SEC Sued by Madoff Investors for Missing Ponzi Scheme

SEC Sued by Madoff Investors for Missing Ponzi Scheme

Oct. 14 (Bloomberg) -- Two of Bernard Madoff’s victims sued the U.S. Securities Exchange Commission for failing to uncover the con man’s $65 billion Ponzi scheme, in a case that could trigger a wave of lawsuits if it isn’t dismissed.

The government’s “sovereign immunity” from lawsuits should be waived under a law that permits cases against the U.S. if its workers were negligent, according to a complaint filed in Manhattan federal court seeking the return of $2.4 million.

Through a “pattern of incompetence,” the SEC missed at least six opportunities to uncover Madoff’s fraud even after receiving detailed tips from an expert explaining how Madoff’s high returns and mysterious investment strategy were proof of the world’s biggest Ponzi scheme, according to the complaint.

“Had the SEC carried out its functions with even a minimum of reasonable due care, many, if not most, of Madoff’s victims would have been spared the financial ruin they face today,” the two New York investors said in their 63-page complaint.

The lawsuit was filed by Phyllis Molchatsky, a disabled retiree and single mother who lost $1.7 million, and Steven Schneider, a doctor who lost almost $753,000. The SEC earlier denied the investors’ administrative claims, clearing the way for them to file today’s suit under the Federal Tort Claims Act.

“Based on our initial understanding of the matter, we believe there is no merit to the complaint,” SEC spokesman John Heine said today in a statement.

Acted ‘Unreasonably’

The investors are represented by Howard Elisofon, a lawyer with Herrick, Feinstein LLP in New York. The firm filed seven additional administrative claims with the SEC, which could lead to a new round of lawsuits if they’re denied.

“I don’t think the suit is likely to win,” Professor Peter Henning of Wayne State University Law School said in a phone interview. “They have to show the SEC was negligent, that it acted unreasonably.” As a law enforcement agency, it’s up to the SEC to decide where to commit its resources, he said.

Henning said the lawsuit, if it succeeded, would expose the government to thousands of lawsuits and “massive liabilities” in the Madoff case and any other fraud that the SEC failed to stop.

“That’s why courts are generally reluctant to let these cases go very far,” Henning said.

Difficult to Succeed

Professor Paul Figley of American University’s Washington College of Law also said the lawsuit isn’t likely to succeed.

“There have been a lot of tort suits that have been filed against the government over the years that have succeeded, but none that had to do with the government failing to catch and prosecute a criminal,” Figley said.

Many lawsuits filed under the statute fail because of a provision that protects the U.S. when the disputed acts are so- called discretionary functions, the professors said. The investors say that won’t protect the SEC in this case.

“The conduct was clearly not discretionary,” Elisofon said in a phone interview. “This isn’t about the SEC failing to undertake an inquiry or failing to implement a policy. This is about the SEC investigating and examining Madoff and failing to follow its own policies and procedures.”

Discretion Involved

Elisofon compared the SEC’s actions to those of a driver for the U.S. Postal Service who would be sued if he injured a citizen through reckless driving.

“There’s discretion involved in how he drives the vehicle,” Elisofon said. “But if he drives it negligently, and he injures citizens, they have a right to sue under this act.”

The complaint against the SEC follows earlier suits by victims against banks and other third parties that did business with Madoff, accusing them of failing to conduct due diligence when placing investor money with Madoff, or with firms that directed money to the con man.

“Plaintiffs relied on the SEC to protect them and, instead, time after time, the SEC’s agents looked the other way, allowing an obvious danger to grow exponentially, until massive injuries to the plaintiffs and other Madoff investors became inevitable,” according to the complaint.

The SEC, already faulted by Congress for missing the scheme, has been busy trying to restore faith in its abilities after an internal report released last month outlined its failures in the Madoff matter.

SEC Plan

According to a draft five-year strategic plan released Oct. 8, the agency will seek to improve training and tackle “structural issues” that hurt communication in its Office of Compliance Inspections and Examinations.

The plan followed SEC Inspector General H. David Kotz’s Sept. 29 report that said the agency missed at least six opportunities to spot Madoff’s fraud because it assigned inexperienced employees to inquiries and failed to pursue leads.

The SEC’s own investigators said the agency was unwise when choosing cases and that it rewards its workers based on “quantity” rather than “quality.”

Madoff, 71, is serving a 150-year sentence for running the fraud. His family members and his biggest investors have been sued for as much as $15 billion by the bankruptcy liquidator for New York-based Bernard L. Madoff Investment Securities LLC.

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