Thursday, February 28, 2013

Ninth Circuit Holds SEC Cannot Be Sued For Alleged
Negligence in Madoff Ponzi-Scheme Investigations

On January 28, 2013, the Ninth Circuit weighed in on the travesty that is the Madoff Ponzi scheme by upholding a district court ruling that dismissed with prejudice a lawsuit by Madoff investors against the Security and Exchange Commission (“SEC”)  in Dichter-Mad Family Partners v. United States, Case No. 11-55577 (9th Cir. 2013).  The district court held that the “discretionary function” of the Federal Tort Claims Act (“FTCA”) precluded suits against the SEC for actions (or omissions) in the investigation and ultimate prosecution of the Madoff Ponzi scheme.  In large part, the Ninth Circuit simply adopted the extensive and detailed ruling of the district court.

Four investors of Madoff filed suit in the Central District of California alleging negligence by the SEC in the investigation of Madoff.  The plaintiffs asserted that the SEC was negligent in its investigation of the Madoff Ponzi scheme.  The heart of the plaintiffs’ complaint is that the SEC could have discovered the Madoff fraud as early as 1992 had the SEC conducted a proper investigation.  Accordingly, the plaintiffs asserted the SEC was liable for their losses in the Madoff Ponzi Scheme.

The government filed its motion to dismiss and asserted that the “discretionary function” exemption in the FTCA insulated and protected the SEC from the type of lawsuit brought by the plaintiffs.  Therefore, the government argued, the district court did not have jurisdiction over the case and the claims asserted.

For the uninitiated to the FTCA, the “discretionary function” exemption protects government entities and employees from tort claims where a statute, regulation, or policy confers discretion on the government actor or the course of action was of the kind that is susceptible to policy analysis.  Establishing either of these options creates a strong presumption that the exemption applies.  Plaintiffs then carry the burden to demonstrate essentially the opposite – that the decisions were subject to mandatory action or was not susceptible policy analysis.

Here, the district court thoroughly analyzed the actions of the SEC and ultimately held that the SEC’s actions of how and in what manner to investigate Madoff were entirely discretionary.  The district court held that the plaintiffs had not alleged in any specific detail what mandatory obligations existed and how those obligations were violated by the SEC.  The district court, in fact, noted that several of the plaintiffs’ arguments were rebutted by the SEC report incorporated by the plaintiffs into their complaint.  Without any specific factual allegations, the district court granted the motion to dismiss but gave plaintiffs leave to amend.  However, the amended complaint failed to satisfy the district court’s requirements of specific allegations and was dismissed – this time with prejudice.  Plaintiffs then appealed the ruling to the Ninth Circuit which upheld the ruling of the district court.

This opinion, while not flattering to the SEC, appears to foreclose claims by Madoff investors against the SEC unless a plaintiff can establish a mandatory requirement to act by the SEC.  The plaintiffs’ difficulty here was that the SEC lacked policies and procedures that would require action.  Ironically, this lack of policy and procedure that insulates it from prosecution would have arguably discovered the Madoff fraud in 1992. Accordingly, it is uncertain whether the amount of reform that will be undertaken given that the creation of mandatory required actions will have the potential to expose the SEC to liability under the FTCA.

Cathy L. Reece
Fennemore Craig, P.C.
Phoenix, AZ 85016

Anthony Austin
Fennemore Craig, P.C.
Phoenix, AZ 85016

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