The Securities and Exchange Commission had plenty of warning that there was fraud afoot at Bernie Madoff’s shop, but it mishandled its investigations of what turned out to be the biggest Ponzi scheme in history.

The agency’s three exams and two investigations of Madoff’s business were incompetent, according to a report by the agency’s inspector general, David Kotz. Kotz found that no one had acted improperly, just that they did a horrible job. The news came as no surprise to University of Chicago law professor Richard Epstein. “These guys were so incompetent,” he said. “Is there anyone who doubts that these guys were inept?”

There’s a bigger issue, said Epstein, a Hoover fellow, and that is whether the scope of the SEC and its regulators should be broadened, as has been proposed. “It proves again how dangerous it is to have an SEC get broader jurisdiction,” he said. “You want them to do fewer things better rather than more things badly.”

Hal Scott, Nomura Professor of International Financial Systems at Harvard Law School, said the problems that the SEC had catching an out-and-out financial crook like Madoff were a reflection of an overly legalistic agency culture that is good at enforcing rules but not good at understanding complex business issues such as options trading. “They just didn’t have the knowledge or resources to detect this,” he said. “My takeaway is that they were understaffed. And not only were they understaffed…they lacked economic sophistication.”

Scott, who is also a member of the board at Lazard and directs the nonprofit Committee on Capital Markets Regulation, has been calling for a broader regulatory agency that would attract business talent, instead of the legal talent that the SEC currently draws. “You could attract to that enterprise the business talent…that the SEC does not,” he said.

SEC Chairman Mary Schapiro said the agency was implementing changes so that it could avoid in future mistakes similar to those made in its dealings with Madoff. “The findings contained in the report reinforce my view that the many changes we have made since January will help the agency better detect fraud,” Schapiro said in a statement. The SEC, she pointed out, has filed more than twice as many emergency restraining orders this year related to Ponzi schemes as it did during the same period last year.

But the report outlines a series of missed opportunities to catch Madoff before his fraud could balloon into the multibillion-dollar Ponzi scheme that broke all the records. Madoff is serving 150 years for his crimes in a federal prison in North Carolina.

Between June 1992 and December 2008, the SEC received six “substantive complaints that raised significant red flags concerning Madoff's hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading,” according to the report.

Turns out, Madoff wasn’t actually trading. He was running a Ponzi scheme that left thousands, from ordinary investors to high-flying hedge funds and movie moguls, significantly poorer when the scheme was finally exposed last year.

But the SEC had plenty of chances to catch him long before last year. The first complaint brought to the SEC’s attention came in 1992, when allegations came to the SEC’s attention that an unregistered company was offering safe investments with consistent and high returns. The SEC suspected fraud. Those investments went through Madoff’s firm without a single loss. The SEC suspected a Madoff associate might have been involved in a Ponzi scheme, but never focused on Madoff himself, according to the report.

The SEC made sure that the associate’s clients got their money back in 1992, but nothing was done about Madoff himself, even though the SEC had learned the investment decisions were made by Madoff.

In May 2000, March 2001, and October 2005, the SEC received complaints about 30 red flags pointing toward Madoff’s operations. The complaint submitted in 2005 was entitled, “The World’s Largest Hedge Fund is a Fraud.”

At the heart of several of the complaints were the unusually consistent returns from Madoff’s fund, returns that could not be duplicated by any other fund. From 1992 through 2008, the SEC conducted two investigations and three examinations related to Madoff’s activities. But the agency never verified through a third party Madoff’s trading.

In 2004 and 2005, the SEC conducted two examinations of Madoff’s activities. The teams were “relatively inexperienced,” according to today’s report. Both examinations were open at the same time in different offices, with neither team knowing the other was examining Madoff. But still, they found “suspicious information” and “caught Madoff in contradictions and inconsistencies.”

Nevertheless, the teams accepted Madoff’s answers at face value, even when they seemed implausible.

That was a pattern. The investigation that arose from what the report calls “the most credible” complaint, the one that said it was “highly likely” Madoff was running a Ponzi scheme, “never really investigated the possibility of a Ponzi scheme.” And when they caught Madoff in contradictions, that team, too, accepted the fraudster’s answers at face value.

The actions of the SEC toward Madoff, said Epstein, were an outrage.

“I’m not surprised. I am sad. I get angry, actually, because I think it’s a public disgrace,” he said. “They were actually told by many competent people what to do and what to look for. It’s one thing to ask them to be Julia Child and make up the recipe, but they couldn’t even follow the recipe.”

And Epstein said he thought Madoff could have kept getting away with it if the economy hadn’t crashed, making it impossible to find new investors to feed money to the older investors.

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Kent Bernhard Jr. is News Editor of Portfolio.com