Brouwer v. Raffensperger, Hughes & Co. ( 2000 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 99-1286
VIRGINIA E. BROUWER, WESLEY BAXTER,
ALBERTA E. HAESSIG, HARDY HICKS, JR.,
NATALIE HICKS, GERALD J. MOSS,
VIOLA ROBINETTE, JUNE YOST, and
RUTH WILCHER, individually and on
behalf of all others similarly situated,
Plaintiffs-Appellants,
v.
RAFFENSPERGER, HUGHES & CO.,
CATHERINE L. BRIDGE, and
BARNES & THORNBURG,
Defendants-Appellees.
Appeal from the United States District Court
for the Southern District of Indiana, Indianapolis Division.
No. 92-753-C-D/F--S. Hugh Dillin, Judge.
Argued September 30, 1999--Decided January 13, 2000
Before HARLINGTON WOOD, JR., COFFEY, and EVANS,
Circuit Judges.
EVANS, Circuit Judge. Today we find ourselves
looking at the intersection between a substantive
RICO violation of 18 U.S.C. sec. 1962(c) (the
Racketeering and Corrupt Organizations Act) and
a conspiracy violation pursuant to sec. 1962(d),
that is, trying to reconcile Reves v. Ernst &
Young, 507 U.S. 170, 113 S. Ct. 1163 (1993), with
Salinas v. United States, 522 U.S. 52, 118 S. Ct.
469 (1997). Our vehicle for trying to reconcile
these cases is this suit brought by a class of
unhappy investors against several defendants,
including an underwriting firm and a law firm,
growing out of work they did for an Indianapolis
company called the Firstmark Corporation which is
now bankrupt. The underwriting firm, a "Qualified
Independent Underwriter" (a QIU in securities
argot), is Raffensperger, Hughes & Co., Inc.
which got out of the case on its motion to
dismiss; Attorney Catherine L. Bridge and her law
firm, Barnes & Thornburg of Indianapolis, were
granted summary judgment. Motions to reconsider
were filed, the last one based on what was then
the new decision in Salinas. The motions were
denied and this appeal was filed.
The issue in this case is, says the plaintiff-
class, a purely legal one regarding the
requirements for a RICO conspiracy violation
under 18 U.S.C. sec. 1962(d), specifically,
whether a party must agree to personally
participate in the operation, management, or
conduct of the racketeering enterprise for a
conspiracy violation to exist under sec. 1962(d),
as defendants claim and the district court found;
or whether it is enough that a party agrees that
some member of the conspiracy conduct or
participate in the operation or management of an
enterprise, as plaintiffs argue. It is not
exactly a matter of first impression in this
circuit, yet the starkness with which the issue
is raised requires that we take a close look at
several of our cases.
The district court’s characterization of the
facts/1 is not disputed on this appeal; we will
present only a very brief summary. Firstmark is
an Indiana holding company whose subsidiaries
engaged in various financial services. The
conspiracy here is alleged to have begun around
1981 when two defendants, Leonard Rochwarger and
William Smith (who have settled the claims
against them, as have several other persons
originally named as defendants), devised a plan
for Firstmark to become a wholly owned subsidiary
of Rockmont Corporation, of which Rochwarger was
president and CEO. Firstmark immediately began to
have serious financial trouble. In fact, the
transaction caused what is described as "crushing
debt." As a result, Rochwarger began to sell off
Firstmark assets as well as debt securities,
including commercial paper. Firstmark’s troubles
continued in 1986, and its value as a going
concern dropped.
At this time it is alleged that Rochwarger and
the other defendants devised a scheme to conceal
the true financial condition of Firstmark by
increasing the margin between the quantity of
notes sold to investors and those redeemed by
investors. Proceeds from the note sales were used
to pay interest and principal on previously sold
notes and to finance the sale of more notes. To
do this, the conspirators are alleged to have
deceived investors into purchasing new notes,
rolling over current notes, or otherwise
refraining from redeeming their notes. At the
same time, insiders were siphoning off the assets
of Firstmark. The result was an ever-growing
pyramid of debt that forced Firstmark into
bankruptcy in 1988. The plaintiff-class fell for
the scheme and lost a bundle--$57 million.
The rules of the National Association of
Securities Dealers require its members (such as
Firstmark) to use the services of QIUs to perform
due diligence on registration statements and to
recommend a minimum yield for the sale of notes
like the ones involved here. That’s how
Raffensperger became involved with Firstmark;
then the Barnes & Thornburg law firm was hired to
perform the due diligence that would be the basis
for providing the minimum yields at which the
notes would be sold. The allegations are that the
yields bore no relation to reality. In fact, it
is alleged that the yields were set deceptively
low to make the notes appear less risky to
elderly investors. It is also alleged that both
defendants knew that the investors were likely,
if not certain, to lose their entire investment.
The law firm allegedly had three main roles: to
provide due diligence; to conceal the conspiracy
and the substantive violations in registration
statements and, when informed of a problem with
cash flow by the Indiana Securities Commission,
to halt the issuance of certain notes so that
Firstmark’s problems would not become public;
and, once all hope of further note sales was
lost, to facilitate the sale of Firstmark to
another of the law firm’s clients, Capitol
Securities, despite knowing of the dire straits
that the company was in.
The RICO conspiracy statute [sec. 1962(d)]
provides:
It shall be unlawful for any person to conspire
to violate any of the provisions of subsection
(a), (b), or (c) of this section.
The defendants in this case were accused of
conspiring to violate subsection (c), which
provides:
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.
The elements of a subsection (c) offense are (1)
conduct (2) of an enterprise (3) through a
pattern of racketeering activity. A pattern is
the commission of at least two statutorily
enumerated "predicate acts." Sedima, S.P.R.L. v.
Imrex Co., 473 U.S. 479 (1985).
What the Court did in Reves was to clarify what
"participate" and "to conduct" mean under
subsection (c); in other words, what the
substantive offense is. Reves involved whether an
outside accounting firm could be liable under
subsection (c) for its activities relating to an
inflated valuation of a gasohol plant on the
financial statements of a farm cooperative. The
Court said no, observing that although liability
is not limited to the "upper management" of an
enterprise, to "’conduct or participate, directly
or indirectly, in the conduct of such
enterprise’s affairs,’ sec. 1962(c), one must
participate in the operation or management of the
enterprise itself." 507 U.S. at 185. The Court
concluded that "participate" requires that one
have some part in directing the affairs of the
enterprise, not primary responsibility, but "some
part in directing the enterprise’s affairs is
required." 507 U.S. at 179. In other words, the
statute applies not to "any person," but to any
person associated with an enterprise who
participates in the operation or management of
the enterprise.
As to "outsiders," the Court rejected the
argument that its analysis meant that they could
never be held accountable under sec. 1962(c).
What the Court said, in part, is:
Of course, "outsiders" may be liable under sec.
1962(c) if they are "associated with" an
enterprise and participate in the conduct of its
affairs--that is, participate in the operation or
management of the enterprise itself . . . .
507 U.S. at 185.
The question remains, however, as to what is
required to conspire to violate the substantive
provision. This is where Salinas comes in.
Salinas, which was a criminal RICO prosecution,
involved the requirement for predicate acts. The
defendant in Salinas argued that he could not be
convicted of a subsection (d) conspiracy offense
unless the government proved that he personally
agreed to commit two predicate acts. Using
general conspiracy principles, the Court rejected
the argument, concluding:
A conspirator must intend to further an endeavor
which, if completed, would satisfy all of the
elements of a substantive criminal offense, but
it suffices that he adopt the goal of furthering
or facilitating the criminal endeavor. He may do
so in any number of ways short of agreeing to
undertake all of the acts necessary for the
crime’s completion.
118 S. Ct. at 477. To be convicted of conspiracy
a person must agree with other persons that they
will engage in conduct that constitutes a crime.
The purpose of the agreement is to facilitate the
commission of a crime, even though a particular
defendant need not perform all of the criminal
acts. A conspirator must intend to further an
endeavor which, if completed, would satisfy all
of the elements of a criminal offense. Salinas.
Salinas, applying as it does to predicate acts,
did not specifically change the law of this
circuit. As far back as United States v.
Neapolitan, 791 F.2d 489 (7th Cir. 1986), we said
that a conspiracy to violate RICO can be analyzed
as two agreements: "an agreement to conduct or
participate in the affairs of an enterprise and
an agreement to the commission of at least two
predicate acts." At 499. As the sentence
structure indicates, we have not required
personal participation in the commission of the
predicate acts. But also the sentence structure
shows, at least implicitly, that we have required
personal participation in the affairs of the
enterprise. It is this requirement that the
plaintiffs argue must be altered in light of
Salinas. The argument is that if the general law
of conspiracy applies to subsection (d), then it
is wrong to require personal participation in the
conduct of the affairs of the enterprise. Rather,
if it is enough that one agree that someone
commit the predicate acts, it should also be
enough for a subsection (d) claim that a person
agree that someone should conduct the affairs of
the enterprise.
Thus the issue before us is whether Salinas
means that one does not need to personally
participate in the operation or management of the
enterprise in order to violate subsection (d).
Salinas, focused as it was on the issue of
predicate acts, is not directly helpful in
supplying an answer to the question. It referred,
however fleetingly, to the enterprise requirement
but said only that although an enterprise can
exist with only one actor to conduct it, in most
cases there will be more than one. That fact may
"make it somewhat difficult to determine just
where the enterprise ends and the conspiracy
begins . . . ." 118 S. Ct. at 478.
To summarize that which is clear, subsection
(d) of sec. 1962 requires an agreement to violate
another provision of the statute, in this case
subsection (c). As we have seen, after Reves
subsection (c) applies only to those with some
degree of management or control over the RICO
enterprise. But under general conspiracy law,
which Salinas says applies to subsection (d), a
defendant does not have to agree personally to
perform every aspect of a violation and, in
particular, one does not need to agree personally
to commit the predicate acts. But that leaves a
question: what level of participation in the
conduct of the enterprise, then, does it take to
conspire to violate subsection (c)? It is a
question which has received a bit of attention
both before and after Salinas. See, e.g., United
States v. Antar, 53 F.3d 568 (3d Cir. 1995);
Neibel v. Trans World Assurance Co., 108 F.3d
1123 (9th Cir. 1997); United States v. Posada-
Rios, 158 F.3d 832 (5th Cir. 1998).
There are various possible answers. Conceivably,
it could mean one must agree to actually manage
or control, a notion we rejected in United States
v. Quintanilla, 2 F.3d 1469 (1993). It could mean
one has to agree to participate in the conduct of
the enterprise. It could mean one has to agree to
"maintain an interest in or control of an
enterprise or to participate in the affairs of an
enterprise through a patten of racketeering
activity," which was our formulation in Goren v.
New Vision Int’l, Inc., 156 F.3d 721 (1998). It
could mean one has to agree to exercise "some
measure" of control over the corporation, as we
put it in Bachman v. Bear, Stearns & Co., 178
F.3d 930 (1999). It could mean, as the plaintiffs
argue, that one agrees that someone will
participate in the control of the enterprise--
that is, that one does not need to agree to
personally participate in the control of the
enterprise, one needs to agree only that someone
should be in charge. Or it could mean something
like the formulation of the plaintiffs, offered
at oral argument, that a RICO defendant must have
knowledge of a violation and agree to facilitate
any part of the subsection (c) violation.
In our long-established, two-part analysis of
subsection (d) we have consistently required
personal participation as to the first element
and only an agreement that someone should perform
the predicate acts. Neapolitan, 791 F.2d at 499.
In Goren we concluded that a defendant can be
charged under (d) even if he cannot be
characterized as an operator or manager of a RICO
enterprise under Reves. However, we also said
that subsection (d) should not be used to
criminalize mere association with an enterprise.
In order to state a claim under subsection (d)
Ms. Goren must allege (1) that each defendant
agreed to maintain an interest in or control of
an enterprise or to participate in the affairs of
an enterprise through a pattern of racketeering
activity and (2) that each defendant further
agreed that someone would commit at least two
predicate acts to accomplish those goals.
156 F.3d at 732. Goren indicates that the first
element requires "each defendant" to participate,
while the second requires only that each
defendant agree that someone should commit the
predicate acts.
In Bachman we noted that Bear Stearns, which
was allegedly hired to undervalue a business,/2
was a mere hireling. As to a subsection (d)
claim, we said, in dicta, that Bear Stearns
cannot be thought to have been conducting or to
have agreed to conduct the affairs of any
corporation. "That would require Bear Stearns to
have exercised (or agreed to exercise, in order
to be liable as a RICO conspirator) at least some
measure of control over the corporations." 178
F.3d at 932.
We see no reason to disturb the requirement for
some degree of personal participation as to the
first element. It is not enough that one agree
that someone should run the enterprise and then
have no further concern about it. The
participation element is different in kind from
the requirement for a pattern of racketeering
activity. Reves makes clear that subsection (c)
does not criminalize the actions of everyone who
works for a RICO enterprise, nor does it bring
within RICO everyone who commits what would be
two predicate acts. It only applies to those who
participate in the conduct of the enterprise
through a pattern of racketeering activity.
Agreeing to participate somehow in an enterprise
is active; it is personal. In Salinas the Court
noted a close identity between the enterprise
itself and the conspiracy to run it. An agreement
to join a conspiracy is highly personal;
similarly, an agreement to participate in the
conduct of an enterprise is also personal and
active. But how one agrees to get the job done--
through a pattern of racketeering activity--is
not necessarily personal; it can be delegated.
We suspect that the perception of a conflict
between Reves and Salinas does not arise solely
or even primarily over a requirement for some
degree of personal participation in the affairs
of the enterprise. Rather, the conflict is over
the level at which personal participation in the
enterprise is required. The conflict is a result
of the limitation set out in Reves as to who can
be liable for the substantive offense--not
everyone associated with the enterprise, but only
those who somehow operate or manage the
enterprise. How does that square with conspiracy
law? Intuitively, it seems wrong that a person
could conspire to violate a law which does not
apply to him. The problem can be illustrated by
contrasting a RICO conspiracy to violate
subsection (c) with a more familiar conspiracy--
say one to distribute narcotics. To oversimplify,
in a drug distribution conspiracy, a street
seller can be a member of the conspiracy if he
agrees with the goal of the conspiracy--to
distribute drugs. The underlying statute which he
is conspiring to violate makes it unlawful for
"any person knowingly or intentionally (1) to
manufacture, distribute, or dispense, or possess
with intent to manufacture, distribute, or
dispense, a controlled substance[.]" (Emphasis
added.) 21 U.S.C. sec. 841. The law makes clear
that any person who conspires to commit a drug
offense is subject to the same penalties as a
person who violates the substantive provision. 21
U.S.C. sec. 846. In other words, sec. 841 does
not apply only to those persons who "participate,
directly or indirectly, in the control" of the
distribution network. If it did, would we
confidently say that a street seller could be a
conspirator?/3 In contrast, the limitation on
the universe of people that subsection (c) of
sec. 1962 applies to is what makes a conspiracy
to violate that section conceptually difficult.
It is a conspiracy to violate a very specific
statute which only applies to those who meet the
operation or management test of Reves.
Yet we previously have said that to be a
conspirator under subsection (d) one does not
need to be an operator or manager. MCM Partners
v. Andrews-Bartlett & Assocs., 62 F.3d 967 (7th
Cir. 1995), cert. denied, ___ S. Ct. ___ (Oct. 4,
1999). Although in Bachman we said that one must
agree to exercise "at least some measure of
control" over the corporation, we most often say
that a defendant may conspire to violate
subsection (c) "if [he] agreed ’to conduct or
participate in the affairs of an enterprise
through a pattern of racketeering activity . . .
.’" 62 F.3d at 980; see also Neapolitan, Goren,
and Quintanilla. We think our formulation
continues to describe in a general way the proper
standard.
But it needs to be clarified because of a
discussion in Reves which may cause the phrase to
be misunderstood or to have taken on a meaning
slightly different from that we intended prior to
Reves.
We know now that our phrase "conduct or
participate in the affairs" of the corporation is
broader than the formulation under Reves for the
underlying substantive offense. The Court in
Reves explained:
The more difficult question is what to make of
the word "participate." This Court previously has
characterized this word as a "ter[m] . . . of
breadth." Petitioners argue that Congress used
"participate" as a synonym for "aid and abet."
That would be a term of breadth indeed, for "aid
and abet" "comprehends all assistance rendered by
words, acts, encouragement, support, or
presence." But within the context of sec.
1962(c), "participate" appears to have a narrower
meaning. We may mark the limits of what the term
might mean by looking again at what Congress did
not say. On the one hand, "to participate . . .
in the conduct of . . . affairs" must be broader
than "to conduct affairs" or the "participate"
phrase would be superfluous. On the other hand,
as we already have noted, "to participate . . .
in the conduct of . . . affairs" must be narrower
than "to participate in affairs" or Congress’
repetition of the word "conduct" would serve no
purpose.
507 U.S. at 178-179 (internal citations omitted).
The phrase "participate in the conduct of affairs
of an enterprise" has taken on the attributes of
a term of art. It follows that our long-used
phrase "participate in the affairs" may also have
a subtly altered meaning after Reves, a meaning
we could not have anticipated in Neapolitan. At
the risk of splitting hairs that are already
split, we will attempt to make sense out of all
of this, reconcile Salinas and Reves, and explain
the kind of personal participation we hold is
necessary to violate subsection (d).
To conspire to commit a subsection (c) offense,
one would not need, necessarily, to meet the
Reves requirements: one does not need to agree
personally to be an operator or manager. On the
other hand, one cannot conspire to violate
subsection (c) by agreeing that somehow an
enterprise should be operated or managed by
someone. That would impose a meaningless
requirement and cast a frighteningly wide net.
Rather, one’s agreement must be to knowingly
facilitate the activities of the operators or
managers to whom subsection (c) applies. One must
knowingly agree to perform services of a kind
which facilitate the activities of those who are
operating the enterprise in an illegal manner. It
is an agreement, not to operate or manage the
enterprise, but personally to facilitate the
activities of those who do.
All of this said, we are painfully aware that
this is not a bright line, that district judges
will have to evaluate whether what a defendant
agreed to do is sufficient to bring his conduct
within subsection (d). The district court in this
case did a remarkable job of evaluating these
issues. His conclusion, however, was that to be
in violation of subsection (d) one must agree to
personally participate in the operation or
management of the enterprise. That conclusion was
wrong. Therefore, we must reverse the court’s
judgment and remand the case for reevaluation of
the liability of these defendants consistent with
this opinion./4
REVERSED AND REMANDED.
/1 The district court correctly assumed facts
favorable to the plaintiffs to be true when
considering the defendants’ motions. We, of
course, must do the same.
/2 When we reviewed Bachman, which came to us on a
challenge to a Rule 12(b)(6) dismissal, we
assumed all alleged facts to be true without, as
Chief Judge Posner noted, "vouching for their
truth."
/3 The drug laws, of course, contain provisions
which apply only to those in control; e.g.,
enhanced sentencing penalties for organizers or
leaders. See 21 U.S.C. sec. 848(c). But that
limitation is not found in sec. 841.
/4 Because this case presents a close question, our
opinion has been circulated, pre-publication, to
the full court under Circuit Rule 40(e). No judge
voted in favor of hearing the case en banc.
Circuit Judge Joel M. Flaum did not participate
in this case.