WASHINGTON (Reuters) - The $50 billion fraud allegedly committed by broker Bernard Madoff is a major embarrassment for the US Securities and Exchange Commission and adds to questions already being asked about the regulator's competence.

The SEC's inability to uncover the scandal until Madoff's sons went to authorities last week comes at a particularly bad time for the SEC and its chairman, Christopher Cox. They have already been accused by some lawmakers and market experts of being asleep at the wheel while the credit crisis exploded on Wall Street.

The agency's future existence as a separate agency is already under threat as Washington looks at overhauling the regulation of the financial services industry.

"This will be profoundly embarrassing for the SEC," said Columbia University law school professor John Coffee, who has been critical of the agency for failing to properly regulate the failed investments banks. "Congress will predictably give them little mercy."

Madoff, a former Nasdaq Stock Market chairman, was arrested and charged last week with running a massive "Ponzi" scheme using his investment advisory firm.

A rapidly growing number of banks, investment funds, charities and wealthy individuals disclosed this week that they had invested in companies controlled by Madoff.

There had already been a number of red flags about the way Madoff operated his investment business going back many years, including an article in the financial newspaper Barron's in 2001 that questioned how Madoff made stunning double-digit returns year after year.

The Wall Street Journal also reported on Friday that Harry Markopolos, who years ago worked for a rival firm, researched Madoff's stock-options strategy and was convinced the results likely were not real. Markopolos pursued his accusations over the past nine years, dealing with both the New York and Boston offices of the SEC, according to documents he sent to the SEC, the newspaper said.

"I'm sure people will look closely at them (the SEC)," said Carl Loewenson, a partner in the New York law office of Morrison & Foerster, who warned against blaming the SEC too quickly.

He said the SEC may not completely be at fault for not catching Madoff's activities sooner, even if some publications questioned his investment returns. If Madoff was able to fool sophisticated hedge funds, institutions and individuals, he probably would have been able work around regulators too.

"Those people had every incentive to do the utmost due diligence and a lot of them did and a lot of them didn't discover the fraud," he said. "The victims here are not Moms and Pops."

An SEC spokesman declined to comment on the criticism or give any details of inquiries into Madoff's activities.

House Financial Services Committee chairman Barney Frank is likely to examine how the SEC handled the matter, which also involves a criminal investigation.

Frank's spokesman, Steven Adamske, said he would not comment on the matter until the criminal investigation was resolved, but said the committee will not ignore the matter either.

"In due time, however, we will look at what happened with the SEC and work with them to see if there was a failing of policy here," Adamske said. "If so, there will be an appropriate course of action. But it is not something we will ignore."

Frank, a Massachusetts Democrat, is a key lawmaker who could help determine how regulation of the financial services industry will be overhauled, given the failings by banking and securities regulators to reign in a bottomless appetite for risk.

He and Christopher Dodd, chairman of the Senate Banking Committee are likely to head the reform efforts in Congress.

Dodd is concerned about the people caught up in the scheme who may have been misled and also how such a massive fraud could have gone undetected, his spokeswoman, Kate Szostak, said.