Washington Lawyer

Honest-Services Fraud

From Washington Lawyer, December 2010

By Anna Stolley Persky

bennettAlmost 10 years ago, Enron Corporation crashed into bankruptcy. Unquestionably, we are still feeling the reverberations, from the current economic crisis to new laws and regulations governing corporate conduct. And, to this date, federal prosecutors are still trying to show that they can, indeed, be tough on corporate crime.

At the time of Enron’s demise, former chief executive officer Jeffrey K. Skilling’s creative financing solutions were the subject of scorn, eventually leading to criminal charges. In 2004 he was indicted on 36 counts of fraud, insider trading, and other crimes. In 2006 Skilling was found guilty of 19 counts of conspiracy, securities fraud, insider trading, and lying to auditors.

Prosecutors from the U.S. Department of Justice thought they had finally caught Skilling, proving they could punish corporate wrongdoers. But in their zeal, prosecutors may, in fact, have done more harm than good to the prosecutorial cause.

On June 24, 2010, the U.S. Supreme Court sent Skilling’s case back because of a particular section under which he was charged: section 1346 of title 18 of the U.S. Code, which makes it illegal to engage in “a scheme or artifice to deprive another of the intangible right of honest services.”

In reversing, the justices unanimously ruled that a broad interpretation of the law was unconstitutionally vague. Justice Ruth Bader Ginsburg, writing for the majority, said the deprivation of honest services should be limited to cases of bribery or kickbacks.

Convictions in Jeopardy?
According to criminal defense lawyers, honest–services fraud has been a 28–word “catch–all” provision helping prosecutors nab their prey in even the weakest of cases. According to prosecutors, it is a law targeted to catch the greediest of criminals who would otherwise escape prosecution.

“Prosecutors used to be able to use the statute as a tool for anything that looked unseemly, like an undisclosed conflict of interest,” says Timothy P. O’Toole, a Washington, D.C.–based lawyer specializing in white collar criminal defense at Miller & Chevalier Chartered. “That particular theory is dead.”

Criminal defense lawyers and academics are nevertheless busy reviewing the Court’s decision to understand its full impact. It is as yet unclear to what extent the ruling can be applied retroactively, and whether a slew of convictions are in jeopardy of reversal. Criminal law experts also are attempting to parse out what elements of the once-powerful tool actually remain intact.

“The Supreme Court left standing a law focused on when a public official or a private individual with a fiduciary duty takes bribes or kickbacks,” O’Toole says. “Yes, that’s what’s left. But what does that exactly mean?”

Certainly, prosecutors and their advocates are worried that the ruling will result in a slew of criminals escaping punishment.

Melanie Sloan, executive director of Citizens for Responsibility and Ethics in Washington (CREW), says the Supreme Court “took away a very important tool for fighting public corruption.”

“Because there had been so many prosecutions under honest–services fraud, officials were on warning that taking gifts could be used against them in an indictment,” Sloan says.

Sloan warns that public officials “now know how much harder it will be for the government to bring charges against them and will be less cautious in their behavior.”

As Washington Lawyer went to press, Skilling was scheduled for a federal appeals court hearing on his request for a retrial. In the meantime, he is serving a 24–year prison sentence in a Colorado penitentiary.

“The government tried the honest-services fraud theory in tandem with a securities fraud theory,” says Daniel Petrocelli, the lead attorney for Skilling. “There was substantial argument and evidence presented in support of the flawed theory, and they can’t make it vanish into thin air. In our view, it’s impossible under any fair reading of the record to conclude that this was harmless error.”

Fuzzy, Fuzzy Situations’
Criminal defense lawyers have long complained that prosecutors toted out the honest–services fraud theory whenever they lacked enough evidence for other crimes with higher proof requirements. The statute, they say, is bereft in legislative history to explain its scope and, therefore, was used to cover a wide range of activities that may or may not otherwise be illegal.

“There was such ambiguity in what was covered by the statute that it enabled a jury to convict somebody in very fuzzy, fuzzy situations,” says Robert S. Bennett, a well-known criminal defense lawyer and a partner at Hogan Lovells in its Washington, D.C., and New York offices. “It’s true that after this ruling, people who engaged in questionable conduct may not be held accountable, but it will force prosecutors to bring better cases—and that is a good thing.”

The list of recent prosecutions under the honest-services fraud theory includes some high–profile names. Former New York senate majority leader Joseph L. Bruno and former governors George Ryan of Illinois and Don Siegelman of Alabama are just some of the famous politicians convicted of deprivation of honest services.

At the time of the High Court’s ruling, the Justice Department released the following statement:

While we are disappointed that today’s Supreme Court decisions narrowed the honest services statute, we are pleased that the court upheld many of the core provisions that have been used for decades to prosecute corrupt public officials and corporate executives who have breached their duties to their constituents, clients, and investors.

The American people are entitled to the honest services of both public servants and corporate executives, and the Department will continue to bring all appropriate cases in order to hold corrupt officials accountable for their actions.

In a hearing in September, Assistant Attorney General Lanny Breuer asked that Congress pass legislation to “fill the gap” created by the Court’s decision. “[O]ne of the tools that we have relied upon for more than two decades was significantly eroded” by the Court’s ruling, Breuer said.

Intangible Rights
Enacted in 1872, the original mail fraud law criminalized the use of mails to advance “any scheme or artifice to defraud.” In 1909 Congress amended the statute to prohibit any scheme or artifice to defraud, or to obtain money or property by means of false or fraudulent pretenses, representations, or promises. The question remained whether Congress intended to include not just money or property, but also intangible rights.

Honest-services fraud was born in 1941, from a case in which a public official received bribes in exchange for favoritism in a city contract. The Fifth U.S. Circuit Court of Appeals said that even though the city saved money in the end, a scheme to defraud the public should not be tolerated because it denied the public its right to honest services.

“It is not true that because the [city] was to make and did make a saving by the operations there could not have been an intent to defraud,” the court found in Shushan v. United States.[1] “A scheme to get a public contract on more favorable terms than would likely be got otherwise by bribing a public official would not only be a plan to commit the crime of bribery, but would also be a scheme to defraud the public.”

A strict quid pro quo was not required in these cases. In other words, both sides did not have to benefit in order for the deal to be considered fraud. As case law developed, honest–services fraud could be applied to both public officials and private individuals. Courts also expanded the mail fraud and honest-services fraud concepts to include intangible rights, such as privacy violations.

In 1987 the Supreme Court jumped into the fray in McNally v. United States.[2] The case involved a Kentucky state official who selected the state’s insurance agent and, in the process, arranged to get a share of the agent’s commissions through kickbacks paid to the companies that official partially controlled. The prosecutor argued that the kickback scheme defrauded the citizens and government of Kentucky from having their state’s affairs conducted honestly.

In McNally the Supreme Court limited the mail and wire fraud statutes, including the deprivation of honest services, to the protection of tangible property rights. The Court said that Congress could, at any time, explicitly include intangible rights as protected under the statutes.

“At the time, there was this uproar from the prosecuting community that this was going to deny them the necessary tools to put away corrupt officials and employees,” says Robert Plotkin, a partner at McGuireWoods LLP and head of the firm’s U.S. Securities and Exchange Commission defense enforcement practice group. “Congress heard them, loud and clear.”

Just one year after the Court’s ruling, Congress amended the mail and wire fraud statutes to include “a scheme or artifice to deprive another of the intangible right of honest services.” But despite this amendment, Congress left undefined what constitutes the right of honest services, who is entitled to the right, and what actions constitute a scheme to defraud.

Setting Up Perimeters
Since 1988, prosecutors have been charging honest-services fraud with increasing frequency in both public and private sector corruption cases.

“In public corruption cases, it allowed prosecutors to prove a pattern of gifts to public officials, a pattern of ‘you scratch my back, I’ll scratch yours’ that didn’t quite meet the higher evidentiary hurdles of the bribery statutes,” says Randall D. Eliason, former chief of the Public Corruption/Government Fraud Section of the U.S. Attorney’s Office for the District of Columbia.

The honest–services fraud theory was key in some high-profile prosecutions, including a string of cases involving former lobbyist Jack Abramoff. And prosecutors used the same theory against corporate executives such as former HealthSouth Corporation founder and chief executive officer Richard Scrushy.

“The honest services theory was used in a variety of contexts and in very different fact scenarios,” says David Z. Seide, a partner focusing on white collar crime at Curtis, Mallet-Prevost, Colt & Mosle LLP. “It had great application. It was in the heartland of often–used statutes.”

But there has been a series of cases, according to criminal defense lawyers, that heightened concerns that prosecutors were targeting seemingly ambiguous conduct.

In 2006 a case against a mid-level state employee raised more than a few eyebrows. Georgia Thompson, a Wisconsin state employee, was part of a panel that considered competitive bids for the state’s travel contract. Thompson was indicted on charges that she steered the contract to a company that contributed to the governor’s reelection campaign. However, the travel company also happened to be the lowest bidder. During her trial, federal prosecutors argued that Thompson received praise and a $1,000 raise for her efforts.

Thompson was convicted of two felonies, including honest-services fraud. In an unusual move, the Seventh Circuit Court of Appeals, at the end of oral arguments, ordered Thompson immediately released from federal prison.

A little more than two weeks after ordering her release, the court issued its written opinion in United States v. Thompson.[3] “The United States has not cited, and we have not found, any appellate decision holding that an increase in official salary, or a psychic benefit such as basking in a superior’s approbation (and thinking one’s job more secure) is the sort of ‘private gain’ that makes an act criminal” under the key sections, Chief Judge Frank H. Easterbrook wrote for the unanimous panel.

Easterbrook suggested that Congress might want to take another look at the “wisdom of enacting ambulatory criminal prohibitions.” Easterbrook further wrote: “Haziness designed to avoid loopholes through which bad persons can wriggle can impose high costs on people the statute was not designed to catch.”

Thompson’s case depicts why the Supreme Court likely felt compelled to take on the issue of the perimeters of honest-services fraud, criminal defense lawyers say.

“She picked the lowest bidder, and she ended up in jail?” says Peter R. Zeidenberg, a litigation partner specializing in white collar criminal cases at DLA Piper LLP. “That case just shows how this statute was being pulled and twisted into shapes it shouldn’t have gone.”

The Skilling Story
While the Supreme Court ultimately picked up three cases involving honest-services fraud, the case that received the most scrutiny was Skilling’s winding, tortured tale.

Anyone who has followed the story of Enron, the once-great energy trader, knows that Skilling played a pivotal role in the company’s success and ultimate failure.

Skilling is often credited with taking Enron from a relatively obscure natural gas pipeline company to an energy trading powerhouse. But Skilling’s talent also lay in creating innovative techniques to help Enron appear healthy when it was actually in a weakened state. In August 2001, Skilling resigned unexpectedly. Less than four months later, Enron spiraled into bankruptcy. The company’s stock plunged from $90 per share in August 2000 to pennies per share in late 2001.

The Justice Department created the Enron Task Force to figure out what went wrong and who was to blame. The government’s investigation uncovered what it described as a complicated conspiracy to prop up Enron’s stock prices by overstating its financial health.

In 2004 a federal grand jury indicted Skilling, Enron founder and former chair Kenneth Lay, and Richard Causey, the defunct company’s former chief accounting officer. The indictment alleged that by lying to Enron’s shareholders and the investing public about Enron’s state of finances, Skilling denied them their right to his honest services. In addition, Skilling, Lay, and Causey were accused of enriching themselves through salary, bonuses, stock options, and other profits.

According to Petrocelli, “the government had a wafer-thin case on securities fraud, so they relied on honest services as key pillar of their case.”

“I believe they thought it was easier to prove, that it covered and criminalized any manner of acting inappropriately. It was an extremely broad and amorphous concept,” says Petrocelli, a partner in the Los Angeles, California, office of O’Melveny & Myers LLP.

Causey eventually entered a guilty plea before trial. Lay was found guilty of fraud and other crimes, but died before sentencing. Skilling’s case made its way to the Supreme Court, which heard arguments in March.

Smorgasbord Offerings
The High Court ruled in June. In sending Skilling’s case back to the lower court, Justice Ginsburg stated that when it is interpreted to encompass only bribery and kickback schemes, honest-services fraud stays within the Fifth Amendment guarantee that “no person shall be … deprived of life, liberty or property, without due process of law.”

“A prohibition on fraudulently depriving another of one’s honest services by accepting bribes or kickbacks presents neither a fair–notice nor an arbitrary–prosecution problem,” Ginsburg wrote.

“As to fair notice, it has always been clear that bribes and kickbacks constitute honest-services fraud, and the statute’s mens rea requirement further blunts any notice concern. As to arbitrary prosecutions, the Court perceives no significant risk that the honest-services statute, as here interpreted, will be stretched out of shape.” (Citations omitted.)

Ginsburg concluded that reading the statute “to proscribe a wider range of offensive conduct, we acknowledge, would raise the due process concerns underlying the vagueness doctrine.”

But despite the majority’s holding, the ruling was far from clear-cut. Justices Antonin Scalia, Anthony Kennedy, and Clarence Thomas said in a concurring opinion that the law should have been eviscerated completely, rather than limited in scope.

“Among all the pre-McNally smörgåsbord-offerings of varieties of honest-services fraud, not one is limited to bribery and kickbacks,” Scalia wrote. “That is a dish the Court has cooked up all on its own.”

Skilling’s lawyers also argued that he did not get a fair trial due to intense news coverage and Houston jurors distressed by Enron’s collapse. However, the Supreme Court rejected those arguments, 6–3.

The justices also sent back to the appeals court an honest-services fraud case against media baron Conrad M. Black. The Seventh Circuit Court of Appeals in Chicago heard arguments in September, but has not yet rendered a decision.

In a brief, unsigned opinion, the justices also returned a third honest-services case to the lower court. The case involves former Alaska legislator Bruce Weyhrauch, accused of failing to disclose soliciting work from a company with business before the state legislature.

Parade of Cases
Even though it is clear that the Supreme Court narrowed the scope of honest-services fraud, it left room for debate, interpretation, and, inevitably, litigation. In any review of a Supreme Court decision, the question inevitably pops up: In what contexts can the decision be applied retroactively? At this point, criminal defense lawyers and prosecutors alike are trying to untangle the decision’s retroactivity and impact.

“There has been a concern that there would be a parade of cases that would be overturned as a result,” says Eliason, who teaches white collar crime at the law schools of American University and The George Washington University. “That remains to be seen.”

A few days after its decision in Skilling v. United States, the Supreme Court ordered an appeals court to review the twin convictions of Siegelman and Scrushy. At their respective trials, Siegelman and Scrushy were found to have engaged in a bribery and kickback scheme, with Siegelman rewarding Scrushy a seat on a state health care board in exchange for a $500,000 contribution to Siegelman’s campaign for a state lottery. But their lawyers have repeatedly argued that there never was an explicit quid pro quo agreement between the two.

In July, a federal judge in New Jersey vacated the fraud conviction of Joseph A. Ferriero, former chair of the Democratic Party in Bergen County. That conviction had been based, in part, on the honest-services provision.

And lawyers for David Zachary Scruggs, law firm partner and son of trial lawyer Richard F. Scruggs, already are requesting that his guilty plea be vacated. In March 2008, Scruggs pleaded guilty to failing to report an illegal conversation with the judge in a legal fees lawsuit over Hurricane Katrina insurance cases. Prosecutors built its case against Scruggs and his father on the notion that the chat led to a scheme to deprive the public of Circuit Judge Henry Lackey’s “honest services.”

Scruggs now argues in court papers that the changing perimeters of honest-services fraud show that the basis for prosecutors’ claims was faulty, and that the crime he is accused of committing is no longer considered a crime.

Judges will soon have to examine cases with multiple convictions and determine whether the entire trial became inextricably tainted when it was prosecuted side by side with accusations of honest-services fraud.

“The government will likely argue that it was harmless error because there was this other conviction, and defense lawyers will likely argue that the tainted convictions poisoned the jury and affected the trial outcome on the other charges,” Seide says. “Judges will have to rule on each case based on the facts. It’s going to be very fact-intensive.”

Cases Thwarted
Justice Department officials have expressed concern that the limits on honest–services fraud will hamper efforts to fight corporate crime. But most defense attorneys say prosecutors have more than enough weapons in their arsenal to go after white collar criminals.

“The government has so many tools to go after fraud that the truth is, they don’t need the honest-services statute,” says Barry J. Pollack, who practices white collar criminal defense at Miller & Chevalier.

Pollack asserts that narrowing the applicability of honest-services fraud could actually benefit prosecutors by forcing them to tighten their cases, rather than shooting for the most creative option.

“Defense lawyers love it when the government overreaches because it gives us something to shoot at,” Pollack says. “When the government starts off with a tight case, it does not leave the defense with as many opportunities to poke holes in it.”

But legal observers predict the Justice Department nevertheless will be thwarted from prosecuting a number of cases it is planning to pursue. In fact, in recent months, the department has informed a number of public officials who had been targets of criminal investigations that they would not be prosecuted.

In August, for example, prosecutors filed a motion to dismiss the fraud case they had aggressively pursued for seven years against former Westar Energy, Inc. executives Douglas Lake and David Wittig. Their first trial ended in mistrial because of disagreements among the jurors. While the second trial resulted in convictions, the 10th U.S. Circuit Court of Appeals reversed in 2007.

“The law no longer supported our position,” said Barry Grissom, U.S. Attorney in Kansas, in a statement. “We were duty-bound not go forward with prosecution.”

Some observers, however, say the Justice Department’s decision to bow out may have more to do with the case’s troubled path, than with the specific Supreme Court ruling.

“This is a case that had all kinds of problems for the government,” Pollack says. “Truthfully, this may have just been a graceful way for the government to fold its tent and go home.”

Left to Untangle
In the wake of the High Court’s ruling, criminal defense lawyers, prosecutors, and academics are mulling over what’s left of honest-services fraud.

“What’s left to untangle is how the elements of basic fraud fit into the honest-services fraud provision now. Do prosecutors have to show a misrepresentation of fact? It’s my belief that they do,” O’Toole says.

In Skilling, Ginsburg emphasized that honest-services fraud cases usually involve payments supplied by a third party who is not being deceived. Therefore, the victim—whether the public or a private company—need not have provided the benefit, just that the defendant received a benefit as the result of a bribe or kickback. However, as O’Toole points out, the Court never defined either bribe or kickback.

“You could see prosecutors who might want to test the limits of the statute as it is now, and apply it to situations without an express agreement,” says O’Toole, former chief of the Special Litigation Division of the Public Defender Service for the District of Columbia.

O’Toole cites a situation he describes as “corporate hospitality,” where a corporation might take a potential client, like a middle manager at another corporation, out to fancy dinners, and then that middle manager ends up giving them business.

“That would be a crazy theory of prosecution unless you could show an express agreement, but it certainly is potentially out there,” he says. “It’s how the world works, but certainly somebody could try to say that it is bribery.”

Judges across the country are wrangling with how to apply the statute in the wake of the High Court’s ruling. In August, a federal judge in the District ruled that a second corruption case against former congressional aide Kevin Ring could continue. Ring, facing honest-services fraud charges, among others, is accused of conspiring with convicted ex-lobbyist Abramoff.

U.S. District Judge Ellen Segal Huvelle struggled with what to tell a jury about the requirement that Ring and public officials must be proven to have violated a “lawful duty” to the public, according to the Web site Main Justice.

“I can’t even define for myself what a ‘lawful duty’ is,” said Huvelle during a court hearing. “How am I supposed to define it for a jury?”

Natural Consequence
Both supporters and detractors of the aggressive use of honest-services fraud say that it allowed prosecutors to pursue behavior that fell under no other criminal statute. But some observers say there will certainly be other conduct that will once again fall through the cracks.

“Defense attorneys all cheered because of a general view that the statute was overused or misused in cases where conduct was perhaps unethical, but not necessarily illegal,” DLA Piper’s Zeidenberg says. “But you are going to have situations where the conduct perhaps should be illegal, but doesn’t quite fit into any category. Inevitably, some people will slide by and not be punished—that’s a natural consequence of forcing the government to be more specific in its charges.”

The theory of honest-services fraud had found its way into both public official and private corporation cases. But lawyers say the biggest impact of the ruling will be in the public sector.

“The government might now shy away from some of those cases that operate in the gray, such as somebody having an undisclosed interest in the outcome of a piece of legislation,” Pollack says. “Those cases can be dealt with more effectively through the political process than by criminalizing our system of lobbying, anyway.”

In the private context, there is a question as to whether employees who once could be held accountable for conduct that did not quite meet the traditional elements of fraud will now recognize that they are free to blur the lines once again.

Zeidenberg doesn’t think the decision will have much impact on mid-level or even upper-tier management.

“It never had that much of a deterrent effect in those situations. Someone in a private firm ripping off [his or her] employer didn’t really think, I could be found guilty of a scheme to defraud,” Zeidenberg says. “There are other punishments—disciplinary action, being fired. Those are pretty significant. But in this context, for prosecutors to become involved, it’s literally making a federal case out of a private employment beef.”

Lawyers also point out that the government can still sue for any material misrepresentation in the investment context.

Congressional Fix
But supporters of an expansive use of honest-services fraud are looking once again to Congress to amend the law.

The nonprofit group CREW has been shopping around a congressional fix in the aftermath of the Supreme Court ruling. CREW is proposing to amend section 208 of title 18 of the U.S. Code, the conflict-of-interest statute that applies to the executive branch, so that it applies to members of Congress and their staff, as well as state and local officials.

“It’s critical that our public officials be focused on the public interest and not their own financial interest,” says Sloan, the executive director of CREW.

Eliason also says Congress “needs to preserve the ability of prosecutors to go after public corruption cases by refining the applicable statutes to include self-dealing and Abramoff-style strings of bribes or gratuities.”

In September, Senate Judiciary Committee Chair Patrick Leahy (D–Vt.) introduced legislation to specifically expand the honest-services statute to cover undisclosed self-dealing. The Honest Services Restoration Act would prohibit public officials and corporate officers and directors from secretly acting in their own financial interest at the expense of the public or the company for which they work.

But Congress also may want to follow the High Court’s warning. In a footnote in Skilling, the Supreme Court suggested that if Congress were to add new crimes under the law, it should do so with “particular care.” The Court also noted that if Congress chooses to criminalize conduct like undisclosed self–dealing without requiring proof of a bribe or kickback, it will find it difficult to do so without creating yet another unconstitutionally vague statute.

Some criminal defense lawyers say, albeit tentatively, that congressional clarity on the topic could be a positive development, if done with care.

“If there’s going to be a statute criminalizing deprivation of honest services, it would be a good thing to have the terms properly defined,” says Plotkin, who handles financial fraud and securities violations cases at McGuireWoods. “Whenever something is a crime, it’s a good thing to have it well defined so that people can know what they can and can’t do. Clarity and specificity would be very helpful.”

Notes
[1] Shushan v. United States, 117 F.2d 110 (1941).
[2] McNally v. United States, 483 U.S. 350.
[3] United States v. Thompson, 484 F.3d 877 (2007).

Freelance writer Anna Stolley Persky wrote about the changing school environment and its impact on the constitutional rights of students in the September 2010 issue of Washington Lawyer.