Professionals' Liability under RICO after Reves v. Ernst & Young


Periodical: Defense Research Institute, Defending the Professional:   Liability & Insurance Issues

Date: 1998

I.          INTRODUCTION

Under section 1962(c) of the Racketeer Influenced and Corrupt Organizations Act ("RICO"),1 it is unlawful, inter alia, "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 . . ."2  Racketeering activity" can consist of many types of wrongful conduct, referred to in the statute as "predicate acts," including "securities fraud" and "mail fraud."3  A "pattern" of racketeering activity requires the commission of at least two predicate racketeering acts within ten years.4

Given the reference to "racketeer influenced" in the statute's name, one would normally conclude that the primary targets of RICO are organized crime syndicates engaged in the acts of violence typically thought of as constituting "racketeering."  Indeed, the "legislative history forcefully supports the view that the major purpose of [RICO] is to address the infiltration of legitimate business by organized crime."5  Nevertheless, RICO, with its provision of an attractive treble damage remedy to "any person injured in his business or property by reason of a violation of section 1962,"6 has increasingly become a vehicle which plaintiffs rely on to  convert claims traditionally asserted under state law for common law fraud.  "[I]n its private civil version, RICO is evolving into something quite different from the original conception of its enactors . . . [T]he civil RICO statute quite simply revolutionizes private litigation; it validates the federalization of broad areas of state common law of frauds, and it approves the displacement of well-established federal remedial provision."7

Many federal courts have used expansive interpretations of RICO to impose liability for conduct that in no way resembles traditional notions of "organized crime" or "racketeering."  These interpretations are often justified by reference to RICO's "liberal construction clause," which directs that the "provisions of this title shall be liberally construed to effectuate its remedial purposes."8  Armed with these precedents, innovative plaintiffs in the 1980s and early 1990s were able to extend RICO's provision to encompass claims against attorneys and accountants  relating to their rendering of professional services that would normally have been considered garden variety malpractice claims under state law.9

In Reves v. Ernst & Young,10 the United States Supreme Court limited the right of plaintiffs to assert RICO claims against professionals such as attorneys and accounts.  The Court declined to extent RICO liability to a professional who had ;provided services to a client engaged in a pattern of racketeering activity absent a showing that the professional himself/herself had "participated" in the conduct of an enterprise's affairs.  The Court explained that a professional must play "some part in directing the enterprise's affairs" through involvement in its "operation or management"11 in order for RICO liability to attach.  Post-Reves cases involving claims against attorneys and accountants demonstrate that Reves provides a potent defense to professionals facing claims under RICO.  

II.        Reves v. Ernst & Young

Reves involved a claim against the public accounting firm, Arthur Young & Company ("Arthur Young"), which had audited the financial statements of a farmers' cooperative ("co-op").  Arthur Young had allegedly failed to inform the co-op's management of the overvaluation of the co-op's principal asset (a gasohol plant) on the co-op's financial statements.

The co-op had sold demand notes to obtain financing.  After the co-op experienced a run on the demand notes (some of which were held by the plaintiffs), it was unable to obtain further financing.  The co-op filed for bankruptcy, freezing the demand notes and rendering them no longer redeemable by noteholders like the plaintiffs.  The plaintiffs sued various defendants, including Arthur Young, for violations of state and federal securities laws and for violating section 1962(c).12  Arthur Young eventually obtained summary judgment on the section 1962(c) claim against it.  The Eighth Circuit Court of Appeals affirmed, 13 and, on certiorari, the Supreme Court affirmed.

Critical to the affirmance of the summary judgment in favor of Arthur Young on the section 1962(c) claim was the Court's view that RICO liability under that subsection could attach only upon a showing that the defendant had participated "in the operation or management of the enterprise itself."14  This conclusion was based on the following interpretation of the language of section 1962(c):

• The word "conduct," which appears twice in section 1962(c), indicates "some degree of direction" of the enterprise's affairs.15

• The word "participate" is not synonymous with "aid or abet."  To "aid and abet . . . comprehends all assistance rendered by words, acts, encouragement, support or presence."  "Participate" appears to have a narrower meaning within the context of section 1962(c).16

• The phrase "directly or indirectly" means that RICO liability under section 1962(c) is not limited to those with primary responsibility for the enterprise's affairs or to those with a formal position in the enterprise.  Instead, it extends to those who have "some part in directing the enterprise's affairs."17

• The "operation or management" test expresses the "participation" requirement in a formulation that is easy to apply.18

Applying the "operation or management" test to the facts before it in Reves, the Supreme Court concluded that the court of appeals had correctly affirmed the summary judgment entered in Arthur Young's favor by the district court.  Arthur Young had relied upon the co-op's records in preparing the audited reports challenged as inaccurate by the plaintiffs.  Arthur Young's failure to inform the co-op's board that a gasohol plant shown as an asset on the co-op's financial statements should have been valued at its fair market value (rather than a value based on the co-op's investment in the plant) did no constitute "participation" in the operation or management of the co-op itself.  Thus, summary judgment in favor of Arthur Young was proper.19

Justice Souter, joined by Justice White, dissented.  Justice Souter felt that the word "conduct" in section 1962(c)¾when construed as both a noun and a verb in light of Congress's direction that RICO be given a "liberal construction"¾did not include "any restricting element of direction or control."20  Even accepting the need to meet the majority's "operation or management" test as a prerequisite to establishing liability  under section 1962(c), Justice Souter believed that the requirement had been met based on the facts before the Court in Reves.  Arthur Young had not merely performed tasks traditionally performed by an outside auditor, but it had also "created the very financial statements it was hired, and purported, to audit."21  Arthur Young decided in the first instance what value to assign to the co-op's most important fixed asset, the gasohol plant.  Because Arthur Young was involved in the "operation or management" of the co-op's affairs, the court of appeals erroneously affirmed entry of summary judgment in favor of Arthur Young, according to Justice Souter.22

III.       APPLICATION OF REVES TO LIMIT PROFESSIONALS' LIABILITY UNDER RICO

The expectations of those who greeted Reves as a means of rebutting the Pavlovian use RICO by plaintiffs' attorneys seeking to convert professional malpractice claims under state law into federal treble damage claims have, in large measure, been fulfilled.  Federal courts throughout the country have construed Reves as protecting legal, accounting, and other professionals from RICO claims based on their rendering of professional services to clients who themselves were allegedly engaged in racketeering activities.  In many instances, these professionals have avoided RICO liability in the face of evidence or allegations of their substantial involvement in the affairs of their clients.

A.        Cases against Attorneys

In Baumer v. Pachl,23 suit was initiated by investors in limited partnerships found to have engaged in the unlawful sale of registered securities after an investigation by the California Department of Corporations.  The California Commission (sic) demanded that no further sales be undertaken, and the organizers of the partnerships sought legal advice from attorney James Pachl.  The investors thereafter brought suit, charging Pachl with knowingly filing a false partnership agreement in which he inflated the number of limited partners, and with mailing this agreement to the limited partners to create the false impression that the partnership was formed and operated in accordance with the law.

The investors included a RICO count against Pachl, asserting that he had violated mail fraud and securities statutes.  The court granted the attorney's motion to dismiss for failure to state a claim, and the Ninth Circuit affirmed.  The court found that:

Pachl at no time held any formal position in the limited partnership.  Nor did he play any part in directing the affairs of the enterprise. Pachl's role was limited to providing legal services to the limited partnership . . . Whether Pachl rendered his services well or poorly, properly or improperly, is irrelevant to the Reves test.  We are therefore compelled to conclude that under the Reves "operation or management" test the complaint fails to allege a §1962(c) cause of action as to Pachl.24

The plaintiffs in Morin v. Trupin25 were groups of investors in various limited partnerships that were involved in real estate and equipment leasing.  Some of the tax benefits allegedly promised to investors in these limited partnerships were disallowed by the Internal Revenue Service, and all of the properties owned and operated by the partnerships were the subjects of foreclosure.  The investors brought various actions alleging securities fraud and violations of RICO.

Relying on Reves, the district court dismissed the RICO claims against the law firm because "there is no suggestion that the [law from] defendants ever directed anyone to do anything.  The [p]laintiffs have alleged that the defendants provided counsel and advice, but nothing more.  Even if this court found that 'these [d]efendants had substantial persuasive power to induce management to take certain actions,' this is still 'not equivalent to having the power to "conduct or participate directly or indirectly in the conduct of the affairs of those corporations . . . In other words, the [d]efendants' conduct consisted of providing legal services to the general partners and to the limited partnership.  This is not, under Reves, sufficient to support liability under § 1962(c)".26

In Gilmore v. Berg,27 an action was brought by plaintiffs who had purchased unregistered securities in a limited partnership.  The limited partnership acquired an interest in two office buildings at a cost of $5,300,000.  Unbeknownst to the plaintiffs when they invested in the partnership, the two office buildings had been acquired from a bankrupt entity at a cost of $2,500,000 by companies owned by the same person (Berg) who also controlled the general partner in the limited partnership.  The investors claimed that this undisclosed "step-up" in the value of the buildings diminished the likelihood that the partnership would ever realize the desired profits and appreciation that had motivated the plaintiffs' investment.

The investors sued various persons and entities affiliated with Berg, the person who controlled the general partner and who also had an interest in the company which purchased the buildings from the bankruptcy entity.  Included among the defendants were the lawyer and his law firm which had reviewed and revised a tax opinion for the general partner to use in syndicating the property.  The tax opinion letter stated that the purchase price of $5,300,000 reflected the fair market value of the property as determined by the general partner and further stated that the  opinion would be amended to reflect any variation between information in the memorandum and any later developed facts.  The law firm had also reviewed the private placement memorandum circulated to potential investors and had assisted in preparing documentation needed in connection with the purchase of the buildings from the bankrupt entity.

The investors sued the law firm and the lawyer for violations of sections 1962(c) and 1962(d).  The district court granted the defendants' motions for summary judgment because the plaintiffs presented  no evidence that the lawyer (or the accountant, who was also named as a defendant in the RICO counts) "played any role in initiating or formulating the process of syndication."28

The preparation by the [attorney] and [the accountant] of the allegedly misleading opinion and forecast letters merely constituted the rendition of professional services to Berg and the corporate entities he controlled.  Such conduct does not constitute participation in the direction of the affairs of any of the corporate entities involved in the syndication or sale of interest in [the limited partnership in which the plaintiffs bought interests].29

The Gilmore court rejected the plaintiffs' attempts to show that they had met the "operation or control" test of Reves through characterization of the syndication (the transactions related to and including the sale of interests in the limited partnership) as the "enterprise" controlled by the law firm which had overseen the details of the syndication.  "Plaintiffs' definition of enterprise is untenable.  It confuses the enterprise with the activities of the enterprise.  Legal transactions, such as the purchase of property or the sale of interests in a limited  partnership, cannot constitute a RICO enterprise."30

Similarly, the court rejected the contention that the Reves test had been satisfied because the lawyer "was 'intimately involved in virtually every aspect of the syndication.'"  Intimate involvement in the affairs of the enterprise did not in and of itself demonstrate that the lawyer "participated in or directing [sic] the affairs" of the entities constituting the enterprise.31

B.        Cases against Accountants

The suit in University of Maryland at Baltimore v. Peat, Marwick, Main & Co.32 arose out of insolvency proceedings involving an insurance company, Mutual Fire, Marine & Inland Insurance Company ("Mutual Fire").  The plaintiffs alleged that Peat, Marwick, Main & Company ("Peat Marwick") had performed materially deficient audits of Mutual Fire.  In particular, the plaintiffs claimed that Peat Marwick issued unqualified auditor's opinions informing the public that Peat Marwick had a reasonable basis for concluding that Mutual Fire's financial statements were accurate and that Mutual Fire was financed, but that, in fact, the financial statements were false and misleading.

The plaintiffs alleged that Peat Marwick had participated in the affairs of Mutual Fire by performing deficient audits, attending meetings of the Mutual Fire board of directors, and performing consulting services (such as computerizing certain accounting functions and valuation of a subsidiary).  The district court dismissed the RICO claims against Peat Marwick, and the Third Circuit affirmed.  The court rejected the allegations of wrongdoing against Peat Marwick as sufficient to meet the Reves "operation or control" test.  "The Reves Court made clear that merely performing financial services and attending board meetings do not show that Peat Marwick was participating in the affairs of the enterprise."33

That the services provided by Peat Marwick were alleged to have been important to the success of the racketeering enterprise was also insufficient to satisfy Reves.

Simply because one provides goods or services that ultimately benefit the enterprise does not mean that one becomes liable under RICO as a result.  There must be a nexus between the person and the conduct in the affairs of an enterprise.  The operation or management test goes to that nexus.  In other words, the person must knowingly engage in" directing the enterprise's affairs" through a pattern of racketeering activity.

The plaintiffs have nowhere averred that Peat Marwick had any part in operating or managing the affairs of Mutual Fire.  Although they make much ado about how important and indispensable Peat Marwick's services were to Mutual Fire, the same can be said of many who are connected with Mutual Fire . . . [T]he plaintiffs' amended complaint, when distilled to its essence, is nothing more than an allegation that Peat Marwick performed materially deficient financial services.  It cannot be said that by merely performing what are generic financial and related services to an insurance company, even if they are later found to be deficient, an accounting firm has opened itself to liability under the federal racketeering statute.34

More recently, in Dep't of Economic Development v. Arthur Andersen & Co.,35 another accounting firm was charged with RICO violations.  Two predecessors of the Department of Economic Development, an agency of the British government operating principally in Northern Ireland, had advanced monies to companies controlled by John DeLorean to be used to develop a distinctive sports car.  Pursuant to the Master Agreement between these government agencies and the DeLorean companies, the DeLorean companies were obligated to furnish certain audited financial statements.  The statements furnished had been prepared by Arthur Andersen & Co.  ("Arthur Andersen").

The DeLorean entities subsequently collapsed, and the Department of Economic Development alleged that it suffered millions of dollars in damages as a result of their demise.  The Department brought suit against Arthur Andersen and three of its partners, alleging that the statements furnished the Department's predecessor agencies which had made loans to and invested in the DeLorean companies were false and misleading.  In particular, the plaintiff contended that Arthur Andersen's reports failed to disclosed questionable business transactions involving the DeLorean entities.

The Department sought to recover damages from Arthur Andersen under various theories of securities fraud, as well as for violation of RICO.  Addressing the various causes of action in the Department's second amended complaint, the district court dismissed the RICO claims alleging violation of section 1962(c), aiding and abetting RICO violations, and conspiracy to commit RICO violations in violation of section 1962(d).

The Department attempted to avoid dismissal of its complaint by distinguishing Reves, arguing that Arthur Andersen in fact "participated in the management of" two of the defunct DeLorean entities.  The plaintiff pointed to Arthur Andersen's activities in "lending its reputation to the companies' courtship of public and private investors, participating directly in negotiations with prospective governmental investors, developing asset and earnings projections relied on by the investors, advocating the companies' positions before the [Securities Exchange Commission], chartering the Northern Ireland subsidiary, lending its staff to serve as company accountants, developing internal corporate policies, establishing accounting and information systems, creating the financial records and generating from them the financial statements it purported to audit, and even employing its partners and its venerable reputation to shield the companies from the slings and arrows of adverse publicity."36  Thus, the plaintiff reasoned that Arthur Andersen "is liable under § 1962(c) because the firm performed tasks that were 'well beyond anything that could be characterized as routine auditing or accounting.'"37

The district court disagreed.  "[P]roviding important services to a racketeering enterprise is not the same as directing the affairs of the enterprise."38  The court further stated that "[a]n outsider who merely enjoys 'substantial persuasive power to induce management to take certain actions,'. . . unlike an outsider who bribes, does not exercise control over the enterprise within the meaning of Reves.  Similarly, it is not enough to control even fraudulent activity that is ancillary to the fraud carried out by the RICO enterprise.39

The court also dismissed that portion of the Department's RICO claim which was premised on the theory that Arthur Andersen had "aided and abetted" the DeLorean companies' pattern of racketeering.  Relying on the Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.40 that no private cause of action for aiding and abetting securities fraud arises under Section 10b(5) of the Securities Exchange Act of 1934, the district court adhered to the Supreme Court's observation that "there is no general presumption that the plaintiff may also sue aiders and abettors."41  The district court thus agreed with Arthur Andersen's contention "that there is no civil aiding and abetting liability under RICO."42

The district court also considered the plaintiff's claims that Arthur Andersen could be held liable for violating section 1962(d), which prohibits conspiracies to violate sections 1962(a)-(c).  As will be more fully discussed, the "operation or management" test enunciated by Reves was based on the Court's construction of concepts of "conduct or participate" found in the language of section 1962(c); thus, the "operation or management" test is not applicable when evaluating an alleged co-conspirator's liability under section 1962(d).  Nevertheless, the district court in Dep't of Economic Development concluded that summary judgment should be entered in favor of Arthur Andersen on the RICO conspiracy claims asserted against it under section 1962(d) because "no direct evidence in the voluminous record in this case [indicated] any agreement between DeLorean and members of AA [Arthur Andersen] to commit predicate acts of securities fraud or mail fraud."43

C.        Cases against Other Professionals

            1.         Appraisers

In Fidelity Federal Savings & Loan Ass'n v. Felicetti,44 the litigation involved a suit brought by lenders against the Louis J. Iatarola Realty Appraisal Group, Ltd. and Louis J. Iatarola (collectively "Iatarola") for preparing misleading and fraudulent real estate appraisals that the plaintiffs relied upon in extending certain loans.  In response to the plaintiffs' claim that they had violated section 1962(c), the appraisers moved for summary judgment.  Concluding that the plaintiff lenders had not met the "operation or control" test of Reves, the district court granted the motion.

Here, the gist of plaintiffs' argument in favor of 1962(c) liability is that because of the nature of the enterprise at issue here, a federal savings and loan institution, and the important role real estate appraisals play in that business, Iatarola's intentional preparation and submission of misleading appraisals so substantially influenced the decision making of FidFed's Board of Directors as to effectively operate or manage FidFed.  We do not question that the appraisals were the keystone of the Board's decision to grant the various loan requests.  However, the accountant's financial report in Reves was equally pivotal to all the financial decisions of the enterprise . . . Thus, we find that even when the wrongdoers provide misleading or fraudulent information which significantly influences a major decision of the enterprise, this still does not constitute "operation or management" of the enterprise in order to 1962(c) liability to attach.45

2.         Loan Brokers

A. I. Credit Corp. v. Hartford Computer Group, Inc.46 was initiated by three lenders who claimed that they were fraudulently induced to grant loans to two corporations¾Marine Capital Group ("Marine") and Dreamstreet Holsteins, Inc. ("Dreamstreet")¾by the defendants Hartford Computer Group and its principal officer, Paul Graffia.  Some of the misrepresentations related to the finances of a third company, Hera, in which the borrowers were shareholders.

The corporate defendant Hartford acted as a loan broker.  Marine and Dreamstreet initially borrowed money from Hartford, giving Hartford a promissory note.  Hartford sold the note to one of the plaintiffs, taking for itself a broker's commission.  The borrowers entered into two subsequent transactions in which they borrowed money from Hartford, which sold the promissory notes documenting the loans to the other two plaintiffs after subtracting a commission for itself.

Marine and Dreamstreet defaulted on their notes; one went into bankruptcy and the other dissolved.  After liquidating their collateral, the lenders were still owed money.  They sued the loan broker Hartford (and its officer Graffia) contending that they had participated in the borrowers' fraudulent scheme to induce them to make the loans.  The lenders contended, inter alia, that the borrowers' auditors had, in concert with the defendant loan broker, misrepresented the borrowers' financial condition by overstating the value of certain assets.  The plaintiffs did not, however, allege that the loan broker (as opposed to the borrowers or their auditor) were aware that the financial statements were false and misleading.

The plaintiffs further charged that defendant Graffia also prepared financial statements for Hera, a company which was 28 percent owned by one of the borrowers, Marine, with knowledge that the borrowers would be submitting these statements to prospective lenders in order to borrow money.  The financial statements were allegedly misleading because they overstated the value of a gas lease held by the subsidiary and did not adequately disclose amounts payable by the borrower to the subsidiary for gas purchased by the borrower.  The statements did not comply with generally accepted accounting principles, and no disclosure was made that they had been prepared by Graffia, who was not a disinterested auditor but rather was a loan broker who was arranging loans for the company's shareholders.

The borrowers sued the loan brokers under various theories and statutes, including RICO,47 to recover their losses; the defendants moved to dismiss their claims.  With respect to the plaintiffs’ RICO claim, the plaintiffs contended that the two borrowers whose loans the defendants brokered constituted the RICO enterprise.  The loan brokers denied that they “conducted or participated in the conduct of its affairs” as required under Reves.  In granting the motion to dismiss the section 1962(c) claim, the district court engaged in the following analysis:

Hartford and Graffia were outsiders, not formally affiliated with either Dreamstreet or Marine.  The allegations do not tend to show that Graffia and Hartford participated in the direction of the enterprise’s affairs rather than their own [citing Reves].  Neither Graffia nor Hartford had any power of control, direct or indirect, over the enterprise.  It was, of course, not only to Hartford and Graffia’s advantage that the Dreamstreet/Marine enterprise obtained the fraudulently induced loans; the loans were primarily for the enterprise’s benefit.  To the extent Hartford and Graffia were acting as a broker, they were not participating in the conduct of the enterprise.  Perhaps they coached the enterprise in the art of fraud; the Complaint states that the 1986 Dreamstreet financial statements were prepared by its auditors acting in concern with Graffia.  Hartford and Ralston.  But this is too thin a speculative thread to support a reasonable inference of participation in the control or management of the enterprise.48

3.         Banks

The plaintiffs in De Wit v. Firstar Corp.49 were investors in and suppliers to a cattle investment whereby investors brought interests entitling them to proceeds from the sale of cattle.  The investment scheme was organized by John Morken and was financed through Firstar Corporation, a bank holding company, and various banks owned by Firstar. The plaintiffs alleged that the banks had loaned money to the enterprise operated by Morken by permitting the enterprise to write checks on various accounts which did not have sufficient funds to cover the checks.  The plaintiffs alleged that the banks loaned money in this manner in order to circumvent banking regulations.  According to the plaintiffs, the bank also solicited investors and promoted the business of Adventure Capital by creating a false picture of the enterprise’s finances.  The banks facilitated the operations of the enterprise and kept it afloat by honoring overdrafts at a time when no other bank would have loaned money to such a shaky business.  Eventually, the banks decided to stop honoring overdrafts, forcing Morken and the business into bankruptcy.  The investors sustained substantial losses which they sued the banks to recover.

The plaintiffs sought to meet the Reves standards by asserting that “defendants participated directly and indirectly in the establishment and operation of the banking scheme which allowed Morken’s RICO enterprise to operate.”50  The banks, on the other hand, argued “that, far from being the architects and operators of this banking scheme which allowed the RICO enterprise to operate, they were  the principal victims of Morken’s operation and manipulation of the banking scheme.”51 

In granting the motion to dismiss, the district court concluded that the plaintiffs had not alleged that defendants participated in the conduct of Morken’s RICO enterprise itself.

Rather, they have alleged only that defendants conducted that enterprise’s banking scheme.  As alleged, the court concludes that defendants’ conduct was one step removed from management of the RICO enterprise itself, and thus liability will not lie under § 1962(c).  This is not to say that plaintiffs have necessarily failed to allege that defendants’ conduct was wrongful, either because it might be contrary to acceptable banking practices, fraudulent, or otherwise tortious.  However, that conduct, if wrongful, is not cognizable under RICO’s § 1962(c).

The De Wit court also disagreed with the plaintiffs’ attempt to distinguish Reves and its progeny.

The fact that a bank is selective in honoring or dishonoring checks of one of its customers, again, may be wrongful conduct, but it does not amount to control of the underlying RICO enterprise.  It is merely incidental to a bank’s conduct of its own affairs when faced with an over-extended account.  Similarly, the fact that a bank can “walk away” from a customer, and that customer may have no other avenue for obtaining certain services, is a matter of the bank’s conduct of its own affairs, not the affairs of the customer.52

However, the court subsequently permitted the plaintiffs to amend their RICO claim against the banking defendants by reformulating their definition of “enterprise” as an association-in-fact of some of the bank defendants with Morken and the cattle exchange.53  The court observed that it is sometimes possible to satisfy the Reves “operation or management” test and save the RICO claims by redefining the enterprise.54

IV.       LIMITATIONS ON THE USE OF REVES TO PROTECT PROFESSIONALS FROM RICO CLAIMS

Notwithstanding the willingness of federal courts to apply Reves to limit professionals’ liability under RICO, some courts have ruled that circumstances still exist post-Reves in which professionals may be liable for RICO violations arising out of the rendering of professional services.  These cases involve situations where the professionals’ involvement in their clients’ affairs is sufficiently pervasive to meet the “operation or management” test of Reves or where plaintiffs have evidence sufficient to support a conspiracy theory under section 1962(d), a portion of RICO not subject to the Reves “operation or management” test.

A.        Satisfaction of the “Operation or Management” Test

While adhering to the test dictated by Reves, several courts have found that professional defendants have been sufficiently involved in the "operations or management" of their clients' affairs that they are not protected by Reves.

In Napoli v. United States,55 a petition for habeas corpus was brought by attorneys and law firm investigators seeking collateral review of their convictions for racketeering resulting form their "pattern of mail fraud and witness bribery by pursuing counterfeit claims and using false witnesses in personal injury trials.56  The evidence at the petitioners' criminal trial established that the defendants had engaged in acts "including pressuring accident witnesses to testify falsely that they had witnessed accidents, paying unfavorable witnesses not to testify, and creating false photographs, documents, and physical evidence of accidents for use before and during trial."57

The petitioners' criminal trial had taken place prior to the Supreme Court's decision in Reves.  The court had instructed the jury that "[t]he prosecution is not required to prove that the defendant participated in the management or control of the enterprise."58  The principal matter before the court in Napoli was whether this charge--correct under Second Circuit law at the time of the trial but assumed by the Napoli court to be erroneous under Reves59--could serve as the basis of a collateral attack on the petitioners' criminal convictions.  The Second Circuit concluded that it could not, as the plaintiffs had nonetheless satisfied the Reves test.

Although [the defendants] contend that they were not more than outside, "Of Counsel," attorneys to the [fraudulent law] firm, the evidence demonstrated that they were not merely providing peripheral advice, but had participated in the core activities of the ... firm, namely, trying cases and obtaining settlements.  Moreover, they discharged their responsibility through a pattern of illegal acts. . .

As attorneys for the...firm with primary responsibility for the actual litigation of lawsuits, [the defendants] exercised a significant degree of direction over the affairs of the enterprise.  Their role plainly involved participating in the control or management of the firm, within the definition of Reves.60

Clark v. Milam61 was an action initiated by the Commissioner of Insurance in West Virginia in his capacity as receiver for a life insurance company whose assets had allegedly been looted as a result of a conspiracy aided and abetted by the defendants, who had audited the insurance company and its subsidiaries.  The allegations against the defendants went beyond allegations that their auditing work was deficient.  "In the instant case the allegations of participation suggest that the Defendants did more than merely perform deficient work; it is alleged that they knowingly performed such work to protected other defendants by concealing those defendants' RICO violations from state insurance regulators."62

The Clark court concluded that these allegations were sufficient to meet the Reves standard of control:

The [p]laintiff has alleged that these defendants knowingly concealed the activity of other defendants who exercised day-to-day control over the enterprise.  The concealment of the other defendants' conduct is alleged to have been integral to the continuing operation of the RICO enterprise [footnote omitted].  Although the [d]efendants' conduct may not have been as active as the conduct they were concealing, and although they may not have received the same benefits as other defendants [footnote omitted], their control need not have been significant to impose liability under § 1962(c) [citing Reves]...63

The Clark  court's equation of concealment integral to the enterprise's activities to "control" of the enterprise has met with criticism.  In Dep't of Economic Development,64 the district court expressly declined to follow Clark:

Clark equates concealment of an enterprise's fraudulent activities with control over the affairs of the enterprise.  The Clark Court reasoned that because the concealment was "integral to the continuing operation" of the enterprise, those who concealed the fraud controlled the enterprise.  But it is difficult to see where the chain of control stops under that logic.  An accountant's audit reports. or a lawyer's opinion letters, are always "integral to the continuing operation" of the enterprise in the sense that professional services are essential to the continued existence of a business.  But so is the electricity supplied to the enterprise's offices, and it would be absurd to say that the public utility that provides the electricity participates in the operation of management of the enterprise.  The Clark Court's "integral to the continuing operation" formulation thus seems at odds with the Reves requirement of "some part in directing the enterprise's affairs"  ... Moreover, the Clark logic runs afoul of the rule, uniformly applied by the lower courts that have reached the issue, that the provision of services¾even essential services¾to a RICO enterprise is not the same as controlling the enterprise's affairs.65

A plaintiff's reliance on Clark to impose section 1962(c) liability on an outsider who merely concealed the fraud of those actually in control of an enterprise is thus subject to challenge.

The law firm sued for RICO violations in Handeen v. Lemaire66 represented a client who had been convicted of aggravated assault.  The victim of the aggravated assault had obtained a civil judgment against the client.  The attorneys counseled the client and his family to avoid liability on the judgment by filing bankruptcy and then inflating his debts and concealing earnings. The victim sued the family and the law firm under RICO, alleging that they had violated section 1962(c) by conducting the affairs of the bankruptcy estate (the enterprise) through a pattern of racketeering activity.  The district court dismissed the RICO claims (as well as related state law causes of action).  The Eighth Circuit reversed.

The Handeen court conceded that after Reves, RICO liability did not attach to those who furnished a client (even one engaged in a RICO enterprise) "with ordinary professional assistance" and that "RICO is not a surrogate for professional malpractice actions."67  Nevertheless, the court found that Reves did not insulate the law firm from liability fro RICO where the firm, in representing its clients in a bankruptcy proceeding, allegeldy directed the clients to create false promissory notes and other sham debts to dilute the estate; defended the family's fraudulent claims against objections; prepared filing and schedules with the court which contained erroneous information; formulated and promoted fraudulent repayment plans; participated in a scheme to conceal the client's new job (and increased earnings); and otherwise controlled the bankruptcy estate to permit the client to avoid the judgment against him.68

[T]his would not be a case where a lawyer merely extended advice on possible ways to manage an enterprise's affairs . . . Instead, if the Firm truly did associate with the enterprise to the degree encompassed by the Complaint, we would not hesitate to hold that the attorneys "participated in the core activities that constituted the affairs of the [estate]. . ."69

A multidistrict proceeding arose as a result of allegations that high level executives of American Honda received kickbacks from various dealers in exchange for favors, primarily increased allocates of automobiles or the award of new dealerships, in American Honda Motor Co., Inc., Dealerships Relations Litigation.70  Included among the defendants was the law firm of yon & Lyon, which was accused of participating in the concealment of the illegal scheme.  The plaintiffs asserted RICO violations under section 1962(c) based on acts of alleged mail fraud arising from the mailing of false statements that American Honda would deal with the plaintiffs fairly and distribute Honda products to them in a fair and reasonable manner.

The plaintiffs alleged that Lyon & Lyon was not only American Honda's general counsel but also had attorneys serving as voting directors of the company.  Lyon & Lyon conducted training sessions at sales meetings and handled allegations of misconduct, including conflict of interest complaints involving dealers or potential dealers.  The plaintiffs alleged that after Lyon & Lyon received dealer complaints about the kickback scheme, it took action s to conceal the scheme, amounting to obstruction of justice.  Lyon & Lyon attorneys allegedly counseled witnesses to give evasive or incomplete testimony and intentionally limited an investigation of the kickback allegations by not interviewing key witnesses.  Lyon & Lyon attorneys also allegedly directed American Honda to make false and misleading assertions about the results of its investigation in a hearing.71

Lyon & Lyon's motion to dismiss the section 1962(c) claim against it was denied.  In denying the motion, the American Honda court initially found that Lyon & Lyon had a sufficient role in the enterprise's activities to satisfy the Reves "operation or control" test:

[F]or over ten years Lyon & Lyon took on the responsibility of pretending to enforce American Honda's conflict of interest policy and of not following up on dealer complaints in order to perpetuate the kickback scheme.  Concealment is a necessary element of any ongoing illegal activity, and a person who is in charge of the coverup plays an operational and management role in the enterprise conducting that activity.72

However, the American Honda court did not feel that Lyon & Lyon's participation in the management of the racketeering enterprise was in and of itself sufficient to impose RICO liability on the law firm.  It is not enough, however, for a defendant to have 'conduct[ed] or participate[d] directly or indirectly, in the conduct of [an] enterprise's affairs' in order for him to be held liable under § 1962(c).  He also must have done so 'through a pattern of racketeering activity.'"73  The American Honda court noted that the predicate acts of racketeering charged by the plaintiffs were acts of mail fraud, and that Lyon & Lyon did not mail any of the fraudulent materials involved.74  Moreover, the court did not dispute the "conventional wisdom that feels that aiding and abetting liability under § 1962(c) does not survive the Supreme Court's ruling in Central Bank of Denver v. First Interstate Bank of Denver..."75

Nevertheless, the American Honda court concluded that "[t]his does not mean, however, that aiding and abetting principles do not apply in considering whether a defendant has participated in the enterprise 'through a pattern of racketeering activity,' i.e., whether he has committed at least two predicate acts."76  Rather, where a person involved in the management or control of a racketeering enterprise aids and abets in the commission of predicate acts, the person faces liability under § 1962(c), because a distinction must be made between aiding and abetting a violation of section 1962(c) (an offense which does not survive the holding of Reves and Central Bank of Denver) and aiding and abetting in the commission of a substantive offense constituting a predicate act.

Unless the distinction is recognized, in most cases there would be no principled basis for imposing § 1962(c) liability upon a class of defendants whom Congress surely intended should be within the statute's purview:  leaders of enterprises who do not themselves commit predicate acts but who cause others to do so.77

. . .

Although Lyon & Lyon may only have aided and abetted the commission of the predicate acts of mail fraud, as indicated above its management role in concealing the scheme is sufficient to meet the "operation and management" test of Reves.  Plaintiffs have therefore stated a viable § 1962(c) claim against Lyons & Lyons.78

American Honda thus suggests that the concealment of a pattern of racketeering by one who also exercises some element of control over the racketeering enterprise is sufficient to impose section 1962(c) liability.79

B.        Conspiracy Claims against Professionals under Section 1962(c)

Where a plaintiff is able to establish that the professional conspired by agreeing to commit at least two predicate cats of racketeering in violation of section 1962(d), the plaintiff may be able to state a RICO violation even without satisfying the "operation or management" standard enunciated in Reves as required for a claim under section 1962(c).

Section 1962(c) provides that "[i]t shall be unlawful for any person to conspire to violate any of the provisions of subsection (a), (b), or (c) of this section."80  Many circuits that have decided post-Reves cases raising the issue of liability for conspiring to violate RICO under section 1962(d) have concluded that a defendant can be guilty of a RICO conspiracy under section 1962(d) even if he or she does not fall within the class of persons who could violate RICO directly under section 1962(c).81  On the other hand, in the Third and Ninth Circuits, section 1962(d) liability can be imposed only if the alleged co-conspirator conspired to operate and manage the enterprise; it is not sufficient that an outsider having no control over the direction of the enterprise conspired with someone who is an operator or manager.82

Obviously, to the extent that artful pleading can avoid dismissal of a section 1962(d) conspiracy claim against an outside professional who cannot be held liable under section 1962(c) because he or she has no voice in directing the affairs of the enterprise, the protections of Reves may be severely curtailed.  "[C]ourts risk eviscerating Reves by blanketly approving conspiracy convictions when substantive convictions under section 1962(c) are unavailable . . .  As one commentator has explained, '[i]f Congress' restriction of section 1962(c) liability to those who operate or manage the enterprise can be avoided simply by alleging that a defendant aided and abetted or conspired with someone who operated or managed the enterprise, Reves would be rendered almost nugatory.'"83

V.            CONCLUSION

Without doubt, Reves has limited the ability of plaintiffs to seek to recover treble damages under federal racketeering statutes based upon conduct involving no more than the rendering of allegedly inadequate professional services or the rendering of professional services to clients who may themselves be engaged in RICO violations.  However, Reves does not provide protection to professionals who are actively involved in the operation and control of a RICO enterprise, nor does Reves necessarily protect professionals who, though not in control of the racketeering enterprise, agree to commit two or more predicate acts of racketeering in violation of the conspiracy provisions of RICO found in section 1962(d).

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