Madoff Investors Can’t Sue SEC, U.S. Appeals Court Rules

Bernard Madoff’s investors can’t sue the U.S. Securities and Exchange Commission for failing to uncover his massive Ponzi scheme, a federal appeals court ruled.

The regulator’s “regrettable inaction” is shielded by law, the New York-based appeals panel said today, upholding a lower-court decision to dismiss suits in which investors accused the SEC of negligence.

The three-judge panel ruled that the “discretionary function” exception to a law permitting people to sue the U.S. government applies in cases filed by Madoff victims.

“Despite our sympathy for plaintiffs’ predicament (and our antipathy for the SEC’s conduct), Congress’s intent to shield regulatory agencies’ discretionary use of specific investigative powers” defeats the investors’ claims, the court said.

In April 2011, U.S. District Judge Laura Taylor Swain in Manhattan threw out a $2.5 million suit filed two years earlier by investors Phyllis Molchatsky and Steven Schneider, who blamed what they described as the SEC’s grossly negligent oversight of Madoff’s firm for their losses.

In a similar decision in January, the federal appeals court in San Francisco ruled against a Madoff investor suit against the SEC.

The SEC’s inspector general found in a 2009 report that the agency had failed to make a “thorough and competent” investigation of Madoff’s firm, Bernard L. Madoff Investment Securities Inc., despite having received detailed complaints.

‘Financial Illiteracy’

Those who tried to alert the SEC to Madoff included Harry Markopolos, who said he tried for years to warn the regulator that the returns Madoff claimed to generate for investors were impossible. In congressional testimony, Markopolos accused the SEC of “investigative ineptitude and financial illiteracy” for failing to follow up on complaints and uncover the Madoff fraud.

Madoff, 74, pleaded guilty to orchestrating the biggest Ponzi scheme in history, which defrauded individuals, charities and financial institutions out of an estimated $17 billion in principal. Madoff, who was arrested in 2008, is serving a 150-year sentence in federal prison in North Carolina.

“We believe that our clients were wronged (both by Madoff and the SEC), and their rights needed to be vindicated,” Howard Elisofon, a lawyer for some of the investors, said in an e-mailed statement today. “We recognized that challenging the SEC would be difficult, but this was a case that needed to be fought.”

The case is Molchatsky v. U.S., 11-02510, U.S. Court of Appeals for the Second Circuit (New York).

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