The SEC had received allegations about Madoff dating back to 1999
The top US financial regulatory body has ordered an in-house investigation into why it did not detect the $50bn (£33bn) Madoff fraud case sooner.
The Securities and Exchange Commission (SEC) head, Christopher Cox, launched an inquiry into what he called a serious agency breakdown.
It has been revealed the SEC received warnings about Wall St figure Bernard Madoff almost 10 years ago, in 1999.
Mr Madoff has been charged with fraud in one of the biggest-ever such cases.
Investors, banks and charities across the world fear they may have lost billions of dollars since Mr Madoff's arrest.
It is thought that Mr Madoff was running what was essentially the world's largest pyramid scheme, the BBC's Andy Gallacher reports from Washington.
Now serious questions are being asked about the SEC's role in not preventing it in the first place, our correspondent says.
'Credible and specific'
The SEC chairman said he was "gravely concerned by the apparent multiple failures" of SEC staff to look into claims about Mr Madoff.
Mr Cox said: "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."
This meant staff had to rely on data voluntarily produced by Mr Madoff's firm, rather than use a subpoena to obtain information, he said.
Mr Madoff, who was arrested on Thursday, ran a fund that paid annual interest of about 10% but prosecutors say it was, in effect, similar to a pyramid scheme, with money from new investors paying off old ones.
The long-time Wall Street executive, 70, is due to appear in court shortly for a hearing on his $10m bail bond.
Victims of the alleged scheme include some of the world's biggest banks, as well as hundreds of private investors.
The SEC has been under pressure for not detecting the alleged "Ponzi scheme" earlier.
WHAT IS A PONZI SCHEME?
A fraudulent investment scheme paying investors from money paid in by other investors rather than real profits
Named after Charles Ponzi who notoriously used the technique in the United States in 1919-20
Differs from pyramid selling in that individuals all tend to invest with the same person
Jon Moulton of Alchemy Partners said some investors had complained about Mr Madoff's scheme as early as 1999.
"The SEC did remarkably well" to avoid spotting any problems, he said.
Steven Bell of GLC fund managers said: "Apparently people reported these concerns to the SEC, they highlighted them."
"It's almost like someone saying 'my next-door neighbour's a burglar, go and have a check' and they didn't, apparently," he added.
Dominique Strauss-Kahn, director general of the International Monetary Fund, also expressed shock that US regulators had failed to identify and prevent the alleged fraud.
MAJOR POTENTIAL LOSSES
Clients of Santander, Spain - $3.1bn
HSBC, UK - $1bn
Natixis, France - $605m
Royal Bank of Scotland, UK - $601m
BNP Paribas, France - $460m
BBVA, Spain - $400m
Man Group, UK - $360m
Reichmuth & Co, Switzerland - $325m
Nomura, Japan - $303m
Banks and financial institutions across the world had investments with Mr Madoff, but not all have yet confirmed what their potential losses might be.
Among the potential losers is Spain's largest bank, Santander, which owns the UK High Street banks Abbey, Alliance & Leicester and Bradford & Bingley.
Japanese financial giant Nomura said it could lose up to $303m.
Some of the biggest private losers seem to have been members of the Palm Beach country club, where many of Mr Madoff's wealthy clients were recruited.
Charities appear also to have suffered such as the New York-based JEHT foundation, which said it was freezing all its grants and would shut by the end of January, and film director Stephen Spielberg's Wunderkinder Foundation charity.