Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Wednesday, April 20, 2011

Madoff Victims Can't Sue Government for SEC's Incompetence

In Molchatsky v. U.S. (S.D.N.Y. Apr. 19, 2011), the federal district court held that two Madoff victims could not sue the U.S. government under the Federal Tort Claims Act for the SEC's "gross negligence" in failing to discover the fraud.  The opinion recounts at some length the allegations of the agency's ineptitude, largely taken from the SEC Office of Inspector General's Report, but nevertheless ultimately agrees with the government that the agency's conduct is protected under the Discretionary Function Exception (DFE) of the Federal Tort Claims Act.  Because the SEC's decision regarding whom to investigate and how to conduct an investigation are discretionary,  any negligence or even abuse of that discretion is shielded from suit by sovereign immunity.  The court explains that

[T]he DFE bars suit only if two conditions are met: (1) the acts alleged to be negligent must be 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,” ....

Plaintiff, however, cannot carry her burden of burden to establish subject matter jurisdiction:

Scandalous and outrageous as Plaintiffs' allegations (and findings of the OIG Report on which they are based) are, Plaintiffs fail to identify any specific, mandatory duty that the SEC violated in its numerous instances of sloppy, uninformed, irresponsible behavior. ... That the conduct in question defied common sense and reeked of incompetency does not indicate that any formal, specific, mandatory policy was “likely” violated. Plaintiffs have not identified any mandatory directive that requires, for instance, that a certain type of investigative team investigate a certain type of complaint, that investigative teams be staffed with employees with a certain amount of experience or level of expertise, that investigations begin within a certain window of time after a complaint is received, or that teams or offices share information or coordinate investigations in a particular way.

With respect to the second, public policy prong, the court observed that:

The DFE protects the agency's ability to exercise properly the full scope of its discretion by insulating from civil litigation even those discretionary decisions that were, improperly, actually made for inappropriate reasons. Indeed, the DFE expressly provides that it applies to claims “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.” 28 U.S.C.A. § 2680(a) (West 2006) (emphasis supplied).

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