Commercial Litigation and Arbitration

RICO — No PSLRA Bar to Tax Shelter Suit against Law Firm for Opinion Letters — Securities Only Incidental to the Fraud — 4 Letters over 5 Years (3 of Them within 2 Months) Satisfy Continuity

Ouwinga v. Benistar 419 Plan Services, Inc., 2012 U.S. App. LEXIS 19632 (6th Cir. Sept. 19, 2012):

Plaintiff-Appellants Stephen, Leann, David, and Christine Ouwinga and their company, Stoney Creek Fisheries and Equipment, Inc., (the "Ouwingas") appeal the dismissal of their Complaint against various Defendant-Appellees related to a purported tax-deductible welfare benefit plan--the Benistar 419 Plan ("Benistar Plan" or "Plan")--marketed and sold by the Appellees to the Ouwingas. The Internal Revenue Service determined that the Plan was an abusive tax shelter, and the Ouwingas were ultimately assessed back taxes, interest, and penalties. They filed this class action on behalf of themselves and all others similarly situated, alleging violations of the Racketeer Influenced and Corrupt Organizations Act ("RICO") as well as several state law claims. For the following reasons, we REVERSE the district court's dismissal of the Amended Complaint and remand for further proceedings. ***


A. Factual Background

*** Plaintiffs Stephen, Leann, David, and Christine Ouwinga own Plaintiff Stoney Creek Fisheries and Equipment, Inc., a company based in Newaygo County, Michigan. In September 2001, the Ouwingas were approached by Defendant Kris Lesley (a former high school classmate of David Ouwinga) about financial products offered by Defendant John Hancock. The Ouwingas attended a meeting with Lesley and his supervisor, Defendant Robert Fogg, at which both highlighted the "incredible tax liabilities" of the Ouwingas and offered to research potential tax-liability-reduction options.

The Ouwingas met again with Lesley and Fogg who presented the Benistar 419 Plan and explained the purported tax benefits of the Plan, asserting that Plan contributions were tax-deductible and that the Ouwingas could take money out of the Plan at any time tax-free. ***A tax attorney for the John Hancock entities participated telephonically, providing legal assurances to the Ouwingas and affirming the representations about the Plan's tax benefits.

Lesley and Fogg then forwarded several documents to the Ouwingas including John Hancock's legal authority regarding welfare benefit trusts. They presented the Benistar 419 Plan and Trust in the form of two large loose-leaf binders produced by the Benistar Admin Services, Inc. ("the Benistar Books"). These Books contained information about the Plan in general; touted its purported advantages, tax and otherwise; and provided a legal opinion from Defendants Edwards Angell Palmer & Dodge LLP ("Edwards Angell") and John Reid. The Ouwingas allege that the John Hancock entities adopted and advanced the representations made in these Books. Defendant John Hancock Life Insurance Company inserted certain disclaimers into these Books, asserting the Insurance Company made no representations about the tax benefits of the Benistar Plan. ***

Based on the representations of Lesley and Fogg and the legal opinion of Edwards Angell, the Ouwingas agreed to participate in the Benistar Plan in late 2001 and each Plaintiff made substantial contributions. These contributions were used by the Plan to pay premiums to the John Hancock entities to purchase large insurance policies on the lives of the Ouwingas. ***

In 2003, Lesley and Fogg told the Ouwingas that the IRS had changed the rules; that the Ouwingas would need to contribute additional money so the Plan could purchase new life insurance policies to keep the Plan compliant; and that each year they would need to form a new plan. Lesley and Fogg assured the Ouwingas that, while this might signal that the "loophole" in the Code might be closing soon, there was no reason to be concerned about the tax benefits that had already been claimed in prior years or the benefits that were going to be claimed in 2003. Reid of Edwards Angell also issued letters dated October 24, 2003; November 4, 2003; and December 19, 2003 assuring that under the "new IRS rules" the Benistar plan was still not a tax shelter and was viable against any challenge by the IRS. ***

In 2006, the Ouwingas decided to terminate and/or transfer policies out of the Benistar Plans. The John Hancock entities again advised the Ouwingas that there would be no taxable consequences of this transaction and that the Benistar Plan continued to meet the IRS requirements for tax deductible treatment. They also assured the Ouwingas that there "had [been] no audits or problems with clients who did buy outs." ***

B. Procedural Background

On January 22, 2009, the Ouwingas filed a class action Complaint against Benistar 419 Plan Services, Inc. and Benistar Ltd. (the "Benistar Defendants"); John Hancock Variable Insurance Company and John Hancock Insurance Company (the "Hancock Defendants"); Edwards Angell Palmer & Dodge LLP and John Reid (the "Lawyer Defendants"); and Kris Lesley, Robert Fogg, and Pasciak John Hancock Agency LLC f/k/a West Michigan Pasciak General Agency (the "Agent Defendants"). ***The Amended Complaint alleges that the Defendants conspired to defraud employers such as the Ouwingas into adopting welfare benefits plans supposedly in compliance with IRC § 419A(f)(6), which allows significant tax benefits. Specifically, the Ouwingas assert violations of RICO, 18 U.S.C. §§ 1962(c), (d), and negligent misrepresentation against all Defendants; and additional claims of fraudulent misrepresentation/omission, unjust enrichment, breach of fiduciary duty, breach of contract, and violations of state consumer protection laws against the Hancock Defendants.***




In the Private Securities Litigation Reform Act, Pub. L. No. 104-67, 109 Stat. 737 (1995), Congress amended RICO to exclude "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 purpose behind this amendment was to avoid duplicative recovery for fraud actionable under the securities laws: "Because the securities laws generally provide adequate remedies for those injured by securities fraud, it is both necessary [sic] and unfair to expose defendants in securities cases to the threat of treble damages and other extraordinary remedies provided by RICO." 141 Cong. Rec. H13, 691-08, at H13, 704 (daily ed. Nov. 28, 1995) (statement of SEC Chairman Arthur Levitt). The amendment 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. See Bald Eagle Area Sch. Dist. v. Keystone Fin., Inc., 189 F.3d 321, 330 (3d Cir. 1991). The Ouwingas' RICO claims are based on the purchases of variable life insurance policies which, because they are "variable," qualify as securities. The district court held that the PSLRA does not bar the claims of the Ouwingas because the "securities transactions" — the sale of the policies — were not integral to or "in connection with" the fraudulent scheme as a whole.

The Defendants assert that even though the Ouwingas did not allege securities fraud, their complaint could present a claim for violation of securities laws and is thus barred by the PSLRA. The Defendants, however, fail to provide any specific reference to a securities action available based on the Amended Complaint's allegations. Instead, the Defendants support their argument that fraud in the sale of the Benistar Plan was "in connection with" the purchase of securities by citing cases primarily involving fraud that directly coincided with the securities transaction. See, e.g., SEC v. Zandford, 535 U.S. 813, 820 (2002) ("[R]espondent's fraud coincided with the sales themselves."); Swartz v. KPMG LLP, 476 F.3d 756, 761 (9th Cir. 2007) (finding that "[t]he entire purpose" of the scheme was to allow the transfer of stock so that the plaintiff's basis in those assets would be artificially inflated).

The Ouwingas respond that they do not allege fraud relating to the purchase of the variable life insurance policies by the Plan. They note that their fraud claim relates only to the tax consequences of the Benistar Plan, and it is merely incidental that the policies happened to be securities. The Southern District of New York articulated the distinction well:

Plaintiffs do not allege a securities fraud, but rather a tax fraud. There was nothing per se fraudulent from a securities standpoint about the financial mechanism and schemes used to generate the tax losses. While the alleged fraud could not have occurred without the sale of securities at the inflated basis (which created the artificial loss to offset Plaintiffs' major capital gains), it is inaccurate to suggest that the actual purchase and sale of securities were fraudulent. In actuality, the securities performed exactly as planned and marketed; it was the overall scheme that allegedly defrauded the Plaintiffs and Class Members. . . . This Court as well finds that the alleged fraud here involved a tax scheme, with the securities transactions only incidental to any underlying fraud. Accordingly this Court will not apply the PSLRA bar to Plaintiffs' RICO claims.

Kottler v. Deutsche Bank AG, 607 F. Supp. 2d 447, 458 n.9 (S.D.N.Y. 2009). The Ninth Circuit relied on similar reasoning when it found a tax-shelter RICO claim was not barred by the PSLRA, holding that it was "not sufficient merely to allege a defendant has committed a proscribed act in a transaction of which the pledge of a security is a part." Rezner v. Bayerische Hypo-Und Vereinsband AG, 630 F.3d 866, 871-72 (9th Cir. 2010) (citation and alteration omitted).

The analysis in the cases cited by the Ouwingas, including Kottler and Rezner, applied to the factual allegations in this case support the finding that the securities transactions here were not integral to or "in connection with" the fraudulent scheme as a whole. The district court correctly found that the PSLRA did not bar the Ouwingas' RICO claims because the fraud and the securities transactions were essentially independent events.

C. RICO Violation under § 1962(c)

The Ouwingas challenge the dismissal of their substantive RICO claim under 18 U.S.C. § 1962(c), which provides:

It shall be unlawful for any person employed by or associated with any enterprise engaged in, or the activities of which affect, interstate or foreign commerce, to conduct or participate, directly or indirectly, in the conduct of such enterprise's affairs through a pattern of racketeering activity or collection of unlawful debt.

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." Moon v. Harrison Piping Supply, 465 F.3d 719, 723 (6th Cir. 2006) (quoting Sedima, S.P.R.L. v. Imrex Co., Inc., 473 U.S. 479, 496 (1985)). ***

1. "Conduct"

A plaintiff must set forth allegations to establish that the defendant conducted or participated, "directly or indirectly, in the conduct of [the RICO] enterprise's affairs." 18 U.S.C. § 1962(c). In Reves v. Ernst & Young, the Supreme Court held that participation in the conduct of an enterprise's affairs requires proof that the defendant participated in the "operation or management" of the enterprise. 507 U.S. 170, 183 (1993). RICO liability is not limited to those with primary responsibility for the enterprise's affairs; only "some part" in directing the enterprise's affairs is required. Id. at 179. However, defendants must have "conducted or participated in the conduct of the 'enterprise's affairs,' not just their own affairs." Id. at 185 (emphasis in original). Concluding that the Agents sold "pre-packaged" Plans and the Lawyers merely rendered traditional legal services, the district court held the Ouwingas failed to allege that the Defendants participated in any affairs beyond the operation of their own businesses.

We disagree. The Amended Complaint alleges participation by the Defendants in the enterprise sufficiently to satisfy the "operation or management" test. We have held:

Although Reves does not explain what it means to have some part in directing the enterprise's affairs, subsequent decisions from our sister circuits have persuasively explained that it can be accomplished either by making decisions on behalf of the enterprise or by knowingly carrying them out.

United States v. Fowler, 535 F.3d 408, 418 (6th Cir. 2008) (emphasis added). Even if the Benistar Plan was designed by the Benistar entities, the Agent and Lawyer Defendants carried out the directions of the Benistar entities by marketing the Plan directly to investors and providing allegedly incomplete and misleading legal opinions. Importantly, the Ouwingas allege the Defendants carried out these directions, all the while knowing that contributions to the Plan were not likely to be allowed as deductions by the IRS. The district court held these allegations to be merely conclusory. The Amended Complaint reveals otherwise--it lists the specific IRS rulings and notices that should have put the Defendants on notice of the likelihood that the Benistar Plan was not compliant with IRC § 419A(f)(6), but which were allegedly ignored in favor of older rulings and notices that were more favorable. Assuming the truth of these allegations, as a court must for a 12(b)(6) motion, it is plausible that the Defendants were aware of the falsity of the tax benefits that they represented as flowing from the Benistar Plans and that they promoted to the Ouwingas.

The Defendants rely on Stone v. Kirk, 8 F.3d 1079 (6th Cir. 1993), to argue that the marketing of a fraudulent plan is not sufficient participation to satisfy the "operation or management" test. In Stone, the defendant was a sales representative for Sagittarius Recording Company, which used fraudulent appraisals and other misrepresentations to lure investors into a master-recording leasing program. Id. at 1082. In fact, Sagittarius was so convincing about the tax benefits of the leasing program that the agent defendant invested some of his own money in the program. Id. With little explanation, Stone held that the agent defendant did not participate in the operation or management of the RICO entity, which was defined to be Sagittarius and its associates. Id. at 1092.

The Agent Defendants here argue that they, like the defendant in Stone, were merely sales agents and did not participate in the operation or management of the alleged RICO enterprise. However, the Amended Complaint alleges: that the Agent Defendants were more than a mere conduit of information supplied by Benistar; that all the Defendants were aware of the IRS notices, which put the Plan's legality into question; and that, notwithstanding, the Agent Defendants continued to represent the tax benefits of the Benistar Plan over several years. Fowler makes clear that knowingly carrying out the orders of the enterprise satisfies the "operation or management" test. 535 F.3d at 418.

Though the Lawyer Defendants provided opinion letters to a client, Benistar, relating the tax consequences of the Benistar Plan, the Ouwingas allege that they knew the purpose of the Benistar 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. In Davis v. Mutual Life Insurance Co. of New York, we relied on the knowledge and continued endorsement of a fraudulent scheme by an insurance company, MONY, to find the "conduct" element satisfied:

[E]ven after MONY had received numerous warnings concerning [the agent's] fraudulent sales tactics, MONY continued to allow, if not actively encourage, [the agent] and his associates to carry on with their scheme. In light of this state of affairs, and of the central role that MONY's life insurance policies played in [the] scheme, we have little difficulty in ruling that MONY exercised sufficient control over the affairs of the RICO enterprise to withstand scrutiny under Reves.

6 F.3d 367, 380 (6th Cir. 1993). Because the Ouwingas alleged the continued promotion of the Benistar Plan by all the Defendants in the face of this information, the Amended Complaint plausibly alleges that the Defendants participated in the enterprise's affairs and not merely their own.

We recognize that although this analysis applies to all Defendants, the various Defendants acted in different capacities and those differences may ultimately impact the determination of whether a particular Defendant only participated in his own affairs. But that is a matter to be fleshed out in discovery and to be resolved through motion practice or by the jury. At this stage in the litigation, the Ouwingas have alleged sufficient facts to satisfy Reves's "operation or management" test, as interpreted in this circuit by Fowler, and the district court erred in finding otherwise.

2. "Enterprise"

RICO defines an "enterprise" as "any individual, corporation, association, or other legal entity and any union or group of individuals associated in fact although not a legal entity." 18 U.S.C. § 1961(4). The Ouwingas allege that 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) that the members of the enterprise functioned as a continuing unit with established duties; and (3) that the enterprise was separate and distinct from the pattern of racketeering activity in which it engaged. United States v. Chance, 306 F.3d 356, 372 (6th Cir. 2002) (citing Frank v. D'Ambrosi, 4 F.3d 1378, 1386 (6th Cir. 1993)). ***

The Supreme Court recently clarified what is required to show an association-in-fact enterprise in Boyle v. United States, 556 U.S. 938 (2009). The Court stated that "an association-in-fact enterprise must have at least three structural features: a purpose, relationships among those associated with the enterprise, and longevity sufficient to permit these associates to pursue the enterprise's purpose." Id. at 946. An association-in-fact enterprise "require[s] a certain amount of organizational structure which eliminates simple conspiracies from the Act's reach." VanDenBroeck v. CommonPoint Mortg. Co., 210 F.3d 696, 699 (6th Cir. 2000), abrogated on other grounds by Bridge v. Phoenix Bond & Indem. Co., 553 U.S. 639 (2008). The Supreme Court clarified that this organizational structure need not be hierarchical, can make decisions on an ad hoc basis, and does not require the members to have fixed roles. Boyle, 556 U.S. at 948. Put another way, a plaintiff must show "simply a continuing unit that functions with a common purpose." Id.; see also id. at 949 (emphasizing "the breadth of the 'enterprise' concept").

Though the district court recognized both the importance of the wide reach of RICO to stymie corruption and the refusal of Boyle to narrowly interpret the statute, it determined that the Ouwingas did not allege a structure distinct from the pattern of racketeering. It warned that if allegations of mirror-image, ill-motivated activity of normal business conduct are sufficient to establish an enterprise, all business conduct gone awry would constitute a per se RICO enterprise. This concern is not well founded and ignores the statutory requirement of liberal construction to effectuate RICO's remedial purposes. Moreover, our decision in Hofstetter v. Fletcher, 905 F.2d 897 (6th Cir. 1988), directly addresses the issue:

"RICO applies both to legitimate enterprises conducted through racketeering operations as well as illegitimate enterprises." United States v. Qaoud, 777 F.2d 1105, 1115 (6th Cir. 1985) (citing United States v. Turkette, 452 U.S. 576 (1981)). In Qaoud, we held that although "enterprise" and "pattern of racketeering activity" are separate elements, they may be proved by the same evidence.

905 F.2d at 903 (finding an association-in-fact enterprise consisting of a group of insurance agents who joined together to sell insurance policies by emphasizing false tax advantages). This understanding is consistent with Boyle, where the Supreme Court recognized that although the existence of an enterprise is a separate element that must be proved, the evidence used to prove the pattern of racketeering activity and the evidence establishing an enterprise "may in particular cases coalesce." 556 U.S. at 947 (quoting Turkette, 452 U.S. at 583). In Boyle, the Court upheld an instruction that allowed a jury to find an association-in-fact enterprise "form[ed] solely for the purpose of carrying out a pattern of racketeering acts" and instructed that "[c]ommon sense suggests that the existence of an association-in-fact is oftentimes more readily proven by what it does, rather than by abstract analysis of its structure." Id. at 942 n.1. "[A] pattern of racketeering activity may be sufficient in a particular case to permit a jury to infer the existence of an association-in-fact [enterprise]." Id. at 951.

The Amended Complaint alleges an organizational structure that satisfies the standard in Boyle. It delineates the specific roles and relationships of the Defendants, alleges the enterprise functioned at least five years, and alleges it functioned for the common purpose of promoting a fraudulent welfare benefit plan to generate commissions and related fees. That pattern of activity is sufficient to permit a jury to infer the existence of an enterprise. See Hofstetter, 905 F.2d at 903. 3. "Pattern of Racketeering"

To establish a substantive RICO violation, a plaintiff must show "a pattern of racketeering activity." 18 U.S.C. § 1962(c). A pattern of racketeering activity requires, at a minimum, two acts of racketeering activity within ten years of each other. 18 U.S.C. § 1961(5) (emphasis in original). The Supreme Court has held, however, that the minimum two acts are not necessarily sufficient and that a plaintiff must show "that the racketeering predicates are related, and that they amount to or pose a threat of continued criminal activity." H.J. Inc. v. Nw. Bell Tel. Co., 492 U.S. 229, 237-39 (1989) (emphasis in original). This requirement is known as the "relationship plus continuity" test. See Brown v. Cassens Transp. Co., 546 F.3d 347, 355 (6th Cir. 2008).

The relationship prong is satisfied by showing the predicate acts have "similar purposes, results, participants, victims, or methods of commission, or otherwise are interrelated by distinguishing characteristics and are not isolated events." H.J. Inc., 492 U.S. at 240. A particular defendant's predicate acts are not required to be interrelated with each other; instead, the predicate acts must be connected to the affairs and operations of the criminal enterprise. Fowler, 535 F.3d at 421. The Ouwingas allege as predicate acts mail and wire fraud based on the various communications from the Defendants, which fraudulently misrepresented the tax consequences of the Benistar Plan. All predicate acts allegedly had the same purpose of misrepresenting the Plan's tax consequences, were directed toward the Ouwingas, and were presented to the Ouwingas through the same participants, the Agent Defendants, purportedly as continued assurances about the Plan's benefits. The relationship prong is satisfied here.

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)." Heinrich v. Waiting Angels Adoption Servs., 668 F.3d 393, 409-10 (6th Cir. 2012) (citing H.J. Inc., 492 U.S. at 241-42). In other words, the continuity prong "is sufficiently established where the predicates can be attributed to a defendant operating as part of a long-term association that exists for criminal purposes." H.J. Inc., 492 U.S. at 242-43. This prong is clearly met for the Agent and Hancock Defendants who communicated consistently with the Ouwingas for at least five years.

The analysis is closer for the Lawyer Defendants. The Lawyer Defendants issued four opinion letters, the first dated in 1998 and the other three sent over the span of two months in 2003. The similarity in the representations of tax consequences in all letters can plausibly indicate that the Lawyer Defendants participated in the fraudulent enterprise over that entire period. The allegations against the Lawyer Defendants in the Amended Complaint are sufficient to withstand a motion to dismiss.

D. RICO Conspiracy under § 1962(d)

The district court dismissed the Ouwingas' RICO conspiracy claim under § 1962(d) "for the same reason" it dismissed their § 1962(c) claim and because it found the allegations regarding a conspiracy to be merely conclusory. Although the Amended Complaint's allegations in the conspiracy section appear to be conclusory, the Amended Complaint expressly incorporates all prior allegations therein. It is a plausible inference from the incorporated factual allegations that the Defendants agreed and conspired to commit the predicate acts in furtherance of the fraudulent scheme. Therefore, the Amended Complaint "contain[s] sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face.'" Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007)). Because the allegations are not merely conclusory, and because the Ouwingas have pled a claim under § 1962(c), the district court erred in dismissing the Ouwingas' RICO conspiracy claim under § 1962(d).

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