Addressing an issue of first impression in the Second Circuit, the court in MLSMK Investment Company v. JP Morgan Chase & Co., 2011 WL 2640579 (2d Cir. 2011), recently held that the plaintiff was barred by Section 107 of the Private Securities Litigation Reform Act (the “PSLRA”), 18 U.S.C. § 1964(c), from asserting a civil Racketeering Influenced and Corrupt Organizations Act (“RICO”) claim against a bank that allegedly aided the Ponzi scheme perpetrated by Bernard L. Madoff (“Madoff”). The court found that allegations of securities fraud, upon which plaintiff based its predicate act allegation to support its RICO claim, was insufficient even though the plaintiff was legally precluded from bringing a private securities claim against the bank.
Facts & Procedural History
Plaintiff MLSMK Investment Company (“MLSMK”) allegedly invested $12.8 million with Madoff’s investment company between October and December 2008. Defendants JP Morgan Chase & Co. and JP Morgan Chase Bank, N.A. (collectively, “JPMC”) allegedly were trading partners with Madoff’s market-making business and the bank where Madoff’s investment company’s account was maintained. MLSMK allegedly lost its entire investment on December 11, 2008, when Madoff’s assets were seized.
On April 23, 2009, plaintiff filed suit in the United States District Court for the Southern District of New York against JPMC alleging New York state law claims for aiding and abetting breach of fiduciary duty, commercial bad faith and negligence. Plaintiff also asserted a federal claim that JPMC had conspired with Madoff in violation of RICO, and sought treble damages in connection with its RICO claim. In support of its claims, the complaint alleged that in late Summer 2008, JPMC became suspicious of Madoff and undertook a due diligence investigation of Madoff’s business activities which revealed that “Madofff’s investment business was a thoroughly fraudulent enterprise.” The complaint further alleged that from about September 2008 to December 2008 JPMC conspired to violate RICO by “knowingly and purposely conspir[ing] with Madoff to further Madoff’s racketeering enterprise by providing Madoff with banking services that were integral to the functioning of the racketeering enterprise and by engaging in various RICO predicate acts, including numerous interstate wire communications, for which the defendants were paid substantial fees . . . derived entirely from Madoff’s racketeering enterprise.”
JPMC moved to dismiss the entire complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure. Specifically, JPMC argued that plaintiff has not adequately plead the required elements of the state law claims, and that the RICO claim was barred by Section 107 of the PSLRA, 18 U.S.C. § 1964(c) (the “RICO Amendment”). The district court dismissed the complaint in its entirety. With respect to the RICO claim, the district court concluded that plaintiff had failed to plead adequately the defendants’ requisite state of mind.
Plaintiff appealed the district court’s decision to the Second Circuit Court of Appeals. By summary order dated June 6, 2011, MLSMK Inv. Co. v. JP Morgan Chase & Co., No. 10-3040-cv, 2011 WL 2176152 (2d Cir. June 6, 2011), the Second Circuit affirmed the District Court’s dismissal of the state law claims. In a July 7, 2011 decision, the Second Circuit addressed plaintiff’s RICO claim.
The legal issue in dispute in connection with the RICO claim was the scope of the RICO Amendment’s bar of civil RICO claims based upon allegations of securities fraud. The RICO Amendment provides that “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 section 1962.” 18 U.S.C. § 1964(c). The Second Circuit explained that, prior to the RICO Amendment, plaintiffs “regularly” elevated claims for securities violations based upon fraud to RICO violations to take advantage of the treble damages provided for RICO violations (citing Bald Eagle Area Sch. Dist. v. Keystone Fin., Inc., 189 F.3d 321, 327 (3d Cir. 1999)). The court further explained that the RICO Amendment “changed the use of that tactic” by barring plaintiffs from bringing civil RICO claims based upon allegations of securities fraud.
The court addressed the issue of whether an exception exists to the RICO Amendment bar “where, as here, the plaintiff cannot bring a securities fraud claim against the defendant because the plaintiff alleges only an aiding and abetting claim, which cannot serve as a basis for a private right of action.” JPMC argued that the bar applies to “claims based on conduct that could be actionable under the securities laws even when the [particular] plaintiff . . . cannot bring a cause of action under the securities laws,” whereas the plaintiff argued that the viability of a RICO claim turns on the claims available against the defendant. The court observed that, while the Second Circuit had not previously addressed the issue, there was inconsistency among the district court judges within the Second Circuit. Specifically, the court stated that at least three district court decisions in the Second Circuit had accepted the argument advanced by JPMC, whereas at least two district court decisions in the Second Circuit had interpreted the RICO Amendment bar more narrowly.
In support of JPMC’s arguments, the Second Circuit pointed to the district court cases of Fezzani v. Bear Stearns & Co., 2005 WL 500377, 2005 U.S. Dist. LEXIS 3266 (S.D.N.Y. Mar. 2, 2005), Thomas H. Lee Equity Fund V, L.P. v. Mayer Brown, Rowe & Maw LLP, 612 F. Supp. 2d 267 (S.D.N.Y. 2009), and Cohain v. Klimley, 2010 WL 3701362, 2010 U.S. Dist. LEXIS 98870 (S.D.N.Y. Sept. 20, 2010). The court explained that the Fezzani court rejected, as inconsistent with Congress’s purpose, the particularly narrow interpretation of the RICO Amendment which would allow civil RICO claims based upon aiding and abetting securities fraud. The Fezzani court also specifically rejected MLSMK’s argument made in this case that plaintiffs should be able to pursue RICO claims against the aider and abettor because the securities laws do not create a provide cause of action for aiding and abetting securities fraud. The court further explained that the rationale for the Fezzani court decision was the court’s concern that “if it were to accept the plaintiffs’ interpretation, a plaintiff could too easily manipulate a complaint to skirt the RICO Amendment’s limitations.”
The Second Circuit explained that the district court in Thomas H. Lee adopted the reasoning of Fezzani determining that an interpretation of the RICO Amendment “under which ‘so long as [plaintiffs] are pursuing aiders and abettors[, ]they may proceed under RICO’ because their securities claims are not actionable—is ‘treacherous.’” Consistent with Fezzani, the Second Circuit further explained that, in Thomas H. Lee the court noted that language of the RICO Amendment does not support the argument that “for a RICO claim to be barred, the plaintiff who sues under RICO must be able to sue under securities laws, or that the conduct ‘actionable as securities fraud’ on which the plaintiff relies to establish the RICO violation must be that of the defendant.” Finally, the Thomas H. Lee court seemed to suggest that the narrower interpretation of the RICO Amendment would be inconsistent with Congressional intent. The Second Circuit observed that the Thomas H. Lee court had concluded:
It would be strange indeed if Congress, in a statute that otherwise bars private causes of action under RICO for predicate acts that describe conduct actionable as securities fraud, nevertheless chose to allow enhanced RICO remedies—treble damages and attorneys’ fees—against only the very parties that Congress simultaneously made immune from private suit under the securities laws. The better interpretation—and the one supported by the plain meaning of § 107 [of the PSLRA]—is that the RICO Amendment bars claims based on conduct that could be actionable under the securities laws even when the plaintiff, himself, cannot bring a cause of action under the securities laws.
The Second Circuit noted that the district court in Cohain similarly adopted the interpretation of the RICO Amendment set forth in Thomas H. Lee and Fezzani.
In contrast, in support of plaintiff’s more narrow interpretation of the RICO Amendment, the Second Circuit pointed to OSRecovery, Inc. v. One Groupe Int’l Inc., 354 F. Supp. 2d 357 (S.D.N.Y. 2005), and Renner v. Chase Manhattan Bank, 1999 WL 47239, 1999 U.S. Dist. LEXIS 978 (S.D.N.Y. Feb. 3, 1999). The court explained that the district court in OSRecovery interpreted the RICO Amendment to bar only RICO claims based on predicate acts of securities fraud that the plaintiffs could have pursued as securities claims against the defendant. The Second Circuit further explained that the OSRecovery court thought the relevant question under the RICO Amendment to be whether the specific defendant’s alleged conduct is actionable under the securities laws. Therefore, the OSRecovery court concluded that because there is no private right of action for aiding and abetting under the securities laws, the RICO Amendment does not bar such claims. The Second Circuit noted that Remmer similarly determined that the RICO Amendment did not bar the RICO claim because the plaintiff’s aiding and abetting claim did not provide a valid basis for a securities claim and would not have been actionable under the securities laws.
Ultimately, the Second Circuit agreed with JPMC that the reasoning of the district courts in Fezzani and Thomas H. Lee is persuasive and concluded that the RICO Amendment bars civil RICO claims alleging predicate acts of securities fraud, including aiding and abetting securities fraud, even where a plaintiff cannot pursue a securities fraud claim against the defendant. The court rejected plaintiff’s attempt to distinguish Thomas H. Lee and Fezzani on the grounds that those cases involved circumstances where the plaintiffs pled fraud and securities claims in the alternative, in contrast to this case where the plaintiff pleaded only a civil RICO claim. Although the Second Circuit acknowledged the factual difference in the cases, it explained that the decisions were not limited to concerns about gamesmanship in pleadings and analyzed the meaning of the statutory language independently from the specific facts of the cases before them. Further, the court was not swayed by plaintiff’s reliance on OSRecovery. The court noted that plaintiff did not seem to consider JPMC’s interpretation of the RICO Amendment, which was accepted by the district court in Thomas H. Lee and Fezzani, nor “that it was Congress’s intention that the applicability of the RICO amendment to a plaintiff’s civil RICO claim would not depend on the plaintiff’s ability to bring a private securities law action against a particular defendant.”
Additionally, the Second Circuit explained that the plain language of the RICO Amendment “does not require that the same plaintiff who sues under RICO must be the one who can sue under securities laws; its wording . . . does not make such a connection” (quoting In re Enron Corp. Sec., Derivative & ERISA Litig., 284 F. Supp. 2d 511, 620 (S.D. Tex. 2003)). The court further agreed that the RICO Amendment is worded broadly and does not indicate that Congress intended it to be applied in the limited manner that plaintiff urged.
Next, although the Second Circuit found the language of the RICO Amendment to be unambiguous, it noted that the legislative history of the RICO Amendment supported its holding. Specifically, the court explained that the Conference Committee Report provides that Congress intended that the section would eliminate securities fraud as a predicate offense in a civil RICO action (citing H.R. Rep. 104–369, at 47 (1995) (Conf. Rep.), reprinted in 1995 U.S.C.C.A.N. 730, 746.). The court noted further that the Committee explained that the purpose of the RICO Amendment was to remove as a predicate act of racketeering any conduct that would have been actionable as fraud in the purchase or sale of securities as racketeering activity under civil RICO (citing id.; accord S. Rep. 104–98, at 19, 1995 U.S.C.C.A.N. at 698). The court explained that “Congress did not say that it was removing any claim that would have been actionable” rather “[i]ts focus was on the behavior alleged to satisfy RICO’s predicate-act requirement.” The court further explained that the Senate Report made clear that Congress was aware that the RICO Amendment would bar some claims, including aiding and abetting securities law violations. Finally, the court commented that its decision is consistent with analogous cases in other circuits.
In MLSMK Investment, the Second Circuit settled a simmering disagreement within the Circuit about whether the RICO Amendment bars a plaintiff from asserting a civil RICO claim premised upon predicate acts of securities fraud, including mail or wire fraud, even where the plaintiff could not bring a private securities law claim against the defendant. In ruling that it does, the court affirmed the judgment of the district court dismissing the RICO claim against JPMC.