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Civil RICO - What Remains After Anza?
June 26, 2006
Copyright ©2006 Daily Journal Corp. Reprinted and/or posted with permission. This file cannot be downloaded from this page. The Daily Journal’s definition of reprint and posting permission does not include the downloading, copying by third parties or any other type of transmission of any posted articles.
Congress enacted the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. §§ 1961-1968 (“RICO”) in 1970 to eradicate organized crime in the United States. To that end, RICO imposes severe criminal penalties on any individual or entity that engages in “racketeering activity,” which is broadly defined to include an extensive list of actionable predicate acts, including mail and wire fraud. 18 U.S.C. § 1961(1). RICO also provides a private right of action for treble damages in favor of any person “injured in his business or property by reason of” a RICO violation. 18 U.S.C. § 1964(c).
Described as “the litigation equivalent of a thermonuclear device,” the civil RICO statute has been criticized as evolving beyond Congress’ original intent of eradicating organized crime. See Sedima, S. P. R. L. v. Imrex Co., Inc., 473 U.S. 479 (1985). In Sedima, the Supreme Court acknowledged that private civil actions under RICO “are being brought almost solely against [business enterprises], rather than against the archetypal, intimidating mobster.” The Sedima Court nevertheless refused to limit RICO, reasoning instead that the statute was inherently broader, “and its correction must lie with Congress.”
While Congress did limit the civil RICO statute in 1995 by removing securities fraud as a predicate act (see Private Securities Litigation Reform Act of 1995, Pub. L. 104-67, § 107, 109 Stat. 758 (“PSLRA”)), the Supreme Court has also narrowed its scope in two important decisions by requiring a strict showing of proximate causation. Seven years after deciding Sedima, it held that the “injured … by reason of” clause of Section 1964(c) “demanded … some direct relation between the injury asserted and the injurious conduct alleged.” See Holmes v. Securities Investor Protection Corporation, 503 U.S. 258, 268 (1992).
In Holmes, the plaintiff brought a securities and civil RICO suit alleging that the defendant-conspirator’s manipulation of the stock market had caused two broker-dealers to fail, thus triggering the plaintiff’s contractual duty to reimburse customers of those broker-dealers. Borrowing from the civil action provisions of federal antitrust law, the Supreme Court articulated a “proximate cause” standard far stricter than “but for” causation. It held that the plaintiff’s injury derived from its status as a surrogate for the broker-dealers’ customers, and were not proximately caused by the market manipulation. Rather, the injury was derivative of the harm caused to the broker-dealers by the alleged securities fraud in the first instance, and was thus indirect.
Very recently, the Supreme Court further limited civil RICO claims by strictly applying Holmes’ proximate cause standard to a suit between competitors. See Anza v. Ideal Steel Supply Corp., 2006 DJDAR 6857 (June 5, 2006). There, plaintiff Ideal Steel Supply Corp. (“Ideal”) brought a civil RICO suit alleging that its principal competitor and business neighbor National Steel Supply, Inc. (“National”) failed to charge state sales tax to its cash-paying customers, thereby allowing it to reduce its prices without affecting its profits and causing Ideal to lose market share. Ideal claimed that National perfected this scheme by filing false state tax returns, which constituted predicate racketeering acts of mail and wire fraud in violation of Section 1962(c), and that National violated Section 1962(a) by investing its unlawful profits to open a store that also caused Ideal to lose business and market share.
Writing for the majority, Justice Kennedy held that Ideal’s alleged injury under Section 1962(a) was too attenuated to satisfy the Holmes “directness” requirement because it was caused by alleged conduct (offering lower prices) entirely distinct from the alleged RICO violation (defrauding the State). In so concluding, the Justice Kennedy relied on the policy considerations underlying the proximate cause standard articulated in Holmes. “One motivating principle is the difficulty that can arise when a court attempts to ascertain the damages caused by some remote action.” The Court reasoned that National could have lowered prices for reasons unrelated to the asserted tax fraud; similarly, Ideal’s lost sales could have resulted from other factors besides National’s lowered prices.
Further, the purportedly speculative nature of the claimed damages would require the trial court to calculate the portion of National’s price drop attributable to the pattern of racketeering activity and then calculate the portion of Ideal’s lost sales attributable to the relevant part of the price drop: “The element of proximate causation recognized in Holmes is meant to prevent these types of intricate, uncertain inquiries from overrunning RICO litigation.” Finally, the Court concluded that a direct causal connection was particularly warranted where the immediate victim – in this case, the State of New York - could be expected to vindicate RICO by pursuing its own direct claim.
Anza has several important ramifications. Previously, the Holmes decision and the enactment of the PSLRA had a pronounced effect on civil RICO suits, as their frequency had decreased by about one third since 1996. This trend will likely sharpen because Anza raises the proximate causation bar above Holmes by requiring a more direct connection between the wrongful conduct and claimed damages.
In Holmes, several steps stood between the violation and the harm – the alleged fraud caused the broker-dealers to incur losses, resulting in business failure and the inability to pay customers, which in turn triggered the plaintiff’s duty to reimburse the customers and thus its damages. In Anza, however, the loss of market share was caused, not by the State of New York’s injury, but by National’s underpayment of tax, which allowed it to undercut Ideal’s prices and market share. The Anza Court’s holding that this closer connection was nevertheless insufficient further tightens the proximate cause standard.
Moreover, Anza now precludes claims between competitors where the illegal prediate conduct is directed at third parties. Absent some direct injury, allegations that a competitor engaged in conduct designed to increase market share at the claimant’s expense do not meet the proximate cause standard enunciated in Anza. In other words, damages arising from an indirect competitive effect of the predicate wrong are not recoverable under the civil RICO statute.
Nevertheless, the Anza reasoning leaves several questions unanswered. For example, the concept of “direct injury” remains somewhat ambiguous in that it is necessarily tethered to Court’s expressed policy against “uncertain inquiries” into remote, speculative damages. Thus, a claimant could conceivably plead proximate cause by alleging a clearly defined connection between the wrongful conduct and injury, and by pleading damages calculations with sufficient factual detail to demonstrate the inapplicability of the policy concerns articulated in Anza.
On the other hand, the damages claimed by Ideal in Anza would not have involved particularly complex analysis either, undercutting the Court’s policy analysis. Ideal alleged that it lost customers, business and profits of approximately $5 million because National was able to underbid Ideal due to its “cash, no tax” scam, which allowed it to cut prices in a discreet geographic market where direct competition was predicated primarily on the basis of price. These allegations arguably would require no more complex analysis than commonly involved in antitrust cases.
Further, the Anza Court’s reasoning that the alleged RICO wrongs could be vindicated by the State of New York may allow worthy claims to slip through. Indeed, if the existence of a public entity to prosecute a claim against RICO defendants was sufficient to defeat proximate cause, then the private RICO statute would be severely undercut since every RICO predicate offense is prosecutable by the government in any event. Ultimately, practitioners will have to rely on federal and state unfair competition claims to fill the gap created by Anza.
While the Anza decision may ultimately exclude meritorious RICO claims, sound considerations justify this result. Based on the facts presented, a contrary decision might have jolted the floodgates of litigation by endorsing civil RICO claims based on allegations of tax or accounting fraud. For example, the Internal Revenue Service annually assesses hundreds of thousands of civil penalties for corporate underreporting and underpayment of taxes. See U.S. Dept. of the Treasury, Internal Revenue Service Data Book 2004, at 45, table 47 (2005). Each of these violations could be pled as mail or wire fraud and might provide a basis for a treble damages RICO suit by a competitor. Similarly, in the wake of the recent accounting fraud scandals, a different decision in Anza might have permitted competitors to frame civil RICO suits based on predicate accounting fraud for indirect competitive injury.
At any rate, Anza will not be the last chapter of the Supreme Court’s efforts to narrow civil RICO liability. For example, the Court did not address whether its articulated proximate cause standard would also apply to a claim under Section 1962(a), which makes it unlawful for a person “to use or invest” income derived from a pattern of racketeering activity in an enterprise engaged in or affecting interstate or foreign commerce. Because claims under 1962(a) and (c) are both predicated on the “by reason of” language of Section 1964, it is likely that the Court will extend the Anza standard to suits between competitors under Section 1962(a).
The Anza Court also unceremoniously declined to address National’s argument on appeal that the RICO claims were also barred because Ideal could not plead that it had relied on any fraudulent conduct. Instead, the Court left “the substantial question of whether a showing of reliance is required” for another day. Perhaps the question will be resolved in the not so distant future as competitors effectively plead proximate causation.
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