Partners v. U.S.A

• Decision Date: 20 April 2010
• Docket Number: No. CV 09-9061 SVW (FMOx).,CV 09-9061 SVW (FMOx).
• Parties: DICHTER-MAD FAMILY PARTNERS, LLP; Philip Dichter; Claudia Gvirtzman Dichter; and Richard H. Gordon, Plaintiffs,v.UNITED STATES of America; Securities Exchange Commission, and Does 1-10, Defendants.
• Court: U.S. District Court — Central District of California

707 F.Supp.2d 1016

DICHTER-MAD FAMILY PARTNERS, LLP; Philip Dichter; Claudia Gvirtzman Dichter; and Richard H. Gordon, Plaintiffs,v.UNITED STATES of America; Securities Exchange Commission, and Does 1-10, Defendants.

No. CV 09-9061 SVW (FMOx).

United States District Court,

C.D. California.

April 20, 2010.

COPYRIGHT MATERIAL OMITTED

Philip J. Dichter, Philip J. Dichter Law Offices, Malibu, CA, for Plaintiffs.

Richard M. Gordon, Beverly Hills, CA, pro se.

Jeffrey Paul Ehrlich, United States Department of Justice, Washington, DC, for Defendants.

ORDER GRANTING DEFENDANTS' MOTIONS TO DISMISS FOR LACK OF JURISDICTION [6, 7]

STEPHEN V. WILSON, District Judge.

I. INTRODUCTIONA. BACKGROUND

Plaintiffs were investors in Bernard Madoff's Ponzi scheme.¹ Plaintiffs are bringing a Federal Tort Claims Act (“FTCA”) action against the Securities and Exchange Commission (“SEC”) and the United States (“Government” or “Defendant”). Plaintiffs assert that the SEC “owes a duty of reasonable due care to all members of the general public including all investors in U.S. financial markets who are foreseeably endangered by its conduct.” (Compl. ¶ 163.) Plaintiffs also assert that the SEC's negligent acts and omissions “caused Madoff's scheme to continue, perpetuate, and expand,” and that the SEC “fail[ed] to terminate Madoff's Ponzi scheme despite its multiple opportunities to do so.” (Compl. ¶ 2; see also Compl. ¶ 164.) Plaintiffs further assert that “Plaintiffs here were among those victimized by Madoff. Plaintiffs made their investments in reliance on Madoff's reputation, clean regulatory record, and the SEC's implied stamp of approval.” (Compl. ¶ 8.) Because of the SEC's alleged negligence, Plaintiffs seek to recover their losses from their investments with Madoff.

Defendants have brought a pair of Motions to Dismiss, arguing that the Court lacks jurisdiction to hear the claims under the FTCA, 28 U.S.C. § 2674 et seq. Under the “discretionary function exception” to the FTCA, federal courts are barred from adjudicating tort actions arising out of federal officers' discretionary acts. 28 U.S.C. § 2680(a). In brief, officers are only liable if (1) the officers' actions were prescribed by statute, regulation, or policy, or (2) the officers' conduct was not susceptible to analysis on social, economic, or political policy grounds. See United States v. Gaubert, 499 U.S. 315, 322, 111 S.Ct. 1267, 113 L.Ed.2d 335 (1991).²

The Complaint contains over fifty pages of allegations summarizing the SEC's failure to uncover Madoff's fraud. The Complaint also attaches five exhibits, the most substantial of which is the SEC Office of Inspector General's 450-page Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme-Public Version [hereinafter “the Report”], which was released in August 2009. (Compl., Ex. A.) ³ Plaintiffs purport to adopt the “factual allegations or determinations made in the report” by “fully incorporat[ing] by reference” the Report as a part of the Complaint. (Compl. ¶ 1 n. 3.) This request is technically impermissible under Fed.R.Civ.P. 10(c), which only permits the incorporation of a legally operable “written instrument” such as a contract, check, letter, or affidavit. See, e.g., Rennie & Laughlin, Inc. v. Chrysler Corp., 242 F.2d 208, 209 & n. 209 (9th Cir.1957); see also Wright & Miller, 5A Federal Practice & Procedure § 1327 n. 1 (3d ed. 2009 update). In contrast, items such as “newspaper articles, commentaries and editorial cartoons” are not properly incorporated into the complaint by reference. Perkins v. Silverstein, 939 F.2d 463, 467 n. 2 (7th Cir.1991); see also Wright & Miller, 5A Federal Practice & Procedure § 1327 n. 2.

That said, Defendants have not objected to Plaintiffs' attempt to incorporate the Report by reference into the Complaint. ( See generally Defs.' Motion; Defs.' Reply.) Additionally, Fed.R.Civ.P. 8(e) requires the Court to “construe[ ] pleadings so as to do justice.” In order for the Court to comply with Rule 8(e) and give Plaintiffs the benefit of any plausible inferences contained in the Report (as Plaintiffs repeatedly urged the Court to do see, e.g. Compl. ¶ 1 n. 3, Sur-reply at 5 n. 1), the Court has reviewed the full Report and treats it as though it were fully included in Plaintiffs' Complaint. Although this is an unusual procedure, there is clear legal authority permitting the Court to do so: Plaintiffs' Complaint “reference[s]” the Report “extensively,” and the factual allegations contained in the Report are “integral to [their] claim.” United States v. Ritchie, 342 F.3d 903, 908 (9th Cir.2003) (citations omitted). Thus, it is appropriate in this particular instance to consider the Report as part of Plaintiffs' allegations for purposes of the present Motion to Dismiss.

Although the inclusion of the Report results in an unusually long Complaint, the Ninth Circuit has counseled that an overly detailed complaint is acceptable under Fed.R.Civ.P. 8(a) if, for example, it is “organized, [and is] divided into a description of the parties, a chronological factual background, and a presentation of enumerated legal claims, each of which lists the liable Defendants and legal basis therefor.” Hearns v. San Bernardino Police Dept., 530 F.3d 1124, 1132 (9th Cir.2008). In the present case, both the Complaint and the Report satisfy these criteria. Accordingly, because the Report is both attached to and incorporated-by-reference into the Complaint, it is properly considered on the Motion to Dismiss. ( See also infra Part III.A.)

Many of Plaintiffs' allegations (including the factual averments contained in the Report) identify decisions that, in hindsight, could have and should have been made differently. Other allegations reveal the SEC's sheer incompetence in regulating Madoff's broker-dealer, market-making, and investment-management operations. What is lacking in the present Complaint, however, is any plausible allegation revealing that the SEC violated its clear, non-discretionary duties, or otherwise undertook a course of action that is not potentially susceptible to policy analysis.

B. FACTUAL ALLEGATIONS

The facts of the Madoff fraud need little introduction. A thorough summary of Madoff's operations can be found in the recent decision In re Bernard L. Madoff Inv. Secs. LLC, 424 B.R. 122, 127-32 (Bkrtcy.S.D.N.Y.2010) (order affirming trustee's determination of former investors' net equity).

In the present case, Plaintiffs' central allegations are largely drawn from the Inspector General's Report, which Plaintiffs have incorporated by reference into the Complaint. (Compl. ¶ 1 n. 3.) The Complaint alleges the following.

The first warning sign of Madoff's fraud came in 1992, when Avellino & Bienes, a firm that invested exclusively through Madoff's brokerage, was exposed as a Ponzi scheme. (Compl. ¶¶ 29-40; Ex. A at 42-61.) Plaintiffs explain that the SEC's investigators were “woefully inexperienced” in the area of Ponzi schemes (Compl. ¶ 32) and failed to obtain trading records from the Depository Trust Corporation that could have revealed that Madoff's operations were fraudulent. (Compl. ¶¶ 35, 37.) Because the SEC was focused on Avellino & Bienes rather than Madoff, the SEC staff failed to make a number of other “common sense” inquiries into Madoff's operations that “should have” been done. (Compl. ¶¶ 34, 37, 39.)

The second warning sign came in May 2000, when industry analyst Harry Markopolos provided an eight-page complaint to the Boston SEC office. (Compl. ¶¶ 42-46; Ex. A at 61-67.) The complaint provided evidence “questioning the legitimacy of Madoff's reported returns.” (Compl. ¶ 42.) Markopolos presented his findings to an unqualified senior staff member (Compl. ¶ 44), and although the staffer stated that he forwarded the matter to the New York office, he did not actually do so. (Compl. ¶ 45.)

The third warning sign came in March 2001, when Markopolos submitted a second complaint to the Boston office containing new, simplified information. (Compl. ¶¶ 47-50; Ex. A at 67-74.) This time, the matter was forwarded to New York, but “after just one day” the lead enforcement attorney in New York “rejected it out of hand.” (Compl. ¶ 49.) Although Markopolos's complaint was more detailed than the average complaint, the attorney wrote a short email stating “I don't think we should pursue this matter further.” (Compl. ¶¶ 49-50.) ⁴

The fourth warning sign came in May 2001, when industry publications MARHedge and Barron's published articles discussing the secrecy of Madoff's operations and the improbability of his consistently strong returns. (Compl. ¶¶ 51-57; Ex. A at 74-77, 80-81, 86.) An SEC staff member in the Boston office asked the New York team reviewing Markopolos's complaint if they were interested in reading the articles. (Compl. ¶ 55.) The New York team apparently did not read the articles. ( Id.) At the same time, the articles piqued a Washington supervisor's interest. (Compl. ¶ 56.) Although the supervisor wrote a note on the article stating that “[t]his is a great exam[ination] for us!,” no further actions were taken in the Washington office. (Compl. ¶ 56; Ex. A at 86.)

The first major investigative event came in May 2003, when a hedge fund manager provided a complaint to the SEC's Office of Compliance Inspections and Examinations in Washington D.C. (Compl. ¶¶ 58-81; Ex. A at 77-145.) The fund manager's complaint summarized a number of red flags that suggested that Madoff was running a Ponzi scheme. (Compl. ¶ 59.) The Investment Management team in Washington, which was more qualified to handle an investigation into a Ponzi scheme, referred the matter to the Washington office's Broker-Dealer team. (Compl. ¶¶ 61-62.) The two teams never conferred on the investigation. (Compl. ¶ 62.) Compounding this failure to confer, the Broker-Dealer team employed a number of inexperienced staff members at that time. (Compl. ¶¶ 63-64.) One team member explained that “[a]t the time ... we...