Palumbo v. IM Simon & Co.

• Decision Date: 29 December 1988
• Docket Number: No. 88 C 4282.,88 C 4282.
• Citation: 701 F. Supp. 1407
• Court: U.S. District Court — Northern District of Illinois
• Parties: Frank PALUMBO and Michael Palumbo, Plaintiffs, v. I.M. SIMON & CO., et al., Defendants.

701 F. Supp. 1407

Frank PALUMBO and Michael Palumbo, Plaintiffs, v. I.M. SIMON & CO., et al., Defendants.

No. 88 C 4282.

United States District Court, N.D. Illinois, E.D.

December 29, 1988.

Barry T. McNamara, Samuel T. Brkich, D'Ancona & Pflaum, Chicago, Ill., for plaintiffs.

Gregory D. Hoffmann, Gerald P. Greiman, Green, Hoffmann & Dankenbring, St. Louis, Mo., Jeffrey T. Gilbert, Sachnoff, Weaver & Rubenstein, Ltd., Chicago, Ill., for defendants.

MEMORANDUM ORDER

BUA, District Judge.

Plaintiffs' amended complaint alleges a violation of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961-1968 (1982), and asserts common law claims of fraud, negligence, negligent supervision, and breach of fiduciary duty. Defendants, arguing that plaintiffs' allegations fail to state a RICO claim and federal jurisdiction is lacking for the common law claims, have moved to dismiss the amended complaint in its entirety. For the reasons stated herein, the court finds plaintiffs' RICO allegations sufficient to state a claim only against defendant Mary A. DeMarte. Since DeMarte is the only proper RICO defendant, there is no independent federal jurisdiction over the other defendants. Accordingly, the court dismisses all defendants except DeMarte from each count of the amended complaint.

I. FACTS¹

Plaintiffs Frank and Michael Palumbo are unmarried brothers who reside together in Chicago. Over the past 30-40 years, through working, saving, and investing, the brothers managed to accumulate a large sum of money. By late 1982, the Palumbos had amassed over $350,000. In early 1983, the Palumbos began investing in certain bond issues through defendant Mary A. DeMarte, who had acted as one of their investment brokers since at least the mid-1970s. At all times relevant to this litigation,² DeMarte was an employee and agent of one of the following two entities, which also are defendants in this action: I.M. Simon & Co., a partnership,³ and I.M. Simon & Co., Inc., a corporation formed from the partnership in August 1983 (collectively, "Simon").

Over the course of a thirteen-month period, from February 1983 to March 1984, the Palumbos invested a total of $320,000 in various bond issues through DeMarte and Simon. During that time, the Palumbos made nine separate investments in four different types of bonds recommended by DeMarte. Prior to each transaction, DeMarte made certain material misrepresentations and omissions which caused the Palumbos to mistakenly believe that the bonds were of greater value and lesser risk than they actually were. The Palumbos purchased the bonds in reliance on these misrepresentations.

By October 1985, each issuer of the bonds the Palumbos purchased had experienced financial difficulty, filed bankruptcy, and defaulted on the bonds. As a result, to date, the Palumbos have received no payments in principal or interest on any of the bonds, and they do not expect to receive any such payments. In effect, the Palumbos have lost their entire investment.

The Palumbos' amended complaint asserts that defendants' material representations and omissions constitute "fraud in the sale of securities" and "mail fraud," which are included in RICO's broad definition of "racketeering activity." See 18 U.S.C. § 1961. The Palumbos claim that the defendants' fraudulent acts, viewed as a whole, constitute a "pattern of racketeering" for which defendants are liable under § 1962(a) and (c) of RICO. In addition, the Palumbos assert various common law claims.

II. DISCUSSION

A. The Palumbos' § 1962(a) Claim: The Causation Requirement Under § 1964 of RICO

RICO contains four substantive prohibitions which are outlined in 18 U.S.C. § 1962.⁴ These prohibitions may be enforced by private plaintiffs in civil actions. Under § 1964 of RICO, any person injured in his business or property "by reason of" a violation of one of RICO's substantive prohibitions may bring a civil cause of action in federal court to redress his injury. The "by reason of" language in § 1964 operates as a proximate cause requirement which all civil RICO plaintiffs must satisfy to state a claim. Haroco v. American National Bank & Trust Company of Chicago, 747 F.2d 384, 398 (7th Cir.1984), aff'd 473 U.S. 606, 105 S.Ct. 3291, 87 L.Ed.2d 437 (1985). Therefore, to properly plead a civil RICO claim, a plaintiff must allege: (1) that defendant violated one of the substantive prohibitions in § 1962; and (2) that defendant's violation of § 1962 proximately caused plaintiff's injuries.

In the instant case, the Palumbos allege that defendants violated § 1962(a). That section provides in part:

It shall be unlawful for any person who has received income derived ... from a pattern of racketeering activity ... to use or invest ... such income ... in the acquisition of any interest in, or the establishment or operation of, any enterprise which is engaged in, or the activities of which affect, interstate or foreign commerce.

Defendants respond that the Palumbos' RICO claim is deficient even assuming, arguendo, that it sets forth a violation of § 1962(a) by defendants. Defendants argue that the Palumbos' claim fails to meet the second requirement of § 1964—the proximate cause requirement—because it lacks any allegation that the Palumbos were injured "by reason of" defendants' § 1962 violation. Specifically, defendants maintain the Palumbos do not claim that they suffered any injury from what § 1962(a) proscribes: the defendants' use or investment of the money which defendants allegedly derived from a pattern of racketeering. Conversely, the Palumbos contend that they do not need to allege that they were injured "by reason of" defendants' use or investment of the income derived from racketeering activity. The Palumbos' position is that it is sufficient if they allege, as they have, that they were injured "by reason of" the racketeering acts committed by defendants.

Both the Palumbos' and the defendants' positions on this issue have been accepted by district courts within and outside of this district. Several courts have held that a RICO claim based on a violation of § 1962(a) is sufficient where plaintiff alleges he sustained injury "by reason of" the racketeering act or acts committed by the defendant. See Mid-State Fertilizer Co. v. The Exchange National Bank of Chicago, 693 F.Supp. 666, 671-72 (N.D.Ill.1988); Avirgan v. Hull, 691 F.Supp. 1357, 1362 (S.D.Fla.1988); Continental Grain Co. v. Pullman Standard, Inc., 690 F.Supp. 628, 632-33 (N.D.Ill.1988); In re National Mortgage Equity Corporation Pool Certificates Securities Litigation, 682 F.Supp. 1073, 1081-82 (C.D.Cal.1987); Smith v. MCI Telecommunications Corp., 678 F.Supp. 823, 828-29 (D.Kan.1987); Louisiana Power & Light Co. v. United Gas Pipe Line Co., 642 F.Supp. 781, 805-07 (E.D.La.1986). However, the majority position is that in order to satisfy the proximate cause requirement of § 1964, a RICO claim based on § 1962(a) must allege injury suffered "by reason of" the use or investment of the funds derived from the racketeering activity. See Rose v. Bartle, 692 F.Supp. 521, 533 (E.D.Pa.1988); Leonard v. Shearson Lehman/American Express, Inc., 687 F.Supp. 177, 181 (E.D.Pa.1988); In re Reexplore, Inc., Securities Litigation, 685 F.Supp. 1132, 1141-42 (N.D.Cal. 1988); P.M.F. Services, Inc. v. Grady, 681 F.Supp. 549, 555-56 (N.D.Ill.1988); Latigo Ventures v. Laventhol & Horwath, No. 85 C 9584 (N.D.Ill. Nov. 27, 1987) (available on Westlaw 1987 WL 26237); Waldo v. North American Van Lines, Inc., 669 F.Supp. 722, 738 (W.D.Pa.1987); Omega Construction Co. v. Altman, 667 F.Supp. 453, 465 (W.D.Mich.1987); Airlines Reporting Corp. v. Barry, 666 F.Supp. 1311, 1314-15 (D.Minn.1987); Gas Reclamation, Inc., Securities Litigation, 659 F.Supp. 493, 511 (S.D.N.Y.1987); Prodex, Inc. v. Legg Mason Wood Walker, No. 86 1950 (E.D.Pa. Feb. 9, 1987) (available on Westlaw 1987 WL 6329); Donohoe v. Consolidated Operating & Production Corp., No. 86 C 7543 (N.D.Ill. Jan. 8, 1987) (available on Westlaw 1987 WL 5226); Cincinnati Gas & Electric Co. v. General Electric Co., 656 F.Supp. 49, 84 (S.D.Ohio 1986); Gilbert v. Prudential-Bache Securities, Inc., 643 F.Supp. 107, 109-10 (E.D.Pa.1986); DeMuro v. E.F. Hutton, 643 F.Supp. 63, 66-67 (S.D.N.Y.1986); Eastern Corporate Federal Credit Union v. Peat, Marwick, Mitchell & Co., 639 F.Supp. 1532, 1537 (D.Mass. 1986); Heritage Insurance Co. of America v. First National Bank of Cicero, 629 F.Supp. 1412, 1417 (N.D.Ill.1986); Whobrey v. Health-Mor, Inc., No. 85 C 9451 (N.D.Ill. June 11, 1986) (available on Westlaw 1986 WL 303).

This court finds that the majority position is the rational one. As noted, under § 1964, only persons injured "by reason of" a violation of one of the subsections in § 1962 can bring a civil RICO claim. A violation of subsection (a) of § 1962, which is alleged in the instant case, requires the use or investment of income derived from a pattern of racketeering. The verbs "use" and "invest" describe what acts constitute a violation of § 1962(a). The remaining language in the subsection merely describes the circumstances and conditions under which these acts are prohibited.⁵ The use or investment is the crux of the violation. Therefore, in order to allege injury "by reason of" a violation of § 1962(a), a RICO plaintiff must claim he was injured "by reason of" the use or investment of the income derived from racketeering. Undeniably, RICO's plain language mandates that conclusion. See P.M.F. Services, 681 F.Supp. at 555-56.

Courts reaching the opposite conclusion have expounded several justifications for doing so. Some of these courts claim that holding otherwise would create an inconsistency in how the proximate cause requirement in § 1964 is applied to the various subsections of § 1962. For example, in Mid-State Fertilizer, supra, the court pointed out it is well-established that under § 1962(c) it is sufficient for proximate cause purposes if plaintiff al...