Tuesday, September 11, 2012

Federal Court Dismisses One Negligence Claim Against SEC, But Second Claim May Proceed Based on Alleged SEC Duty to Report Broker/Adviser to SIPC

A claim that the SEC negligently approved an investment adviser's annual amended registration could not proceed, but a claim that the Commission breached its duty to timely report the alleged Robert Stanford and Stanford Group Company Ponzi scheme to the SIPC may continue, according to the U.S. District Court for the Southern District of Florida.

The case arose from Robert Stanford’s alleged operation of a Ponzi scheme involving the sale of fraudulent offshore certificates of deposit. Stanford Group Company, allegedly created by Stanford to promote these investments, was registered with the SEC as a broker-dealer and investment adviser. The SEC investigated numerous complaints about Stanford and the company from 1997 to 2004 and each time found that Stanford was operating a Ponzi scheme.

The plaintiffs sued the Commission for negligence under the Federal Tort Claims Act (FTCA). Specifically, plaintiffs alleged the SEC failed to timely report the Stanford Ponzi scheme to the SIPC under the SIPA once it determined that Stanford’s company was in or approaching financial difficulty. The plaintiffs also claimed the SEC negligently approved annual amendments to the company’s Investment Advisers Act registration after finding Stanford’s company was a Ponzi scheme.

The government moved to dismiss the case for lack of subject matter jurisdiction. When a motion to dismiss for lack of subject matter jurisdiction involves a factual attack that implicates an element of the claim, the court should find jurisdiction exists and instead treat the motion as a direct attack on the merits of the case, said the court. Thus, the government’s motion was treated as if it were a motion to dismiss for failure to state a claim and the plaintiffs’ allegations were accepted as true.

The U.S. argued that both of plaintiffs’ claims fell within the discretionary function exception to the FTCA, thus depriving the court of subject matter jurisdiction. The court used a two-part test to determine whether this exception to the FTCA’s limited waiver of sovereign immunity applied. First, the government act must be discretionary in nature (i.e., it involves judgment or choice). A nondiscretionary law or rule, however, leaves the government no option but to comply. Second, if the act is discretionary, the court examines whether it is capable of policy analysis. No weighing of policy options is required because the court presumes that a discretionary act is grounded in policy.

The court rejected the government’s main argument that the SEC’s decision to report a broker-dealer’s financial troubles to the SIPC is discretionary. The U.S. argued that determining Stanford’s company was a Ponzi scheme was not the same as concluding that the company was in or approaching financial difficulty under the SIPA. The court, however, said that if plaintiffs’ allegation that the Commission had found Stanford’s company to be a Ponzi scheme was true, then by definition the company was in or approaching financial difficulty. Although the determination that a firm is in or approaching financial difficulty itself involves discretion, the statutory obligation to report to the SIPC upon making this finding is nondiscretionary. Thus, the plaintiffs’ sufficiently alleged that the SEC had a non-discretionary duty to report Stanford’s company to the SIPC.

The court declined to consider the government’s other arguments that the SEC had not determined Stanford’s company was a Ponzi scheme or that the SEC and the SIPC would have discretion to act even following a report to the SIPC. These arguments were inappropriate for a motion to dismiss where all of plaintiffs’ claims are accepted as true. The U.S., however, may revive these arguments at the summary judgment stage or at another appropriate time.

By contrast, the court held that plaintiffs may not proceed with their claim that the SEC negligently approved Stanford’s company's annual amended Advisers Act registration. The plaintiffs alleged that the Commission had a nondiscretionary duty to review annual amendments to the company’s registration. The court noted that plaintiffs did not allege SEC negligence in reviewing the company's initial adviser application. The SEC must either grant or investigate whether to deny initial adviser registrations.
The court instead credited the government’s argument that the SEC owed no duty to grant or deny amendments to adviser registrations because the relevant laws and rules do not mandate SEC action. Even if SEC approval of these amendments was required, said the court, the act of granting or denying amendments to an Adviser Act registration is discretionary. Commission decisions on amended adviser registrations, thus, are within the FTCA's discretionary function exception.
Zelaya, et. al. v. United States of America (No. 11-62644-Civ-SCOLA, September 7, 2012, Scola, Jr., J).