Swindled Madoff Investors Sue U.S. Gov't for Ignoring 'Smoking Guns' in Ponzi Scheme

Oct. 14, 2009 — -- Investors "lured" by the impressive returns of Bernie Madoff's billion-dollar fraud are pointing the finger at the U.S. government for failing to stop the massive Ponzi scheme, accusing the U.S. Securities and Exchange Commission (SEC) with "serial, gross negligence" in investigating Madoff's investment firm and saying the SEC "botched" opportunities to protect investors from criminal activity.

Citing examples from a scathing internal investigation by the SEC's own inspector general, a lawsuit filed today charges "the SEC was presented with innumerable smoking guns unveiling Madoff's wrongdoing," but "SEC staff failed to follow up and failed to recognize any of them for what they were – the keys to unraveling possibly the largest financial fraud in history."

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The suit, filed by two Madoff investors - Phyllis Molchtasky, described as a "disabled retiree and a single mother" who lost her life savings of $1.7 million, and Dr. Steven Schneider, a physician who saw more than $750,000 in retirement savings lost in the scam - is suing for lost funds as well as attorney fees.

Among the missed opportunities highlighted in the lawsuit are charges the SEC assigned junior staffers with "no relevant training or experience" to look into the inquiries and that investigative teams didn't interview third parties to verify trading activities.

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Moreover, they say, "clouding every step of the SEC's various investigations was a perception of Madoff's power and influence that cowed staff members into giving him the benefit of the doubt, despite their suspicions – or even knowledge – that he had lied to them."

SEC spokesman John H. Heiney told ABCNews.com that, "Based on our initial understanding of the matter, we believe there is no merit to the complaint."

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Following his arrest, Madoff himself revealed that on one occasion he boldly lied to SEC investigators on a Friday about the location of billions of dollars in client assets, fully expecting to be discovered and arrested the following Monday, but apparently no one from the SEC actually checked the accounts.

The agency's inspector general, David Kotz , was highly critical of the SEC's failure to detect Madoff's Ponzi scheme in a strongly worded internal investigation released in September. The investigation concluded that the SEC received "more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation" of Madoff.

But, Kotz said, "Despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed."

Part of the problem, Kotz found, was that the SEC staffers handling the issue were "relatively inexperienced", causing them to accept Madoff's "seemingly implausible" explanations, fail to follow up on inconsistencies, and decline whistleblower's offers for additional evidence. Also, two SEC examinations of Madoff were taking place at the same time in different agency offices – and neither office knew about the other's efforts.

The suit filed today is the not the first to be filed this month, as fingers continue to point blame at those who accusers believe should have prevented Madoff from defrauding investors for so many years.

The federal bankruptcy trustee overseeing the liquidation of the Madoff business and his assets filed suit against Madoff's sons, brother and niece Oct. 2, alleging that the Ponzi scheme might have never succeeded or continued for so long if the family members had not been "completely derelict" in their duties as firm employees.

Angela Hill and Rhonda Schwartz contributed to this report.

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