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

Kathy is a senior business trial attorney with more than 30 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. She also handles SEC and CFTC whistleblower claims. 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

Friday, February 22, 2013

Yet Another Ponzi Scheme Victim's Negligence Suit Against the SEC Fails

Posted by Kathy Bazoian Phelps

   Understandably, defrauded victims of Ponzi schemes are angry – angry at the perpetrators, angry at everyone associated which the scheme, and angry at the government for failing to stop the scheme before they were victimized and lost their life savings. Occasionally that anger at the government is expressed in a suit against the government. The Ponzi Scheme Blog has been following these cases (see the September 11, 2012 blog: Finger-Pointing at the SEC: Whose Fault Is It That Ponzi Schemes Thrive?) and, so far, no case against the government on this basis has succeeded.

   The latest to fail is Dichter-Mad Family Partners, LLP v. United States, 707 F. Supp. 2d 1016 (C.D. Cal. 2010), aff’d, 2013 U.S. App. LEXIS 2900 (9th Cir. Feb. 12, 2013). In that case, the plaintiffs, who were investors in Madoff’s Ponzi scheme, filed a claim for damages under the Federal Tort Claims Act ("FTCA"), asserting that the Securities and Exchange Commission was negligent in failing "to terminate Madoff's Ponzi scheme despite its multiple opportunities to do so." The fifty page complaint reviews in detail the warning signs about Madoff that the SEC had and its several failed investigations of him. The complaint also incorporates by reference the SEC Office of Inspector General’s 450 page Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme--Public Version, released in August 2009.

   The FTCA, 28 U.S.C. § 1346(b), grants the federal courts jurisdiction over claims:
for injury or loss of property, or personal injury or death caused by the negligent or wrongful act or omission of any employee of the Government while acting within the scope of his office or employment, under circumstances where the United States, if a private person, would be liable to the claimant in accordance with the law of the place where the act or omission occurred.   The district court, however, readily dismissed the claim, concluding that it was barred by the "discretionary function exception" of the FTCA. Under this exception in 28 U.S.C. § 2680(a), the government is not to be liable for:
Any claim based upon an act or omission of an employee of the Government ... based upon the exercise or performance or the failure to exercise or perform a discretionary function or duty on the part of a federal agency or an employee of the Government, whether or not the discretion involved be abused.   In Dichter-Mad Family Partners, the district court found that "the alleged wrongs were done in the course of the SEC’s exercise of its discretion, both in terms of conducting its investigations and deciding whether or not to bring enforcement proceedings." Id. at 1035. For example, Section 21 of the Securities and Exchange Act of 1934, states, "The Commission may, in its discretion, make such investigations as it deems necessary to determine whether any person has violated, is violating, or is about to violate any provision of this chapter, [or] the rules or regulations thereunder . . ." 15 U.S.C. § 78u (emphasis added). The district court further found that the plaintiff’s conclusory allegations had failed to rebut the presumption that discretionary function exception applied. Id. at 1041.

   The Ninth Circuit affirmed in a per curiam decision, adopting most of the district court’s "comprehensive and well-reasoned opinion" as its own. Therefore, these Madoff victims are left without a remedy against the government despite findings of the SEC Inspector General that the agency had missed several opportunities over the years to stop Madoff’s fraud.

   As noted, however, this is not the first such decision dismissing a negligence suit filed by Madoff victims against the SEC. See Donohue v. United States, 870 F. Supp. 2d 97 (D.D.C. 2012); Baer v. United States, 2011 U.S. Dist. LEXIS 141243 (D.N.J. Dec. 8, 2011); Molchatsky v. United States, 778 F. Supp. 2d 421 (S.D.N.Y. 2011).

   Similarly, in the Allen Stanford Ponzi scheme, victims were also unsuccessful in pursuing their negligence claims against the SEC. See Robert Juan Dartez, LLC v. United States, 824 F. Supp. 2d 743 (N.D. Tex. 2011).

   As reported in the September 11, 2102 blog, one case, Zelaya v. United States, 2012 U.S. Dist. LEXIS 127233 (S.D. Fla. Sept. 7, 2012), does offer a glimmer of hope to defrauded victims. In that case, the district court dismissed all of the plaintiffs’ negligence claims except the claim that the SEC violated its nondiscretionary duty to report Stanford to the Securities Investor Protection Corporation, as required by 15 U.S.C. § 78eee(a)(1). A review of the docket in that case shows that it is now in the discovery phase. No trial date has been set.

   These cases raise the question of what is fair when the government is negligent? As a policy matter, should the FTCA be changed to require the government to compensate Ponzi scheme victims when it negligently stops a scheme later than it should have if it had exercised due care? If Congress does decide to do that, which seems highly unlikely, Congress should then also increase the SEC’s resources, both for investigating Ponzi schemes and for paying victims’ claims. The societal cost of increased resources for better government due diligence may ultimately be far less than the cost to victims from losses from these types of fraudulent schemes.

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