Federal Court Cites the Securities And Exchange Commission Dithering

April 6, 2015

It was not the Securities and Exchange Commission's ("SEC's") finest hour -- some would even say it was a lost decade of regulation. The failures to timely detect and investigate Madoff and Stanford. The dismissive attitude towards the likes of Harry Markopolos. The disgraceful in-house politics that thwarted SEC investigator Gary Aguirre and eventually drove him from the regulator itself. Not a shining legacy.

In 2015, we are told that much has changed at the SEC; that it is invigorated by Mary Jo White's leadership, by Enforcement Chief Andrew Ceresney's aggressive agenda, and by Commissioner Daniel Gallagher's bully pulpit. Frankly, even as cynical a skeptic as I will give those three individuals credit for injecting new zeal into the federal regulator. On the other hand, it is important to remind ourselves of where we were in the not-so distant past. Indeed, we paid and continue to pay a painful price for unenlightened SEC administrators, a politicized regulatory agenda, and lackluster performance. To that extent, the past is still very much with us.

SEC Dithered In Stanford

Only a few days ago, we were reminded by the federal courts of the SEC's failure as a regulator. In Carlos Zelaya, individually, and George Glantz, individually and as trustee of the George Glantz Revocable Trust, for themselves and on behalf of all those persons similarly situated,  Plaintiffs-Appellants, v. United States of America, Defendant-Appellee.(Opinion, 11th Circuit, 13-14780, 11-CV-62644, March 30, 2015), the 11th Circuit offered this introductory synopsis:

The plaintiffs in this case, Carlos Zelaya and George Glantz, are victims of one of the largest Ponzi schemes in American history: the much-publicized Ponzi scheme orchestrated by R. Allen Stanford. All Ponzi operations eventually unravel, and when the scheme that had victimized Plaintiffs was publicly revealed to have been a fraud, Plaintiffs were taken by surprise. Yet, according to Plaintiffs, the federal agency entrusted with the duty of trying to prevent, or at least reveal, Ponzi schemes was not all that surprised. To the contrary, this agency, the United States Securities and Exchange Commission ("SEC"), had been alerted over a decade before that Stanford was likely running a Ponzi operation. According to Plaintiffs, notwithstanding its knowledge of Stanford's likely nefarious dealings, the SEC dithered for twelve years, content not to call out Stanford and protect future investors from his fraud. And even though the SEC eventually roused itself to take action in 2009, by then, of course, the money was long gone, and many people lost most of their investments

Pursuant to the Federal Tort Claims Act, Plaintiffs sued the United States in federal court, alleging that the SEC had acted negligently. The federal government moved to dismiss, arguing that it enjoyed sovereign immunity from the lawsuit. The district court agreed, and dismissed Plaintiffs' case. Plaintiffs now appeal that dismissal to this Court. In reviewing the district court's dismissal, we reach no conclusions as to the SEC's conduct, or whether the latter's actions deserve Plaintiffs' condemnation. We do, however, conclude that the United States is shielded from liability for the SEC's alleged negligence in this case. We therefore affirm the district court's dismissal of the Plaintiffs' complaint.

Page 2 -3 of the 11th Circuit Opinion

In considering an appeal by victims of what the 11th Circuit described as "one of the largest Ponzi schemes in American history," we are stunned when we read the characterization of the SEC's response to Stanford's "nefarious dealings" as one in which the federal regulator:

dithered for twelve years, content not to call out Stanford and protect future investors from his fraud

Dithering is not an accolade. It is not the desired regulatory agenda for Wall Street's pre-eminent cop. After shaking our heads in disbelief at the allegations against the SEC, we learn the the 11th Circuit found that its hands were tied and affirmed the district court's prior dismissal of the claims. In effect, a negligent SEC is deemed shielded from liability. 

SEC Negligence in Madoff

Zelaya is not an aberrant decision but, rather, one based on precedent. Zelaya is but one of an unfortunately developing line of cases in which the federal courts do not hold the SEC accountable for its apparent negligence. As reported two years ago in "Second Circuit Pounds Last Nail Into Madoff Plaintiffs' Coffin" (BrokeAndBroker.com Blog, April 10, 2013), the Second Circuit reached a similar decision in Molchatsky, et al. v. United States (2nd Circuit, 11-2510 April 10, 2013). As set forth in the 2nd Circuit's initial synopsis of the appeal:

Plaintiffs-Appellants Phyllis Molchatsky, et al. ("Plaintiffs") appeal from an April 19, 2011 Opinion and Order by the United States District Court for the Southern District of New York (Swain, J.) granting Defendant-Appellee the United States' motion to dismiss Plaintiffs' complaints against the United States Securities and Exchange Commission (the "SEC") for lack of subject matter jurisdiction pursuant to Federal Rule of Civil Procedure 12(b)(1). Plaintiffs also appeal from the district court's January 24, 2011 Memorandum Order denying Plaintiffs' motion for relief from a judgment under Federal Rule of Civil Procedure 60(b). Plaintiffs seek to hold the United States liable for SEC employees' failure to detect Bernard Madoff's Ponzi scheme and for the financial losses that Plaintiffs claim they suffered as a result. Because we find that the SEC's actions, along with its regrettable inaction, are shielded by the Discretionary Function Exception, we affirm the district court's dismissal of Plaintiffs' claims for lack of subject matter jurisdiction.

Pages 2 - 3 of the 2nd Circuit Opinion

Barely containing its disappointment with the SEC's conduct, the 2nd Circuit offered this stinging commentary in Molchatsky:

Plaintiffs' harm ultimately stems from the SEC's failure to investigate Madoff and uncover his Ponzi scheme. As a result, the conduct Plaintiffs seek to challenge is "too intertwined with purely discretionary decisions" made by SEC personnel. Gray v. Bell, 712 F.2d 490, 515 (D.C. Cir. 1983); see generally id. at 515-16. Despite our sympathy for Plaintiffs' predicament (and our antipathy for the SEC's conduct), Congress's intent to shield regulatory agencies' discretionary use of specific investigative powers via the DFE is fatal to Plaintiffs' claims. . .

Page 7 of the 2nd Circuit Opinion

Sure -- the SEC may have celebrated the 2nd Circuit's ruling, which shielded the regulator from damages claims, but even the federal appellate court concluded that "Plaintiffs' harm ultimately stems from the SEC's failure to investigate Madoff and uncover his Ponzi scheme."  That conclusion is made more stinging by the 2nd Circuit's concession that it sympathized with the Plaintiff's and had antipathy for the SEC's conduct.

As with most federal agencies, the SEC has a shield. One would hope that the motto emblazoned upon that emblem is not "Dithering And Negligence."