Sept. 10 (Bloomberg) -- It boasts 457 pages of scandal, deceit and even a little bit of sex, but the “Investigation of Failure of the SEC to Uncover Bernard Madoff’s Scheme” released by the Securities and Exchange Commission just at the start of Labor Day weekend, left me wanting more.

Don’t get me wrong. OIG-509, as it’s recorded at the SEC’s Office of the Inspector General, headed by H. David Kotz, is the bureaucrats’ version of a page-turner. The report includes comprehensive play-by-plays of the agency’s inability to turn credible tips about Madoff into an action to shut down his Ponzi scheme.

It offers mind-boggling illustrations of regulators who kowtow to the firms they regulate, accept as truth the information they get from outfits they’re probing for fraud, and run field trips for new employees to visit the trading rooms of brokerage firms they will be overseeing. That includes -- you guessed it -- SEC outings to Bernard L. Madoff Investment Securities LLC, which was shut down after Madoff confessed to his crimes in December.

Read past page 400 and you even get dish about the courtship of Bernie Madoff’s niece, Shana Madoff, by former SEC examiner Eric Swanson. (Don’t let the kids read the part where Swanson testifies to Kotz that, after an evening of socializing among regulators and brokers, he felt that “if I had wanted to take it further that night, I could have, but I didn’t.” Who knew a regulatory report could be so much fun?) The two wound up marrying, but Kotz said the relationship wasn’t intimate during the period Swanson was involved in examining the firm.

Clueless at the Top

What you don’t learn is how the agency got to the point of such dysfunction, and why the big bosses -- the various chairman and their top directors -- either were clueless or didn’t care about the poisoned SEC culture. Kotz talked to eight senior officials at the SEC and found “no evidence of improper influence” by them based on possible relationships with Madoff.

Among the SEC bigwigs were two former chairmen -- Christopher Cox and William Donaldson -- who testified under oath. A third, Arthur Levitt, was interviewed but not under oath, the report said.

Levitt is a director of Bloomberg LP, parent of Bloomberg News.

Kotz says in the report that he is satisfied that none of the top men and women “directly attempted to influence” probes of Madoff, or “interfered with staff’s ability to perform its work.” Indeed, of the eight, only former compliance director Lori Richards, whose office was examining Madoff during her tenure, was aware of any exams, investigations or complaints about him.

In the Tower

When you slog through the 400-plus pages and learn about the number of tips received, and the staff time devoted to scrutinizing Madoff, you’ve got to wonder how the people in the ivory tower could have been out of the loop on so much. But they were.

OK, so maybe there never was a time when an SEC chairman picked up his phone and told an investigator to lay off his pal Bernie. But he didn’t need to.

Madoff was handpicked to sit on SEC panels and even an SEC advisory committee, and SEC lawyers were encouraged to be speakers at a breakfast series run by Madoff’s niece. When the newbie SEC lawyers were herded into Madoff’s trading room during field trips, “There was a general sense by the more senior staff that brought us, that they were appreciative of the efforts of the Madoff team in general,” a former staff attorney in the division of market regulation told Kotz. It was people up top who established or maintained that atmosphere.

Madoff’s Weight

In the meantime, Madoff was throwing his weight around with the investigators kicking his firm’s tires. He dropped names of high-level people at the SEC to his examiners, even telling them that Christopher Cox would be named chairman “a few weeks prior” to when the announcement was made in 2005.

Kotz, though, doesn’t tell us how Madoff acquired that confidential information. Nor does he tell us whether there was anything to it when Madoff told the same SEC examiners that he had been on a “short list” to be SEC chairman himself in 2003. If that is true, wouldn’t you like to know who his political and regulatory supporters were for the job?

Kotz said in a telephone interview that “it was a comprehensive report that included all relevant details about that issue” and that he had nothing to add about Madoff’s inside knowledge about Cox, or his claims of being up for the SEC chairman slot.

There were people high up at the SEC who helped establish Madoff as a credible member of the investment community in the eyes of the agency’s staffers. Who picked Madoff for those committees and advisory panels? Who established a training program that shuttled new SEC lawyers to visit firms the SEC regulates?

Stopping Short

Kotz is a smart guy who has a history of telling it like it is in his SEC reports. This time, he stops short of taking the honchos to task for the comfy bond that existed between regulators and the regulated.

Among Kotz’s recommendations is one that the SEC should “seek to learn” from some of the business people who were on to Madoff early on. Let’s hope the SEC figures out its own training program and that such an idea doesn’t fly. The folks who oversee our securities markets have gone on enough field trips to Wall Street for a while.

(Susan Antilla is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Susan Antilla in New York at santilla@bloomberg.net

Last Updated: September 9, 2009 21:00 EDT