Honest Services Fraud: A Thin Line Between Innocent Conduct and Criminal Conduct

1. Honest Services Fraud: A Thin Line Between Innocent Conduct and Criminal Conduct New York American Inn of Court October 28, 2009 At the offices of Willkie Farr & Gallagher

2. Theft of honest services applies to private employees too: • Plain language of the “honest services” doctrine codified in § 1346: • The use of the mails/wires + employee dishonesty is a crime. • U.S. v. Vinyard, 266 F.3d 320 (4th Cir. 2001) (citing U.S. v. Frost, 125 F.3d 246 (6th Cir. 1997)

3. Limiting § 1346 when applied to private employees: • Broad application could make an employee criminally liable for any misstatement or breach of contract with his or her employer. • Courts have been hesitant to apply § 1346 this broadly, and have crafted limitations.

4. Something beyond mere dishonesty • Proof that the employer simply suffered only the loss of loyalty and fidelity of the employee is insufficient to convict. • U.S. v. Sun-Diamond Growers, 138 F.3d 961 (D.C. Cir. 1998)

5. Two standards:

6. MaterialityTest • Focus on the employer’s response • Would the misstatement or omission naturally tend to lead or be capable of leading a reasonable employer to change its conduct? • U.S. v. Jain: “When there is not tangible harm to the victim of a private scheme, it is hard to discern what intangible ‘rights’ have been violated.”

7. Reasonably Foreseeable Harm Test • Focus on employee’s intent • Defendant reasonably should have foreseen that the breach of duty to his or her employer would create an identifiable economic risk to the victim. • U.S. v. Vinyard: the test is met if “the employee could foresee that the scheme potentially might be detrimental to the employer’s economic well-being.” • The government need not prove actual harm- merely that employee anticipated or intended such harm.

8. Employer’s Incenting • A private employee does not commit honest services fraud where the employer “intentionally aligns the interests of the employee with a specific corporate goal where the employee perceives his pursuit of that goal as mutually benefiting him and the employer,” and conducts himself accordingly. U.S. v. Brown, 459 F.3d 509

9. United States v. Skilling • Unlike in Brown, the 5th circuit in Skilling affirmed Jeffrey Skilling’s honest services fraud conviction. Skilling’s employer incenting argument failed, because no one senior to Skilling at Enron approved of or directed his conduct.

10. Theft of Honest Services • 18 USC § § 1341 and 1343 – Mail and wire fraud statutes: “Whoever, having devised or intending to devise any scheme or artifice to defraud…” • 18 USC § 1346 – Honest Services fraud: “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.”

11. U.S. v. Thompson(7th Cir. 2007) • A state government employee awarded a contract to a company that was not initially the lowest bidder. • Three months later the employee received a $1,000 increase in her annual salary. • The 7th Circuit reversed the conviction finding that the increase in salary which was approved through above-board channels was not a “private gain” that makes an act criminal under 18 USC § 1346.

12. U.S. v. Kincaid-Chauncey(9th Cir. 2009) • County commissioner was given cash bribes in exchange for votes on various ordinances. • The commissioner did not reveal the conflict of interest to the commission. • The court ruled that there can be a violation of 18 USC § 1346 if there is a failure to disclose a conflict of interest even if there is no quid pro quo.

13. U.S. v. Sorich(7th Cir. 2008) • Defendants worked for the City of Chicago and arranged for jobs to be given to “political cronies.” • The court determined that the “private gain” does not have to be the wrong-doer’s gain – instead it can be a benefit given to a third party.

14. U.S. v. Thompson(7th Cir. 2007) • A state government employee awarded a contract to a company that was not initially the lowest bidder. • Three months later the employee received a $1,000 increase in her annual salary. • The 7th Circuit reversed the conviction finding that the increase in salary which was approved through above-board channels was not a “private gain” that makes an act criminal under 18 USC § 1346.

15. U.S. v. Weyhrauch9th Cir. 2008 • An Alaska state representative, also a practicing attorney, was accused of soliciting future legal work from an oil services company in exchange for voting a certain way on proposed oil tax legislation. • The defendant argued that because he did not violate state law – Alaska did not require disclosure of the potential conflict – the conduct could not form the basis of a federal violation. • The Court rejected this “state law limiting principle”, holding that 18 USC § 1346 does not require a state law violation.

16. U.S. v. Brumley5th Cir. 1997 • Texas state official who was responsible for handling workers’ compensation claims received $100K + in “loans” from local attorneys representing applicants. The loans were never repaid. • The Court held that a violation of 18 USC § 1346 by a public official requires that services were owed under state law and not delivered. • Since the “loans” violated several state laws, Brumley’s conviction was affirmed.

17. United States v. Conrad Black

18. Black was a publishing magnate. He controlled Hollinger International, which owned over 400 newspapers in North America. Most of them were small, community papers but a few were large and well-known, like the Chicago Sun Times. I LOVE buying the newspaper

20. Mammoth Lakes, CA Population: 7,093

21. The ConductHollinger's general counsel prepared and signed on behalf of APC an agreement to pay Black and others $5.5 million in exchange for promises not to compete with APC for three years after leaving Hollinger.

23. The Defense • The $5.5 million represented management fees owed to Ravelston. • The fees had been characterized as compensation for non-compete agreements in the hope of avoiding Canadian income tax. • The fees were legitimate, and Hollinger suffered no economic harm.

25. Jury Instructions • The jury was permitted to convict of honest services fraud if it found that defendant: • “misused his position for private gain for himself and/or a co-schemer” and • “knowingly and intentionally breached his duty of loyalty” under Delaware law • The jury was NOT required to find that there was any foreseeable harm to Hollinger

26. Convicted✗ 3 counts of mail fraud and wire fraud✗ 1 count obstruction of justice

27. will spend 6.5 years in

28. “On the eve of his incarceration, Black continued to protest his innocence and said that going to jail is "not the end of the world". He claimed: "There's no violence there. I expect it to be somewhat boring." On a lighter note, he added: "It's a hell of a way to lose weight but I'll lose weight.” He threw a going away party at his Miami mansion.  The Daily Mail

29. What did they mean by honest services? According to Judge Posner and the 7th Circuit, “honest services fraud” occurs when corporate executives misuse their positions for private gain. They affirmed Black’s conviction because, by misappropriating millions for themselves, Black and his co-defendants "deliberately failed to render honest services" to the company they owed their honest services to - Hollinger International.

30. Question Presented Whether 18 U.S.C. § 1346 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.

31. In Justice Colton’s chambers ... His law clerk, Michelle, briefs him on the upcoming case, US v. Weyhrauch.

32. United States Court of Appeals For the Ninth Circuit ____________________________________________ United States of America, v. Bruce Weyhrauch. ____________________________________________ Filed November 26, 2008.

33. In the Alaska House of Representatives . . .

34. State Representative Bruce Weyhrauch

35. In 2006 VECO Corp., an oil field services company, is particularly interested in legislation that would alter how Alaska taxed oil production . . .

36. Bruce makes some friends in the oil field . . .

37. Two VECO execs have a series of contacts with Bruce regarding the pending legislation. . .

38. Bruce is a lawyer . . . Bruce wants legal work. Suddenly, he has a bright idea. He solicits VECO executives via mail, phone, and in-person.

39. THE PROBLEM Veco gives legal work to Bruce Weyhrauch’s firm in exchange for voting on the oil tax legislation as VECO instructs.

40. Bruce Gets Indicted United States District Court District of Alaska September 2007 United States of America, v. I N D I C T M E N T Bruce Weyhrauch Defendant.

41. The Grand Jury Charges: COUNT SEVEN 1. Weyhrauch devised a scheme and artifice to defraud and deprive the State of Alaska of its intangibe right to [his] honest services . . . performed free from deceit, self-dealing, bias and concealment and attempting to execute this scheme by mailing his resume to VECO.

42. Bruce goes to trial ...

43. And the District Court lets him off the hook . . . • The District Court finds that the evidence only related to duties to disclose a conflict of interest under state law, and that “state law did not require Weyhrauch to disclose the conflict of interest he faced in discharging his duties while negotiating for future employment with a company affected by the pending legislation.” • Thus, “any duty to disclose sufficient to support the [honest services fraud] charges here must be a duty imposed by state law.”

44. Bruce leaves the courthouse a free man!

45. The Government Appeals . . .

46. The Ninth Circuit hears the State’s Appeal . . . “Because Weyhrauch’s conduct falls comfortably within the two categories long recognized as the core of honest services fraud [(1)an undisclosed conflict of interest and (2) an inference of a quid pro quo arrangement], we need not define the outer limits of public honest services fraud in this case. . . . “

47. “Accordingly, the government may proceed on its theory that Weyhrauch committed honest services fraud by failing to disclose a conflict of interest of by taking official actions with the expectation that he would receive future legal work for doing so. . . .”

48. Bruce is not happy . . .

49. Justice Sarafa says: Try Again, Congress “Rather than construe the statute in a manner that leaves its outer boundaries ambiguous and involves the Federal Government in setting standards of disclosure and good government for local and state officials, we read § 1341 as limited in scope to the protection of property rights. If Congress desires to go further, it must peak more clearly than it has.” McNally v. United States, 483 US 350 (1987)

50. Justice Sarafa says: Try Again, Congress Vagueness / Notice Concerns “If the ‘honest services theory . . . is taken seriously and carried to its logical conclusion, presumably the statute also renders criminal a state legislator’s decision to vote for a bill because he expects it will curry favor with a small minority essential to his reelection . . . . Indeed, it would seemingly cover a salaried employee’s phoning in sick to go to a ball game.” “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.” Federalism Concerns “Is it the role of Federal Government to define the fiduciary duties that a town alderman or school board trustee owes to his constituents?” Justice Scalia, dissenting from denial of cert in Sorich v. United States 50