Securities Law Blog

Two of Bernard Madoff’s victims sued the U.S. Securities Exchange Commission last week for failing to uncover Madoff’s $65 billion Ponzi scheme. The lawsuit was filed by Phyllis Molchatsky, a disabled retiree and single mother who lost $1.7 million, and Steven Schneider, a doctor who lost almost $753,000. The SEC earlier denied the investors’ administrative claims, clearing the way for them to file today’s suit under the Federal Tort Claims Act. The government’s “sovereign immunity” from lawsuits should be waived under a law that permits cases against the U.S. if its workers were negligent, according to the complaint filed in Manhattan federal court seeking the return of $2.4 million. Through a “pattern of incompetence,”the SEC missed at least six opportunities to uncover Madoff’s fraud even after receiving detailed tips from an expert explaining how Madoff’s high returns and mysterious investment strategy were proof of the world’s biggest Ponzi scheme, according to the complaint. “Had the SEC carried out its functions with even a minimum of reasonable due care, many, if not most, of Madoff’s victims would have been spared the financial ruin they face today,” the two New York investors said in their 63-page complaint. “Plaintiffs relied on the SEC to protect them and, instead, time after time, the SEC’s agents looked the other way, allowing an obvious danger to grow exponentially, until massive injuries to the plaintiffs and other Madoff investors became inevitable,” according to the complaint.

The SEC, already faulted by Congress for missing the scheme, has been busy trying to restore faith in its abilities after an internal report released last month outlined its failures in the Madoff matter. According to a draft five-year strategic plan released Oct. 8, the agency will seek to improve training and tackle “structural issues” that hurt communication in its Office of Compliance Inspections and Examinations. The plan followed SEC Inspector General, H. David Kotz’s Sept. 29 report that said the agency missed at least six opportunities to spot Madoff’s fraud because it assigned inexperienced employees to inquiries and failed to pursue leads. The SEC’s own investigators said the agency was unwise when choosing cases and that it rewards its workers based on “quantity” rather than “quality.”

Madoff, 71, is serving a 150-year sentence for running the fraud. His family members and his biggest investors have been sued for as much as $15 billion by the bankruptcy liquidator for New York-based Bernard L. Madoff Investment Securities LLC.