High Court Limits Use of RICO Act on Advisers : Law: Lawyers, accountants and other outside consultants will no longer face triple damages in fraud prosecutions under anti-racketeer statute.

WASHINGTON —  The Supreme Court, in a blow to investors and government officials trying to recover money from failed savings institutions, ruled Wednesday that outside accountants, lawyers and investment bankers cannot be sued under the federal anti-racketeering law for their roles in massive frauds.

In a 7-2 decision, the justices said that the Racketeer Influenced and Corrupt Organizations Act can be used only against people who “participate in the operation or management” of a criminal enterprise.

Managers of a fraudulent enterprise, as well as those “who exert control” over them, will still be subject to suits under the law, either by government prosecutors or defrauded investors, the high court said. Outside professionals still will be subject to lawsuits under other federal fraud statutes--but none of those laws carry penalties as severe as those provided by the racketeering law.

Congress passed the 1970 law to combat organized crime. But in the 1980s, the law became the weapon of choice for attacking fraudulent business schemes of all sorts.

Once a business was convicted of repeatedly violating a federal law--such as a stock fraud--the courts could label the business a “racketeering enterprise” and require, under provisions of the 1970 law, that the business pay damages to victims equal to three times their actual losses.

That threat of triple damages has persuaded many outside advisers to pay to settle suits rather than face a trial. Last year, for example, three accounting firms, two law firms and an investment house paid more than $250 million to settle charges growing out of the collapse of Charles H. Keating Jr.’s savings and loan empire.

“RICO was the hammer we held over them,” said Los Angeles attorney Kevin P. Roddy, who represented the 23,000 investors who sued Keating, owner of now-defunct Lincoln Savings & Loan, and his business advisers. That settlement will not be affected by Wednesday’s ruling.

Until Wednesday, the Justice Department and most lower courts had assumed that outside advisers who played a key role in setting up a stock fraud or a real estate scheme could be sued and forced to pay damages under the racketeering law. They still can be found liable under other federal securities laws, which carry penalties equal to the actual losses suffered by the victims.

While Wednesday’s ruling grew out of a civil suit filed by defrauded investors, legal experts said that the opinion almost certainly will be used to limit criminal suits filed by the government under the 1970 law.

“This is a potentially sweeping decision,” said Ira Raphaelson, a Washington attorney who until recently headed a Justice Department unit that prosecuted financial frauds. “It will cause the Justice Department to rethink how it brings some of these cases.”

Attorney Roddy, the Los Angeles lawyer who specializes in investment fraud cases, said the racketeering law is needed to deter slick frauds.

“You can’t conduct a sophisticated fraud without accountants, attorneys and other white-collar professionals,” Roddy said. “Now it seems that the court is leaving them off the hook unless they are on the corporate payroll.”

Accountants praised the result and contended that as advisers they should not be required to take full liability for bad decisions by a manager.

Often, they said, the kingpins of a failed savings and loan are quickly bankrupted by court judgments, leaving national accounting firms and prominent law firms to face full responsibility for paying damages.

“This is enormously important for the accounting profession because it limits RICO liability to those who were directly and substantially involved in the criminal enterprise,” said Benito Romano, an attorney who represented the American Institute of Certified Public Accountants.

Over the last decade, the justices repeatedly have criticized the broad sweep of the racketeering law, but usually they have concluded that Congress, not the courts, is responsible for narrowing the law.

In this instance, however, they resolved a split among the federal circuit courts by narrowing the law themselves.

The law says: “It shall be unlawful for any person employed by or associated with any enterprise . . . (to) participate directly or indirectly in the conduct of such enterprise’s affairs through a pattern of racketeering activity.”

Most federal courts had said that this provision covered any person who was even indirectly involved in a racketeering enterprise. But the issue was tested in a suit growing out of the 1984 collapse of the Farmer’s Cooperative of Arkansas and Oklahoma.

The co-op had gone bankrupt after the revelation that it had purchased a heavily indebted gasohol plant. The group’s accountants had failed repeatedly to tell the farmers about the debt.

The farmers sued for fraud and violations of the racketeering act, and a jury handed down a $6.1-million verdict against the accounting firm of Russell Brown & Co., which later merged with the firm of Ernst & Young.

But a federal appeals court in St. Louis, taking the narrow view of the law, threw out the verdict because the accountants did not “participate in the operation or management of the enterprise itself.”

Last year, the justices agreed to hear the farmer’s appeal in the case (Reves vs. Ernst & Young, 91-886) and upheld the appeals court decision.

Justice Harry A. Blackmun, writing for the court, focused on the word “conduct” and said it indicates that the law covers only those who exert “some degree of direction” over the enterprise.

He agreed that the law “is not limited to upper management” of the enterprise but said that it is limited to those who have “some part in directing the enterprise’s affairs.” Because the accountants did not direct the co-op, charges against them under the 1970 law were dismissed.

They may, however, be retried and forced to pay damages for simple fraud.

Justices David H. Souter and Byron R. White dissented, noting that Congress had said that the racketeering law should be “liberally construed,” not restricted by narrow court interpretations.

Times correspondent Ted Johnson in Orange County contributed to this story.