International Data Bank, Ltd. v. Zepkin

• Decision Date: 20 February 1987
• Docket Number: No. 86-2052,86-2052
• Citation: 812 F.2d 149
• Parties: , Fed. Sec. L. Rep. P 93,160, RICO Bus.Disp.Guide 6564 INTERNATIONAL DATA BANK, LTD., Appellant, v. Eugene ZEPKIN; Harold Grossman; Southern Investment Corporation, a Virginia corporation; BIC, Ltd., a Virginia corporation, Appellees.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 149

812 F.2d 149

55 USLW 2475, Fed. Sec. L. Rep. P 93,160,

RICO Bus.Disp.Guide 6564

INTERNATIONAL DATA BANK, LTD., Appellant, v. Eugene ZEPKIN; Harold Grossman; Southern Investment Corporation, a Virginia corporation; BIC, Ltd., a Virginia corporation, Appellees.

No. 86-2052.

United States Court of Appeals, Fourth Circuit.

Argued Nov. 11, 1986.

Decided Feb. 20, 1987.

Robert E. Brown (Howell, Daugherty, Brown & Lawrence, Norfolk, Va., on brief), for appellant.

Beth H. Stann (H. Vincent Conway, Jr., Downing, Conway & Beale, Newport News, Va., on brief), for appellees.

Before CHAPMAN and WILKINSON, Circuit Judges, and BOYLE, United States District Judge for the Eastern District of North Carolina, sitting by designation.

WILKINSON, Circuit Judge:

Eugene Zepkin and Harold Grossman issued a stock prospectus for their new firm, International Data Bank (IDB). The outside investors, who have since ousted Zepkin and Grossman, now control IDB. IDB has sued Zepkin and Grossman, claiming that the prospectus included a fraudulent statement in violation of federal securities laws. IDB seeks treble damages and attorneys' fees for civil violations of the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. Secs. 1961-68.

The district court dismissed the suit. It reasoned that IDB lacked standing to bring a RICO claim based on securities fraud because it had not bought or sold any securities. We hold that IDB lacked standing to sue and that it cannot point to a "pattern of racketeering activity" as required by the RICO statute. We therefore affirm.

I.

Plaintiff IDB is a corporation headquartered in Newport News, Virginia. It was formed in 1983 to provide financial and administrative services to companies engaged in international trade. Zepkin and Grossman obtained $500,000 for IDB from ten outside investors. In the offering prospectus for IDB, Zepkin and Grossman stated that they had advanced $116,685 in start-up costs and equipment to the firm through their partnership (defendant BIC) and their corporation (defendant SIC). They also stated in the prospectus that the funds would later be repaid by the firm.

IDB repaid the funds that Zepkin and Grossman claimed. IDB, now the plaintiff-appellant, alleges that Zepkin and Grossman falsified the extent of the advance. In some instances, according to IDB, Zepkin and Grossman claimed reimbursement for the cost of equipment that they never bought. In other instances, they claimed reimbursement for the cost of new equipment when they actually bought used equipment. IDB contends that at least $75,000 of the $116,685 "advance" was claimed fraudulently.

II.

We begin with a brief discussion of the pertinent provisions of the RICO statute. Under 18 U.S.C. Sec. 1964(c), a private right of action is permitted under RICO to "[a]ny person injured in his business or property by reason of a violation" of the statute. The violations are described, in turn, by 18 U.S.C. Sec. 1962. In this case, IDB alleges a violation of Sec. 1962(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 term "racketeering activity" is in turn defined by Sec. 1961(1)(D) to include "any offense involving ... fraud in the sale of securities." Under Sec. 1961(5), a plaintiff must, at a minimum, allege two acts of racketeering to plead a "pattern of racketeering activity." This requirement is commonly known as the predicate act requirement; that is, the plaintiff must allege at least two predicate acts to form a RICO claim. A plaintiff bringing a civil RICO claim for securities fraud must allege two acts that constitute securities fraud offenses.

IDB has properly alleged that Zepkin and Grossman committed two such acts in the course of soliciting funds for the company. In particular, they have alleged violations of SEC Rule 10b-5, 17 C.F.R. Sec. 240.10b-5, which prohibits fraud "in connection with the purchase or sale of any security." On appeal, IDB has also alleged violations of Sec. 17(a) of the Securities Act of 1933, 15 U.S.C. Sec. 77q(a). Because the claim under Sec. 17(a) was not presented to the district court, however, we will consider only the alleged 10b-5 violations here.

Beyond the initial requirement of two predicate acts, a plaintiff must meet a number of additional requirements. In this case, IDB has failed two of them: it has not suffered a legally cognizable injury from the predicate acts of securities fraud, and the predicate acts do not constitute a pattern of racketeering activity.

III.

The facts alleged by IDB may afford it a common law claim based on fraud, breach of contract, or perhaps another cause of action, for the recovery of the improper reimbursement. A cause of action for violation of federal securities laws is another matter. The outside investors may well have such an action. Because IDB's injury did not result from its purchase or sale of securities, it has suffered no injury cognizable under Rule 10b-5. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975). Because IDB based its RICO claim on a Rule 10b-5 predicate offense, the district court properly applied the standing requirements of that Rule in dismissing the action. ^*

IDB did not purchase any of its own stock. Nor is fraud claimed by the corporation in its capacity as a seller. Although IDB did sell its stock in the initial offering, it has not alleged that it was injured by virtue of the sale or that it was fraudulently induced to sell its stock. Rather, it complains that it was induced to repay Zepkin and Grossman--a fraud that occurred after the stock offering had already taken place. Thus, IDB brings its claim as neither a purchaser nor a seller.

In Blue Chip Stamps, the Supreme Court held that only actual purchasers or sellers of securities have standing to bring a private action for Rule 10b-5 violations. Parties who are affected by a securities fraud only indirectly cannot sue under 10b-5. Appellants argue, however, that the phrase "[a]ny person injured" in Sec. 1964(c) of RICO confers standing in securities fraud cases upon broad categories of non-traditional plaintiffs. The question before us, then, is whether Congress intended the purchaser-seller restriction to apply to a RICO claim based on 10b-5 violations.

We begin, of course, with the language of the statute. Here, as in many cases, we are left to infer as best we can the legislative intent. Congress did not explicitly address whether RICO actions involving securities fraud were to be limited to injured buyers and injured sellers of securities. The statutory language describing the predicate offense--"fraud in the sale of securities"--is, however, narrow and suggests the pivotal role of the actual sales transaction. One commentator has noted that "in section 1961(1)(D), no mention is made of 'purchasers,' which are included in rule 10b-5, nor of 'offers,' which are included in section 17(a)." MacIntosh, Racketeer Influenced and Corrupt Organization Act: Powerful New Tool of the Defrauded Securities Plaintiff, 31 Kan.L.Rev. 7, 35 (1982). Nor is the broad rule 10b-5 phrase "in connection with," which has been read to impose liability on some non-seller defendants, Norris v. Wirtz, 719 F.2d 256 (7th Cir.1983), used in 18 U.S.C. Sec. 1961(1)(D). In contrast, Congress did use the broader language "any offense involving fraud connected with a case under title 11 [bankruptcy]" in the same part of the RICO statute.

It is wise not to make overmuch of statutory omissions. Congress is presumed, however, to choose its words with care and is presumed not to be oblivious to the intensely semantical character of litigation in the field of securities enactments. We need not decide whether the term "fraud in the sale of securities" in 18 U.S.C. Sec. 1961(1)(D) merely incorporates by reference the standing provisions of securities fraud statutes or whether it also limits of its own force RICO standing to the actual parties to a sale. Under either formulation, where the RICO plaintiff pleads a 10b-5 predicate offense, standing would be limited to the actual purchaser or seller of securities. See MacIntosh, supra, at 37.

Congress, moreover, did not write the RICO statute in a vacuum. It enacted this legislation in 1970 against the developed backdrop of almost forty years of federal securities law. As the Supreme Court later noted in Blue Chip Stamps, "virtually all lower federal courts" facing the issue in "hundreds" of decisions spanning "the past quarter century" had reaffirmed the conclusion of Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.1952) that the plaintiff class in "Sec. 10(b) and Rule 10b-5 private damage actions is limited to purchasers and sellers of securities." 421 U.S. at 731-32, 95 S.Ct. at 1923. If Congress had intended the drastic result of overturning this consensus, it surely would have done so in a more explicit way. Other 10b-5 requirements, such as scienter, reliance, materiality, and causation, are apparently incorporated in the predicate offense. It is difficult to discern why Congress would then have insisted on statutory inconsistency solely with respect to "injury."

The possibility that Congress meant to allow plaintiffs to circumvent the requirements of Birnbaum seems even more remote when we consider the general context in which RICO provides a private cause of action for securities fraud. The civil remedies provided by Sec. 1964(c) cover not just securities fraud, but all the offenses enumerated in Sec. 1961(1). These include a broad spectrum of state and federal crimes, such as murder, kidnapping, arson, robbery, drug distribution, bribery, pension fund embezzlement, and...