In Johnson v. United States, the Second Circuit clarified the limits of federal fraud liability while also underscoring the challenges prosecutors face when relying on alternative theories of fraud in complex financial transactions.
The Transaction and the Theories of Fraud
Mark Johnson, former global head of a bank and financial services group's foreign exchange (FX) trading desk, was convicted in 2017 of wire fraud and conspiracy to commit wire fraud. The charges stemmed from a 2011 transaction in which an energy client sold its Indian subsidiary for $3.5 billion and converted the proceeds to pounds using a "fix" benchmark exchange rate transaction structure. The government presented two theories at trial against Johnson:
- Right-to-Control Theory: Johnson allegedly deprived the energy client of information necessary to make discretionary economic decisions, specifically by misleading it about the bank's trading strategy and the risk of "ramping" up the fix benchmark in such a way that would increase the bank's profits.
- Misappropriation Theory: Johnson allegedly breached a duty to the energy client by using confidential information to make proprietary trades that benefited the bank at the energy client's expense.
The jury returned a general verdict, convicting Johnson without specifying which theory it relied upon, and he was sentenced to 24 months' imprisonment. On appeal, the Second Circuit upheld his conviction on the right-to-control theory, expressly deciding not to reach his arguments on the misappropriation theory.
The Supreme Court's Ciminelli Decision and Its Aftermath
As Johnson was completing his sentence, the Supreme Court decided Ciminelli v. United States, holding that the right-to-control theory is not a valid basis for federal fraud liability. Johnson promptly sought a writ of coram nobis, arguing that his conviction could not stand because the jury may have relied on the now-invalid theory.
The district court denied relief, finding that the jury would have convicted Johnson under the misappropriation theory regardless and thus the inclusion of the invalid right-to-control theory to the jury was harmless. Johnson appealed back to the Second Circuit.
The Second Circuit's Analysis: Harmless Error and the Weakness of the Government's Case
In its opinion, the Second Circuit panel reversed the district court, holding that the error in submitting the now-invalid right-to-control theory to the jury was not harmless. Further, the court's analysis focused on two key, deficient elements of the misappropriation theory conviction:
- Fiduciary Relationship: The court found the evidence that Johnson owed a fiduciary or quasi-fiduciary duty to the energy client to be "decidedly weak." The transaction was structured as principal-to-principal, and the parties' agreements explicitly disclaimed any fiduciary relationship. The court emphasized that such a relationship "cannot be 'lightly implied'" and that only the "strongest parol evidence" could override the presumption against a fiduciary duty in this context.
- Misappropriation of Confidential Information: The court was similarly skeptical that Johnson's use of the energy client's information was "misappropriative." The evidence showed that the bank's traders acted as they "normally" would in executing a fix transaction, and the government failed to show that Johnson's conduct was abnormal or knowingly impermissible.
Given these weaknesses, the court concluded it had "grave doubt" that the jury would have convicted Johnson on the misappropriation theory alone, especially when the right-to-control theory provided a more straightforward path to conviction.
Key Takeaways
- The End of Right-to-Control as a Federal Fraud Theory: The Second Circuit's decision reinforces that, post-Ciminelli, prosecutors cannot rely on the right-to-control theory to support fraud convictions. Financial institutions should review ongoing and past investigations to assess whether any charges or convictions rest on this now-invalid theory.
- Heightened Scrutiny of Fiduciary Duties in Principal-to-Principal Transactions: The court's skepticism regarding the existence of a fiduciary relationship in arm's-length, principal-to-principal transactions provides important guidance. Explicit contractual disclaimers of fiduciary duties will carry significant weight, and only clear, deliberate conduct can override such disclaimers.
- The Bar for Misappropriation in the FX Context: The opinion recognizes the unique features of the FX market, particularly non-commission trades where pre-hedging and trading ahead are standard practices. Prosecutors must show that a defendant's conduct was not just typical market behavior but was knowingly impermissible and outside industry norms.
- The Importance of Clear Jury Instructions and Verdicts: When multiple theories of liability are presented, a general verdict can create significant appellate risk if one theory is later invalidated.
Conclusion
Johnson v. United States is a cautionary tale for both prosecutors and financial institutions. It underscores the importance of clear legal theories in jury verdicts, fiduciary disclaimers, and the need for robust compliance programs that reflect both legal requirements and industry norms. As the landscape of federal fraud prosecutions continues to evolve, staying abreast of appellate developments is more critical than ever.
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