The Coming Honest-Services Storm

Influential Criticisms

The statute, which reaches conduct in both the private and public sector, 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. Despite that core formulation and the statute's frequent use, numerous important questions about ' 1346 have percolated through the circuit courts for years, generating a variety of different limiting rules. The resulting uncertainty has engendered increasing criticism from influential voices arguing that ' 1346 is unconstitutionally vague and that, in effect, the doctrine rests on no sounder footing than it did before McNally.

In United States v. Rybicki, the leading private-sector honest-services case, now-Chief Judge Dennis Jacobs argued in dissent that “the plain meaning of ' 1346 simply provides no clue to the public or the courts as to what conduct is prohibited under the statute.” 343 F.3d 124, 158 (2d Cir. 2003) (en banc). Although every circuit that has addressed the issue has so far upheld the constitutionality of ' 1346 against vagueness challenges, Justice Scalia recently fanned the flames of speculation in his dissent from the denial of certiorari in Sorich v. United States, 129 S. Ct. 1308, 1311 (Feb. 23, 2009), questioning the constitutionality of the statute and suggesting that it was “irresponsible to let the current chaos prevail.” Among the open questions are:

• Should private-sector honest-services cases, which could be seen as subject to abuse, be subject to any judicially crafted limiting principle?
• If so, should the principle be that the scheme could potentially cause economic harm, or merely that the undisclosed information would be material to the decision at issue?
• Is a violation of state law required, particularly in public-sector honest-services cases?
• Must the duty of honest services owed be fiduciary in nature?
• Is private gain necessary?
• Is the doctrine simply too vague to pass constitutional muster?

United States v. Black

Perhaps catalyzed by these questions, the Court recently agreed to hear United States v. Black, 530 F.3d 596 (7th Cir. 2008). Defendant Conrad Black, who controlled the media company Hollinger International, schemed with his co-defendants to extract $5.5 million from a Hollinger subsidiary by using a bogus non-compete agreement. Defendants argued that the payment was owed to them as a management fee, but had been disguised in an attempt to avoid paying Canadian taxes.

On appeal, the defendants did not dispute that they breached fiduciary duties or that they did so for private gain. Instead, they argued that, because the gain was at the expense of the Canadian government and not at the expense of the company to which they owed their honest services, no honest-services fraud occurred. Judge Posner rejected this as an impermissible “no harm-no foul” argument. The question now before the Supreme Court is whether an honest-services violation requires that the actor contemplated (or should have contemplated) identifiable economic harm to the person to whom he owed honest services. The government rejects any such requirement as an invention found nowhere in the statute and argues that the “materiality” requirement ' a traditional element in mail fraud cases ' is sufficient to prevent overbreadth. Notably, then-Judge Sonia Sotomayor joined the Rybicki en banc majority's 2003 rejection of the “reasonably foreseeable economic harm” requirement in favor of the materiality standard alone.

United States v. Weyhrauch

Six weeks after the Court granted certiorari in Black, it also agreed to review United States v. Weyhrauch, 548 F.3d 1237 (9th Cir. 2008). In that case, Alaska state legislator Bruce Weyhrauch was indicted on an honest-services theory following his failure to report his solicitation of future legal work (which never came) from VECO Corp., an Alaska oil company, in exchange for legislative actions favorable to that company. The district court, relying on Fifth Circuit law, held that “any duty to disclose sufficient to support the mail and wire fraud charges here must be a duty imposed by state law.” In accordance with that ruling, it excluded some of the government's evidence. Weyhrauch, 548 F.3d at 1240. On interlocutory appeal, the Ninth Circuit rejected the state law limiting principle because it destroys the uniformity of federal law and because “Congress has given no indication it intended the criminality of official conduct under federal law to depend on geography.”

The Supreme Court's certiorari grant is limited to the question of whether the government must prove that the defendant violated a disclosure duty imposed by state law. 129 S.Ct. at 2863. Weyhrauch argues that the Ninth Circuit's rationale amounts to creating a uniform federal common law for determining when a state official's failure to disclose becomes a federal crime ' a result that some members of the Court have disfavored. Petitioners also raise federalism concerns that have occasionally been raised but not been fully addressed in major ' 1346 cases. Finally, as many others have done without ultimate success, Weyhrauch also contends that the statute is ambiguous and fails to provide fair notice, invoking both the rule of lenity and the prospect that the statute is void for vagueness.

The government counters that a state law violation requirement would run afoul of Congress's purpose in uniform application of federal law, and that nothing in the statute suggests such a gloss. Although the constitutionality of ' 1346 is not squarely implicated, it's a safe bet that Justice Scalia, at a minimum, may raise it and ask whether the state law limiting principle would be sufficient to save the statute's constitutionality.

United States v. Skilling

The high-profile case of United States v. Skilling, 554 F.3d 529 (5th Cir. 2009), most squarely presents the question of the constitutionality of ' 1346. The defendant, eventually CEO of Enron, was charged with orchestrating an elaborate conspiracy to conceal the true state of Enron's fiscal health through a variety misrepresentations and manipulations. A jury convicted Skilling of charges that included a conspiracy count alleging as one of its objects depriving Enron of its intangible right to Skilling's honest services.

Skilling appealed to the Fifth Circuit arguing, among other things, that his conduct did not meet the elements of honest-services fraud. Citing particularly broad language in a prior Fifth Circuit honest-services reversal, United States v. Brown, 459 F.3d 509 (5th Cir. 2006), Skilling argued that his conduct was not secret (and therefore not fraudulent), that it was not against Enron's interest, and that he obtained no “private gain” from it. The Fifth Circuit rejected Skilling's reading of Brown's broad language, explaining that Brown provides a defense for lower-level employees accused of honest-services fraud for acts done at their boss's direction “when an employer (1) creates a particular goal, (2) aligns the employees' interests with the employer's interest in achieving that goal, and (3) has higher-level management sanction improper conduct to reach the goal.” Noting that Skilling had never argued that his actions were expressly directed by anyone else, the panel held that tacit board approval was not the same as higher-level sanction and upheld the conviction.

Skilling ' which will be argued by itself some time after the joint Dec. 8 argument in Black and Weyhrauch ' seems particularly well suited to a vagueness challenge. In a regime where the various circuits do not agree even on the elements of the crime, the Fifth Circuit has effectively created a complex three-element exception to the application of the statute. This escalating complexity increases the likelihood that the Court could either invoke the rule of lenity in favor of the defendant, or decide that the statute is simply too vague to pass constitutional muster. At a certain point, either the rule of lenity should be involved to interpret ambiguities in the statute in favor of the defendant; otherwise, an as-applied vagueness challenge may well succeed. Or the Court may avoid reaching the constitutional issue by deciding in Skilling's favor the first question presented: whether the intent to achieve “private gain” is an element of honest-services fraud.

Conclusion

It is easy to understand why the Supreme Court accepted these cases. Although the factual heartland of honest-services fraud ' wrongful self-dealing by public servants, fiduciaries, and employees ' is well established, outliers like Black and Skilling continue to make the business and legal communities nervous. Whatever the Court's ultimate view of foreseeable economic harm, violation of state law, private gain, and the like, it can perform a valuable service by either clarifying what the statute means or by telling Congress to go back to the drawing board.

Daniel R. Alonso, a member of this newsletter's Board of Editors, is a former federal and state prosecutor currently practicing at Kaye Scholer LLP. As an Assistant U.S. Attorney, he handled the trial and appeal of United States v. Rybicki, mentioned in the text. D. Stan O'Loughlin is an associate at the firm.

Not since 1987, when the Supreme Court issued its bombshell decision in McNally v. United States , 483 U.S. 350 (1987), has the honest-services mail fraud doctrine received as much attention as in recent months. In addition to the continuing drumbeat of high-profile federal prosecutions in district courts ' from lobbyist Jack Abramoff to former Governor Rod Blagojevic of Illinois to powerhouse New York state senator Joe Bruno ' the Supreme Court will hear three cases this term involving the controversial doctrine. When the dust settles, it is possible that one of prosecutors' favorite weapons will have been sharply restricted or taken away.

A Bit of History

The honest-services doctrine sprang to life in the early 1970s as a creative application of the mail and wire fraud statutes. It was later eliminated outright by McNally but reborn, Phoenix-like, in 1988 as a tersely worded statute: “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.” 18 U.S.C. ' 1346. The modern development of the honest-services doctrine has by now been well documented in these pages. See Daniel R. Alonso, Milberg Weiss and the 'Nigerian Barge' Case: Contours of Honest-Services Mail Fraud, Bus. Crimes Bull., Sept. 2006, at 1.

Influential Criticisms

The statute, which reaches conduct in both the private and public sector, 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. Despite that core formulation and the statute's frequent use, numerous important questions about ' 1346 have percolated through the circuit courts for years, generating a variety of different limiting rules. The resulting uncertainty has engendered increasing criticism from influential voices arguing that ' 1346 is unconstitutionally vague and that, in effect, the doctrine rests on no sounder footing than it did before McNally.

In United States v. Rybicki, the leading private-sector honest-services case, now-Chief Judge Dennis Jacobs argued in dissent that “the plain meaning of ' 1346 simply provides no clue to the public or the courts as to what conduct is prohibited under the statute.” 343 F.3d 124, 158 (2d Cir. 2003) (en banc). Although every circuit that has addressed the issue has so far upheld the constitutionality of ' 1346 against vagueness challenges, Justice Scalia recently fanned the flames of speculation in his dissent from the denial of certiorari in Sorich v. United States , 129 S. Ct. 1308, 1311 (Feb. 23, 2009), questioning the constitutionality of the statute and suggesting that it was “irresponsible to let the current chaos prevail.” Among the open questions are:

• Should private-sector honest-services cases, which could be seen as subject to abuse, be subject to any judicially crafted limiting principle?
• If so, should the principle be that the scheme could potentially cause economic harm, or merely that the undisclosed information would be material to the decision at issue?
• Is a violation of state law required, particularly in public-sector honest-services cases?
• Must the duty of honest services owed be fiduciary in nature?
• Is private gain necessary?
• Is the doctrine simply too vague to pass constitutional muster?

United States v. Black

Perhaps catalyzed by these questions, the Court recently agreed to hear United States v. Black , 530 F.3d 596 (7th Cir. 2008). Defendant Conrad Black, who controlled the media company Hollinger International, schemed with his co-defendants to extract $5.5 million from a Hollinger subsidiary by using a bogus non-compete agreement. Defendants argued that the payment was owed to them as a management fee, but had been disguised in an attempt to avoid paying Canadian taxes.

On appeal, the defendants did not dispute that they breached fiduciary duties or that they did so for private gain. Instead, they argued that, because the gain was at the expense of the Canadian government and not at the expense of the company to which they owed their honest services, no honest-services fraud occurred. Judge Posner rejected this as an impermissible “no harm-no foul” argument. The question now before the Supreme Court is whether an honest-services violation requires that the actor contemplated (or should have contemplated) identifiable economic harm to the person to whom he owed honest services. The government rejects any such requirement as an invention found nowhere in the statute and argues that the “materiality” requirement ' a traditional element in mail fraud cases ' is sufficient to prevent overbreadth. Notably, then-Judge Sonia Sotomayor joined the Rybicki en banc majority's 2003 rejection of the “reasonably foreseeable economic harm” requirement in favor of the materiality standard alone.

United States v. Weyhrauch

Six weeks after the Court granted certiorari in Black , it also agreed to review United States v. Weyhrauch , 548 F.3d 1237 (9th Cir. 2008). In that case, Alaska state legislator Bruce Weyhrauch was indicted on an honest-services theory following his failure to report his solicitation of future legal work (which never came) from VECO Corp., an Alaska oil company, in exchange for legislative actions favorable to that company. The district court, relying on Fifth Circuit law, held that “any duty to disclose sufficient to support the mail and wire fraud charges here must be a duty imposed by state law.” In accordance with that ruling, it excluded some of the government's evidence. Weyhrauch, 548 F.3d at 1240. On interlocutory appeal, the Ninth Circuit rejected the state law limiting principle because it destroys the uniformity of federal law and because “Congress has given no indication it intended the criminality of official conduct under federal law to depend on geography.”

The Supreme Court's certiorari grant is limited to the question of whether the government must prove that the defendant violated a disclosure duty imposed by state law. 129 S.Ct. at 2863. Weyhrauch argues that the Ninth Circuit's rationale amounts to creating a uniform federal common law for determining when a state official's failure to disclose becomes a federal crime ' a result that some members of the Court have disfavored. Petitioners also raise federalism concerns that have occasionally been raised but not been fully addressed in major ' 1346 cases. Finally, as many others have done without ultimate success, Weyhrauch also contends that the statute is ambiguous and fails to provide fair notice, invoking both the rule of lenity and the prospect that the statute is void for vagueness.

The government counters that a state law violation requirement would run afoul of Congress's purpose in uniform application of federal law, and that nothing in the statute suggests such a gloss. Although the constitutionality of ' 1346 is not squarely implicated, it's a safe bet that Justice Scalia, at a minimum, may raise it and ask whether the state law limiting principle would be sufficient to save the statute's constitutionality.

United States v. Skilling

The high-profile case of United States v. Skilling , 554 F.3d 529 (5th Cir. 2009), most squarely presents the question of the constitutionality of ' 1346. The defendant, eventually CEO of Enron, was charged with orchestrating an elaborate conspiracy to conceal the true state of Enron's fiscal health through a variety misrepresentations and manipulations. A jury convicted Skilling of charges that included a conspiracy count alleging as one of its objects depriving Enron of its intangible right to Skilling's honest services.

Skilling appealed to the Fifth Circuit arguing, among other things, that his conduct did not meet the elements of honest-services fraud. Citing particularly broad language in a prior Fifth Circuit honest-services reversal, United States v. Brown , 459 F.3d 509 (5th Cir. 2006), Skilling argued that his conduct was not secret (and therefore not fraudulent), that it was not against Enron's interest, and that he obtained no “private gain” from it. The Fifth Circuit rejected Skilling's reading of Brown's broad language, explaining that Brown provides a defense for lower-level employees accused of honest-services fraud for acts done at their boss's direction “when an employer (1) creates a particular goal, (2) aligns the employees' interests with the employer's interest in achieving that goal, and (3) has higher-level management sanction improper conduct to reach the goal.” Noting that Skilling had never argued that his actions were expressly directed by anyone else, the panel held that tacit board approval was not the same as higher-level sanction and upheld the conviction.

Skilling ' which will be argued by itself some time after the joint Dec. 8 argument in Black and Weyhrauch ' seems particularly well suited to a vagueness challenge. In a regime where the various circuits do not agree even on the elements of the crime, the Fifth Circuit has effectively created a complex three-element exception to the application of the statute. This escalating complexity increases the likelihood that the Court could either invoke the rule of lenity in favor of the defendant, or decide that the statute is simply too vague to pass constitutional muster. At a certain point, either the rule of lenity should be involved to interpret ambiguities in the statute in favor of the defendant; otherwise, an as-applied vagueness challenge may well succeed. Or the Court may avoid reaching the constitutional issue by deciding in Skilling's favor the first question presented: whether the intent to achieve “private gain” is an element of honest-services fraud.

Conclusion

It is easy to understand why the Supreme Court accepted these cases. Although the factual heartland of honest-services fraud ' wrongful self-dealing by public servants, fiduciaries, and employees ' is well established, outliers like Black and Skilling continue to make the business and legal communities nervous. Whatever the Court's ultimate view of foreseeable economic harm, violation of state law, private gain, and the like, it can perform a valuable service by either clarifying what the statute means or by telling Congress to go back to the drawing board.

Daniel R. Alonso, a member of this newsletter's Board of Editors, is a former federal and state prosecutor currently practicing at Kaye Scholer LLP. As an Assistant U.S. Attorney, he handled the trial and appeal of United States v. Rybicki, mentioned in the text. D. Stan O'Loughlin is an associate at the firm.