In a case of first impression, the court of appeals for the 2nd Circuit affirmed the dismissal of a plaintiff investment company’s civil RICO claim against JPMorgan Chase & Co. (JPMC) for allegedly aiding and abetting Bernard L. Madoff Investment Securities (Madoff) in securities fraud. (MLSMK Investment Company v. JPMorgan Chase & Company, No. 10-3040-cv.) The decision resolves a split in the district courts regarding the scope of the RICO Amendment, extending the federal ban on civil RICO claims based on securities fraud to cover the “aiding and abetting” of such frauds, thereby preventing plaintiffs from collecting RICO’s award of treble damages.
The decision should be welcomed with open arms. The plaintiff asserted New York state-law claims against JPMorgan, including aiding and abetting Madoff’s breach of fiduciary duty, commercial bad faith and negligence. The 2nd Circuit had affirmed the district court’s dismissal of plaintiff’s state-law claims, focusing instead on plaintiff’s federal claim for violations of the RICO statute.
Seeking treble damages under RICO, the complaint alleged that the defendants “knowingly and purposely” conspired with Madoff to “fleece” his victims, both through JPMC’s trading with Madoff, as well as through the housing of the Madoff’s account at JPMC’s affiliate, providing services that were “integral to the functioning of the racketeering enterprise” and by engaging in RICO predicate acts, including “numerous interstate wire communications.” Plaintiff alleged a loss of $12.8 million due to its investment with Madoff between Oct. and Dec. 2008.
In detailing its racketeering allegations, plaintiff asserted that defendants became suspicious of Madoff’s business, undertaking a “due diligence” investigation that revealed that the investment company was “a thoroughly fraudulent enterprise,” yet JPMC still provided market-making and banking services to plaintiff, deriving substantial fees. The complaint alleged that JPMC even developed a derivative product “specifically for use with Madoff-related investments.” It was in connection with the derivative product that JPMC allegedly became suspicious of Madoff’s results, including the product’s “consistently strong returns despite the market mayhem.”
Ultimately, plaintiff asserted that the failure to freeze Madoff’s accounts at JPMC caused the defendants to become “liable for conspiracy to violate RICO by aiding and abetting Madoff’s breach of fiduciary duty, commercial bad faith, and negligence.” The 2nd Circuit disagreed, finding the racketeering claims based on allegations of securities fraud were precluded by Section 107 of the Private Securities Litigation Reform Act (PSLRA), 18 U.S.C. §1964(c) (the “RICO Amendment”), which provides 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.”
Citing the reasoning in Fezzani v. Bear, Stearns & Company, No. 99 Civ. 0793 (S.D.N.Y. March 2, 2005), and other Southern District precedent, the 2nd Circuit concluded 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.” As a result, although plaintiff had pled only a civil RICO claim, and not fraud and RICO claims collectively, the 2nd Circuit found that where the complaint relied on allegations of fraud to establish liability under RICO, the RICO claims still fell “squarely within the scope of the PSLRA bar.” The court also noted that to hold otherwise would allow plaintiffs to artfully plead aiding and abetting a securities violation, in lieu of the violation itself, in order to obtain treble damages.
In short, the court held that the PSLRA’s RICO Amendment did not allow plaintiff’s civil RICO claim premised upon predicate acts of securities fraud, even where the plaintiff could not itself bring a private securities claim. Whether there will be agreement among the rest of the circuit courts remains to be seen.