As Bernard Madoff was being fitted for an electronic ankle bracelet and ordered to stay inside his house, the heat was being turned up on the cop that didn’t catch him: the SEC. How and why—despite many warnings—did the SEC completely miss the alleged largest financial scam in history?

“They were asleep at the switch,” said Sen. Charles Grassley, R-Iowa, of the SEC's failure to uncover Madoff’s alleged scam. Former SEC Chairman Arthur Levitt, said in a Bloomberg radio interview the SEC’s system of monitoring the industry is “broken and needs to be fixed.”

Chairman Cox released a statement yesterday saying that while a full internal investigation was underway, preliminary findings were “deeply troubling.” In the statement, Cox says, “The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action.” (In 1999, Harry Markopolous complained to the SEC’s Boston office that Madoff’s profits were impossible to replicate legally. In the spring of 2001, then-Barron’s reporter Erin Arvedlund wrote a story questioning Madoff’s strategy, quoting a few Wall Street insiders openly wondering how his steady returns were possible using the strategy that he was using.) Further, Cox said instead of requesting a subpoena to look into the multiple allegations, staff relied on information Madoff voluntarily shared.

Which attorneys in which office Cox is referring to is unknown at this time, but it is the Office of Compliance Inspections and Examinations (OCIE) which through its headquarters in D.C. and 11 regional offices handles complaints and administers inspections and examinations related to registered investment firms, investment advisors and broker/dealers. OCIE can informally address issues with “deficiency letters,” or refer more egregious cases to the Division of Enforcement. According to Levitt, resources at OCIE are spread extremely thin for a division expected to watch over a huge growth industry: In 2004, the agency had 477 people in its inspection office, overseeing about 8,000 investment advisors, Levitt told Bloomberg. Today, 430 people regulate 11,300 advisors, along with about 16,000 mutual funds.

Besides procedural mistakes or failings, Inspector General Kotz will be looking at whether the SEC got too close to Madoff’s firm and family. Shana Madoff—Bernard Madoff’s niece and compliance attorney for Madoff’s firm—married SEC investigator Eric Swanson in 2007 and had been dating him since 2006. The SEC's compliance office recently issued a statement saying that Swanson was part of a team that looked into Madoff's securities brokerage operation in 1999 and 2004. A spokesperson for Swanson has denied their relationship affected any examination or investigation.

For the SEC—already connected with the collapse of Lehman Brothers and Bear Stearns—Madoff will likely serve as the centerpiece of a discussion in Congress over regulatory restructuring. On Tuesday, Paul Kanjorski, chairman of the House Financial Services subcommittee on capital markets, said he plans to convene a congressional inquiry into the SEC’s failings in order to help the full committee, chaired by Barney Frank, D-Mass., come up with ideas for change. Max Bachus, the committee’s top Republican, also wants to hold hearings regarding the SEC’s adequacy and the possibility of supplemental oversight by the Financial Industry Regulatory Authority (FINRA). In the Senate, Banking Committee Chairman, Senator Chris Dodd, D-Conn., also may hold hearings.