Despite the 'regrettable inaction' by the Securities and
Exchange Commission ("SEC") in failing to detect Bernard Madoff's
historic $65 billion Ponzi scheme, a federal appeals court ruled
that those victimized by Madoff's fraud could not hold the SEC accountable for
negligence. Citing a law that protects federal agencies in the exercise
of their discretionary powers, a three-judge appellate panel of the Second
Circuit Court of Appeals upheld a lower court's dismissal of the lawsuit.
Investors brought the lawsuit after a highly critical
report by the SEC's inspector general that highlighted a myriad of missed
opportunities to detect Madoff's fraud at an earlier stage that could have
prevented billions of dollars in losses. This included several reports
by Harry Markopolos, an independent financial fraud investigator who
raised questions regarding the legitimacy of Madoff's operation. These
claims went largely unheeded, aided by an inter-office communication system
that effectively impeded the flow of information between various SEC branch
offices. This disconnect between branch offices was highlighted in the Second
Circuit's opinion, which noted:
"As a result of the S.E.C.'s repeated failure to alert
other branch offices of ongoing investigations, properly review complaints and
staff subsequent inquiries, and follow up on disputed facts elicited in
interviews, the S.E.C. missed many opportunities to uncover Madoff's
Following the report by the inspector general, the SEC
took extensive steps not only to discipline those responsible for failing to
detect Madoff, but also orchestrated a massive overhaul of the way the agency
deals with the receipt of tips and complaints. After the internal
watchdog's report was filed, the SEC hired an outside Washington law firm to
recommend disciplinary action against any employees associated with Madoff's
fraud. By law, the SEC is prohibited from disciplining former employees,
and the decision to terminate any employee must come directly from the agency's
human resource director. The law firm's investigation ultimately recommended
the termination of one employee unless that would have an adverse effect on the
agency's work. That employee was ultimately suspended for thirty days
without pay, demoted, and had their pay decreased. Seven other employees
were also disciplined, with punishments ranging from a seven-day suspension to
The SEC also focused on encouraging the flow of
information between its regional offices, enacting
reforms that dealt mainly with the inflow of tips and complaints from the
public. Under the previous system, access to tips and complaints was
limited to the specific branch office where originally received. Thus, a
complaint received at the Boston office was essentially inaccessible to any
other regional office for review or dissemination to other employees. In
March 2011, the SEC implemented a Tips, Complaints and Referrals database
which, known to insiders as TCR, established a database for inter-agency use.
An important addition was the new partnership with the Federal Bureau of
Investigation, which allowed the agencies to cooperate on investigations.
As a result of TCR, all SEC employees are now able to view and add
information once a tip or complaint is received by their office.
Earlier this year, another federal appeals court reached
result in dismissing a separate lawsuit filed by Madoff investors against
the SEC, again finding that the suit fell within the Commission's discretionary
powers and thus was shielded under an exception to the Federal Tort Claims Act.
One of the attorneys representing the victims, Howard
Kleinhendler, has vowed to appeal the issue to the United States Supreme Court.
A copy of the Report of Investigation conducted by the
Office of Inspector General is here.
For more news and analysis of Ponzi schemes, visit
Ponzitracker, a blog by Jordan Maglich, an attorney at Wiand Guerra King P.L.
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