Zohar CDO 2003-1, Ltd. v. Patriarch, 2017 WL 6628609, __ F. Supp.3d ___ (SDNY, Dec. 28, 2017)
In the above case, Judge William Pauley III granted the Defendants’ motions to dismiss a civil RICO action for being in violation of the PSLRA Amendment to RICO which bars any civil RICO claim that is actionable as fraud in the purchase or sale of securities. See 18 U.S.C. section 1965(c) (“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.”)
This dismissal was issued on the same date as Judge Pauley’s dismissal of another civil RICO action, Dotan Newman v. Jewish Agency for Israel, et al., 2017 WL 6628616 (SDNY, Dec. 28, 2017), and follows a long line of dismissals of civil RICO actions in the SDNY where complex civil RICO cases find themselves on the proverbial chopping block. See e.g., Zamora v. JPMorgan Chase, 2015 WL 4653234 (SDNY, July 31, 2015) (J. Pauley). Judge Pauley’s decisions are well-researched, coherent, and detailed, but the dismissal of the subject Zohar case based on a stringent view of the PSLRA Amendment is concerning.
In Zohar, the Plaintiffs asserted a dozen claims against Defendants predicated on a massive racketeering conspiracy involving the illegal investment and mis-management of Zohar’s assets. Defendants exploited their fiduciary status to expropriate Zohar’s equity in its portfolio companies, pay themselves dividends, and deceive Zohar and its investors into paying exorbitant fees by misreporting the value of Zohar’s collateral.
The legal issue is whether the alleged scheme is actionable as fraud in the purchase or sale of securities, and if any one predicate is so barred, the entire claim is foreclosed by the securities fraud bar codified in the RICO statute.
Judge Pauley discussed precedent that if the alleged conduct could form the basis of a securities fraud claim against any party—be it against, or on behalf of, the plaintiff, defendants or a non-party—it may not be fashioned as a civil RICO claim. To best define what constitutes conduct actionable as fraud in the purchase or sale of securities, courts have consulted an obvious source in Section 10(b) of the Securities Exchange Act of 1934, which—while not identical to the language of the RICO Amendment—covers a broad range of securities fraud. Judge Pauley stated that If even “one predicate act alleges breaches of duty coincident with securities transactions then the whole scheme is subject to the [RICO Amendment].”
This pillar is the death knell for Zohar’s claims. Although finding that two of Defendants’ schemes did not coincide with the purchase or sale of securities as they involved fraud which occurred separate and apart from the sale of Zohar’s CLOs, the court found the because the Complaint alleges a single, ongoing fraudulent scheme, all of Defendants’ alleged acts must be considered together. Thus, while two schemes (the OC Test and Monthly Report allegations) escaped the RICO bar, the allegations relating to Defendants’ theft of Zohar’s equity interests and distributions were fatal to the RICO claim as these equity transactions, tendered as common stock, preferred stock, and LLC membership interests, were governed by the federal securities laws.
The purchase of stock was integral to the scheme to defraud since, without it, Defendants would have lacked the position to claim dividends and exercise control over the portfolio companies. *11. The Judge concluded that while certain allegations here may fall into that category of exempted conduct, there was clearly another component to Defendants’ overarching scheme that involved activity forming the basis for an actionable claim under the securities laws. Here, the post-investment looting involved the purchase and sale of securities.
Therefore, the Judge ruled that a single securities transaction that coincides with the fraudulent scheme can be the death knell of a RICO claim, Zohar’s civil RICO claim was dismissed.
Ed Note: This conclusion severely limits civil RICO plaintiff suits when there may exist just one “single securities transaction” coinciding with the fraudulent scheme despite many other instances of mail and wire fraud which themselves do NOT fall within the PSLRA exception. It will be interesting to see how the Second Circuit views this decision (which would assuredly be appealed).
David J. Stander, Esq. is a civil RICO Attorney who regularly maintains his blog for all to follow recent civil RICO court decisions.