Frаud actions that require proof of individual reliance cannot be certified as Fed.R.Civ.P. 23(b)(3) class actions because individual, rather than common, issues will predominate. The district court certified a nationwide Rule 23(b)(3) class in this RICO
I
A
Plaintiff Sandwich Chef of Texas, Inc., d/b/a Wall Street Deli (“Wall Street”),
Premiums for retrospectively-rated workers’ compensation insurance are based on expense factors and loss experience calculated as of the end of the policy period. Policyholders pay an initial premium, subject to a negotiated minimum and maximum range, аnd receive refunds or credits or pay additional premiums based on losses.
Most employers purchase workers’ compensation coverage in the voluntary market. Those who cannot may obtain insurance through legislatively-established involuntary markets, sometimes called “residual markets,” “assigned risk markets,” or “assigned risk pools.” Some states require workers’ compensation insurance carriers to reinsure that state’s “residual markets,” which often results in additional costs to them when operating deficits occur. When residual market assessments dramatically in
Option V is a rating plan for retrospectively rated workers’ compensation insurance policies. NCCI’s WC 00 05 endorsement is the approved form in all 45 pertinent jurisdictions for Option V pricing. States set rates for workers’ compensation insurance and require that insurers use only approved rates, rating plans, and policy forms. Insurers who sell Option V policies cannot deviate from these rates without regulatory approval. Wall Street purchased four workers’ compensation insurance policies from defendant Reliance Insurance Company (“Reb-anee”)
Wall Street maintains that insurers sought to pass on RML expenses to their Option V policyholders in the voluntary market, contrary to the terms of the approved rating plan. Defendants instructed NCCI to ask state regulators to amend the Option Y rating plan to allow them to pass through their RMLs as an element of the tax multiplier. The tax multiplier is a compоnent of the premium that includes taxes and other assessments that carriers pay. Defendants also began including un-filed and unapproved RML surcharges in tax multipbers for Option V coverage. All defendants overcharged, and they prevented competition through collusion, such as by sharing information about RML charges.
Wall Street also alleges that defendants used NCCI to deceive state regulators. NCCI filed R-1244, in which it requested that regulators authorize a residual market subsidy to be added to the Option V tax multiplier. R-1244 falsely represented that defendants were not presently including RMLs in their rates and intended only to pass through part of the residual market burden to policyholders. Some regulators accepted R-1244; others granted only part of the request or denied it. Defendants nevertheless passed through their full RML expenses. They used NCCI to make other Option V tax multiplier filings after R-1244, which falsely reflected only partial RML subsidies rather than defendants’ actual practice of charging full RML expense.
Wall Street avers that regulators required NCCI to review defendants’ Option V applications for compliance with lawful rates and to approve only applications that contained authorized rates. Defendants’ applications falsely represented that they were charging approved rates for Option V coverage. In turn, state regulators received NCCI-approved applications that concealed defendants’ overcharges. NCCI knew of these overcharges but never disclosed them to the regulators. Defendants routinely provided unapproved forms, rating plans, and rates to policyholders that they did not give regulators. In these forms, defendants characterized their unapproved charges as state assessments or taxes. Defendants also failed to dis
Defendants have a different view of the pertinent facts. They assert that when Wall Street requested that Reliance make a proposal for commercial insurance, Wall Street offered to pay the RML expenses that are the subject of its complaint. Wall Street and Reliance negotiated all pricing and payment terms, including RML expenses, and Reliance disclosed to Wall Street that the residual market charges differed from its rate filings. Wall Street bargained for other terms that reduced its insurance costs and that also varied from Reliance’s rate filings. Other large employers in the certified class negotiated customized insurance packages that were designed to meet their specified needs at the lowest cost; the policyholders did not want insurance programs that were constricted by filed rating plans; they bargained for programs that departed from filed rates; and, althоugh the programs included residual market charges, they had other features that reduced net costs to below what could have been charged under filed rates. Defendants argue that “each negotiation among a policyholder, its broker, and its insurer created a unique record of oral and written communications directly relevant to the RICO fraud claim.” Appellants Br. at 5.
Defendants contend that, due to their complexity, retrospectively rated workers’ compensation insurance policies are almost always written for large employers who pay annual premiums that can amount to millions of dollars. Policyholders usually operate in several states and require multiple lines of insurance coverage. Consequently, they frequently request that brokers seek proposals from several carriers. The brokers, in turn, solicit proposals that include requested coverage, services, and pаyment terms for many types of insurance, including workers’ compensation, general liability, and commercial automobile liability, to insure the policyholder in multiple states. Quoted premiums often specify one formula for all such coverage. Negotiations can include face-to-face meetings, telephone conversations, and correspondence that vary in form depending on the deal. Brokers and others, such as professional risk managers, insurance consultants, and lawyers, frequently participate. Employers and their representatives negotiate customized retrospectively-rated programs that reflect their different operations, risk tolerances, coverage needs, and cash-flow preferences. They also bargain for premium formulas and payment terms that vary according to program.
Defendants also posit that policyholders sought ways to reduce thеir costs below those set by filed rating plans. Carriers and policyholders negotiated rates that were not as provided in filed rating plans or state regulations, thereby reducing overall program prices below levels that could be charged under the plans. The total cost of the negotiated program depended on many individually-negotiated terms, and the fact that one premium factor, such as the tax multiplier, was higher than that prescribed in a filed plan did not necessarily cause the net cost to exceed what the filed plan allowed. Policyholders usually focused on lowest net cost, not on a single component of cost.
B
Wall Street moved for class certification. Defendants opposed the motion, contending that Wall Street had failed to meet its burden of establishing the adequacy and typicality requirements of Rule 23(a) and the predominance, manageability, and superiority requiremеnts of Rule 23(b)(3). They argued, inter alia, that proof con
All purchasers (excluding policyholders with a captive insurance company that ultimately reinsure their workers’ compensation risk, the defendants and co-conspirators) of workers’ compensation insurance policies, effective on or аfter January 1, 1987, endorsed with a Retrospective Premium Endorsement (NCCI form WC 00 05 series) and not closed by a final premium calculation on or before May 6, 1994, excluding purchasers of policies endorsed as a Large Risk Alternative Rating Option[.]
Sandwich Chef of Tex., Inc. v. Reliance Nat’l Indem. Ins. Co.,
In the context of analyzing Rule 23(b)(3) predominance, the district court rejected defendants’ argument that a trial of class claims was impossible due to the predominance of individual issues. Id. at 497. The court noted that RICO required both “but for” and “proximate” causation. Id. It held that, under our decision in Summit Properties Inc. v. Hoechst Celanese Corp.,
The court reasoned that Wall Street could establish causation under the target wing of Summit — where individual reliance by class members would not be an issue — based on a fraud-on-the-regulator theory. Id. Applying a conclusion it had reached in its earlier summary judgment ruling in Sandwich Chef of Texas, Inc. v. Reliance National Indemnity Insurance Co.,
The district court rejected defendants’ contention that members of the plaintiff class would be required to demonstrate
The district court also held that Wall Street could meet its obligation to prove proximate cause, without requiring individual proof of reliance, through the reliance wing of Summit by means of its invoice theory. Id. at 499. The court recognized that, in Patterson v. Mobil Oil Corp.,
According to the district court’s reasoning, under Wall Street’s theory of the case, each class member sustained the same injury: an overcharge caused by an inflated invoice. This was classic mail fraud because defendants knowingly sent policyholders invoices that they knew were higher than the filed rates. Since defendants’ records provided all information needed to measure the injury for the class and each class member, the invoice theory did not raise complicating factors that would defeat Rule 23(b)(3) certification. The invoice theory also alleged that defendants made but one type of direct misrepresentation to their policyholders: the written invoices. Id. at 499-500.
The district court also held that class certification was particularly appropriate when purchasers sought redress for widespread commercial abuses, and that individual proof of reliance did not preclude class certification, because the act of paying an invoice could establish circumstantial evidence of reliance. Id. at 500. It concluded that, in a RICO fraud case alleging overcharges, proximate cause (reliance and injury) can be proved by circumstantial evidence of the transаction that results in the overcharge. Id. at 500-01. Wall Street sought to prove reliance by circumstantial evidence that the invoices contained inflated premiums that constituted material misrepresentations, omissions, or both, and that the class members paid overcharges as a result. Wall Street and the class were allowed to use the invoices and payment of the invoices as circumstantial evidence of detrimental reliance. They could also present expert witness testimony that businesses customarily and reasonably rely on the accuracy of invoices, especially invoices sent by regulated entities, and that commercial transactions between businesses occur based on an ethic of honesty and fair dealing. Id. at 501.
C
After the district court certified a class, defendants petitioned and obtained leave to appeal under Rule 23(f). They maintain, inter alia, that the district court abused its discretion in certifying a class because individual issues of reliance and
II
Before we turn to the merits of this appeal, we must address a threshold matter.
Wall Street contends that defendants have improperly cited materials that are outside the evidentiary record and must be stricken.
We disagree with Wall Street’s argument to the extent it is addressed to evidence we have considered on appeal.
Citing Jones v. Diamond,
The evidence on which defendants rely to contend there are individual issues of reliance and causation is properly part of the record below and on appeal.
Ill
We turn now to the merits. Defendants contend the district court abused its discretion in certifying this case as a class action because, inter alia, individual issues of reliance and causation defeat Rule 23(b)(3) predominance.
We review the district court’s class certification decision for abuse of discretion. Stirman v. Exxon Corp.,
To obtain class certification,
Rule 23(a) requires the plaintiff to show that the class is too numerous to allow simple joinder; there are common questions of law or fact; the claims or defenses of the class representatives are typical of those of the class; and the class representatives will adequately protect the interests of the class. To receive (b)(3) certification, a plaintiff must also show that the common issues predominate, and that class treatment is the superior way of resolving the dispute.
Patterson,
Causation is one issue to be tried in the present case. “RICO creates a civil cause of actiоn for ‘“[a]ny person ‘injured in his business or property by reason of a violation of section 1962.’ ” ’ ” St. Paul Mercury Ins. Co. v. Williamson,
Proximate cause generally demands that a misrepresentation be relied upon by the plaintiff, individually. See Summit,
“[I]ndividual findings of reliance nеcessary to establish RICO liability and damages preclude ... (b)(3) certification^]” Bolin,
While there may be an issue of fact common to all class members ... that question does not predominate over the question of whether or not each member of the class suffered a RICO injury.... To determine reliance for each individual class member would defeat the economies ordinarily associated with the class action device.
Patterson,
The pervasive issues of individual reliance that generally exist in RICO fraud actions create a working presumption against class certification. The district court avoided individual issues of reliance by concluding on substantive grounds that these issues would not predominate. If the court erred in these holdings, its class certification decision was necessarily an abuse of discretion and must be reversed. See Sikes,
B
Relying on our decision in Summit, the district court held for two reasons that Wall Street could circumvent individual issues of reliance and causation that usually preclude a finding of predominance. We ruled in Summit that, “[i]n general, fraud addresses liability between persons with direct relationships — assured by the requirement that a plaintiff has either been the target of a fraud or has relied upon the fraudulent conduct of the defendants.” Summit,
We turn first to the reliance wing, which the district court found Wall Street had met through its invoice theory. The district court viewed Wall Street’s invoice theory as a relatively simple one. Sandwich Chef II,
We conclude that this reasoning is legally flawed. Certification of a class under Rule 23(b)(3) requires that the district court consider how the plaintiffs’ claims would be tried. See Castaño,
Defendants maintain that Wall Street and other potential class members, directly or through others (e.g., brokers), negotiated premiums that varied from filed rates for retrospectively rated workers’ compensation insurance. They contend that plaintiffs were aware that carriers were charging them more than the filed rates. Knowledge that invoices charged unlawful rates, but did so according to a prior agreement between the insurer and the policyholder, would eliminate reliance and break the chain of causation. See Summit,
WaU Street and the other plaintiffs must establish at trial that they detrimentally relied on the misrepresentations in the invoices the insurers sent them. Defendants are entitled to attempt to undercut this proof with evidence that might persuade the trier of fact that pobcyholders knew the amounts being charged varied from rates filed with regulators and that they had agreed to pay such premiums.
Accordingly, we hold that the invoice theory does not satisfy the reliance wing of Summit and eliminate individual issues of reliance and causation that preclude a finding of predominance of common issues of law or fact. See id. (holding that facts of case required individual proof of reliance that would “defeat the economics ordinarily associated with the class action device”).
C
The district court also concluded that Wall Street could avoid individual issues of reliance under Summit’s target wing, based on a theory of fraud-on-the-regulator. The court reasoned that, under the target wing, individual rebanee by class members was not an issue because rebanee upon a fraudulent representation or omission by a third person was sufficient if the plaintiff was injured as a result. Wall Street could establish proximate cause by demonstrating that the class members were injured by the regulators’ reliance on defendants’ misrepresentations and omissions. Sandwich Chef II,
Wе hold that the district court erred in concluding that the target theory could be invoked to excuse proof of individual reliance on fraudulent predicate acts. We have applied the target theory narrowly. See Procter & Gamble Co. v. Amway Corp.,
In Procter & Gamble we applied the target theory to hold that Procter & Gamble had stated a RICO claim sufficient to survive Rule 12(b)(6) dismissal where its competitor had allegedly spread a rumor that caused consumers to stop purchasing Procter & Gamble’s products. Procter & Gamble,
The reasons for our narrow application of the target theory, and for its inapplicability in the present case, can be derived from foundational principles of RICO causation jurisprudence. Before the Supreme Court decided Holmes, “[t]he Courts of Appeals ha[d] overwhelmingly held that not mere factual, but proximate, causation is required.” Holmes,
Here we use “proximate cause” to label generically the judicial tools used to limit a person’s responsibility for the consequences of that person’s own acts. At bottom, the notion of proximate cause reflects “ideas of what justice demands, or of what is administratively possible and convenient.” Accordingly, among the many shapes this concept took at common law was a demand for some direct relation between the injury asserted and the injurious conduct alleged. Thus, a plaintiff who complained of harm flowing merely from the misfortunes visited upon a third person by the defendant’s acts was generally said to stand at too remote a distance to recover.
Id. at 268-69,
In enacting RICO, Congress obviously adopted “the Clayton Act direct-injury limitation among the requirements of § 1964(c).” Id. at 272,
Holmes therefore teaches that a RICO plaintiff must show a “direct relation between the injury asserted and injurious conduсt alleged[,]” and that a RICO predicate act “visited upon a third person” is generally too remote to permit a recovery from a person who complains of injury flowing from that act. Id. at 268,
Thus under the target wing recognized in Summit and applied in Procter & Gamble, there is a narrow exception to the requirement that the plaintiff prove direct reliance on the defendant’s fraudulent predicate act. This exception only comes into play when the plaintiff can demonstrate injury as a direct and contemporaneous result of fraud committed against a third party, because in this limited context there is a sufficient “direct relation between the injury asserted and the injurious conduct аlleged” to comport with the RICO requirement of proximate cause. This understanding of Holmes and our jurisprudence clearly explains how the narrow exception was correctly applied in Mid Atlantic and Procter & Gamble. The facts of these cases illuminate the guiding principle of Summit’s narrow exception and the critical distinction between cases that properly apply it and those that do not.
In Mid Atlantic and Procter & Gamble there were direct and contemporaneous relationships between the acts of fraud directed against the third parties and the harm the plaintiffs incurred. When Mid Atlantic’s customers relied on fraudulent communications about rates, it had to low
But the exception adopted in Summit has clear and cоnstricted parameters that Wall Street cannot satisfy in this case. Under Wall Street’s target theory, there is no similar direct and contemporaneous relationship between the fraudulent acts directed against regulators and the harm Wall Street and the other plaintiffs incurred. Assuming that defendants and NCCI misrepresented in regulatory filings that they were charging lawful rates, the injury to plaintiffs could have arisen only after defendants attempted to charge plaintiffs inflated premiums, and the regulators — because they had been deceived— did not intercede to prevent the fraud. When Wall Street’s theory is analyzed properly, it is apparent that no injury could have been incurred without a plaintiffs subsequent reliance on an inflated invoice. The fact that a regulator was completely in the dark about a carrier’s true premium charges would not of itself have injured a policyholder. We do not reject the possibility that defrauding a regulator could, in the proper case, proximately cause injury. But we hold that fraud on the regulator, as Wall Street contemplates it, does not constitute a direct and contemporaneous RICO injury to a policyholder because it would always be necessary for the regulator to be deceived and for the policyholder to pay an unlawfully-inflated premium. Although disclosure of the true premiums to a regulator could prevent injury to policyholders by prompting the regulator to interdict the carrier’s attempt to bill at an inflated rate, concealment of inflated premiums would not result in direct and contemporaneous injury to the policyholder without the additional act of billing. The regulator’s reliance on the fraudulent act would not alone be enough to result in a direct and contemporaneous injury to a policyholder that satisfies RICO’s proximate cause requirement.
We therefore disagrеe with the district court that the fraud-on-the-regulator theory is a common issue faced by. all class members that may be proved or disproved at trial from a common set of facts. Because Wall Street cannot rely on Summit ’s target wing, plaintiffs must demonstrate causation on an individual basis, which defeats predominance and certification of a Rule 23(b)(3) class.
The district court relied in error on certain legal principles to eliminate individual issues that predominate in this RICO fraud case and that preclude certification of a Rule 23(b)(3) class. These RICO fraud cases must be tried individually. Wall Street and other plaintiffs are entitled to prove at trial that the insurers with whom they contracted to provide workers’ compensation insurance defrauded them, in violation of 18 U.S.C. § 1962, by charging premiums that exceeded approved rates. But defendants are equally entitled to defend themselves by offering, for example, evidence that аn individual plaintiff, directly or through a broker, negotiated a premium that varied from the filed rate, was aware that the insurer was charging more than what regulators had approved, and therefore was not a victim of fraud. Accordingly, the class certification order is
REVERSED.
Notes
. Racketeer Influenced and Corrupt Organizations Act, 18U.S.C. §§ 1961-1968.
. Wall Street states in its brief that it is now known as Wall Street Deli, Inc.
. During the pendency of this appeal, five defendants, including Reliance, which is currently in liquidation, moved to sever and stay their appeals. A panel of this court granted the motion. The motion panel denied without prejudice to reconsideration by this panel defendants' alternative motion to sever and remand the appeal for immediate dismissal. Because we are reversing the class certification order, we need not reconsider the motion panel’s order.
. Defendants also argue that proving injury presents significant individual issues of fact and variations in state law; that conspiracy allegations do not eliminate the predominance of individual issues that defeat class certification; and that a class action is not superior to other available methods of adjudication. In view of our disposition of defendants’ first argument, we need not address these contentions.
. Wall Street also moved to strike defendants' brief and reply brief and to vacate our order granting them leave to appeal. A panel of this court denied the motion.
. Wall Street objects to 140 citations that defendants make to materials that it contends are outside the class certification record. We have neither relied on any evidence that the district court explicitly excluded nor on factual recitations contained in state court cases that defendants maintain are similar to the instant action.
. We reject Wall Street's assertions in its brief and at oral argument that defendants did not adduce evidence in the district court to support their allegations of individual negotiations and knowledge and lack of reliance on alleged misrepresentations.
. Citations are to the volume and page of the record on appeal.
. Another holding in Jones supports defendants’ position. We concluded that "[i]f the court finds ... that an evidentiary hearing on the class is appropriate or essential, it should inform the parties that a full hearing will precede the decision on certification, and that any facts on which they intend to rely to support the motion must be introduced in evidence at that time.” Id. at 1099. In the present case, the district court did not advise the parties that the facts would be limited to those introduced during the hearing; it did the opposite.
. Defendants also argue that the district court abused its discretion in its application of the filed rate doctrine and the parol еvidence rule. We need not address these contentions. Wall Street acknowledged during oral argument that the filed rate doctrine and parol evidence rule "cannot eliminate materials that would be exculpatory” and asserted that the district court did not exclude evidence on this basis. See Tr. Oral Arg. at 22-23. We agree that neither the filed rate doctrine nor the parol evidence rule prevents a carrier from defending against a fraud claim based on evidence that a policyholder knew of, or agreed to, the rate being charged. And the district court's certification opinion indicates that its discussion of this doctrine and rule related mostly to its assessment of typi
. "All RICO violations under 18 U.S.C. § 1962 entail '(1) a person who engages in (2) a pattern of racketeering activity, (3) connected to the acquisition, establishment, conduct, or control of an enterprise.' " In re MasterCard Int'l Inc.,
. In a post-argument brief, Wall Street maintains that a holding in the Third Circuit's recent decision in In re Linerboard Antitrust Litigation,
. We have no occasion to address in all its dimensions what constitutes proximate cause in a RICO fraud case. Consistent with Holmes,