Cohen v. United States

PRECEDENTIAL

IN THE UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

________________________

No. 12-1319

________________________

STANLEY BAER: JESSE L. COHEN; ALAN ROTH;

ELAINE RUTH SCHAFFER; LENORE H. SCHUPAK,

Appellants

v.

THE UNITED STATES OF AMERICA

_______________________________________

On Appeal from the United States District Court

for the District Of New Jersey

(District Court No. 2-11-cv-01277)

District Judge: Hon. Stanley R. Chesler

_______________________________________

Argued February 12, 2013

Before: HARDIMAN and ALDISERT, Circuit Judges, and

STARK, District Judge.

(Filed: July 1, 2013)

Helen D. Chaitman [Argued]

Becker & Poliakoff

45 Broadway, 8th Floor

New York, New York 10006

Attorney for the Appellants

Stuart F. Delery

Paul J. Fishman

Mark B. Stern

Lindsey Powell [Argued]

U.S. Department of Justice

950 Pennsylvania Ave., NW

Washington, DC 20530

Attorneys for the Appellee

________________________

OPINION OF THE COURT

________________________



Honorable Leonard P. Stark, Judge of the United States

District Court for the District of Delaware, sitting by

designation.

2

STARK, District Judge.

This case arises from the well-known Ponzi scheme

operated by Bernard L. Madoff. Plaintiffs-Appellants Stanley

Baer, Jesse L. Cohen, Alan Roth, Elaine Ruth Schaffer, and

Lenore H. Schupak (“Appellants”) were customers of

Bernard L. Madoff Investment Securities LLC (“BLMIS”).

On March 7, 2011, Appellants brought suit against the United

States under the Federal Tort Claims Act, 28 U.S.C. §§

1346(b), 2671 et seq. (“FTCA”), to recover damages for

injuries resulting from the failure of the Securities and

Exchange Commission (“SEC”) to uncover and terminate

Madoff‟s Ponzi scheme in a timely manner. The District

Court for the District of New Jersey dismissed the complaint

based on lack of subject matter jurisdiction, finding that

Appellants‟ claims were barred by the discretionary function

exception (“DFE”) to the FTCA. See 28 U.S.C. § 2680(a).

The District Court also denied Appellants‟ requests for

jurisdictional discovery and to amend the complaint. We will

affirm.

I

As this is an appeal from the District Court‟s grant of a

motion to dismiss, we, like the District Court, accept the well-

pleaded factual allegations in the complaint as true and

construe them in the light most favorable to Appellants. See

Lora-Pena v. FBI, 529 F.3d 503, 505 (3d Cir. 2008) (per

curiam). The allegations contained in Appellants‟ complaint

are derived substantially from a 457-page report prepared by

the SEC‟s Office of Investigations (the “OIG Report”), which

describes in detail the SEC‟s failed multi-year investigation

of Madoff‟s Ponzi scheme:

3

The OIG investigation found that

the SEC received numerous

substantive complaints since 1992

that raised significant red flags

concerning Madoff‟s hedge fund

operations and should have led to

questions about whether Madoff

was actually engaged in trading

and should have led to a thorough

examination and/or investigation

of the possibility that Madoff was

operating a Ponzi scheme.

However, the OIG found that

although the SEC conducted five

examinations and investigations

of Madoff based upon these

substantive complaints, they never

took the necessary and basic steps

to determine if Madoff was

misrepresenting his trading. [The

OIG] also found that had these

efforts been made with

appropriate follow-up, the SEC

could have uncovered the Ponzi

scheme well before Madoff

confessed.

(OIG Report at 456).1

1

More thorough descriptions of Madoff‟s operations and the

SEC‟s investigations of them are set forth in numerous recent

decisions of other courts and need not be repeated here. See,

4

Appellants contend that had the SEC investigated

BLMIS with even the most basic level of competence,

Madoff‟s scheme would have been discovered and

Appellants‟ losses would have been prevented. Their

complaint alleges three causes of action under the FTCA: (1)

that the SEC was negligent in its investigations of BLMIS;

(2) that the SEC aided and abetted breaches of fiduciary duty

committed by BLMIS; and (3) that the SEC aided and abetted

the fraud perpetrated by BLMIS.2 The government moved to

dismiss for lack of jurisdiction, contending that the alleged

misconduct fell within the discretionary function exception to

the FTCA. The District Court agreed with the government

and dismissed the complaint. The District Court also denied

Appellants‟ motions seeking jurisdictional discovery and

leave to amend the complaint. Appellants timely appealed.

II

We have appellate jurisdiction pursuant to 28 U.S.C. §

1291. We “exercise plenary review over application of the

e.g., In re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. 122,

126-32 (Bankr. S.D.N.Y. 2010); Dichter-Mad Family

Partners, LLP v. United States, 707 F. Supp. 2d 1016, 1020-

24 (C.D. Cal. 2010), aff‟d, 709 F.3d 749 (9th Cir. 2013) (per

curiam).

2

Although Appellants contend that the District Court erred by

not differentiating among their three causes of action,

Appellants do not explain why these causes of action, which

are based on the same set of operative facts, should be

analyzed separately. Indeed, Appellants‟ opening and reply

briefs do not distinguish among the three causes of action.

5

FTCA‟s discretionary function exception.” Merando v.

United States, 517 F.3d 160, 163-64 (3d Cir. 2008).

“Questions of subject matter jurisdiction raised on a motion to

dismiss under Rule 12(b)(1) are also reviewed de novo.” Free

Speech Coal., Inc. v. Att‟y Gen., 677 F.3d 519, 530 (3d Cir.

2012).

Appellants “bear[] the burden of demonstrating that

[their] claims fall within the scope of the FTCA‟s waiver of

government immunity,” while the government “has the

burden of proving the applicability of the discretionary

function exception.” Merando, 517 F.3d at 164 (internal

quotation marks omitted). As we explain, the District Court

correctly concluded that it lacked subject matter jurisdiction.

III

The FTCA waives the federal government‟s sovereign

immunity with respect to tort claims for money damages. See

28 U.S.C. § 1346(b)(1). The discretionary function exception

limits that waiver, eliminating jurisdiction for claims based

upon the exercise of a discretionary function on the part of an

employee of the government. See 28 U.S.C. § 2680(a).

Specifically, pursuant to the DFE, the government retains

sovereign immunity with respect to “[a]ny claim . . . based

upon the exercise or performance or the failure to exercise or

perform a discretionary function or duty on the part of a

federal agency or an employee of the Government, whether or

not the discretion involved be abused.” Id. In this way, the

discretionary function exception draws a “boundary between

Congress‟ willingness to impose tort liability upon the United

States and its desire to protect certain governmental activities

from exposure to suit by private individuals.” United States

v. Varig Airlines, 467 U.S. 797, 808 (1984). Congress

6

enacted the DFE to “prevent judicial „second-guessing‟ of

legislative and administrative decisions grounded in social,

economic, and political policy through the medium of an

action in tort.” Id. at 814.

To determine whether the DFE applies, courts employ

a two-part test. First, a court must “consider whether the

action is a matter of choice for the acting employee. This

inquiry is mandated by the language of the exception; conduct

cannot be discretionary unless it involves an element of

judgment or choice.” Berkovitz v. United States, 486 U.S.

531, 536 (1988). Second, a court must determine whether the

judgment exercised “is of the kind that the discretionary

function exception was designed to shield.” Id. This is

because the DFE “protects only governmental actions and

decisions based on considerations of public policy.” Id. at

537. Notably, “if a regulation allows the employee

discretion, the very existence of the regulation creates a

strong presumption that a discretionary act authorized by the

regulation involves consideration of the same policies which

led to the promulgation of the regulations.” United States v.

Gaubert, 499 U.S. 315, 324 (1991).

IV

Appellants contend that the SEC is not protected from

liability under the DFE because neither part of the two-part

test is satisfied here. In particular, Appellants argue that the

SEC conduct challenged by their complaint violated

numerous mandatory, non-discretionary statutes and

regulations. Appellants further assert that any discretion

exercised by the SEC is not susceptible to policy analysis.

7

In most respects, Appellants‟ arguments repeat those

uniformly rejected by other courts that have considered suits

against the SEC brought by victims of the Madoff Ponzi

scheme. After briefly describing how we reach the same

conclusions as these other courts on the overlapping issues,

we focus on the two bases on which Appellants seek to

distinguish their complaint.

A

Appellants contend that the SEC violated several

mandatory internal procedures during the BLMIS

investigation by: (1) failing to obtain trading verifications; (2)

failing to commence investigations promptly; (3) failing to

draft closing reports; and (4) failing to log investigations into

the SEC‟s examination tracking system. Appellants have not

demonstrated, however, that the procedures on which they

rely are anything more than discretionary guidelines for SEC

personnel.

For example, although Appellants argue that “[t]rading

verifications must be obtained from third parties,” such as the

National Association of Securities Dealers (App. Br. at 30)

(emphasis added), they cite no source for such a mandatory

duty. To the contrary, the OIG Report – which forms the

basis for Appellants‟ complaint – states that “verifying

trading activity from an independent source was not an

‘essential’ part of a Ponzi scheme investigation.” (OIG

Report at 325) (emphasis added). Likewise, Appellants

contend in their briefing that “[i]nvestigations must be

commenced promptly and MUIs [(Matters Under Inquiry)]

must be opened at the beginning of the investigation” (App.

Br. at 30) (emphasis added), but they ground this assertion in

no regulation, and even their complaint only alleges that

8

“MUI‟s should be opened promptly,” that is within “days,

hours, [or] weeks” (A49 ¶ 61, A64 ¶ 129) (emphasis added).

Appellants‟ contention that SEC employees “must draft

closing reports at the end of investigations” (App. Br. at 30)

(emphasis added) is belied by the portion of the OIG Report

on which they rely, which states, instead, that preparing “a

closing report at the conclusion of an examination is „good

practice‟” (OIG Report at 136). Similarly, although

Appellants allege that “[i]nvestigations must be logged into

the SEC‟s STARS tracking system” (App. Br. at 30)

(emphasis added), they base this assertion on 15 U.S.C. §

78q(k),3 which provides that the “Commission and the

examining authorities . . . shall eliminate any unnecessary and

burdensome duplication” and “shall share such information . .

. as appropriate to foster a coordinated approach” (emphasis

added). As the emphasized statutory language illustrates, an

element of discretion is involved in determining what

investigative material is to be logged into the STARS tracking

system. (See also OIG Report at 133) (“Again, there was no

rule or policy about it, but I think the information-sharing at

that level between offices was not always great.”) (emphasis

added).

Hence, we agree with the District Court, as well as the

other federal courts that have considered these issues, and

conclude that Appellants have failed to identify any violation

of a mandatory policy or guideline by any SEC employee.

See Donahue v. United States, 870 F. Supp. 2d 97, 103-14

(D.D.C. 2012); Molchatsky v. United States, 778 F. Supp. 2d

421, 431-34 (S.D.N.Y. 2011), aff‟d, 713 F.3d 159 (2d Cir.

3

In 2010, section 78q(k) was re-designated as section 78q(j).

9

2013); Dichter-Mad, 707 F. Supp. 2d at 1035-51, aff‟d, 709

F.3d 749.

B

Appellants‟ principal argument for an outcome

different from that in all of the similar lawsuits to date is that

Appellants, unlike other victims, allege the SEC had no

discretion to favor Madoff, “a Wall Street bigwig,” and for

this reason the SEC‟s conduct is not protected by the DFE.

Appellants cite to four SEC regulations as the bases for a

mandatory duty that the SEC not accord preferential

treatment to anyone, including someone of Madoff‟s former

stature. See 5 C.F.R. § 2635.101(b)(8); 17 C.F.R. § 200.64;

17 C.F.R. § 200.61; 17 C.F.R. § 200.735-2(a). For example,

5 C.F.R. § 2635.101(b)(8) provides: “Employees shall act

impartially and not give preferential treatment to any private

organization or individual.”

The problem for Appellants is that the regulations on

which they rely are inherently intertwined with the SEC‟s

discretionary authority to determine the timing, manner, and

scope of SEC investigations. See, e.g., Gen. Pub. Utils. Corp.

v. United States, 745 F.2d 239, 245 (3d Cir. 1984) (“The

extent and scope of an investigation remains a matter of the

agency‟s discretion.”); Vickers v. United States, 228 F.3d

944, 951 (9th Cir. 2000) (“[The] discretionary function

exception protects agency decisions concerning the scope and

manner in which it conducts an investigation so long as the

agency does not violate a mandatory directive.”). As set out

in statute, the SEC:

may, in its discretion, make such

investigations as it deems

10

necessary to determine whether

any person has violated, is

violating, or is about to violate

any provision of this chapter . . .

. The Commission is authorized

in its discretion . . . to investigate

any facts, conditions, practices, or

matters which it may deem

necessary or proper to aid in the

enforcement of such provisions.

15 U.S.C. § 78u(a)(1) (emphasis added). SEC regulations

likewise reflect that the SEC‟s investigative authority is

discretionary:

The Commission may, in its

discretion, make such formal

investigations and authorize the

use of process as it deems

necessary to determine whether

any person has violated, is

violating, or is about to violate

any provision of the federal

securities laws or the rules of a

self-regulatory organization of

which the person is a member or

participant.

17 C.F.R. § 202.5(a) (emphasis added).

That Appellants are, in essence, challenging

discretionary decisions relating to the timing, manner, and

scope of SEC investigations is evident from Appellants‟

specific allegations as to how the SEC violated its purportedly

11

mandatory duty of non-preferential treatment. Appellants

allege that the SEC discouraged junior examiners from

questioning Madoff‟s responses to SEC inquiries, failed to

scrutinize evidence provided by Madoff, delayed the Madoff

investigation, and reassigned examiners who raised concerns

with respect to the investigation. All of these actions involve

government actors‟ exercise of judgment and choice of the

kind the discretionary function was designed to shield. See

generally Varig, 467 U.S. at 809-10 (“[The DFE is] designed

to preclude application of the [FTCA] to a claim based upon

an alleged abuse of discretionary authority by a regulatory or

licensing agency – for example, the Federal Trade

Commission, the Securities and Exchange Commission, the

Foreign Funds Control Office of the Treasury, or others. It is

neither desirable nor intended that the constitutionality of

legislation, the legality of regulations, or the propriety of a

discretionary administrative act should be tested through the

medium of a damage suit for tort.”) (citing H.R. Rep. No. 77-

2245, at 10) (1942) (internal quotation marks omitted);

United States v. Pooler, 787 F.2d 868, 871 (3d Cir. 1986)

(“[W]hen the sole complaint is addressed, as here, to the

quality of the investigation as judged by its outcome, the

discretionary function [exception] should, and we hold, does

apply. Congress did not intend to provide for judicial review

of the quality of investigative efforts.”), abrogated on other

grounds by Millbrook v. United States, 133 S. Ct. 1441 (Mar.

27, 2013).4

4

Appellants‟ reliance on cases such as Fair v. United States,

234 F.2d 288 (5th Cir. 1956), is unhelpful, as these involve

plaintiffs challenging government actions that created

reliance interests for specific individuals, as opposed to “only

12

The regulations identified by Appellants also do not

prescribe any particular course of action for the SEC to

follow. See Berkovitz, 486 U.S. at 536. At most, these

regulations attempt to limit the scope of discretion afforded

the SEC during the course of an investigation. While a

violation of these regulations may amount to an abuse of

discretion, that is not sufficient to waive the federal

government‟s sovereign immunity, as the discretionary

function exception applies “whether or not the discretion

involved be abused.” 28 U.S.C. § 2680(a).

Additionally, because SEC regulations afford

examiners discretion regarding the timing, manner, and scope

of investigations, there is a strong presumption that the SEC‟s

conduct is susceptible to policy analysis. See Gaubert, 499

U.S. at 324. Appellants‟ attempt to rebut this presumption by

alleging an SEC intent to protect a “Wall Street bigwig” is

unavailing. “The focus of the inquiry is not on the agent’s

subjective intent in exercising the discretion conferred by

statute or regulation, but on the nature of the actions taken

and on whether they are susceptible to policy analysis.” Id. at

325 (emphasis added). Whether to pursue a lead, to request a

document, or to assign additional examiners to an

investigation are all discretionary decisions, which

necessarily involve considerations of, among other things,

resource allocation and opportunity costs. See generally Bd.

of Trade v. SEC, 883 F.2d 525, 531 (7th Cir. 1989) (“Courts

cannot intelligently supervise the Commission‟s allocation of

its staff‟s time, because although judges see clearly the claim

an activity designed to be protective of the interest of that

amorphous group known as the public as a whole,” id. at 293,

as is the case here.

13

the Commission has declined to redress, they do not see at all

the tasks the staff may accomplish with the time released.”).

The discretionary function exception immunizes the

government from a lawsuit based on such discretionary

judgments.5

Moreover, were we to agree that a preferential

treatment allegation is sufficient to overcome application of

the discretionary function exception, we would effectively

eliminate the discretionary function exception for SEC

investigations. Any investigative decision by the SEC could

potentially be challenged by someone as the product of

favoritism or discrimination. A plaintiff should not be

permitted to overcome application of the DFE through

creative pleading. See Fisher Bros. Sales v. United States, 46

F.3d 279, 286 (3d Cir. 1995) (en banc); see also Molchatsky,

713 F.3d at 162 (“The DFE is not about fairness, it „is about

power‟; the sovereign „reserve[s] to itself the right to act

without liability for misjudgment and carelessness in the

formulation of policy.‟”) (quoting Nat‟l Union Fire Ins. v.

United States, 115 F.3d 1415, 1422 (9th Cir. 1997)).

C

Appellants‟ other basis for distinguishing this case is

the allegation that the SEC does not have discretion to

commit misprision of felony. According to Appellants, if the

SEC had conducted a proper investigation, it would have

discovered Madoff‟s fraudulent scheme and, once discovered,

it would have acquired a mandatory duty to disclose the fraud

5

Appellants‟ characterization of the SEC‟s failings as being

due to “laziness” does nothing to alter our analysis.

14

to the public, regardless of whether the SEC made a

discretionary decision to pursue an enforcement proceeding.

Appellants rely on 18 U.S.C. § 4, the federal

misprision of felony statute, which provides:

Whoever, having knowledge of

the actual commission of a felony

cognizable by a court of the

United States, conceals and does

not as soon as possible make

known the same to some judge or

other person in civil or military

authority under the United States,

shall be fined under this title or

imprisoned not more than three

years, or both.

The elements of misprision of felony are: “(1) the principal

committed and completed the felony alleged; (2) the

defendant had full knowledge of that fact; (3) the defendant

failed to notify authorities; and (4) the defendant took steps to

conceal the crime.” United States v. Gebbie, 294 F.3d 540,

544 (3d Cir. 2002).

There is no dispute that Madoff committed a felony.

However, none of the remaining elements of misprision of

felony is present here. Most importantly, the SEC did not

have “full knowledge” of Madoff‟s fraud. Indeed, the

complaint alleges that “the SEC failed to take the most basic

investigatory steps that would have uncovered and put an

immediate end to Madoff‟s fraud.” (A35 ¶ 6(a)) (emphasis

added). Accepting this allegation as true, the SEC necessarily

lacked full knowledge of Madoff‟s criminal conduct.

15

Lacking such knowledge, the SEC also could not have failed

to notify authorities nor taken steps to conceal Madoff‟s

crime. For at least these reasons, Appellants‟ contentions

regarding misprision of felony do not create subject matter

jurisdiction for their claims.

V

Appellants also challenge the District Court‟s

discretionary decisions to deny them jurisdictional discovery

and leave to file an amended complaint.

A

We review a district court‟s denial of jurisdictional

discovery for abuse of discretion. See Toys “R” Us, Inc. v.

Step Two, S.A., 318 F.3d 446, 455 (3d Cir. 2003). Here, the

District Court did not abuse its discretion when it denied

Appellants‟ request to conduct discovery regarding the

existence of additional SEC internal procedures. Appellants

had and relied on the SEC‟s detailed 457-page OIG Report,

which includes a discussion of numerous SEC procedures and

policies. The SEC subsequently issued a follow-up report

that examines the Office of Compliance Inspections and

Examinations‟ “modules, policies, procedures and guidance

associated with the conduct of its examinations.” SEC OIG

Rpt. No. 468, Review and Analysis of OCIE Examinations of

Bernard L. Madoff Investment Securities, LLC, at 2 (Sept.

29, 2009). The SEC‟s Enforcement Manual is available

online. Despite these materials, Appellants have been unable

to identify any regulation, policy, or procedure that would

overcome application of the discretionary function exception.

Appellants cannot establish a “reasonable expectation that

16

discovery will reveal evidence of” any such policy. See Bell

Atl. Corp. v. Twombly, 550 U.S. 544, 556 (2007).

B

Appellants contend that the District Court improperly

denied their request to amend the complaint to include

allegations that: (1) the SEC knowingly destroyed records

from the Madoff investigations in violation of federal law;

and (2) certain SEC employees involved in the Madoff

investigations were subject to internal discipline. We review

a district court‟s denial of a motion to amend a pleading for

abuse of discretion. See Burtch v. Milberg Factors, Inc., 662

F.3d 212, 220 (3d Cir. 2011). Again, we find no abuse of

discretion.

Appellants‟ allegation of improper document

destruction is not relevant to the claims at issue. Indeed,

Appellants‟ proposed amended complaint does not add any

separate cause of action based on the improper destruction of

documents. The addition of allegations that documents were

improperly destroyed would not take Appellants‟ claims

outside the application of the discretionary function

exception. Likewise, the allegation that disciplinary

proceedings have been brought against certain SEC

examiners does not help Appellants establish that any SEC

employee violated a mandatory policy, and, thus, does not

allow Appellants to overcome application of the DFE.

VI

Accordingly, we will affirm the judgment of the

District Court.

17