The official who formerly targeted ethical problems at the Securities and Exchange Commission was himself blamed for ethical breaches in a probe related to a $7 billion Ponzi scheme. The official may also have had a conflict in his review of the Bernard L. Madoff case, a watchdog said.
Former SEC Inspector General David Kotz had a "personal relationship" with Dr. Gaytri Kachroo, a lawyer for victims of R. Allen Stanford Ponzi scheme, and he violated ethics rules by opening an investigation into the receiver for the failed Stanford brokerage after she asked him to, the U.S. Postal Service Inspector General concluded in a report.
The watchdog also determined Mr. Kotz is a "very good friend" of Harry Markopolos, who warned the SEC repeatedly that Mr. Madoff was running a giant fraud. Mr. Kotz excoriated the SEC for not uncovering Mr. Madoff's fraud in an August 2009 report.
Mr. Kotz would have violated government ethics standards if the friendship began before or during Mr. Kotz's investigation into the Madoff matter, the watchdog said, adding that it couldn't determine exactly when the two became friends.
Mr. Kotz didn't respond to a request for comment.
The former SEC watchdog was a polarizing figure during his four-year tenure at the agency. Current and former agency officials said his tactics were ruthless, while congressional Republicans saw him as effective in highlighting waste and mismanagement at the SEC.
Mr. Kotz's often scathing reports covered everything from the SEC's failure to catch Mr. Madoff's fraud to disclosures that some staffers surfed for pornography on work computers to a botched office-leasing program implemented after the Dodd-Frank financial overhaul.
Federal rules require executive-branch employees to act impartially and avoid creating the appearance they are committing violations.
The SEC called the postal-service watchdog to investigate the matter after an employee in the watchdog's office made allegations of misconduct against Mr. Kotz and another official.
"The allegations that were brought to us merited an independent review. We appreciate the Postal Service Inspector General's report," SEC spokesman John Nester said.
"The report reveals poor judgment by several top employees, including the former inspector general himself," Sen. Chuck Grassley (R., Iowa) said. "However, the report also found that the integrity of important audit and investigative work conducted by the office was not compromised, and the core allegations were unsubstantiated."
Ms. Kachroo on July 8, 2011, wrote to Mr. Kotz asking him to open an investigation into Ralph Janvey, the receiver for the defunct Stanford brokerage. Mr. Janvey had been widely faulted for running up too many costs and returning little money to victims, and several lawmakers had also inquired about the receiver.
On July 25, Mr. Kotz opened the investigation. The postal watchdog found drafts of a future business plan stored on Mr. Kotz's work computer that listed Ms. Kachroo as a "personal friend."
Mr. Kotz told the postal watchdog his relationship with Ms. Kachroo had no impact on the Stanford receivership investigation. The watchdog found no evidence the relationship was a romantic one.
Ms. Kachroo said Mr. Kotz received numerous complaints about the Stanford receiver before her, a point the Postal report "appears to substantiate." Her request, she added, was made on behalf of hundreds of Stanford victims she represents "who have no relationship with Mr. Kotz whatsoever."
The watchdog also found Mr. Kotz had an inappropriate personal relationship with an unnamed SEC employee that featured "flirtatious communications" during an investigation into an SEC office reorganization project. Mr. Kotz should have recused himself from the investigation, the watchdog said.