Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters

Kathy is a senior business trial attorney with more than 28 years experience prosecuting and defending claims for high net worth clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases under standard fee and alternative fee arrangements. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring detailed knowledge about fraud or Ponzi schemes.

Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
Equity Receivers
Bankruptcy Trustees
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors

Tuesday, September 11, 2012

Finger-Pointing at the SEC: Whose Fault Is It That Ponzi Schemes Thrive?

Posted by Kathy Bazoian Phelps

When a Ponzi scheme crash lands, all kinds of things go flying. The dollars go into the wind, the tangible assets go underground, the perpetrator is thrown into jail, and the allegations of wrongdoing are strewn about with a vengeance.

The defrauded investors, and society at large, should of course be the most upset with the perpetrator himself or herself. But that person is usually already sitting in jail, sometimes even for what is the balance of their lives as is the case with Bernie Madoff and Allen Stanford. Retribution is one of the more minor of the objectives of the criminal justice system; however, it is a significant element of a defrauded investor’s mental state in trying to reconstruct what went wrong and who to blame. A defrauded investor left in financial ruin must live day-to-day with the loss caused by the jailed perpetrator. Story after story of the country club nature of some of the prisons in which these perpetrators now reside merely serves to inflame an already financially devastated life.

Defrauded investors, therefore, quite understandably want more accountability from someone. They can’t get any more out of the perpetrator sitting in jail. So they look to our protectors and ask why the government gatekeepers did not stop the fraud. The government allocates sizeable portions of the federal budget to run governmental agencies designed to protect us from fraud. The SEC is, of course, the most visible of such organizations and the one that we most count on to protect our interests and to stop fraud in its tracks. Unfortunately, there has not been much fraud-stopping in the higher profile cases of late.

Investors have tried and failed to hold the SEC liable for failing to detect the Madoff fraud. See, e.g., Donahue v. United States, 2012 U.S. Dist. LEXIS 84353 (D.C. June 19, 2012). Now, in the Ponzi scheme case of R. Allen Stanford, some investors are seeking to hold the SEC liable for negligence in not stopping the Stanford Ponzi scheme. The plaintiffs in Zelaya v. United States, 2012 U.S. Dist. LEXIS 127233(S.D. Fla. Sept. 7, 2012), have sued the SEC for negligence for failing to follow two statutory obligations which they allege were nondiscretionary. If the duties were nondiscretionary, then the SEC would be unable to assert sovereign immunity to shield itself from liability. 

First, the plaintiffs alleged that the SEC knew as early as 1997 that Stanford was operating a Ponzi scheme, yet failed to comply with the nondiscretionary obligation to report that fact to SPIC. Second, the plaintiffs allege that the SEC did not review the investment advisor’s registration amendments and did not deny the annual registration after the SEC had allegedly concluded that Stanford was operating as a Ponzi scheme. 

The court denied in part and granted in part the SEC’s motion to dismiss the negligence claims against it. The court concluded:
While the determination of whether a broker/dealer is in or approaching financial difficulty is inherently discretionary, once the Securities and Exchange Commission concludes that a broker/dealer is in or approaching financial difficulty a nondiscretionary duty to report this information to the Securities Investor Protection Corporation arises. However, the Securities and Exchange Commission's treatment of an investment advisor's amendment to its Section 80b-3 registration application involves an element of judgment grounded in policy considerations, and thus falls under the discretionary function exception of the FTCA.

So it remains to be seen whether these investors will succeed in holding the SEC liable for their losses. On the one remaining claim, they will need to show that the SEC knew that Stanford was operating a Ponzi scheme, which may still present a big hurdle for the investors.

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