In Ouwinga v. Benistar 419 Plan Services, Inc., 694 F.3d 783 (6th Cir. 2012), the Sixth Circuit held a group of investors could maintain a racketeering claim against a law firm (the “Law Firm”) over a series of legal opinion letters the firm wrote to its client (the “Client”). The investors were not the Law Firm’s clients.

The plaintiffs were approached by one of the defendants, Kris Leslie, who was not an employee of the Law Firm, about financial products offered by the Law Firm’s Client. The plaintiffs attended a meeting with Lesley and his supervisor, Robert Fogg, at which they highlighted the “incredible tax liabilities” of the plaintiffs and offered to research potential tax-liability-reduction options. The plaintiffs later met again with Lesley and Fogg who presented the Benistar 419 Plan (the “Plan”) and explained the purported tax benefits of the Plan, asserting Plan contributions were taxdeductible and the plaintiffs could take money out of the Plan at any time tax-free. The plaintiffs, their accountant, and their attorney later met with Lesley and Fogg, who gave a detailed presentation regarding the structure and purported tax benefits of the Plan.

Lesley and Fogg then forwarded several documents to the plaintiffs concerning the Plan, including two large loose-leaf binders. The binders contained information about the Plan in general, touted its purported tax advantages, and provided a legal opinion from the Law Firm.

Based in part on the Law Firm’s legal opinion, the plaintiffs agreed to participate in the Plan in late 2001 and each plaintiff made substantial contributions. These contributions were used by the Plan to pay premiums to the Client to purchase large insurance policies on the lives of the plaintiffs.

In 2003, Lesley and Fogg told the plaintiffs the IRS had changed the rules concerning the Plan and the plaintiffs would need to contribute additional money so the Plan could purchase new life insurance policies to keep the Plan compliant with the tax laws. The Law Firm issued letters to the Client dated October 24, 2003, November 4, 2003, and December 19, 2003 assuring that under the “new IRS rules” the Plan was still not an illegal tax shelter and was viable against any challenge by the IRS.

In 2006, the plaintiffs decided to terminate and/or transfer policies out of the Plan. The Client again advised the plaintiffs there would be no taxable consequences of this transaction and the Plan continued to meet the IRS requirements for tax deductible treatment. The Client also assured the plaintiffs there “had [been] no audits or problems with clients who did buy outs.” At that time, the plaintiffs were asked to and did sign a “Plan Termination and Policy Release Form” for each transaction. By letter dated January 23, 2007, the IRS notified the plaintiffs their tax returns for the years 2003 and 2004 were to be examined. In early 2008, the IRS notified the plaintiffs it disallowed deductions related to the Plan. The IRS ultimately assessed back taxes, interest, and penalties as a result of the tax benefits the plaintiffs claimed from the Plan, which the IRS deemed to be an “abusive tax shelter.”

On January 22, 2009, the plaintiffs filed a class action Complaint against numerous defendants, including the Law Firm. The plaintiffs alleged the defendants conspired to defraud employers like the plaintiffs into adopting welfare benefits plans supposedly in compliance with IRC § 419A(f)(6), which allows significant tax benefits. Specifically, the plaintiffs assert violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”) and negligent misrepresentation against all defendants.

The Sixth Circuit ruled the plaintiffs’ RICO claims could proceed against the defendants, including the Law Firm. The Defendants argued RICO excludes “any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation of section 1962.” The purpose behind this provision is to avoid duplicative recovery for fraud actionable under the securities laws. The provision not only eliminates securities fraud as a predicate act in civil RICO claims, but also prevents plaintiffs from relying on other predicate acts if they are based on conduct that would have been actionable as securities fraud. The Sixth Circuit noted the plaintiffs’ RICO claims were based on the purchases of variable life insurance policies which, because they are “variable,” qualify as securities. The defendants asserted that even though the plaintiffs did not allege securities fraud, their complaint could present a claim for violation of securities laws and is thus barred by the statute. The Court stated the defendants failed to provide any specific reference to a securities action available based on the Amended Complaint’s allegations. Instead, the defendants supported their argument that fraud in the sale of the Plan was “in connection with” the purchase of securities by citing cases primarily involving fraud that directly coincided with the securities transaction. The plaintiffs respond they do not allege fraud relating to the purchase of the variable life insurance policies by the Plan. The plaintiffs argued their fraud claim relates only to the tax consequences of the Plan, and it is merely incidental that the policies happened to be securities. The Sixth Circuit accepted this argument by the plaintiffs and ruled the plaintiffs claims were not barred by the statute because the fraud and the securities transactions were essentially independent events.

The Sixth Circuit then analyzed whether the plaintiffs’ substantive RICO claim under 18 U.S.C. § 1962(c) could proceed. To state a RICO claim, a plaintiff must plead the following elements:

  1. conduct
  2. of an enterprise
  3. through a pattern
  4. of racketeering activity.

With regard to conduct, a plaintiff must set forth allegations to establish the defendant conducted or participated, “directly or indirectly, in the conduct of the RICO enterprise’s affairs. Participation in the conduct of an enterprise's affairs requires proof the defendant participated in the “operation or management” of the enterprise. RICO liability is not limited to those with primary responsibility for the enterprise’s affairs. Instead, only “some part” in directing the enterprise’s affairs is required. However, defendants must have conducted or participated in the conduct of the “enterprise’s affairs,” not just their own affairs.

The Sixth Circuit held the Amended Complaint alleged participation by the Defendants in the enterprise sufficiently to satisfy the “operation or management” test. The Court stated although the Plan was designed by the other entities, the Law Firm carried out the directions of those entities by providing allegedly incomplete and misleading legal opinions. Importantly, the plaintiffs alleged the Law Firm carried out these directions, while knowing contributions to the Plan were not likely to be allowed as deductions by the IRS. Though the Law Firm provided opinion letters to a client relating the tax consequences of the Plan, the plaintiffs allege the Law Firm knew the purpose of the Plan was to falsely represent tax benefits, knew of IRS warnings that these type of plans would not qualify for deductions, and created their opinions letters for the purpose of falsely promoting the plan as a tax-saving device to potential investors.

The Sixth Circuit then analyzed where the Amended Complaint sufficiently alleges defendants engaged in an “enterprise” for purposes of RICO liability. The plaintiffs alleged the defendants created an “association-in-fact” enterprise. In order to establish the existence of an “enterprise” under § 1962(c), a plaintiff is required to prove:

  1. an ongoing organization with some sort of framework or superstructure for making and carrying out decisions;
  2. the members of the enterprise functioned as a continuing unit with established duties; and
  3. the enterprise was separate and distinct from the pattern of racketeering activity in which it engaged.

The Court held the Amended Complaint sufficiently alleged an organizational structure that satisfies the standard for RICO recovery. It delineated the specific roles and relationships of the defendants, alleged the enterprise functioned at least five years, and alleged it functioned for the common purpose of promoting a fraudulent welfare benefit Plan to generate commissions and related fees.

The Sixth Circuit next analyzed where the plaintiffs sufficiently pled a pattern of racketeering activity. A pattern of racketeering activity requires, at a minimum, two acts of racketeering activity within ten years of each other. The minimum two acts, however, are not necessarily sufficient in all cases. A plaintiff must show the racketeering predicates are related (the “relationship prong”) and they amount to or pose a threat of continued criminal activity (the “continuity prong”). The Court noted the plaintiffs alleged as predicate acts mail and wire fraud based on the various communications from the defendants, which fraudulently misrepresented the tax consequences of the Plan. All predicate acts allegedly had the same purpose of misrepresenting the Plan’s tax consequences, were directed toward the plaintiffs, and were presented to the plaintiffs through the same participants purportedly as continued assurances about the Plan's benefits. Thus, the Court ruled the relationship prong was satisfied. The continuity prong of the test is satisfied by demonstrating either a “close-ended’ pattern (a series of related predicate acts extending over a substantial period of time) or an “open-ended” pattern (a set of predicate acts that poses a threat of continuing criminal conduct extending beyond the period in which the predicate acts were performed). The Court described this analysis as a “close” one for the Law Firm. The Law Firm issued four opinion letters, the first dated in 1998 and the other three sent over the span of two months in 2003. According to the Court, the similarity in the representations of tax consequences in all letters can plausibly indicate the Law Firm participated in the fraudulent enterprise over that entire period. Thus, the Court ruled the allegations against the Law Firm in the Amended Complaint were sufficient to withstand the motion to dismiss.

Having found the plaintiffs sufficiently pled a claim against the defendants, including the Law Firm, for RICO violations, the Court turned to the plaintiffs’ claims of fraudulent and negligence misrepresentation against the Law Firm. The Law Firm argued the claim should be dismissed because its opinion letters stated they were not to be relied on by anyone else besides the Law Firm’s client and because opinions could not form the basis for misrepresentations. The Court determined it could not consider the disclaimer in the letters at the motion to dismiss stage because the letters were not part of the pleadings.

Only in limited circumstances, not present in this case, can a court go beyond the pleadings when deciding a motion to dismiss.

The Law Firm also argued the letters contained only opinions, which are generally not actionable as misrepresentations. The plaintiffs responded by arguing the purpose of the opinion letters was to add a “legal stamp of approval” to the fraudulent tax plan and to give potential clients the peace of mind to participate in the Plan. Thus, they alleged the Law Firm gave legal tax advice not only to its client, but also to the intended recipients, taxpayers evaluating the Plan. The Sixth Circuit agreed with the plaintiffs, citing a Supreme Court case for the proposition that “[w]hen an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice.” Thus, the Sixth Circuit held, it is plausible the plaintiffs could show reliance on the opinion letters.

The Ouwinga decision might cause lawyers to give pause before advising a client on an investment matter. Before Ouwinga, a law firm, generally, could be held liable to non-clients only if it were reasonably foreseeable that a third party would rely on its opinions. Ouwinga may expand the potential liability for RICO violations and misrepresentation of lawyers who provide opinions to clients on investment matters. Another implication of the decision is that attorneys found liable for RICO violations may not have coverage under their malpractice liability insurance, which typically does not cover intentional or fraudulent acts.