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Second Circuit Takes Broad View of RICO Amendment

By Sara E. Costello, Litigation News Associate Editor – October 27, 2011

In a recent case stemming from the “massive and now infamous Ponzi scheme perpetrated by Bernard L. Madoff,” the U.S. Court of Appeals for the Second Circuit endorsed a broad interpretation of section 107 of the Private Securities Litigation Reform Act, 18 U.S.C. § 1964(c) (the RICO Amendment). The Second Circuit held that this provision, known as the Racketeer Influenced and Corrupt Organizations Act (RICO) Amendment, bars all civil RICO claims involving securities fraud, even if a plaintiff cannot bring a securities claim against the defendant. The appellate court’s holding in MLSMK Investment Co. v. JP Morgan Chase & Co. [PDF] also settled a split within the Second Circuit.

MLSMK Claims JP Morgan Chase Conspired with Madoff
After losing the $12.8 million investment it made with Madoff’s company, MLSMK Investment Company filed suit against JP Morgan Chase & Co., Madoff’s trading partner, and JP Morgan Chase Bank, N.A., the bank where Madoff’s investment company had its accounts. According to MLSMK, JP Morgan Chase conspired with Madoff “to fleece his victims.”

MLSMK further claimed that JP Morgan Chase investigated Madoff in September 2008, and was aware that his investment business was a “thoroughly fraudulent enterprise.” MLSMK alleged that, despite this knowledge, JP Morgan Chase “continued to trade with and provide banking services” to Madoff.

“By failing to freeze Madoff’s accounts, the defendants became liable for conspiracy to violate” RICO, asserted MLSMK. MLSMK sought treble damages under RICO on the theory that JP Morgan Chase aided and abetted Madoff.

The RICO Amendment
JP Morgan Chase moved to dismiss the conspiracy claim, contending that the RICO Amendment precluded it. Under the amendment, “no person may rely upon any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation” of RICO. Taking an expansive view, JP Morgan Chase asserted that the provision applied “to all civil RICO claims predicated upon securities fraud.”

In contrast, MLSMK contended that the RICO Amendment contained an exception. Namely, that “because securities fraud laws do not create a private cause of action for aiding and abetting securities, mail, or wire fraud, a plaintiff should be able to pursue a RICO claim against an alleged aider and abetter of securities fraud.”

All Civil RICO Claims Relying on Securities Fraud Barred
Prior to this case, the Second Circuit had not settled the scope of the RICO Amendment’s bar, and district courts within the circuit had reached different conclusions on how to interpret the amendment. For example, in Thomas H. Lee Equity Fund V, L.P. v. Mayer Brown, Rowe & Maw LLP, the court rejected a narrow interpretation of the amendment. While in OSRecovery, Inc. v. One Groupe Int’l Inc., the court denied a motion to dismiss a RICO claim based on the alleged aiding and abetting of securities laws violations.

Here, noting that the purpose of the RICO Amendment was to prevent plaintiffs from “using artful pleading to boot-strap securities fraud cases into RICO cases,” the Second Circuit rejected MLSMK’s narrow interpretation. The appellate court found that the amendment “bars civil RICO claims alleging predicate acts of securities fraud, even where a plaintiff cannot itself pursue a securities fraud action against the defendant.” The Second Circuit supported its holding by pointing to the plain language of the statute. “When Congress stated that ‘no person’ could bring a civil RICO action alleging conduct that would have been actionable as securities fraud, it meant just that.”

Although the Second Circuit found the language of the amendment to be unambiguous, it stated that the statute’s legislative history also supported its finding. In enacting the statute, “Congress was aware that the RICO Amendment would place some claims—such as those for aiding and abetting securities laws violations—outside the reach of private civil RICO suits.” With its ruling, the Second Circuit joined the Third, Fifth [PDF], Ninth, and Tenth [PDF] Circuits in adopting a broad reading of the RICO Amendment.

RICO’s High Bar
The Second Circuit “drove home the point, that a plaintiff cannot artificially transform a securities fraud claim that is not actionable into a RICO claim,” says Ghillaine A. Reid, New York City, cochair of the ABA Section of Litigation’s Securities Litigation Committee. “RICO has a high bar,” she maintains, and the Second Circuit is “not letting plaintiffs off the hook of meeting this burden.”

The Second Circuit’s ruling forecloses plaintiffs from pursuing RICO claims against those accused of aiding and abetting securities laws violations. But there are “good public policy reasons” to permit securities-based RICO claims to proceed, believes Eduard Korsinsky, New York City, a member of Section of Litigation’s Securities Litigation Committee. Companies, such as JP Morgan Chase, have “no incentive to investigate” potential fraud if they know they won’t be held liable, he adds, thus can keep their “eyes closed” without consequences.

Supreme Court Review Possible
According to a report in Real Clear Markets, MLSMK may appeal the ruling to the Supreme Court. “The current Supreme Court has issued a remarkable amount of securities decisions,” notes Robert W. Brownlie, San Diego, cochair of the Section’s Securities Litigation Committee. “I wouldn’t be shocked if the Court heard this case, but I would be surprised if the Supreme Court turned the statutory scheme of the Private Securities Litigation Reform Act on its head.”

Keywords: litigation, RICO Amendment, securities fraud, Second Circuit

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