Commercial Litigation and Arbitration

PSLRA’s RICO Bar Applies to Extraterritorial Securities Fraud Not Actionable in U.S. — Key Is Nature of Conduct, Not Actionability — If One Prong of Conduct Is Barred, Entire Scheme Barred

Perkumpulan Investor Crisis Center Dressel – WBG v. Wong, 2014 U.S. Dist. LEXIS 33797 (W.D. Wash. Mar. 14, 2014):

C. RICO and the Private Securities Litigation Reform Act

Congress enacted the Racketeer Influenced  [*21] and Corrupt Organizations Act of 1970 ("RICO") to "seek the eradication of organized crime in the United States[.]" Organized Crime Control Act of 1970, Statement of Findings and Purpose, Pub.L. No. 91-452, 84 Stat. 922 (1970). The most oft-used provision, which Plaintiff relies upon here, prohibits "person[s] employed by or associated with" an enterprise engaged in or affecting interstate commerce from conducting the enterprise's affairs through a "pattern of racketeering activity." 18 U.S.C. § 1964(c). "Racketeering activity" includes a long list of statutorily defined predicate acts such as mail and wire fraud, bank fraud, money laundering, and transacting in stolen property. See 18 U.S.C. § 1961(1)(B). In addition to its criminal prohibitions, RICO provides a private cause of action that entitles a successful private plaintiff to treble damages and reasonable attorney's fees. To establish the basic elements of a civil RICO claim, a private plaintiff must allege (1) conduct (2) of an enterprise (3) through a pattern (4) of racketeering activity. Sedima S.P.R.L. v. Imrex Co., 473 U.S. 479, 496 (1985). The plaintiff must also allege that he was injured in his business or property "by  [*22] reason of the RICO violation. 18 U.S.C. § 1964(c).

Section 107 of the Private Securities Litigation Reform Act of 1995 ("PSLRA") sought to curtail abusive litigation by eliminating securities fraud as a predicate act in civil RICO claims.5 Section 1964(c), which establishes RICO's civil cause of action, now provides in relevant part:

   Any person injured in his business or property by reason of a violation of section 1962 of this chapter may sue therefor in any appropriate United States district court and shall recover threefold the damages he sustains and the cost of the suit, including a reasonable attorney's fee, except 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) (emphasis added). In amending this provision, "Congress reasoned [that] securities laws generally provide an adequate remedy for securities fraud and that imposition of the treble damages provided by RICO was unfair in those cases." MJK Partners, LLC v. Husman, 877 F. Supp. 2d 596, 603 (N.D. Ill. 2012); see Bald Eagle Area School District v. Keystone Financial Inc., 189 F.3d 321, 327 (3d Cir. 1999)  [*23] (explaining that the focus of the RICO amendment was on "completely eliminating the so-called 'treble damage blunderbuss of RICO' in securities fraud cases") (quotation omitted)).

5   The so-called "RICO Amendment" contains one limited exception. A private plaintiff may rely on securities-fraud conduct in a civil suit if the defendant was criminally convicted of the securities fraud. See 18 U.S.C. § 1964(c). This exception is not relevant to the instant case.

In practice, "Congress intended not only to eliminate securities fraud as a predicate offense in a civil RICO action, but also to prevent plaintiffs from attempting to plead other specified offenses, such as mail or wire fraud, as predicate acts under civil RICO if such offenses are based on conduct that would have been actionable as securities fraud." Id.; Howard v. America Online Inc., 208 F.3d 741, 749-50 (9th Cir.), cert. denied, 531 U.S. 828 (2000) (plaintiff cannot assert RICO claim based on predicate acts that sound in securities fraud even if the claim is pleaded as a matter of mail or wire fraud). The PSLRA exclusion similarly applies even if the RICO plaintiff could not actually assert a securities fraud claim. Howard, 208 F.3d at 749-50;  [*24] Swartz v. KPMG LLP, 401 F. Supp. 2d 1146, 1151 (W.D. Wash. 2004) aff'd, 476 F.3d 756, 761 (9th Cir. 2007). And finally, Courts have consistently concluded that where a plaintiff alleges a "single scheme" and any predicate act is barred under the PSLRA, the entire RICO claim is precluded. See In re Libor-Based Financial Instruments Antitrust Litig., 935 F. Supp.2d 666, 730 (S.D.N.Y. 2013); Gilmore v. Gilmore, No. C09-6230, 2011 WL 3874880, at *4 (S.D.N.Y. Sept. 1, 2011), aff'd, 503 Fed. Appx. 97 (2d Cir. 2012) (where defendants' acts were part of a single fraudulent scheme, plaintiff could not divide the scheme into its component parts, as "such surgical presentation . . . would undermine the Congressional purposes" behind the RICO amendment).

In light of the PSLRA, the Court must examine whether Perkumpulan's RICO claim is based on conduct of the type that would have been actionable as fraud in the purchase or sale of securities. A review of Plaintiff's allegations, accepted as true, demonstrates that Perkumpulan seeks to recover RICO's "bonanza of treble damages" and attorneys' fees for conduct that Congress expressly sought to remove from the statute's reach. See Bald Eagle, 189 F.3d at 330.

1.  [*25] The Investment Contracts Constitute Securities

The Court first determines whether Plaintiff's claim involves "securities" in the specific sense of the term. Under United States securities laws, an "investment contract" is delineated a security. See S.E.C. v. Edwards, 540 U.S. 389, 393 (2004); 15 U.S.C. §§ 77b(a)(1), 78c(a)(10). The definition of an investment contract is "a flexible rather than a static principle, one that is capable of adaption to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." Edwards, 540 U.S. at 393 (quoting S.E.C. v. W.J. Howey, Co., 328 U.S. 293 (1946)). The Ninth Circuit has distilled the Supreme Court's definition of an investment contract into a three-part test requiring "(1) an investment of money (2) in a common enterprise (3) with the expectation of profits induced by the efforts of others." S.E.C. v. Rubera, 350 F.3d 1084, 1090 (9th Cir. 2003) (Congress did not intend the definition of security to be restrictive, but defined the term "sufficiently broadly to encompass virtually any instrument that might be sold as an investment"); see S.E.C. v. R.G. Reynolds Enters., Inc., 952 F.2d 1125, 1130 (9th Cir. 1991).

Here,  [*26] Perkumpulan itself argues that the Dressel fraud involved "securities." (Dkt. No. 412 at 17) ("the [Dressel] defendants executed a United States-based RICO conspiracy that involved a securities fraud abroad"). Nor could there be any dispute that the solicited investments in the instant scheme constitute securities as subject to the United States securities laws. Plaintiff's complaint alleges that its defrauded members (1) invested money (2) in one of two funds run by the Dressel enterprise, known as the "SPORTSMANS" and "GMP" funds, (3) upon the promise of receiving between twenty-four and twenty-eight percent returns and while relying upon the misrepresented experience and expertise of Dressel's managers. (See Dkt. No. 381 at ¶¶ 1.1-1.2, 3.5-3.13, 4.3-4.34.) Each time an investor did so, Dressel issued an investment certificate out of one of its administrative offices in the United States or Asia. (Id. at ¶¶ 4.6, 4.9.) Based on these allegations in the complaint and Plaintiff's own concessions, the Court is satisfied that Dressel's investment certificates were "securities."

2. Plaintiff Relies on Conduct Actionable as Securities Fraud

The Court next addresses whether the defendants'  [*27] alleged conduct "would have been actionable as fraud in the purchase or sale of securities." 18 U.S.C. § 1964(c). Courts making this determination often turn to section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 to provide the basic guideposts of such an analysis. Those authorities make it "unlawful for any person . . . [t]o use or employ, in connection with the purchase or sale of any security," "any device, scheme, or artifice to defraud." See 15 U.S.C. § 78j(b); S.E.C. v. Zandford, 535 U.S. 813 (2002); In re Libor-Based Financial Instruments Antitrust Litig., 935 F. Supp. 2d 666, 726 (S.D.N.Y. 2013) (the SEC may assert a cause of action for securities fraud [under Rule 10b-5] if it alleges that the defendant: "(1) made a material misrepresentation or a material omission as to which he had a duty to speak, or used a fraudulent device; (2) with scienter; (3) in connection with the purchase or sale of securities"). The Supreme Court has endorsed a "broad reading" of the phrase "in connection with," holding that "it is enough that the scheme to defraud and the sale of securities coincide." Zandford, 535 U.S. at 820; see Rezner v. Bayerische HypoUndVereinsbank AG, 630 F.3d 866, 871-72 (9th Cir. 2010).  [*28] Ultimately, whether Perkumpulan itself could bring a successful claim subject to the securities laws is irrelevant. The appropriate inquiry is whether the conduct alleged is of the type generally actionable under the securities laws. See, e.g., Howard, 208 F.3d at 749 (affirming dismissal under RICO Amendment where plaintiffs conceded that they had no standing to pursue securities fraud claim); MLSMK Inv. Co. v. JP Morgan Chase & Co., 651 F.3d 268, 277 (2d Cir. 2011) ("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.").

Here, Defendants' alleged conduct is of the type generally actionable under the United States securities laws and "would have been actionable" under RICO if not for the PSLRA. See 18 U.S.C. § 1964(c). In its complaint, Plaintiff specifically alleges that the RICO Defendants made "material misrepresentations" to investors (a) at multiple in-person meetings in Indonesia; (b) through hard-copy brochures provided to investors; and (c) through its website, e-mails, and letters mailed to investors and to WBG, which were then  [*29] passed on to investors. (See Dkt. No. 381 at ¶¶ 1.2, 4.5, 4.7, 4.13-4.31, 4.42, 4.50, 4.52-4.58, 4.62-4.65, 6.3, 6.5.) The misrepresentations included statements regarding the false qualifications of the Dressel managers, the expected returns on the funds, the types of investments that were to be made with investors' money, and the fact that the investment schemes were legitimate. (Id. at ¶¶ 4.5, 4.7, 4.13-4.31.) Perkumpulan further alleges that the RICO Defendants had a fiduciary duty to provide truthful information and manage the investors' funds as fiduciary agents, (see id. at ¶ 4.6), and that each Defendant acted with the requisite scienter--that is, that "[i]n making these misrepresentations, the Ponzi Scheme Defendants intended to deceive [investors] by making them believe that Dressel BVI was a legitimate investment program and that the Dressel directors had the qualifications they claimed to have." (Id. at ¶ 6.5; see id. at ¶ 6.9.) Finally, Plaintiff's allegations make clear that these fraudulent statements were made at the very time that Defendants induced individuals into investing and afterwards, so as to perpetuate and subsequently hide the scheme. Indeed, Plaintiff alleges  [*30] that the fraudulent statements were made for the purpose of inducing individuals to invest in this "classic Ponzi scheme."6 (Id. at ¶¶ 1.2, 4.4, 4.7-4.8, 4.32, 6.5.) The Court accordingly concludes that Perkumpulan alleges conduct that (a) is generally actionable as fraud in the purchase or sale of securities and (b) would have been actionable under civil RICO as fraud in the purchase or sale of securities prior to the PSLRA's enactment. Plaintiff may not rely on such conduct to support its RICO claim.7

6   For example, Plaintiff explains it its complaint that one investor, Halim Chandra, learned of the investment opportunity in August 2004. After being assured that the investment funds were "legitimate" and reviewing the Dressel brochures and website, Mr. Chandra "relied on the affirmative misrepresentations" contained in the brochure and website and decided to invest $60,000 in the SPORTSMAN fund. He then signed the "Portfolio Management Agreement for Strategic Portfolio Management Scheme" and received an investment certificate. (Dkt. No. 381 at ¶ 4.32.) Thus, by Plaintiff's own allegations, investors relied upon fraudulent misrepresentations in deciding to purchase the investments Dressel  [*31] was selling.

7   Additionally, Plaintiff may not rely on the remaining predicate acts that it alleges--money laundering; distributing the proceeds of unlawful activity; engaging in monetary transactions in property derived from specified unlawful activity; interstate and foreign travel in aid of racketeering enterprises; and transportation and concealment of stolen moneys--because it expressly alleges that all of this conduct was undertaken to keep the Ponzi scheme going. (Dkt. No. 6.14-6.19.) Courts have repeatedly found that the RICO amendment "bars RICO claims based on conduct that perpetuates a Ponzi scheme." Picard v. Kohn, 907 F. Supp. 2d 392, 398 (S.D.N.Y. 2012); see Bald Eagle Area Sch. Dist. v. Keystone Fin., Inc., 189 F.3d 321, 330 (3d Cir. 1999) (concluding 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."); MLSMK, 651 F.3d at 277 n.11 (quoting Bald Eagle with approval).

To avoid this conclusion, Perkumpulan argues  [*32] that its hypothetical securities fraud claim would be legally insufficient--and thus, not "actionable" in its eyes--under the Supreme Court's decision in Morrison v. Nat'l Australia Bank, Ltd., which established that § 10(b) of the Securities Exchange Act does not apply extraterritorially. 561 U.S. 247 (2010). The thrust of the argument is that while Defendants allegedly committed a domestic RICO violation,8 the predicate acts upon which that claim is based constitute extraterritorial securities fraud--i.e., fraud for which neither Perkumpulan nor the S.E.C. could obtain relief under the securities laws in light of Morrison. Upon review of Plaintiff's argument and additional research, the Court finds this reading of the RICO Amendment and Morrison unpersuasive.

8   The Court now questions this premise. There is a certain irony to Perkumpulan's argument that Defendants' predicate acts are "extraterritorial," given that it previously argued that its "wire fraud" predicate acts were sufficiently domestic to survive an extraterritoriality challenge. In a previous Order, the Court denied a motion to dismiss Plaintiff's complaint on extraterritoriality grounds. (Dkt. No. 169.) In doing so, the  [*33] Court declined to rely on Morrison and instead examined whether the alleged predicate acts, such as wire fraud, were extraterritorial in nature under Pasquatino v. United States, 544 U.S. 349 (2005). The Ninth Circuit subsequently clarified in United States v. Xu, 706 F.3d 965 (9th Cir. 2013), that RICO does not apply extraterritorially in light of Morrison. Under Xu, the Court is directed to analyze the "focus" of the RICO claim to determine whether its application is extraterritorial, which is the pattern of racketeering activity. Such an analysis is in direct contrast to the analysis of whether the predicate acts themselves are extraterritorial in nature. Under the appropriate analysis, where a fraud is predicated on extraterritorial activity, it is beyond RICO's reach even if proceeds of the fraud ultimately reach the United States. Xu, 706 F.3d at 978. In light of Xu as intervening authority, the Court need not accept as law of the case its previous holding regarding the domestic nature of the Dressel Ponzi scheme. Because the Court finds Plaintiff's RICO claim to be barred under the PSLRA, however, it sees no need to revisit the extraterritoriality issue. Instead, the Court notes  [*34] its skepticism that Plaintiff's claims would be sufficiently "domestic" to state a claim in light of Morrison and Xu.

The only other court to address this issue persuasively rejected the same argument as contrary to the language and purpose of the statute. In Picard v. Kohn, the plaintiff-trustee brought a RICO claim against foreign defendants that allegedly played a role in Bernie Madoff's infamous Ponzi scheme. Like Perkumpulan, the trustee sought to avoid the PSLRA's clear preclusion of securities fraud, arguing that "the Securities Exchange Act [under Morrison], and thus the RICO amendment, does not apply to financial products that, like those the defendants sold here, did not trade on an American exchange." 907 F. Supp. 2d 392, 399 (S.D.N.Y. 2012). The trustee reasoned that "even though he can neither prosecute foreign securities fraud nor base a RICO claim on domestic securities fraud [under the PSLRA], he can base a RICO claim on the prosecution of foreign securities fraud." Id. Judge Rakoff rejected this argument outright, explaining that the plaintiff's approach would result in a "RICO exception to the Exchange Act's territorial reach, allowing artfully pled prosecution of  [*35] foreign conduct that constitutes securities fraud whenever such conduct potentially relates to alleged RICO enterprise activity occurring in the United States." Id. Such an exception would be implausible and "too clever by half," the court concluded, because it would "in many cases allow artful pleading to eviscerate either the territorial reach of the Securities Exchange Act or the purpose of the 'RICO Amendment' to the PSLRA." Id.

This Court is in agreement with the Picard court's reasoning. The PSLRA explicitly removes securities-fraud type conduct from the civil RICO arsenal,9 regardless of whether the plaintiff or the S.E.C. could successfully pursue a securities fraud claim based on the same alleged conduct. See MLSMK Inv. Co. v. JP Morgan Chase & Co., 651 F.3d 268, 275 (2d Cir. 2011) ("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.'") (citation omitted); Howard, 208 F.3d at 749. It is of no moment that Plaintiff believes its securities claims would fail under Morrison. The  [*36] reason is that the securities laws are better suited to the task of providing or precluding a cause of action and remedy for securities fraud. See MJK Partners, 877 F. Supp. at 603 ("Congress reasoned [that] securities laws generally provide an adequate remedy for securities fraud[.]"). Thus, in cases where plaintiffs have sought to avoid the RICO Amendment by alleging only "aiding and abetting" type securities fraud as a RICO predicate act--which if brought under the securities laws, would fail to state a claim--courts have refused to allow such artful pleading as a way of obtaining RICO's treble damages. See MLSMK, 651 F.3d at 277 n.11. One court explained its reasoning in a way that is particularly applicable to situation at hand:

   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.

Thomas H. Lee Equity Fund, LP v. Mayer Brown, Rowe & Maw LLP, 612 F. Supp. 2d 267 (S.D.N.Y. 2009)  [*37] (emphasis in original). It would be similarly strange and inappropriate to permit Perkumpulan to invoke RICO's civil cause of action for extraterritorial securities fraud when the securities laws themselves do not make such a claim available.10

9   The PSLRA House Report contained the following title for section 107, the RICO Amendment: "Inapplicability of [RICO] to Private Securities Actions." H.R. Conf. Rep. No. 104-369, at 47 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 747. Numerous courts have noted that Congress's intent was "to eliminate securities fraud as a predicate act of racketeering in a civil RICO action." See MLSMK Inv. Co. v. JP Morgan Chase & Co., 651 F.3d 268, 275 (2d Cir. 2011); 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) (accepting argument, which was later approved in MLSMK, 651 F.3d at 279, 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[.]").

10   Plaintiff's proffered approach would also be "precisely the opposite" of the purpose underlying the RICO Amendment,  [*38] which sought to completely eliminate the use of securities fraud in RICO actions. See Gregory P. Joseph, Civil RICO: A Definitive Guide 122-23 (2010). This is because Plaintiff's argument would create a loophole to "expand, rather than restrict, the use of securities claims as predicate acts." Id.

In the course of its argument, Perkumpulan asserts that in the above cases, the S.E.C. could have brought an action, whereas here, the S.E.C. would also be precluded from initiating an enforcement action given the extraterritorial nature of the conduct. In making this argument, Perkumpulan urges the Court not to rely on the Second Circuit's decision in MLSMK Inv. Co. v. JP Morgan Chase & Co., 651 F.3d 268 (2d Cir. 2011). In that case, the Court addressed the question of whether the PSLRA 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[.]" MLSMK, 651 F.3d at 274 (quotations omitted). There, the plaintiff based its RICO claim on conduct that was not actionable under the securities laws by a private plaintiff, since the conduct was merely "aiding and abetting"  [*39] securities fraud. Id. Notwithstanding that fact, the Second Circuit concluded in a thorough analysis that 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." Id. at 277. The Court also rejected the plaintiff's argument that its RICO claim was necessarily permissible under the PSLRA because a securities claim based on the defendant's conduct would not withstand a 12(b)(6) analysis under a specific securities fraud theory. Id. n.11. The Court's decision in MLSMK did not depend solely on the fact that the S.E.C. could have successfully brought the securities fraud claim.

Perkumpulan's argument is a red herring. First, the Court has not relied on the specific holding of MLSMK, but merely discussed it among numerous other cases for the basic propositions in the "RICO Amendment" context. Furthermore, Plaintiff's conclusion would be unavailing even if the Court adopted its proposed approach and determined that its ability to bring a securities-fraud-based RICO claim depended on Morrison's extraterritoriality analysis. In its attempt to shoehorn a securities fraud claim into  [*40] its RICO cause of action, Perkumpulan fails to note that after the Supreme Court decided Morrison, Congress expressly sought to preserve the S.E.C.'s enforcement authority as it relates to extraterritorial securities fraud. See S.E.C. v. Tourre, No. C10-3229, 2013 WL 2407172, at *1, 4 (S.D.N.Y. June 4, 2013) (noting that the Dodd-Frank Act "effectively reversed Morrison in the context of SEC enforcement actions" and declining to require a Morrison analysis for fraudulent conduct that occurred after the Dodd-Frank Act was passed); S.E.C. v. Gruss, No. C11-2420, 2012 WL 3306166, at *3 (S.D.N.Y. Aug. 13, 2012) ("Section 929P(b) of the Dodd--Frank Act allows the SEC to commence civil actions extraterritorially in certain cases."); 15 U.S.C. § 77v(c). Thus, it appears that its claims would be "actionable" as fraud in the purchase or sale of securities by the S.E.C. even if the Court were to engage in Plaintiff's proposed analysis.

Finally, whether the S.E.C. could prevail is beside the point. As explained above (and even in MLSMK), the PLSRA analysis does not depend on whether one could ultimately prevail on a securities fraud claim under a Rule 12(b)(6)-style analysis. Instead, the question  [*41] is whether the conduct alleged is of the type generally actionable under the securities laws--that is, whether it is conduct that involved fraud in connection with the purchase or sale of securities. MLSMK, 651 F.3d at 278 (discussing legislative history and explaining that "Congress did not say that it was removing 'any claim that would have been actionable'") (emphasis in original). The fact that Plaintiff or the S.E.C. could not ultimately succeed on a securities claim against Defendants does not in turn salvage their RICO claim, which is unquestionably premised upon "fraud made in connection with the purchase and sale of securities" under even the most basic definition of securities fraud. Cf. id. at 280. Ultimately, Perkumpulan's proffered approach is contrary to the purpose of the RICO Amendment, would expand rather than limit the use of securities fraud in the RICO context, and has been persuasively rejected by another court faced with the same argument. The Court thus finds Plaintiff's distinction to be unpersuasive.

Because Perkumpulan cannot rely on the conduct of Defendants it has alleged to support its RICO cause of action, it cannot state a valid claim under the statute.  [*42] The Court does not believe that allowing Plaintiff to file another amended complaint is necessary, since under any internally consistent set of facts, the alleged scheme was one based upon securities fraud. Swartz, 476 F.3d at 761; see Albrecht v. Lund, 845 F.2d 193, 195 (9th Cir. 1988) (if "the allegation of other facts consistent with the challenged pleading could not possibly cure the deficiency, then . . . dismissal without leave to amend is proper.") (internal quotation, citation omitted). Section 107 of the PSLRA thus requires that Plaintiff's RICO claim be dismissed with prejudice.

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