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SEC Must Defend Negligence Case in Stanford Ponzi Scheme

The U.S. Securities and Exchange Commission must defend a negligence lawsuit alleging that the agency failed to act appropriately after concluding that R. Allen Stanford was operating a Ponzi scheme, a judge ruled.

Investors Carlos Zelaya and George Glantz may proceed with a claim that agency examiners determined four times before 2009 that Stanford was running a Ponzi scheme, U.S. District Judge Robert Scola Jr. ruled yesterday in federal court in Miami. Stanford is serving 110 years in prison for his $7 billion fraud.

The lawsuit claims the SEC had a “nondiscretionary duty” to report Stanford to the Securities Investor Protection Corp., which compensates victims, after examinations in 1997, 1998, 2003 and 2004. The SEC sued Stanford in February 2009, alleging a “massive fraud” at Antigua-based Stanford International Bank.

“Accepting the plaintiffs’ allegations as true, the Securities and Exchange Commission was obligated to report Stanford’s company to the Securities Investor Protection Corp.,” Scola ruled. “This obligation to report was not discretionary because the controlling statute mandates that the report be made.”

The judge ruled that the next stage of the litigation may be more appropriate for the SEC to raise the agency’s argument that it hadn’t concluded before 2009 that Stanford was running a Ponzi scheme. Investors still face several legal hurdles.

SEC spokesman John Nester declined to comment.

Sovereign Immunity

In a Feb. 14 court filing, the SEC urged Scola to dismiss the complaint, filed under the Federal Tort Claims Act, because it couldn’t overcome the agency’s sovereign immunity.

The agency argued that it was shielded from liability because it had discretion in determining whether to take enforcement or regulatory action against Stanford.

“The SEC enjoys complete discretion under the 1934 Securities Exchange Act in deciding whether and how to investigate suspected wrongdoing,” according to the filing. “Based on these sweeping grants of authority, courts have uniformly dismissed FTCA suits challenging SEC decisions regarding whether and how to investigate alleged wrongdoing.”

Scola also dismissed the investor claims that the SEC had a duty to deny renewal of the Stanford annual registration.

In 2010, the SEC’s inspector general issued a report criticizing the four earlier investigations of Stanford’s operations. The examiners concluded as early as 1997 that Stanford was “likely operating a Ponzi scheme,” it said.

Scheme’s Complexity

Each time, the agency decided against a full investigation. Investigators with the SEC’s enforcement division were also notified by whistle-blowers that Stanford might be operating a Ponzi scheme, and failed to follow up, the report said.

The inspector general found that investigators shied away because of the scheme’s complexity, preferring to tackle easier topics because the staffers felt they were being evaluated based on the number of cases they made.

“As a result, cases like Stanford, which were not considered ‘quick-hit’ or ‘slam-dunk’ cases were not encouraged,” the inspector general found.

Investor attorney Gaytri Kachroo said yesterday the judge’s decision was the first to overcome the SEC’s sovereign immunity.

“The ruling handed down today is a bold statement and a warning to the government: if you fail to carry out your statutory obligations to protect the public against wrongdoing with massive repercussions to the investing public, you will be held liable,” Kachroo said in a statement.

The case is Zelaya v. United States, 11-cv-62644, U.S. District Court, Southern District of Florida (Miami).

To contact the reporters on this story: David Voreacos in Newark, New Jersey, at dvoreacos@bloomberg.net; Susannah Nesmith in Fort Lauderdale, Florida, at susannahnesmith@yahoo.com.

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net

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