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Can the SEC Protect Investors? Not According to Madoff

Disgraced, convicted, and jailed Ponzi scheme perpetrator Bernie Madoff has plenty of time on his hands (150 years, to be exact) to do some thinking -- not about why he got caught, but about why he didn't.

If Madoff -- the man who bilked billions of dollars from many supposedly sophisticated investors, including banks and charities, and got away with his crimes for more than two decades -- is ready and willing to show us where our financial regulatory weakness lies, should we listen?

So long as Madoff doesn't profit from dispensing his "wisdom," why not hear him out? MarketWatch did. In an interview with MarketWatch, Madoff said the Securities and Exchange Commission is woefully short on the resources needed to uncover financial misdeeds.

"The SEC is grossly undercapitalized and it doesn't have money to hire the right people," he said. "It's a training ground, by the time people are qualified they leave and work for private firms."

The SEC's new chairwoman, Mary Jo White, must agree with Madoff's assessment. Last month she appeared before a Senate Appropriations subcommittee and asked for $1.67 billion for fiscal year 2014 -- a 26% budget increase.

White noted that with the added duties of writing new rules for the Dodd-Frank Act, as well as new oversight responsibility over hedge funds and the derivatives market, the SEC is having a hard time keeping up. And when it comes to inspecting investment advisors -- such as Madoff -- only 8% of them were reviewed by the SEC in 2012. "The current level of resources is not sufficient to permit the S.E.C. to examine regulated entities and enforce compliance with the securities laws in a way that investors deserve and expect," White said.

One case where the SEC did not seem to follow through with its oversight duties due to cost concerns involved a bribery scandal at Tysons Foods (NYSE: TSN  ) . Even after the company admitted in 2011 to the longtime bribing of veterinarians in a Mexican poultry-processing plant, the SEC had not brought charges against any Tysons employees. Why? It seems the cost of going forward with the prosecution of foreign witnesses would be just too high.

Why does the SEC have to beg for more money to do its job? Its budget does not come out of taxpayers' pockets, but from user fees paid by the investment industry. Yet even though the SEC's funding mechanism is considered deficit-neutral, its budget requests have been getting short shift from Congress. In 2011, the House Appropriations Committee threw out the SEC's requested budget increase even as it expanded the SEC's duties.

Ironically, the committee's report pointed to the SEC's "track record" in catching Ponzi schemes (such as Madoff's) as one reason for withholding a budget increase. This logic -- that is, because the SEC didn't catch Madoff, Congress won't give the SEC enough resources to catch another Madoff -- is the kind of self-defeating feedback loop that will all but guarantee more Madoffs in the future.

As the SEC's enforcement statistics show, financial fraud cases have dropped from 199 in 2003 to only 79 in 2012. Does that mean we live in a world with less white-collar crime? I doubt it. It just means our regulators don't have the resources to go after the scofflaws. And that means investors like us can't assume the SEC always has our back.

With so much of the financial industry getting bad press these days, it may be time to get greedy while others are fearful. Unsurprisingly, some of Warren Buffett's biggest investments are in the space. In the Motley Fool's free report "The Stocks Only the Smartest Investors Are Buying," you can learn about a small, under-the-radar bank that's too tiny for Buffett's billions -- too bad, because it has better operating metrics than his favorites. Just click here to keep reading.

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