Krear v. Malek

961 F.Supp. 1065 (1997)

William KREAR, Vonda Krear, The William Krear Revocable Living Trust, Tad Krear, Elizabeth Krear, David Gonynor, Sadie Gonynor, Robert Bacon, Gail, Peter Manetta, Bruce Abbott, Diana Abbott, Peerless Polymers, Ltd., Defined Benefit Pension Plan, Peerless Polymers, Ltd., Pension and Profit Sharing Plan, Polly Kenton, Kevin McQuigg, Frances Pistorius, David Rich, Shelbyco, a Michigan corporation, Gerald Gadowski, M.D., Sharon Gadowski, Steven Gateman, Dorotha Reynolds, George S. Stevens, Burt Stillman, M.D., Bengt Swenson, Elaine Swenson, Scott Wasserman, Lisa Wasserman, L. Brooks Patterson, Alfred Woody, and Gerald McCarthy, Plaintiffs,
v.
William MALEK, Dean Turner, Lease Equities Fund, Inc., National Business Funding, Inc., NBF Cable Systems, Inc. and Dean Witter Reynolds, Inc., Defendants.

Civil Action No. 95-40468.

United States District Court, E.D. Michigan, Southern Division.

March 31, 1997.

Robert A. Hudson, James P. Murphy, Berry, Moorman, King & Hudson, Detroit, MI, for plaintiffs.

Arnold S. Schafer, Robert S. McWhorter, Schafer & Weiner, Jack J. Mazzara, Brian Witus, Hertz, Schram and Saretsky, Bloomfield Hills, MI, Leslie K. Carr, Giarmarco & Bill, Troy, MI, Mark R. Werder, Honigman, Miller, Schwartz & Cohn, Detroit, MI, for defendants.

MEMORANDUM OPINION AND ORDER GRANTING, IN PART, DEFENDANTS' MOTION TO DISMISS PLAINTIFFS' SECOND AMENDED COMPLAINT

GADOLA, District Judge.

Before the court are defendants, Dean Turner ("Turner") and William Malek ("Malek") (hereinafter "Defendants") motion to dismiss filed on March 29, 1996 and January 3, 1997 respectively.^[1] Oral argument was heard on February 27, 1997. For the reasons discussed below, this court will grant the defendants' motion to dismiss, in part, and allow plaintiffs to amend their complaint/rico case statement as directed by this opinion.

Background

This action involves a purported securities fraud scheme ("Ponzi scheme") allegedly perpetrated upon the various plaintiffs by defendants William Malek ("Malek") and Turner separately or together. Defendant Dean Witter Reynolds, Inc. ("DWR") employed Turner, and as such, derivative liability is asserted against it. Defendants Lease Equities Inc. ("Lease Equities"), National Business Funding, Inc. ("NBF"), and National NBF Cable Systems Inc. ("NBF Cable") are the alleged vehicles through which the scheme was perpetrated.

The alleged Ponzi scheme occurred from late 1989 through late 1995. Essentially Malek and Turner are alleged to have offered the plaintiffs the opportunity to transfer money to defendant Lease Equities, a corporation which was dissolved in 1993, in exchange for promissory notes. Those notes, by their terms, secured assignments by Lease Equities of equipment leases entered into between Lease Equities and third parties. Plaintiffs claim that each alleged secured loan transaction was a sham. That although plaintiffs were told that the stream of income arising from the business leases was used as collateral for the repayment of the promissory notes, the same leases were assigned multiple times to secure various promissory notes.

It is further alleged that the individual defendants, through the use of the corporate defendants Lease Equities, NBF and NBF Cable, perpetrated the Ponzi scheme by using new investor funds to pay out old promissory notes. In addition, plaintiffs allege, many of the initial promissory notes were for lesser and smaller amounts, while the later promissory notes were for increasingly larger amounts up to $500,000.00. Plaintiffs further allege that the monies received by the defendants from the plaintiffs were not used for any proper business purpose and that some of the defendants have diverted and/or absconded with the monies obtained from the plaintiffs and have additionally used those funds to repay other notes.

It is also alleged that the defendants induced certain plaintiffs to enter into short term loan transactions to raise finds to discharge a loan Lease Equities had secured from First National Bank of Pittsburgh.

On December 8, 1995, the original complaint, alleging claims for violations of various federal securities laws and RICO^[2] as well as state laws, was filed by some twenty plaintiffs. Thereafter, a first amended complaint ("FAC") was filed on March 4, 1996 and a second amended complaint ("SAC") on March 12, 1996 with new plaintiffs being added each time. On September 18, 1996, this court dismissed plaintiffs' state law claims contained in Counts IV-VI, IX, XIII-XVI, XIX-XXII. On October 15, 1996, plaintiffs filed their RICO case statement ("RCS")in response to this court's September 17, 1996 order for a case statement. On January 17, 1997, plaintiffs filed a first amended RICO case statement ("FARCS").

On August 6, 1996, Malek pleaded guilty to six counts of wire fraud in connection with the sale of notes in Lease Equities. Four of the counts involved sale of notes to five plaintiffs in this case. They are: Gail and Robert Bacon, David Rich, and Bruce and Diana Abbott.

Discussion

The thrust of the defendants' motions to dismiss, pursuant to Federal Rule of Civil Procedure 12(b)(6), is that plaintiffs have failed to allege fraud with particularity as required by Federal Rule of Civil Procedure 9(b). In deciding a motion to dismiss under Rule 9(b) this court is guided by the Sixth Circuit's opinion in Michaels Building Co. v. Ameritrust Co.. N.A., 848 F.2d 674 (6th Cir. 1988). In Michaels, the Sixth Circuit stated, in relevant part, that:

In ruling upon a motion to dismiss under Rule 9(b) for failure to plead fraud "with particularity," a court must factor in the policy of simplicity in pleading which the drafters of the Federal Rules codified in Rule 8. Rule 8 requires a "short and plain statement of the claim," and calls for "simple, concise, and direct" allegations. [^[3]] Indeed, Rule 9(b)'s particularity requirement does not mute the general principles set out in Rule 8; rather, the two rules must be read in harmony. (citation omitted). "Thus, it is inappropriate to focus exclusively on the fact that Rule 9(b) requires particularity in pleading fraud. This is too narrow an approach and fails to take account of the general simplicity and flexibility contemplated by the rules." (citation omitted)

* * * * * *

Given this backdrop admonition of simplicity in pleading, we note that the purpose undergirding the particularity requirement of Rule 9(b) is to provide a defendant fair notice of the substance of a plaintiff's claim in order that the defendant may prepare a responsive pleading. (citation omitted)

Id. at 679. Judge Taylor in Pittiglio v. Michigan National Corp., 906 F.Supp. 1145 (E.D.Mich.1995) explained Michaels by stating:

... In the Sixth Circuit, however, strict application of Rule 9(b) in complex securities fraud cases is disfavored.... The purpose of Rule 9(b) is to provide defendants with notice adequate to prepare a proper responsive pleading. The particularity requirement also protects defendants' reputations, and "inhibits the filing of complaints that are a pretext for the discovery of unknown wrongs, or that are groundless claims designed to coerce a settlement out of defendants who wish to avoid the time and expense of defending themselves." (citations omitted).

Id. at 1152.

Because of the unusual posture of this case, which is due in large part to delays in reassignment of this case as well as other later filed companion cases, this court has the benefit of being apprised of certain developments which have occurred during the past fourteen months. Specifically, as a result of ongoing parallel criminal investigations, as well as discovery that has taken place in the civil cases, this court is now aware that Malek stands convicted of six felony counts relating to a scheme to defraud. A decision on whether Turner will be indicted is expected by May. Accordingly, it is abundantly clear to this court that plaintiffs have not filed suit for any of the improper purposes identified by Judge Taylor.

That alone, however, does not relieve plaintiffs of their obligations under Federal Rules of Civil Procedure 8, 9, and 11. In Michaels, the Sixth Circuit noted that fraud was sufficiently pleaded where the complaint specifies 1) the parties and the participants to the alleged fraud; 2) the representations made; 3) the nature in which the statements are alleged to be misleading or false; 4) the time, place and content of the representations; 5) the fraudulent scheme; 6) the fraudulent intent of the defendants; 7) reliance on the fraud; and 8) the injury resulting from the fraud. Michaels, 848 F.2d at 679. In addition, the fraudulent loan documents were identified and copies of them were attached. Id.

While this court finds that plaintiffs have generally complied with the requirements of Michaels, certain aspects of the SAC and FARCS^[4] are lacking in factual support as to the time and place of the alleged misrepresentations. This court is mindful that there are allegedly hundreds of misrepresentations and that it is unnecessary for plaintiffs to recite each one. However, those alleged representations that are referenced in the SAC and the FARCS must be identified by time and place since they are necessarily within the knowledge of the plaintiffs. Cf. of Trustees of Plumbers & Pipefitters Nat'l Pension Fund v. Transworld Mechanical Inc., 886 F.Supp. 1134, 1142 (S.D.N.Y.1995) ("Rule 9's strictures are relaxed where the alleged fraud concerns facts ``peculiarly within the opposing party's knowledge'") (quoting DiVittorio v. Equidyne Extractive Industries, Inc., 822 F.2d 1242, 1247 (2d Cir.1987)). Accordingly, plaintiffs may further amend their second amended complaint and their first amended RICO case statement so as to correct the deficiencies therein as to sufficient designation of times and places of alleged misrepresentations. See also discussion infra, p. 1070.

This court notes, however, that since there are more than eighty alleged transactions involved in this case, it would be unduly burdensome for plaintiffs to have to attach copies of each note involved in those transactions to the complaint. Accordingly, this court finds that it is sufficient that plaintiffs have accurately identified each of the alleged transactions.

This court will now specifically address the arguments made in each of the two motions.

Dean Turner's Motion to Dismiss

Turner seeks to dismiss Counts I-IV, X-XIII, XVII-XVIII, XX and XXII. On September 18, 1996, this court dismissed plaintiffs' state law claims contained in Counts IV-VI, IX, XIII-XVI, XIX-XXII. Accordingly, Turner is now only seeking dismissal of Counts I-III, X-XII and XVII-XVIII.

a. Counts II, III, X-XII

Turner argues that counts II, III, and X-XII should be dismissed because they fail to allege fraud and violations of RICO with sufficient particularity as required by Fed. R.Civ. P. 9(b). In Counts II and III, plaintiffs allege securities fraud violations under § 10(b) of the Securities and Exchange Act ("SEA") of 1934. In Counts X-XII, plaintiffs allege violations of RICO § 1962(b), 1962(c), and 1962(d) respectively.

Specifically, Turner contends that plaintiffs' SAC does not distinguish between individual plaintiffs, individual defendants, and specific investments nor does it specifically allege the misrepresentations relied upon by plaintiffs.

While Turner's argument may have been more compelling prior to the filing of plaintiffs' RICO case statement, that argument is no longer convincing. In the FARCS, plaintiffs sufficiently distinguish between individual plaintiffs, between individual defendants, and the specific investments as well as specifically allege the misrepresentations which were relied upon. As stated above, however, plaintiffs have failed to plead the time and place of the misrepresentations with sufficient specificity. For instance, in response to ¶ 5(c) of this court's order for case statement, the FARCS identifies more than ten alleged misrepresentations with respect to plaintiffs Bruce and Diana Abbott, yet only identify one place where a representation took place, to wit: "Dean Witter's Troy Office." FARCS p. 29. Moreover, the SAC and FARCS only generally refer to the times when misrepresentations occurred, to wit: "Summer of 1994" FARCS p. 30; "latter in 1994" FARCS p. 32. These examples are in no way to be construed as exhaustive. Unless plaintiffs can identify the time^[5] and place of each alleged misrepresentation, then they have failed to satisfy the Rule 9(b) pleading requirements, even under the relaxed standard set forth in Michaels supra. If plaintiffs can sufficiently plead the alleged misrepresentations, and they have, then they necessarily can and must plead the time and place that those misrepresentations took place.

As to the RICO claims, Turner makes four arguments. First, he argues that plaintiffs have failed to plead the elements of a RICO claim because the SAC contains conclusory allegations. Second, he argues that plaintiffs' § 1962(c) claim does not properly allege an "enterprise" since it alleges that Lease Equities, NBF, NBF Cable, Turner and Malek were alter egos of each other and that a RICO defendant, i.e. Malek, Turner or Lease Equities, cannot also be an "enterprise". Third, he argues that plaintiffs' § 1962(d) claim does not allege an "agreement" to conspire. Finally, he argues that even if an "agreement" is properly alleged, it cannot survive in any event since intra-corporate conspiracies are not actionable under § 1962(d) and plaintiffs have alleged that Malek and Turner were officers of Lease Equities.

Turner's arguments are, however, without merit. First, plaintiffs' SAC as supplemented by their FARCS sufficiently alleges a RICO claim notwithstanding the defects discussed above regarding pleading the time and place of alleged misrepresentations.

With regards to Turner's second argument, it should be noted at the outset that plaintiffs' "alter ego" allegation (Count XIX) was apparently pleaded in the alternative to the RICO claims and has, in any event, been dismissed by this court's prior order dismissing state law claims. Regardless, plaintiffs have sufficiently alleged an "enterprise" in that they have alleged an association-in-fact between Lease Equities, NBF, NBF Cable, Turner and Malek. See Frank v. D'Ambrosi, 4 F.3d 1378, 1386 (6th Cir.1993). In Frank, the Sixth Circuit stated that: "To satisfy the enterprise requirement, an association-in-fact must be an ongoing organization, its members must function as a continuing unit, and it must be separate from the pattern of racketeering activity in which it engages." Id. (citing United States v. Turkette, 452 U.S. 576, 583, 101 S.Ct. 2524, 2528-29, 69 L.Ed.2d 246 (1981)).

Plaintiffs have properly alleged that the racketeering activity, i.e., the sale of notes through Lease Equities to perpetuate the alleged Ponzi scheme, is distinct from the association-in-fact which associated for legitimate business purposes, to wit: Lease Equities entered into legitimate leases with third parties; NBF Cable entered into legitimate cable television contracts; and Lease Equities was a secured creditor of NBF Cable.

Third, plaintiffs have sufficiently alleged, under § 1962(d), that defendants conspired to violate §§ 1962(b) and (c). To state a claim under § 1962(d), a plaintiff must plead that the defendant agreed to join the conspiracy, agreed to commit predicate acts, and knew that those acts were part of a pattern of racketeering activity. See Glessner v. Kenny, 952 F.2d 702, 714 (3rd Cir. 1991). While plaintiffs have not used the word "agreement" per se, they have stated that defendants Malek, Turner and Lease Equities "have conspired to violate RICO," and have well-pleaded a set of facts from which a conspiracy can be inferred in the FARCS. See Baumer v. Pachl, 8 F.3d 1341, 1346 (9th Cir.1993); Manning v. Stigger, 919 F.Supp. 249, 254 (E.D.Ky.1996).^[6]

Finally, Turner's reliance on the intra-corporate conspiracy doctrine is not well taken. The Sixth Circuit, in Johnson v. Hills & Dales Gen. Hosp., 40 F.3d 837 (6th Cir. 1994), recognized that the doctrine is limited to circumstances in which the corporate agent is operating within the scope of his or her corporate authority. Id. at 841. In this regard, the Johnson court indicated that "corporate actors might be beyond the scope of their employment where the aim of the conspiracy exceeds the reach of legitimate corporate activity." Id. at 840. While plaintiffs' do allege that Turner was an employee of Lease Equities in their RICO statement, they also allege that it was in the course of his employment as an agent of DWR and the enterprise, not Lease Equities, that he conducted racketeering activity. Moreover, plaintiffs allege conduct which exceeds the reach of legitimate corporate activity and therefore arguably takes Turner's conduct outside the scope of the intra-corporate doctrine. Accordingly, plaintiffs have sufficiently alleged facts from which this court could infer that Turner was not acting in the course of his employment with Lease Equities and therefore an intra-corporate conspiracy is not alleged.

b. Count I

Turner contends that plaintiffs have failed to allege that Turner actually and successfully solicited Lease Equities notes pursuant to § 12(1) of the Securities Act.

Once again, while this argument may have been more availing prior to plaintiffs' filing their RICO case statements, the RICO case statements make unequivocal allegations that Turner solicited Lease Equities notes. Accordingly, this argument is rejected.

C. Counts XVII, XVIII

Turner contends that plaintiffs have failed to sufficiently allege that Turner was a controlling person for purposes of control person liability pursuant to § 15 of the Securities Act of 1933^[7] and § 20(a) of the Securities Act of 1934.^[8]

To establish control person liability, the Sixth Circuit has stated that the plaintiff must plead that the alleged controlling person 1) actually participated in the operations of the primary defendant in general, and 2) possessed the power to control the specific transaction or activity that constitutes the primary violation. Sanders Confectionery Products, Inc. v. Heller Financial, Inc., 973 F.2d 474, 486 (6th Cir.1992).

Plaintiffs, in their SAC and FARCS have sufficiently pleaded facts which establish a prima facie case of control person liability. The SAC and FARCS allege that Turner brought plaintiffs to Lease Equities, that Turner diverted Lease Equities' funds to NBF Cable or to himself and that he invested Lease Equities funds in a failed business to provide airline service from New York to Detroit City Airport. Accordingly, this argument is rejected.

William Malek's Motion to Dismiss

Malek seeks dismissal of plaintiffs' entire complaint.

a. All Counts Based on Fraud

Malek argues, as did Turner, that all counts based on fraud, i.e. the RICO and securities fraud claims, should be dismissed for failure to satisfy Fed. R.Civ. P. 9(b). Specifically, Malek contends that plaintiffs have failed to plead with particularity the time and place of any of the alleged misrepresentations; the contents and identity of alleged misrepresentations; to attach any promissory notes or security agreements; or to allege any communication by Malek using the mails or wire fraud.

For the reasons stated above, plaintiffs' FARCS cures most of the defects in the SAC with respect to pleading fraud with particularity and also alleges specific communications of Malek using the mails or wire communications. As stated, the only exception is that plaintiffs failed to particularly plead the time and place of the alleged misrepresentations.

Malek also contends that plaintiffs have failed to plead a "strong inference" of scienter pursuant to § 21D(b)(2) of the Exchange Act, 15 U.S.C. § 78u-4. That section provides, in pertinent part:

In any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.

For the same reason that fraud is pleaded with sufficient particularity, notwithstanding the failure to plead the time and place of certain alleged misrepresentations, plaintiffs have sufficiently alleged a strong inference of scienter.

b. RICO Counts

Malek makes three arguments. First, Malek argues that securities fraud no longer serves as a predicate act for a RICO claim in light of the Private Securities Litigation Reform Act of 1995^[9] ("PSLRA"). Second, Malek argues that plaintiffs have not stated a § 1962(c) claim because they fail to allege a separate enterprise or a pattern of racketeering activity. Third, Malek argues that plaintiffs have not stated a § 1962(d) claim because they allege a conspiracy in conclusory terms or alternatively if they have sufficiently alleged a conspiracy it is an intra-corporate conspiracy which is not actionable.

Taken out of order, Malek's second and third arguments have previously been covered under the discussion of Turner's motion to dismiss with the exception of Malek's contention that plaintiffs have failed to plead a pattern of racketeering. This argument is derivative of Malek's argument that plaintiffs have failed to plead fraud with particularity and is therefore similarly rejected with the same proviso that plaintiffs amend their SAC or FARCS, as necessary, to plead the time and place of alleged misrepresentations. Accordingly, plaintiffs have sufficiently pleaded a pattern of racketeering.

Malek's first argument, however, raises novel questions of law. Section 107 of the PSLRA amends 18 U.S.C.1964(c)^[10] to read as follows:

Any person injured in his business or property by reason of a violation of section 1962 of this Chapter may sue therefore 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 entirely rely upon any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation of 1962. The exception contained in the preceding sentence does not apply to an action against any person that is criminally convicted in connection with the fraud, in which case the statute of limitations shall start to run on the date on which the conviction becomes final.

18 U.S.C.1964(c) (amended text emphasized). See Section 107 (Pub.L. No. 104-67, 109 Stat. 737, 758 (Dec. 22, 1995)).

The first question raised by this amendment is whether the PSLRA, which was enacted on December 22, 1995 applies to some or all of the plaintiffs since the original complaint was filed on December 8, 1995, the FAC was filed on March 4, 1996 and the SAC was filed on March 12, 1996. In other words, is the amendment to be applied retrospectively.

This court is persuaded by the reasoning of its sister court in Tennessee which recently addressed this issue and concluded that the statute should, indeed, be applied retrospectively. See Rowe et al., v. Marietta Corporation et al., 955 F.Supp. 836, 848-49 (W.D.Tenn.1997). In Rowe, Judge Donald concluded that:

The fact that Congress provided no express temporal reach for the application of § 107 to RICO, although expressly providing that Title I of the Reform Act would not operate retroactively against the 1933 and 1934 Acts, leads the Court to conclude that Congress knew it was amending a jurisdictional statute and correcting a mistake, and that Congress intended the regular judicial rules of construction to apply to this amendment.

Id. The judicial rule of construction Judge Donald was referring to was inclusio unius est exclusio alterius. The applicability of the PSLRA is addressed in § 108 of the Act and provides that: "The amendments made by this title shall not affect or apply to any private action arising under title I of the Securities Exchange Act of 1934 or title I of the Securities Act of 1933, commenced before and pending on the date of enactment of this Act." The amendment's express reference to prospective applicability in regards to title I of the Securities and Exchange Acts of 1934 and 1933 respectively, while omitting any reference to RICO, lead Judge Donald to reason that Congress did not intend the RICO amendment to be limited to prospective application.

Moreover, Judge Donald noted Congress' clear intent to rectify an unintended situation, to wit: plaintiffs were recovering treble damages under RICO for securities fraud injuries. See Rowe, 955 F.Supp. at 847-48.^[11] The judge reasoned that since a plaintiff's right to recover for securities fraud under RICO was an unintended situation, retrospective application of the amendment would not impair any rights that the plaintiff therein had when he acted. Id. (citing Landgraf v. USI Film Prods., 511 U.S. 244, 280-81, 114 S.Ct. 1483, 1505, 128 L.Ed.2d 229 (1994) (instructing that a statute would have impermissible retroactive effect where, inter alia, it would impair the rights a party possessed when he acted)). Cf. General Motors Corp. v. Romein, 503 U.S. 181, 191, 112 S.Ct. 1105, 1112, 117 L.Ed.2d 328 (1992) (impermissible retroactive effect where a party is deprived of legitimate expectation or impacted by settled transactions.)

Judge Donald then distinguished those cases which have not applied the amendment retrospectively.^[12] He stated that: "Of the cases finding against retrospective application, all share one common characteristic pertinent to the disposition of the instant case — the plaintiffs in all five cases were barred from bringing § 10(b) actions by the limitations period adopted in [Lampf v. Gilbertson, 501 U.S. 350, 111 S.Ct. 2773, 115 L.Ed.2d 321 (1991)]." Id. at 846.^[13] Judge Donald reasoned that since Rowe had timely filed his federal securities fraud claims, the retrospective application of the amendment would not impair his right to recover for the alleged securities fraud. Id. at 846-48 (citing Landgraf, 511 U.S. at 280-81, 114 S.Ct. at 1505). Judge Donald, quoting Reading Wireless Cable Television Partnership v. Steingold, 1996 WL 741432 (D.Nev. July 30, 1996), concluded that:

The nature of the amendment made by § 107 does not bring it within the class of enactments as to which the presumption against retroactivity arises. As has been seen, the amendment was to remove what Congress considered an unnecessary and unfair provision for damages. This taken together with the implication given by the omission from § 108's specific temporal reach language of any mention of the RICO amendment, calls for retrospective application of [§ 107] as to plaintiffs' RICO claims.

Rowe, 955 F.Supp. at 847 (quoting Reading Wireless, 1996 WL 741432, at *3.)

In the instant case, this court is faced with an analogous situation to Rowe and Reading Wireless, namely, that the plaintiffs' herein who have asserted pre-amendment RICO claims have also asserted § 10(b) claims in a timely fashion. Accordingly, this court finds that the retrospective application of the amendment to § 1964(c) does not impair those plaintiffs' rights to recover for alleged securities fraud. As such, this court will apply the amendment to all plaintiffs including those plaintiffs who filed suit before December 22, 1995.

The second question is whether the amendment applies only to plaintiffs' predicate acts alleging securities fraud or to those alleging mail fraud and wire fraud as well. On this issue, there is some guidance from Congress. The House Conf. Rep. No. 104-369 states in relevant part:

The Conference Committee amends section 1964(c) of title 18 of the U.S.Code to remove any conduct that would have been actionable as fraud in the purchase or sale of securities as racketeering activity under civil RICO. The Committee intends this amendment to eliminate securities fraud as a predicate offense in a civil RICO action. In addition. the Conference Committee intends that a plaintiff may not plead 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. (emphasis added).

Id. at p. 47. The Senate Committee Report contains identical language regarding Congressional intent. See P.L. 104-67, Private Securities Litigation Reform Act of 1994, Senate Report No. 104-98 (June 19, 1995). See also Baker, 940 F.Supp. at 1175 note 7.

It is abundantly clear that Congress intended that conduct constituting wire and mail fraud not form the basis of a predicate act under the amendment if such conduct would also be actionable as securities fraud. Since plaintiffs herein have pleaded predicate acts of mail fraud arid wire fraud based on conduct that also forms the basis of their claims of securities fraud, all of plaintiffs' RICO claims must be dismissed unless an exception applies.

This raises a third issue, that being: what is the applicable scope of the "conviction exception" language in the amendment. In other words, which plaintiffs, if any, can avail themselves of the "conviction exception" and maintain a RICO action against the defendants. The relevant statutory language provides that:

The exception contained in the preceding sentence does not apply to an action against any person that is criminally convicted in connection with the fraud, in which case the statute of limitations shall start to run on the date on-which the conviction becomes final.

After a thorough review of the case law it is apparent to this court that the application of the "conviction exception" is an issue of first impression. Moreover, the Congressional record is devoid of any substantive discussion of the exception. While there is legislative history regarding the amendment generally, none of it addresses the "conviction exception" specifically.^[14] Regardless, the purpose of the amendment, generally, also serves to instruct this court as to the purpose for the exception.

The reason for the elimination of conduct constituting securities fraud as a RICO predicate act, as proffered in the Senate Report, is to reduce the cost of raising capital. See Senate Report, supra, p. 7. Representative Cox of California, who introduced the bill, stated on the Congressional record that:

... [O]ur economy's health depends on the efficient operation of America's capital markets. We must continue to balance the provisions of adequate remedies for injured investors and the imposition of excessive penalties on all participants in our capital markets. The treble damage blunderbuss of RICO undermines this balance and imposes exorbitant litigation costs, impedes the raising of capital and ultimately puts these costs on the shoulders of consumers and emerging innovative companies.

141 Cong. Rec. H2773.

Mr. Cox further explained that the aim of the amendment was to correct the misapplication of RICO. Mr. Cox, invoking the Supreme Court's opinion in Sedima, S.P.R.L. v. Imrex Co. Inc.,^[15] stated that "[i]n its private civil version RICO is evolving into something quite different from the original conception of its enactors; in other words, Congress." 141 Cong. Rec. H2772 (Statement of Rep. Cox). Mr. Cox quoted Chief Justice Rehnquist who stated: "Virtually everyone who has addressed the question agrees that civil RICO is now being used in ways that Congress never intended when it enacted the statute in 1970. Most of the civil suits filed under the statute have nothing to do with organized crime." Id. (quoting Rehnquist, Reforming Diversity Jurisdiction and Civil RICO, St. Mary's L.J. 5, 9 (1989)).^[16] Representative Cox went on to state that:

Because many claims that could be asserted as securities laws claims can also be characterized as mail or wire fraud, and because mail and wire fraud are also predicates for civil RICO liability, Plaintiffs' attorneys have a devastating, potent, and readily available alternative for bringing actions under RICO instead of under our securities laws. As the SEC general counsel stated in his 1989 testimony before the House Committee on the Judiciary, and I quote now,

The commission is concerned that the civil liability provisions of RICO can, in many cases, convert private securities law fraud claims into RICO claims. Successful plaintiffs in such cases are entitled to treble damages, despite the express limitations on recovery under the securities laws to actual damages. Private plaintiffs may be able to bypass the carefully crafted liability provisions of the securities laws and thereby recover damages in cases in which Congress or the courts have determined that no recovery should be available.

* * * * * *

[T]he failure to adopt this amendment would undermine the reforms we are hoping to achieve because attorneys could then do an end run around all of the reform by simply using the RICO statute....

141 Cong. Rec. H2771 (statement of Rep. Cox). Finally, Mr. Cox concluded that:

It is certainly important that criminals be prosecuted and that is exactly what will happen before and after this amendment. But what we do not want to see is for our carefully crafted Federal securities laws to be shunted aside and instead for people to be able to use a statute never intended to apply in these civil cases in this way so that they can get treble damages, something not provided for in our securities laws, so that they can get discovery going all the way back 10 years to show a pattern which is part of RICO, not part of the securities laws, and in short so they can gin up settlements where a settlement is not in order.

141 Cong. Rec. H2778 (Statement of Rep. Cox).

At the outset, it is clear from the plain language of the "conviction exception" that it can only apply, at this time, to Malek and not Turner. This is so because only Malek now stands "convicted in connection with the fraud." This, of course, would change if Turner is subsequently convicted. Accordingly, all RICO claims against Turner are dismissed without prejudice.^[17]

The issue as to which plaintiffs can take advantage of the "conviction exception" as against Malek is, however, more involved. Malek argues that only those persons who are named in the information to which he pleaded guilty are entitled to invoke this exception, i.e. plaintiffs Robert and Gail Bacon, Bruce and Diana Abbott and David Rich. Plaintiffs, on the other hand, contend that they are all entitled to invoke the exception since the scheme to defraud to which Malek pleaded guilty was, in effect, a Ponzi scheme and therefore all of their claims are "in connection with" that scheme.

As evidenced from the Congressional record cited above, Congress, by enacting this amendment, was intending to correct the misapplication of RICO in the securities fraud context. Moreover, the record reveals that Congress was weary of the susceptibility of civil RICO to litigation abuses in the securities fraud area. In recognition of Congress' intention and mindful of its concerns, this court is inclined to interpret the "conviction exception" language as narrowly as possible so that the exception is only available to those plaintiffs against whom a defendant has specifically been convicted of criminal fraud.

If this court were to find otherwise, plaintiffs who were not found to have been criminally defrauded would be allowed to "bootstrap" their RICO claims to the claims of those plaintiffs who were found to have been criminally defrauded. This would necessarily cause the "conviction exception" to swallow the rule which prohibits civil RICO claims for securities fraud.

For instance, the plaintiffs who were not named in the information but who claim to have been defrauded by the same scheme to defraud which is identified in the information argue that they should therefore be able to bring a RICO action against Malek under the "conviction exception." However, Malek was not convicted of a scheme to defraud all of the thirty-three named plaintiffs. Nor was he, of course, convicted of a "Ponzi scheme." Instead, he was convicted of a scheme to defraud as to only those individuals named in the information. Under these circumstances, the exception would swallow the rule if plaintiffs who cannot show that they were criminally defrauded would, nevertheless, be able to bring a civil RICO action based on alleged securities fraud.

The information provides, in relevant part, that Malek:

intended to devise and devised and carried out a scheme to defraud and obtain money from numerous individuals from within the State of Michigan and elsewhere, by means of false or fraudulent pretenses and representations, and, for the purpose of executing such scheme, did knowingly cause mail to be delivered by the United States Postal Service....

It was a part of the scheme to defraud that defendant [Malek], would and did offer for sale, and did in fact sell, promissory notes to the following individuals, in the following amounts .... [naming individuals] (emphasis added).

Although the information refers to "a scheme to defraud numerous individuals," it does not necessarily follow that every plaintiff who claims to be a victim of the alleged Ponzi scheme was criminally defrauded. It is quite possible that certain transactions between those plaintiffs and Malek were entirely legal, notwithstanding that those plaintiffs may have lost money on their investment. Simply put, those plaintiffs who were not found to have been criminally defrauded cannot, by merely asserting that a Ponzi scheme existed, invoke the "conviction exception." Unless the plaintiffs are named victims of the scheme to defraud in the information, this court cannot find that they have been criminally defrauded and are thereby entitled to invoke the "conviction exception." To hold otherwise would allow the anomalous situation of permitting a plaintiff who was not criminally defrauded and who would not otherwise be entitled to bring a civil RICO action to, in fact, bring such an action simply because he claims to be part of an alleged Ponzi scheme.

This court is mindful that a seemingly inequitable result may be compelled under certain circumstances. For instance, the United States attorney may have elected to name only certain victims of the scheme to defraud based on the evidence available to him at the time the indictment was sought or the information filed. Moreover, the prosecutor may not name more victims of the scheme to defraud due to practical considerations such as the relative ease of obtaining a conviction based on a minimum showing of a scheme to defraud rather than exposing an entire elaborate scheme.^[18] In addition, defendants could plead guilty to defrauding only certain plaintiffs as part of a plea agreement. This court, however, must presume that Congress was sufficiently familiar with the criminal prosecution process, including plea bargaining, so that it understood that a defendant who may have defrauded many plaintiffs could be convicted of defrauding only certain of those plaintiffs.^[19]

While it may be that the fraudulent conduct that Malek pleaded guilty to indirectly effected other plaintiffs of the alleged Ponzi scheme, by helping to facilitate that scheme, this court is not prepared to read the "conviction exception" language so broadly as to include any plaintiff who claims to have been defrauded by that scheme. Such an interpretation would be contrary to the Act's goal to significantly limit, if not eliminate, a defendant's exposure to treble damages for securities fraud.

Nor will this court find, on these facts, that an exception to the "conviction exception" is warranted which would allow plaintiffs who were not criminally defrauded, per se, to maintain a civil RICO action when the defendant is convicted of a scheme to defraud in which they claim to have been defrauded. While this court appreciates that the facts of this case lend themselves well to making such an argument, this court is, nevertheless, constrained by the old adage that "hard facts make bad law." See United States v. McRee, 7 F.3d 976, 983 (11th Cir.1993) (dissenting opinion); United States v. Stagman, 446 F.2d 489, 494 (6th Cir.1971) (dissenting opinion).^[20] Accordingly, this court will find that the "conviction exception" only applies to those plaintiffs whom Malek was specifically convicted of defrauding.

ORDER

IT IS THEREFORE HEREBY ORDERED that plaintiffs are GRANTED leave to amend their second amended complaint and first amended RICO case statement to correct the deficiencies therein herein before noted, such amendments to be filed within thirty (30) days.

IT IS FURTHER ORDERED that all RICO claims contained in Counts X, XI, XII are DISMISSED, with prejudice, against all defendants except all RICO claims in Counts X, XI, XII against defendant WILLIAM MALEK by plaintiffs ROBERT and GAIL BACON, BRUCE and DIANA ABBOTT and DAVID RICH and except that all RICO claims against defendant DEAN TURNER contained in Counts X, XI, XII are DISMISSED, without prejudice.

SO ORDERED.

NOTES

[1] The defendants filed a joint brief in support of Malek's motion to dismiss which was filed in all four of the cases that were consolidated at that time, i.e. Krear. et al. v. Malek et al., 95-40468; Eder et al. v. Malek et al., 96-40255; McMaster et al. v. Malek et al., 96-40268; and Calamari et al. v. Malek et al., 96-40346. This court, of course, will only consider this brief to the extent it addresses issues in the Krear case.

[2] Racketeer Influenced Corrupt Organization Act ("RICO"), 18 U.S.C. § 1961.

[3] Fed.R.Civ.P. 8 provides, in pertinent part:

(a) Claims for Relief. A pleading which sets forth a claim for relief, whether an original claim, counterclaim, cross-claim, or third-party claim, shall contain ... (2) a short and plain statement of the claim showing that the pleader is entitled to relief ...

* * * * * *

(e) Pleading to be Concise and Direct; Consistency.

(1) Each averment of a pleading shall be simple, concise, and direct. No technical forms of pleading or motions are required.

[4] This court notes that a RICO case statement can be used to supplement a complaint. See McLaughlin v. Anderson, 962 F.2d 187, 189 (2nd Cir.1992); Guidry v. Bank of LaPlace, 954 F.2d 278, 281 (5th Cir.1992); Domestic Linen Supply & Laundry Co. v. Central States, 722 F.Supp. 1472 (E.D.Mich.1989).

[5] While this court is mindful of the burden of pleading the exact date of the alleged misrepresentations in every instance, more specificity than "Summer of 1994" or "later in 1994" is required.

[6] This court notes, however, that plaintiffs would do well, in light of this court's decision to allow an amendment to the SAC or the FARCS, to include the word "agreement" in that amendment.

[7] 15 U.S.C. § 77o

[8] 15 U.S.C. § 78t

[9] Pub.L.No.104-67, 109 Stat. 737 (1995).

[10] § 1964(c) provides the civil remedies for RICO violations.

[11] See also this court's discussion of legislative intent infra, pgs. 1075-1076.

[12] See, e.g., District 65 Retirement Trust v. Prudential Securities, Inc., 925 F.Supp. 1551 (N.D.Ga.1996); Baker v. Pfeifer, 940 F.Supp. 1168 (S.D.Ohio 1996); Klein v. Boyd, 1996 WL 675554 (E.D.Pa. Nov.19, 1996); In re Prudential Sec. Inc. Ltd. Partnerships Litig., 930 F.Supp. 68 (S.D.N.Y.1996); Mathews v. Kidder, Peabody & Co., Inc., 947 F.Supp. 180 (W.D.Pa.1996).

[13] See, e.g, District 65 Retirement Trust, 925 F.Supp. at 1570; Baker, 940 F.Supp. at 1179; Klein, 1996 WL 675554, at *29; In re Prudential, 930 F.Supp. at 79; Mathews, 947 F.Supp. at 185-86.

[14] The "conviction exception" language was added after Senator Biden offered it as amendment 1481 to the Senate bill, S.240, on June 27, 1995. See 141 Cong. Rec. § 9163 (Statement of Sen. Biden). The relevant legislative history is as follows:

H.R. 1058 was introduced in the House on February 27, 1995. It passed the House on March 8, 1995. On June 19, 1995, the Senate Committee on Banking, Housing, and Urban Affairs reported S. 240, a companion bill to H.R. 1058, to the Senate. On June 28, 1995, H.R. 1058 was passed, as amended, in the Senate. After disagreeing on the amendment, H.R. 1058 was sent to conference which filed a report on November 28, 1995. Both the Senate and the House agreed to the conference report on December 5th and 6th of 1995 respectively. On December 19, 1995 President Clinton vetoed H.R. 1058. On December 20, 1995 and December 22, 1995, the House and Senate, respectively, passed H.R. 1058 by override.

[15] 473 U.S. 479, 105 S.Ct. 3275, 87 L.Ed.2d 346 (1985).

[16] See also 141 Cong. Rec. H2773-74 (Statement of Rep. McCollum) (stating that "Congress never intended for the RICO statute to be used as the principal means of litigating disputes over securities transactions. The securities laws themselves provide aggrieved buyers and sellers with private causes of action so that they may seek compensation for their losses. The increases in the use of the racketeering statue (sic) for this purpose, however, has produced consequences that Congress never intended. The threat of RICO sanctions has had a chilling effect on entrepreneurship and ultimately economic growth."); 141 Cong. Rec. H2775 (Statement of Rep. Fields) (stating that "... we enacted civil RICO many years ago to provide private citizens with a weapon against organized crime and racketeering. We did not intend RICO to be a supplement to the Federal securities laws. We never intended to give trial lawyers treble damages in these types of civil lawsuits. Nonetheless, unless we adopt this amendment, plaintiffs' attorneys will use RICO to evade our efforts of reform."); 141 Cong. Rec. H2776 (Statement of Rep. White) (stating: "That is why a statute designed to apply to racketeering and organized crime in 40 percent of the cases now applies to securities lawsuits. This is a statute that is out of control. If we do not exempt this litigation from this statute, we will never get this job done.")

[17] This court notes that in the event Turner is subsequently convicted, the "conviction exception" provides that the statute of limitations for filing a RICO claim against Turner shall start to run on the date on which his conviction becomes final.

[18] The United States Attorney may also rely upon establishing relevant conduct at the time of sentencing to show the extent of the scheme to defraud. See United States Sentencing Commission, Guidelines Manual, § 1B1.3 (Nov.1995)

[19] While a discussion of the relative strengths and weaknesses of the negotiated plea bargain process is beyond the scope of this court's analysis, it should be noted that, notwithstanding the inability of those plaintiffs not specifically named in the information and subsequent Rule 11 plea agreement to recover under RICO, the instant plea bargain has enured to the benefit of plaintiffs as a whole in that they have been speedily provided with discovery that may not have otherwise been available in such a timely manner, if at all. For instance, were it not for the Rule 11 plea agreement, Malek would not be available for deposition, at least in any meaningful way, as he would most assuredly invoke his Fifth Amendment privilege.

[20] While this court is loath to engage in judicial legislation, it does note that Congress could certainly have been more lucid in the drafting of this amendment. Representative Dingell recognized as much when he stated:

[T]he hard fact is the legislation is poorly drawn, it is hurried to the floor without proper hearings, without any intelligent consideration, and it has results far different, far broader, far worse from the standpoint of RICO, law enforcement, and getting at criminals generally. That is what is involved here.

The amendment ought to be rejected, if for no other reason than it is sloppy work. It is an embarrassment to the House. It may not embarrass the author of the amendment, but it assuredly embarrasses me, because I believe that this body should legislate well and efficiently. it should legislate wisely, so we do not surprise ourselves with the stupid consequences of irresponsible, unwise, and careless work. I urge that the amendment be rejected.

141 Cong. Rec. H2778 (Statement of Rep. Dingell).

Notably, Mr. Dingell made these remarks before the "conviction exception" language was added as an amendment to the bill on the Senate floor. The "conviction exception" language has only served to further muddy an already murky amendment. Congress would do well to reconsider precisely what problems it intended RICO remedies to address with particular attention being given to the meaning of the phrase "in connection with the fraud." As Representative McCollum noted:

... adopting this amendment will not remedy all of the problems with the way the civil RICO statute is being misused. As chairman of the Subcommittee on Crime, where jurisdiction over this issue resides, I intend to introduce RICO reform. It is my hope that the subcommittee will bring forward legislation to help ensure that the RICO statutes are used in the manner that Congress originally intended.

141 Cong. Rec. H2773 (Statement of Rep. McCollum).