The future of honest services fraud.

• Author: Rowe, Jennifer I.

JUSTICE BREYER: Well, the Sherman Act criminalizes price fixing. You see, I can say that in two words, intentional price fixing. Do you think what we have been talking about this morning can be reduced to anything like these two words?

[DEPUTY SOLICITOR GENERAL MICHAEL] DREEBEN: I think I have got it down to around eight. (1)

This exchange took place at the Supreme Court in December of 2009 as the Justices heard oral arguments in the first pair of three cases accepted for the term to tackle a particularly knotty problem in the law of white-collar crime. The problem was what to do with 18 U.S.C. [section] 1346, a twenty-eight-word statute criminalizing what is known as "honest services fraud." (2) The brevity of the statute is deceptive, since the conduct it addresses has proven very difficult to pin down. In its entirety, [section] 1346 reads: "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." (3) There are two reasons why it is hard to say exactly what is criminalized by this language. First, the idea of "intangible rights" often means there is no direct pecuniary harm to the person whose rights are violated. Second, the conflicts of interest which typically lead to the violation of intangible rights are only sometimes prohibited, and only sometimes subject to disclosure requirements. The qualifications and conditions surrounding the criminalization of nondisclosure are what made it difficult for justice and counsel to gloss the statute easily.

In June of 2010, the Court handed down its decision on the honest services fraud statute, confining the behavior criminalized by [section] 1346 to bribery and kickback schemes only. (4) Excluding the more uncertain territory occupied by various forms of nondisclosure and self-dealing protects the statute from vagueness, and allowed the Court to settle on a core of behavior which at least can be described in two or three words. Even with its difficulties, however, the former, fuller reach of [section] 1346 was essential in enforcing an important aspect of the public trust. This comment suggests that further legislation is needed to delineate an acceptably clear standard for criminalizing nondisclosure of a conflict of interest. Congress should amend [section] 1346 to add a limiting principle for nondisclosure requiring scienter, materiality, official action, and benefit, and should consider adding a second statute addressing material nondisclosure violations not captured by the first.

Discussion will begin with a capsule history of honest services fraud and [section] 1346, a topic that has been canvassed thoroughly in the last twenty years. The next section will detangle the concepts of intangible rights and conflict of interest nondisclosure, using the facts of Weyhrauch v. United States (5) and its argument before the Court as the chief illustration. All fifty states have addressed the ethical dimensions of honest services in some way, and the rationales and methods of the states will be explored. Finally, the reasons for the necessity of some federal enforcement in the area of honest services fraud will be addressed, along with a brief detour, for historical context, to the New York City of the Tammany Hall era. The comment will conclude with recommendations for Congressional amendment of the honest services fraud statute.

1. THE HISTORY OF HONEST SERVICES FRAUD

   The honest services fraud statute is a companion to the mail fraud statute which first uses the term "scheme or artifice to defraud." (6) Section 1346 was enacted by Congress in 1988, (7) but the mail fraud statute itself is much older; the original version was passed in 1872. (8)

   The mail fraud statute, also known as "the white-collar federal prosecutor's Louisville Slugger," (9) has been used broadly to prosecute all manner of frauds. While "[i]nitially, the statute served to prevent the use of the mails to carry instruments of fraud such as false advertisements of get-rich-quick schemes," (10) the idea that people can be defrauded of things other than money or property--of "intangible rights"--gradually came to be accepted by the courts. (11) In the 1970s, on the strength of a post-Watergate federal interest in cleaning up public corruption, the mail fraud statute enabled a "flood tide" (12) of prosecutions aimed at public officials who were said to have defrauded the public of its "intangible right" to the honest services of its elected representatives. As a recent commentator noted, "[i]t's especially useful for prosecuting secret deals that are corrupt but do not involve an obvious transfer of money." (13) A representative case is United States v. Mandel (14) in which the Fourth Circuit addressed the Governor of Maryland's hidden business involvement with, and payment by, entities which benefitted from Mandel-aided state legislation on racetracks. "The fraud involved," the court said, "lies in the fact that the public official is not exercising his independent judgment in passing on official matters.... [T]he public is not receiving what it expects and is entitled to, the public official's honest and faithful service." (15)

   The mail fraud statute has enabled many prosecutions that would have been impossible without it. Using an honest services fraud charge, "[t]he government is able to prosecute corruption not only by federal government officials but also by state and local government officials." (16) Crucially, "[t]he government does not need to prove that a fraud resulted in a loss to the public of money or tangible property." (17)

   In 1987, the Supreme Court put a sudden stop to honest services prosecutions with its decision in McNally v. United States. (18) McNally was an associate of a Kentucky official who received kickbacks from certain insurance companies in exchange for the state's business. (19) No loss to the state of money or property was alleged. (20) The Court held squarely that "[t]he mail fraud statute clearly protects property rights, but does not refer to the intangible right of the citizenry to good government." (21) Justice Stevens's dissent notwithstanding, the Court was not inclined to read the mail fraud statute as expansively as lower courts had done: "If Congress desires to go further, it must speak more clearly than it has." (22)

   Congress took up that challenge promptly, enacting [section] 1346 the following year with the avowed goal of restoring pre-McNally case law to its former effect. (23) One of the bill's sponsors, Senator Biden, explained that the intent was simply to "reverse the McNally decision and allow Federal prosecutors to bring the kinds of public corruption charges that they were able to bring before 1987." (24) Prosecutors picked up where they had left off. Sections 1346 and 1341 together were used in recent years to charge prominent public figures such as Connecticut Governor John Rowland, (25) Illinois Governor Rod Blagojevich, (26) New York State Senator Joseph Bruno, (27) Congressman Robert Ney, (28) and lobbyist Jack Abramoff, (29) among others. Honest services mail fraud was also extended to financial fraud in the private sector; thus, one of the cases before the Supreme Court in the 2010 term was that of Enron Chief Executive Jeffrey Skilling. (30) Proposals for further expansion included use of the statute against Major League Baseball players and against the perpetrators of environmental crimes. (31)

   Meanwhile, a growing chorus of voices suggested that some limits on the reach of the honest services statute would be prudent. (32) There were charges of vagueness; there were federalism concerns. Referring to honest services, Justice Scalia wrote in a dissent early in 2009 that "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." (33) A growing body of lower court opinions espoused a variety of limiting principles, putting the circuit courts in serious conflict. (34) The Third Circuit limited the application of the honest services statute to situations where the defendant violated a fiduciary duty established by any state or federal law. (35) The First Circuit required more than a "conflict of interest alone." (36) The Seventh Circuit put forward the "misuse-of-position-for-private-gain limitation," (37) and the Eighth and Tenth Circuits required materiality and fraudulent intent. (38) The Supreme Court rejected all of these principles, even as it stopped short of invalidating the statute altogether.

   The theory of honest services fraud has thus expanded and contracted repeatedly from its inception, first cut off by McNally and restored by [section] 1346, then limited unevenly over time by the circuit courts, and now contained by Skilling v. United States to bribery and kickback schemes only. There remains a need for a flexible standard that preserves the theory's intent--to punish conduct that erodes the public trust. The next section will examine that intent more closely.

2. INTANGIBLE RIGHTS AND CONFLICT OF INTEREST NONDISCLOSURE--WEYHRAUCH V. UNITED STATES

   The Fifth Circuit's "state law limiting principle" was at issue in Weyhrauch v. United States, (39) the public sector honest services case argued in late 2009 before the Supreme Court. (40) In 1997, the Fifth Circuit delivered a strongly federalist opinion in United States v. Brumley (41) which established the principle. Brumley, a Texas state official, accepted "loans" from attorneys who appeared in worker's compensation board hearings before him. (42) There was no evidence he changed the outcome of any hearings as a result of the payments. (43) The Court of Appeals, following Congress's direction to pre-McNally case law, found that "before McNally the doctrine of honest services was not a unified set of...