Conseco, pursuant to a Credit Agreement, loaned an additional $5,000,000
to NALF secured by a note maturing on December 31, 1997. In connection
with this note, NALF issued to Conseco warrants to purchase 275,000
shares of NALF common stock at an exercise price of $.15 per share and
agreed to amend the exercise price of the Conseco warrants to $.15 per
share from $12.625 and $14.25 per share.
On August 21, 1997, NALF and Conseco entered into an Investment
Agreement, and a first amendment to the June 23, 1997 Credit Agreement.
In the Investment Agreement, Conseco acquired 5,000,000 shares of NALF
stock for $5 million, and purchased all of NALF's outstanding convertible
debentures held by third parties other than Conseco. The Investment
Agreement also provided that Conseco would not "initiate or cooperate in
the initiation of any reorganization or liquidation proceeding with
respect to the Company under the Bankruptcy Act" until the date of
Closing, which was October 1, 1997.
On October 1, 1997, Conseco converted many of the debentures it owned
into NALF common stock, which resulted in Conseco's ownership of 73.6% of
the company, and agreed to convert its remaining debentures into NALF
common stock once the company had sufficient authorized shares available
for issuance upon conversion. In addition, NALF's Board of Directors was
increased from four to six members and the number of Conseco designees on
the Board was raised from one to four. Conseco also agreed that it would
not pursue a cash-out merger of NALF's public shareholders prior to March
23, 1998 without the approval of a majority of the company's minority
stockholders, and that it would not pursue a cash-out merger prior to
December 23, 1998 without the approval of a majority of disinterested
Plaintiff alleges that on November 29, 1997, Conseco caused NALF to
mail to its shareholders and file electronically with the SEC its
November 1997 Proxy.*fn2 The proxy disclosed that NALF was continuing to
experience serious difficulties, and was mailed with an amendment to the
Company's Certificate of Incorporation that increased the number of
authorized NALF shares from 50,000,000 to 100,000,000, allegedly to allow
Conseco to convert its remaining debentures and increase its control to
On March 23, 1998, NALF filed a Chapter 11 petition for bankruptcy.
Plaintiff alleges that Conseco caused the filing of this petition, and
that the filing was improperly intended to enable Conseco to acquire NALF
without adequate consideration to its public shareholders.
Plaintiff alleges two claims. First, plaintiff asserts a claim against
Conseco for violation of RICO on behalf of himself and a purported class
of all other persons and their successors in interest who purchased NALF
common stock on or after April 25, 1996, and who still own such stock.
Second, plaintiff asserts a claim against Sands, for violation of Section
10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, on
behalf of himself and a purported class consisting of purchasers of NALF
common stock between April 25, 1996 and August 21, 1997. Both Conseco and
Sands move pursuant to Fed.R.Civ.P. Rules 12(b)(6) and 9(b), alleging
that the complaint fails to state a claim under RICO or Rule 10b-5.
I. Count I — Plaintiff's RICO Allegations
A. Mail and Wire Fraud
Conseco's challenges to the complaint's RICO allegations are
essentially that they do not adequately allege a scheme to defraud, a
pattern of racketeering activity, or
causation. In relevant part, RICO prohibits
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.
18 U.S.C. § 1962(c).*fn3 A "pattern of racketeering activity"
requires at least two acts of racketeering activity within the past ten
years. 18 U.S.C. § 1961 (5). Mail and wire fraud are included within
the definition of "racketeering activity." 18 U.S.C. § 1961 (1).
The elements of a mail or wire fraud violation are (1) a scheme to
defraud, (2) money or property as the object of the scheme, and (3) the
use of the mails or wires to further the scheme. United States v.
Dinome, 86 F.3d 277, 283 (2d Cir. 1996) (citing United States v. Miller,
997 F.2d 1010, 1017 (2d Cir. 1993)). Allegations of mail and wire fraud
must be pleaded with particularity under Fed. R.Civ.P. 9(b). McLaughlin
v. Anderson, 962 F.2d 187, 191 (2d Cir. 1992); A. Terzi Productions,
Inc. v. Theatrical Protective Union, 2 F. Supp.2d 485, 499 (S.D.N Y
1998). This means that the "complaint must adequately specify the
statements it claims were false or misleading, give particulars as to the
respect in which plaintiffs contend the statements were fraudulent, state
when and where the statements were made, and identify those responsible
for the statements." McLaughlin, 962 F.2d at 191 (citing Cosmas v.
Hassett, 886 F.2d 8, 11 (2d Cir. 1989)). "Plaintiffs asserting mail [or
wire] fraud must also identify the purpose of the mailing within the
defendant's fraudulent scheme." Id.
While it is true that mail or wire communications that contain no
false, information may satisfy the transmission element of the offenses,
the mail or wire communications must be "incident to an essential part of
the scheme." Schmuck v. United States, 489 U.S. 705, 712, 715, 109 S.Ct.
1443, 103 L.Ed.2d 734 (1989). In other words, in cases in which the
communications are not themselves misleading, "a detailed description of
the underlying scheme and the connection therewith of the mail and/or
wire communications, is sufficient to satisfy Rule 9(b)." In re Sumitomo
Copper Litigation, 995 F. Supp. 451, 456 (S.D.N.Y. 1998).
In this case, plaintiff does not contend that the mail and wire
communications that allegedly formed the RICO predicate acts contained
false or misleading information. Rather, plaintiff claims that the mails
and wires were used in furtherance of the scheme to defraud. Thus, the
ability of plaintiff's mail and wire fraud allegations to withstand this
motion to dismiss depends first on the adequacy of the plaintiff's
pleading of the scheme to defraud.
Plaintiff cites United States v. Trapilo, 130 F.3d 547 (2d Cir. 1997)
in support of his argument that his complaint sufficiently alleges a
scheme to defraud. In that case, our Court of Appeals found that
smuggling came within the meaning of a "scheme to defraud," stating,
"[t]he term `scheme to defraud' is measured by a `"nontechnical
standard. It is a reflection of moral uprightness, of fundamental
honesty, fair play and right dealing in the general [and] business life
of members of society."'" Trapilo, 130 F.3d at 550 n. 3 (citing United
States v. Von Barta, 635 F.2d 999, 1005 n. 12 (2d Cir. 1980)) (other
citations omitted). As the A. Terzi Productions, Inc. court noted,
however, Trapilo merely "under-scor[ed] the accepted notion that a
defendant, by his conduct alone, can intend to deceive another and engage
in a scheme to defraud, even though the defendant's
statements themselves contain no misrepresentations." A. Terzi
Productions, Inc., 2 F. Supp.2d at 501. Thus, while smuggling was an
inherently dishonest and deceptive act, the conduct challenged in A.
Terzi Productions, Inc. — coercing plaintiffs into entering a labor
agreement through threatening and abusive conduct — was not
dishonest or deceptive, and did not constitute a scheme to defraud.*fn4
Id. at 500.
In fact, a scheme to defraud "requires `fraudulent or deceptive means,
such as material misrepresentation or concealment'" A. Terzi
Productions, Inc. v. Theatrical Protective Union, 2 F. Supp.2d 485; 499
(S.D.N.Y. 1998) (quoting Center Cadillac, Inc. v. Bank Leumi Trust Co.,
808 F. Supp. 213, 227 (S.D.N.Y. 1992), aff'd, 99 F.3d 401 (2d Cir. 1995))
(other citations omitted). Here however, plaintiff's complaint contains
no allegations that Conseco employed fraudulent or deceptive means. While
plaintiff alleges that Conseco moved to acquire a controlling interest by
arranging to acquire NALF shares at a discount and attempting to acquire
the remaining interest without paying adequate consideration, no
fraudulent or deceptive actions are alleged with respect to Conseco. In
addition, while plaintiff claims that Conseco caused NALF to file for
bankruptcy on the first day it could contractually do so, this allegation
is also insufficient to support the existence of a scheme to defraud.*fn5
And while plaintiff contends that Conseco's actions were "coercive,"
coercion alone does not constitute a scheme to defraud. See, e.g., A
Terzi Productions, Inc., 2 F. Supp.2d at 500 (allegations of threats and
abusive conduct do not constitute scheme to defraud) (citing Fasulo v.
United States, 272 U.S. 620, 47 S.Ct. 200, 71 L.Ed. 443 (1926)).
In essence, the complaint alleges, at most, that from time to time
Conseco and NALF voluntarily entered into various contractual
agreements. Under those agreements, NALF received large cash infusions
from Conseco, and NALF ultimately granted Conseco the express rights to
obtain ownership of 86% of NALF's shares. The terms of the agreements in
question were disclosed to NALF's shareholders, and Conseco's conduct in
acquiring and converting debentures, in increasing its ownership of NALF
stock and expanding its presence on NALF's Board of Directors were all
acts consistent with the parties' agreements. The agreements expressly
delineated Conseco's right to initiate NALF's reorganization in
bankruptcy and there are no sufficient allegations in the
complaint that Conseco's actions violated the parties' agreements.
However aggressive or self-interested the bargains Conseco struck for
itself might have been, the fact remains that there is "nothing
deceptive. . . . about the exercise of an express contractual right."
Samuels v. Old Kent Bank, No. 96 C 6667, 1997 WL 458434, *9 (N.D.Ill.
Aug.1, 1997). Since plaintiff has failed to properly allege a scheme to
defraud, his RICO allegations against defendant Conseco must be
B. Pattern of Racketeering Activity
Even if plaintiff's mail and wire fraud allegations were sufficient,
plaintiff has failed to properly allege a pattern of racketeering
activity. In order to plead a pattern of racketeering activity, plaintiff
must allege two or more predicate acts by defendant that are sufficiently
related and amount to, or pose a threat of, continued criminal activity.
H.J. Inc. v. Northwestern Bell Telephone Co., 492 U.S. 229, 240, 109
S.Ct. 2893, 106 L.Ed.2d 195 (1989). Showing the threat of continued
criminal activity requires the allegation of either an "open-ended"
(i.e., past criminal conduct with a threat of future criminal conduct) or
"closed-ended" (i.e., past criminal activity extending over a substantial
period of time) pattern of racketeering activity. GICC Capital Corp. v.
Technology Fin. Group, Inc., 67 F.3d 463, 466 (2d Cir. 1995).
With respect to an open-ended pattern of racketeering activity, our
Circuit has noted:
in cases in which the acts of the defendant or the
enterprise were inherently unlawful, such as murder or
obstruction of justice, and were in pursuit of
inherently unlawful goals, such as narcotics
trafficking or embezzlement, the courts generally have
concluded that the requisite threat of continuity was
adequately established by the nature of the activity,
even though the period spanned by the racketeering
acts was short. In contrast, in cases concerning
alleged racketeering activity in furtherance of
endeavors that are not inherently unlawful, such as
frauds in the sale of property, the courts generally
have found no threat of continuing criminal activity
arising from conduct that extended over even longer
United States v. Aulicino, 44 F.3d 1102, 1111 (2d Cir. 1995). In this
case, plaintiff challenges the manner in which Conseco acquired another
company, an endeavor that is not inherently unlawful. The predicate acts
that plaintiff alleges are the mailings of proxy statements and the
making of phone calls that were not in themselves false or deceptive. As
Conseco points out, once NALF's bankruptcy petition is confirmed,
Conseco's alleged scheme to gain control of NALF at the expense of its
public shareholders will end. As such, the allegations in the complaint
carry with them no threat of continued or future criminal activity. While
plaintiff suggests that the manner in which Conseco acquired NALF is the
regular way that Conseco conducts its ongoing business in the sub-prime
auto lending industry, plaintiff does not allege that Conseco's
acquisition of other companies came as a result of any illegal, much less
racketeering activity. As such, plaintiff's speculative allegations
regarding Conseco's other acquisitions do not give rise to a threat of
future criminal activity. Accordingly, plaintiff's complaint fails to
allege an open-ended pattern of racketeering activity.
Whether a closed-ended pattern of racketeering activity exists depends
on analysis of a number of non-dispositive factors, including the length
of time over which the alleged predicate acts took place, the number and
variety of acts, the number of participants, the number of victims, and
the presence of separate schemes. GICC Capital Corp., 67 F.3d at 467. Our
Circuit has been sparing in finding closed-ended continuity. See id.
(noting that since H.J. Inc., the Second Circuit had found closed-ended
continuity only twice). Here, plaintiff alleges that Conseco's
racketeering conduct began May 2,
1996, with the mailing of a proxy statement to NALF shareholders, and
continued until March 23, 1998, with the filing of the Chapter 11
petition. That period of almost twenty..three months, plaintiff claims, is
sufficient to support a finding of closed-ended continuity. See
Metromedia v. Fugazy, 983 F.2d 350, 369 (2d Cir. 1992) (finding two year
period sufficient to support closed-ended continuity, stating, "Periods of
19 or 20 months . . . have been held sufficient to support a finding of
continuity"). While, when taken in isolation, the time period of the
alleged racketeering conduct may support a finding of closed-ended
continuity, such a finding is not automatic in light of the other factors
to be considered. See Feirstein v. Nanbar Realty Corp., 963 F. Supp. 254,
260 (S.D.N Y 1997) (finding plaintiffs' allegations insufficient for
closed-ended continuity although acts occurred over a three-year
Plaintiff's RICO claim alleges a scheme to defraud by a single
defendant, Conseco, with the goal of seizing control of NALF at the
expense of a single class of victims — NALF's public shareholders.
While plaintiff's complaint alleges a number of predicate mail and wire
fraud acts in furtherance of this scheme, these acts are in themselves
innocuous and are not alleged to be false or misleading in any way. These
acts, though allegedly undertaken over a period of 23 months, are
insufficient to state a closed-ended pattern of racketeering activity. As
the court in Pier Connection, Inc. v. Lakhani, 907 F. Supp. 72 (S.D.N Y
1995) stated, in language equally applicable here,
the Complaint demonstrates that Defendants engaged in
one scheme whose single goal was to seize control of
Pier Connection's business. That Defendants used
several different tactics to achieve this goal does
not turn Defendants' scheme into one with multiple
goals and/or victims, and does not mandate a finding
of continuity sufficient to support a RICO claim.
Id. at 78. Likewise, in this case, plaintiff alleges that Conseco was
engaged in one scheme, with the single goal of seizing control of NALF as
cheaply as possible. Despite plaintiff's claims that the predicate acts
occurred over a period of twentythree months, the fact that Conseco
allegedly used mail and wire communications that in themselves contained
no deceptive or misleading statements to further its single goal does not
mandate a finding of closed-ended continuity. Plaintiff's RICO
allegations are deficient as a consequence of their failure to state a
pattern of racketeering activity.*fn6
An additional deficiency in plaintiff's RICO allegations is his failure
adequately to allege that his injury was both caused in fact, and
proximately caused, by the conduct alleged to constitute the predicate
acts under RICO. Holmes v. Securities Investor Protection Corp.,
503 U.S. 258, 268, 112 S.Ct. 1311, 117 L.Ed.2d 532 (1992); Hecht v. Commerce
Clearing House, Inc., 897 F.2d 21, 23 (2d Cir. 1990). Hecht teaches that
an injury is "proximately caused" by a RICO violation if the predicate
acts "are a substantial factor in the sequence of responsible causation,
and if the injury is reasonably foreseeable or anticipated as a natural
consequence." Hecht, 897 F.2d at 23-24.
Two types of potential injuries are alleged in the complaint. The first
is a decline in the NALF share price as a result of defendants' conduct.
The second is the anticipated future loss to all common shareholders
(including plaintiff and Conseco) when, and if, a reorganization plan is
formulated, approved by the creditors, and confirmed by the bankruptcy
court. But this latter injury is simply too speculative to meet the
causation requirements articulated in Holmes and Hecht and cannot,
therefore, constitute RICO injury. See,
e.g., First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 767 (2d
Cir. 1994); Hecht, 897 F.2d at 24; Bankers Trust Co. v. Rhoades,
859 F.2d 1096, 1105-06 (2d Cir. 1988).
With respect to the first type of injury alleged, although the
complaint asserts proximate causation in a conclusory fashion, our Court
of Appeals requires that a plaintiff allege loss causation with enough
particularity to permit a determination whether the factual basis for a
claim, if proven, could support an inference of proximate cause. First
Nationwide Bank, 27 F.3d at 770. Here, plaintiff's RICO claims contain no
facts that, if proven, would establish a nexus between the loss in share
price alleged and Conseco's conduct. Even on plaintiff's version of
events, NALF's share price dropped because of a fundamental deterioration
in NALF's business and the reflection of that fact in its share price.
"When factors other than the defendant's fraud are an intervening direct
cause of plaintiff's injury, the same injury cannot be said to have
occurred by reason of defendant's action." First Nationwide Bank, 27 F.3d
at 769. See also Powers v. British Vita, P.L.C., 57 F.3d 176, 189 (2d
Cir. 1995). Thus, in view of plaintiff's failure to allege properly a
scheme to defraud, a pattern of racketeering activity, or proximate
causation in either his complaint or RICO statement, plaintiff's RICO
claims are dismissed with prejudice, and his motion to amend his
complaint is denied.
II. Count II-Plaintiff's Security Fraud Allegations
Plaintiff also asserts claims' against Sands for the alleged violation
of § 10(b) of the Securities Exchange Act of 1934,
15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder by the
SEC. Section 10(b) prohibits: "any person . . . to use or employ, in
connection with the purchase or sale of any security . . . any
manipulative or deceptive device or contrivance In contravention of [SEC
rules]." 15 U.S.C. § 78j(b); Santa Fe Industries, Inc. v. Green,
430 U.S. 462, 471, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977). Rule 10b-5
It shall be unlawful for any person, directly or
indirectly, by the use of any means or instrumentality
of interstate commerce, or of the mails or of any
facility of any national securities exchange, (a) to
employ any device, scheme, or artifice to defraud, (b)
to make any untrue statement of a material fact
necessary in order to make the statements made, in
light of the circumstances under which they were
made, not misleading, or (c) to engage in any act,
practice or course of business which operates or would
operate as a fraud or deceit upon any person, in
connection with the purchase or sale of any security.
17 C.F.R. § 240.10b-5.