Promising "the most substantial rewrite of the laws governing the U.S. financial markets since the Great Depression," a Congressional committee has released a list of witnesses that it has called for hearings on the Bernard Madoff scandal, starting this Monday. And the makeup of the list suggests that lawmakers are serious about getting to the bottom of the Madoff matter, and preventing a repeat.

According to a press release, Rep. Paul Kanjorski will call the following witnesses before the House Financial Services committee:

- Mr. H. David Kotz, Inspector General, U.S. Securities and Exchange Commission
- Mr. Stephen P. Harbeck, President, Securities Investor Protection Corporation
- Mr. Harry Markopolos, an independent financial fraud investigator for institutional investors and others seeking forensic accounting expertise, as well as a Chartered - Financial Analyst and Certified Fraud Examiner
- Mr. Allan Goldstein, a retiree and investor with Bernard L. Madoff Investment Securities
- Ms. Tamar Frankel, Professor of Law and Michaels Faculty Research Scholar, Boston University School of Law
- Mr. Leon Metzger, adjunct faculty member at Columbia University, Cornell University, New York University, and Yale University

There are a number of interesting things here....

As SEC IG, Kotz is, at the request of the agency's chair Chris Cox, looking into how the SEC missed an alleged fraud of Madoff's size, during several investigations into his business over the last decade. So the invitation to Kotz to testify suggests that Kanjorski and his colleagues will focus in part on fixing the SEC's myriad problems.

The SIPC is a federal fund created to cover fraud losses in brokerage accounts, which is preparing to compensate Madoff investors. So the inclusion of its president, Stephen Harbeck, suggests the committee will also focus on the pressing question of which of Madoff's alleged victims will be made whole -- an issue that currently remains opaque. That impression is reinforced by the inclusion of a Madoff investor, Allan Goldstein, on the list.

But the name Harry Markopolos may stand out the most. It was Markopolos, then a rival broker, who first argued, in a detailed complaint to the SEC, that Madoff's returns were too consistently high to have been achieved honestly. His testimony could provide some preliminary insight into how Madoff set up a system that deceived investors and regulators for so long.

We'll bring you all the news from the hearings next week...

Looks like another victim of the Bernard Madoff mess -- albeit a very minor one -- is the US taxpayer.

In September, as part of its bailout effort, the Treasury Department made an $85 billion loan to insurance giant AIG, and got a 79.9 percent stake in the company.

And AIG appears to be exposed to Madoff's alleged fraud. As part of its homeowners coverage, the company offers a "fraud safeguard" policy, which would seem to cover some Madoff investors.

From the company's website:

AIG Fraud SafeGuard® - Personal financial loss can come in many forms: identity theft, investment schemes, dishonest advisors, forgery, etc. Coverage is available to help protect you and your family. (itals ours)

We're not talking big numbers here. An AIG spokesman told TPMmuckraker that the company had so far received 85 "notices" of claims related to Madoff, which cover up to $100,000. Even if you assume that all those claims will be paid out at the $100,000 maximum (which they almost certainly won't), that only puts the company on the hook for $8.5 million -- pocket change for a firm of AIG's size. The company could yet receive more claims, but the total dollar amount at issue would likely remain relatively small.

Still, Madoff's fall appears to have been precipitated by the spiraling financial crisis -- he was unable, it appears, to meet obligations to the rush of investors spooked by the turmoil and wanting to withdraw their money. So it's ironic that, thanks to that same crisis, we all could technically be on the hook for his alleged crimes.

Almost since the news broke that Bernard Madoff had confessed to running a "$50 billion Ponzi scheme", one of the key unanswered questions has been, what happened to all that money?

The short answer is, we don't know yet. "It is still too early to say with any certainty what was going on inside Madoff's business," said Stephen Harbeck -- who heads the SIPC, which is serving as the receiver for Madoff's now-defunct brokerage firm -- at a press conference outside U.S. bankruptcy court last week.

It's worth noting at the outset that the $50 billion figure, which came from the SEC complaint quoting Madoff's own confession, may be inflated. The Associated Press has calculated that investors cumulatively have said they have lost $30 billion.

That's not exactly pocket change. And despite Madoff's lavish lifestyle, it would be virtually impossible for him to have blown through that amount, or even a significant fraction of it, on his own or his family's personal expenses.

Madoff has promised to give an accounting of all his assets by the end of the year. But until the legions of forensic accountants with the FBI, the SEC, and other investigative bodies complete their enormous task of independently tracing the funds, we'll likely remain largely in the dark.

Still, piecing together various reports, several possible answers are beginning to emerge, which, taken together, may go some way to explaining the mystery.

Living the High Life
Madoff may have used some small amount of client money to fund his and/or his family's lifestyle. He owns an apartment on the Upper East Side of Manhattan, estimated at over $5 million, a $3-million beachfront mansion in the Hamptons, a $9.4-million home in Palm Beach, Florida, and a villa on the French Riviera. He also has shares in two jets, and a 55.5-foot yacht. But it bears repeating, this spending can't have accounted for more than a small fraction of the total amount that Madoff investors lost.

Foreign Bank Accounts
Madoff may have stashed some of the money in overseas accounts. The Observer of London reported over the weekend that accountants going over Madoff's books think he regularly directed large sums to offshore accounts in the Caribbean and Europe. But again, there probably wasn't too much in there, or Madoff would likely have tapped it rather than allowing the whole alleged scheme to collapse when he couldn't meet obligations to investors who wanted to withdraw money earlier this month.

Robbing Peter To Pay Paul
More substantially, Madoff's alleged Ponzi scheme appears to have been based on using money provided by new investors to make payouts to existing investors. In other words, much of the money may have been withdrawn by investors who believed they had turned a legitimate profit. And if those gains prove to be a result of Madoff's deception, they would likely be re-appropriated as part of the forthcoming effort to compensate the alleged victims.

Hiding His Losses
Madoff may also simply have lost some of the money through bad trades, and tried to use a Ponzi scheme to cover it up. Note that the criminal complaint filed against him earlier this month says that he confessed to having "had personally traded and lost money for institutional clients, and that it was all his fault." (itals ours)

Still, right now, there are more questions than answers. As Robert Lenzner, a financial reporter for Forbes, who has been covering the story closely, said on CNBC this afternoon: "Nobody can figure out how this was done."

In his statement released last week in response to the SEC's failure to catch Bernard Madoff's alleged "$50 billion ponzi scheme", commission chair Chris Cox lamented his staff's failure, during previous investigations, to seek subpoenas to compel Madoff to provide information. But according to a veteran agency source, under Cox's leadership the commission has made it increasingly difficult for investigators to obtain subpoenas, with the inevitable result that they have become less likely to ask for them.

In the statement, Cox wrote:

I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them. Moreover, a consequence of the failure to seek a formal order of investigation from the Commission is that subpoena power was not used to obtain information, but rather the staff relied upon information voluntarily produced by Mr. Madoff and his firm.

That passage appears to refer most directly to a 2006-2007 SEC probe in which investigators relied only on documents handed over voluntarily by Madoff, and which has emerged as the most glaring example of SEC failure on Madoff. But according to a longtime enforcement staffer, the failure to seek subpoena power in this case was in large part a natural result of the chairman's own policy.

"Under Cox, increasingly burdensome standards were applied to obtain subpoena power," the source told TPMmuckraker in an interview. For investigators to obtain subpoena power, they're required to write a memo to the SEC's commissioners. Previous commissioners were more willing to respond by granting subpoena requests. "But under Cox," the source continued, "when you bring your memo down there, they pepper you with questions. It dies a thousand-cuts death."

The source added that a running joke has developed among enforcement staffers that the commissioners apply a "summary judgment standard" -- in other words, requiring enough evidence to make a full ruling -- merely to agree to issue a subpoena. (SEC humor, perhaps -- but indicative of what the source describes as the commissioners' extreme reluctance to issue subpoenas.)

That in turn produced "a chilling effect", said the source, in which investigators became less and less likely to ask for subpoena power -- exactly what Cox appears to criticize his enforcement staff for in his statement on the Madoff case.

The source made clear that the commissioners' greater reluctance, under Cox, to issue subpoenas was part of Cox's well-documented "ideological bent against enforcement," especially in regard to large financial entities.

The revelation that Bernard Madoff -- who himself had in the past served as an adviser to the SEC on electronic trading -- was running an alleged "$50 billion ponzi scheme" has rocked the SEC to its core, according to a current long-serving member of the commission's enforcement division.

"This has put the agency into a state of complete panic," the SECer told TPMmuckraker in an interview.

The source said that one associate director in the enforcement division had in recent days ordered junior staff to review every case that's been closed over the last few years, to ensure that violations weren't missed -- as they appear to have been in the 2006 investigation of Madoff. "There's a real paranoia around here," the source added.

That paranoia -- or at least extreme concern -- apparently extends to commission officials in Washington. The source said that since the Madoff allegations came to light last week, SEC brass had sent out numerous emails warning staffers not to destroy documents relating to the case -- which is being investigated both by SEC enforcement and by the FBI. There have also been several warnings not to speak with the press, the source added.

Separate from the SEC and FBI investigations, SEC chair Chris Cox announced last week that he has has asked the commission's inspector general to probe how the SEC failed to uncover catch Madoff after receiving several complaints going back to 1999.

There's no longer much debate about the fact that the SEC badly slipped up by failing to catch Bernard Madoff's alleged "$50 billion ponzi scheme." Even commission chair Chris Cox lamented "multiple failures over at least a decade" in the matter. And yesterday President-elect Barack Obama declared that the commission had "dropped the ball."

But it's also becoming clear that the Madoff failures didn't arise out of nowhere. In recent years, particularly under Cox, a former California GOP congressman, the SEC has pursued a policy of de-emphasizing enforcement, part of the broader anti-regulatory philosophy of the Bush years -- helping to make Madoff, and perhaps others like him, possible.

"[Cox] in many ways worked to dismantle the SEC," Ed Nordlinger, a former longtime enforcement director in the commission's New York office, told TPMmuckraker. "He slowed everything down. I don't think he believed in heavy regulation."

That view has been echoed by several others in a position to know. Ross Albert told TPMmuckraker for a post published yesterday: "Under Cox, SEC had de-emphasized the enforcement program. Cox worshipped at the same altar of de-regulation that the rest of the Bush administration worshipped at."

And a former enforcement division supervisor told Portfolio for a lengthy October story about the SEC under Cox: "It was like someone poured molasses on the enforcement division."

How, specifically? Let us count the ways -- many of them detailed in that Portfolio story -- which focused on what it described as Cox's scaling back of the commission's enforcement role and was titled "SEC No Evil" -- as well as a followup web piece by the same writer, Scott Paltrow.

First, the SEC under Cox did not take steps to make sure that it had enough inspectors to look into the fast-growing number of financial institutions requiring regulation.

The enforcement division has actually lost staff under Cox, even as its workload increased. "Since Cox took office in 2005, the staff count in the division has dropped 9 percent, to 1,124 people this year," reports Portfolio.

Cox's predecessor, William Donaldson, a friend of the Bush family, told the magazine, carefully: "With the kind of problems we have now, any attempt to reduce the effective role of the S.E.C. as a policeman has been a mistake."

We're hoping to have more extensive numbers on this later today, but former SEC chair Arthur Levitt recently told Bloomberg that in 2004, the agency had 477 people in its inspection office, overseeing about 8,000 investment advisers, while today, 430 people regulate 11,300 advisers.

And a union rep for SEC workers told the Washington Post for a story published today that employees were "outgunned" and "underfunded."

Cox also, according to Portfolio, didn't replace the head of the S.E.C.'s new risk-assessment office -- created under Donaldson to improve the commission's ability to anticipate financial upheavals like the one we're in now -- for nearly two years.

But it's not just a human resources problem. According to the magazine, Cox instituted new rules which gave the commissioners, rather than the enforcement staffers, the power to negotiate fines against public companies in certain cases. The result has been a drop in penalties since the rule came into effect.

Portfolio added:

A January analysis by the law firm Morgan Lewis found that S.E.C. penalties have dropped by a "staggering degree" and that "the numbers suggest a philosophical shift by the Cox commission in what constitutes an appropriate penalty."

And Cox distanced himself from the enforcement division, according to Portfolio, rarely consulting with its director. His predecessors had conferred daily with their enforcement directors.

The commission also appears to have passed over for promotion staff members who were too aggressive in their approach to enforcement. Veteran S.E.C. lawyer James Coffman told Portfolio that he was told he didn't get a promotion because he was "too tough." He left the SEC soon after.

In addition, Cox failed to fix a communications problem within the commission, which made enforcement harder. Portfolio reports:

Madoff was required to tell one S.E.C. office how much money he managed as an investment adviser, but was required to report his actual trading positions to another office.

Katz [a former secretary to the commission] said if the two had been compared, investigators may well have discovered a big discrepancy that would have triggered a focused investigation.

Cox will step down when the Bush administration leaves office. Obama's pick for the job, Mary Schapiro, has a reputation as a dedicated regulator, and close SEC watchers expect her to move the commission back toward its enforcement mission -- a shift that appears to have been necessary long before Bernard Madoff became a household name.

As readers who have been following this story know, the SEC conducted a number of reviews of Bernard Madoff's brokerage business over the last decade, and found no serious problems.

But if the SEC can be said to be on trial, one recent investigation may be emerging as Exhibit A for the prosecution.

That's the one, highlighted by the Wall Street Journal this morning, that begun in 2006 in response to a long and detailed complaint from Harry Markopolos, a rival broker, and wrapped up the following year with its only significant action being to require Madoff to register as an investment adviser.

But is it fair to blame that SEC team for falling down on the job? And was the wrap on the knuckles ultimately prescribed by the commission an example of Madoff getting special treatment?

To a lay person, the details of the case appear pretty damning. In an SEC enforcement document entitled "Case Closing Recommendation" and posted by the Journal, an SEC staffer wrote:

[I]n the course of a preliminary inquiry into [Markopolos' allegations that Madoff's hedge fund profits were the result of fraud], the staff learned that during a recent examination of BLM by NERO's broker-dealer examination staff, Bernard Madoff, the sole owner of BLM, did not fully disclose to the examination staff either the nature of the trading conducted in the hedge fund accounts or the number of such accounts at BLM.

Under "Conclusions Reached", the document reads:

The staff found no evidence of fraud. The staff did find, however, that BLM acted as an investment adviser to certain hedge funds, institutions, and high-net -worth individuals in violation of the registration requirements of the Advisers Act ... As a result of discussions with the staff, BLM registered with the Commission as an investment adviser.

Then, under "Reasons for Closing":

We recommended closing this investigation because ... BLM ... voluntarily remedied the uncovered violations, and because those violations were not so serious as to warrant an enforcement action.

The document is said to have been "prepared by Simona Suh, Staff Attorney, and reviewed and approved by Doria Bachenheimer, Assistant Regional Director and Meaghan Cheung, Branch Chief."

There are two separate questions here:

First, did the SEC stumble by not detecting the fraud that Madoff himself would confess to the following year? It certainly looks that way.

"Were there sufficient red flags for SEC to have caught this?" asked Ross Albert, a partner at Morris, Manning & Martin in Atlanta, and a former SEC senior special counsel. "Absolutely, without a doubt."

"Would a more aggressive team have caught it?," he continued. "Yes."

James Cox, a securities expert at Duke Law School, agreed, calling it "pretty amazing" that the commission failed to detect what appears to have been such large-scale fraud.

But given what SEC did find, was the mild action they took -- merely requiring that Madoff register as an investment advisor -- appropriate?

Albert said that it was. He pointed out that SEC ultimately found only that Madoff did not disclose certain information to examiners, not that he necessarily misled them, as the original inquiry had alleged. And given that the major problem identified was his failure to register as an investment adviser, requiring him to do so was an obvious and appropriate remedy.

Albert identified a less tangible, more philosophical problem as one major factor in the failure to catch Madoff. "Under [commission chair Chris] Cox, SEC had de-emphasized the enforcement program," he said. "Cox worshipped at the same altar of de-regulation that the rest of the Bush administration worshipped at."

That can work OK in good times, he said. But in bad, it can lead to disaster.

It looks like President-elect Barack Obama is on board with the emerging consensus about the Securities and Exchange Commission's failure to properly probe Bernard Madoff despite several warnings.

At a press conference this morning to announce key members of his financial regulatory team, including SEC chair, Obama declared:

In the last few days, the alleged scandal at Madoff Investment Securities has reminded us yet again of how badly reform is needed when it comes to the rules and regulations that govern our markets. Charities that invested in Madoff could end up losing savings on which millions depend - a massive fraud that was made possible in part because the regulators who were assigned to oversee Wall Street dropped the ball. And if the financial crisis has taught us anything, it's that this failure of oversight and accountability doesn't just harm the individuals involved, it has the potential to devastate our entire economy. That's a failure we cannot afford.

As SEC chair, Obama named Mary Schapiro, a former SEC commissioner and Commodity Futures Trading Commission chair who now runs the Financial Industry Regulatory Authority, the largest regulator for all securities firms that do business with the United States.

A securities enforcement veteran has added his name to the growing consensus that the SEC's failure to detect Bernard Madoff's alleged "$50 billion ponzi scheme" likely represented a serious failure on the part of the commission.

Robert Fusfeld, who spent 31 years as an SEC enforcement lawyer, and for 15 managed the trial unit in the commission's Denver office before retiring in 2006, told TPMmuckraker in an interview last night that Madoff's profile contained several "classic red flags" that should have attracted the SEC's attention.

Among those, he said, were the facts that Madoff's outside auditor was a three-person firm operating out of a small suburban office (one employee was a secretary, and another a 78-year old living in Florida); that Madoff is said to have used a secretive "black box" algorithm to determine when to buy and sell stocks; and that he had social ties -- often through the Jewish community -- to many of his investors.

Fusfeld said that these characteristics should certainly have alerted enforcement lawyers to the possibility of fraud -- though he stressed that he had no direct knowledge of the case, and that the facts still remained opaque.

On Tuesday night, SEC chair Chris Cox acknowledged in a statement that there had been "apparent multiple failures over at least a decade" to thoroughly investigate claims against Madoff.

Since 1999, the SEC has conducted several reviews of Madoff's brokerage business -- though none, it appears, of his investment advisory business, where the fraud is alleged to have taken place. A 2005 inquiry found several rule violations, but a subsequent review last year -- conducted after he had registered with the commission in 2006 -- gave Madoff a clean bill of health.

Fusfeld added that during the 90's he had used Madoff as a witness in a securities case to which Madoff was tangentially connected. "The man had charisma," said Fusfeld."He was one of those people that, when he walked into a room, everyone stopped what they were doing and watched him."

Had the SEC watched him a little closer, however, numerous investors might have been saved some crippling losses.

We've seen a lot about the philanthropic organizations, many of them focused on Jewish issues, that have taken huge hits after entrusting their money to Bernard Madoff. And Madoff's own philanthropic foundation was managed by its proprietor's investment firm, of course.

But Madoff's sons had their own foundations -- and it looks like they did things differently. Rather than entrusting the money to their father, Mark and Andrew Madoff appear to have relied on Neuberger Berman and Lehman Brothers to manage the funds, according to documents dug up by the blog Cityfile New York. (Until September, Lehman was Neuberger's parent company.)

Even with Lehman's collapse -- which ultimately led to Neuberger being taken over by its top executives, pending approval by a bankruptcy court, the brothers appear to have made a very wise decision*.

That's not to suggest that Mark and Andrew, who both worked for their father's company, supervising the firm's stock-trading desks, knew anything about their father's operation that led them to turn to an outside firm

The New York Times reports today that investigators have so far found no evidence that would contradict Madoff's initial statement, according to a criminal complaint filed last week, that it was "all his fault."

But at the very least, it suggests they perhaps didn't view their father as the omniscient wizard of the market that he often seemed to present himself as.

* This sentence has been corrected from an earlier version.

Bernard Madoff may be accused of running a "$50 billion ponzi scheme", but he certainly professed to have a high regard for the system of regulation that he allegedly beat for so long.

At a roundtable discussion on "the future of Wall Street" held last year, he noted at one point:

In today's regulatory environment it is virtually impossible to violate rules ... It's impossible for a violation to go undetected, certainly not for a considerable period of time.

He also said, later in the same discussion, that by using computers instead of humans, he had helped his firm to avoid violating the law. Although, he added, laughing, "I guess you could also program your computer to violate regulation, we haven't got there yet."

Watch the video:

As has been widely reported, one of the reasons why Bernard Madoff may have avoided regulatory scrutiny for so long is that he frequently served as an advisor to the SEC -- the very agency that should have been watchdogging him.

And here's an example of the kind of advice he was giving. During a 2004 meeting to discuss a proposed regulation of market trades, designed to protect investors, Madoff argued for making it easier for investors to opt out of the rule:

Again, you start -- have to start with, and I know this -- the modern times today does not support, you know, this amount of good faith in your brokerage firm. But you really have to start with the assumption that most of us in this industry really have their clients' interests, you know, coming first. Not necessarily the firm's self-interest.

It's worth being clear that Madoff is talking about brokerage firms, not investment advisers -- which is the arm of his business now being accused of massive fraud. But his apparent faith in the integrity of financial managers is striking, nonetheless.

We've been focusing lately on the growing signs of negligence by the SEC in the Bernie Madoff case. And now the commission itself has done the same.

In an extraordinary admission of failure, SEC chairman Christopher Cox last night ordered a full review by of why his agency failed to act on complaints about Bernard Madoff, citing "deeply troubling" findings in its initial investigation since news broke last week of Madoff's alleged "$50 billion ponzi scheme".

Wrote Cox in a statement:

The Commission has learned that credible and specific allegations regarding Mr. Madoff's financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action.

Cox lamented "apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them."

The past reviews of Madoff's brokerage business -- not the investment business where the alleged fraud took place -- appear to have been little more than cursory. Cox wrote that the commission didn't use its subpoena power, but instead "relied upon information voluntarily produced by Mr. Madoff and his firm."

And there's a suggestion that Madoff's and his family's personal relationships with SEC officials may have led the commission to go easy.

The investigation should also include all staff contact and relationships with the Madoff family and firm, and their impact, if any, on decisions by staff regarding the firm.

Cox added that he had ordered "the mandatory recusal from the ongoing investigation of matters related to SEC v. Madoff of any SEC staff who have had more than insubstantial personal contacts with Mr. Madoff or his family, under guidance to be issued by the Office of the Ethics Counsel."

Madoff's niece, who works as a compliance lawyer at his firm, in 2007 married a former SEC official, who had previously participated in the reviews of Madoff's brokerage business.

Cox wrote that the investigation will be conducted by the SEC's inspector general.

The Bernie Madoff fiasco is looking more and more like a serious regulatory failure by the Securities and Exchange Commission.

The Washington Post confirms that, despite several complaints dating back to 1999, the SEC never examined Madoff's investment advisory business. And it pieces together a preliminary explanation for why that might have been the case.

First, Madoff appears to have had a cozy relationship with regulators. After helping to create the NASDAQ, which was the first electronic stock exchange, he went on to advise the SEC on electronic trading.

In this video from a roundtable discussion held last year about the future of the stock market, he brags: "I'm very close to regulators. In fact my niece just married one." (It's at the 1-hour, 51-minute mark.)

In addition, Madoff's investment business was organized as a private investment pool, which is subject to limited oversight by regulators*. And, says the Post, "Madoff constructed his investment business to avoid most of it."

But part of the problem may be the way the SEC is set up -- including a lack of resources. Reports the Post:

The SEC does not have the resources to examine investment advisers on a regular schedule. Instead, the agency prioritizes examinations of companies based on their risk profile, which is basically a process of judging books by their covers. People familiar with the process said the SEC tends to focus on high-risk investment strategies, such as trading in derivatives.

Lori A. Richards, director of the SEC's Office of Compliance Inspections and Examinations, said that only 10 percent of the 11,300 investment advisers registered with the SEC are examined on a regular basis -- those with high-risk characteristics. They are examined every three years. Others might be examined randomly or where there is cause, Richards said.

From 1998 to 2002, the SEC aimed to examine every adviser at least once every five years and to examine newly registered advisers during their first year, but a 50 percent increase in the number of advisers since 2002 ended that practice, Richards said.

Still, there were warning flags that the SEC should have caught, some experts told the Post:

The brokerage arm of Madoff's firm had generated consistent complaints going back to 1999 for its unusually consistent returns, and had been reviewed by the SEC several times (but had largely been given a clean bill of health).

In addition, Friehling and Horowitz, the firm acting as Madoff's outside auditor had only three employees, one of whom was a secretary and another of whom was a 78-year old living in Florida. Only a few auditing firms have the resources to audit a company managing $17 billion on assets -- which is what Madoff had reported to the SEC -- and Friehling and Horowitz was certainly not among them.

There are still more questions than answers though -- not least about exactly what Madoff's alleged scam consisted of. We'll keep you posted as things become clearer.

* This sentence originally, and incorrectly, stated that Madoff's investment business was organized as a hedge fund. In fact, as the New York Times reported Friday:

Mr. Madoff was not running an actual hedge fund, but instead managing accounts for investors inside his own securities firm. The difference, though seemingly minor, is crucial. Hedge funds typically hold their portfolios at banks and brokerage firms like JPMorgan Chase and Goldman Sachs. Outside auditors can check with those banks and brokerage firms to make sure the funds exist. But because he had his own securities firm, Mr. Madoff kept custody over his clients' accounts and processed all their stock trades himself.

So that distinction helps further explain why Madoff escaped scrutiny for so long.

We told you earlier that the niece of Bernard Madoff -- who's accused of running a "$50 billion ponzi scheme" through his investment firm -- is married to a former top SEC compliance official who had been involved in two reviews of Madoff's firm. And that Madoff bragged about the family connection last year.

But it's worth piecing together the extent of what we know about the cozy web of family ties that may have allowed Madoff to escape scrutiny for so long.

CNBC reports that the compliance department of Bernard Madoff's firm is run by Bernard Madoff's brother Peter, and by Bernard Madoff's niece, Shana Madoff Swanson, who's married to the former SEC official, Eric Swanson. That team appears to also include Bernard Madoff's son, Mark Madoff, who the Wall Street Journal last week identified as the firm's senior managing director and chief compliance officer.

The Journal added that Bernard Madoff's other son, Andrew Madoff is the firm's director of trading.

And it looks like Mark Madoff and the former SEC official, Eric Swanson, were at least acquainted with each other before Swanson married Mark Madoff's cousin Shana, and, just as important, before Swanson had left the SEC. Here's a picture of Mark Madoff and Eric Swanson appearing together on a 2006 panel organized by the Securities Traders Association. Swanson is identified as being with the SEC at the time.

It's also worth noting that Eric Swanson and Shana Madoff met through their work in that industry trade association, according to Eric Swanson's current employer. (That spokesman also said that when Swanson participated in an SEC review of Madoff's firm in 2004, he and Shana Madoff were not in a relationship. They married in 2007.)

And to cap things off, the Journal today reports that investigators are looking into the role that Bernard Madoff's wife, Ruth, may have played in the alleged scam.

It looks like the all-in-the-family nature of Madoff's business could have helped him pull off the alleged fraud -- at least before his sons fully wised up and decided to tell their lawyer.

Madoff, a former Nasdaq chair, is scheduled for a bond hearing at 2pm today.

The failure of the SEC to effectively investigate Bernard Madoff's brokerage/investment firm is shaping up as a major piece of the Madoff story.

And today Politico reports that Madoff's niece, Shana Madoff Swanson, who works as a compliance attorney at his firm, is married to a former top SEC official, Eric Swanson.

Madoff himself wasn't above bragging about his family connections to the regulatory authority that should have been watch-dogging him. ABCNews.com reports:

At a business roundtable meeting last year, Madoff boasted of his "very close" relationship with a SEC regulator, chuckling as he said, "in fact, my niece even married one."

Politico make clear that Swanson was in a key post relating to SEC's enforcement of securities law :

Swanson was the assistant director in the SEC's Office of Compliance Inspections and Examinations' market oversight unit in Washington. According to his biography, Swanson "supervised and conducted inspections and examinations that involved a wide range of issues including best execution, order handling, insider trading [and] market manipulation."

But there are some mitigating factors here. The SEC's director of compliance and examinations told Politico that Swanson participated in two investigations of Madoff's broker-dealer operation -- in 1999 and 2004 -- but not the 2005 probe*.

Swanson left the SEC in 2006, and the couple were married the following year. So were they dating when Swanson helped out on the 2004 investigation?

A spokesman for Swanson's current employer, BATS, which describes itself as the third largest stock exchange in New York, says no:

Eric Swanson worked at the SEC for 10 years and did not participate in any inquiry of Bernard Madoff Securities or its affiliates while involved in a relationship with Shana, whom he met through her trade association work in the industry.

It's impossible to know right now whether Madoff's family connection allowed him to exert any improper influence on the SEC. But something tells us we're going to hear more on this...

* A spokesman for Eric Swanson's firm tells TPMmuckraker in an email that Politico was wrong on one detail: "Eric Swanson joined the group in question at the SEC in 2000 and thus was not part of the 1999 investigation of Madoff."

Four days after Bernard Madoff was arrested for allegedly running a "$50 billion ponzi scheme" disguised as an investment advisory business, attention is beginning to focus on what looks like a glaring failure of oversight by government regulators.

Let's step back for a second. Part of what may have helped Madoff escape scrutiny is that his company consisted of two separate arms -- a securities brokerage, which acted as a middleman between buyers and sellers of shares, and a straight investment business. According to the SEC complaint filed last week, Madoff ran the investment arm as a secretive business separate from the brokerage, and it was this arm that was used to perpetrate the alleged fraud.

Bloomberg reported yesterday that since Madoff registered the investment arm with the Securities and Exchange Commission in 2006, that agency hadn't got around to looking at the business's books. The SEC usually tries to go through the books of newly registered firms in their first year.

"If the SEC didn't come in and inspect (the Madoff hedge fund), then they have a hell of a lot to answer for," one expert told the Associated Press.

But the problem doesn't appear to have started in 2006.

As early as 1999, an executive in the securities industry had urged the SEC to probe Madoff, on the basis of the remarkably steady returns that his investment business seemed to provide. The executive, Harry Markopolos, argued that Madoff must be generating those returns by "front-running" -- that is, using the brokerage arm of his company to illegally provide information to the investment arm.

The SEC said in a statement that it had conducted two investigations into the brokerage arm -- not the investment arm -- of Madoff's company, in 2005 and 2007. The first, begun in response to allegations of front-running, found three violations of rules requiring brokers to obtain the best possible price for customer orders. That investigation appears to have led to Madoff agreeing to register with the SEC the following year, giving the agency access to far more information than it previously had. But the 2007 probe, conducted after Madoff registered, found no evidence of anything improper.

It's unclear why the probes focused on the brokerage arm when it was the investment arm that had generated complaints in the past -- and which apparently would have been the arm that improperly profited from any front-running activity.

So there are still far more questions than answers, including in regard to the performance of government regulators. But so far, the SEC doesn't appear to have covered itself in glory on this one.

You might have seen the news that a former chair of the Nasdaq was arrested yesterday for running what federal investigators called a "$50 billion swindle."

Bernard Madoff was turned in by his sons, who said that their father had admitted to them that his investment advisory business was "a giant ponzi scheme," reports the Wall Street Journal.

But a close look at what happened suggests that Madoff's alleged crime may merely have represented an extreme version of the type of financial chicanery that helped cause the current economic crisis.

In a criminal complaint, an FBI agent wrote that Madoff, 70, had:

deceived investors by operating a securities business in which he traded and lost investor money, and then paid certain investors purported returns on investment with the principal received from other, different investors, which resulted in losses of approximately billions of dollars.

Madoff's firm, Bernard L. Madoff Investment Securities, serves primarily as a middleman between buyers and sellers of shares. But an offshoot of the company manages investments for hedge funds and other institutions, as well as wealthy individuals. According to a civil complaint filed by the SEC, the alleged fraud was run through this investment business.

The steady returns that this business provided appear to have caused skepticism over the years. The Journal reports:

A number of traders suggested [Madoff's] firm could be buying shares for its own account just before it filled orders for customers, an illegal act called front-running. In 2001, Mr. Madoff told Barron's that charges of front-running were "ridiculous."

An executive in the securities industry, Harry Markopolos, contacted the SEC's Boston office in May 1999, urging regulators to investigate Mr. Madoff. Mr. Markopolos continued to pursue his accusations over the past nine years, he said in an interview on Thursday, and according to documents he sent to the SEC that were reviewed by The Wall Street Journal.

"Bernie Madoff's returns aren't real and if they are real, then they would almost certainly have been generated by front-running customer order flow from the broker-dealer arm of Madoff Investment Securities LLC," Mr. Markopolos wrote to the SEC in November 2005.

The criminal complaint filed by the FBI quotes two employees -- believed to be Madoff's sons -- as saying that Madoff was "cryptic" about the activities of the company's investment arm, and kept the investment offices on a separate floor.

Things appear to have come to a head earlier this month, when Madoff told one of his sons that "clients had requested approximately $7 billion in redemptions, that he was struggling to obtain the liquidity necessary to meet those obligations."

[On Wednesday] the sons met with Mr. Madoff ... at his Manhattan apartment, the complaint says.

...At the apartment, Mr. Madoff confessed that his business was a fraud and that he was "finished." He said he had "absolutely nothing," that "it's all just one big lie," and that it was "basically, a giant Ponzi scheme." He told them the firm was insolvent, according to the complaint.

In other words, Madoff got himself into a situation where he didn't have enough money to pay back investors -- jut like those Wall Street banks we just bailed out. That's not to say that the charges against Madoff aren't serious -- it's only to point out that they're not unconnected to the broader economic turmoil.

Madoff, who is said to have started his business with $5000 he saved from working as a lifeguard at Rockaway Beach, didn't enter a plea during a court hearing last night. A preliminary hearing is scheduled for Jan. 12, 2009.