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The recent indictment of the securities class-action powerhouse Milberg Weiss Bershad & Schulman and two of its named partners has been the topic of much recent discussion, centering on the law firm's notable refusal to waive the attorney-client privilege during the government investigation, which likely contributed to the government's decision to indict the firm. But the indictment is also notable as the latest high-profile use of the federal mail and wire fraud statutes to combat private-sector corruption.
Under the category of fraud based on the deprivation of the intangible right of honest services, the government has long attacked kickbacks and other forms of concealed self-dealing by agents, employees, and fiduciaries. The crime is now firmly established in the landscape of federal prosecution despite its history of controversy among courts, commentators, and the defense bar.
Honest-services fraud is sufficiently complicated, however, that defense counsel need to be ever vigilant as to its contours, and prosecutors need to be reminded that those contours are not limitless. The Fifth Circuit recently issued a stark admonition to that effect in the Enron 'Nigerian Barge' case, reversing all convictions in that case that were predicated on an honest-services theory of wire fraud. United States v. Brown, 2006 WL 2130525 (5th Cir. August 1, 2006).
Development of the Honest- Services Doctrine
The mail and wire fraud statutes, 18 U.S.C. ” 1341 and 1343, historically enabled prosecutors to combat not only traditional frauds committed for the purpose of wrongfully obtaining money and property, but also, and less obviously, a wide range of corruption involving kickbacks, bribery, and self-dealing in local government and the private sector. Beginning in the early 1970s, courts consistently held that the term 'scheme or artifice to defraud' in the statutes included schemes whose object was the deprivation of certain intangible rights, including the right of 'loyal and honest services.'
Despite unanimity among the circuits that the statutes protected such rights, the Supreme Court overturned this line of cases in McNally v. United States, 483 U.S. 350 (1987), reasoning that Congress had intended the statutes to protect only property rights, and the intangible-rights doctrine was an impermissible judicial expansion of criminal liability: '[W]e read ' 1341 as limited in scope to the protection of property rights. If Congress wishes to go further, it must speak more clearly than it has.'
Congress responded promptly by enacting 18 U.S.C. ' 1346, which reads: 'For the purposes of this chapter the term 'scheme or artifice to defraud' includes a scheme or artifice to deprive another of the intangible right of honest services.' The precise meaning of this surprisingly terse statute is difficult to discern without understanding its history.
Core Meaning
Cases are legion that decline to attach mail fraud liability to mere breaches of fiduciary duty; instead, ' 1346 at its core requires an undisclosed financial interest, most often a kickback, in a situation where an agent, employee, or fiduciary has discretion to handle the principal's affairs. In the seminal case of United States v. Rybicki, 354 F.3d 124 (2d Cir. 2003) (en banc), the Second Circuit described honest-services fraud in the private sector as follows:
[A] scheme or artifice to use the mails or wires to enable an officer or employee of a private entity (or a person in a relationship that gives rise to a duty of loyalty comparable to that owed by employees to employers) purporting to act for and in the interest of his or her employer (or of the other person to whom the duty of loyalty is owed) secretly to act in his or her or the defendant's own interests instead, accompanied by a material misrepresentation made or omission of information disclosed to the employer or other person.
The element of misrepresentation or omission is typically satisfied by the failure to disclose a kickback or other financial interest in the transaction.
Not surprisingly, defendants have repeatedly challenged ' 1346 as void for vagueness under the due process clause, either facially or as applied. Nearly every circuit has by now considered and rejected such a challenge. The leading cases are Rybicki, in which the Second Circuit en banc upheld the statute by a 7-4 vote, and United States v. Brumley, 116 F.3d728 (5th cir. 1997) (en banc), decided by a 14-3 vote.
Like Milberg Weiss, the Rybicki case involved lawyers and a law firm charged with paying kickbacks, in this instance to insurance adjusters in connection with the settlement of tort cases. The Second Circuit held that the many pre-McNally cases on honest-services fraud gave the language used in ' 1346 a 'well-settled meaning' which provided sufficient notice of criminality even if the words in a vacuum might not.
Milberg Weiss
Prosecutors have alleged that Milberg Weiss schemed with named plaintiffs in securities fraud class actions and shareholder derivative suits to defraud absent class members by paying undisclosed kickbacks to the named plaintiffs. Because named plaintiffs owe a fiduciary duty to the absent class, and because their compensation is limited by law, the government claims that the receipt of secret payments from Milberg Weiss deprived the absent class of the honest services of the named plaintiffs. The indictment thus presents a classic case of honest-services fraud: the receipt of kickbacks by a fiduciary in connection with a transaction in which the fiduciary has discretion to act on behalf of the principal, creating the risk that that discretion would be exercised to favor Milberg Weiss at the potential expense of the class members. If prosecutors can prove that the Milberg Weiss defendants knowingly and intentionally made secret material payments to the named plaintiffs, they will have satisfied the elements of an honest-services fraud.
Less straightforward is the government's theory that the Milberg Weiss firm and its lawyers deprived the absent class members of their right to the firm's honest services, by breaching their duty to disclose to the court (and thus to the class) any material information that could influence its ability to represent the absent class adequately. To be sure, if proven, this would be a fiduciary breach, but it is likely to fall in the category of a 'mere' fiduciary breach that some courts have found outside the limits of the honest-services doctrine. Because the firm itself had no secret financial interest in the lawsuits at issue (as distinguished from aiding and abetting the named plaintiffs' alleged interest), this theory rests on a shaky foundation.
The 'Nigerian Barge' Case
The Fifth Circuit reversed the convictions in the Barge case for a similar reason. There, Enron employees concealed from shareholders a profit-generating transaction in which Merrill Lynch employees agreed to purchase an interest in three power-generating barges off the Nigerian coast in exchange for an oral promise to buy it back at a profit to Merrill through an off-balance sheet entity. In so doing, the Enron employees stood to gain increased bonuses from their own company by meeting earnings targets. That distinction is critical. In cases where secret payments have resulted in convictions for honest-services fraud, the payments have come from third parties or been the result of a concealed personal financial interest. Because of this distinction, the court held that this breach did not constitute 'a criminal breach of duty to Enron.' Brown, 2006 WL 2130525 (slip op. at 28).
The court also focused on the fact that the object of the scheme ' increased earnings ' was itself a legitimate corporate goal, aligned with Enron's interests. In so doing, it used particularly broad language that might be seized upon in the future to suggest that an employee's fiduciary breach might not rise to the level of honest-services fraud if the employee is acting for purposes aligned with those of the employer:
[W]here an employer intentionally aligns the interests of the employee with a specified corporate goal, where the employee perceives his pursuit of that goal as mutually benefiting him and his employer, and where the employee's conduct is consistent with that perception of the mutual interest, such conduct is beyond the reach of the honest-services theory of fraud as it has hitherto been applied.
At first blush, this language might seem like good news to many honest services defendants, who often claim ' even in the face of proof of kickbacks ' that their actions were beneficial to the principal. Indeed, Milberg Weiss made statements to similar effect in response to its indictment. Although the language above does lend support to this argument, it is unlikely to prevail in a case where, unlike Brown, there is proof of self-dealing in the form of third-party payments.
In the end, the 'Barge' prosecutors made a common mistake by incorrectly charging honest-services fraud in the apparent hope that the broad language of ' 1346 would make their case easier to prove. That is not always the case; the crime has a number of different elements, which prosecutors ignore at their peril. Ironically, the 'Barge' indictment did include a money and property theory (as well as a false books and records theory), but because a special verdict had not been requested of the jury, the convictions were overturned without examining the viability of the other theories.
Conclusion
The dissenters in the 'Barge' case, Rybicki, and other cases have made impassioned arguments that ' 1346 is vague, and that either Congress should redraft it or the Supreme Court should strike it down. Until that happens, defense counsel should be ready to pounce whenever the government charges honest-services fraud as a mere backup without taking care that the case falls squarely within the crime's parameters.
Daniel R. Alonso ([email protected]) is a partner at Kaye Scholer LLP, where he concentrates on white-collar litigation and internal investigations. As an Assistant U.S. Attorney, he handled the trial and appeal of United States v. Rybicki, mentioned in the text.
The recent indictment of the securities class-action powerhouse
Under the category of fraud based on the deprivation of the intangible right of honest services, the government has long attacked kickbacks and other forms of concealed self-dealing by agents, employees, and fiduciaries. The crime is now firmly established in the landscape of federal prosecution despite its history of controversy among courts, commentators, and the defense bar.
Honest-services fraud is sufficiently complicated, however, that defense counsel need to be ever vigilant as to its contours, and prosecutors need to be reminded that those contours are not limitless. The Fifth Circuit recently issued a stark admonition to that effect in the Enron 'Nigerian Barge' case, reversing all convictions in that case that were predicated on an honest-services theory of wire fraud. United States v. Brown, 2006 WL 2130525 (5th Cir. August 1, 2006).
Development of the Honest- Services Doctrine
The mail and wire fraud statutes, 18 U.S.C. ” 1341 and 1343, historically enabled prosecutors to combat not only traditional frauds committed for the purpose of wrongfully obtaining money and property, but also, and less obviously, a wide range of corruption involving kickbacks, bribery, and self-dealing in local government and the private sector. Beginning in the early 1970s, courts consistently held that the term 'scheme or artifice to defraud' in the statutes included schemes whose object was the deprivation of certain intangible rights, including the right of 'loyal and honest services.'
Despite unanimity among the circuits that the statutes protected such rights, the Supreme Court overturned this line of cases in
Congress responded promptly by enacting 18 U.S.C. ' 1346, which reads: 'For the purposes of this chapter the term 'scheme or artifice to defraud' includes a scheme or artifice to deprive another of the intangible right of honest services.' The precise meaning of this surprisingly terse statute is difficult to discern without understanding its history.
Core Meaning
Cases are legion that decline to attach mail fraud liability to mere breaches of fiduciary duty; instead, ' 1346 at its core requires an undisclosed financial interest, most often a kickback, in a situation where an agent, employee, or fiduciary has discretion to handle the principal's affairs. In the seminal case of
[A] scheme or artifice to use the mails or wires to enable an officer or employee of a private entity (or a person in a relationship that gives rise to a duty of loyalty comparable to that owed by employees to employers) purporting to act for and in the interest of his or her employer (or of the other person to whom the duty of loyalty is owed) secretly to act in his or her or the defendant's own interests instead, accompanied by a material misrepresentation made or omission of information disclosed to the employer or other person.
The element of misrepresentation or omission is typically satisfied by the failure to disclose a kickback or other financial interest in the transaction.
Not surprisingly, defendants have repeatedly challenged ' 1346 as void for vagueness under the due process clause, either facially or as applied. Nearly every circuit has by now considered and rejected such a challenge. The leading cases are Rybicki, in which the Second Circuit en banc upheld the statute by a 7-4 vote, and United States v. Brumley, 116 F.3d728 (5th cir. 1997) (en banc), decided by a 14-3 vote.
Like
Prosecutors have alleged that
Less straightforward is the government's theory that the
The 'Nigerian Barge' Case
The Fifth Circuit reversed the convictions in the Barge case for a similar reason. There, Enron employees concealed from shareholders a profit-generating transaction in which
The court also focused on the fact that the object of the scheme ' increased earnings ' was itself a legitimate corporate goal, aligned with Enron's interests. In so doing, it used particularly broad language that might be seized upon in the future to suggest that an employee's fiduciary breach might not rise to the level of honest-services fraud if the employee is acting for purposes aligned with those of the employer:
[W]here an employer intentionally aligns the interests of the employee with a specified corporate goal, where the employee perceives his pursuit of that goal as mutually benefiting him and his employer, and where the employee's conduct is consistent with that perception of the mutual interest, such conduct is beyond the reach of the honest-services theory of fraud as it has hitherto been applied.
At first blush, this language might seem like good news to many honest services defendants, who often claim ' even in the face of proof of kickbacks ' that their actions were beneficial to the principal. Indeed,
In the end, the 'Barge' prosecutors made a common mistake by incorrectly charging honest-services fraud in the apparent hope that the broad language of ' 1346 would make their case easier to prove. That is not always the case; the crime has a number of different elements, which prosecutors ignore at their peril. Ironically, the 'Barge' indictment did include a money and property theory (as well as a false books and records theory), but because a special verdict had not been requested of the jury, the convictions were overturned without examining the viability of the other theories.
Conclusion
The dissenters in the 'Barge' case, Rybicki, and other cases have made impassioned arguments that ' 1346 is vague, and that either Congress should redraft it or the Supreme Court should strike it down. Until that happens, defense counsel should be ready to pounce whenever the government charges honest-services fraud as a mere backup without taking care that the case falls squarely within the crime's parameters.
Daniel R. Alonso ([email protected]) is a partner at
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