Dec. 19 (Bloomberg) -- U.S. regulators, trying to unravel the breadth of Bernard Madoff’s alleged $50 billion fraud, have found evidence of misconduct stretching back to at least the 1970s, two people familiar with the inquiry said.

Madoff’s investment advisory business, where he allegedly operated the biggest Ponzi scheme in history, is now estimated to have had more than 4,000 customers, the people said, declining to be identified because the inquiry isn’t public. An advisory unit Madoff registered with the Securities and Exchange Commission claimed in a January filing to have no more than 25 clients. People familiar with the investigation said Dec. 14 he also ran a secret unregistered business.

The Madoff case is fueling efforts by President-elect Barack Obama and Congress to overhaul oversight of brokerages and investment advisers. The SEC will likely also examine whether hedge funds investing with Madoff performed the due diligence promised to clients, two people familiar with the agency’s concerns said.

“The key question to us is to find out why the SEC didn’t get into it more” before the scheme collapsed this month, House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said in an interview. “It’s clear we need to improve regulation, and that will be one of the major questions we will focus on early next year.”

SEC spokesman John Nester declined to comment.

Madoff’s attorney, Ira “Ike” Sorkin of Dickstein Shapiro in New York, wasn’t available to comment. In an interview yesterday, Sorkin said Madoff’s company is “cooperating fully with the government.”

Earlier Misconduct

The SEC, combing through records from Bernard L. Madoff Investment Securities LLC in New York, hasn’t developed a complete assessment of the earlier misconduct or determined how the alleged Ponzi scheme evolved, one of the people familiar with the case said. They also haven’t concluded how the scheme intertwined, if at all, with sales of unregistered securities targeted in a 1992 SEC lawsuit. Proceeds from those sales were invested with Madoff, who gave documents to an auditor in that case and wasn’t accused of wrongdoing, court records show.

Madoff was arrested Dec. 11 and charged with a single count of securities fraud. In court documents, prosecutors and the SEC said he admitted his investment advisory business was “all just one big lie.” He hasn’t entered a plea in the case.

SEC Chairman Christopher Cox said Dec. 16 the agency failed to act on “credible, specific” allegations about Madoff dating back at least to 1999. Madoff had kept several sets of books, and provided misinformation about his advisory business to investors and regulators, Cox noted.

Avellino & Bienes

In its 1992 lawsuit, the SEC claimed accountants Frank Avellino and Michael Bienes began raising money in 1962 and placing it with Madoff while promising investors returns of 13.5 percent to 20 percent, according to court documents obtained by Bloomberg. As of October 1992, their firm, Avellino & Bienes, had issued $441 million in unregistered notes to 3,200 people and entities, court papers say. They invested solely with Madoff, who opened his business in 1960.

Avellino and Bienes, who were represented by Sorkin, agreed in November 1992 to shut down their business and reimburse clients. Lee Richards, the court-appointed trustee over Avellino & Bienes, hired auditors Price Waterhouse to scrutinize the books of the firm, which operated as an unregistered investment company, according to the SEC.

Few Records

Price Waterhouse said Avellino & Bienes kept few records and asked Madoff to provide copies of account statements issued to the firm, which he did, court records show. Richards, who was named receiver for Madoff’s foreign units on Dec. 12, didn’t investigate Madoff while overseeing Avellino & Bienes, the records show.

Avellino didn’t return calls to his homes in New York, Florida, and Nantucket, Massachusetts. Bienes didn’t return a message left with his housekeeper.

Madoff’s case will be at the center of planned congressional hearings on reforming the SEC, a senior Senate official said this week, declining to be identified. Obama said yesterday the scandal “has reminded us yet again of how badly reform is needed when it comes to the rules and regulations that govern our markets.”

Any new rules may stir privacy concerns among clients of broker-dealers and money managers, said David Becker, a former SEC general counsel.

“It’s very easy to detect Ponzi schemes once we suspect that a Ponzi scheme exists. It requires confirming account balances with customers,” said Becker, who’s now in private practice at Cleary Gottlieb Steen & Hamilton in Washington. “However, customers don’t really like it when the federal government calls them up and asks them what’s in their account.”

To contact the reporter on this story: David Scheer in New York at dscheer@bloomberg.net.

Last Updated: December 19, 2008 15:12 EST