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Editor's Desk: The SEC Tipster Files

If the Securities and Exchange Commission had systematically documented numerous complaints about Bernard Madoff made over 10 years by financial analyst Harry Markopolos, who argued that Madoff's returns were mathematically impossible; known that two of SEC offices were independently investigating Madoff, unbeknownst to one another; and heeded the advice of one of its own examiners five years before the $18 billion scandal came to light-it might have seen the bigger picture and stopped Madoff in his tracks.

One of the SEC's Office of Compliance Inspections and Examinations attorneys in 2004 found numerous inconsistencies at Madoff's company and recommended further questioning. However, because of the ongoing mutual fund market-timing probe, the SEC opted to focus on that instead.

The SEC is now, finally, working to prevent such lapses in oversight with a centralized "tipster database" to coordinate information and search for patterns. And it's high time, not only in light of the Commission's spectacular failure on Madoff, but in light of the eXtensible Business Reporting Language tagging that mutual funds must embed in their prospectuses starting Jan. 1.

Under the direction of Enforcement Chief Robert Khuzami, the SEC is now in the process of creating standardized questions to ask informants who report suspicious activity. Depending on the type of allegations, the SEC will ask whistleblowers the same questions online, by telephone or via in-person interviews. For those complaints received by e-mail or U.S. mail, SEC enforcement staff will key the information into the standardized format.

This way, the information can be used as a searchable database.

If the SEC is smart, it will include intelligence from its compliance examiners in this database, too.

Once this data management system is in place in 2011, the SEC will then create additional search and analysis tools to be able to detect patterns of particular risk or pinpoint individuals or corporations with the most red flags. For example, the SEC might decide to give priority to complaints from people with access to key information, such as former auditors.

The mutual fund and hedge fund industries need SEC examiners to be effective in preventing fraud, not just to protect investors but to support their faith in asset management.