THE SECOND CIRCUIT UPHOLDS IDEAL STEEL’S “INVESTMENT INJURY” RICO CLAIM

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 In 2006 the Supreme Court decided Anza v. Ideal Steel Corp. holding that Ideal’s  RICO claim against a competitor National Steel, a rival steel business in New York City, predicated upon National’s alleged failure to pay sales taxes, could not proceed.  In the Court’s view, there were two fatal flaws in Ideal’s RICO case.  First, there could have been many reasons why National was able to charge lower prices than Ideal.  So the non-payment of sales taxes may have had nothing to do with National’s pricing.  Therefore Ideal’s theory of injury failed the test of “proximate causation.”

“Proximate causation” has been required under RICO since 1992.  That means a plaintiff must be able to prove that the alleged RICO violation was close enough to his (or its) injury to be deemed the “legal cause” of that injury.  There is no simple definition of “proximate causation.”  This is one area of the law where judges have tremendous discretion to apply their own opinions as to what is just.  The Supreme Court’s decision did not do so convincingly, in my opinion.  We should judge Ideal’s theory of causation from the standpoint of economics.  In a competitive market a firm cannot choose its prices.  Prices are set by the forces of supply and demand.  A firm that lowers its prices because it cheats on its taxes, or any other reason, will lose money because its price is below its marginal cost of production.  It will quickly go bankrupt.  The Supreme Court’s opinion did not mention this quite fundamental rule of economics.  Rather, it held that the “direct” victim of National’s alleged tax cheating was New York State, which lost sales tax revenue.  Thus, if anyone had the right to sue for being injured by this scheme to violate RICO, it was the State.  Ideal was two steps removed, and therefore only “indirectly” injured by the RICO violations.

This raises the question as to whether courts should decide RICO cases based upon principles of economics or ill-defined rules (really no more than presumptions), like “direct injury.”  A court applying law and economics principles would have dismissed Ideal Steel’s complaint and required it to replead its theory of damages with more specificity.  Does it believe National Steel had sufficient market power to lower its prices below marginal cost?  And if not, then how could National Steel stay in business while charging less than its marginal cost for its products?    But that did not happen, and we ended up with what seemed to be an unjust and unsatisfying  result to the case.  Why couldn’t there be two different victims to the same “scheme?”  If Ideal Steel was damaged by National’s tax cheating scheme, why shouldn’t it be allowed to prove this damage theory in court?

Now, more than five years later, the Second Circuit, which had ruled in favor of Ideal Steel only to be reversed by the Supreme Court, has revived Ideal Steel’s RICO case after prolonged litigation on the remainder of the case in the district court in New York City.  (Remember that the Supreme Court’s opinion only dismissed Ideal Steel’s claim brough pursuant to section 1962(c) of RICO.  It remanded (sent back to the lower court) the Company’s claim brought pursuant to section 1962(a).  That section forbids the investment of money derived from racketeering activity into an enterprise.)  Ideal Steel argues that National Steel violated section 1962(a) by investing the money it saved in its tax cheating scheme into building a new retail store in the Bronx which competes with Ideal Steel’s Bronx store and caused Ideal to lose a third of its sales.  The Second Circuit was persuaded by the fact that Ideal Steel learned through pretrial discovery that National Steel filed amended tax returns after the case began showing significantly higher income than it had reported earlier, confirming Ideal’s theory of the case.  This impressed the Second Circuit.  The Court stated, “if [National Steel’s] investment of the proceeds of [its] alleged pattern of mail and wire frauds has not sufficiently harmed Ideal to meet the standard of proximate cause, we find it difficult to envision annyone who could show injury proximately caused by that investment or to fathom to whom Congress meant to grant a private right of action under subsection (a).”

Dissenting Judge Cabranes predicted the Supreme Court would now have to take the case a second time to resolve the question of whether Ideal Steel’s “investment injury” theory states a valid RICO claim.  Does Ideal’s theory of unfair competition satisfy the “proximate cause” standard?  As I stated above, this is not an easy question to answer because we have never been told what “proximate causation” is.  The concept is vague, and the fact that Ideal Steel confirmed through pretrial discovery that National Steel understated its taxable income, apparently corroborating its sales tax evasion allegations, does not mean these that the section 1962(a) claim has more teeth than the prior one.  The court assumed the truth of the tax avoidance allegations the first time around, as it was required to do on a motion to dismiss under Federal Rule of Civil Procedure 12.  Its analysis that New York State was the only party  having standing to sue under RICO should not be affected by the apparent truth of the tax scheme.

But analyzing the Complaint from the economic standpoint, it does make a difference.  If National Steel was able to undercut Ideal Steel in prices by cheating on its taxes, or for any other reason, then it suggests the two firms are not operating in a competitive market.  This may be because they are in two separate geographic markets (Queens, where the two firms competed, and the Bronx, where National opened a new retail store in 2002, after allegedly cheating on its sales taxes for years, enabling it to expand), or that National has sufficient market power in the Bronx (likely more than 70% of the sale of steel products) to raise prices or lower them contrary to the usual forces of supply and demand.  But Ideal pleaded that it, not National, had a “dominant” position in the Bronx market before National moved in.  Ideal Steel Supply Corp. v. Anza, _F.3d _, 2011 WL 2557618  at *12.  (2d Cir. 2011).  If  National moved in to the market and was able to take away a third of Ideal’s sales, then it may mean that Ideal was reaping monopoly profits by keeping its prices artifically high.  If so, then Ideal’s lost sales were not caused byNational.  Rather, Ideal was earning profits that were too high in the first place by  limiting production in order to drive its prices up to supra-competetive levels.

Unfortunately, after years of litigation, we till don’t know how National was able to sell steel products profitably but at lower prices than Ideal.  If it lowered its prices because of its non-payment of sales taxes, then it should be able to proceed with its RICO case.  If it lowered them because it has a more efficient business model, and this has nothing to do with the payment of state sales taxes, then it should lose its RICO case.  And given the new opinion, the chances of this type of analysis ever being undertaken are slim.

But for the moment the Second Circuit has revived the use of civil RICO as a remedy against unfair competition.  This is all to the good, as that was one of the express purposes of enacting the law 40 years ago.  The proponents of RICO knew that organized crime was able to invest the proceeds of its activities into legitimate appearing businesses (think of Tony Soprano’s waste management business) and with this added boost, compete unfairly against law-abiding firms.  Essentially this is what Ideal Steel has accused National Steel of doing.  But proving competition is unfair requires, or should require, the services of an economist, and so far the courts have not said so in this incredibly long case.