bailiwick. but also they could be prosecuted criminally as you know, senator lierman. >> one oth question in terms of -- i need to get clarified ov going to minority contractors. for some reason we find it difficult to get this kind of -- get this kind of data. i know we're oh e oh with the stimulus money, outside contractors are being let in order to process this do we have any information on that, mr. nabors in terms of how we're handling that for minority contractors? specifically, do you have an black contractors?

>> i don't have the numbers specifically for black contractors. but some of the more recent mbers that we have with regard to some of our small business targets -- sma businesses have received about 22% of the contracting dollars. >> you're talking about small nine north businesses? >> no. i'll go through a list of numbers for you. 22% for small businesses. about 3% for disabld veterans businesses and 5.9 for historically underutilized business owned contractors which in some ways capture the minority businesses. i don't have a specific number for black businesses. i can see if i can get that number for you. >> would you, please, and hispanics as well. hispanic and black businesses. there's deep concern about making sure there are skills in these areas and that our

government is being aggressive in sporting thoseype of businesses for their economic survivability. i did have a question, but i got so wrapped up in that one -- mr. liebowitz, in terms of the numbers, you gave senator collins th numbers, was it 270,000 and $30 million. >> for the four cases that we brought along. we knowhere's more fraud out there involving the stimulus. in the cases we brought thus far, that's our estimate of the number of consumers harmed and the amount of the potential harm. some of these schemes involve initial payments on a credit card of, say, $1.99 or $2.99. then there's a negative options scam that's part of this where they have your credit card number, they keep billing you

every month and until you figure out th you can canl it and if you cancel it in a timely manner, then you keep on paying. as someone in a different context who has been a victim of a negative options scam, they are sometimes hard for the individual consumers to detect. again, we also know there are more people out there who a probab victims. we watch the internet. we look at advertisements all the time. we look at our consumer database. we try to do as best we can to stop these types of frauds. >> mr. delaney, are we going to have a new website as federal reporting dot gov 2.0 or is recovery.gov up and running. it's up and running right now. it will be rlaced by a newer version around the first part of october. >> i just told a couple people to go to recovery.gov.

>> you still o go there and you'll get the newer version when we put that up. >> thank you, mr. chairman. >> thanks very much, senator burris. senator coburn. >> let me personally thank each of you for your service. you have a tough job, a really tough job. what we want to be is not somebody that's critical, but really someone that's helpful. mr. nabors,n your testimony you said each of the stimulus projects is carefully reviewed by omb to ensure tir uses of recovery act funds are thoughtful and appropriate. you work with agencies to identify and revise projects that do not meet that threshold. could you make the list of those projects that you've identified and revised available to the committee? >> i don't know that there is a consolidated list of those types of activities. let me go back to the office and see what we have and what we can provide to the committee.

>> one other concern that i have, and again i'm sure these are old nuers. the government executive article on august 31st, 2009 said that more than half the recovery act contracts to federal agencies have been awarded on a cost-plus basis. i agree with the president. that's exaly what we don't want to do. we want fixed price coracts. we don't want cost-plus contracts. cost-plus contracts always cost more. what is the administration doing, mr. nabors, to make sure that this trend is reported in this article doesn't continue? it's 53% of all the conacts let so far are cost-pluses, which is pretty worrisome? >> i think we're doing two things. first, the director of omb and the president put out instruction toss the agencies that are preferenced when at all possible is to use competitive

processes and to ensure that as much as possible that we are ing fixed price contr@cts. i think what we're seeing with the cost-plus is somewhat an anomaly because a lot of that is being driven byhe department of energy. where we've seen a lot of fixed price contracts -- a lot of variable priced contracts used is when you have things like r&d where therue costs are not known up front. if you look at most of the money for that category of contracts right now, about 90% of the money is the department of energy which was not unexpected. that having be said - >> that went out earlier than much of the other months. so that's tended to skew it. i'm willing to stand corrected on the numbers. i know that's just a snapshot. all i'm saying is i'm ccerned about it. i know the president is concerned about it. the other point i would make though, and we made it several times, if you don't get a buy-in of company's capital on

research --n other words, them having capital at risk when they get these contracts, they're not ever going to be as efficient. so my message to you would be, even though it's department of energy and even though it's research, they ought to put capital at risk. that's one of the ways we'll control the costs. when they're cost-plus, managing those are difficult. and it's kind of like gener devaney s said in the past, you're looking at it after the fact rather than preventing it in the future. the way to get that is to make sure that those contracts, those companies have to have some of theicapital at risk at well. >> your point is well taken. >> that will help us a lot. mr. devaney, for you and mr. nabors, i'm very appreciate of your work. are we going to be on time with recovery.gov, the website? >> absolutely.

>> is coming up on the 10tor the 11th of october. >> it will be up before that. >> one of the things bothering me little bit. you differentiate beten integrity and quality. i don't have any doubt that you're going to make sure that the integrity of the data that you're putting up is accurate. but i'm wondering can you reach further to make sure the quality ofata is accurate? >> it's a major concern, senator, and growing, quite frankly, that we have at the board. we're asking, as i mentioned in my oral remarks for recipients to report far more things to the federal government than they ever have before. and it's a tough job. i have he to meet the deadline of reporting which is october 10th. and they're doing some unique things out there.

for instance, 30-plus states are going to be reporting centrally in bulkform. and i think they're doing that to ensure that they report on time and to maybe give themselves a tad more time to look at the data at the state level to ensure it comes in in an accurate way. having said that, i'm concerned that the public's view of inaccurate data would actually harm rather than enhance transparency. so i want -- the board and i have want to do everything possible to allow folks to go in and check that data once it's gone in, to make revisions if they have to. we're going to track those changes very closely. >> is it going to be started on the website so everyone else can see it's been changed? >> we're going to be tracking

and chronicling those changes on a daily basis and make all that for anybody who wants to see that, for instance, download it, and just take it off and look at it for themselves. we're going to make that capacity available. but also we're going to put up on the website a dashboard, if you will, with pie charts and graphs that shows where the changes weremade, what categories changes were made in, whether or not x percent was over at the deparent of commerce we'll make all that available for everybody to see after those changes take place. >> part of your statement was the fact that you think this is going to change the way the government operates. actually the president, senator carper and myself and senator mccain put through usaspending.gov. recovery.gov will be great and i agree with you.

but th quality of the data, the integrity can be fine, but if the data is not any good and it not a true reflection of what's happening we really haven't bgught anything. i guess my final comment or question was, what is in force, wh is going to be in force to make sure that the agencies which are going to be responsible for the quality of data -- at least that' what i understood you to say -- bring good quality data to you? >> well, the agencies are going to be tively in looking at that data along with their state and recipient counterparts and to get it in the best shape possible. my suspicion is it will get better -- the second quarter will be better than the first quarter, et cetera, et cetera. as you may know, when u.s.a. spending was set up, initially 51% of the data was inaccurate.

we're 2 1/2 years later and it's 13%, 14% inaccate. so it's a hard thing for recipients to report data seemingly. we're asking them in this instance to report more data than they ever have before. it's going to take a leveraging of resources. omb is going to play a role. the agencies will play a role. i can assure you the recovery board will do its best to aid in that process. >> if i might, just one follow-up. you're having a prkblem with quality right now. is that correct? >> right. >> so the site will be up, but full implementation of the site probably is going to be some time. is that correct? >> well,he site will be up and very interactive. as i mentioned earlier, going to be able to do a lot of things and slice and dice the data any number of ways you want. our hope is that the data will be as accurate as it possibly can be, knowing it won't be

fully accurate initially, and it will get better. and i really do belie that once people get used to doing this, this being the first time and coming at an awkward time of year -- october is usually an awkward time for most financial entities, particularly in the states, we'll have a lot of good data in there after period of time. >> thank you very much. >> thanks senator coburn. senator mccain. >> thank you, mr. chairman. i thank the witnesses for being here today and all of their hard work. mr. mihm, in march the gao announced a hotline website for citizenr to report waste, fraud or abuse. how many complaints has thatod line received? >> senator, we're reviewing -- we've got 80 credible or initially credible responses

that came in. of those we're doing eight detailed investigations. from those another 12 or so are pending, and then 22 of them that we referred over to the inspectors general. i don't have the hotline number. but 80 of them were creble ou to warrant investigation. >> thank you. i noticed in your prepared statement, mr. mihm, that one of the charts figure 2, estimated federal recovery act out lays to states and localities. in 2009 as a share of the total, and then it goes on to show 87% of estimated federal recovery act out lays to states will be in the nine programs that you have reviewed. >> yes, sir. >> 63% has been in medicaid? >> yes, sir. that's the adjustment, the increase in the f map as there was a 6.2% across the board that

went to all states, increasing the federal match, and then an additional bum up up for states that had significant increases in unemployment rates. for the first couple of rounds, this is what's out there. most of the states are receiving it in order to maintain many of the states told us is in addition to helping with eligibility and case loads, it also freed up state money. and then the state money has allowed them to do less draconian cuts than they would have otherwise done. the short answer to your question, sir, is they are not subject to the reporting requirements we're talking

about. >> how much money are we talking about in the 63% that went for medicaid? >> it will be $87 billion over a two-year period. the exact money -- just to make sure i refer to this, is it's $19.6 billion from october 1 to september 4 in the 17 locations we've been looking at. >> do you have any comment on that, mr. nabors? i concur wh the assessment. i think our view of the importance of the f map program is exactly how mr. him laid it out. what the states have told us is because they have access to this f map money in other areas such as education or law enforcement, there's reduced pressure on their budget and they're able to both create and retain other types of jobs through the availability of the f map money. >> sort of a trickle-down economics i would ess.

plvmt nabkrs, i've seen many administraon witnesses and i understand you have to tout the success ofhatever program that the administration is running. i do think it might be well to complete the record that when the stimulus packageas being considered in the united states senate, the economic advisers to the president, the director of omb said maximum unemployment would be 8%. it's now9.7%. i just came back from spending a lot of time in my state as many members did. and my state is one of the hardest hit. our small business owners that are closing their doors and storefronts and shutting down are asking me why they're too small to save, andinancial institutions are too big to fail. i have yet to come up with a

very good response to that. the fact that unemployment is at 9%, lag or not lag, is not -- comes as small comfort to the citizens of my state who are unemployed and the people who are unable to remain in their homes with one of the highest foreclosure rates in the country. i would be glad to hear your response to that diatribe. >> sir, i don't disagree with anything that you've just said. our initial asssments of the state of the economy was based on inaccurate and incomplete inrmation. and the downturn in the economy turned out to be much more significant, much more severe than originally projected in january and february. as we look at the unemployment

growth -- it' not just the numbers that we're seeing day, but the numbers that we put out in our mid session riew project that unemployment could reach as high as 10%. that is unacceptable to us. and as i said to the chairman and to the ranking member, we're trying very hard as much as possible to increase the spending coming out of the recovery act. and to try to do everything possible to minimize the impact of this recession on the american people. >> i thank you for that answer, mr. nabors. mr. mihm,n your prepared statement there was aumber of recommendations that gao had proposed. there's not a page number. it says gao recommendations, accountability a trance paspare. then you have various bullets.

have those recommendations been largely complied with? if not, maybe for the record you could provide us with the areas where you think there needs to be further accountability and transparency. >> the second half of your question, yes, sir. in our september report, the one that's coming out in a couple weeks, we'll give an assessment of all the recommendations we've been making and where omb and other federal agencies are in that regard. to the first half as to whether or not they've been complied withas i mentioned earlier, i think the pilot program that director nabors was talking about for single audit is very important to addressing many of the concerns that we have in regards to the accountability and transparency aspects here. that is that we need these internal control can testing earlier. not get into too much of the weeds on this stuff, but most state fiscal years end on june 30th. the single audits then comeut nine months after that. that's the required date. often they lag a little bit more than that. so we will note knowing how

things are goi from an audit perspective in states in some cases -- well, for the fiscal year that jt began, until march of 2011. there's been too much money by that point of recovery act money that will be out the door. then it will be just a historical document rather than a document that can help people manage and help us to address risks. that's why we need the risk assessments to be coming out earlier from the state auditors so that as a deficiency or weakness is identified, they can be dealtith before they become a big crisis and show up over at ftc. these are the type of things -- focusing on the pilot is ver important to us. i know it's a major focus of the administration. >> i thank you. mr. chairman, my time has expired. i want to thank the witnesses. mr. liebowitz, i'm not sure we need this pact. but it's very good information. thank you. >> thanks, senator mccain for your thoughtful questions and, i might add, your high quality

diatribes. senator mccass skill. >> i'm going to try to live up the example -- >> i have every confidence. >> -- of the diatribe. i couldn't agree more with senator tester. these people tt are out there preying upon folks at this point in time, they are pond scum and they should go to jail. and whatever we need to do to help them go to jail, you need to let us know because, you know, i know you're doing sweeps. i know you're doing all this, but nothing counts more than cuffing somebody. >> i absolutely agree with you. in the context of the commerce committee reauthorization that we hope to see later this year or early next year, we'll have some ideas we can talk over with you. >> okay. great. i don't mean you to think, mr. nabors that i'm picking on you. it's going to feel like i'm picking on you.

we sent out requests for all the state auditors asking for input on how they thi this is going in light of their single audit responsibilities and the stimulus funds that are out there. one of the things that came back loud and clear was the ridiculous -- i think ridiculous notion that we are mechanicall making the decisio that any program that gets ara funds becomes a type a high-risk program. let me give you a good example. foster care. f foster care is a low risk type a program under a-133. and theara funding is approximately 2%. and what you do now is you push that into high risk as an a-level program which takes a trenus amount of resources in terms of auditing.

i really think you have missed the boat in terms of usinthe exrtise on the ground of the state auditors that are doing these single audits to make decisions about high risk and low risk as it relates to these moneys. i'm just curious. i don't mean to be a smart aleck. but is there anyone making these decisions over there that's ever done a single audit? >> the answer is yes. i takeour -- i don't feel you're picking on me and i will try to answer appropriately. there are people in our shop that have done single audits. we're in constant communication with the auditing community. in essence, the pilot program that we are proposing today was born out of bonversations that we had with gao, with some of your staff and with the audit commity. that conversation is going to be on going and we'll continue to

have that conversation with them. >> okay. now i've got to really pour lighter fluid on the charcoal brick kets here. if we're just rolling out a pilot program, do we have specifics on when -- really this -- i think mr. mihm will back me up, mr. devaney will back me up. you've got -- the barn door is already open, and, you know, the cow is out of the barn and we're announcing the rollout of the pilot program. it will have no value whatsoever, as mr. mihm just id, if this pilot program isn't on the ground asap. i'm worried we've gone this many months and we're announcing a pilot program. how many states are in the pilot? how are you informing the states of the pilot? state auditors in missouri don't know anything about it. how long will the pilot last? how much relief from other programs is being given in connection with the pilot

program? >> t pilot program was just announced tay by the deputy director of the office of management and budget. so we will be providing additional guidance about the pilot going forward. but this is something that we plan on implementing almost immediately. we do want to make sure we're in very tight coordination with the gao. it's one of the thingshere we believe we've made a change in the oversight regime. too often omb and gao go off on their separate ways. in this instance we actually sat down and tried to figure out what actually makes the most sense. in terms of some of the specifics wee already flushed out, the number of states, it actually would be available to any state that wants to involve themselves in the pilot. we're calling it a pilot mainly because we're using pilot authority. that's the authority we have available to us to make these types of determinations. but it would be as expansive as the number of states that want to participate i the program. our initial vision of the program is that we would look at

the ten highest risk programs based on conversation with cao and the agencies and say, of that list, a state that wants to participate in the pilot has to select two of those programs for expedited audits. if the they select those programs- if they want to participate in the project and they make those two selections, then what we will do is we will give them relief from doi audits on smler, lower-risk programs. >> well that would be -- that's terrific. i'm glad to hear it's going to be available to anybody that wants to participate. i'm pleased you're working closely be gao. i do know you're in contact th the state auditors. if you will let loose of the reig a littleit as it relates to the single audit knowing next year's single audit is big because of the way this money is rolling out, i think you'll find out you'll get a

better product that will provide more transparency and accountability than saying everything that gets to ara is high risk. i think that's a huge mistake. >> i take your point -- >> exception is really hard, you guys. it's hard. it's a big bunch of paperwork. i've asked for exceptions before. i know that it is like arm wrestling a gorilla, to try to get an exception. so i think it would be better if you guys could figure out a way to loosen up a little bit. i wod like to use the last few conds i have to -- mr. devey probably won't like this. but i had never met mr. devaney until i came to washington. i know he spent 20 years in the secret service, director of criminal enforcement of the a for eight years, been inspector general for ten years, in the department of interior. i would say that he and the staff he directed caught jaabra of. i think to use his name on a

list of cheap political hits is unfair to him as a public servant. i think th members of this body should rise up and defend people like earl devaney who have clearly not come to government to make big money, who clearly do not have political allegiance, clearly have done everything in their career to look after the public's money. an i think including him and others on some cheap political hit list by some cable commentator does a disservice to him and many of the other people serving in positions of accountability. i wanted to put that on the record before i finished. >> thank you very much, senator. >> senator. >> thanks, senator mccaskill, i appreciate what you said. i identify myself with your remarks. from visual observation, you're right, mr. devaney was very uncomfortable as you were praising him. senator harper. >> i thought he was uncomfortable at first but the more you got into it, the more

he relaxed. so towards the end, he was enjoying it. all right. was going to take a cheap hit at you, cheap shot, but i guess i won't. sometimes we run into people in our business on this side of the table people know we're elected officials. are you some politician? you're one of those politicians, aren't you? and over time i've taken to eith either say, well, actually, i'm not, i know some who are, but i'm sometimes i'll describe myself as i'm just a servant. or sometimes i'll say well actually i'm a atesman. i used to be a politician. but now i'm a statesman. so i -- whenever i hear folks c@ll government bureaucrat, i don't take too kindly to that. so we thank you for your service and i, too, would like to reidentifyith the remarks of senator mcskas kill. that's one of the nicest things i've ever heard you say about

anything or anybody. so treasury this day. mr. chairman, that was all i had. no, that's not all i h senator coburn are is is gone but he and i share an interest in a number of things along with others on our committee. one of the things we have an interest in is trying to recover money that's been misappropriated or misspent. one of the laws we have to comply with deals with improper payments. we know that every year agencies are supposed to report their improper payments. last year, omb told said we're up to $72 billion of improper payments, mostly overpayment, we're offering legislation this year to not just tighten that money up but to go after and recover more of the money that's inappropriately spent. and when folks asked me, how are we going to pay for health care? where is the money going to come

from without cutting people's benefits in ways that are untoward? and i talked to them about what we're doing in going after money in the medicare program that's been inappropriate ly or fraudulently spent. the last couple of years, we've been going after trying to recover money from medicare. lot of it was swindled, fraud. first year, we tried to do, didn't get anything. second year, we got a little bit of money back. last year, $700 million in just three state, post audit recovery. this year, we're going after recoveries in the other 47 st e states that goes well, we hope to be able to do the same kind of thing in medicaid. i wanted just to ask you all to share some thoughts with us about when we find, ant tight of this health care follow the money, an update on stimulus spending and fraud prevention. i want to talk about when we find where there's been fraud or monies misspent, inappropriately

spent. what are we doing or prepared to do to go after and relame the money for the treasury for the taxpayers? >> i'll take a stab at that. >> please. >> i think that early on the board and all of the igs have been interacting with department of justice. there's an already existing task force, procurement grant fraud task force that provides sort of entree into the 35 attorney generals offices around the country when a case comes up, we're going to be very aggressive to see that gets prosecut prosecuted. as aggressive as we possibly can be, if the facts support those kinds of things. so the answer is we've got about nine ace casesight now that are in the various u.s. attorneys' offices, which is a very small amount and quite frankly i'm surprised it's that small. but as soon as we see it, we make sure the appropriate ig is doing an investigation and that

gets brought into a u.s. attorney for review. and we work closely with the department of justice. and i know from talking to them, they're very interested in sending some very loud signals early, as often as they can with this money. >> anyone else at the table want to respond? >> from our perspective, when we see consumers as victims an that's where our jurisdiction is, we go after it. we work with treasury and justice. in some case, we refer for criminal prosecution because the sfraud so egregious and state igs who are better equipped to get fines and go after malefactors in their jurisdiction. we also look at where the ney is going. it's really the title of this hearing fraudsters are

opportunistic, they go where the money is. you want to try and at least try and figure out where it's going a little bit in advance so you can get there maybe a little bit before sometimes. >> i think if i didn't understand, senator mccaskill used the word pond scum. not a word we hear every day. >> it's a legal term of art, actually. >> but probably a well chosen word in this case, describing folks trying to take advantage of people with this money involvement for stimulus recovery. she said there's nothing more effective than maybe cuffing somebody that's been behaving not just badly but criminally. i say the other thing that's really important is we follow the money and the money that's ended up where it shouldn't be, let's get it back. to the extent that we can get the money back, we need to do that. and it's fine to cuff people, that's good. if they ought to be cuffed, we ought to get the money back as much as we can. the other thing i want to mantion is our governor, congressman, our colleague and i were down in an area between

wilmington and dover the other day where senatorlieberman has driven by a time or two. s campaign trail comes right by this way. mar expansion of all things a park and ride, which sits right alongside of two major north/south highways in a bedroom commity, a miss calle middlewn, we were expanding the park and ride. we're putting in a bicycle path and pedestrian walkways from some of the neighborhoods so people can get to the park and rid and initiating new bus service for the park and ride, so it's a nice mull tie modal deal, the anticipated cost is $900,000. the project came in at $600,000. what i'm starting to notice, i don'ow if you notice in projects in your state, we got a lot of people, contractors hunting for work and anxious to bid. i know senator coburn expressed concern about cost-plus

contracts, but we're finding that probably better than any time that i can rember bids coming in under, way under in some case, the anticipation. i don't know if others are seeing that. my colleagues and i had yet. but mr. mihm, any comments on that? >> yes, senator carper, your experience is consistent with what we've seen in other stats,s transportation officials are telling us bids are 5 % to 30% below what they estimated. the economy is in bad shape, but it also shows it's a good deal that they're able to do additional projects because of that your experience, again,consistent with what we've seen elsewhere. >> in th case, it was a deldot projects, but the money stays in the state and can be used for other deldot projects. that's good. that's a silver lining in what could be an otherwise ratr dark cloud. thank you for your stewardship. thank you for being, giving the

term government bureaucrats a good name, a good name. thank you. >> thanks, senator carper, very much. senator collins and i each have a few more questions. we'll try to them as quickly as we can. mr. nabors in your opening sdatement, i would say you volunteered slightly into mr. leibowitz' territo into consumer protection wrrd to the report of the council of economic advisers today. i was interested in it and i appreciate it. i think what you were saying is that this first quarterly report of the council of economic advisers today on the stimulus act will produce results that will be greater than the recipient reports that come in in october. and i presume in j creation, particularly.

and this whole aroused some perhaps when the second reports come in, will arouse some controversy. so i appreciate you doing cea to do is calculate the impact of the recovery act overal in the economy and there is more than just direct jobs from direct federal spending involved in that. as i mentioned in the conversation with senator mccain, even something like fmap is viewed as having an economic benefit. even though it doesn't directly create a job, it does free up money for states to use in other areas and those areas are seen

as producing jobs either foraw enforcement or education or other fields. so what the cea report will do is two major things that are different from the recipient reporting. one, it will calculate a broad base of job creation. it's not just capturing direct jo but it's capturing direct, indirect and what we call induced jobs. the jobs that are created as a result of manufacturers producing things for highway companies that are building the roads. all of that will have an economic essentially a trickle, throughout the entire economy. the second thing that the cea will be doing is when you loo at the direct jobs that the recipients will be calculating,

it's not necessarily clear that they have all of the information with regard -- with regard to jobs that are nessarily retained as a result of that money that is something that's very important. in the overall context of the economy. and that's something that cea's report will also be capturing. >> i want to move on to one more question. it sounds to me as if you're saying they're both right. they're both answering diffent questions, but is it correct to infer that you're also sing that the cea answer is more comprehensive answer? >> absolutely. >> and therefore perhaps ultimately more accurate. it's not that the recipients are being inaccurate, but they're not calculating all the effects of the stimulus. >> it depends on what precise question you're asking. if you want to know how many jobs the tnsportation project in your created. then the recipient reporting is probably more act are the. >> ght. >> if you want to know the economic impact of the recovery act in all of its manifestation are, then the cea estimate is

going to be more accurate. >> that's a great transition to my next question. i mentioned in in my opening statement that in meetings i had last week with some building trades people in connecticut, there were great complaints about the fact they didn't see much work. it was particularly perplexing because i had convened a meeting either right before the stimulus act was aor right afterward with the state transportation department, constructi firms and labor unions and the state said that the jobs were permit and ready to go and the money came forward. my staff did d some background on this and unfortunately ended up with a result that was unsettling, dismaying to me about my ownstate, but i want to ask you if it's broader and i'm going to ask the state to respond instead of connecticut as well. here's what i fou. the state of connecticut has received -- this is what you talked about before. i'm using the language of

obligation, money authorized and outlay, money actually spent. according to the numbers we found, the state of connecticut received a total of $454 million for my way and mass transit, through the middle of the last month. approximately 59% or $269 million of e stimulus act funds have been obligated in this case meaning that the project is officially chosen and the department of transportation has been notified, but here's the stunning number to me. only $506,000 of that has been outlaid in the state. now i'm checking, that turns out to be one of the lowest payout rates in the country accord iin to the white house. so i wanted to ask you from your perspective, overseeing this program, what's happening there? and is this occurring in a lot of other states?

and if association what is the administration doing about it? or what can the administration do about it? >> it is something that we are seeing in a variety of different states. i think connecticut is on the extreme side of things. i think there are two issues here. one is that, as i've mentioned previously, this is a relatively unique aspect of the highway transportation fund and other transportation monies. and i think that in part what has occurreis the state tranortation offices have gotten used to do businesshe same way every year with regard to their normal money. if you were looking at their annual appropriations, this would be a similar type of pattern that you would see. what we are doing and what the vice president is personally doing is reaching out directly to the governors and state le e legislatures and saying this isn't a normal time. we need to make sure the money is getting out the door and stimulating the economy in a

much more direct way and people are being responsive to those requests and will continue to make those requests of the state s. >> okay. thank you. thanks, senator collins. >> thank you, mr. chairman. mr. mihm, let me follow up on the issue of how we track the number of jobs that have either been createdr saved by the recovery act. for most of us looking at the job creati or the job saved number, is a very important measure as to whether the stimulus bill is achieving the goals that those of us who support it had hoped for. omb is allowingwo different method for counting the jobs created under the bill or saved. the first is direct counting. it's obvus what that means. butomb also allows a secon

option, which is an extrapolation, an estimate based on project information. my concern about having two different methods of measuring job creation or the number of jobs saved is that it could serve to undermine the public's confidence in the credibility of the numbers. could you comment on the issue of do we need two different ways? or do we just need one set or one appach to measurhng jobs created or saved? >> that's exactly one of the questions we're going to be looking at as we look at these recipient reports, the methodologist they use and -- well, a couple of things. first,there transparency in the reporting as to which methodologies they use. does a user of this understand how they got the number? and then second, as we do our

asse assessment, does it make sense at a high level why people would choose one methodology over another. that is is it done for all the right reasons? our approach is over theext couple of weeks, our state teams that are out there in those 16 states in the district are sitting down with officials in the states which are the dirt recipients who wl have to be doing the reporting to feder federalreporting.gov and understanding at the controls you'll have in place, how are you going to be reporting on the jobs to the extend that you're relying on information from some recipient, what are you going to be doing to assure yourselves you get good data? that's all before the reporting takes place. then after the rorts come in, we're going to go back o there and say, did you actually do what you said you were going to do? and then beyond that, then test for some subecipients go down and find out it flows all the way down. as i mentioned earlier, i our primary focus is going on this

time around, transportation progra highway program, that's where a lot of money is already and that's also, in my economist friends tell me that's where we can expect job impacts to the extent we're going to see them. so that's going to be the focus. but you're asking exactly the right question. the transparency on that is very important. >> it's critical. i'm very pleased that maine has the opposite situation of connecticut. we rank first in the nation in the expenditure of stimulus funds for transportation projects. and it was very heartening to me to meet simply with the owner of a construction company who told me that there were 100 people working who otherwise would not have been just fromhis one particular project. but it also became clear to me that this becomes very complicated on how you count. if you have a project with 100 people working on it, that project ends and then there's

another project that hires 50 of those people. how is that measured? are those 50 new jobs? so the total is 150 or is that a subset of the 100 that was originally counted? it becomes difficult. and the problems are obvious as you try to measure that, which is why i think it's important to that we have an agreed-upon measurement system and just stick with it. so the same standards are used everywhere and we have got apples to apples. >> on the particular example you're talking about. >> yes. >> i'm obviously defer to director nabors on this,ut omb has tried to address that by asking recipients to report on fte basis rather than on a specific job. so we don't get into these. >> double counting. >> because the one you were describing an argument could be made did that second job kill 50

jobs? that's not what we're trying to get at. so the fte, the full-time equivalent calculation is designed to make sur we're comparing apples to apples across the board. >> thank you. mr. leibowitz, i want to go back to the issue that senator mccaskillaised about what happens to these con artists. the ftc does a terrific job of shutting dn the website, doing the sweep, but obviously you can't cuff them as she puts it or you can't prosecute it, you have to refer the case to the juste department. >> sure. >> s that raises the question is it the justice department receptive to pursuing these cases? what you always wonder and you always worry about and i've done a lot of work over the decades on consumer fraud issues is the

fear is that it's viewed as small potatoes. and that a case is never brought unless it reaches a certain threshold. and what happens particularly in the internet aid is that con artist then goes on to set up another website and scams the next set of victims. that's closed down. the prosecution is declid because it's small again. although it's probably not because the range of victims is probab far greater than it's realized. but how receptive is the justice department to folwing through on these cases? and i'm reading -- >> you've identified all the problems without a diatribe by the way. we work with the justice department, there's always a tension. i've been on the commission for five year, there's always a tension at the justice

department between the things that are highest priori, terrorism. >> hard core crime and things like fraud, which sometimes fall through the cracks. but attorney general holder and lenny burr who is the head of the criminal division have have been very, very reseptemberistive with the idea of bring iing more cases an we have relationships with u.s. attorneys. so we go directly to where the malfactors or. my recollection is that one of the cases that we brought, grand connect, one of the malfactors is in jail now. the husband who started the scam who was taken over over by his wife, the former mrs. neff valued da is in jail. so we are pretty good at getting cases to the justice department and the folks who can put these bad guys in jail, we have a

criminal liaison unit that's been good at referring cases. it's an ongoing effort. but we also respect the justice department's priorities, so we want to be in there as quickly as we can. so but i'll get back to you on that parcular case and we'll keep the effort up and again, they've been very receptive at the justice department. >> thank you. mr. devaney, i'm not familiar with the story that senator mccaskill brought up this morning. while there are obvious issues with congressional oversight, accountability and transparency with the creation of new czar positions within the office of the president, that is the totally different issue from senate confirmed individuals who are performing important roles who do testify before us regularly. and although i'm not familiar

with the report that senator mccaskill brought up, it is extremely unfair if your position is being lumped in to the category of these other issues. let me just ask you one qck final question. you brought up a difficult issue in passing and that is you said that the board that you're overseeing is not involved in making judgments over the quality of projects for which stimulus money is spent. and that your focus, if it's a direct bar against funding, an aquarium, for example, then you would come in to play or if there's fraud, obviously. or improper payments. but that raises a question of whether there's a gap here. because there are in projects

that have been reported in the press, for example, building a guardrail around an evaporated lake, that clearly should not be fu funded. and traditionally i've looked to the gao or the ig to identify those projects. so if it's not your job to rai a red flag on those projects and i understand why you think it may not be, who's job is it? >> well, we are seeing things like that. and when we do, we bring that to the attention of either the agency directly and we've made a lot of referrals directly to the agencies, you need to look at this. and also omb. reflecting back on something director nabors said earlier, there's a very aggressive approach on the part of the vice president and his staff to get right on this. i mean if they see something

like that, they have been very -- my observation is from a distance, they've been very aggressive about that. i suspect when the data starts to roll in, we will see more of that, we will see mor questionable projects. and we certainly are going to make sure that all of that informion that we get and the data gets out to the right people, gets over to the departnts so they can look at that project, see if it was approved, wasn't approved. and do some watchful thinking about whether or not that was a smart thing to do. but there are going to be projects that two or three people look at in very different ways. was that amart bridg or was that a bridge to nowhere? and there's going to be aot of opinions out there when people see this data. that's what i meant earlier about it's going to be an interesting time when people get to see that.

and we don't want to get involved in those sort of subjective judgments. we weren't to be very clear about that. but nonetheless, if we see something we think is clely wrong, we're going to make sure that gets sent to the right place. >> thank you. mr. chairman, i just want to thank you for your leadership on this set of hearin that we've been holding. as you mentioned, this is the best oversight hearing. and i also want to thank our staff for their work and i particularly want to thank my staff for their work on the consumer fraud issues. i've long been very interested in those issues since my days in state government and also as chairman of psi. and i appreciate your including that aspect in this hearing. thank you. >> thank you, senator collins. thank you for your leadership in all the efforts that were leading up to this hearing and i

appreciate also the work that your staff did on the consumer protection part of the hearing and the work that both of our staffs did together in the overall hearing. i must say i'm proud of the members of the committee, i ought the questions were thoughtful, there were one or two diatribes. but this is exactly what we want to do here. and in my net impression is that the stimulus act is having a positive effect on the economy. it's not perfect. i appreciate the fact, mr. nabors, that you said the administration, vice president leading the effort is particularly committed to trying to accelerate the spending and the vice president and his characteristic way is hands on. i thought it was very important you told me he's on the phone himself. calling governors in state where the outlaw h lay of the actual spending is not what we hoped it would be. i thank you mr. devaney and

mr. mihm for the work that you're doing to assist us really in our oversight. this was an extraordinary legislative act, with an enormous amount of money in it. we did it because of the sense of urgency we had about where our economy was heading. we worried it was heading over the cliff. we're comforted to feel now it's not anywhere near the cliff but still there's a lot of suffer, but the bottom line here is that with this much moneyeing spent this quickly, w feel ourselves, a sense of accountability and responsibility and you're out there working for us in the various ways you are, sharing that responsibility and it's comforting to us and reward for all your good work is that we're probably going to call you back here some time at the end of october or early november, particularly after the recovery.gov get up and we begin to receive recipient rerts to see how -- what that tes us about how we're doing.

mr. leibowitz, you add a very important dimension here. i appreciate that you were re. you could tell from both the public questioning by the members and i can tell you from the sort of private conversations as people were coming by the chair here, that the numbers are very interested and concerned about the scam artists. it's been a long time since i've heard the term pond scum. and in an age where we soon may be referring topod scums, not pond scums. but in anyca case, there is interest among the committee in exploring any changes in law hat could improve or >> strength the work that you're doing by way of deterrence, by putting me power in the hands of not only the commission but the justice department, and so i ask that you work with our staff and your staff with ours to see

if there's something constructive that we can do with that regard. >> we'd be delighted to do that. i had discussions with senator collins because she is the ranking member of the appropriation subcommittee. i mean, i'll get back to you with a list but part of it is growing the agency. we are 30% smaller than we were 30 years ago even though the population has grown from 225 million to 555 million in the united states. part of it is having a sort of stronger deterrence. one thing that we're interested in and that there's growing support for is giving us fining authority. another of us is giving us easier rule-making authority. in t omnibus, you gave us, congress gave us, the ability to do a rulemaking involving mortges through the apa rulemaking, which is easier rulemaking. we're working on something more

medieval and because of that we will do something very, very useful that sets a clear baseline and so thank you for that support and we're gng to stay on top of this issue and we'll get back to you >> good, we'll work together on it. thanyou all. the record of the hearing will be held open for 15 days for any additional questions or statements people would like to submit. thank you very, very much for your very important public service. the hearing is adjourned.

>> now, a look at the securities and exchange coission's investigation into the bernie madoff ponzi scheme and why the sec failed to identify it. witnesses also address how to improve sec performance. is hearing is held by the senate banng committee. >> the committee will come to order. and let them thank all of our guests here today in the banking committee and my colleagues and staff. today's hearing is entitled the oversight of the sec's failure

to identify the bernie madoff ponzi scheme and how to improve sec performance. and let them thank the staff and others for the work that they've done on this issue and the follow-on we'll need to do as well, not that this one hearing will complete the examination of this question 'cause obviously the significance of it, americans are well aware of including the most recent reports about taped conversations between mr. madoff and others and his contempt for the process, the sec, the americ people is quite evident. obviously, as he says, fir of all, this conversation never took place, okay? some indication of what were the psychopathic individual that we're dealing with on these issues. i want to make some brief opening statements, and then i'll turn to senator shelby for

opening comments and following the bob corker rule there will be no statements made by any member of the committee until -- until the opening round. that way we can get through the first round. >> mr. chairman, is that who we have to be thankful to? >> i don't know. [laughter] >> ask bob corker about that rule. and then if anyone feels absolutely compelled that they'd like to say something, obviously, i try to accommodate my colleagues' request. bernie madoff stole $50 million, maybe more. he stole from individuals. he stole from pension nds. he stole from charities, municipalities like communiti fairfield and my home state of connecticut, he stole more than money. he stole the retirement savings and the economic security of families and individuals, organizations, charities all across the united states. and the very agency charged with

the responsibility of policing mr. madoff the securities and exchange commission didn't stop him. there can be no excuse for that colossal failure but i demand as well as my colleagues here democrats and republicans the victims of this fraud, somef whom hail from my home state and many, of course, all across the country that have testified before this committee, as some have, also demand an explanation. how did this happen? what went on. who was on the beat? what was going on that allowed this colossal, colossal thievery to occur? and so today we hold our third hearing on ponzi schemes. and our second on the madoff fraud in particular. to find out how this could possibly have happened. and what we need to do as a government, as a an exchange commisson as well as the congress of the united states to minimize this ever occurring again. incredibly it emerged late last year that the sec staff had

received multiple complaints. over a period of 16 years, 16 years, 1992 to 2008, that bernie madoff's business was not legitimate. but hadn't taken any effective action. to his credit then chairman christopher cox, director of the sec inspector general, to conduct a full investigation of why these credible reports had been ignored. the inspector general released a report last week and it is deeply disturbing to put it mildly. the sec received, i'm quoting, more than ample information in the form of detailed and substantive complaints but a thorough and competent investigation or examination was never performed, end of quote. the report goes on to describe an embarrassing internal failures in the sec one incompetent supervisors directed their officers to look only for

the types of fraud they understood and failed to recognize the types that were being done. number two inexperienced sec staff simply accepted mr. madoff's claims without making the single phone call or sending a single letter that it would have taken to verify the information they were given. number three, no one ever thought it merited a closer look when mr. madoff said he traded in europe with a firm that reported there was no activity -- a firm thateported there was no activity in the account. and fourthly, divisions in offices failed to coordinate with shared inrmation. this is ugly stuff to put it mildly. beginning in 1992, 16 years ago, 17 years ago, the sec received information that should have led to the quick end of bernie madoff's ponzi scheme. but because the task of following up on that information was assigned to junior staff or

supervisors with insufficient experience in the securities market, because that staff failed to ask obvious questions or take simple steps to verify what mr. madoff told them and because their supervisors actually discouraged in some cases furthe investigation, in short because the sec failed to do its job, bernie madoff stole $50 billion. today we're going to hear from the inspector general about his report. we'll hear from harry markopolos, an individual we've talked about in this committee who early, early on sent the early warning signals i detailed information on what he determined was a ponzi scheme. he's an investment analyst who continually attempted to get the sec's attention with regard to e madoff fraud about his ideas for improving the organization. and we'll hear from the heads of the office of compliance, inspections and examinations and a division of enforcement about what the sec has done in light

of the madoff revelations and about what chairman schapiro intends to go forward. there are clear -- several clear steps that i believe and i hope my colleagues and others need to be taken. one, the sec staff should be trained in markets and investment strategies so they can know fraud when they see it and the sec should hire staff with real world experience. the very culture needs to be reformed to encourage aggressive oversight. staff should verify, self-serving statements of facts made by targets of investigations and coordination between the sec's offices and divisions must be improved and that is a point by the way that i'm going to come back to over and over again. this idea of coordinating activities so we don't he this stovepipe problems and the sec is not the only organization that suffers from stovepipe mentality. it happens all across government for that matter but particularly here where divisions within the

organization are required o communicate with each other so you share information and knowledge arriving at decisions as to whether or not to go forward in matters like this. and lastly, there should we'll have more rigorous information for tips and articles in the financial press. well, like many americans who obviously have been following these events since last fall, i'm stunned and angry as many people aren this country, that this fraud was allowed to happen. but i also believe that the sec can do better. let them say as well because, obviously, we're going to talk about the sec. a lot of people work there and this is not part of my prepared remarks. i have a high regard for the many, manyeople who work at the sec and do a terrific job every day. and so i don't want this to be seen as some sweeping indictment ofverybody who works at this organization, far from it. i have a high regard for people who dedicate their lives and work long hours to ferret out problems that exist. and so this is really trying to find out where we go from here.

obviously, how this happened and how we can step forward. and i'm pretty confident i speak for all of us up here to reflect for literally hundreds of people who dedicate their lives at this agency and i thank you personally for the kind of work that you do and we're going to ask you to help us to make sure we minimize, if not prohibit and stop forever this kind of an event ever occurring again. i literally get emails every day, almost every day from constituents of my from connecticut. these are not wealthy people who work every day and hard every day to save and retire, to provide some security for themselves. they've been ruined, at least in their minds, by what happened here. they've been wiped out by what's happened. dr. backy, who was a constituent of mine testified in january before this very committee about what happened to him and the people in his medical practice in connecticut. these people have literally been devastated by what's occurred. and i don't know if there's any way we can compensate them adequately, sipc doesn't seem to

require us to do much about it. i'd like to hear from me colleagues' thoughts about the sec but we have to make sure that this isn't happen again. but i don't want every individual working at the sec to feel somehow this is an indictment across the spectrum of everyone there, hardly from it. but clearly we' got to do a better job and this is infuriating what happened in this case. with that let them turn to senator shelby. >> thank you, mr. chairman. last january right here in this room, a little more than a month after bernie madoff confessed to running a $50 billion multidecade ponzi scheme, this committee ld a hearing to try to understand how a fraud of that magnitude cld go undetected by the securities and exchange commission for so many years. unfortunately, that hearinc yielded few answers. in the intervening seven months since sec inspector's general who's with us today has been piecing together what really happened. his report sets out a chronology

that tracks 15 years of missed opportunities and considerable incompetence. the i.g. found the office of compliance and inspections and examinations and the divisn of enforcement at the securities and exchange commission were made aware at least six times that there might be something wrong in madoff's firm. potentially, fruitful leads were not pursued while significant aff resources were devoted to running down clearly unprotective avenues. the investigations were unfocused, understaffed and improperly documented. communication across the sec offices was so badly flawed that madoff himself had to alert the new york examiners that their counterparts in the sec had been looking at similar issues. the i.g. determined that the sec culture and organizational

structure discouraged employees at the sec from reaching out to one another to share market intelligence, obtain expert advice or to compare notes about their cases. the securities and exchange employees did not give information and it would be dismissed hastily by another. the report also documents that mr. madoff despite his persistent misrepresentations to the securiti and exchange commission received greater deference by the staff at the sec than the tippers who spotted his fraud. ultimately, in each case, the report indicates that the lingering questions and concerns of the sec employees were swept under the rug by the sec that asking the logical next question would take to long or would be outside the scope of the

examination, how absurd. in the aftermath of the botched madoff investigation, the sec has claimed that more funding will address its failures. will it? the report, however, clearly describes an agency that does not know how to use the information and resourceshat it already has. fixing sec will not merely involve more resources. it's going to take much more. the commission is going to have to make a broad-based change if it hopes to become a smarter, more flexible, more productive and ultitely accountable organization. i'm hopeful that the sec will learn from its failures and seize this opportunity to reform itself from within. if it refuses to do so, congress will do it for them, thank you, mr. chairman. >> thank you very much, senator. i'm now going to introduce our panelists. and these introductions are a ttle bit longer than i

normally to give but it's important to note these are very talented people who recentl joined the sec to come on board and i think knowing a bit about their ckgrounds in a public setting like this will hopefully be a source of some encouragement to people about steps that have already been taken under the leadership at the sec. first of all, welcome, david kotz, who's not with the sec but rather is the inspector general of the sec. joined sec in december of 2007. previously served as inspector general for the peace corps, having been former peace corps volunteer when thomas jefferson was president of the united states going back a number of years, i seems that long, i welcome your previous experience in covering the peace corps. and prior to that, worked at the u.s. agency of international development and in private law firms and he prepared the extensive report we're examining today and will be our first example. and our second witness you've already heard me speak of harry

markopolos who gave detailed alysis on the sec staff whether bernie madoff violated securities laws such as by operating a ponzi scheme from 2000 to 2008, over an eight-year period. . markopolos holds professional certifications as the chartered financial analyst and as a certified fraud examiner. he's the past president of the bost security analyst society, currently works as an independent fraud investigator with attorneys pursuing actions under the false claims act and other statutes. from '91 to '04 he worked with rampart investment management company where it became its chief investment officer. john walsh was appointed acting director of the office of compliance investigations and examinations. the sec in august 2009, just a few weeks ago. he has served athe sec for 20 years including service in the office of geral counsel, the division of enforcementnd the special counsel to chairman author leavitt. he has been a member of the ocie

staff since 1995. robert khuzami, i hope i pronounced that correctly, he was appointed as director of the sec divisionf enforcement in february of 2009. he came to the sec from deutsche bank where he had served as general counsel for the americas since 2004. earlier as global head of litigation and regulatory investigations and prior to this, mr. khuzami served as a federal prosecutor for 11 years with the u.s. attorney's office for the southern district of new york prosecuting complex securies and white collar criminal matters including insider trading, ponzi schemes and accounting fraud. obviously, an extensive background. we thank all of our witnesses today for being with us. mr. kotz, i'll begin with you. i'm going to have the lights on to watch your time. we don't want to cut you too short but we'd like to move along as well and get to the questions. so thank you again for the tremendous work you've done and that of your staff in preparing this report. >> thank you for the opportunity

to testify today before this committee as the inspector general of the securities and exchange commission. in my testimony i'm representing the office of inspector general and the views that i expressed of tho in my office and do not necessarily reflect the views of the commission. immediately after bernie madoff confessed to operating a multibillion dollar ponzi scheme my office investigation of why the sec did not see the scheme. we issued an agency wide document preservation notice and submitted requests for email records from the sec's office of information technology. over the course of the investigation, we saw emails from over 70 current and former sec employees for various time periods relevant to the investigation ranging from 1999 to 2009. in all we estimate that we obtained and searched approximately 3.7 million emails. during the investigation we reviewed files of sec files from 1990 till december 11th, 2008. and sght documention from

third parties such as finra and dtc to undertake our own analysis of madoff's trading records. to assist us in the investigation, we retained two sets ofutside consultants. february, 2009, we retained fdi consulting, inc. of the examinations by madoff that were conducted in sec. in june, 2009 we retained first advantage litigation consulting services to assist us in the restoration and production of madoff-related emails that the sec had been unable to provide due to gaps in electronic data. we conducted 140 testimonies under oath or interviews of 122 individuals with knowledge of facts or circumstances surrounding the sec's examinations and/or investigations of madoff. i would like to acknowledge the extraordinary efforts of the oig investigative team that i've been honored to lead in conducting this important investigation. these include deputy inspector director, and david fielder and senior counsels heidi, stieber, david witherspoon and

chriopher wilson. without their incredible devotion and exceptional work we would not have been able to complete the investigation and present a thoroughnd comprehensive report in such a short period of time. on august 31, 2009, we issued to the sec chairman a comprehensive report of investigation in the madoff matter containing over 450 pages of analysis in our report we found that between june 1992 and december 2008 when madoff confessed, the sec received six substantive complaints that raised significant red flags concerning madoff's investment advisor operations and should have led to questions about wheer madoff was actually engaged in trading. we also found the sec was aware of twm articles regarding madoff's investment operations that appeared in reparable publications and 2009 and questioned madoff's unusually consistent investment returns. the sec never conducted a competent and thorough exination or investigation of madoff for operating a ponzi scheme and that had such a

proper examination or investigation been conducted, the sec would have been able to uncover the fraud. the first complaint which was received by the sec in 1992 alleged that an unregistered investment company was offering 100% safe investments with high and extremely consistent rates of return over significant periods of time to special customers. the second complaint was very specific and different erg haves of it were provided to the sec in may, 2000, march 2001, and october, 2005. the complaints submitted in 2005 entitled the world's largest hedge fund is a fraud detailed approximately 30 redlags indicating that madoff was operating a ponzi scheme, a scenario described as highly likely. in may 2003 the sec received a third complaint from respected hedge fund mager identifying numerous concerns of madoff's strategy and reported returns. it questioned whether madoff was trading options in the volume that he claimed and noted madoff's strategy and purported returns had no correlation to the overall equity markets in

over 10 years. according to an sec manager, the complaint laid out issues that we indish shah of a ponzi scheme. the fourth complaint was a certificates of internal emails of another registrant that the sec discovered in april 2004. the emails described the red flags that employees identified while performing due diligence using widely available information. these red flags including madoff's unusually fills for equi trades, his misrepresentation of his option trading, his unusually consistent nonvolatileepurns over several years. one of the internal emails provided a clear step-by-step analysis of why madoff must be misrepresenting his trading. examiners who initially discovered the emails viewed them as to suspicion whether madoff is trading at all. the sec received the fifth complaint in october of 2005 from an anonymous informant which stated i know madoff's company is very secretive about their operationsnd they refuse to disclose anything. if my suspicions are true then

they are running a highly sophisticated scheme on a massive scale and they have been doing it for a long time. the sixth complaint was sent to the sec by a concerned citizen in december 2006 and to look at madoff and his firm referencing a potential scandal of major proportion which was executed by the investment firm bernard l. madoff. in 2008 the chairman's office received another company of the 2006 complaint with the additional information that madoff kept two sets of records and implying that a false set of records were kept on madoff's computer. these complaints all contained specific information and could not have been fully and adequately resolved without a thorough investigation and examination of madoff for operating a ponzi scheme. according to our experts the most critical step in investigating a ponzi scheme is through an independent third-party. we found that the sec conducted two investigations and three examinations related to madoff's investment advisor business. based on the detailed and

credible complaints that madf could have been operating a ponzi scheme. yet at no time did the sec ever verify madoff's trading through an independent third-party and never actually conducted a ponzi scheme examination or investigation of madoff. in the first examination and investigation conducted in 1992, based on suspicions that a madoff associate had been operating a ponzi scheme the sec focus on madoff's associate and after learning after madoff made all the investment decisions and had a consistent returns over a period of numerous years with a very basic trading strategy. the sec seemed not to have considered the possibility that madoff could have taken the money that he used to pay the associates customers back from other brokerage clients. in 2004 and 2005, the sec's examination unit ocie conducted two parallel cause examinations of madoff. the examiners were similarly flawed. there was delays in the examinations notwithstanding of the urgency of the complaints

and the teams assbled were inexperienced. the scope of the exams were too narrowly focused on the possibility of front running with no significant attemptses made to analyze the numerous red flags about madoff's trading and return. during both these examinations the exam team discovere suspicious information and evidence and caught madoff in contradictions and inconsistencies. however, they either disregarded these concerns or simply asked madoff about them and accepted his seemingly and plausible answers at face value. astoundingly both examinations were open at the same time in different offices without either office knowing the other one was conducting a virtually identical investigation. itas madoff himself who informed one of the exam teams that the other team had already received information being sought from him. both examinations failed to follow up with outside entities. in the first examination the examiners drafted aetter seeking independent trade data but never sent the letter claiming it would have been too time-consuming to examine the data. it would have provided the information necessary toeveal

madoff's ponzicheme in the second examination the director obtained information from a financial information indicating there was no transaction activity in madoff's account for a specified time period but failed to conduct any follow-up or even shared the informati withhe exam team. the investigation that arose from a complaint that explicitly stated it was highly likely that madoff was operating a ponzi scheme never investigated the possibility of a ponzi scheme. the enforcement staff failed to herb poo the significance of the analysis of the complaint and directed their investigation at determining whether madoff should register as an investment advisor. the staff again almost immediately caught madoff lies and misrepresentations but failed to follow upn inconsistencies. in fact, when madoff provided evasive or contradictory answers to important questions in testimony, the staff simply accepted his explanations as plausible. although the enforcement staff attempted to seek information from independent third parti, they failed to follow up. for example, when they received a report from the nasd that madoff had no option positions

on a certain date, they did not take any further steps. further, enforcement drafted but decided not to send a letter seeking documentation from european counter-parties. had any of these efforts been fully executed they would have led to madoff's ponzi scheme to be uncovered. we recommend the chairman review our report and share the portions othe report that relate to performance failures by those employees who still work at the sec so that appropriate action is taken on an employee by employee basis. my office also plans to issue three additional reports relating to the sec's failures regarding madoff. because of the systematic breakdowns we will have two reports with concrete recommendations to improve the operations of both o.c. and enforcement. they are finalizing a report of the o.c.'s exam process and provide numerous lessons learned with specific and concrete recommendations to improve nearly every aspect of the operations. these recommendations which are currently in draft status are detailed in my written

testimony. we are also finalizing a report that analyzing lessons learned and proscribed recommendations with the enforcement want. the recommendations we are currentlconsidering are also detailed in my written testimony. both reports will be finalized and issued within the next few weeks. we also plan to iue an additional report november 2009 analyzing the reasons why o.c.'s investment advisor unit did not conduct an investigation of madoff after he was forced to register as an investment advisor. my office is committed to following up on all the recommendations that we will be making to ensure the significant changes and improvements are made in the sec's operations as a result of our findings. we are confident that under chairman schapiro's leadership the sec will take the appropriate steps to implement our recommendation and ensure that changes are made in the sec's operations so the errors and failings we found in our investigation are properly remedied and not repeated. thank you. >> well, thank you very much. for the very comprehensive work you and your staff have done. and we appreciate it.

i'm going to ask the clerk to keep on about 7 or 8 minutes here for the first round. we have a second panel to go to. and i know several colleagues have other oversight hearings and responsibilities they'll be coming in and out and i'm going to leave the record open by the way for questions as well if they're unable to make it here so they have a chance to make sure their questions will be answered. i appreciate to the extent a lot of work you have in front of you and that you respond to these questions as soon as possible and i make that request for the second panel so they can hear that as well. let them just quickly if i can jump in. the report describes a number of very critical instances in which the sec staff failed to seek information you just enumerated these in your testimony. getting information from third parties to verify mr. madoff's claims about his trades. steps as simple as sending a letter that was already drafted, in fact, in one case, a drafted letter just needed to be sent would probably put an end to

this thing years ago. by making a single phone call to the trust corporation -- just a single phone call, is that wha you're saying? that's a single letter being sent, a single phone call having been mad in your view could have brought this to a screeching fault and exposed it for what it was. >> yes, that's right. the concern was that they would get tremendous amounts of information that would take a long time it off peruse but, in fact,, of course, since madoff wasn't engaged in trading they would have received very little information and immediately they would have seen on certain days that madoff was claiming in customer statements he had $2 billion in options, for example, there are no records of those. >> he made no trades. >> that's right. he had broker-dealer operation and it was in very different amounts. we actually during the course of our investigation, we went to

d.t.c. and we got specific dates, for example, the date that madoff testified before the sec and we compared the documents, the customer statements with the documents from the d.t.c. and immediately we saw that there was, you know -- there was no question that madoff wasn't making anywhere nearhe volume that he said that he was. and with respect to the nsad as well i mean, there are entities that clear trades -- those are independent entities. madoff can't have -- give them documents. those documents are independent. and had they done that, they would have uncovered the scam. >> so a single phone call, a single letter would have exposed this for what it was. >> that's right. >> is your testimony. to what do you attribute -- again, this is a broad question but try to be brief in your answer for the lack of follow-through. the agency culture, lack of staff commitment, staff not wanting to antagonize powerful people within the industry, the office of compliance, investigation and examination

enforcement. do they employ trusting people i presume ty do but i raise the question with you here. to what -- what should the sec do in your view as a general matter to address this issue? >> well, i think there are a couple of reasons. one, they were too trusting of madoff. i think a lot of people simply didn't believe that madoff could be operating ponzi scheme notwithstanding the fact tha they got complaints that gave indicia of that ponzi scheme. i think also they set the scope of their examinations and investigations too narrowly so when the junior folks wanted to continue, the senior people said that's not within the scope. i think that there was too much of an emphasis on numbers, how many exams we're going to get done that year. and there was a certain time period where the examiners were at madoff's firm conducting an examination. they wanted to continue. and their supervisor said time's up. we have to move on to the next one without really going back to ensure that you did a full and though job on that one.

skepticism is very important. no matter who it is. i mean, madoff certainly used the fact that he washe sole contact for many of the examinations, particularly, involving junior examiners. they sat with bernie madoff for hours a day and he told them stories about how he was on the short list to be the next sec chairman an gave them information, dropped a lot of names. and there wasn't sufficient support from the senior level people. you cannot allow a junior-level person tbe put in that position. madoff was very aggressive when they would ask for information that he was to provide and they didn't get enough support and backup from their senior-level people. madoff tried to focus them toward front running toward these limited areas so they would not get to the real issues and he was successful in doing that. >> there are 41 accounts in your report and as a follow-on you're

going to be doing in the file but 41 i counted. this is a hard question, how do you prioritize these? the recommendations, which are the ones that you believe are deserving of immediate attention to minimize if not entirely stop this kind of -- this kind of example of happening again? >> yeah, i think there's specific things that haveo be done within particularly the examination program. in terms of ensuring that when a complaint comes in, all aspects of the complaint are reviewed. they have to ensure that the planning memorandum are done appropriately. they have to ensure that the conduct of the exam is done sufficiently. they have to go to independent third parties. i think those are very important areas. i think you mentioned earlier about coordination among staff. i think that's one that has to be addressed right away. you cannot have a situation where one side of the sec doesn't know what the other side is ing. i mean, in that examination, the examers were ready to confront madoff with some inconsistencies.

when they confronted him, he pushed that and said i already provided these to your colleagues. they were embarrassed and taken aback and it's difficult to continue that momentum and examination when, you know, it seems as though the individual you're examining knows me than do you. it has to be remedied right away. the fact is that the sec as a whole got numerous complaints over the years. bunobody kind of counted it up to see, hey, wait a minute, we got this complaint and this complaint and this complaint and taking it all in, there must be more to it than just simply front-running. so that's something that i think mel gibson addressed right away. >> steven pearlstine writes in the "washington post" -- wrote a column recently in which he suggested there's a culture at the sec and i'm not going to quote him exactly that minimizes the following-on of tips. that there's sort of a rejection of the tips coming in as just

not really worthy of follow-up. do you agree with that? >> certainly in the case of harry markopolos's complaint. the enforcement investigators felt that he wasn't an insider and immediately discounted his complaint. and we asked them when we did the investigation, what else could harry markopolos have provided other than perhaps bernie madoff told me he was operating a ponzi scheme and if head provided that then we wouldn't need the sec. so there was thatase that unless it's an insider, you know, they had concerns about harrmarkopolos because he made a reference to a bounty. that he's on him out for money and they discounted him for that. in fact, if you look carefully at his complaint he had two scenarios. one was a ponzi scheme which he viewed as highly likely. one was front-running which he reviewed as unlikely. front-running he could potentially get a bountyot the ponzi. but, yes, there was definitely a sense particularly in

investigations that we looked at of them not taking seriously enough complaints like harry markopolos's complaint because that person was an insider. because the information wasn't given to them, wrapped up in a bow and carly the sec got sufficient information to then move the ball -- i mean, that was one of our concerns about the entire proces the sec g detailed complaints. they never really took it anywhere. from where the complaints were. notwithstanding the fact they spent significant time and as you say, doing other things, for example, contacting independent third parties would have immediately moved the ball. >> yeah. how about justn terms of the otr boston office, the new york office, these tngs go on. is the jealousies of other offices, who gets it and who gets credit. d you encounter that? >> it's interesting the boston office was very impressed with harry markopolos's complaint. understood -- >> they wanted an investigation.

they sent it down to new york. >> right. at that time there was a concern in the agency that offices were hoarding cases. and so rightly so the boston office felt they shouldn't hoard this chase they should send it to new york where madoff was. it didn't make sense for boston to do it. but when the heads of the boston office sent it to new york, they made special efforts. they had the head of the boston office email the head of the new york office directly to make re that they understood that this is not a complaint we just want to give you because we don'want to take the good ones. this was a very significant complaint. then they followed up -- >> is that an extraordinary kind of communication. >> yeah, it was, absolutely. and then they followed up a couple of weeks later to make sure that someone was assigned to that case. even after the first follow-up. so they did what they could to ensure that new york was doing it appropriately. ironically, had they hoarded the case, as was the case and was a concern within the agency, they would have likely taken the appropriate steps to uncover the ponzi scheme. >> uh-huh. lastly, and my time is up, the silo problem that you've already

addressed to some degree, and i say this is not a unique problem. i mean, we see this i think in private organizations as well as public ones this kind of approach where there's the not the kind of communication between divisions for a variety of reasons. how serious is a problem of this and what do y recommend on it? >> it was a concern. you had broker-dealer relationships who didn't understand the investment manager side. i do believe and john walsh will talk about that ter that that issue has been rectified and now they are doing exams with the joint groups so i think that is on its way of being resolved. on the enforcement side the concern was that madoff would say his trading was in europe. we have an office of international affairs. if you have questions about trading in europe you go to the office of international affairs. that's their purpose. the enforcement division didn't do that and i think that's something that needs to be encouraged among enforcement attoeys. if they don't understand particular issues, they need to seek assistancemy] in the agenc. there are people in the agency who do understand it but they

need to seek assistance from them so they can conduct these investigations. >> is there anything as simple as an enter agency task force to determine whether or not there ought to be some cross pollination in their efforts. >> i think that's a great ea. where you have an investigati that involves foreign issues i think there should be some recording that efforts were made by the enforcement investigators almost like a checklist. that they checked off that they spoke to this office. so you force people -- there wasn't sufficient planning. when they first got this complaint they didn't sit down and say how do we go abo investigating a ponzi scheme. if they had done that they would have gone to independent third parties. they need to have that floss place. they need to have the experience to understand and they need to be required to take certain steps. and a step involving european trading would be asking questions of our international folks. >> yeah. my time is long since up but i just want to make sure as you ge these reports and the

further examination recommendation whether or not we actually hold another hearing onhis or not but i want to maintain that we get that information right away from you. and, obviously, we'll follow up with it but i want you to keep very much in ctact with this committee on these recommendations and specifically, if there are any statutory recommendations. i'm not recommending there be any at this point but i'd like to know whether onot you think there needs to be. whether or not this committee has to take some action beyond holding hearings as to whether or not whether it's additional resources for the sec to do a job or anything else, i think all of usould like to know whether or not you're making any recommendations which would require the action by the congress. i want to know that, okay? >> absolutely. >> thank you. senatoshelby? >> thank you. mr. kotz, just simply providing more resources without other structural changes address the problems you've identified at the sec? >> yeah, i think it's more than just resources. >> absolutely. it's structure, too, isn't it and leadership? >> yes, yes. while resources was @ factor in

that they didn't have a branch chief on certain examinations at the end of the day, the sec spent years investigating madoff but didn't do the appropriate things. so additional people, if they're not going to do the appropriate things will not solve the problem. >> just waste resources? >> yes. >> in your report and it's very lengthy and thorough and we appreciate it, what you've done, noted some investors viewed the fact that the sec had inspected the madoff firm as a sort of regulatory seal of approval for the firm. what steps can be taken in your judgment to help investors understand that the fact that a firm registered with or inspected by the securities and exchange commission does not mean that the firm is legitimate or guarantee that it's operating in full compliance with the law? how do we thread that needle there? >> yeah, i think there has to be a better educational process without a doubt because that was

a significant issue. we found folks who reinvested with madoff based on their feeling that the sec had checked out madoff. i had a very sophisticated hedge fund individual say to me, he knew for sure that madoff wasn't running a ponzi scheme because he had seen harry markopolos's complaint and he knew that the sec would look at that carefully and there's no way they wouldn't have caught the ponzi scheme. so part of that means the sec needs to do a better job in its investigations but they also need to explain to the public and investors out there, you know, exactly what it means when they close an investigation. it doesn't mean they're doing everything right. >> uh-huh. >> and bernie madoff certainly used that fact constantl referring to the sec just being in here, which they were, as a way to convince people who were perhaps hesitant about investing with him. >> your report also describes a series of failures at the sec that enabled mr. madoff to continue to swindle investors

for decades. given that failures occurred repeatedly and throughout different parts of the securities and exchange commission, can we assume that other similar frauds are likely are occurring or have occurred without detection? >> well, i mean, we haven't looked at other specific matters, t, yeah, it was a concern that the same pattern seemed to take place across the spectrum. if you look at the examinations and investigations from '92 to the present it was very similar, limited focus, not enough aggressiveness in the investigations and examinations, inexperienced junior people not beg supported by supervisors, so it's a great concern. obviously, we spent a lot of timenalyzing the madoff situation and issued a very long report but we don't know what else is out there and it is a great concern that these seem to be systemic issues and i think the agency needs to address those issues in a systemic way. >> you also -- some of your

recommended reforms in your report, you offer a number of recommendations at the end of your report to improve the process by which matters are handled. it's very important. one of the examiners you talked to, however, lamented the fact that and i'll quote the typical sec examiner walks into a room where there are a bunch of dead bodies lying around and they notice that the clocks are 10 minutes fast. in oth words, they notice the wrong thing. are you concerned that even if your recommendations are implemented, we hope, that the culture of the sec is such that examiners will be rewarded for focusing on only technical violations of the securities laws rather than the real substance looking behind compliance, checklists and identifying more serious problems such as this massive fraud. >> yes, i mean, that's a concern. we devoted an entire section of the report to many interviews we had with folks outside in the private sector who conducted due

diligence. and we tred to compare the methods that they used when they conducted due diligence to what the sec used. and what we found was exactly that. they take a who holistic approach and they look at larger issues rather than kind of a checklist of approach did you file this form, was this signed, are the clocks on time, et cetera. and so it's a concern. i think the way toesolve that is to get more input from these private sector folks. there's a lot of very smart people in the private sector who make very good decisions about investments. folks who loo at moff and immediately realized that there was something wrong with his returns. the sec can get -- have educational opportunities for training from these outside entities and i think that will help them to focus more on big-picture issues rather than have a checklist and go by and not notice the fraud in the corner of the room. >> you also noted in your report, you spoke with private entities that had conducted due diligence that you alluded to

and concluded that madoff's purported returns were not legitimate. in other words, they raised concern. given that there seems to have been many people who suspected something was wrong at the madoff firm, why do you think that more whistle blowers did not come forward to the sec or were there enough whistle blowers but not enough diligence at the sec? >> i mean, i think that there were sufficient complaints. i think that there were a lot of people who were skeptical of madoff's returns. he was using what examiners called a plain vanilla trading strate. i don't think that there were a lot of people who did due diligence who necessarily assumed it was a ponzi scheme. many people thought he was doing perhaps something else illegal. but not necessarily a ponzi scheme. so that may be a reason why there wasn't more people -- >> he had reason to believe something was not right, did he? >> yes. people are nervous about coming forward. i think one of the other issues

is to look at is to encourage people to come forward. people are nervouso come forward. one of thendividuals who came forward asked us to keep his name anonymous in this report. many of the people we talked to about due diligence asked specifically not to have their name reported. when the report came out even though we took out their names and they called are you sure there's no way that our name is anywhere in the report? i mean, there is a concern out there about bringing information forward. so when you have somebody like harry markopolos who is willing to come forward, you have to take that and do the appropriate investigation. but i think something needs to be done to look at how to encourage more people to file complaints 'cause the folks out in private instry, they have a good sense of what's going on. >> is it mind-boggling to you as you did your research and investigation here that a fraud of such magnitude, $50 billion

or more, i assume is one of the largest sec's ever dealt with or failedo deal with -- how could it have happened, right. >> absolutely, absolutely. bernie madoff had a very good reputation. and i think that played a part in this whole issue which is no one really believed that bernie madoff could be opeting a ponzi scheme. and i think that's a reason why many investors continued to invest with him. my position would be after doing this investigation that if you get a complaint that says bernie madoff is operating a ponzi scheme, you need to be able to believe it in order to conduct an appropriate investigation. at that point, you need to allow for the possibility that it's happening and check it out. and when you start checking it out and you see bernie madoff that are saying things that are contradictory you got to keep going. >> he not only fooled the sec he

fooled the sec investors didn't he. >> yes. >> the chairman of the subcommittee, jack reed. >> thank you, mr. chairman. thank you, mr. kotz, for an extraordinarily insightful and informative rert. we appreciate it vermuch yr efforts. approximately how many tips, complaints accusations do you think the sec gets a year. >> quite a number. >> they're not of the order of specificity and detail mr. markopolos is as clearly? >> yes, yes. >> i'm going forward, are you confident that there's a triage stem for one of a better term in place to sarate those that have -- you know, that are not on at least first inspection compelling and identify, you know, the compelling ones? >> yeah, one thing that the sec is definitely doing is revamping

the entire system so they have made great efforts and the sec folks can tal about it more detail. but there has been a major effo to revamp that ente process. i think there were some concerns about the triage system but they are certainly exerting a great deal of energy to fix that system so that there is a good tria system in place. >> let them turn to angther area going forward. that is the data and the systems that the sec has, everyone has alluded it, the chairman and the senator shelby about the ovepiping and you indicated very clearly two groups going in, one being played off against the other by the -- by madoff, is the plan or is the capability there today to basically, you know, go to a terminal and be able to call up all the information relative to a particular individual or a particular case? >> yeah, i mean, i think there needs to be some improvements in that area.

i mean, ironically the exam program actually had a system for putting examinations in to a database. the problem was twofold. one, the folks who did the exam didn't put them in and the folks who looked - who were doing another exam didn't check and they were going on at the same time but the exam wasn't in the system and the other entity didn't check to see if the exam was in the system anyway. you know, when you have those databases, they have to be used. i think that the sec is making renewed efforts to ensure that they put information into the databases so that people know what the other side is doing. >> that's, you know, kind of surprising that i would assume that entering the data was a basic requirement of the investigative team and they failed to do that? >> yes. >> was that routine or was that

an exception in this case? >> at that time we understood it was not uncommon for people not to put their exams in the database. i believe things have changed since then. >> yes. >> but at that time we were told in our investigati that it wasn't uncommon at all. >> was madoff aware of these structural and cultural ortcomings which allowed him to operate so successfully? i mean, did he have better intel than the sec? >> well, i mean, he was certainly aware that the sec was coucting two examinations of. at the same time and, you know, certainly he used his knowledge generally in the industry to impress the exiners. so in many ways, he knew which buttons to push. he knew how to impress the examiners. and he knew how to get them off the track that would have disclosed the ponzi scheme. >> again, this whole area has been extraordinarily shocking to all of us and your report has

been extremely helpful and useful. there are changes that you've alluded to with respect to technology, with respect to entering cases, different enforcement policies. i presume, but i don't want to put a conclusion forward without your comment that at least the sec seems to be headed in the right direction now. >> yeah, well, absolutely. i mean, this thing has really affected the sec greatly. and, you know, chairman schapiro understands the importance of changing things. i've met with her many times on these issues. we are going to make many, many recommendations, a lot of things have begun before our report came out. i aske for briefings. i will follow up in two reports in the next few weeks that will make 50 some-odd recommendations that we will ensure are

implemented so the sec understands, i believe, that things need to be done and are taking actions. >> this final question, the more i sort of look at institutions and differentspects both here in the united states and across the globe, culture plays a huge role in how people operate, how institutions operate. can you make any comments on the culture then of the sec and the culture now? are there variables that you would sort of point to in terms of -- that have to be changed that aren't strictly resourced or strictly organizational charts? >> yes, i think there are couple. i think historically the enforcement division in my opinion has been very resistant to changes in general. there's a new director. mr. khuzami, who is undergoing a major restructuring and there will be significant changes to the enforcement division which is something that i think is unique to his leadership. i think that's something that may not have happened that much in the past.

so that's an area where i think things are going to be different today than they were previously. >> thank you very much. thank you. >> thank you very much, senator. senator johanns? >> mr. chairman, thank you. let them just express my appreciation for the chairman and the ranking member following up on is. i think it's enormously important. since this story broke, we've all had an opportunity, i'm sure, to watch the victims interviewed and the tragic stories i mean, just make you want to weep for them. people who are in their senior years who just have no chance of making this money back. i mean, they are not going to live long enough. i read your report and i reach the obvious conclusion. the federal government plea it. -- blew it. at's their remedy? where do they go from here?

>> yeah, i don't know. there are, i guess, legal issues about what victims can do. through the course of our investigation we met victims as well. they weren't as, you know, senator dodd said, they weren't real rich people. they weren't people who lost $100 million and have $100 million left. you know, i talked to people who said for them december 11th was their 9/11. december 11th was like september 11 for them. their lives were devastated and thers no question that we in the federal government must do better. >> i don't want to necessarily draw you in to a political debate because that's not the purpose of this hearing, but so many things are happening these days. big, huge federal government programs, healthcare on and on. and i read something like this and i just wonder, tell me

something that will assure me that the federal government can handle what it is headingut to embrace when it does this so poorly. >> i mean, i can't speak for the healthcare system but -- i mean, it is a concern at least on the sec level that there were so many opportunities, it seemed relatively easy to uncover this and it wasn't done. so i can understand why there is a concern about the operation of a government agency. i do think, however, that the sec can improve its operations so that it get better and it is able to do its job in the long run. >> you know, that's the other part that i take away from your report, boy, when you really came down to it kind of a no-brainer. you say it's very, very easy to scratch into this even a little bit below the surface and there's this enormous ponzi

scheme going on. .. >> we found there was no evidence that that relationship had an impact. we did find that madoff was able

to use his stature to impress the junior examiners. so ithat way madoff was able to use, but there was nothing that we found that was direct. and we look very hard, followed up on a lot of lead in that area, and there was just no evidence that it happened. and as we talk to the examiners and you go through the document, you can see exactly how it happened. and there was no point in time, something switched or that they were about to get something and somebody pulled them off. there was just no evidence of anything from the top or improper influence of. >> i d't know if i should be reassured by that or not, because what you just described for me is massive complete, total bureaucratic incompetence. you know, they weren't even doing it because they were on the ta or being bought off. they just simply were incompetent.

>> and in fact many of the examiners and iestigars, the junior was, worked very hard and spent a lot of time. they weren't lazy, just filing out at 4:00. they spent a lot of time working on it, but they were not going in the right direction. they were not doing the right things. they spent a lot of time spinning their wheels when if they just had gone to an indie than a third party it would have come out. >> let me ask you this and let me lay some groundwork for this. $50 billion plus got out the back door. before this thing collapsed. d you know the reality is i don't know if we caught up with it so much as it just collapsed. you have statements being published every month. on what every periodic basis to give investigators turning inside and out trying to figure out this and that. the next thing you've got an organization that apparently is

trying, claiming it is doing trade that is not doing trade. you've got customers tt are calling in and saying what's going on here? i mean, for all intents and purposes it's acting like it is actually doing something when actually what it really is doing is getting the money out the back door. and i appreciate the importance of this question, but it is a question that needs to be asked. did you believe that bernie madoff, with all that going on, acted alone? >> yeah, i'm really not in a position to be able to know. i mean we did not look into that aspect of the operations. we focus on the sec. so i don't know that i could give an educated answer on that question. it seems to meo have been -- >> why don't you give an uneducat answers. >> i can give an uducated answer on any question i guess. it seems to me to be a pretty

large enterprise that would be diffult even for bernie madoff to pull off himself. but that is not based on information that i found during the investigation, just based on kind some understanding of how this worked. >> you know, what i'm driving at here is this. you probably have people on the hearing room who are victims. user to have people who are watching this on tv who are victims. their lawyers and probably themselves are trying to figure out where does this tangled web lead to, and if we follow in this direction there may be assets after that we have not yet capped into. and all the people i think sadly our only going to get pennies on the dollar by pursuing that, that is still something. and that's what i think that question is enormously important, because if we had any role here, it's to protect the public. and i think you are saying beyond any shadow of a doubt, the federal government with this

agency that is supposed to protect the public, failed miserably. so help me try to figure out how this committee embraces this very difficult issue and picks up the mantle for these poor people and helps them do what we should have done years ago, which is protect them. >> one thing i can say, in the course of our investigation we had communications with the federal prosecutors who are working on the prosecution of folks related to the madoff ponzi scheme. and i can tell you that they are working very earnestly to ensure that if there are people out there who worked with the bernie madoff, that they can do justice. i can assure you that a lot of actions are being taken in that respect. and then there's obviously questions about how to refund of the investors money, but we are not specifically involved with

that. but as i said, i heard heart-wrenching stories myself about people whose lives were destroyed. because of what happened, and througno fault of their own. you know, i talk to people about we do not surprise that you kept getting these solid returns and everybody else was losing money in the market? one person said to me, you know, i was very concerned about it but three days before the madoff confess i got a statement and the statement showed that i still had money in the. he said when you get a bank statement, do you go to the bank to see if the cache is still in their quest he believed the money was there. he didn't have any reason to think it wasn't. he was concerned about it but he saw that he had a statement. while he believed that it was all made up? >> let me ask just one last question if the chairman will permit me. as you know, in another life i worked with an inspector general. i was secretary of the department of agriculture.

and grew to really respect the work of our inspector general. can't always say i celebrate those briefings that i would get, but grew to respect their work. do you find it shocking, flabbergasting, that you have a whistleblower, you've got a roadmap that pretty well lays out ponzi scheme, that you folks were brought into this earlier? i think if i would've gotten a letter like that, i would have first of all thank you, and once revived i would've called my inspector general, my general counsel, my deputy, and the white house and everybody else under the sun to say we've got to do something about this. >> yeah, it's interesting because one of the things we found in the investigation is that all these complaints were kept at relatively low levels to our office was not involved. it wasn't even at the highest level of the enforcement

division or the compliance office. it was relatively junior and mid-level folks who made the decision to look into it and closed the case. and really, the commission was never informed about the complaints. our office and it was built with more at a junior level. >> thank you, mr. chairman. >> those are great questions and i think senator johanns imminently. i think all of us share those questions as well. and this committee is going to take a look at the victims of the compensapion issue to some degree. i'm not encouraged by some of the answers i received already but certainly pursuing, for whatever it is worth in my mind, this could never have been a one man opetion, in my view. you don't steal $50 billion engaging phony transactions over the period of time and doing it by yourself.

that just defies logic. so i welcome the fact the serious investigation being pursued and that may offer some opportunity to provide some compensation to victims as senator johanns as pointed out. but there may be other means as well and we need to examine that possibility. and deal with this. like it is a flabbergasting case. and so we are very interested in other recommendations you would make. let me turn to senator menendez. there is a vote that is going to occur in four minutes, five minutes and what i would like to recoend is tt senator menendez go forward with his questions. that those of us go and cast votes, we will recess after i got after your questions and come back and finish up. others may come back in and we'll try to get to that second panel. senator menendez, why did you go ahead? >> thank you, mr. chairman. i appreciate that. let me just make a comment i was listening to our colleague,

senator johanns beginning of his question. i have the same dismay he has about how the security's and exchange commission work in this regard. and i know you raised the question as to whether we can't have a successful agency do this, had to have a successful agency do something else. i come ta different point of view on that is how do we correct this. it is similar to the consequences before you were the secretary of agriculture, the discrimination that black and hispanic farmers faced in the department of agriculture that has been recognized most recently in a $1 billion settlement. and so the question is do we have less of a department of agriculture, or do we correct what was wrong? in this case, do we correct what is wrong with the sec. and so i look at it in that vein. i clearly believe the sec staff

was from everything i've read in your report, grossly untined, uncoordinated and lazy. in their investigations. one sec team consisted of only of lawyers without any traitors in it, lacking the expertise to do i think a lot of the critical analysis and questions that were necessary to do the job. you mentioned the lack of ordination between new york and washington's offices, independently conducting investigations and finding that only out through madoff who used that against them. repeatedly, not sending documents for third party verification, of transacons that madoff made. or supposedly made it because they believe that the volumes of documents they would get back would be too voluminous for them

to reveal. now, it doesn't take a fraud investigator or a rocket scientist to figure out that verifying information with third parties is necessary to find out if someone is passionate or as these legitimate or not. i am a lawyer by training but i don't think it takes a lawyeto understand that third party veracity is important. so my question is who is held accountable for these grossly incompetent performance as? >> i think the entire sec should be held accountable for at happened. clearly there are systemic problems, and for that reason we are having report with recommendations to do with the systemic issues. i also recommended my report be shared to the extent that there are current sec employees who are still here, the supervisors are those sec employees, to make a determination on an employee by employee base is about what to do about the specific

situations. >> how many people who work at the sec eight mistakes in the course of these five severely botched investigations? >> i would say over 20 over 20. and of those 20 people, to your knowledge how many have been fired because of his gross incompetence? >> well, i don't believe anybody has been fired specifically related to this investigation at. >> well, i have to tell you it seems to me that you could run the company and you can't conduct a government service in which you have gross incompetence, and those people are allowed to stay at their jobs. so we will look forward to seeing what the sec is going to do here. because the first thing you have to do is clean house. if there is a culture of incompetence, youave to change that culture. at the end of the day. you know, it seems to me that -n

madoff misled the sec about the strategy he used for customer accounts, withheld information about the accounts and violated fcc rules by operating as an unregistered investment advisor, why didn't the sec use its subpoena power to collect information from both madoff and independent third parties rather than just rely on madoff's word? >> well, madoff, the information we receive from the investigators who panel the matter was that madoff responded to the document request. they would ask for documents. you would produce documents. so at least in the enforcement investigation they didn't feel subpoena power was necessary. they could've gone to the indendent third parties without subpoenas. the sec certainly has the ability to get records from nasd, they oversee that. and the sec can get dtc records as well. we did our investigation, we

went to dtc. we asked them for records. they provided a. there were no problems. there was no question that they could have received information. even without a subpoena to mac so i was 80 information. it wasn't their gss incompetence of pursuing the information? >> they never asked for the right information. they never even asked for it in the first placeere followed through on their requests. >> now, mr. kotz, i understand you are not the inspector general during this peri of time. so let me preface my question. i appreciate the work you've done here. but who at the s is responsible for overseeing that investigations are done properly and that leaves are followed up on? >> wel i would say though that the heads othe enforcement division are responsible for ensuring that investigations within the division are conducted appropriately. >> now, and i agree with you. but did we have inspecto general's of the department

during this period of time? where were they? >> there was an inspector general who came in prior to me, yes. >> where were they? >> well -- >> we had a 16 year period here. where was the inspector general? >> there was no complaint ever brought to the inspector general's attention. there was no -- about any complaint to the inspector general that the inspector general's office wasn't aware of anyissue. and in fact, an office of inspector general can't go out and do a ponzi scheme investigation. >> so you have reviewed this and ended 16 years there was not one complaint at the inspector general's office about wt madoff was doing? >> that's correct. >> okay. that's critically important. let me ask you one last question. isn't it something to consider

that an effective and objective audit of madoff would have quickly revealed his scheme? sense of madoff fund was not public, he was not required have an audit from the pcaob case. doesn't this scandal show the need to more closely monitor private firms as well as public company? >> i think that is correct. i think that would have assisted in this process to the extent the sec didn't catch it you would've had another avenue to catch it. so i agree with that. >> one final question. in your opinion, based upon what you abound in terms of this incompetence and negligence here, those are my words, not yours, but certainly i believe they are incompent and negligent. should other sec investigation to be reopened based on the incompetence of this case the? >> well, if there is certainly information leading them to believe that the same circumstances auker, then i would say yes. >> thank you very much.

>> we stand in recess until we called adjourn. thank you. [inaudible conversations] >> the hearing will come to order. senator dodd had another pressing engagement, so he asked me to chair the second part of this hearing. so what we are going to do, since i'm the last questioner of the inspector general, i will give arief opening statement, ask the inspector general of the questions. and then we'll get right along to the second panel. the will be one of the person coming back to ask questions when i'm finished.

okay. so first, inspector general, i want to thank you for justifying and conducting this investigation of the sec's failure to ferret out bernie madoff's decade-long failure with front. with everything we already know about the scope and the scale of madoff's fraud, i was still stunned by the details of your report. in fact, i am starting to believe the only thing more amazing than the size of his ponzi scheme was the failure of theec to catch him. like the old saying goes, the sec appently couldn't hit the broadside of a barn if you gave him a shotgun and directions. and in that, we will see later from mr. markopolos, i read what he said to the sec. it was aost like color by numbers. all they have to do is take the number six pencil and color in the number six with the lines and they would have found the whole thing. it is just utterly amazing it as

you absolutely make clear, there were so many warnings and inconsistencies, you would think that madoff i would have been one giant red flag. and yet, time and time again, kids were ignored, he was ae to bully the agency into submission before full investigation were even started. just a breathtaking. and i worry, not only about the sec's ability to catch the next swindlers, but also about its ability to do its most basic job, which is to oversee the capital markets. one thing that has become clear to me is that as our markets have evolved, the sec is simply not kept pace. while the financial world has only gotten more and more sophisticated, the agency has, at best, stood still. if not gone backward in terms of staffing, resources and sophistication. i have great confidence in the work of chairman schapiro, and the changes she is trying to

bring to the agency, but frankly the sec is outgunned. the sec's staff from 3650 oversees 35000 entities. the sheriff of wall street is trying to police a town full of howitzer with a six shooter. the sec clearly needs more resources but it is only one of two financial regulators that must go being to congress every year for appropriations. even though it brings millions more in fees than congress allows it to spend. this leaves the sec without a stable source of funding that would allow them to invest in the personnel and technology they nd t keep pace with the markets they are supposed to police. that is why i plan to introduce legislation allowing the sec to keep all of the transaction and registration fees it collects from public companies so it can attract and retain the kind of expertise required to catch sophisticated thieves and invest

in the technology required to monitor today's rapidly expanding and increasingly complex marke. the ttom line is while the sec may need new laws and new tools, they had all the laws necessary on the books to catch madoff. they didn't have the personnel, the expertise, the sophistication, th organization. they needetter people. more of them, better paid, and people who are paid enough that they stay a long period of time. they don't discount for three years and then leave and then go to a hedge fund at because a lot of business is simple experience. and the sec people didn't have it. now, i have a few quick questions for you because i know my colleague, jeff, has been waiting patiently. he is always very patient. a very good. and so let me ask you these questions. first, ifou had to assign a lett grade to the sec for its performance in the madoff

investigations, what would it be from a to f.? >> f. spec if you could go lower would you give them a lower grade than that? >> perhaps. >> okay. your report highlights the inexperien and lack of resources as impornt causes of the sec's failures in this case. so would you support the concept, i am not asking you the language, but the concept of the bill i plan to introduce that would result in millions of more dollars for the sec to allow them easy to go directly to funding the sec as it used to be and would allow them to invest in better and more qualified personnel? >> i think certainly resources was something we saw that had an impact in the different examinations and investigations that was conducted. for example, in one of the major examinations there was no branching on the exams of the junior examiners were left kind of to their own devices, didn't get enough support. that was because they didn't have an available person.

another examination was moving forward making some progress and they decided to put it on the back burner in favor of another matter. that was an issue also that relates to resources. the limited focus decisions, perhaps also relate to resources and that they decided that they had the manpower to look at a discrete issue rather than looking at larger issues. there was a request for documents but they were concerned with gaining mounds of documents which they didn't feel they had resources to look at. so there is no questions there are aspects of what i found that relates to a lack of resources. >> all right. senator merkley. >> thank you very much, mr. chair, and thank you for your testimony. artier this year we had a chance to take a little bit of a look at this and it is nice to revisit that with your report. your report emphasizes very starkly the number of investigations over a span of 16

years, six investigations. and the fact that there were both sophisticat and very straightforward measures that should have caused a real interest on the part of the sec on the sophisticated side. we have this extraordinary report, mr. markopolos, with 29 red flags. i read this earlier this year, and i asked the question of another sec member, how often do you get such a sophisticated critique as opposed to just a simple tip that maybe there is something wrong somewhere. i said i wanted to ask you the same question. is this quite an unusual document to someone to lay out such a sophisticated analysis of a firm with 29 red flags? >> we asked that question too many people in our investigation and the answer was almost uniform. it was very unusual. there were people who told us even people who dealt with complaints directly who had never seen such a detailed complaint.

>> so on the one hand, we have this vy sophisticated point, and then we had many people with similar observation that there was no evidence of counterparties that a standard consistent return on the hedge fund doesn't match the expense of any hedge fund anywhere under the sun. under very market conditions. that there wasn't evdence of corresponding traits, etc. etc. and so forth. very simple. so i look at this and i think even a novice investigator, even a novice investigator sing such a sophisticated report on the one hand, or simple basic how can this possibly square off to be intrigued and say there is something here to look after. and i just simply cannot accept that it is simply a case of inexperience. or a case of resources. was there a general culture of life after he said he, like of

wanting inconvenience, big players, lack of reward t investigators who had hard-hitting investigations, that had damaged their career path? one of the managerial issues? i didn't see in your report any kind of sign of the culture that generated such failure. >> there was certainly concerned about the focus being on finishing the investigation and moving onto the next matter. and so for that reason, they didn't want necessarily to look at the larger issues. they would stick to the more limited issues, which were easier to deal with which were resolved quickly. we were surprised as well that a enforcement investigators simply didn't understand how unusual madoff's investment were. and they asked madoff in the testimony how -- he said he had

an amazing get feel for the market. is gut feel was based on standing on the trading for. he could feel when the market would move. and madoff was able, he had perfect timing. he was able to get in and out every day, at nearly the exact right point. and we asked him how did you believe madoff's explanation. and they simply didn't understand that it was so unusual to have such consistent returns over a long period of time, that no windows was able to duplicate. >> does this raise serious questions about the type of training that the investigators received? >> yes. i think absolutely. that is one of the things that enforcement is looking to change. i think in the past, the sec enforcement lawyers were generalists. they were smart, hard-working individuals but they did have a particular specialized experience in an area and i don't think in this case that was specific. if you don't understand options or drink you are not capable of

doing that type of investigation. so i think that there is a move towards specialization which will allow people who really understand h to operate a case to take an investigation. one of our recommendations that we are considering is to require at least a certain number of individuals on every investigation that have done a ponzi scheme investigation before. none of the people in the investigationad evedone a ponzi scheme. you cannot do a ponzi scheme investigation without understanding how to do it and just bng a smart person whose general as i don't is sufficient. >> how could in the face of such a comprehensive report like mr. markopolos compiled, how could the investigative team not include an experienced investigator who would have knowledge of ponzi scheme's? >> that's a very good question. at no point in time was there anybody on the case went on a

ponzi scheme investigation before. at no point in time did they go and sitown and say let's see, how does one do a ponzi scheme investigation. if we don't know because we haven't had experience let's go to our many colleagues who know. they didn't. they didn't know the information that was needed and they didn't seek out that information from others in order to know it themselves. >> did you happen to ask the investigators and offer questions, what a proper portion be along this line. were you concerned that if you pushed and prodded that complaints would be made to your superiors and your career might damaged? >> we did ask those questions to all the major players and all the examinations and investigations. and they said no. we did not find that they were concerned that they would attack bernie madoff or make allegations of bernie madoff and their careers would be affected. i think there is some enforcement lawyers who would like to bring a case against somebody like bernie madoff, but they simply didn't have the

skills to be able to match up with them. >> did the sec routinely bring in consultants, folks who might have a career, knowledge, sophisticated knowledge to come in for two hours to review the case or provide advice or direction or any type of assistance? >> we weren't aware of that happening in the course of the examinations and investigations. when we spoke to folks on the outside they said they would be willing to do it. and that is one of the areas we are looking at towards recommendations, to encourage private sector folks to explain to the sec individuals how to go about and conduct this due diligence. >> the investigation occurred over the 16 year period, that is an extended length of time with many, many different folks involved. and so i don't dirt this toward any one individual, but we did have 2005, 2008 christopher cox who had his management philosophy of light

touch regulation. was there kind of -- was there any equivalent investigative branch of being light touch investigators for fear of, i don't know, discouraging inappropriately interfering with firms? >> i didn't find that was happening, at least in connection with the madoff investigations and examinations. >> i appreciate your report very much, and the series of recommendations. i am not completely satisfied because there has to be a factor of cultural management that affects what te of investigators you hire, whether you hire consultants, whethe you press folks to really get to the bottom, when you ask, since questions, whether there is mentors in the department you can consult with, etc. and i just feel like if we're going to have a very successful team in the future, that

management philosophy is going to be critical to bring us back on track. >> yes, i agree with that. absolutely. >> thank you, senator merkley. thank you mr. cobbs and we will now call our next panel forward. harry markopolos, john walsh, robert khuzami, these come forward. >> [inaudible conversations]

>> okay. let's get started, and i know that senator dodd has already inoduced the witnesses so we're not going to do that again. each of you has a limited mr. markopolos, seven, mr. walsh, mr. khuzami five each so we have time for questions try to keep your statements within those limits. there is a little clock up there, and your entire statement will be read into the record, so it will b part of the record. mr. markopolos, you may begin. >> thank you, mr. chairman. thank you ranking member, thank you numbers of the committee. i was approximately one third of the inspector general's 477 page report either directly or indirectly, so i can speak to that one thirdf the report.

i did submit three different complaints to the sec in may 2000,arch of 2001 and in the fall of 2005. if the inspector general's report was falsified, inaccurate or a whitewash, i would be denouncing it before you today, but i find his report to be extremely accurate, exceptionally well written, phenomenally well researched. it is a very comprehensive. it is hard-hitting. it gets right to the fact of the matter. in a nutshell, the sec staff was not capable of finding ice cream at a dairy queen. but i never at any point in time saw any criminal act hippity by any member of the securities and exchange commission. i do not believe that such criminal activity occurred. i know that the inspector general was very comprehensive in his investigation. he went down all avenues. he was looking, he was asking pointed questions asking if

there was any inappropriate behavior by sec staff at the highest level. at the lowest levels of the organization, mainly at the team and branch chief levels. at all levels in between. he never determined that such activity occurred. i suspect if he would have found it he was digging as hard as he could. certainly he would have been far less damaging to the reputation of the sec if criminal activity had been found and you can blame one or two bad apples in the bunch and say it was their fault and they're going to prison. they were trying very hard to make the criminal case. i do not believe that such a case existed. they certainly never found one. i doubt there was any criminal act hippity. the report was so well done, the inspector general went down every avenue. and when you do an investigation, you have to go down every avenue. and most of those will be dead ends. and this was a typical investigation, except that it was exceptionally poor performer and i commend it to you. it is great reading. for the victims out the and i know you are watching. you definitely want to read all

477 pages. it is hard-hitting. it is like watching a train wreck in slow motion and 477 different angles and it has the same tragic inning on each page. it is unbelievable. sadly, it is true. is a true report. keep in mind that the madoff case was the twilight zone of all fraud cases. there was nothing about his case that was ever believable. the scope, mr. madoff, was in 40 different countries. he had over 339 funded defined beating him in new victims. over 59 different management companies were involved with mr. madoff and over 40 nations. he had a lot of help. this is perhaps the biggest international conspiracy of modern times. is a recordbreaker of cases. i think it shows that the sec is apparently not functional. at present there but they are on theight track. the sec, prior to december 11, was not in the fight for

fraudsters. fraudsters are winning on all fronts. they are winning the battle. none of the regulators did their jobs. basically, our financial regulators, all of them, stole their paychecks from the taxpayers. white-collar fraud is a cancer on this nation's soul. it is the white-collar fraudsters that caused the most damage, not the violent criminals, not the bank robbers, not the armed robbers, not the drug dealers. it is the white-collar fraudsters. they have the best resume. they went to the best schools, liven the nicest homes and the finest neighborhoods. and yet they caused the most damage. they are the ones that bankrupt our companies, destroy pensions, destroyed life savings and victims. and let me tell you have this report affected me personally. i have faith in all government prior to december 11, it wasn't until i met mr. kotz and saw the investigation that he underwent that restored my faith.

mr. kotz and the entire inspector general team reaffirmed my faith in government. is hard-hitting report is as honest as the day is long. it is a great report. i have three young sons, all aged six or under at home watching today. when they grow up i hope that they will turn out to be like david kotz. that is how much i think of the inspector general. it is a hard-hitting report. i don't think there's ever been a finer report released. i commit to everybody. i think chairman schapiro for her leadership and allowing his report to written and released to the public knowing how damaging it would be to the reputation of the sec, but before you can recover you have to hit rock bottom. and i think this report takes the sat to rock-bottrock-bott om. they have made tremendous improvements since february 4 and i have seen a lot of improvements. i am impressed. it is certainly not taking place. mary schapiro like to tell her staff that she wants them to act like an arizona by. i ink shackley missed states the case. i think she is on fire lately.

it needs to keep gnassingbe is going for. the job is far from done. you have to crawl before you can walk into have to walk before you can run. right now, the sec is learning how to crawl all or again. they are heading in the right direction. they probably have been out of the fraud by for about two decades and they need to get back into the fight. thank you, mr. chairman. >> thank you, mr. markopolos. matches were testimony but for your persistence, encourage and i think when the chapters are written on, how this happened and how it is corrected, you deservly will play a large and stellar role. mr. walsh? >> chairman dodd, ranking member shalle, members of the committee. i appreciate the opportunity to appear before the committee today to testify on behalf of the securities and exchange commission. my name is john walsh, and i'm the acting rector of the office of compliance inspections

and examinations at the sec. first, let me say without qualification that we all sincerely regret that we did not detect the madoff rod. as i believe i speak you're for everyone in the examination program, we view the madoff case as a terribly unfortunate example of what happens when we fail in our mission. the type of fraud perpetrated by mr. madoff is the kind of misconduct we spend our days trying to uncover. that is why we feel the way we do. and that is why we are working soiligently to address the problems that contributed to the senator. let me assure you. we have not been sitting idly by awaiting the inspector general's report. indeed, from the time that we first learned of madoff's fraud, we have been working hard to revamp the way that we operate.

since being appointed acting director last month, my most important goal has been to continue to reshape the examination program. for example, we are actively recruiting staff with specialized industry experience. we are enhancing our training programs, including widespread anticipation and outside courses such as the certified fraud examiner program. we are requiring examiners to retain the reach out to counterparties, custodians, and customers to verify that assets actually exist. we are integrating broker-dealer and investment advisor examinations to make sure that the right expertise is being deployed in every examination. we are considering new risk assessment techniques to more proactively identify areas of risk to investors. we are ensuring that examiners know they have management support, as they follow the

facts wherever the facts lead. but we know more can be done. so like others in the agency, we are carefully studying the inspector general's report, and will continue to do so. the report shows that some examiners asked the right questions. but it also shows we did not pursue all the answers. the report shows that some examiners were moving forward on the right path, but we did not take all necessary steps. to put it bluntly, the report shows that we simply didn't do what we needed to do, and investors have suffered. going forward, you have our commitment that we will continue to lrn from our mistakes, and we will continue to assess how we can improve our examinations. thank you. >> thank you, mr. walsh, for your candor. mr. khuzami? >> chairman dodd, ranking member shall be, members of the

committee, thank you for this opportunity to testify on behalf of the securities and exchange commission. having read the inspector general's report and its litany of missed opportunities, it is clear that no one can or should defend, excuse, or to flecked responsibility for the sec's handling of the madoff matter. simply stated, in this case, we failed in our fundamental mission to protect investors. and we must continue vigorously to reform the way we operate. we have read the letters from harvard investors that were filed with the court in connection with the madoff's sentencing. it is a sobering and humbling experience. i am hereo commit to you and to investors across the country that we will carefully study the findings of the inspector general's report, and any forthcoming audit, and that we will implement the changes necessary to strengthen our enforcement and examinations program. i am also here to personally pledge my own wavering

commitment and effort toward revitalizing the enforcement division and firmly reestablishing the trust and respect of th investors with who we are charged to protect. i know that my colleagues in the office of compliance inspections exam share this commitment. as you know, even before the inspector general's report was issued, this agency had already begun to institute extensive reforms. these include hiring additional staff with expertise, streamlining its management, expanding training, restructuring our processes to better share information, leveraging the knowledge to third parties parties, eliminating unnecessary process and procedure, and revamping the wawe handle the hundreds and thousands of tips and complaints and referrals that we reive each year. despite these changes, we recognize that more needs to be done. we intend to learn every lesson we can to help build upon reform we have already put in place. with respect to the division of enforcement, almost immediately after beginning my tenure as a

director on march the 30th of this year, i together with other enforcement staff came in today talked about self-assessment of our operations. the marching orders were creatively and there are no sacred cows. that self-assessment resulted in numerous changes we are now implemented. , deadly, they have been described as the biggest reorganization in at least three decades of the division of enforcement of these changes which will begin to address some of the issues raised by the inspector general include creating five specialized investigative units, national in scope, we'll combine expertise, training, and industry and investigative know-how to conduct smarter and more proactive investigations. to reduce management levels by almost 40% and deploy those experienced investigators back full-time to the critical work of condug front-li investigations. and establishing an office of mark intelligence, a single unit within the enforcement

division armed with enhanced technology where we will collect, analyze, prioritize, and monitor the more than 700,000 hits and complaints the agency receives annually. over the past year, the criticism surrounding the sec and the madoff rod has been sharp and steady. we have taken a lesson to heart and we're in the process of implementing a far-reaching program of change and improvement. there has been no complacency it is not business as usual. there is an institutional wide commitment to heighten doubles up tenacity and professionalism. criticism arising should not obscure 75 year tradition of vigorous enforcement resulting from the dedicated efforts of thousands of public servant who worked tirelessly everyday with impressive results to protect the investing public. these staffers continue to vigorously investigate wide range of activities, cases relating to the creditrisis,

market abuse, accounting and financial fraud, structured products, and fraud inviting hedge fund. said chairman schapiro to leadership in january, the sec has filed 45 separate enforcement actions involving ponzi schemes, substantially more in the same period in 2008 did our mission is investor protecon. thmadoff case serves as a terrible reminder to each of us of the consequences of not getting the job done properly. there is a lesson we will not and shod not forget. our job is to protect investors from wrongdoers, and to hold those wrongdoers accountable for their actions. we recognize that as we hold othersccountable, we mus also be ready to accept responsibility for our failures. we stand ready to be so, and again on behalf of the commission we pledge our commitmentdo everything in our power to regain your confidence and the confidence of the investing public. thank you for your time. >> thank you, mr. khuzami. i have a who bunch of

questions you. i want to ask mr. walsh, he was there at the time. yet still when you read mr. kotz's report, when you see mr. markoff was his complaint, it's just astounding. this wasn't just a mistake. this wasn't just saying we regret it. even mr. khuzami says not going to marva 75 year tradition of the agency. well, you know, when i got to congress in 1980 the sec was one of the premier serval service organizations in the government. like the justice department. wow, has it gone downhill. it is just amazing. of course it will market. so my first question, you can speak from, you know, how the heck did this happen? marc coppola, who is man of great integrity said he could not find any front. it was just sheer incompetence. but incompetence when you read the ig report, i mean, you

didn't have to have any training as an investigator to do the kinds of follow-up that might have revealed this to happen. all you had to do was have an iq of about 100. and even a semi-desire to find out what happened. you didn't have to have a burning desire. you didn't have to turn over every stone. so please share with us because i am still befuddled, and maybe mr. khuzami, because you have to think about this aot, trances have spoken on this and we have his articles and things like that. just share with us how the heck this happened. because most people if they just read what happened they would say there has to be fraud. you know, somebody had to deliberately do some of tse things to let madoff biscay. now we have no evidence of that, and it is unfair to leap to the conclusion. and i don't. but i am just totally befuddled. the most rudimentary -- in other

words, if you set a 15 year-old, you know, sophomore in high school and said here is what is going on figure out, just follow it through as a homework assignment. they would've to do sgme of these things. tell me, what was going on here? was there an attitude that we should look, you know, this sof touch whatever it is cled, investigating? just, you know, and i don'tast any shadow on your integry at all, mr. walsh, bui need to know. we need to know. america needs to know. it is just too confounding to accept an answer, well, it was a mistake, a very bad mistake. we are sorry. by the way, and this will be my next question to all of you. it make you think there must be 30 more of these, maybe not at the scope of madoff but there has to be more of the. we were in the go-go 20. other people had to be thinking of this. i just read about some brookland ponzi scheme uncovered yesterday

that there must be scored more of these if the investigating ability was so rudimentary and so blog. go ahead, mr. walsh. >> i attributed it to two primary causes and bothf these were highlighted by the inspector general, and i agree with them. one, i think was the failure to obtain third party verification of the information that madoff was giving them. and this was very unfortunate. >> be the sec failed to get third party verification routinely on just about everything you? at the time these examinations were done, third party verification was used as the examiners believes appropriate. we have changed that. we now require third party verification as a routine part of our examinations. we provide detailed training to examiners to make sure they understand -- >> i'm not asking how you corrected. i understand that. i am asking because, so there was almost never a third pty

verification? >> it was an occasionally, but as we saw here are too many people decided it wasn't needed in their particular examination. so i believed that wasn't the first -- >> with the sec, you've been there 20 years, with the sec, the universe came in, do more third party verification than they did in the 18th year? >> it's difficult for me to say, to quantify and to be honest, i am really not sure. probably we do so much more i 2009 that we have ever done before. it's hard to say, sir. i've only been an examiner for some yearsand action and in house lawyer -- >> try to get somebody who might be fraudulent, do you have some allegations pretty serious ones like markopolos, can come you don't have to be albert einstein to figure out you ought to get some third party verification and not accept the potential defraud or at their word. yes, sir. >> markopolos, what do you think

about this? >> trained and funded him and know that you never go to the person that you suspect of e fraud first. you go to that person last. you go to all the other people in the organization. you question them. you build a chain of documents and to verify everything. and here, the examiners found and caught mr. madoff in numerous lies. and yet they had no -- >> why do you think? is befuddling. >> they have no professional skepticism. they had no formal fraud examining training. and so they took the lives and they didn't dig deeper and he didn't increase the scope of their examination. they didn't request more resources. it was a failure of thought examination one owe one. it was a failure of audit one owe one. it was a failure -- >> it is almost an attitude they didn want to find things. is that fair to y? >> they lack any kind of regulatory zeal. they were not compensated or measured on the quality of exams

or the amount of fraud caught. they were measured and rewarded through promotions based on the number of exams conducted, which is a meaningless statistic that we should care about the number of fraud caught and the number of fraud that we deterred and the amount of damages that were recovered for investors. so they were measuring the wrong thing. >> so you're saying the basic system of inceives probably wasn't just neutral, butushed people away from doing a thorough investigation. >> that is correct. >> mr. khuzami, do you agree with that? >> i guess i would see it slightly affiliates early on in force as i. whate know is the enforcement division recently entering the kind of these events has brought numerous cases based on vague complaints, based on press articles, the ig testified earlier didn't find any evidence that the investigative folks were lazy, were not committed. so we know that the

investigators know how to do the job and there is a long history of cases to underscore that. so the question really for me was this appeared to be, to use an overused term, a perfect storm, that a conflnce of events including a lack of experience by thendividuals, a lack of going to sources of competent to give advice, perhaps some personality conflicts, a lack of rigorous supervision, and a number of other factors meant that, and perhaps mr. madoff himself while ere was a finding that there was not undue influence, you know, it takes a little while for your mind to get around the fact i suspect if you are not careful that someone like mr. madoff may be running a $50 billion ponzi scheme. there is lots of initiative legitimacy that he had from the nature of his institution inveors to his stature to

other factors. i think unfortunately, and this was a terrible result, that all these factors came together to lead to conclusion that we missed this. but it wasn't for reasons that i think you can draw significantly greater lessons across the entire division. >> i used to watch dragnet when i was a kid. i watched daw and order timing, i am notn investigative. i know, especially if someone brings up a complex real four times come you go and check with someone else. >> that's correct. and there was consultation that was made. >> no. you go out and they would have caught him cold, right? >> absolutely right. and we do that across the whole categories of our investigation. third party verification, not just in the investment advisor contacts. but in every case. >> you are a starting policeman in the investigative unit. you know to do third party verification. >> that's correct.

>> i agree. with examinations as well. and where emphasizing that very strongly. two major people do that. spirit let me ask all three of you. it seems to me almost a certainty given how bad things were with madoff, that there were probably other ponzi schemes, i don't know how large, that they haven't uncovered yet. what do you have to say about that, markopolos first. >> certainly there is always the fraud present. fraudsters are very smart. this past year helped the last a lot of the ponzi scheme because you always need new money coming in. and investors are very gun shy these days, and rightly so. so we are seeing a lot more of them collapsed and that is what you are reading about so many. i am sure there are more out there and more fraudsters will be caught. >> would you guys agree? that there are probably more? >> we are actively looking for more. we have got a very vigorously and conducted examination of ti