

summary indicating that 359 of 2,806 customer orders reviewed were executed at a price 

worse than the inside bid or ask at the time of execution, a summary of the amount of 

losses to customers and the amount of gains to the firm, and two charts showing summary 

statistics of the data reviewed. Id. 

The OCIE Staff Attorney explained that the November 10, 2003 memorandum 

was based on a different analysis of the trading data he reviewed in the September 12, 

2003 memorandum. OCIE Staff Attorney Testimony Tr. at pgs. 28, 31-32. This 

452 
 

memorandum focused on Madoff’s execution quality and what clients were getting 

versus what the market was offering. Id. at p. 31. The OCIE Staff Attorney testified his 

conclusion “looks like, basically, I believe, that this was significant activity” and noted 

that his memorandum recommended that a deficiency letter be sent out. Id. at p. 32. He 

also did not receive any feedback on this memorandum. Id. at p. 25. 

8. There is no Record of a Deficiency Letter being Issued to Madoff 

The OCIE Staff Attorney stated that, although his November 10, 2003 

memorandum recommended that a deficiency letter be issued, he did not believe any 

deficiency letter was ever sent, stating, “At least I don’t remember drafting one. I 

honestly think that this just kind of got sucked into that black hole wherein some of these 

exams just went.” Id. at p. 33. He never received any further direction on the 

examination, which he stated was not uncommon, noting: 

we do our fact-finding...and say like okay, what do we do 

next. And there just was never any further direction; or, 

we’d write a memo summarizing whatever we thought we 

had found when the wind gained further input. So that was 

a pretty common occurrence. I don’t know if I ever heard 

back from [Swanson]. He may have given more feedback. 

I don’t know. 

Id. at p. 25-26. 

The OCIE Staff Attorney testified that in OCIE new matters would get prioritized 

over old matters and noted: “there was a lot of projects at the time that would just kind of 

die off. I mean, you know, you do some initial review and you go up the chain. And I 

think the superiors had determined, well, I got other things to worry about. Those old 

projects just kind of languished; and, I had a lot of projects like that.” Id. at p. 26. 

Daugherty did not recall what the staff found during the Madoff examination, 

saying he was “out of the loop” at that point. Daugherty Testimony Tr. at p. 53. He did 

acknowledge after reviewing the November 10, 2003 memorandum that “they had -- 

potentially have some issues with execution quality, and some gains,” and “based on the 

activity outlined in this memo, the staff believes that there is a best execution problem 

with Madoff.” Id. 

Swanson testified that he did not know if Madoff was sent a deficiency letter. 

Swanson Testimony Tr. at p. 32. Echoing the OCIE Staff Attorney, Swanson testified 

there were a lot of matters going on and it might have gotten lost in the shuffle, stating: 

Well, I -- yeah. I definitely -- I agree with that -- with that 

testimony, and I don’t know whether a deficiency letter was 

sent on this, and, frankly, I -- I can tell you that since I have 

-- I don’t recall even this document. It -- it’s likely to me 

453 
that we were inundated with a lot of projects. This is over 

the same period of time when we were pushing hard on the 

exchange trading ahead cases and so I was very distracted 

by that at the time. 

So I don’t know, you know, the extent to which this died on 

the vine, as it were, but there were situations where we 

opened inquiries and, you know, to my knowledge, they 

may never have gotten completely resolved because we 

were busy with other more high-priority matters and this – 

it’s very possible that this is one of those situations. 

Id. at pgs. 33-34. 

McCarthy did not recall that the “staff had found numerous inconsistent instances 

of bad executions by Madoff resulting in some loss to the customers involved,” but 

agreed that the staff “believed that there’s a best execution problem with Madoff.” 

McCarthy Testimony Tr. at pgs. 37-38. McCarthy also did not recall that the staff 

recommended a deficiency letter be sent out to Madoff in connection with the QQQ 

examination or if a deficiency letter was ever sent to Madoff, but acknowledged that was 

the staff’s recommendation. Id. at pgs. 38-39. McCarthy stated if a deficiency letter was 

sent out, “It should be in the work papers, yes.” Id. at p. 40. In connection with the 

Madoff investigation, the Office of the Inspector General reviewed OCIE’s 2003 Madoff 

QQQ examination work papers and did not find a deficiency letter for this examination. 

McCarthy disagreed with the OCIE Staff Attorney’s characterization that projects 

would “die off,” and stated, “Well, I mean, he’s – that’s his perception of what was 

going on at the time, but – above him, but I would disagree with that description.” Id. at 

p. 41. 

On June 19, 2009, after his testimony, Swanson provided supplemental 

information to the OIG about the QQQ examination. Despite the fact that during his 

testimony, Swanson stated that he had no recollection of whether or why a deficiency 

letter was not sent to BMIS, Swanson provided, in his supplemental filing, the following: 

Mr. Swanson does not have access to the memorandum 

recommending that a deficiency letter be issued to BMIS 

regarding trading in the QQQs so he is not 100% certain of 

all the underlying facts or legal theories underlying the 

recommendation. Mr. Swanson, however, does have a 

specific recollection that the matter involved an attempt by 

the staff to apply the NASD’s Manning Rule (NASD Rule 

2110) to market orders as well as the application of the 

NASD’s best execution rule (NASD Rule 2320). Further, 

Mr. Swanson has a specific recollection of discussions at 

that time with the NASD regarding the scope of these rules. 

454 
 

 

 

Mr. Swanson recalls that at that time, the NASD’s Manning 

Rule only prevented brokers from trading ahead of limit 

orders, and the scope of the NASD’s best execution rule 

was limited to transactions directly with “customers.” The 

scope of the best execution rule did not include transactions 

with other broker-dealers even if those transactions were 

for the account of a “customer.” While Mr. Swanson does 

not recall all the specifics of the BMIS QQQ matter, he 

does believe that the decision not to issue a deficiency letter 

was made because the recommended deficiencies would 

have either required application of Manning to market 

orders, which was not possible, or they would have 

required application of the NASD’s best execution rule to 

executions by BMIS on behalf of broker-dealer clients of 

BMIS, not on behalf of “customers” as defined in the 

NASD rule, which again was not possible. Mr. Swanson 

further believes, based on his recollection, that the QQQ 

memorandum provided to him did not clearly highlight the 

full scope of these jurisdictional difficulties. The NASD 

since amended its rules such that there a now a Manning 

Rule for market orders and such that the best execution rule 

applies to transactions with other broker-dealers if the 

transactions are for the benefit of “customers.”... 

Letter dated June 19, 2009 from Michael Wolk, Counsel to Swanson, to IG Kotz, at pgs 

1-2, at Exhibit 183. 

The OIG investigation found that at the time of the QQQ examination, the SEC 

believed that it did not have a basis to issue a deficiency letter for the violations as 

outlined in the Madoff QQQ examination report memorandum. During that time period, 

the SEC had determined the NASD did not have rules that explicitly prohibited: 

1) market makers from trading ahead of customer market orders in Nasdaq or Bulletin 

Board securities; or 2) third-market market makers from trading ahead of market or limit 

orders in other OTC securities. Action Memorandum dated September 22, 2004 from 

OCIE to The Commission, at pgs. 19-20, at Exhibit 536. As a result, the SEC was not 

issuing deficiency letters or recommending enforcement action against market makers 

because they traded ahead of customer market orders in Nasdaq securities or third market 

makers that traded ahead of market or limit orders in OTC securities. Id. at p. 20. 

In addition, the OIG investigation found that at the time of the QQQ examination, 

the NASD’s best execution rule was not applicable to market makers for orders received 

from other broker-dealers. Id. at p. 23. The NASD’s best execution rule required market 

makers to use reasonable diligence to obtain a price most favorable price for “customer” 

orders as possible under prevailing market conditions. Id. However, NASD rule 0120(g) 

excluded brokers-dealers from the definition of a “customer.”298 Id. at pgs. 24-25. Thus, 

298 NASD Rule 0120(g) states: “The term ‘customer’ shall not include a broker or dealer.” Id. at p. 24. 

455 
 

 

the staff determined NASD’s best execution rule was not applicable to trades a market 

maker received from another broker-dealer, even though the trades were ultimately for 

the benefit of the other broker-dealer’s customers. 

9. Conclusion 

The QQQ examination of BMIS was limited in scope and unrelated to the 

investment advisory business of Bernard Madoff’s firm. Thus, there is no evidence that 

this examination should or could have uncovered Madoff’s Ponzi scheme since 

investment advisory account data and trading records were not the subject of the review. 

However, there are significant concerns about the conduct of the QQQ 

examination, including the fact that apparent violations were discovered and a deficiency 

letter was recommended, but was never sent out. Even if it were the case that the SEC 

did not have a basis to issue a deficiency letter against Madoff, there should have been 

some record of this determination in the examination files. In addition, it is noteworthy 

that one of the staff attorneys involved in the examination stated that it was not 

uncommon for projects to just “die off” without coming to an appropriate conclusion and 

stated he often did not get any feedback or direction on his work. This apparent 

weakness in the examination process would reappear during the 2004 OCIE Cause 

Examination and seemed to demonstrate a systemic flaw in the OCIE examination 

299 process.

Conclusion 

The OIG investigation found that the SEC received numerous substantive 

complaints since 1992 that raised significant red flags concerning Madoff’s hedge fund 

operations and should have led to questions about whether Madoff was actually engaged 

in trading and should have led to a thorough examination and/or investigation of the 

possibility that Madoff was operating a Ponzi scheme. However, the OIG found that 

although the SEC conducted five examinations and investigations of Madoff based upon 

these substantive complaints, they never took the necessary and basic steps to determine 

if Madoff was misrepresenting his trading. We also found that had these efforts been 

made with appropriate follow-up, the SEC could have uncovered the Ponzi scheme well 

before Madoff confessed. 

299 It is also worth noting that this QQQ examination was occurring at the same time that the initial 

complaint was received by OCIE from the hedge fund manager (in May 2003) that triggered the 2004 

OCIE Cause Examination of Madoff, and thus, OCIE lost an opportunity to respond to the hedge fund 

manager’s complaint in a much more timely fashion. 

456