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MICHELE NORRIS, Host:

And I'm Michele Norris. Late this afternoon, New York Law School filed the first lawsuit in the Bernard Madoff investment scandal. It's a class action suit, not against Madoff, but against the investment firm Ascot Partners and its auditor. The firm invested some of the school's money with Bernard Madoff. This is likely to be the first of many such suits.

BLOCK: Madoff was a revered figure on Wall Street, and his arrest has shocked people in the financial industry. But there were some who tried to warn regulators. And they say authorities failed to act against Madoff until it was too late. NPR's Jim Zarroli reports.

ZARROLI: 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 and 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.

NORRIS: 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.

ZARROLI: 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 more 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 market. She was also concerned that Madoff didn't seem to have an adequate auditing staff. So she steered clear of him. And so did a lot of others.

NORRIS: There were many, many people in the hedge fund industry that shared these reservations.

ZARROLI: 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.

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

ZARROLI: 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 may have been the dual nature of his operation. Arthur Levitt says back when he was chairman of the SEC in the '90s, Madoff was mostly known for the trading firm that bore his name.

NORRIS: He was a broker-dealer. That's all I knew about him. 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.

ZARROLI: 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.

P: 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.

ZARROLI: Why is that? Just not enough manpower?

P: Resources. Money, money, money, money.

ZARROLI: But critics say the SEC received at least one complaint about Madoff's investment practices as far back as 1999, but Madoff was able to escape scrutiny for years and register as an investment adviser two years ago. In an unusual admission of failure tonight, SEC Chairman Christopher Cox acknowledged that the agency had received credible and specific allegations against Madoff, but he said staffers failed to pass the allegations on to the commissioners and had instead relied on voluntary information from Madoff's firm. Cox said he was gravely concerned about the failure of the agency to investigate Madoff. Jim Zarroli, NPR News, New York.

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