Supreme Court To Review 'Honest Services'By Audrey Strauss, NY Law Journal, july 02, 2009
After a highly-publicized, four-month trial in federal court in Chicago,
Conrad Black and his codefendants were acquitted of almost all charges that they had looted
Hollinger International Inc. (of which Black had been CEO). However, they were convicted of three counts of mail fraud related to payments they had received under
non-compete agreements (and Black alone was convicted of one count of
obstruction of justice) (see also wikipedia "
obstruction of justice"- Editor) .1 The three mail fraud counts on which Black stands convicted were based on
18 U.S.C. §§1341 and
1346. The latter section supplemented the
mail fraud statute in 1988 by defining a
scheme to defraud to include depriving another of "the intangible right of honest services." Although Black's conviction on these three counts was affirmed by the Seventh Circuit in a decision written by
Judge Richard Posner, (pictured at left) on May 18, the Supreme Court granted the petition for certiorari by Black and two of his co-defendants to review the application of the
"honest services" statute in their case.2
The Supreme Court's decision next term in the Black case will be one of the most significant
white-collar crime rulings in recent memory. The lower federal courts have struggled with the meaning of "the intangible right of honest services" since §1346 was enacted in 1988. Given the elasticity of the words and the lack of any previously established legal definition for the terms, the government has used this opening to expand federal prosecutions for mail and wire fraud to breaches of
fiduciary duty committed by corporate officers and employees. The
Seventh Circuit upheld Black's conviction where the jury was allowed to convict for a failure to disclose to company directors that corporate payments had been structured to achieve a personal tax benefit—even though the benefit imposed no cost or injury on the company.
This article will briefly review the background of the enactment of the "honest services" provision; the Black prosecution; the split in the Circuits on the definition of the "honest services" provision; and the outlook for the Supreme Court's review of the issue.
A Response to the 'McNally' Decision
Well before the enactment of §1346, the mail and wire fraud statutes had offered federal prosecutors an oversized net within which to snag a wide range of criminal conduct.3 By the 1980's, the mail fraud statute was being used, among many other things, to prosecute corrupt state and local officials.4 This line of mail fraud prosecutions required an adjustment of the concept of "money and property" under the statute's language. Typically, a corrupt state judge who has taken bribes from a litigant would not have caused any provable "money and property" loss to the taxpayer. In the face of the language of the mail fraud statute—which, by its terms, protects against schemes for obtaining "money and property" by false promises or representations—prosecutors nonetheless won judicial approval for the theory taxpayers had an intangible right, protected by the mail fraud statute, to have the judge perform his official duties honestly.5
In 1987, in McNally v. United States, 483 U.S. 350, the Supreme Court tried to call a halt to this expansion of the mail fraud statute by holding, 7-2, that the statute was limited to frauds directed at "property rights" and could not be stretched to cover intangible rights such as the public's right to honest government. In McNally, the conspirators had agreed to cause the Kentucky state government to purchase its insurance coverage through a particular agency in return for kickbacks paid out of the commissions that agency received from the insurers. The jury was instructed that it could convict without proof that the scheme had led the state to pay more for insurance coverage. The Court reversed the convictions as outside the scope of the mail fraud statute, saying "If Congress desires to go further, it must speak more clearly than it has." Id. at 360.
Soon thereafter, Congress responded to the challenge by enacting §1346.6 This provision was a late insertion in a larger piece of omnibus legislation and the legislative history is very scanty.7 While the legislative history demonstrated that Congress was responding to McNally, it was unclear whether Congress was seeking only to overturn McNally or attempting to broaden the statute even further.
Prosecutors, on the other hand, saw an opportunity and seized it, rapidly expanding prosecutions under the "honest services" provision beyond public-corruption cases, such as McNally, to the private business context. The McNally majority opinion contained no discussion of the application of the honest-services doctrine to private-sector activity, although Justice Stevens' dissent cited some cases from lower courts in which the doctrine had been so applied. Nor did the sparse legislative history of §1346 contain any indication that Congress had considered how the statute should apply to the private sector.8
The Black Prosecution
The central figure in the case now before the Supreme Court is Conrad Black, famous long before the Hollinger matter made headlines. Among other things, he was an old-style press baron who built a worldwide media empire that included the Chicago Sun-Times and the (London) Daily Telegraph; a member of the U.K. House of Lords; and a biographer of Franklin Roosevelt and Richard Nixon. While serving as CEO of Hollinger, a public company, Black also owned a majority stake in a private company which effectively held the controlling interest in Hollinger through various intermediate holding companies. In 2003, Hollinger's independent directors formed a special committee that hired former SEC Chairman Richard Breeden to conduct an investigation, resulting in a 500-plus-page report concluding that Black had presided over a "kleptocracy" and had with various associates wrongfully diverted approximately $400 million in corporate assets for personal benefit. Black was ultimately ousted from control after a trial in the Delaware Chancery Court which resulted in a 70-page opinion from Vice Chancellor Strine finding him to have breached his fiduciary duties.9
In 2005, Black and several other former Hollinger officers were indicted in the Northern District of Illinois. As noted above, however, the defendants were acquitted at trial of all significant charges that they had looted Hollinger. The mail fraud counts on which they were convicted were primarily based on non-compete agreements. For example, one of the agreements at issue involved a payment of $5.5 million to Black and others to refrain from competing with a company that at the time operated a single small weekly paper. The government's theory was that the amount paid was so disproportionate to the value of excluding competition from the relevant market that the agreement was a sham. The defense contended that the money was owed to Black and the others as legitimate management fees but that the payments had been recharacterized as having been made under a non-compete agreement as a lawful way to give the individuals favorable treatment under Canadian tax law.
The jury was charged that they could convict either on a traditional fraud theory (namely, that the defendants had obtained these payments by fraud via a sham transaction) or on an honest services theory (namely, that even if the company would otherwise have paid the defendants the same money as management fees, the defendants deprived the company of its "intangible right" to their "honest services" by failing to disclose that they would reap a personal tax benefit by recharacterizing the transaction).10 In affirming the convictions, Judge Posner's opinion focused largely on the sufficiency of evidence to sustain a conviction on the traditional fraud theory. The key claim before the Supreme Court, however, is that there can be no certainty that the jury in fact convicted on that theory and that the instructions on the alternative honest services theory were fatally flawed.11
A Circuit Split
New York white collar practitioners will recall the Second Circuit's en banc decision in United States v. Rybicki, 354 F.3d 124 (2d Cir. 2003), which grappled extensively with the "honest services" provision of §1346. The majority of the en banc Court (which included Judge Sotomayor) rejected a claim that the statute was unconstitutionally void for vagueness.12 Not finding a sufficiently precise meaning of the words "the intangible right of honest services" by consulting dictionaries and similar resources, the majority concluded that Congress had intended to revive the pre-McNally cases in various circuits, and that the content of those precedents could give the provision a sufficiently definite content to avoid constitutional infirmity. After surveying pre-McNally law in detail and trying to harmonize the precedents to determine a consensus position, the majority concluded (id. at 147) that, in the private sector context, §1346 criminalized use of the mails or wires "to enable an officer or employee of a private entity…purporting to act for and in the interests of his or her employer…secretly to act in his or her…own interests instead, accompanied by a material misrepresentation made or omission of information disclosed to the employer…." The majority additionally noted that "in self-dealing cases, unlike bribery or kickback cases, there may also be a requirement of proof that the conflict caused, or at least was capable of causing, some detriment" to the employer.
By contrast, the Second Circuit dissenters (in an opinion written by Judge Jacobs and joined by Judges Walker, Cabranes and Parker) refuted the majority's effort to find a sufficiently precise meaning for the statutory language in the pre-McNally case law, noting that the majority's resulting formulation was only applicable to one of several different recurrent categories of cases. Accordingly, the dissenters concluded that the statutory language was unconstitutionally vague because it had "no settled meaning" that was "capable of providing constitutionally adequate notice" of exactly what conduct was proscribed. Since the dissenters found it impossible to read principled limitations into the "honest services" provision, they concluded that the statute was unconstitutional on its face. Judge Jacobs also highlighted concerns about the statute's vague language providing no constraints on prosecutorial discretion and permitting federal prosecution in areas traditionally governed by state law. The dissent pointed out that numerous courts had grappled with the issues presented by the statute but failed to converge on a single answer to the key issues the statute presented, such as what mens rea was required; whether tangible harm needed to be proven; what duty had to be breached; the source of the duty; and what body of law applied. The dissent concluded that it was inappropriate for the judiciary to attempt to salvage the statute by reading additional requirements into it to cure its vagueness, because that would draw the judiciary into the long-condemned process of creating common-law federal crimes.
While constitutional challenges have not succeeded in any other circuits, those courts have taken a number of different positions on what the statute means. Some have taken the view that although "honest services" may be an "intangible right," its deprivation must involve, or at least threaten, tangible harm in order to constitute a federal crime. For example, the D.C. Circuit has held that "[a]bsent reasonably foreseeable economic harm, proof that the employer simply suffered only the loss of the loyalty and fidelity of the [defendant employee] is insufficient to convict."13 The First Circuit has required evidence that the defendant knew or contemplated that the conduct "pose[d] an independent business risk" or "reasonably foreseeable economic harm" to the employer.14 At least four other circuits (Fourth, Sixth, Eighth, and Eleventh) have taken a similar approach.
By contrast, the Fifth Circuit has held that while there must be evidence of "some detriment" to a private employer, the non-disclosure to the employer of material information the employee had a duty to disclose is itself a sufficient "detriment," without any need to link the non-disclosure to a risk of tangible harm.15
The Seventh Circuit in the Black case focused on the "personal gain" to the employee from the failure to disclose, without any consideration of whether that gain came at the employer's expense or otherwise caused tangible harm to the employer.
Outlook in the Supreme Court
To put the granting of Black's petition in context, it is helpful to know that a few months prior to the grant of certiorari, the Supreme Court denied certiorari in another Seventh Circuit case, Sorich v. United States, over a vigorous dissent from Justice Scalia, who called for the Court to "squarely confront both the meaning and the constitutionality of §1346."16 Justice Scalia noted that the statute has been "invoked to impose criminal penalties upon a staggeringly broad swath of behavior" and could, if construed broadly, criminalize as wire fraud the dishonesty incident to "a salaried employee's phoning in sick to go to a ball game." Absent a "coherent limiting principle," he went on, the "expansive" language of the statute "invites abuse by headline-grabbing prosecutors," but the search for such a principle has required judicial craftsmanship, and courts have not agreed as to how to proceed. Significantly, Justice Scalia quoted from Judge Jacobs' en banc dissent in Rybicki that would have held the statute unconstitutional on its face, and suggested that it "is simply not fair to prosecute someone for a crime that has not been defined until the judicial decision that sends him to jail."
One development to watch for will be to what extent Justice Scalia attempts to use the Black case to consider whether the "honest services" statute is unconstitutionally vague. Although the Black cert petition was narrowly drafted to attack the jury charge on "honest services," Justice Scalia's interest in the constitutional issue may create an opportunity for a broader challenge to the statute.
At the very least, the Black case will finally tell us after 20 years what the Court thinks of the congressional response to the challenge set out in McNally to "speak more clearly."17 The Court will need to consider whether there is a definition of "the intangible right of honest services" that proves workable as a criminal statute without simply creating a common law crime. Does the term "honest services" have a logical stopping point? Does the statute provide due process notice of what conduct is illegal? Is "honest services" the same as state law fiduciary duties—that vary from state to state? Could Congress possibly have intended the statute to incorporate state law fiduciary duties? We await the answers to these questions and perhaps to the question of whether the statute has been unconstitutionally vague for 20 years.
Audrey Strauss is a member of Fried, Frank, Harris, Shriver & Jacobson. Her colleagues John W. Brewer and Nowles Heinrich assisted in the preparation of this article.
Endnotes:
1. The case is now pending as No. 08-876 in the U.S. Supreme Court, where certiorari was granted on May 18, 2009. The validity of Black's conviction on the obstruction count is not before the Supreme Court as such. However, the cert. petition argued that if the fraud convictions were to be reversed the obstruction conviction should be vacated due to prejudicial spillover and other issues. Three codefendants also were convicted of mail fraud on counts relating to the same underlying transactions (one of whom was subsequently acquitted of one of those counts following post-verdict motions). Two of the three co-defendants joined in the cert petition, and their convictions are also now before the Supreme Court. This article will sometimes focus on Black as an individual for ease of exposition.
2. Certiorari was also granted on the separate issue of whether the defendants' objection to particular instructions was waived by their failure to agree to a special form of verdict proposed by the government. The resolution of this issue may be significant for federal criminal practice generally, but will not be discussed in the present article.
3. In a classic article, now-Judge Jed Rakoff analogized the mail fraud statute in the hands of a federal prosecutor investigating a white-collar offense to a "Stradivarius…Colt 45…Louisville Slugger…[and/or] Cuisinart." "The Federal Mail Fraud Statute (Part 1)," 18 Duquesne L. Rev. 771 (1980).
4. United States v. Holzer, 816 F.2d 304 (7th Cir. 1987); United States v. Brown, 540 F.2d 364 (8th Cir. 1976); United States v. Bush, 522 F.2d 641 (7th Cir. 1975).
5. See Holzer, 816 F.2d at 308.
6. The section reads in its entirety: "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."
7. The legislative history is discussed at length in the dissenting en banc opinion in United States v. Brumley, 116 F.3d 728, 742-749 (5th Cir. 1997).
8. Significantly, however, on June 29, the Supreme Court agreed to review another "honest services" case in which the defendant was a state legislator rather than private businessman. Weyhrauch v. United States, No. 08-1196. The question on which certiorari was granted is "Whether, to convict a state official for depriving the public of its right to the defendant's honest services through the non-disclosure of material information…the government must prove that the defendant violated a disclosure duty imposed by state law."
Whether in the public-sector or private-sector context, the pre-McNally case law was in any event not a unified and coherent whole with a single consistent definition of "honest services" that Congress might have meant to codify in section 1346. Brumley, 116 F.3d at 733. Thus, to the extent the statute was simply intended to revive the earlier precedents the lower courts rejected in McNally, it provided no direct guidance as to how to resolve conflicts among those precedents.
9. Hollinger Int'l Inc. v. Black, 844 A.2d 1022 (Del. Ch. 2004), aff'd, 872 A.2d 559 (Del. 2005).
10. Even on the traditional fraud theory, however, it is worth noting that the amounts in question were only a tiny fraction of the hundreds of millions of dollars in misappropriation claimed by the Breeden report.
11. The Seventh Circuit also held that the defendants had waived their challenge to the instruction on the alternative "honest services" theory. As noted above, the validity of that waiver holding, although not discussed in this article, is also before the Supreme Court.
12. The constitutional challenge in Rybicki was limited to a "plain error" review because it had not been raised before the district court. The constitutional issues were presented at length to the Second Circuit in an amicus brief filed by the New York Council of Defense Lawyers. One of the authors of that brief, Richard Greenberg, now represents one of Black's co-defendants before the Supreme Court.
13. United States v. Sun-Diamond Growers, 138 F.3d 961, 973 (D.C. Cir. 1998) (internal quotation and citation omitted).
14. United States v. Martin, 228 F.3d 1, 17-18 (1st Cir. 2000) (internal quotations omitted).
15. United States v. Brown, 459 F.3d 509, 519 (5th Cir. 2006).
16. Sorich v. United States, 129 S. Ct. 1308 (2009) (Scalia, J., dissenting from denial of certiorari).
17. Congress is also currently considering a proposed "Public Corruption Prosecution Improvements Act," S. 49, co-sponsored by Senator Leahy (Chair of the Judiciary Committee), which would among other things further expand the reach of the mail fraud statute.
DOJ may rein in use of 'honest services' statuteLynne Marek, NYJL, June 15, 2009
A key weapon in the arsenal of
U.S. Attorney Patrick Fitzgerald (pictured at left) and his prosecutors in Chicago has been a section of the
federal anti-fraud statute that makes it a crime to deprive citizens or corporate shareholders of "honest services."
It's been used to convict dozens of state and local government officials, as well as newspaper magnate Conrad Black and former
Gov. George Ryan of Illinois (pictured at left). Fitzgerald cited the honest services in the April indictment of another ex-Illinois governor, Rod Blagojevich.
But the U.S. Supreme Court's May decision to review Black's 2007 conviction may put the brakes on the honest services provision. The U.S. Department of Justice is likely to rein in use of the provision, 18 U.S.C. 1346, until the high court rules on Black's appeal next term, former federal prosecutors say. "Anytime that there's a high-profile review of a conviction, the department tends to just stop in its tracks, and this is a very high-profile review," said Matt Orwig, a partner and criminal defense attorney in the Dallas office of Sonnenschein Nath & Rosenthal and former U.S. attorney for the Eastern District of Texas. "There's going to have to be some very careful analysis of how they've approached these cases in the past."
Using the honest services section of the fraud statute allows prosecutors to charge defendants with robbing a general group of people, such as shareholders of a public company or residents of a state or city, of the honest fiduciary duties or government services they are due. It's typically used to shore up other fraud counts, but increasingly has been used as a primary count as well.
Orwig, who didn't recall using the charge when he was a U.S. attorney, said he thinks the section has been "over-used." It was the lead charge lodged by U.S. attorney offices against 79 suspects in fiscal year 2007, up from 63 in 2005 and 28 in 2000. (The Justice Department doesn't consistently track it as a secondary charge.)
AGGRESSIVE USEFitzgerald, the special counsel who won a conviction against vice presidential aide I. Lewis Libby Jr., so far is bucking the usual turnover for U.S. attorneys and is extending his eight-year stint in Chicago from the Republican Bush administration into the Democratic Obama administration.
Former federal prosecutors-turned-criminal defense lawyers in the Northern District of Illinois said they believe Fitzgerald's office has been among the most aggressive in using the honest services charge. Although statistics show that his office used the law only twice in fiscal year 2007 as a lead charge, the office has often used the statute as a secondary allegation in cases targeting Illinois and Chicago officials for political corruption.
"The Northern District has argued for an aggressive interpretation of this statute on many occasions," said Robert Kent, a partner in the Chicago office of Baker & McKenzie who was formerly chief of the complex fraud section in the U.S. attorney's office there.
The office has met with success, posting an overall conviction rate for fiscal year 2008 of 96%, compared to the national rate of 92%. Randall Samborn, a spokesman for the office, declined to comment on use of the charge or the Black case.
The criminal defense lawyers said the Supreme Court is likely to focus on the second question presented by the Black petitioners: whether the law "applies to the conduct of a private individual whose alleged 'scheme to defraud' did not contemplate economic or other property harm to the private party to whom honest services were owed."
Black's Supreme Court counsel, Miguel Estrada of the Washington office of Gibson, Dunn & Crutcher, didn't return calls seeking comment, but argued in the petition that the "vagueness" of Section 1346 and differing appellate courts' interpretation of the law call out for Supreme Court clarification.
Solicitor General Elena Kagan contends in response that the law is clear: The government need not show that a defendant intended to deprive a victim of property or money, and the appellate courts differ only slightly in determining whether a given honest services fraud is "material."
The court's decision to grant certiorari in the Black case led to a release from prison of one of Black's three co-defendants, John Boultbee, and Black may resubmit a request for release in the Northern District of Illinois after Justice John Paul Stevens denied his request for release on bail on June 11.
The defendants argue that the Supreme Court may very well overturn their three mail fraud convictions. Black's counsel contends that he would then have to be retried on the only other outstanding charge against him, an obstruction of justice charge, because of the "highly inflammatory evidence" presented in support of the fraud counts.
In the case, prosecutors charged Black and his fellow executives from Hollinger International Inc., publisher of the Chicago Sun-Times and other newspapers, with fraud for pocketing money from bogus noncompete agreements drawn up when the company was selling off its smaller newspapers in the 1990s. Prosecutors argued that millions of dollars should have gone to shareholders of the company. Black was convicted by a jury on four of the 13 counts against him.
U.S. attorney's offices will pursue "honest services" infractions much more carefully while Black's case is pending before the high court to avoid having cases overturned in the future, the criminal defense lawyers said. Prosecutors are more likely to use it to shore up other charges or avoid it altogether, they said. "It's likely to mean that prosecutors will only use it in the circumstances that every court agrees it would work — that way they'll have some level of confidence no matter what happens," Kent said. "At this point, it would be risky to do anything else."
Still, in cases such as the one against Blagojevich, which includes a host of other criminal charges, anticipation of the Supreme Court's decision on Black is unlikely to make a difference, the lawyers said.
A SCALIA DISSENT
Justice Antonin Scalia in February dissented when the Supreme Court declined to grant certiorari in another honest services conviction case against a top aide to Chicago Mayor Richard Daley, also prosecuted by Fitzgerald's office. In his dissent, he said that not taking the case allowed "the current chaos" in application of the statute to prevail. Now it seems Scalia has managed to win over three additional justices on the honest services issue with respect to the Black case.
"They need some sharper definition," said Mark Rotert, a Chicago criminal defense attorney at Stetler & Duffy and a former federal prosecutor who was once chief of the major crimes division in Chicago's U.S. attorney's office. "There are some real questions about...the appropriate reach of the criminal statute."
Scalia in his dissent regarding the case of Daley aide Robert Sorich said that the circuits are clearly divided on how to interpret the honest services section. The U.S. Court of Appeals for the 5th Circuit has held that the statute criminalizes only the unlawful deprivation of services, though other courts have disagreed with that, he stated. The 7th Circuit has read the statute to prohibit the abuse of a post for private gain, while some circuits don't see such a gain as part of the crime, he said.
"Without some coherent limiting principle to define what the 'intangible right of honest services' is, whence it derives, and how it is violated, this expansive phrase invites abuse by headline-grabbing prosecutors in pursuit of local officials, state legislators, and corporate CEOs who engage in any manner of unappealing or ethically questionable conduct," Scalia wrote.
At the core of the issue is the notion that would-be defendants have a right of due process that provides clarity in the laws that they are expected to obey, said criminal defense attorneys.
This isn't the first time that the Court has wrestled with the statute. In its 1987 ruling in McNally v. U.S. , the Supreme Court dismissed prosecutors' and courts' widely held view that the mail fraud statute could be used to fight public corruption and misconduct on the basis that citizens had an 'intangible right' to good government. Congress the following year enacted the honest services section to revive the practice of prosecuting under that right.
"The confusion arises in part from the fact that the law appears to apply differently to public officials and private individuals," said John Cline, a partner in Jones Day's San Francisco office who represented Sorich in his appeal. "It will be interesting to see if the Supreme Court tries to develop a unified standard for the two types of cases."
Some attorneys expect the high court to rule narrowly on the application of the law to private individuals, such as corporate chieftains like Black and avoid weighing in on circumstances related to public officials, at least for now.
Lynne Marek can be contacted at lynne.marek@incisivemedia.com.
