Cohen v. United States , 722 F.3d 168 ( 2013 )

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