Anyone who’s been following the Madoff story already knew that the SEC botched its chances to catch him, and that it had plenty of them. But now we have a report that says as much.

I wrote back in February about the loudest of the Madoff whistleblowers, Harry Markopolus, an accountant and former investment manager who helpfully provided the SEC with not just a memo or a hunch, but the equivalent of several dissertations on the subject of Madoff’s suspicious activities, and a blueprint on how to trap him. And yet the SEC investigators (I use that term sarcastically) did virtually nothing.

Those same SEC investigators are called “inexperienced” in the IG’s SEC report. That they may indeed have been, but their failures went far beyond that lack. They also seemed to have been devoid of what one might call common sense—or really any sort of sense at all:

The SEC enforcement staff, conducting investigations of Madoff’s business, “almost immediately caught (him) in lies and misrepresentations, but failed to follow up on inconsistencies” and rejected whistleblowers’ offers to provide additional evidence, the report says.

But at least one “whistleblower”—in the person of Markopolus—had already provided evidence galore, scads of it. One of the difficulties was that the information never got to anyone with the background to understand it. This had nothing to do with inexperience; it had to do with knowledge and basic judgment. As Markopolus later described the situation:

Over the past nine years, Markopolos sent detailed and multiple reports to the SEC pointing out red flags in Madoff’s fund operation, all to no avail. He could not get the New York office to understand what he was saying…”In my conversations with [New York SEC head Meaghan Cheung], I did not believe that she had the derivatives or mathematical background to understand the violation,” Markopolos wrote”¦

As for Markopolos’ reference to her supposed lack of mathematical acumen, Cheung said, “Investigations are conducted by lawyers and examiners and investigators. We have experts available to help us.”

Cheung is a lawyer, with a degree from Yale University and Fordham University Law School. I have read nothing about her background in finance; my sense is that she didn’t have one. As for her reference to calling in experts, she seems to have not done so—certainly not the obvious ones who might have been able to explain the more arcane facts in Markolpous’s memo.

I’m no financial expert—au contraire!—but at least I know I’m not. Had I been in Cheung’s shoes I would have gotten to those experts and even conducted an independent audit; this sort of decision is not rocket science. Cheung apparently didn’t even follow the most basic course of action, which would have been to speak to Markopolus. He stated back in February, in testimony before Congress, as to the shocking level of ignorance and omission not only on Cheung’s part, but on the part of most of the SEC officials:

[Markopolus] believed only one SEC staff member, Ed Manion, understood Madoff’s scheme and “the threat it posed to the public.” “My experiences with other SEC officials proved to be a systemic disappointment and lead me to conclude that the SEC securities’ lawyers, if only through their investigative ineptitude and financial illiteracy, colluded to maintain large frauds such as the one to which Madoff later confessed…“Ms. Cheung never expressed even the slightest interest in asking me questions…

This is more than inexperience, this is stupidity. And apparently the problem extended to almost all the SEC investigators, who seem to have almost uniformly been lawyers.

Now, unlike many people, I’ve got nothing against lawyers (some of my best friends are…). I believe they run the full gamut of good and bad, just like most of humanity. But I cannot believe it would have been all that difficult for the SEC to have hired a bunch of lawyers who not only knew a fair amount about law, but a fair amount about finance and the stock market as well—and, even more importantly, who knew what it was that they didn’t know, and who might have been able to judge when to call on the help of people more expert. After all, what good are “available experts” if the person in charge lacks the judgment to know when it’s time to make use of them?

Even Madoff was shocked, positively shocked, at the SEC’s ineptitude in that most basic of ways, the failure to undertake any independent audit of him (and although Madoff could have rightly been called an “expert,” he wasn’t about to offer the SEC any help on that score):

[IG] Kotz said the SEC’s “most egregious” lapse was its failure to verify Madoff’s purported trading with any independent third parties, even after it took testimony from Madoff in May 2006.

Madoff later admitted that he thought it was “game over” after testifying to having cleared his trades through the Depository Trust Co, part of the U.S. Federal Reserve, and provided his account number. He said he was “astonished” that the SEC did not follow up.

Here’s more from Kotz’s report:

Kotz quoted one senior-level SEC examiner as saying, “Clearly, if someone … has a Ponzi and they’re stealing money, they’re not going to hesitate to lie to create records,” and thus “some independent third-party verification” such as through the DTC would be essential.

He said the SEC had made a “surprising discovery” earlier this decade that Madoff’s hedge fund business was making far more money than his better known market-making business, but no one thought this was a “cause for concern.”

Mind-blowing incompetence. If I were a Madoff victim, I’d be nearly as angry at the SEC as at Madoff himself.

[NOTE: In another Madoff-related matter, I reported back in April that Madoff right-hand man Frank DiPascali was about to spill the beans on his former boss. Somehow I missed the fact that in mid-August he began to do so. DiPascali still doesn’t seem to have implicated any Madoff family members in knowledge of the Ponzi scheme aspect of Madoff’s operations, an issue that has interested me from the start. So the jury remains out on that.]

[ADDENDUM: The full text of the IG’s executive summary on the failures of the SEC investigation is here. I haven’t had a chance to read it yet, but I hope to.]