RICO: Freeze-Out Merger Does Not Constitute Fraud in the Sale of Securities within PSLRA Bar — Shareholder Cannot Show Proximate Cause If Injury Is Derivative of Harm to Corporation

Amos v. Franklin Fin’l Servs. Corp., 2011 WL 5903875 (M.D. Pa. November 22, 2011), aff’d, 2013 U.S. App. LEXIS 868 (3d Cir. Jan. 11, 2013) (the following is from the Court of Appeals’ affirmance):

Matthew P. Amos and twenty four other plaintiffs have appealed the district court's order dismissing their first amended complaint for failure to adequately plead a civil action under the Racketeer Influenced and Corrupt Organizations Act ("RICO"). They allege violations of 18 U.S.C. §§ 1962(b), (c) and (d), based on predicate acts of mail and wire fraud, 18 U.S.C. §§ 1341 and 1343, respectively. For the reasons that follow, we will affirm. ***

Amos and the other twenty-four plaintiffs (hereinafter "Amos") are former shareholders in Community Financial, Inc. ("CFI"). Franklin Financial Services Corporation acquired CFI in a merger whereby CFI ceased to exist and its shareholders and third parties were paid cash for their shares. Amos filed an action against Franklin Financial and seven individual defendants, viz., Lowell R. Gates, William T. Habacivch, Nicholas J. Dunphy, Charles J. Henry, Andrew J. Kohr, Susan Russell and Linda Gates (hereinafter "Lowell Gates"), most of whom were shareholders and officers of CFI, alleging that in the years leading up to the merger, Lowell Gates operated CFI in a manner that diluted the value of Amos' shares upon the merger relative to the value of Lowell Gates' shares. Amos alleges that to accomplish this goal, Lowell Gates devised a fraudulent scheme and engaged in fraudulent conduct directed at Amos and other non-defendant shareholders.

As we noted at the outset, Amos asserted claims under civil RICO, alleging violations of 18 U.S.C. §§ 1962(b), (c), and (d) where the predicate acts are alleged to have been mail and wire fraud, 18 U.S.C. §§ 1341 and 1343, respectively. *** The district court eventually dismissed the first amended complaint based on its conclusion that Amos failed to state civil RICO claims because of the statutory exception for fraud claims in the sale of securities found in 18 U.S.C. § 1964(c). Amos v. Franklin Financial Services Corp., 2011 WL 2111991 (M.D. Pa. May 26, 2011).

Thereafter, Amos filed a motion for reconsideration under Fed.R.Civ.P. 59(e), arguing, inter alia, that the district court erred in dismissing the complaint because the transaction in question was a "freeze-out merger" and, therefore, could not constitute securities fraud. After briefing, the district court issued a Memorandum Opinion on November 22, 2011 in which it agreed with Amos. Amos v. Franklin Financial Services Corp., 2011 WL 5903875 (M.D. Pa. November 22, 2011). However, the district court again dismissed the first amended complaint, finding that it failed to satisfy the pleading requirements for a civil RICO action. Id. at *6-15. ***

In its opinion dismissing Amos' first amended complaint, the district court gave a number of reasons why the first amended complaint failed to adequately allege a civil RICO action under 18 U.S.C. §§ 1962(b), (c), or (d). First, it found that Amos failed to show proximate cause because the injury alleged in the first amended complaint is derivative of injury to CFI, not a direct injury to Amos. 2011 WL 5903875 at *6-9. Second, it found that Amos' RICO claims failed because the first amended complaint did not plead a pattern of racketeering activity on the part of both the individual defendants and Franklin Financial. Id. at *9-14. Third, it found that the first amended complaint failed to plead the existence of an association-in-fact enterprise. Id. at 14-15. Fourth, it found that Amos's RICO conspiracy claim failed because the first amended complaint did not adequately allege violations of §§ 1962(b) or (c). ***

In its through and well-reasoned November 22, 2011, opinion, the district court fully and completely explained why the first amended complaint failed to adequately allege a civil RICO action and why dismissal of the first amended complaint was appropriate. We can add nothing to the district court's thoughtful analysis and discussion. Accordingly, we will affirm substantially for the reasons set forth in the district court's November 22, 2011, opinion.

[Private Securities Litigation Reform Act]