By Jonathan Stempel
NEW YORK (Reuters) - A federal judge dismissed a lawsuit by two of Bernard Madoff's former customers accusing the U.S. Securities and Exchange Commission of negligence for failing to uncover the now-imprisoned swindler's Ponzi scheme.
U.S. District Judge Laura Taylor Swain in Manhattan said the plaintiffs, Phyllis Molchatsky and Steven Schneider, failed to show the SEC violated any statute or rule governing how it should have investigated Madoff prior to his December 2008 arrest.
"Scandalous and outrageous as plaintiffs' allegations are, plaintiffs fail to identify any specific, mandatory duty that the SEC violated in its numerous instances of sloppy, uninformed, irresponsible behavior," the judge wrote.
Molchatsky and Schneider had sued the SEC under the Federal Tort Claims Act in October 2009, after the regulator rejected their claims. The government countered that it was up to the SEC to decide whom and how to investigate.
Howard Elisofon, a partner at Herrick Feinstein LLP, said the plaintiffs are reviewing their next step.
"We are disappointed with the judge's opinion and continue to believe that the court is well-suited to oversee the SEC's actions and inactions, which were inarguably negligent," he said. "In our professional view, that's what the Federal Tort Claims Act not only enables, but actually mandates."
SEC spokeswoman Florence Harmon declined to comment. Other investors have also sued the SEC, and Swain's ruling could affect how those cases are decided.
According to court papers, Molchatsky is a disabled retiree who lost $1.7 million after investing her life savings in a "feeder fund" that funneled money to Madoff, while Schneider is a doctor who lost about $750,000 with Madoff.
In September 2009, SEC Inspector General David Kotz issued a report faulting the regulator for repeatedly mishandling warnings about Madoff, once dismissing whistleblower Harry Markopolos as a "self identified independent fraud analyst" whose warnings on Madoff constituted a "fishing expedition."
Kotz said this caused the SEC to botch five probes starting in the early 1990s that might have unearthed Madoff's fraud.
Mary Schapiro, the current SEC chairman, has implemented reforms designed to avoid a repeat.
Madoff, 72, pleaded guilty in March 2009 to running what prosecutors called a $65 billion Ponzi scheme. He is serving a 150-year sentence in a North Carolina federal prison.
Irving Picard, a court-appointed trustee seeking money for former Madoff investors, has filed more than 1,000 lawsuits to recover roughly $100 billion, including from Madoff's main bank, JPMorgan Chase & Co. He has recovered about $10 billion so far.
The case is Molchatsky et al. v. United States of America, U.S. District Court, Southern District of New York, No. 09-08697.
(Additional reporting by Grant McCool in New York and Rachelle Younglai in Washington, D.C.; Editing by Gerald E. McCormick and Steve Orlofsky)