Molchatsky et al v. United States Of America
Filing
46
OPINION AND ORDER: #100233 Defendant's motion to dismiss the Complaint is granted. This Opinion and Order resolves docket entry no. 5. The Clerk of Court is respectfully requested to enter judgment dismissing the Complaint for lack of subject matter jurisdiction and close this case. SO ORDERED. (Signed by Judge Laura Taylor Swain on 4/19/2011) (lnl) Modified on 4/21/2011 (ajc).
USDCSDNY
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
DOCUM"ENT
,,ELEC-"TRONICAl.LY· FILED
-------------------------------------------------------x
DOC #:
Plaintiffs,
No. 09 Civ. 8697 (L TS)(AJP)
-v-
UNITED STATES OF AMERICA,
Defendant.
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OPINION AND ORDER
ApPEARANCES:
HERRICK, FEINSTEIN LLP
By: Howard Elisofon, Esq.
Christopher J. Sullivan, Esq.
John Oleske, Esq.
Kerry K. Jardine, Esq.
2 Park Avenue
New York, NY 10016
PREET BHARARA
United States Attorney
Southern District of New York
By: Sarah S. Normand
Assistant United States Attorney
86 Chambers St., Third Floor
New York, NY 10007
Counsel for Plaintiffs
UNITED STATES DEPARTMENT OF
JUSTICE
By: Tony West
Assistant Attorney General
By: Phyllis J. Pyles
Director, Torts Branch
By: Mary M. Leach
Assistant Director, Torts Branch
By: Jeffrey Paul Ehrlich, Esq.
Trial Attorney, Torts Branch
Benjamin Franklin Station
Post Office Box 888
Benjamin Franklin Station
Washington, DC 20044
Counsel for Defendant
MOLCHATSKY,MTD.WPD
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~:!~!~~:-:dY~~]~; J
PHYLLIS MOLCHATSKY AND
STEVEN SCHNEIDER,
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LAURA TAYLOR SWAIN, UNITED STATES DISTRICT JUDGE:
Plaintiffs Phyllis Molchatsky ("Molchatsky") and Steven Schneider ("Schneider")
(collectively, "Plaintiffs") bring suit against Defendant United States of America ("Defendant" or
"the Government") under the Federal Tort Claims Act ("FTC A"), 28 U.S.c. §§ 2671-80, alleging
gross negligence by the Securities and Exchange Commission ("SEC") and its agents and
employees in their oversight, investigations, and examinations of Bernard Madoff ("Madoff')
and his firm, Bernard
Madoff Investment Securities LLC ("BLMIS").l Pending before the
Court is Defendant's motion to dismiss Plaintiffs' Complaint pursuant to Federal Rule of Civil
Procedure 12(b)(1) for lack of subject matter jurisdiction. Plaintiffs assert that the Court has
jurisdiction of this action pursuant to 28 U.S.c. §§ 1331 and 1346(b). For the following reasons,
Defendant's motion is granted.
BACKGROUND
Plaintiffs, who allege that they suffered losses in connection with the notorious
Ponzi scheme operated by Madoff and BLMIS, seek to recover damages from the United States
on the ground that the SEC failed, despite numerous tips, warnings and putative investigations,
to discover, disclose and put an end to the scheme from 1992 until 2008. The allegations
contained in the Complaint are derived substantially from the SEC Office ofInspector General's
4S7-page Report entitled "Investigation of Failure of the SEC to Uncover Bernard Madoff's
Ponzi Scheme - Public Version" ("the OIG Report"), which was released on August 31 2009,
Plaintiffs have complied with the FTCA requirement that a "tort claim against the
United States ... be ... presented in writing to the appropriate Federal agency
within two years after such claim accrues." 28 U.S.C.A. § 2401(b) (West 2006).
See Compi. ~~ 20-23.
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and is attached to the Complaint as Exhibit A,2 The following facts are derived from the
allegations of the Complaint, which are taken as true for purposes of Defendant's motion
pursuant to Rule 12(b)(1).
The Court presumes familiarity with the Complaint and the voluminous
documents on which it relies and summarizes here the specific allegations only to the extent
necessary.3 Between 1992 and 2008, the SEC received numerous detailed, credible complaints
regarding Madoff and BLMIS. (Compi. 'Ill.) The investigations and examinations of Madoff
and BLMIS that were undertaken by the SEC in response to these complaints were flawed in
numerous respects. (Id. 'Il'll1-2.) As a result of the SEC's actions and inactions, Madoffs
scheme continued and expanded, eventually resulting in billions of dollars in losses by investors,
and directly causing Plaintiffs more than $2.4 million in losses.
M,r 2.)
Between 1992 and 2008, the SEC received at least eight complaints indicating
that Madoffwas operating a Ponzi scheme. (Id.
~[S.)
In response, the SEC conducted four
formal investigations or examinations. (Id.)
The OIG Report revealed multiple and various failures of SEC staff that allowed
the Madoff scheme to continue undiscovered, notwithstanding the complaints and investigations.
(Id.
,r 12.)
2
The OIG Report concluded that, despite numerous red flags raised with the SEC, the
The OIG Report "relied on the ~IG's extensive review of documents and sworn
testimony obtained from numerous current and former SEC employees, email and
document searches, document requests to third parties, and a team of experts and
consultants with unique and specialized experience." (Compi. 'Ill n.2.)
The facts and circumstances of Madoffs fraud have been outlined elsewhere
previously. See In re Bernard L. MadoffInv. Secs. LLC, 424 B.R. 1
127-32
(Bkrtcy. S.D.N.Y. 2010) and Dichter-Mad Family Partners, LLP v. United States,
707 F. Supp. 2d 1016, 1020-24 (C.D. Cal. 2010).
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SEC never took the "necessary and basic steps to determine ifMadoffwas misrepresenting his
trading." (Id.
~
13, quoting OIG Report at 456.) The OIG Report concluded that the SEC's
investigations were conducted by inexperienced staff and that their scope and execution were
deeply flawed. (Id.'[ 13.) The OIG found that there was a "systematic breakdown in the manner
in which the SEC conducted its examinations and investigations." (Id., quoting OIG Report at
457.)
The SEC negligently performed its 1992 investigation into a firm known as
Avellino & Bienes, the investments of which Madoffhad complete control, and which touted
100% safe investments. (Id.
~~
32-34.) The SEC team assembled to conduct the investigation
was inexperienced and the investigation was limited in scope, failing to verify information by
using third parties or to obtain records from sources other than Madoffhimself. (Id.
~~
35-38.)
The team took no action regarding suspicious information provided to them by Madoff.
M
~~
39-41.) The negligent conduct of, and failure to follow the leads presented by, the Avellino &
Bienes investigation lead the SEC to miss an early opportunity to discover Madoffs Ponzi
scheme. (Id. '['142-44.) When Plaintiff Schneider invested with Madoffin June 1997, he did not
know that the SEC had conducted its Avellino & Bienes investigation the way it had.
M
~~
45
46.)
In May 2000, a complaint, including evidence and analysis, regarding Madoffs
returns was filed by an industry analyst and Certified Fraud Examiner, Harry Markopolos
("Markopolos"). (Id.
~
47.) The resulting SEC investigation assigned the case to an unqualified
staff member in its Boston office who lacked a basic understanding of finance, who also failed to
forward the complaint to the SEC's New York office despite his claims that he had. (Id.
MOLCHATSKY.MTD.wPD
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~~
49
4
51.)
In March 2001, Markopolos filed a second complaint with the SEC's Boston
office regarding Madoffs returns versus the S&P 500.
iliL ~ 52.)
This complaint contained
evidence and analysis in addition to that presented by Markopolos' May 2000 complaint. (lQ, ~~
52-53.) The March 2001 complaint was forwarded to the New York office, which promptly
decided not to investigate its claims. (Id. ~I 54.) The staff member in New York who declined to
investigate did so without consultation with other, more experienced staff members. (Id.
~~
45
46.)
In May 2001, the industry publications MARHedge and Barron's publicly
questioned Madoffs operations and returns. (Id.
~I~r
56-59.) In response to a query from a staffer
at the SEC's Boston office, a staffer at the New York office expressed no interest in the Barron 's
article questioning Madoffs operations, and the OIG Report found no evidence that anyone at
the New York office reviewed the relevant article prior to 2005. (Id.
~
60.) A staffer in the
Washington office noticed the Barron's article but took no action after having read it. (Id.
~
61.)
In late 2001, Molchatsky invested with Madoff. (lQ, ~ 63.)
In May 2003, the SEC's Washington Investment Management team received a
detailed complaint, which included extensive documentation and pointed out numerous red flags,
against Madoff from a reputable hedge fund manager. (Id. ~~ 64-65.) The Washington SEC
office referred the complaint to its Broker-Dealer team despite the team's lack of experience with
Ponzi schemes or investment-management issues. (Id.
~
67.) Due to an atmosphere ofjealousy
and secrecy, the Broker-Dealer team never conferred with the Investment Management team for
support or information concerning the complaint. (Id.
MOI.oMTSKYMTD.wPD
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~
68.) The investigation was conducted by
a team that lacked adequate training or knowledge of the relevant financial industry.
M
~~
69
70.) The inexperienced team began its investigation seven months after receiving the complaint
by looking into "front-running" rather than into the allegations that Madoffwas running a Ponzi
scheme. (Id.
~~
71-73.) The single plan of investigation that was actually responsive to the
allegations that had been made in the complaint was never executed because doing so presented
the possibility of needing to review a volume of documents that was considered "burdensome."
(Id.
'I~
74-76.) During the investigation, junior team members realized that Madoffwas lying to
the SEC, but his answers were continually relied upon, and were never verified with third parties
or independent sources. (Id.
~~
78-81.) The investigation team declined even to ask Madoff
himself for certain documents that would have exposed his fraud because the documents would
have been voluminous and their review would have been time-consuming. (Id.
~~
82-83.) In
April 2004, the team investigating the May 2003 complaint was directed to cease its efforts so
that resources could be directed elsewhere. (Id.
~
84.) The investigation was never formally
concluded, and a final report was never produced, nor was a case-opening report entered into the
SEC's case-management system. (Id.
~~
84, 86.) The OIG Report found the investigation into
the May 2003 complaint to be deficient in a number of significant respects.
M
~
87.)
In April 2004, an investigation being conducted by the SEC's New York office
into a firm unrelated to Madoff revealed internal emails that raised questions about whether
Madoffwas engaged in illegal activity. M
~
88.) The emails contained some of the same
information that had been presented in the complaints from Markopolos and the public news
stories that questioned Madoffs legitimacy. M
~
90.) In response to these emails, and after a
delay often months, a Broker-Dealer team in the New York office began investigating Madoff
MOLCHATSKy,rvnn WPD
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(ld. ~ 93.) The investigative team failed to draft a planning memorandum to guide their
investigation, and again focused its investigation on "front-running." (Id.
~~
93-94.) Like the
earlier investigation, this investigation was driven by the knowledge base of the team rather than
the allegations of the complaint. (ld.
~~
94-95.) The investigation again involved asking Madoff
questions and accepting his answers, even those that made staff members suspicious, at face
value without verification of any kind. (Id.
~~
96-102.) When junior staff members eventually
expressed a desire to verify Madoff's answers, they were vetoed by senior staff members who
claim to have believed that such verification could result in personal liability.
ili:l ~~
103-04.)
The only verification attempt that the New York team conducted, and which revealed that
Madoffhad lied to investigators, was not inquired about further and did not result in further
verification attempts. (Id.
~
107.) When the New York team asked Madofffor documents,
Madoffinfornled the team that he had already supplied such documents to the Washington
office, a fact of which the New York team was unaware due to the offices' lack of coordination
and communication, and their failure to use the SEC's internal case-tracking system. (Id.
~~
108
09.)
Even after Madoffinformed the New York office of the investigation that was
being conducted at the Washington office, the two offices shared relatively little information and
communicated only minimally.
ili:l ~~
110-11.) Supervisors at the New York office determined
that, because the Washington office had looked into similar issues, the issues must have been
resolved properly, although the Washington investigation had never actually been concluded.
(Id.
,r 112.)
In September 2005, the New York office closed its investigation and reported that all
red flags had been addressed by information and documents provided by Madoff.
MOLCHATSKY.MTD. WPD
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ili:l ~ 113.)
Of
7
the investigation that resulted from the April 2004 email, the OIG Report concluded: "A
compelling and credible complaint was provided with several significant red flags. However, the
examination was not staffed appropriately, delayed in outset, focused in error, conducted without
obtaining critical independent data, examiners were not allowed to follow up on their suspicions,
and it concluded with unresolved issues remaining and with a closing report that relied too
heavily on the representations of Madoff. Because of these mistakes, an opportunity to uncover
Madoff's Ponzi scheme was missed." (Id.
~
115, quoting OIG Report at 235.)
In October 2005, Markopo10s gave the SEC's Boston office another version of his
report, claiming that Madoff's hedge fund was a fraud. (Id.
~
116.) The report provided detailed,
extensive evidence that Madoffwas operating a Ponzi scheme and told the SEC that
Markopolos' conclusions could be confirmed by speaking with a number of other industry
professionals, names and contact information for whom was included in the report. (Id.
~~
117,
120.) The report was forwarded to the New York office, where it was assigned to an
~~
Enforcement team with no useful experience in conducting Ponzi scheme investigations. (Id.
123-24.) Much of the investigative work was done by an inexperienced, junior staff member,
and the investigation was compromised by the vendetta of a supervisor against Markopolos.
~~
®
124-28.) Miscommunication with the Broker-Dealer team, delays, misplaced priorities, and a
failure to properly open and record developments in the SEC's internal case-tracking system also
characterized the investigation. (Id.
~~
130-32.) Despite these flaws, the investigation team
managed to catch Madoffin a pattern of lies. (Id.
~
133.) In February 2006, the Enforcement
staff reached out to the SEC's Office of Economic Analysis ("OEA") for investigative assistance,
but the OEA failed to respond to the request for assistance. (Id.
MOLCHA TSKY.MTD. WPD
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134.) When the Enforcement
staff reached out a second time, it failed to provide OEA with a copy of Marko polos' 2005
complaint, and the Enforcement team never followed up. (Id. ~~ 134-35.)
Despite not understanding the subjects of their own investigation, the
Enforcement team did not reach out to other SEC divisions for assistance, and conducted its own
sworn examination of Madoff. (Id.
~~
137-38.) At his examination, Madoffprovided evasive,
inconsistent, suspicious answers to SEC inquiries, but the Enforcement team accepted at face
value his explanations for his consistently high returns. (Id.
~
141.) The Enforcement team
failed to verify answers Madoffhad given, which would have uncovered his massive fraud.
~~
M
142-43.) When a subsequent verification call was made, the inexperienced staff failed to
comprehend the significance of answers that were inconsistent with Madoffs representations,
and failed to ask appropriate follow-up questions. (Id.
~~
144-46.) Despite the evidence
available to the Enforcement team, the only enforcement action it took was to procure Madoffs
agreement to register as an investment advisor since he had lied about his number of investment
advisory clients.
M 'l,r 150-51.)
The investigation concluded by June 2007 without resolving
any of the red flags about which Markopolos had complained.
M
~
152.)
In December 2006, the SEC received an anonymous complaint stating that Madoff
was commingling customer funds with his own. (Id.
~'1154-55.)
In response, the same
Enforcement team that had investigated Markopolos' third complaint called Madoffs lawyer,
who denied that the investor was a Madoff client, a denial which turned out to be false. (Id.
~
156.) Without any further action or attempt to verify the lawyer's denial, the investigation was
concluded. (Id.)
In June 2007, Markopolos again contacted the SEC about Madoff. (Id.
MOLCHA TSKy.MTD. WPD
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~
157.)
9
His email warning to the supervisor of the New York Enforcement team was ignored. (Id.)
In March 200S, the Chairman of the SEC received a warning from the same
person who had written in December 2006 regarding the commingling of funds. (Id.
~
ISS.) The
new complaint was forwarded to the same New York Enforcement team, which told the
Chairman's office that the complaint would not be pursued. (Id.
~
159.)
The economic crisis ofmid-200S created a need for cash and, among Madoffs
investors, a skepticism about keeping money in the market. (Id.
~
160.) Lacking new investors
to compensate for these forces, Madoffs Ponzi scheme finally became unsustainable, and was
disclosed to the public, in December 200S. (Id.
~
161.)
The OIG Report concluded that, "despite numerous credible and detailed
complaints, the SEC never properly examined or investigated Madoffs trading and never took
the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme. Had these
efforts been made with appropriate follow-up at any time beginning in June of 1992 until
December 200S, the SEC could have uncovered the Ponzi scheme well before Madoff
confessed." (Id.
~
163, quoting OIG Report at 41.) Plaintiffs contend that, if the SEC had
performed its functions with the most basic level of competence, it would have discovered
Madoffs scheme, and the losses to Plaintiffs would have been prevented. (Id.
~
164.)
DISCUSSION
Defendant argues that, because the decisions of the SEC regarding whom to
investigate and how to conduct such investigations are discretionary, any negligence or abuse of
that discretion is shielded from suit by sovereign immunity, and that this Court therefore lacks
subject matter jurisdiction of Plaintiffs' claims.
MOLCHATSKY.MTD. WPD
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"A case is properly dismissed for lack of subject matter jurisdiction under Rule
12(b)(1) when the district court lacks the statutory or constitutional power to adjudicate it."
Makarova v. United States, 201 F.3d 110, 113 (2d Cir. 2000). Here, the question of whether the
Court has subject matter jurisdiction of Plaintiffs' claims turns on whether the Government has
waived its sovereign immunity.
Plaintiffs bring their claims against the United States pursuant to the FTCA. The
FTCA, a limited waiver of sovereign immunity, provides for United States Government liability
"for money damages ... for injury or loss of property, or personal injury or death caused by the
negligent or wrongful act or omission of any employee of the Government while acting within
the scope of his office or employment, under circumstances where the United States, if a private
person, would be liable to the claimant in accordance with the law of the place where the act or
omission occurred." 28 U.S.C.A. § 1346(b)(1) (West 2006). In other words, the FTCA
functions as an exception to the general prohibition on suits against the United States
Government.
A discretionary function exception ("DFE") provision of the statute limits,
however, the extent to which the FTC A waives sovereign immunity. The DFE excepts from the
FTCA's coverage "[a]ny claim ... based upon the exercise or perfornlance or the failure to
exercise or perform a discretionary function or duty on the part of a federal agency or an
employee of the Government, whether or not the discretion involved be abused." 28 V.S.C.A.
§ 2680(a) (West 2006). "(T]he DFE bars suit only if two conditions are met: (1) the acts alleged
to be negligent must be discretionary, in that they involve an "element ofjudgment or choice"
and are not compelled by statute or regulation and (2) the judgment or choice in question must be
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II
grounded in 'considerations of public policy' or susceptible to policy analysis," Coulthurst v,
United States, 214 F3d 106, 109 (2d Cif. 2000) (citing United States v, Gaubert, 499 U.S, 315,
322-23 (1991) and Berkovitz v, United States, 486 U.S. 531,536-37 (1988)),
Regarding the first prong, "[t]he requirement ofjudgment or choice is not
satisfied," and the DFE therefore does not apply, "if a 'federal statute, regulation, or policy
specifically prescribes a course of action for an employee to follow,' because 'the employee has
no rightful option but to adhere to the directive.'" Gaubert, 499 U.S, at 322 (quoting Berkovitz,
486 U.S. at 536). Where a matter is committed to the discretion of a government actor, the
discretionary function exception bars claims based "on decisions at the policy or planning level"
as well as claims "based on day-to-day management decisions if those decisions require
judgment as to which of a range of permissible courses is wisest." Fazi v. United States, 935
F.2d 535,537-38 (2d Cir. 1991).
As to the second prong, a discretionary decision is within the exception if the
judgment at issue '''is of the kind that the discretionary function exception was designed to
shield.'" Gaubert, 499 U.S. at 322-23 (quoting Berkovitz, 486 U.S. at 536). In assessing the
second prong, "if a regulation allows the employee discretion, the very existence of the
regulation creates a strong presumption that a discretionary act authorized by the regulation
involves consideration of the same policies which led to the promUlgation of the regulations." Id.
at 324. Thus, "[w]hen established governmental policy, as expressed or implied by statute,
regulation, or agency guidelines, allows a Government agent to exercise discretion, it must be
presumed that the agent's acts are grounded in policy when exercising that discretion." Id. If the
applicable statute or regulation does not give the employee discretion, no presumption attaches,
MOLCHATSKY.MTD.IVPD
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and the court must detennine whether the decisions were "of the kind" that are "susceptible to
policy analysis." ld. at 323. Where there is no statute, regulation, or policy on point (either
conferring discretion or limiting discretion), a court must examine the nature of the actions taken
and whether they are susceptible of policy analysis, rather than focus on whether the decision
was in fact the result of a policy-based decision making process. ld. at 325. Sovereign immunity
and the DFE serve three core principles: separation of powers, protection of decisionmaking by
government policymakers, and preservation of public revenues and property. Gray v. Bell, 712
F.2d 490,511 (D.C. Cir. 1983), cert. denied, 465 U.S. 1100 (1984). The DFE "is about power,
not fairness." Nat'} Union Fire Ins. v. United States, 115 F.3d 1415, 1422 (9th Cir. 1997). Thus,
detrimental reliance by members of the public on assumptions that government agencies will
perfonn regulatory functions competently is not detenninative ofthe ability of injured citizens to
seek redress against the Government in a civil action.
In opposing a motion to dismiss a complaint pursuant to Federal Rule of Civil
Procedure 12(b)(1), the party invoking the Court's jurisdiction bears the burden of demonstrating
that subject matter jurisdiction exists. Lerner v. Fleet Bank, N.A., 318 F.3d 113, 128 (2d Cir.
2003); see also APWU v. Potter, 343 F.3d 619, 623 (2d Cir. 2003) (the party asserting
jurisdiction has the burden of showing by a preponderance of the evidence that subject matter
jurisdiction exists, and that showing "is not made by drawing from the pleadings inferences
favorable to [that party].") (internal citation and quotation marks omitted). In the FTCA context,
because the United States, as a sovereign, is immune from all suits against it absent an express
waiver of its immunity, United States v. Sherwood, 312 U.S. 584, 586 (1941), a plaintiff bears
the burden of showing that the DFE does not apply to his claim. See, e.g., Welch v. United
MOLCHAISKYMTD,wPO
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States, 409 F.3d 646, 650-51 (4th Cif. 2005).
A complaint can survive a motion to dismiss based on lack of subject matter
jurisdiction if it alleges facts that could embrace a non-discretionary decision that caused the
injury and the United States does not "establish that the decision in question was grounded in
questions of public policy." Coulthurst v. United States, 214 F.3d at 110-11 (2d Cir. 2000). It is
a plaintiffs burden in the first instance to come forward with a complaint that adequately alleges
a claim that not barred by the DFE. Id. at 111. If the Government responds by demonstrating
that the action falls within a discretionary framework, a plaintiff must rebut the Government's
showing sufficiently to demonstrate that there is a plausible case for non-discretionary or nonpolicy action in order to defeat dismissal. Id. at 110. 4
Sufficiency of Plaintiffs' Allegations to Demonstrate Inapplicability ofDFE
Plaintiffs argue that the Complaint presents four categories of allegations that fall
outside of the scope of the DFE: (1) that the SEC violated provisions of its statutory mandate as
4
Plaintiffs argue that the Court should treat the Government's assertion of the DFE as
an affirmative defense, thus placing on the Government the burden of proving the
DFE's applicability in the first instance. In advancing this argument, Plaintiffs rely
on various decisions that speak to which party bears the ultimate burden of proof
with respect to the DFE. Those decisions do not, however, alter the plaintiffs
obligation first to demonstrate a basis for the exercise ofjurisdiction. See, e.g.,
Merando v. United States, 517 F.3d 160, 164 (3rd Cir. 2008) (plaintiff bears the
burden of demonstrating that his claims fall within the scope of the FTCA's waiver
of sovereign immunity, but the United States has the burden of proving the
applicability of the discretionary function exception) (internal citations and
quotations omitted); Prescott v. United States, 973 F.2d 696, 701-02 (9th Cif. 1992)
("[0 ]nly after a plaintiff has successfully invoked jurisdiction by a pleading that
facially alleges matters not excepted by § 2680 [the DFE] does the burden fall on the
government to prove the applicability of a specific provision of § 2680") (quoting
Carlyle v. United States, 674 F.2d 554, 556 (6th Cir. 1982» (holding the same in
reviewing a post-trial judgment, and stating that "[a]ny other reading of 28 U.S.C. §
1346(b) and § 2680 would conflict with the general rule that a party invoking federal
jurisdiction must allege facts necessary to establish subject matter jurisdiction.").
MOLCHATSKYMTD. WPD
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set forth in the Securities Exchange Act of 1934 ("1934 Act") (citing CampI. '1'40,68,69, 75,
76,80,84,92, 109, 111, 129, 134, 136, 137); (2) that the SEC violated internal policies
regarding the filing of reports and the use of its computer system (citing CampI. '1'184,86,109,
130, 131); (3) that the SEC acted or failed to act in ways that "likely violated formal SEC
policies" such as by failing to request materials from third parties (citing CompI. '1'135, 37, 38,
39,40,49,67,69,70,71,73,80,83,94,95,103,104,106, 107, 124, 125, 127, 128,132,138,
140, 147); and (4) "other allegations of admittedly negligent conduct that mayor may not have
violated any written policies but which were nevertheless outside any permissible range of
conduct and were prohibited as a matter of practice within the SEC" (citing Compi.
~'138,
77,78,81,91,97,99, 100, 102, 103, 107, 133, 134, 142, 144, 145, 146, 149).
PIs' Mem. of
66, 76,
Law in Opp. to Mot. to Dismiss 5-7.) Plaintiffs also contend (citing Compi. 'il'il68, 69, 75, 76,
82,83) that none of the conduct described above was in fact grounded in "legitimate policy
considerations."
Plaintiffs state that their "allegations of specific SEC policy violations, as well as
the absence of any legitimate policy considerations in the SEC's decision making, are based
wholly on the Government's admissions in the [OIG] Report." (See PIs' Mem. of Law in Opp.
to Mot. to Dismiss 7.) Plaintiffs argue that they are entitled to jurisdictional discovery because
the OIG Report lacks detailed information about what specific mandatory policies existed and
were potentially violated by the SEC. The Court will address the sufficiency of Plaintiffs'
allegations and the Government's response to them before addressing Plaintiffs' request for
discovery.
MOLCI1ATSK\~MTD,WPD
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The SEC's Statutory Mandate
Plaintiffs allege that the SEC violated provisions of its statutory mandate as set
forth in the 1934 Act. The passages of the Complaint that Plaintiffs cite to support this argument
include passages: summarizing post-hoc assessments from SEC employees concluding that
investigations of Madoffwere carried out in a sloppy manner and failed to comply with the
dictates of common sense; describing failures of investigative teams to coordinate or
communicate; describing inexplicable failures to begin or follow through with investigations;
suggesting that the staff was motivated primarily by its own laziness; identifying misplaced
investigative priorities; describing employees' lack of training and experience; identifying
failures to open cases in the SEC's internal case tracking system; describing miscommunications
between investigative teams; and noting staff members' ignorance regarding the type of conduct
they were assigned to investigate.
Plaintiffs' only specific argument regarding any 1934 Act mandate contends that
the SEC violated 15 U.S.c. § 78q(k)(2), which relates to the sharing of information in aid of the
coordination of examinations with other examining authorities. 15 US.c. § 78q(k)(2) provides
that "[t]he Commission and the examining authorities[5] shall share such information [regarding
securities exchanges and their members, brokers and dealers, ratings organizations, and clearing
agencies], including reports of examinations, customer complaint information, and other
nonpublic regulatory information, as appropriate to foster a coordinated approach to regulatory
"For purposes of this subsection, the term 'examining authority' means a
self-regulatory organization registered with the Commission under this chapter
(other than a registered clearing agency) with the authority to examine, inspect, and
otherwise oversee the activities of a registered broker or dealer." 15 US.C.A.
§ 78q(k)(5) (West 2009).
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oversight of brokers and dealers that are subject to examination by more than one examining
authority." 15 U.S.C.A. § 78q(k)(2) (West 2009). Emphasizing the statute's use of the word
"shall," Plaintiffs argue that section 78q(k)(2) imposes a mandatory obligation to share all
complaint and investigative information with other agencies, and assert that their injuries are
traceable to the SEC's failure to do so in connection with Madoff. Plaintiffs ignore the portion of
the statute that directs the SEC to engage in such coordination activities "as appropriate," a
qualification that clearly confers discretion to determine whether, when, to what extent, and how
information is to be shared in order to coordinate oversight activity. See Dichter-Mad, 707 F.
Supp. 2d at 1042-43 (concluding that the legislative history of subsection (k)(2) reveals that it is
"purely discretionary" and that it is not the place of courts to second-guess how the SEC
accomplishes the multiple policy goals embodied in section 78q(k)(2)). Plaintiffs' reliance on
section 78q(k)(2) to demonstrate the existence of a mandatory duty to disclose investigatory
information to other authorities is thus misplaced, and they fail to allege a violation outside the
scope of the DFE in this regard.
SEC Internal Policies Regarding Reports and Computer System
Plaintiffs argue that the SEC violated mandatory internal policies regarding the
filing of reports and the use of its computer system. The passages of the Complaint that
Plaintiffs cite to support this argument refer to failures to follow protocols and the failure of
investigative teams to enter reports into the SEC's STARS case-management system or check the
system for existing reports. The Court interprets this category to include all of Plaintiffs'
allegations regarding various administrative case management tasks. Plaintiffs' arguments with
respect to case management are unsupported by any factual allegations identifYing mandatory
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duties. 6 The characterizations proffered in Plaintiffs' Complaint notwithstanding, the
voluminous OIG Report, to which Plaintiffs' Complaint repeatedly refers, describes no
mandatory case-opening, case-management, or other administrative or investigative protocols.
Cf. 15 U.S.C. § 78u(a)(J) (permitting the SEC to decide "as it deems necessary" how to
"investigate any facts, conditions, practices, or matters," whether through "a statement in writing,
under oath or otherwise."). Plaintiffs thus fail to proffer facts demonstrating the existence of a
non-DFE-covered claim for violation of internal policies and protocols.
Allegedly "Likely" Violation ofOther Formal SEC Policies
Plaintiffs also argue that the SEC acted or failed to act in various ways that "likely
violated formal SEC policies." The Court, based on the passages of the Complaint to which
Plaintiffs refer, interprets this category to include all of Plaintiffs' allegations regarding the
SEC's hiring, training, and staffing decisions; improper personal motivations for staff members'
investigatory conduct; the failures of investigative teams to communicate or coordinate; and the
failure to verify information obtained in the course of investigations.
In connection with this allegation of "likely" violations of formal SEC policies,
Plaintiffs refer to passages of the OIG Report concluding, inter alia, that SEC staff should have
been aware of certain information, that investigative teams' actions and inactions defied common
sense, and that inexperience, interpersonal dynamics, and laziness led to missed opportunities to
expose Madoff's fraud.
6
MOLCHATSKYMTD. WPD
For instance, Plaintiffs cite to Compl. ~ 84 to support their argument that mandatory
case management directives were disregarded. However, the Complaint merely
alleges that there was "a serious failure to follow appropriate protocols" and cites to
a passage of the OIG Report that references no protocols whatsoever.
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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. Cf.
Gaubert, 499 U.S. at 322. That the conduct in question defied common sense and reeked of
incompetency does not indicate that any formal, specific, mandatory policy was "likely" violated.
Plaintiffs have not identified any mandatory directive that requires, for instance, that a certain
type of investigative team investigate a certain type of complaint, that investigative teams be
staffed with employees with a certain amount of experience or level of expertise, that
investigations begin within a certain window of time after a complaint is received, or that teams
or offices share information or coordinate investigations in a particular way.
Other Conduct Allegedly Outside ofAny Permissible Range of Conduct
Plaintiffs argue that their claims are also based on admittedly negligent conduct
that, while it may not have violated any written policies, was nevertheless "outside any
permissible range of conduct" and was prohibited as a matter of practice within the SEC. The
sections of the Complaint that Plaintiffs cite to support this contention refer to instances of SEC
failures to conduct investigations in a thorough manner, employee laziness, and other
deficiencies in investigations.
Plaintiffs' arguments that the SEC's conduct defied common sense or violated an
unwritten permissible code of conduct do not provide the necessary factual demonstration that
the conduct of which they complain is not covered by the DFE. Plaintiffs are required to allege
the existence of a policy that is specific and mandatory, and to identify injury arising from
Government violation of such a policy. Plaintiffs' vague claims about unacceptable conduct do
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not allege adequately the violation of a specific and mandatory directive or policy that would take
their claims outside the scope of the DFE.
In sum, Plaintiffs have not identified any specific, non-discretionary mandate that
the SEC conduct investigations under particular circumstances, or that such investigations be
conducted in a particular manner. Plaintiffs' Complaint cites isolated staff statements, quoted by
the OIG, that certain reports should have been made or that actions should have been recorded in
particular ways, and Plaintiffs argue that common sense approaches to this important work
would have dictated more regular and effective actions in all of the underlying areas. Plaintiffs
also assert, without any supporting factual proffers, that no discretion was in fact exercised at
key points of the SEC's interactions with and investigations of Madoff.
The boundaries of the DFE are not, however, delineated by best practices or even
the absence oflogical, responsible practices. Claims escape its scope only where the injury
producing government action was specifically non-discretionary, or where a discretionary action
that caused injury was not one that was susceptible to policy analysis. Gaubert, 499 U.S. at 322
23; Berkovitz, 486 U.S. at 536-37. Here, Plaintiffs fall short of meeting their initial burden of
demonstrating that their injuries could have arisen from the negligent violation of a non
discretionary duty. See Coulthurst, 214 F .3d at 110-11. Plaintiffs proffer no non-conclusory
factual allegations identifying non-discretionary duties.
Ashcroft v. Iqbal, 129 S. Ct. 1937,
1950 (2009) ("While legal conclusions can provide the framework of a complaint, they must be
supported by factual allegations."). Plaintiffs fail to identify any non-discretionary statutes,
regulations, or rules that were violated.
Furthermore, their injury arises from the scope, manner, and results of
investigative activity, which is inherently discretionary and policy-driven, rather than from
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individual failures to perform specific tasks competently. The Complaint identifies the failure to
uncover and stop Madoff as the proximate cause of Plaintiffs' harm. Plaintiffs' sole cause of
action - sounding in negligence - attributes their injury to the SEC's failure to oversee, expose,
and end Madoffs fraud. 7 However, despite Plaintiffs' aggressive reading of the OIG Report, the
Complaint never identifies a duty imposed on the SEC to conduct its investigations in a
particular way. In the absence of allegations demonstrating relevant mandatory obligations, the
Court presumes that the challenged acts and omissions are discretionary and not amenable to suit.
Ignatiev, 238 F.3d at 466-67 (citing Gaubert, 499 U.S. at 324-25).8
7
Plaintiffs' reliance on Coulthurst in arguing the sufficiency oftheir Complaint is
misplaced. Whereas in Coulthurst, the direct instrument of injury was the collapse
of prison exercise equipment and there was an open factual question as to whether
the collapse was due to failure to follow a specific maintenance or inspection
mandate or a more general failure to establish an appropriate policy for maintenance
and oversight, the claim of injury here sterns from the SEC's failure to either take
actions itself or communicate sufficient information to other organizations to
prompt them to act. The quotidian failures alleged (~, incorrect staffing,
incompetent handling of information and reporting) were elements of the
background against which SEC made bad decisions (or failed to exercise its
investigative authority). Unlike the pleading in Coulthurst, therefore, the Complaint
provides no factual framework that, read in light most favorable to Plaintiffs, could
embrace a non-discretionary, non-policy decision that caused injury. See also Sloan
v. United States Dep't of Housing and Urban Dev., 236 F.3d 756, 761-62 (D.C. Cir.
2001) (rejecting an FTCA challenge to an underlying investigation and audit
because the underlying conduct caused no harm distinct from the ultimate,
discretionary prosecutorial decision which relied on the investigation); Fisher Bros.
Sales, Inc. v. United States, 46 F.3d 279,282 (3rd Cif. 1995) (rejecting FTCA
plaintiffs' attempt to circumvent the DFE by targeting the negligence of lab
technicians on whose research the FDA relied in banning Chilean fruit bound for the
United States, holding that plaintiffs' injury was caused by decisions susceptible to
policy analysis and made within the discretion afforded the FDA Commissioner); cf.
Freeman, 556 F.3d at 339 (collecting FTCA cases holding that ostensibly mandatory
responsibilities often require, or are embedded in a framework premised on,
discretion such that the DFE applies).
Cf. Treats Intern. Enters., Inc. v. Sec. and Exch. Comm'n, 828 F. Supp. 16, 18
(S.D.N.Y. 1993) (finding no judicially manageable standard for judging when or
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Government's Demonstration of Discretionary Framework
If a plaintiff "fairly alleges negligence outside the scope of the DFE," the
Government must establish that "an activity is not mandated by statute and involves some
element ofjudgment or choice" and that the decision in question was susceptible to policy
analysis. Coulthurst, 214 F .3d at 111, 110. In its motion papers, the Government demonstrates
that, contrary to the allegations in the Complaint, the SEC's investigatory powers are
discretionary. Here, Plaintiffs have not plead facts showing that the challenged conduct is
outside the DFE, and the Government has, in its motion, demonstrated that the conduct is indeed
covered by the DFE.
The 1934 Act and the SEC's own regulations define the SEC's investigative and
enforcement powers as permissive and discretionary. The 1934 Act provides, inter alia, that:
The Commission may, in its discretion, make such investigations as it deems
necessary to determine whether any person has violated, is violating, or is about to
violate any provision of this chapter ... The Commission is authorized in its
discretion, to publish information concerning any such violations, and to
investigate any facts, conditions, practices, or matters which it may deem
necessary or proper to aid in the enforcement of such provisions ... [,]
15 US.C.A. § 78u(a)(I) (West 2009) (emphasis supplied), and that
Whenever it shall appear to the Commission that any person is engaged or is
about to engage in acts or practices constituting a violation of any provision of
this chapter ... it may in its discretion bring an action in the proper district court
... to enjoin such acts or practices, and upon a proper showing a permanent or
temporary injunction or restraining order shall be granted without bond. The
Commission may transmit such evidence as may be available concerning such
acts or practices ... to the Attorney General ... [,]
15 U.S.c.A. § 78u(d)(I) (West 2009) (emphasis supplied). The SEC's regulations provide that:
how the SEC should use its investigatory discretion).
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Where, from complaints received from members of the public, communications
from Federal or State agencies, examination of filings made with the Commission,
or otherwise, it appears that there may be violation of the acts administered by the
Commission or the rules or regulations thereunder, a preliminary investigation is
generally made. In such preliminary investigation no process is issued or
testimony compelled. The Commission may, in its discretion, make such formal
investigations and authorize the use of process as it deems necessary to determine
whether any person has violated, is violating, or is about to violate any provision
of the federal securities laws or the rules of a self-regulatory organization of
which the person is a member or participant. Unless otherwise ordered by the
Commission, the investigation or examination is non-public and the reports
thereon are for staff and Commission use only.
17 C.F.R. § 202.5(a) (2010) (emphasis supplied). The regulations further provide that
After investigation or otherwise the Commission may in its discretion take one or
more of the following actions: Institution of administrative proceedings looking to
the imposition of remedial sanctions, initiation of injunctive proceedings in the
courts, and, in the case of a willful violation, reference of the matter to the
Department of Justice for criminal prosecution. The Commission may also, on
some occasions, refer the matter to, or grant requests for access to its files made
by, domestic and foreign governmental authorities or foreign securities
authorities, self-regulatory organizations such as stock exchanges or the National
Association of Securities Dealers, Inc., and other persons or entities.
17 C.F.R. § 202.5(b) (2010) (emphasis supplied). These statutes and regulations give rise to a
"strong presumption" that the conduct at issue was based in public policy. See Gaubert, 499 U.S.
at 324. In light of this statutory and regulatory language, the courts have "unanimously" rejected
challenges to the SEC's use of its investigatory or enforcement powers. Dichter-Mad, 707 F.
Supp. 2d at 1036-39 (collecting cases).
The Government has thus proffered regulations and statutory authority
demonstrating that the proximate cause of Plaintiffs' injury - the SEC's ultimate non
intervention
was within the scope of activity clearly committed to SEC discretion. The DFE
applies when "discretion intervenes between an alleged government wrongdoer and the harm
suffered by a plaintiff," even if the wrongdoer violated a mandatory duty. General Dynamics
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Corp. v. United States, 139 F.3d 1280, 1285 (9th Cir. 1998). The General Dynamics court held
that a plaintiff cannot avoid the DFE's protection of pro secutorial conduct by targeting
underlying conduct. The existence of intervening discretion between the underlying disregard of
a mandatory duty and a plaintiffs injury defeats an attempt to artfully plead around the DFE. Id.
at 1283-84. Here, Plaintiffs have failed to identify any underlying disregard of a mandatory duty,
and, even if they had, it would have been necessary for the SEC, in its discretion, to decide how
to proceed had the underlying investigative conduct yielded different information or conclusions.
Susceptibility to Policy Analysis
With respect to the second prong of the Gaubert/Berkovitz standard, Plaintiffs
contend that none of the conduct of which they complain was grounded in "legitimate policy
considerations." Indeed, Plaintiffs refer to findings in the OIG Report that investigative action
and inaction was undertaken based on jealousy, secrecy, laziness, inexperience, and, in some
instances, for reasons that are to this day inexplicable. However, the proper "focus of the inquiry
is not on the agent's subjective intent in exercising the discretion conferred by statute or
regulation, but on the nature of the actions taken and on whether they are susceptible to policy
analysis." Gaubert, 499 U.S. at 325. The individual actors' motivations are thus insufficient to
defeat the DFE. The Court looks, instead, at the general nature of the conduct at issue. The
conduct at issue here clearly relates to discretionary decisions that are susceptible to policy-based
analysis
~,following
one lead versus another, deciding which complaints to pursue and how.
Courts are ill-suited to oversee the decisions of the SEC precisely because of their inherent
policy-oriented nature, often involving considerations of resource allocation and opportunity
costs. See Bd. of Trade of Chicago v. SEC, 883 F.2d 525, 531 (7th Cit. 1989). The DFE
MOLCHATSKY~1TD< WPD
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protects the agency's ability to exercise properly the full scope of its discretion by insulating
fyom civil litigation even those discretionary decisions that were, improperly, actually made for
inappropriate reasons, Indeed, the DFE expressly provides that it applies to claims "based upon
the exercise or perfOlmance or the failure to exercise or perfonn a discretionary function or duty
on the part of a federal agency or an employee of the Government whether or not the discretion
involved be abused." 28 U.S.C.A. § 2680(a) (West 2006) (emphasis supplied).
The Court also recognizes that the FTCA's legislative history indicates that, when
drafting and debating the statute, members of Congress repeatedly indicated that the DFE was
intended to apply to the SEC. See United States v. S.A. Empresa De Viacao Area Rio Grandense
(Varig Airlines), 467 U.S. 797, 809-10 (1983) (noting that, when Assistant Attorney General
Francis M. Shea appeared before the House Committee and described the discretionary function
exception as "highly important," he stated that «[The DFE is] designed to preclude application of
the act to a claim based upon an alleged abuse of discretionary authority by a regulatory or
licensing agency-for example, the ... Securities and Exchange Commission .... It is neither
desirable nor intended that the ... the propriety of a discretionary administrative act should be
tested through the medium of a damage suit for tort."); Dalehite v. United States, 346 U.S. 15,
29, n.21 (1953) (legislative record illustrates that the DFE was explicitly designed to preclude
suit against the SEC).
Plaintiffs' Request for Jurisdictional Discovery
A party seeking jurisdictional discovery, like a party seeking other kinds of
discovery, bears the burden of showing necessity. When a plaintiff in an FTCA suit alleges facts
showing sufficient reason to believe mandatory guidelines have been disregarded, but that such
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I
I
!
guidelines are unknown or unknowable without discovery, courts have granted jurisdictional
I
discovery. See Ignatiev, 238 F.3d at 467. A plaintiff is not, however, entitled to jurisdictional
discovery if it cannot show that the requested discovery is "likely to produce the facts needed to
withstand a Rule 12(b)(1) motion." Freeman, 556 F.3d at 342-43 (collecting cases and holding
that this rule is particularly apt in the context of a FTCA suit where a plaintiff is "attempting to
disprove the applicability of an immunity-derived bar to suit because immunity is intended to
shield the defendant from the burdens of defending the suit, including the burdens of discovery")
(citing Williamson v. United States Dep't of Agric., 815 F.2d 368,382 (5th Cir. 1987)).
In Ignatiev, where the claim arose from alleged failures of the Secret Service to
provide appropriate protection for a foreign embassy, the plaintiff demonstrated, based on a
specific passage in the United States Code, that there was reason to believe relevant mandatory
guidelines existed, because the Secret Service's statutory mandate made specific mention of
perfonning duties as may be "prescribe[d]." Id. Because the very nature ofthe Secret Service's
mission leads logically to confidentiality of the rules and duties that govern its conduct, plaintiffs
would "have no way to know what mandatory policies may bind the Secret Service." 238 F.3d at
467. Here, by contrast, Plaintiffs have identified no statutory or regulatory provision that
suggests the existence of prescriptive rules for the conduct of SEC investigations, and there is no
reason to believe that infonnation concerning any such duties would not be publicly available.
Indeed, the public availability of the extensive OIG Report upon which Plaintiffs rely heavily,
and of the SEC's current Enforcement Manual, suggest that Plaintiffs are not likely to uncover
hidden mandatory rules through discovery.
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Plaintiffs' request for jurisdictional discovery is, accordingly, denied. 9
CONCLUSION
For the foregoing reasons, Defendant's motion to dismiss the Complaint is
granted. This Opinion and Order resolves docket entry no. 5. The Clerk of Court is respectfully
requested to enter judgment dismissing the Complaint for lack of subject matter jurisdiction and
9
Plaintiffs also request that the Court convert the instant motion into one for
summary judgment because the facts relating to jurisdiction are intertwined with the
facts relevant to the underlying merits. In light of the Court's determinations
regarding jurisdictional discovery and the parties' respective burdens in connection
with this motion practice, this request is also denied.
Plaintiffs also argue that they are entitled to jurisdictional discovery because their
Freedom ofInformation Act ("FOrA") request was improperly rebuffed. Plaintiffs'
contend that the SEC improperly objected to the request on the bases of overbreadth
and the law enforcement exemption to FOrA. See Pis.' Sur-Reply Mem. of Law in
Opp. to Def.'s Mot. to Dismiss 8; Decl. of Howard R. Elisofon in Supp. of Pis. '
Opp. to Def.'s Mot. to Dismiss ("Elisofon Decl.") Ex. C. The SEC's overbreadth
objection was made in response to Plaintiffs' request for a broad range of materials
that encompassed potential policies (see, e.g., Elisofon DecL Ex. A at 2, seeking
from the SEC, inter alia, "Any written eommunications or documents concerning
any manuals, policies, procedures, practices, rules, regulations, directives, orders,
instructions or customs concerning the conduct by the SEC of audits, inquiries or
other investigations ofbroker/dealers, investment advisory firms, or hedge funds.").
The SEC's law-enforcement privilege objection appears to have been made in
response to Plaintiffs' request for specific Madoff-related investigation files (see
Elisofon Decl. Ex. B).
Whatever merit Plaintiffs' arguments may have with respect to FOIA compliance,
however, Plaintiffs have not made the showing necessary to warrant jurisdictional
discovery in this action. Given the nature of the SEC's mission and public
disclosures of materials, its objections to Plaintiffs' FOIA requests are insufficient to
demonstrate that any relevant policies are unknown and unknowable without
discovery. Cf. Ignatiev, 238 F.3d at 467.
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I.
!
I
close this case.
SO ORDERED.
Dated: New York, New York
Apri119,2011
~RSWAIN
United States District Judge
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