[House Hearing, 111 Congress] [From the U.S. Government Publishing Office] ASSESSING THE MADOFF PONZI SCHEME AND REGULATORY FAILURES ======================================================================= HEARING BEFORE THE SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED ENTERPRISES OF THE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED ELEVENTH CONGRESS FIRST SESSION __________ FEBRUARY 4, 2009 __________ Printed for the use of the Committee on Financial Services Serial No. 111-2 U.S. GOVERNMENT PRINTING OFFICE 48-673 WASHINGTON : 2009 ----------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gov Phone: toll free (866) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 HOUSE COMMITTEE ON FINANCIAL SERVICES 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 RUBEN HINOJOSA, Texas SHELLEY MOORE CAPITO, West WM. LACY CLAY, Missouri Virginia CAROLYN McCARTHY, New York JEB HENSARLING, Texas 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 TRAVIS CHILDERS, Mississippi WALT MINNICK, Idaho JOHN ADLER, New Jersey MARY JO KILROY, Ohio STEVE DRIEHAUS, Ohio SUZANNE KOSMAS, Florida ALAN GRAYSON, Florida JIM HIMES, Connecticut GARY PETERS, Michigan DAN MAFFEI, New York Jeanne M. Roslanowick, Staff Director and Chief Counsel Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises 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 CAROLYN B. MALONEY, New York JEB HENSARLING, Texas 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 BILL FOSTER, Illinois WALT MINNICK, Idaho JOHN ADLER, New Jersey MARY JO KILROY, Ohio SUZANNE KOSMAS, Florida ALAN GRAYSON, Florida JIM HIMES, Connecticut GARY PETERS, Michigan C O N T E N T S ---------- Page Hearing held on: February 4, 2009............................................. 1 Appendix: February 4, 2009............................................. 89 WITNESSES 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 APPENDIX 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 ASSESSING THE MADOFF PONZI SCHEME 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 ordered. 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 system. 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 innovations. 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 comments. 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 inconsistency. 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. STATEMENT OF HARRY MARKOPOLOS, CFA, CFE, CHARTERED FINANCIAL ANALYST AND CERTIFIED FRAUD EXAMINER; ACCOMPANIED BY GAYTRI KACHROO AND PHILIP MICHAEL, COUNSEL 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 situation. 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 discovered. 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 priorities. 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. Chairman. [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 section. 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 Century. Chairman Kanjorski. Do you think it is time to shoot the lawyers? 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 need. 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 assessment? 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 come. 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 did. 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 that? 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 America. Mr. Garrett. I appreciate it. Thank you. Chairman Kanjorski. The gentleman from New York, Mr. Ackerman. 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 existed-- 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 this? 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 with? 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 committee? 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 investigation? 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 businesses. 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 word. 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 not? 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 adequacy. 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 believe. 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 investors. 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 me. 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 them? 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 industry. 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 nature? 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 like-- 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 began. Is there something we should be doing with respect to accounting firms for large hedge funds and large security brokers? 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 them. 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 this: 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 soon. Mrs. Capito. All right. Well, I want to thank you too for your very in-depth analysis of the SEC and the regulatory environment. 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 was. 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 happened. 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. Neugebauer. 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 again? 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 frustrating. 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 need. 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 this. Mr. Lynch. All right. That is what I wanted to get out of you. 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 thousands? 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 record. 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 right? 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 were. 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 fraud. 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. Madoff. 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 forward. 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 time. 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 done. 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 SEC. 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 fraud. 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 further? Mr. Markopolos. He is leading a life of luxury, and he does have serious complaints. He is not able to go out for his knosh. 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. Foster. 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 these. 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 questions. 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 Nation. 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 York. 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 itself? 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 business. 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 that. 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. Ackerman? 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 out. 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 investor. 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 reform. 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. STATEMENT OF LINDA THOMSEN, DIRECTOR, DIVISION OF ENFORCEMENT, U.S. SECURITIES AND EXCHANGE COMMISSION 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. Madoff. 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 Commission. STATEMENT OF ANDREW J. DONOHUE, DIRECTOR, DIVISION OF INVESTOR MANAGEMENT, U.S. SECURITIES AND EXCHANGE COMMISSION 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 issues. 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. STATEMENT OF ERIK SIRRI, DIRECTOR, DIVISION OF TRADING AND MARKETS, U.S. SECURITIES AND EXCHANGE COMMISSION 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 operate. 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. STATEMENT OF ANDREW VOLLMER, ACTING GENERAL COUNSEL, U.S. SECURITIES AND EXCHANGE COMMISSION 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 staff. 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 exams. 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. STATEMENT OF LORI A. RICHARDS, DIRECTOR, OFFICE OF COMPLIANCE INSPECTIONS AND EXAMINATIONS, U.S. SECURITIES AND EXCHANGE COMMISSION 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 agencies. 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 oversight. 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 have. 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. STATEMENT OF STEPHEN LUPARELLO, INTERIM CHIEF EXECUTIVE OFFICER, FINANCIAL INDUSTRY REGULATORY AUTHORITY 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 him. 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 advisers. 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 whole. 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. [Recess] 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 something. 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 pursue. 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 process. 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 of-- 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 employees. 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 that. 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, profoundly. 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 half-- Mr. Ackerman. Listen, I am sure you have medals and ribbons-- 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 this? 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 themselves. 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 proceed. 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 lawyer. 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. Vollmer? Mr. Vollmer. --in response to requests for information from the Congress. Mr. Ackerman. Are you citing Executive Branch immunity, Mr. Vollmer? 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 question. 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 doctrines. 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 privilege. 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 Agency. Mr. Vollmer. No, the Commission makes the decisions for the Agency-- 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 position. 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 sure. 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 that? 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 inquiry? 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 which? 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 minutes. 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 us-- 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 information. 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 malfeasance? 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 investigation. 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 is? 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 referral? 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 stories. 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 minutes. 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 mistaken. 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 with-- 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 flag? Ms. Richards. Yes, sir, I absolutely would. The SEC does not-- 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 flag? 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 situation? 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 registered-- 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 done. 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 investigation. 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: http://www.mccarter.com/new/ homenew.aspx?searchlink=showarticlenew&Show=3229 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 [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]