After bungling five probes that should have uncovered Bernard Madoff's $65 billion fraud, regulators must learn to aggressively investigate tips and complaints to catch wrongdoers, the U.S. Securities and Exchange Commission's internal watchdog said on Thursday.

A scathing report issued last week by SEC Inspector General David Kotz found that the agency missed numerous red flags, did not properly follow up on leads and dismissed tips and complaints that might have uncovered Madoff's investment sham.

At a congressional hearing to examine the SEC's shortcomings, Kotz outlined dozens of recommendations to improve SEC procedures for handling tips and examining individuals and companies.

He urged the SEC to make sure that complaints were properly vetted, saying tips and complaints had to be reviewed by staff who had related experience.

Kotz's report detailed, for example, how three staffers discounted a detailed 2005 complaint about Madoff by Harry Markopolos because he was a competitor rather than a Madoff employee or investor.

The three staffers -- two of which were relatively senior employees -- had never investigated a Ponzi scheme, where initial investors are paid with money from newer investors.

SEC Chairman Mary Schapiro has already asked Congress to give the agency authority to compensate whistleblowers.

Schapiro and her new director of enforcement, Robert Khuzami, have instituted changes to speed up the pace of enforcement, such as making it easier for staff attorneys to negotiate penalties and use subpoenas. Khuzami has also cut the number of managers at the SEC and plans to create specialized teams to investigate cases.

Some lawmakers are seeking more money for the SEC, which is understaffed and underfunded when compared to banking regulators.

New York Senator Charles Schumer, a senior member of the Banking Committee, supports a bigger budget for the agency and says the SEC should keep all the feeds it collects.

Madoff pleaded guilty in March to orchestrating a Ponzi scheme and is now serving a 150-year prison term.

(Reporting by Rachelle Younglai; Editing by Neil Stempleman)