Bald Eagle Area School District v. Keystone Financial, Inc. ( 1999 )

Opinions of the United
1999 Decisions States Court of Appeals
for the Third Circuit
8-31-1999
Bald Eagle Area School Dist. v. Keystone Financial,
Inc.
Precedential or Non-Precedential:
Docket 99-3119
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Filed August 31, 1999
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 99-3119
BALD EAGLE AREA SCHOOL DISTRICT; SOUTH BUTLER
COUNTY SCHOOL DISTRICT, School Districts of the
Third Class, Individually and on behalf of all others
similarly situated,
v.
KEYSTONE FINANCIAL, INC., a Bank Holding Company;
MID-STATE BANK & TRUST CO., a Pennsylvania Bank
and Trust Company; WILLIAM H. BOGEL;
NANCY F. FOGEL; ROBERT LEECH;
ROBERT R. MAGILL, individuals
BALD EAGLE AREA SCHOOL DISTRICT and
SOUTH BUTLER COUNTY SCHOOL DISTRICT,
individually and on behalf of all others
similarly situated,
Appellants
Appeal from the United States District Court for
the Western District of Pennsylvania
Civil Action No. 98-cv-00930
District Judge: Hon. Donetta W. Ambrose
Argued: July 29, 1999
Before: SCIRICA and McKEE, Circuit Judges, and
BROTMAN, Senior District Judge*
(Filed: August 31, 1999)
_________________________________________________________________
*The Honorable Stanley S. Brotman, Senior United States District Judge
for the District of New Jersey, sitting by designation.
RICHARD A. FINBERG, ESQ.
(Argued)
RUDY A. FABIAN, ESQ.
Malakoff, Doyle & Finberg, P. C.
The Frick Building, Suite 200
Pittsburgh, PA 15219
RICHARD R. NELSON, II, ESQ.
NANCY HEILMAN, ESQ.
Cohen & Gribsby, P. C.
11 Stanwix Street, 15th Floor
Pittsburgh, PA 15222
Attorneys for Appellants
ANDREW B. WEISSMAN, ESQ.
(Argued)
CHARLES E. DAVIDOW, ESQ.
WILLIAM K. SHIREY, ESQ.
Wilmer, Cutler & Pickering
2445 M Street, N. W.
Washington, D. C. 20037
WILLIAM M. WYCOFF, ESQ.
MICHAEL H. WOJCIK, ESQ.
One Riverfront Center
Pittsburgh, PA 15222
Attorneys for Appellees
OPINION OF THE COURT
McKEE, Circuit Judge.
Bald Eagle Area School District and South Butler County
School District filed a putative class action complaint
asserting, inter alia, four claims against Keystone Financial,
Inc., Mid-State Bank & Trust Co., and certain named
individuals under the Racketeer Influenced Corrupt
Organizations Act ("RICO"), 18 U.S. C. S 1962, by which
they sought to recover approximately $70 million that they
lost as a result of a Ponzi scheme. The District Court,
concluded that S 107 of the Private Securities Litigation
Reform Act of 1995 ("PSLRA") amended RICO so as to
preclude the School Districts' civil RICO action, and
2
dismissed the complaint under Fed. R. Civ. P. 12(b)(6). For
the reasons that follow, we will affirm.
I.
Various school districts, municipalities and other
governmental units were purported victims of a Ponzi
scheme1 run by John Gardner Black through his
_________________________________________________________________
1. Ponzi schemes take their name from Charles Ponzi. Following the
collapse of his fraudulent investment scheme, a number of investors
began lawsuits to recover their investments. Some litigation ultimately
reached the Supreme Court, which described the operation of Ponzi's
fraudulent investment scheme.
The litigation grows out of the remarkable criminal career of
Charles
Ponzi. In December, 1919, with a capital of $150, he began the
business of borrowing money on his promissory notes. He did not
profess to receive money for investment for account of the lender.
He
borrowed the money on his credit only. He spread the false tale
that
on his own account he was engaged in buying international postal
coupons in foreign countries and selling them in other countries at
100% profit, and that this was made possible by the excessive
differences in the rates of exchange following the war. He was
willing, he said, to give others the opportunity to share with him
this
profit. By a written promise in 90 days to pay them $150 for every
$100 loaned, he induced thousands to lend him. He stimulated their
avidity by paying his 90-day notes in full at the end of 45 days,
and
by circulating the notice that he would pay any unmatured note
presented in less than 45 days at 100% of the loan. Within eight
months he took in $9,582,000, for which he issued his notes for
$14,374,000. He paid his agents a commission of 10%. With the
50%. promised to lenders, every loan paid in full with the profit
would cost him 60%. He was always insolvent, and became daily
more so, the more his business succeeded. He made no investments
of any kind, so that all the money he had at any time was solely
the
result of loans by his dupes.
Cunningham v. Brown, 265 U.S. 1, 7-8 (1924). Nowadays, "[a] `Ponzi'
scheme is a term generally used to describe an investment scheme
which is not really supported by any underlying business venture. The
investors are paid profits from the principal sums paid in by newly
attracted investors. Usually those who invest in the scheme are promised
large returns on their principal investments. The initial investors are
indeed paid the sizable promised returns. This attracts additional
3
companies: Devon Capital Management2 ("Devon") and
Financial Management Services, Inc.3 ("FMS") (hereinafter
collectively referred to as "Devon."). The various local
government units appointed Devon to act as their
investment advisor for the proceeds of bonds, loans and
other revenues. On September 26, 1997, the Securities and
Exchange Commission obtained a freeze of all assets under
the control of Devon. The original SEC action has been
closed and a number of the investors have received only a
small fraction of their original investments. Certain of the
investors then began an involuntary bankruptcy action
against Black, Devon and FMS and that action has halted
any other litigation in which Black, Devon and FMS were
named as defendants.
Bald Eagle Area School District and South Butler County
School District (hereinafter "School Districts") were among
Black's clients. From 1990 to 1997, they retained Devon as
their investment advisor for the investment of proceeds
from bonds sold to finance school construction. The School
Districts entered into a series of Investment Advisory
Agreements with Devon pursuant to which Devon would
invest bond proceeds on their behalf and distribute funds
_________________________________________________________________
investors. More and more investors need to be attracted into the scheme
so that the growing number of investors on top can get paid. The person
who runs this scheme typically uses some of the money invested for
personal use. Usually, this pyramid collapses and most investors not
only do not get paid their profits, but also lose their principal
investments." Mark A. McDermott, Ponzi Schemes and the Law of
Fraudulent and Preferential Transfers, 72 Am. Bankr. L. J. 157, 158
(1998).
2. Devon was a Maryland corporation started by Black in 1989, with its
principal place of business in Tyrone, Pennsylvania. Devon was
registered with the SEC as an investment advisor. It was not registered
with the SEC as a broker or dealer of securities. Complaint at P 23.
Black was the president, portfolio manager and sole shareholder of
Devon. SEC v. Black, 163 F.3d 188, 191 n.1 (3d Cir. 1998).
3. FMS was formed by Black in 1992 and began operations in 1993. It
was not registered as an investment advisor or broker or dealer of
securities. Its principal place of business was also in Tyrone,
Pennsylvania. Complaint at P 24. Black is the sole owner of FMS, which
is a Pennsylvania corporation. SEC v. Black, 163 F.3d at 191 n.1.
4
as they were needed to pay construction costs. The
Investment Advisory Agreements gave Devon discretion to
invest in securities authorized by law but provided that
Devon would not take possession of, or act as custodian
for, the cash, securities or other assets of the School
Districts. Instead, the Investment Advisory Agreements
provided for Devon's appointment of a custodian for the
accounts in which the School Districts' assets were held.
Pursuant to the Investment Advisory Agreements, Devon
entered into a Custodian Agreement with Mid-State Bank &
Trust Co. Under the Custodian Agreement, Mid-State was
to maintain custody of the School Districts' assets, which
were at all times to be 100% secured by collateral. Chief
among Mid-States' duties under the Custodian Agreement
was implementation of securities investment decisions
made by Devon as the School Districts' investment advisor.
Essentially, Mid-State acted as the intermediary which
processed the securities trades that were directed by
Devon. Its specific obligations under the Custodian
Agreement included receiving funds for investment from
Devon's clients, executing securities transactions with these
funds based on instructions from Devon, executing further
purchases and sales of securities held in the custodial
accounts based on instructions from Devon; collecting and
crediting all payments received on the securities, including
dividends, interest, or principal payments; and providing
monthly account statements of the assets held in each
custodial account.
From 1990 through 1993, the relationship between
Devon and the School Districts was lucrative. However,
starting in 1993, in response to competitive pressures in
the marketplace, Devon sought ways to get a better return
on the funds entrusted to it. One way Devon attempted to
earn better returns was by purchasing riskier investments,
including volatile derivative securities.
To facilitate the purchase of the riskier investments,
Devon directed Mid-State beginning in mid-1994 to invest
a portion of the clients' funds in Collateralized Investment
Agreements ("CIAs") issued by FMS.4 The CIAs had varying
_________________________________________________________________
4. FMS and Mid-State entered into a Custodian Agreement on May 10,
1993, pursuant to which Mid-State agreed to perform custodian and
other duties similar to those created by the Custodian Agreement
between Devon and Mid-State.
5
fixed income returns, but they all required that FMS
maintain collateral equal to 100% of the principal amount
invested. Each CIA had a fixed maturity date and a demand
element permitting the School Districts to request
repayment before the maturity date. FMS pooled the funds
from the sale of the CIAs, invested them in risky securities
and used those securities as collateral for the CIAs.
Pursuant to Devon's instructions, Mid-State sold
securities in Devon's client accounts and purchased CIAs
issued by FMS. Following the placement of the CIAs in
client accounts, Mid-State continued to provide monthly
account statements for Devon clients as required by the
Custodian Agreement. The statements reported the
transactions in the accounts, including deposits,
withdrawals and interest earned. The CIAs were reported in
the statements as cash equivalents with current value
equal to the principal amount owed by FMS.
However, FMS began to suffer large trading losses in the
risky derivative investments in its collateral account. Other
losses resulted from Black's misuse of assets held as CIA
collateral and his transfer of CIA collateral to other Devon
advisory clients for less than full value. By early 1995, the
collateral in the FMS accounts was approximately $56
million less than FMS' liabilities under the CIAs.
Nevertheless, pursuant to Devon's instructions, FMS
continued to sell and repurchase its CIAs at face value.
Consequently, Devon permitted its clients to redeem their
CIAs at full price even though the value of the underlying
collateral had plummeted, while at the same time Devon
(through instructions to Mid-State) helped fund these
redemptions with new sales of CIAs at full face value. In the
aggregate, between June 1994 and September 1997, Mid-
State, at Devon's direction, purchased and sold hundreds of
millions of dollars of CIAs for the account of Devon clients
for whom Mid-State had custodial accounts. These
transactions were all for the face value of the CIAs
regardless of the value of the securities in FMS' CIA
collateral accounts. The purchases and sales between FMS
and Devon's clients continued until the SEC revealed on
September 26, 1997, that the Devon CIA investment
program was a securities fraud.
6
Thereafter, the SEC commenced a civil action against
Black, Devon and FMS alleging that they had perpetrated a
massive Ponzi scheme through the purchase and sale of the
CIA securities in violation of S 10(b) of the Securities
Exchange Act of 1934, SEC Rule 10b-5, and other
provisions of federal securities law. The SEC alleged that
Devon continued to accept new funds from investment
advisory clients for purchases of CIAs without disclosing
that, as a result of the shortfall in the collateral for the
funds already invested in those securities, any new funds
invested would immediately diminish in value by as much
as 45 percent. The SEC further alleged that the Devon
advisory clients who had invested in the CIA program had
suffered a combined loss of their principal investment of
approximately $71 million. On December 12, 1997, the
District Court issued an injunction against Black, Devon
and FMS barring future violations of securities law
including S 10(b), and Rule 10b-5.
II.
On May 27, 1998, the School Districts filed this putative
class action asserting four RICO claims, and seeking to
recover the $70 million lost as a result of the Ponzi scheme.
Counts 1 through 3 assert claims for violations of 18 U.S.C.
S 1962(c).5 The predicate acts are alleged to consist of wire,
_________________________________________________________________
5. 18 U.S.C. S 1962 provides:
(a) It shall be unlawful for any person who has received any income
derived, directly or indirectly, from a pattern of racketeering
activity
or through collection of an unlawful debt in which such person has
participated as a principal within the meaning of section 2, title
18,
United States Code, to use or invest, directly or indirectly, any
part
of such income, or the proceeds of such income, in acquisition of
any interest in, or the establishment or operation of, any
enterprise
which is engaged in, or the activities of which affect, interstate
or
foreign commerce. A purchase of securities on the open market for
purposes of investment, and without the intention of controlling or
participating in the control of the issuer, or of assisting another
to
do so, shall not be unlawful under this subsection if the
securities
of the issuer held by the purchaser, the members of his immediate
family, and his or their accomplices in any pattern or racketeering
7
mail and bank fraud. Count 4 asserts a claim for
conspiracy to violate S 1962(c). In addition, the complaint
asserts six state law claims. The complaint named Mid-
State, Keystone Financial, Inc., (Mid-State's corporate
parent); William H. Bogel, Senior VP and Director of Trust
Department at Mid-State; Nancy F. Fogel, VP, Trust Officer
and Head of Operations for Mid-State; Robert Leech,
Director of Trust Services for Keystone; and Robert R.
Magill, VP and Head of Trust Operations for Keystone
(hereinafter collectively referred to as "Mid-State") as
defendants.6
The Ponzi scheme is the foundation of this complaint.
The School Districts allege that Mid-State knowingly
participated in, and furthered, the Ponzi scheme through
numerous acts of mail, wire and bank fraud. The School
Districts' theory is that Mid-State's role in the Ponzi scheme
_________________________________________________________________
activity or the collection of an unlawful debt after such purchase
do
not amount in the aggregate to one percent of the outstanding
securities of any one class, and do not confer, either in law or in
fact, the power to elect one or more directors of the issuer.
(b) It shall be unlawful for any person through a pattern of
racketeering activity or through collection of an unlawful debt to
acquire or maintain, directly or indirectly, any interest in or
control
of any enterprise which is engaged in, or the activities of which
affect, interstate or foreign commerce.
(c) It shall be unlawful 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 or collection of unlawful debt.
(d) It shall be unlawful for any person to conspire to violate any
of
the provisions of subsection (a), (b), or (c) of this section.
6. As noted, Keystone is Mid-State's corporate parent. Keystone, through
its division known as Keystone Financial Trust Operations ("KFTO")
maintained central trust accounting functions for Mid-State and other
Keystone subsidiaries. Among other things, KFTO processed and
accounted for trades, and posted income and other transactions for Mid-
State, Devon and FMS. KFTO also prepared and printed account
statements for the trust and custodian accounts of its subsidiaries,
including Mid-State.
8
was essential to the scheme's existence and continuation.
Mid-State accepted deposits into custodian accounts and
those funds were exchanged for CIAs, by which FMS
promised to repay the funds with earnings. Bald Eagle and
South Butler allege not only that Mid-State acted as a
"back office" for Devon and FMS, but also that the Ponzi
scheme could not have operated without Mid-State's
participation. That argument is based upon the assertion
that the putative class members' funds could be held only
in custodian accounts and had to be fully secured.
Plaintiffs also allege that although Mid-State was well aware
of the shortfalls in the FMS collateral accounts, Mid-State
seized upon the volatility of the investments as a means of
recovering the losses in hope of limiting its own liability.
Plaintiffs further allege that, at the same time, Mid-State
took affirmative steps to conceal the scheme by knowingly
preparing trust statements which falsely inflated the
market values of the investments despite knowing that the
collateral was grossly insufficient. The School Districts
contend that whenever funds were requested by Devon
clients, Mid-State paid out the full amount requested even
though there was insufficient collateral to pay all putative
class members and other clients.
The School Districts also allege that Mid-State gave a
false explanation to the FDIC and other bank regulators to
explain the collateral shortfall, and that Mid-State received
a cash flow projection from Black which indicated that FMS
would be in full balance by November of 1998. However,
according to plaintiffs, Mid-State knew that Black's
projection required, among other things, the receipt of an
additional $330 million of custodian funds between March
1996 and November 1998 -- i.e., Mid-State knew that in
order for FMS to be in full balance as projected by Black,
the Ponzi scheme needed to be continued.
On August 10, 1998, Mid-State moved to dismiss the
School Districts' civil RICO claims under Fed. R. Civ. P. 9(b)
and 12(b)(6). Mid-State asserted that (1) the civil RICO
action was barred by S 107 of the PSLRA; (2) the complaint
was not supported by adequate averments of fraud as
required by Fed. R. Civ. P. 9(b); (3) the alleged predicate
acts were not the proximate cause of the School Districts'
9
injuries; and (4) the complaint failed to satisfy other
required elements for civil RICO claims. On February 9,
1999, the District Court held that S 107 of the PSLRA
barred the School Districts' civil RICO claims, and granted
Mid-State's motion to dismiss. The court did not discuss
the other grounds for dismissal advanced by Mid-State, and
the District Court declined to exercise supplemental
jurisdiction over the School Districts' state law claims. This
appeal followed.7
III.
Prior to 1995, a private plaintiff could assert a civil RICO
claim for securities law violations sounding in "garden
variety" fraud.. See Sedima S.P.R.L. v. Imrex Co., Inc., 473
U.S. 479, 504-505 (1985)(Marshall, J., dissenting).
Inasmuch as "fraud in the sale of securities" was a
predicate offense in both criminal and civil RICO actions,
Id. at 504, plaintiffs regularly elevated fraud to RICO
violations because RICO offered the potential bonanza of
recovering treble damages. However, in 1995, Congress
enacted the Private Securities Litigation Reform Act
("PSLRA"), Pub.L. No. 104-67, 109 Stat. 737 (1995). The
PSLRA amended RICO by narrowing the kind of conduct
that could qualify as a predicate act. Section 107 of the
PSLRA (known as the "RICO Amendment") amended 18
U.S.C. S 1964(c), to provide in relevant part as follows:
Any person injured in his business or property by reason of a
violation of section 1962 of this chapter may sue therefor in any
appropriate United States District Court and shall recover
threefold
the damages he sustains and the cost of the suit, including a
reasonable attorney's fee, except that no person may rely upon any
_________________________________________________________________
7. "Whether the District Court properly dismissed the . . . complaint
under Federal Rule of Civil Procedure 12(b)(6) for failure to state a RICO
claim is subject to plenary review, and we apply the same standard as
the District Court. We construe the complaint liberally and take all
material allegations as admitted. All reasonable inferences are drawn in
favor of the plaintiffs. We will not affirm the dismissal unless the
plaintiffs could prove no set of facts that would entitle them to relief."
University of Maryland at Baltimore v. Peak, Marwick, Main & Co., 996
F.2d 1534, 1537-38 (3d Cir. 1993)(citations omitted).
10
conduct that would have been actionable as fraud in the purchase or
sale of securities to establish a violation of section 1962.
18 U.S.C. S 1964(c)(emphasis added).
The Conference Committee Report accompanying S 107
states that the amendment was intended not simply"to
eliminate securities fraud as a predicate offense in a civil
RICO action," but also to prevent a plaintiff from "plead[ing]
other specified offenses, such as mail or wire fraud, as
predicate acts under civil RICO if such offenses are based
on conduct that would have been actionable as securities
fraud." H. R. Conf. Rep. No. 104-369, at 47 (1995).
We recently held that S 107 eliminated "any conduct
actionable as fraud in the purchase or sale of securities" as
a predicate act for a private cause of action under RICO.
Mathews v. Kidder, Peabody & Co., Inc., 161 F.3d 156, 157
(3d Cir. 1998).8 We stated that the legislative history shows
that Congress enacted the RICO Amendment "to address a
significant number of frivolous actions based on alleged
securities law violations." Id. at 164 (quoting 141 Cong.
Rec. H2771 (daily ed. Mar. 7, 1995)(statement of Rep. Cox)).
The "focus" of the Amendment was on "completely
eliminating the so-called `treble damage blunderbuss of
RICO' in securities fraud cases." Id. (quoting 141 Cong.
Rec. H2771).
Here, careful examination of the School Districts'
complaint discloses the District Court correctly concluded
that the School Districts' Civil RICO Action is barred by
S 107. In the SEC's civil action against Black, Devon and
FMS, the SEC has alleged that a massive Ponzi scheme was
perpetrated through the purchase and sale of CIAs in
violation of the securities laws including S 10(b) of the
Securities Exchange Act of 1934, and SEC Rule 10b-5 and
other provisions of the securities law. SEC Complaint, App.
at 523-39. That same Ponzi scheme is at the heart of this
RICO action. Plaintiff's allegations include the following:
_________________________________________________________________
8. In Mathews, we held that the RICO Amendment does not apply
retrospectively, i.e., "it does not apply to cases pending at the time the
[PSLRA] was enacted." 161 F.3d at 171.
11
P. 3. Bald Eagle and South Butler bring this class
action under . . . [RICO] . . . to recover their losses
caused by [Mid-States'] participation in an elaborate,
but carefully concealed municipal fraud of immense
magnitude, that ultimately became nothing more than
an old-fashioned Ponzi Scheme. . . .
P 4. The Ponzi scheme was revealed publicly on
September 26, 1997, when the Securities and
Exchange Commission ("SEC") commenced a civil
enforcement action . . . against . . . [Black, Devon and
FMS] . . . . As detailed in the SEC's enforcement action,
Black illegally perpetrated such a scheme upon . . .
[the School Districts and other class members] . . .
causing them to lose approximately $70,000,000.
However, Black could not conduct this scheme alone,
and, in fact, [Mid-State] joined and participated in such
scheme through multiple acts of bank, mail and wire
fraud, . . . .
Plaintiffs allege that Mid-State joined, assisted and
participated in Black's Ponzi scheme:
P 5. [A]lthough Black's Ponzi scheme wasfirst revealed
publicly in September 1997, [Mid-State] discovered it
years before the SEC uncovered it. Rather than reveal
the scheme, and put a stop to it, however, [Mid-State]
joined in the scheme and enabled it to continue in the
hope that Black could recover his massive losses and,
more importantly, thereby avoid any claims against
[Mid-State](emphasis in original) . . . .
P 94. [Mid-State] ignored [its] obligations to class
members because [it] became embroiled in, and
participated in, a Ponzi scheme that depended upon
the unauthorized pooling of class members' funds, the
investment of those funds in risky, impermissible
investment, the fraudulent reporting of market values,
and the infusion of more money to keep the scheme
going. . . .
P 95. [B]ecause neither Devon nor FMS were licensed
as a broker or dealer in securities, Black used Mid-
State . . . as the "back office" for Devon. In this
capacity, Mid-State . . . essentially acted as the
12
intermediar[y] which processed the securities trades
that were directed by Black. . . .
P 126. [Mid-State], whose role[ ], inter alia, custodian
and "back office," [was] essential to Black's Ponzi
scheme, had by now knowingly joined the scheme as
participant[ ]. . . .
P 133. Because bond proceeds and certain other funds
of school districts and other governmental units can
only be deposited with custodian banks, such as[Mid-
State], it was impossible for Black to continue his Ponzi
scheme, once disclosed and fully understood, without
the knowing participation and assistance of [Mid-
State]. Rather than stop this fraud, however, and
fearing that [Mid-State] would be liable for tens of
millions of dollars of past losses, and that individual
Defendants' jobs and careers were in jeopardy, [Mid-
State] elected not to reveal the Ponzi scheme, but
rather, to join, assist, and continue it.
These few excerpts demonstrate, in the School Districts'
own words, that Mid-State's "role in the Ponzi scheme was
essential to its existence and continuation." Appellants' Br.
at 8. The School Districts allege that Black's Ponzi scheme
was securities fraud. We, like the District Court, must
accept these allegations as true for purposes of a motion to
dismiss under Rule 12(b)(6)9 University of Maryland v. Peak,
Marwick, Main & Co., 996 F.2d 1534, 1537-38 (3d Cir.
1993). Therefore, the alleged conduct is "conduct that
would have been actionable as fraud in the purchase and
sale of securities," S 107 PSLRA, and it cannot constitute
predicate acts of a RICO violation. Accordingly, it is clear
that the RICO action is barred by S 107.
_________________________________________________________________
9. In its opinion, the District Court, while reciting that Mid-State had
filed a motion to dismiss, recited the standards for granting summary
judgment under Fed. R. Civ. P. 56. However, it is clear from reading the
opinion that the District Court was conducting a 12(b)(6) analysis.
Further, the parties to this appeal acknowledge that it was a 12(b)(6)
motion. See, e.g., Mid-States' Br. at 5 n.1 ("For purposes of this appeal
appellees accept the allegations in the complaint as true but do not
otherwise concede their accuracy.").
13
The School Districts attempt to avoid the unavoidable by
arguing here, as they did before the District Court, that the
challenged conduct "does constitute bank fraud, wire fraud
and mail fraud, but does not constitute securities fraud."
Appellants' Br. at 11-12 (emphasis in original). However,
they also concede that some of the conduct alleged as
predicate offenses of mail, wire, and bank fraud does
constitute securities fraud. See Reply Br. at 28 ("The
District Court correctly stated that `the issue before me
appears to be whether the RICO amendment bars an action
where only some of the predicate acts would have been
actionable as [securities] fraud.") Plaintiffs assert that if
only some of the conduct alleged is securities fraud, then
"obviously some other portion of [Mid-State's] conduct is
not actionable as securities fraud." Id. And, it is this "other
portion" of Mid-State's conduct which the School Districts
argue constitutes the predicate offenses of mail, wire and
bank fraud.
The School Districts submit that the "other portion" of
the conduct consists of "obtaining deposits of funds, failing
to maintain collateral, failing to maintain custody of funds,
paying out more funds to withdrawing clients than the fair
value of their account, providing false trust statements
(after deposits are obtained), and lying to bank regulators."
School Districts' Br. At 12 (emphasis in original).
The School Districts' position ignores two significant and
intertwined facts. First, as noted earlier, the RICO
Amendment removed securities fraud as a predicate offense
in a civil RICO action. Section 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. S 78j(b), 10 and SEC Rule
_________________________________________________________________
10. Section 10(b) provides: "It shall be unlawful for any person, directly
or indirectly, by the use of any means or instrumentality of interstate
commerce or of the mails, or of any facility of any national securities
exchange --
******************************
(b) To use or employ, in connection with the purchase or sale of any
security registered on a national securities exchange or any security not
so registered, any manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the Commission may
prescribe as necessary or appropriate in the public interest or for the
protection of investors."
14
10b-5, 17 C.F.R. S 240.10b-5,11 are directed at fraud "in
connection with the purchase or sale" of securities. Blue
Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 733
(1975) (emphasis added). The School Districts' position
ignores the reality that the same set of facts can support
convictions for mail fraud, wire fraud, bank fraud and
securities fraud without giving rise to any multiplicity
problems. See United States v. Faulhaber, 929 F.2d 16 (1st
Cir. 1991) and United States v. Reed, 639 F.2d 896 (2d Cir.
1981). Each of those offenses requires proof of a fact which
the others do not. See Blockburger v. United States, 284 U.
S. 299 (1932). Consequently, a plaintiff cannot avoid the
RICO Amendment's bar by pleading mail fraud, wire fraud
and bank fraud as predicate offenses in a civil RICO action
if the conduct giving rise to those predicate offenses
amounts to securities fraud. Allowing such surgical
presentation of the cause of action here would undermine
the congressional intent behind the RICO Amendment.
Second, the contention that the conduct alleged as
predicate offenses was not in connection with the purchase
or sale of securities completely ignores the hard reality that
the conduct was an integral part of Black's securities fraud
Ponzi scheme. A Ponzi scheme is ongoing, and it continues
only so long as new investors can be lured into it so that
the early investors can be paid a return on their
"investment." Consequently, conduct undertaken to keep a
securities fraud Ponzi scheme alive is conduct undertaken
in connection with the purchase and sale of securities. For
_________________________________________________________________
11. SEC Rule 10b-5 provides: "It shall be unlawful for any person,
directly or indirectly, by the use of any means or instrumentality of
interstate commerce, or of the mails or of any facility of any national
securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state
a material fact necessary in order to make the statements made, in the
light of the circumstances under which they were made, not misleading,
or
(c) To engage in any act, practice, or course of business which operates
or would operate as a fraud or deceit upon any person, in connection
with the purchase or sale of any security."
15
example, the CIAs purchased by the School Districts were
worth significantly less than their purchase price because
of the shortfall in the collateral in the funds already
under management. However, it is alleged that Mid-State
either misrepresented, or failed to disclose, the collateral
shortfall in account statements it prepared. This
misrepresentation/omission, induced new investments.
Such conduct may well constitute wire, mail or bank fraud,
but it was also undertaken in connection with the purchase
of a security. Thus, it cannot support a civil RICO claim
after enactment of the PSLRA.
The District Court held that the RICO Amendment barred
the School Districts' civil RICO action because the conduct
underlying the RICO claims is "intrinsically connected to,
and dependent upon conduct which would be actionable
under Federal securities law." Dist. Ct. Op. at 13. But, the
proper focus of the analysis is on whether the conduct pled
as predicate offenses is "actionable" as securities fraud --
not on whether the conduct is "intrinsically connected to,
and dependent upon" conduct actionable as securities
fraud. Because the District Court appeared to center its
attention on whether the conduct alleged as predicate
offenses was connected to and dependent upon securities
fraud, rather than on whether the conduct was actionable
as securities fraud, the School Districts argue that the
District Court gave an "overly expansive" reading to the
RICO Amendment. Appellants' Br. at 11. However, on a
close reading of the District Court's opinion, it is clear that
the District Court's analysis was properly focused on
whether the conduct was actionable as securities fraud.
The tenor of the opinion demonstrates that the District
Court found the conduct alleged as predicate acts was so
closely connected to and dependent upon conduct
undertaken in connection with the purchase or sale of
securities that it was actionable as securities fraud.
Consequently, we find no merit in the School Districts'
argument that the District Court's reading of the RICO
Amendment was overly expansive.
IV.
For the above reasons, we will affirm the decision of the
District Court.
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A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
17