Victims of the Madoff Ponzi scheme have been repeatedly unsuccessful in efforts to sue the SEC for the agency's negligence in handling and investigating the Madoff Ponzi scheme. Last week, however, a federal court in Florida ruled that a case brought by victims of the Stanford Ponzi scheme alleging negligence against the SEC could go forward -- a rare and perhaps unprecedented victory in this type of case against the government.

As discussed here, at least four such lawsuits by Madoff victims against the SEC have been dismissed by federal courts already, with courts consistently ruling that there were no allegations that the SEC violated any "mandatory obligations." Rather, these courts found, plaintiffs were complaining about actions and inactions of the SEC that fell within the agency's "discretion and professional judgment," and the SEC was therefore immune from any liability for negligence under the Federal Tort Claims Act.

In the Florida case (Zelaya et al. v. United States), plaintiffs claim that despite an SEC investigation that went on for many years, the SEC was negligent in failing to take any action against Stanford's Ponzi scheme until 2009. Specifically, the plaintiffs allege that the SEC "was negligent when, after concluding that Stanford's company had been operating as a Ponzi scheme, it failed to notify the Securities Investor Protection Corporation about Stanford's company's illicit activities."  

The plaintiffs assert that under 15 U.S.C. § 78eee(a)(1), the SEC has a nondiscretionary statutory obligation to immediately notify the Securities Investor Protection Corporation if it "is aware of facts which lead it to believe that any broker or dealer subject to its regulation is in or approaching financial difficulty." Plaintiffs allege that the SEC concluded that Stanford's company had been operating as a Ponzi scheme well before 2009, and that the SEC therefore believed that Stanford's company "was in or approaching financial difficulty" because "Ponzi schemes by their very nature are insolvent at their inception."

The SEC first argued that a determination that Stanford's company was operating as a Ponzi scheme is not the same as a determination, for purposes of 15 U.S.C. § 78eee(a)(1), that the company was "in or approaching financial difficulty." The court found that this was "not convincing," however, as a Ponzi scheme is by definition "in or

approaching financial difficulty."

The SEC also argued that, in any event, it had not concluded that Stanford's company was operating as a Ponzi scheme. The court ruled that this argument was 

more appropriately raised on summary judgment. If the Plaintiffs are unable to prove their allegations that the Securities and Exchange Commission concluded that Stanford's company was operating as a Ponzi scheme, then a dismissal for lack of jurisdiction would then be warranted. However, at this stage of the litigation the Plaintiffs' allegations are accepted as true.

As a result of the court's ruling, the Florida case will proceed forward. Gaytri Kachroo, a lawyer for the plaintiffs, called the decision "historic," and said that "the ruling handed down today is a bold statement and a warning to the government: If you fail to carry out your statutory obligations to protect the public against wrongdoing with massive repercussions to the investing public, you will be held liable. Today marks the first time that a lawsuit survived the government's motion to dismiss."

The prediction that that the SEC "will be held liable" may prove to be inaccurate, as the case has simply gotten past a motion to dismiss at this point. But the ruling surely has the SEC's full attention, as it may now be forced to litigate facts about its Stanford investigation such as what it knew and when it knew it.