As the details of Bernard Madoff's $17 billion scam surface, one thing is abundantly clear (unfortunately that one thing is not how Madoff pulled off history's largest Ponzi scheme, nor is it an answer to the questions of where the money is or who else was involved): the Securities and Exchange Commission will be overhauled.
As I listened to the first of many Congressional hearings on the Madoff scandal, I could hear the anger and disbelief in many of the questioners' voices as they queried the SEC's inspector general (you couldn't help but feel a little sorry for the guy). Their disappointment was not grounded in the fact that Madoff pulled the wool over sophisticated investors' eyes, but rather in the idea that their very own SEC did not catch on to the plethora of red flags and stop the scheme before it got this bad. Had Madoff not essentially given himself up, there's no telling how long the scam may have persisted.
The public, too, is disappointed in the SEC. The public looks to the SEC to police Wall Street -- to protect and to serve investors. One Congressman went so far as to say we should do away with the SEC altogether because it gives investors a false sense of security. His logic is that investors don't do their own due diligence because they assume the SEC has inspected firms and deemed them legitimate. Obviously that is not the case with Madoff Investment Securities or many other firms where fraud has taken a foothold over the years.
The point was raised that the SEC and FINRA traditionally have had oversight of broker-dealers, not investment firms. The SEC apparently does review "a handful" of investment management firms each year, but they have not been the regulator's main focus. And FINRA doesn't have any oversight of investment management firms at all. Now this could change.
Although the SEC inspector general had few answers for any of Congress' questions, he did outline a number of issues the SEC will examine, including: (1) the complaints the SEC received regarding Madoff and whether they were handled properly; (2) the relationship between SEC officials and Madoff's staff; (3) why the SEC missed so many red flags; and (4) the extent to which the reputation and status of Madoff (because he participated on industry boards and panels) affected his examinations. On a broader scale, the SEC said, it planned to review, among other things, complaint handling at the Division of Enforcement, internal incentives regarding which complaints are reviewed first, whether complaints are being looked into, whether policies and procedures are being followed, and the relationships between divisions within the Commission and whether there is enough cooperation between them.
Overall Congress has called for a 21st-century regulator to oversee the markets in the 21st century. To create this, a complete review and overhaul of the current regulatory process is critical. Expect change to come sooner rather than later.