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January 29, 2013

SEC Immune from Suit Over Alleged Failure to Investigate Madoff Fraud

By Rodney F. Tonkovic, J.D.

A Ninth Circuit panel held that a district court properly concluded that it lacked jurisdiction to entertain claims brought by investors in Bernard Madoff's Ponzi scheme arising out of the SEC's alleged failure to investigate Madoff's activities. The investors' claims, the court concluded, fall within the "discretionary function" exception to the United States' waiver of sovereign immunity in the Federal Tort Claims Act. The complaint's allegations regarding the SEC's failure to perform its mandatory duties were also insufficient to overcome the discretionary function exception because the duties were not in fact mandatory (Dichter-Mad Family Partners, LLP v. U.S., January 28, 2013, per curiam).

The investors brought suit against the SEC under the Federal Tort Claims Act (FTCA), alleging that the Commission's negligence caused Madoff's scheme to continue and expand. The investors alleged further that the Commission failed to put an end to the scheme despite multiple opportunities to do so over the course of sixteen years. The complaint stated that the investors relied on Madoff's reputation, his clean record, and the SEC's "implied stamp of approval" and that their losses were caused by the SEC's alleged negligence.

The Federal Tort Claims Act. The circuit court adopted the portion of the district court's opinion dismissing the claims for lack of subject matter jurisdiction. Under the FTCA's discretionary function exception, federal courts are barred from adjudicating tort actions arising out of federal officers' discretionary acts; such officers are only liable if their actions were prescribed by statute, regulation, or policy, or if their conduct cannot be analyzed on social, economic, or political policy grounds. The district court observed that many of the SEC's decisions could have been made differently and that there was "sheer incompetence in regulating." There was, however, no "plausible allegation revealing that the SEC violated its clear, non-discretionary duties, or otherwise undertook a course of action that is not potentially susceptible to policy analysis."

After an overview of the facts and relevant law, the district court first examined the legislative history of the FTCA. The court noted at the outset that Congress intended the discretionary function exception to apply to the SEC. The court then concluded that the government satisfied its threshold burden of showing that its actions were discretionary. There was, accordingly, a strong presumption that the actions were based on public policy considerations, and the investors were unable to rebut this presumption. Among other items, the court noted that the Exchange Act and SEC regulations establish the Commission's investigative and enforcement powers as discretionary. Courts have been unanimous in holding that the Commission is immune from liability for its investigative and enforcement actions, the court stated, and a number have held that SEC decisions are unreviewable under the FTCA.

The district court also determined that the complaint's broad allegations of misconduct on the part of the SEC were unavailing. Broad allegations regarding "policies and procedures" are insufficient in the Ninth Circuit, the court stated. The investors also failed to point to either any specific mandatory policies that were violated or any actions that were not susceptible to policy analysis. Having found that the investors failed to overcome the presumption that the SEC's investigative and enforcement decisions were discretionary, the district court dismissed the complaint for lack of subject matter jurisdiction.

Mandatory duties. The circuit court also affirmed the district court's dismissal, in an unpublished order, of allegations regarding the SEC's failure to perform its mandatory duties. According to the circuit court, virtually all of the duties at issue were not in fact mandatory and thus would not fall under the discretionary function exception. The policies that were arguably mandatory, the court continued, lacked a causal relationship to the alleged injuries.

Additional discovery. Finally, the circuit court affirmed the district court's denial of the investors' request for additional discovery. The district court concluded that the investors failed to meet the burden of showing that the evidence they sought existed and that the relevant information would be unavailable in the absence of discovery. The circuit court stated that the district court's finding was a proper exercise of its discretion.

The case is No. 11-55577.

Attorneys: Philip Jay Dichter (Law Offices of Philip J. Dichter) for Dichter-Mad Family Partners, L.L.P., Philip J. Dichter and Claudia Gvirtzman Dichter. Jeffrey Paul Ehrlich, Lindsey Powell, Sparkle Sooknanan and Mark B. Stern (U.S. Department of Justice) for the United States of America.

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