Madoff Was Magnet For Some, Not All, Investors

The FBI says it has set up a hotline for investors who believe they were cheated by money manager Bernie Madoff. Officials are hoping to collect any documents or other evidence that might shed light on how the scandal unfolded.

The arrest of Madoff, a revered figure on Wall Street, has sent shock waves throughout the financial industry. But there were also those who tried to warn regulators about Madoff, and they say authorities failed to act against him until it was much too late.

Steering Clear

Bernie Madoff's reputation as a money manager was so great that investors literally pleaded with him to take their money. He consistently made returns of 10 or 12 percent even in bad times. And hedge funds, charities and rich people were all dazzled by his track record.

But not everybody.

A few years ago, Millicent Holmes was working for a fund of funds — a sort of giant hedge fund that invests in lots of smaller funds — and she was looking for places to invest her clients' money.

"[I] contacted the firm, spoke with Madoff, who described the strategy in a very matter-of-fact way. When I called the firm back to discuss getting complete transparency on [the] trades, the information given at that point was very concerning," says Holmes.

Madoff told her he engaged in what's known in the investment world as a split-strike conversion strategy. That's when an investor tries to balance different kinds of options trades to provide predictable returns. But Holmes says Madoff's numbers didn't add up. She says trades as large as Madoff was claiming didn't seem to show up in the options markets. So she steered clear of him. And so did a lot of others.

"There were many, many people in the hedge fund industry that shared these reservations," she says.

Today Holmes works for Crowe Wealth Management, and she is surprised by how long it took regulators to go after Madoff. In 2001, Barron's ran an article questioning his returns.

"And many people in the hedge fund industry thought after that article the authorities would take a very close look at Madoff," she says. "Sadly, I don't think that happened."

Operating With Little Oversight

Why that didn't happen is a question a lot of people are asking right now. Madoff was able to operate for years with little apparent oversight from the Securities and Exchange Commission, and it's not clear regulators would have caught on to his crimes had his sons not turned him in.

Part of the problem was the dual nature of his operation. Arthur Levitt says back when he was chairman of the SEC in the 1990s, Madoff was mostly known for the trading firm that bore his name.

"He was a broker-dealer. That's all I knew about him," Levitt says. "He wasn't managing anybody's money as far as I knew, so nobody spoke about Madoff making money for them. He was making money for himself by trading."

But at some point Madoff also began attracting money and lots of it — some $17 billion for an array of distinguished clients. The SEC is supposed to inspect registered investment advisers on a regular basis. And they have the authority to look at their books anytime. But Joseph Grundfest, a professor of law and business at Stanford University, says the commission doesn't pursue such firms very aggressively.

"There are thousands of these firms out there and the SEC's inspection schedule doesn't allow it to get to them on a frequent basis," says Grundfest. Why is that? Grundfest says it is a question of resources and money.

But critics note that the SEC had received at least one complaint about Madoff's investment practices as far back as 1999. A securities industry executive warned that Madoff's returns were too good to be true and urged it to investigate him. Yet Madoff was able to keep operating and even register as an investment adviser in 2006.

SEC officials say they can't discuss what they knew or didn't know about Madoff because the case against him is still open.

What is clear is that U.S. officials appear to have done little to stop Madoff, even though a lot of other people in the financial markets were raising questions about him.

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