He looked at Madoff's returns, the strategy they claimed they were using and took "4 hours" at home to figure out that it was fraud.
Here is a choice section of Markopolos's testimony: http://www.youtube.com/watch?v=q1A7LdW0Y_s
That said, I just can't see how they could ever attract or develop the financial minds required to keep up with wall street.
I was actually primarily referring to the non-financial side of the employment decision which I would argue is huge. That's why I said "they want to work for big dogs rather than wimpy bureaucrats" instead of pointing out that the SEC could never pay them as well as BMO or GS.
Setting aside whether you think this to be true the perception among undergrads headed into finance is that investment banks offer work environments which are high intensity, committed to excellence, meritocratic and so on. To them the idea of being involved in some sort of paper shuffling bureaucracy is really repulsive.
The truth is there are still lots of people who don't hear that their buddy got a job at GS and immediately think they are some sort of a scumbag.
I haven't responded to the comment below about the CIA but I think that rather than proving the point that its all about the SEC being underfunded it actually shows how culture/ perceived importance of the work/ mission/ impressing your friends etc etc can totally outweigh an organizations ability to pay when it comes to attracting talent (Wimpy bureaucrat certainly isn't the first thing that comes to my mind when someone says the CIA or the NSA). The CIA's entry level economic analyst positions top out at 90k which is where most entry level IB positions start, yet the CIA still manages to attract some of the United States' best and brightest econ/math/finance graduates.
What world would you rather live in? One in which a not so smart but rather well paid institutional investor puts money (your pension) in a scheme that apparently is a blatant fraught for anybody who cares to actually look at the numbers for more than a sec. Or one in which the rather smart but morally flexible investor saw through it and took a well educated guess how long it would hold up and be profitable?