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From Securities Regulation Daily, July 18, 2017

U.S. not liable for inviting Ponzi schemer to pitch to employees

By Anne Sherry, J.D.

The U.S. government is immune from suit over a Ponzi scheme run by one of its alleged employees, an Eleventh Circuit panel held. The essential element of the plaintiffs’ allegations was misrepresentation, and misrepresentations are excepted from the general waiver of sovereign immunity under the Federal Tort Claims Act. In a special concurrence, one judge cautioned against construing the FTCA more broadly than is necessary (Alvarez v. U.S., July 17, 2017, Higginbotham, P.).

Ponzi scheme. Kenneth Wayne McLeod founded and ran the Federal Employee Benefits Group, Inc. Bond Fund and pitched it to federal employees under contracts with various agencies. The plaintiffs, current and former federal law enforcement employees and their spouses, invested in the FEBG Bond Fund, in some cases their life savings. The scheme survived for years, but the fund began experiencing financial trouble in 2008. An investor complained to the SEC in 2010, and McLeod admitted the fund was a Ponzi scheme. He died by suicide approximately a week later.

FTCA lawsuit. The plaintiffs sued the United States under the FTCA, amending their complaint to allege that McLeod was a government employee, not a contractor. The amended complaint alleged, among its six counts, that McLeod was negligent per se for selling unregistered securities in violation of Florida securities law and that government employees aided and abetted those sales. The district court accepted the allegation that McLeod acted as a U.S. employee for FTCA purposes and concluded that the plaintiffs’ claims were barred because their injuries were dependent on misrepresentations and omissions.

The FTCA generally waives the government’s sovereign immunity when it comes to tort claims, but an exception keeps the bar in place for claims arising out of misrepresentation. In Zelaya v. U.S. (11th Cir 2015), the Eleventh Circuit affirmed dismissal of a negligence suit against the SEC for failing to stop the Stanford Ponzi scheme. The court observed that the misrepresentation exception turns on "whether the essence of the claim involves the government’s failure to use due care in obtaining and communicating information."

The claim against McLeod for negligence per se had to be dismissed for one of two reasons. Assuming, as the plaintiffs argued, that McLeod was a government employee, the claim is barred because it arises out of misrepresentation. If he is not considered a government employee, then the claim is not actionable because the FTCA allows recovery only for injuries caused by a government employee. The plaintiffs’ other claims were similarly barred because they arise out of misrepresentation.

Sheridan argument. The plaintiffs argued that the claims were viable under the intentional tort gate opened by Sheridan v. U.S. (U.S. 1988). In that case, an intoxicated off-duty servicemember injured plaintiffs by shooting a rifle into their car. Three naval corpsmen had encountered the servicemember, but fled upon seeing his rifle, neither subduing him nor alerting authorities. The Supreme Court held that the intentional tort exception did not apply and the plaintiffs’ claims could proceed. The Court expressly declined to rely on a view that the government’s negligence could give rise to liability even if the original actor’s tort would not. It instead relied on a second theory that the intentional tort exception simply does not apply to torts that fall outside the FTCA’s general waiver.

Analyzing the facts under Sheridan, the Eleventh Circuit panel observed that under the first theory, McLeod’s individual involvement would not give rise to governmental liability, but government agents’ antecedent negligence could. The circuit has not adopted the first theory, however, and the panel saw no good reason to do so. Furthermore, the second theory did not apply because the government’s alleged negligence was closely related to McLeod’s employment status.

Concurrence. Judge Rosenbaum concurred specially in an effort to constrain the "harsh exception to the … waiver of sovereign immunity" to the narrowest interpretation possible given its language and Sheridan. Although he agreed that sovereign immunity precluded suit against the government, the judge disagreed with the panel opinion’s understanding of Sheridan and Zelaya. The former case involved an assault and battery, which has no counterpart in negligence—unlike misrepresentation—and the court need go no further.

In Judge Rosenbaum’s view, the panel’s further analysis could be read to mistakenly suggest that the case’s rule applies only when the tortfeasor (the servicemember/McLeod analogue) did not act within the scope of government employment. On the contrary, the Supreme Court expressly said that the assailant’s employment status was irrelevant to the outcome of the case. The judge also took issue with the panel’s alternative analysis of the case under the first Sheridan theory, which the Supreme Court expressly declined to adopt, and which would not be applicable on these facts even if it were binding law.

As to Zelaya, any discussion of its causation analysis must include a word of caution about the opinion’s statement, in dicta, that the phrase "arising out of" in the FTCA "is interpreted broadly to include all injuries that are dependent upon one of the listed torts having been committed." In Judge Rosenbaum’s view, this statement of the law and the opinion it cites are not good law.

The case is No. 16-16479.

Attorneys: Ray M. Shepard (The Shepard Law Firm, LLC) for Rene Alvarez. Sonia McNeil, U.S. Department of Justice, for the United States.

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