On April 19, 2011, Judge Laura Taylor Swain of the U.S. District Court for the Southern District of New York dismissed a $2.4 million suit against the U.S. government alleging gross negligence on the part of the Securities and Exchange Commission (SEC) in the agency’s failure to uncover Bernard Madoff’s massive Ponzi scheme. In Molchatsky v. U.S., 09-cv-08697 (S.D.N.Y. April 19, 2011), Judge Swain granted the federal government’s motion to dismiss for lack of subject matter jurisdiction.
The plaintiffs derived the allegations of their complaint from the SEC Office of the Inspector General’s (OIG) report on the causes of SEC’s failure to discover Madoff’s Ponzi scheme. The OIG’s report detailed numerous tips sent to the SEC that indicated, with varying levels of specificity, that Madoff was duping his investors. The SEC conducted four formal inquiries as a result of these tips. The plaintiffs alleged, citing the OIG’s report, that numerous factors, including: departmental rivalry, failure to verify information provided by Madoff, failure to forward complaints to the New York office of the SEC, misinformation, incompetence, and inexperienced, often-unqualified staff, compromised the investigations. The plaintiffs argued that if the SEC had properly conducted its investigations, it would have uncovered Madoff’s Ponzi scheme, and their losses would have been prevented.
Although the plaintiffs alleged a litany of examples in their complaint of the SEC’s purported incompetence, negligence and failure to adequately investigate the tips it received, Judge Swain held that sovereign immunity shielded the federal government from suit. Judge Swain explained that the federal government had no legal duty to investigate Madoff or to competently handle the investigations that it did conduct.
But the same may not be so for individual SEC officials. According to a recent report issued by the OIG, the SEC’s general counsel, David Becker, may not have competently handled his responsibilities as the architect of the SEC’s policies regarding the Madoff case, and, as a result, could face a criminal investigation.
Among other things, Becker was principally responsible for creating the SEC’s position in Securities Investor Protection Corp.’s liquidation proceedings in connection with Bernard L. Madoff Investment Securities LLC (BLMIS). Becker also was tasked with determining the SEC’s position in terms of defining BLMIS customers’ interests in the Madoff liquidation and providing comments on a proposed amendment to the Securities Investor Protection Act (SIPA) that would have “severely curtailed the trustee’s power to bring clawback suits against individuals like him in the Madoff liquidation.”
Becker and his two brothers inherited an interest in a Madoff account when their mother passed away in 2004. In other words, Becker allegedly was in a position to financially benefit from Madoff’s scheme during the same time that he was working on the case for the SEC. According to the OIG report, “[B]ecker participated personally and substantially in particular matters in which he had a personal financial interest by virtue of his inheritance of the proceeds of his mother’s estate’s Madoff account, and that the matters on which he advised could have directly impacted his financial position.”
The OIG provided the results of its investigation to the Office of Government Ethics, which recommended that it refer the matter to the U.S. Department of Justice for a criminal investigation into the conflict of interest. It remains to be seen whether any criminal investigation actually goes forward.
Although Madoff investors, including the two plaintiffs in Molchatsky, may be precluded from litigating any claims directly against the SEC in federal court, at least they can take some solace in the fact the U.S. government is giving serious attention to alleged wrongdoing by SEC officials in handling the Madoff case.