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David Kotz, the SEC's inspector general, made the suggestions in a letter to Rep. Paul Kanjorski, D-Pa., chairman of the House of Representatives subcommittee on capital markets. Kanjorski has been pressing Kotz for information on how the SEC missed the immense fraud orchestrated by Bernard Madoff before Congress takes up President Obama's new regulatory reform package. According to Kotz, the SEC's oversight of the financial industry would be improved if a custodial rule -- similar to one already in place for mutual funds -- was in place for hedge funds. "This custodian requirement essentially removes the ability of an investment adviser to fraudulently use the proceeds invested by new investors to make payments to old investors," Kotz wrote to Kanjorski. In another suggestion based on a rule already in place, Kotz said hedge fund and investment advisers should have to sign a pledge -- under penalty of law -- that they have conducted due diligence, much like CEOs are required to certify their companies' financial statements under the 2002 Sarbanes-Oxley Act. Kotz also backed putting in place "bounty" programs that would provide "necessary incentives" for individuals to bring complaints about possible illegal activity. "Although the bounty system has been in place at the SEC for more than 20 years, there have been relatively few awards made," he said. The current system applied only to insider trading cases, and criteria for judging awards were "vague." The inspector general also want to empower the Public Company Accounting Oversight Board to audit reports prepared by accounting firms. In his letter Kotz reiterated that the agency has not completed its investigation into the Madoff fraud but is proceeding "in an expeditious manner." The results of the Madoff investigation are expected to be published by the end of August, Kotz said. Two other reports that will provide specific recommendations on improving the SEC's various divisions are expected on Sept. 30. - Donna Block
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The Securities and Exchange Commission's inspector general says the regulator should pay whistleblowers for information about fraud, and hedge funds should be forced to use independent custodians and certify that they have conducted proper due diligence. 
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