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An Overview of Honest Services Fraud After Skilling

July 12, 2011, by The McKellar Law Firm, PLLC

When Enron collapsed and filed for bankruptcy in 2001, tens of thousands of people suffered the financial fallout. Many employees lost their jobs along with their life savings. Many more still lost money as the value of Enron's stock plummeted from over $80 per share in December 2000 to virtually nothing one year later. Public anger at Enron was fierce, and the company came to symbolize the effects of greed and corruption in corporate America. As federal investigations into the Enron scandal mounted following the company's collapse, prosecutors had to decide what charges should be brought against the executive officers and board members who had either engineered or ignored the accounting practices that contributed to Enron's downfall. In the case of former CEO Jeffrey Skilling, prosecutors alleged that Skilling and other top Enron officials engaged in a conspiracy to commit honest services fraud under 18 U.S.C. §§ 371, 1343, and 1346.

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Federal wire fraud statutes are designed to punish those who devise or intend to devise "any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises" and then transmits information by "wire, radio, or television communication in interstate or foreign commerce . . . for the purpose of executing such scheme or artifice." The statute specifically includes schemes to obtain "money or property," but courts have also interpreted § 1343 to include so-called "honest services fraud" as well.

In Skilling's case, the indictment charged that Skilling and other Enron executives had devised a scheme to trick investors and Enron shareholders regarding Enron's performance by 1) "manipulating Enron's publically reported financial results," and 2) "making public statements and representations about Enron's financial performance and results that were false and misleading." Prosecutors charged that in doing so, Skilling had "depriv[ed] Enron and its shareholders of the intangible right of [his] honest services." He was ultimately convicted under § 1346. On appeal, Skilling challenged the constitutionality of § 1346, claiming that it was unconstitutionally vague. If a law fails to describe an 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" then the statute does not satisfy due process and will be held unconstitutional. Skilling claimed that the phrase "the intangible right of honest services" in § 1346 does not sufficiently define the conduct that it prohibits, rendering it void for vagueness.

The Supreme Court ultimately upheld § 1346, finding it was not unconstitutionally vague. The Court did, however, dramatically limit the scope of the law; in doing so, the Court ordered the Court of Appeals to review Skilling's conviction in light of its decision. The majority looked at the circumstances that led to the statute's enactment in 1988 in reaching its decision. Congress passed § 1346 in response to the Supreme Court's decision in McNally. Prior to that decision, all federal courts had adopted an interpretation of "scheme or artifice to defraud" that included deprivation of honest services. When McNally overturned that interpretation, Congress enacted § 1346. The Court interpreted this to mean that Congress intended § 1346 to apply in the same way that case law had applied prior to McNally. Most pre-McNally cases for deprivation of honest services involved payment of bribes or kickbacks. Thus, the Court concluded that Congress intended § 1346 to include such schemes at a minimum. The Court determined, however, that penalizing any further conduct raised issues of vagueness, so only schemes involving bribery or kickbacks fall within the scope of § 1346.

There were no allegations that Skilling received any bribes or kickbacks. The government's case against Skilling was that he and other Enron executives had conspired to defraud shareholders by lying about the company's financial health. These false reports caused Enron's stock price to become inflated. Skilling and the other conspirators benefited because they received bonuses based on the artificially high stock prices. The Court determined that Skilling did not take a bribe from a third-party and then make the misrepresentations in return; therefore, he did not commit honest services fraud by depriving Enron of his honest services within the meaning of § 1346. The Court remanded the case to the Fifth Circuit Court of Appeals so that court could determine whether Skilling's conspiracy conviction must be vacated.

Justice Scalia concurred in the judgment in the case, but disagreed strongly with the majority's logic; Justice Scalia would have vacated the conviction under § 1346 because the statute is vague as applied in Skilling's case. He points out that the statute fails to clearly define what guilt is under § 1346, what honest services are, or who is required to provide them. Justice Scalia also notes that prior to the Court's decision in McNally, many honest services fraud cases included allegations of bribery or kickbacks, but none were limited to those types of misconduct. Pointing out that the pre-McNally cases reached no consensus on what conduct qualifies as a denial of the right of honest services, Justice Scalia observes such conduct could "range from any action that is contrary to public policy or otherwise immoral, to only the disloyalty of a public official or employee to his principal, to only the secret use of a perpetrator's position of trust in order to harm whomever he is beholden to." Justice Scalia continued, noting "[t]he duty probably did not have to be rooted in state law, but maybe it did. It might have been more demanding in the case of public officials, but perhaps not. At the time § 1346 was enacted there was no settled criterion for choosing among these options . . . ." Essentially, Justice Scalia opined that the majority was creating a whole new law in its opinion rather than interpreting or clarifying the existing legal landscape.

The Court's decision significantly narrowed the scope of § 1346. Going forward, prosecutors will probably not be able to use this statute as a catch-all for behavior that is unethical or improper, but probably not otherwise criminal. It will also be interesting to see whether Congress will act - as it did after McNally - to expand the law to include not just bribes and kickbacks, but other conduct as well.