Ponzi Scheme Victims Can't Sue SEC

In a decision Monday, the Third Circuit denied a suit against the SEC by Ponzi scheme victims of Bernie Madoff to recover losses due to his notorious fraud.

The suit against the Securities and Exchange Commission (SEC) claimed that the Commission was negligent in not uncovering and terminating Madoff’s infamous Ponzi scheme before the appellants suffered financial injuries.

The Third Circuit echoed many courts on this issue; you can’t sue the SEC for using its discretion in how it deals with fraud cases.

Federal Torts Claim Act

Appellants in U.S. v. Baer sued the SEC under the Federal Torts Claim Act (FTCA), which in its relevant part states that government employees can be sued for "injury or loss of property" caused by negligence or wrongdoing of a government employee acting in the scope of her employment.

Anyone who is familiar with the Bernie Madoff Ponzi scheme cases would agree that this was a case where the SEC's investigations failed to shut down a massive source of fraud. However, there is an exemption under the FTCA for "discretionary functions" which allows these government entities to escape liability.

Discretion Is Protected

The thrust of the appellants' claims, other than being royally ticked off about their money disappearing into Bernie's pockets, is that the SEC is not protected by the discretion exemption because several SEC regulations mandated action.

Sparing you the Third Circuit's cursory review of the alleged "mandatory" regulations, the Court needed only point to 15 USC § 78u(a)(1) which states explicitly that the SEC has discretion over whether to investigate for suspected SEC violations.

Even if the appellants were able to prove that the SEC abused its discretion under these other regulations, the "discretionary function exemption applies 'whether or not the discretion involved be abused.'"

The Baer Court opines that accepting a preferential treatment allegation (i.e. Madoff was ignored as a Wall Street "bigwig") to overcome the discretion exemption would essentially eviscerate any future protection for discretion in SEC investigations, but the appellants had one more argument.

One Last Stab

The Ponzi victims claim that the SEC, in not doing a better job investigating Madoff, was essentially aiding and abetting his various felonies, in violation of 18 U.S.C. § 4.

The Court found this silly, and it is. The appellants, by their own admission, claim the SEC failed to uncover Madoff's scheme, so they couldn't have had full knowledge enough to be knowingly concealing his crimes.

Bottom Line

The FTCA's exemption is designed to insulate government employees who make judgment calls in carrying out their duties, and hindsight is not a convincing enough reason to hold the SEC liable for missing Madoff.

Related Resources:

• 'Not All Securities Frauds are Ponzi Schemes' (FindLaw's U.S. 5th Circuit Blog)
• Ponzi Schemer Tom Petters' 50-Year Sentence Upheld (FindLaw's U.S. 8th Circuit Blog)
• Are Ponzi Scheme Proceeds Dischargeable in Bankruptcy? (FindLaw's U.S. 10th Circuit Blog)
• Alleged Ponzi-Schemer's Ex Wins Asset Freeze Dismissal (FindLaw's U.S. 2nd Circuit Blog)