[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]

                        AND REGULATORY FAILURES



                               BEFORE THE


                       INSURANCE, AND GOVERNMENT

                         SPONSORED ENTERPRISES

                                 OF THE


                     U.S. HOUSE OF REPRESENTATIVES


                             FIRST SESSION


                            FEBRUARY 4, 2009


       Printed for the use of the Committee on Financial Services

                            Serial No. 111-2

48-673                    WASHINGTON : 2009
For sale by the Superintendent of Documents, U.S. Government Printing 
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Fax: (202) 512-2104  Mail: Stop IDCC, Washington, DC 20402-0001


                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
WM. LACY CLAY, Missouri                  Virginia
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
JOHN ADLER, New Jersey
JIM HIMES, Connecticut

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
 Subcommittee on Capital Markets, Insurance, and Government Sponsored 

               PAUL E. KANJORSKI, Pennsylvania, Chairman

GARY L. ACKERMAN, New York           SCOTT GARRETT, New Jersey
BRAD SHERMAN, California             TOM PRICE, Georgia
MICHAEL E. CAPUANO, Massachusetts    MICHAEL N. CASTLE, Delaware
RUBEN HINOJOSA, Texas                PETER T. KING, New York
CAROLYN McCARTHY, New York           FRANK D. LUCAS, Oklahoma
JOE BACA, California                 DONALD A. MANZULLO, Illinois
STEPHEN F. LYNCH, Massachusetts      EDWARD R. ROYCE, California
BRAD MILLER, North Carolina          JUDY BIGGERT, Illinois
DAVID SCOTT, Georgia                 SHELLEY MOORE CAPITO, West 
NYDIA M. VELAZQUEZ, New York             Virginia
MELISSA L. BEAN, Illinois            ADAM PUTNAM, Florida
GWEN MOORE, Wisconsin                J. GRESHAM BARRETT, South Carolina
PAUL W. HODES, New Hampshire         JIM GERLACH, Pennsylvania
RON KLEIN, Florida                   JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                THADDEUS G. McCOTTER, Michigan
ANDRE CARSON, Indiana                RANDY NEUGEBAUER, Texas
JACKIE SPEIER, California            KEVIN McCARTHY, California
TRAVIS CHILDERS, Mississippi         BILL POSEY, Florida
CHARLES A. WILSON, Ohio              LYNN JENKINS, Kansas
JOHN ADLER, New Jersey
JIM HIMES, Connecticut

                            C O N T E N T S

Hearing held on:
    February 4, 2009.............................................     1
    February 4, 2009.............................................    89

                      Wednesday, February 4, 2009

Donohue, Andrew J., Director, Division of Investor Management, 
  U.S. Securities and Exchange Commission........................    49
Luparello, Stephen, Interim Chief Executive Officer, Financial 
  Industry Regulatory Authority..................................    56
Markopolos, Harry, CFA, CFE, Chartered Financial Analyst and 
  Certified Fraud Examiner; accompanied by Gaytri Kachroo and 
  Philip Michael, Counsel........................................     5
Richards, Lori A., Director, Office of Compliance Inspections and 
  Examinations, U.S. Securities and Exchange Commission..........    54
Sirri, Erik, Director, Division of Trading and Markets, U.S. 
  Securities and Exchange Commission.............................    51
Thomsen, Linda, Director, Division of Enforcement, U.S. 
  Securities and Exchange Commission.............................    48
Vollmer, Andrew, Acting General Counsel, U.S. Securities and 
  Exchange Commission............................................    53


Prepared statements:
    Baca, Hon. Joe...............................................    90
    Bachmann, Hon. Michele.......................................    91
    Garrett, Hon. Scott..........................................    93
    Luparello, Stephen...........................................    94
    Markopolos, Harry............................................   101
    U.S. Securities and Exchange Commission joint written 
      statement..................................................   174

              Additional Material Submitted for the Record

Bachus, Hon. Spencer:
    Letter to Hon. Christopher Cox, then-Chairman of the SEC, 
      dated January 23, 2007.....................................   189
    Letter to Hon. Arthur Levitt, then-Chairman of the SEC, from 
      the Jefferson County Commission, dated November 17, 1997...   190

                        AND REGULATORY FAILURES


                      Wednesday, February 4, 2009

             U.S. House of Representatives,
                   Subcommittee on Capital Markets,
                          Insurance, and Government
                             Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 9:38 a.m., in 
room 2128, Rayburn House Office Building, Hon. Paul E. 
Kanjorski [chairman of the subcommittee] presiding.
    Members present: Representatives Kanjorski, Ackerman, 
Sherman, Capuano, Hinojosa, McCarthy of New York, Baca, Lynch, 
Miller of North Carolina, Scott, Maloney, Bean, Klein, 
Perlmutter, Donnelly, Speier, Wilson, Foster, Kosmas, Grayson, 
Himes, Peters; Garrett, Castle, Manzullo, Royce, Biggert, 
Capito, Neugebauer, Posey, and Jenkins.
    Ex officio present: Representatives Frank and Bachus.
    Also present: Representatives Green, Maffei, and Arcuri.
    Chairman Kanjorski. This hearing of the Subcommittee on 
Capital Markets, Insurance, and Government Sponsored 
Enterprises will come to order.
    I ask unanimous consent that Mr. Arcuri has permission to 
participate in today's hearing. Without objection, it is so 
    Pursuant to the agreement with the ranking member and to 
allow as much time as possible for testimony and members' 
questions, opening statements today will be limited to 5 
minutes on each side. Without objection, all members may submit 
opening statements in writing that will be made a part of the 
record. Without objection, it is so ordered.
    Good morning, everyone. We meet today to continue our 
review of the $50 billion Ponzi scheme allegedly perpetrated by 
Mr. Bernard Madoff. This is the second in our series of 
hearings on this topic. As my colleagues know, we are using the 
largest known instance of securities fraud as a case study to 
guide the work of the Financial Services Committee in reshaping 
and reforming our Nation's financial services regulatory 
    We preside at a crucial moment in our history, and our work 
on these matters in the 111th Congress will influence the 
securities industry for generations to come. After all, the 
Congress last undertook a wholesale rewrite of these laws in 
the wake of the Great Depression. We have only periodically 
tinkered with that regulatory engine over the last 75 years. 
The world, however, has now changed, and the motor is broken 
beyond repair. We therefore need to invent a new engine to 
ensure that the securities regulatory system reflects today's 
realities and can respond effectively to tomorrow's 
    The low tide in our financial markets has exposed many 
individual frauds and many problems in our regulatory system. 
Since the Madoff scandal came to light in December, we have 
learned of other sizable schemes and frauds. Some of these 
cases which are now under investigation include the flight and 
capture of Arthur Nadel, a wayward hedge fund advisor in 
Florida, the $50 million con organized by Joseph Forte in 
Philadelphia, and the $370 million scam of Nicholas Cosmo in 
Long Island, who promised 48 percent annual returns.
    During the last month, I have also heard from numerous 
victims not only of Mr. Madoff's swindle but many of these 
other cases. They want the help of their government. I have 
great sympathy for these individuals, including Mr. Goldstein, 
who joined us at our last meeting. They expected regulators to 
perform their jobs effectively. The Securities and Exchange 
Commission, the Financial Industry Regulatory Authority, the 
Securities Investor Protection Corporation, the Internal 
Revenue Service, the Justice Department, State securities 
regulators, and other appropriate authorities therefore must 
move quickly and do all they can to provide restitution, 
especially for retirees, charities, and pension funds.
    Today, we will begin our proceeding by hearing from Mr. 
Harry Markopolos, an external whistleblower and conscientious 
citizen. We are pleased to welcome him to the subcommittee. I 
also greatly appreciate the effort he has put into preparing 
his testimony.
    Unlike many others who suspected that something was wrong 
and amiss in Mr. Madoff's operations, Mr. Markopolos took the 
extra step of alerting authorities at the Securities and 
Exchange Commission about his concerns. As we will learn from 
his testimony, Mr. Markopolos was justifiably relentless in 
ringing alarm bells. Unfortunately, our regulators failed to 
follow his roadmap and heed his warnings. As a result, 
thousands of investors were hurt.
    With today's second panel, we will hear from the frontline 
regulators at the Securities and Exchange Commission and the 
current leader of the Financial Industry Regulatory Authority. 
These individuals will help us to identify the loopholes that 
allowed the Madoff Ponzi scheme and other securities frauds to 
take place and offer recommendations for reform. These experts 
will additionally respond to the concerns raised by the victims 
of the Ponzi scheme and the observations of Mr. Markopolos.
    Going forward, the committee has an enormous task ahead of 
itself. We need to pursue large-scale reforms by creating an 
effective method for monitoring systemic risk. While we have 
already begun work to craft wholesale regulatory reforms, I 
will also introduce legislation in the coming days that 
responds to one of the unique problems identified in the Madoff 
case. Specifically, my bill will close a legal loophole and 
permit the Public Company Accounting Oversight Board to conduct 
inspections and examinations of the auditors of broker-dealers.
    In closing, I would like to welcome Scott Garrett as the 
Capital Markets Subcommittee's most senior Republican for the 
111th Congress. I look forward to working with him to reach a 
bipartisan consensus and develop good public policy on the many 
matters under our jurisdiction.
    And now, I would like to recognize the ranking member for 
his opening statement. Mr. Garrett.
    Mr. Garrett. Thank you. And before I begin, I just thank 
you and I look forward to working with you on this very 
important issue and, noting your comments on the air this 
morning, that I think I concurred on a number of the positions 
that we will be taking on this going forward. I am looking 
forward to it.
    So thank you. I will yield myself 3 minutes for my 
    Thank you, Mr. Chairman, for holding this hearing and also 
for the witnesses who are here today. I believe that there are 
three main points that need to be addressed.
    First, there will be some talk that there are gaps in the 
current regulations that need to be filled. I don't know if 
that is actually the case. Each and every one of Mr. Madoff's 
relevant businesses were actually regulated by someone. There 
was not a gap in the sense that one sector was not covered by a 
regulator that needs a new regulator or more regulation.
    Second, the failure at best, as we can see it today, came 
in part from a lack of coordination or basic information 
sharing between the agencies, specifically between the 
divisions within the SEC as well as FINRA. You know in 2006, 
Mr. Madoff was required to finally register his investment 
advisory business with the SEC. Traditionally firms such as Mr. 
Madoff's that had both an advisory business as well as a 
broker-dealer business had the broker-dealer arm process the 
trades made by the investment advisory arm. The SEC is well 
aware of this relationship between an investment advisory 
business and a broker-dealer business and how they work 
together when they are part of the same company. But over the 
last 10 years, FINRA has not conducted audits of his broker-
dealer arm with the knowledge that Madoff's investment advisory 
unit even existed. So in light of the multiple infractions on 
his broker-dealer arm, it seemed incumbent upon the SEC that 
they should have ordered an internal audit when the investment 
advisory business registered in 2006. Unfortunately, I don't 
think we will learn today why that was not done. At the very 
least, they should have informed FINRA of the newly registered 
business advisory business and recommended to them to look back 
over their audits of the broker-dealer business with this new 
information and going forward to examine any other 
    Third, while I appreciate that the SEC cannot follow up on 
every single complaint--they say they get literally tens of 
thousands of them--with the specificity that we would like, I 
do not see that the failures were from a lack of funding or 
authority but in performing and executing the responsibility 
under the powers that they already had.
    For example, we understand that there were recommendations 
for changes in the examination procedure and data collection in 
the various divisions. And for reasons not entirely clear, they 
were never implemented for over more than a 10-year period.
    So in conclusion, we really cannot end all fraud nor 
guarantee that changes that we will be recommended or that the 
chairman will recommend to make sure that this never possibly 
happens in the future. But at least some of the things, had 
they been implemented earlier, at least in this case, it 
appears that the improprieties would have been discovered much 
earlier. It is sad when you think about but for the fact that 
Mr. Madoff came out and confessed this scandal, this scam would 
still be going on today.
    And with that, I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Garrett. I now 
recognize Mr. Royce for 2 minutes.
    Mr. Royce. Well, thank you, Mr. Chairman. And I really want 
to thank Mr. Markopolos for testifying here today. I can only 
imagine the degree of angst and frustration over the years that 
he felt going forward to the SEC with his analysis, repeatedly 
preparing that, preparing reports, showing the magnitude of the 
fraud. We are not discussing here how we stop all fraud. We are 
discussing the greatest fraud on record. We are talking about a 
systemic fraud here that has done untold damage really in terms 
of confidence of the system. And we are also talking about a 
fraud in which a few things surfaced. We will hear about some 
of it in your testimony later.
    But I think that the concept of overlawyering, the fact 
that--and with we saw this in Britain, too, with the FSA. You 
have bureaucrats. You have people, you know, who are attorneys 
who don't understand the complexities of the market. And when 
somebody brings them and lays out for them that complexity--
this was a discovery that was made in Britain actually after 
they missed Northern Rock. After they missed a number of 
things, they said, well, we have to reach out and bring into 
our FSA people who have experience in the markets to unravel 
some of the intricacies. And this was what I think was partly 
missing here.
    But also what was missing was the type of discipline which 
would cause someone to sit down and try to walk through and 
understand. There was not the capacity on the part of many of 
these attorneys, I take it, to really follow what you were 
laying out for them. And what I guess hits all of us the most 
is that you didn't give up on these efforts. You tried 
repeatedly, and you tried to encourage others to look into this 
in order to protect investors not only here but around the 
world. And for that, we want to express our appreciation, our 
appreciation for you being here today.
    I have read your testimony and look forward to the 
questions that we can ask you because we have to re-engineer 
the SEC in going forward so that these kind of systemic risks 
are presented, especially when a citizen like you comes forward 
and does their best in order to lay out the case.
    Thank you very much, Mr. Chairman.
    Chairman Kanjorski. Thank you, Mr. Royce. And now I am 
pleased to introduce our first panel, our first witness. 
Without objection, your written statements will be made a part 
of the record. You will be recognized for a 5-minute summary of 
your written testimony.
    We are pleased to have Mr. Harry Markopolos, an independent 
financial fraud investigator and a chartered financial analyst 
and certified fraud examiner. Mr. Markopolos is joined at the 
witness table by his attorneys, Ms. Gaytri Kachroo and Mr. 
Philip Michael. His attorneys are here for advice only and will 
not be testifying themselves. Mr. Markopolos, it is all yours.


    Mr. Markopolos. Thank you, Mr. Chairman. Good morning. 
Thank you for inviting me here to testify before your committee 
today regarding my 9-year long investigation into the Madoff 
Ponzi scheme. I would also like to recognize my Congressman, 
Stephen Lynch, who is a member of the committee. I look forward 
to explaining to Congress today and the SEC's Inspector General 
tomorrow what I saw, when I saw it, and what my dealings with 
the SEC were that led to this case being repeatedly ignored 
over an 8\1/2\ year period between May 2000 and December 2008.
    First, I would like to extend my deepest sympathy to the 
many thousands of victims of this scheme. We know that many 
victims have lost their retirement savings and are too old to 
start over. We also know that others have lost medical 
services, community services, and scholarships provided by 
charities that were wiped out by the Madoff fraud. This pains 
me greatly and I will do my best to inform you, the victims, 
about my repeated and detailed warnings to the SEC. You, above 
all others, deserve to know the truth about this Agency's 
failings, and I will do my best to explain them to you today.
    You will hear me talk a great deal about overlawyering at 
the SEC very soon. Let me say I have nothing against lawyers. 
In fact, I brought two of my own here today. As today's 
testimony will reveal, my team and I tried our best to get the 
SEC to investigate and shut down the Madoff Ponzi scheme with 
repeated and credible warnings to the SEC that started in May 
2000 when the Madoff Ponzi scheme was only a $3- to $7 billion 
fraud. We knew then that we had provided enough red flags and 
mathematical proofs to the SEC for them where they should have 
been able to shut him down right then and there at under $7 
billion. But unfortunately, the SEC staff lacks the financial 
expertise and is incapable of understanding the complex 
financial instruments being traded in the 21st Century.
    In October 2001, when Madoff was still in a $12- to $20 
billion range, again we felt confident that we had provided 
even more evidence to the SEC such that he should have been 
stopped at well under $20 billion. And again in November 2005, 
when Mr. Madoff was at $30 billion, 29 red flags were handed to 
the SEC. And yet again, they failed to properly investigate and 
shut down Mr. Madoff's operation.
    Unfortunately, as they didn't respond to my written 
submissions in 2000, 2001, 2005, 2007, and 2008, here we are 
today. A fraud that should have been stopped at under $7 
billion in 2000 has now grown to $50 billion. I know that you 
want to know why there was over $40 billion in additional 
damages, and I hope to be able to provide some of those answers 
to you today.
    Just as there is no ``I'' in TEAM, I had a brave, highly-
trained team that assisted me throughout the 9-year Madoff 
investigation. Let me briefly introduce the key team members to 
you. Neil Chelo, director of research for Benchmark Plus, a $1 
billion-plus fund of funds, checked every formula, every math 
calculation, and every modeling technique, while also obtaining 
key financial statements and marketing documents from Madoff 
feeder funds. Mr. Chelo also interviewed senior level marketing 
staff and risk managers at these Madoff feeder funds.
    Frank Casey, North American president for London-based 
Fortune Asset Management, a $5 billion hedge fund solutions 
advisory firm, closely tracked the Madoff feeder funds here and 
abroad, collected their marketing documents, and figured out 
Madoff's assets under management and his current cash 
    The final member of this four-person team was Michael 
Ocrant, recruited into the team by Mr. Casey. Mr. Ocrant was 
then an investigative reporter at institutional investor who 
made key contributions to the investigation. Mr. Ocrant was the 
only member of my team who ever met Mr. Madoff or stepped 
inside the Madoff operation. He conducted a key interview in 
April 2001. On May 1, 2001, his publication, MAR Hedge, 
printed, ``Madoff tops charts: Skeptics asked how.'' It was an 
expose. It contained several red flags that the SEC ignored.
    These three gentlemen were my eyes and ears out into the 
hedge fund world, closely tracking who Madoff was dealing with 
and questioning the staff of the Madoff feeder funds to collect 
additional pieces of the puzzle. My Army Special Operations 
background trained me to build intelligence networks, collect 
reports from field operatives, devise lists of additional 
questions to fill in the blanks, analyze the data and send 
draft reports for review and error correction to my team before 
submitting them to the SEC. In order to minimize the risk of 
discovery of our activities and the potential threat of harm to 
me, my team, and to our families, I submitted these reports to 
the SEC without signing them. Only a few key trusted people at 
the SEC knew my name and my name only, not those of my team, in 
order to compartmentalize the damage if Mr. Madoff found out 
that we were tracking him. Mr. Madoff was already facing life 
in prison if he were caught, so he would face little to no 
downside to removing whatever threat he felt we posed. At 
various points in time throughout these past 9 years, each of 
us feared for our lives. Each time any of us collected 
information, we took risks, and fortunately for us we were not 
    I would also like to recognize Ed Manion of the Boston 
regional office of the SEC. He was my constant confidant 
throughout the past 9 years. If not for his encouragement and 
bravery, I would have quit the investigation after my second 
submission, which was in October 2001. Mr. Manion told me that 
his Agency had dropped the ball, but that I had a public duty 
to keep investigating because the Madoff Ponzi scheme was such 
a clear and present danger to the Nation's capital markets that 
if the SEC wasn't going to investigate, well, someone had to, 
and he didn't think there was anybody better qualified than me 
to lead the investigation. Mr. Manion kept taking the case to 
his superiors at the SEC and he kept getting ignored because he 
was not a securities lawyer, only a chartered financial analyst 
with 25 years of trading and portfolio management experience in 
the industry. Sadly, the SEC distrusts anyone with industry 
experience. I am very surprised that the SEC did not fire Mr. 
Manion for his constant pestering about Mr. Madoff. The SEC to 
this day holds against him the fact that he kept bringing this 
case to their attention, and I believe he would be fired if he 
ever went public and told investors how strong an advocate he 
was on their behalf.
    Boston Branch Chief Mike Garrity was the other SEC official 
who distinguished himself during the case. In October-November 
2005 he examined my evidence, investigated and found 
irregularities, vouched for my credentials, and put me in touch 
with the appropriate SEC staff at the New York regional office. 
Since Mr. Madoff's operation was located in New York City, the 
New York regional office had jurisdiction.
    In 2000, Mr. Manion warned me that relations between the 
New York and Boston regional offices were about as warm and 
friendly as the Yankees-Red Sox rivalry, and that New York does 
not like to receive tips from Boston. Truer words were never 
spoken. There was no centralized office of the whistleblower in 
Washington, staffed with industry professionals who knew how to 
determine if whistleblower complaints being submitted were 
credible and of sufficient quality to merit immediate 
investigation. Instead, I had to go through the Boston SEC 
regional office which had to forward me to the New York 
regional office. Unfortunately, these two offices did not get 
along, and I wasn't able to go directly to the SEC's 
headquarters in Washington and have them referee and lead this 
entire process. Regional turf battles definitely played a part, 
a determining factor in fact, in how disastrously this case was 
handled by the SEC.
    In April 2008, I went to the SEC's Director of Risk 
Assessment with this case and got no response. I told the SEC 
exactly where to look, providing them with a long series of 
clear warnings that any trained investment professional would 
have immediately understood. Inexplicably, the SEC never acted 
upon those repeated multiple warnings on a 9-year time span. 
And as my formal written testimony makes clear, the SEC is 
overlawyered and has too few staff with relative industry 
experience and professional credentials to find fraud, even 
when a multi-billion dollar case is handed to them on a silver 
platter. Worse, my team and I kept collecting additional 
information and I kept sending it to the SEC and they kept 
ignoring it.
    The SEC is also captive to the industry it regulates, and 
it is afraid of bringing big cases against the largest, most 
powerful firms. Mr. Madoff was one of the most powerful men on 
Wall Street. He owned a prestigious brokerage firm. He and his 
brother held numerous top-level positions on the most 
influential industry association boards. Clearly, the SEC was 
afraid of Mr. Madoff.
    The SEC says it lives for the big cases, but the evidence 
shows that the only financial regulators bringing the big cases 
in the 21st Century are the New York Attorney General's Office 
and the Massachusetts Security Division. New York and 
Massachusetts brought the big cases against the market timing 
scandals and the auction rates securities scandals, while the 
SEC watched quietly from the sidelines. Even today after 
Merrill Lynch paid out $6 billion in bonuses after losing 
untold tens of billions of dollars and is being propped up by 
government bailout money, only the New York Attorney General is 
investigating. The SEC continues to roar like a mouse and bite 
like a flea.
    But what I find the most disturbing about the Madoff case 
is that no one from the SEC has stepped forward to admit 
personal responsibility. Instead, all we have heard is one 
senior official after another saying that they cannot comment 
about the Madoff investigation because it is ongoing. We have 
also heard senior SEC officials bemoan the lack of both staff 
and resources while telling us that they receive thousands of 
tips each year and that they have to conduct triage and can 
only respond to the highest priority matters. I gift-wrapped 
and delivered the largest Ponzi scheme in history to them, and 
somehow they couldn't be bothered to conduct a thorough and 
proper investigation because they were too busy on matters of 
higher priority. If a $50 billion Ponzi scheme doesn't make the 
SEC's priority list, then I want to know who sets their 
    The Troubled Asset Relief Program was funded to the tune of 
$700 billion by the previous Congress. Therefore, I can think 
of $700 billion reasons why the American public deserves 
answers from the SEC about its refusal to tackle the big cases 
and why all five major Wall Street investment banks under SEC 
supervision either failed, were forced by the government to 
merge with commercial banks, or became bankholding companies 
propped up by the Federal Reserve and the U.S. Treasury. When 
an entire industry that you were supposed to be regulating 
disappears due to unregulated unchecked greed, then you are 
both a captive regulator and a failed regulator. You have no 
excuses. But you darn well have a lot of explaining to do to 
the American taxpayers and you darn well better be apologizing 
to the Madoff victims.
    The incoming SEC Chairwoman needs to come in and clean 
house with a wide broom. The SEC needs new senior staff because 
the current staff has led our Nation's financial system to the 
brink of collapse. They ignored the rating agency scandals. 
They allowed the investment banks to engage and package and 
sell toxic subprime securities to investors. They ignored 
auction-rate securities and allowed these toxic securities to 
be sold to investors. They ignored mutual fund market timing 
until embarrassed by State regulators into acting, and they 
ignored the Madoff Ponzi scheme. They haven't earned their 
paychecks and they need to be replaced.
    This concludes my oral testimony. Thank you very much, Mr. 
    [The prepared statement of Mr. Markopolos can be found on 
page 101 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Markopolos. 
Now we will open for questioning, and I will take the first 
    Those are pretty tough charges you make against the SEC. At 
any time, do you feel that the Securities and Exchange 
Commission did perform its mission in the past and there was a 
weakening, or has this been a structural weakening since its 
very inception?
    Mr. Markopolos. Mr. Chairman, I think leadership starts at 
the top. The tone at the top is very important. I think we have 
had good SEC staff in the past. It all depends on who the 
Chairman is. I thought that William Donaldson was great. He was 
a fox who came to guard the hen house. He came from industry. 
He knew where the skeletons were buried, and he had his staff 
dig them up one at a time. And I think that is what led to his 
dismissal in 2006.
    Chairman Kanjorski. If you had to look at the need for 
reform and how it should be done, do you feel there is anything 
in the existing regulatory scheme that should just be corrected 
or do we have to start over from the bottom and reconstruct the 
regulatory scheme?
    Mr. Markopolos. I think we need to start over at the top. I 
think you need an overarching department perhaps called the 
Financial Supervisory Authority, and I think it needs to have 
all of the security and capital markets and financial 
regulators underneath it. And I think you need to combine a lot 
of the existing regulators, just to simplify command and 
control to make sure that there is unity of effort and to 
eliminate expensive duplication of effort. And you also want to 
make clear the reporting lines to industry. They deserve to 
have better regulation, fewer regulators, and fewer different 
conflicting sets of laws to respond to.
    I also think you need to start at the bottom, and you need 
to replace the staff that you currently have and replace them 
with industry professionals. If you have too many lawyers 
without industry experience, they really don't comprehend the 
frauds of the 21st Century. You need people who can take apart 
and put back together again the complex instruments of the 21st 
    Chairman Kanjorski. Do you think it is time to shoot the 
    Mr. Markopolos. No. I actually think you need to spin them 
out of the regulatory agencies and have a separate enforcement 
unit where the lawyers can do both the civil and the criminal 
prosecutions that are dedicated just to securities and capital 
markets frauds. But you need to keep them separate because if 
you have them in the mix, it becomes toxic.
    Chairman Kanjorski. The revolving door problem that we all 
hear about; that is, people who work at the Agency and then end 
up on Wall Street and vice versa, is there something that can 
be done to prevent that? And is there any infection that is 
being carried from one entity to the other?
    Mr. Markopolos. That is a great point, Mr. Chairman. There 
is an infection if the people coming to the SEC are too young 
and looking to make their bones and look at it as a 
steppingstone. And that is why I have a recommendation that you 
hire senior people from industry who have been there for a long 
time, who have gray hair or no hair. You would be perfect. You 
want them coming in, and this is the capstone to an already 
spectacular career. They have made lots of money in industry. 
They don't need any more money. They are not going to go back 
to industry. So I guess you want to have reverse age 
discrimination where you are looking to hire the old foxes to 
come in and police up the hen house. And that is what we really 
    Chairman Kanjorski. Well, there have been now recently 
complaints about not having the staff and not having the funds 
available. But not too many years ago you may recall that the 
Agency recommended to the Congress that certain fees be reduced 
or no charges made on those fees because there was an 
overabundance of revenue coming in to the SEC. And the Congress 
and this committee actually in the early 2000 period took that 
action to get rid of that fee schedule. I think it was as much 
as $1.5 billion a year that was anticipated was not necessary. 
Do you think that was a misjudgment, a misstatement? Or was 
that a purposeful act on the part of the Agency to follow in 
the ideology of deregulation?
    Mr. Markopolos. I think it was ideological and idiotic 
because the industry only gets the message by the size of the 
fines. They know what a kick in the pants looks like, and they 
know what a slap on the wrist looks like. When you only slap 
them on the wrist, that sends a message that fraud is green 
lighted here. We don't do the big cases and we don't punish the 
big firms.
    Chairman Kanjorski. If you had your way, what would be your 
highest recommended action by this Congress to take in regard 
to the regulatory scheme in the country right now?
    Mr. Markopolos. Combine regulators into one super financial 
organization with the departments underneath, like the SEC, 
some national insurance regulator, some bank regulator, 
probably the Fed, to handle all these market functions and have 
one super regulator above them so that there is no drop in 
coordination. I would centralize the databases so that an 
enforcement action by one agency gets noticed and picked up by 
the others. Mr. Madoff got caught in 1992, and no one 
apparently knew that in the New Millennium.
    Chairman Kanjorski. Very good. Thank you very much for 
coming forward. And now we will hear from our ranking member, 
Mr. Garrett.
    Mr. Garrett. Thank you. And again thank you for your work 
in this area. I will begin with what my last comment on my 
opening statement was, that but for the statement by Mr. Madoff 
to his two sons about what he had done, we may very well not be 
having this hearing today, that it would not have been 
uncovered officially at least. Do you concur with that 
    Mr. Markopolos. Yes. The SEC was never capable of catching 
Mr. Madoff. He could have easily gone to $100 billion if we 
hadn't had the financial crisis last year and run out of money 
to pay off existing investors.
    Mr. Garrett. So that is basically the end game, I guess, 
for any Ponzi scheme, right, is that you can keep on running 
until you have run out of investors. And had the market 
actually been continuing on the uptick bubbles that we had, we 
might be seeing him being able to continue for some time to 
    Mr. Markopolos. Correct. The SEC would never have caught 
him. He basically had to run out of money first.
    Mr. Garrett. You have indicated on the second or third page 
of your testimony in the statement that you have here how you 
were able to collect various different pieces of information 
along the line. You indicated three or four other people who 
worked alongside of you in doing this. Was there anything that 
you were doing--I actually know the answer to this but I will 
ask you--is there anything that you were doing that really was 
outside the purview of parameters or the authority of the SEC 
that had they committed the time, attention, and resources, if 
you will, to it could have picked up on those things as well?
    Mr. Markopolos. Everything that my team and I investigated 
was a matter of public record. It was basically marketing 
materials from the Madoff feeder funds and there were 
interviews collected of those feeder funds. We never had the 
access that the SEC had. We couldn't walk into his office, 
collect his documents. We never saw his smoking gun e-mails. We 
never talked to any of his staff. We did not have the inside 
smoking gun evidence available to us, but the SEC certainly 
    Mr. Garrett. Is part of the problem, from your testimony, 
that the euphemism that we use here is, stovepipe conduct by an 
agency as far as the sharing of information? I referenced it in 
part as far as whether--just every aspect here, every part of 
Madoff's business was regulated by someone. The investment 
advisory arm, they are being regulated over here. FINRA is 
taking care of the broker-dealer section over here. And to use 
the euphemism, Washington stovepipe aspect, is that the crux of 
the issue here? And if the answer is yes, is that necessarily 
resolved by combining them under an umbrella organization? 
Because sometimes, as you already have indicated within the 
SEC, in the SEC you have one organization but different regions 
that are all within it. You have the Boston region, I believe 
it was, that was not sharing information. So would that be 
counterfactual, as the other chairman would say, some time to 
show that even when you are in one organization the information 
is not always being shared?
    Mr. Markopolos. I agree. I think you need a super regulator 
to supervise all the different--and I would minimize the number 
of subregulators I had underneath there. But I want one 
centralized database of all enforcement actions so that the 
banking regulators know what the capital regulators are doing 
and also know what the insurance regulators are doing because 
right now you have these conglomerate firms that deal with all 
aspects of finance. They have insurance. They do banking. They 
do securities. And you need to combine the regulation database 
so that people are aware of all the infractions. You can't 
afford to be split into an army of ants. You need to be as 
giant as the conglomerates that you are regulating.
    Mr. Garrett. And part of the argument goes is that while 
until Madoff registered as an investment advisor, he really 
didn't appear on anybody's screen. Can you just comment on 
    Mr. Markopolos. He was operating and acting as an asset 
manager, as a hedge fund operator. But he was registered as a 
broker-dealer. He exploited the regulatory gaps and he fell 
through the cracks. And no one knew what he really was doing. 
Even though the regulators went in there multiple times, they 
never figured it out because they went in piecemeal. And you 
really need to have a combined task force of regulators to go 
after the big frauds. You need to have people from each agency 
in there at the same time.
    Mr. Garrett. I only have 10 seconds left. How did you 
know--you actually laid out the dollar figure in your 
testimony. It was this much here, this much here, this much 
here. How did you get that piecemeal information as to the size 
of it? Because we are still trying to get that question. Is it 
really $50 billion today? You seem to know that it was $7 
billion here, $20 billion here, and so on.
    Mr. Markopolos. My team was out there in the field, out 
talking to the Madoff feeder funds and identifying who they 
were. And we were tracking them very closely through Europe. We 
identified 14 feeder funds, only 2 of which have come public. 
There are 12 more out there hiding low in the weeds in Europe 
that you have not heard about yet. My team and I plan to meet 
with Mr. Kotz, the SEC's Inspector General, tomorrow and turn 
over this very critical list so that the French and Swiss 
authorities can attack these--can inspect these organizations. 
Because right now if they don't inspect them, if they don't 
know about them, that looks very bad for the United States of 
    Mr. Garrett. I appreciate it. Thank you.
    Chairman Kanjorski. The gentleman from New York, Mr. 
    Mr. Ackerman. Thank you very much. Congratulations on your 
good work. What was the key tip-off that made you think that 
Bernie Madoff was a fraud?
    Mr. Markopolos. The key tip-off--and it took me about 5 
minutes to figure out that he was a fraud. So it took extensive 
time and research. I basically read his strategy description. 
And I knew that wasn't the source of his returns. I knew right 
away by looking at his performance chart. I wish I had a white 
board and an easel here, but I don't, so I will give you a hand 
signal. I am going to show you what his performance return line 
looked like. It was a 45 degree angle without any variation. It 
only went in one direction, up. It never had variation like the 
market does, like this. And that was the key tip-off because 
there is no such performance line as Bernie Madoff's that has 
    Mr. Ackerman. Let the record show the witness said this--
    Let me ask you this, were you commissioned to do this? Did 
somebody hire you to do this investigation?
    Mr. Markopolos. No. I did it on my own.
    Mr. Ackerman. How were you compensated? How much time has 
this taken out of your week, your year?
    Mr. Markopolos. There was no compensation. We did it for 
the flag, the flag of the United States of America. We saw him 
as a clear and present danger to the capital market system and 
to our Nation's reputation. We were from the industry. I 
actually was in a competing firm. And when you have a bad 
player on the field, a dirty player, you want him removed from 
the playing field. I tried to remove him from the playing 
field, but the referee wasn't listening.
    Mr. Ackerman. So how much time--I am trying to figure out 
how much time the SEC should have or could have invested to 
figure this out. How much time did you and your group put in 
    Mr. Markopolos. We never kept track. We are not lawyers. We 
don't do the billable hours thing. But I can tell you, this 
stack of evidence, you see over 311 pages of documents and 
exhibits that we provided to the Congress. We were missing the 
e-mails from 1999 through the third quarter of 2005. But I 
assure you that if we had access to those e-mails, which we do 
not, then the stack of evidence would have been this high. So 
it is however many hundreds of hours it took to do that. I am 
not sure.
    Mr. Ackerman. Several hundred hours.
    Mr. Markopolos. Yes.
    Mr. Ackerman. So in several hundred hours, the SEC could 
have investigated this and come up with what you have come up 
    Mr. Markopolos. It took me 5 minutes, but I did about 4 
hours of modeling just to prove the math and come out with the 
math proof. So in total, it took me 4 hours of work.
    Mr. Ackerman. This is just because of the straight-up 
graphic of his success that led you to suspect--that is not 
evidence or proof of anything. That could be, you know--that 
could be just good luck for a long time, one would suppose. But 
it is not evidence. Did you have any hard evidence that this 
was a corrupt scheme, besides that it smelled bad?
    Mr. Markopolos. Oh, definitely. I think the hardest 
evidence that we had right at the beginning was just opening up 
the Wall Street Journal to the options section, in the C 
section, the money and investing section, and just looking at 
how many options contracts were in existence. And you can 
clearly tell that Mr. Madoff was several times the size of the 
entire marketplace for those index options. And so clearly he 
was a fraud. That took about 20 minutes though.
    Mr. Ackerman. The few statements that I have seen of 
victims of Mr. Madoff indicate that at the end of the reporting 
period he swept everything out of the account and put them in 
Treasuries. Was that his modus operandi?
    Mr. Markopolos. It was.
    Mr. Ackerman. Is that because then he had no need to report 
to the SEC because he had nothing at the end of the reporting 
period except Treasuries and they don't do Treasuries? Is that 
how I understand the deal?
    Mr. Markopolos. You hit the nail on the head, Congressman. 
There was another reason why you do that. We did obtain the 
year-end financial statements for 2004, 2005, and 2006 of 
Greenwich Sentry, which is also known as Fairfield Sentry. That 
was the largest Madoff feeder fund. It was about $7.5 billion 
toward the end that they lost with Mr. Madoff.
    Mr. Ackerman. I have only seen a couple of these statements 
and came to that conclusion pretty quickly that something--but 
that is not hard evidence. But it is indicative to me if that 
was the case across-the-board with everybody with whom he 
dealt, should there not be a regulation in place that allows 
the SEC or whatever entity that going forward is going to be 
investigating to look into accounts of people who sweep things 
into securities and then think they don't have to report to the 
SEC? Would that be an appropriate thing for us to tackle as a 
    Mr. Markopolos. It would. If you are not holding any 
financial instruments that are reportable at year-end marking 
periods or quarter-end marking periods, especially if you are 
in Treasury bills, which are book entry form only, there are no 
physical securities there, there was nothing for the auditors 
ever to inspect. And what Greenwich Sentry was doing, they used 
3 different year-end auditors in 2004, 2005, and 2006. That 
made me very suspicious that there was auditor shopping going 
on because why would you have three different auditors in three 
different countries?
    Mr. Ackerman. Understood. Might I impose on the Chair for 
one final question? Could Mr. Madoff have done this himself 
with thousands of clients?
    Mr. Markopolos. No. He had a lot of help. He had a robust 
information technology department that made sure the financial 
statements he sent out to clients each month footed because a 
lot of these retirees, they check those things and they make 
sure they match to the penny. He also had people taking in 
money, wire transfers from new victims, and sending out money 
to the existing clients, the old victims if you will. So he had 
a lot of help.
    Mr. Ackerman. Thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mr. Ackerman. Mr. 
Royce from California.
    Mr. Royce. Yes, thank you. You pointed out that pretty 
early by analyzing this 45-degree return on investment, the 
absurdity of consistency of it and the unfailing nature of it 
that it was clear to you. I was wondering if there were some 
other flags there to the SEC beside what you brought them in 
the single entity custodial arrangement that existed, the one-
person accounting firm that might have been a red flag, the 
lack of electronic account access, certainly the firm secrecy. 
I saw a piece in Investors Business Daily which early on, you 
know, that raised this issue that has been passed around. So 
there was some reporting in the financial press, too, that the 
SEC didn't pick up, the critical managerial compliance 
positions held by Madoff and people in his family who were in 
that position. Any number of these probably could have 
triggered an investigation.
    What is your reflection on the totality of all of this on 
top of your analysis that you provided some 9 years ago to the 
SEC and maybe your thoughts on why this wasn't undertaken in a 
more deliberative manner by the SEC in terms of the 
    Mr. Markopolos. I think the overarching answer to your 
question is, they don't have financial professionals on the 
staff and they certainly don't have financial professionals on 
the staff who understand complex derivative instruments of the 
21st Century. If you send out a team of lawyers to look at 
derivative transactions, you are not going to be able to find 
them. You need to have an experienced finance team in there 
that is highly compensated, highly trained, highly incentivized 
to find fraud. There are no incentives at the SEC to find 
fraud. That is why they shy away from the big cases.
    Mr. Royce. As you speak of the overlawyering at the SEC and 
you reflect back on the years of dealing with the various 
officials at the Securities and Exchange Commission, do you 
believe that the reason for the inaction was a lack of 
understanding of the models that you presented to them? Or was 
it just a lack of desire to pursue this case? As you think 
about the personalities involved, how would you analyze that?
    Mr. Markopolos. I think it was a mix of the two that you 
just described. I think they didn't understand the red flags, 
the 29 red flags that I handed them. They had no idea how to do 
the math. They were totally incapable of doing that math. They 
have no one on their staff probably systemwide who could do 
that math. And the other part was, they are a captive 
regulator. Mr. Madoff was certainly one of the most powerful 
individuals on Wall Street. He had a respected broker-dealer 
arm. He traded a substantial percentage of over-the-counter and 
New York Stock Exchange listed stock volume every day. And they 
just looked at his size and said, he is a big firm and we don't 
attack big firms.
    Mr. Royce. As we look at your original analysis as to what 
really struck you in terms of the magnitude of the fraud 
involved in this case, and looking at the macro level at the 
SEC, from your experiences over this last 9 years, what do you 
think needs to be changed to go after the systemic risk problem 
here, to make certain that in the future, if there are entities 
or frauds as deep as these, that the SEC would be at least 
guaranteed to look at them? What specific changes would you 
give us or policy prescriptions right now? And I imagine that 
within the SEC there would be people pushing for these types of 
changes for some time. Let's discuss what those would be.
    Mr. Markopolos. I would attack it from three different 
areas. First, I would replace the senior staff at the SEC 
because they have the wrong senior staff right now. And then, I 
would go to the bottom of the organization. You need to change 
who the people on those teams are; they can't be young 20-
somethings without industry experience. You need to get higher, 
senior, seasoned professionals. And the third thing you need to 
do, you need an Office of the Whistleblower to centralize these 
thousands of complaints that they get so they are not handled 
ad hoc by 11 regional offices. You need one centralized 
location, the Office of the Whistleblower. And you also need to 
compensate those whistleblowers for the risks that they are 
taking because once you turn a case in, you are blacklisted 
from industry and you had better make it worth their while. If 
you do those three things, I think we can solve this problem.
    Mr. Royce. I hope we can revisit. After this case is closed 
on Madoff, I hope we can revisit here and look at the 
recommendations you have given, and at that point a lot more 
will have surfaced as this case goes forward. I thank you again 
for your efforts on behalf of so many investors and on behalf 
of honesty and transparency in the system. Thank you.
    Chairman Kanjorski. Thank you, Mr. Royce. The gentleman 
from Massachusetts, Mr. Capuano.
    Mr. Capuano. Thank you, Mr. Chairman. Mr. Markopolos, first 
of all, thank you for being a good citizen. It is not often 
that we get too many people at that table whom I would consider 
necessarily good citizens. Second of all, more importantly, 
before my time runs out, I only have 5 minutes here. If you 
were offered a job at the SEC in charge of this whistleblower 
bureau, would you take it?
    Mr. Markopolos. No. I have pressing family obligations at 
home that would prevent me from taking any SEC job for 2 years.
    Mr. Capuano. So in 2 years, if you were offered the job, 
would you take it? We will talk.
    Mr. Markopolos, my concern is a couple of things. The 
Madoff situation is one thing and it is one item. But I am just 
curious, I know how I feel. I want your opinion. Do you think 
that the problems you have encountered with this particular 
case are isolated in this case or are they endemic throughout 
all of the regulatory structure, particularly the SEC but not 
just the SEC?
    Mr. Markopolos. The SEC is overmatched. They are too slow. 
They are too young. They are too undereducated.
    Mr. Capuano. So it is not just this case?
    Mr. Markopolos. No. It is with all the regulators in the 
financial system. The Fed did an even worse job of regulating 
the banks than the SEC did of regulating the capital markets.
    Mr. Capuano. I agree with you. And I like your concept 
about an overlawyered type of regulator with some substance 
below it. But I just want to make sure, are you just talking 
about fraud regulators? Because there are also regulators or an 
aspect of regulation that does not just deal with fraud, also 
deals with regular, ordinary, everyday capitalization 
requirements, etc., etc. We are all thinking about doing 
something about systemic risk as well in addition to fraud. And 
I would argue that some of those things may require us to have 
a little bit more complicated regulatory scheme. Is that 
something you have considered or not?
    Mr. Markopolos. I wouldn't say more complicated. I would 
say more simplified, more streamlined because remember, 
American business wants as few regulators as possible. They are 
paying for the regulation. They want a value-added proposition. 
For every dollar they spend toward regulation, they want to 
receive that value back because right now without proper 
regulation, there is no trust in our capital markets, which 
raises the cost of capital or makes it unavailable to American 
    Mr. Capuano. That is the other thing we want to talk about. 
The one thing, for years I have never thought that 
``regulation'' is a swear word. I don't think you would feel 
that way either. However, this country over the last 20 years 
has considered the word ``regulation'' as some sort of swear 
    I particularly want to talk about this case. My 
understanding is that most of this money was not lost by mom 
and pops. Most of this money comes from relatively 
sophisticated investors. Is that accurate?
    Mr. Markopolos. It is. They were high net worth individuals 
who received no protection from the SEC. They are considered 
sophisticated investors, and I would argue that they deserve 
protection as well.
    Mr. Capuano. I would agree with you. Thus far all I have 
heard from the SEC and others is that sophisticated investors 
somehow don't need anything. It doesn't cause--it doesn't run a 
systemic risk. And if some multi-billionaire wants to lose a 
billion dollars, why should we worry about it? I think this 
particular case, even what this case indicates beyond it, would 
argue just the opposite. I am hoping that is something you 
would agree with.
    Mr. Markopolos. Because of the people who were involved and 
their wealth, a lot of charities were wiped out. Medical 
services are not being provided today to people in the 
communities, community services, scholarships, people have no 
retirement income left. They are wiped out. So I would--I think 
those wealthy people deserve protection as well.
    Mr. Capuano. I agree with you. Again, and I just want to 
make sure that this is not--I have had my problems with the SEC 
in the last couple of years because I think they have been 
asleep at the switch. Again, not just at the Madoff case. I 
didn't see this, but I think the entire problem we have right 
now is probably--you can't pick one item. But if you had to 
pick one item I think the lack of regulation is it. And I just 
want to hear from you, too. It is my understanding that if we 
had had aggressive or at least adequate regulation across the 
board, that first of all the Madoff situation might have been 
if not avoided--you always have criminals--at least minimized 
and maybe we wouldn't be in some of the economic problems we 
are having today. Would you find that statement agreeable or 
    Mr. Markopolos. To police up the capital markets, you have 
to increase the risk of detection of the frauds. Right now it 
is such a high reward, low risk equation to commit fraud, the 
markets feel a green light to do anything they want because 
they have gotten away with it for so long. And until you 
restore trust, the American investor isn't coming back into our 
markets and, worse, foreign investors won't either.
    Mr. Capuano. Do you think that absent the structure of it 
and absent the adequacy of the individuals or the pay of the 
individuals, the laws relative to what is legal and what is not 
legal, if they were fairly interpreted do you think the laws we 
have now are currently adequate or are they totally inadequate? 
I am not talking about fine-tuning. I am talking about major 
    Mr. Markopolos. You need a lot more laws because you are 
always going to be outdated as soon as you pass a new set of 
laws because of new financial instruments created to avoid 
whatever existing regulatory scheme there is. So you are always 
going to be behind the 8-ball. So you really have to look at 
the securities laws as the absolute bare minimum standard that 
you follow. And then you have to have regulators that enforce a 
much higher standard, which is good ethics, full transparency, 
fair dealing for all, and full disclosure. And if you do that, 
if you set ethics as a higher standard than the law, which it 
always is, then I think--and you have a regulator that is 
willing to attack bad ethics, you will get somewhere.
    Mr. Capuano. Thank you, Mr. Markopolos. And think about 
that job, will you?
    Chairman Kanjorski. Thank you very much, Mr. Capuano. The 
gentleman from Alabama.
    Mr. Bachus. Thank you. Mr. Markopolos, thank you. Reading 
your testimony and having talked to you last month and to the 
staff, you called the SEC, you wrote the SEC, you pleaded with 
them, you badgered them. There are four pages of contacts with 
them; I mean, probably over 100 attempts on your behalf to lay 
out a case. You had extended telephone conversations, extended 
meetings with them, and you laid out chapter and verse, you 
know, handed them a case on a silver platter.
    Was it incompetence? I am amazed that they could have 
ignored what you gave them. Was it incompetence? Was it a 
conflict of interest? Was it just a lack of willingness to take 
on Madoff?
    Mr. Markopolos. I think it was a combination of 
incompetence and an unwillingness to take on a major player 
like Mr. Madoff. They fear the big cases.
    Mr. Bachus. The chairman has talked about more funding, 
more investigators. But you know that doesn't seem to be the 
case here. I mean it seems like they are not using the 
resources they have. Do you get any ideas on that? And there 
were all kinds of regulations. You laid out regulations, laws, 
there were all sorts of violations.
    Mr. Markopolos. There were turf battles. You had regional 
rivalries between New York and Boston. And by the way, neither 
New York nor Boston likes Washington very much.
    Mr. Bachus. So dumping more money on it doesn't solve those 
problems, does it?
    Mr. Markopolos. It doesn't solve the problems. They do need 
some more funding though. They need a lot more funding in 
certain areas. They need to increase the compensation levels so 
they can attract industry-experienced veterans on the team 
level because--
    Mr. Bachus. They have already been authorized to do that, I 
    Mr. Markopolos. They need to have incentive compensation. 
Just like Wall Street, it is base salary plus incentive for 
what you bring in. So you are incentivized to bring--
    Mr. Bachus. In other words, if you catch people, if your 
job is to catch people, you catch them--
    Mr. Markopolos. Yes.
    Mr. Bachus. --you are rewarded. If you don't, you are not?
    Mr. Markopolos. Right. And what I like about that is, if 
someone tries to stop you from bringing a big case and you are 
incentivized to bring a big case, you will run over them with a 
bulldozer if you have to to get that big case in the door. And 
right now there is no incentive, no reward, for bringing those 
big cases in the door.
    Mr. Bachus. So it is not just throwing more money at it, it 
is doing it the right, smart way; and incentives are the way to 
do that.
    How do you address those turf fights? How do you address 
sort of the sacred cows out there that they just sort won't 
take on?
    Mr. Markopolos. I think that if you are in Boston and 
referring a case to New York, you get incentive credit for that 
as part of the bonus scheme for turning in a case to another 
region. You need to increase cooperation that way.
    Mr. Bachus. Thank you.
    What would you ask us to do? What could we do differently?
    Mr. Markopolos. As a Congress?
    Mr. Bachus. Yes.
    And I will tell you this: You have heard the so-called 
``pay to play'' in municipal bonds?
    Mr. Markopolos. Yes.
    Mr. Bachus. Well, actually, 10 years ago we laid out a case 
to the SEC on what was going on. Again, 2 years ago, we laid 
out a case exactly what was going on in Jefferson County. They 
did nothing for a year. Finally, someone, a whistleblower, 
someone came, followed on something else and was caught. So, I 
mean your experience, you know, is very similar experience to 
one some of us on the Hill have had.
    Mr. Markopolos. Congressman, I know what happened in 
Birmingham, Alabama, and it happened in my hometown of Erie, 
Pennsylvania, the same thing with municipal securities fraud.
    It happened in Massachusetts as well. The Massachusetts 
Turnpike Authority lost $450 million on some over-the-counter 
swaptions that they never understood, that they were deceived 
into entering into a transaction with several Wall Street 
investment banks. And the SEC has been nowhere to be found 
regulating there, enforcing action for the crimes that 
occurred. As a result, Massachusetts plans on doubling our 
tolls. We are going to pay for that out of our own pockets.
    Mr. Bachus. Right. And that happened under the Clinton 
Administration, it happened under the Bush Administration. My 
letter was actually to the Clinton Administration.
    But I would like, with permission of the committee, with 
unanimous consent, to introduce my letter to the SEC detailing 
a similar experience.
    Now, the difference is, I was relying on other people. I 
actually had trusted them or relied on them to look at the 
information and tell me whether it was true or false. And they 
told me there wasn't anything to it, basically.
    Mr. Markopolos. I think what you will see is that the SEC 
is busy protecting the big financial predators from investors. 
And that is their modus operandi right now.
    Mr. Bachus. I appreciate that. And I want to again just 
tell you how truly grateful we are to you. Unfortunately, if 
your warnings had been taken and if the warnings of other 
people had been taken 10 and 12 years ago, there would be 
literally millions of Americans who wouldn't be suffering today 
from losing their entire retirement.
    So, thank you.
    Chairman Kanjorski. Thank you very much. And without 
objection, the letter of the gentleman from Alabama will be 
entered into the record.
    The Chair hearing none, it is so ordered.
    Mr. Sherman of California for 5 minutes.
    Mr. Sherman. Thank you.
    I build on the comments of Mr. Capuano. We need you in 
government service. And maybe that whistleblower office needs 
to be established in Boston for the next 2 years. I look 
forward to working with my colleagues to make the changes 
necessary in law so that we don't have a circumstance where 
today Madoff is on the streets and his accountant has not even 
been arrested or indicted.
    You point out how you were able to use your professional 
skills in roughly 4 hours, if not 4 minutes, to convince 
yourself that there was probably fraud going on here. I am a 
CPA by training, and I would think it would take someone who is 
a CPA about the same amount of time--maybe even a little less. 
Because as I understand it, the financial statements filed by 
Madoff showed numbers as high as like $10- to $17 billion; is 
that right?
    Mr. Markopolos. Yes. Let me explain.
    I think there are going to be two numbers that the press 
will start reporting--$50 billion is what Madoff himself 
reported. And that was the notional amount of loss from all the 
investor statements combined of what they thought they had 
earned over many decades of investment returns with Mr. Madoff. 
And it is a different number--probably a truer number is much 
lower--and that number is probably between $15- and $25 
billion, which was actually cash received by Mr. Madoff.
    Mr. Sherman. I am focusing on a different number. And that 
is, if you just looked at the financial statements filed by Mr. 
Madoff, they would show numbers well over $10 billion. And then 
they would be attested to by the Friehling accounting firm, 
which had one active CPA. So the first thing anybody looking at 
those financial statements would have done is say, well, this 
is a pretty big operation, $10-, $20-, $17 billion and the 
accounting firm isn't registered with the PCAOB. And what 
accounting firm is this? Oh, they have only one CPA.
    Now, it is physically impossible for one CPA to audit a $17 
billion firm. But even if it was possible, you are supposed to 
be an independent auditor. Independence includes not getting 
more than, say, about a fifth of your revenue from any one 
client. So unless you think that one CPA can audit a $17 
billion operation and be done in a couple of months, you have a 
fraudulent financial statement in your hand. Not to mention 
your professional expertise focused on the fact that you cannot 
earn those kinds of continuously positive, even returns.
    I think either of our two professions could have spotted 
this rather quickly. Did you have a chance to bring your 
accusations to FINRA or the NASD?
    Mr. Markopolos. I would have never taken them to the NASD 
or FINRA. I had a lot of bad experiences as an over-the-counter 
trader in the late 1980's with the NASD. What I found them to 
be was a very corrupt, self-regulatory organization, that if 
you took a fraud to them, they would ignore it as soon as they 
received it. They were there to assist industry by avoiding 
stricter regulation from the SEC.
    Mr. Sherman. Sir, you are using some strong terms. And from 
anybody else, you know, we would say, oh, that is the wild-eyed 
populist. But you have basically said that our two main 
securities regulatory agencies see their role as protecting the 
major institutions on Wall Street rather than protecting 
    You have talked about some circumstances where the 
whistleblower is compensated. Have you suggested some private 
right of action? In a number of other statutes we have what we 
call private attorneys general, where the whistleblower doesn't 
just blow the whistle and hope that somebody takes action, but 
rather is able to bring an enforcement or civil case 
themselves, and if they win, do quite well.
    What would you think of a proposal like that?
    Mr. Markopolos. I would be wholly in favor of it. As you 
know, the False Claims Act already gives the right of private 
action on behalf of the government. The SEC has section 21A(e), 
of the 1934 Act, which does provide for a whistleblower bounty, 
but it is only for insider trading theory cases. I would like 
to see that expanded to include all financial fraud cases so 
that you incentivize the foxes out there in the field to come 
forward and bring cases against their firm with specific and 
credible allegations with inside books and records, transaction 
reports, with smoking gun e-mails, and basically give the 
government a case on a silver platter like I did.
    And if the government refuses it, give them a right of 
private action to take it forward.
    Mr. Sherman. And finally, I don't think there is another 
$50 billion Madoff out there, but in your estimation, are there 
some mini-Madoffs and medium-sized Madoffs; could somebody do 
what he did and not be as powerful as he was?
    Mr. Markopolos. There is. I plan on turning in at least a 
$1 billion, if not bigger, mini-Madoff to the SEC's Inspector 
General tomorrow. I hope this time they will actually listen to 
    Mr. Sherman. Oh, I think they will.
    Chairman Kanjorski. Thank you very much, Mr. Sherman.
    The gentleman from Delaware, Mr. Castle.
    Mr. Castle. Thank you, Mr. Chairman.
    I also thank you, Mr. Markopolos, for your testimony here 
today, and I have a couple of questions. One I wasn't going to 
ask, but something you answered before calls me to.
    Do you put FINRA and the NASD in the same camp of being 
ineffective because they are basically part of the entity that 
Madoff and others have come from? Or do you separate the two of 
    Mr. Markopolos. I would separate them. I would say that the 
FINRA is even less competent than the SEC. And I never thought 
that the SEC was corrupt. In fact, I am living proof here today 
that they are not. But FINRA definitely is in bed with 
    Mr. Castle. And the NASD you sort of condemned in your 
previous answer. I assume that hasn't changed.
    Mr. Markopolos. They are more like RICO.
    Mr. Castle. Okay.
    I may have this wrong, but I believe that the rules, as far 
as officials at the SEC, are that senior officials there can go 
to work for a firm, but for 1 year, they can't deal with the 
SEC, at least in the area in which they have previously worked.
    Would we be wise to pass legislation expanding the limits 
on SEC employment transferring over to the firms which they 
have regulated--just a surmise--3 years or something of that 
    And following up on your concept of trying to get people at 
adequate compensation with senior experience, my concern is, we 
have a lot of people at the SEC who are thinking, gee, at some 
point I am going to be going to work for these firms. I need to 
be a little bit careful about what I am doing.
    If we had a greater prohibition about their ability to do 
that, perhaps we would limit that happening. I would just be 
interested in your thoughts about that.
    Mr. Markopolos. That is why I would like to see incentive 
compensation for when you bring a big case you get a big bonus. 
Because that way they can make their bones, punch their ticket, 
and go to industry. If you prevent them from going to industry, 
you will never get them in the first place. That is why I 
    Mr. Castle. I was thinking in terms of those who have been 
in industry, as you indicated, with the gray hair--no hair, 
whatever it may be--coming to work for the SEC in their 50's 
perhaps or whatever with the experience. I mean, they may not 
be going back to Wall Street, is my point.
    Mr. Markopolos. Yes, I would like to see a lot of gray hair 
in those senior positions tackle the big cases, because they 
have already made all the money on Wall Street that they will 
ever need. They are not going to be able to spend what they 
have already made.
    But you want them on your team, and you want them as your 
best public servants; you want them leading the charge.
    Mr. Castle. Mr. Capuano, who is here, and I introduced 
legislation called the Hedge Fund Adviser Registration Act to 
require all the hedge fund managers to register with the SEC, 
all of them, which I believe may be a good start in overseeing 
that particular industry.
    Do you have other ideas about either registration or other 
things to make all this more transparent? Even though you made 
it very transparent to the SEC and they didn't respond, are 
there ways systemically that we can make all of this more 
transparent to the SEC, so there are no excuses as far as 
future activities are concerned?
    Mr. Markopolos. Yes. One thing that Congress definitely 
needs to pass legislation regarding is the regulation of over-
the-counter derivatives, because where there is no light and 
only darkness, that is where the financial criminals will tend 
to congregate. You see that in the over-the-counter markets. 
And that goes to Congressman Bachus's remarks about lack of 
regulation in the municipal securities area. You can't leave 
those dark corners.
    Mr. Castle. The accounting firm that has been brought up 
here--and I don't know much about this, but I remember reading 
about it at the time--and that is, this accounting firm was 
apparently not of national note, was apparently doing just 
about this, and seemed to have disappeared when all the trouble 
    Is there something we should be doing with respect to 
accounting firms for large hedge funds and large security 
    Mr. Markopolos. I would like to think that there is, but 
when I looked at the Greenwich Sentry financial statements, 
they had a Big Four accounting firm, PricewaterhouseCoopers in 
the Netherlands, and PricewaterhouseCoopers in Toronto, Canada, 
as their auditor, and they didn't spot it either. All they saw 
were Treasury bills with those year-end financial statements, 
which are in book entry form. There were no securities 
positions in the inventory for the auditors to actually 
inspect. And as we all know, Mr. Madoff self-custodied.
    So one thing you could do is make sure there are 
independent custodians, and I think that would go a long way 
toward solving this problem.
    Mr. Castle. Thank you very much. And thanks for all your 
work in the area.
    I yield back, Mr. Chairman. I yield back, sir.
    Chairman Kanjorski. Thank you very much.
    We now have Mr. Hinojosa from Texas.
    Mr. Hinojosa. Thank you, Mr. Chairman.
    Mr. Markopolos, I am very impressed with the evidence and 
the presentation that you have brought before our committee. 
And I want to say that here in Congress--and you probably know 
this--we have divided jurisdiction over our markets.
    Considering all that has transpired, would you support 
transferring the jurisdiction over derivatives to this full 
Committee on Financial Services as one centralized location? 
And I might add to that question that I have no problem with 
leaving the commodities for the Agriculture Committee.
    Mr. Markopolos. I would actually be against leaving the 
commodities and futures for the Agriculture Committee. I think 
all financial instruments--and even commodities are financial 
instruments--need to be under one central regulator and that 
the CFTC's function should be folded into the SEC.
    American taxpayers deserve to have the lowest cost for the 
regulation, and they deserve not to have regulatory gaps 
between enforcement agencies.
    Mr. Hinojosa. Okay.
    What changes, if any, would you recommend to FINRA, the 
Financial Industry Regulatory Authority, based upon your 
research into the Madoff Ponzi scheme?
    Mr. Markopolos. I don't have any recommendations for FINRA. 
I never really considered them in my written testimony to you. 
I was just asked to diagram what the SEC needed.
    I think what they could do is read my report and take the 
best ideas from there that would apply to FINRA and implement 
    Mr. Hinojosa. I am very concerned, as you are, and my 
colleagues here, on the money lost by the investors. Is there 
any way to ensure that they will be made whole?
    Mr. Markopolos. That is not my decision to make.
    Mr. Hinojosa. Mr. Chairman, I yield back.
    Chairman Kanjorski. Thank you very much.
    The gentlelady from West Virginia, Mrs. Capito.
    Mrs. Capito. Thank you, Mr. Chairman.
    Thank you, Mr. Markopolos, for your contribution and your 
insight in today's hearing. I noticed over the course of 10 
years you have conducted this investigation and reported, and 
with much frustration as well.
    I am wondering--and obviously a lot of the folks who 
invested with Mr. Madoff were sophisticated fund managers and 
sophisticated investors, and certainly they--or let me ask you 
    Did you make your hue and cry--did you make them aware, the 
fund managers and other folks who were investing with Madoff, 
of your suspicions; and what was their reaction to you at the 
time? You know--and did you become sort of an I-don't-know-what 
on Wall Street where you were questioned, or did people look 
into this more deeply with you?
    Mr. Markopolos. If you look at who the victims were not, 
that you would have expected to see but did not see as victims 
in New York, and certainly in Boston's financial district, I 
was warning the firms where I had close relationships, where 
the people were competent and understood financial mathematics 
and derivative securities; and those people all stayed away.
    They were big investment banks here in the United States. 
They were big consulting firms. They were big private client 
offices. They were big funds of funds. And they all avoided Mr. 
Madoff because they knew me, and I warned them.
    And there were people at the feeder funds that I--
    Mrs. Capito. Could you explain to me what the theater 
funds, what that entails?
    Mr. Markopolos. A feeder fund--
    Mrs. Capito. Oh, feeder fund. I thought you were saying 
``theater fund.''
    Mr. Markopolos. A feeder fund.
    Mrs. Capito. I understand a feeder fund. Thank you.
    You know, in our notes it has that--and I might be 
pronouncing this incorrectly--Acacia LLC put out a statement 
the day that Mr. Madoff was arrested that they would no longer 
recommend the Madoff feeder funds. So obviously, this net had 
been cast pretty wide. People were becoming very suspicious.
    What was the precipitating event to cause them to--was it 
people calling in their money and not finding satisfaction? 
Evasion by Mr. Madoff? What, in your book, happened that caused 
them to change their minds and others' right at the time that 
it became public--right before?
    Mr. Markopolos. When this became public, anybody who had 
anything to do with Mr. Madoff went into hiding. You could ask 
people who were at the feeder fund staffs what their dealings 
with Mr. Madoff were, and they would run for the hills. No one 
wants to answer to the victims from the feeder funds.
    I think they feel they will be answering in court very 
    Mrs. Capito. All right. Well, I want to thank you too for 
your very in-depth analysis of the SEC and the regulatory 
    I think--in my view, I think some of the problem is the 
complex instruments that develop so quickly over time and the 
lack of the ability of the regulatory agencies to move with 
flexibility and speed to be able to follow and track the 
instruments that they are tasked with overseeing. Would you 
agree with that statement?
    Mr. Markopolos. Most definitely. I don't think the SEC had 
anyone who understood a split strike conversion except Mr. 
Manion in the Boston SEC regional office. I don't know how many 
people they have with 25 years of industry experience; I would 
say rather few.
    Mrs. Capito. All right. Thank you.
    I yield back.
    Chairman Kanjorski. Thank you very much.
    The next member is Ms. McCarthy of New York.
    Mrs. McCarthy. Thank you, Mr. Chairman.
    And thank you, Mr. Markopolos. One of the things I want to 
touch on is the Ponzi schemes. When we had a hearing a couple 
of weeks ago, I asked the witnesses, you know, how many more of 
these schemes possibly could be out there? And obviously, we 
did have one on Long Island, where I come from.
    Is there anything that we can do to go forward on basically 
trying to prevent these things? I know we can educate the 
public, but unfortunately the old adage, ``If it sounds too 
good, it is probably not good,'' we keep saying that, but 
unfortunately people keep going through it.
    And the other thing that I would like to ask you, because a 
lot of the questions that I was thinking of asking you have 
already been asked and answered:
    One of the problems we are obviously going to be facing for 
probably a very long future is the confidence of the American 
public, whether it is in banking, whether it is in the 
financial institutions, obviously even in government, mainly 
because everything has failed. So, with that, if you have any 
ideas on how we build that trust up? I know you have offered 
some suggestions.
    But one other thing, too:
    With the SEC not responding to you--and you had mentioned 
the attorney general of New York, and then Massachusetts, 
obviously bringing charges forward, did the New York attorney 
general, did you think about going to them, or even the FBI, 
being that it was, you know, a criminal offense?
    Mr. Markopolos. Yes. I didn't think I could go to the FBI 
after being rejected multiple times by the SEC, because with 
the FBI, I would have to make full disclosure. And if I told 
them I gave this to the SEC multiple times and the SEC did 
nothing to investigate, then I would have zero credibility with 
the FBI. They would automatically assume, and be wrong, but 
they would assume that the SEC was competent, when it was not.
    As far as the New York attorney general, I actually did 
make an attempt to contact him. Mr. Eliot Spitzer was at the 
JFK Library a number of years ago. I went there with a package, 
with my submission to the SEC. I knew through the grapevine 
that he was a big hedge fund investor through his family 
trusts. And I figured the odds were high that he was a Madoff 
investor, which turned out to be the case. And to the staff of 
the JFK Library, I handed a packet. I made copies such that my 
fingerprints were never on that package. I handled it only with 
gloves, because I thought that he was an investor, and it 
turned out to be. I think the New York Times reported that he 
    So I did go there. And I don't know that he saw the 
envelope. I never saw him receive it. So I don't know what 
    Mrs. McCarthy. When you were working with the SEC--and you 
had mentioned earlier in your testimony that only a few knew 
your name, obviously because you didn't want your name out 
there--do you think that might have hurt, with the SEC not 
responding to you?
    Mr. Markopolos. No. Boston knew who I was. You know, I was 
the past president of the 5,000-member Boston Security Analysts 
Society. They knew my qualifications in derivatives. I managed 
billions of these as a chief investment officer at a very well-
regarded firm in Boston.
    So that definitely wasn't it. Boston vouched for me every 
step of the way.
    Mrs. McCarthy. Well, with that being said, couldn't they 
have taken your case and pushed it a little bit more, even if 
they didn't have a good relationship with the New York or the 
Washington offices?
    Mr. Markopolos. Not really. In fact, I made an offer to the 
SEC in my October 2001 submission. If you read it closely, you 
will see I offered to go undercover for the SEC under their 
command and control and have no one know where I was except my 
wife. And I would have no contact with my family during this 
time; I would have assumed a disguise, as I was trained to in 
the Army, and gone undercover and led that team to a successful 
result very quickly.
    I don't know what more I could do to put it on the line and 
bring this man to justice than I attempted to do in my October 
2001 submission.
    Mrs. McCarthy. I think what makes me nervous is obviously 
you never gave up on this, and there are probably many other 
people out there that are watching this testimony and saying, 
well, I know something, but what is the sense of me going 
forward if no one is going to pay any attention to me? 
Especially when you tried so many different avenues.
    I thank you for your service. I am sorry that the 
government failed you and everybody else failed you.
    With that, I yield back the balance of my time.
    Chairman Kanjorski. The gentleman from Texas, Mr. 
    Mrs. Biggert. Not the gentleman from Texas, but the 
gentlelady from Illinois.
    Mrs. Biggert. Thank you. Thank you, Mr. Chairman.
    Thank you, Mr. Markopolos. Everybody seems to be 
pronouncing it differently, but I am not sure of the correct 
pronunciation. And thank you for all that you have 
accomplished. It is almost like reading a good book, I think 
all that you have gone through. I hope at some time this is all 
put down in your words, because it is fascinating.
    You know, what we need now is for you to help us to restore 
confidence in the capital markets industry and the financial 
institutions and the economy. I mean, this is such a story that 
I think it has taken its toll on everyone. And I think what we 
are seeking really are what measures should Congress take to 
reform the regulations or the laws related to the case. What 
loopholes are left open that somebody is going to discover, and 
how can we close those to prevent something like this happening 
    But on the other hand, this market has always been 
innovative, creative; and we have brought--there have been a 
lot of ways that people use to make money legally and to 
advance different systems. So that--how could we maneuver 
through that without really stifling the creativity and 
innovation? And should we be looking at the regulations and the 
laws on the books and trying to decide whether they are 
adequate enough to address this issue, or is this more a 
failure, really, of enforcement?
    Go ahead.
    Mr. Markopolos. It is both, Congresswoman. It is, we need a 
few more regulations; we can leave no more dark spots 
unregulated and unguarded for financial predators to congregate 
in. There needs to be sunshine everywhere in our capital 
markets. Everybody deserves full transparency and a square deal 
when they are dealing with investments, to restore trust.
    And the second part is, we need better people in the 
enforcement agencies. They really need to replace a lot of 
their staffs, especially at the senior levels.
    Mrs. Biggert. Being a lawyer, I can understand that you 
need somebody who really is in the industry. And yet, this is 
difficult, isn't it, as you said? And that concerns me. You 
talked about being a whistleblower; then you are blacklisted by 
the industry.
    What is your position now?
    Mr. Markopolos. I actually work full-time on fraud 
investigations, mainly involving cases where there is fraud 
against the government--Medicaid, Medicare, Department of 
Defense fraud, and IRS tax fraud.
    Mrs. Biggert. That is great. Is this as an independent or 
with a regulator?
    Mr. Markopolos. I am independent. I do work with attorneys, 
most of whom are former assistant U.S. Attorneys, Federal 
prosecutors who prosecute high-level white collar cases. Those 
are the people with whom I tend to work with most closely.
    Mrs. Biggert. Thank you. I am sure that as this moves along 
we will be in touch with you for more specifics; and I think 
that you have given some of those in your testimony and to the 
members about what we should be doing.
    But I think this is a very great hearing for us to have, 
you know, from somebody that has really delved into this so 
much. And I thank you.
    With that, I yield back.
    Chairman Kanjorski. Thank you very much, Mrs. Biggert.
    The gentleman from Massachusetts, Mr. Lynch.
    Mr. Lynch. Thank you, Mr. Chairman. I want to thank the 
ranking member as well.
    Harry, thank you very much for coming forward and for your 
great work on that. And above all, for your persistence, having 
been rejected so many times. I am sure it must have been 
    I also want to thank you for the power of your example. I 
know in my office we have received contacts from a number of 
former SEC employees and current SEC employees to raise a 
number of concerns similar in respect to what you have said 
here this morning.
    I think, first of all, the former SEC Chairman Harvey Pitt 
had written an article, an editorial, I believe, entitled, 
``Overlawyered at the SEC.'' So I am not giving up his 
confidence in saying that he early on pointed to the same 
deficiency, and not having enough economists and accountants in 
play to be able just to analyze a lot of the data that was 
coming in and recognizing the problems. So that is a structural 
    Another structural need that you mentioned in passing with 
respect to the gentleman from Delaware's questions, a number of 
people that I have questioned at the SEC about the inability to 
discover this early on, they said that the way that Mr. Madoff 
had this structured was somewhat unusual in that he was 
executing the trade, but that he was also his own custodian 
bank. He didn't use State Street or another third-party 
custodial bank, as many of the legitimate firms do.
    Do you see a need there? Is there a way that we can put a 
trip wire in if we separate that custodial responsibility 
versus the trading responsibility? Would that allow us to at 
least compare, or to have the SEC go in there and compare the 
books of both entities?
    Mr. Markopolos. Yes. You need separate custodians. They 
can't be--one and the same organization was one of the big ways 
that he hid this fraud for so long.
    But the SEC had enough. Even with Mr. Madoff being self-
custody, all they had to do was go into his operation, take the 
road map I gave them, take those 29 red flags, and say, let me 
talk to your derivatives trading staff; and they would not have 
found one single derivatives trader there. Because the key mark 
of a Ponzi scheme is, there is no underlying product or 
service. It is all a fraud. There is nothing underneath it. The 
emperor wears no clothes.
    The other thing they could have done was go to the Chicago 
Board Options Exchange, where these OEX Standard & Poor's 100 
index options actually traded, and talk to the people trading 
them: ``Have you ever received an order from Mr. Madoff?'' And 
they would have told you he was a fraud.
    Mr. Lynch. All right. But you still think the separate 
custodial bank idea is a good idea?
    Mr. Markopolos. It is a must-have. You really need to do 
    Mr. Lynch. All right. That is what I wanted to get out of 
    The other thing that I keep hearing from some current SEC--
and former--is that, well, there is a whistle--let me rephrase 
that. There is a hotline. I was told that senior SEC management 
had actually gone to an industry--a financial services industry 
conference and basically said to the firms out there, if you 
feel that you are being too aggressively investigated, then I 
want you to call this office. And that was a senior person, two 
senior people at the SEC. I know that these employees took that 
message as meaning, you know, we have to back off a little bit, 
in that the senior management at the SEC was actually captured 
by the industry and that it wasn't doing the intense 
investigating that we would expect from them.
    Have you run into that sort of dynamic with the people of 
the SEC that you have been dealing with?
    Mr. Markopolos. Yes, I did. In fact, I brought with me the 
Association of Certified Fraud Examiners 2008 Report to the 
Nation, and it lists in here that the best way to find fraud; 
54 percent of the frauds get discovered by tips, whistleblower 
tips; only 4 percent by external auditors which--the SEC is an 
external auditor. Therefore, whistleblower tips are 13 times 
more effective than external auditing. So why wouldn't we want 
the SEC to be 13 times more effective? Lord knows, this Agency 
needs to be more effective.
    Mr. Lynch. Right. It just struck me, there was a hotline to 
stop an investigation or to slow it down at the SEC, but there 
wasn't one to speed it up or initiate it. It just seemed 
counterintuitive to me, given the mission of the Agency itself.
    Again, I want to--my time is short, and I have run out, 
actually. I want to thank you again for your willingness to 
come here and help this committee with its work. Thank you.
    I yield back.
    Mr. Markopolos. Thank you.
    Chairman Kanjorski. Thank you very much.
    Now the gentleman from Illinois, Mr. Manzullo.
    Mr. Manzullo. Thank you, Mr. Chairman.
    Mr. Markopolos, could you draw any parallels between what 
happened in Madoff's case and those with the hedge fund 
operator, Arthur Nadel? And also whether or not you are 
familiar with any rules of distribution as to--in the event 
that money is recovered, whether or not those investors who had 
received distributions would be preferred over those--those 
investors who had not received distributions would be preferred 
over those who had received distributions, i.e., a clawback?
    Mr. Markopolos. It is a God awful mess with the clawback. I 
know only what I have read. I am not a lawyer to make legal 
interpretations, so I prefer not to.
    Mr. Manzullo. The first part: the parallels between Nadel 
and Madoff?
    Mr. Markopolos. There are parallels with every Ponzi 
scheme. And the SEC, you would have thought, would know these, 
but apparently they do not. They do not have the experienced 
staff at the junior levels, and they are even worse off at the 
senior levels. One of the things about a Ponzi scheme is, it is 
a cash-eating monster. It has a voracious appetite for cash. 
You need new cash to pay off the existing old investors. So 
that is always--that is there for every Ponzi scheme.
    The other thing is, the numbers are always too good to be 
true. And the SEC has so little investment management 
experience that they don't know what the industry standards for 
good performance are and what the industry standards for 
unbelievable fraudulent performance are?
    And there were other red flags. But those are the two main 
ones for the Ponzi scheme.
    But they are so easy to recognize on the surface. If 
someone is advertising returns that are too good to be true and 
too smooth, you don't have enough down months, it is always up, 
up, up and away, how can you not see these if you are the SEC? 
And those are the questions you are probably going to be asking 
the next panel.
    Mr. Manzullo. Are you familiar with the hedge fund 
registration law that is being proposed by Mr. Castle and Mr. 
Capuano, and if that had been in effect, whether or not that 
could have saved investors at Nadel?
    Mr. Markopolos. Registration always helps. But if the SEC 
doesn't send trained teams in to do the inspections and 
examinations, it is not going to really lead to a better 
result. Because the SEC already has jurisdiction over Ponzi 
schemes. If there is fraud out there, it doesn't matter if you 
are registered or unregistered, the SEC has the authority to 
attack it. They just don't have the ability or the willingness.
    Mr. Manzullo. In the Nadel case, he was disbarred as an 
attorney from the New York Bar. And there is some thought that 
if the investor into his hedge funds had had some knowledge of 
that, that obviously that could have been a deterrent.
    In the registration that takes place presently, would that 
type of character flaw or legal issue come up in the 
registration that a person had been disbarred?
    Mr. Markopolos. Oh, certainly in the SEC Form ADV, if you 
are a registered investment adviser, you would make disclosure 
there. But I don't know how you are going to get these people 
to register if they are running a hidden Ponzi scheme. I don't 
know that investors know enough to go to the SEC's Web site and 
check for the ADV registration forms.
    So I think these people aren't going to go on the map. I 
think they are going to remain hidden below the surface or 
underneath the rocks. So I don't know that registration is the 
be-all and end-all.
    You certainly want them to register; and if they are not 
registered and the SEC receives a tip on them, well, that is a 
glaring red flag that fraud is taking place here. So it is an 
immediate red flag to the SEC that there is something here, 
they are not registered, we are getting a complaint about 
someone who is not registered. And they can go in expecting to 
find fraud, and chances are, they will find it. So I just think 
it is a great idea to make them register.
    Mr. Manzullo. I have a last question. That is--you 
obviously brought this to the attention of the SEC. Do you have 
any idea how many other funds, characters, had been brought to 
the attention of the SEC? Is it in the tens, the hundreds, the 
    Mr. Markopolos. I just know that you saw the example of my 
work that I turned in. I have seen several examples just like 
that of at least as high a quality that were turned into the 
SEC by people who have come to me asking for advice, how to go 
to the SEC, because they know--they knew that I was going to 
the SEC. And they submitted their complaints to the SEC that 
were at least as good as mine, and the SEC never bothered to 
pick up the phone or even show up to investigate.
    So this is common and systemic. They ignore the big cases.
    Mr. Manzullo. Thank you.
    Chairman Kanjorski. Thank you very much, Mr. Manzullo.
    Now Mr. Perlmutter of Colorado.
    Mr. Perlmutter. Thank you, Mr. Chairman.
    And, Mr. Markopolos, thank you for your testimony today and 
your persistence in this. I really appreciate sort of the 
forensic approach you took to this.
    But first I have to make a statement, because you talked 
about it: It starts at the top down. And I want to take a shot 
at my friends on the other side of the aisle. When you vilify 
people who are regulating the system so that taxpayers don't 
have to pick up the pieces, or that the depositors of a bank 
don't have to pick up the pieces, or shareholders don't have to 
pick up the pieces, but you vilify those regulators and you 
make them out to be the bad guys in the system, then they 
become the bad guys in the system.
    So there are philosophical differences between my side of 
the aisle and the need for regulation so that the taxpayer 
doesn't pick up all the pieces when everything goes to hell and 
wanting to keep the markets completely free so that the guy can 
make the last obscene buck. So that is my statement for the 
    Now let's just talk about a couple of things. I think you 
are right on the money with young people, inexperienced, 
ultimately wanting to go into the business, you know, to go to 
investment bankers, etc., being the regulators in the first 
place. They are going to be nervous. And you are right about 
picking some people who have seen this stuff before. This is 
not rocket science, finding a Ponzi scheme. You found it in 4 
hours, and I know you were looking for it. But when it is too 
good to be true, then you stop and you take a breath and say, 
what is going on here?
    My questions are, you went to the media and you had stories 
written about this. You have, supposedly, sophisticated 
investment fund managers who were investing into this. What 
happened with them? Why didn't they see this?
    Mr. Markopolos. I think one big reason is the feeder funds 
were preying on the people that they were close to. Ponzi 
schemes are, above all, an affinity fraud. We saw that in the 
United States, where Mr. Madoff was Jewish, he preyed on the 
Jewish community. But that is all he did here.
    Overseas, he used different connections, and he actually 
took royal families to the cleaners, European aristocracy and 
high-born families and the nouveau riche. So I think the losses 
in Europe will actually be bigger than they are here in the 
United States; but they are going to be more hidden because a 
lot of that money invested from overseas was untaxed money in 
offshore jurisdictions, and they can't admit the losses or else 
their host nation authorities will come and investigate them.
    So there are reasons for this failure.
    Mr. Perlmutter. Here is my question. I mean, you were 
looking for this, I think. You know, I look at your timeline, 
your chart here, which is very good; and you were asked by 
Rampart Investment to try to figure out what this, you know, 
split strike strategy--which, in my opinion, is a bunch of 
baloney; you know, it is like the black box that everybody uses 
for a Ponzi scheme.
    But you were asked and you discovered this. Shouldn't those 
investment managers have seen something that just didn't smell 
    Mr. Markopolos. But they were paid so much to look the 
other way.
    Let me explain the fee scheme in the Madoff Ponzi.
    Mr. Perlmutter. Please. Thank you.
    Mr. Markopolos. Mr. Madoff was purporting to only be taking 
commissions from this product, even though he was a hedge fund 
manager who usually would take a 1 percent management fee and 
20 percent of the profits. He was so generous a human being 
that he was offering those fees to the feeder funds to lure in 
new victims.
    And so, let me explain the fee structure to you. To deliver 
12 percent annual returns, he needed to be earning 16 percent 
gross, because there were 4 percent in fees. He was passing the 
4 percent in fees along to the feeder funds and keeping only a 
smidgen for himself. And so those feeder funds were 
incentivized not to ask the questions, to be willfully blind, 
if you will, and not get too intrusive into the Madoff scheme.
    Mr. Perlmutter. Okay.
    What happened--you know, I noticed, in December of 2005, 
you went to the Wall Street Journal. What happened? Did they 
publish anything about this? It says you went to--I start to 
doubt New York SEC and contact WSJ. I assume that is the Wall 
Street Journal, Washington Bureau.
    Mr. Markopolos. I did go to them, and I lost confidence 
quickly in the New York regional SEC to conduct this 
investigation. I lost it very quickly; it just took a couple 
weeks to lose confidence in them. I could see how bumbling they 
    And I was worried with my safety because the New York 
branch chief and the team leader knew my name. And if they were 
corrupt, I thought I was a dead man. And so to protect myself, 
I went to the Wall Street Journal's Washington Bureau; and that 
reporter, who was very senior and very good, was ready to come 
on a plane to Boston several times in 2006-2007. But I believe 
that senior editors at that publication respected and feared 
Mr. Madoff, and they never let him get on a plane, no matter 
how much he wanted to get on that plane.
    Mr. Perlmutter. Thank you for your testimony. Thank you for 
your service on this.
    Chairman Kanjorski. Thank you, Mr. Perlmutter.
    Mr. Donnelly of Indiana.
    Mr. Donnelly. Thank you, Mr. Chairman.
    Mr. Markopolos, thank you for being here. You talked about 
respect and fear of Mr. Madoff. And in reading your document 
entitled, ``The World's Largest Hedge Fund is a Fraud,'' you 
mentioned some pretty prominent financial organizations that 
basically said, oh, we don't touch this guy; we know it is a 
    Do you know if any of those organizations also contacted 
the SEC with their concerns, in effect putting more weight 
behind what you were saying?
    Mr. Markopolos. I am not privy to all the complaints that 
the SEC receives, so I can't answer that question from their 
perspective. But I believe that I was the only one to 
investigate and do the math proofs. And my team were the only 
ones out there closely tracking Mr. Madoff every step of the 
way and building a voluminous volume of information against Mr. 
    So I think my team was the only one out there tracking him. 
And we feared for our lives if he discovered that we were 
tracking him.
    Mr. Donnelly. And these very prominent Wall Street 
organizations that said, hey, Madoff is a fraud, we stay away, 
was it in effect a club-like atmosphere where, well, we are not 
going to say anything about Bernie because, you know, that 
might come back on our business?
    Was that atmosphere rife throughout the people you were 
dealing with?
    Mr. Markopolos. In Wall Street there is a code of silence. 
And when you live in a glass house, you do not throw stones.
    Mr. Donnelly. And with that code of silence, this is with 
the very same people that the American people are looking to 
trust, because they are giving every dollar of retirement 
savings or the funds they have accumulated, working hard every 
day at the shop, that they have been placing their trust in.
    Mr. Markopolos. If it is misplaced trust in fraudsters, 
especially the white collar variety. These people are much more 
dangerous than any bank robber or armed robber because these 
people, the white collar fraudsters, are the most prestigious 
citizens, they live in the biggest and best houses and have the 
most impressive resumes.
    So when they commit a fraud scheme, they destroy companies 
and they throw thousands of people out of work, and they 
destroy confidence in the American system such that capital 
becomes unavailable at any price or it raises the price of 
capital. We cannot afford not to find white collar criminals 
out and punish them severely.
    Mr. Donnelly. And is there--you mentioned that so many of 
the companies knew Bernie was a fraud, Bernie Madoff was a 
fraud. Is there also, even today, within these organizations 
like a list of other companies that they look at and say, we 
stay away from these guys; it doesn't smell right, it is not 
working right? Is there a whole group that people are staying 
away from at this time?
    Mr. Markopolos. Yes, there are. And they don't come 
    There could be many reasons. I think the main reason is, if 
you are committing fraud yourself, you are not going to tell on 
somebody else's fraud scheme for fear somebody will do the same 
to you. And so they remain silent; there is a code of silence. 
They know who these people are, the fraudsters are.
    They need to start coming forward. Otherwise, our Nation's 
system of finance falls apart, investors will stay away, and 
businesses won't have access to capital.
    Mr. Donnelly. So one of the things the SEC--it would be 
beneficial to do is, find out who else the organizations that 
are--that there are concerns about out there; and go through 
their books and find out how they are running their businesses 
and find out who has red flags out there.
    Mr. Markopolos. Right now, there are no incentives for the 
SEC. Right now, the SEC exists to protect financial predatory 
organizations from investors. That seems to be their mission 
statement. And we need to change the whole focus.
    The only way you can do that is to offer incentives to the 
staff such that anybody that gets in their way when they go 
after a fraud scheme, for whatever reason, they run them over 
with a bulldozer, because they have their own bonus on the line 
and they want their bonus.
    Mr. Donnelly. We asked the Inspector General of the SEC 
when he was here, or the question I asked him was, ``How many 
red flags do you need before it sets off an alarm with a 
particular organization that you send the examiners in?'' And 
he said, ``It should only be one.''
    In the Madoff case, in your document, I think you were in 
the 20s on red flags; but certainly just in that testimony, we 
had four or five.
    And so they should, the SEC, have a list of organizations 
that there are red flags that they can look at to make sure 
that investors, that Americans who are working hard every day, 
can have confidence again.
    Mr. Markopolos. That is true. They have both an inability 
to find fraud, and they lack the willingness to attack fraud. 
And that needs to change. And I think the only way you are 
going to change that is, change the tone at the top. And you 
need to replace the senior staff of the SEC, because right now 
the junior rank and file out in those regional offices has lost 
confidence in their senior staff.
    Mr. Donnelly. Mr. Markopolos, thank you very much for your 
    And, Mr. Chairman, thank you for having this hearing.
    Chairman Kanjorski. Thank you, Mr. Donnelly.
    Now the gentlelady from California, Ms. Speier.
    Ms. Speier. Thank you, Mr. Chairman. Maybe we should get it 
straight. Is it ``Markopolos'' or ``Markopolos?''
    Mr. Markopolos. I answer to all.
    Ms. Speier. All right. Mr. Markopolos, I would like to just 
say for the record that I see you as a modern day Greek hero; 
and I want to thank you for the perseverance.
    I was kind of amused a little bit to note that after all 
these years, you finally quit the investigation earlier last 
year. Why was that?
    Mr. Markopolos. It was so much pent-up frustration. To that 
point, I had been on the SEC's doormat for 8 years and taken a 
lot of abuse from that Agency, and was ignored by that Agency.
    I only had two champions within the SEC out of 3,500, so 
3,498 people at the SEC were not helping me. I had two 
advocates, two champions, in Boston--Ed Manion and Mike 
Garrity. That was the only support I got. And Mr. Manion told 
me it was my public duty to keep leading the investigative team 
forward because if I didn't do it, no one would; and it was 
such a danger to our capital markets if this was left unchecked 
that I needed to step into the breach and do something.
    But after my April 2nd submission of last year to the SEC's 
Director of Risk Assessment, Mr. Jonathan Sokobin, and I got no 
response back, at that point I lost all confidence in the SEC.
    Ms. Speier. You spoke about not using your name, handing 
over documents with gloves on. You know, that is a bit of 
paranoia, one might say. And I want to know why you had that 
concern and if you suffered any recriminations.
    Mr. Markopolos. I don't consider it paranoia. And the 
reason is Mr. Madoff was running such a large scheme of 
unimaginable size and complexity. And he had a lot of dirty 
money. Let me describe dirty money to you. When you are that 
big and that secretive, you are going to attract a lot of 
organized crime money and--which we now know came from the 
Russian mob and the Latin America drug cartels. And when you 
are zeroing out mobsters, you have a lot to fear. He could not 
afford to get caught, because once he was caught and once he 
knew--if he would have known my name, and he knew that he had a 
team tracking him, I didn't think I was long for this world.
    Ms. Speier. All right.
    In your testimony, you reference Ms. Cheung in New York as 
the Branch Chief. And you say, ``She never grasped any of the 
concepts of my report, nor was she ambitious enough or 
courteous enough to ask questions of me. Her arrogance was 
highly unprofessional, given my understanding of her 
responsibilities and mandates.
    ``When I questioned whether she understood the proofs, she 
dismissed me by telling me that she had handled the 
multibillion-dollar Adelphi case. I then replied that Adelphi 
was a mere few-billion-dollar accounting fraud, and that Madoff 
was a much more complex derivative fraud that would easily be 
several times the size of Adelphi. She never expressed even the 
slightest interest in asking me questions.
    ``She told me that she had my report, and if she needed 
more information, she would call me. She should be fired.''
    Mr. Markopolos. She already left the Agency, but otherwise 
I would agree.
    It is too late.
    Ms. Speier. You referenced that you thought there needed to 
be housecleaning. And yet there are people, by your own 
reference, in the New York attorney general's office and in the 
Massachusetts Securities Division who are doing great work.
    So it is not a lack of talent out there. It is a lack of 
really identifying the talent and bringing them in; wouldn't 
you say that?
    Mr. Markopolos. I would agree. And I would urge the 
Congress to consider the fine examples set by the New York 
attorney general's office and the Massachusetts Securities 
Division. They give great regulation on the big cases that are 
nationwide fraud cases, and they get full restitution to the 
victims. They are aggressive.
    But they are small. They don't do a lot of examinations. 
All they do is take in whistleblower tips and act upon them and 
act vigorously. They are pit bulls against financial 
fraudsters. And here we have a pip-squeak of a flea in the SEC.
    So it is not the size of the dog, it is the size of the 
fight in the dog. And that is why I commend those two State 
regulators. They are very aggressive.
    And if the SEC does not reform itself, you have an option. 
Just disband the SEC, zero out their budget, put all 3,500 of 
those people on the streets, because they are not protecting us 
right now; and just fund the New York attorney general's office 
and the Massachusetts Securities Division.
    Ms. Speier. All right. My time is about to expire so let me 
ask you one final question: Fairfield Greenwich and Tremont, 
sophisticated investors, and yet they did not do their due 
diligence. Should we be going after them as well? Should 
someone be going after them because they ripped off the 
American people?
    Mr. Markopolos. I would say they need to be looked into. If 
they didn't know, they were willfully blind, and they got paid 
a lot of money to be willfully blind.
    Ms. Speier. Since I have opportunity for one more question, 
there was a reference made to the attorney in the SEC who later 
married Mr. Madoff's niece.
    Do you know any more about that?
    Mr. Markopolos. I am not privy to the SEC's investigation.
    Ms. Speier. Thank you.
    Chairman Kanjorski. The gentleman from Ohio, Mr. Wilson.
    Mr. Wilson. Thank you, Mr. Chairman.
    Thank you, Mr. Markopolos, for coming forward today and for 
what you have done to this point to point out the greed and 
what is really going on. It always amazes me in America that we 
can lock up a single mother for stealing a can of spaghetti 
sauce at the convenience store, but we allow this kind of stuff 
to go on. It is just hard to understand.
    Do you think that the size of the SEC--you said 3,500 
people--is that they need 4,000; or do they need a little 
mission statement or maybe some integrity in there? What--in 
your own opinion, what do you think can be done with the SEC to 
make them effective?
    Mr. Markopolos. First of all, I think 3,500 is a lot of 
people. You need 3,500 better people to start with. Before you 
get bigger, you need to get better. You need to replace the 
people that you currently have, upgrade them with industry 
veterans. And then you need to equip them adequately for the 
fight. Right now they do not use Bloomberg's. Every portfolio 
manager, every trader, every analyst on Wall Street uses a 
Bloomberg machine. And the SEC, they are lucky if they have one 
per regional office. If you are not equipped with the tools to 
do the fight, you are showing up at the gun fight without a 
gun, you are going to lose every time, and that is why they 
lose every time.
    Mr. Wilson. So in other words, the quality of what they are 
doing, the equipment to work with, and the ability to move 
forward and actually make change is what really needs to be 
    Mr. Markopolos. Yes.
    Mr. Wilson. My second question has to do with auditing, 
which I would think is one of the things the primary would 
focus when there are wrong things being done. Could it be a 
random assigned auditor rather than the same old same old that 
they have every time?
    Mr. Markopolos. I would rotate the teams personally. You 
want a fresh set of eyes looking at the books and they want a 
fresh set of trained eyes. Right now those eyes are not 
trained. They are also not trained in human intelligence 
gathering. When they come in to inspect a firm, they are led to 
a conference room. They meet the compliance staff and they are 
fed controlled pieces of paper. That is what they do. They 
inspect pieces of paper because they are too untrained to 
realize what to look for on the financial end. All they are 
looking for is pieces of paper. If they see the pieces of 
paper, you are going to get a fine audit report back from the 
    What they need to be doing is talking to the portfolio 
managers, to the traders, to the marketing people, to the 
client service officers, the information technology people. And 
they need to be interacting with them and saying, is there any 
fraud here? Is there anything illegal or unethical happening 
here? And if you get a ``no'' answer, say fine, thank you. Is 
there any fraud anywhere else in any other organization that 
your firm deals with or that you know about? And then you hand 
them your business card. And you say if there is, if you ever 
discover a fraud, please let me know. And hand them the card. I 
think if you do that, you will increase audit effectiveness.
    Mr. Wilson. It sounds like a pretty good commonsense way to 
approach it. I guess part of my question, too, is instead of 
having the same firm each time where a lot of times you know we 
could see just the cover pages change and the numbers reflect 
whatever happened that year. But are they really reaching in 
and interviewing with the people who are preparing those papers 
with them? As you said, are they really drilling down on it and 
saying, is there fraud? Is there anything that you are upset 
about or that you are concerned about? And yes, here is my 
card. And contact me as soon as possible if there is anything 
you can help us with.
    Mr. Markopolos. The SEC staff are afraid to ask those 
questions because they fear the answer would be yes, there is 
    Mr. Wilson. That is tough. What about the bounty hunter 
situation that has been mentioned? Is that any kind of a way to 
look to try to get a grip on this thing, to get a handle on it?
    Mr. Markopolos. If you incentivize private parties who work 
at these firms that are committing fraud and you incentivize 
them enough, they will come forward with the books and records 
that solve the case quickly, easily, at low or no expense to 
the government. They would be your best source.
    Mr. Wilson. That is good to hear. Sounds like some pretty 
good commonsense things could correct a lot of what is going 
on. Thank you, Mr. Markopolos.
    Chairman Kanjorski. Thank you very much, Mr. Wilson. The 
gentleman from Florida, Mr. Grayson.
    Mr. Grayson. Thank you, Mr. Chairman. Mr. Markopolos, in 
the year 2000, the last year of the Clinton Administration, the 
SEC brought 69 cases of securities fraud and prosecuted them. 
In the year 2007, the 7th year of the Bush Administration, it 
brought 9 cases; that is 69 versus 9 cases. What is your 
experience in general with the enforcement of the securities 
laws in the Bush years?
    Mr. Markopolos. There is a difference between zero 
tolerance for fraud and zero enforcement of fraud, and I think 
we have had zero enforcement.
    Mr. Grayson. Zero enforcement for the past 8 years?
    Mr. Markopolos. Correct.
    Mr. Grayson. Now you have referred to this several times, 
the Ponzi scheme. Is that a rather newfangled thing?
    Mr. Markopolos. It is rather old. It is from where I am, 
Boston, Massachusetts, 131 School Street in downtown Boston. 
These are rather old schemes. You would think that the SEC 
would be on to them by now, but apparently they are not.
    Mr. Grayson. So when did Mr. Ponzi actually operate?
    Mr. Markopolos. He operated in, I believe, the early 
1930's, late 1920's.
    Mr. Grayson. So this isn't a question of mastering some 
complicated derivatives, right?
    Mr. Markopolos. No. Mr. Madoff was actually not using any 
derivatives whatsoever. That was just the hook, that was just 
the facade. Underneath it, there was nothing.
    Mr. Grayson. I understand that in 2005 you wrote a letter 
regarding the scheme and the title was, ``The World's Largest 
Hedge Fund Is a Fraud''; is that correct?
    Mr. Markopolos. It is.
    Mr. Grayson. Could you have possibly been more explicit?
    Mr. Markopolos. I even drew pictures. So I don't know how I 
could have been more explicit. I gave them a roadmap and a 
flashlight to find fraud and they didn't go where I told them 
to go or ask the questions that I told them to ask or call the 
people that I told them to call.
    Mr. Grayson. Who did you address that letter to?
    Mr. Markopolos. I initially sent it to the SEC regional 
office in Boston, to Mr. Ed Manion. He put me in touch with 
Mike Garrity, an SEC Branch Chief in Boston, who actually 
believed me, and knew my credentials, he vouched for me, found 
several irregularities. In a week's time, he did more than the 
entire New York regional office and he said, there is something 
here. I am going to put you in touch with that New York 
regional office. And he did. But they refused to follow up.
    Mr. Grayson. The year before you sent that letter in 2004, 
I understand the SEC convened a session and a gentleman made 
this statement at that session regarding what he proposed, the 
deregulation of Wall Street firms. He said, ``You really have 
to start with the assumption that most of us in this industry 
really are our clients' interest coming first.'' Do you know 
who made that statement?
    Mr. Markopolos. No.
    Mr. Grayson. Mr. Madoff made that statement. Are you 
familiar with the concept of capture when you are talking about 
regulation? What is that? Do you know that concept?
    Mr. Markopolos. Yes. It is basically when the regulator is 
in bed with the industry they purport to regulate and do not 
regulate the industry. In fact they consider the industry the 
clients, not the public citizens.
    Mr. Grayson. And have you seen that in action?
    Mr. Markopolos. Yes. At the Food and Drug Administration 
and at the SEC.
    Mr. Grayson. As of now, Mr. Madoff was arrested and he is 
confined, correct?
    Mr. Markopolos. He is under penthouse arrest.
    Mr. Grayson. Penthouse arrest. Can you explain that 
    Mr. Markopolos. He is leading a life of luxury, and he does 
have serious complaints. He is not able to go out for his 
    Mr. Grayson. I understand that his luxury apartment costs 
$7 million. Does that sound about right?
    Mr. Markopolos. It does.
    Mr. Grayson. Where did he get that $7 million from?
    Mr. Markopolos. From the victims.
    Mr. Grayson. Now I also understand that he is confined and 
his confinement is regulated and guaranteed by security guards, 
is that correct?
    Mr. Markopolos. Yes.
    Mr. Grayson. And who hired those security guards?
    Mr. Markopolos. I am not aware of who hired them.
    Mr. Grayson. Actually he hired them. Isn't that correct?
    Mr. Markopolos. I am not sure.
    Mr. Grayson. I yield back the rest of my time. Thank you, 
Mr. Chairman.
    Chairman Kanjorski. The gentleman from Illinois, Mr. 
    Mr. Foster. You had mentioned that actually you are 
blacklisted from industry if you bring forth one of these 
cases. Are there more specifics that you can give us on that or 
examples where that has happened?
    Mr. Markopolos. Yes, me. I have crossed the Rubicon. I can 
never go back.
    Mr. Foster. Are you aware of other similar cases where 
people are basically not allowed to participate or are 
informally blacklisted?
    Mr. Markopolos. Yes.
    Mr. Foster. Like this?
    Mr. Markopolos. Many.
    Mr. Foster. I guess it is unreasonable to ask about 
details, but I may ask you privately about that.
    You know, I am very interested in this issue of the 
principles from right sizing the SEC, that there be some sort 
of balance between the losses that are suffered from the SEC 
from securities fraud and the amount of money you put in. I 
guess that may have been handled recently, but I think that is 
the fundamental question that this committee has to deal with, 
to make it so that, you know, perhaps automatically the SEC is 
scaled as the industry expands so that it has the right level 
of staffing competence and, well, competence and manpower for 
    One of the things that troubled me was the whole issue of 
secrecy. I guess there is something that is absolutely 
necessary that these things have to be handled secretly because 
if nothing else, for the possibility of market manipulation. I 
was wondering if you are experienced with the necessity of 
secrecy during these investigations. Is that something that you 
view as an essential thing or something you have been 
frustrated with when you see it not operating properly or not 
operating properly in secret?
    Mr. Markopolos. For me, I had to remain secret. We have 
feared for our health and safety. The government should have no 
fear, but it seemed all they did have was fear of Mr. Madoff 
and fear of the big cases.
    Mr. Foster. And then another thing that struck me was the 
business of segmenting and compartmentalizing what the 
regulators were looking at. I was wondering if it was easier 
for the SEC to be overseeing a more compartmentalized interest, 
if there were not things like dual registration and self-
custodians, if you had people whose job it was just to look at 
custodianship issues and they would just go through everyone 
that claimed to be a custodian and they would have a simple set 
of things to look at. If you are understanding what I am 
saying. Just putting up firewalls and very clear separations in 
the segments of the industry, that might solve part of the 
problem with the--sort of the competence issue that it is 
easier--you know, that is one of the young kids that you 
referred to that aren't really well trained could be taught, 
here is exactly what you look at for custodianship issues, and 
make the oversight more effective.
    Mr. Markopolos. You can do that. You need subject matter 
experts who are very familiar with specific areas. But you need 
to have combined enforcement teams, where that is one person on 
your team. You also have the investment manager guy or gal who 
came from industry and knows exactly what to look for. You also 
need the accountant on the team who knows how to read the 
financial statements with a fine-toothed comb. So you need to 
combine those people on the same team and have them coordinate 
and communicate among themselves in order to attack the truly 
big frauds.
    Mr. Foster. Okay. I just thought--probably reiterate my 
respect for what you have done. We need thousands more like you 
out there.
    Mr. Markopolos. Thank you.
    Mr. Foster. I yield back.
    Chairman Kanjorski. The gentleman from Texas, Mr. Green.
    Mr. Green. Thank you, Mr. Chairman. And I especially thank 
you because I am an interloper today. I am grateful you have 
allowed me the opportunity to ask Mr. Markopolos a few 
    Mr. Markopolos, or Markopolos, by any name, you have done 
your country a great service. By any name, your country owes 
you a debt of gratitude.
    Mr. Markopolos. Thank you.
    Mr. Green. And by any name, I and many others can 
understand why you were in fear of your life. And I believe 
that fear to have been well-founded because you were dealing 
with a ruthless person who was in bed with other ruthless 
people. When you deal with the kind of characters that you were 
trying to bring to the bar of justice, you have to be concerned 
not only about yourself but about other family members who are 
near and dear to you.
    I am not sure that the American people really know who you 
are. You are not just some person off the street. And while 
every person is important and all life is precious, you are not 
just a person off the street. You are a person with 
credentials. You are a person who has paid dues and who is 
respected. And I would like for you, if you would, to share 
some of your credentials with the public so that people can 
really understand who you are.
    Mr. Markopolos. Thank you, Congressman. I am a Chartered 
Financial Analyst. I am a Certified Fraud Examiner. I have an 
undergraduate degree in business administration from Loyola 
College in Baltimore, Maryland. I have a masters in science in 
finance degree from Boston College. I used to manage billions 
and billions of dollars in equity derivatives and trade these 
securities as chief investment officer for a rather mid-sized 
firm in Boston. I have a military background. I served this 
Nation for 17 years as an officer. I commanded troops at every 
level from second lieutenant to major. My last 7 years were in 
Army Special Operations where my unit that I commanded had 
teams overseas. This was a reserve unit. This is part time. I 
had people overseas 24/7 every day of the year serving this 
    Mr. Green. Thank you. Two other points, and I will yield 
back the balance of my time. The first is, do you agree that 
the tone and tenor of the behavior of those who serve at the 
bottom is shaped by those who serve at the top?
    Mr. Markopolos. I do. You lead from the front. If the SEC 
Chair is not aggressive and competent, the organization cannot 
succeed. Everything comes from the top.
    Mr. Green. And do you also agree, sir, that we could have a 
million people in place to perform the investigative function. 
But if we don't have the will to perform that function, the 
number of people becomes to some extent inconsequential?
    Mr. Markopolos. I would agree. Right now, the SEC staff 
consists of 3,500 chickens. We need to put some foxes in there 
and we need to compensate them. We need to give them 
incentives. We need to get the right people. I don't think it 
is a matter of right sizing. It is a matter of right staffing. 
And right now we have the wrong staff, particularly at the 
senior levels.
    Mr. Green. And finally, sir, in your quest for justice, did 
you happen to go by way of your own entry or by way of some 
sort of communication device, a communication to the Inspector 
General's Office? And I am asking, did you go personally or did 
you send some message to the Inspector General's Office which 
has some degree of oversight?
    Mr. Markopolos. I did not.
    Mr. Green. For edification purposes, if you had the chance 
to do this one more time, and I pray that you will never have 
to do what you have done again, would that be an office that 
you would consider taking your evidence to? Or were there 
reasons that you would like to share as to why the Inspector 
General's Office was not a part of the circle that you tried to 
get this intelligence to?
    Mr. Markopolos. An Inspector General's Office is only as 
good as the Inspector General in the office. And with Mr. Cox, 
if he had been the Inspector General back then when I was doing 
this investigation, I would have gladly gone to him and trusted 
him to do the right thing. But the prior occupants of that 
office, I would have never gone to them.
    Mr. Green. Thank you, Mr. Chairman. I yield back the 
balance of my time.
    Chairman Kanjorski. Thank you very much, Mr. Green. Now we 
have had a nonmember of the committee waiting for an awfully 
long time, Mr. Arcuri. And Mr. Maffei, who is a member of the 
committee, has kindly consented to passing over his right under 
the rules to be heard now to give it to you. So Mr. Arcuri, 
your 5 minutes.
    Mr. Arcuri. Thank you, Mr. Chairman and Mr. Ranking Member, 
for allowing me to sit in on this hearing. It is very 
interesting. And thank you for holding the hearing. And Mr. 
Markopolos, thank you very much for what you have done.
    You know, I think many people look at the Madoff scandal 
and they think that it is just the wealthy and sophisticated 
investors who have been hit by this. But I am here today to 
talk a little bit about some of the other people who have been 
hit by it. I just want to mention a few of the groups: The 
Bricklayers, Allied Craft Workers, the International Union of 
Operating Engineers, the United Association of Journeymen, 
United Association--a second group of journeymen, Local 267, 73 
and 112 of New York, the Carpenter's Local 747 out of Syracuse, 
and the United Union of Roofers. All of these groups are from 
upstate New York. They were hit for pension and health care 
benefits between $300- and $400 million. These are not very 
wealthy people. These are hard-working people who have lost not 
only their health care benefits but also their entire 
retirement. There has been a long line outside of my office 
door. And I think I can speak for my colleague, Mr. Maffei, 
outside of his door as well, as we both represent upstate New 
    Obviously, my concern is this, many of these investors are 
not the very sophisticated investors. They are--they manage 
small pension funds. What can the small investors do to keep an 
eye out for the sharks that are out there like Mr. Madoff?
    Mr. Markopolos. I am afraid that they may be on their own 
unless they hire consultants and trust those consultants, and 
hire only competent consultants because clearly the SEC is not 
out there guarding the hen house.
    Mr. Arcuri. You know, and the point that you made when you 
held your arm out and showed the 45 degree angle curve. And you 
can't help but think, if it looks too good to be true, it 
probably is. Does the market itself, do they look at, you know, 
competitors who are out there, who are doing jobs that are too 
good to be true and say, hey, something must be wrong here; 
somebody needs to look into this?
    Mr. Markopolos. Well, I am afraid not. They missed 
subprime. They missed the collateralized debt obligations, the 
collateralized loan obligations. They missed so much it is hard 
to just trust in the professionals. You need competent 
regulators as well, and you also need common sense.
    Mr. Arcuri. My concern is this, if I am an investor and I 
am looking at the two prospective groups to invest my money in 
and one is doing everything legally and they are giving, let's 
say, 5 or 6 percent, and then you are looking at a Madoff who 
is giving a return of, say, 10 or 12 percent, the person who is 
giving the 5 or 6 percent has to be looking at Madoff and 
saying, something has to be wrong here, someone needs to look 
at that. Isn't there more pressure from the actual private 
sector itself to look into these?
    Mr. Markopolos. I am afraid the private sector would look 
at the Madoff returns and say, he is getting more return, 
taking less units of risk, therefore I love Mr. Madoff better 
and I want to invest with him more. So greed often overrules 
common sense.
    Mr. Arcuri. Now do you think there is a way to strike a 
balance between the SEC type of oversight and oversight from 
the private sector itself?
    Mr. Markopolos. I am sorry.
    Mr. Arcuri. Is there any way to strike a balance between 
actual oversight by the SEC type entities or the New York 
Attorney General and the private sector in terms of overseeing 
    Mr. Markopolos. Regulators overseeing itself or private 
sector overseeing itself?
    Mr. Arcuri. Private sector, yes.
    Mr. Markopolos. That is why I recommended a whistleblower 
program to compensate people from within the industry who know 
about the fraud but fear blacklisting, to step forward 
anonymously--or the government would know who they are so that 
an investigation could be conducted immediately and put a quick 
halt to these frauds before they lure in too many victims.
    Mr. Arcuri. And the last question I have for you is this: 
You talk about needing the SEC to be looking at bringing in the 
people who have been in the private sector for a while, who are 
the fox that you call them, and putting them in charge. But 
then you make references to the New York Attorney General, to 
the--I think it was the Massachusetts.
    Mr. Markopolos. Securities Division.
    Mr. Arcuri. Securities, thank you. And yet they don't have 
that type of people in their office. They have small, lean 
offices. How do they do it and the SEC is not able to do it?
    Mr. Markopolos. It is easy. They rely on whistleblowers to 
come in with tips which they vigorously pursue. When the SEC 
gets a tip, it vigorously ignores it.
    Mr. Arcuri. I want to thank you again very much and thank 
you on behalf of the hundreds, in effect thousands, of people 
in my district who have been ripped off and, hopefully more 
importantly, to thank you for the people that you have 
prevented from being ripped off because you were able to stop 
this and blow the whistle on Mr. Madoff. So thank you for what 
you have done.
    Mr. Markopolos. Thank you.
    Mr. Arcuri. Thank you, and I yield back, Mr. Chairman.
    Chairman Kanjorski. Thank you, Mr. Arcuri. Finally, Mr. 
Maffei of New York.
    Mr. Maffei. Thank you, Mr. Markopolos. Thank you, Mr. 
Chairman. I, too, am not on the subcommittee, though I am a 
member of the full Financial Services Committee. As Mr. Arcuri 
pointed out, I do have a neighboring district and many of those 
same groups overlap in my district and then there are some 
additional ones. I wanted to ask you just a couple of questions 
that may be along roughly the same lines. It is interesting 
that you said that you worked for a competitor of the firm that 
Madoff had. And I actually worked until coming to Congress for 
a small locally owned broker-dealer that was actually a 
competitor of some of these feeding broker-dealers. I guess we 
weren't quite as smart as you. We couldn't figure out how in 
the world they were getting back these returns. But of course 
we didn't know enough about what they were doing to avoid that 
risk. But it is interesting. There are a lot of victims here in 
terms of the good players in the financial services industry 
who didn't do these practices, who have been missing out on 
    But what I would like to know, do you think, given that it 
took you 5 minutes and then 4 hours, do you think that any 
responsible broker-dealer or investment adviser should have 
known there was something wrong?
    Mr. Markopolos. Yes. But I also think that they were so 
highly compensated--because a majority of the fees--and this is 
where Madoff was very clever. He left them 3 to 4 percent of 
the fees and took just a tiny bit for himself. So they became 
blinded by greed or willfully blind, if you will, and 
assiduously looked the other way.
    Mr. Maffei. Thank you. Given the fact that, according to 
your testimony, the Securities and Exchange Commission so 
dropped the ball on regulating this, so dropped the ball on 
catching this, do you think that like in so many other areas 
that the Federal Government has dropped the ball on regulation, 
that we have some responsibility to not make these investors 
whole again maybe but to do something for them, do some sort of 
a program?
    Mr. Markopolos. I will leave that to the Congress. I can't 
make those decisions for you. But clearly if the government had 
acted and acted responsibly, we wouldn't be dealing with these 
victims. So there is some obligation. We pay taxes. We want 
good government. We expect it to be provided. If we have 
regulators receiving paychecks, we want them to earn those 
paychecks and they did not in this case. So I think the victims 
would like some justice. I think they want heads to roll at the 
SEC. They want someone to clean house with a very wide broom.
    Mr. Maffei. Okay. Thank you. And I guess my last question 
is, who do you want to play you in the movie?
    Mr. Markopolos. Well, it had better be someone who is a Red 
Sox fan. That is all I ask.
    Mr. Maffei. I will avoid commenting on that. But I do 
appreciate your service to our country, Mr. Markopolos. Thank 
you very much.
    Chairman Kanjorski. Do you want somebody with hair?
    Mr. Markopolos. Not necessarily. Michael Chiklis is Greek 
and from Massachusetts, so I think he would be perfect.
    Chairman Kanjorski. Let me follow up on one little question 
there regarding the SEC. Feeder funds have to disclose their 
fees and commissions paid to the SEC in some audited form, is 
that correct?
    Mr. Markopolos. The feeder funds?
    Chairman Kanjorski. Yes.
    Mr. Markopolos. The feeder funds that are registered with 
the SEC do make disclosures about fees in their ADV form, yes.
    Chairman Kanjorski. Examining this thing of appealing to 
the greed of the feeder funds, somebody at the SEC, if they are 
going over this, were passing over it, but think about a $7 
billion fund that was being operated by Madoff from a feeder 
fund. And you are saying rather than a 1 percent fee going to 
them, he was allowing them to get 4 percent, which was huge. 
That is huge. It is $280 million. And somebody sitting down at 
the SEC should have looked at that, it seems to me, and said, 
that is quite a fee for just placing money, getting it from the 
client and placing it with the actual investment company. And 
so obviously they were not checking these audits or these 
reports. Or is that passed over and no one considers the 
difference in fees? It does not really matter?
    Mr. Markopolos. I don't think the SEC staff came from 
industry and understood how unusual and absurd this 
relationship is. Why would the ultimate investment manager, Mr. 
Madoff, take just a smidgen for himself, just commissions, and 
why would he allow the 1 percent asset under management fee to 
be charged plus the 20 percent override of profits each year 
which, as you totally spoke about, $280 million a year is what 
Fairfield Sentry was getting in fees each year, and they 
weren't looking very closely, were they? No. But the SEC never 
spotted it. And that leads me to say that the SEC examiners are 
very, very underqualified. What is worse is the Wickford Fund, 
which came out in May of 2007, offered 3 to 1 leverage to the 
Fairfield Sentry Fund. And I sent that to the SEC, Meaghan 
Cheung, New York City Branch Chief, on June 29, 2007, with more 
glaring red flags. And again they ignored the evidence.
    Chairman Kanjorski. Now if I remember some of your earlier 
responses to some of the other members, you indicated that you 
felt that the FINRA you felt was corrupt but the SEC was just 
incompetent. That is correct?
    Mr. Markopolos. That is correct.
    Chairman Kanjorski. Which is better, to be incompetent or 
to be corrupt?
    Mr. Markopolos. I would say I would give an A-plus to the 
SEC for incompetence and I would give the same grade to FINRA 
for corruption. And fortunately, the SEC was not corrupt as far 
as I could determine in this case. I think I am living proof of 
    Chairman Kanjorski. In what way? They saved your life in 
some way?
    Mr. Markopolos. I am still standing. I don't think I would 
have been if they had taken money to look the other way and 
told Mr. Madoff my identity and, by the way, these are the 
SEC's submissions he has been giving us over the years. I don't 
think I would be here today.
    Chairman Kanjorski. Very good. Well, we are going to have 
the SEC's representatives testify on the next panel. So we are 
looking forward to some of their responses.
    Mr. Garrett, do you have any further questions? Mr. 
    Mr. Ackerman. Thank you very much, Mr. Chairman. If I could 
address for just a moment what I generally would categorize as 
the cloak and dagger aspects of this, you have referenced, I 
think 7 or 8 times, about a fear for your life and handing 
documents over wearing gloves so that you didn't leave 
fingerprints and the fact that you are still alive, just a 
moment ago. Is that because the dollars are so big? Or was 
there some kind of threat that you actually perceived and 
reported or didn't report to lawful authorities? And following 
up on that, you made reference to, I believe in a question by 
one of our colleagues, that we now know that organized crime 
and the Russian mob were involved and investors. I am afraid we 
don't know that. Or at least I don't know that, and neither 
does any of the people that I have checked with on this side.
    Could you explain the involvement of the Russian mob and 
organized crime investing in Madoff? And how do you know, as I 
would presume they don't register as the Russian mob and put it 
in that name.
    Mr. Markopolos. We knew because of the offshore feeder 
funds and just the--
    Mr. Ackerman. Offshore feeder funds.
    Mr. Markopolos. The feeder funds that were offshore in tax-
haven nations attract dirty money. The only reason you go 
offshore is if it is dirty money, and we knew a very high 
percentage of that was from organized crime in various locales.
    Mr. Ackerman. How much of it is from organized crime?
    Mr. Markopolos. When you are dealing with offshore, 
anywhere from 5 to 50 percent would be--
    Mr. Ackerman. How much would Madoff in dollars, what 
percent was offshore?
    Mr. Markopolos. I would say--
    Mr. Ackerman. And how do you know that?
    Mr. Markopolos. I knew that from my June 2002 trip to 
Europe where I was meeting private client banks in France and 
Switzerland. I knew many of them were operating offshore. And 
just given the size, it is a statistical conclusion. If 5 
percent of the world's currency comes from organized crime, 
well, Mr. Madoff was going to be at least 5 percent organized 
crime for his investors. It is just common sense. But because 
it is a hedge fund that was so secretive and the returns were 
so good, it was a great bet, a very high odds bet that it was a 
lot larger percentage for Mr. Madoff.
    Mr. Ackerman. You are talking about all foreign investors 
from foreign countries?
    Mr. Markopolos. Not all.
    Mr. Ackerman. I am talking about when you talk about the 
Russian mob and organized crime. These are people who invested 
through European investors or European feeder funds?
    Mr. Markopolos. Correct. And I didn't fear them. I didn't 
think they were going to come after me. I want to make this 
perfectly clear to all those Russian mobsters and Latin 
American drug cartels out there.
    Mr. Ackerman. You are talking directly to them.
    Mr. Markopolos. I was acting on your behalf, trying to stop 
him from zeroing out your accounts. I am the good guy here. 
Make that clear.
    Mr. Ackerman. Yes. I think we registered that.
    The final question, I represent a large number of people 
who invested with Mr. Madoff, recently impoverished former 
philanthropists among them. The question that we get asked, all 
of us all the time, is, why didn't people do due diligence? If 
the SEC didn't pick it up, if the feeder funds who, as you say, 
were disincentivized from picking it up and everybody else, how 
were others, even sophisticated investors or large investors, 
able to do due diligence? Why didn't anybody else pick this up? 
What could they have done?
    Mr. Markopolos. The reason they didn't pick it up is that 
they looked at their friends at the country clubs--
    Mr. Ackerman. Yes. We know what happened. It was, you know, 
fabled and you look pretty stupid if you didn't.
    Mr. Markopolos. Correct.
    Mr. Ackerman. In some of those circles. The question is, 
what should they have done to have picked this up besides 
calling you? Is there nothing they could have done to figure 
this out? They all, as you say, got their statements. They 
figured it out. It was to the penny.
    Mr. Markopolos. I don't think that anybody had figured it 
    Mr. Ackerman. Could anybody have figured it out?
    Mr. Markopolos. If you did not have a derivatives and 
quantitative finance background, it would have been very 
difficult to figure this out on your own as an individual 
    Mr. Ackerman. The people who are blaming the victims for 
being stupid and not doing due diligence are off the mark?
    Mr. Markopolos. A lot of the victims thought they were 
getting highly diversified portfolios. This is the beauty of 
Mr. Madoff's scheme. He was purporting to own 30 to 35 of the 
bluest chip stocks, the largest companies in America, and they 
would see that on their statement, and they felt very 
comfortable owning those companies and they considered it a 
very diversified basket because it really was a very 
diversified basket.
    Mr. Ackerman. But there was nothing they could do to check 
it out, that he didn't actually buy it.
    Mr. Markopolos. You could. As an individual investor, you 
could not. But as a feeder fund, you should have been able to 
go to the New York Stock Exchange and see that those volumes of 
stock did not trade on that day at that price. They could have 
gone to the option price reporting authority that the Chicago 
Board Options Exchange offers, and you would have seen that no 
OEX index options traded at those prices that day. That is what 
you could have done and no one did that.
    Mr. Ackerman. And the SEC could have done that, too?
    Mr. Markopolos. If they knew how to do it, they could have 
done it. And if they had the willingness to do it, they could 
have done it. But they did not.
    Mr. Ackerman. Thank you very much.
    Chairman Kanjorski. If they knew how to do it. Are you 
suggesting they do not know to do that?
    Mr. Markopolos. I am suggesting that if you flew the entire 
SEC staff to Boston and sat them in Fenway Park for an 
afternoon, that they would not be able to find first base.
    Chairman Kanjorski. Well, one of the questions that struck 
me after they were forced to register in 2006--it is the usual 
custom that there is an audit performed within the first year 
after registration, and that was not done for whatever reason? 
But further, it did not have to be an extensive audit. Somebody 
just walked in and asked to see the securities, physically. 
That would have set off the alarm and there are not any, is 
that not correct?
    Mr. Markopolos. That was Basic Auditing 101. And the SEC 
staff was incapable of even that level of due diligence.
    Chairman Kanjorski. Would you like to change places with us 
when we get the SEC up here next so you can ask some questions?
    Mr. Markopolos. I would like that.
    Chairman Kanjorski. Thank you very much, Mr. Markopolos. We 
are delighted with your willingness to come forward. It is a 
compliment to the committee that you chose this committee to 
make this public disclosure of your long-term investigation, 
and we thank you for that. We want to work with you closely and 
hope that your services will be further available to the 
subcommittee and the committee as we move on toward regulatory 
    Obviously we can see from the example in your testimony and 
in the interest of the membership that we have a long road to 
haul. But certainly you have made it in significant ways here 
in shining light on this particular problem. And of course as 
you know we are using the Madoff scandal as a platform to set 
the basis for regulatory reform, long-term regulatory reform. 
This is a major step in the right direction in my opinion.
    So thank you very much. Your life may be in jeopardy, but I 
would say Mr. Madoff, if he took the mob and the Russian Mafia 
on, maybe he should stay in that $7 million apartment.
    Mr. Markopolos. Thank you, Mr. Chairman. It has been a 
singular honor.
    Chairman Kanjorski. Thank you very much. Okay. We will now 
have the second panel. If they will step to the desk, we will 
start the introductions thereof.
    I am pleased to welcome our second panel. First we have Ms. 
Linda Thomsen, Director of the Division of Enforcement at the 
Securities and Exchange Commission. Ms. Thomsen.


    Ms. Thomsen. Good afternoon. Chairman Kanjorski--excuse me. 
Let me start again, Chairman Kanjorski, Ranking Member Garrett, 
and members of the subcommittee, I appreciate very much the 
opportunity to appear today on behalf of the Securities and 
Exchange Commission to discuss the mission and mandate of the 
SEC, our critical work to protect investors, the work of the 
Division of Enforcement, and certain general information with 
respect to the alleged fraud perpetrated by Bernard L. Madoff 
and Bernard L. Madoff Investment Securities LLC.
    I am Linda Thomsen, and for nearly 14 years it has been my 
privilege to serve on the staff of the SEC's Division of 
Enforcement. Let me assure the subcommittee that the Commission 
and every single member of the SEC staff takes the alleged 
Madoff fraud very seriously. The losses incurred by investors 
as a result of his alleged fraud are tragic. And we appreciate 
the impact of those losses on the lives of those investors. The 
activities and conduct of Mr. Madoff and others are under 
active and ongoing investigation by criminal authorities, by 
the SEC's Enforcement Division and, with respect to past 
regulatory activities, by the SEC's Office of Inspector 
General. We are not authorized to provide specific information 
about matters under active investigation or past regulatory 
activities in this matter. We simply cannot jeopardize the 
process of holding the perpetrators accountable.
    On December 11, 2008, the SEC sued Mr. Madoff and his firm 
for securities and investment advisory fraud in connection with 
an alleged Ponzi scheme that allegedly resulted in substantial 
losses to investors in the United States and other countries. 
The Commission's complaint alleges that Mr. Madoff admitted to 
two senior employees of his firm that for many years he had 
been conducting the investment advisory business of his firm as 
a Ponzi scheme using funds received from new investors to pay 
returns to previous investors, and he estimated that the scheme 
had resulted in losses of approximately $50 billion. The 
complaint alleges that Mr. Madoff also informed these senior 
employees of his firm that he had approximately $200 to $300 
million left which he planned to use to make payments to 
selected employees, family, and friends before turning himself 
in to authorities.
    The SEC immediately sought and obtained a preliminary 
injunction and other emergency relief to prevent the 
dissipation of any remaining assets. The SEC's Enforcement 
Division is coordinating its ongoing investigation with that of 
the United States Attorney's Office for the Southern District 
of New York, which filed a parallel criminal action on December 
11, 2008, in connection with Mr. Madoff's alleged Ponzi scheme. 
These two actions, filed by the SEC and the United States 
Attorney's Office, could potentially result in billions of 
dollars in liability and decades of incarceration for Mr. 
    As noted in our written testimony, which we have submitted 
to the committee for all witnesses on behalf of the Commission, 
the SEC's New York regional office commenced an investigation 
of Mr. Madoff and his firm in early 2006. Two years later, in 
January of 2008, that investigation was closed without any 
recommendation of enforcement action.
    Returning if I might to the broader picture, the mission of 
the SEC is to protect investors, maintain fair, orderly, and 
efficient markets, and to facilitate capital formation. The 
Agency's staff is dedicated, hardworking, and committed to the 
mission of the SEC. Our investor protection mission is more 
compelling than ever. As investors turn to the markets to help 
secure their futures, pay for homes, and send children to 
college, they must have confidence that their interests are 
being protected.
    Crucial to the SEC's effectiveness is its enforcement 
authority. Each year the SEC brings hundreds of civil 
enforcement actions against individuals and companies for 
violations of the securities laws. The Division of Enforcement 
investigates possible violations and enforcement lawyers, 
accountants, and investigators investigate these violations, 
recommend that the Commission bring civil action in Federal 
court or before an administrative law judge and prosecute those 
cases on behalf of the Commission.
    Enforcement staff obtain information about possible 
violations of the securities laws from many sources, including 
market surveillance activities, investor tips and complaints, 
other divisions and offices of the SEC, the self-regulatory 
organizations, and other security industry sources and media 
reports. The SEC staff receives hundreds of thousands of tips 
each year from various sources with various levels of 
specificity and credibility. While the SEC does not have the 
resources to fully investigate all tips and complaints 
received, we use the staff's expertise, skill, and judgment to 
triage the complaints to devote attention to the most promising 
leads and the most serious potential violations.
    Of the approximately 600 enforcement actions that are 
brought each year, many first came to the attention of the 
staff through a complaint or a tip. Yet SEC staff is now also 
working on ways to improve the handling of complaints, tips, 
and referrals to make optimal use of resources. This is just 
one of our efforts to improve the identification and assessment 
of risk. Collectively, together with Chairman Schapiro and the 
Commissioners, we are committed to reducing opportunities for 
fraud, to detecting it quickly, and to best protect investors 
from those who would seek to prey upon them.
    In conclusion, let me reiterate our commitment on behalf of 
the SEC and its staff to the vigorous protection of the 
American investors. Thank you, and I would be delighted to take 
questions, as I think would my colleagues.
    [The joint prepared statement of the SEC can be found on 
page 174 of the appendix.]
    Chairman Kanjorski. Thank you, Ms. Thomsen.
    Next, we have Mr. Andrew Donohue, Director of the Division 
of Investor Management at the Securities and Exchange 


    Mr. Donohue. Chairman Kanjorski, Ranking Member Garrett, 
and members of the subcommittee, I am Andrew Donohue, Director 
of the SEC's Division of Investment Management. I appreciate 
the opportunity to appear today on behalf of the SEC to discuss 
the mission and mandate of the SEC, our critical work to 
protect investors, the work at the Division of Investment 
Management, and certain general information with fraud 
perpetrated by Bernard L. Madoff and Bernard L. Madoff 
Investment Securities LLC.
    As an initial matter, let me say that each member of the 
Division of Investment Management takes our role in protecting 
America's investors and the integrity of our markets very 
seriously. I deeply regret the losses suffered by Madoff 
investors. As you have heard, the activities and conduct of Mr. 
Madoff and others are under active and ongoing investigation by 
criminal authorities, by SEC's Division of Enforcement and, 
with respect to past regulatory activities, by the SEC's Office 
of Inspector General.
    I am not authorized to provide specific information about 
past regulatory oversight of the regulatory firm. I am not 
participating in the current investigation or examinations 
involving the alleged Madoff fraud. I can provide the following 
general information concerning our work at the Division of 
Investment Management.
    The Division of Investment Management conducts regulatory 
activities on behalf of the Commission with respect to 
investment companies, including mutual funds and investment 
advisers. The Division of Investment Management reviews 
investment company disclosures for the compliance with Federal 
securities laws, responds to no action requests and requests 
for exemptive relief, develops rulemaking recommendations 
concerning investment companies and investment advisers for 
Commission consideration, interprets laws and regulations for 
the public and for SEC inspection and enforcement staff, and 
assists the Commission and its staff in enforcement matters 
involving investment company and investment advisers.
    The Division of Investment Management has approximately 150 
staff members. The investment management industry is large and 
diverse, including approximately 11,300 investment advisers and 
950 investment company complexes representing over 4,600 
registered investment companies. The number of registered 
investment advisers has increased dramatically in recent years, 
going from 7,547 in 2002 to nearly 11,300 today.
    As you know, Bernard L. Madoff Investment Securities LLC 
registered with the Commission in September of 2006. As 
described more fully in our written testimony, it is unlawful 
for an investment adviser to defraud clients or prospective 
clients. Investment advisers have a fiduciary duty to their 
clients to act in their best interest and to avoid conflicts of 
interest or to fully disclose them. The anti-fraud provisions 
apply to all persons and firms meeting the definition of an 
investment adviser whether or not registered with the 
Commission. In addition, investment advisers registered with 
the Commission are required, among other things, to have 
written policies and procedures designed to prevent violations 
of the law and rules, to designate a chief compliance officer 
responsible for administrating the adviser's compliance 
policies and procedures, to maintain and preserve specified 
books and records, and make them available to Commission 
examiners for examination, and to deliver to advisory clients 
and prospective clients a written disclosure statement or a 
brochure describing the adviser's business practices and 
material disciplinary events.
    Under the custody rule, registered investment advisers must 
maintain client securities and funds with a qualified custodian 
which includes regulated banks, registered broker dealers, 
registered future commission merchants, and foreign financial 
institutions that meet certain conditions. Investment advisers 
may have self-custody or use an affiliated custodian if the 
adviser or affiliate is also registered as a broker-dealer, 
futures commission merchant, or it is regulated as a bank.
    The Division of Investment Management actively coordinates 
its functional responsibilities with staff of the Commission's 
other divisions and offices. For example, the Division of 
Investment Management staff often consult with the Office of 
Compliance Inspections and Examinations and enforcement staff, 
providing legal advice in connection with examinations or 
investigations involving investment management regulatory 
    Finally, there are some ideas that the Division of 
Investment Management is considering recommending to the 
Commission to explore in light of the Madoff matter, including 
both changes and improvements to regulation and oversight which 
might make fraud less likely to occur and improve the ability 
to detect it. We are reviewing the adequacy of the custody rule 
to determine whether to recommend to the Commission any 
amendments that enhance the safety of client assets. We also 
are reviewing the adequacy of disclosures that advisers are 
currently making and required to make to the Commission--to 
determine whether additional required information would enhance 
the staff's ability to detect and prevent fraud by advisers.
    In addition, the Division is looking at ways to improve the 
assessment of risk and at the adequacy of information required 
to be filed by registered firms and used to assess risk and 
whether the risk assessment process would be improved with 
routine access to additional information.
    In a range of ways, we are thinking expansively and 
creatively about changes that could reduce opportunities for 
fraud as American investors deserve the best possible 
protection from Ponzi schemes and other frauds.
    Thank you, and I would be happy to take any questions.
    Chairman Kanjorski. Thank you very much, Mr. Donohue. Next 
we have Mr. Erik Sirri, Director of the Division of Trading and 
Markets at the Securities and Exchange Commission. Mr. Sirri.


    Mr. Sirri. Chairman Kanjorski, Ranking Member Garrett, and 
members of the subcommittee, I appreciate the opportunity to 
appear today on behalf of the Securities and Exchange 
Commission. I am the Director of the Division of Trading and 
Markets, which is responsible for administering statutes and 
rules designed to establish and maintain standards for fair, 
orderly, and efficient securities markets. Bernard L. Madoff 
Investment Securities was a registered broker-dealer. Given the 
focus of this hearing today, I will briefly discuss two 
functions of the division related to broker-dealers: first, 
administering the broker-dealer financial responsibility rules; 
and, second, providing oversight of Securities Investor 
Protection Corporation, or SIPC.
    Broker-dealers are subject to extensive financial 
responsibility rules designed to protect customers from a 
firm's illiquidity or misuse of customer funds and securities. 
These rules impose a system of requirements intended to reduce 
the likelihood of customer abuse, including requirements for 
capital, a safe keeping of customer cash and securities, the 
making and maintaining of books and records, and the filing of 
periodic financial statements and annual audits with SROs and 
with the Commission. The broker-dealer net capital rules is 
designed to ensure that a firm maintains sufficient liquid 
assets, such that if the firm fails it can promptly liquidate 
and pay all claims to customers and other creditors without the 
need for a formal bankruptcy proceeding. The rule requires an 
absolute minimum amount of net capital in order for the broker-
dealer to conduct a securities business, below which it cannot 
    In addition, a broker-dealer must immediately notify the 
Commission and the relevant SRO if its net capital falls below 
certain early warning levels. The broker-dealer's customer 
protection rule is designed to safeguard customer securities 
and consists of two parts.
    First, firms are required to maintain possession and 
control of all fully paid and excess margin securities carried 
for customers. Second, all net cash owed to customers must be 
deposited in a special reserve bank account for the exclusive 
benefit of customers. The rule prevents a broker-dealer from 
using customer cash and securities for its own proprietary 
business, and it is designed to keep these assets available for 
prompt return to customers in the event a broker-dealer fails.
    The Commission's books and records rules require broker-
dealers to make and keep extensive written records on their 
business. These include stock records that show the amount and 
locations of the securities carried by the broker-dealer, 
ledgers showing cash positions and securities purchased sold, 
received or transferred to or from other customer accounts, the 
records of the net capital computation and the customer reserve 
fund computation.
    The Commission also requires broker-dealers to file 
periodic financial reports with the SROs. These financial 
reports must contain a statement of financial condition, a 
statement of income, a statement of cash flows, a statement of 
changes in stockholders' partners or sole proprietors' equity, 
a statement of changes in liabilities subordinated to the 
claims the general creditors and supporting schedules, 
including the computation of net capital, a computation for the 
termination of the reserve fund requirement, and information 
related to the possession or control requirements under the 
customer protection rule.
    With a few limited exceptions, broker-dealers registered 
with the Commission are required to follow similar information 
in annual audit reports with the Commission and with each SRO 
of which the broker-dealer is a member. The audit report also 
requires that the scope of the accountant's audit and review 
must provide reasonable assurance that any material 
inadequacies existing on the date of the examination would be 
disclosed. If an accountant finds any material inadequacies on 
the part of its review, a special report must be provided to 
the Commission.
    With respect to the matter of the registration of broker-
dealer auditors with the Public Company Accounting Oversight 
Board, I note that while Sarbanes-Oxley requires auditors of 
registered broker-dealers to be registered with a PCAOB, the 
Act focuses on PCAOB's responsibility, specifically on the 
auditors of public companies. Most broker-dealers are not 
public companies either because they are privately held or are 
subsidiaries of public companies. The Commission gave temporary 
exemptions from registration while discussing with the PCAOB 
the treatment of these broker-dealer auditors. Subsequently, 
the PCAOB determined that the statute does not give it the 
necessary authority to examine auditors of nonpublic broker-
dealers after they have registered or to discipline them for 
audit failures after which the Commission determined to let 
these exemptions expire.
    Finally, I note that the Division is primarily responsible 
for administering the Commission's oversight of SIPC. This 
oversight includes examination authority as well as the 
authority to review the rules SIPC adopts with respect to the 
conduct of SIPC liquidations. Generally, all broker-dealers 
registered with the Commission must be SIPC members. SIPC must 
pay advances to compensate customers when the amount of 
securities and cash recovered from a failed firm are 
insufficient to make customers whole. These advances are 
limited to $500,000 per customer, including a maximum of 
$100,000 for cash claims. SIPC initially pays for customer 
advances and the administrative costs of liquidation out of the 
SIPC fund, which is funded through member assessments.
    I would be happy to take any questions.
    Chairman Kanjorski. Thank you, Mr. Sirri.
    Next we have Mr. Andrew Vollmer, Acting General Counsel at 
the Securities and Exchange Commission. Mr. Vollmer.


    Mr. Vollmer. Thank you for inviting me today. The Office of 
the General Counsel provides a variety of legal services to the 
Commission and the Commission staff, such as preparing all of 
the Commission's appellate briefs and providing legal advice 
and counseling concerning the Federal securities laws, 
administrative laws, and government ethics rules.
    The SEC witnesses here today prepared a joint written 
statement on behalf of the Commission. I would like to ask that 
it be included in the record. To the extent questions seek 
information beyond the scope of the written statement, each of 
us will be expressing our own personal views that do not 
necessarily reflect the views of the Commission or other SEC 
    This hearing is being held at the same time that several 
important investigations into matters related to Mr. Madoff are 
open and being actively pursued. Some of them are pending law 
enforcement proceedings and investigations.
    In December 2008, the Commission filed a civil law 
enforcement complaint in the Southern District of New York 
against Mr. Madoff and his securities firm. The SEC's Division 
of Enforcement is both litigating that case and conducting 
associated investigations into possible violations of the 
securities laws by others. It is also coordinating its 
investigation with a criminal investigation being conducted by 
the United States Attorney's Office in the Southern District of 
New York, and that office filed a parallel criminal action also 
in December of 2008 against Mr. Madoff.
    A third investigation is the one by the Inspector General 
of the SEC into past investigations and examinations of Mr. 
Madoff's firm by divisions and offices of the SEC. He is also 
looking into any SEC staff relationships with persons related 
to Mr. Madoff that might have affected those investigations and 
    Questions that seek information that could bear on or be 
relevant to any of the Madoff investigations could affect the 
independence and integrity of the investigations and could harm 
law enforcement efforts. I want to express my appreciation to 
the subcommittee for its understanding of these concerns.
    Chairman Kanjorski. Thank you, Mr. Vollmer.
    Next we have Ms. Lori Richards, Director of the Office of 
Compliance Inspections and Examinations at the Securities and 
Exchange Commission.
    Ms. Richards.


    Ms. Richards. Thank you, Chairman Kanjorski, Ranking Member 
Garrett, and members of the subcommittee. I am Lori Richards, 
Director of the SEC's Office of Compliance Inspections and 
Examinations, and I very much appreciate the opportunity to 
appear here today to discuss the important work of the SEC to 
protect American investors, the work of the Office of 
Compliance Inspections and Examinations, and to provide certain 
general information with respect to the alleged fraud committed 
by Bernard Madoff.
    I want to assure this committee at the outset that the SEC 
takes the alleged fraud by Mr. Madoff extremely seriously, and 
that collectively, together with Chairman Schapiro and the 
other Commissioners, we are focused very hard on identifying 
possible improvements, both to regulation and to oversight, 
which might make fraud less likely to occur in the first place, 
and more likely to be detected.
    I begin by noting that I have served as a member of the 
Commission staff for more than 20 years, and that the Agency 
staff are dedicated, they are hardworking, and they are keenly 
committed to the Agency's mission to protect investors.
    As described more fully in our written testimony, the 
Office of Compliance Inspections and Examinations is the 
functional program at the SEC that administers the SEC's 
nationwide compliance examination program for firms that are 
registered with the SEC. So those include self-regulatory 
organizations, broker-dealers, transfer agents, clearing 
agencies, investment companies, investment advisers, and rating 
    As you have heard, the activities and conduct of Mr. Madoff 
and others are under active and ongoing investigation by 
criminal authorities, by the SEC's Division of Enforcement, 
and, with respect to past regulatory activities, by the SEC's 
Office of the Inspector General. I am not authorized to provide 
specific information about past regulatory oversight of the 
Madoff firm, and I am not participating in the current 
investigation or examinations involving the alleged Madoff 
fraud. I can, however, provide you with the following general 
information concerning examinations of the Madoff business.
    The Madoff firm became registered as an investment adviser 
in September of 2006. The SEC staff did not examine the 
investment advisory operations of the firm. The Madoff broker-
dealer operation was subject to routine examination oversight 
by the Financial Industry Regulatory Authority, and was also 
subject to several limited-scope examinations by the SEC for 
compliance with, among other things, trading rules that require 
the best execution of customer orders, the display of limit 
orders, and possible front running, most recently in 2004 and 
2005. These examinations were focused on the firm's broker-
dealer activities. The firm's investment advisory business, as 
I said, became registered in 2006, and was not examined by the 
SEC. For the reasons I noted, I must not detail or discuss 
these examinations in any greater detail.
    By way of background, in a compliance examination, 
examiners, accountants or lawyers, and these people are not 
just lawyers, they are also examiners and CPAs and CFAs and 
other people with experience, they review the books and records 
and gather information that can indicate whether a firm is in 
compliance with the securities laws. Examinations also include 
often interviews with relevant personnel at a firm. These 
examinations are not audits. They are limited in their scope, 
and they are targeted to specific firms and to specific 
activities of a registered firm.
    The firms that we examine vary in size and in type, and 
they include firms that are run honestly and in compliance with 
the law, and they also include firms that may be engaged in 
deception, dishonesty, falsification of records, and fraud of 
various kinds. I can assure you that examiners don't pull 
punches based on the type of firm that we examine or inspect. 
They are meant to identify deficiencies and violations of the 
law, and to ensure that those are corrected, regardless of the 
size or type or nature of the firm under examination.
    Broker-dealers are under primary oversight by a self-
regulatory organization that conducts periodic routine 
examinations. Investment advisers, mutual funds, and other 
types of registrants are not subject to routine examination by 
a self-regulatory organization. For these firms, the SEC 
provides primary examination oversight.
    The SEC has about 425 staff people dedicated to 
examinations of all registered investment advisers and mutual 
funds, and about 315 staff dedicated to examinations of 
registered broker-dealers. Given the number of registered 
investment advisers today, over 11,000, and the fact that this 
population has grown significantly in recent years, the SEC 
cannot examine every investment adviser on a routine frequency. 
A small percentage of investment advisers are examined on a 
routine frequency.
    The SEC also conducts cause examinations when we learn of a 
possible complaint or a problem that could indicate a violation 
of the law. We conduct random examinations of investment 
advisers, as well as sweep examinations focused on a particular 
risk issue.
    Finally, I want to assure this subcommittee that at the SEC 
we are thinking expansively and creatively about changes that 
could reduce the opportunities for fraud. And we are committed 
to protecting investors from those who would prey on them in 
Ponzi schemes and other types of fraud.
    Our testimony describes generally some ideas that the staff 
of the SEC are considering, and these are subject to refinement 
as more analysis is conducted and more facts are learned. But 
among the ideas that we are considering are the examination 
frequencies for investment advisers, the existence of 
unregistered investment advisers and funds, the different 
regulatory structures that surround broker-dealers and 
investment advisers, the existence of unregulated products, and 
the need to strengthen custody and audit requirements for 
regulated firms.
    We are also looking very hard at ways that we can improve 
the assessment of risk and the adequacy of information that is 
required to be filed by registered firms and used by the SEC to 
assess risks, and whether the risk-assessment process could be 
improved with routine access to additional information.
    In addition, we are targeting firms for examinations of 
their custody of assets, and we are expanding our efforts to 
examine investment advisers and broker-dealers in a coordinated 
approach to reduce the opportunities for firms to shift 
activities to areas where they may not be subject to regulatory 
    In conclusion, I want to assure this subcommittee that in a 
range of ways we are thinking expansively and creatively about 
changes that could reduce the opportunities for fraud, as 
American investors deserve the best possible protection from 
Ponzi schemes and other types of frauds.
    Thank you. I would be happy to answer any questions you 
    Chairman Kanjorski. Thank you, Ms. Richards.
    And lastly, we will here from Mr. Stephen Luparello, 
interim Chief Executive Officer of the Financial Industry 
Regulatory Authority.
    Mr. Luparello.


    Mr. Luparello. Chairman Kanjorski, Ranking Member Garrett, 
and members of the subcommittee, thank you for the opportunity 
to testify today. My name is Steve Luparello. I currently serve 
as interim CEO of the Financial Industry Regulatory Authority. 
Also known as FINRA, we are the primary nongovernmental 
regulator for securities brokerage firms doing business in the 
United States.
    Unfortunately, we are all here today because the fraud that 
Bernard Madoff reportedly conducted has had tragic results for 
investors who entrusted their money to him. Investors are 
disillusioned and angry, and are rightfully asking what 
happened to the system that was meant to protect them. There 
was no doubt that Madoff knew that system well, and perhaps 
that knowledge assisted him in avoiding detection and 
defrauding so many unsuspecting individuals and institutions. 
By all accounts, it appears that Mr. Madoff engaged in 
deceptive and manipulative conduct for an extended period of 
time during which he defrauded the customers who invested with 
him and misled those that had the responsibility to regulate 
    Mr. Madoff's alleged fraud highlights how our current 
fragmented regulatory system can allow bad actors to engage in 
misconduct outside the view and reach of some regulators. It is 
undeniable that in this instance the system failed to protect 
investors. Investor protection is the core of FINRA's mission, 
and we share your commitment to identifying the regulatory gaps 
and weaknesses that allowed this fraud to go undetected, as 
well as potential changes to the regulatory framework that 
could prevent it from happening in the future.
    Bernie Madoff's broker-dealer was registered with FINRA and 
its predecessor organization, NASD, since 1960. Prior to 2006, 
Mr. Madoff also operated an unregistered money-management 
business. In 2006, the SEC required Mr. Madoff to register that 
money-management business as an investment adviser.
    While Congress authorized FINRA to regulate broker-dealers 
in 1938, FINRA is not authorized to examine for or enforce 
compliance with the Investment Advisers Act. Only the SEC and 
the States have that authority. In fact, while we have the 
authority to bar broker-dealers and registered persons from the 
brokerage industry, FINRA is often powerless to prevent those 
persons from reentering the financial services industry as 
    Within Madoff's firms there were two discrete lines of 
business, the broker-dealer and the money-management business 
that ultimately registered as an investment adviser. Given the 
limitations imposed by Federal law, FINRA's authority over 
Madoff was and is limited to its broker-dealer operations, even 
though the Madoff-registered investment adviser was in the same 
legal entity.
    For two decades, FINRA examined Madoff's broker-dealer 
operations at least every other year. We began a separate 
market regulation exam program in 1996, and conducted that exam 
at the Madoff broker-dealer each year since. The Madoff broker-
dealer consistently reported to FINRA that 90 percent of its 
revenue was generated by market making and 10 percent by 
proprietary trading.
    When examining the Madoff broker-dealer operations, FINRA 
found no evidence of trading for customer accounts, which is 
consistent with the market-making model, and no evidence of the 
kind of fraud that Madoff allegedly carried out through his 
advisory business. While we did receive a small number of 
customer complaints throughout the years, those complaints were 
filed by customers of other broker-dealers that had transacted 
business with the Madoff broker-dealer. FINRA did not receive 
any retail customer complaints that might have alerted us to 
the existence of the advisory accounts, and there were no 
complaints related to the investment advisory business as a 
    FINRA also did not receive whistleblower complaints 
alleging either front running or Ponzi schemes at the Madoff 
money-management business, nor did the SEC share the tip it 
received or alert FINRA to any concerns that it may have had 
with Madoff.
    FINRA has long expressed concerns regarding a firm's 
ability to avoid our jurisdiction by keeping its customers 
outside the FINRA-registered broker-dealer. As early as the 
1980's, NASD officials issued public statements urging reform. 
As recently as this past year, FINRA's former CEO, Mary 
Schapiro, personally raised these issues with the SEC Chairman. 
Unfortunately, the statutory limits of FINRA's jurisdiction did 
not allow it to be an extra set of eyes looking at the totality 
of the business. Any number of misrepresentations that can 
facilitate a fraud like this--the firm did have customers or it 
didn't, the trades ran through the broker-dealer or they 
didn't, the firm custodied the assets or they didn't--might 
have come to light much earlier. And one of the key parts of 
the FINRA exam program is that we confirm the existence and 
location of customer assets that are reflected in customer 
accounts on the broker-dealer. We follow the money to where the 
regulated firm says it is and ensure that those customer assets 
are properly segregated from those of the firm itself.
    As I stated at the outset, what has happened to Madoff's 
investors is tragic. The fact is no regulator is perfect, and 
Ponzi schemes can be difficult to uncover. But that is all the 
more reason to give regulators the tools they need to ferret 
out fraud. As I have testified today, we take our mission very 
seriously. We have vigorous exams and enforcement programs, and 
have not hesitated to take actions against firms of any size 
for wrongdoing, or any individual, regardless of their position 
in the industry.
    Mr. Chairman, investors should receive the same basic 
regulatory safeguards and protections no matter which 
investment product or service they choose. FINRA is committed 
to working with this committee as it considers how best to move 
forward on these important issues.
    [The prepared statement of Mr. Luparello can be found on 
page 94 of the appendix.]
    Chairman Kanjorski. Thank you very much, panel. We have a 
vote on. It is a 15-minute vote, but if we take the break now, 
we will all be able to return, and I expect to take more than 
one round of 5 minutes. All of the members are welcome to 
participate in the additional round.
    This is going to be a difficult panel to work with. As you 
know, they are asserting certain rights to not respond to 
certain questions. But I think this panel has the capacity to 
invade the self-restrictive protective devices of this panel.
    With no other statements, we are going to take a break, 
recess the committee to get the vote, and then we will return 
for questions.
    Chairman Kanjorski. The committee will reconvene. Thank you 
for being here as a panel.
    There was a little consternation before you arrived here, 
so I just want the record to be corrected, because, Mr. 
Vollmer, when you testified, you thanked us for our 
understanding of the limitations of this panel to the 
committee, and I think that was premature, because I do not 
recognize any right of the Agency to lay down limitations as to 
what members of the SEC have to testify to or not testify to 
before the Congress of the United States. And unless I am 
mistaken, if there is any objection to be made, it will be 
raised either by the Department of Justice or others.
    But that notwithstanding, I think we are going to try and 
be as amenable as we can and as civil as we can just with the 
idea that I want it clear to the members of this panel, and 
particularly to you, Mr. Vollmer, that in our discussions and 
prior preparations for the testimony of this panel, it became 
obvious to me that there seems to be a dysfunction between the 
Securities and Exchange Commission and this committee of the 
Congress in that there seems to be a misunderstanding as to who 
created whom and who is responsible to whom under the 
Constitution. And I hope we can disabuse ourselves of that 
misunderstanding. If we cannot, we should probably take any 
legal proceedings necessary to determine that, because I think 
we are involved in an extremely serious case that requires 
litigation. And from listening to the testimony of this panel, 
it appears to me that if these cases remain, as they very 
easily may, for years in trial and work, and it is the position 
of the SEC that they cannot discuss the matter, cannot be 
called upon to testify on the matter, and are completely 
removed from participating with the Congress in creating 
legislation that may be necessary to correct the matters.
    And although I take great sympathy as a lawyer with the 
protection of cases to be prosecuted and not to compromise the 
same, we are obviously dealing here with two different 
situations. One is what laws have to be made or changed to 
protect the greater members of the public, and what kind of 
potential compromises would that cause to a particular case.
    And in terms of hearing the testimony today of Mr. 
Markopolos, I have tentatively come to the conclusion that the 
Securities and Exchange Commission has been annointed by God to 
be all righteous. I hope I can disabuse the members of this 
panel of that fact, because, quite frankly, we are about to 
decide just in what nature and how the Securities and Exchange 
Commission should continue to exist. And the lack of 
cooperation shown in the last several weeks, and I think the 
abuse of authority, or the attempt to bring a protective shield 
over an executive agency or independent agency of this 
government is not acceptable. And if that is going to be the 
process, the easiest thing is to follow Mr. Markopolos's advice 
and just do away with the entire regulatory system as it is 
presently constructed and start anew.
    I make that point obvious for a reason. There are several 
things that have happened in the last several years that should 
be embarrassing to the SEC. Let me ask that question. Are you 
embarrassed as members of the higher echelon of the SEC with 
how the Madoff case has been handled, or do you feel that 
embarrassment does not come into it, and it is unimportant, and 
that you are above all those things? Would anybody like to tell 
me that?
    Ms. Thomsen. Let me start. First of all, if we have in any 
way suggested a self-righteousness to you, I don't feel that. I 
don't feel it towards the Congress.
    Chairman Kanjorski. So it is understood, and I will break a 
confidence, one of the members of the panel here originally 
told me he was not going to testify because he is exempt. And 
it precipitated a call, myself, to the Chairman, which I rarely 
make, although I know her very personally and have known all 
the Chairmen for 20 years. But it was so annoying to me that 
when that individual thought he did not have to testify before 
a committee of the Congress of the United States, I made it 
very clear that either he would be here today or appropriate 
subpoenas would be issued. And those subpoenas would have been 
issued to everybody who is here today. Quite frankly, we would 
not have accepted any excuse offered or request for lack of 
testimony on any facts and have structured a case. And let us 
just see what kind of protections you would have under the law 
for not testifying.
    If we cannot have comity between two branches of government 
to handle the people's business, we have a serious problem. And 
right now as this panel is constituted, and as I have heard the 
testimony, I mean--you know, I like oatmeal, and that is about 
how I classify the testimony I heard today. And I do not know 
whether that testimony was written that way and presented that 
way in order to be a slap at this committee or the Chairman 
himself, but it is not appreciated. We did not call you up here 
for us to hear a traveler's guide of the Securities and 
Exchange Commission.
    We are spending our time and effort, many of us, to get to 
the roots of how a Madoff scandal continues to occur for more 
than 10 years, when a rather credible expert in the field tries 
to do everything he can year in and year out to alert the 
appropriate regulator of the Federal Government that they 
should have handled or looked into that.
    That is a little therapy on my part. Now let me hear your 
response of how good you intend to be.
    Ms. Thomsen. Mr. Chairman, we are here to help you in your 
effort. We think this is an important hearing.
    As to your original question, I don't think--I think I 
speak for everyone when I say we hate fraud. We hate the fact 
that people are victimized by fraud. We wish it never happened. 
We wish we could get to every--
    Chairman Kanjorski. But your job is to prevent fraud, not 
to hate it.
    Ms. Thomsen. Well, in the Enforcement Division and the 
division that I know the best, our job is in part to prevent 
it, but only as a derivative effect of our enforcement actions, 
because we can only bring actions when a violation of the law 
has occurred. Now, we want to get to every violation the 
instant it happens, and we hope that by our actions there is 
less fraud to pursue. That is our mission. That is our passion.
    I have heard today issues about wanting to avoid going 
after big players. There is nothing that makes a member of my 
staff happier than bringing a case. The only thing that makes 
them happier is a big case. And if it is against someone of 
some notoriety or fame, that makes them happier still. We live 
for bringing those cases. We hate the fact that people lose 
money. And we bring hundreds of them every year.
    And I have to say that sitting here today, it is every law 
enforcer's worst nightmare to miss something, and yet it is 
something that we know is going to happen because there is--
    Chairman Kanjorski. How do you explain the fact that you 
not only missed this, but now that the Congress is attempting 
to close the loopholes and attend to it, you feel disposed not 
to cooperate 100 percent to see that we do that to protect 
other frauds that may be occurring and going on right now?
    Ms. Thomsen. Let me try to address it. And I understand 
your frustration, but when we talk about moving forward, what 
we can do to address it, the first and, to my mind, most 
important thing we can do to address it is to hold fraudsters 
accountable, to bring them to justice, to bring the full force 
of the law against them. That includes criminal prosecution, 
civil prosecution. And, for example, quite specifically, when 
you talk about what we did in the past, some of what happened 
in the past may in and of itself violate Federal criminal law. 
And the ability to pursue those cases to the full extent that 
we can is what we are here to protect. That does not mean that 
we should not examine what happened and even examine it 
theoretically to think what we could do, make assumptions about 
what the past was, and move from there.
    Chairman Kanjorski. Okay. Let me just say that justice 
delayed very often is justice denied. And if we are going to 
have cooperation, and we are going to have an effective 
enforcement tool of the Securities and Exchange Commission, we 
cannot have the culture or mentality that I sense over there 
that in examination and investigation, a process can go on 
forever. I mean, I have stories that will shrivel your ears 
with how long enforcement proceedings have just laid around 
with no action having been taken. I am getting the impression 
that is the culture now, that there is not an intent to do 
    So one of the things the committee will be considering in 
some of this legislation is whether or not we can impose a 180-
day rule. You know, if we can get criminal prosecutions within 
180 days in this country, it seems to me once we charge some 
corporate activity as being a violation of the SEC, let us move 
along; 180 days get to a trial, let us get it decided. 
Something like this.
    I want to ask the question, how long do you need to resolve 
the problems that are causing you not to speak or cooperate 
with this committee? How long do you think these prosecutions 
are going to take before you can speak up?
    Ms. Thomsen. I honestly don't know the answer. And there 
are three things that are going on.
    Chairman Kanjorski. So if that is the case, you do not know 
the answer, it could be years; is that correct?
    Ms. Thomsen. I don't know.
    Chairman Kanjorski. Well, if it is years, and you do not 
intend to say anything, if I listen to how your statement and 
your counsel structured the statement, there are three things. 
You cannot help if it is a pending criminal investigation; you 
cannot help if the Inspector General is doing something; you 
cannot help if it is an ongoing violation. I mean, if there is 
a snowstorm in Washington, the SEC cannot help. That must be 
one of the conditions.
    What I want to find out is, how long is it going to take 
for that to be vitiated? And when can we get together and 
cooperate in developing legislation that will protect the 
people other than Madoff?
    Ms. Thomsen. Sure. Let me suggest an approach that may 
help, because I understand your concerns about how much time it 
takes to get to specifics. But if you want to try to think 
about how we can help generally, we can make assumptions. So, 
for example, you could assume that--to my mind, I like to 
assume a case where I think the solution is the hardest, 
because if we find that solution, we will be considerably 
better off. So when I look at a potential investigation, let me 
hypothesize. The SEC gets a credible lead, a lead is followed 
up on to a certain extent, and the investigation is closed 
without action, as it can happen.
    Now, when an investigation is closed, it seems to me there 
are one of two possibilities--well, maybe four. Either there 
was nothing to be found, and nothing was found; or there was 
something to be found, and it wasn't found--there are probably 
more. But in those circumstances, if we assume that something 
could have been found and wasn't, what are the reasons 
underlying that? And if it is complete and utter corruption, 
the answer is easy: You get rid of that which is corrupt.
    If, on the other hand, the answer is that people of good 
will were trying very hard, the answer may be they lacked 
training. And so that is one of the issues that I know has been 
addressed. Or they lack expertise. So what do we do to provide 
additional expertise to people so that they have the expertise 
to look further? It could also be that it is a resource issue. 
That is you look, you find nothing, you keep looking, you find 
nothing, and then something else blows up somewhere else that 
is appearing to be more important at the time.
    I mean, one of the issues that we are obviously struggling 
with is if we knew going into something that it was a fraud, a 
provable fraud, with evidence that we could present to a fact 
finder, it would be easy. When you don't know, that is what you 
    So I think we would be happy to have that conversation, 
that dialogue, to make the assumptions to make us better. We 
try every day to learn from our experience. And so among other 
things we are thinking about, as the committee has suggested, 
what can we do on risk? What can we do for expertise? What can 
we do to maximize our resources? And those are precisely the 
kinds of things that we are thinking about, even though we 
can't necessarily share the specifics with the committee.
    Chairman Kanjorski. Thank you, Ms. Thomsen.
    I am going to call on my ranking member here, who obviously 
has some additional questions. I took more than enough time. 
Particularly I had to have therapy.
    Mr. Garrett. I thank you. And you know, Mr. Chairman, when 
I began my remarks, before I got into my remarks, I commended 
you on the statements that you made earlier today on CNBC with 
regard to the hearing with regard to what needed to be done. 
And it was actually by watching that program I learned a bit of 
other information. On there they were issuing--talking about an 
OIG, an Inspector General's report that was just listed on 
their Web site either today or yesterday with regard to a 
different issue, but still within the SEC. And it is regarding 
to uncollected disgorgement, what it is called.
    That is not the point of this here, but after seeing that 
on, I guess it is Squawk Box, I had my staff go and we pulled 
out a copy of the report because it didn't really go to what we 
are talking about here, but after going through it, it does in 
two ways. One, it goes to--on the weed side or getting into it, 
it goes to the issue of enforcement and whether there is being 
enforcement done in general.
    And as I assume the panel knows, this report raises a 
number of serious questions. There is about $177 million in 
uncollected disgorgement. And for those who don't know, 
disgorgement just means once you have a case, and you find the 
guy, and you get the guy who did the bad thing, and then you 
want to go after him and actually get back those revenues from 
him, the ill-gotten gains. I guess the OIG says there is at 
least $176-, $177 million in uncollected disgorgement. That 
would be one issue.
    But the larger issue is in going through it, this goes back 
all the way through 1999, I believe it was at the very 
beginning, talking about that the OIG had done similar studies 
or reviews. And then if you go back at the very end to look to 
the Inspector General's responses to the management's comments, 
since the OIG gives their opinion, and then management is able 
to give the response, and then OIG gives a response to that, 
the very ending of it is--this is obviously OIG speaking--
notwithstanding this effort--speaking to, in other words, the 
OIG saying over the last 1999, 2001, 2002, 2003, 2004, 2005, so 
almost 8 years, 9 years--notwithstanding the efforts of trying 
to address this situation, the language and the tone of the 
Enforcement's response leaves us unconvinced that Enforcement 
will take the OIG's findings seriously and implement tangible 
and concrete measures to improve its disgorgement waiver 
    I know, Mr. Chairman, we are not going into the issue of 
disgorgement. It just did raise a proverbial red flag that if 
there has been 7 or 8 years or more of OIGs saying--as an 
auditor basically saying, here is our recommendations to make 
changes, and 8 or 9 years later there are still those 
questions, it raises the flag here is that if this as a body 
comes up with our recommendations saying that we will just 
leave it to the SEC to act unilaterally to try to implement 
changes, that we may very well, as the chairman says, be 
waiting a long time. So it just raises those questions. I 
appreciate the fact I was able to learn that by watching the TV 
today, quite literally.
    What I would like to learn a little bit more, though, is 
going into some of the issues that the first panel raised. And 
here is an easy one to start things out, to whomever can either 
address this right now or address it later on. And I see a lot 
of gray-haired people sitting in front of me, the gentlemen 
that is, which the previous panel was speaking to the issue 
    Ms. Thomsen. There is gray here, too.
    Mr. Garrett. Well, I was never going to go there.
    The issue was as far as the experience of the people who 
are conducting in the enforcement side and the examination 
side. Can you provide us with a response to that as to your 
number of employees, the salaries of your employees, the years 
of experience that they have within the Department?
    Now, I noticed a number of you spoke to your experience 
here within the Agency, the SEC. First panel, Mr. Markopolos 
would probably indicate that he would be suggesting, as others 
would, that we look for experience outside of the Agency as 
well. So if you could provide that to us, a detailed summary of 
that as prior experience to address that issue. And if anybody 
would like to, I know you are not going to have that at your 
fingertips right now, want to address that general allegation, 
if you will, that the SEC is made up of folks who really come 
to the table without the adequate practical business experience 
necessary to get the job, and that they are simply government 
    Ms. Thomsen. Sure. I think we would probably all appreciate 
the opportunity to get specifics to you. Why don't I start, 
because my division is probably the division that has the 
greatest characteristic that was complained of. We do have a 
lot of lawyers in the Division of Enforcement, and that is 
because we have to prove our cases in court.
    Mr. Garrett. Can we just run through? I see my time has 
almost run out.
    Ms. Thomsen. Okay. Never mind. Let me stop. We have 
lawyers, accountants, and analysts, as well as market 
surveillance types. But I would let the others talk.
    Ms. Richards. Do I have time to supplement that?
    Mr. Garrett. Sure.
    Ms. Richards. In the examination program, we are mostly 
accountants and examiners. There are some lawyers, but the 
majority of the staff are examiners and accountants. They are 
CFAs and CPAs.
    After the Congress adopted pay parity legislation, it gave 
the SEC the authority to pay our staff at higher salaries that 
were commensurate with other Federal banking regulators. It 
allowed us to bring in a greater number of staff that had 
experience; either experience in the industry, in auditing, in 
compliance. And so in the last, I would expect, 4 years, 5 
years, our staff has become much more experienced, much more 
well-rounded than they were in earlier years, where they were 
more likely to be hired right out of school.
    So that happened with the change that Congress gave us to 
pay our people a little bit more. And as a result, we began to 
keep people longer so they could gain experience in 
examinations, gain experience in dealing with complex products, 
complex strategies, and emerging types of compliance risks. So 
in the last 4 or 5 years, I believe it is a much better 
situation at the SEC in terms of the caliber and the experience 
of the examination staff.
    Mr. Garrett. With the chairman's permission to ask for 
elaboration on that, the suggestion was, and it is probably a 
good one, that if you were able to get some people who were in 
the industry, have worked in the industry most of their lives, 
and then come into the SEC to start doing enforcement, 
examination, rulemaking, etc., is that a practice to actually 
go out and seek that individual who has the 20-some-odd years' 
experience who is about to--well, whatever to go into this 
field later on in life?
    Mr. Sirri. Let me see if I can answer that question. We 
understand that such people are very valuable, they are very 
desirable. It is simply hard to recruit them. We absolutely go 
out of our way to find people with industry experience. And we 
have such people in our division, Trading and Markets.
    More to the point, within the Division of Trading and 
Markets, we have a group of people who are explicitly not 
lawyers who are collected together to supervise certain risk 
issues at broker-dealers. These are people with Ph.D.s in 
economics, accounting, statistics; master's degrees; exactly 
the kind of people you would think of you would want who have 
quantitative backgrounds to deal with just these kind of 
issues. And I will point out that some of them teach courses in 
derivatives on their own time, either before they came to the 
SEC or as they are at the SEC in the evenings to just those MBA 
students that were referred to on the prior panel.
    Ms. Richards. I also just want to add, just to supplement 
that, that we have in recent years hired former traders in the 
exam program, which is extremely beneficial to help us look at 
trading records and unscramble what could be violative trading 
patterns. And that expertise brought in from the industry has 
been extremely valuable to us.
    One of the things we really want to do going forward is to 
expand that expertise to hire more quants, to hire more 
economists, to hire more former traders so that they can 
provide a resource, that expertise as a resource, to all the 
staff at the SEC.
    Mr. Garrett. I would just close on this. And let us say 
that the dilemma that I think that any government regulator is 
going to have was expressed to me by someone in the industry, 
and that is when they deal with you, that if they find 
somebody, whether he is a young guy out of school or somebody 
who has been around for a long time and can teach the course or 
do these other things, and he is a real top-notch guy, no 
matter what you guys are offering him, in the private market 
they are going to offer him a whole lot more. And so we are 
always going to have that dilemma of trying to get the best and 
the brightest, because the best and brightest are going to go 
where the pay is, and that may not be with the SEC. But I thank 
you for the latitude to expand.
    Chairman Kanjorski. Mr. Ackerman.
    Mr. Ackerman. I am frustrated beyond belief. We are talking 
to ourselves, and you are pretending to be here. I really don't 
understand what is going on. The previous witness said that you 
guys as an Agency act like you are deaf, dumb, and blind. I 
figured you were coming here, and you were going to testify 
before Congress. Don't you dare tell anybody you testified 
before Congress. You are going to be subjected to violation of 
false advertising lawsuits. All right?
    You have told us nothing, and I believe that is your 
intention. I figured you would leave your blindfolds and your 
duct tape and your earplugs behind, but you seem to be wearing 
them today. And instead of telling us anything, you read from 
the preamble of your mission statement and broke it up into 
five segments.
    What the heck went on? You said your mission was to protect 
investors and detect fraud quickly. How did that work out? What 
went wrong? It seems to me a private--with all of your 
investigators and all of your Agency and everything that you 
all described, one guy with a few friends and helpers 
discovered this thing nearly a decade ago, led you to this pile 
of dung that is Bernie Madoff, and stuck your nose in it, and 
you couldn't figure it out. You couldn't find your backside 
with two hands if the lights were on.
    Could you explain yourselves? You have single-handedly 
defused the American people of any sense of confidence in our 
financial markets if you are the watchdogs. You have totally 
and thoroughly failed in your mission. Don't you get it? And 
now other people are investigating what you should have found 
out, and you are hiding behind, well, maybe we can't talk 
because someone else is looking at it. Well, you forfeited your 
right to investigate by not doing it, certainly not doing it 
properly or adequately. And now you are trying to tell us that 
because other people are looking at it, you are not going to 
tell us what is going on? Like hell you won't.
    What happened here? That is a question. Do we start with 
hear no evil, see no evil, or do no evil? Take your pick. I 
only have 5 minutes.
    Ms. Thomsen. Let me start with Enforcement. As I said, we 
did an investigation--we began an investigation in 2006, and it 
was closed without action.
    Mr. Ackerman. Why was it closed without action? What did 
you investigate? What methodology did you use?
    Ms. Thomsen. And in the interests--
    Mr. Ackerman. Were you suspicious when the guy had a one-
man accounting firm investigating a $50 billion empire? And you 
keep saying alleged, alleged. This guy confessed on national 
television, you might have noticed.
    Ms. Thomsen. And as I said, our objective is to actually 
hold him accountable in a court of law, bearing our burden of--
    Mr. Ackerman. You missed your chance.
    Ms. Thomsen. We have a pending action pending in the 
Southern District of New York.
    Mr. Ackerman. You took action after the guy confessed. He 
turned himself in. Don't give yourself any pat on the back for 
    Ms. Thomsen. Congressman, every time--
    Mr. Ackerman. Why didn't you find him, is the question?
    Ms. Thomsen. I understand your question, and we cannot 
answer as to the specifics. I can talk generally--
    Mr. Ackerman. You know, if anybody made the case better 
than Mr. Markopolos, and I didn't think anybody could, about 
you people being completely inept, you have made the case 
better than him.
    Ms. Thomsen. Well, sir, I am sorry you feel that way, 
    Mr. Ackerman. I think I am reflecting what the American 
public feels. How are they supposed to have confidence that if 
somebody goes to you with a complaint, gives it to you on a 
silver platter, with all of the investigation, with all of the 
numbers, with all the of the data, tell you exactly what he 
did, how he did it, and why he did it and how he knows that, 
and after a period of 6 or 8 years, you don't know anything.
    Ms. Thomsen. I can only talk about what we do overall.
    Mr. Ackerman. No, no, we want to know specifically. I don't 
want to know what your general purpose in life is. I don't need 
you to come here to tell me that you hate fraud. I hate when 
that happens, don't you? You are supposed to find it out before 
it happens.
    Ms. Thomsen. In Enforcement, obviously we can't. And I 
understand that concern. In Enforcement we bring--last year we 
brought 670-some-odd cases. In the past 2 years, we brought 70 
cases involving Ponzi schemes. In those 70 cases, close to 
    Mr. Ackerman. Listen, I am sure you have medals and 
    Ms. Thomsen. No, sir.
    Mr. Ackerman. --and stuff like that. And congratulations on 
all the good stuff you have done. I don't want to belittle any 
of that. But this is huge. How do you miss that? And we know 
that there are many Madoffs out there. They are starting to 
surface. You missed all of those, too. But this one you were 
pointed at. And Mr. Markopolos says he is going to give you 
another one tomorrow. He is not even giving it to you. He is 
giving it out to someone else because nobody has confidence in 
you guys anymore.
    Maybe the General Counsel, Mr. Vollmer, I believe you were 
the one who thought that your people didn't have to testify 
here today. I don't know where you got that, but some of us 
think otherwise. Maybe you could tell us. How did they miss all 
    Mr. Vollmer. We are as committed as each of you--
    Mr. Ackerman. That is not the question. We give you credit 
for being committed.
    Mr. Vollmer. Perhaps you could let me answer.
    Mr. Ackerman. Perhaps you can try to answer.
    Mr. Vollmer. And what we are asking--
    Mr. Ackerman. No, no, we are asking. You have to tell us 
things. You are forgetting what this procedure is. You aren't 
coming here to ask. We are asking you. How did you screw up?
    Mr. Vollmer. Let the process work. It is a process Congress 
set up to identify the facts that we all need to make these 
judgments. Let us let the system work that Congress created. 
There will be some recommendations. There will be time for this 
committee to look at the facts and to think of recommendations 
    Mr. Ackerman. Tell that to people who have lost their whole 
lives, that they have time.
    Mr. Vollmer. And that is the appropriate way to proceed in 
this matter.
    Mr. Ackerman. People don't have time. We need you to tell 
us something instead of lecturing us, Mr. Vollmer.
    Mr. Vollmer. And the other thing that matters is that there 
are law enforcement proceedings going on, there are personal 
rights at stake, there is the integrity of the investigation.
    Mr. Ackerman. We wouldn't be in this mess if you people did 
your job.
    Mr. Vollmer. And that is why we have asked the committee to 
bear with--
    Mr. Ackerman. No, we are asking you. We are asking you.
    Mr. Vollmer. --these investigations to allow them to 
    Mr. Ackerman. Could you cite whatever authority you are 
citing and have cited?
    Mr. Vollmer. I would be delighted, I would be happy to do 
that. I would be happy to talk with your--
    Mr. Ackerman. Because you have a right not to answer the 
Constitution's fifth amendment procedure.
    Mr. Vollmer. --your lawyer.
    Mr. Ackerman. I am not a lawyer. I am a citizen.
    Mr. Vollmer. I would be happy to talk to your lawyer.
    Mr. Ackerman. I am a frustrated citizen.
    Mr. Vollmer. Happy to give the references to you or to your 
    Mr. Ackerman. I am listening. Give us the references.
    Mr. Vollmer. There is a very important opinion from 
Attorney General Robert Jackson in 1941, where he explained the 
need to discharge the constitutional and statutory obligations 
of the Executive Branch in connection with law enforcement and 
civil litigation--
    Mr. Ackerman. Are you citing Executive Branch immunity, Mr. 
    Mr. Vollmer. --in response to requests for information from 
the Congress.
    Mr. Ackerman. Are you citing Executive Branch immunity, Mr. 
    Mr. Vollmer. There are various protections--
    Mr. Ackerman. Are you citing Executive Branch privilege, 
Mr. Vollmer?
    Mr. Vollmer. I would like you to allow me to answer your 
    Mr. Ackerman. It is a yes or no question, sir. Either you 
are or you are not.
    Mr. Vollmer. No, it is not. There are a variety of reasons 
and privileges and protections. One of them is Executive Branch 
protections. There is a deliberative process protection. They 
stem from the same desires that you have. And we are asking 
that you allow those processes to work.
    Mr. Ackerman. We are out of patience. And the question, 
obviously, is a yes or no question. Either you are citing 
Executive privilege immunity or you are not doing that.
    Mr. Vollmer. I have just explained there are various 
    Mr. Ackerman. You know, if you are citing your fifth 
amendment privilege, you don't make a speech.
    Mr. Vollmer. And that one of them was the Executive 
    Mr. Ackerman. Was that a yes, you are citing Executive 
privilege immunity?
    Mr. Vollmer. I said in part it is, yes.
    Mr. Ackerman. I am sorry?
    Mr. Vollmer. I said yes, it is in part.
    Chairman Kanjorski. Have you inquired of the Justice 
Department or someone else that they have analyzed that 
position for this hearing today, and they found that the 
Securities and Exchange Commission, requested by Congress to 
discuss a very important pending piece of legislation that is 
being established to protect hundreds of thousands, perhaps 
millions, of people, that you have a right, representing the 
Executive Branch, the President of the United States, to stand 
on that authority? Have you posed that question to the Attorney 
General or--
    Mr. Vollmer. No.
    Chairman Kanjorski. Then this is on your interpretation?
    Mr. Vollmer. This is the position of the Agency.
    Chairman Kanjorski. And you are the General Counsel for the 
Agency. I assume you make the legal determinations for the 
    Mr. Vollmer. No, the Commission makes the decisions for the 
    Chairman Kanjorski. So this question--
    Mr. Vollmer. --after obtaining advice from a variety of 
sources, and the General Counsel's Office is one of them.
    Chairman Kanjorski. So this has been passed through the new 
Director or Chairman of the Commission, and the members of the 
Commission, and they agree and have instructed you to instruct 
this panel not to respond to the questions of Congress because 
of Executive privilege and maybe other privileges contained in 
the 1941 Supreme Court case; is that correct?
    Mr. Vollmer. The Commission supports this position.
    Mr. Ackerman. That wasn't the chairman's question.
    Mr. Vollmer. The answer to that specific question is no.
    Mr. Ackerman. The answer is no. So you are acting on your 
own volition.
    Mr. Vollmer. No, I didn't say that. No, and I would 
disagree with that.
    Mr. Ackerman. You know, most of us speak English, and we 
are having a hard time getting an answer from you. This was not 
discussed by the Commission, but it is the Commission's 
position. Is that what you just said? Do you divine that?
    Mr. Vollmer. The Commission has approved taking this 
    Mr. Ackerman. The Commission has voted the position that 
you will cite Executive privilege in not testifying before this 
committee and answering its questions.
    Mr. Vollmer. I couldn't say that to you honestly, because 
the specific reasons--
    Mr. Ackerman. Obviously.
    Mr. Vollmer. --weren't discussed and given by the 
Commission. But the basis is that we were--
    Mr. Ackerman. Your value to us is useless.
    Mr. Vollmer. --in accommodation--
    Mr. Ackerman. Your value to the American people is 
worthless. Your contribution in this proceeding is zero.
    Mr. Vollmer. We ask that you take into account the concerns 
that have been well settled over many years, and we would ask 
you to take those into account.
    Mr. Ackerman. Our economy is in crisis, Mr. Vollmer. We 
thought the enemy was Mr. Madoff. I think it is you. You were 
the shield. You were the protector. And you come here and 
fumble through make believe answers that you concoct and 
attribute it to Executive privilege that you have not consulted 
with the Executive Branch on.
    Mr. Chairman, I am through.
    Chairman Kanjorski. May I just add a second, were you all 
in the room when we had a prior witness? If I remember 
correctly, his testimony was that FINRA was corrupt, and the 
SEC was incompetent. Do you all not want to defend against 
that, or do you all accept that?
    Ms. Thomsen. Of course not.
    Mr. Luparello. Mr. Chairman, on behalf of FINRA, we take 
great issue with the representation that we as an organization 
are corrupt.
    Chairman Kanjorski. Are you going to break your--are you 
asserting the same Executive authority or--
    Mr. Luparello. I am not.
    Chairman Kanjorski. --privilege?
    Mr. Luparello. I am not.
    Chairman Kanjorski. So you are willing to break any rights 
or privileges you have in order to speak? I just want to make 
    Mr. Luparello. FINRA is not involved in the investigation. 
It is therefore a little bit less complicated for FINRA. But I 
am here to answer any question you would ask.
    Chairman Kanjorski. Very good.
    Mr. Royce, we are going to give you a shot to see if you 
can get any responses.
    Mr. Royce. Well, in order to try to do that, maybe what we 
could do is go back to Mr. Markopolos's testimony, and maybe we 
can try to get an answer to some of the points that he raised. 
Specifically, one was what he described as the overlawyering at 
the SEC. His argument was that it was the inability for some of 
the regulators to even comprehend the complicated investment 
strategies that he presented them. Is there a concurrence that 
perhaps that was indeed the problem, or can anybody speak to 
    Ms. Thomsen. Well, I don't know if Erik wanted to start. I 
will start from the--
    Mr. Royce. Why don't you start, because this would be 
Enforcement, right? And you are the Director for the Division 
of Enforcement. And I think that is the big question mark here. 
Was he right in that assertion? And then we can go to the next 
point he raised. Okay?
    Ms. Thomsen. Sure. I think without speaking specifically 
about whether he was right or not, let us talk about the issue 
of expertise, and I think that is a fair and important issue to 
discuss. As I said earlier, the Enforcement Division is largely 
lawyers, because our expertise is trying and winning cases. We 
have to comply with court rules. We have to meet burdens of 
proof. And that is traditionally a lawyer job.
    Within Enforcement, we have lots of accountants who help 
us, lots of market specialists and investigators to help us on 
the core mission of the specific cases. Ours is a pretty micro 
job. Did this person commit a fraud? A ``Can I prove it'' kind 
of question. Now--
    Mr. Royce. Right, but the complexity of the fraud is the 
problem. And you have a few people who had maybe 25 years 
experience as portfolio managers, but unfortunately they were 
on his side in this debate. They got shut out by the lawyers 
apparently. He had his allies in the SEC, but obviously--
    Ms. Thomsen. Again, let me not talk about the specifics--
    Mr. Royce. Okay.
    Ms. Thomsen. --but talk about the expertise that we do have 
available to us within the Agency. And lots of them are 
represented to my left. We do go to our peers at the Division 
of Investment Management. We go to Trading and Markets, an 
enormously valuable resource for us when we are dealing with 
broker-dealers, broker-dealer issues. We have our Office of 
Risk Assessment, which is growing. It is a need we recognized 
some time ago. We have the Office of the Chief Economist.
    Mr. Royce. Let me get to a question really quick then.
    Ms. Thomsen. Sure. Of course.
    Mr. Royce. The percentage maybe, if you could give me an 
estimate in your division there, of broker-dealers or 
investment advisers or those who have that experience in the 
exchanges or rating agencies that also maybe are lawyers, but 
have that kind of experience--
    Ms. Thomsen. Within the Division itself?
    Mr. Royce. --who are basically in a position to be key 
decisionmakers on these kinds of cases.
    Ms. Thomsen. Within the division itself, very few.
    Mr. Royce. I think that was his point, wasn't it?
    Ms. Thomsen. I understand the point. And I think the issue 
of expertise is one that I mentioned earlier we do need to 
address. We have--
    Mr. Royce. Let me--because my time is limited, let me go to 
Erik Sirri really quick with a question, because the testimony 
this morning mentioned the vast difference in fraud cases 
uncovered from cases initiated by industry tips. And that then 
was explained against those from audits by regulatory bodies. 
And you must have been struck, as we were, by the discordant--
by the extreme difference in terms of how many of these came 
from people in the industry that apparently knew more and 
discovered more in advance. Somehow the private sector was well 
aware of the Madoff Ponzi scheme before the SEC.
    And so, you know, do you believe that is an accurate 
assessment? And do you believe the investigative priorities 
maybe of the SEC are properly set, given the outcome, that we 
are not just talking about one case here; he was taking in 
aggregate the number of cases brought because of 
whistleblowers, how much more effective that was than the 
experience of the auditing by the regulatory body.
    Mr. Sirri. I did understand the point that he made, and I, 
too, was struck by that point, though in many ways not 
surprised by it. People on the inside, of course, have 
knowledge, and they have their own motivation for releasing 
that information. When you are on the outside, of course, it is 
much more difficult to make those inferences and ferret it out.
    The division I supervise is a policy division. We do not 
have examiners. We don't have an enforcement function, so I 
can't speak, I think, to the heart of what you asked. But I 
would like to follow up on a point that Linda Thomsen made.
    The questions that you had asked were on expertise, and I 
think this event that has happened with Mr. Madoff has caused 
us to think about the way I think we deploy expertise. Chairman 
Schapiro, in her opening e-mail to us as a staff, said it is 
time to think about self-evaluation, and that we need to 
honestly take a look at what we are doing and how we are doing 
it. And I think we all as staff take that precisely to heart. 
When it comes to a point like expertise, nothing could be truer 
because that doesn't cost more money. That is just a matter of 
working smarter. And I think we try do that as best we can.
    We have resources within the SEC. The Office of Economic 
Analysis, almost exclusively economists with Ph.D.s; my 
division, mostly lawyers; but as I said, many, many other 
folks. I have a Ph.D. in finance, so I price derivatives for a 
living at times, so I am comfortable with that. Nonetheless, 
not all those people are brought to bear on the right problem 
at the right time. That is clearly something we need to work 
on. And when we see instructions like we got from Chairman 
Schapiro, I think it is a clue to all of us to figure it out so 
something like this doesn't happen again.
    Mr. Royce. Thank you, Mr. Chairman.
    Chairman Kanjorski. Let me see, Melissa Bean from Illinois. 
Where did you appear from?
    Ms. Bean. I snuck in on you. Thank you, Mr. Chairman. And 
thank you all for your testimony here today.
    I guess I would direct my questions either to Ms. Thomsen 
of Enforcement or Lori Richards of Compliance. I am not sure 
where this would fall, but clearly, the challenges that people 
feel we are facing as a Nation where there has been lack of 
compliance and enforcement isn't new to the SEC. Congress 
certainly provided additional funding. We all remember Enron 
and WorldCom and other situations where there needed to be 
greater scrutiny than has been provided.
    I guess my question is how proactive is--and what level of 
best practices are in place to ensure that, number one, when 
people actually make complaints and suggest someone gets looked 
at, are lower-level staffers allowed to just dismiss those 
without a full investigation? And should that continue? Or 
should things have to be escalated automatically through at 
least several levels of authority before dropping further 
    And where there haven't been any issues raised, what types 
of best practices are in place to go out there proactively in 
the industry to seek where there may be problems and 
investigate that at least on a sampling type of basis?
    Ms. Thomsen. Why don't I start with the complaint process, 
and perhaps Ms. Richards can talk about some of the examination 
process which is directed at proactively identifying issues.
    On the complaint process, as we mentioned in our testimony, 
we literally receive hundreds of thousands of complaints every 
year, hundreds of thousands. So we simply--we can't investigate 
all of them. We take them all seriously. We try to respond to 
them. So the process for us is trying to triage them to 
identify those which have the greatest risk of the greatest 
harm, as well as the greatest likelihood of being accurate or 
verifiable. And all of you get all kinds of information, tips, 
mail, too. And the real challenge is you can get something that 
looks terribly credible with lots of detail and lots of 
exhibits, and it can be, for whatever reason, not true, not 
verifiable, etc.
    Ms. Bean. If I can interrupt only because we have limited 
time. Given that, and given the constraints of resources, what 
is the criteria when you get multiple complaints about the same 
organization year after year; how is it that this doesn't rise 
to senior-level attention?
    Ms. Thomsen. Let me just back up. So we are not being 
specific about this particular issue, but complaints get 
followed up. They get triaged, and they are worked. If someone 
decides to pursue it--it is not an on-off switch. You look at 
something, you do some work on it, you consult with your 
supervisors along the way. You may do a little investigation. 
If it looks promising, you may do more. How much more you do is 
a decision that gets made along the way, balanced against what 
you are finding.
    Ms. Bean. So there are no checks and balances within the 
SEC to say if someone has decided based on their--the degree of 
knowledge they have taken to pursue how big the risk or harm 
is--clearly if we look at the Madoff scenario, if we have met 
both of those criteria, what are the checks and balances in 
place to say that someone else decided that that was worth 
moving past?
    Ms. Thomsen. I am struggling with how to answer that 
because in the specifics--
    Ms. Bean. Does that have to happen, or can it just be 
arbitrarily dismissed by an individual?
    Ms. Thomsen. It is going to be assessed within an 
organizational group through--up through supervisors. And I 
think that is as far as I can go specifically.
    Now, there are certain kinds of complaints that do have 
specific procedures. For example, if we get online complaints, 
there are very specific procedures that are followed in terms 
of responding. And which ones get picked up for further 
investigation also involve judgment calls. There are specific 
procedures with respect to SARS, suspicious activity reports, 
that we review. We try to--for example, depending on the nature 
of the complaint, if it is an accounting complaint, we have 
people with accounting expertise review them, all with an eye 
towards bringing expertise to those complaints.
    Ms. Bean. Let me interrupt again. So given that obviously 
this was a really big miss, and was dropped repeatedly, is it a 
lack of resources or a lack of skill sets among those who are 
in place who are making these decisions, in your opinion?
    Ms. Thomsen. What I would like--let us not assume--
    Ms. Bean. Well, I am not assuming, I am asking. So which is 
    Ms. Thomsen. Well, first, there is a premise I would like 
to address first. I would not necessarily assume that a 
complaint was not addressed.
    Ms. Bean. The assessment was inaccurate. Is that a skill 
set issue?
    Ms. Thomsen. Not--and I am not trying to quibble, because 
the issue is, if the assess--assume there is a complaint with a 
very--which led to something, as you say, dramatic and 
specific. That complaint in a matter--as a matter of practice 
would be pursued in an investigative way. Then the question 
becomes, what happens in the investigation? And that depends on 
what you find by way of--
    Ms. Bean. My time is up. So I will yield back.
    Ms. Thomsen. Thank you.
    Chairman Kanjorski. Thank you very much.
    Mr. Posey wishes to examine for 3 minutes and reserve 2 
    Mr. Posey.
    Mr. Posey. Thank you very much, Mr. Chairman.
    I was watching this on TV, eating my lunch, and it just 
occurred to me how shocked I would be if somebody dropped into 
my local police department and said, you know, there is a bank 
robbery going on down the street. Can you do something about 
it? And they said, yes, if we get around to it, we will. Or, 
well, we have done bigger robberies than that before. We are 
not going to worry about that.
    It is amazing to hear the stories and the testimony that we 
have heard today, truly amazing.
    A question for Ms. Richards at this point, and then I would 
like to reserve some of my time. You stated that you had been 
recused from the Madoff investigation, and I was just wondering 
why that was.
    Ms. Richards. Yes. Thank you for the question.
    I am not participating in the current examinations or 
investigation due to the fact that a former employee who was 
under my chain of command married a member of the Madoff 
family, and I attended the wedding. So the SEC has established 
a process that would allow the staff to recuse themselves from 
any current or ongoing investigation or examination so as to 
ensure that no possible questions are raised about the 
objectivity or the impartiality of the examination or the 
inspection. So for those reasons, I am not participating in the 
current examinations of the firm.
    Mr. Posey. Could I follow up, Mr. Chairman?
    Chairman Kanjorski. Yes.
    Mr. Posey. So you asked to be recused?
    Ms. Richards. Chairman Cox in December decided that the SEC 
would establish a process for SEC staff to ensure that there 
were no questions--
    Mr. Posey. I understand. But you asked to be recused; is 
that correct?
    Ms. Richards. Yes. When guidance was provided by our ethics 
counsel, I then took that guidance and recused myself.
    Mr. Posey. Do you think had you not been recused, you could 
have added anything, any information at all whatsoever that 
would be at all pertinent?
    Ms. Richards. Add it to this testimony? To today's hearing, 
you mean?
    Mr. Posey. No, to the investigation. It is a question that 
begs for an answer. Is it innocuous that you recused yourself, 
and it would have no effect on it? Or do you consider your 
knowledge and insight and service to be of any value in this?
    Ms. Richards. I am sorry, sir. I didn't understand your 
question. There are very senior staff at the SEC, very 
experienced staff examiners who were working on the examination 
and on the investigation. So I don't believe that there will be 
any compromises to the quality of the work.
    Mr. Posey. Thank you.
    I thank you, Mr. Chairman.
    Mr. Ackerman. [presiding] The gentlewoman from New York, 
Mrs. Maloney.
    Mrs. Maloney. Thank you very much.
    Mr. Markopolos in his testimony earlier testified that he 
brought complaints 5 times in writing to the SEC, and these 
were detailed complaints. It wasn't, ``I think something's 
wrong.'' These were detailed complaints that this is wrong. 
They are not trading. They are not doing this. There is 
examples. And it was a very specific complaint, not once, not 
twice, not 3 times, but 5 times to the SEC. He said he had the 
support of some people in the SEC, professionals, saying that 
this needed to be investigated. And how many more times would a 
whistleblower have to bring complaints to the SEC for them to 
have investigated the Madoff case?
    Ms. Thomsen. As I think we have made clear, we did 
investigate in 2006, and the investigation resulted in no 
action--no recommendation of enforcement action. So the issue, 
I think, to a certain extent becomes in investigations--with 
any complaint, our job is to verify the information.
    Mrs. Maloney. But one of the things he said was that Madoff 
wasn't conducting trades. Now, if you went in and just asked 
for the trade slips or proved that they were doing trades when 
whistleblowers were saying they weren't doing trades, then you 
could have shut him down in one-half hour. You could have shut 
Madoff down in one-half hour by just following up on one of his 
allegations that they were not conducting trades.
    So did the SEC ever use any tools to confirm that Madoff's 
trades could be confirmed in market transactions?
    Ms. Thomsen. As to the specifics of the investigation, I 
can't answer. As to what we do when we investigate, we try to 
confirm if we can--if there is a complaint, we try to confirm 
the elements of the complaint. Oftentimes a complaint takes 
    Mrs. Maloney. Well, let me tell you something. I am not an 
SEC official, I am not an attorney, but I have common sense, 
and if I were sent in to find out whether or not he was 
trading, I would ask, where are your trade slips? Where is the 
proof that you are trading? It doesn't have to be classified 
    I find this absolutely outrageous, and if you won't answer 
it, I think I am going to appeal to the chairman to subpoena 
and find out what you did in this case.
    He further testified today in very riveting testimony that 
in 2001, he offered to go undercover. He offered to risk his 
life to work with the SEC to prove this fraud. Why was that 
request turned down?
    Ms. Thomsen. Without talking about the specifics, let me 
say that we are a civil law enforcement agency and do not do 
undercover operations. They are exclusively the province of 
the--of criminal authorities. We don't do them.
    Mrs. Maloney. He also said, and I quote, and he wrote in 
his testimony, that Madoff was, ``one of the most powerful men 
on Wall Street and in a position to easily end our careers or 
worse.'' He told me he was afraid for his life that he was 
bringing these allegations. He was afraid Madoff would have 
somebody kill him because he was bringing these allegations, 
and yet, they were brought in a very comprehensive way that 
would have been easy to prove. And you can't testify as to what 
tools you used or what results you got on looking at, whether 
or not he was conducting trades.
    I mean, that is pretty basic. When people say, he is not 
conducting trades, it is a complete lie, that would have been 
able to be proved within a half hour if you looked at it. But 
maybe the SEC was afraid of--do you think the personnel were 
afraid of having their careers ended or worse if they looked at 
Madoff, as Mr. Markopolos said?
    Ms. Thomsen. On that one, again, without regard to Mr. 
Madoff, absolutely not. Absolutely not.
    Mrs. Maloney. Have any employees at the SEC ever gone to 
work for Madoff?
    Ms. Thomsen. I don't know the answer to that.
    Mrs. Maloney. Can you look into that?
    Ms. Thomsen. I think we can. I think we can. And I would 
say that the issue of revolving doors, the ethics rules are 
very seriously--we take them seriously.
    Mrs. Maloney. I know we have ethics rules. My question was, 
have any SEC employees gone to work for Madoff?
    Ms. Thomsen. I don't know the answer, but we will find out.
    Mrs. Maloney. The Madoff feeder funds were advertising 
unbelievably high sharp ratios. Can you tell us what a high 
sharp ratio is?
    Mr. Sirri. Yes, I can. A sharp ratio is the ratio between 
the expected return on the fund and the risk of the fund. So a 
high sharp ratio means that fund is returning a great deal of 
return for a unit of risk.
    Mrs. Maloney. And Mr. Markopolos testified about the sharp 
ratios advertised by Madoff and his feeder funds. Or do you 
agree that the sharp ratios shown by Madoff's equivalent to a 
baseball hitter hit 150 home runs a year, wouldn't you think 
that was a warning sign? His ratios were so successful; wasn't 
that a warning? No one else could get those numbers.
    Mr. Sirri. I have not seen those ratios, so I can't say 
anything specifically again about this case.
    Mrs. Maloney. Maybe it is something the SEC should have 
looked at.
    Mr. Ackerman. The time has expired.
    The Chair will next recognize the gentleman from Colorado, 
Mr. Perlmutter, and request of him if he would yield me 1 
minute, I would be glad to extend his time by that amount.
    Mr. Perlmutter. Mr. Chairman, I will so yield.
    Mr. Ackerman. You will be made whole.
    I just wanted to follow up on Mrs. Maloney's very important 
question to which the answer was neither opaque nor vague. It 
was just avoiding. But let me--inasmuch as you are not going to 
talk to us about specifics, which is why we invited you, could 
I ask you a hypothetical question? Hypothetically, if somebody 
came to you with evidence and a charge that somebody was 
committing a multibillion-dollar Ponzi scheme and said that 
person was not actually even making trades, would it not be 
standard operating procedure for you to go and see if he had 
trade slips?
    Ms. Thomsen. Our investigations would follow--
    Mr. Ackerman. This is a yes or no question.
    Ms. Thomsen. There is no standard operating procedure other 
than if we took a complaint seriously, we would try to find out 
whether the facts were true or not.
    Mr. Ackerman. If you took a complaint seriously, which 
obviously you did not, is that what you just told us?
    Ms. Thomsen. No, sir. That is not what I said.
    Mr. Ackerman. Then if somebody brought you evidence and 
made a charge that somebody was committing this type of fraud 
hypothetically, would your procedure and investigation--I am 
asking you a procedural question now, having nothing to do with 
Bernie anybody. If somebody brought you this information 
tomorrow, would it not be reasonable to expect that you would 
ask to see their trade slips?
    Ms. Thomsen. I think it would be fair to say those are 
among the things that we would look at.
    Mr. Ackerman. And if you did not, would you consider that 
    Ms. Thomsen. Not necessarily, depending on what we saw.
    Mr. Ackerman. Thank you very much.
    Mr. Perlmutter.
    Mr. Perlmutter. Thanks, Mr. Chairman.
    I have to say just as an opening statement, the charges and 
the vehemence that Mr. Markopolos directed towards all of you, 
the only person who had any emotion in her voice in the initial 
opening statements was Ms. Richards. Cozy; captive; gullible; 
go along, get along; lazy; he couldn't have used any more 
adjectives to describe what he felt about this particular 
    We have heard about all the red flags. I don't want to talk 
about that. I would like to know, Mr. Donohue, what a split 
strike strategy is, if you know.
    Mr. Donohue. First, I would start off by saying that I have 
only been at the Commission for 3 years. I started on Wall 
Street in 1975 and had many different positions in Wall Street 
prior to coming to the SEC.
    Mr. Perlmutter. Do you know what a split strike strategy 
    Mr. Donohue. I understand what a split strike strategy is, 
that one creates a collar. You will buy either stocks or a 
basket of stocks and sell a call, which limits your upside 
opportunity, and you would buy a put, which would limit your 
downside risk.
    Mr. Perlmutter. Had you in your experience ever used a 
split strike strategy?
    Mr. Donohue. No, I had not.
    Mr. Perlmutter. Mr. Luparello, what is your understanding 
of what a split strike strategy is?
    Mr. Luparello. Similar to what Mr. Donohue's is.
    Mr. Perlmutter. In your experience, have you ever used 
split strike strategy?
    Mr. Luparello. I have not.
    Mr. Perlmutter. Just so you two know, I asked Mr. Cox and 
Mr. Harbeck the same question a month ago. They didn't have any 
clue what a split strike strategy was. They had never used it. 
And it is classic Ponzi scheme doubletalk. Okay? You can call 
it whatever it is. And then there is, you know, secrecy and all 
that sort of stuff.
    Let us drop back here for a second because I really wanted 
to give all of you the benefit of the doubt coming into this 
thing. But, Mr. Donohue, there actually was a guy named Jim 
Donohue, James Donohue, in Colorado with a little company 
called Hedged Investments. It had exactly the same Ponzi scheme 
in 1992, only $100 million was stolen, not $50 billion. My 
question is, when you are training your people, do you talk 
about; it is too good to be true, therefore, it has to be? What 
kinds of things do you ask your people to look for so they are 
sheriffs, they are cops, they stop this stuff from happening? 
Mr. Donohue?
    Mr. Donohue. I will start off by saying that my division is 
a policy division. I don't have any examiners. I do ask folks 
when they are looking at registration statements and things of 
that nature that they look at things that might be abnormal, 
things that are too good to be true. And that is one of the 
things that we do ask people to look at. There is no free 
lunch, and that is one of the things I do try and impress on 
folks who are in my division.
    Ms. Richards. Can I answer that question, sir, with respect 
to examiners? It is the field office examination staff who go 
out and conduct examinations. The risk of Ponzi schemes, the 
risk of theft is foremost in their minds. So they are examining 
for compliance with lots of provisions of the Federal 
securities laws. But they are always alert to the possibility 
of fraud. So one of the things that examiners do is they verify 
records that are provided to them. They would never, for 
example, just simply ask, are you in compliance with the law, 
or are you engaged in fraud? That wouldn't be enough for an 
examiner. They want to see backup records. And one of the 
routine aspects of every routine investment advisory exam is to 
seek confirmation of the holdings of clients directly with a 
third-party custodian. It is a very basic audit step. And then 
the examiners will match that with the records that they see at 
the advisor--
    Mr. Perlmutter. That sounds great.
    Let me ask you the question point blank, and anybody can 
answer this, and then I am going to yield the balance of my 
time to Mr. Arcuri. The coziness, okay, those sound like very 
good precautions. Is the SEC too cozy with the industry? Are 
they captive by this industry, or are they looking out for us, 
looking out for the taxpayers? Ms. Richards, you answer that.
    Ms. Richards. Absolutely not. Examiners, as I said at the 
outset, they are taught to pull no punches. They are taught to 
communicate deficiencies in violations without regard to the 
type of firm, the influence of the person. They are blind to 
the type or the nature of the firm that they are examining. 
They truly have a ``pull no punches'' attitude.
    Mr. Perlmutter. I would like, Mr. Chairman, to give my last 
minute to Mr. Arcuri if I could. I have 1 more minute, right, 
because I had given a minute?
    Mr. Ackerman. Yes.
    Mr. Perlmutter. I would yield that to Mr. Arcuri.
    Mr. Arcuri. Thank you. I thank the gentleman.
    Really quickly, Ms. Thomsen, how long were the Madoff 
actions allegedly going on?
    Ms. Thomsen. Well, I can't answer that as to the specifics.
    Mr. Arcuri. The answer is, you don't know.
    The next question is, you talked about credible lead. What 
do you consider a credible lead?
    Ms. Thomsen. Whether or not a lead is credible and how we 
assess it depends on the nature of the--
    Mr. Arcuri. I understand the process. I am a former 
prosecutor. What do you consider a credible lead for the SEC?
    Ms. Thomsen. It depends on what is in it. It depends on the 
specificity and how important, how big it is.
    Mr. Arcuri. I get it. Do you look at the person who is 
giving you the lead?
    Ms. Thomsen. Absolutely.
    Mr. Arcuri. And obviously you weigh the credibility of the 
person who is presenting the lead to you; do you not?
    Ms. Thomsen. Yes.
    Mr. Arcuri. You give certain greater credibility to people 
who you deem to be a credible person and less to someone you 
would deem to be noncredible?
    Ms. Thomsen. Generally speaking, yes, although I have to 
say that some people who appear incredible have credible leads.
    Mr. Arcuri. That is true.
    Now, when Mr. Markopolos came before you, did you consider 
that a credible lead?
    Ms. Thomsen. I can't answer that.
    Mr. Arcuri. You can't answer that? How does that affect 
your ability to investigate or Mr. Madoff's investigation?
    Ms. Thomsen. Because that is subject of the Inspector 
General's investigation, and--
    Mr. Arcuri. Ma'am, I have used that excuse a number of 
times, and I can't even fathom how this could in some way be 
affecting the investigation.
    All right. Let me ask you this.
    Ms. Thomsen. Sure.
    Mr. Arcuri. In 2006, when you investigated, did you make a 
determination of any wrongdoing on Mr. Madoff?
    Ms. Thomsen. We did not bring an enforcement action, and we 
did not--
    Mr. Arcuri. That was not my question. Did you make a 
determination whether or not there was any wrongdoing?
    Ms. Thomsen. Again, I can't answer the specifics on the 
underlying investigation other than to say what is public was 
that there was no enforcement action.
    Mr. Arcuri. Did you make a referral based upon your 
analysis in 2006?
    Ms. Thomsen. I can't answer that.
    Mr. Arcuri. You can't answer whether or not you made a 
    Ms. Thomsen. I cannot. And again, this goes back to whether 
or not--it is to protect the criminal prosecution.
    Mr. Arcuri. I understand. Thank you. I understand about a 
defendant's rights. But you can't answer whether or not you 
made a referral?
    Ms. Thomsen. No.
    Mr. Arcuri. Okay. Now, my next question is this--do I have 
any more time, Mr. Chairman?
    Chairman Kanjorski. I don't know whether we should--
    Mr. Arcuri. I yield back the balance of my time. Thank you.
    Chairman Kanjorski. Thank you.
    We have Mr. Posey here. We will give him 2 minutes, so 
maybe he can crack this egg.
    Mr. Posey. Thank you, Mr. Chairman. And I will yield back a 
minute or two to him if I have any left.
    It is just such an incredulous tale, I think, for everybody 
up here to understand. Maybe you all don't have that kind of a 
problem grasping with it, but it is just incredibly 
unbelievable to the people in this committee to hear these 
    Besides Mr. Markopolos, we have the Barron's article, we 
had what is called the Ocrant article. We had Merrill Lynch, 
Goldman Sachs telling their investors, don't touch this. This 
is impossible. This has got to be a scam. We have hedge fund 
managers, money managers with the absolute minimal amount of 
due diligence, you know, telling their clients by the 
thousands, this is a joke. This cannot possibly be working. 
Stay away from this thing. And yet, you know, our enforcement 
agency is blind to the whole--I mean, it is literally hard for 
everybody to believe. And, you know, the question I have is, 
did anyone else report to you like Mr. Markopolos did and ask 
you to look at this? You know, report the bank robbery going on 
a block over?
    Ms. Thomsen. While I can't answer it specifically as to 
this, I can verify one of the things Mr. Markopolos talked 
about, which is a reluctance on the part of people in the 
industry to bring information to us about their peers or others 
in the industry. It is a frustration to us that people who--
legitimate actors in the securities business who ought to be 
protecting the legitimacy of their business sometimes do not 
come to us sort of with leads about potential problems.
    So, that I can say. I can't talk specifically about this 
particular situation. And if I could turn to--I think we all 
understand your frustration. And if we knew going into 
something that it actually was a fraud, we wouldn't 
investigate. We would bring that action. If we had the evidence 
to bring it, we would bring it. There is nothing--I mean, in a 
perverse way--there is nothing that makes us happier than 
bringing those kinds of cases.
    Mr. Posey. I think a lot of frustration was probably 
because we can't believe when they reported the bank robbery in 
process, nobody bothered to look, number one. And since you 
brought it up, all these insiders who kept their mouths shut 
who apparently knew something was going on, is there anything 
in the statutes that would make them culpable in this crime? I 
mean, if I see somebody being mugged, and I am able to do 
something about it, and I don't, I think I share some guilt 
with the crime.
    Ms. Thomsen. I think, sir, you may at a sort of moral or 
ethical level. I think legally the issues become whether you 
participated enough to be responsible as either a cause or an 
aider or an abettor. And we will, in all investigations, look--
cast our net wide and deep to bring--
    Mr. Posey. Okay. Let us say it wasn't illegal. When you 
license people, don't they have to have a relatively clean 
background, be free of what they call moral turpitude? And 
wouldn't that blemish the license of every licensed person if 
they knew something--maybe it is not illegal, but it is a 
breach of morality at least held by most people in this country 
that would be a view. And I would think anyone that you suspect 
that knew this was going on and didn't report it--although 
obviously it would have been unacknowledged even if they had--
but had they not reported it, I think their licenses should be 
in jeopardy, just on the grounds of the moral-turpitude-free 
background that you expect them to be when they get licensed.
    Ms. Thomsen. Let me defer that issue to those who know the 
licensing issues. I don't necessarily disagree.
    Chairman Kanjorski. Mr. Donnelly, you are recognized for 5 
    Mr. Donnelly. Thank you, Mr. Chairman.
    I asked the Inspector General when he came how many red 
flags are enough red flags that you stop what is going on? And 
one of the flags was a $50 billion fund with a one-person 
accounting firm. Why was that one flag not enough for you to 
shut this down earlier?
    Ms. Thomsen. Without regard to the specifics of this 
particular case--
    Mr. Donnelly. Let us have a theoretical $50 billion fund 
with a theoretical one-man accounting firm.
    Ms. Thomsen. That is where I was headed. We need evidence, 
and that is what we pursue, and if we have enough evidence of 
fraud, we bring those cases.
    Mr. Donnelly. How early on did you know that there was a 
one-man accounting firm involved?
    Ms. Thomsen. I can't answer that question.
    Mr. Donnelly. You were told that in 2001, if I am not 
    Ms. Thomsen. Sir, I simply can't discuss the specifics of 
this one.
    Mr. Donnelly. Then let me ask you the next question, which 
is, is there a form for examination when your examiners go in, 
things that if you see these, you say, this is a red flag, 
something has to be done?
    Ms. Thomsen. Let me defer to Ms. Richards, who is the 
expert on examinations.
    Mr. Donnelly. Let me ask Ms. Richards.
    Ms. Richards. In the examination context, sir, given the 
number of registered investment advisors--and I am assuming 
your question goes to investment advisors and the breadth of 
activity--we have to take a risk-based approach to deciding 
both which firms to examine and which issues--
    Mr. Donnelly. Let me ask you this: When you go in and your 
examiners go in, and they see a $50 billion firm and one 
accountant, does that tip them off that there may be a 
situation here?
    Ms. Richards. Investment advisors are not required to have 
an audit, so the fact that it was a small auditor or a no-name 
auditor may or may not present a risk. We would look at other 
things, however, like how are the assets custodied, what are 
the performance claims the advisor is making.
    Mr. Donnelly. How about you combine the accounting with the 
fact that they go into cash at the end of every quarter? Does 
that then start to smell a little differently?
    Ms. Richards. If examiners had selected that firm for 
examination and had gone in, they would definitely look at the 
trading in client accounts and look at whether it is consistent 
    Mr. Donnelly. So in and of itself, those are not red flags 
to you?
    Ms. Richards. It could be. It certainly could be depending 
on what representations the advisor made to the customer.
    Mr. Donnelly. Do you have a form of examination that here 
are some absolutely critical things that we will never pass on 
when we do an exam? One, two, three, four, five; these are 
things when we go in we look for? These are things when we look 
at each company, the basics we want to see?
    Ms. Richards. Yes. When we conduct a routine examination of 
an investment advisor, we are looking at such things as do they 
have--what are the representations they make to clients? Are 
they living by those disclosures? What are the expenses that 
they are deducting from client accounts? Are they in some way--
    Mr. Donnelly. I am going to give my last minute to Mr. 
Arcuri after this question, but it is this: Back home in 
Indiana, there is a fellow running a tool and die shop who is 
looking to put a few bucks back into his mutual fund to try to 
save for his retirement. Why should he have any confidence that 
the organizations out there have been thoroughly vetted by you?
    Ms. Richards. Well, with respect to mutual funds, which is 
your question--
    Mr. Donnelly. Or hedge funds. Or like any of these security 
funds. The organizations that you have jurisdiction over.
    Ms. Richards. We have examination responsibility over firms 
that are registered with the SEC, so that may not include hedge 
funds. It does include mutual funds. There is a robust 
regulatory structure around mutual funds. They are also subject 
to examination by the SEC, though given our resources, we don't 
examine every mutual fund firm on a regular basis.
    Mr. Donnelly. Let me say one last thing, and then I will 
turn it over to Mr. Arcuri. We had a 78-year-old man, I believe 
he was a friend of Mr. Ackerman's, who came before us. And in 
2001, you were contacted by Mr. Markopolos. He continued to put 
money in, this gentleman did, into the Madoff funds because he 
had confidence in the system, in the SEC. He believed in you 
guys as a gold standard. He has zero now, and they are going to 
foreclose on his house.
    Mr. Arcuri.
    Mr. Arcuri. Thank you, Mr. Donnelly.
    Ms. Richards, if you were to see an investor continually 
over, let us say, a 10-year period consistently make a 10 or 12 
percent return for his investors, would you consider that a red 
    Ms. Richards. Yes, sir, I absolutely would. The SEC does 
    Mr. Arcuri. If you were to receive that, you would consider 
that possibly a red flag?
    Ms. Richards. Yes, sir.
    Mr. Arcuri. My next question is, how about if you saw an 
investor who was giving 4 percent of the profit he would 
normally receive to the feeder companies; would you think that 
might be a red flag?
    Ms. Richards. It would be an unusual situation.
    Mr. Arcuri. Okay. How about if you saw a company that 
continually at the end of each period turned their cash into 
government securities; would you consider that perhaps a red 
    Ms. Richards. We would want to understand why.
    Mr. Arcuri. Okay. Now, if you had those sort of situations, 
and then you had someone come in who maybe you considered to be 
a credible lead, give you information, what would then prevent 
you from investigating that? Why would you not investigate that 
    Ms. Richards. My office has authority to conduct 
examinations, routine and cause, of registered investment 
advisors. So the first threshold is, is it a firm that is 
    Mr. Arcuri. But if you were see those situations, wouldn't 
it be something--and you were to receive what would be a 
credible lead, wouldn't that be the kind of thing that you 
would want to look into?
    Ms. Richards. In situations where we receive credible 
leads, the first step is, is it a registered advisor? If it is, 
we send examiners out immediately. They show their badges 
without notice.
    Mr. Arcuri. The bottom line is, you didn't do it. You had 
all of these situations in a particular case, and nothing was 
done by the SEC, correct? That is a yes or a no. Nothing was 
    Ms. Richards. This firm registered with the SEC in 2006. 
Following that, there was no SEC exam of--
    Mr. Arcuri. So you had the scenarios that I just described; 
you had a credible lead, and yet nothing was done by the SEC, 
correct? There was nothing done by the SEC, was there?
    Ms. Richards. I think that is not correct. I have testified 
about the extent of the regulatory examinations of the firm. 
And Ms. Thomsen talked about--
    Mr. Arcuri. Well, you just indicated these things would be 
possible red flags. Ms. Thomsen said that maybe it was a 
credible lead. You had all these situations, either somebody 
wasn't talking to someone, or there was no investigation done.
    I have nothing further. I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Arcuri.
    The ranking member of the full committee, Mr. Bachus.
    Mr. Bachus. Thank you.
    Ms. Thomsen, in your testimony you say you can't pursue 
every tip. And are you characterizing Mr. Markopolos's dialogue 
as a tip?
    Ms. Thomsen. I do characterize it as a lead or a tip, just 
like others.
    Mr. Bachus. Well, at some point, it became much more than a 
tip or a lead, right? Because Madoff was already under 
    Ms. Thomsen. I can't talk about it specifically.
    Mr. Bachus. No. I am saying that in a case where someone is 
already under investigation, and someone gives you--in 42 
different contacts--and I am talking about meetings, 
discussions--they gave you a case on a silver platter, he 
described what was going on to a T. And the auditor for Madoff 
was one person in a storefront on Long Island. This begs for 
investigators. Would you agree that a case like that, with all 
that information, should have caused someone already under 
investigation--someone that had failed to register, that that 
begged for investigation?
    Ms. Thomsen. Without reference to the specifics, the more 
credible, the more informative a complaint is, the more we are 
going to investigate. And a complaint or a lead, no matter 
what, our job is to turn it into evidence. And that is what we 
love to do. When we follow things up, we are looking for 
evidence. We can take leads that are very unspecific.
    Mr. Bachus. I am talking about those where they--where you 
know, public knowledge, what is published in the newspaper. 
What you knew from his operation, because you had investigated 
it, you knew that he had failed to comply for years with the 
law. Was there any penalty for that? Was he sanctioned, or was 
he penalized for that? Was there a heightened--when someone has 
violated the law for years in billions of dollars in 
transactions, is there any punishment or heightened 
investigation, particularly when someone comes to you, a 
credible source, and gives you documented evidence?
    Ms. Thomsen. Without reference to the specifics, there are 
penalties that may be applied to failing to register for--
    Mr. Bachus. But they were not applied to him?
    Ms. Thomsen. There is no enforcement action. There is no 
public enforcement action prior to the action that we brought 
in December as to Mr.--
    Mr. Bachus. Well, that is after it all blew up.
    Ms. Thomsen. Yes, sir. And as I have indicated, 
unfortunately--and this is one of the great sort of limits of 
law enforcement. It is always after the fact when we come in. 
We don't want it to be--we want it to be as close in time to 
the illegality as possible.
    Mr. Bachus. I will characterize this. He gave you a case on 
a silver platter, someone you had been investigating for years, 
someone who had failed to comply with your own rules, and he 
wasn't even penalized.
    Let me take another pay for play. In 1997, my now chief of 
financial services helped compose a letter with 42 pages of 
documentation on what was happening. What we didn't know--we 
had no idea what was alleged to have happened in Jefferson 
County. Mr. Markopolos said it was happening all over the 
country. Municipalities are out billions of dollars from this 
pay-for-play scheme. We sent that information to the SEC, 
chapter and verse. I have now determined that there was 
apparently no follow-up. Is a county commissioner with 
documented evidence and a Congressman writing, is that not 
credible information?
    Over 2 years ago I wrote again pointing out that now some 
of these people have been disclosures and cases in Birmingham 
that substantiated all this, and I asked for an investigation. 
Now, I think at a certain point after meeting with the 
Commissioner himself, actually calling and asking him to come 
to my office, finally there was some initiation. But, you know, 
it was all in the paper by the time that y'all--
    Ms. Thomsen. Well, more generally about municipal 
securities issues, municipal securities issues are a priority 
for us. We have a working group focused on it. We have brought 
several cases over the last years. And it is one of those areas 
where, unlike some broker dealers, etc., there are fewer 
regulatory speed bumps along the way, so that our tools are 
predominantly enforcement, and our ability to discover the 
issues is limited as a consequence. But I agree it is an 
important area to pursue.
    Mr. Bachus. Let me just--and I will close with this. I have 
requested that you consider disgorgement for these folks or for 
the feeder groups in the Madoff scheme, that they disgorge 
their profit; that these wrongdoers in the pay-for-play scheme, 
that they disgorge to the ratepayers and the taxpayers all over 
America their ill-gotten gains. And I have heard nothing. I 
have had no response to multiple requests that you all consider 
that. I would ask you to pursue that.
    Ms. Thomsen. I would be happy to get back to you on that.
    Mr. Bachus. Thank you.
    Chairman Kanjorski. Thank you very much, Mr. Bachus.
    We are ready to close because we have another markup that 
has to proceed immediately. We have 2 minutes for Ms. Speier. 
But I will hold you to 2 minutes.
    Ms. Speier. All right. I want you to each grade the SEC on 
how they handled the Madoff case, very quickly.
    Ms. Thomsen. Can't do it.
    Ms. Speier. Why can't do you it?
    Ms. Thomsen. Because it would inevitably--
    Ms. Speier. You are giving an opinion. Did the SEC do a 
good job? A, B, C, D, or F?
    Ms. Thomsen. I wish we had found it earlier.
    Ms. Speier. Would you give the SEC an F?
    Ms. Thomsen. I would not. I would not grade it.
    Ms. Speier. What is the employee salary in the Compliance 
and Enforcement Section on average? What are they making?
    Ms. Thomsen. You know, I don't know. It is in the hundreds 
of something.
    Ms. Speier. So they are making $100,000, $150,000.
    Ms. Richards. I can give you more specific information. 
This is the range of salaries for an examiner in our New York 
office. So a typical examiner could range from $47,000 a year 
to as high as $177,000.
    Ms. Speier. All right, $40,000 to $170,000. How many of 
your employees--what percentage of your employees in those two 
branches, Enforcement and Compliance, leave the SEC and go to 
work for an SEC-regulated entity?
    Ms. Thomsen. In enforcement, it is very few. Most, if they 
leave, go to private practice of law.
    Ms. Speier. Ms. Richards.
    Ms. Richards. I think fewer people leave the SEC than they 
used to, but when they do go, they often go to a regulated 
entity in the compliance area.
    Ms. Speier. Mr. Swanson was the lead attorney on this case. 
He leaves the SEC, marries Mr. Madoff's niece. Did you for 1 
minute think that maybe you should go back and look at how he 
handled that case?
    Ms. Richards. Yes. And that is exactly what the Inspector 
General is investigating, the role of current and former SEC 
employees and their interactions with the Madoff firm, and 
whether those interactions in any way, in any way, impacted the 
conduct of the regulatory oversight of the firm. That is 
exactly what the Inspector General is looking at.
    Ms. Speier. Mr. Einhorn complained about Allied. He came to 
the SEC. The attorney who handled that case, Mr. Braswell, 
criticized him instead of Allied. Mr. Braswell left the SEC and 
then went to become a lobbyist for Allied. Do you see any kind 
of pattern here?
    Ms. Thomsen. I don't know enough to know whether there was 
a pattern.
    Chairman Kanjorski. Okay. We will have to close it there. I 
am sorry, Ms. Speier.
    Mr. Maffei, we are going to give you 2 minutes, but I ask 
you to take 1 minute.
    Mr. Maffei. Yes, I will, Mr. Chairman. Thank you very much.
    I just have one question. We heard a lot about the general 
policy for enforcement at the SEC. Ms. Richards talked about 
the ``pull no punches'' attitude. And indeed, I have talked to 
folks who are very, you know--in the financial services 
industry who are very afraid of an SEC investigation. But what 
I want to know, given the apparent mess of the Madoff scheme, 
is can you give us any data--and I really would like to know. 
If you can't do it now, can you provide any data on the size of 
the companies on which the investigatory or enforcement actions 
have been taken so that we will be assured that you are not 
just picking on the little guys and throwing the big fish back?
    Ms. Thomsen. I think we can get you that. But among other 
things, I would point to the auction rate securities cases, 
which we talked about before this committee not very long ago. 
I think it was in August. And some of the aiding and abetting 
cases we brought against the biggest financial institutions in 
this country for aiding and abetting Enron's fraud--Citi, 
Merrill, JPMorgan Chase.
    Mr. Maffei. I would appreciate the specific data.
    Ms. Richards. Can I just add that we inspect firms, small 
firms and large firms, in much the same way with the same pull 
no punches attitude, and those include firms with billions and 
billions and billions of dollars in management. So all types of 
firms are subject to inspection.
    Mr. Maffei. I would, of course, hope that there is the same 
standard. And then obviously the question continues, why did we 
miss Madoff? But I know that is a specific case, so I am not 
asking that question.
    Thank you very much, Mr. Chairman.
    Chairman Kanjorski. Mr. Posey, 12 words.
    Mr. Posey. Thank you, Mr. Chairman. I haven't seen this 
much bobbing and weaving since Muhammad Ali's rope-a-dope.
    Mr. Bachus. Mr. Chairman, I would like to acknowledge Ms. 
Thomsen and Ms. Richards and Mr. Donohue, that there has been 
some very good investigative actions by the SEC, and you have 
some top-flight professionals over there. And we don't mean--at 
least I don't mean to convey that there hasn't been some very 
good work by the SEC.
    Ms. Thomsen. Thank you very much.
    Chairman Kanjorski. Thank you very much.
    The Chair notes that some members may have additional 
questions for today's witnesses, which they may wish to submit 
in writing. Without objection, the record will remain open for 
30 days for members to submit written questions to today's 
participants and to place their responses in the record.
    Before we adjourn, the following documents and/or written 
statements will be made part of the record of this hearing: Mr. 
Markopolos's communications with the Securities and Exchange 
Commission. Without objection, it is so ordered.

    The complete set of documents referred to above can be 
accessed at the following link:


    Before we adjourn the panel, I just wish to say we are 
going to inquire into a process or procedure to see whether the 
limitations placed upon this panel's testimony comport with the 
law, and whether or not we are able to take such action as to 
overcome those objections. We will be proceeding with that in 
the immediate future.
    The panel is dismissed, and this hearing is adjourned.
    [Whereupon, at 2:46 p.m., the hearing was adjourned.]

                            A P P E N D I X

                            February 4, 2009