Criminalizing the Contractual: Have We Finally Seen the End of “Honest Services” Fraud?

enron annual report 2000

Try this on for size:

For the purposes of this chapter, the term “scheme or artifice to defraud” includes:

(1) a scheme or artifice by a government official whereby the government official’s position is used for the private gain of any person or entity; or

(2) a scheme or artifice by an officer of a corporation, partnership, nonprofit organization or labor union, whereby the officer’s position is used for the private gain of any person or entity and not for the benefit of the officer’s shareholders or members.

If Congress had half a brain, this is what 18 U.S.C. § 1346 would look like. The whole point of the section is to prevent official corruption. A politician or bureaucrat who steers a contract to a buddy, or a corporate CEO who enriches himself instead of his shareholders, or a union boss who mismanages the pension fund — basically anyone who breaches a trust to act on behalf of those he represents.

But instead, Congress wrote this nonsense:

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.

For one thing, anyone can commit this crime, not just people who owe a duty to a constituency. Moreover, instead of a straightforward definition, this is hopelessly vague. Nobody knows what “the intangible right of honest services” means. Does it include an employee who’s playing solitaire instead of reviewing a file? Does it include a politician making promises he can’t keep?

Nobody knows.

And that’s just how federal prosecutors like it. Actual corruption charges, like bribery and extortion, are notoriously difficult to prove. But a mail/wire fraud charge, based on deprivation of “honest services” — that could mean anything, and so anything they can prove could count. Actions that don’t fit any particular category get to be called “fraud.”

Unethical behavior is now criminal. Contractual breaches, especially in the employment arena, also seem to count.

The courts have had a hard time applying this statute, differing widely on what counts and on how to instruct juries. Earlier this term, the Justices on the Supreme Court sounded like they have real problems with the statute. They seem even to wonder whether it’s void for vagueness. Criminal laws have to be specific enough to put you on notice that certain conduct could land you in jail, and a law where nobody even knows what it means certainly could be unconstitutionally vague. The Court hasn’t decided those open cases yet, presumably because they were waiting for one more to be argued.

And that gets us to today’s Supreme Court arguments in the case of Enron’s former CEO, Jeff Skilling.

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Enron was the nation’s 7th-largest company in 2001, when it suddenly came to light that its net worth was zilch. Bright people who had no clue what they were doing had created a bizarre house of cards that came tumbling down in an instant. The city of Houston, Enron’s headquarters, was devastated for years to come. Some people had clearly done wrong — CFO Andy Fastow and friends had profited hugely from schemes that broke the rules. It was less clear, however, whether CEO Jeff Skilling had acted improperly, or whether he even knew of any shenanigans. It was hard to say that he or the directors misrepresented anything to investors, as the company’s activities were pretty well documented. (For an excellent account of what happened and didn’t happen, see Kurt Eichenwald’s definitive “Conspiracy of Fools.” Malcolm Gladwell did an excellent piece in the New Yorker, as well, called “The Talent Myth,” about the culture there, and another one called “Open Secrets,” about the paradox of too much disclosure.)

Jeff Skilling was convicted in 2006 by a federal jury in Houston. The main charge against him was that he committed wire fraud in order to deprive the shareholders of his “honest services.” He got 24 years.

Skilling’s case is now before the Supreme Court on two grounds. The first is whether he was deprived of a fair trial by not moving the case somewhere other than Houston. The second is whether “honest services fraud” is constitutional.

Skilling’s merits brief says it’s unconstitutional, because it’s so vague that even the courts can’t define it. The DOJ responded that the law is perfectly fine, that the lower court rulings follow a general three-pronged rule: “a breach of the duty of loyalty, intent to deceive, and materiality.” Artificially increasing Enron’s stock price was his way of getting “additional personal benefits at the expense of stockholders.”

Leaving aside the paradox of screwing shareholders by increasing the value of their shares, the government’s argument makes academic sense. We like it when an underlying policy can be found that explains a disparate variety of court decisions. It helps us figure out what the next court decision will probably be, and why. Maybe even help us influence that decision.

But still, there is no denying that the honest services statute has been roundly criticized from the get-go. And we mustn’t forget that Congress passed it in the first place, back in 1988, in response to the Supreme Court’s ruling in McNally v. U.S., expressly rejecting the idea that one could defraud others, not just of money, but also of this intangible “right.”

“How can the public be expected to know what the statute means when the judges and prosecutors themselves do not know, or must make it up as they go along?” asked Judge Jacobs of the Second Circuit, in his 2003 dissent in U.S. v. Rybicki.

And back in December, during oral arguments in the cases of Conrad Black and Bruce Weyhrauch, the Supreme Court justices seemed to be unanimous in their dislike of the statute. We all knew Scalia despises the law, previously writing that it “invites abuses by headline-grabbing prosecutors in pursuit of local officials, state legislators, and corporate CEOs. It seems to me quite irresponsible to let the current chaos prevail.” During the December arguments, he called it “mush,” and the other justices joined in. Breyer and Roberts went so far as to suggest from the bench that the law might be unconstitutional, it’s so vague. The justices pretty much ignored the underlying facts of the cases, and just talked about whether the law itself was any good. None of them suggested that it was.

So it’s hardly surprising that Skilling’s case got advanced on the calendar, so it could be included in the set of opinions to come down on this issue.

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At oral argument this afternoon, the justices repeated their seemingly unanimous disapproval of the statute.

Roberts started off by throwing Skilling’s lawyer a softball question: “Skilling owed the Enron shareholders honest services. He acted dishonestly in a way that harmed them. I don’t understand the difficulty.” Given Roberts’ known difficulties with the statute, this was obviously a cue for counsel to explain exactly why there is a problem here. It took the lawyer a little hemming and hawing to get around to it, but soon he was on a roll, and the justices let him go for a good long time without interruption. They didn’t challenge him once on his explanations of why the statute is overbroad, or why it is unconstitutionally vague.

When the government’s lawyer got up, however, they jumped all over him. First about the voir dire/venue issue, and then right into this one (after a snarky segue by the Chief). Kennedy got the ball rolling with “the point is that the courts shouldn’t rewrite the statute; that’s for the Congress to do.”

Scalia picked up on his own language from the December 9 oral arguments and said “Well, suppose you have a statute that makes it criminal to do any bad thing, okay? Now, it’s clear that murder would be covered. All right? Nobody would say that murder is not covered by that. Does that make the statute non-vague? Just because you can pick something that everybody would agree comes within a denial of honest services, doesn’t mean that when you say nothing but honest services, you are saying something that has sufficient content to support a criminal prosecution.”

The government replied that “honest services” has become a term of art. But Roberts stepped in, saying that’s nonsense, because a term of art is shorthand for something that has a defined meaning, and this phrase has anything but a well-defined meaning. The case law on point is “fuzzy.” If people have to wait for the definition to evolve by common-law judicial opinions, then “it kind of puts the prospective defendant in an awfully difficult position. Two cases the government wins, one it loses, and he’s supposed to keep track of that. That doesn’t sound like fair notice of what’s criminal.”

Justice Ginsberg asked what the jury was instructed in this particular case, and the government lawyer had to agree with Scalia that its definition was “a little circular.”

When given a hypothetical situation of an employee using a company computer for personal use, the government said it wouldn’t count, because there’s no fiduciary duty. This got a reaction from several of the justices. This was a new interpretation of the rule, and Scalia asked where it came from, and the government lamely replied “I think it’s inherent.” Kennedy asked “what authority do I look to, to see that some employees are fiduciaries and others are not?” The government said it would come out of agency law.

Alito wondered how there could be a situation where there’s a fraud, when the benefit is in the form of a fully-disclosed compensation. The government admitted that this is a “logical extension” of its position, and “the Court can evaluate” whether it counts here.

Then things got silly for a bit. Sotomayor said, hold on a moment, suppose “I’m a councilperson in a jurisdiction that is considering a tax increase or a tax break, and I vote for the tax break, and I happen to have property that qualifies. Is that a breach of the statute?” The government said it may well be criminal. It depends on whether the government can prove intent to screw the voters. The prosecution would have to have evidence that this was an intentional thing, before it could press charges. “That doesn’t give me a whole lot of comfort,” replied Scalia.

Scalia pointed out that you could satisfy all of the government’s prongs, and still only have a contract violation. “So I know I am liable to have the contract terminated, and maybe for damages for the contract. And you say: And also, by the way, you know, you can go to jail for a number of years, because, oh, yeah, it’s very vague, but you intended to deceive and that’s all, that’s all you need to know.”

Breyer pointed out a contradiction between the government’s position here, and its position in December: “You said intent to deceive, intent to violate the law. I believe in another case you are saying they don’t have to have an intent to violate the law because there was no State law that prohibited whatever was at issue.” This is “a big difference.” In response to the government’s reply, Breyer said that people would now need “to carry around with them an agency treatise” to figure out if they’re committing a crime or not. The problem is, people won’t know what’s unlawful.

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This has to be very heartening for Mr. Skilling. We like to call cases ahead of time here, so we’re going to go out on a limb — though probably not all that far out, really — and predict that Mr. Skilling is going to be getting a new trial.

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