Executive pay and the law of fraud
on Dec 4, 2009 at 7:43 pm
The Supreme Court will hear one hour of argument at 10 a.m. Tuesday on Black, Boultbee and Kipnis v. U.S. (08-876). Speaking for the former executives of media conglomerate Hollinger International, Inc., will be Miguel A. Estrada of Gibson, Dunn & in Washington, D.C., and for the federalgovernment will be Deputy Solicitor General Michael R. Dreeben.
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At a time when the super-sized pay for high-ranking corporate executives is a major politicalissue, the Supreme Court has agreed to sort out whether a pay package can actually amount to criminal fraud, on the theory that it deprives the company or its stockholders of “honest services” in the executive suite. The issue arises in the high-profile prosecution, and conviction, of Canadian media mogul, Conrad M. Black, and two of his fellow executives at Hollinger International, Inc. Their case, in fact, is one of three the Court is reviewing this Term on the “honest services” fraud issue in federal law.
Background
Two decades ago, Congress sought to revive federal prosecutors’ broad authority to pursue public corruption cases, after the Supreme Court had significantly cut back on that power. The Court did so in the 1987 case of McNally v. U.S. — a decision that lasted one year before Congress moved to undo it. Now, 21 years after Congress passed the so-called “honest services fraud” law, its meaning is still deeply uncertain, and even its constitutionality is a matter of strong debate.
At issue in the McNally case was an old standby law for federal prosecutors, dating back to 1872: the law that makes it a crime to use the mails to carry out a fraud — specifically, the law applies to “any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises.”
In that case, a former Kentucky state official, James E. Gray, and a private individual, Charles J. McNally, were convicted of committing fraud against the citizens of Kentucky for their role in a scheme to channel state workmen’s compensation insurance commissions to a company controlled by McNally and in which Gray had an interest. The prosecutor’s theory was that they had defrauded Kentucky’s citizens of their right to honest government — technically, denying citizens their “intangible right” to honest services.
The Supreme Court, dividing 7-2, ruled that the mail fraud law only sought to protect property rights, and “does not refer to the intangible right of the citizenry to good government.” If Congress wants to go further, the Court remarked, “it must speak more clearly than it has.” (The only members of the Court at that time who are still serving are Justices Antonin Scalia, who voted in the majority, and John Paul Stevens, who dissented.) Within a year, Congress voted to overturn that decision, passing what is now Section 1346 of the federal criminal code. The new provision, discussed only briefly before passage, defines the phrase “scheme or artifice to defraud” to include “a scheme or artifice to deprive another of the intangible right of honest services.”
Whatever Congress’ specific intent then, the most significant dispute over what Section 1346 now means is whether it applies, at all, to private conduct, where both the person accused and the alleged victim are private, or whether it is simply a public corruption law. (The breadth of its application in public corruption cases is also an issue that the Court is now considering, in a separate case.) What is directly at stake in the new case of Black, et al., v. U.S. is whether it applies to private conduct when prosecutors have not proved explicitly that the alleged fraud caused any economic harm to the victim — in this case, the media company. The lower courts are split on that question, as they are on most other discrete issues involving Section 1346.l
The case has had a high visibility because of the prominence in media circles of Conrad M. Black, former chairman and CEO of Hollinger. He and others built one of the world’s largest media conglomerates, which owned newspapers and other media properties in the U.S., Canada and elsewhere — including the Chicago Sun-Times, the Jerusalem Post, the London Daily Telegraph, and Canada’s National Post.
Prosecutors charged that lack, John A. Boultree and Mark S. Kipnis “stole” $5.5 million in compensation by defrauding Hollinger, and that their actions deprived Hollingerof their “honest services.” Since those were separate theories, prosecutors sought a split verdict, but defense lawyers objected. The jury reached a general guilty verdict, without specifying what theory had persuaded them. Before the verdict, the judge had refused to instruct the jury, as defense lawyers had asked, that they could convict the executives of “honest services” fraud ionly if prosecutors proved to the jury that the executives did economic harm to Hollinger.
Black was convicted of three counts of mail fraud and one count of obstruction of justice and was sentenced to 78 months in prison, required to pay Hollinger $6.1 million, and fined $125,000. Boultree, the company’s executive vice president and former chief financial officer, was convicted of three fraud counts and was sentenced to 27 months in prison. Kipnis, a Chicago lawyer and the company’s corporate counsel and secretary, also was found guilty of two  fraud counts, and was sentenced to six months of home detention.
In their appeal to the Seventh Circuit Court, Black, and his colleagues argued that the “honest services” law did not reach their conduct, since their compensation packages — management fees to which they insisted they were entitled — were not bogus, and were designed only to ease their Canadian tax burden. Since Hollinger suffered no economic harm, it was not deprived of their honest services, they contended.
The Circuit Court upheld their convictions, finding no legaldefect in the trial judge’s failure to instruct jurors on what proof was needed to show “honest services” fraud in the private sector. The Circuit Court suggested that, if the jury had thought the management fees were legitimate, it would not have convicted them, so it must have found they wrongly took Hollinger’smoney. The Circuit Court, however, had an alternative basis for its ruling: it said that, whatever the scope of the “honest services” law, Black and his colleagues had not been harmed because they had resisted having the jury reach a special verdict, so they had “forfeited” any claim on that point.
The lawyers for Black, Boultbee and Kipnis then took the case to the Supreme Court, filing their petition for review on Jan. 9. Before the Court acted on their case months later, Justice Scalia issued a scathing dissent in a separate case (in February), denouncing the sweep that the “honest services” fraud law had now acquired, noting the disputes among lower courts about the law’s scope, and urging the Court to “squarely confront both the meaning and the constitutionality ” of Section 1346.
Petition for Certiorari
The Hollinger executives’ petition was fairly narrow in scope, not specifically raising a constitutional argument about the validity of Section 1346 and making no claim that the law did not apply at all to private conduct. It did hint at a vagueness argument (with some constitutional implication), saying that the Circuit Court ruling allowed federal courts to “fashion — at the government’s urging — private sector ‘crimes’ that no reasonable person could anticipate.”
Its stress on Section 1346 was on the deep division among the Circuits on what the law means, when applied to private conduct, and the specific disagreement about what kind of proof of harm — if any — had to be offered to support an “honest services” fraud charge. Black and the others, it contended, were convicted of crimes based on “jury findings that would have been insufficient to convict in at least five circuits.”
The first question thus focused on whether Section 1346 applied in a private case where the alleged fraud “did not contemplate economic or other property harm to the private party to whom honest services were owed.”  In discussing that issue, the petition also complained strenuously of the “unprecedented federalization of wholly private conduct that is properly the concern of state, not federal, law.”
The petition also raised a second question, challenging the Seventh Circuit’s “retroactive” creation of a rule that an accused in a criminal case forfeits any claim of error in the jury instruction by resisting a split verdict approach. In pursuing that issue, the petition strongly condemned the use of split verdicts in criminal cases, saying they undermine the jury system by pressuring reluctant jurors to vote for conviction, by depriving jurors of the option of a general verdict, by undermining jurors’ use of common sense, and by risking confusion among jurors.
The Justice Department urged the Supreme Court not to hear the case. Picking up on the forfeiture conclusion of the Seventh Circuit, Solicitor General Elena Kagan argued that the executives’ defense lawyers did not salvage their claim that the jury had to find economic harm to the company. The instructions they did propose, the response contended, had nothing to do with the proof required for “honest services” fraud. In fact, the government said, the defense lawyers had disavowed in the appeals court the legal claim they were not advancing.
Even so, the Solicitor General went on, the mail fraud law as expanded by Congress in Section 1346 overturned the part of the McNally decision saying that the fraud law only applied to schemes that take away money or property. Those are the ingredients of “property-rights fraud,” and Congress did not restrict “honest services” fraud to those concepts. Thus, the brief contended, prosecutors in an “honest services” case — whether involving public or private activity — need not show harm to the victim’s money or property.
Section 1346 is not unlimited in scope, the Solicitor General said, since an accused is guilty of “honest services” fraud only if the fraud is “material” — that is, it was central to the success of the scheme to act dishonestly. The brief insisted that, on that point, the Circuit Courts “differ somewhat in their articulation” of what is material and what is not.
If there were an error in the jury instructions in this case, the brief said, it was harmless. No guilty verdict would have emerged, it explained, if the jury believed the defense theory about the legitimacy of the executives’ management fees.
The Solicitor General also contended that the second question raised — on the forfeiture of the claim about the jury instruction — was not worthy of the Court’s time.
The Court granted review on May 18. (After doing so, Black’s efforts to getfree on bail were twice denied by Justice Stevens, as Circuit Justice for the Seventh Circuit. Black is in federal prison in Florida. Boultreehas been freed by the trialjudge pending the appeal, and Kipnis received no prison time.)
Merits Briefs
Broadening their challenge significantly, the former Hollingerexecutives’ merits briefs not only condemned the breadth of the law as a license to prosecutors “to target anything that offends their ethical sensibilities,” but also suggested that, if Section 1346 is not read narrowly to require proof of economic harm in the private sector, it would run afoul of the Constitution.
The brief suggested that construing the law as broadly as the federal government does in this case, and others, risked violating separation-of-powers doctrine, because that would constitute “judicial lawmaking” that intruded on Congress’s exclusive power to define what is criminal, risked violating federalism principles, because of a deep intrusion on the states’ power to decide what private conduct to condemn, and risked violating due process principles, because of the effort to criminalize any “dishonest” conduct in the private sector.
In arguing for a requirement of proof of intended economic harm, the brief suggested that it is not necessary for prosecutors to show that such harm actually did occur, but was “contemplated” as part of the scheme. The mail fraud law, it noted, deals not require proof of a completed fraud, but of a scheme to defraud.
The former executives’ brief borrowed from the D.C. Circuit Court, in the 1983 ruling in U.S. v. Lemire, a standard of proof on the economic harm question. The Court should hold, the brief said, that in a case involving claimed “honest services” fraud by an employee, there must be proof of “a failure to disclose something” which the employee kinew posed “an independent business risk to the employer.”
The executives are supported in the case by defense lawyers’ groups, by the U.S. Chamber of Commerce, and by an Enron Corp. executive who also has an “honest services” case under review by the Court this Term: Jeffrey K. Skilling. The Skilling brief sought to persuade the Court to reaffirm the notion — not in dispute in the Blackcase — that a violation of Section 1346 required proof of an effort tores pursue private gain (proof tht was not required in Skilling’s case). The Chamber of Commerce brief focused on the constitutional argument about Section 1346’s supposed vagueness.
The federal government’s brief responded directly to the newly advanced constitutional arguments, contending that Section 1346 is actually limited in scope, and asserting that “Congress did not criminalize all manner of dishonesty.” What the provision basically covers, the brief said, are bribes and kickbacks and “undisclosed self-dealing” and “conflicts of interest.” Those in a position of trust in a company or other entity who become disloyal, the government contended “have ample notice of their criminal conduct.”
Addressing the intended scope of the “honest services” fraud statute, the Solicitor General said that provision would be rendered “largely insignificant” if the Court were to require proof that the dishonest person or executive had intended to cause economic harm. Proof of that kind of harm can be prosecuted under normal fraud principles, involving loss of money or property. What Section 1346 added, according to the brief, was the new and distinct form of non-property liability.
If the executives’ approach were embraced, the Solicitor General contended, it would even put the McNally facts beyond prosecution under the statute that was intended to criminalize that very kind of misconduct.
If the Court is troubled by the Seventh Circuit’s approach to the jury instructions issue in the case, the government suggested, a new trial should not be required, but rather a return to the appeals court to re-examine the harmlessness question.
The government’s side in the case is supported by Citizens for Responsibility and Ethics in Washington, a non-profit advocate of integrity in government, arguing the indispensability of Section 1346 as prosecutors have used it.
Analysis
The Court’s active interest in the “honest services” fraud law’s scope, clear from its willingness to hear three cases on the law this Term alone, suggests strongly that the Court is troubled by the sweep of the law. Justice Scalia’s determined effort to get the sweep of the law before the Court would appear to have had a significant impact on his colleagues. While none may yet be prepared to join him in a constitutional ruling against the law, the prospects seem great for some significant limitation on the law’s breadth.
It is unclear, before the oral argument, whether the Court has any genuine interest in the argument by the government and the Seventh Circuit that the Hollinger executives have forfeited their entire claim about the breadth of the law, because of the defense lawyers’ handling of the jury instruction question. If the Court were looking for a way to avoid a ruling on the substantive statutory question, however, that argument is at hand. The merits briefs, on both sides, tend to play down that issue, and the Court’s grant of review in the face of the government’s use of that argument would indicate that it may not make the difference on whether the merits are reached.
The difficulty, if the Court wants to stay away from constitutional issues, of finding a way to interpret Section 1346 in order to save it is apparent. Lower courts have had difficulty finding common ground in fashioning narrowing interpretations, and there is no reason to think that task would be any easier for the Justices.  The key may be how a majority of the Court reads Congress’s basic purpose in 1988 in seeking to overturn the McNally decision. Despite the limited legislative history, the Court may well find that it has to decide for itself what Congress actually meant to do.
