Fiduciary Relationships

One area where honest services mail or wire fraud may arise in the fiduciary context is the private employment relationship. Such a breach occurs when a seller offers a kickback to a purchasing agent, for example. The requisite deprivation of the employer’s property interest is found in the profits he is legally entitled to that are lost as a result of the kickback payment.

Such a breach of a fiduciary relationship must be accompanied by a failure to disclose material information to the employer in order for the mail or wire fraud statute to apply. Moreover, it must be shown that some harm or injury was contemplated by the scheme. In other words, it can’t be just a deprivation of loyal service, but must be accompanied by a misrepresentation or failure to disclose as well as the specific intent to work an injury. Absent a showing of actual harm, the courts are split on how far to stretch the “property” concept. Some have found an intangible right of an employer to monitor and police the behavior of the corporation and its officers; others have found an intangible right to allocate resources or make decisions. Many courts require that the breach of the fiduciary relationship be accompanied by misrepresentations in order for the statute to apply.

The murkiest area of honest services fraud is in the fiduciary relationship setting. Corporate officers are can no longer solely rely on Section 144 of the General Corporate Law of Delaware, the Interested Director Transactions law, in order to conform their business conduct with the laws. A thorough knowledge of the inner workings of the honest services fraud statute is becoming necessary for white collar criminal defense attorneys, as honest services fraud becomes more and more popular among prosecutors.

In its heyday, the statute was applied to nearly every type of corporate misconduct conceivable, as each director and officer owed a fiduciary duty to the shareholders. Insider trading, inflated stock pricing, and self-dealing all fell within its broad prohibition, as such corporate actors were held to owe their shareholders the intangible right to have the company run openly and honestly. Persons serving on multiple boards of directors had to be especially vigilant against potential conflicts of interest: A failure to disclose the conflict, even with the best intentions, could suffice to make the chairman eligible for prosecution under the statute for theft of honest and loyal services. So far was the net cast that the Supreme Court again saw it necessary to define the outer limits of the honest services fraud statute, at least in the context of fiduciary relationships.

In Skilling v. United States, 130 S. Ct. 2896 (2010), a former executive of the infamous Enron Corporation faced a host of criminal charges stemming from the lurid accounting practices that fraudulently inflated the company’s stock price for over a decade. Included were several counts of honest services fraud, based on the theory that Skilling had breached his fiduciary duty to the company’s shareholders and superiors. The case perfectly illustrated a glaring problem with the broad application of the honest services statute: Who is deprived of what when the action taken by the employee actually benefits the company and raises the stock price, as was the case with Enron? With an entire corporate culture built around driving up the stock price at all costs, how could a measure taken in furtherance of that goal be characterized as a deprivation? In a severely limiting construction of the statute (as an alternative to striking it down as unconstitutional for vagueness and overbreadth), the United States Supreme Court announced that in the employment context, only activities involving bribery or kickback payments could be prosecuted solely under the statute. However, as we discuss below, a mere non-disclosure can constitute a violation of other federal laws such as the Sarbanes-Oxley Act of 2002, and thus count as a scheme to defraud for the purposes of honest services fraud. The landmark pronouncement from the Court in Skilling resulted in many vacated sentences and convictions. However, even with the narrowing interpretation, some defendants were not so lucky as to walk away exonerated.

Consider the recent case of New York Senator Joseph Bruno, a Senator of over 30 years and one of the most powerful men in New York. At trial, he was convicted of two counts of honest services fraud and sentenced to two years. He was alleged to have used his influence to make money in his sideline consulting business, thereby depriving taxpayers of their right to honest services. However, his conviction and sentence were vacated by the appellate court in light of Skilling, on the grounds that the government failed to allege any bribery or kickbacks. However, Bruno was not saved by the constitutional prohibition against double jeopardy. A mid-level court of appeals found that there were enough additional details regarding his official actions to support a second indictment.

It is alleged that a business friend of Bruno’s paid around $440,000 in consulting fees to Bruno’s firm from 2004-05, and that he also paid Bruno $80,000 for a useless racehorse. In return, the government alleges that Bruno caused $250,000 to be granted to Evident Technologies, a company in which the friend is an investor. Moreover, it is alleged that Bruno influenced a $2,500,000 grant to Sage Colleges, a school that benefits Evident Technologies.

The initial investigation was triggered by Bruno’s frequent recreational use of his friend’s private jet. The retrial is scheduled for February 2013, and the key issue will be the characterization of the transactions (bribes/kickbacks or incidental business dealings), as well as the intentions of the parties.

The Sarbanes-Oxley Act of 2002 introduced a host of new duties and obligations for corporate officers, the breach of which can serve as a scheme to defraud for the purposes of the honest services statute. Take, for example, the mandated 12-month “cooling off period” prescribed by the legislation. The rule states that an accounting firm cannot audit a public company if one of the company’s management team worked for the accounting firm on the company’s audit within the past 12 months. This situation arises often, as public companies hire most of their upper level accounting officers from big accounting firms. The idea of the rule is that an officer of the public company who just worked for an accounting firm would be familiar with the audit procedures and therefore able to effectively conceal any shady accounts or transactions. Suppose an accounting executive at XCorp, who was hired in the past year from Ernst and Young, failed to reveal this conflict of interest. He could not only be prosecuted under Sarbanes-Oxley, but also face charges of honest services fraud stemming from his breach of fiduciary duty to his employer. Since use of the mails or wires is almost inevitable in connection to completion of an audit, the jurisdictional element would be easily satisfied.

IS THIS TRUE AFTER SKILLING?

The answer I uncovered in my research is highlighted in red toward the end of the Skilling discussion. Basically, a non-disclosure that violates SOX or another federal statute counts as a scheme to defraud an employer of their right to honest services, but the honest services statute does not criminalize other non-disclosures on its own. In this sense the statute requires a “predicate” offense for anything other than bribery or kickback payment schemes in the fiduciary context.