Madoff Investors’ Suit Claiming SEC Was Negligent in Oversight Dismissed

Two of Bernard L. Madoff’s investors lost their bid to bring a $2.5 million suit against the U.S. Securities and Exchange Commission for allegedly gross negligent oversight in failing to uncover his fraudulent scheme.

U.S. District Judge Laura Taylor Swain in New York today threw out the 2009 lawsuit by investors Phyllis Molchatsky and Steven Schneider which blamed the SEC for failing to detect and end the scheme.

“Plaintiffs have identified no statutory or regulatory provision that suggests the existence of prescriptive rules for the conduct of SEC investigations,” Swain said in a 28-page ruling, adding “there is no reason to believe that information concerning any such duties would not be publicly available.”

Swain has 27 similar cases, according to the court docket.

“These lawsuits are not going to survive,” said Peter Henning, a professor at Wayne State University in Detroit and a former SEC lawyer. “The SEC did not cover itself in glory in the Madoff investigation, but it has discretion conducting its investigations.”

Madoff, 72, is serving a 150-year sentence for running the fraud through his New York-based Bernard L. Madoff Investment Securities LLC. Investors lost about $17 billion of principal in the Ponzi scheme, according to the latest calculations of the trustee liquidating the Madoff firm, who reported the number in a court filing yesterday.

Disappointed

“We are disappointed with the judge’s opinion and continue to believe that the court is well-suited to oversee the SEC’s actions and inactions, which were inarguably negligent,” plaintiffs’ lawyer Howard Elisofon of New York-based Herrick Feinstein LLP said in an e-mailed statement.

“We are reviewing this opinion and conferring with our clients before announcing our next step,” Elisofon said.

Kevin Callahan, a spokesman for the SEC, declined to comment on the court’s ruling.

“Scandalous and outrageous as plaintiffs’ allegations (and findings of the OIG Report on which they are based) are, plaintiffs fail to identify any specific mandatory duty that the SEC violated in its numerous instances of sloppy, uninformed, irresponsible behavior,” the judge wrote.

Swain issued a separate order addressing plaintiffs and their lawyers in the 27 similar suits, directing them to file with the court by May 31 a statement outlining their positions “as to what further proceedings are appropriate,” in light of her ruling in the Molchatsky-Schneider case.

Conference Scheduled

The judge also scheduled a June 7 conference to discuss the issue with all sides. Proceedings in each of the cases are now stayed.

Molchatsky, a disabled retiree and single mother who claims she lost $1.7 million in the fraud, and Schneider, a doctor who said he lost almost $753,000, filed the lawsuit under the Federal Tort Claims Act in October 2009 after the SEC denied their administrative claims.

Their complaint relied for its underpinnings upon an August 2009 report by the SEC’s Office of the Inspector General which said the agency had received “numerous, detailed, credible complaints regarding Madoff” between 1992 and 2008, and “flawed” investigations, Swain said.

The U.S. asked the court to dismiss the case, claiming the government is immune from suits and the SEC has discretion in deciding who to investigate and how to conduct its queries.

The case is Molchatsky vs. U.S., 1:09-cv-08697, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporters on this story: Andrew Harris in Chicago at aharris16@bloomberg.net; and Linda Sandler in New York at lsandler@bloomberg.net.

To contact the editor responsible for this story: John Pickering at jpickering@bloomberg.net.

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