RICO — Second Circuit Upholds 1962(a) Claim in Anza, in Which Supreme Court Rejected 1962(c) Claim — 12(c) Motion Should Not Be Granted If Holes in Complaint Can Be Filled By Discovery Already Taken

From Ideal Steel Supply Corp. v. Anza, 2011 U.S. App. LEXIS 13176 (2d Cir. 2011) (2-1 decision):

This case returns to us from the United States District Court for the Southern District of New York, Richard M. Berman, Judge, following the entry of a final judgment dismissing the third amended complaint (or "Complaint") of plaintiff Ideal Steel Supply Corporation ("Ideal") under the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961-1968, which principally alleged injury to Ideal's business by reason of defendants' establishment of a competing commercial enterprise through the investment of income derived from a pattern of racketeering activity — to wit, mail fraud and wire fraud in violation of 18 U.S.C. §§1341 and 1343, in the filing of fraudulent tax returns and related information enabling the evasion of more than $1 million in income taxes — in violation of 18 U.S.C. § 1962(a). ***

Much of the factual background of this litigation is described in prior opinions, familiarity with which is assumed. See Ideal Steel Supply Corp. v. Anza, 254 F.Supp.2d 464, 465-66 (S.D.N.Y. 2003) ("Ideal Steel I"). vacated and remanded, 373 F.3d 251, 253-56, 265 (2d Cir. 2004) ("Ideal Steel II"), reversed in part, and vacated and remanded in part, 547 U.S. 451, 453-56, 462 (2006) ("Ideal Steel III"). ***

Ideal operates a retail business in the New York City boroughs of Queens and the Bronx, selling steel mill products and related hardware and services to professional ironworkers, small steel fabricators, and do-it-yourself homeowners in the New York, New Jersey, and Connecticut area. Defendant National Steel Supply, Inc., is owned by defendants Joseph and Vincent Anza (collectively "the Anzas") and is Ideal's competitor. National operates two retail outlets, one in Queens and one in the Bronx, each located a few minutes' drive from the Ideal store in that borough. Ideal and National sell substantially the same products to essentially the same customer base.

Ideal commenced the present action in 2002, principally asserting two civil RICO claims. First, it asserted a claim against the Anzas, alleging that they had conducted, or participated in the conduct of, the affairs of an interstate-business enterprise through a pattern of racketeering activity, in violation of 18 U.S.C. § 1962(c). Ideal alleged that, since at least 1998, National at its Queens store, at the direction of the Anzas, had engaged in a pattern of racketeering activity by (a) not charging sales tax to any customers who paid for their purchases in cash (the "cash-no-tax" scheme), thereby violating state laws that required merchants to charge and collect such taxes, and (b) then submitting, by mail and wire, fraudulent sales and income tax reports and returns that concealed National's cash sales and misrepresented its total taxable sales, thereby evading substantial sums in income tax. Ideal alleged that by engaging in the cash-no-tax scheme through a pattern of mail and wire frauds in violation of § 1962(c), National injured Ideal's business by luring away customers who chose to buy from National simply in order to save more than eight percent on their purchases by not paying the required sales tax.

Second, Ideal alleged that in 1999 and 2000, the Anzas and National, in violation of § 1962(a), invested funds derived from National's Queens store's cash-no-tax scheme to establish National's store in the Bronx. The opening of that facility caused Ideal to lose a substantial amount of business at its Bronx store. Ideal also asserted a state-law claim for breach of an agreement that had settled prior litigation between Ideal and National.***

In Ideal III, 547 U.S. 451, the Supreme Court reversed in part, and vacated and remanded in part, our decision in Ideal II. With respect to Ideal's claim under § 1962(c), the Court reversed, noting its holding in Holmes "that a plaintiff may sue under § 1964 (c) only if the alleged RICO viol at ion was the proximate cause of the plaintiff's injury," Ideal III, 547 U.S. at 453, and stating that the critical question for the present case was thus "whether the alleged violation led directly to the plaintiff's injuries," not whether the violation intentionally targeted the plaintiff, id. at 460-61. RICO provides a civil right of action for "[a]ny person injured in his business or property by reason of a violation of section 1962," 18 U.S.C. § 1964(c).***

The Supreme Court found it clear that there was no direct relation between the injury asserted by Ideal and the Anzas' alleged mail and wire frauds: ***

Ideal's lost sales could have resulted from factors other than petitioners' alleged acts of fraud. Businesses lose and gain customers for many reasons, and it would require a complex assessment to establish what portion of Ideal's lost sales were the product of National's decreased prices.


With respect to Ideal's claim under § 1962(a), however, the Supreme Court vacated and remanded for further consideration. Because Ideal II had focused principally on Ideal's § 1962(c) claim, without addressing the issue of proximate cause in connection with the claim under § 1962(a), and because the parties had devoted nearly all of their attention in the Supreme Court to the § 1962 (c) claim, the Ideal III Court declined to resolve the viability of Ideal's § 1962(a) claim. The Court remanded for further consideration of the proximate-cause issue in light of the differences between the two subsections:

[i]t is true that private actions for violations of § 1962(a), like actions for violations of § 1962(c), must be asserted under § 1964(c). It likewise is true that a claim is cognizable under § 1964(c) only if the defendant's alleged violation proximately caused the plaintiff's injury. The proximate-cause inquiry, however, requires careful consideration of the "relation between the injury asserted and the injurious conduct alleged." Holmes, supra, at 268. Because § 1962 (c) and § 1962 (a) set forth distinct prohibitions, it is at least debatable whether Ideal's two claims should be analyzed in an identical fashion for proximate-cause purposes.

Ideal III, 547 U.S. at 461-62***.

This Court remanded the matter to the district court for consideration, in light of Ideal III, of the issue of proximate cause with respect to Ideal's claim under § 1962(a). Following our remand, Ideal filed its present Complaint, reasserting only its § 1962(a) claim and its state-law breach-of-contract claim, and additional discovery was conducted.

The Complaint again described the cash-no-tax scheme conducted at National's Queens facility in the late 1990s and early 2000s, and the attendant mail and wire frauds that allowed defendants to retain unreported profits and avoid paying proper taxes. It alleged that defendants used the concealed unlawful profits and tax savings to finance the opening of the National store in the Bronx to compete with Ideal. According to the Complaint and materials developed in discovery, for 1999 and 2000 National filed tax returns reporting total income of $145,118, Following the commencement of the present lawsuit, however, National filed amended tax returns showing that its total income for those years had instead been nearly $1.7 million, and that for the period 1998-2003 National had underreported its taxable income by a total of $4.3 million, allowing it to underpay its taxes by approximately $1.7 million. Discovery and other proceedings revealed that the Anzas had created a corporation called Easton Development Corporation ("Easton Corporation") to purchase property in 1999 to enable National to open its store in the Bronx, and that the cash portion of the purchase price was $500,000, which was paid by National. (See Deposition of Joseph Anza at 34; Declaration of Vincent Anza dated December 12, 2008 ("Anza Decl."), ¶¶ 10, 11; Deposition of Vincent Anza ("Anza Dep.") at 188.) National began operating its Bronx store in 2000. (See Anza Decl. ¶ 4.) Defendants stated that "National expended approximately $850,000 to open its Bronx facility" (id. ¶5); a report prepared by accountants retained by Ideal concluded that National had spent considerably more.

Ideal asserted that prior to 2000 there were no companies capable--in either size or breadth of offerings — of competing with Ideal in the Bronx, and that in 1998-2000, Ideal consistently had annual sales in the range of $4 million - $4.6 million. It alleged that defendants' opening of the National store in the Bronx injured Ideal in two ways. First, simply by being there and offering products and services comparable to those offered by Ideal, the new National store took customers from Ideal, causing Ideal's annual sales in 2001-2002 to drop by about one-third, to $2.7 million - $2.9 million. Second, Ideal asserts that at the Bronx store National engaged in the same cash-no-tax scheme that it conducted in the Queens store, thus allowing National to lure customers with the lower prices financed by the prior tax frauds.

We conclude that to the extent that Ideal claims injury from National's continuation in its Bronx store of the cash-no-tax scheme conducted in the Queens store, that claim appears to be conceptually indistinguishable from the § 1962(c) claim rejected the Supreme Court in Ideal III. The lower prices afforded to National's customers through this scheme do not involve the investment" or "use" of the illegally derived funds.

To the extent, however, that Ideal claims that it lost sales to National because defendants invested the proceeds of their pattern of racketeering activity to establish and operate National's new store in the Bronx, we reject defendants' contentions and conclude, for the reasons that follow, that the district court erred in granting judgment on the pleadings on the basis of Twombly, and erred in granting summary judgment. ***

Subsection (a) of § 1962 — the remaining federal-law focus of the present litigation — provides, in pertinent part, that

[i]t shall be unlawful for any person who has received any income derived, directly or indirectly, from a pattern of racketeering activity . . . to use or invest, directly or indirectly, any part of such income, or the proceeds of such income, in . . . the establishment or operation of, any enterprise which is engaged in, or the activities of which affect, interstate or foreign commerce.

***Subsection (c) of § 1962, which was the principal focus of Ideal I, II, and III, makes it unlawful for any person employed by or associated with a commerce-affecting enterprise "to conduct or participate, directly or indirectly, in the conduct of such enterprise's affairs through a pattern of racketeering activity." 18 U.S.C. § 1962(c). Thus, "the compensable injury flowing from a violation of that provision 'necessarily is the harm caused by predicate acts sufficiently related to constitute a pattern.'" Ideal III, 547 U.S. at 457 (quoting Sedima, 473 U.S. at 497) (emphasis ours).

Subsection (a), in contrast, focuses the inquiry on conduct different from the conduct constituting the pattern of racketeering activity. After there have been sufficient predicate acts to constitute such a pattern, what is forbidden by subsection (a) is the investment or use of the proceeds of that activity to establish or operate a commerce-affecting enterprise. Thus, the plaintiff asserting a civil RICO claim based on a violation of subsection (a) must show injury caused not by the pattern of racketeering activity itself, but rather by the use or investment of the proceeds of that activity, see, e.g., Ouaknine v. MacFarlane, 897 F.2d 75, 82-83 (2d Cir. 1990).

Further, the numerous disjuncts in § 1962(a) create a broad prohibition. Assuming a pattern of racketeering activity and a commerce-affecting enterprise, both the funds derived "directly or indirectly" from such activity and the "proceeds of such income" are tainted: no part of the "income, or the proceeds of such income" may lawfully be "use[d] or invest[ed]," whether "directly or indirectly," in "the establishment or operation" of that enterprise. Thus, although the injury alleged to result from the violation of subsection (a) — as from the violation of any other subsection of § 1962 — must be sufficiently directly related to the violation to meet the legal standard of proximate cause implied in § 1964(c), the many disjuncts in § 1962(a) mean that any of dozens of combinations or permutations will constitute a violation of that section. ***

Finally, in keeping with the proper recognition of RICO's breadth, we note that "income" as used in § 1962(a) was doubtless not intended by Congress to be interpreted restrictively to exclude moneys unlawfully retained by means of racketeering activity. In describing the RICO sections of the bill that became the OCCA, the report of the Judiciary Committee of the House of Representatives stated that "[s]ubsection (a) makes it unlawful to invest funds derived from a pattern of racketeering activity, as defined in section 1961 (1)," H.R. Rep. No. 91-1549, at 57, reprinted in 1970 U.S. Code Cong. & Admin. News 4007, 4036 (emphasis added). We can discern no meaningful distinction, for RICO purposes, between income fraudulently acquired and income fraudulently retained; both result in funds not otherwise available but for the fraud. Thus we view moneys unlawfully saved or withheld by means of a pattern of mail and wire frauds, as is alleged in the present case, as falling within the meaning of § 1962 (a)'s reference to "income." Nor have defendants urged a narrower interpretation.

In sum, with respect to Ideal's claim under § 1962(c), "[t]he proper referent of the proximate-cause analysis [was the] alleged practice of conducting National's business through a pattern of" mail and wire fraud in connection with its tax obligations, "defrauding the State." Ideal III, 547 U.S. at 458. Given this frame of reference, Ideal's injury, i.e., loss of sales to National, was "attenuated," id. at 459, because the direct victim of that activity was the State of New York. But "[p]roximate cause requires only 'some direct relation between the injury asserted and the injurious conduct alleged,' and excludes only those 'link[s] that are too remote, purely contingent, or indirect.'" Staub v. Proctor Hospital, 131 S. Ct. 1186, 1192 (2011) (quoting Hemi Group, LLC v. City of New York, 130 S. Ct. 983, 989 (2010) ("Hemi")). With respect to the claim under § 1962(a), the proper referent in the proximate-cause analysis is defendants' "use or invest[ment]" of the funds, derived directly or indirectly from the alleged pattern of racketeering activity, to establish or operate the National facility in the Bronx. ***

The district court in Ideal IV demanded of Ideal a pleading at a level of specificity that was not justified by Twombly. The Complaint's "allegations that Defendants substantially decreased Ideal's sales, profits, and local market share, and eliminated Ideal's dominant market position, by using racketeering proceeds to acquire, establish, and operate their Bronx business operation," Ideal IV, 2009 WL 1883272, at *4 (internal quotation marks omitted), were not properly characterized as "labels," id., nor could the allegations — as they were set forth in the Complaint — be considered a mere formulaic repetition of the statutory language or considered so conclusory as to lack facial plausibility. The Complaint alleged, inter alia, that the income of National, as a Subchapter S corporation under the Internal Revenue Code, passed through to the Anzas as its sole shareholders (see Complaint ¶ 26); that from at least 1996 to the spring of 2004, National and the Anzas filed fraudulent tax returns understating the amount of their taxable income and enabling them to save and amass substantial funds (see, e.g., id. ¶¶ 28, 30, 61); that after the commencement of this lawsuit in 2002, defendants admitted the falsity of those income tax returns by filing amended returns showing that they had falsely underreported National's income to tax authorities for several years (see id. ¶ 29); that defendants' false tax returns from 1996 to spring 2004 were filed by mail and fax, violated federal laws against mail and wire fraud, and constituted a pattern of racketeering activity in violation of RICO (see id. ¶¶ 34-35, 45, 61); that for each of the years 1999 and 2000, defendants reported taxable income of less than $100,000 (see id. ¶ 38); that the purchase and renovation expenses for National's Bronx facility were capital expenses that could not be funded with pre-tax dollars (see id. ¶ 39); that the expense of purchasing, renovating, equipping, stocking, and opening National's Bronx facility was estimated by Ideal to be in excess of $1 million (see id. ¶ 37); and that in 1999-2000, defendants fraudulently underreported their income by more than $1 million (see id. ¶ 40). The Complaint alleged that before National opened its Bronx facility, Ideal had a dominant market position there, with no serious competitors, as no other Bronx vendors offered as comprehensive an array of goods and services as Ideal (see id. ¶ 11); that National's Bronx facility, opened in the summer of 2000 a mere eight minutes' drive from Ideal's facility, began to offer an array of goods and services similar to those offered by Ideal (see id. ¶¶ 9-15); and that the opening of National's Bronx facility caused a substantial decrease in Ideal's sales, profits, and local market share (see id. ¶ 43). We see nothing implausible in the allegations that a plaintiff business entity that had once enjoyed a dominant market position, with no serious competition from other, more limited, entities, lost business when a large competitor comparable in size and offerings to the plaintiff opened nearby.

Second, although the standards for dismissal pursuant to Rule 12(c) are the same as for a dismissal pursuant to Rule 12(b)(6), see, e.g., Rivera v. Heyman, 157 F.3d 101, 103 (2d Cir. 1998), and the standard set by Twombly for evaluation of the viability of the pleading is the same under each Rule, see, e.g., Hayden v. Paterson, 594 F.3d 150, 160-61 (2d Cir. 2010), we view the district court's focus solely on the allegations of the Complaint, given the posture of this case, as a misapplication of Twombly. Twombly is meant to allow the parties and the court to avoid the expense of discovery and other pretrial motion practice when the complaint states no plausible claim on which relief can be granted:

[W]hen the allegations in a complaint, however true, could not raise a claim of entitlement to relief, this basic deficiency should . . . be exposed at the point of minimum expenditure of time and money by the parties and the court.

Twombly, 550 U.S. at 558 (internal quotation marks omitted) (emphasis ours). In the present case, the point of minimum expense had long since been passed. The case had been addressed at each of the three levels of the federal judicial system; and, by the time of Ideal IV, discovery had been completed. To be sure, whether the complaint states a claim upon which relief can be granted is a question of law, and that question may be raised even as late as at the trial of the action, see Fed. R. Civ. P. 12(h)(2). But pleadings often may be amended. Prior to trial, after the time to amend as of right has passed, "[t]he court should freely give leave [to amend] when justice so requires," Fed. R. Civ. P. 15(a)(2); see, e.g., Rachman Bag Co. v. Liberty Mutual Insurance Co., 46 F.3d 230, 234-35 (2d Cir. 1995); see also Fed. R. Civ. P. 15(b)(1) (even at trial, "[t]he court should freely permit an amendment" to conform the pleadings to the proof, unless the objecting party can show prejudice). Indeed, the availability of "amendment of pleadings" was one of the reasons for Congress's expectation that the private right of action for RICO violations would be an effective tool, S. Rep. No. 91-617, at 82.

In light of the fact that discovery in this case had been completed prior to the decision in Ideal IV, we do not regard Twombly as requiring that defendants' Rule 12(c) motion be granted if evidence that had already been produced during discovery would fill the perceived gaps in the Complaint. ***

***C. Summary Judgment ***

As a general matter, the district court viewed the proximate cause inquiry as the same for a claim under subsection (a) as for one under subsection (c), and it does not appear to have given effect to the different referents required by the different prohibitions. In Ideal III, the Court found that proximate cause was lacking for Ideal's subsection (c) claim because "the cause of Ideal's harm was 'a set of actions (offering lower prices) entirely distinct from the alleged RICO violation (defrauding the State).'" Hemi, 130 S. Ct. at 990 (describing and quoting Ideal III, 547 U.S. at 458). Hemi emphasized that the Supreme Court's RICO proximate cause precedents make "clear . . . that 'the compensable injury flowing from a [RICO] violation . . . "necessarily is the harm caused by [the] predicate acts."'" 130 S. Ct. at 991 (quoting Ideal III, 547 U.S. at 457 (quoting Sedima, 473 U.S. at 497)). With respect to Ideal's subsection (a) claim, however, the act constituting the violation is the very act that causes the harm: the use or investment of the funds derived from the pattern of mail and wire frauds to establish and operate the Bronx store is both the violation and the cause of Ideal's lost sales. The district court, in stating that "[t]he decisions of individual purchasers . . . have been held to constitute an independent intervening act between the alleged RICO violations and the alleged injuries," Ideal IV, 2009 WL 1883272, at *5, does not appear to have focused on the fact that the alleged subsection (a) violation itself, the investment or use of all or part of the income derived directly or indirectly from the racketeering activity in the establishment or operation of a store that simply by its existence attracts customers away from a competitor, may be the direct cause of injury to the plaintiff in its business or property.

We note also that the only cases cited by the district court as holding that decisions of individual purchasers are an intervening cause that defeats proximate cause were district court cases. In Bridge v. Phoenix Bond & Indemnity Co., 553 U.S. 639, 651 (2008), the Supreme Court, in rejecting the proposition that a civil RICO plaintiff complaining of a pattern of mail fraud must prove its own reliance, proffered the following hypothetical:

suppose an enterprise that wants to get rid of rival businesses mails misrepresentations about them to their customers and suppliers, but not to the rivals themselves. If the rival businesses lose money as a result of the misrepresentations, it would certainly seem that they were injured in their business "by reason of" a pattern of mail fraud, even though they never received, and therefore never relied on, the fraudulent mailings.

Id. at 649-50. Plainly, in this hypothetical, the fact that the plaintiff's loss of business would have resulted from customer decisions does not defeat proximate cause.

The majority decision does not address the fact that there is actually case law on what constitutes “income” for RICO purposes. Nor does it address a significant problem with its analysis. What if National built three warehouses in three different locations, each of which had a different competitor? For all we know, it did. On the majority’s reasoning, every affected competitor could separately sue under § 1962(a). Money is fungible. That each has a § 1962(a) claim is a function of the proximate cause analysis, and the question whether illicit savings of money derived from legitimate sources constitutes RICO “income” and whether tracing of some sort is required to satisfy § 1962(a). These issues are addressed in my book, Civil RICO: A Definitive Guide (3d ed. 2010), at pages 164-165. (Note also the implications for the majority rule, including in the Second Circuit, that money reinvested by a corporation in itself does not generally satisfy the investment injury requirement of a § 1962(a) claim. Id. at 62-64.)

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