SEC FILES MOTION TO DISMISS IN SUIT BROUGHT BY MADOFF INVESTORS

In October we commented on the lawsuit brought in the United States District Court for the Southern District of New York by Phyllis Molchatsky and Stephen Schneider against the SEC for failure to detect Bernard L. Madoff’s Ponzi scheme. Last week the SEC filed its motion to dismiss, and as expected the SEC argued that the lawsuit brought by the two plaintiffs is barred by the discretionary functions exception to the Federal Tort Claims Act.

In the motion, the SEC notes that the discretionary functions exception "provides that the United States may not be held liable 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." The motion notes that the Supreme Court has prescribed a two-part test for the discretionary functions exception. First, the challenged conduct must involve an element of judgment or choice. Second, the conduct must involve considerations of public policy.

With regard to the first element, the SEC's motion alleges that "[u]nder the 1934 Securities Exchange Act, the SEC has complete discretion in deciding whether, and to what extent, it should investigate suspected violations of the securities laws." Moreover, the SEC argues that it "enjoys similar discretion in its examinations of brokers, dealers, and investment advisors." With regard to the second element, the SEC argues that "[t]he challenged conduct here—for example, whether to refer a complaint to a particular investigative team, to obtain evidence from one source or another, or to assign significance to a specific fact—are all decisions that are susceptible to policy analysis."

As we noted in our previous post regarding this case, defeating the SEC's argument that this exception applies will be an uphill battle for the plaintiffs. However, given what is at stake - not just for the two plaintiffs but also for the system at large due to the precedent which will be set - we can expect this case to be hard fought at every turn. We will continue to monitor the case as it progresses.

A copy of the AmLaw Litigation Daily article discussing and linking to a copy of the SEC's motion to dismiss can be found here.