Molchatsky v. U.S.

• Decision Date: 19 April 2011
• Docket Number: No. 09 Civ. 8697(LTS)(AJP).,09 Civ. 8697(LTS)(AJP).
• Citation: 778 F.Supp.2d 421
• Parties: Phyllis MOLCHATSKY and Steven Schneider, Plaintiffs,v.UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of New York

778 F.Supp.2d 421

Phyllis MOLCHATSKY and Steven Schneider, Plaintiffs,

v.UNITED STATES of America, Defendant.

No. 09 Civ. 8697(LTS)(AJP).

United States District Court, S.D. New York.

April 19, 2011.

Herrick, Feinstein LLP, by Howard Elisofon, Esq., Christopher J. Sullivan, Esq., John Oleske, Esq., Kerry K. Jardine, Esq., New York, NY, for Plaintiffs.Preet Bharara, United States Attorney, Southern District of New York, by Sarah S. Normand, Assistant United States Attorney, New York, NY, United States Department of Justice, by Tony West, Assistant Attorney General, Phyllis J. Pyles, Director, Torts Branch, Mary M. Leach, Assistant Director, Torts Branch, Jeffrey Paul Ehrlich, Esq., Trial Attorney, Torts Branch, Washington, DC, for Defendant.

Opinion and Order

LAURA TAYLOR SWAIN, District Judge:

Plaintiffs Phyllis Molchatsky (“Molchatsky”) and Steven Schneider (“Schneider”) (collectively, “Plaintiffs”) bring suit against Defendant United States of America (“Defendant” or “the Government”) under the Federal Tort Claims Act (“FTCA”), 28 U.S.C. §§ 2671–80, alleging gross negligence by the Securities and Exchange Commission (“SEC”) and its agents and employees in their oversight, investigations, and examinations of Bernard Madoff (“Madoff”) and his firm, Bernard L, Madoff Investment Securities LLC (“BLMIS”). ¹ Pending before the Court is Defendant's motion to dismiss Plaintiffs' Complaint pursuant to Federal Rule of Civil Procedure 12(b)(1) for lack of subject matter jurisdiction. Plaintiffs assert that the Court has jurisdiction of this action pursuant to 28 U.S.C. §§ 1331 and 1346(b). For the following reasons, Defendant's motion is granted.

Background

Plaintiffs, who allege that they suffered losses in connection with the notorious Ponzi scheme operated by Madoff and BLMIS, seek to recover damages from the United States on the ground that the SEC failed, despite numerous tips, warnings and putative investigations, to discover, disclose and put an end to the scheme from 1992 until 2008. The allegations contained in the Complaint are derived substantially from the SEC Office of Inspector General's 457–page Report entitled “Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme—Public Version” (“the OIG Report”), which was released on August 31, 2009, and is attached to the Complaint as Exhibit A, ² The following facts are derived from the allegations of the Complaint, which are taken as true for purposes of Defendant's motion pursuant to Rule 12(b)(1).

The Court presumes familiarity with the Complaint and the voluminous documents on which it relies and summarizes here the specific allegations only to the extent necessary.³ Between 1992 and 2008, the SEC received numerous detailed, credible complaints regarding Madoff and BLMIS. (Compl. ¶ 1.) The investigations and examinations of Madoff and BLMIS that were undertaken by the SEC in response to these complaints were flawed in numerous respects. ( Id. ¶¶ 1–2.) As a result of the SEC's actions and inactions, Madoff's scheme continued and expanded, eventually resulting in billions of dollars in losses by investors, and directly causing Plaintiffs more than $2.4 million in losses. ( Id. ¶ 2.)

Between 1992 and 2008, the SEC received at least eight complaints indicating that Madoff was operating a Ponzi scheme. ( Id. ¶ 5.) In response, the SEC conducted four formal investigations or examinations. ( Id.)

The OIG Report revealed multiple and various failures of SEC staff that allowed the Madoff scheme to continue undiscovered, notwithstanding the complaints and investigations. ( Id. ¶ 12.) The OIG Report concluded that, despite numerous red flags raised with the SEC, the SEC never took the “necessary and basic steps to determine if Madoff was misrepresenting his trading.” ( Id. ¶ 13, quoting OIG Report at 456.) The OIG Report concluded that the SEC's investigations were conducted by inexperienced staff and that their scope and execution were deeply flawed. ( Id. ¶ 13.) The OIG found that there was a “systematic breakdown in the manner in which the SEC conducted its examinations and investigations.” ( Id., quoting OIG Report at 457.)

The SEC negligently performed its 1992 investigation into a firm known as Avellino & Bienes, the investments of which Madoff had complete control, and which touted 100% safe investments. ( Id. ¶¶ 32–34.) The SEC team assembled to conduct the investigation was inexperienced and the investigation was limited in scope, failing to verify information by using third parties or to obtain records from sources other than Madoff himself. ( Id. ¶¶ 35–38.) The team took no action regarding suspicious information provided to them by Madoff. ( Id. ¶¶ 39–41.) The negligent conduct of, and failure to follow the leads presented by, the Avellino & Bienes investigation lead the SEC to miss an early opportunity to discover Madoff's Ponzi scheme. ( Id. ¶¶ 42–44.) When Plaintiff Schneider invested with Madoff in June 1997, he did not know that the SEC had conducted its Avellino & Bienes investigation the way it had. ( Id. ¶¶ 45–46.)

In May 2000, a complaint, including evidence and analysis, regarding Madoff's returns was filed by an industry analyst and Certified Fraud Examiner, Harry Markopolos (“Markopolos”). ( Id. ¶ 47.) The resulting SEC investigation assigned the case to an unqualified staff member in its Boston office who lacked a basic understanding of finance, who also failed to forward the complaint to the SEC's New York office despite his claims that he had. ( Id. ¶¶ 49–51.)

In March 2001, Markopolos filed a second complaint with the SEC's Boston office regarding Madoff's returns versus the S & P 500. ( Id. ¶ 52.) This complaint contained evidence and analysis in addition to that presented by Markopolos' May 2000 complaint. ( Id. ¶¶ 52–53.) The March 2001 complaint was forwarded to the New York office, which promptly decided not to investigate its claims. ( Id. ¶ 54.) The staff member in New York who declined to investigate did so without consultation with other, more experienced staff members. ( Id. ¶ ¶ 45–46.)

In May 2001, the industry publications MARHedge and Barron's publicly questioned Madoff's operations and returns. ( Id. ¶¶ 56–59.) In response to a query from a staffer at the SEC's Boston office, a staffer at the New York office expressed no interest in the Barron's article questioning Madoff's operations, and the OIG Report found no evidence that anyone at the New York office reviewed the relevant article prior to 2005. ( Id. ¶ 60.) A staffer in the Washington office noticed the Barron's article but took no action after having read it. ( Id. ¶ 61.) In late 2001, Molchatsky invested with Madoff. ( Id. ¶ 63.)

In May 2003, the SEC's Washington Investment Management team received a detailed complaint, which included extensive documentation and pointed out numerous red flags, against Madoff from a reputable hedge fund manager. ( Id. ¶ ¶ 64–65.) The Washington SEC office referred the complaint to its Broker–Dealer team despite the team's lack of experience with Ponzi schemes or investment-management issues. ( Id. ¶ 67.) Due to an atmosphere of jealousy and secrecy, the Broker–Dealer team never conferred with the Investment Management team for support or information concerning the complaint. ( Id. ¶ 68.) The investigation was conducted by a team that lacked adequate training or knowledge of the relevant financial industry. ( Id. ¶¶ 69–70.) The inexperienced team began its investigation seven months after receiving the complaint by looking into “front-running” rather than into the allegations that Madoff was running a Ponzi scheme. ( Id. ¶¶ 71–73.) The single plan of investigation that was actually responsive to the allegations that had been made in the complaint was never executed because doing so presented the possibility of needing to review a volume of documents that was considered “burdensome.” ( Id. ¶¶ 74–76.) During the investigation, junior team members realized that Madoff was lying to the SEC, but his answers were continually relied upon, and were never verified with third parties or independent sources. ( Id. ¶¶ 78–81.) The investigation team declined even to ask Madoff himself for certain documents that would have exposed his fraud because the documents would have been voluminous and their review would have been time-consuming. ( Id. ¶¶ 82–83.) In April 2004, the team investigating the May 2003 complaint was directed to cease its efforts so that resources could be directed elsewhere. ( Id. ¶ 84.) The investigation was never formally concluded, and a final report was never produced, nor was a case-opening report entered into the SEC's case-management system. ( Id. ¶¶ 84, 86.) The OIG Report found the investigation into the May 2003 complaint to be deficient in a number of significant respects. ( Id. ¶ 87.)

In April 2004, an investigation being conducted by the SEC's New York office into a firm unrelated to Madoff revealed internal emails that raised questions about whether Madoff was engaged in illegal activity. ( Id. ¶ 88.) The emails contained some of the same information that had been presented in the complaints from Markopolos and the public news stories that questioned Madoff's legitimacy. ( Id. ¶ 90.) In response to these emails, and after a delay of ten months, a Broker–Dealer team in the New York office began investigating Madoff. ( Id. ¶ 93.) The investigative team failed to draft a planning memorandum to guide their investigation, and again focused its investigation on “front-running.” ( Id. ¶¶ 93–94.) Like the earlier investigation, this investigation was driven by the knowledge base of the team rather than the allegations of the complaint. ( Id. ¶¶ 94–95.) The investigation again involved asking Madoff questions and accepting his answers, even those that made staff members suspicious, at face value without verification of any kind. ( Id. ¶¶ 96–102.) When junior staff members eventually...