Wooldridge, Thomas, “ON
BEHALF OF THE KING: USING CIVIL RICO AGAINST INTERNET AND INDIAN CIGARETTE
VENDORS WHO FAILTO COMPLY WITH THE JENKINS ACT”
ABSTRACT
Internet and Indian reservation cigarette vendors (“IICVs”), are marketing cigarettes for sale over the internet and on Indian reservations as “tax-free.” However, “tax-free” cigarettes are an illusion. Rather than being tax-free, IICVs are violating the Jenkins Act by intentionally failing to report the cigarette sales to the appropriate state taxing authority. A Jenkins Act violation is also a RICO violation because mailing the cigarettes, along with marketing the cigarettes through the internet, amount to mail fraud and wire fraud, predicate offenses under RICO. IICVs are profiting at the State’s expense while gaining a competitive advantage over companies that pay the appropriate excise taxes. Because local businesses loose revenue through competition with the IICVs, local businesses have a valid RICO claim against the IICVs. The claim should originate in a Second Circuit District Court because the law and policy in the Second Circuit is significantly developed on many of the key issues.
CONTENTS
I
OVERVIEW....................................................................................................................... 02
II.
THE SCHEME TO DEFRAUD........................................................................................ 03
III.
THE JENKINS ACT......................................................................................................... 04
IV. USING CIVIL RICO TO
ATTACK THE SCHEME TO DEFRAUD............................ 05
A.
The Plaintiff......................................................................................................... 05
B.
Standing............................................................................................................... 06
1.
A Violation of 18 U.S.C. § 1962............................................................... 06
a. The Dual Requirements of a Distinct
b. Racketeering Activity.................................................................. 10
2.
Injury to business or Property.................................................................. 11
3.
Causation.................................................................................................. 12
4.
Damages................................................................................................... 15
C. Potential Hurdles.................................................................................................. 16
1. Native American Sovereignty.................................................................. 16
2. Internet Tax Free Act............................................................................... 17
V. CONCLUSION................................................................................................................... 18
APPENDIX................................................................................................................................... 19
Thomas Colin Wooldridge
ON BEHALF OF THE KING: USING CIVIL RICO AGAINST
INTERNET AND INDIAN CIGARETTE VENDORS WHO
FAILTO COMPLY WITH THE JENKINS
ACT[1]
I. OVERVIEW
Cigarette
excise taxes are designed to both discourage tobacco consumption and increase
state revenue. Because each state sets
its own excise tax rates, there have always been attempts to evade higher taxes
by crossing state borders to buy cigarettes.
Sometimes crossing state borders means traveling from
Though
states have had some success taxing sales made over the internet, they have
thus far stayed out of the murky waters of Indian reservations’ cigarette
sales. However, experts on tobacco
control policy, such as the
II. THE SCHEME TO DEFRAUD
Despite
claims by IICVs, “tax-free” cigarettes are an illusion. Rather than being tax-free, IICVs are intentionally
failing to report cigarette sales to the appropriate state tax authority, as
required under the Jenkins Act. The IICV’s
business plan depends on both false marketing claims and concealing the cigarette
sales from state authorities. IICVs
located on Indian reservations claim they are exempt from state taxation by
virtue of their status as sovereign nations and as such, states have no
authority to tax activities carried on within the boundaries of an Indian
reservation. Though it is true that tribal
sales to other tribal members are not taxed, the non-Indian consumers are still
required to pay excise taxes on cigarette purchases. Moe v. Confederated Salish and Kootenai Tribes, 425
The
United States Supreme Court unknowingly made the racketeering scheme easier
when they decided the case of Quill Corp. v. North Dakota, 504 U.S. 298 (1992). In Quill
Corp. the Court held
out-of-state vendors, with no physical presence in a given state, do not have
to collect sales and excise taxes that are due the state.
The
most authoritative source of information on how the IICVs ignore the Jenkins
Act is the GAO Report. The GAO report
identified and examined 147 internet websites offering cigarettes for
sale. Of the 147 websites surveyed, over
100 were located in
III. THE JENKINS ACT
To
respond to the problem of “cross-border” cigarette tax evasion, Congress passed
the Jenkins Act. 15 U.S.C. §§375-378
(1949). The Jenkins Act was enacted as a
response to:
(1) The large and increasing loss of state revenue, caused by the
evasion of sales and use taxes on cigarettes shipped in interstate commerce to
consumers;
(2) The discrimination caused by this evasion against sellers of cigarettes
whom comply with the appropriate reporting requirements; and
(3) The fact that this evasion was accomplished through the use of the United
States mail.
S. Rep. No. 1147,
84th Cong., 1st Sess., U.S.Code Cong. and Admin.News 2883 (1955).
The Jenkins Act requires any vendor who sells
and ships cigarettes across a state line (other than to a licensed distributor),
to report the sale to the buyer’s state tax authority. The seller of interstate cigarettes must
register with the tax administrator of each state where they sell
cigarettes. This registration must
provide the seller’s name, trade name, and the addresses of all business
locations. Subsequently, on a monthly
basis, the seller must submit reports listing 1) the name of the buyer; 2) the
brands of cigarettes shipped; and 3) the quantities shipped. This notifies the state tax authority of each
sale of cigarettes so that the tax administrator may collect the tax from the
buyer. In absence of these monthly
reports, the state tax authority has no basis to impose taxes.
IV. USING CIVIL RICO TO
ATTACK THE SCHEME TO DEFRAUD
The Racketeer Influenced and Corrupt Organizations Act (“RICO”) has the objective of encouraging civil litigation to supplement government efforts to deter crime; the object of a RICO action is not merely to compensate victims, but to turn them into prosecutors dedicated to eliminating racketeering activity. 18 U.S.C. §§ 1961 et seq. One of RICO’s remedial provisions permits a private civil action to recover treble damages in favor of any person who sustains an injury to his or her property. 18 U.S.C. §1962. Here, a Civil RICO action would allow the victim to enforce the Jenkins Act, help the state to discourage smoking, and compensate the Plaintiffs for their loss of revenue as a result of the Jenkins violations.
A.
The
Plaintiff
The plaintiff must be the victim of the scheme to defraud. Here, the victims of the IICVs scheme to defraud are: 1) the state and 2) the business loosing sales revenue as a result of direct competition from IICVs. Here, the claim should be brought on behalf of the traditional brick and mortar business which loses revenue each time a person chooses to purchase cigarettes from IICVs.
The Jenkins Act’s legislative history provides evidence the Act was designed to benefit law abiding businesses:
“The interests of hundreds of wholesalers and thousands of retailers who depend for their livelihood on the sale of cigarettes. The constantly increasing abuse of State cigarette tax laws deprives these merchants of the sales they are rightfully entitled to and would have had it not for the illicit shipment of cigarettes into their state. These deserving businessmen are penalized merely because they are located in a state which imposes a cigarette tax.” 95 CONG. REC. 6347, 6355 (1947) (Statement of Rep. Thomas Jenkins).
As such, the most appropriate plaintiff is a business or group of businesses in direct competition with, and loosing sales as a result of, the IICVs scheme to defraud.
B. Standing
A plaintiff has standing under Civil RICO when they successfully plead: (1) a violation of 18 U.S.C. § 1962; (2) injury to their business or property; (3) causation of the injury by the defendant’s violation. 18 U.S.C. § 1964(c); Motorola Credit Corp. v. Uzan, 322 F. 3d 130 (2d Cir. 2003).
(1) A violation of 18 U.S.C. § 1962
The RICO Act, 18 U.S.C. § 1962(c), provides in part: “it shall be
unlawful for any person employed by or associated with any enterprise engaged
in, or the activities which affect, interstate or foreign commerce, to conduct or
participate, directly or indirectly, in the conduct of such enterprise’s
affairs through a pattern of racketeering activity…” 18 U.S.C.§1962(c). Thus the elements of a § 1962(c) violation are: (a) conduct; (b) of an
enterprise; (c) through a pattern; (d) of racketeering activity. S.P.R.L.
v. Imrex Co., 473
a. The Dual Requirements of a Distinct
The RICO statute defines enterprise
as “any individual, partnership, corporation, association, or other legal
entity.” 18 U.S.C. §1961(4). The statute
defines “person” to include any individual or entity capable of holding a legal
or beneficial interest in property. 18
U.S.C. § 1961 (3). Because §1962(c)
speaks separately of a RICO ‘person’ acting on or conducting the affairs of the
‘enterprise,’ the Supreme Court has determined liability under § 1962(c) can
only be established by “alleg[ing] and prove[ing] the existence of two distinct
entities: (1) a ‘person;’ and (2) an ‘enterprise’ that is not simply the same
‘person’ referred to by a different name.”
Cedric Kushner Promotions, Ltd. v.
King, 533
The “McCullough test,” originating in the Seventh Circuit and adopted by
other circuits for more than 15 years, reasons the enterprise and the defendant
must "either [be] formally or practically separable." McCullough, 757 F.2d at 144. The
“McCullough test” applies a two part
analysis, looking first to whether there is legal distinctness between the
person and enterprise (such as where the defendant is a natural person and the
enterprise is the corporation that employs him); and, second, if there is no
legal distinctness, their might still be a practical distinction (such as where
the defendant operates a sole proprietorship-enterprise that has employees
other than the owner).
Here, the defendants would be both legally and practically distinct. The likely defendants in this lawsuit would be the IICVs in their corporate form, and any person who owns the company. This scenario is nearly identical to Kushner, thus the legal distinctiveness would be satisfied because the two parties have different legal rights and responsibilities. In addition to Kushner, the Second Circuit determined in Moses v. Martin, 2004 U.S. Dist. Lexis 24568 (S.D. N.Y. Dec. 3, 2004) that a RICO claim against Deborah Martin Agency, Inc. and principal, Deborah Martin, was sufficiently pled where the ‘person’ was identified as Deborah Martin and the ‘enterprise’ was the corporation. In this circumstance, the “McCullough test” is clear that defendant’s choice to use a corporate form, rather than carry out the scheme in his own name, is sufficient to meet the RICO distinctiveness requirement. McCullough, 757 F.2d at 144.
If the defendant were to use a sole
proprietorship to carry out the scheme to defraud, McCullough’s “practically separable” standard would govern the
determination of distinctness. In this
case, factors such as the defendant's employment of others to conduct the
enterprise’s business would be sufficient to render the defendant distinct from
the enterprise.
Though Kushner clearly proscribes the requirements for distinctiveness,
the district court in Cyco.Net dismissed
The district court erred in granting
the defendant’s motion to dismiss. Plaintiff’s
amended complaint alleged the enterprise was the corporation and the person was
the owner and operator of the corporation.
City of
It is important to note that even if Nexicon is upheld in the Second Circuit,
Additionally, the city seems to have
a very sound argument that the Second Circuit historically has accepted without
discussing the notion that both the person and the Corporate form are responsible
for the Jenkins Act reports.
The city has indicated they plan on appealing the district court’s decision and applying Kushner, Martin and the “McCullough test.” The city will likely prevail over the district court’s illusionary standard.
b. Racketeering
Activity
Racketeering activity is defined as “the commission of one of the predicate acts enumerated in 18 U.S.C. §1961(1).” Specifically, racketeering activity includes mail fraud in violation of 18 U.S.C. § 1341; wire fraud in violation of 18 U.S.C. § 1343; and violation of the Contraband Cigarette Act, 18 U.S.C. § 2341. As a result of Jenkins Act violations, the defendants commit mail fraud when they ship their cigarettes through the mail, and they commit wire fraud when they either advertise or sale their cigarettes over the internet. Additionally, although not premised on the Jenkins Act, any sell of cigarettes in violation of state tax laws is considered racketeering activity under the Contraband Cigarette Act.
In
2) Injury to Business or Property
Civil RICO’s second standing requirement is an injury to the plaintiff’s business or property. Hecht v. Commerce Clearing House Inc., 897 F.2d 21, 25 (2d Cir. 1990). §1964(c) expressly grants a private plaintiff the right to sue for damages caused by a RICO violation, and defines the proper recovery broadly. Here, the damage to the business is lost sales revenue and lost profit because consumers purchase cigarettes over the internet instead of at the traditional shops. The Second Circuit has consistently held lost profits are recoverable under Civil RICO.
In
Sound Video Unlimited, Inc. v. Video Shack, Inc., 700 F. Supp. 127 (S.D.N.Y. 1988), defendants argued a plaintiff
may not recover lost profits under Civil RICO.
The district court noted this was a question of first impression and looked
to authority from other federal district courts.
Since
the district court’s decision in Sound
Video, the Second Circuit has had several opportunities to contemplate the
availability of lost revenue or profit damages under Civil RICO. In Terminate
Control Corp. v. Horowitz, 28 F.3d
1335, 1343 (2d Cir. 1994), for example, the Second Circuit upheld
an award of profits to a contractor who established defendants' RICO conspiracy
caused the contractor to lose contracts which might have obtained “but for” the
illegal conduct. In Moore v. PaineWebber, Inc., 189 F.3d 165 (2d Cir. 1999), the court reversed the
grant of a motion to dismiss a RICO claim which alleged that, “but for” the
defendants' fraud, the plaintiffs would not have purchased the defendants'
investment packages, but would instead have invested their funds in a different
package. The court explained the
plaintiff adequately alleged a cause of action to recover "the foregone
returns of the alternative IRA or other retirement savings plan in which, “but
for” PaineWebber's misrepresentations, the plaintiffs ... would have placed the
money that they put into [PaineWebber's plan]."
Like in Sound Video, Termite Control and Moore, here the Plaintiff will need to plead and establish a loss of profit or revenue. If an expert can establish the amount of lost revenue in a manner that is not speculative, the standing requirement would be met.
3) Causation
The
clause “by reason of” in 18 U.S.C. §1964(c) limits standing to those plaintiffs
who allege the asserted RICO violation was the proximate cause as well as the
“but for” cause of their injury. Holmes v. Securities Investor Protection
Corp., 503
Here, the causation theory is relatively simple. Because of wire and mail fraud, the legitimate cigarette companies are loosing business to illegally operating IICVs. The Second Circuit has long held lost profits are recoverable when a competitor receives benefits from their scheme to defraud. In order to meet the causation requirements, it will be sufficient to plead loss of revenue as a proximate cause of the damages; and that the loss of revenue is reasonably foreseeable where the defendant advertises their cigarettes as tax free.
In
Lerner v. Fleet Bank, N.A., 318 F.3d
113 (2d Cir. 2003) the Second Circuit articulated a two part test to determine
proximate causation.
In
Ideal Steel, a retail outlet, National
Steel, attracted customers by not charging them sales taxes on cash purchases.
National
moved the court to dismiss the Civil RICO claim for lack of causation because
Ideal’s “business losses may have resulted from any number of economic factors
unrelated to National’s alleged practice of failing to charge and pay sales
taxes.”
The
Court reasoned that while generally the plaintiff in a civil RICO action must
prove reliance on the misrepresentations “in each of
the above cases in which we approved the summary dismissal of the complaint, we
noted that the plaintiffs were not competitors of the racketeering enterprise
or targets of alleged racketeering activity.”
In
Cyco.Net, New York City’s mail fraud
claim survived a motion to dismiss where the City alleged the failure of the internet companies
to file Jenkins Act reports meant the City had no way to place local taxes on
the cigarette buyers. Cyco.Net, 383
F. Supp. 2d at 560. This was so because
the city was reliant on the Jenkins Act reports to assess local taxes. The district court determined the reliance
element was met because the state relied on the internet tobacco companies to
file reports, and the city relied on the state to provide it with information
from the reports.
4) Damages
The IICVs failure to file Jenkins
Act reports makes it difficult to estimate the loss of tax and sales
revenue. However, Forrester Research has
estimated online sales would top more than $5 billion in 2005, equal to roughly
14% of total sales, with some $1.4 billion in lost tax revenue. GAO Report at 1. Specifically in
B. Potential
Hurdles
No good idea is unopposed and there will certainly be challenges to this lawsuit. The GAO Report identified the IICV’s main legal rationale for their decision to ignore the Jenkins Act’s reporting requirement. Over 40% of the IICVs surveyed indicated they were not required to report based largely on Native American sovereignty. GAO Report at 17. Several other IICVS claimed the Internet Tax Freedom Act supercedes the Jenkins Act reporting obligations. The IICVS wrongly rely on both defenses.
1. Native American Sovereignty
Businesses operating on Indian reservations continue to aggressively market tax-free cigarettes to non-Indian consumers via the internet, openly asserting Native American sovereignty exempts them from the Jenkins Act’s reporting requirements. The GAO Report found over 40% of the Internet companies surveyed claimed they were exempt from the Jenkins Act reporting requirements due to their sovereign status. There is no basis in law or fact for the internet companies reliance on sovereign status exemptions.
The
decision to ignore the reporting requirements is contrary to Supreme Court
precedent established in Moe v. Salish & Kootenai Tribes, 425 U.S. 463 (1976). In Kootenai
Tribes, the Supreme Court upheld
This
term the Supreme Court decided Wangon v.
Praire Band Potawatomi Nation, 126 S. Ct. 676 (2005), holding the State of
Kansas can tax fuel sold on American Indian reservations without violating
tribal sovereignty. The Tribe sought a
declaration that the collection of
Applying
the “who” test, along with Moe and Wangon, the excise tax falls on the non-indian
buyer, rather than the Indian seller. As
such, the tax in no way violates Indian sovereignty. Additionally the Jenkins Act is not a tax
statute, it is a reporting statute, and thus the requirements of the Jenkins
Act do not seek to tax any party.
2. Internet Tax Freedom
Act
The GAO report
indicated many IICVs intentionally violate the Jenkins Act because they believe
it has been superceded by the Internet Tax Freedom Act, P.L. 105-277, Div. C, Title
XI,
V. CONCLUSION
A Civil RICO claim against IICVs would likely survive all standing requirements and would face no significant challenge from sovereignty or ITFA defenses. The claim would successfully undermine the profitability of IICVs, allow for a sizable recovery for the plaintiff’s and help state’s collect excise tax revenue.
APPENDIX
TATE
EXCISE TAX RATES ON CIGARETTES
(
|
STATE |
TAX RATE |
|
|
STATE |
TAX RATE |
RANK |
|
|
42.5 |
39 |
|
|
64 |
30 |
|
|
160 |
7 |
|
|
80 |
25 |
|
|
118 |
16 |
|
|
80 |
25 |
|
|
59 |
32 |
|
|
240 |
2 |
|
|
87 |
23 |
|
|
91 |
22 |
|
|
84 |
24 |
|
|
150 |
10 |
|
|
151 |
8 |
|
|
30 |
45 |
|
|
55 |
35 |
|
|
44 |
38 |
|
|
33.9 |
44 |
|
|
125 |
13 |
|
|
37 |
41 |
|
|
103 |
18 |
|
|
140 |
11 |
|
|
118 |
16 |
|
|
57 |
33 |
|
|
135 |
12 |
|
|
98 |
21 |
|
|
246 |
1 |
|
|
55.5 |
34 |
|
|
7 |
51 |
|
|
36 |
42 |
|
|
53 |
37 |
|
|
79 |
27 |
|
|
20 |
48 |
|
|
30 |
45 |
|
|
41 |
40 |
|
|
36 |
42 |
|
|
69.5 |
29 |
|
|
200 |
4 |
|
|
119 |
15 |
|
|
100 |
19 |
|
|
30 |
45 |
|
|
151 |
8 |
|
|
202.5 |
3 |
|
|
200 |
4 |
|
|
55 |
35 |
|
|
123 |
14 |
|
|
77 |
28 |
|
|
18 |
49 |
|
|
60 |
31 |
|
|
17 |
50 |
|
Dist. of Columbia |
100 |
19 |
|
|
170 |
6 |
|
|
|
|
|
|
|
|
|
U. S. Median |
80.0 |
|
[1] I’d like to thank Eric Proshansky, Assistant
Corporation Counsel for the City of New York, for his assistance in providing
many of the briefs and arguments from City
of New York v. Cyco.Net, 383 F. Supp.2d 526 (2005). The briefs were invaluable in helping to sort
out the issues and develop a strategy for a private cause of action.
[2] The current excise taxes for each state are attached as Appendix A.
[3] M. Tsai, Crackdown
On Otamedia Could Help
[4] All 147 companies are listed with business addresses
and website addresses in the GAO Report.
[5]
Medscape, http://www.medscape.com/viewarticle/469253_print
(last visited
[6]
http://www.tobacco.neu.edu/litigation/resources/internet/NYC_Internet_Case.pdf, last
visited
[7] Nexicon and
Cyco.Net are the same case. Cyco.Net was sold to Nexicon in
[8] http://www.factalliance.org/facts.html, last accessed
[9] The