Dichter-Mad Family Partners v. United States

FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

DICHTER -MAD FAMILY PARTNERS, No. 11-55577

LLP; PHILIP JAY DICHTER ; CLAUDIA

GVIRTZMAN DICHTER ; RICHARD M. D.C. No.

GORDON , 2:09-cv-09061-

Plaintiffs-Appellants, SVW-FMO

v.

OPINION

UNITED STATES OF AMERICA ,

Defendant-Appellee.

Appeal from the United States District Court

for the Central District of California

Stephen V. Wilson, District Judge, Presiding

Argued and Submitted

January 10, 2013—Pasadena, California

Filed January 28, 2013

Before: Stephen Reinhardt, Kim McLane Wardlaw,

and Richard A. Paez, Circuit Judges.

Per Curiam Opinion

2 DICHTER -MAD FAMILY PARTNERS V . UNITED STATES

SUMMARY*

Federal Tort Claims Act

The panel affirmed the district court’s dismissal of an

action alleging claims under the Federal Tort Claims Act.

The panel held that the district court correctly concluded

that it lacked jurisdiction to entertain appellants’ claims

because they fell within the “discretionary function”

exception to the United States’ waiver of sovereign immunity

in the Federal Tort Claims Act. The panel affirmed the

district court’s judgment of dismissal for lack of subject

matter jurisdiction, and adopted Parts I through V of the

district court’s April 20, 2010 opinion, Dichter-Mad Family

Partners, LLP v. United States, 707 F. Supp.2d 1016 (C.D.

Cal. 2010). The panel also held that the additional allegations

made in the Second Amended Complaint were insufficient to

overcome the discretionary function exception to the Act’s

waiver of sovereign immunity. Finally, the panel held that

the district court did not abuse its discretion in denying

appellants’ request for additional discovery.

COUNSEL

Richard H. Gordon (argued), Beverly Hills, California and

Philip J. Dichter, Malibu, California, for Appellants.

*

This summary constitutes no part of the opinion of the court. It has

been prepared by court staff for the convenience of the reader.

DICHTER -MAD FAMILY PARTNERS V . UNITED STATES 3

Sparkle Sooknanan (argued), Lindsey Powell, Mark B. Stern,

and Tony West, United States Department of Justice,

Washington, D.C.; and André Birotte, Jr., United States

Attorney, Los Angeles, California, for Appellee.

OPINION

PER CURIAM:

After careful de novo review of the record in this appeal,

we conclude that the district court correctly concluded that it

lacked jurisdiction to entertain Appellants’ claims because

they fall within the “discretionary function” exception to the

United States’ waiver of sovereign immunity in the Federal

Tort Claims Act. 28 U.S.C. § 2680(a). Thus, we affirm the

district court’s judgment of dismissal for lack of subject

matter jurisdiction and adopt Parts I through V of the district

court’s comprehensive and well-reasoned April 20, 2010

opinion, Dichter-Mad Family Partners, LLP v. United States,

707 F. Supp. 2d 1016 (C.D. Cal. 2010), as our own, and

attach it to this opinion as an Appendix.

We further hold, as the district court also concluded in an

unpublished order dismissing Appellants’ claims with

prejudice, that the additional allegations made in the Second

Amended Complaint1 are insufficient to overcome the

discretionary function exception to the Federal Tort Claims

Act’s waiver of sovereign immunity. Virtually all of the

newly alleged mandatory duties are not in fact mandatory

1

The duties alleged in the Second Amended Complaint are taken from

the SEC Enforcement Manual, which the district court ordered the

government to produce.

4 DICHTER -MAD FAMILY PARTNERS V . UNITED STATES

directives that would deprive the United States of its

discretionary function immunity. See Terbush v. United

States, 516 F.3d 1125, 1138 (9th Cir. 2008); Sabow v. United

States, 93 F.3d 1445, 1453 (9th Cir. 1996) (“[T]he presence

of a few, isolated provisions cast in mandatory language does

not transform an otherwise suggestive set of guidelines into

binding agency regulations.”). Those policies that are

arguably mandatory lack the causal relationship to the

plaintiffs’ alleged injuries required to establish jurisdiction,

even under a generous reading of the complaint. “Where, as

here, the harm actually flows from the prosecutor’s exercise

of discretion, an attempt to recharacterize the action as

something else must fail.” Gen. Dynamics Corp. v. United

States, 139 F.3d 1280, 1286 (9th Cir. 1998).

Finally, the district court did not abuse its discretion in

denying Appellants’ request for additional discovery. “As we

have explained, ‘broad discretion is vested in the trial court

to permit or deny discovery, and its decision to deny

discovery will not be disturbed except upon the clearest

showing that denial of discovery results in actual and

substantial prejudice to the complaining litigant.’” Hallett v.

Morgan, 296 F.3d 732, 751 (9th Cir. 2002) (alteration

omitted) (quoting Goehring v. Brophy, 94 F.3d 1294, 1305

(9th Cir. 1996)). A plaintiff seeking discovery must allege

“enough fact to raise a reasonable expectation that discovery

will reveal” the evidence he seeks. Bell Atlantic Corp. v.

Twombly, 550 U.S. 544, 556 (2007); see also Gager v. United

States, 149 F.3d 918, 922 (9th Cir. 1998) (“It is

well-established that the burden is on the party seeking to

conduct additional discovery to put forth sufficient facts to

show that the evidence sought exists.”) (internal quotation

marks and alterations omitted). The district court’s reasoned

DICHTER -MAD FAMILY PARTNERS V . UNITED STATES 5

finding that the plaintiffs failed to meet this burden was a

proper exercise of its discretion. See Hallett, 296 F.3d at 751.

AFFIRMED.

6 DICHTER -MAD FAMILY PARTNERS V . UNITED STATES

APPENDIX

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 1 of 79 Page ID #:734

1

2

3

4

5

6

7

UNITED STATES DISTRICT COURT

8

CENTRAL DISTRICT OF CALIFORNIA

9

10

DICHTER-MAD FAMILY PARTNERS, LLP; ) CV 09-9061 SVW (FMOx)

11 PHILIP DICHTER; CLAUDIA GVIRTZMAN )

DICHTER; and RICHARD H. GORDON, ) ORDER GRANTING DEFENDANTS’

12 ) MOTIONS TO DISMISS FOR LACK OF

) JURISDICTION [6,7]

13 Plaintiffs, )

)

14 v. )

)

15 UNITED STATES OF AMERICA; )

SECURITIES EXCHANGE COMMISSION, )

16 and Does 1-10, )

)

17 Defendants. )

)

18

19

20 I. INTRODUCTION

21

22 A. BACKGROUND

23 Plaintiffs were investors in Bernard Madoff’s Ponzi scheme.1

24 Plaintiffs are bringing a Federal Tort Claims Act (“FTCA”) action

25

26

1

The plaintiffs are:

27 -Dichter-Mad Family Partners, LLP (a Florida partnership represented

by attorney Philip Dichter, an investor in the partnership),

28 -Philip Dichter (who is a lawyer representing himself),

-Claudia Gvirtzman Dichter (represented by Philip Dichter), and

-Richard M. Gordon (who is a lawyer representing himself).

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 2 of 79 Page ID #:735

1 against the Securities and Exchange Commission (“SEC”) and the United

2 States (“Government” or “Defendant”). Plaintiffs assert that the SEC

3 “owes a duty of reasonable due care to all members of the general

4 public including all investors in U.S. financial markets who are

5 foreseeably endangered by its conduct.” (Compl. ¶ 163.) Plaintiffs

6 also assert that the SEC’s negligent acts and omissions “caused

7 Madoff’s scheme to continue, perpetuate, and expand,” and that the SEC

8 “fail[ed] to terminate Madoff’s Ponzi scheme despite its multiple

9 opportunities to do so.” (Compl. ¶ 2; see also Compl. ¶ 164.)

10 Plaintiffs further assert that “Plaintiffs here were among those

11 victimized by Madoff. Plaintiffs made their investments in reliance on

12 Madoff’s reputation, clean regulatory record, and the SEC’s implied

13 stamp of approval.” (Compl. ¶ 8.) Because of the SEC’s alleged

14 negligence, Plaintiffs seek to recover their losses from their

15 investments with Madoff.

16 Defendants have brought a pair of Motions to Dismiss, arguing that

17 the Court lacks jurisdiction to hear the claims under the FTCA, 28

18 U.S.C. § 2674 et seq. Under the “discretionary function exception” to

19 the FTCA, federal courts are barred from adjudicating tort actions

20 arising out of federal officers’ discretionary acts. 28 U.S.C. §

21 2680(a). In brief, officers are only liable if (1) the officers’

22 actions were prescribed by statute, regulation, or policy, or (2) the

23 officers’ conduct was not susceptible to analysis on social, economic,

24 or political policy grounds. See United States v. Gaubert, 499 U.S.

25 315, 322 (1991). 2

26

2

27 There are, of course, various other requirements and exceptions in the

FTCA. This brief summary only relates to the matter at issue here — the

28 discretionary function exception.

2

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 3 of 79 Page ID #:736

1 The Complaint contains over fifty pages of allegations summarizing

2 the SEC’s failure to uncover Madoff’s fraud. The Complaint also

3 attaches five exhibits, the most substantial of which is the SEC Office

4 of Inspector General’s 450-page Investigation of Failure of the SEC to

5 Uncover Bernard Madoff’s Ponzi Scheme - Public Version [hereinafter

6 “the Report”], which was released in August 2009. (Compl., Ex. A.)3

7 Plaintiffs purport to adopt the “factual allegations or determinations

8 made in the report” by “fully incorporat[ing] by reference” the Report

9 as a part of the Complaint. (Compl. ¶ 1 n.3.) This request is

10 technically impermissible under Fed. R. Civ. P. 10(c), which only

11 permits the incorporation of a legally operable “written instrument”

12 such as a contract, check, letter, or affidavit. See, e.g., Rennie &

13 Laughlin, Inc. v. Chrysler Corp., 242 F.2d 208, 209 & n.209 (9th Cir.

14 1957); see also Wright & Miller, 5A Federal Practice & Procedure § 1327

15 n.1 (3d ed. 2009 update). In contrast, items such as “newspaper

16 articles, commentaries and editorial cartoons” are not properly

17 incorporated into the complaint by reference. Perkins v. Silverstein,

18 939 F.2d 463, 467 n.2 (7th Cir. 1991); see also Wright & Miller, 5A

19 Federal Practice & Procedure § 1327 n.2.

20 That said, Defendants have not objected to Plaintiffs’ attempt to

21 incorporate the Report by reference into the Complaint. (See generally

22 Defs.’ Motion; Defs.’ Reply.) Additionally, Fed. R. Civ. P. 8(e)

23 requires the Court to “construe[] pleadings so as to do justice.” In

24 order for the Court to comply with Rule 8(e) and give Plaintiffs the

25 benefit of any plausible inferences contained in the Report (as

26

27

3

This Order refers to the Office of Inspector General’s report as “the

28 Report,” and pin-citations to the Report are abbreviated as “Ex. A.”

3

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 4 of 79 Page ID #:737

1 Plaintiffs repeatedly urged the Court to do, see, e.g. Compl. ¶ 1 n.3,

2 Sur-reply at 5 n.1), the Court has reviewed the full Report and treats

3 it as though it were fully included in Plaintiffs’ Complaint. Although

4 this is an unusual procedure, there is clear legal authority permitting

5 the Court to do so: Plaintiffs’ Complaint “reference[s]” the Report

6 “extensively,” and the factual allegations contained in the Report are

7 “integral to [their] claim.” United States v. Ritchie, 342 F.3d 903,

8 908 (9th Cir. 2003) (citations omitted). Thus, it is appropriate in

9 this particular instance to consider the Report as part of Plaintiffs’

10 allegations for purposes of the present Motion to Dismiss.

11 Although the inclusion of the Report results in an unusually long

12 Complaint, the Ninth Circuit has counseled that an overly detailed

13 complaint is acceptable under Fed. R. Civ. P. 8(a) if, for example, it

14 is “organized, [and is] divided into a description of the parties, a

15 chronological factual background, and a presentation of enumerated

16 legal claims, each of which lists the liable Defendants and legal basis

17 therefor.” Hearns v. San Bernardino Police Dept., 530 F.3d 1124, 1132

18 (9th Cir. 2008). In the present case, both the Complaint and the

19 Report satisfy these criteria. Accordingly, because the Report is both

20 attached to and incorporated-by-reference into the Complaint, it is

21 properly considered on the Motion to Dismiss. (See also infra Part

22 III.A.)

23 Many of Plaintiffs’ allegations (including the factual averments

24 contained in the Report) identify decisions that, in hindsight, could

25 have and should have been made differently. Other allegations reveal

26 the SEC’s sheer incompetence in regulating Madoff’s broker-dealer,

27 market-making, and investment-management operations. What is lacking

28

4

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 5 of 79 Page ID #:738

1 in the present Complaint, however, is any plausible allegation

2 revealing that the SEC violated its clear, non-discretionary duties, or

3 otherwise undertook a course of action that is not potentially

4 susceptible to policy analysis.

5 B. FACTUAL ALLEGATIONS

6 The facts of the Madoff fraud need little introduction. A

7 thorough summary of Madoff’s operations can be found in the recent

8 decision In re Bernard L. Madoff Inv. Secs. LLC, 424 B.R. 122, 127-32

9 (Bkrtcy. S.D.N.Y. 2010) (order affirming trustee’s determination of

10 former investors’ net equity).

11 In the present case, Plaintiffs’ central allegations are largely

12 drawn from the Inspector General’s Report, which Plaintiffs have

13 incorporated by reference into the Complaint. (Compl. ¶ 1 n.3.) The

14 Complaint alleges the following.

15 The first warning sign of Madoff’s fraud came in 1992, when

16 Avellino & Bienes, a firm that invested exclusively through Madoff’s

17 brokerage, was exposed as a Ponzi scheme. (Compl. ¶¶ 29-40; Ex. A at

18 42-61.) Plaintiffs explain that the SEC’s investigators were “woefully

19 inexperienced” in the area of Ponzi schemes (Compl. ¶ 32) and failed to

20 obtain trading records from the Depository Trust Corporation that could

21 have revealed that Madoff’s operations were fraudulent. (Compl. ¶¶ 35,

22 37.) Because the SEC was focused on Avellino & Bienes rather than

23 Madoff, the SEC staff failed to make a number of other “common sense”

24 inquiries into Madoff’s operations that “should have” been done.

25 (Compl. ¶¶ 34, 37, 39.)

26 The second warning sign came in May 2000, when industry analyst

27 Harry Markopolos provided an eight-page complaint to the Boston SEC

28

5

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 6 of 79 Page ID #:739

1 office. (Compl. ¶¶ 42-46; Ex. A at 61-67.) The complaint provided

2 evidence “questioning the legitimacy of Madoff’s reported returns.”

3 (Compl. ¶ 42.) Markopolos presented his findings to an unqualified

4 senior staff member (Compl. ¶ 44), and although the staffer stated that

5 he forwarded the matter to the New York office, he did not actually do

6 so. (Compl. ¶ 45.)

7 The third warning sign came in March 2001, when Markopolos

8 submitted a second complaint to the Boston office containing new,

9 simplified information. (Compl. ¶¶ 47-50; Ex. A at 67-74.) This time,

10 the matter was forwarded to New York, but “after just one day” the lead

11 enforcement attorney in New York “rejected it out of hand.” (Compl. ¶

12 49.) Although Markopolos’s complaint was more detailed than the

13 average complaint, the attorney wrote a short email stating “I don’t

14 think we should pursue this matter further.” (Compl. ¶¶ 49-50.)4

15 The fourth warning sign came in May 2001, when industry

16 publications MARHedge and Barron’s published articles discussing the

17 secrecy of Madoff’s operations and the improbability of his

18 consistently strong returns. (Compl. ¶¶ 51-57; Ex. A at 74-77, 80-81,

19 86.) An SEC staff member in the Boston office asked the New York team

20 reviewing Markopolos’s complaint if they were interested in reading the

21 articles. (Compl. ¶ 55.) The New York team apparently did not read

22 the articles. (Id.) At the same time, the articles piqued a

23 Washington supervisor’s interest. (Compl. ¶ 56.) Although the

24

25

4

In full, the email stated: “As we discussed, after reviewing the complaint

26 received (via the [Boston office]) from Harry Markopol[o]s of Rampart

Investments about purported performance claims for funds managed by Bernard

27 Madoff, and some information about Madoff and others identified in the

complaint, I don’t think we should pursue this matter further.” (Ex. A at

28 72.)

6

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 7 of 79 Page ID #:740

1 supervisor wrote a note on the article stating that “[t]his is a great

2 exam[ination] for us!,” no further actions were taken in the Washington

3 office. (Compl. ¶ 56; Ex. A at 86.)

4 The first major investigative event came in May 2003, when a hedge

5 fund manager provided a complaint to the SEC’s Office of Compliance

6 Inspections and Examinations in Washington D.C. (Compl. ¶¶ 58-81; Ex.

7 A at 77-145.) The fund manager’s complaint summarized a number of red

8 flags that suggested that Madoff was running a Ponzi scheme. (Compl. ¶

9 59.) The Investment Management team in Washington, which was more

10 qualified to handle an investigation into a Ponzi scheme, referred the

11 matter to the Washington office’s Broker-Dealer team. (Compl. ¶¶ 61-

12 62.) The two teams never conferred on the investigation. (Compl. ¶

13 62.) Compounding this failure to confer, the Broker-Dealer team

14 employed a number of inexperienced staff members at that time. (Compl.

15 ¶¶ 63-64.) One team member explained that “[a]t the time . . . we were

16 expanding rapidly,” (Compl. ¶ 63, quoting Ex. A, at 90) and various

17 staff members recalled that they received little-to-no formal training.

18 (Compl. ¶¶ 63-64.)

19 Upon receiving the case, the Washington Broker-Dealer team

20 inexplicably failed to begin its investigation for nine months and

21 failed to log its investigation into the SEC’s Super Tracking and

22 Reporting System (STARS), a computer database used to track

23 examinations. (Compl. ¶¶ 65-67; Ex. A at 85 n.54.) This failure to

24 log the investigation was consistent with the SEC’s regular practice at

25 the time. (Id.) Once the investigation commenced, the team focused

26 ///

27 ///

28

7

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 8 of 79 Page ID #:741

1 its attention on potential front-running5 – with which it was more

2 familiar — rather than a Ponzi scheme. (Compl. ¶¶ 65-67.) The team

3 created a written plan, but the plan was “too narrowly focused” (Ex. A

4 at 142) and the team did not follow through by obtaining relevant

5 information from third parties. (Compl. ¶ 70.) At one point, the

6 Broker-Dealer team drafted a letter “to the [National Association of

7 Securities Dealers] to confirm Madoff’s trading activity,” but

8 refrained from sending the letter because, according to one staff

9 member, “it would have been too burdensome and time-consuming for the

10 staff to review the documents that the [National Association of

11 Securities Dealers] would have supplied in response.” (Compl. ¶¶ 69-

12 70, paraphrasing Ex. A at 98.) Similarly, “the team failed to consult

13 the Chicago Board Options Exchange,” even though Madoff’s purported

14 options trades were being processed through it. (Compl. ¶ 74.)

15 Instead of receiving this information from third parties that “would

16 have assisted in independently verifying [Madoff’s] trading activity,”

17 the team “rel[ied] solely on verbal answers” from Madoff, which,

18 according to the Office of the Inspector General’s consultants, “is not

19 an appropriate method of examination.” (Compl. ¶¶ 70, 72, quoting Ex.

20 A at 111 n.74, 206 n.143.) The team supervisor admitted that it was

21 “asinine” for the team not to obtain a proper audit trail, which

22 Plaintiffs characterize as a “common-sense procedure” in such an

23 investigation. (Compl. ¶ 77, quoting Ex. A at 109.)

24 ///

25

26

5

Front-running is the practice in which a “broker execut[es] orders on a

27 security for its own account while taking advantage of advance knowledge of

pending orders from its customers.” (Compl. ¶ 66.) See also Black’s Law

28 Dictionary 739 (9th ed. 2009) (defining term in similar manner).

8

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 9 of 79 Page ID #:742

1 The Washington team stopped its investigation in April 2004

2 because SEC supervisors “determined that a new investigation probing

3 mutual funds was more important than following up on Madoff.” (Compl.

4 ¶ 78.) 6

At the end of the investigation, the team failed to produce a

5 final report, which according to the Report was a “critical error” that

6 later led to unnecessary duplication of efforts. (Compl. ¶ 78, quoting

7 Ex. A at 144.)

8 The second major investigation started in the Northeast Regional

9 (New York) Office in April 2004, just as the Washington investigation

10 was being put on indefinite hold. (Compl. ¶¶ 82-109.) The New York

11 investigation was prompted by the SEC’s discovery of internal emails

12 from a hedge fund that had invested with Madoff through a feeder fund

13 that invested directly in Madoff’s funds. Upon conducting due

14 diligence, the hedge fund had decided to withdraw its investments from

15 the Madoff feeder fund. (Compl. ¶¶ 82-83.) The emails summarized the

16 investor’s concerns about Madoff’s activities, and essentially tracked

17 the issues raised in the Markopolos reports and the articles that had

18 appeared in MARHedge and Barron’s. (Compl. ¶¶ 83-84.)

19 The New York investigation proceeded in a similar manner as the

20 Washington investigation. (Compl. ¶ 86.) The case was transferred

21 from an Investment Management team to an ill-equipped Broker-Dealer

22 team; the Broker-Dealer team was not even assembled for seven months,

23 and did not begin working for yet another three months; and, once the

24 investigation commenced, the Broker-Dealer team never consulted the

25

26 6

One examiner later wrote that “[i]n early 2004, [the Office of Compliance

Inspections and Examinations] made it a priority to examine mutual funds’

27 undisclosed payments to broker-dealers,” (Ex. A at 125, quoting July 1, 2009

letter from Lori Richards to Inspector General David Kotz), and contemporary

28 records confirm this. (Ex. A at 125-26.)

9

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 10 of 79 Page ID #:743

1 Investment Management team for guidance and advice. (Compl. ¶¶ 86,

2 88.) Unlike the team that conducted the Washington investigation, the

3 New York Broker-Dealer team failed to even draft a planning memorandum,

4 let alone follow it. (Compl. ¶ 87.) When conducting the

5 investigation, the team accepted Madoff’s assertions at face value,

6 even though they knew or should have known that Madoff was lying – for

7 example, by saying that he was no longer trading options (which was

8 contradicted by readily available records, see Ex. A at 172, 207) and

9 that he was satisfied with foregoing hundreds of millions of dollars in

10 potential management fees and receiving only brokerage commissions

11 instead. (Compl. ¶¶ 90-92.) The team focused its investigation on

12 their own area of expertise (front-running and “cherry-picking”7), while

13 ignoring other potential areas of investigation such as looking for a

14 Ponzi scheme. (Compl. ¶¶ 88-89.)8 They generally failed to corroborate

15 information with third parties or follow up on red flags such as

16 Madoff’s auditor’s conflict of interest and obvious inadequacy to audit

17 a complex operation like Madoff’s. (Compl. ¶¶ 94-96.)

18 In spite of these failings, the New York investigation came

19 remarkably close to uncovering Madoff’s fraud in June 2005. The team

20 conducted a two-to-three month on-site investigation (see Ex. A at 179)

21

7

22 “[C]herry-picking is generally a scheme in which trades, once they

are determined to be favorable, are allocated to a favored account at

23 the expense of other accounts.” (Ex. A at 146 n.92.)

24 8

One of the investigators explained that he interpreted the initial

complaint and referral as suggesting that the investigation “focus

25 exclusively on whether Madoff was using his market making capability to

cherry pick trades or to front run market making trades for the benefit of

26 his hedge fund clients.” (Ex. A at 167, paraphrasing testimony of John

Nee.) Another team members explained that “he focused on abusive trading

27 practices rather than the other issues raised in the [referral] e-mail, in

part, because order leakage was a prominent issue at the time of the

28 examination.” (Ex. A at 168, paraphrasing testimony of Robert Sollazzo.)

10

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 11 of 79 Page ID #:744

1 and had a formal interview with Madoff in late May (Ex. A at 193-95).

2 Embarrassingly for the SEC, it was during the May meeting that the New

3 York team first learned — from Madoff himself — about the prior

4 Washington investigation. (Compl. ¶¶ 102-04.) Shortly after the

5 interview, the examiners decided that they should contact Madoff’s

6 clients to corroborate his trading activity. (Ex. A at 219-21.) The

7 investigators successfully obtained useful information from one

8 relevant third party (Barclays), but they failed to follow up on it

9 because of a mistaken belief that they could not obtain audit-trail

10 data from Barclays’s foreign affiliates. (Compl. ¶ 101.) Another

11 staffer stated that, to his understanding, SEC had a general policy of

12 not contacting third parties to follow up on leads. (Compl. ¶ 100.)

13 The team also planned on requesting written responses to follow-up on

14 their face-to-face meeting with Madoff, but ultimately failed to do so,

15 even though they had drafted such an inquiry letter. (Compl. ¶ 108;

16 Ex. A at 203-04.)

17 When the New York investigators finally suggested conducting on-

18 site visits of Madoff’s clients, the team supervisor vetoed the

19 suggestion. (Compl. ¶¶ 97-99.) A Washington investigator had

20 explained that he “was hesitant to make trouble for someone so ‘well

21 connected’” (Compl. ¶ 97, quoting Ex. A at 194), and the New York

22 supervisor “expressed a fear that he (and the junior staffers) could be

23 sued as individuals if their inquiries to third parties somehow damaged

24 Madoff’s business.” (Compl. ¶ 98.) Within days of the decision not to

25 visit Madoff’s clients, the New York investigators began drafting their

26 case-closing memorandum, and the case was closed by September 2005.

27 (Compl. ¶ 107.) Madoff himself believed that had the investigators

28

11

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 12 of 79 Page ID #:745

1 contacted third-party trading partners, account holders, and/or trade-

2 clearing and -settlement agencies, they would likely have exposed the

3 fraud. (Ex. A at 206-07.)

4 Almost immediately after the New York team closed its

5 investigation, Harry Markopolos provided the Boston office with a third

6 version of his report on Madoff’s alleged fraud, sparking off yet

7 another investigation in Madoff’s operations. (Compl. ¶¶ 110-146.)

8 Markopolos’s report summarized the many warning signs that Madoff was

9 running a Ponzi scheme, and referred the SEC to a handful of industry

10 insiders who could corroborate Markopolos’s suspicions. (Compl. ¶¶

11 111-16.) Markopolos even recommended that the SEC simply compare

12 Madoff’s purported over-the-counter options trading to the publicly-

13 reported information regarding exchange-based options trading. (Compl.

14 ¶ 115; see also Ex. C, at 6-7.) Markopolos explained that if Madoff

15 were truly trading in options, his high-volume trades would have a

16 visible effect in the market. (Compl. ¶ 115.).

17 The Boston office referred the matter to the New York office, and

18 emphasized to the New York staff that the report deserved close

19 attention. (Compl. ¶ 117.) The New York office, instead of staffing

20 the matter with experts in Ponzi schemes, placed relatively

21 inexperienced staff members on the case. (Compl. ¶ 118.) The

22 investigators failed to treat the matter as a Ponzi scheme

23 investigation, and generally refused to credit Markopolos’s report

24 because of interpersonal tensions (Compl. ¶¶ 119-20, 122) and a

25 misguided belief that Markopolos was seeking a reward for uncovering

26 the fraud. (Compl. ¶ 121.) The team also relied on the earlier New

27 York team’s incorrect assertion that it had in fact investigated the

28

12

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 13 of 79 Page ID #:746

1 Ponzi-scheme angle, which deterred the new team from fully following up

2 on Markopolos’s suggestions. (Compl. ¶ 123.) Additionally, because

3 the new team had failed to file a “matter under inquiry” report for two

4 months, a new tip — this time from an anonymous investor who stated

5 that he had invested with Madoff but withdrew his money when he began

6 suspecting fraud — was improperly ignored. (Compl. ¶¶ 124-25.)

7 Because the team felt outmatched by the technical aspects of Madoff’s

8 operations, they forwarded certain matters to the SEC’s Office of

9 Economic Analysis, but due to miscommunications running in both

10 directions, these efforts failed to produce useful insights. (Compl.

11 ¶¶ 128-30.)

12 The unprepared New York investigations team eventually proceeded

13 with its investigation and interviewed Madoff directly. (Compl. ¶¶

14 132-36.) At one point, the interview produced potentially

15 incriminating information — Madoff’s account number with the Depository

16 Trust Company — but the investigators failed to properly follow up on

17 the matter. (Compl. ¶¶ 136-37.) When a junior staffer contacted the

18 Depository Trust Company, the staffer failed to recognize the

19 significance of the fact that Madoff held his assets in commingled

20 accounts, and the staffer also failed to ask about the size of the

21 account. (Compl. ¶¶ 138-39; Ex. A at 323-24.) Madoff himself has

22 acknowledged that had the investigators simply asked to see the size of

23 the account, they immediately would have discovered that Madoff’s

24 trading positions were nowhere near as large as he had claimed. The

25 staff believed, based on Madoff’s representations, that the Depository

26 Trust Company account held over $2 billion of securities; in fact, the

27 account held only between $10 and $30 million. (Ex. A at 332-33.)

28

13

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 14 of 79 Page ID #:747

1 The investigators also failed to recognize the significance of the

2 fact that the National Association of Securities Dealers told them that

3 Madoff had no option positions on a particular date, even though

4 Madoff’s purported trading strategy was based on options trades.

5 (Compl. ¶ 140.) Finally, the investigators made, in the Report’s

6 description, an “inexplicable decision” not to send a letter to obtain

7 information from Madoff’s purported European counterparties. (Compl. ¶

8 141; Ex. A at 371.) The team closed the investigation in June 2006,

9 having overlooked various clear indications of Madoff’s fraud. (Compl.

10 ¶¶ 144-47.) The team also failed to follow up on possible charges

11 related to Madoff’s various misrepresentations and non-disclosures

12 during the interview and examinations. (See Ex. A at 322-23.)

13 Following that investigation, the SEC received three more tips

14 that might have uncovered the fraud. (Compl. ¶¶ 148-53.) The first

15 was dismissed when Madoff’s attorney told the SEC that the tipster was

16 not actually a Madoff client (Compl. ¶ 150); the second was yet another

17 Markopolos warning that was simply ignored because the staff believed

18 that it had fully examined the Ponzi-scheme allegations (Compl. ¶ 151;

19 Ex. A at 354-55); and the third tip (from the former Madoff investor

20 whose earlier complaint had arrived just prior to the opening of the

21 final investigation) was likewise ignored because the investigation was

22 deemed complete. (Compl. ¶¶ 152-53.)

23 More than two years after the closure of the final investigation,

24 Madoff’s fraud was exposed. (Compl. ¶¶ 154-55.) The fraud could have

25 been discovered at any number of points in the previous sixteen years

26 had the SEC “performed its everyday, non-discretionary functions with

27 the most basic level of competence.” (Compl. ¶ 158.) At various

28

14

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 15 of 79 Page ID #:748

1 points, even “a single action, performed diligently and ably, or even

2 with the most minimal competence, would have exposed the scheme.”

3 (Compl. ¶ 159.)

4

5 II. PRELIMINARY PROCEDURAL ISSUES

6

7 A. THE SECURITIES AND EXCHANGE COMMISSION IS NOT A PROPER

8 DEFENDANT

9 The three Dichter Plaintiffs (that is, the Dichter-Mad investment

10 partnership, Philip Dichter, and Claudia G. Dichter) voluntarily

11 dismissed the SEC and the Doe Defendants on January 11, 2010.

12 The SEC brings a separate Motion to Dismiss Plaintiff Gordon’s

13 claims against it. [Docket no. 7.] In its one-page motion, the SEC

14 cites clear controlling authority that bars Gordon’s claims. See,

15 e.g., FDIC v. Craft, 157 F.3d 697, 706 (9th Cir. 1998) (“The FTCA is

16 the exclusive remedy for tortious conduct by the United States, and it

17 only allows claims against the United States. Although such claims can

18 arise from the acts or omissions of United States agencies (28 U.S.C. §

19 2671), an agency itself cannot be sued under the FTCA.”); see also

20 Standifer v. SEC, 542 F. Supp. 2d 1312, 1317 (N.D. Ga. 2008) (“The SEC

21 cannot be sued under the FTCA.”)

22 In Gordon’s Opposition,9 he does not even attempt to argue that his

23

24

9

Gordon’s “Opposition” brief is 37-pages long, well above the 25-page limit

25 set by this Court. In addition, Gordon did not file his substantive brief

with this Court until March 1, which was one week later than the deadline

26 set by this Court’s Local Rules. The Court accordingly STRIKES Gordon’s

Opposition. However, as the document raises the same issues as are raised

27 in Plaintiffs’ joint Opposition and Sur-Reply (which the Court has

considered despite its procedural irregularities), the Court has addressed

28 all the issues raised in Gordon’s stricken submission.

15

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 16 of 79 Page ID #:749

1 claims against the SEC are viable. Accordingly, the SEC’s Motion is

2 GRANTED. Gordon’s claims against the SEC are DISMISSED.

3 B. THE DOE DEFENDANTS ARE PERMISSIBLE

4 As for the Doe Defendants, Gordon properly points out that the

5 Government does not necessarily have standing to object to their

6 presence. For purposes of this motion, then, the Doe Defendants’

7 liability is linked with that of the United States.

8

9 III. LEGAL STANDARDS

10

11 A. MOTION TO DISMISS FOR LACK OF SUBJECT MATTER JURISDICTION

12 In order to comply with the notice pleading standards of Fed. R.

13 Civ. P. 8(a), a plaintiff’s complaint “must contain sufficient factual

14 matter, accepted as true, to ‘state a claim to relief that is plausible

15 on its face.’” Ashcroft v. Iqbal, __ U.S. __, 129 S.Ct. 1937, 1949

16 (2009) (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007)).

17 “A claim has facial plausibility when the plaintiff pleads factual

18 content that allows the court to draw the reasonable inference that the

19 defendant is liable for the misconduct alleged.” Id. A complaint that

20 offers mere “labels and conclusions” or “a formulaic recitation of the

21 elements of a cause of action will not do.” Id.; see also Moss v. U.S.

22 Secret Service, 572 F.3d 962, 969 (9th Cir. 2009) (citing Iqbal, 129

23 S.Ct. at 1951).10

24

25 10

Although the present motion is a motion to dismiss for lack of

jurisdiction under Fed. R. Civ. 12(b)(1) rather than a motion to dismiss for

26 failure to state a claim under Fed. R. Civ. P. 12(b)(6), motions to dismiss

on jurisdictional grounds are governed by the standard pleading rules of

27 Fed. R. Civ. P. 8(a). See Doe v. Holy See, 557 F.3d 1066, 1074 (9th Cir.

2009) (per curiam) (citing Twombly, 127 S.Ct. at 1964-65), cert. filed (June

28 25, 2009). In addition, it should be noted that Twombly and Iqbal, while

16

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 17 of 79 Page ID #:750

1 Generally, the Court’s analysis is limited to the contents of the

2 complaint. See Schneider v. Cal. Dept. Of Corrections, 151 F.3d 1194,

3 1197 n.1 (9th Cir. 1998) (citations omitted). However, “[w]hen a

4 plaintiff has attached various exhibits to the complaint, those

5 exhibits may be considered in determining whether dismissal [i]s

6 proper.” Parks School of Business, Inc. v. Symington, 51 F.3d 1480,

7 1484 (9th Cir. 1995) (citation omitted). Likewise, the Court “may . .

8 . consider certain materials — documents attached to the complaint,

9 documents incorporated by reference in the complaint, or matters of

10 judicial notice — without converting the motion to dismiss into a

11 motion for summary judgment.” United States v. Ritchie, 342 F.3d 903,

12 907 (9th Cir. 2003).

13 When a motion to dismiss is granted, ordinarily “any dismissal[,]

14 . . . except one for lack of jurisdiction, improper venue, or failure

15 to join a party under Rule 19[,] operates as an adjudication on the

16 merits.” Fed. R. Civ. P. 41(b) (emphasis added).

17 B. FEDERAL TORT CLAIMS ACT

18 The Federal Tort Claims Act (“FTCA”) “gives federal courts

19 jurisdiction over claims against the United States for money damages

20 ‘for injury or loss of property, or personal injury or death caused by

21

technically brought under Fed. R. Civ. 12(b)(6), focused their analysis on

22 the notice pleading requirements of Fed. R. Civ. P. 8(a). Twombly and Iqbal

therefore state the proper standard for addressing the sufficiency of

23 Plaintiffs’ allegations with respect to the Court’s subject matter

jurisdiction.

24 In the only post-Twombly circuit court to address pleading standards

in the FTCA context, the Fifth Circuit cited Twombly as the operative

25 standard governing a jurisdictional dispute like the present one. Castro v.

United States, 560 F.3d 381, 386 (5th Cir. 2009) (citing Lane v.

26 Halliburton, 529 F.3d 548, 557 (5th Cir. 2008)). In addition, the Ninth

Circuit has explicitly applied Twombly when analyzing a complaint under the

27 discretionary function exception caselaw, but only had occasion to do so

under the Foreign Sovereign Immunities Act, not the FTCA. Doe v. Holy See,

28 557 F.3d at 1073-74, 1084-85.

17

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 18 of 79 Page ID #:751

1 the negligent or wrongful act or omission of any employee of the

2 Government while acting within the scope of his office or employment,

3 under circumstances where the United States, if a private person, would

4 be liable to the claimant in accordance with the law of the place where

5 the act or omission occurred.’” Sheridan v. United States, 487 U.S.

6 393, 398 (1988) (quoting 28 U.S.C. § 1346(b)). The FTCA provides,

7 however, that the government shall not be liable for “[a]ny claim based

8 upon an act or omission of an employee of the Government . . . based

9 upon the exercise or performance or the failure to exercise or perform

10 a discretionary function or duty on the part of a federal agency or an

11 employee of the Government, whether or not the discretion involved be

12 abused.” 28 U.S.C. § 2680(a). This statutory provision, known as the

13 “discretionary function exception,” lies at the heart of the present

14 motion. Because the FTCA is jurisdictional, it must be emphasized that

15 the present analysis is focused on jurisdictional considerations rather

16 than the merits of Plaintiffs’ Complaint.

17 C. DISCRETIONARY FUNCTION EXCEPTION

18 The discretionary function exception provides the government with

19 immunity from suit for “[a]ny claim . . . based upon the exercise or

20 performance of the failure to exercise or perform a discretionary

21 function or duty on the part of a federal agency or employee of the

22 Government, whether or not the discretion involved be abused.” 28

23 U.S.C. § 2680(a). “In this way, the discretionary function exception

24 serves to insulate certain governmental decision-making from ‘judicial

25 second guessing of legislative and administrative decisions grounded in

26 social, economic, and political policy through the medium of an action

27 in tort.’” Terbush v. United States, 516 F.3d 1125, 1129 (9th Cir.

28

18

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 19 of 79 Page ID #:752

1 2008) (quoting United States v. S.A. Empresa de Viacao Aerea Rio

2 Grandense (Varig Airlines), 467 U.S. 797 (1984)); accord Marbury v.

3 Madison, 5 U.S. (1 Cranch) 137, 170 (1803) (“The province of the court

4 is, solely, to decide on the rights of individuals, not to inquire how

5 the executive, or executive officers, perform duties in which they have

6 discretion.”).

7 Whether a given action by a government employee is protected by

8 the discretionary function exception involves a two-part inquiry.

9 First, the court must determine whether the challenged action

10 involves an “element of judgment or choice.” United States v. Gaubert,

11 499 U.S. 315, 322 (1991). If “a federal statute, regulation, or policy

12 specifically prescribes a course of action for the employee to follow,”

13 then the employee can be held liable for failing to follow the

14 prescribed directive. Id. (emphasis added).

15 Second, “even assuming the challenged conduct involves an element

16 of judgment, it remains to be decided whether that judgment is of the

17 kind that the discretionary function exception was designed to shield.”

18 Id. “Because the purpose of this exception is to prevent judicial

19 second-guessing of legislative and administrative decisions grounded in

20 social, economic, and political policy . . . , the exception protects

21 only governmental actions and decisions based on considerations of

22 public policy.” Id. at 323.

23 In assessing the second step, it is important to keep in mind that

24 “if a regulation allows the employee discretion, the very existence of

25 the regulation creates a strong presumption that a discretionary act

26 authorized by the regulation involves consideration of the same

27 policies which led to the promulgation of the regulations.” Id. at 324

28

19

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 20 of 79 Page ID #:753

1 (emphasis added). Thus, “[w]hen established governmental policy, as

2 expressed or implied by statute, regulation, or agency guidelines,

3 allows a Government agent to exercise discretion, it must be presumed

4 that the agent’s acts are grounded in policy when exercising that

5 discretion.” Id. In contrast, if the applicable statute or regulation

6 does not give the employee discretion, no presumption attaches, and the

7 court must determine whether the decisions were “of the kind” that are

8 “susceptible to policy analysis.” Gaubert, 499 U.S. at 323, 325.

9 Where there is no statute, regulation, or policy on point (either

10 conferring discretion or limiting discretion), the relevant question is

11 not whether the decision was the result of an actual policy-based

12 decision-making process. As the Ninth Circuit has repeatedly

13 explained, “we do not need actual evidence that policy-weighing was

14 undertaken.” Terbush, 516 F.3d at 1136 n.5 (citing Gaubert, 499 U.S.

15 at 324-25). Instead, “[t]he focus of the inquiry is . . . on the

16 nature of the actions taken and on whether they are susceptible to

17 policy analysis.” See Gaubert, 499 U.S. at 325 (emphasis added); see

18 also GATX/Airlog Co., 286 F.3d at 1178 (“[T]he question is not whether

19 policy factors necessary for a finding of immunity were in fact taken

20 into consideration, but merely whether such a decision is susceptible

21 to policy analysis.”); Nurse v. United States, 226 F.3d 996, 1001 (9th

22 Cir. 2000) (“the challenged decision need not actually be grounded in

23 policy considerations so long as it is, by its nature, susceptible to a

24 policy analysis.”); Childers v. United States, 40 F.3d 973, 974 n.1

25 (9th Cir. 1994) (“The application of the exception does not depend,

26 however, on whether federal officials actually took public policy

27 considerations into account. All that is required is that the

28

20

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 21 of 79 Page ID #:754

1 applicable statute or regulation gave the government agent discretion

2 to take policy goals into account.”); Lesoeur v. United States, 21 F.3d

3 965, 969 (9th Cir. 1994) (“[Appellants] argue that the discretionary

4 function exception cannot apply in the absence of a ‘conscious

5 decision.’ The statute is not so limited. . . . The language is

6 directed at the nature of the conduct, and does not require an analysis

7 of the decision-making process.”) (quoting In re Consol. United States

8 Atmos. Testing Litig., 820 F.2d 982, 988-89 (9th Cir. 1987)).

9 The Ninth Circuit has noted that “the distinction between

10 protected and unprotected decisions can be difficult to apprehend, but

11 this is the result of the nature of government actions – they fall

12 ‘along a spectrum, ranging from those totally divorced from the sphere

13 of policy analysis, such as driving a car, to those fully grounded in

14 regulatory policy, such as the regulation and oversight of a bank.’”

15 Soldano v. United States, 453 F.3d 1140, 1145 (9th Cir. 2006) (quoting

16 Whisnant v. United States, 400 F.3d 1177, 1181 (9th Cir. 2005)). This

17 distinction is drawn in part from the Supreme Court’s discussion in

18 Gaubert, in which the Court explained:

19 There are obviously discretionary acts performed by a Government

20 agent that are within the scope of his employment but not within

21 the discretionary function exception because these acts cannot be

22 said to be based on the purposes that the regulatory regime seeks

23 to accomplish. If one of the officials involved in this case

24 drove an automobile on a mission connected with his official

25 duties and negligently collided with another car, the exception

26 would not apply. Although driving requires the constant exercise

27

28

21

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 22 of 79 Page ID #:755

1 of discretion, the official’s decisions in exercising that

2 discretion can hardly be said to be grounded in regulatory policy.

3 Gaubert, 499 U.S. at 325 n.7.

4 In addition to these general principles, it should also be noted

5 that the courts have rejected “a rigid dichotomy between ‘planning’ and

6 ‘operational’ decisions and activities.” Terbush, 516 U.S. at 1130

7 (citing Gaubert, 499 U.S. at 324). The courts have likewise rejected

8 the argument that the government is per se immune when conducting

9 “uniquely governmental functions,” as such an analysis would “push the

10 courts into the ‘non-governmental’-‘governmental’ quagmire that has

11 long plagued the law of municipal corporations.” Indian Towing Co v.

12 United States, 350 U.S. 61, 64 (1955); see also United States v. Olson,

13 546 U.S. 43, 46 (2005) (reaffirming Indian Towing).

14 D. PROCEDURAL CONSIDERATIONS RELATING TO THE DISCRETIONARY

15 FUNCTION EXCEPTION

16 In deciding whether to grant Defendant’s Motion to Dismiss for

17 lack of subject matter jurisdiction, the Court “must accept as true the

18 factual allegations in the complaint.” Terbush v. United States, 516

19 F.3d 1125, 1128 (9th Cir. 2008) (citing GATX/Airlog Co. v. United

20 States, 286 F.3d 1168, 1173 (9th Cir. 2002)). “The United States bears

21 the burden of proving the applicability of the discretionary function

22 exception.” Id. (citing Prescott v. United States, 973 F.2d 696, 702

23 (9th Cir. 1992)). The government must prove that each of the allegedly

24 wrongful acts, by each allegedly negligent actor, is covered by the

25 discretionary function exception. GATX/Airlog, 286 F.3d at 1174

26 (“[W]hen determining whether the discretionary function exception is

27 applicable, ‘the proper question to ask is not whether the Government

28

22

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 23 of 79 Page ID #:756

1 as a whole had discretion at any point, but whether its allegedly

2 negligent agents did in each instance.’”) (citing In re Glacier Bay, 71

3 F.3d 1447, 1451 (9th Cir. 1995)) (alterations omitted). In examining

4 each of the government’s particular acts, “the question of how the

5 government is alleged to have been negligent is critical.” Whisnant v.

6 United States, 400 F.3d 1177, 1185 (9th Cir. 2005) (emphasis added)

7 (citing Glacier Bay, 71 F.3d at 1451). The central question is

8 whether, “at this stage of the case” — and under the standard of proof

9 applicable at this stage — “the government has [or has] not established

10 that choices exercised by government officials involved policy

11 judgments.” Prescott, 973 F.2d at 703.

12 These considerations can be summarized succinctly by reference to

13 the two-step analysis set forth in Gaubert, 499 U.S. at 322-25. The

14 government can meet its initial burden in one of two ways, and the

15 plaintiffs can respond to each showing in one of two ways.

16 First, the government may show that a statute, regulation or

17 policy confers discretion on the government actor; this gives rise to a

18 “strong presumption” that the alleged harmful act was guided by policy

19 judgment. Id. at 324. Second, the government may show that the

20 actor’s course of action was “of the kind” that is “susceptible to

21 policy analysis.” Id. at 323, 325. Either of these showings will

22 satisfy the government’s “burden of proving application of the

23 discretionary function exception.” Blackburn v. United States, 100

24 F.3d 1426, 1436 (9th Cir. 1996).

25 “[O]nce the Government met its burden, . . . the party opposing

26 [the application of the discretionary function exception] ha[s] to

27 present sufficient evidence to withstand dismissal” for lack of

28

23

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 24 of 79 Page ID #:757

1 jurisdiction. Id. Under Gaubert, the plaintiffs may meet their the

2 burden by showing either (1) that there are mandatory rules prescribing

3 the actor’s course of action, or (2) that the actor’s course of action

4 was not “of the kind” that is “susceptible to policy analysis.”

5 Gaubert, 499 U.S. at 323-25.

6 E. ILLUSTRATIVE CASELAW

7 As explained by a leading treatise, “cases under the [Federal Tort

8 Claims] Act can be roughly grouped into there categories: (1) claims

9 based upon [non-regulatory] determinations or decisions or other acts

10 of choice or judgment of government officials and administrators; (2)

11 claims based upon the regulatory activities of regulatory agencies or

12 officials; and (3) claims arising from the design or execution of

13 public works and other authorized governmental programs.” Lester S.

14 Jayson & Robert C. Longstreth, 2 Handling Federal Tort Claims, §

15 12.05[1] (2009 update).

16 “Whatever else the discretionary function exception may include, .

17 . . it plainly was intended ‘to encompass the discretionary acts of the

18 Government acting in its role as regulator of the conduct of private

19 individuals.’” Jayson & Longstreth, Federal Tort Claims, § 12.07

20 (quoting United States v. Varig Airlines, 467 U.S. 797, 813-14 (1984)).

21 That is not to say that regulatory actions enjoy blanket immunity: the

22 “uniquely government functions” approach was rejected by the Supreme

23 Court over half-a-century ago. See Indian Towing, 350 U.S. at 64. But

24 at the very least, it appears from the caselaw and secondary

25 authorities that regulatory actions are more likely to be deemed

26 “discretionary functions” than non-regulatory actions are.

27 ///

28

24

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 25 of 79 Page ID #:758

1 A leading case involving government regulators is United States v.

2 Gaubert, 499 U.S. 315 (1991). In that case, the plaintiff alleged that

3 the Federal Home Loan Bank Board and the Federal Home Loan Bank Dallas

4 branch “had been negligent in carrying out their supervisory

5 activities” following their take-over of a failing Texas savings-and-

6 loan. Id. at 318. The plaintiff, who was the chairman and largest

7 shareholder of the thrift, sought to recover the lost value of his

8 shares and the value of his personal guarantee of the corporation’s

9 debts, amounting to $100 million in total. Id. at 319-20. In

10 particular, the plaintiff alleged that the Federal Home Loan Bank

11 Dallas branch had pressured the failed thrift’s sitting officers and

12 directors to resign and then recommended their replacements. Id. at

13 319. The Dallas branch then became significantly involved in the

14 thrift’s day-to-day operations. Id. at 319-20. The plaintiff’s

15 allegations centered on the “alleged negligence of federal officials in

16 selecting the new officers and directors and in participating in the

17 day-to-day management of” the thrift. Id. at 320.

18 The Supreme Court, after restating the basic two-part test for the

19 discretionary function exception, held that “[d]ay-to-day management of

20 banking affairs, like the management of other businesses, regularly

21 requires judgment as to which of a range of permissible courses is the

22 wisest.” Id. at 325. In this regard, the Court rejected the proposed

23 distinction between “policymaking” and “operational” functions. Id.

24 In order to determine whether the alleged acts were discretionary or

25 not, the Court reviewed the complaint’s allegations of the government’s

26 involvement in the thrift’s day-to-day affairs. These allegations

27 focused on the government’s involvement in day-to-day management

28

25

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 26 of 79 Page ID #:759

1 decisions, hiring and salary decisions, operational matters, financial

2 matters, asset management, and legal affairs. Id. at 327-28. The

3 government became involved in strategic planning, for example by

4 recommending that the thrift change from being state-chartered to

5 becoming federally-chartered, and by giving advice regarding a

6 potential bankruptcy filing. Id. at 328.

7 Ultimately, the Court rejected the plaintiff’s argument “that the

8 challenged actions fall outside the discretionary function exception

9 because they involved the mere application of technical skills and

10 business expertise.” Id. at 331. The Court explained that the day-to-

11 day operations of a bank require more than mere “mathematical

12 calculations” that “involve no choice or judgment in carrying out the

13 calculations.” Id. Importantly, the Court also noted that “neither

14 party has identified formal regulations governing the conduct in

15 question.” Id. at 329 (emphasis added). The Court identified broad

16 statutory grants of discretion to the Federal Home Loan Bank to engage

17 in formal supervisory actions, and found no prohibition on the agency’s

18 use of less formal supervisory tools. Id. The Court also identified a

19 formal policy statement from the government in which the agency

20 explained its policy “that supervisory actions must be tailored to each

21 case,” ranging from “informal supervisory guidance and oversight,” to

22 implementation of a “supervisory agreement,” and, in the most

23 problematic cases, an immediate “cease-and-desist order.” Id. at 330-

24 31 (quoting FHLBB Resolution No. 82-381 (May 26, 1982)).

25 Notably, the Court approvingly quoted from the lower court’s

26 explanation that the agency undertook its day-to-day role in an effort

27 to further “social, economic, or political policies”:

28

26

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 27 of 79 Page ID #:760

1 First, they sought to protect the solvency of the savings and loan

2 industry at large, and maintain the public’s confidence in that

3 industry. Second, they sought to preserve the assets of [the

4 thrift] for the benefit of depositors and shareholders, of which

5 [plaintiff] was one.

6 Id. at 332 (quoting 885 F.2d 1284, 1290 (5th Cir. 1989)). In this

7 regard, the Supreme Court highlighted the fact that “[t]here are no

8 allegations that the regulators gave anything other than the kind of

9 advice that was within the purview of the policies behind the

10 statutes.” Id. at 333. For example, the plaintiff admitted “the

11 regulators replaced [the thrift’s] management in order to protect the

12 [federal savings and loan insurance corporation’s] insurance fund.”

13 Id. at 332.

14 “In the end,” the Court concluded, “Gaubert’s amended complaint

15 alleges nothing more than negligence on the part of the regulators.”

16 Id. at 334. The Court explained that even day-to-day regulatory

17 decisions were protected by the discretionary function exception: “If

18 the routine or frequent nature of a decision were sufficient to remove

19 an otherwise discretionary act from the scope of the exception, then

20 countless policy-based decisions by regulators exercising day-to-day

21 supervisory authority would be actionable. This is not the rule of our

22 cases.” Id.

23 Gaubert, then, is a guidepost for two reasons: one, because it is

24 the most recent Supreme Court authority in this area, and two, because

25 it involved a roughly analogous factual scenario — the conduct of

26 financial regulators in their day-to-day regulatory activities.

27 (Additional cases that specifically discuss the SEC are discussed

28

27

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 28 of 79 Page ID #:761

1 infra.) It is worth noting, then, that Gaubert’s reasoning weighs

2 heavily in favor of Defendant’s position.

3 A pair of other cases are worth discussing at length. These cases

4 set forth principles that have guided the Ninth Circuit’s analysis

5 where cases involve a combination of discretionary and non-

6 discretionary duties.

7 In Glacier Bay, the Ninth Circuit held that hydrographers for the

8 National Oceanic and Atmospheric Administration could be sued for their

9 non-discretionary actions made while preparing nautical charts. 71

10 F.3d at 1452-54. The government had argued that its supervising

11 hydrographers retained discretion when reviewing and approving the

12 charts, and that this final level of discretion immunized all of the

13 allegedly negligent conduct during the oceanic surveys and drafting of

14 the charts. Id. at 1451. The court explained that the final review

15 was indeed discretionary, because the supervisors had to decide whether

16 the survey was sufficiently accurate and whether the social, economic,

17 and political benefits of conducting further surveys outweighed the

18 costs of doing so. Id. at 1454. However, the court also determined

19 that the discretionary final review could not insulate the surveying

20 staff’s negligent acts that violated the surveyors’ mandatory duties.

21 Id. at 1451. Instead, the court explained that the relevant question

22 is whether “each person taking an allegedly negligent action had

23 discretion,” not whether “the Government as a whole had discretion at

24 any point.” Id.11

25

11

26 The court also noted, however, that the presence of a discretionary final

review might affect the merits of the claim because the plaintiff would be

27 unable to show that the negligent acts proximately caused the plaintiff’s

harm. Id. (citing Routh v. United States, 941 F.2d 853, 855 (9th Cir.

28 1991).)

28

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 29 of 79 Page ID #:762

1 The court then engaged in a close analysis of the surveyors’

2 actions to determine if they violated any non-discretionary duties.

3 Id. at 1452-54. To find these mandatory duties, the court looked to

4 “the Department of Commerce’s ‘Hydrographic Manual’ and [] the 1964 and

5 1975 Project Instructions specifically drafted for the two surveys [at

6 issue].’” Id. at 1452. The court noted that, contrary to the

7 government’s assertion, such internal guidelines were in fact “binding

8 for purposes of the discretionary function inquiry.” Id. at 1452 n.1.

9 The court found that the Hydrographic Manual and Project Instructions

10 established a number of mandatory procedures for conducting oceanic

11 surveys. Id. at 1451-52. Much of the “discretion” available to the

12 surveyors involved purely scientific judgments, not judgments based on

13 “economic, political and social policy” that would be shielded from

14 scrutiny under the FTCA. Id. at 1453. Notably, the court contrasted

15 the 1964 survey instructions with the 1975 survey instructions and

16 found that the former contained mandatory language -– “[a]ll

17 indications of shoals shall be thoroughly investigated” –- whereas the

18 latter did not contain such language, and instead stated that surveys

19 “should be guided by [27 different] considerations . . . and [the

20 surveyor’s] past experience in similar areas.” Id. at 1453 (quoting

21 Hydrographic Manual and 1964 Survey Instructions). Accordingly, the

22 earlier 1964 survey was deemed non-discretionary, whereas the 1975

23 survey — requiring surveyors to carefully balance 27 different

24 considerations – was discretionary. Id.

25 Three years later, the Ninth Circuit clarified its holding in

26 Glacier Bay, explaining that in some instances, an underlying violation

27 of a mandatory duty will be immune from suit if another government

28

29

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 30 of 79 Page ID #:763

1 agent’s own exercise of discretion intervened prior to the plaintiff’s

2 injury. The court explained that the discretionary function exception

3 applies whenever a “robust exercise of discretion intervenes between an

4 alleged government wrongdoer and the harm suffered by a plaintiff.”

5 General Dynamics Corp. v. United States, 139 F.3d 1280, 1285 (9th Cir.

6 1998). The court proceeded to distinguish the case at hand from

7 Glacier Bay. The plaintiff in General Dynamics alleged that government

8 auditors had negligently performed an audit that led prosecutors to

9 indict the plaintiff for defrauding the United States, a charge which

10 the plaintiff successfully defended. Id. at 1282. The court held that

11 the plaintiff, by attempting to recover for the auditors’ professional

12 negligence rather than the prosecutors’ clearly discretionary decision

13 to prosecute, was improperly attempting to plead around the

14 discretionary function exception. Id. at 1283-84. The court refused

15 to “accord amaranthine obeisance to a plaintiff’s designation of

16 targeted employees” when, in sum and substance, the complaint was

17 alleging prosecutorial misconduct. Id. at 1283.

18 The General Dynamics court distinguished Glacier Bay by

19 emphasizing that the central focus is the nature of the allegedly

20 harmful act. Id. at 1284-85. Obviously, “many actions within an

21 agency pass through the hands of somebody with some discretion at some

22 stage”; the mere presence of discretion at one stage in the process

23 does not automatically immunize the non-discretionary negligent conduct

24 that precedes. Id. at 1284. Accordingly, when an oceanic chart is

25 negligently investigated and drafted in violation of mandatory rules,

26 the presence of a discretionary final review does not immunize the

27 negligent investigations and drafting. Id. In this regard, the court

28

30

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 31 of 79 Page ID #:764

1 noted that Glacier Bay involved a “tight coupling between

2 hydrographers, reviewers, charts, and results.” Id. at 1284.

3 But when an actor with “broad based discretion” such as the

4 prosecutor in General Dynamics undertakes “a totally separate exercise

5 of discretion” that is independent of the underlying negligent act, all

6 of the government’s acts are immunized — including the earlier actions

7 that may have violated mandatory duties. Id. at 1285. The court

8 explained that prosecutors have “access to a great deal of information

9 beyond that submitted by any one agency” such as the negligent

10 auditors. Because “the prosecutors could have had even more

11 information if they had chosen to pursue it,” the prosecutor’s decision

12 to prosecute the plaintiff was a sufficiently “robust exercise of

13 discretion” to trigger application of the discretionary function

14 exception. Id. As a result, all of government’s negligent acts were

15 immunized — even the ones that violated non-discretionary auditing

16 principles.

17 Although they are factually distinguishable from the present case,

18 two out-of-circuit decisions are also worth noting in order to show

19 that the reasoning in General Dynamics has been adopted in other

20 circuits.12 In Sloan v. United States Dept. of Housing and Urban

21 Development, 236 F.3d 756 (D.C. Cir. 2001), a contractor sued the

22 Department of Housing and Urban Development under the FTCA for

23 negligently conducting an audit of his construction site and for

24 suspending him from government contract work based on the erroneous

25 audit. 236 F.3d at 758-59. On appeal from the district court’s

26

27

12

The summaries of these cases are drawn from Jerome Stevens Pharma., Inc.

28 v. Food & Drug Admin., 402 F.3d 1249, 1254-55 (D.C. Cir. 2005).

31

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 32 of 79 Page ID #:765

1 dismissal of the complaint for lack of subject matter jurisdiction, the

2 contractor contended that while the suspension of his government

3 contract work was a discretionary function, the audit was not a

4 discretionary function because it was governed by standards of

5 professional practice. Id. at 761. The court rejected that

6 contention, holding that there was “no meaningful way in which the

7 allegedly negligent investigatory acts could be considered apart from

8 the totality of the prosecution.” Id. (quoting Gray v. Bell, 712 F.2d

9 490, 516 (D.C. Cir. 1983)) (internal quotation marks omitted). The

10 court noted that “[t]he complaint does not allege any damages arising

11 from the investigation itself, but only harm caused by the suspension

12 to which it assertedly led.” Id. at 762.

13 In Fisher Bros. Sales, Inc. v United States, 46 F.3d 279 (3d Cir.

14 1995) (en banc), Chilean fruit growers sued the Food and Drug

15 Administration under the FTCA for banning the importation of Chilean

16 fruit based on a negligently conducted laboratory test concluding that

17 the fruit contained cyanide. 46 F.3d at 282-83. Recognizing that the

18 Commissioner’s decision to ban the fruit was a discretionary function,

19 the fruit growers alleged injury “based upon” the negligence of the

20 laboratory technicians, who were bound by the agency’s Regulatory

21 Procedures Manual. Id. at 286. The Third Circuit rejected this

22 characterization of the claim, reasoning that “[t]he reality here is

23 that the injuries of which the plaintiffs complain were caused by the

24 Commissioner’s decisions and, as a matter of law, their claims are

25 therefore ‘based upon’ those decisions.” Id. The court concluded that

26 “a claim must be ‘based upon’ the exercise of a discretionary function

27 whenever the immediate cause of the plaintiff’s injury is a decision

28

32

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 33 of 79 Page ID #:766

1 which is susceptible of policy analysis and which is made by an

2 official legally authorized to make it.” Id. at 282.

3 F. UNDERLYING POLICIES OF THE DISCRETIONARY FUNCTION EXCEPTION

4 Before analyzing the parties’ specific arguments, it is also

5 helpful to explain the policies that animate the discretionary function

6 exception. As summarized succinctly in Gray v. Bell, 712 F.2d 490

7 (D.C. Cir. 1983), cert. denied, 465 U.S. 1100 (1984):

8 The modern policy basis justifying sovereign immunity from suit

9 has three principal themes. First, and most important, under

10 traditional principles of separation of powers, courts should

11 refrain from reviewing or judging the propriety of the

12 policymaking acts of coordinate branches. Second, consistent with

13 the related doctrine of official immunity, courts should not

14 subject the sovereign to liability where doing so would inhibit

15 vigorous decisionmaking by government policymakers. Third, in the

16 interest of preserving public revenues and property, courts should

17 be wary of creating huge and unpredictable governmental

18 liabilities by exposing the sovereign to damage claims for broad

19 policy decisions that necessarily impact large numbers of people.

20 Framed in different fashions, each of these themes appears again

21 and again, alone or in combination, as a modern justification for

22 retaining a form of immunity, under the general rationale that

23 courts should not “interfere” with government operations and

24 policymaking.

25 Id. at 511 (emphasis added, internal footnotes omitted).

26 ///

27 ///

28

33

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 34 of 79 Page ID #:767

1 Notably absent from this rationale is any mention of “fairness.”

2 As explained in National Un. Fire Ins. v. United States, 115 F.3d 1415

3 (9th Cir. 1997):

4 Private actors generally must pay for the harm they do by

5 carelessness. The government’s power to tax enables it, better

6 than any private actor, to perform its conduct with reasonable

7 care for the safety of persons and property, and to spread the

8 cost over all the beneficiaries if its conduct negligently causes

9 harm. Fairness might seem to suggest that the government should

10 be liable more broadly than private actors. But at its root, the

11 discretionary function exception is about power, not fairness.

12 Id. at 1422.

13 As a result of these underlying policies and principles,

14 Plaintiffs are misguided when they argue that “there is no oversight at

15 all available to the taxpaying citizens, as well as the nation, to

16 insure that the SEC does its job.” (Opp. at 15.) This broad policy

17 argument is unavailing.

18

19 IV. ANALYSIS AND DISCUSSION

20

21 A. RELEVANT LEGISLATIVE HISTORY

22 It is often remarked that Congressional intent is particularly

23 relevant to the Federal Tort Claims Act because “no action lies against

24 the United States unless the legislature has authorized it.” E.g.,

25 Dalehite v. United States, 346 U.S. 15, 30 (1953) (collecting cases).

26 As a result, “the basic inquiry concerning the application of the

27 discretionary function exception is whether the challenged acts of a

28

34

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 35 of 79 Page ID #:768

1 Government employee - whatever his or her rank - are of the nature and

2 quality that Congress intended to shield from tort liability.” United

3 States v. S.A. Empresa de Viacao Aerea Rio Grandense (Varig Airlines),

4 467 U.S. 797, 813-814 (1984) (emphasis added).

5 It is notable, then, that Congress, when drafting and debating the

6 Federal Tort Claims Act, repeatedly and explicitly suggested that the

7 discretionary function exception was intended to apply to the SEC. See

8 Dalehite v. United States, 346 U.S. 15, 29 & n.21(1953) (noting that

9 this particular “paragraph [] appears time and again” in the

10 legislative history). Congress explained that the discretionary

11 function exception was:

12 designed to preclude application of the bill to a claim against a

13 regulatory agency, such as the Federal Trade Commission or the

14 Securities and Exchange Commission, based upon an alleged abuse of

15 discretionary authority by an officer or employee, whether or not

16 negligence is alleged to have been involved. To take another

17 example, claims based upon an allegedly negligent exercise by the

18 Treasury Department of the blacklisting or freezing powers are

19 also intended to be excepted. The bill is not intended to

20 authorize a suit for damages to test the validity of or provide a

21 remedy on account of such discretionary acts even though

22 negligently performed and involving an abuse of discretion.

23 Dalehite, 346 U.S. at 29 n. 21 (quoting H.R.Rep.No. 2245, 77th Cong.,

24 2d Sess., p. 10; S.Rep.No. 1196, 77th Cong., 2d Sess., p. 7;

25 H.R.Rep.No. 1287, 79th Cong., 1st Sess., pp. 5-6; Hearings before

26 H.Com. on Judiciary on H.R. 5373 and H.R. 6463, 77th Cong., 2d Sess.,

27

28

35

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 36 of 79 Page ID #:769

1 p. 33); see also Defs.’ Mot. at 10 & n.29 (quoting House Rep. 79-1287,

2 at 5-6).

3 B. THE GOVERNMENT HAS SATISFIED ITS THRESHOLD BURDEN BY

4 IDENTIFYING STATUTES, REGULATIONS, AND CASES DISCUSSING THE

5 SEC’S GENERAL POWERS AND DUTIES

6 In its Motion, the Government sets forth a number of general,

7 broad principles governing the SEC’s duties and functions. These legal

8 assertions establish that the alleged wrongs were done in the course of

9 the SEC’s exercise of its discretion, both in terms of conducting its

10 investigations and deciding whether or not to bring enforcement

11 proceedings. These basic conclusions are supported by statutes,

12 regulations, and caselaw. Defendant has therefore satisfied its

13 threshold burden under Gaubert of establishing that the relevant

14 statutes and regulations “allow[] the employee[s] discretion.”

15 Gaubert, 499 U.S. at 323. Accordingly, there is “a strong presumption”

16 that the alleged acts were “based on considerations of public policy,”

17 and Plaintiffs bear the burden of rebutting this presumption. Id.

18 This section discusses the Government’s threshold showing that its

19 actions were discretionary and are presumed to be susceptible to policy

20 analysis. The following section discusses Plaintiffs’ attempt to rebut

21 this strong presumption.

22 1. SEC’s Investigative Powers

23 Section 21 of the Securities and Exchange Act of 1934, codified at

24 15 U.S.C. § 78u, establishes the SEC’s investigatory powers. The

25 statute explicitly provides discretion to the SEC:

26 The Commission may, in its discretion, make such investigations as

27 it deems necessary to determine whether any person has violated,

28

36

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 37 of 79 Page ID #:770

1 is violating, or is about to violate any provision of this

2 chapter, [or] the rules or regulations thereunder, . . . and may

3 require or permit any person to file with it a statement in

4 writing, under oath or otherwise as the Commission shall

5 determine, as to all the facts and circumstances concerning the

6 matter to be investigated. The Commission is authorized in its

7 discretion, . . . to investigate any facts, conditions, practices,

8 or matters which it may deem necessary or proper to aid in the

9 enforcement of such provisions. . . .

10 15 U.S.C. § 78u(a)(1) (emphasis added).

11 Little discussion is necessary. The statute repeatedly uses

12 permissive language rather than mandatory language. The SEC has

13 discretion to decide both the timing of when it “make[s] such

14 investigations,” and the manner and scope of how to “investigate any

15 facts, conditions, practices, or matters,” whether through “a statement

16 in writing, under oath or otherwise.” Id. (emphasis added). All of

17 these decisions are framed in permissive language (“[t]he Commission

18 may . . .”) and the SEC is permitted to proceed “as it deems

19 necessary.” Id. In other words, the statute is discretionary — the

20 SEC retains discretion over when and how to conduct its investigations.

21 This leads to a strong presumption that the SEC’s actions were

22 discretionary. Gaubert, 499 U.S. at 324; see also Vickers v. United

23 States, 228 F.3d 944, 951 (9th Cir. 2000) (“[T]he discretionary

24 function exception protects agency decisions concerning the scope and

25 manner in which it conducts an investigation so long as the agency does

26 not violate a mandatory directive.”).

27

28

37

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 38 of 79 Page ID #:771

1 The SEC’s own regulations are similarly discretionary. As

2 explained in the SEC’s formal policies regarding Enforcement

3 Activities, as summarized in 17 C.F.R. § 202.5:

4 Where, from complaints received from members of the public,

5 communications from Federal or State agencies, examination of

6 filings made with the Commission, or otherwise, it appears that

7 there may be violation of the acts administered by the Commission

8 or the rules or regulations thereunder, a preliminary

9 investigation is generally made. In such preliminary

10 investigation no process is issued or testimony compelled. The

11 Commission may, in its discretion, make such formal investigations

12 and authorize the use of process as it deems necessary to

13 determine whether any person has violated, is violating, or is

14 about to violate any provision of the federal securities laws or

15 the rules of a self-regulatory organization of which the person is

16 a member or participant. . . .

17 17 C.F.R. § 202.5(a) (emphasis added). This regulation does not

18 require the SEC to conduct its investigations in any particular manner;

19 rather, the agency retains broad discretion to decide how to conduct

20 its investigations.

21 In light of this statutory and regulatory language, the courts

22 have unanimously rejected challenges to the SEC’s use of its

23 investigatory powers. In a pre-FTCA case, Justice Vinson, then a

24 member of the District of Columbia Court of Appeals, wrote an opinion

25 that, inter alia, granted official immunity to members of the SEC for

26 their investigatory activities. Jones v. Kennedy, 121 F.2d 40, 43-44

27 (D.C. Cir. 1941). In a terse discussion, the court explained:

28

38

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 39 of 79 Page ID #:772

1 the carrying out of investigations and the turning over of

2 evidence to the Attorney General for presentation to a grand jury

3 come under the authorized duties of the Commission. And likewise,

4 plaintiff has not met, in these allegations, the task of showing

5 acts which fall outside of the [SEC’s] immunity.

6 Id. at 43-44 (internal footnote omitted) (emphasis added) (citing 15

7 U.S.C. §§ 77h(e), 77s(c), 77t(b)).

8 Numerous subsequent courts have held that the SEC is immune from

9 liability for its investigative actions. In Schmidt v. United States,

10 198 F.2d 32 (7th Cir. 1952), the court applied the discretionary

11 function exception to bar a claim that the SEC was investigating a

12 corporation and publicizing its investigation for the improper purpose

13 of destroying the company. Id. at 33, 36. The court explained that

14 the SEC’s decision to institute an investigation and conduct it in a

15 particular manner “was . . . clearly within the scope of its

16 discretionary authority” under the 1934 Exchange Act. Id. at 36.

17 Nothing more was said, and nothing more needed to be said. The point

18 was — and remains to this day — “perfectly clear [] under the terms of

19 the applicable statutes.” Id.

20 The same point has been stated in subsequent cases including

21 Sprecher v. Von Stein, 772 F.2d 16, 18 (2d Cir. 1985), and other cases

22 discussed infra, subsection 3.

23 2. SEC’s Enforcement Powers

24 The SEC likewise has discretion regarding the use of its

25 enforcement powers. Under 15 U.S.C. § 78u(d)(1), the SEC has

26 discretion over decisions to seek an injunction against ongoing

27 violations of the Exchange Act:

28

39

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 40 of 79 Page ID #:773

1 Whenever it shall appear to the Commission that any person is

2 engaged or is about to engage in acts or practices constituting a

3 violation of any provision of this chapter [or] the rules or

4 regulations thereunder, . . . it may in its discretion bring an

5 action in the proper district court of the United States . . . to

6 enjoin such acts or practices. . . .

7 15 U.S.C. § 78u(d)(1) (emphasis added).

8 The SEC retains similar discretion regarding whether to seek

9 monetary relief or other injunctive relief. See § 78u(d)(3) (“the

10 Commission may bring an action in a United States district court to

11 seek . . . a civil penalty to be paid by the person who committed such

12 violation.”) (emphasis added); § 78u(d)(5) (“the Commission may seek .

13 . . any equitable relief that may be appropriate or necessary for the

14 benefit of investors.”) (emphasis added).

15 The regulations are similarly discretionary. Again under 17

16 C.F.R. § 202.5:

17 After investigation or otherwise the Commission may in its

18 discretion take one or more of the following actions: Institution

19 of administrative proceedings looking to the imposition of

20 remedial sanctions, initiation of injunctive proceedings in the

21 courts, and, in the case of a willful violation, reference of the

22 matter to the Department of Justice for criminal prosecution. The

23 Commission may also, on some occasions, refer the matter to, or

24 grant requests for access to its files made by, domestic and

25 foreign governmental authorities or foreign securities

26 authorities, self-regulatory organizations such as stock exchanges

27

28

40

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 41 of 79 Page ID #:774

1 or the National Association of Securities Dealers, Inc., and other

2 persons or entities.

3 17 C.F.R. § 202.5 (emphasis added).

4 Again, the courts are unanimous in holding that these statutory

5 powers are discretionary. In SEC v. Research Automation Corp., 521

6 F.2d 585, 590 (2d Cir. 1975), the court summarily dismissed a

7 defendant’s FTCA-based counterclaim because the SEC had discretion “to

8 institute and maintain the present [enforcement] action.”

9 The same conclusion was reached in S.E.C. v. Better Life Club of

10 America, Inc., 995 F. Supp. 167, 180 (D.D.C. 1998), aff’d, 203 F.3d 54

11 (D.C. Cir. 1999), cert. denied sub nom. Taylor v. S.E.C., 528 U.S. 867

12 (1999). In that case, a defendant in an SEC enforcement action brought

13 counterclaims for tortious interference with contract and intentional

14 infliction of emotional distress on account of its enforcement actions.

15 The court dismissed these counterclaims under the discretionary

16 function exception because “[i]nvestigation and prosecution under § 21

17 of the Securities Acts is discretionary; therefore the United States is

18 immune to these claims.” Id. at 180 (citing Board of Trade of City of

19 Chicago v. SEC, 883 F.2d 525, 531 (7th Cir. 1989)).

20 3. The Unanimous Precedent is Supported by the

21 Justifications of the Discretionary Function Exception

22 The Better Life Club court relied on an Administrative Procedures

23 Act case decided by the Seventh Circuit, Board of Trade v. SEC, 883

24 F.2d 525, 531 (7th Cir. 1989). In Board of Trade, the court refused to

25 exercise jurisdiction over two futures exchanges’ claims that SEC had

26 abused its discretion by issuing a no-action order and refraining from

27 prosecuting a competing non-exchange “system” that acted as a clearing

28

41

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 42 of 79 Page ID #:775

1 agency for options trades. The court explained that the “[r]efusal to

2 prosecute is a classic illustration of a decision committed to agency

3 discretion,” and under the Securities Exchange Act, “[i]nvestigation

4 and prosecution under § 21 are discretionary, not mandatory.” 883 F.2d

5 at 530-31. Judge Easterbrook explained at length the reasons why these

6 decisions are discretionary and involve policy judgment:

7 Doing nothing may be the most constructive use of the

8 Commission’s resources. Congress gives the SEC a budget, setting

9 a cap on its personnel. With limited numbers of staff-years, the

10 Commission must enforce several complex statutes. To do this

11 intelligently the Commissioners must assign priorities.

12 Prosecuting the System means less time for something else --

13 investigating claims of fraud in issuing new stock or conducting a

14 takeover contest, resolving disputes under the Investment Company

15 Act, and so on. Agencies may find it worthwhile to give short

16 shrift to a particular claim if the aggrieved party can file its

17 own suit (as the [plaintiff] futures markets may), for turning the

18 subject over to private litigation frees up time without

19 necessarily diminishing the enforcement of the statute. Yet even

20 when the aggrieved party cannot vindicate its own rights, as with

21 the National Labor Relations Act - indeed, even when the person

22 complaining about failure to prosecute is a defendant whose

23 business is going down the tubes - decisions about the best use of

24 the staff’s time are for the prosecutor’s judgment.

25 Courts cannot intelligently supervise the Commission’s

26 allocation of its staff’s time, because although judges see

27 clearly the claim the Commission has declined to redress, they do

28

42

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 43 of 79 Page ID #:776

1 not see at all the tasks the staff may accomplish with the time

2 released. Agencies must compare the value of pursuing one case

3 against the value of pursuing another; declining a particular case

4 hardly means that the SEC’s lawyers and economists will go twiddle

5 their thumbs; case-versus-case is the daily tradeoff. Judges

6 compare the case at hand against a rule of law or an abstract

7 standard of diligence and do not see the opportunity costs of

8 reallocations within the agency. That fundamental difference in

9 the perspectives of the two bodies is why agencies (and other

10 prosecutors) rather than courts must make the decisions on

11 pursuing or dropping claims. Resource allocation is not a task

12 governed by “law”. It is governed by budgets and opportunities.

13 Agencies “take Care that the Laws be faithfully executed” (Art.

14 II, § 3) by doing the best they can with the resources Congress

15 allows them. Judges could make allocative decisions only by

16 taking over the job of planning the agency’s entire agenda,

17 something neither authorized by statute nor part of their

18 constitutional role.

19 Id. at 531 (internal citations omitted).

20 Thus, even if the plain language of the Securities Exchange Act

21 were insufficient to bar Plaintiffs’ claims, Judge Easterbrook’s policy

22 analysis explains the various reasons that the discretionary function

23 exception applies to the SEC’s actions in the present case. Little

24 more needs to be said, except that numerous other court decisions

25 support this conclusion.

26 A large number of courts have held that SEC decisions are

27 unreviewable under the FTCA and/or the Administrative Procedures Act.

28

43

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 44 of 79 Page ID #:777

1 See, e.g., Block v. SEC, 50 F.3d 1078, 1084 (D.C. Cir. 1995) (rejecting

2 an Administrative Procedures Act action seeking to compel SEC action,

3 because “[s]o far, it appears, the Commission has found [its chosen

4 means] sufficient to induce compliance with the law. That the

5 petitioners prefer a different means of enforcement is irrelevant. . .

6 . [T]he agency alone, and neither a private party nor a court, is

7 charged with the allocation of enforcement resources.”); Sprecher v.

8 Von Stein, 772 F.2d 16, 18 (2d Cir. 1985) (claims arising out of

9 agency’s investigative operations are barred by FTCA immunity);

10 Sprecher v. Graber, 716 F.2d 968, 975 (2d Cir. 1983) (claims arising

11 out of agency’s investigative operations are barred by common law

12 immunity); Treats Intern. Ents., Inc. v. S.E.C., 828 F. Supp. 16, 18-19

13 (S.D.N.Y. 1993) (SEC’s investigative decisions are unreviewable under

14 Administrative Procedures Act); Standifer v. SEC, 542 F. Supp. 2d 1312,

15 1318 (N.D. Ga. 2008) (dismissing FTCA claims against SEC for numerous

16 reasons, including the fact that “[t]he SEC is granted broad discretion

17 by Congress to investigate possible violations of the securities laws

18 and to determine whether to bring civil or criminal actions to remedy

19 those violations.”); Leytman v. New York Stock Exchange, No. 95 CV 902,

20 1995 WL 761843, at *3 (E.D.N.Y. Dec. 6, 1995) (“Plaintiff [] seeks

21 damages from the Commission for its failure to investigate his claims

22 about the [New York Stock] Exchange’s alleged misconduct. . . . The

23 Securities Exchange Act of 1934 provides that stock exchange records

24 are subject to investigation by the [Securities and Exchange]

25 Commission ‘as the Commission . . . deems necessary or appropriate.’

26 15 U.S.C. 78q(b). The decision of whether or not to investigate a

27 stock exchange is left in the discretion of the Commission. [Under the

28

44

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 45 of 79 Page ID #:778

1 FTCA,] [e]ven if the Commission abuses that discretion, the court may

2 not intervene.”); see also Thomas Lee Hazen, 6 The Law of Securities

3 Regulation, § 16.2, at 213 n.313 (6th ed. 2010 supp.) (collecting cases

4 involving SEC and non-governmental regulatory bodies).

5 In addition, courts have repeatedly held in other contexts that

6 the conduct of regulatory investigations are immune from FTCA liability

7 unless there are mandatory directives that limit the investigators’

8 discretion to determine both the scope and the manner of the

9 investigation. See, e.g., Alfrey v. United States, 276 F.3d 557, 565-

10 66 (9th Cir. 2002) (prison guards had discretion to determine how

11 thoroughly to search prisoners’ cells); Sloan v. U.S. Dept. of Housing

12 and Urban Devel., 236 F.3d 756, 762 (D.C. Cir. 2001) (“[T]he sifting of

13 evidence, the weighing of its significance, and the myriad other

14 decisions made during investigations plainly involve elements of

15 judgment and choice.”); Vickers v. United States, 228 F.3d 944, 951

16 (9th Cir. 2000) (stating that “the discretionary function exception

17 protects agency decisions concerning the scope and manner in which it

18 conducts an investigation so long as the agency does not violate a

19 mandatory directive.”); Gen. Dynamics Corp. v. United States, 139 F.3d

20 1280, 1283-1284 (9th Cir. 1998) (government was immune under the

21 discretionary function exception where its auditors’ allegedly

22 negligent investigations provided the factual basis for the

23 prosecutor’s discretionary decision to prosecute); Sabow v. United

24 States, 93 F.3d 1445, 1452 (9th Cir. 1996) (government was immune under

25 the discretionary function exception for its investigators’ allegedly

26 tortious investigation where “the guidelines promulgated by the

27 [agency] in its investigative manual were meant to be followed at the

28

45

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 46 of 79 Page ID #:779

1 discretion of [the agency’s] investigating officers in light of the

2 specific circumstances surrounding a particular investigation.”);

3 Fisher Bros. Sales, Inc. v. United States, 46 F.3d 279, 282 (3d Cir.

4 1995) (en banc) (government was immune under the discretionary function

5 exception where laboratory technicians’ allegedly negligent

6 investigations done pursuant to mandatory guidelines provided the

7 factual basis for the Food and Drug Administration to seize allegedly

8 tainted fruit).

9 The weight and logic of this caselaw leads directly to the

10 conclusions proposed by the Government: the decisions of whether and

11 how to conduct investigations and enforcement actions are firmly lodged

12 in the SEC’s discretion.

13 4. Procedural Effect of SEC’s Statutory and Regulatory

14 Discretionary

15 As explained in Gaubert, “[w]hen established governmental policy,

16 as expressed or implied by statute, regulation, or agency guidelines,

17 allows a Government agent to exercise discretion, it must be presumed

18 that the agent’s acts are grounded in policy when exercising that

19 discretion.” 499 U.S. at 324. Because the Government has satisfied

20 this threshold burden the burden shifts to Plaintiffs to identify

21 particular acts and decisions that were either (1) mandatorily

22 prescribed by statute, regulation, or policy, or (2) were not

23 “susceptible to policy analysis.” Id. at 323, 325.

24 B. PLAINTIFFS’ BROAD ALLEGATIONS OF MISCONDUCT ARE UNAVAILING

25 At various points in their Complaint and moving papers, Plaintiffs

26 assert that the SEC violated various unidentified “[p]olicies and

27 practices,” and “common-sense.” (E.g., Compl. ¶ 12 (alleging that the

28

46

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 47 of 79 Page ID #:780

1 SEC staff “fail[ed] to follow the SEC’s clear policies and

2 practices”)).13

3 To the extent that Plaintiffs rely on conclusory allegations about

4 “policies,” “practices,” and “common-sense,” they have failed to rebut

5 Defendant’s threshold showing. Broad allegations regarding undefined

6 “policies and practices” are insufficient under clear Ninth Circuit

7 precedent. In the recent decision in Doe v. Holy See, 557 F.3d at

8 1084-85, the Ninth Circuit examined the adequacy of a plaintiff’s

9 pleadings under the discretionary function exception as articulated by

10 the Supreme Court in Gaubert.14 The court held that the complaint

11 failed to adequately allege the existence of non-discretionary duties

12 imposed on the government’s officials because it only “refer[red]

13 vaguely . . . to the [defendant’s] ‘policies, practices, and

14 procedures.’” Id. at 1084 (quoting complaint). The court explained

15 that “nowhere does [plaintiff] allege the existence of a policy that is

16 ‘specific and mandatory’ on the [defendant]. He does not state the

17 terms of this alleged policy, or describe any documents, promulgations,

18 or orders embodying it.” Id. (quoting Kennewick Irrig. Dist. v. United

19 States, 880 F.2d 1018, 1026 (9th Cir. 1989)). In addition, the alleged

20 harmful acts were plainly susceptible to policy judgment, and under

21

13

22 Plaintiffs explain that “‘policies’ refer[s] to formal or informal

policies, rules, standards, guidelines, procedures, codes, routines or other

23 directives implemented by the SEC to govern the conduct of its agents.”

(Compl. ¶ 4 n.4.) “‘Practices’ refers to common-sense standards of conduct

24 required of SEC agents in the course of exercising their duties with

reasonable due care, regardless of whether the SEC had promulgated any

25 formal or informal policies with respect to that conduct.” (Id.)

Under Gaubert, Plaintiffs’ “practices” are clearly an inadequate basis

26 for showing a mandatory SEC duty.

14

27 Technically, Doe v. Holy See involves the Foreign Sovereign Immunities Act

rather than the FTCA, but, as noted supra, the court solely examined FTCA

28 caselaw.

47

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 48 of 79 Page ID #:781

1 Circuit precedent, were “the type of discretionary judgments that the

2 [discretion function exception] was designed to protect.” Id. Because

3 of these glaring inadequacies, the court held that the discretionary

4 function exception applied.

5 Like the plaintiff in Doe v. Holy See, Plaintiffs in this case

6 largely fail to identify any mandatory “policies” or “practices” that

7 were violated in this case. (Cf. infra Part IV.C.) Plaintiffs’

8 “labels and conclusions” are insufficient to satisfy the pleading

9 requirements of Fed. R. Civ. P. 8(a)(2). See Iqbal, 129 S.Ct. at 1949

10 (quoting Twombly, 550 U.S. 544).

11 Likewise, Plaintiffs have wholly failed to identify any of the

12 SEC’s actions that were not “susceptible to policy analysis.” See

13 Gaubert, 499 U.S. at 325 (emphasis added). Their Complaint and their

14 moving papers do not contain any attempt to rebut the Government’s

15 preliminary showing that the SEC retained discretion to decide when to

16 investigate, how to investigate, and whether or not to take enforcement

17 actions. Plaintiffs attempt to recharacterize the nature of

18 Defendant’s burden, and argue that the Government bears the burden of

19 showing that the SEC’s actions were susceptible to policy analysis.

20 Plaintiffs are misguided. The Government has in fact satisfied its

21 burden: it has identified specific and discretionary statutes,

22 regulations, and caselaw-based policy arguments. See Doe v. Holy See,

23 557 F.3d at 1084-85 (where defendant identifies statutes, regulations,

24 and caselaw conferring policy-based discretion on actor, burden shifts

25 to plaintiff to identify allegations to rebut this showing).

26 Plaintiffs have failed to rebut Defendant’s showing.

27 ///

28

48

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 49 of 79 Page ID #:782

1 In light of the Government’s showing that the SEC retains broad

2 discretion to regulate securities markets through formal and informal

3 means (see supra Part III.A), the Government has sufficiently satisfied

4 its threshold burden of showing that the relevant investigative and

5 enforcement decisions were discretionary and/or susceptible to policy

6 judgments. Under Gaubert, this threshold showing creates a “strong

7 presumption” that the discretionary function exception is satisfied.

8 Gaubert, 499 U.S at 324. Plaintiffs’ conclusory allegations regarding

9 “policies and practices” fail to rebut this presumption. See Doe v.

10 Holy See, 557 F.3d at 1084-85.

11 C. PLAINTIFFS’ ARGUMENTS ABOUT MANDATORY POLICIES ARE UNAVAILING

12 In an oversized sur-reply,15 Plaintiffs attempt to satisfy their

13 burden of rebuttal by identifying five purportedly mandatory duties

14 imposed on the SEC and its staff. These are: sharing information;

15 obtaining trading records and other information from third parties;

16 hiring, training, and/or deploying qualified staff members; avoiding

17 improper personal motivations; and engaging in various administrative

18 case-management tasks.

19 As Plaintiffs themselves point out in their sur-reply, “it is

20 important to specifically identify the allegations of the Complaint

21 relating to the SEC’s violation of mandatory policies.” (Surreply at

22

23 15

The Court never granted Plaintiffs leave to file a sur-reply. Nor did the

Court grant Plaintiffs leave to file an oversized brief. In addition, the

24 sur-reply goes far beyond the scope of the arguments raised in the

Government’s Reply. Even if the Court had granted Plaintiffs leave to file

25 an oversized sur-reply, Plaintiffs would only have been allowed to address

Defendant’s specific arguments in the Reply. Plaintiffs’ sur-reply is

26 therefore procedurally improper.

It is therefore well within the Court’s discretion to strike the sur-

27 reply. However, while the Court would ordinarily strike such an improper

filing, the Court will consider the merits of Plaintiffs’ arguments in order

28 to foreclose certain of these claims in future proceedings.

49

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 50 of 79 Page ID #:783

1 5.) Yet Plaintiffs’ factual allegations (which purport to incorporate

2 the Report in its entirety) fail to support these conclusions.

3 Plaintiffs almost wholly fail to allege that SEC’s agents violated any

4 mandatory duties, and where Plaintiffs’ allegations provide an

5 inference that such mandatory duties existed, Plaintiffs’ arguments are

6 defeated by the holding in General Dynamics, 139 F.3d at 1284-85.

7 Plaintiffs therefore have failed to overcome the presumption that the

8 SEC’s investigative and enforcement decisions were discretionary.

9 Accordingly, Plaintiffs’ Complaint must be dismissed for lack of

10 subject matter jurisdiction.

11 1. Duty to Share Information

12 Plaintiffs’ Complaint alleges that SEC teams failed to coordinate

13 their investigations among themselves and with the National Association

14 of Securities Dealers and Chicago Board of Options Exchange. (Surreply

15 at 6, citing Compl. ¶¶ 37, 62, 63, 78, 86, 103, 105, 123, 128, 130,

16 131.) According to Plaintiffs, these “negligent failures to

17 communicate . . . were prohibited by law.” (Id.)

18 Plaintiffs have failed to support their assertions. Plaintiffs’

19 conclusory allegations fail to establish that SEC examiners were guided

20 by any mandatory duties requiring them to share information and

21 coordinate their activities.

22 Plaintiffs argue that Section 17 of the Securities Exchange Act of

23 1934, codified at 15 U.S.C. § 78q, imposes mandatory duties requiring

24 SEC staff to share information. The statute reads:

25

26

27

28

50

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 51 of 79 Page ID #:784

1 The Commission and the examining authorities16 shall share such

2 information [regarding securities exchanges and their members,

3 brokers and dealers, ratings organizations, and clearing

4 agencies], including reports of examinations, customer complaint

5 information, and other nonpublic regulatory information, as

6 appropriate to foster a coordinated approach to regulatory

7 oversight of brokers and dealers that are subject to examination

8 by more than one examining authority.

9 15 U.S.C. § 78q(k)(2) (emphasis added).

10 The statute clearly provides for SEC discretion. The mandatory

11 “shall” is modified by the discretionary “as appropriate.” See Sabow,

12 93 F.3d at 1452 (distinguishing between “suggestive (‘should’) [and]

13 mandatory (‘must’) terms”) (collecting cases). The statute itself

14 describes the nature of “appropriate” information-sharing: the

15 information-sharing must be “appropriate to foster a coordinated

16 approach to regulatory oversight.” 15 U.S.C. § 78q(k)(2) (emphasis

17 added). When the SEC is tasked with making decisions to “foster a

18 coordinated approach to regulatory oversight,” these decisions are

19 inherently “grounded in social, economic, and political policy.”

20 Gaubert, 499 U.S. at 323. Accordingly, the discretionary function

21 exception applies to information-sharing under § 78q(k)(2).

22 The legislative history supports this conclusion. This particular

23 subsection (formerly labeled subsection (i)) was added to the statute

24 in 1996 by the National Securities Markets Improvement Act of 1996,

25

26 16

“For purposes of this subsection, the term ‘examining authority’ means a

self-regulatory organization registered with the Commission under this

27 chapter (other than a registered clearing agency) with the authority to

examine, inspect, and otherwise oversee the activities of a registered

28 broker or dealer.” 15 U.S.C. § 78q(k)(5).

51

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 52 of 79 Page ID #:785

1 Pub.L. 104-290, § 108. It is instructive to contrast the statute’s

2 final language with the language of the original House bill. The

3 House’s bill included a complex set of reporting and coordination

4 requirements for self-regulatory organizations. See H.R. Rep. 104-622,

5 104th Cong., 2d Sess., 1996 U.S.C.C.A.N. 3877, 3877 (1996). The

6 original bill required, inter alia: annual meetings between the SEC and

7 self-regulatory organizations, § 108(a)(i)(2), periodic standardized

8 reporting requirements for the SEC and self-regulatory organizations, §

9 108(a)(i)(3), annual evaluations by an SEC-created panel,

10 § 108(a)(i)(7), and annual reports to Congress, § 108(a)(i)(8). Id.

11 These requirements were mandatory, not discretionary: the SEC and the

12 self-regulatory organizations had no flexibility in implementing these

13 clear congressional directives.

14 However, after some legislative wrangling, see H.R. Conf. Rep.

15 104-864, 1996 U.S.C.C.A.N. 3920, 3920 (1996), the House-Senate

16 conference committee stripped all of the above-mentioned requirements

17 and left intact only a few generalized requirements.17 The central

18 purpose of the final bill, as explained by the conference committee,

19 was to streamline regulation between federal and state authorities.

20 See id. at 3920-21. The purpose of the remaining portions of the bill

21 — apparently including § 108 — was “to eliminate duplication, promote

22 efficiency and protect investors.” Id. at 3921. This broad language

23 sets forth three general policy goals, the balancing of which requires

24

25

17

As part of the compromise, the revised law required that the SEC

26 coordinate its activities with the self-regulatory organizations (whereas

the old bill merely required the self-regulatory organizations to coordinate

27 their activities). Compare 15 U.S.C. § 78q(k)(2) (“The Commission and the

examining authorities shall share . . .”) with H.R. 3005, § 108(a)(4)(A) in

28 H.R. Rep. 104-622 (“The examining authorities shall share . . .”).

52

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 53 of 79 Page ID #:786

1 the SEC to make inherently discretionary judgments. See also Milton R.

2 Schroeder, The Law of Regulation of Financial Institutions, ¶ 8.06[1]

3 (2009 update) (“The Act . . . calls for information sharing between

4 authorities and the elimination of unnecessary and burdensome

5 duplication in the examination process.”); Rutherford B. Campbell, Jr.,

6 Blue Sky Laws and the Recent Congressional Preemption Failure, 22 J.

7 Corp. L. 175, 204 n.156 (1997) (“The Act . . . mandates that federal

8 authorities attempt to eliminate duplication and enhance coordination

9 and cooperation with the states as concerns the regulation of

10 brokers.”).

11 In short, the law cited by Plaintiffs is purely discretionary.

12 Under the well-established requirements of the discretionary function

13 exception, this Court cannot second-guess the SEC’s failure to

14 simultaneously accomplish all three of these competing policy goals set

15 out by Congress. The goals require policy judgment and resource

16 allocation, and are therefore subject to the discretionary function

17 exception.

18 b. Plaintiffs’ factual allegations

19 In addition to these clear statutory rules, Plaintiffs’ Complaint

20 expressly alleges that formal policies did not exist. The Report

21 (which is incorporated into the Complaint by reference) quotes one

22 staff member as stating that “there was no rule or policy about . . .

23 information-sharing at [the investigative] level between offices.”

24 (Report at 133, 198, quoting testimony of Eric Swanson.) Taking this

25 allegation as true, Plaintiffs’ Complaint directly contradicts the

26 conclusory assertions in their sur-reply.

27 ///

28

53

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 54 of 79 Page ID #:787

1 c. Summary re: duty to share information

2 Plaintiffs have therefore failed to meet their burden of

3 identifying either a mandatory duty requiring the SEC to share

4 information with other regulators, or plausible allegations that the

5 SEC’s decisions regarding information-sharing were not susceptible to

6 policy analysis. The SEC retained discretion to determine the manner

7 and scope of its investigations. See Vickers, 228 F.3d at 951 (“[T]he

8 discretionary function exception protects agency decisions concerning

9 the scope and manner in which it conducts an investigation so long as

10 the agency does not violate a mandatory directive.”).

11 2. Failing to Request Materials from Third Parties

12 Plaintiffs argue that the SEC violated “formal SEC policies” and

13 “basic auditing principles” by “repeatedly fail[ing] to request

14 materials from third parties to substantiate Madoff’s claimed trading

15 activity.” (Surreply at 8, citing Compl. ¶¶ 34-36, 67, 74, 77, 101,

16 143.) Again, Plaintiffs fail to identify any of the “formal SEC

17 policies” upon which they rely. But Plaintiffs insist that “SEC

18 staffers themselves considered it mandatory [to determine if Madoff was

19 actually making the trades he purported to be making], given one

20 staffer’s characterization of the failure to do so as ‘asinine.’”

21 (Surreply at 10, quoting Compl. ¶ 77.)

22 Plaintiffs’ arguments are not supported by their allegations. It

23 is unclear why an SEC staff member’s use of the word “asinine” provides

24 evidence of an SEC policy. “Asinine” means “unintelligent, stupid,

25 silly, [or] obstinate.” Webster’s Third New International Dictionary

26 128 (1981). “Asinine” does not mean that a person has violated a non-

27

28

54

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 55 of 79 Page ID #:788

1 discretionary legal duty; nor does “asinine” mean that the person has

2 made a decision that is not susceptible to policy judgment.

3 Plaintiffs fail to identify any other allegations that state or

4 even imply the existence of mandatory duties to obtain records from

5 third parties. In fact, the Complaint is replete with factual

6 allegations suggesting that there were no SEC policies regarding

7 requesting information from third parties. The Report quotes a former

8 SEC staff member as stating that the SEC “always” obtained Depository

9 Trust Company statements “from the firm” being investigated rather than

10 from the Depository Trust Company itself. (Ex. A at 48, quoting

11 testimony of Demetrios Vasilakis, emphasis added.) The Report also

12 quotes a supervisor as stating that “most of the time we do not send

13 out [requests for trading] confirmations and do asset verification.”

14 (Ex. A at 206, quoting testimony of Robert Sollazzo.) As a result of

15 these and other statements, the Report explained it was “common

16 practice” to rely on the firm under investigation, (Ex. A at 48), and

17 that “it was not unusual for [examiners] to rely exclusively on records

18 and data produced by the” firm being investigated. (Ex. A at 98,

19 emphasis added; see also Ex. A at 191 (noting that “it was not normal

20 practice in the exam program to reach out to entities” that centrally

21 cleared and settled trades).)

22 Because Plaintiffs’ Complaint attempts to incorporate the Report

23 in its entirety, Plaintiffs therefore allege that there was an absence

24 of mandatory duties requiring SEC staff to use specific investigative

25 techniques. Although it may have been good practice for the SEC to

26 follow up with third parties, it was not required by mandatory SEC

27 policies. (See Compl. ¶ 35, citing Ex. A, at 290 n.202.)

28

55

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 56 of 79 Page ID #:789

1 Plaintiffs have therefore failed to plead facts that overcome the

2 discretionary function exception. The statutes, regulations, and

3 caselaw discussed supra establish beyond peradventure that the SEC

4 retained full discretion to determine the manner and scope of its

5 investigation. See Vickers, 228 F.3d at 951 (“[T]he discretionary

6 function exception protects agency decisions concerning the scope and

7 manner in which it conducts an investigation so long as the agency does

8 not violate a mandatory directive.”). Plaintiffs’ allegations fail to

9 rebut this presumption, by identifying either a formal mandatory duty

10 or a specific decision that was not susceptible to policy analysis.

11 3. Assigning Unqualified Staff Members to Investigative

12 Teams

13 Plaintiffs argue that “several SEC staffers were inexcusably

14 unqualified for their positions,” and that the SEC “assigned []

15 staffers who had no understanding of securities transactions, and were

16 otherwise unqualified, to the Madoff investigations.” (Surreply at 8,

17 citing Compl. ¶¶ 32, 37, 46, 61-64, 67, 88-89, 100, 118, 126, 132,

18 134.)

19 It is well-established that “employment, supervision and training”

20 decisions “fall squarely within the discretionary function exception.”

21 Nurse v. United States, 226 F.3d 996, 1001 (9th Cir. 2000); see also

22 Doe v. Holy See, 557 F.3d at 1084 (“the decision of whether and how to

23 retain and supervise an employee . . . [is] the type of discretionary

24 judgments that the exclusion was designed to protect. We have held the

25 hiring, supervision, and training of employees to be discretionary

26 acts.”); Gager v. United States, 149 F.3d 918 (9th Cir. 1998) (“The

27 [postal service’s] decision not to provide universal training and

28

56

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 57 of 79 Page ID #:790

1 supervision in mail bomb detection involved judgment or choice grounded

2 in social, economic, and political policy.”).

3 Plaintiffs have failed to identify any allegations that would

4 bring their case outside the purview of the Ninth Circuit’s general

5 caselaw on this question. Accordingly, Defendant has satisfied its

6 burden of showing that the relevant decisions fall within the

7 discretionary function exception, and Plaintiffs have not alleged any

8 facts to the contrary.

9 4. Staff Members’ Personally Motivated Acts

10 Plaintiffs argue that SEC “staffers [] acted out of personal

11 animus, unfounded fear of individual liability, and improper deference

12 to Madoff on account of his reputation,” and that “one staffer ignored

13 a whistleblower out of spite.” (Surreply at 8, citing Compl. ¶¶ 23,

14 97-99, 119, 121-22.)

15 All of these assertions strike at the manner in which the SEC

16 conducted its investigations. As noted repeatedly in this Order, the

17 SEC retained discretion to make policy-based decisions about the manner

18 and scope of its investigations. See 15 U.S.C. § 78u(a)(1) (permitting

19 SEC to decide “as it deems necessary” how to “investigate any facts,

20 conditions, practices, or matters,” whether through “a statement in

21 writing, under oath or otherwise.”); see also Vickers, 228 F.3d at 951

22 (“[T]he discretionary function exception protects agency decisions

23 concerning the scope and manner in which it conducts an investigation

24 so long as the agency does not violate a mandatory directive.”).

25 Plaintiffs’ allegations, taken as true, at most establish that the

26 SEC staff abused its discretion when conducting investigations into

27 Madoff’s operations. However, the FTCA clearly states that the

28

57

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 58 of 79 Page ID #:791

1 discretionary function applies “whether or not the discretion involved

2 be abused.” 28 U.S.C. § 2680(a). In addition, Supreme Court precedent

3 requires this Court to examine “the nature of the actions taken and []

4 whether they are susceptible to policy analysis,” not “the agent’s

5 subjective intent in exercising the discretion conferred by statute or

6 regulation.” Gaubert, 499 U.S. at 324 (emphasis added). Accordingly,

7 the SEC staff’s subjective reasons for deciding how to investigate

8 Madoff are irrelevant to the present inquiry.18

9 Furthermore, the relevant question is not, as Plaintiffs suggest,

10 whether the agents’ activities were actually “grounded in any

11 legitimate policy considerations.” (Surreply at 9.) Rather, the

12 question is whether the agents’ activities were susceptible to policy

13 analysis. See Gaubert, 499 U.S. at 324; Terbush, 516 F.3d at 1129.

14 Investigative decisions are inherently susceptible to policy analysis,

15 and Plaintiffs fail to identify any mandatory laws, regulations, or

16 policies that prescribe a specific course of action for the staff to

17 follow when conducting investigations. Accordingly, these decisions

18 are subject to the discretionary function exception.

19 5. Failing to Follow Case-Management Procedures

20 Plaintiffs next argue that the SEC “violated its own internal

21 policies” regarding case-management by doing the following: (1)

22 “failing to obey rules regarding the filing of reports and the use of

23 the SEC’s STARS [Super Tracking and Reporting System] computer system,”

24 (2) failing to consult the Super Tracking and Reporting System database

25

18

26 To the extent that SEC staff members were truly acting for personal

purposes, such activities would not constitute a “negligent or wrongful act

27 or omission of any employee of the Government while acting within the scope

of his office or employment,” and the FTCA would not provide an avenue for

28 recovery. 28 U.S.C. § 1346(b)(1) (emphasis added).

58

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 59 of 79 Page ID #:792

1 before beginning examinations, (3) “fail[ing] to submit Matter Under

2 Inquiry [] reports with respect to . . . open investigations,” and (4)

3 failing to file case-opening and case-closing reports. (Surreply at

4 7.)

5 Plaintiffs have adequately alleged that the SEC teams failed to

6 conduct each of these tasks at one time or another. Plaintiffs have

7 not, however, adequately alleged that these tasks were mandatory or

8 were not otherwise susceptible to policy judgment. Because the SEC

9 staff had broad discretion to determine how to conduct its

10 investigations, see supra Part IV.B, Plaintiffs bear the burden of

11 identifying plausible allegations that non-discretionary duties were

12 imposed on the investigators. See, e.g., Sabow, 93 F.3d at 1452-53

13 (closely examining Naval Investigative Service/Judge Advocate General

14 investigation manuals to determine whether investigators were obligated

15 to conduct investigations in particular manner); Alfrey v. United

16 States, 276 F.3d 557, 563 (9th Cir. 2002) (holding that prison guard’s

17 failure to search a computer database was part of discretionary

18 investigatory decision where there was no policy requiring such a

19 search to be conducted); cf. Franklin Sav. Corp. v. United States, 180

20 F.3d 1124, 1132-33 (10th Cir. 1999) (agency not immune where its

21 employees failed to prepare mandatory case memoranda; however,

22 plaintiff’s claims were dismissed on the merits because no injury

23 flowed from the failure to prepare the memoranda). Plaintiffs have not

24 met their burden.

25 a. Factual Allegations

26 In May 2003, the Washington-based Office of Compliance Inspections

27 and Examinations received a tip and referred the matter to a team in

28

59

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 60 of 79 Page ID #:793

1 the Broker-Dealer section. In December 2003, the Washington team

2 received a second tip and opened its investigation into Madoff.

3 According to Plaintiffs, the team failed to file case-opening report in

4 the STARS computer system. (Compl. ¶ 80.) There is one allegation

5 suggesting that case-opening report is mandatory: the Report quotes a

6 supervisor’s statement that the staff members were “supposed to” enter

7 their case-opening “information into the tracking system.” (Ex. A at

8 132, quoting McCarthy testimony.) The Washington team also failed to

9 follow its case-planning memo. (Compl. ¶ 69.) There are no factual

10 allegations, however, that there is a mandatory duty to follow a case-

11 planning memorandum.

12 In April 2004, the Washington team closed its investigation and

13 failed to file a case-closing memorandum. (Compl. ¶¶ 78, 80.) There

14 is one allegation that the case-closing memo may have been mandatory:

15 the Report quotes a supervisor’s statement that “[t]ypically, staff is

16 supposed to — when they finish an exam[ination] they’re supposed to

17 close it out and I think there should have been a close-out memo is my

18 understanding.” (Compl. ¶ 78 & n.15, quoting Ex. A at 136 (quoting

19 McCarthy testimony).)

20 At the same time that the Washington team closed its investigation

21 (April 2004), the first New York enforcement team received a tip, and

22 in December 2004 the New York team opened its investigation. (Compl. ¶

23 86.) This team failed to draft a planning memorandum. (Compl. ¶¶ 87,

24 108.) Plaintiffs state in a conclusory fashion that there was an SEC

25 “policy or practice” requiring such a memorandum, but support this

26 assertion by citing to a factual statement in the Report that quotes

27

28

60

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 61 of 79 Page ID #:794

1 staff members saying that there was not such a policy at the time of

2 the investigation. (Compl. ¶ 87, citing Ex. A at 166.)

3 The New York team failed to consult the STARs computer system to

4 see if any prior case-opening reports had been filed. (Compl. ¶¶ 103,

5 108.) There is no specific allegation that there is a mandatory duty

6 to check the computer system; however, Plaintiffs allege that SEC

7 policy required that “there should never be two examinations of the

8 same entity being conducted at the same time without both teams being

9 aware of each other’s examination.” (Compl. ¶ 103, quoting Ex. A at

10 132.) In the Ninth Circuit, the word “should” is generally viewed as

11 suggestive rather than mandatory, see, e.g., Sabow, 93 F.3d at 1452,

12 and a person’s subjective belief that something “should” be done is

13 inadequate evidence that there is “in fact [a] mandatory [duty] under

14 some federal regulation or [internal] policy.” Alfrey, 276 F.3d at

15 563. However, viewing this quotation in the light most favorable to

16 Plaintiffs, there may be a plausible inference that there was a

17 mandatory policy to check the STARs computer system or that the

18 decision to check the STARs computer was not susceptible to policy

19 analysis. (See surreply at 12, 25.) Plaintiffs therefore allege that

20 the Washington and first New York teams violated internal policies

21 and/or made decisions that were not susceptible to policy judgment.

22 These acts and omissions will be examined in greater detail infra.

23 Plaintiffs further allege that the first New York team learned

24 about the previous Washington examination while the New York team was

25 interviewing Madoff in mid-to-late May 2005. (Ex. A at 195.) In early

26 June 2005, the Washington team sent its files to the New York team, and

27 the New York team performed a “cursory review” of the Washington team’s

28

61

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 62 of 79 Page ID #:795

1 findings because the information “seemed so similar to what we [the New

2 York team] were receiving in real time.” (Compl. ¶ 105, quoting Ex. A

3 at 200.) Plaintiffs allege that the two teams’ failures to fully

4 communicate “resulted in embarrassment and a waste of Commission

5 resources as two examination teams from two different offices

6 essentially conducted the same examination.” (Ex. A at 142; see also

7 Compl. ¶ 1 n.3 (incorporating Report in its entirety into Complaint).)

8 In September 2005, the first New York team formally closed its

9 investigation. In October 2005, after Harry Markopolos’s third report

10 was referred from the Boston office, a different New York team began a

11 new investigation into Madoff’s operations. In December 2005, this

12 second New York team filed its “Matter Under Inquiry” report. (Compl.

13 ¶ 124.) The New York office received another tip about Madoff between

14 the October 2005 opening of the investigation and the December 2005

15 filing of the Matter Under Inquiry report. (Compl. ¶ 125.) Plaintiffs

16 allege that, had the Matter Under Inquiry been filed in October, this

17 new tip would have been part of the second New York team’s

18 investigation. (Compl. ¶ 125.) However, there are no factual

19 allegations that SEC policy requires that a Matter Under Inquiry form

20 be filed immediately, other than Plaintiffs’ conclusory allegations

21 that this a “required step at the beginning of any Enforcement

22 investigation.” (Compl. ¶ 124.) Contradicting this conclusory

23 assertion, Plaintiffs’ Complaint contains specific factual assertions

24 that, although the Matter Under Inquiry “should” have been opened

25 sooner, the SEC’s enforcement manual states that staff members “may”

26 file a Matter Under Inquiry if and when they determine that a complaint

27 is “serious and substantial.” (Compl. ¶ 125, citing Ex. A at 263

28

62

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 63 of 79 Page ID #:796

1 (quoting SEC Enforcement Manual) (emphasis added).) Plaintiffs further

2 allege that “it is unclear whether the tip would have made any

3 difference in the conduct or the result of the [second New York team’s]

4 investigation because . . . of [the investigating attorney’s] view that

5 anonymous tips, ‘on their face’ were not credible.” (Ex. A at 265; see

6 also Compl. ¶ 1 n.3 (incorporating Report in its entirety into

7 Complaint).)

8 In June 2006, after completing its examination, the second New

9 York team filed its case-closing report despite the fact that it had

10 failed to resolve all of the red flags it identified. (Compl. ¶ 147.)

11 However, there are no allegations that the SEC staff is required to

12 resolve red flags before deciding to close a case and file a case-

13 closing report. (See Compl. ¶ 147.)

14 b. Discussion and Analysis

15 In short, viewing the plausible inferences of the Complaint’s

16 factual averments in favor of Plaintiffs, the Complaint alleges three

17 acts that violated mandatory duties and/or were not susceptible to

18 policy judgment:

19 (1) the Washington team failed to file a case-opening report;

20 (2) the first New York team failed to consult the STARs computer

21 database to find prior case-opening reports regarding Madoff; and

22 (3) the Washington team failed to file a case-closing memorandum.

23 Plaintiffs’ other assertions are either unsupported by any factual

24 allegations whatsoever19 or are supported by factual allegations that

25

26

19

There are no specific allegations stating that there was a requirement to

27 follow a case-planning memorandum. Nor are there specific allegations

stating that there was a requirement to resolve red flags prior to closing a

28 case and preparing a case-closing memorandum.

63

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 64 of 79 Page ID #:797

1 plainly contradict Plaintiffs’ conclusory assertions that there was a

2 mandatory duty and/or decision not susceptible to policy analysis.20

3 Plaintiffs further allege that the three specific SEC omissions had an

4 extremely limited impact. Plaintiffs assert that the New York team,

5 prior to closing its investigation, received and reviewed the

6 Washington files — albeit in a “cursory” manner because the information

7 appeared duplicative of the New York team’s ongoing investigations.

8 (Compl. ¶ 105, citing Ex. A at 200.)

9 Ultimately, then, Plaintiffs are alleging that two SEC offices

10 violated mandatory policies and thereby failed to adequately coordinate

11 their investigations and otherwise conduct their investigations in a

12 thorough and adequate manner.

13 As has been shown repeatedly throughout this Order, the SEC

14 retained discretion to decide how to conduct its investigations — which

15 includes decisions about how to coordinate investigations between

16 offices. (See supra Parts. IV.B.1, IV.B.3.) At the risk of being

17 repetitive, it is useful to refer back to 15 U.S.C. § 78u(a)(1), which

18 permits the SEC to decide “as it deems necessary” how to “investigate

19 any facts, conditions, practices, or matters,” whether through “a

20 statement in writing, under oath or otherwise.” In addition, 15 U.S.C.

21 § 78u(d)(1) permits the SEC “in its discretion” to bring an enforcement

22 action when it detects a securities violation during its

23 investigations. There are, in short, no mandatory obligations

24

25

20

Plaintiffs’ conclusory assertions that there were mandatory duties are

26 contradicted by their specific allegations in the Report that there was no

policy requiring staff to prepare a case-planning memorandum and there was a

27 discretionary policy (which used the suggestive “should” and the permissive

“may,” see Sabow, 93 F.3d at 1452) regarding staff members’ decisions to

28 file a Matter Under Inquiry report.

64

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 65 of 79 Page ID #:798

1 requiring the SEC to conduct its investigations in a particular manner

2 or to bring an enforcement action in particular situations. These

3 decisions are fundamentally discretionary and require staff to make

4 policy-based judgments. See, e.g., Sloan, 236 F.3d at 762 (“[T]he

5 sifting of evidence, the weighing of its significance, and the myriad

6 other decisions made during investigations plainly involve elements of

7 judgment and choice.”); Vickers, 228 F.3d at 951 (“[T]he discretionary

8 function exception protects agency decisions concerning the scope and

9 manner in which it conducts an investigation.”).

10 In light of this broad investigatory discretion, General

11 Dynamics is therefore directly on point regarding the small handful of

12 mandatory procedural obligations imposed on SEC staff. In General

13 Dynamics, the Ninth Circuit explained that an otherwise actionable

14 agency decision is immune from suit if “a totally separate exercise” of

15 “independent” and “broad based discretion” “intervenes between an

16 alleged government wrongdoer and the harm suffered by a plaintiff.”

17 139 F.3d at 1285. There, prosecutors brought a criminal action against

18 General Dynamics based solely on facts stated in a negligently prepared

19 auditing statement. The court explained that the prosecutors’

20 affirmative decision to prosecute constituted an independent exercise

21 of broad-based discretion that thereby insulated the government from a

22 lawsuit based on the auditors’ non-discretionary actions. Id. The

23 court noted that the “source of the [plaintiff’s] injury” was the

24 independent and “discretionary” decision to prosecute. Id. Although

25 the prosecutors could have sought more information and could have

26 double-checked the auditors’ reports, they retained discretion to

27 ///

28

65

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 66 of 79 Page ID #:799

1 choose whether or not to do so, and they affirmatively decided to rely

2 only on the inaccurate reports. Id.

3 In contrast, in Glacier Bay, hydrographers prepared oceanographic

4 charts pursuant to mandatory requirements stated in their handbook.

5 They then presented these charts to their supervisor, who had

6 discretion regarding whether or not to approve those charts. The court

7 held that the supervisor’s limited exercise of discretion did not

8 immunize the hydrographers’ negligent preparation of the charts in

9 violation of mandatory guidelines. As the court later explained in

10 General Dynamics, “little intervened between the hydrographers’

11 wrongdoing and the injury to the plaintiff.” General Dynamics, 139

12 F.3d at 1285. Instead, there was a “tight coupling between

13 hydrographers, reviewers, charts, and results,” such that the plaintiff

14 was injured by the hydrographers’ violation of the mandatory guidelines

15 in preparing the charts, and was not injured by the supervisor’s

16 discretionary approval of the charts. Id. at 1284.

17 The allegations in the present case are far more analogous to the

18 facts in General Dynamics than in Glacier Bay. Plaintiffs allege in

19 essence that the first New York investigative team had a mandatory duty

20 to be aware of the prior Washington investigation. Plaintiffs’

21 allegations are neatly summarized in a quotation in the Complaint:

22 under SEC policy “there should never be two examinations of the same

23 entity being conducted at the same time without both teams being aware

24 of each other’s examination.” (Compl. ¶ 102, quoting Ex. A at 132,

25 emphasis added by Court.) 21

26

21

27 Again, the Court notes that the word “should” is suggestive rather than

mandatory and officials’ subjective beliefs are insufficient evidence of a

28 mandatory policy. However, at the present stage of proceedings, plausible

66

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 67 of 79 Page ID #:800

1 However, even though these two teams’ conduct violated mandatory

2 policies or otherwise involved non-judgment-based decisions, the

3 discretionary function exception will apply if “a totally separate

4 exercise” of “independent” and “broad based discretion” “intervenes

5 between an alleged government wrongdoer and the harm suffered by a

6 plaintiff.” General Dynamics, 139 F.3d at 1285. Here, Plaintiffs were

7 harmed by the investigators’ failure to discover the Madoff fraud and

8 publicize or prosecute it. Plaintiffs were not harmed by the teams’

9 failure to follow case-management procedures because the first team of

10 New York investigators undertook an independent exercise of discretion

11 when they (1) received and reviewed the Washington team’s files and

12 determined that the Washington team’s investigative materials were

13 duplicative of their own investigation (Compl. ¶ 105, quoting Ex. A at

14 200), (2) conducted their own independent investigation into Madoff’s

15 operations (Compl. ¶¶ 82-109), and (3) determined that there was no

16 basis for bringing an enforcement action against Madoff (Compl. ¶ 107).

17 Each of these three acts by the New York team was a “totally

18 separate exercise of discretion” that was unrelated to the

19 investigators’ non-discretionary violations of mandatory case-

20 management rules. See General Dynamics, 139 F.3d at 1285. The New

21 York investigators retained “broad based discretion,” id. at 1285, to

22 select the manner and scope of their investigation of Madoff and their

23 review of the Washington team’s files. This “broad based discretion”

24 is derived both from the SEC’s congressionally-authorized discretion to

25

26

inferences in the Complaint must be drawn in Plaintiffs’ favor. This

27 quotation, combined with the other factual allegations discussed supra,

provide a plausible inference that these particular case-management

28 obligations were mandatory.

67

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 68 of 79 Page ID #:801

1 choose the manner and scope of its investigations, see 17 U.S.C. §§

2 78u(a)(1), 78u(d)(1), and from the inherently discretionary nature of

3 investigative activities. See, e.g., Sloan, 236 F.3d at 762 (“[T]he

4 sifting of evidence, the weighing of its significance, and the myriad

5 other decisions made during investigations plainly involve elements of

6 judgment and choice.”); Vickers, 228 F.3d at 951 (“[T]he discretionary

7 function exception protects agency decisions concerning the scope and

8 manner in which it conducts an investigation.”).

9 In addition, the New York team, after conducting an independent

10 and discretionary review of both Madoff’s operations and the Washington

11 team’s files, made an independent decision to close its investigation

12 in September 2005 without bringing an enforcement action against

13 Madoff. The decision of whether or not to bring an enforcement action

14 is plainly discretionary. See 17 U.S.C. § 78u(d)(1) (permitting SEC

15 “in its discretion” to bring enforcement actions); 17 C.F.R. § 202.5

16 (stating that SEC “may in its discretion” select from various

17 enforcement tools if it believes that enforcement action is necessary).

18 Although FTCA claims most often involved negligent agency actions

19 rather than failures to act, the New York team’s decision not to act

20 was fully within its discretion in selecting the manner and scope of

21 its investigations and enforcement actions. See, e.g., Block v. SEC,

22 50 F.3d at 1084 (in Administrative Procedures Act action, SEC cannot be

23 compelled to undertake certain enforcement actions); Board of Trade v.

24 SEC, 883 F.2d at 531 (same); Leytman v. New York Stock Exchange, 1995

25 WL 761843, at *3 (dismissing FTCA claims alleging that SEC failed to

26 investigate alleged wrongdoing).

27 ///

28

68

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 69 of 79 Page ID #:802

1 In short, General Dynamics applies to the allegedly negligent acts

2 by the Washington team and the first New York team. The New York

3 team’s intervening discretionary actions are closely analogous to the

4 General Dynamics prosecutors’ actions in at least two ways:

5 (1) In General Dynamics, the prosecutors reviewed and relied on

6 information contained in a negligently-conducted investigation when

7 choosing to pursue a prosecution. Here, the first New York team

8 reviewed the Washington team’s allegedly negligently-prepared files and

9 the New York team relied (at least part) on those files in choosing to

10 close the case without pursuing an enforcement action. In both cases,

11 the second actor retained discretion to decide how thoroughly to rely

12 on (or discredit) the underlying information received from a previous

13 investigation. In both cases, the second actor exercised that

14 discretion: in General Dynamics, the prosecutors elected not to conduct

15 a further investigation, and here, the New York team elected to conduct

16 a “cursory” review of the Washington team’s files.

17 (2) In General Dynamics, the prosecutors retained discretion to

18 conduct additional independent investigations before deciding whether

19 or not to file a criminal action; they elected to file the action

20 without seeking additional information beyond that contained in the

21 auditing reports. Here, the first New York team retained discretion to

22 conduct further investigations into Madoff’s affairs before deciding

23 whether or not to bring enforcement actions against Madoff. Unlike the

24 prosecutors in General Dynamics, the New York team elected to conduct

25 additional independent investigations beyond those contained in the

26 Washington team’s files, and the New York team further elected to close

27 ///

28

69

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 70 of 79 Page ID #:803

1 its case without bringing an enforcement action.22 The New York team in

2 fact exercised greater discretion than the prosecutors in General

3 Dynamics – the prosecutors in General Dynamics were presented with

4 clear (albeit incorrect) evidence showing fraud; it does not exactly

5 require “a robust exercise of discretion” to decide to prosecute that

6 fraud. 139 F.3d at 1285. Here, however, neither the Washington team

7 nor the New York team uncovered any actionable wrongdoing.

8 Accordingly, the New York team exercised relatively “robust” discretion

9 by deciding to investigate the allegations further and ultimately

10 concluding on the basis of that investigation not to bring an

11 enforcement action.

12 Thus, the New York team’s actions – its affirmative choice to

13 review the Washington team’s files; its affirmative choice to conduct

14 additional investigations into Madoff’s operations; and its affirmative

15 choice not to bring an enforcement action — constituted intervening

16 exercises of independent and broad-based discretion. Both the facts

17 and holding of General Dynamics are directly on-point. As such, the

18 discretionary function exception bars Plaintiffs’ claims regarding the

19 Washington and New York investigators’ alleged failures to follow

20 mandatory case-management procedures.

21 ///

22

23

22

Even though Plaintiffs allege that the New York team’s review of the

24 Washington team’s files was “cursory,” the General Dynamics court clearly

explained that it is inappropriate to consider the thoroughness or accuracy

25 of an intervening exercise of “broad based discretion.” See 139 F.3d at

1285. The General Dynamics prosecutors “could have had even more

26 information if they had chosen to pursue it.” Id. (emphasis added).

Likewise, the first New York team could have conducted additional

27 investigations into Madoff’s operations or reviewed the Washington team’s

files more thoroughly. However, the first New York team retained “broad

28 based discretion” to choose the methods and scope of its investigation.

70

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 71 of 79 Page ID #:804

1 6. Conclusion Regarding Plaintiffs’ Purportedly Mandatory

2 Duties

3 Plaintiffs have failed to identify any of the SEC’s non-

4 discretionary acts that are actionable under Ninth Circuit precedent.

5 As such, they have not rebutted the “strong presumption” established in

6 the statutes, regulations, and caselaw in Defendant’s favor. Gaubert,

7 499 U.S. at 324. The discretionary function exception bars Plaintiffs’

8 claims.

9

10 V. PLAINTIFFS’ REQUEST TO CONDUCT DISCOVERY

11

12 Plaintiffs insist that as-yet-undiscovered internal policies and

13 guidelines will reveal that the SEC’s actions violated clear mandatory

14 rules. (Surreply at 9, 11.) However, Plaintiffs have not plausibly

15 alleged any facts suggesting that such mandatory rules exist. In

16 addition, Plaintiffs have failed to identify the specific types of

17 rules that are likely to exist. Finally, Plaintiffs have failed to

18 consult the voluminous public record that might bolster their

19 conclusory assertions or potentially contradict them. In short,

20 Plaintiffs have failed to allege sufficient “facts to raise a

21 reasonable expectation that discovery will reveal evidence” supporting

22 their conclusory assertions. Twombly, 550 U.S. at 556. This Court is

23 barred from “unlock[ing] the doors of discovery for a plaintiff armed

24 with nothing more than conclusions.” Ashcroft v. Iqbal, 129 S. Ct. at

25 1950. Accordingly, discovery is inappropriate at this juncture.

26 ///

27 ///

28

71

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 72 of 79 Page ID #:805

1 A. LEGAL STANDARD

2 “[W]here pertinent facts bearing on the question of jurisdiction

3 are in dispute, discovery should be allowed.” Am. West Airlines, Inc.

4 v. GPA Group, Ltd., 877 F.2d 793, 801 (9th Cir. 1989). However, a

5 “court’s refusal to allow further discovery before dismissing on

6 jurisdictional grounds is not an abuse of discretion ‘when it is clear

7 that further discovery would not demonstrate facts sufficient to

8 constitute a basis for jurisdiction.’” Id. at 801 (quoting Wells Fargo

9 & Co. v. Wells Fargo Express Co., 556 F.2d 406, 430-31, n. 24 (9th Cir.

10 1977)).

11 In the FTCA immunity context, “[i]t is well-established that ‘the

12 burden is on the party seeking to conduct additional discovery to put

13 forth sufficient facts to show that the evidence sought exists.’”

14 Gager v. United States, 149 F.3d 918, 922 (9th Cir. 1998) (quoting

15 Conkle v. Jeong, 73 F.3d 909, 914 (9th Cir. 1995)) (internal

16 alterations omitted). In this regard, it is important to remember that

17 the Rule 8 pleading requirements prevent parties from filing complaints

18 in order to conduct aimless fishing expeditions in the hope that some

19 helpful evidence might possibly be uncovered. See Ashcroft v. Iqbal,

20 129 S. Ct. at 1950 (“Rule 8 . . . does not unlock the doors of

21 discovery for a plaintiff armed with nothing more than conclusions.”);

22 Twombly, 550 U.S. at 556 (“[A]sking for plausible grounds to infer”

23 that a wrongful act occurred requires plaintiff to plead “enough facts

24 to raise a reasonable expectation that discovery will reveal evidence

25 of” that wrongful act) (emphasis added).

26 The Ninth Circuit applied Twombly to the discretionary function

27 exception in Doe v. Holy See, 557 F.3d at 1084-86. The court affirmed

28

72

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 73 of 79 Page ID #:806

1 a dismissal under the Foreign Sovereign Immunities Act’s discretionary

2 function exception where the defendant made only a “facial attack on

3 the allegations of subject-matter jurisdiction in the complaint.” Id.

4 at 1086. The court dismissed the complaint because it contained only

5 conclusory assertions that the defendant had adopted a mandatory policy

6 relevant to the cause of action, and the plaintiff wholly failed to

7 “state the terms of this alleged policy, or describe any documents,

8 promulgations, or orders embodying it.” Id. Notably, the court did

9 not require that the plaintiff have an opportunity to conduct discovery

10 into the existence of this alleged policy. See id. at 1084-86.

11 Instead, the court merely analyzed the adequacy of the plaintiff’s

12 pleadings, and, finding them to be insufficient under Twombly, affirmed

13 dismissal under the discretionary function exception. Id. at 1086.

14 Even prior to the Supreme Court’s re-articulation of the proper

15 pleading requirements in Twombly and Iqbal, it was not unusual for

16 courts to dismiss FTCA claims under the discretionary function

17 exception without giving litigants an opportunity to conduct discovery.

18 See, e.g., Abreu v. United States, 468 F.3d 20, 33 (1st Cir. 2006);

19 Dalli v. Frech, 70 Fed. Appx. 46 (2d Cir. 2003); see also Mesa v.

20 United States, 123 F.3d 1435, 1439 (11th Cir. 1997) (affirming

21 dismissal under discretion function exception where “[plaintiffs] have

22 pointed to no act of these DEA agents that could fall outside of the

23 discretionary function exception, nor have the [plaintiffs] pointed to

24 any requested discovery that could reasonably be expected to reveal any

25 such act.”); accord Razore v. Tulalip Tribe of Wash., 66 F.3d 236, 240

26 (9th Cir. 1995) (affirming dismissal of CERCLA action on jurisdictional

27 grounds without permitting parties to conduct discovery); but see

28

73

Case 2:09-cv-09061-SVW-FMO Document 17 Filed 04/20/10 Page 74 of 79 Page ID #:807

1 Ignatiev v. United States, 238 F.3d 464, 467 (D.C. Cir. 2001) (holding

2 that D.C. Circuit “require[s] that plaintiffs be given an opportunity

3 for discovery of facts . . . [regarding the] existence [or not] of

4 internal governmental policies guiding that action.”).23

5 B. DISCUSSION AND ANALYSIS

6 Additional discovery is not appropriate at present. Plaintiffs

7 have not pleaded “enough facts to raise a reasonable expectation that

8 discovery will reveal evidence of” the sought-after SEC policies and

9 guidelines. Twombly, 550 U.S. at 556. In their request for discovery

10 contained in the sur-reply, Plaintiffs have failed to meet their

11 burden of “put[ting] forth sufficient facts to show that the evidence

12 sought exists.” Gager, 149 F.3d at 922.

13 A salient analogy can be found in Freeman v. United Sta

This text is long and has been trimmed here. Open the source document for the complete record.