By James Hamilton, J.D., LL.M.
A federal judge (ED Pa) ruled that a member of the Philadelphia Stock Exchange could not challenge the demutualization of the exchange under federal racketeering laws. The RICO claims levied against exchange senior executives were derivative or otherwise non-actionable, said the court, and did not confer standing on the member for any of its RICO claims because there was no proximate cause. Here, Judge Brody cited the Supreme Court’s landmark 1992 decision in Holmes v. SIPC, CCH Fed. Sec. L. Rep. ¶96,555, for the proposition that RICO liability attaches only for harm proximately caused by RICO violations. Finding that amending the RICO claims would be futile, the court dismissed the member’s complaint with prejudice. (Penn Mont Securities v. Frucher, ED Pa., No. 05-CV6686, Aug. 15, 2007).
Demutualization is the conversion of a mutual non-profit organization into a for profit corporation, which issues stock. In connection with the plan of demutualization, trading privileges were separated from corporate ownership of the exchange and made available exclusively through trading permits. The SEC approved the demutualization of the exchange on January 16, 2004 in Release No. 34-49098. Exchange demutualizations are generally effected to expand sources of capital and revenue and facilitate the exchange’s ability to enter into relationships with strategic or financial partners.
It is axiomatic that RICO prohibits racketeering activity and entitles a victorious plaintiff to treble damages. Standing under civil RICO is conditioned on suffering an injury to
business or property interest by reason of a violation of section 1962, which contains a list of distinct injuries. The Supreme Court taught in Holmes that the ``by reason of’’ language in the statute means that the RICO violation must have proximately caused the injury to business or property. Indirect or derivative claims do not confer RICO standing.
Here, the exchange member said that it was injured by RICO violations in a number of distinct ways, primarily that shareholders lost seat rent and suffered share dilution through demutualization. The member also alleged that it incurred legal fees on account of investigations by internal regulatory officers of the exchange who targeted the member at the behest of the exchange CEO.
But the court concluded that these alleged injuries were derivative under RICO and failed to confer standing to bring federal racketeering claims against exchange senior officers. For example, the member’s allegation of share dilution absent a controlling shareholder describes a derivative injury to the corporation. Even assuming that dilution resulted from a RICO injury, reasoned the court, the violation would have directly injured the corporation under a proximate cause analysis; and only then have indirectly injured the member. This type of derivative injury is too attenuated to support a RICO claim.
Similarly, the member’s allegation that it incurred legal fees to defend against internal regulatory proceedings brought by the exchange did not save its RICO claim because, although legal fees may constitute direct, actionable injuries under RICO, the member did not allege that these injuries were proximately caused by any predicate act.