Second Circuit Pounds Last Nail Into Madoff Plaintiffs' Coffin

April 10, 2013

In Molchatsky, et al. v. United States (2nd Circuit, 11-2510 April 10, 2013), Plaintiffs were investors victimized by Bernard Madoff and Bernard L. Madoff Investment Securities LLC. Plaintiffs sought to hold the United States liable for the United States Securities and Exchange Commission (the "SEC"). employees' failure to detect Bernard Madoff's Ponzi scheme over a 16-year period and for the financial losses sustained.

Pointedly, Plaintiffs asserted that the SEC had missed many opportunities to timely uncover the Madoff Ponzi fraud because of the SEC's:
  • repeated failure to alert other branch offices of ongoing investigations;
  • properly review complaints and staff  subsequent inquiries; and
  • follow up on disputed facts elicited in interviews.
Trying To End Run Around Immunity
The Federal Tort Claims Act ("FTCA") is an exception to the immunity rule that generally protects the United States from lawsuit. In relevant part, the FTCA provides that federal courts shall have exclusive jurisdiction of certain civil actions on claims against the United States caused by the negligent or wrongful act or omission of any Government employee while acting within the scope of his/her position in circumstances similar to those where a private individual would be legally liable

Plaintiffs had argued that their claims fell within the FTCA because the SEC had negligently failed to adequately investigate Bernard Madoff despite numerous warnings.  Accordingly, it was argued that the SEC's negligent conduct constituted violations of its own internal policies and of federal statutes and regulations.

SDNY Dismisses

On April 19, 2011, the Southern District of New York ("SDNY") granted Defendant United States' Motion to Dismiss, finding, in part that the Discretionary Function Exception ("DFE") barred Plaintiffs' claims:

[a]ny claim based upon an act or omission of an employee of the Government, exercising due care, in the execution of a statute or regulation, whether or not such statute or regulation be valid, or 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.

As such, the DFE bars suit if:
  1. the acts alleged to be negligent are discretionary, in that they involve an "element of judgment or choice" and are not  compelled by statute or regulation; and
  2. the judgment or choice in question must be grounded in "considerations of public policy" or "susceptible to policy analysis."
2nd Circuit Affirms

On April 10, 2013, the Second Circuit concluded that Plaintiffs' harm ultimately stemmed from the SEC's failure to investigate Madoff and uncover his Ponzi scheme, which was deemed as conduct "too intertwined with purely discretionary decisions" made by SEC personnel.

The Circuit Court found that first prong of the DFE was satisfied because the SEC retained complete discretion over when, whether and to  what extent to investigate and bring an action against an individual or entity. Morever, the cited misconduct also satisfied the second DFE prong by virtue of the SEC's choices regarding allocation of agency time and resources being sufficiently grounded in economic, social and policy considerations. 
Notwithstanding the Circuit Court's decision to affirm the dismissal by SDNY, there was clearly compassion and anger on the bench, as evidenced by this comment:

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.