Investors who lost their life savings at the hands of Bernard Madoff can’t sue over the Securities and Exchange Commission’s failure to uncover earlier his multibillion-dollar Ponzi scheme, the largest in history.

The U.S. Court of Appeals for the Third Circuit ruled on Monday that the SEC is shielded by a Federal Tort Claims Act exception for an exercise of discretion by a federal agency or employee, even if it is abused.

In a precedential opinion, Baer v. U.S., No. 12-1319, the court affirmed U.S. District Judge Stanley Chesler’s dismissal of the suit.

The panel agreed that the discretionary-function exception applied because the plaintiffs were essentially challenging discretionary decisions relating to the timing, manner, and scope of SEC investigations.

Madoff pleaded guilty in March 2009 to duping thousands of clients out of billions of dollars by pretending to invest their money and sending them phony statements showing high returns.

The plaintiffs are New Jersey residents who invested funds with Bernard L. Madoff Investment Securities (BLMIS) and allegedly lost their life savings when the Ponzi scheme collapsed in late 2008.

They asserted claims for negligence, aiding and abetting Madoff’s fraud and his breach of fiduciary duty, alleging their losses “were a natural, probable and foreseeable outcome of the SEC’s failure to uncover the Madoff Ponzi scheme and of the SEC’s false assurances to the public, as early as December 1992, that the operations of BLMIS were legitimate.”

Backing up their position was a report by the SEC’s own Office of Internal Investigations that faulted the agency for its failure to act on numerous substantive complaints since 1992 that “raised significant red flags” about Madoff’s operations that should have led to questions about whether Madoff was actually engaged in trading and to a thorough examination of the possibility he was operating a Ponzi scheme.

The report found that the SEC conducted five examinations and investigations of Madoff based on those complaints but “never took the necessary and basic steps to determine if Madoff was misrepresenting his trading.” It concluded that had the SEC done so, it “could have uncovered the Ponzi scheme well before Madoff confessed.”

The plaintiffs also quoted a Dec. 18, 2008, press release in which SEC Chairman Christopher Cox admitted the agency’s failure to thoroughly investigate “credible and specific allegations regarding Mr. Madoff’s financial wrongdoing” that were repeatedly brought to the attention of his staff.

The plaintiffs argued against applying the discretionary-function exception because the SEC “flagrantly frustrated” its own “essential purpose” by failing to abide by federal law, its own internal standards and the standards of competence it imposed on third parties.

They alleged the SEC “treated Madoff with ‘kid gloves’ because of his stature in the industry and his friendship with senior SEC officials.”

The appeals court, in affirming Chesler’s 2011 grant of the SEC’s motion to dismiss, said the plaintiffs had not identified any mandatory policy or guideline that was violated by any SEC employee in investigating the complaints against Madoff.

Nor was the court persuaded by the argument that Madoff received preferential treatment despite SEC regulations that require impartiality.

“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,” wrote U.S. District Judge Leonard Stark of the District of Delaware, sitting by designation.

For example, allegations that the SEC discouraged junior examiners from questioning Madoff’s responses to inquiries, failed to scrutinize evidence he provided, delayed the investigation and reassigned examiners who raised concerns about it all involved the “exercise of judgment and choice of the kind the discretionary function was designed to shield,” Stark said.

The rules on which the plaintiffs relied “do not prescribe any particular course of action for the SEC to follow” but at most attempt to limit the scope of SEC discretion during an investigation, he continued.

A violation of the regulations might amount to an abuse of discretion but not one sufficient to waive sovereign immunity, because the discretionary-function exception applies even where the discretion at issue is abused, added Stark, who was joined by Circuit Judges Thomas Hardiman and Ruggero Aldisert.

Other courts have reached the same conclusion, including the U.S. Court of Appeals for the Second Circuit, on April 13, in Molchatsky v. U.S., No. 11-2510, and the U.S. District Court for the Central District of California, in Dichter-Mad Family Partners v. U.S., 707 F. Supp. 2d 1016 (C.D. Cal. 2010).

The Third Circuit also upheld Chesler’s refusal to allow the filing of an amended complaint containing allegations that the SEC knowingly destroyed documents from the Madoff investigations and his denial of the plaintiffs’ request to conduct further discovery on the subject.

The Department of Justice, which represented the SEC, did not respond to a request for comment.

Plaintiffs’ attorney Helen Davis Chaitman, of New York’s Becker & Poliakoff, declines comment.

Chaitman, herself a Madoff victim, has lobbied Congress to tighten investor protections and has a website, www.chaitmanonmadoff.com, that discusses the Baer lawsuit and other Madoff-related litigation in which she is involved.