May 22, 2019
from the United States District Court for the Northern
District of Illinois, Eastern Division. No. l:15-cv-3403 -
John Robert Blakey, Judge.
Hamilton, Scudder, and St. Eve, Circuit Judges.
Scudder, Circuit Judge.
executive Steven Menzies sold over $64 million in his
company's stock but did not report any capital gains on
his 2006 federal income tax return. He alleges that his
underpayment of capital gains taxes (and the related
penalties and interest subsequently imposed by the Internal
Revenue Service) was because of a fraudulent tax shelter
peddled to him and others by a lawyer, law firm, and two
financial services firms. Menzies advanced this contention in
claims he brought under the Racketeer Influenced and Corrupt
Organizations Act or RICO and Illinois law. The district
court dismissed all claims.
RICO claim falls short on the statute's
partern-of-racketeering element. Courts have labored mightily
to articulate what the pattern element requires, and
Menzies's claim presents a close question. In the end, we
believe Menzies failed to plead not only the particulars of
how the defendants marketed the same or a similar tax shelter
to other taxpayers, but also facts to support a finding that
the alleged racketeering activity would continue. To conclude
otherwise would allow an ordinary (albeit grave) claim of
fraud to advance in the name of RICO-an outcome we have time
and again cautioned should not occur. In so holding, we in no
way question whether a fraudulent tax shelter scheme can
violate RICO. The shortcoming here is one of pleading alone,
and it occurred after the district court authorized discovery
to allow Menzies to develop his claims.
Menzies's state law claims, we hold that an Illinois
statute bars as untimely the claims advanced against the
lawyer and law firm defendants. The claims against the two
remaining financial services defendants can proceed, however.
affirm in part, reverse in part, and remand.
original and amended complaints supply the operative facts on
a motion to dismiss. On appeal we treat all allegations as
true, viewing them in the light most favorable to Steven
Menzies. See Moranski v. Gen. Motors Corp., 433 F.3d
537, 539 (7th Cir. 2005).
is the co-founder and president of an insurance company
called Applied Underwriters, Inc. or AUI. In 2002 advisers
from Northern Trust approached him to begin a financial
planning relationship. In time these advisers pitched Menzies
and his colleague and AUI co-founder Sydney Ferenc on a tax
planning strategy (dubbed the Euram Oak Strategy) to shield
capital gains on major stock sales from federal tax
liability. Not knowing the strategy reflected what the IRS
would later deem an abusive tax shelter, Menzies agreed to go
along with the scheme. He conducted a series of transactions
that, through the substitution of various assets and the
operation of multiple trusts, created an artificial tax loss
used to offset the capital gains he realized upon later
selling his AUI stock.
Trust worked with others in marketing and implementing the
strategy. Christiana Bank, for example, served as trustee for
some of Menzies's trusts while tax attorney Graham Taylor
and his law firm, Seyfarth Shaw, provided legal advice.
Taylor repeatedly assured Menzies and Ferenc of the tax
shelter's legality, eventually opining that there was a
"greater than 50 percent likelihood that the tax
treatment described will be upheld if challenged by the
IRS." Taylor stood by his more-likely-than-not opinion
even after being indicted in 2005 for the commission of
unrelated tax fraud-a development he never disclosed to
Menzies sold his AUI stock to Berkshire Hathaway for over $64
million. Nowhere in his 2006 federal income tax return did
Menzies report the sale or any related capital gains. Nor did
Christiana Bank, which filed tax returns on behalf of
Menzies's trusts, report any taxable income from the
stock sale. When the IRS learned of these developments, it
commenced what became a three-year audit and found that the
primary purpose of the Euram Oak Strategy was tax evasion.
Facing large fines and potential adverse legal action,
Menzies agreed in October 2013 to settle with the IRS, paying
over $10 million in back taxes, penalties, and interest.
April 2015 Menzies filed suit in the Northern District of
Illinois, advancing a civil RICO claim and various Illinois
law claims against Taylor, Seyfarth Shaw, Northern Trust, and
Christiana Bank. The district court granted the
defendants' motion to dismiss, but from there twice
allowed Menzies to amend his complaint. Indeed, the district
court afforded Menzies a full year of discovery to develop
facts to support renewed pleading of the RICO claim that
appeared in his second amended complaint in August 2017. On
the defendants' motion, the district court dismissed that
complaint for failure to state any claim. Menzies now
The RICO Bar for Actionable Securities Fraud
addressing the district court's dismissal of
Menzies's RICO claim, we confront a threshold issue
pressed by the defendants-whether an amendment to the RICO
statute added by the Private Securities Litigation Reform Act
of 1995 or PSLRA precluded Menzies from bringing a RICO claim
in the first instance. We agree with the district court that
the bar now embodied in 18 U.S.C. § 1964(c) did not
prevent Menzies from pursuing a RICO claim on the facts
alleged in his complaint.
enacting the PSLRA, Congress did more than seek to curb
abusive practices in securities class actions by, for
example, imposing a heightened pleading standard, requiring a
class representative to be the most adequate plaintiff, and
limiting damages. See Amgen Inc. v. Connecticut Ret.
Plans & Trust Funds, 568 U.S. 455, 475-76 (2013)
(describing the PSLRA). The enactment also amended RICO to
prohibit a cause of action based on "any conduct that
would have been actionable as fraud in the purchase or
sale of securities." 18 U.S.C. § 1964(c)
reviewing the allegations in Menzies's original
complaint, the district court denied the defendants'
motion to dismiss the RICO claim based on the bar in §
1964(c). The district court started with the observation that
"nothing about the sale of his AUI stock itself was
fraudulent." Menzies v. Seyforth Shaw LLP, 197
F.Supp.3d 1076, 1116 (N.D. 111. 2016) ("Menzies
I"). "By selling Plaintiff a bogus tax shelter
plan," the court reasoned, "[d]efendants were
attempting to hide the resulting income from Plaintiff's
sale of stock from the IRS," and "[i]n both form
and substance" this was a "case about tax shelter
fraud, not securities fraud." Id.
defendants urge us to reverse, contending that the RICO bar
applies because the whole point of the Euram Oak Strategy was
for Menzies to avoid realizing taxable gains from a stock
sale. But for the stock sale, the tax shelter meant nothing,
thereby easily satisfying, as the defendants see it, the
requirement for the alleged fraud to be "in connection
with" the sale of a security and thus actionable as
securities fraud under section 10(b) of the Securities and
Exchange Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule
10b-5, 17 C.F.R. § 240.10b-5.
the analysis as more difficult. By its terms, the bar in
§ 1964(c), as the district court recognized, requires
asking whether the fraud Menzies alleged in his complaint
would be actionable under the securities laws, in particular
under section 10(b) and Rule 10b-5. See Rezner v.
Bayerische Hypo-Und VereinsbankAG, 630 F.3d 866, 871
(9th Cir. 2010) (assessing the PSLRA bar and explaining that
"[a]ctions for fraud in the purchase or sale of
securities are controlled by section 10(b) of the Securities
Exchange Act of 1934"); Bixler v. Foster, 596
F.3d 751, 759-60 (10th Cir. 2010) (adopting a similar
approach); Affco Investments 2001, LLC v. Proskauer Rose,
LLP, 625 F.3d 185, 189-90 (5th Cir. 2010) (same).
sought to plead a securities fraud claim under those
provisions, Menzies would have had to allege a material
misrepresentation or omission by a defendant, scienter, a
connection between the misrepresentation or omission and the
purchase or sale of a security, reliance, economic loss, and
loss causation. See Glickenhaus & Co. v. Household
Int'L, Inc., 787 F.3d 408, 414 (7th Cir. 2015)
(citing Halliburton Co. v. Erica P. John Fund, Inc.,
573 U.S. 258, 267 (2014)). The district court got it right in
concluding that the allegations in Menzies's original
complaint did not amount to actionable securities fraud under
Supreme Court supplied substantial direction in SEC v.
Zandford, 535 U.S. 813 (2002). The SEC brought a civil
securities fraud action against a stockbroker who sold his
elderly and disabled clients' securities and pocketed the
proceeds. See id. at 815. The Court granted review
to determine whether the stockbroker's theft, which the
SEC alleged also constituted securities fraud, was
sufficiently "in connection with" the sale of the
clients' securities to fall within section 10(b) and
Rule10b-5. The Court answered yes, explaining that both
provisions "should be construed 'not technically and
restrictively, but flexibly to effectuate its remedial
purposes.'" Id. at 819 (quoting
Affiliated Ute Citizens of Utah v. United States,
406 U.S. 128, 151 (1972)). As a practical pleading matter,
the Court continued, that meant a plaintiff need not allege
any misrepresentation or omission about a security's
value. Nor was it necessary to allege misappropriation or,
even more generally, another form of manipulation of a
security. What would be enough, the Court held, are
allegations where "the scheme to defraud and the sale of
securities coincide." Id. at 822.
SEC's allegations met this standard because the
stockbroker defendant, alongside affirmatively
misrepresenting how he intended to manage his clients'
investments-he "secretly intend[ed] from the very
beginning to keep the proceeds"-acted on that intent by
engaging in unauthorized securities sales. Id. at
824. This misconduct "deprived [his clients] of any
compensation for the sale of their valuable securities."
Id. at 822. The "securities transactions and
breaches of fiduciary duty coincide[d]," the Court
explained, because the "[clients'] securities did
not have value for the [stockbroker] apart from their use in
a securities transaction and the fraud was not complete
before the sale of securities occurred." Id. at
824-25. Put another way, the SEC's allegations left no
daylight between the alleged fraud and the securities sale.
by these Zandford standards, Menzies's
allegations do not satisfy the "in connection with"
requirement for an actionable claim under section 10(b) or
Rule 10b-5. Start with the alleged fraud itself.
Menzies's complaint focused not on the AUI stock sale,
but instead on its tax consequences. He alleged that the
defendants marketed a tax shelter that they knew was
abusive-that would conceal capital gains from the U.S.
Treasury-and caused him to incur not just unexpected taxes
and related interest and penalties but also substantial
professional fees. Yes, this may be enough to show that but
for following the defendants' advice and selling his AUI
stock he would not have incurred the taxes and related
interest and penalties. Yet we know that such "but
for" allegations do not satisfy section 10(b) under the
teachings of Zandford. See Ray v. Citigroup
Global Mkts., Inc., 482 F.3d 991, 995 (7th Cir. 2007)
(explaining that "[i]t is not sufficient [under section
10(b) and Rule 10b-5] for an investor to allege only that it
would not have invested but for the fraud" and instead
the investor must go further and "allege that, but for
the circumstances that the fraud concealed, the investment
... would not have lost its value") (quoting
Caremark, Inc. v. Coram Healthcare Corp., 113 F.3d
645, 648-49 (7th Cir. 1997)).
Menzies had tried to bring a securities fraud claim, he would
have had to close this pleading gap. His complaint would have
had to tether more directly the fraud to the stock sale by
including allegations that went beyond any "but
for" link and allowed a finding that the defendants'
misrepresentations more closely coincided with Menzies's
sale of his AUI stock. Menzies, in short, would have needed
to plead facts demonstrating that he incurred his alleged
losses as a more direct consequence of misrepresentations
that closely touched the stock sale itself and not just its
tax consequences. That the purpose of the tax shelter aimed
to maximize the profits that Menzies realized from his stock
sale cannot itself bridge this gap. See Ouwinga v.
Benistar 419 Plan Servs., Inc., 694 F.3d 783, 791 (6th
Cir. 2012) (affirming a district court's conclusion that
the RICO bar did not apply because the plaintiffs'
"fraud claim relates only to the tax consequences of the
Benistar Plan, and it is merely incidental that the
[insurance] policies happen to be securities");
Rezner, 630 F.3d at 872 (concluding the RICO bar did
not apply where, in a tax shelter fraud, "the securities
were merely a happenstance cog in the scheme").
come at the analysis another way. No aspect of the complaint
challenged any term or condition on which Menzies sold his
AUI shares to Berkshire Hathaway. The complaint all but says
every aspect of the stock sale itself was entirely lawful.
Even more generally, no portion of the complaint alleged that
any defendant engaged in an irregularity that tainted or
affected the stock-sale transaction, including, for example,
by influencing the sales price or somehow causing the
proceeds to be mishandled. Every indication is that Menzies
received every last dollar he expected from the sale. The
fraud Menzies alleged is at least one step removed-focused
not on the sale of the AUI stock but on how and why he
charted a particular course in his treatment of the sale for
federal tax purposes and the losses he sustained by doing so.
read us to say that Menzies failed to allege fraud. He
plainly did when considered through the prism of common law
standards. What we cannot say, though, is that-for purposes
of applying the RICO bar in § 1964(c)-Menzies's
allegations amounted to actionable securities fraud under the
standards the Supreme Court has told us are required by
section 10(b) and Rule 10b-5.
not aligning with the defendants' view of the law, our
holding does seem on all fours with what we see and do not
see in the securities fraud case law. Our research, limited
though it is to reported decisions, reveals no meaningful
number of section 10(b) and Rule 10b-5 private federal
securities fraud claims brought to challenge abusive tax
shelters. Nor do we see an indication that the SEC has
brought many enforcement proceedings alleging securities
fraud to combat abusive tax shelters. None of this suggests
that fraud perpetrated as part of a scheme to evade taxes can
never be actionable under section 10(b). Our point is limited
only to the observation that the federal reporters do not
contain many examples of such actions, whether by private
parties or the SEC. And perhaps that reality owes itself, at
least in part, to the demanding requirements for pleading a
federal securities law claim.
to conclude that Menzies's allegations of fraud would be
actionable under section 10(b) or Rule 10b-5, we turn, as did
the district court, to his civil RICO claim.
Civil RICO Claims and the Pattern Element
in response to long-term criminal activity, including, of
course, acts of organized crime, RICO provides a civil cause
of action for private plaintiffs and authorizes substantial
remedies, including the availability of treble damages and
attorneys' fees. See 18 U.S.C. § 1964(c).
Establishing a RICO violation requires proof by a
preponderance of the evidence of "(1) conduct (2) of an
enterprise (3) through a pattern (4) of racketeering
activity." Sedima, S.P.R.L. v. Imrex Co., 473
U.S. 479, 496-97 (1985) (interpreting § 1964(c)). It
follows that a plaintiff must plead these elements to state a
claim. Congress defined a "pattern of racketeering
activity" to require "at least two acts of
racketeering activity" within a ten-year period. 18
U.S.C. § 1961(5).
the pattern element is no easy feat and its precise
requirements have bedeviled courts. See Jennings v. Auto
Meter Prod., Inc., 495 F.3d 466, 472 (7th Cir. 2007)
(emphasizing that "courts carefully scrutinize the
pattern requirement"); J.D. Marshall Int'l, Inc.
v. Redstart, Inc., 935 F.2d 815, 820 (7th Cir. 1991)
("Satisfying the pattern requirements-that there be
continuity and relationship among the predicate acts-is not
easy in practice.").
Supreme Court has considered the issue at least twice, and
our case law shows many efforts to articulate what a
plaintiff must plead to establish a pattern of racketeering
activity. See, e.g., Sedima, 473 U.S. at 496;
H.J., Inc. v. Northwestern Bell Tel. Co., 492 U.S.
229, 237-38 (1989); Vicom, Inc. v. Harbridge Merchant
Servs., Inc., 20 F.3d 771, 779-80 (7th Cir. 1994);
McDonald v. Schencker, 18 F.3d 491, 497 (7th Cir.
1994). Over these many cases the law has landed on a pleading
and proof requirement designed "to forestall RICO's
use against isolated or sporadic criminal activity, and to
prevent RICO from becoming a surrogate for garden-variety
fraud actions properly brought under state law."
Midwest Grinding Co., Inc. v. Spitz, 976 F.2d 1016,
1022 (7th Cir. 1992) (citing H.J., Inc., 492 U.S. at
plead a pattern of racketeering activity, "a plaintiff
must demonstrate a relationship between the predicate acts as
well as a threat of continuing activity" -a standard
known as the "continuity plus relationship" test.
DeGuelle v. Camilli, 664 F.3d 192, 199 (7th Cir.
2011). The Supreme Court announced this test in H.J.,
Inc. and made plain that the relationship prong is
satisfied by acts of criminal conduct close in time and
character, undertaken for similar purposes, or involving the
same or similar victims, participants, or means of
commission. See 492 U.S. at 240. The relatedness of the
predicate acts often does not yield much disagreement, and
much more often the focus is on the continuity prong of the
test. See Vicom, 20 F.3d at 780.
here: the battleground in this appeal is whether Menzies
adequately pleaded the continuity dimension of the
continuity-plus-relationship test. Doing so requires
"(1) demonstrating a closed-ended series of conduct that
existed for such an extended period of time that a threat of
future harm is implicit, or (2) an open-ended series of
conduct that, while short-lived, shows clear signs of
threatening to continue into the future." Roger
Whitmore's Auto Servs., Inc. v. Lake County, III.,
424 F.3d 659, 673 (7th Cir. 2005).
let the labels create confusion. The big picture question is
whether Menzies adequately alleged that the challenged
conduct occurred and went on long enough and with enough of a
relationship with itself to constitute a pattern. Answering
that question is aided by focusing on two, more particular,
inquiries. One of those inquiries-designed to ascertain the
presence of a so-called "closed-ended" series of
misconduct-asks whether there were enough predicate acts over
a finite time to support a conclusion that the criminal
behavior would continue. See Vicom, 20 F.3d at
779-80. The focus, therefore, is on "the number and
variety of predicate acts and the length of time over which
they were committed, the number of victims, the presence of
separate schemes and the occurrence of distinct
injuries." Id. at 780 (quoting Morgan v.
Bank of Waukegan, 804 F.2d 970, 975 (7th Cir. 1986)).
alternative continuity inquiry-applicable to an
"open-ended" series of misconduct-focuses not on
what acts occurred in the past but on whether a concrete
threat remains for the conduct to continue moving forward.
See id. at 782. This can be done by showing that a
defendant's actions pose a specific threat of repetition;
that the predicate acts form part of the defendant's
ongoing and regular way of doing business; or that the
defendant operates a long-term association for criminal
purposes. See Empress Casino Joliet Corp. v. Balmoral
Racing Club, Inc., 831 F.3d 815, 828 (7th Cir. 2016). On
these fronts, it is not enough to base an open-ended
continuity theory on just one prior predicate act and an
otherwise unsupported assertion that criminal activity will
continue into the future. See Gamboa v. Velez, 457
F.3d 703, 709 (7th Cir. 2006) (explaining that when "a
complaint explicitly presents a distinct and non-recurring
scheme with a built-in termination point and provides no
indication that the perpetrators have engaged or will engage
in similar misconduct, the complaint does not sufficiently
complexity enters where, as here, a plaintiff seeks to plead
RICO's pattern element through predicate acts of mail or
wire fraud. When that occurs the heightened pleading
requirements of Fed.R.Civ.P. 9(b) apply and require a
plaintiff to do more than allege fraud generally. See
Jepson v. Makita Corp., 34 F.3d 1321, 1327 (7th Cir.
1994) ("Of course, Rule 9(b) applies to allegations of
mail and wire fraud and by extension to RICO claims that rest
on predicate acts of mail and wire fraud."). Rule 9(b)
requires a plaintiff to provide "precision and some
measure of substantiation" to each fraud allegation.
United States ex rel. Presser v. Acacia Mental Health
Clinic, LLC, 836 F.3d 770, 776 (7th Cir. 2016). Put more
simply, a plaintiff must plead the "who, what, when,
where, and how" of the alleged fraud. Vanzant v.
Hill's Pet Nutrition, Inc., 934 F.3d 730, 738 (7th
these heightened pleading standards and Congress's
insistence that a RICO claim entail a clear pattern of
racketeering activity, we have cautioned that "we do not
look favorably on many instances of mail and wire fraud to
form a pattern." Midwest Grinding, 976 F.2d at
1024-25 (quoting Hariz v. Friedman, 919 F.2d 469,
473 (7th Cir. 1990)); see also Jennings, 495 F.3d at
475 (explaining that this court "repeatedly reject[s]
RICO claims that rely so heavily on mail and wire fraud
allegations to establish a pattern"). We can leave for
another day a more fulsome articulation of the
interrelationship of RICO's pattern requirement and mail
and wire fraud as predicate acts. Our focus here is whether
Menzies, within the four corners of his complaint, alleged
with sufficient particularity the acts of mail and wire fraud
he believes demonstrate a pattern of racketeering activity.
Menzies's Allegations of Racketeering Activity
second amended complaint, Menzies detailed chapter and verse
the fraud the defendants allegedly perpetrated on him. He
told of the defendants approaching and pitching him the tax
benefits of the Euram Oak Strategy. Reassured multiple times
of the shelter's legality, Menzies relied on the
defendants' representations, executed the strategy's
component steps through transactions with trusts and the
like, and ultimately sold his AUI stock for over $64 million
to Berkshire Hathaway. Again relying on the defendants'
assurances, he then filed his 2006 tax return without
reporting his AUI stock sale as a taxable event.
sought to plead RICO's pattern element by including
allegations that the defendants marketed the identical or a
substantially-similar tax shelter to three others-his
business partner and co-founder of AUI, Sydney Ferenc, and
two other investors, one in North Carolina and another in
alleged that Northern Trust contacted him and Ferenc at the
same time to develop a financial advisory relationship. See
SAC ¶¶ 25, 42, and 43. The complaint provides
substantial detail on the defendants' interactions with
Ferenc, including the dates and content of phone calls,
emails, and meetings geared toward selling and advancing the
scheme. See SAC ¶¶ 58, 62, 63, 76, 81, 86, 88, and
115. By way of example, consider these two factual
allegations detailing the timing and substance of
Ferenc's interactions with attorney Graham Taylor:
• "On September 30, 2003, Taylor provided Ferenc
with an outline of the pre-arranged steps of the Euram Oak
Strategy via email, assuring Ferenc that the strategy was
legitimate tax planning." SAC ¶ 81.
• "On or about August 5, 2004, August 11, 2004 and
August 18, 2004, Taylor sent Ferenc a revised version of the
tax opinion letter via e-mail assuring Ferenc (and Menzies)
that the Euram Oak Strategy was legitimate tax
planning." SAC ¶ 115.
there Menzies alleged that Ferenc ultimately "entered
into a transaction substantially similar" to the one
undertaken by Menzies, including by receiving a loan from
Euram Bank, establishing a grantor trust, and maneuvering
various assets in anticipation of a major stock sale-all in
accordance with the instructions supplied by Taylor and
others. SAC ¶ 91.
the complaint clearly alleges the defendants marketed the
same fraudulent tax shelter to Ferenc, Menzies stopped short
of alleging whether Ferenc followed through with his sale of
AUI stock and incurred substantial capital gains tax
liability and related penalties and interest as a result of
subsequent IRS scrutiny. The absence of such allegations in
no way meant that Menzies failed to plead a predicate act of
mail and wire fraud involving Ferenc, however. See United
States v. Koen, 982 F.2d 1101, 1106 (7th Cir. 1992)
(explaining that mail fraud under 18 U.S.C. § 1341
requires not actual and successful deception but only
"(1) a scheme to defraud and (2) use of the mail for the
purpose of executing, or attempting to execute, the scheme to
further alleged an Arizona investor fell victim to the
defendants' scheme. The second amended complaint alleged
that the Arizona investor received legal opinions from Taylor
and Seyfarth Shaw regarding the Euram Oak Strategy sometime
in 2004. From there, though, the complaint says little more,
alleging only that it is "reasonable to assume that any
such opinion letter asserts the legality of the [Euram Oak]
Strategy." SAC ¶ 162. On "information and
belief," the complaint then alleges that the Arizona
investor incurred unspecified damages from the tax deficiency
that resulted from the scheme, penalties and interest,
professional and attorneys' fees, and the lost
opportunity to invest in a legitimate tax planning vehicle.
See SAC ¶ 165.
the same way, Menzies included similar allegations of fraud
against a North Carolina investor. According to the
complaint, the defendants approached this investor not with
the Euram Oak Strategy but with a different abusive tax
shelter of the same nature called the Euram Rowan Strategy.
See SAC ¶¶ 166, 167. With the exception of Northern
Trust, the other defendants pushed the Euram Rowan Strategy,
which "involved a series of integrated, pre-arranged,
and scripted steps designed to provide a taxpayer who had
significant ordinary or capital gain with a non-economic
ordinary or capital loss." SAC ¶ 167. Here too,
however, the second amended complaint adds few details. In
2003 the North Carolina investor received legal opinions from
Taylor and Sey-farth Shaw-leaving Menzies to allege that
"it is reasonable to assume that any such opinion letter
asserted the legality of the transaction." ...