Supreme Court Narrows Honest Services Fraud Statute in Appeal of DOJ's Blockbuster Corporate Fraud Conviction United States v. Skilling

07 July 2010 Publication
Authors: Pamela L. Johnston

Legal News Alert

On June 24, 2010, six Justices of the U.S. Supreme Court defied the predictions of some court watchers by saving the so-called honest services fraud statute, 18 U.S.C. § 1346 (Section 1346), from constitutional infirmity by narrowing its breadth to proscribe only bribes and kickbacks. Skilling v. United States, 561 U.S. ___, No. 08-1394 (June 24, 2010). Writing for the majority of the Court, Justice Ruth Bader Ginsburg concluded that “[i]n proscribing fraudulent deprivations of ‘the intangible right of honest services,’ § 1346, Congress intended at least to reach schemes to defraud involving bribes and kickbacks[.]” This, Justice Ginsburg wrote, represented the “core of the pre-McNally1 case law” used to circumscribe the limits of what is included within honest services fraud.

The Court rejected the United States’ argument that undisclosed self-dealing by public officials and private employees should survive the defendant’s due process challenge. Applying the rule of lenity, the Court eliminated the “conflict of interest” theory of criminal liability in the honest services fraud cases that have been decided across the circuits. The majority did not identify the source of the law that litigants should look to when seeking to identify the nature of the violation of a breach of fiduciary duty, seeking instead to focus on the serious nature of the culpable conduct involved.

While narrowing the breadth of Section 1346, the Court did not eliminate the possibility that the convictions of Jeffrey K. Skilling, the former chief executive officer of Enron Corp., and Conrad M. Black, the former chairman and CEO of Hollinger International, Inc., may be affirmed after remand. The Court instead remanded Mr. Skilling’s case to the U.S. Court of Appeals for the Fifth Circuit to determine whether the inclusion of honest services fraud as one of the three objects of the conspiracy of which he was convicted was harmless error. Similarly, but in a separate opinion, the Court remanded Mr. Black’s case to the U.S. Court of Appeals for the Seventh Circuit to determine whether the error in the instructions provided to the jury regarding honest services fraud was ultimately harmless. Black v. United States, 561 U.S. ___, No. 08-876 (June 24, 2010).

The mail and wire fraud statutes, Sections 1341 and 1343 of Title 18, criminalize any “scheme or artifice to defraud” that deprives a person of money or property. In 1988, Congress enacted the honest services fraud statute, Section 1346, in response to McNally, where the Court limited the federal mail fraud statute to deprivations of tangible property. Section 1346 broadened the definition of a “scheme or artifice to defraud” to include a scheme to “deprive another of the intangible right to honest services.”

Federal prosecutors used the flexibility inherent in this language to charge individuals in a wide variety of circumstances where money or property was not taken by the defendants. Noteworthy individuals who have been indicted or convicted under the honest services fraud statute include lobbyist Jack A. Abramoff and former Illinois governors Rod R. Blagojevich and George H. Ryan, not to mention the defendants in the cases before the Court.

The Court unanimously concluded in Skilling2 that — without any kind of limitation — Section 1346 would be unconstitutionally void for vagueness if it were left alone, thereby violating due process. Limiting Section 1346 to prohibit bribes and kickbacks accomplished Congress’ intent in passing the statute, Justice Ginsburg explained, without encountering “a vagueness shoal.” If Congress meant to go further and proscribe additional conduct, it could try again, but the Court gave a stern warning that a new conflict-of-interest criminal statute would need to be carefully drawn.

Significant Aspects of Skilling

  • All nine Justices were convinced that Section 1346 was insufficiently clear to pass constitutional muster. These honest services decisions breathe new life into the due process principle that punitive statutes should be obvious and simple to follow for the average person.
  • A majority of the Court, comprising Chief Justice John G. Roberts Jr. and Justices John Paul Stevens, Ginsburg, Stephen G. Breyer, Samuel A. Alito Jr., and Sonia Sotomayor, was willing to save the criminal statute by limiting it to apply to only bribes and kickbacks. Mr. Skilling, in asking the Court to do otherwise, was “[swimming] against our case law’s current, which requires us, if we can, to construe, not condemn, Congress’ enactments.”
  • The Court’s decision to limit Section 1346 to bribes and kickbacks was based on a review of the origin of the honest services fraud doctrine and its subsequent application in the various circuits, despite the fact that these decisions “were not models of clarity or consistency.” The limitation of the statute was based, in the Court’s view, on its ability to “pare that body of precedent down to its core.” According to the majority, this core is what Congress intended to enact with the honest services fraud statute.
  • The Court relied, in part, on the rule of lenity to reach its decision. “Ambiguity concerning the ambit of criminal statutes,” Justice Ginsburg explained, quoting a prior Court decision, “should be resolved in favor of lenity.” The Court invited Congress to try again if it was displeased with the results of Skilling.

Possible Application to the Executive Compensation Clawback Prosecutions by the SEC

These honest services fraud opinions may prove useful in the coming swell of cases and trials involving the SEC because the SEC, after Bernard “Bernie” Madoff, pushes the envelope in different areas of enforcement and thus seeks to expand the reach and impact of certain securities laws in a manner similar to how the U.S. Department of Justice (DOJ) wielded the honest services statute during the past decade. For example, the SEC’s recent expansive reading of Section 304 of the Sarbanes-Oxley Act of 2002, the so-called “Clawback Provision,” 15 U.S.C. § 7243, bears a striking resemblance to how DOJ employed Section 1346 when seeking to punish high flyers and executives who the agency viewed as worthy of punishment. In these clawback cases, the SEC is seeking the return of bonuses and other compensation from former CEOs and CFOs who profited from their companies, but were not personally responsible for the misdeeds of others in the organization. See S.E.C. v. Jenkins, Case No. CV-09-1510-PHX-GMS, 2010 WL 2347020 (D. Ariz. June 9, 2010).

In Skilling, the Court reaffirmed that to:

satisfy due process “a penal statute [must] define the criminal offense [1] with sufficient definiteness that ordinary people can understand what conduct is prohibited, and [2] in a manner that does not encourage arbitrary and discriminatory enforcement.” [citation omitted]. The void-for-vagueness doctrine embraces these requirements.

(Maj. Op. at p. 50).

Thus, in the circumstance where the SEC is using Section 304 to seek to forfeit monies from an executive where that individual has not been charged with personally committing securities fraud, the punitive aspect of that type of civil prosecution may well require a due process analysis for void-for-vagueness. A careful reading of Section 304 could yield a result that the statute is not sufficiently definite that an ordinary person can understand what conduct is prohibited. It would be another way to recognize that no person of ordinary understanding would expect to have his or her compensation forfeited unless that person personally committed securities fraud. Section 304 similarly leads to potentially arbitrary or discriminatory enforcement. Taking money or property in such a circumstance could be understood to violate due process. Following the approach adopted by the majority in Skilling, a lower court could now justifiably narrow the reach of Section 304 to have it mirror more closely the disgorgement and unjust enrichment doctrines so that only persons who have done something wrong need forfeit bonuses or other forms of compensation received. Thus, these honest services cases may provide a transferable framework that can be used to narrow the reach of the statute for executives charged or under scrutiny by the SEC for a clawback suit.

Background of the Honest Services Cases Pending Before the Supreme Court

The Supreme Court granted certiorari in three cases involving honest services fraud convictions. Each had exposed different potential flaws in the statute.

The last honest services fraud case argued before the Court, but the most important of the three, involved Mr. Skilling, a longtime executive of Enron, one of the largest companies in United States before its bankruptcy in 2001. Prosecutors had argued that Mr. Skilling had taken inappropriate measures to maintain and improve Enron’s stock price. These measures included business decisions that allegedly exposed Enron to irresponsible levels of risk. The claim of honest services fraud in Mr. Skilling’s case rested on the theory that, in taking such inappropriate measures, he had committed a material violation of a fiduciary duty owed to Enron and its shareholders. There was no evidence that Mr. Skilling had sought to advance his own private gain, apart from normal compensation incentives, at the expense of Enron or its shareholders. Significantly, Mr. Skilling was the only party who specifically asked the Supreme Court to overturn the statute because it was void for vagueness.

One of the two cases argued first during this term involved Mr. Black, the former chairman and CEO of Hollinger International, Inc. Prosecutors argued that Mr. Black and two of his fellow executives had used Hollinger, which was formerly one of the world’s largest publicly owned media companies, as their own personal piggy bank. The executives received $5.5 million in payments that they were lawfully owed. But in order to receive a tax benefit in Canada, the executives recharacterized the payments as being associated with non-legitimate noncompete deals that the company had entered into with third parties. Prosecutors charged honest services fraud in this case without evidence that the executives had caused harm to Hollinger or its shareholders. Prosecutors argued the executives had breached the duty of loyalty owed to the company and its shareholders.

The other case argued with Black involved Bruce Weyhrauch, an Alaska state legislator and licensed attorney. In the final days of the legislative session, Mr. Weyhrauch solicited employment from an oil field services company opposed to oil tax legislation still pending in the Alaska Legislature. Prosecutors argued that Mr. Weyhrauch’s failure to disclose this contact, without more, deprived the State of Alaska and its citizens of his honest services. Even though the nondisclosure offended neither federal nor state law, prosecutors argued that Mr. Weyhrauch had violated federal common law.

The Court returned all three cases to lower courts for further consideration based on the guidance provided in Skilling.

The Issue Troubling the Court: Void for Vagueness

Although the Court unanimously admitted that Mr. Skilling’s void for vagueness challenge had merit, the majority of Justices demonstrated that — even in the context of the criminal law — they will save a statute where possible through some sort of limiting construction. Striking a statute as impermissibly vague appears to be a last resort for a majority of the Court.

The Court has rarely struck down a statute as being impermissibly void for vagueness and declined to do so here. The last time it did so was more than 10 years ago in Chicago v. Morales, 527 U.S. 41 (1999), a case involving an ordinance that prohibited “criminal street gang members” from “loitering” in any public place. The Constitution mandates that criminal statutes identify prohibited conduct so as to give a person of ordinary intelligence fair notice that conduct is forbidden. A criminal statute may not be so vague so as to encourage arbitrary and erratic arrests and convictions. The Court concluded in Morales that the loitering statue failed on both grounds: It neither adequately specified the standard of conduct proscribed nor established minimal guidelines to govern law enforcement.

Three members of this Court, Justices Antonin Scalia, Clarence Thomas, and Anthony M. Kennedy, were critical of the majority’s efforts to save Section 1346 in Skilling and would have struck the law down entirely. As Justice Scalia wrote, limiting the statute “requires not interpretation but invention.” The Court’s decision, he complained, “replaces a vague criminal standard that Congress adopted with a more narrow one (included within the vague one) that can pass constitutional muster. I know of no precedent for such ‘paring down’ … .”

Criminal Statutes and Federal Common Law

A corollary concern when a criminal statute is vague or open to multiple interpretations is the degree of judicial gloss that courts apply to try to give the statute definition and meaning. Such gloss can grow to become the judicial creation of federal common law when the added meaning was not present in the text of the statute passed by Congress.

A review of the transcripts of the arguments in Skilling, Black, and Weyhrauch reveals that one of the most significant messages in the honest services fraud cases is the Court’s reluctance — from one end of the ideological spectrum to the other — to permit the creation of a federal common law to solve the problem of an ambiguous or vague criminal statute. The dissenting Justices in Skilling would no doubt argue that the majority failed to honor these concerns when it looked to case law in order to pare the honest services fraud statute down to “bribes and kickbacks.”

As Chief Justice Roberts stated during the Skilling argument, “you need lawyers and research before you get an idea of” the state of the law. Several of the other justices echoed these concerns during the arguments and indicated that, even if the phrase “honest services” was widely understood, pronouncements about what conduct is prohibited by federal law should not be buried in hundreds of cases. As Justice Scalia asked, “What is a citizen supposed to do? He’s supposed to go back and read all those … cases?”

In writing for the majority, Justice Ginsburg seemed confident in Skilling that, even if the case law was not a “model[] of clarity or consistency,” it could be pared “down to its core.” Congress was attempting to codify this core, which was widely understood to involve cases of bribes and kickbacks, when it passed Section 1346.

But as Justice Scalia countered in his dissent, “To say that bribery and kickbacks represented ‘the core’ of the doctrine … is not to say that they are the doctrine.” Justice Scalia continued: “Until today, no one has thought (and there is no basis for thinking) that the honest-services statute prohibited only bribery and kickbacks.”

Regardless, the united approach by all the justices to try to avoid the creep that case law can bring in the development of an area of law because it becomes, at some point, the creation of a federal criminal common law. It underscores the Court’s view that individuals should not face criminal prosecution based on an evolving law of which they have little or no notice at the time that they acted or failed to act. As Chief Justice Roberts explained during oral argument in the Weyhrauch case, “[A] citizen has to be able to understand the law, and if he can’t, then the law is invalid.”

It also is a recognition that well drafted statutes — rather than common law — best discourage arbitrary and erratic prosecutions. Before the Court’s decision in Skilling, very little had limited prosecutors in charging honest services fraud. As a result, prosecutions occurred in a wide variety of circumstances and with differing standards such that an action in one part of the country could be viewed as violating a federal criminal statute while the same action elsewhere would not. Justice Scalia noted that many of the prosecutions brought by the United States under this statute were “pushing the envelope.” By providing clear guidance that the honest services fraud statute should apply only to bribes and kickbacks, the Court is insisting that statutes provide sufficient guidance to prosecutors.

But the decision in Skilling was criticized by the dissenters because the approach of paring the statute to its core principles can be viewed as betraying the separation of powers principles set forth in the Constitution. Congress, as the representative branch of government, is entrusted with proscribing conduct. During oral argument, several Justices expressed concern that this is not the proper role of the courts. Problems ensue when these separate spheres are not respected. As Justice Scalia explained during oral argument in the Weyhrauch case, when Congress attempts to codify a body of common law, it might just be referring to “a mistaken series of decisions by the courts of appeal.”

According to the dissent, the decision in Skilling is such a mistake. “I do not believe we have the power, in order to uphold an enactment, to rewrite it,” Justice Scalia wrote in Skilling. Congress enacted “the entirety” of honest services case law, not just its core, “the content of which is (to put it mildly) unclear. In prior vagueness cases, we have resisted the temptation to make all things right with the stroke of our pen.”

Conclusion

In one of the most significant criminal cases decided in recent memory, the Supreme Court exhibited a new willingness to invalidate an important federal criminal statute on due process grounds.



[1] McNally v. United States, 483 U.S. 350 (1987).

[2] The Court’s other two opinions involving Section 1346 are Black v. United States, No. 561 U.S. ___, No. 08–876 (June 24, 2010), and Weyhrauch v. United States, 561 U.S. ___, No. 08–1196 (June 24, 2010) (per curiam).



Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. Questions regarding this discussion may be directed to either of the following practice chairs or attorneys within their practices:

Pamela L. Johnston
Chair, Government Enforcement, Compliance & White Collar Defense Practice
Los Angeles, California
213.972.4632
pjohnston@foley.com  

Barry J. Mandel
Chair, Securities Enforcement & Litigation Practice
New York, New York
212.338.3564
bmandel@foley.com  

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