Phyllis Molchatsky and Stephen Schneider, both New York residents, have sued the SEC in the United States District Court for the Southern District of New York for failure to detect Bernard L. Madoff’s Ponzi scheme.
The two claim that they would not have suffered losses from the Ponzi scheme if the SEC was not negligent in failing to detect the fraud perpetrated by Madoff despite receiving tips about Madoff’s scheme. The lawsuit seeks the $2.4 million lost by the two plaintiffs.
However, the lawsuit faces an uphill battle due to the doctrine of sovereign immunity, which shields the federal government from civil and criminal prosecution unless it has waived its immunity or consented to suit. The Federal Tort Claims Act (“FTCA”) is the statute by which the United States waives immunity and authorizes tort suits to be brought against itself. With exceptions, it makes the United States liable for injuries caused by the negligent or wrongful act or omission of any federal employee acting within the scope of his or her employment, in accordance with the law of the state where the act or omission occurred.
The plaintiffs claim that the SEC staff members were negligent in carrying out their duties by failing to investigate tips about Madoff’s Ponzi scheme. Therefore, their argument is that the FTCA applies and the SEC is not shielded by the doctrine of sovereign immunity.
Although the plaintiffs face a difficult battle, a decision in their favor would have a profound effect on the regulatory environment. Such a decision would open the door for investors to pursue the regulators where the facts may provide for a cause of action. As a result, it can be expected that the any decision in favor of the plaintiffs will likely be appealed to the highest level. We will continue to monitor this case as it progresses.
A copy of the Wall Street Journal article discussing this case can be found here.