RICO Lawsuits Are Tempting, but Tread Lightly

Posted January 16, 2018 4:00 p.m. EST

Charging defendants with racketeering conjures images of Mafia dons like Al Capone and John Gotti overseeing vast criminal enterprises.

The Racketeer Influenced and Corrupt Organizations Act, better known as RICO, is among the federal government’s most powerful tools to combat long-running criminal organizations.

RICO is not limited to mobsters, however, and two civil RICO cases are good illustrations of how broadly the law can be applied, much to the chagrin of defendants.

Unlike most criminal statutes, RICO contains a civil component that allows it to be used to turn ordinary business disputes that would be filed in state courts into federal cases. Proving a violation results in the award of triple damages plus attorney’s fees, so plaintiffs have an incentive to look for ways to turn their grievances into a RICO suit.

Unfortunately for plaintiffs, there are onerous requirements for the complaint to show that there is enough evidence to allow the lawsuit to move forward as a RICO case. Judges take a dim view of efforts to turn what look like ordinary state law claims into federal cases by claiming a RICO violation. For that reason, RICO cases often don’t survive the pleading stage.

A recent complaint that shows how broadly the law can be applied to areas far outside organized crime is the RICO lawsuit filed in December against Harvey Weinstein, the Weinstein Co. and its directors, and others. The complaint accuses them of helping Weinstein cover up a pattern of sexual harassment through what it calls the “Weinstein Sexual Enterprise.” The class action, filed on behalf of women who dealt with Weinstein, claims that the enterprise was designed “to harass, threaten, extort and mislead both Weinstein’s victims and the media to prevent, hinder and avoid the prosecution, reporting or disclosure of his sexual misconduct.”

How can that be a RICO case? The statute requires proving that an “enterprise” engaged in a “pattern of racketeering activity” in violation of federal criminal laws over a substantial period. In this case, the plaintiffs claim that part of covering up the harassment involved obstruction of justice and “multiple instances of mail and wire fraud” to show the criminal pattern, and that by acting to help Weinstein, the defendants formed an enterprise alleged to be an “association in fact.”

Federal fraud statutes are often the vehicle for turning a business dispute into a RICO case. Those statutes make it a crime to engage in a “scheme or artifice to defraud,” so proving deceptive conduct can be the basis for a RICO lawsuit. In many cases, one side claims it was misled in ways involving mail or wire communications, such as emails or bank transactions, that formed a pattern of racketeering activity.

A likely initial challenge by the defendants in the Weinstein case will be a motion to dismiss on the ground that the defendants cannot be shown to have done anything more than occasionally help Weinstein deal with the fallout of various episodes. In Boyle v. United States, the Supreme Court held that there must be three structural features to establish this type of enterprise: “a purpose, relationships among those associated with the enterprise and longevity sufficient to permit these associates to pursue the enterprise’s purpose.”

Whether the plaintiffs have enough evidence in their complaint to show the “association in fact” that was more than just a loose agglomeration of individuals who provided assistance sporadically but not in any organized fashion will be the issue. If the case survives this stage, then its settlement value increases substantially because of the potential for more embarrassing information to come to light during the discovery phase.

Businesses have been hostile to RICO because of the threat of a triple-damage award, and Congress has been receptive to efforts to limit the scope of the law. The dismissal last month of a RICO lawsuit against the private equity financier Lynn Tilton, the so-called Diva of Distress, shows how the law has been limited to keep some disputes out of the federal courts.

That RICO claim was filed by three funds that Tilton and her firm, Patriarch Partners, created to raise more than $2.5 billion from the sale of collateralized loan obligations in which the proceeds were used to invest in distressed companies. The funds, named Zohar, claimed that she had misled them about a significant deterioration in the loans and misappropriated the equity in the companies for her own benefit, which constituted mail and wire fraud by stealing their interests.

The RICO case came on the heels of an administrative enforcement action filed by the Securities and Exchange Commission in 2015. The SEC accused Tilton of violating the Investment Advisers Act by reporting misleading values for the funds’ investments to collect larger management fees. An SEC administrative law judge ruled in her favor by dismissing the case in September, and the agency decided not to appeal that decision, leaving her victory intact.

On Dec. 29, a federal district judge dismissed the RICO claim against her because it ran afoul of an amendment adopted by Congress back in 1995 to limit the scope of the statute. The amendment precludes filing RICO claims if they “rely upon any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation.” In other words, if the alleged violations involve securities fraud, they cannot survive a motion to dismiss even if they could constitute mail or wire fraud.

Though the funds artfully avoided using the term “securities” in the RICO claim, the judge in the case, William H. Pauley III, concluded that he “cannot ignore allegations that an integral component of that scheme to loot included pillaging portfolio companies of their equity, redirecting Zohar’s equity interests for defendants’ benefit and diverting the equity distributions into defendants’ coffers — all actions coinciding with the purchase or sale of securities.” So while there might have been fraud, it was close enough to securities transactions that the case had to be dismissed.

RICO lawsuits are tempting. They allow a plaintiff to sue a variety of defendants by claiming that they acted together and seek an award of triple damages, a bonanza in some business disputes that can run into millions of dollars. But these cases should also come with a bright red warning sign: Tread lightly or see your case thrown out of court before it even gets started.