Madoff exploited weak oversight — did regulators learn their lesson?

Bernie Madoff's legacy as one of Wall Street's most notorious Ponzi schemers will outlive him — and the lessons regulators learned have implications for policymakers today.

The collapse of Madoff's business, along with the discovery that he had been undertaking a $65 billion fleecing of tens of thousands of investors for at least 16 years, caused many within and outside the regulatory community to question how it could have taken place right under the noses of the Securities and Exchange Commission.

"The Bernie Madoff scandal was one of the biggest black eyes the SEC ever received," said James Cox, a law professor at Duke University. "The incident brought about a huge culture change at the SEC in terms of its inspection processes. They needed to show a lot more skepticism."

No major new laws or rules were enacted after the scam was discovered, but it prompted introspection among the country's securities regulators to figure out how Madoff got away with such a huge crime and for so long. The SEC published a list of the reforms it undertook: improving internal controls, enhancing auditing procedures, increasing resources for investigation and investing in more staff and specialized training.

John Coffee, a professor at Columbia University Law School, said that although the scandal prompted the SEC to prioritize the investigation of Ponzi schemes, less has been done to mitigate the broader risk investors face. "The next crisis always comes from the blind side, and the key fact is that the SEC's enforcement budget has not grown in proportion to the size and growth of the market," he said.

Barbara Roper, investor protection director for the Consumer Federation of America, said, "There are a lot of lessons that should have been learned from the Madoff Ponzi scheme, some of which may have been learned better than others."

Roper said the scandal was a cautionary tale for regulators and investors not to suspend their skepticism. "They can't let someone's, or some institution's, stellar reputation cause them to drop their guard," she said, pointing out that many of Madoff's victims were experienced market players. "If they did nothing else, those events should have put an end to the idea that wealth is a reliable predictor of financial sophistication."

Former White House chief ethics lawyer Richard Painter, a professor of corporate law at the University of Minnesota, blamed the concept of "affinity fraud," a con man's tactic of ingratiating himself with a particular demographic or community to gain their trust.

"It's classic fraud," Painter said. "It takes advantage of people's similar religious perspective or cultural identity to get their guard down. I believe the problem was enforcement. We didn't need any new rules in order to prevent Bernie Madoff from happening. We needed to enforce the old rules."

But funding was tight, and Madoff was famous.

Charles Elson, professor of finance at the University of Delaware, said: "It reminds us if it's too good to be true, it probably is. People were suspending their disbelief on the force of his reputation and personality."

Painter blamed a paltry enforcement budget and a lack of financial, technological and human resources dedicated to running down leads and investigating suspicions of fraud — a problem that he said worsened during the last administration.

"In the Trump years, there was enormous hostility to financial regulation," Painter said. "The antipathy you get to regulation you see in the financial community — you see that with former President Donald Trump."

Roper said she was hopeful that President Joe Biden's administration and Gary Gensler, the former head of the Commodities Futures Trading Commission, whom Biden picked to run the SEC, will work to strengthen financial regulation and commit to funding enforcement at the proper level.

"I'm optimistic that we will see a renewed toughness in the SEC's approach to oversight and enforcement now Gary Gensler is confirmed as chairman," she said. "We still haven't taken effective steps to address the very real shortcomings in our oversight of investment advisers."

Painter said there might not appear to be much connection between Madoff's crime and the calls Gensler faces from progressives to create a reporting and disclosure framework for diversity and environmental programs. But a focus on increasing diversity within corporate America, as well as within regulatory agencies themselves, could break the cycle of groupthink that criminals like Madoff can exploit, he said.

Diversity, Painter said, means a wider variety of perspectives and experiences and fewer ingrained assumptions — which can counterbalance complacency. "It helps overcome this affinity fraud problem," he said.