286 F. Supp. 3d 634
S.D. Ill.2017Background
- Zohar I, II, III are CLO special-purpose vehicles that raised over $2.5 billion; Patriarch (and Tilton) served as collateral manager and made investment decisions for the funds.
- Zohar alleges a multi-year scheme in which Tilton, Patriarch, Ark, and Octaluna misvalued collateral in monthly/OC Test reports, diverted equity and dividend distributions, and concealed or transferred Zohar’s equity to defendants or their affiliates.
- The SEC brought an administrative enforcement action against Tilton/Patriarch for valuation/categorization misrepresentations; Zohar’s complaint overlaps with but adds allegations about theft/transfer of portfolio-company equity.
- Zohar pleads civil RICO (seeking treble damages) plus 11 state-law/common-law claims (breach of fiduciary duty, conversion, breach of contract, unjust enrichment, declaratory relief, accounting, etc.).
- Defendants moved to dismiss under Fed. R. Civ. P. 12(b)(6) and 12(b)(1), arguing the RICO claim is barred by the PSLRA RICO Amendment (no RICO for conduct actionable as fraud in purchase/sale of securities).
- The district court dismissed Zohar’s civil RICO claim (and declined to retain supplemental jurisdiction over the state-law claims), reasoning that key alleged predicate acts involved securities transactions (portfolio-equity acquisition/diversion) barred by the RICO Amendment.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether RICO claim is barred by PSLRA RICO Amendment | Zohar contends scheme is post-investment looting distinct from securities fraud; RICO permissible | Defendants argue allegations include fraud "in connection with" sales/purchases of securities (CLOs and portfolio equity) so RICO Amendment bars treble damages | Court: RICO claim dismissed — manipulation of OC Test/monthly reports were not "in connection with" sales, but theft/misappropriation of portfolio equity coincided with securities transactions and triggers RICO Amendment bar |
| Whether OC Test/Monthly Report misrepresentations are securities fraud | Zohar: OC Test manipulations were to preserve fees/control, issued to existing noteholders — not tied to purchases | Defendants: Monthly Reports misled investors and paralleled SEC findings; such misrepresentations could affect buy/sell decisions | Court: OC Test / Monthly Report allegations are post-sale, attenuated from purchase/sale of CLOs and thus not barred by RICO Amendment |
| Whether misappropriation/diversion of portfolio-company equity is securities fraud | Zohar: This is post-investment looting and holder-type wrong not covered by securities law | Defendants: Acquiring/diverting equity and dividends was integral to scheme and occurred in connection with securities transactions | Court: Transactions transferring equity and diverting distributions coincided with securities purchases/sales; those predicate acts render civil RICO claim impermissible under the RICO Amendment |
| Whether to exercise supplemental jurisdiction over state-law claims after RICO dismissal | Zohar sought to keep state claims here for efficiency | Defendants urged federal forum; also filed third-party/state suits | Court: Declined supplemental jurisdiction — common-law claims dismissed without prejudice for state adjudication (Delaware particularly appropriate); denied retaining federal jurisdiction on comity/economy/fairness grounds |
Key Cases Cited
- SEC v. Zandford, 535 U.S. 813 (2002) (Section 10(b) must be construed flexibly; fraud that "coincides" with securities transactions can be securities fraud)
- Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006) (fraud must "coincide" with securities transaction; deception need not target an identifiable buyer or seller)
- MLSMK Inv. Co. v. J.P. Morgan Chase & Co., 651 F.3d 268 (2d Cir. 2011) (RICO Amendment bars civil RICO claims alleging securities fraud predicates even if plaintiff cannot bring securities claim)
- Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) (complaint must plead facts making claim plausible)
- Ashcroft v. Iqbal, 556 U.S. 662 (2009) (pleading standards and plausibility framework)
- Reves v. Ernst & Young, 494 U.S. 56 (1990) (common stock is a federal security)
- Bald Eagle Area Sch. Dist. v. Keystone Fin., 189 F.3d 321 (3d Cir. 1999) (RICO Amendment intended to prevent using RICO to obtain treble damages for securities fraud)