PSLRA Precludes RICO Action Predicated on Aiding and Abetting Securities Fraud and other Conduct that Sounds in Securities Fraud but Is Not Actionable by the Plaintiff

From MLSMK Inv. Co. v. JPMorgan Chase & Co., 2011 U.S. App. LEXIS 13822 (2d Cir. July 7, 2011):

This case arises out of the massive and now infamous Ponzi scheme perpetrated by Bernard L. Madoff ***.

Between October and December 2008, the plaintiff, MLSMK Investment Company ("MLSMK"), invested $12.8 million with Madoff's investment company, Bernard L. Madoff Investment Securities ("BMIS"). The defendants, JP Morgan Chase & Co. ("JPMC") and JP Morgan Chase Bank, N.A. ("Chase Bank"), were, respectively, a trading partner for Madoff's apparently legitimate market-making business and the bank with which Madoff maintained the account for BMIS. MLSMK lost its $12.8 million investment when, on December 11, 2008, Madoff was arrested and his assets seized.

MLSMK subsequently filed this lawsuit in the United States District Court for the Southern District of New York alleging several New York state-law claims against the defendants. It also asserted a federal claim contending that the defendants had conspired with Madoff to "fleece" his victims, in violation of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1962(d) and 1964(c). In that connection, MLSMK alleges that by late summer 2008, the defendants became suspicious of Madoff's business activities and therefore undertook a "due diligence" investigation into Madoff's activities, and that the investigation revealed to the defendants that Madoff's investment business was a thoroughly fraudulent enterprise. Nevertheless, MLSMK asserts, the defendants — eager to continue receiving the substantial fees they derived from Madoff's market-making and banking activity — continued to trade with and provide banking services to him. MLSMK asserts that by failing to freeze Madoff's accounts, the defendants became liable for conspiracy to violate RICO by aiding and abetting Madoff's breach of fiduciary duty, commercial bad faith, and negligence.

***[W]e conclude that the claim also must be dismissed, because it is barred by section 107 of the Private Securities Litigation Reform Act (the "PSLRA"), 18 U.S.C. § 1964(c). ***

Section 107 of the PSLRA — which was enacted as an amendment to the RICO statute and accordingly is often referred to as 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). As explained by the United States District Court for the Southern District of Texas, "[b]efore the RICO Amendment, a plaintiff could allege a private civil RICO claim for securities laws violations sounding in fraud because 'fraud in the sale of securities' was listed as a predicate offense." In re Enron Corp. Sec., Derivative & ERISA Litig., 284 F. Supp. 2d 511, 618 (S.D. Tex. 2003) (citing Bald Eagle Area Sch. Dist. v. Keystone Fin., Inc., 189 F.3d 321, 327 (3d Cir. 1999)). "Inasmuch as 'fraud in the sale of securities' was [, before the 1995 RICO Amendment,] a predicate offense in both criminal and civil RICO actions, plaintiffs regularly elevated fraud to RICO violations because RICO offered the potential bonanza of recovering treble damages." Bald Eagle Area Sch. Dist., 189 F.3d at 327 (citation omitted).

The RICO Amendment changed the use of that tactic by barring civil RICO claims based on allegations of securities fraud. See Thomas H. Lee Equity Fund V, L.P. v. Mayer Brown, Rowe & Maw LLP, 612 F. Supp. 2d 267, 281 (S.D.N.Y. 2009) ("Section 107 of the PSLRA . . . bars private causes of action under RICO for predicate acts that describe conduct that would otherwise be actionable as securities fraud."); see also Bald Eagle Area Sch. Dist., 189 F.3d at 327 ("The PSLRA amended RICO by narrowing the kind of conduct that could qualify as a predicate act."). ***

But the scope of the RICO Amendment's bar is unsettled in this Circuit. The parties dispute whether it applies to all civil RICO claims predicated upon securities fraud, or if there is an exception 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, see Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 177 (1994) (concluding that section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), does not "impos[e] private civil liability on aiders and abettors" of securities fraud). The determinative question, then, is whether the RICO Amendment bars all RICO claims "that would have been actionable as fraud in the purchase or sale of securities," 18 U.S.C. § 1964(c), or only RICO claims in cases where that plaintiff could have asserted a fraud claim against the named defendant. That is, we must determine whether, as the defendants assert, 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," Appellees' Br. 32 (quoting Thomas H. Lee, 612 F. Supp. 2d at 283) (internal quotation marks omitted); see Appellees' Supp. Br. 3-4, or whether, as MLSMK contends, the viability of a RICO claim turns on the "claims available against a particular defendant," Appellant's Reply Br. 19; see Appellant's Supp. Br. 5 ("A court must analyze whether the particular plaintiff has a cause of action sounding in securities fraud against the named defendant.")

This Court has not weighed in on the question. The answers proffered by the district courts in this Circuit diverge, but at least three district court judges in this Circuit have accepted the argument made by the defendants here. *** [1] Fezzani v. Bear, Stearns & Co., No. 99 Civ. 0793, 2005 WL 500377, 2005 U.S. Dist. LEXIS 3266 (S.D.N.Y. Mar. 2, 2005) (Richard C. Casey, Judge)***.

[2] Thomas H. Lee, then-district judge Gerard E. Lynch reached the same conclusion. Thomas H. Lee, 612 F. Supp. 2d at 281-83. ***

At least one other district court has accepted the interpretation adopted in Thomas H. Lee and Fezzani: Cohain v. Klimley, Nos. 08 Civ. 5047, 09 Civ. 4527, 09 Civ. 10584, 2010 WL 3701362, at *8-*9, 2010 U.S. Dist. LEXIS 98870, at *27-*28 (S.D.N.Y. Sept. 20, 2010) (Paul G. Gardephe, Judge) ***.

[A]t least two other district courts in this Circuit have interpreted the RICO Amendment bar more narrowly. See Seippel v. Sidley, Austin, Brown & Wood, LLP, 399 F. Supp. 2d 283, 292 n.47 (S.D.N.Y. 2005) (Shira A. Scheindlin, Judge) ... [and] OSRecovery, Inc. v. One Groupe Int'l Inc., 354 F. Supp. 2d 357 (S.D.N.Y. 2005) ... (Lewis A. Kaplan, Judge)***

.In Renner v. Chase Manhattan Bank, No. 98 Civ. 926, 1999 WL 47239, 1999 U.S. Dist. LEXIS 978 (S.D.N.Y. Feb. 3, 1999) (Charles S. Haight, Jr., Judge), the district court determined that the RICO Amendment did not preclude the plaintiff's RICO claim [predicated on aiding and abetting]. ***

We agree with the defendants that the reasoning of the district courts in Fezzani and Thomas H. Lee is persuasive. We conclude that section 107 of the PSLRA bars civil RICO claims alleging predicate acts of securities fraud, even where a plaintiff cannot itself pursue a securities fraud action against the defendant.

Footnote 11. MLSMK argues for the first time in its supplemental brief that the defendants' conduct is not "actionable securities fraud" because the "the predicate acts alleged in this case could not possibly have induced MLSMK to purchase or sell securities." It contends that the claim therefore does not satisfy the requirements of section 10(b) of the Securities Exchange Act. Compare Appellant's Supp. Br. 6, with Appellees' Supp. Br. 7-8. Even were we not to consider this argument waived because of the lateness of the hour in which it was asserted, we would nonetheless decline to address it because we conclude that the effect of the RICO Amendment does not turn on whether MLSMK would be able to state a valid claim against JPMC and Chase Bank under section 10(b).

To the extent that MLSMK argues that the defendants' alleged conduct does not qualify as securities fraud because it was not "integrally related to the purchase and sale of securities," Appellant's Supp. Br. 6, we conclude that the contention is without merit. In Bald Eagle Area School District, the Third Circuit considered a plaintiff's allegation that a defendant bank had assisted in "a massive Ponzi scheme . . . perpetrated through the purchase and sale of [securities] in violation of securities laws including § 10(b) of the Securities Exchange Act of 1934," and determined that the alleged scheme was "at the heart of th[e plaintiff's] RICO action." Id., 189 F.3d at 328. The court concluded that "[a] Ponzi scheme . . . continues only so long as new investors can be lured into it so that the early investors can be paid a return on their 'investment.' Consequently, conduct undertaken to keep a securities fraud Ponzi scheme alive is conduct undertaken in connection with the purchase and sale of securities." Id. at 330; cf. Sell v. Zions First Nat'l Bank, No. CV-05-0684, 2006 WL 322469, at *10, 2006 U.S. Dist. LEXIS 6558, at *33-*34 (D. Ariz. Feb. 9, 2006) (stating that "the question is not whether a plaintiff can state a claim under a non-securities-related predicate act, but whether the allegations that form the basis of that predicate act occur 'in connection with' securities fraud," and concluding that, in a Ponzi scheme, a bank's "disbursement[s] of money from more recent investors to older investors" are actions "in connection with" securities fraud).

Crucially, the plain language of the statute "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." In re Enron, 284 F. Supp. 2d at 620; see 18 U.S.C. § 1964(c) ("[N]o 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." (emphases added)). As another district court has explained,

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. It did not mean "no person except one who has no other actionable securities fraud claim." It did not specify that the conduct had to be actionable as securities fraud by a particular person to serve as a bar to a RICO claim by that same person.

Hemispherx Biopharma, Inc. v. Asensio, No. Civ. A. 98-5204, 1999 WL 144109, at *4, 1999 U.S. Dist. LEXIS 2849, at *13-*14 (E.D. Pa. Mar. 15, 1999), quoted in In re Enron Corp., 284 F. Supp. 2d at 620. We agree that the RICO Amendment is worded broadly and does not indicate that Congress intended that it be applied in the limited manner that MLSMK urges. Cf. Cent. Bank of Denver, 511 U.S. at 177 (quoting Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 734 (1975) ("When Congress wished to provide a remedy to those who neither purchase nor sell securities, it had little trouble in doing so expressly.")).

This language seems to us to be unambiguous. But it is worth noting in any event that our reading of it also is supported by the PSLRA's legislative history.***

Finally, the interpretation we adopt today finds support in the decisions of several of our sister circuits. See Affco Invs. 2001, L.L.C. v. Proskauer Rose, L.L.P., 625 F.3d 185, 189-91, 191 n.5 (5th Cir. 2010) (affirming the district court's dismissal of a RICO claim as barred by the PSLRA in spite of the fact that, by doing so, the plaintiff was left without an avenue for relief because it could not assert a section 10(b) securities claim against the relevant defendant); Bixler v. Foster, 596 F.3d 751, 759-60 (10th Cir. 2010) (applying the RICO Amendment to mail and wire fraud, which "cannot support a civil RICO claim after enactment of the PSLRA" if the frauds are "undertaken in connection with the purchase of a security" (internal quotation marks omitted)); Howard v. Am. Online Inc., 208 F.3d 741, 749 (9th Cir.) (holding that the RICO Amendment bar applies even where the plaintiff does not have standing to sue under securities laws because the plaintiff did not buy or sell securities), cert. denied, 531 U.S. 828 (2000); Bald Eagle Area Sch. Dist., 189 F.3d at 330 (Third Circuit decision expressing reasoning similar to that in Fezzani and Thomas H. Lee and concluding that the PSLRA precludes a RICO claim based on a Ponzi scheme that was accomplished by the purchase and sale of securities). While none of these cases addresses the precise question presented here, they do deal with other circumstances in which — for various reasons — the plaintiff could not make out a private securities claim against the defendant. Despite the fact that this result left the plaintiffs in those cases, like the plaintiff here, without recourse to a private cause of action under the securities laws, our sister courts nonetheless concluded that the plaintiffs' RICO claims were barred by the RICO Amendment.

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