U.S. securities investigators raised repeated concern over how Bernard Madoff could be running an honest business, but never followed through on the many red flags they uncovered.

Hundreds of documents released on Friday by U.S. Securities and Exchange Commission's portray an agency at times skeptical or dismissive of evidence that the now imprisoned mastermind of the world's largest Ponzi scheme was up to no good.

At other times, it appeared the agency knew that goings-on at Bernard L. Madoff Investment Securities LLC were improper but never followed through on their discoveries or on the allegations of chief whistleblower Harry Markopolos.

I don't think we should worry about Bernie finding out to whom we speak .... we are not telling anybody that we have found anything improper (except for his lies to us, of course), one SEC investigator wrote in a May 16, 2006 e-mail.

In September, SEC Inspector General David Kotz issued his full report on how the agency mishandled warnings and assigned inexperienced lawyers to examine Madoff.

He said this led to five botched probes starting in the early 1990s that might have unearthed Madoff's estimated $65 billion Ponzi scheme.

Madoff is serving a 150-year prison sentence after pleading guilty to the fraud. He told Kotz that if SEC lawyers had done some basic investigative work, it would've been easy for them to see he was a crook.

The documents could prove fodder for the lawyers suing the SEC for negligence on behalf of several Madoff victims.

This week, the court-appointed trustee liquidating Madoff's firm estimated the crime cost investors at least $21.2 billion, but only $534 million of payments have been authorized.

The SEC under current Chairman Mary Schapiro is implementing reforms designed to avoid a repeat, including more oversight by senior lawyers and greater use of subpoenas.

MARKOPOLOS

The new documents highlight the role of Markopolos who in 2001 began asking the SEC how Madoff could sustain high returns for investors in all sorts of market conditions.

He said at the time that Madoff was either incredibly talented and/or lucky, or was using an unspecified process that needed investigation, or was running a Ponzi scheme.

Subsequent e-mails and handwritten notes sent during probes of Madoff's trading business show SEC staffers speculating or forwarding criticisms that it would be impossible for Madoff to perform as well he claimed.

In 2005, some at the SEC dismissed Markopolos when he presented the agency with a report on Madoff, titled The World's Largest Hedge Fund is a Fraud.

I have some qualms about a self identified independent fraud analyst, one investigator wrote to a colleague.

Another said the author's motives are to make money by uncovering the alleged fraud. I think he is on a fishing expedition and doesn't have the detailed understanding of Madoff's operations that we do.

A third admitted that there remained a little mystery about Madoff's operations, but that a Ponzi scheme did not appear likely from what we've seen.

OTHERS HAD SUSPICIONS

Markopolos wasn't the only whistleblower.

In October 2005, the SEC learned about an unnamed investor who claimed to be a former Madoff client and was deeply concerned that Madoff is running a very sophisticated fraudulent pyramid scheme. Six months later, an anonymous letter addressed to then SEC Chairman Christopher Cox warned of a scandal of major proportion brewing at Madoff's firm.

Madoff would later claim astonishment the SEC did not catch him sooner, perhaps because its staff were star-struck by his reputation build over more than four decades on Wall Street.

But Arthur Levitt, who chaired the SEC from 1993 to 2001, disputed that. When asked if the SEC gave preferential treatment to financial titans accused of malfeasance, Levitt said it salivated, and would not go easy on anybody.

(Reporting by Rachelle Younglai and Jonathan Stempel; Editing by Alan Elsner)