A split federal appeals panel has reinstated part of New York City's case claiming online cigarette sellers are guilty of racketeering by skirting a law requiring the reporting of cigarette sales to collect taxes.
The 2nd U.S. Circuit Court of Appeals said the city has standing to sue under the Racketeer Influenced and Corrupt Organizations Act (RICO) "where it has alleged direct injury of lost taxes" caused by Internet retailers' "commission of mail and wire fraud" through the sale of cigarettes to city residents without complying with the reporting requirements of the federal Jenkins Act.
Judge Chester J. Straub wrote the majority opinion in the four consolidated cases led by City of New York v. Smokes-Spirits.Com Inc., 06-1665-cv. He was joined by Judge Sonia Sotomayor.
The Jenkins Act is a criminal law that was intended to be used by the U.S. government against tobacco companies to prevent state tax avoidance. The city sued the online cigarette retailers claiming their failure to file Jenkins Act reports on their sales volumes, as well as their marketing efforts designed to discourage tax collection, amounted to the predicate acts of mail and wire fraud under RICO.
In 2005, Southern District of New York Judge Deborah Batts dismissed racketeering claims and state claims based on common law fraud, New York state's consumer fraud statute, General Business Law §349 and public nuisance claims against the sellers.
But she gave the city leave to refile on the racketeering claims.
The city did so, but Batts dismissed the case in 2006, saying the city's "novel theory" under RICO would not work.
Batts said it was doubtful that the Jenkins Act even applied to civil RICO actions and it was "extremely unlikely" that any party other than the federal government may sue under the act.
Tuesday, the 2nd Circuit reversed by a 2-to-1 vote, with Judge Ralph Winter dissenting. He said he did not view the RICO violation as the proximate cause of the city's alleged injuries and therefore the city lacked standing.
After reversing Batts on the RICO issue and remanding for further proceedings, the majority affirmed the lower court's dismissal of the city's claims for common law fraud in all four cases and a §349 claim in one of them.
The panel then severed and retained jurisdiction over the §349 claim in two of the consolidated cases and all of the city's public nuisance claims.
The circuit also certified two questions to the New York Court of Appeals. The first question was whether the city has standing to sue under §349. The second is whether the city may assert a common law public nuisance claim that is predicated on Public Health Law §1399-11.
Taxes on in-state cigarettes sales are collected through the sale of tax stamps to sellers, but out-of-state cigarettes sellers are not responsible for collecting or paying state or city taxes, a discrepancy the city claimed costs it more than $100 million a year in tax revenues.
The city's theory was that full compliance with the reporting requirements of the Jenkins Act, 15 U.S.C. §§375-78, would enable it to collect taxes directly from purchasers. The city charged that two of the online sellers, Smokes-Spirits and EZTobacco, coach their employees to tell purchasers they are prohibited from giving customer information to tax authorities. In the case of one defendant, Nexicon, the city claimed the company falsely advertised that its cigarettes were sold "tax-free."
The city sought triple the amount of tax revenue lost in damages and an injunction requiring sellers to comply with the Jenkins Act, as well as a requirement that customers be told the cigarettes are subject to taxation.
PROXIMATE CAUSE
The majority's reversal Tuesday on the RICO claim was based on a finding of proximate cause.
Here, Judge Straub said, "measuring the damages is as simple as counting the number of cigarette packs sold by the defendants."
"Moreover, the fact that cigarette purchasers may be partially to blame -- either because they were not aware of their reporting duties or because, as part of the alleged RICO conspiracy, they were intentionally hiding the fact of their purchases -- does not defeat proximate cause," Straub said, adding that there were no "speculative steps" in city's offered "chain of causation."
He also cautioned that, in recognizing the city's right to proceed with the case, "we are neither extending the scope of the mail and wire fraud statutes, nor the scope of RICO, beyond their established reach."
In upholding the dismissal of the common law fraud claims against defendants Smokes-Spirits, EZ Tobacco, NCCigarettes and Nexicon Inc., the circuit agreed with Judge Batts, saying the city failed to plead "reasonable reliance on the part of the plaintiff."
The court affirmed Batts' dismissal of the §349 claim against one defendant, Smokes-Spirits, but certified the standing question to the New York Court of Appeals with regards to two others, Nexicon and EZTobacco, saying "we are aware of no case extending protection under GBL §349 to an entity that was neither harmed as a competitor nor a consumer."
The second certified question concerned the intent of the state Legislature, which passed §1399-11 after finding that "the shipment of cigarettes sold via the Internet or by telephone or mail order to residents of this state poses a serious threat to public health, safety and welfare."
Straub said that while lawmakers clearly believed the sale of cigarettes posed a health risk to New Yorkers, "we have some reservation as to whether the legislature, in passing §1399-11, intended to displace common law nuisance claims with respect to this subject matter."
Randolph H. Barnhouse of Luebben Johnson & Barnhouse in Albuquerque, N.M., represented one group of defendants that included Hemi Group.
"It's unfortunate the court didn't agree with us on the primary RICO allegation but we won everything else aside from the certification issues," Barnhouse said. "I think the dissent was well taken. It really sets out a strong argument for having the 2nd Circuit affirm what we believe was the correct holding of the district court."
Michael B. Powers of Phillips Lytle in Buffalo represented Smokes & Spirits.
David K. Heasley of Silverberg Goldman & Bikoff represented defendants Nexicon Inc.
The Law Department's Elizabeth Natrella, senior counsel; Leonard Koerner, chief of the Appeals Division; and Eric Proshansky, deputy chief for affirmative litigation, represented the city.
In statements Tuesday, Mayor Michael R. Bloomberg and Corporation Counsel Michael Cardozo praised the ruling.
"We will continue moving forward vigorously against those who break the law and deprive the city of vitally needed tax dollars -- especially when such lawbreakers also undercut public health," the mayor said.
"This decision sends a powerful message to all sellers of cigarettes on the Internet: Don't falsely advertise and report your cigarette sales, because if you do, you'll be paying New York City triple the amount of taxes that your sales would have generated," said Cardozo.
