Does SEC Discipline Make Up for Failures in Ponzi Scheme Investigations?

By MICHAEL SMALLBERG

The Washington Post reported on Friday that the Securities and Exchange Commission (SEC) has disciplined eight employees for failing to crack down on Bernard Madoff's multi-billion dollar Ponzi Scheme despite receiving multiple tips indicating that Madoff was cheating investors.

We are pleased to see the SEC finally taking action more than two years after the Office of Inspector General (OIG) issued an exhaustive report detailing the agency's failures since 1992 to follow up on evidence pointing to Madoff’s scheme. But will the discipline be enough to satisfy the agency’s critics and defrauded Madoff investors? And how does it compare with the SEC’s response to other disciplinary recommendations issued by the OIG?

The Post reported that eight employees were subject to disciplinary action that included suspensions, pay cuts, and demotions. A document obtained by the Post showed that the employees included an enforcement manager, a senior officer in the agency’s inspections office, and staff attorneys. An outside law firm, along with the SEC’s head of human resources, had recommended firing one of the employees, but SEC Chairman Mary Schapiro decided that doing so “would harm the agency’s work,” according to an SEC spokesman. That employee received a 30-day suspension along with a reduction in pay and grade.

In its 2009 report, the OIG questioned the performance of 21 of the 56 SEC employees it examined who worked on the Madoff probe. The OIG concluded that “a thorough and competent investigation or examination was never performed” even though the SEC “received more than ample information in the form of detailed and substantive complaints over the years.”

An SEC official recently told Congress that 35 of these employees had left the agency voluntarily, including some who ended up at high-paying jobs in the private sector. Another employee who was a “key participant” in the Madoff probe received a $1,200 cash award that was partly related to his or her work on a follow-up investigation of Madoff. The SEC still has not fired anyone for mistakes related to the Madoff case.

House Oversight and Government Reform Committee Chairman Darrell Issa (R-CA) stated that “[a]fter all the talk about ethics and cleaning up the SEC, the entire Madoff scandal continues to place serious doubt on claims of meaningful progress.”

At a hearing earlier this year, Chairman Schapiro told Congress that the SEC employees who worked on the Madoff case “aren’t bad people. In some cases they were people who were very junior and not adequately trained or supervised.” She also noted that the SEC had to comply with civil service rules in deciding on the appropriate disciplinary action for these employees. In addition to disciplining individual employees, the SEC has also initiated a number of structural reforms to improve its investigation and examination processes in the aftermath of the Madoff debacle.

Earlier this year, POGO sent a letter to Chairman Schapiro raising concerns about the SEC’s recent handling of OIG disciplinary recommendations. Over a roughly two-year period, the OIG recommended disciplinary action for nearly 100 SEC employees, including 17 recommendations for disciplinary action “up to and including dismissal.” However, only 11 employees and contractors were terminated or removed from their contract during this period, according to SEC records provided to Chairman Issa. At least 16 employees resigned rather than facing any disciplinary action.

In addition to the Madoff case, the OIG also reported on the SEC’s failures to crack down on the Ponzi Scheme orchestrated by R. Allen Stanford. While this case may not have received as much media attention as the Madoff debacle, it also exposed serious problems at the SEC, including a failure to follow up on red flags uncovered by the agency’s own examinations staff. In a separate investigation, the OIG found that officials in the SEC’s Fort Worth office mistreated employees who raised concerns about a newly announced program that would have required staffers to waste their time on quick-hit, superficial examinations. (One of these employees, Julie Preuitt, had also raised red flags about Stanford’s scheme as early as 1997.)

Once again, the SEC has dragged its feet in responding to the OIG’s recommendations for disciplinary action stemming from these investigations. At a hearing last fall, SEC Enforcement Director Robert Khuzami told the Senate Banking Committee that the process for considering disciplinary action against the enforcement staff who mishandled the Stanford case was “fully under way.” In response to follow-up questions from the hearing, Rose Romero—one of the officials from the Fort Worth office who was cited by the OIG for taking retaliatory action against her staff—stated that some of the employees who worked on the investigation had actually received an award:

In recognition of their around-the-clock efforts and fortitude in overcoming efforts to obstruct the investigation by Stanford and his cronies, I nominated the attorneys, examiners and managers that completed the investigation for a “Director’s Award.” On my recommendation, Robert Khuzami, Director of the Division of Enforcement, issued the awards on July 1, 2010.

At a hearing earlier this year, it was revealed that a former Enforcement official in the Fort Worth office who did legal work for Stanford after leaving the agency is now the subject of a criminal inquiry by the Department of Justice. But other employees who participated in the bungled investigation have not been disciplined, in many cases because they voluntarily left the SEC.

The SEC also did not discipline Romero or Kimberly Garber, the two officials cited in the OIG report on whistleblower retaliation at the Fort Worth office. The Fort Worth Star-Telegram reported that the SEC declined to take disciplinary action because Garber and Romero had “cleared their moves with human resources,” and HR had no reason to retaliate against anyone. This explanation prompted a scathing letter from Senator Charles Grassley (R-IA), who pointed out that “such a policy would make a mockery of whistleblower protections throughout the government.”

Preuitt told Congress that “right after the report came out that there was retaliation against me, I understand that both the people that retaliated against me received a large bonus,” and that Garber was “put on the executive committee for the national exam program.” Both Romero and Garber stepped down this year without receiving any discipline.

In our letter to Chairman Schapiro earlier this year, we emphasized that it was important for the SEC to hold those who commit misconduct accountable and encourage whistleblowers to step forward:

[T]he SEC should be fostering an internal culture that promotes the detection of waste, fraud, and abuse, protects employees who blow the whistle, and holds employees and contractors fully accountable for their misconduct. Especially at a time when the SEC is encouraging outside whistleblowers to come forward with information on misconduct in the securities industry, it is more important than ever for the SEC to hold wrongdoers accountable within the agency.

Specifically, we recommended that the SEC implement OIG disciplinary recommendations in a timely fashion or explain in the public record why it disagrees with the OIG’s findings; make it a goal to release and post OIG investigative reports that are of public interest or have already been released through FOIA (for instance, the report on whistleblower retaliation at the Fort Worth is still nowhere to be found on the websites of the SEC or OIG); disclose any statutory provisions or agency rules that guide officials in determining what form of disciplinary action to take; and, when utilizing an alternative process for reviewing the OIG’s findings, take every possible step to ensure that the process is fair, transparent, and accountable.