The Supreme Court has granted certiorari in, and will soon resolve, three related cases, all involving the scope of “honest services” fraud under 18 U.S.C. §1346.1 By itself, this is unusual, because the Court usually takes only a single case and remands related cases for reconsideration in light of its decision. Also unusual is the fact that the Court is reconsidering the scope of mail and wire fraud, as §1346 was passed by Congress as a direct rebuff to the Supreme Court following the Court’s last attempt (two decades ago) to trim the ineffably broad scope of the mail and wire fraud statutes. Reversing the narrow reading that the Court had given those statutes in McNally v. United States2 so that they applied only to schemes seeking money or property (and not to deprivation of intangible rights), §1346 broadly criminalized any “scheme to deprive another of the intangible right of honest services,” at least if the mails or interstate wires were used. Not surprisingly, the circuits have split over when this intangible right arises and what it must be based upon.
At this point, many corporate and securities lawyers may yawn and turn the page, thinking that this column is only about substantive criminal law. But it is not. What the Court says about fiduciary duties under the mail fraud statute may carry over to what can be reached in insider trading prosecutions as well, where some form of fiduciary breach is generally also a prerequisite to liability. In addition, two of the defendants in these three cases—Lord Conrad Black and Jeffrey Skilling, the former CEO of Enron—are household names; and the third case involves a public official accused of bribe taking. As a result, the Court appears likely to fashion a comprehensive statement, covering both the private and public sectors, as to when breaches of fiduciary duty or similar confidential relationships violate the mail and wire fraud statutes. Such a recodification should have considerable impact, because over the past 40 years, the breadth of the federal mail and wire fraud statutes has enabled federal prosecutors to reshape the landscape of federal criminal law, both reaching cases involving conflicts of interest in the business world and many forms of political corruption engaged in by public officials at both the state and federal level. No other statute has convicted as many governors, congressmen and CEOs.
But that is exactly why the Supreme Court is concerned. Many criminal law scholars assume that the legal issues surrounding any broad and vaguely defined criminal statute fall into only two Constitutional categories: (1) “fair notice” issues (and virtually every form of civil or even ethical misconduct has been prosecuted at some time under the mail and wire fraud statutes); and (2) “separation of powers” issues, as a body of federal common law typically evolves under such a statute without any clear legislative authorization. Valid as these concerns are, such a binary analysis overlooks a critical third category. What has most concerned the Supreme Court (or at least its more conservative justices) is the impact of §1346 on federalism. Federal prosecutors today regularly oversee political ethics, patronage systems, business conduct, and fundraising practices at the state and municipal level, subjecting them to a uniform federal standard. In so doing, federal control is being quietly asserted over the states. That may best explain why the Supreme Court cut back on the reach of the mail and wire fraud statutes in McNally and why Justices Rehnquist, Scalia and Thomas dissented in the Court’s leading modern decision on the scope of the Hobbs Act.3 There, over their objections, a majority of the Court upheld an expansive scope to that statute, which is the other federal criminal statute principally used by prosecutors to combat state and local political corruption.
Federalism concerns probably best explain the grants of certiorari in these three cases, because the two other concerns have been reasonably addressed. Even if the mail and wire fraud statutes had once generated a sprawling federal common law that reached all sorts of misbehavior—financial, political and even sexual4—the legislature has hardly been outflanked; rather, Congress emphatically endorsed this process by enacting §1346. Of course, even if Congress has now blessed “intangible right” prosecutions, this would not cure a federal statute that was so overarchingly broad that it failed to provide fair notice. Once, a vagueness attack on §1346 might indeed have been appropriate, but the recent trend of the cases has been to cut back substantially on the reach of §1346. This trend is particularly clear in the Second Circuit, where its en banc decision in United States v. Rybicki5 has basically made it clear that only undisclosed self-dealing by agents and corporate officials can offend §1346.
The current division among the Courts of Appeal over §1346 essentially hinges on the asserted need for a state law violation to support an honest-services prosecution. At present, the circuits are divided between those courts that find a violation of state law to be essential to establish a §1346 violation6 and those that find a state law violation to be irrelevant,7 because the federal mail and wire fraud statutes should in their view have a uniform national meaning. That the Court took these cases to resolve this dispute is made clear by the Court’s decision to revise the question presented in United States v. Weyhrauch.8 Originally, the petitioner had defined the question as:
Whether 18 U.S.C. §1346, by criminalizing denials of the intangible right of honest services, mandates the creation by the federal courts of a federal common law defining the disclosure obligations of state government officials.
In granting certiorari, however, the Court rephrased this question to the following one:
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, in violation of the mail fraud statute (18 U.S.C. §§1341 and 1346), the government must prove that the defendant violated a disclosure duty imposed by state law.
This rephrasing suggests that the Court is not inclined to consider broader vagueness or separation of powers issues, but is focused on the federalism issue of whether §1346 looks to federal or state law to determine if honest services have been provided.
In Weyhrauch, the petitioner defendant was a lawyer and member of the Alaska House of Representatives who allegedly solicited a corporation for future legal work in return for his support for favorable tax legislation for that company. The District Court found that Alaskan law did not require the petitioner to disclose his conflict of interest before voting or taking official action on the legislation. The Ninth Circuit reversed, finding that a state official may be convicted of honest services fraud without proof of any state law violation.9
The solicitor general has broadly argued in her brief to the Court that §1346 reaches any state official who takes official action while intentionally concealing a material conflict of interest, regardless of whether any disclosure duty existed under state law. So read, the scope of §1346 extends well beyond that of the Hobbs Act, which essentially requires a quid pro quo before payments or campaign contributions to a public official can be deemed to amount to extortion.10 In the solicitor general’s view, §1346 simply re-instated pre-McNally jurisprudence, which had never required a state law violation.
In contrast, petitioner’s counsel argues that reading §1346 to dispense with the need for a state law violation conflicts with a well-established canon of construction under which “Congress must speak clearly when it acts in a way that invades the usual prerogatives of the states.”11 Because the federal prosecution of state officials for public corruption is a particularly sensitive area in the federal/state relationship, petitioner claims that cases, such as Gregory v. Ashcroft,12 require that Congress use “unmistakably clear” statutory language. But this implicit claim that principles of federalism shield state and local corruption from federal prosecution (at least unless Congress was explicit in its directions) runs up against several problems. First, in enacting §1346, Congress was not altering the federal/state balance, but restoring it, as the mail and wire fraud statutes had already been used against state and local officials for decades—until McNally suddenly invalidated these “intangible right” prosecutions. Context carries meaning. In enacting §1346, Congress was not speaking in muted Delphic tones that were susceptible to ambiguous interpretation; rather, frustrated with the Court, it was angrily reinstating a well-known body of jurisprudence. Second, even apart from mail and wire fraud, the federal/state balance is not being “dramatically restruck” (as petitioners contend in Weyhrauch), because the Hobbs Act has long applied to local corruption whenever a state or local official receives a payment “under color of official right”; similarly, 18 U.S.C. §666 reaches any bribe paid to a local official if the local governmental body receives federal funds. Although Justice Thomas has protested this idea that there is a federal interest in local corruption,13 he has gained no allies in this protest, and it would be a dramatic reversal for the Court to cut back on the reach of §1346 in the case of public sector officials.
In contrast, the cases involving Lord Black and Jeffrey Skilling are closer and more nuanced; also, less is probably at stake. In Conrad Black’s case, the issue is whether the jury had to be instructed that, in order to convict under §1346, they had to find that the “fraudulent scheme contemplated economic harm to the employer.” Lord Black was the CEO and Chairman of Hollinger International, a newspaper publisher. When it began to sell off its community newspapers in 1998, Hollinger would often enter into non-competition agreements under which it promised the purchaser that it would not operate a competing newspaper in the same locality for a specified period of time; Black and his fellow executives would also enter into non-competition agreements, and some of the sales price for these papers would thus be diverted to them (and away from Hollinger’s shareholders). In one extreme instance, involving a small paper in Mammoth Lake, Calif. (which locality had an approximate population of 7,000), Black and his associates received $5.5 million for agreeing that they would not compete with this newspaper for three years after they ceased to work for Hollinger. But here, there was one critical difference: this small paper had not been sold. In effect, Black and his fellow executives were being paid $5.5 million not to compete with their own company. Not only was there no conceivable possibility that they would start a rival paper on their own in Mammoth Lake, Calif., but this transaction was never disclosed to, or approved by, Hollinger’s independent directors. Further, the checks were backdated to the year in which other papers had been sold.
The indictment charged Black with two overlapping theories of mail fraud: (1) that he stole money from Hollinger by causing it to pay him and his cronies the non-competition payments without approval by the Hollinger board; and (2) that he deprived Hollinger of his honest services under §1346. The court instructed the jury that to convict of “honest services” fraud under this second theory the jury had to find that Black and his cohorts misused their positions “for private gain,” but it did not instruct the jury that it must find that this “private gain” was to the detriment of Hollinger and its shareholders. Petitioners had at times during their trial suggested that the payments they received were actually intended to compensate Hollinger’s controlling parent corporation for management advisory services; in order to minimize Canadian tax liability, these management fees were instead re-characterized, they claimed, as non-compete payments.
Thus, in effect, Black’s defense was that he was cheating the Canadian government, not Hollinger and its shareholders. Recognizing that its two alternative theories of mail fraud overlapped, the government asked for a special verdict, but in response defendants insisted instead that special interrogations be given the jury in the event that they convicted. After the defense had objected to the special verdict, the government withdrew its request—thereby allowing petitioners to argue on appeal that there was no way of knowing on which (or both) of these two alternative theories of mail fraud the jury had convicted.14
The brief for the solicitor general in the Black case asserts that §1346 does not require proof of “contemplated economic harm” and that such a test would frustrate the purposes of §1346. Here, the solicitor general may be going a bridge too far. Section 1346 does need to be read (and many lower courts have read it) to require that the defendant either contemplated economic harm or personal gain. As just noted, the jury was only instructed that it must find that the defendant intended “personal gain,” but not that this gain had to come at the expense of the particular person or entity to whom the defendant owed the duty of honest services.
Although a “contemplated harm” requirement is admittedly extratextual, it follows from the rationale for honest services fraud: shareholders and other beneficiaries of the duty fear that undisclosed self-dealing will be to their detriment. However, shareholders do not similarly fear that corporate officials will be overzealous on their behalf, possibly bending legal or ethical rules. Such conduct may be wrongful, but its victims are generally not the shareholders.
Nonetheless, prior to the Second Circuit’s recent tightening of its own definition of honest services fraud in its en banc decision in Rybicki, a series of Second Circuit decision had upheld convictions of corporate officials for making payments to bribe union officials or to establish off-books slush funds—even though such conduct was intended to maximize profits for the company and its shareholders.15 In the most extreme of these cases, United States v. Wallach,16 the defendant was convicted for falsely stating that his invoice for lobbying services was instead for legal services in connection with an initial public offering. The defendant had made this false statement at the paying corporation’s request (because it wanted to hide its expenditures for lobbying), but the Second Circuit still held that this misrepresentation interfered with the shareholders “right to control” their corporation and so violated §1346. After Rybicki, such an overextension of §1346 is no longer possible in the Second Circuit, but it could recur again if the Solicitor General convinces the Court that there should be no “contemplated harm” requirement.
Cases in which a corporate official merely makes a misrepresentation (often at a superior’s instruction) without any associated self-dealing represent too dilute a breach of duty (if there is any breach at all) to merit prosecution (and a potential 20-year sentence) under the mail and wire fraud statutes. Although corrupt payments to obtain business or political favors are indeed serious, they can be better prosecuted today under the Foreign Corrupt Practices Act. Courts need not perpetuate the legal fiction that such payments inherently injure the shareholders of the bribing corporation.
This does not mean that Conrad Black’s conviction should be overturned. There are strong arguments, which the solicitor general has also made, that he and his codefendants waived any right they had to more precise jury instructions when they objected to the special verdict that the government had offered.
This same problem of jury’s general verdict of guilt that might rest on multiple legal theories also clouds the conviction of Jeffrey Skilling. The jury convicted Skilling of one count of conspiracy, which conspiracy under the government’s theory, had three objectives: (1) to commit securities fraud; (2) to commit wire fraud to deprive Enron of money and property, and (3) to commit wire fraud to deprive Enron of the honest services owed it by Skilling.17 Because the jury returned a general verdict, it is unknowable on which of these three theories the jury relied. Skilling’s defense to “honest services” fraud was that his conduct in hiding Enron’s losses did not breach a fiduciary duty to Enron and its shareholders “because his fraud was in the corporate interest and therefore was not self-dealing.”18 Baldly, Skilling asserts that he “acted in pursuit of Enron’s goals of achieving a higher stock price.” Although the Fifth Circuit had earlier held in United States v. Brown,19 which also involved Enron, that lower level corporate officials could use unlawful means to increase corporate profits when they were instructed to do so by corporate superiors, the Skilling panel found that Brown’s rule did not apply to Skilling because he was never instructed, nor authorized, by a superior (such as the Enron board) to use illegal means to maximize corporate profits.20 In this light, the issue for the Supreme Court arguably becomes whether the end justifies the means: does materially unlawful conduct that sought to maximize profits, but that risked and caused great harm to Enron, deprive Enron and its shareholders of their right to honest services under §1346? The magnitude of Skilling’s departure from the requirements of the securities laws dwarfs those cases in which an agent uses incidental means (such as a bribe or a false invoice) to secure a profitable contract for the company. If the Court does overturn Skilling’s conviction, it will need to articulate why massively fraudulent, unauthorized and undisclosed conduct does not give rise to a conflict of interest, such that its non-disclosure deprives the shareholders of honest services.
Suppose the Court answers this question (as it might) by saying that so long as the defendant is not self-dealing, §1346 cannot be violated. Although this probably erroneously assumes that the interests of a CEO conducting a massive fraud are well-aligned with those of the shareholders, it is a bright line test that can be derived from the text of §1346 by deeming the phrase “honest services” to equate with self-dealing. Such an outcome would not leave corporate frauds undeterred because presumably a person in Skilling’s position would still be liable for securities fraud.
In the course of hearing these three cases, the Court must face the issue on which the circuits are most divided: whether a deprivation of honest services under §1346 requires some prior breach of a duty of disclosure under state law. The problem here is not just that a state law breach requirement might “Balkanize” §1346, but that it would undo what §1346 does most effectively: namely, eliminate the need to show an actual economic loss, as opposed to simply contemplated economic harm. The archetypal §1346 prosecution today will involve a kickback or bribe paid to a corporate officer (say, a purchasing agent) by a particular supplier. Yet, the corporate officer may have bought the goods at the apparent market price, and it may not be easy for the prosecution to prove that a better price was obtainable. Under §1346, this showing is not necessary because the receipt of the bribe alone shows a lack of honest services. But if it must be shown that the conduct breaches state law fiduciary standards, the analysis will become more complex in many circumstances. Under the traditional corporate self-dealing statute in many jurisdictions, the fiduciary must either (a) disclose any conflict and all material terms of the transaction to independent directors and obtain their approval, or (b) prove the intrinsic fairness of the transaction. If this disjunctive standard becomes the test for §1346, the defendant may be able in many self-dealing transactions to claim that the terms of the transaction were fair, even if the defendant received an undisclosed payment or other benefit. At a minimum, the prosecution’s task becomes more difficult.
If a “scheme to defraud” under §1346 requires that there must be a violation of a state law duty of disclosure, it will not be long before other defense counsel assert that the term “deceptive device or contrivance” in §10(b) of the Securities Exchange Act of 1934 similarly requires a breach of a fiduciary duty under applicable state law. Otherwise, it will be claimed that §10(b) also invites federal courts to create a standardless and sprawling federal common law. Under Dirks v. SEC,21 insider trading liability presupposes the breach of a fiduciary duty or similar confidential relationship. Already, in some recent insider trading cases, defense counsel have sought to deny that the breach of a contractual agreement to maintain confidentiality could support an insider trading action by the SEC, because the relationship between the contracting parties was not a true fiduciary one. In the SEC’s recent action against Mark Cuban, the district court rejected this claim22 (fortunately, because a contrary ruling would have enabled parties to breach confidentiality agreements in the M&A context with near impunity). But if a requirement of a breach of fiduciary duty under state law is read into §1346 based on federalism concerns, this same argument will surface again in the insider trading context. If so, contractual agreements to maintain confidentiality would not support criminal liability, even though the misbehavior was willful and self-interested.
What then should the Court do? A “contemplated economic harm” requirement should be read into §1346, because otherwise relatively minor and dilute transgressions of aspirational norms could result in federal felonies. But it goes too far to insist that a §1346 prosecution be permissible only when an underlying state law duty has been breached. Congress did not intend that when it sought to reverse McNally.23 If the pre-McNally case law is subjected to a “contemplated economic harm” requirement, the result would be a federal fraud statute that was reasonably limited and no longer threatened to sprawl across the legal landscape.
John C. Coffee Jr. is the Adolf A. Berle professor of law at Columbia University Law School and director of its center on corporate governance.
1. See United States v. Black, 530 F.3d 596 (7th Cir. 2008), cert. granted, 129 S. Ct. 2379 (May 18, 2009); United States v. Skilling, 554 F.3d 529 (5th Cir. 2009), cert. granted, 2009 U.S. LEXIS 7359 (Oct. 13, 2009); United States v. Weyhrauch, 548 F.3d 1237 (9th Cir. 2008), cert. granted, 129 S. Ct. 2863 (June 29, 2009).
2. 483 U.S. 350 (1987). McNally was preceded by a substantial volume of law review articles noting and criticizing the sprawling and seemingly unbounded expansion of the mail and wire fraud statutes. See, e.g., Coffee, “From Tort to Crime: Some Reflections on the Criminalization of Fiduciary Breaches and the Problematic Line Between Law and Ethics,” 19 Am. Crim. L. Rev. 117 (1981).
3. See Evans v. United States, 504 U.S. 255, 290 (1992) (In his dissent, Justice Thomas, joined by Justices Rehnquist and Scalia, argued that corruption by state and local officials is “a field traditionally policed by state and local law”).
4. See United States v. Condolon, 600 F.2d 7 (1979) (obtaining sexual favors through deceit invades right to privacy and therefore violates mail and wire fraud statutes). In this era, courts often said that the “law puts its imprimatur on…accepted moral standards and condemns conduct which fails to match the reflection of moral uprightness, of fundamental honesty, fair play and right dealing in the general business life of members of society.” See Blachly v. United States, 380 F.2d 665, 671 (5th Cir. 1967) (quoted also in United States v. Keane, 522 F.2d 534, 545 (7th Cir. 1975)).
5. 354 F.3d 124 (2d Cir. 2003) (en banc).
6. See United States v. Brumley, 116 F.3d 728, 734 (5th Cir. 1997) (en banc); United States v. Murphy, 323 F.3d 102, 116 (3d Cir. 2003).
7. See United States v. Martin, 195 F.3d 961, 976 (7th Cir. 1999); United States v. Sorich, 523 F.3d 702, 712 (7th Cir. 2008); United States v. Bryan, 58 F.3d 933, 940-41 (4th Cir. 1995); United States v. Rybicki, 354 F.3d 124, 127 (2d Cir. 2003) (en banc).
8. See 129 S. Ct. 2863.
9. See United States v. Weyhrauch, 548 F.3d 1237, 1245 (9th Cir. 2008).
10. See McCormick v. United States, 500 U.S. 257 (1991).
11. See Brief for Petitioner in Weyhbrauch v. United States at 30.
12. 501 U.S. 452 (1991); see also United States v. Bass, 404 U.S. 336, 349 (1971). These cases are often cited for a “clear statement” rule under which Congress must state that it intends to regulate areas usually accorded to state authorities.
13. See Evans v. United States, 504 U.S. 255, 296 (dissenting opinion of Justice Thomas).
14. Under Yates v. United States, 354 U.S. 298 (1957), a general verdict must be set aside if the jury was allowed to rely upon multiple independent grounds, one of which was legally flawed.
16. 935 F.2d 445 (2d Cir. 1991). But see United States v. D’Amato, 39 F.3d 1249, 1257 (2d Cir. 1994).
17. See United States v. Skilling, 554 F.3d 529, 542 (5th Cir. 2009).
18. Id. at 545.
19. 459 F.3d 509, 522 (5th Cir. 2006).
20. 554 F.3d at 546-47.
21. 463 U.S. 646 (1983).
22. See SEC v. Cuban, 634 F. Supp. 2d 713 (N.D. Texas 2009).
23. In Jerome v. United States, 318 U.S. 101, 104 (1943), the Court held that in enacting a statute Congress does not normally make “the application of federal law dependent on state law”; see also, Mississippi Band of Choctaw Indians v. Holyfield, 490 U.S. 30, 43-46 (1989). Unlike case following Gregory v. Ashcroft, supra, this line of cases assumes that words in a federal statute should be given a uniform national meaning.