Originally appeared in 13 RICO Law Reporter 1,443 (1991), 1601 Connecticut NW, Suite 602, Washington, DC

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1 Originally appeared in 13 RICO Law Reporter 1,443 (1991), 1601 Connecticut NW, Suite 602, Washington, DC PROXIMATE CAUSE: A GROWING LIMITATION ON CIVIL RICO ACTIONS by Howard Adler, Jr. & John A. Francis* Few statutes have been more roundly criticized than RICO. Its application to broad areas of business conduct has transformed many common law fraud and breach of contract suits into federal cases for treble damages. However, since 1985 when the Supreme Court decided Sedima, S.P.R.L. v. Imrex Co., 473 U.S. 479 (1985), a trend has begun in the federal courts that promises to impose some limitation on the expansive reach of civil RICO. Sedima established a proximate cause requirement that has led many federal courts to require civil RICO plaintiffs to prove a direct casual connection between the alleged predicate acts and the plaintiff's injury in order to survive a pre-trial motion for dismissal. One of the most recent examples of this trend is Busby v. Crown Supply, Inc., No A, slip op. (E.D.Va. Dec. 19, 1990), where the court granted summary judgment to the defendants because the Sedima "proximate cause standard leads, ineluctably, to the conclusion that plaintiff's injury, if any, was not caused by any of the alleged RICO predicate acts." Busby, slip op. at 3. In almost all of the decisions dismissing civil RICO actions on this ground, the proximate cause analysis is the same. Each begins with the basic proposition that section 1964(c) of RICO requires that the plaintiff demonstrate that he has been "injured in his business or property by reason of [the alleged] violation of section 1962." 18 U.S.C. ' 1964(c) (emphasis added). In Sedima, the Court interpreted this "by reason of" language as importing a proximate cause requirement into private civil RICO actions: Where the plaintiff alleges each element of the violation, the compensable injury necessarily is the harm caused by predicate acts sufficiently related to constitute a pattern, for the essence of the violation is the commission of those acts in connection with the conduct of an enterprise...any recoverable damages occurring by reason of a violation of ' 1962(c) will flow from the commission of the predicate acts. Sedima, 473 U.S. at 497 (emphasis added). "Thus, Sedima teaches that a plaintiff's damages, indeed the injury itself, must flow from the predicate racketeering acts." Busby, slip op. at 2. The federal courts of appeal have explained that this standard "tak[es] into consideration such factors

2 as the foreseeability of the particular injury, the intervention of other independent causes, and the factual directness of the causal connection." Brandenburg v. Seidel, 859 F.2d 1179, 1189 (4th Cir. 1988). In essence, the predicate acts "proximately cause a plaintiff's injury if they are a substantial factor in the sequence of responsible causation, and if the injury is reasonably foreseeable or anticipated as a natural consequence." Hecht v. Commerce Clearing House, Inc., 897 F.2d 21, 24 (2d Cir. 1990) (emphasis added). The courts of appeal have relied on this proximate cause requirement to uphold the dismissal of civil RICO complaints in a variety of contexts. For example, in Brandenburg v. Seidel, the plaintiff depositors in failed savings and loan associations tried to recover their losses by bringing a civil RICO action against the former officers and directors of the thrifts. They claimed that the defendants used the wires and mails to fraudulently induce them into making deposits. However, the Court of Appeals for the Fourth Circuit said "the plaintiffs have failed adequately to plead the requisite causal connection between [their] injury and the predicate acts of racketeering activity that [defendants] are alleged to have committed." Brandenburg, 859 F.2d at The court explained that even though the defendants' use of the mails and wires in communicating the misrepresentations may have been one of the ultimate causes-in-fact of the plaintiffs' loss of money, civil RICO "require[s] not only cause-infact, but 'legal' or 'proximate' cause as well." Id. at Because the injury was not proximately or legally caused by the "defendants' misrepresentations but by their negligent failure to maintain adequate reserves," the court concluded, "that on the facts as alleged the misrepresentations charged to defendants were not so significant and important a cause of the plaintiffs' loss of income on their deposits and accounts that these defendants should be held responsible for them." Id. at In Hecht v. Commerce Clearing House, Inc., the court held that a former employee lacked civil RICO standing for injuries from loss of employment resulting from his failure to aid or abet his employer's alleged RICO violations. The court explained that "[a]lthough Hecht's loss of employment may have been factually caused by defendants' RICO violations, it was not a foreseeable natural consequence sufficient for proximate causation." Hecht, 897 F.2d at 24. "[T]he purpose of civil RICO liability does not extend to deterring any illegal act such as retaliatory firings for which there are state and common law remedies." Id. The Busby case is one of the clearest and most recent applications of this standard by a federal district court. Busby was a commissioned salesman for the defendant Crown. He claimed that Crown had agreed to base his commission on a percentage of the difference between the price at which he sold Crown's goods and the cost of those goods to Crown. Busby further claimed that in two separate schemes to defraud, Crown overstated its cost of goods, thereby reducing the profit margin to which his commission percentage was applied. Busby claimed that the mails and wires were used in a variety of ways to further these alleged fraudulent schemes: Crown used wire facilities to share financial information with its parent company; Busby used wire facilities to solicit and obtain orders for goods based on the alleged false cost information provided by Crown; Crown used the United States mails to send invoices to customers and receive payments from customers; and Crown used the mails to solicit and receive rebates from its suppliers. After searching for a causal link between these uses of the mails and wires and Busby's claimed loss

3 of commissions, the court concluded: Busby, slip op. at 4. Close scrutiny reveals that none of these predicate acts proximately caused Busby's injury. None played any causative or facilitative role in the generation, transmission or use of the alleged false cost data. So far as the fully developed record shows, the alleged false cost data was generated entirely within Crown... Busby failed to point to any record evidence, and the Court found none, that false cost information was transmitted via the mails or wires.... The [allegedly fraudulent] cost book was compiled and delivered wholly within the walls of Crown's office. In Jones v. Baskin, Flaherty, Elliot and Mannino, P.C., 670 F.Supp. 597 (W.D. Pa. 1987), the plaintiffs RICO claim was also based on allegedly fraudulent under-compensation. The plaintiff, a discharged partner, sued his former law firm for, among other things, violating ' 1962(c) of RICO by engaging in a pattern of mail fraud and tax fraud that allegedly caused him to suffer "injury in the form of understated partnership profits due to the fraudulent concealment of escrow payments... Injury [was] also alleged for a reduction in capital payout upon the plaintiff's termination by [the law firm], due to the deferred reporting of paychecks to 'numerous shareholder employees.'" Jones, 670 F.Supp. at The court dismissed the RICO claims under Sedima's proximate cause requirement because "neither the acts of tax fraud nor mail fraud themselves directly caused the injuries suffered by the plaintiff. The injuries alleged by the plaintiff were the direct result of the internal bookkeeping of BFEM and its predecessors, not the mail (or tax) frauds, which are the violations under ' 1962(a)." Id. at 599 (emphasis added). Another example of the trend is In re Gas Reclamation, Inc. Securities Litigation, 663 F.Supp (S. D.N.Y. 1987). There, the plaintiffs were investors in gas reclamation units who, after they lost money on those investments, filed a civil RICO claim against, among others, an accounting firm that had provided services to a second defendant that the plaintiffs claimed was responsible for the financial mismanagement of their investments. The plaintiffs contended that engagement letters the accounting firm sent to the second defendant had induced the plaintiffs to invest in the units and ultimately caused them to sustain a loss. The court dismissed the RICO claim because "[t]he connection between these mailings and the injury which the Abish Investors allegedly sustained is, at best, highly attenuated... There is simply not a sufficient allegation in the pleadings that Peat Marwick's alleged commission of predicate acts proximately caused the loss." Id. at (emphasis added). In virtually all of these cases, the alleged predicate acts were mail and/or wire fraud. These are federal criminal offenses that, in the criminal context, have traditionally been interpreted very broadly. See Atlas Pile Driving Co. v. DiCon Financial Co., 886 F.2d 986, 991 (8th Cir. 1989). In the civil RICO context, however, that breadth is being limited by the proximate cause standard applied in Busby and the other cases discussed above. The result is that the civil RICO versions of mail and wire fraud are being given a narrower reach than those offenses have traditionally been accorded in criminal prosecutions. This result is inevitable because proximate cause is a civil concept that does not exist in criminal mail

4 and wire fraud. Criminal cases have no plaintiffs, no injuries to plaintiffs, no damages, and thus no concern with the causal nexus between the violation of the statute and injury to a plaintiff. Civil RICO actions are different: they do involve a plaintiffs injuries, and, therefore, it makes sense -- both legally and as a matter of public policy -- that they should require clear proof of proximate cause: Civil RICO is of course a statutory tort remedy -- simply one with particularly drastic remedies. Causation principles generally applicable to tort liability must be considered applicable. These require not only cause-in-fact, but "legal" or "proximate" cause as well, the latter involving a policy rather than a purely factual determination: "whether the conduct has been so significant and important a cause that the defendant should be held responsible." Brandenburg, 859 F.2d at 1189 (quoting Prosser and Keeton, Torts, '42 at 272 (5th ed. 1984)). See also Reynolds v. East Dyer Development Co., 882 F.2d 1249, 1253 (7th Cir. 1989). As the last sentence of the Brandenburg passage indicates, a proximate cause limitation ultimately serves a policy purpose. Accord Hecht, 897 F.2d at 23. In the context of civil RICO actions, the Supreme Court made such a policy choice in Sedima when it placed "a limit on the collection of private RICO damages [by interpreting] the language 'by reason of' in section 1964(c)" to import a proximate cause standard into the statute. Cullom, 859 F.2d at As the Court of Appeals for the Second Circuit aptly opined in Sperber v. Boesky, "the doctrine of proximate cause reflects social policy decisions based on shared principles of justice. Applying those principles, we conclude that Congress did not intend us to allow RICO recovery to plaintiffs with claims as attenuated as these." Boesky, 849 F.2d at 65. Notes 1 The Racketeer Influenced and Corrupt Organizations Act of 1970, 18 U.S.C. ' 1961 et. Seq. 2 Two cases with fact patterns similar to Brandenburg are Bastian v. Petren Resources Corp., 892 F.2d 680 (7th Cir. 1990) and Sperber v. Boesky, 849 F.2d 60 (2d Cir. 1988), cert. denied, 110 S.Ct (1990). In Bastian a group of investors who "lost their shirts" in an oil and gas limited partnership filed a civil RICO claim against the promoters of the partnership alleging fraudulent inducement to invest. The court held that because their loss was not directly caused by the offering memorandum's misrepresentations, the plaintiffs failed to satisfy their burden of showing proximate cause. Bastian, 849 F.2d 686. In Boesky, a group of investors brought a RICO action against a securities trader alleging that his illegal trading activities caused the value of their stocks to drop. The court held "that plaintiffs cannot show that their injuries were proximately caused either directly or indirectly by Boesky's racketeering violation." Boesky, 849 F.2d at In many other decisions, the courts of appeal have consistently held that plaintiffs claiming such loss of employment for reporting or refusing to participate in the alleged predicate acts of their employers have not satisfied Sedima's proximate cause requirement. See, e.g., Kramer v. Bachan Aerospace Corp., 912 F.2d 151, 155 (6th Cir. 1990) (employee allegedly discharged for reporting employer's fraudulent scheme could not satisfy proximate cause requirement absent showing "that his discharge

5 was not merely incidental to, but directly caused by a defendant's alleged RICO violations"); Reddy v. Litton Industries, Inc., 912 F.2d 291, 294 (9th Cir. 1990) (employee terminated for refusing to participate in employer's cover-up of illegal bribes lacked standing "because the injury he suffered was the result of his alleged wrongful termination and was not caused by predicate RICO acts"); O'Malley v. O'Neill, 887 F.2d 1557, 1561 (11th Cir. 1989) (emphasizing that "RICO does not provide a remedy for every injury that may be traced to a predicate act" and finding that terminated university employees failed to satisfy the causation requirement because they failed to "show that the defendants' mailing of false reports and statements directly caused them to lose their jobs"), cert. denied, 110 S.Ct (1990); Burdick v. American Express Co., 865 F.2d 527, 529 (2d Cir. 1989) (stockbroker discharged for complaining about his firm's allegedly fraudulent practices had an injury "simply too remotely related to the predicate acts of mail and securities fraud to support a claim under RICO"); Cullom v. Hibernia National Bank, 859 F.2d 1211, 1217 (5th Cir. 1988) (former bank president terminated for refusing to participate in fraudulent loan transactions "fail[edl to meet the causal nexus required under the statutory language"); Pujol v. Shearson/American Express, Inc., 829 F.2d 1201, (1st Cir. 1987) (employee discharged for reporting employer's securities, mail, and wire frauds failed to satisfy proximate cause requirement). 4 The first alleged scheme involved falsifying various costs of certain goods in the cost books provided to the salesmen. The second scheme involved the alleged failure to take account of rebates from Crown's suppliers for volume purchases. Allegedly, these rebates were not passed on to Busby for use in computing commissions. 5 Other district court cases evidencing the trend toward limiting the reach of civil RICO actions with the proximate cause requirement include Miller v. Helmsley, 745 F. Supp. 932 (S.D.N.Y. 1990), Kouvakas v. Inland Steel Company, 646 F. Supp. 474 (N.D. Ind. 1986), and Equitable Life Assurance Society v. Alexander Grant & Co., 627 F. Supp (S.D.N.Y. 1985). 6 Such a distinction is not surprising. Courts have often recognized that more is required in order to prove civil RICO mail and wire fraud than is needed for criminal mail and wire fraud. For example, in Brandenburg the Fourth Circuit said, although "it is not necessary to establish detrimental reliance by the victim in order to make out a violation of the federal mail fraud statute, [citation omitted], such reliance is necessary to establish injury to business or property 'by reason of' a predicate act of mail fraud within the meaning of ' 1964(c)." Brandenburg, 859 F.2d at 1188 n.10 (emphasis added). See also Blount Financial Services, Inc. v. Walter E. Heller and Co., 819 F.2d 151, 152 (6th Cir. 1987); Shaw v. Rolex Watch U.S.A., Inc., 726 F. Supp. 969, 972 (S.D.N.Y. 1989). * Howard Adler, Jr. is a partner in the Washington, D.C. office of Denver's Davis, Graham & Stubbs. John A. Francis is an associate in the same office. With their colleagues Richard P. Holme and Gena E. Cadieux, they were counsel for defendants in Busby v. Crown Supply, Inc. discussed in the text.