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Supreme Court limits RICO.

In a long-awaited decision with a significant impact on the accounting profession, the U.S. Supreme Court limited the use of the Racketeer-Influenced Corrupt Organizations Act (RICO) against accounting firms.

The case, Reves v. Ernst & Young, arose from Ernst's audit of the Farmers' Cooperative of Arkansas and Oklahoma. To raise funds for its operations, the co-op sold investors uncollateralized demand promissory notes. The money was used to fund a company that specialized in making gasohol. When the co-op subsequently went bankrupt, the noteholders filed suit against Ernst (at the time Arthur Young & Company), alleging the firm misvalued the gasohol company, assisted the co-op's manager in a scheme to defraud investors and violated RICO by engaging in a pattern of racketeering activity.

Both the trial court and the U.S. Court of Appeals excluded the RICO claim, reasoning that accountants must be directly involved in managing the corrupt business to be brought within the intended scope of RICO.

The U.S. Supreme Court agreed, ruling seven to two that accountants supplying only audit, review or compilation services to a client without participating, in the management or direction of the business are outside RICO's reach.

The dissenting opinion (by Justice David Souter, joined by Justice Byron White) argued Congress intended to apply RICO broadly and include outside professionals within the law's scope. The dissent further argued that even under a narrow interpretation of RICO, the facts indicated Ernst engaged in the co-op's management and should be subject to the RICO claim.,

The ruling's impact on the accounting profession is substantial. By establishing an "operation or management test" for accountants, the Court appeared to limit RICO's applicability to the profession to cases in which management consulting services were provided. Even in those situations, however, the plaintiff must establish the accounting firm participated in the operation or management of the business when providing management consulting services.

Under the new test, RICO counts against accounting firms will be subject to pretrial dismissal by summary judgment, absent a showing that a factual dispute exists about whether the firm was involved in managing the business.

The ruling also restores balance between plaintiff and defendant in pretrial settlement negotiation. Before the decision, many cases were settled before trial merely to avoid the possibility that treble damages would be imposed against losing RICO defendants. Settlements post-Reves will focus on the accounting firm's actual exposure for alleged negligent acts without adding a settlement premium for alleged RICO conduct.

Since the great majority of cases are resolved pretrial, this impact on settlement discussions should prove significant. (Reves v. Ernst & Young, U.S. Supreme Court No. 91-886)
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Title Annotation:Reves v. Ernst & Young
Publication:Journal of Accountancy
Date:May 1, 1993
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