Reprinted with permission from The New York Law Journal (May 24,1999) Common Purpose Test Under RICO Can Be Effective Dismissal Tool by Ethan M. Posner Ethan M. Posner is a partner at the Washington, D.C. firm of Covington & Burling and co-lead counsel for SmithKline Beecham Clinical Laboratories in the Blue Cross case referred to in this article. The concept of an "enterprise" is critical in any civil case under the Racketeer Influenced and Corrupt Organizations Act. To obtain the benefits of RICO's draconian penalties, plaintiffs must demonstrate that a defendant conducted or participated in the affairs of a specially defined "enterprise," which may consist of an "individual, partnership, corporation" or "any union or group of individuals associated in fact although not a legal entity." 18 U.S.C. E 1961(4). "The central role" of the RICO enterprise, the Seventh Circuit has noted, "cannot be overstated. It is precisely the criminal infiltration and manipulation of organizational structures that created the problems which led to the passage of RICO." United States v. Neapolitan, 791 F.2d 489, 499-500 (7th Cir.), cert. denied, 479 U.S. 940 (1986). Today, many civil RICO claims do not involve "single entity" enterprises such as an individual," "partnership" or "corporation." Instead, they often involve enterprises consisting of an "association in fact" of various individuals and entities, often including some if not all of the defendants. In 1981, in United States v. Turkette, 452 U.S. 576 the Supreme Court concluded that the members of an "association in fact "enterprise must "associate [] together for a common purpose" of engaging in a particular "course of conduct." The Turkette Court provided little guidance on how to apply this "common purpose" test, although the Court did observe that the members of an association in fact enterprise must display an "ongoing organization" and "function as a continuing unit." Id. at 583. The Court left unanswered such questions as whether this "common purpose" test would be satisfied if the members of the enterprise merely participated in the same business transaction, or participated in the same industry, or had similar business goals. Particularly within the Second Circuit, Turkette has been interpreted to require that the members of an association in fact be linked closely by a specific common purpose. It is not enough, these courts explain, for the members to participate generally in the same business transaction, or to participate generally in the same industry. Instead, they must be aware of each - 1 -
other's presence in the alleged enterprise and, if the RICO case is grounded upon allegations of fraud, the members must share a common purpose to defraud. However, since Turkette was decided by the Supreme Court in 1981, there have been only a handful of rulings on the "common purpose" issue. Perhaps this is because Turkette was not specific regarding the commonality of interest required to satisfy the test; perhaps the RICO defense bar has focused on other, more traditional arguments for dismissal of RICO claims. Although little-used, the "common purpose" test can be an effective way to defeat RICO claims at the initial pleading stage. Common Purpose In Turkette, the Supreme Court was not confronted with whether the members of an association in fact enterprise must exhibit a common purpose. Instead, the question presented was whether RICO could be applied to illegitimate as well as legitimate enterprises. In concluding that RICO was applicable to illegitimate enterprises, such as one consisting of individuals involved in bribery and arson, the Court also announced that enterprises could not consist of just any group of individuals or entities. Instead, as noted above, the Court concluded that the members of a RICO enterprise must associate together for a "common purpose," "function as a continuing unit," and display an "ongoing organization." The Court further concluded that the enterprise in question in Turkette had those characteristics because it consisted of a "group of individuals associated in fact for the purpose of illegally trafficking in narcotics" and "committing arsons." 452 U.S. 577. Since that decision, some courts have interpreted the common purpose language to require that the members of an association in fact share a tightly defined common purpose. In First Nationwide Bank v. Gelt Funding Corp., 820 F. Supp. 89 (S.D.N.Y. 1993), for example, the court rejected a far-flung "Borrower Enterprise" consisting of a mortgage broker and various borrowers with which it did business. The plaintiff could not, as Turkette requires, "plead [] any facts regarding the continuity of structure or personnel" of the enterprise, nor show how or whether the various borrower members knew each other or participated in a common scheme to defraud. 820 F. Supp. at 98. It was not enough, the court found, to say that the mortgage brokers were united in a common purpose through their association with the defendant mortgage broker who had defrauded the plaintiff. Nor was it enough, the court also found, to say that the members of the Borrower Enterprise were united through participation in the local "real estate industry." "Conclusory allegations that disparate parties were associated-in-fact by virtue of their involvement in the real estate industry in the 1980s," the court concluded, "are insufficient to sustain a RICO claim." 820 F. Supp. at 98. The First Nationwide Bank decision cited two earlier rulings from the Southern District of New York, Cullen v. Paine Webber Group Inc., 689 F. Supp. 269 (S.D.N.Y 1988), and Moll v. - 2 -
U.S. Life Title Ins. Co., 654 F. Supp. 1012 (S.D.N.Y 1987). In Cullen, the court dismissed a RICO claim in which the association in fact enterprise consisted of ex-clients of the plaintiffs, a group of former Paine Webber brokers who alleged that they had been defrauded out of these clients by Paine Webber. Judge Peter K. Leisure found that "the clients of the broker-plaintiffs did not share a common purpose or associate together; their only link was their broker," in violation of Turkette. Id. at 272-73. Similarly, in Moll, the court found that it was not enough to allege that an association in fact enterprise composed of real estate attorneys and abstractors were united through their participation "in the real estate settlement industry in Orange and Rockland Counties, New York." 654 F. Supp. at 1031. Citing Turkette, the court found this "common purpose" too broad because it failed to describe "how these various individuals and entities functioned as a continuing unit," or whether the members of the very broad enterprise were even aware of each other's presence. in this "real estate industry" enterprise. 654 F. Supp. at 1032. More recently, in Hansel 'N Gretel Brand Inc. v. Savitsky, 2997 WL 543088 (S.D.N.Y. Sept. 3, 1997), the court rejected an enterprise consisting of two defendant companies that allegedly worked in concert with one of the plaintiff company's officers to conduct a kickback and overcharging scheme. The court found that because neither of the companies associated with one another, or were even "aware that their conduct was part of a larger scheme," the enterprise consisted not of a group of entities sharing a "community of interest" or an "ongoing organization," but rather only of "two groups of defendants engaged in similar conduct," which is not a RICO enterprise. Id., *4-5. Finally, there is the case of Blue Cross of California v. SmithKline Beecham Clinical Laboratories Inc., No. 97-CV-1795. Slip op. (D. Conn. June 11, 1998) (Blue Cross). The court there was confronted with an association in fact enterprise consisting of the defendant and its clinical laboratory facilities around the country, plus thousands of doctors and hospitals that were alleged to have ordered clinical laboratory tests from these laboratories but who were not alleged to have participated in the fraud. The plaintiffs claimed that the thousands of members of this enterprise (called the "Billing Network") were united by the common purpose of "billing and testing for medical services." Citing First Nationwide Bank and Moll, the court found that purpose too broad. Tens of thousands of medical and health professionals may assist in the "billing and testing for medical services," the court noted, but the members of a RICO enterprise must exhibit a far narrower common objective in order for them to function as a continuing unit. Slip op. at 14-15. The lesson from these cases is that association in fact enterprises composed of numerous individuals or entities united only by their participation in a broader industry or set of transactions will run afoul of Turkette's "common purpose" test. The courts have not defined the line at which an association in fact becomes too broad or decentralized, but one rule of thumb may be when the members of the enterprise are not aware of each other's presence in the group. Or, to put it another way, an association in fact enterprise is too broad when it is a "hub and - 3 -
spoke" operation that is, when the members of an enterprise are united only through their association with a central "hub." That was the case in First Nationwide Bank, in which the court rejected the proposed enterprise because it consisted of a "classic 'hub and spoke' conspiracy, in which the [mortgage broker] was the 'hub' and the various borrower defendants [with which the broker did business] were the 'spokes'." 820 F. Supp. at 97. That was also the situation in Blue Cross, in which the physician and hospital members of the "Billing Network" enterprise were linked only by their association with SmithKline Beecham Clinical Laboratories, the common "hub." Purpose To Defraud Several courts have also determined that in a RICO case predicated on allegations of fraud, a faithful application of Turkette requires the members of an association in fact to share a common fraudulent purpose. As more than half of all civil RICO claims are predicated on allegations of mail or wire fraud, civil RICO defendants should consider the association in fact enterprise carefully to determine if its members exhibit a "common purpose to defraud." Often, they will not. In Cullen, for example, the court concluded that the enterprise was deficient in large part because there was no allegation that each of the brokers "shared a common purpose to engage in a particular fraudulent course of conduct and work[ed] together to achieve such purposes." 689 F. Supp. at 273. Relying on Turkette, the court found that "courts in [the Second] circuit have held that, for an association of individuals to constitute an "enterprise" for purposes of RICO, the individuals must share a common purpose to engage in a particular fraudulent course of conduct'." 689 F. Supp. at 273. Likewise, in Blue Cross, the court concluded that in a RICO case predicated on fraud, the members of an association in fact must exhibit a common purpose to defraud. The court concluded that the enterprise was deficient because there was no allegation that the physician and hospital members of the association "shared SBCL's alleged common purpose to defraud public and private health care payers." Slip op. at 14. Instead, as the court observed, some of the members of the enterprise were alleged to be the perpetrators of the alleged fraud, while the other members (the doctors and hospital members of the enterprise) were alleged to be the unknowing dupes of the alleged fraudulent activity. Id. at 14-15. These rulings do not mean, of course, that all RICO enterprises must have a fraudulent purpose. Most RICO enterprises, in fact, consist of a single legitimate entity, such as law firm, corporation or union. In addition, not all association in fact enterprises must necessarily have a common fraudulent purpose. There may be, for example, association in fact enterprises in which each member is linked to each other member by some narrowly defined legitimate activity. However, if the RICO claim is predicated on allegations of fraud, and some of the members of the - 4 -
association in fact are alleged to have engaged in fraud, then the other members of the enterprise should also share that common purpose to defraud, consistent with Turkette. Certainly, in any RICO claim founded on an association in fact enterprise, counsel should consider carefully the extent to which the members of the enterprise are linked. In most instances, the members likely will be linked by little more than their participation in a common industry or transaction, or through their association with a common individual or entity. That should not be sufficient under Turkette or its progeny. And, if the members of the enterprise cannot satisfy the common purpose test under Turkette, then the RICO claim cannot survive the initial pleading stage. Copyright 1999 Ethan M. Posner. - 5 -