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SEC Cannot Be Sued for Failing to Stop Ponzi Scheme Sooner

Federal securities regulators are responsible for identifying and stopping fraud that harms investors. But what happens when the regulators act too late? Can the government be held responsible for the negligence of its own officials when they fail to act on obvious warning signs of securities fraud? A federal appeals court recently addressed this question in a Florida case arising from one of the largest Ponzi schemes in U.S. history.

Zelaya v. United States

The two plaintiffs in this case lost upwards of $1.7 million in a Ponzi scheme run by R. Allen Stanford. Stanford used a network of offshore companies to issue billions of dollars worth of high-interest certificates of deposit. The certificates were ultimately worthless, as Stanford never invested any of the money, but rather used new deposits to pay off existing investors.

The U.S. Securities and Exchange Commission put a stop to Stanford’s Ponzi scheme in 2009. But the SEC had previously conducted four investigations into Stanford’s operations, dating back more than 12 years, without taking any action. In 1997, for example, an SEC official in Texas warned a superior that Stanford was advertising “absolutely ludicrous” returns on its CDs and suggested it was a Ponzi scheme. The following year, SEC investigators determined, “Stanford was operating some kind of fraud,” yet once again, no legal action was taken. In 2004, a fourth investigation said Stanford “may in fact be a very large Ponzi scheme,” but again, it took five more years before the SEC did anything about it.

The plaintiffs here filed a lawsuit in Miami against the United States Government, seeking damages under the Federal Tort Claims Act (FTCA). The FTCA allows a party to sue the federal government for “injury or loss of property…caused by the negligent or wrongful act of any employee of the Government while acting within the scope of his office or employment.” The FTCA is necessary because normally, the government cannot be sued without its consent. The FTCA operates as a waiver of this “sovereign immunity,” allowing courts to hear claims that are otherwise barred.

Here, the plaintiffs alleged the SEC’s negligence in failing to halt the Stanford Ponzi scheme before 2009 led to their losses. A federal judge in Miami rejected this argument and dismissed the plaintiffs’ complaint. On appeal, the U.S. 11th Circuit Court of Appeals upheld the district court’s decision.

Among other reasons, the 11th Circuit noted the FTCA contains an exception for “any 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 employee.” In other words, the FTCA does not waive sovereign immunity if a person sues the government because an agency failed to do its job, such as prosecuting an obvious Ponzi scheme. This exception holds even if the agency or employee in question abuses its discretion to the detriment of third parties.

Need Legal Advice?

As this case demonstrates, investors may not be able to hold the federal government accountable for their losses in a Ponzi scheme, but they can still pursue the individuals responsible for such schemes. If you are the victim of a Ponzi scheme and need advice from an experienced Florida securities fraud attorney, contact Gregory Tendrich, P.A., today.

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