Reves v. Ernst & Young

1993-03-03

Headline: Limits on RICO liability: Court rules defendants must take part in operating or managing a business, narrowing when investors can sue outside accountants and others associated with an enterprise.

Holding: In order to be liable under 18 U.S.C. §1962(c), a person must participate in the operation or management of the enterprise itself; mere assistance or routine services are not enough.

Real World Impact:

Narrows when investors can sue outside auditors under civil RICO.
Requires proof of participation in running or managing the enterprise for RICO §1962(c) liability.
Affirms summary judgment for the accounting firm in this case.

Topics: racketeering lawsuits, accountant liability, investor claims, corporate audits

Summary

Background

A group of people who held demand notes from a rural cooperative (noteholders) sued after the cooperative went bankrupt. The cooperative had a gasohol plant tied to large debts. An accounting firm (later Ernst & Young) audited the cooperative’s books, valued the plant at about $4.5 million, and produced condensed financial statements that omitted audit warnings. When the cooperative collapsed, a bankruptcy trustee and noteholders sued the accounting firm under a federal racketeering law (RICO §1962(c)). Lower courts applied a test that required some participation in the enterprise’s operation or management and granted the firm summary judgment.

Reasoning

The Court addressed whether the statute reaches anyone who merely aids wrongdoing or instead reaches only those who take part in directing an enterprise’s affairs. Reading the statute and its history, the Court found that the words “conduct” and “participate” imply some element of direction. The Court adopted an “operation or management” test: to be liable under §1962(c), a person must have some part in operating or managing the enterprise, not merely provide ordinary services. The Court also reviewed legislative history and said the statute should be read to cover operation or management, and that the law’s instruction to construe RICO liberally does not erase that limit. Applying this standard, the Court affirmed judgment for the accounting firm because petitioners did not show the firm took part in running the cooperative.

Real world impact

The decision narrows who can be sued under civil RICO for enterprise wrongdoing. It makes it harder for investors and trustees to hold outside service providers liable unless they helped run or manage the business. Subsections of RICO still address other kinds of infiltration or acquisition, but §1962(c) requires showing participation in management.

Dissents or concurrances

Justice Souter (joined by Justice White) dissented, arguing the statute is broader and that the accounting firm’s creation of the financial statements crossed into management, so he would have allowed the RICO claim to proceed.