Anza v. Idea Steel Supply Corp. (04-433)


Appealed from: United States Court of Appeals, Second Circuit

Oral argument: March 27, 2006

RACKETEER INFLUENCED AND CORRUPT ORGANIZATIONS ACT (RICO), RACKETEERING, BUSINESS INJURY, MAIL FRAUD, WIRE FRAUD, PROXIMATE CAUSE, RELIANCE, BURDEN OF PROOF, STATUTORY INTERPRETATION

Ideal Steel Supply Corporation and National Steel Supply Inc. were competitors for many years in the New York area, with facilities in Queens and later the Bronx. They each sold steel mill products and other hardware, and the owners were even related by marriage. As Ideal Steel’s sales in the Bronx dropped and National Steel’s increased, despite both companies charging the same price for their product, Ideal Steel became suspicious. In particular, Ideal Steel was concerned about National Steel’s “cash, no tax” policy, in which customers of National Steel that paid with cash did not have to pay the sales tax required by New York State. Ideal Steel filed a civil suit in federal district court alleging that the “cash, no tax” policy constituted racketeering under the Racketeer Influenced and Corrupt Organizations Act, in that the failure to charge state sales tax and the filing of false sales tax returns was a pattern of mail and wire fraud intended to give National Steel an unfair competitive advantage over Ideal Steel. The district court dismissed Ideal Steel’s claim, ruling that Ideal Steel failed to allege that there was a sufficient connection between National Steel’s alleged illegal conduct and the harm to its business or lost profits. The Court of Appeals for the Second Circuit reversed and ordered that the suit should proceed, ruling that it was sufficient for Ideal Steel to prove that New York State relied on National Steel’s fraudulent conduct, which allowed the scheme to continue, and ultimately led to the harms alleged. The United States Supreme Court must now examine the Racketeer Influenced and Corrupt Organizations Act and determine whether a company such as Ideal Steel is injured by such violations where the company is not directly defrauded and did not rely on the illegal acts.  

[Question(s) presented] | [Issue(s)] | [Facts] | [Discussion] | [Analysis]

Questions Presented

Whether a competitor is “injured in his business or property by reason of a violation” of the Racketeer Influenced and Corrupt Business Organizations Act (“RICO”) where the alleged predicate acts of racketeering were mail fraud but the competitor was not the party defrauded and did not rely on the alleged fraudulent behavior. 

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Issues

Can a business claim a business injury and bring an action under RICO if it was not the direct victim of a competitor’s fraudulent conduct, or if it did not rely on the conduct? Is reliance by a third party on the fraudulent conduct sufficient to sustain such a claim?

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Facts

The Alleged Scheme

Respondent Ideal Steel Supply Corporation (“Ideal Steel”) and Petitioner Anza’s company, National Steel Supply Inc., are direct competitors in the business of selling steel mill products and other hardware in the Bronx and Queens, New York. Brief for Respondent at 3. Since both companies are located near each other and are the only vendors of substantially similar products in the area, they compete on the basis of price. Id. at 4. Ideal Steel alleged that beginning in 1998, and possibly earlier, Anza’s company engaged in a “cash, no tax” scheme in which they did not charge or collect the 8.25 % sales tax required by New York State law on any transaction in which customers paid in cash. Id. In addition, Ideal Steel alleged that Anza knowingly filed false sales tax returns with New York State, which allowed the company to avoid paying sales tax on a significant amount of their taxable transactions. Id. New York State relied on the accuracy of these tax returns and thus did not audit the company or review its tax returns, allowing the scheme to continue. Id. This scheme, which continued until 2004, allowed Anza to gain an alleged illegitimate competitive advantage because even though both companies charged the same price for their products, Anza’s failure to charge sales tax resulted in a lower cost to customers and higher profits for Anza. Id. Ideal Steel alleged that Anza intended to harm its business with the “cash, no tax” scheme, and that as a direct result Ideal Steel experienced reduced sales at its Bronx location, as well as lost profits exceeding $5 million. Id. at 7.

Proceedings in Federal District Court

Ideal Steel filed a civil claim against Anza in federal district court under the Racketeer Influenced and Corrupt Business Organizations Act (“RICO”) sections  1962(a) and 1962(c). Brief for Petitioners at 6. In their complaint, Ideal Steel alleged that Anza’s company was engaged in an enterprise and that the false sales tax returns were violations of the federal mail and wire fraud statutes, constituting a pattern of racketeering activity. Id. at 7. Although the fraud was perpetrated on the state, Ideal Steel alleged that it was directly injured by Anza’s acts because the conduct was aimed at increasing Anza’s profits and market share at the expense of Ideal Steel. Id. Anza moved to dismiss Ideal Steel’s complaint, stating that Ideal Steel failed to allege proximate causation, or that but for Anza’s action, Ideal Steel’s business would not have been injured. Id. The district court granted Anza’s motion, ruling that the complaint did not assert that Ideal Steel relied on the alleged fraudulent misrepresentations mailed or wired to New York State. Id. at 8.

Proceedings in Federal Appeals Court

Ideal Steel appealed the district court’s decision to the United States Court of Appeals for the Second Circuit. Brief for Respondent at 1. The Second Circuit reversed the district court and vacated the judgment dismissing the RICO claims. Id. While the Second Circuit acknowledged that a civil RICO plaintiff alleging violations of the mail and wire fraud statutes must show that it relied on the fraud, the court concluded that reliance by a third party, in this case New York State, sufficed. Brief for Petitioners at 8. The Court reasoned that “where a complaint contains allegations of facts to show that defendant engaged in a pattern of fraudulent conduct that is within the RICO definition of racketeering activity and that was intended to and did give defendant a competitive advantage over plaintiff, the complaint adequately pleads proximate cause, and the plaintiff has standing to pursue a civil RICO claim … [t]his is so even where the scheme depended on fraudulent communications directed to and relied on by a third party rather than the plaintiff.” Id. Applying this principle to Ideal Steel’s case, the Court ruled that a sufficient causal connection existed between the alleged violation, the mail and wire fraud, and the claimed injury, Ideal Steel’s lost profits and market share, to allow the § 1962(c) claim to go forward. Id. at 9. In addition, the court ruled that Ideal Steel stated a valid claim under § 1962(a) because the proceeds of the alleged scheme could properly be viewed as racketeering income, indirectly derived from the pattern of mail and wire frauds, and the complaint properly alleged that Anza used the fraudulently-derived profits to fund the operation of National’s Bronx location. Id. 

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Discussion

As Ideal Steel states in its brief, this case marks the sixteenth time the United States Supreme Court has addressed the RICO statute. Brief for Respondent at 10. The Court’s decision may have a significant impact on business competitors such as Ideal Steel and Anza’s National Steel Supply, Inc., as well as victims of racketeering schemes such as this one. The main issue in the case is whether a victim of a racketeering scheme, in this case Ideal Steel, actually sustains a business injury if it was neither directly defrauded nor directly relied on the scheme. The Court may interpret the RICO statue broadly and hold that third-party reliance on the scheme is sufficient to support a claim of business injury under the statue. Anza’s company took no direct action to defraud Ideal Steel; instead, it did not charge customers the sales tax required by the state of New York and filed false sales tax return statements that allowed it to continue its illegal policy. New York’s reliance on the accuracy of those statements allowed the scheme to continue, as the state’s failure to investigate the returns allowed Anza to gain an unfair competitive advantage over Ideal Steel by not charging sales tax and thus charging a lower total price than Ideal Steel. Ideal Steel alleges that Anza’s intent in the scheme was not to defraud New York State, but rather to use the false tax returns scheme as part of a larger scheme to harm its direct business competitor. As a result of the larger scheme, Ideal Steel alleges that it was harmed in the form of reduced sales at its Bronx location and reduced profits.

If the Court decides that the type of harm allegedly suffered by Ideal Steel is not within the scope of the RICO statute, one in which it was the victim of a racketeering scheme but was not the party directly defrauded, businesses such as Anza’s will be able to avoid civil liability under the statute and harm their competitors simply by using a third party as the direct victim of their scheme. If the purpose of the RICO statute is to prevent racketeering and fraudulent conduct, however, the Court may expand the scope of the law’s protection to parties such as Ideal Steel and allow them to bring civil suits for the business harms they have suffered as a result of a third party’s reliance on a competitor’s unlawful scheme.

There is potential for abuse of such a rule, though, and the Court may decide that a party such as Ideal Steel that alleges a business injury from a racketeering scheme must prove more than reliance on the scheme by a third party to bring a claim under the RICO statute. Reducing the directness requirement of the statute may make it more difficult to trace alleged business injuries to the alleged violation. For example, in this case, only New York State was directly harmed by the alleged scheme, in that it lost revenue from Anza’s failure to collect sales taxes. Arguably, Ideal Steel’s decreased sales and reduced profits might have resulted from a variety of causes, none of which were related to Anza’s scheme. If the Court allows businesses such as Ideal Steel to bring civil suits against competitors based on nothing more than a third party’s reliance on an alleged scheme, troubled businesses may interpret any competitor’s conduct as a misrepresentation or fraud and seek damages under RICO for “unfair competitive advantages,” even if the conduct was perfectly legal or did not directly affect them. This rule may have a severe chilling effect on normal competitive behavior and give weaker businesses a tool to protect themselves from normal market forces.

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Analysis

Background

Section 1964(c) of the Racketeer Influenced and Corrupt Organizations Act (“RICO”) creates a private right of action for any person “injured in his business or property by reason of” a RICO violation such as the alleged “cash, no tax” fraud alleged in this case. In order to establish standing to sue under § 1964(c), an injured plaintiff must show that he was injured in his business or property “by reason of” a RICO violation. In Holmes v. Securities Investor Protection Corp., 503 U.S. 258 (1992), the Supreme Court interpreted the phrase “by reason of” to require that the RICO violation was both a cause in fact and a proximate cause of the injury to the plaintiff. Holmes v. Securities Investor Protection Corp., 503 U.S. 258, 265-268 (1992). While these requirements seem superficially simple, the “proximate cause” requirement is only vaguely defined in the Holmes case. “Proximate cause,” the Court opines, refers to the “[generic] judicial tools used to limit a person's responsibility for the consequences of that person's own acts.” Id. at 268. Thus, the question that Holmes gives rise to in this case is whether the element of proximate causation can be met where the alleged fraud is directed at a third party and where the plaintiff did not rely on the alleged fraud.

Petitioners’ Argument

The primary contention of petitioners Joseph Anza, Vincent Anza, and National Steel Supply, Inc. (“National”) in this case is that Holmes proximate causation is not satisfied because there is an insufficiently direct relation between Respondent Ideal Steel’s (“Ideal Steel”) injury and National’s alleged fraud. The Holmes case, National contends, holds the directness of the relationship between the fraud and the injury to be a “central element” of proximate cause; [W]hen plaintiffs seek recovery for indirect damages, the “general tendency of the law, in regard to damages at least, is not to go beyond the first step [in the chain of causation].” Id. at 269, 271-272; Brief for Petitioners at 17. Thus, even if Ideal Steel could show that National’s alleged fraud was the cause-in-fact of Ideal Steel’s injury, Ideal Steel would still not be able to sue under § 1964(c) unless they were within a single link in the chain of causation. Brief for Petitioners at 17.

In Holmes, the plaintiff’s RICO suit was unable to meet this standard of directness where the defendant’s stock manipulation led to the bankruptcy of two broker dealers, which in turn led to losses to the broker dealers’ clients, which finally led to the plaintiff’s advancing thirteen million dollars to the clients as part of an insurance scheme. Brief for Petitioners at 14. Although Holmes does not here explicitly exclude third-party fraud as a basis for a § 1964(c) claim, it does suggest that a close causal link is required. In National’s view, Ideal Steel’s injury is beyond the first link in the chain of causation since Ideal Steel’s injury is the result of a “complex chain of events.” Brief for Petitioners at 16. According to National, the relevant chain of events in this case began with the alleged tax fraud, which resulted in savings to National, which allowed National to charge lower prices in competition with Ideal Steel, which resulted in lost sales to Ideal Steel, which finally resulted in lost profits for Ideal Steel. Brief for Petitioner’s at 16-17.

The court in Holmes also considered the policies of efficiency and accuracy in defining the relevant standard of directness. The less direct an injury is, the more difficult it becomes to determine how much of the plaintiff’s injury is attributable to the alleged fraud. Holmes v. Securities Investor Protection Corp., 503 U.S. at 269; Brief for Petitioners at 10. In this case, National contends that Ideal Steel’s distance from the alleged fraud makes it more difficult to determine whether Ideal Steel’s lost profits were due to the alleged fraud, or due to other reasons. Brief for Petitioners at 17. For example, customers might have switched to National from Ideal Steel for some reason unrelated to price, or National’s prices might have been lower than Ideal Steel’s even without the alleged fraudulent pricing, or Ideal Steel’s lost customers might have gone to suppliers other than National, or Ideal Steel might just have had poor business practices. In other words, the exact effects of National’s alleged fraud on Ideal Steel are complicated, and thus, any assignment of damages will be less accurate and efficient. Id.

National also contends that proximate causation, beyond the requirement of directness, also includes the specific element that the plaintiff be the party defrauded by the defendant. Brief for Petitioners at 21. In Holmes, National argues, the Court adopted the common law approach that a plaintiff claiming injury by a defendant’s violation of a statute must show not only that the defendant violated the statute, but also that the plaintiff is protected by the statute. Id. The mail and wire fraud statutes relied on in this case, National stresses, were intended to protect “those whom wrongdoers intend to defraud.” Id. at 22. In Israel Travel Advisory Service, Inc. v. Israel Identity Tours, Inc., the Seventh Circuit upheld the dismissal of a plaintiff’s case brought under § 1341 of the RICO Act where a company alleged that its competitor defrauded its potential customers in seeking their business. 61 F.3d 1250, 1258 (7th Cir. 1995). The statute, the court explained, does not protect the vendors to the defrauded customers—“firms suffering from derivative injury from business torts therefore must rely on the common law and the Lanham Act rather than resorting to RICO.” Id. Thus, National contends, since the common law standard requires that the asserted fraud was perpetrated on Ideal Steel directly, Ideal Steel cannot meet the proximate causation requirement laid out in Holmes. Brief for Petitioners at 22.

Another common law principle which National states that the Court adopted in Holmes was the requirement that the plaintiff relied on the defendant’s alleged fraud. Brief for Petitioners at 24. Among National’s strongest arguments is its claim that the United States Courts of Appeal are nearly unanimous in requiring the plaintiff’s reliance on the defendant’s misrepresentation—in their brief they cite cases supporting this point from the Third, Fourth, Fifth, Sixth, Eighth, and Eleventh Circuit Court of Appeals. Brief for Petitioners at 30-31. Even though the First Circuit previously ruled that reliance is just one way to show proximate causation which can be dispensed with when there are other ways of showing that the defendant’s actions caused the plaintiff’s injury, National argues, that decision improperly conflated reliance and proximate cause—reliance is a separate element of the RICO claim which must be satisfied independently from the proximate cause requirement. Systems Mgmt., Inc. v. Loiselle, 303 F.3rd 100, 104 (1st Cir. 2002); Brief for Petitioners at 30-31.

Finally, National contends that expanding RICO fraud claims to cover cases where plaintiff reliance is not present will open the floodgates to civil RICO fraud claims. Brief for Petitioners at 36. Since companies regularly find themselves dealing with tax issues, if the mere allegation of the filing of inaccurate tax forms constitutes a possible “scheme to defraud” under RICO, then competing companies will have the ability to bring suits for any competitive advantage held by the alleged defrauder. Brief for Petitioners at 36-37. Such an extension would also allow competitors hurt by products which turn out to have been misrepresented to sue for any loss of competitive advantage, even where that misrepresentation is not the sole cause of the defendant’s competitive advantage. Brief for Petitioners at 37-38.

Respondent’s Argument

Ideal Steel agrees with National that the Holmes test for proximate causation is the appropriate standard to be used in this case. Brief for Respondent at 23. However, Ideal Steel strongly disagrees with National’s characterization of the directness standard required by the Holmes test, and further asserts that reliance is not a separate requirement, but an integral, though not dispositive, part of the Holmes proximate causation scheme.

In the case below, the Second Circuit held, and Ideal Steel agreed, that a plaintiff has standing to pursue a civil RICO claim when the defendant is alleged to have committed a RICO violation that was intended to and did give the defendant a competitive advantage over the plaintiff, thus satisfying the proximate cause required by the Holmes case. Anza v. Ideal Steel Supply Corp.373 F.3d 251 (2d Cir. 2004). Under this interpretation of the Holmes test, directness is satisfied by reframing the defendant’s alleged fraud as an illegal competitiveness-building device which directly injures the plaintiff’s sales in the same market.

The Holmes test, Ideal Steel argues, was deliberately structured to avoid a bright line rule absolutely requiring that the plaintiff rely on the defendant’s fraud because, in the words of the Holmes court, "the infinite variety of claims that may arise make it virtually impossible to announce a black letter rule that will dictate the result in every case." Holmes v. Sec. Investor Prot. Corp., 503 U.S. 258, (quoting Associated Gen. Contractors of Cal., Inc. v. Carpenters, 459 U.S. 519 (1983)). Thus, by further citing the fact that Holmes does not require a mechanistic reliance requirement, Ideal Steel attempts to show that plaintiff reliance is not a hard and fast rule, but one non-dispositive issue which only makes up part of the larger question of proximate cause. Brief for Respondent at 30.

Ideal Steel further contends that reliance is not only not dispositive, but also not limited to the plaintiff’s reliance on the defendant—third-party reliance, such as that of a state tax collecting agency on the defendant’s misrepresentations, is also a part of the common law definition of proximate causation. Brief for Respondent at 30-31. In support of this contention, Ideal Steel cites several recent New York cases which allow the allegation of fraud when “a false representation is made to a third party, resulting in injury to the plaintiff.” Id. at 44. Ideal Steel buttresses this position by highlighting the common law reliance on the Second Restatement of Torts’ statement that intentional torts widen the scope of liability. Id. at 46. As such, even if plaintiff reliance is a central, though non-dispositive element of proximate causation, the alleged intent to achieve a competitive advantage over Ideal Steel relevantly expands their standing to bring suit under § 1964(c) of the RICO Act.

Ideal Steel also argues that the policy bases of the Holmes decision are satisfied by Ideal Steel’s case. Brief for Respondent at 23. Although Ideal Steel agrees that the less direct an injury is, the more difficult it becomes to determine how much of the plaintiff’s injury is attributable to the alleged fraud, it disagrees with National’s application of the standards to the facts in this case. See Id. at 23-28. Ideal Steel alleges that there is far less difficulty involved in determining the nature their injury as compared to the plaintiffs in Holmes since the parties involved in this case are head-to-head competitors, as opposed to the parties twice removed in Holmes. Brief for Respondent at 24. If, as Ideal Steel contends, the Holmes standard is meant to be a flexible one, rather than a bright line rule, then Ideal Steel’s fact-specific allegation is more likely to convince the Court to give them standing in this case.

Finally, Ideal Steel contends that the courts should have no fear that a ruling in their favor will open the floodgates to huge amounts of frivolous litigation. According to the United States Administrative Office of Courts, RICO cases currently make up less than 0.03% of federal case filings each year and that number is currently trending downwards. Brief for Respondent at 48-49. Even if a ruling in Ideal Steel’s favor somehow exponentially increases the number of RICO case filings, Ideal Steel argues the job of the Judicial Branch is to administer the laws enacted by Congress—National’s complaints about RICO’s broad reach should therefore be directed to Congress and not the Judiciary. Id. at 48.

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Conclusion

Given that the Holmes standard appears to value flexibility over mechanical interpretation, it seems likely that the Court will interpret the RICO Act broadly, even despite the potential abuse by opportunistic competitors of suspect companies. Although the common law clearly holds reliance as an essential element of fraud, the fact remains that the RICO Act does not on its face require reliance to establish proximate cause, and a conservative Court leery of legislating from the bench will shy away from writing a bright line reliance requirement into the statute.

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Authors

Prepared by: Dennis Chi and Daniel Fisch

Additional Sources

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