The extraterritorial defense: a border to RICO claims arising from international transactions.

• Author: Hargrove, Lorrie L.

WHILE the Racketeer Influenced and Corrupt Organizations Act ("RICO") (1) has its roots in the fight against organized crime, (2) plaintiffs' attorneys, seeking RICO's treble damages and award of attorneys' fees, (3) have long sought to fit the RICO square peg into the round holes of basic fraud and business disputes. International business transactions, in particular, are often vulnerable to RICO claims.

Every RICO claim requires: (1) "racketeering activity" that is (2) conducted through an "enterprise." (4) A RICO "enterprise" is the "vehicle through which the unlawful pattern of racketeering activity is committed." (5) "Racketeering activity" consists of any of the criminal offenses, commonly referred to as "predicate acts," identified in 18 U.S.C. [section] 1961(1). (6) Mail and wire fraud are the most commonly pled predicate acts. (7)

Prior to 2010, federal courts applied varying approaches to resolve the issue whether RICO should apply to a case involving racketeering activity occurring outside of the United States, or involving enterprises, plaintiffs and/or defendants located outside the United States. The RICO statute is silent as to its extraterritorial application.

In 2010, the Supreme Court addressed the issue of whether section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") had extraterritorial application. (8) In concluding it did not, the Supreme Court reiterated the "longstanding principle of American law that ... unless there is the affirmative intention of Congress clearly expressed to give a statute extraterritorial effect, we must presume it is primarily concerned with domestic conditions." (9) Because the Exchange Act is silent as to extraterritorial application, the Court concluded unequivocally: "When a statute gives no clear indication of an extraterritorial application, it has none." (10)

Since Morrison, federal courts have overwhelmingly concluded that because RICO is silent as to its extraterritorial application, it has none. With federal courts consistently concluding that RICO does not apply extraterritorially, the battle lines are drawn at the outset: whether the complaint in question alleges an extraterritorial RICO claim. Predictably, counsel for RICO plaintiffs argue there are no extraterritorial facts, while RICO defendants seek to peel back and expose the extraterritorial elements of the RICO claim. This current battleground is highly relevant to international cross-border business transactions. Courts post-Morrison are all over the board in making this fact-based determination.

The extraterritorial defense can be a powerful weapon for defendants in combatting a RICO claim, which, because of its stigma and potency, has itself been described as the "thermonuclear option" for plaintiffs. (11) This article examines: (1) the pre-Morrison jurisprudence regarding the extraterritorial application of RICO; (2) the Morrison decision; (3) post-Morrison decisions regarding the extraterritorial application of RICO; and (4) an ensuing set of questions to consider when making an effective motion to dismiss a RICO claim based on the extraterritorial defense.

1. Pre-Morrison Jurisprudence Regarding the Extraterritorial Application of RICO

   Pre-Morrison, some courts had held that RICO could not be applied extraterritorially at all, given Congress's silence on the subject. (12) Most federal courts, however, applied variations of the "conduct" test (focusing on whether certain conduct occurred in the United States) and/or the "effects" test (focusing on whether the effects of certain conduct were felt in the United States). (13) The "conduct" and "effects" tests generally were borrowed in the RICO context from tests applied in cases involving the Exchange Act. (14)

   There was some variation among the federal courts in the way in which the "conduct" and "effects" tests were applied. The Ninth Circuit blended the two tests and concluded more generally that provided plaintiffs alleged that defendants were engaged in substantial fraudulent activity in the United States that affected United States citizens and commerce, there was no impermissible extraterritorial application of RICO. (15)

   The Second Circuit affirmed a district court's use of the conducts test only, (16) applying a conducts test more stringent than that applied in other circuits by requiring that the domestic conduct alleged be material to the completion of the fraud and a direct cause of the alleged injury. (17)

   The Eleventh Circuit broadened the Second Circuit's standard by requiring "conduct material to the completion of the racketeering' in the United States (as opposed to conduct material to the completion of the fraud), or "significant effects of the racketeering" to be felt in the United States, for RICO to apply. (18) Both the Second and the Eleventh Circuits cautioned against the use of the conduct test alone, stating that "preparatory" conduct," or conduct "far removed from the consummation of the fraud," alone would not work, such as use of American mail or wires to prepare for or cover up a fraud scheme perpetrated by foreigners against other foreigners." (19)

   The District of Columbia Circuit tweaked its own effects test and required that the conduct have substantial, direct, and foreseeable effect within the United States for RICO to be applicable. (20)

2. The Morrison Decision

   The Supreme Court decided Morrison on June 24, 2010. Morrison did not involve RICO, but rather involved a 10b-5 securities claim made by Australian investors in an Australian bank whose stock was not traded on any exchange in the United States. The Supreme Court in Morrison first had to determine whether Section 10b-5 applied extraterritorially. The Supreme Court stated: "It is a longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States." (21) It then held: "When a statute gives no clear indication of an extraterritorial application, it has none." (22)

   In reaching this conclusion, the Supreme Court examined the circuit courts' jurisprudence on the issue, noting that the Second Circuit had developed two tests for determining whether 10b-5 could be applied extraterritorially in a case: (1) the "effects" test--whether the wrongful conduct had a substantial effect in the United States or on United States citizens; or (2) the "conduct" test--whether the wrongful conduct occurred in the United States. (23) The Supreme Court noted the difficulty in administering the two tests, the Second Circuit's ultimate mixing of the two tests, the actions of other circuits in producing a "proliferation of vaguely relating variations on the [Second Circuit's] 'conduct' and 'effects' tests," and criticism by commentators of the tests based on their unpredictable and inconsistent application. (24) For these reasons, it rejected the "conduct" and "effects" tests. (25) The Supreme Court then simply concluded that because there is no affirmation indication in the Exchange Act that it be applied extraterritorially, the Exchange Act does not. (26)

   The investor plaintiffs in Morrison then argued that they were not seeking its extraterritorial application because the Australian bank had purchased a bank headquartered in Florida, and it was the fraudulent activity of the Florida bank and its executives that gave rise to the 10b-5 claims. (27) This led to the second question answered by the Supreme Court in Morrison and also relevant in the RICO context: when does a complaint seek to apply 1 Ob-5 extraterritorially? The Supreme Court answered this second issue by determining the focus of the Exchange Act: the focus of Exchange Act is not upon the place where the deception originated, but upon purchases and sales of securities in the United States." (28) Thus, the Supreme Court concluded that 10b-5 claims apply only to transactions in securities listed on domestic exchanges or domestic transactions in other securities. (29)

3. The Post-Morrison Landscape: How is it Determined Whether a Complaint States an Extraterritorial RICO Claim?

   Federal courts have unequivocally agreed, post -Morrison, that because RICO is silent as to its extraterritorial application, it cannot be applied extraterritorially. (30) A defendant facing a complaint with a foreign plaintiff, some extraterritorial defendants, some extraterritorial conduct, or even arguably, an extraterritorial enterprise, should examine closely whether it has grounds for a motion to dismiss based on the plaintiff seeking an impermissible application of RICO extraterritorially. The post-Morrison battleground is whether the actual facts in the complaint allege an...