2013 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

7-1-2013

Baer v. USA

Precedential or Non-Precedential: Precedential

Docket No. 12-1319

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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
2

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.
3

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 wellpleaded 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:
4

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

 

1More 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, 
5

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).

2Although 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.
6

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 
7

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.
8

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 
9

“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).
10

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 
11

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 
12

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

 

4Appellants‟ 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
13

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.
14

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 

 

5Appellants‟ characterization of the SEC‟s failings as being 

due to “laziness” does nothing to alter our analysis.
15

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. 
16

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 
17

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.