Reves v. Ernst & Young
507 U.S. 170 (1993)
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Rule of Law:
To be liable for conducting or participating in an enterprise's affairs under the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. § 1962(c), a person must participate in the operation or management of the enterprise itself, not merely provide professional services to it.
Facts:
- The Farmer’s Cooperative of Arkansas and Oklahoma, Inc. (Co-Op) sold promissory demand notes to its members to raise operating capital.
- Jack White, the Co-Op's general manager, began taking loans from the Co-Op to finance his separate company, White Flame Fuels, Inc.
- After White was indicted for tax fraud, he arranged for the Co-Op to acquire White Flame in a deal that relieved him of approximately $4 million in debt to the Co-Op.
- The Co-Op retained the accounting firm Arthur Young (later Ernst & Young) to perform its financial audits for 1981 and 1982.
- Arthur Young's auditors determined that the Co-Op had owned White Flame from its inception, which allowed them to value a gasohol plant at its high construction cost (around $4.5 million) rather than its much lower fair market value (under $1.5 million).
- This inflated valuation made the Co-Op appear solvent on its financial statements when it was, in fact, insolvent.
- At annual meetings, an Arthur Young partner presented condensed financial statements to the Co-Op members that included the inflated asset value but omitted crucial notes from the full audit that questioned the investment's recoverability and detailed significant losses.
- In 1984, the Co-Op filed for bankruptcy, rendering the members' demand notes worthless.
Procedural Posture:
- A class of noteholders (petitioners) sued Arthur Young (respondent) in the U.S. District Court for the Western District of Arkansas for violations of federal and state securities laws and RICO.
- The District Court granted summary judgment for Arthur Young on the RICO claim, finding its activities did not satisfy the 'operation or management' test required by the Eighth Circuit.
- A jury found Arthur Young liable on the securities fraud claims.
- The U.S. Court of Appeals for the Eighth Circuit reversed the jury verdict, holding that the demand notes were not securities.
- The U.S. Supreme Court granted certiorari, reversed the Eighth Circuit's decision, and held that the notes were securities.
- On remand, the Eighth Circuit affirmed the District Court's summary judgment ruling in favor of Arthur Young on the RICO claim.
- The U.S. Supreme Court granted certiorari to resolve a conflict among the Courts of Appeals regarding the standard for liability under § 1962(c).
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Issue:
Does a person have to participate in the operation or management of an enterprise to be liable for 'conduct[ing] or participat[ing], directly or indirectly, in the conduct of such enterprise's affairs' under the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. § 1962(c)?
Opinions:
Majority - Justice Blackmun
Yes. A person must participate in the operation or management of the enterprise itself to be liable under § 1962(c). The Court reasoned that the statutory word 'conduct,' used as both a verb and a noun, implies an element of direction, leadership, or management. To 'participate... in the conduct' of an enterprise's affairs therefore means to have some part in directing those affairs. This 'operation or management' test is supported by RICO's legislative history, which consistently described § 1962(c) as prohibiting the 'operation' of an enterprise through racketeering. The Court clarified that liability is not limited to upper management but extends to lower-rung participants acting under management's direction and even to outsiders who exert control over the enterprise. Here, Arthur Young's actions of preparing fraudulent audit reports and presenting misleading financial statements, while improper, constituted the provision of professional services, not participation in the operation or management of the Co-Op's affairs.
Dissenting - Justice Souter
No. The term 'conduct' does not clearly mandate an 'operation or management' limitation, and RICO’s liberal construction clause requires a broader interpretation. The dissent argued that 'conduct' can mean 'carrying out' without any element of direction, and the statute's broad language covering indirect participation by those merely 'associated with' an enterprise supports this more inclusive reading. Even if the majority's 'operation or management' test were correct, Arthur Young's actions met that standard. The evidence showed Arthur Young went beyond traditional auditing by 'inventing' a value for the Co-Op's main asset and creating the 'blatant fiction' of when the Co-op acquired it. By making these key decisions that were properly management's responsibility, Arthur Young stepped into a managerial role and participated in the operation of the Co-Op.
Analysis:
This decision significantly narrowed the scope of civil liability under RICO § 1962(c) by establishing the 'operation or management' test. It resolved a circuit split and created a higher threshold for holding 'outsiders,' such as accountants, lawyers, and other professionals, liable under the statute. The ruling protects such professionals from RICO liability when they are providing traditional services, even if those services aid a corrupt enterprise, unless their actions cross the line into actual direction or control of the enterprise's affairs. This makes it more difficult for plaintiffs to sue collateral participants in a fraudulent scheme under this powerful provision of federal law.
