In one of the most significant white-collar crime rulings in recent memory, the Supreme Court last Thursday in Skilling v. United States, 561 U.S. ___ (2010) (Case No. 08-1394) held that 18 U.S.C. § 1346, the so-called "honest services" statute, covers only bribery and kickback schemes, considerably limiting the scope of the statute, which, for years, has been considered among the most powerful weapons available to federal prosecutors. In response to an earlier Supreme Court decision, McNally v. United States, 483 U.S. 350 (1987), a public corruption case that limited the scope of the mail fraud statute to schemes for obtaining "money and property" by false promises or representations, § 1346 was enacted in 1988 to broaden the scope of mail and wire fraud to include "a scheme or artifice to deprive another of the intangible right of honest services." Although primarily intended to target public corruption cases – where it is often difficult to prove a monetary or property loss to a third party – prosecutors almost immediately began to apply the new statute to cases involving self-dealing and conflicts-of-interest in the private sector. However, courts struggled to determine the scope and reach of § 1346, which resulted in a confusing landscape of decisions and an unclear picture of precisely what type of conduct constitutes the denial of "honest services." The Skilling decision, in a widely followed case involving Jeffrey Skilling, the former CEO of Enron Corp., has now largely resolved that uncertainty.

In a decision authored by Justice Ginsburg, the Court held that Congress‟s intent in prohibiting fraudulent deprivations of "the intangible right of honest services" was "at least to reach schemes to defraud involving bribery and kickbacks," and that to extend the statute‟s reach beyond that "core meaning" would present vagueness problems, rendering it unconstitutional. 561 U.S. ___ at 1-2. The Court thus held that § 1346 covers only bribery and kickback schemes. Because Skilling‟s alleged misconduct – denying Enron of his "honest services" as the company‟s CEO through the manipulation of Enron‟s public financial records – did not involve any bribe or kickback, the Court held that it did not fall within § 1346‟s proscription. As a result, the Supreme Court remanded the case to the Fifth Circuit for consideration of whether it was harmless error for Skilling to have been convicted of conspiracy on an honest services theory, or whether every count of the conviction was tainted by the honest-services charge. Id. at 2. However, the Supreme Court rejected Skilling‟s argument that § 1346 was unconstitutionally vague in its entirety.

The Skilling Case

Skilling was charged with engaging in a scheme to deceive investors about Enron‟s financial performance by manipulating the company‟s financial reports and making various false and misleading statements. After a highly publicized four-month criminal trial in federal court in Houston, Texas, Skilling was convicted of 12 counts of securities fraud, five counts of making false statements to accountants, one count of insider trading, and one count of conspiracy with one of the objects being that Skilling had denied his employer of his "honest services" by manipulating Enron‟s financial records. Skilling was later sentenced principally to 292 months‟ imprisonment. After the Fifth Circuit rejected his argument that his conduct plainly did not constitute honest-services fraud and declined to address his argument that § 1346 should be invalidated as unconstitutionally vague, Skilling filed a petition for a writ of certiorari to the Supreme Court.

The Honest-Services Statute Applies Only to Schemes Involving Bribes or Kickbacks

The majority opinion in Skilling began by reviewing the origin and subsequent application by the lower courts of the honest-services doctrine under the mail fraud statute, noting that while most cases involved bribery of public officials, many of these courts also recognized private sector honest-services fraud. Id. at 35-36.1 The Court then noted that following the McNally decision in 1987, in which the Court held that a kickback scheme involving a state officer did not qualify as mail fraud because the statute was limited to the protection of property rights, rather than the intangible right to have the state‟s affairs conducted honestly, the Court invited Congress to enact a statute covering the conduct at issue. Congress acted swiftly in enacting § 1346 the following year. Id. at 37-38.

In rejecting Skilling‟s challenge that § 1346 was unconstitutionally vague, the Court attempted to salvage as much as possible of what Congress intended § 1346 to cover. The Court stated that most of "the pre-McNally cases involved fraudulent schemes to deprive another of honest services through bribes or kickbacks supplied by a third party who had not been deceived," and that limited to these "paramount applications," § 1346 was not unconstitutionally vague. Id. at 39-40.

The Court declined to endorse the government‟s position that § 1346 could encompass a third category of conduct, namely "undisclosed self-dealing by a public official or private employee – i.e., the taking of official action by the public official or employee that furthers his own undisclosed financial interests while purporting to act in the interests of those to whom he owes a fiduciary duty.‟" Id. at 45. The Court stated that the varied conflict-of-interests prosecutions that had been brought under § 1346 were an "amorphous category of cases," rather than core applications of the honest-services doctrine that, by application of a reasonable limiting construction, must be excluded in order to avoid unconstitutional vagueness. Id. at 46.

The Court invited yet another round of Congressional action, stating that Congress must act if it wishes to go farther than encompassing only bribes and kickbacks and that, if it decided to criminalize undisclosed self-dealing as the government urged, it "would have to employ standards of sufficient definiteness and specificity to overcome due process concerns." Id. at 47, n. 45. The Court cautioned that Congress would have to take "particular care in attempting to formulate an adequate criminal prohibition in this context" so as to avoid unanswered questions, such as: "How direct or significant does the conflicting financial interest have to be? To what extent does the official action have to further that interest in order to amount to fraud? To whom should the disclosure be made and what information should it convey?" Id.

Because the government had not alleged that Skilling solicited or accepted side payments from a third party in exchange for making misrepresentations about Enron‟s financial health, the Court held that it was therefore "clear" that Skilling did not commit honest-services fraud. Id. at 50. Yet, since the indictment alleged two other objects of the conspiracy in addition to honest-services wire fraud, namely money-or-property wire fraud and securities fraud, the Court remanded the case to the Fifth Circuit for a determination of whether (i) the constitutional error that occurred as a result of the jury returning a verdict on a legally invalid theory was harmless error; and (ii) reversal on the conspiracy count would require reversal of all other counts for which Skilling was convicted because they all hinged on the conspiracy count. Id. at 50-51.2

Applying Skilling: The Conrad Black and Weyhrauch Cases

On the same day as it decided the Skilling case, the Court also issued decisions in two other cases involving prosecutions under § 1346.

First, applying Skilling, the Court issued a decision in the case of Conrad Black, who served as CEO of Hollinger International, a public media company that owned newspapers in the U.S. and abroad. In 2005, Black and other Hollinger executives were indicted for mail fraud based on charges of stealing millions of dollars from Hollinger by paying themselves fraudulent "noncompetition fees" without disclosing those fees to the company‟s shareholders. At trial, the government advanced a traditional fraud theory that the amount paid in non-compete fees to Black and his associates was so egregiously high that they must have been the result of a sham operation. The defense team countered that the noncompete fees were simply a recharacterization of legitimate fees owed to Black and his colleagues, designed to give those individuals favorable treatment under Canadian tax law. Under the defense‟s theory, Hollinger would not have suffered any monetary or property loss because the amounts paid to Black and his colleagues were legitimately owed to them, but arguably would have been denied the honest services of Black and his colleagues, who failed to disclose this recharacterization to the company. 561 U.S. ___, 2 (2010) (Case No. 09-976). The district court instructed the jury as to both theories and, over the defendants‟ objection, specifically with respect to honest-services, instructed the jury that a "person commits honest-services fraud if he misuse[s] his position for private gain for himself and/or a co-schemer‟ and knowingly and intentionally breache[s] his duty of loyalty.‟" Id. at 3. Black and his co-defendants were found guilty of mail fraud, and Black was also found guilty of obstruction of justice. Id. at 4.

On appeal to the Seventh Circuit, Black and his co-defendants argued that the jury instructions in the case on honest-services were invalid because Hollinger, the party to whom honest services were owed, did not suffer any economic or property harm as a result of their activities. In upholding their convictions, the Seventh Circuit, in an opinion authored by Judge Easterbrook, held that despite Black and his co-defendants‟ objection to the honest-services jury instructions at trial, they waived their objection on appeal because they opposed the government‟s request for special verdict forms. In reviewing that decision, the Supreme Court held that the application of § 1346 to schemes involving conduct other than bribery or kickbacks was inconsistent with the Court‟s opinion in Skilling, thus rendering the jury instructions improper (and that no waiver occurred). Id. at 5. The Court found that Black's conduct did not constitute honest-services fraud under the standard articulated in Skilling and remanded the case for determination of whether the error was ultimately harmless or whether "spillover prejudice" from evidence introduced on the mail-fraud counts requires reversal of Black‟s obstruction-of-justice conviction. Id. at 8.

Second, the Supreme Court also issued a per curiam decision in a case involving Bruce Weyhrauch, a lawyer in Alaska who has been charged (but not yet tried) with honest-services fraud pursuant to § 1346 for failing to disclose, while serving on the Alaska State Legislature, that he was allegedly trying to obtain work from VECO Corp., an oil field services company, at the same time that VECO was lobbying him to vote for certain favorable tax measures. Before trial, Weyhrauch argued that because he had no duty to disclose the conflict of interest under Alaska state law, the government should be precluded from introducing evidence that he knowingly concealed a conflict of interest. Agreeing with Weyhrauch, the district court in Alaska held that it would be inappropriate to admit evidence of the conflict of interest where Alaska state law did not impose such a duty to disclose the conflict. The government appealed on an interlocutory basis to the Ninth Circuit, which overturned the district court‟s decision and held that the case against Weyhrauch could proceed even though the government could offer no proof that Weyhrauch had a duty to disclose his conflict of interest under Alaska state law.

Weyhrauch sought review from the Supreme Court on the issue of "whether, to convict a state official for depriving the public of its right to the defendant‟s honest services through the non-disclosure of material information, in violation of the mail-fraud statute (18 U.S.C. §§ 1341 and 1346), the government must prove that the defendant violated a disclosure duty imposed by state law." Petition for a Writ of Certiorari, Weyhrauch v. U.S., 561 U.S. ___ (Case No. 08-1196). In a one sentence per curiam opinion, the Supreme Court remanded the case to the Ninth Circuit for further consideration in light of its decision in Skilling.

The Future of the Honest-Services Statute

While the Supreme Court‟s decision in Skilling defines a bright-line standard for the types of activities that may be prosecuted under § 1346, namely those involving bribery and kickbacks, as Justice Scalia pointed out in his concurring opinion, there are still open questions as to the statute‟s application. It also remains to be seen how many other § 1346 cases will be reexamined in light of the Skilling decision and how prosecutors will adapt to the new limitations articulated by the Court in pursuing public corruption and white collar cases. Indeed, on June 29, 2010, the Supreme Court ordered the Eleventh Circuit to re-examine its decision affirming the bribery and conspiracy convictions of Richard Scrushy, former Chairman of HealthSouth Corp., and former Alabama governor, Don Siegelman.

Moreover, given its current focus on financial fraud, Congress may accept the Supreme Court‟s invitation to take another crack at crafting honest-services fraud legislation that more clearly articulates the precise type of conduct, beyond bribery or kickbacks, which it wishes to criminalize, if any. In the meantime, it will be interesting to see whether prosecutors will embrace the Court‟s limitation of § 1346 with a new zealousness for targeting bribery and kickback schemes, which are notoriously difficult to detect, or whether there will be some effort to frame a myriad of allegations in terms of bribery or kickback schemes in an effort to continue the broad reach of § 1346.

Footnotes

1 For further detail regarding the history of the honest-services doctrine, see Audrey Strauss, Supreme Court to Review 'Honest Services', 242 N.Y.L.J. 2 (2009).

2 The Supreme Court separately addressed a challenge that the large volume and negative tone of the pre-trial publicity surrounding the collapse of Enron resulted in an unfair trial. Id. at 9-10. With regard to that issue, the Court held that Skilling failed to establish that a presumption of juror prejudice arose or that actual bias infected the jury, thus affirming the decision of the Fifth Circuit. Id. at 1.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.