Victims of Bernard Madoff must surmount laws that shield federal workers and agencies from liability if they want to sue regulators and their staffers for not stopping Madoff years before he confessed to a $65 billion Ponzi scheme.

A report by U.S. Securities and Exchange Commission Inspector General David Kotz said the SEC allowed inexperience, indifference and memory lapses by some staffers to thwart five probes of Madoff.

The report, released last week, provides fodder for investors hoping to recover some of their money, either from the government or liquidation of Madoff's assets.

But to get anything from the government, they would have to prove that the SEC and some of its staff were negligent and that could be extremely difficult, lawyers said.

Although a claim against the government itself is at least plausible here, it would be very difficult to overcome the hurdles of sovereign immunity, said Russell Ryan, a former assistant enforcement director at the SEC and now a partner at the law firm King & Spalding in Washington, D.C.

The doctrine of sovereign immunity has roots in English common law and is sometimes summarized as the idea that the king or queen can do no wrong. It helps protect a government from interference with official functions, including from lawsuits.

At Herrick Feinstein LLP, a mid-size New York firm, lawyers are closely examining the 457-page report, which quotes dozens of current and former SEC staffers, many of whom claimed not to have recalled or pursued evidence that in retrospect could have led them to uncover Madoff's fraud.

It confirms what we have been alleging, that the SEC was negligent in its duty to protect the public interest, said Howard Elisofon, a partner who represents nine of Madoff victims.

Madoff pleaded guilty in March to fraud and is serving a 150-year prison term. A court-appointed trustee, Irving Picard, is trying to recover what he can to cover victims' losses.

On Thursday, the Senate Banking Committee is due to hold the first of what may be several Congressional hearings to examine what went wrong and how the SEC can avoid a repeat.

Kotz is among the witnesses expected at the hearing, along with new enforcement director Robert Khuzami, acting director of examinations John Walsh, and Harry Markopolos, a whistle-blower who repeatedly warned the SEC that Madoff's business was a sham.


Kotz's report paints a picture of an agency plagued by inexperience and indifference as it botched five Madoff probes.

In one case, an SEC branch chief said he might have decided in early 2004 not to request a large amount of Madoff trade data, known as audit trail data, because it can be tremendously voluminous and difficult to deal with and is a huge resource issue for us. It takes us a ton of time.

His boss Eric Swanson, whose romantic relationship with Madoff's niece, Shana, did not influence the probes according to Kotz, told investigators he could not explain why the data request had been scuttled. It would have been, frankly, asinine for us to not get the audit trail, he said.

In another example, Kotz said SEC examiners caught Madoff in contradictions and inconsistencies that were seemingly implausible, yet accepted them at face value. And, he said, staffers ignored a 2005 complaint about Madoff because it came from a competitor rather than a Madoff employee or investor.

Still, former federal prosectors and other experts said carelessness may not be enough to overcome the shield protecting government employees from lawsuits.

And although the Federal Tort Claims Act provides a limited waiver of sovereign immunity, it makes it difficult to sue individuals for acts performed in the course of their duties.


You have to be more than just incompetent, you have to be negligent, said John Newcomer, a partner at James, Hoyer, Newcomer, Smiljanich and Yanchunis PA in Tampa, Florida, which represents consumers in class-action lawsuits against mortgage companies.

It is not enough to say, 'We lost money and this agency was supposed to protect investors,' he said.

Kevin O'Connor, a former associate attorney general and SEC enforcement counsel and now a partner at Bracewell & Giuliani LLP, added: Nothing in the (Kotz) report would strike me as a basis to overcome sovereign immunity.

Elisofon, the Herrick lawyer, has filed nine administrative claims accusing the SEC of negligence regarding Madoff.

In June, the SEC rejected his attempt to get the agency to pay $1.7 million to his client, Phyllis Molchatsky of New City, New York.

Yet since the Kotz report came out, Elisofon said, My phone has been ringing off the hook. He said the report could aid future litigation, and is putting a lot of meat on the bones.

(Reporting by Rachelle Younglai and Jonathan Stempel; Editing by Toni Reinhold)