Numerous investors and banks across Wall Street refused to deal with Bernard Madoff for several years before his ultimate arrest on fraud charges, amid widespread rumours of suspect activity at his broking and fund management business, it is becoming clear.
And in an explosive new revelation, Wall Street's chief regulator, the Securities and Exchange Commission, actually investigated the rumours and discovered that Mr Madoff had lied to its officials – but gave him no more than a private rap on the knuckles.
As more investors in Europe and the US came forward yesterday to admit losses in the finance industry's biggest-ever fraud, investigators are hearing numerous tales from market participants who had long believed that Mr Madoff's impressive track record was being faked.
Astonishingly, many of these participants invested with Mr Madoff.
According to documents sent to the SEC in 2005 by Harry Markopolos, the Boston accountant who first raised red flags about Mr Madoff in 1999 and finally got the regulator to launch an investigation more than six years later, several hedge fund managers who were funnelling money into Madoff Investment Securities said they thought the Wall Street veteran was "subsidising" investment returns in down months and "eating the losses" to make his results seem smoother and less risky.
Mr Madoff was arrested last Thursday after confessing to two sons who worked in the broker-dealer arm of the family business that his investment management returns were "all just one big lie", saying his fraud could have cost investors $50bn. That would make it the biggest-ever so-called Ponzi scheme. In such a fraud, a money manager simply pays existing clients with money coming in from new ones.
A Wall Street veteran for almost 50 years, and a founder and former chairman of the Nasdaq stock exchange, Mr Madoff was widely respected. But there were many who were suspicious of the secrecy with which he guarded his investment technique. The system he said he used, buying shares and trading options, could not mathematically have produced the returns he claimed, many people thought.
According to one widespread rumour, he was using insider trading at his broker-dealer business to juice returns. The SEC investigated that rumour, among others, in 2005, in an inquiry that took in concerns that Mr Madoff operated as a "white label" hedge fund, running money on behalf of other funds without that fact being disclosed to their investors.
The SEC also took extensive testimony from Mr Markopolos, who had told them years earlier that – most likely – Mr Madoff was running "the world's largest Ponzi scheme".
The conclusion was that Mr Madoff was indeed evading disclosure rules, and the SEC forced him to register formally as an investment adviser, which would open him up to regular inspections by the organisation – but it did not subpoena documents or dig further.
In his testimony, Mr Markopolos had warned the SEC: "I've found that wherever there is one cockroach in plain sight, many more are lurking behind the corner out of plain view." The SEC has launched an internal investigation into its failures in the Madoff case.
Donald Langevoort, law professor at Georgetown University and a former special counsel at the SEC, said the latest revelations were "dumbfounding". He said: "What we've learnt is that the SEC actually investigated whether Mr Madoff was running a Ponzi scheme. They took aim at exactly the right target. And they missed."
The SEC and the FBI were continuing to examine documents at Mr Madoff's offices in Midtown Manhattan yesterday. They are focusing on the role of his wife, Ruth. Mrs Madoff, who has a degree in nutrition, co-edited a cookbook in 1996 called The Great Chefs of America Cook Kosher, but she was also involved in the family business and investigators are examining if she kept secret records tracking payments. Her lawyer said she had not been charged with any wrongdoing.