Honest services fraud
Honest services fraud is a crime defined in, the federal mail and wire fraud statute. The idea of this law was to criminalize not only schemes to defraud victims of money and property, but also schemes to defraud victims of intangible rights such as the "honest services" of a public official.
The statute states "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." The statute has been applied by federal prosecutors in cases of public corruption as well as in cases in which private individuals breached a fiduciary duty to another. In the former, the courts have been divided on the question of whether a state law violation is necessary for honest services fraud to have occurred. In the latter, the courts have taken differing approaches to determining whether a private individual has committed honest services fraud—a test based on reasonably foreseeable economic harm and a test based on materiality. The statute, which has been a target of criticism, was given a narrow construction by the Supreme Court of the United States in the case of Skilling v. United States. In order to avoid finding the statute to be unconstitutionally vague, the Court interpreted the statute to cover only "fraudulent schemes to deprive another of honest services through bribes or kickbacks supplied by a third party who ha not been deceived".
History and case law
Since at least 1941, particularly in the 1970s and 1980s, and prior to 1987, the courts had interpreted the mail fraud and wire fraud statutes as criminalizing not only schemes to defraud victims of money and property, but also schemes to defraud victims of intangible rights such as the "honest services" of a public official. In 1987, the Supreme Court ruled in McNally v. United States that the mail fraud and wire fraud statutes pertained strictly to schemes to defraud victims of tangible property, including money. In 1988, Congress enacted a new law that specifically criminalized schemes to defraud victims of "the intangible right of honest services."Meaning of "honest services" in public corruption
Honest services fraud is generally more easily proven in the public sphere than in the private, because honest services fraud by public officials can include most unethical conduct, whereas honest services fraud by private individuals only includes some unethical conduct. Federal courts have generally recognized two main areas of public-sector honest service fraud: bribery, where a public official was paid in some way for a particular decision or action, and failure to disclose a conflict of interest, resulting in personal gain.Necessity, or lack thereof, of state law violations
In 1997, the United States Court of Appeals for the Fifth Circuit decided in United States v. Brumley that in order for a state official to have committed honest services fraud, he or she must have violated a state statute defining the services which were owed to the employer.We find nothing to suggest that Congress was attempting in § 1346 to garner to the federal government the right to impose upon states a federal vision of appropriate services—to establish, in other words, an ethical regime for state employees. Such a taking of power would sorely tax separation of powers and erode our federalist structure. Under the most natural reading of the statute, a federal prosecutor must prove that conduct of a state official breached a duty respecting the provision of services owed to the official's employer under state law. Stated directly, the official must act or fail to act contrary to the requirements of his job under state law. This means that if the official does all that is required under state law, alleging that the services were not otherwise done "honestly" does not charge a violation of the mail fraud statute.
However, the First, Fourth, Ninth, and Eleventh Circuit Courts have all held that the federal statute does not limit the meaning of "honest services" to violations of state law. As the Ninth Circuit decided in United States v. Weyhrauch in 2008,
Because laws governing official conduct differ from state to state, conditioning mail fraud convictions on state law means that conduct in one state might violate the mail fraud statute, whereas identical conduct in a neighboring state would not. Congress has given no indication it intended the criminality of official conduct under federal law to depend on geography.
The defendant in that case, Bruce Weyhrauch, appealed that decision to the United States Supreme Court, which ruled in his favor, remanding the case back to the Ninth Circuit, where federal charges were eventually dropped.
Intent to defraud and personal benefit
In 1997, the United States Court of Appeals for the First Circuit set a key limit on honest services fraud in United States v. Czubinski, ruling that a mere workplace violation does not constitute fraud without evidence of depriving the employer of property in some way. Richard Czubinski was employed in Massachusetts by the Internal Revenue Service when, in 1992, he violated IRS rules by carrying out several unauthorized searches of the IRS database and accessing files outside of the course of his official duties. In 1995, he was convicted of wire fraud and computer fraud. The appellate court reversed the honest services fraud conviction on the basis that Czubinski's actions did not amount to anything more than a workplace violation, warranting no more than a dismissal:Czubinski was not bribed or otherwise influenced in any public decisionmaking capacity. Nor did he embezzle funds. He did not receive, nor can it be found that he intended to receive, any tangible benefit.... The conclusive consideration is that the government simply did not prove that Czubinski deprived, or intended to deprive, the public or his employer of their right to his honest services. Although he clearly committed wrongdoing in searching confidential information, there is no suggestion that he failed to carry out his official tasks adequately, or intended to do so.
Czubinski's other convictions were also reversed.
Meaning of "honest services" in private fiduciary relationships
Although the law is most often applied to corrupt public officials, several federal courts have upheld honest services fraud convictions of private individuals who breached a fiduciary duty to another, such as an employer.Generally, the federal circuit courts have adhered to one of two approaches when dealing with honest services fraud cases. One, the "reasonably foreseeable economic harm" test, requires that the defendant intentionally breached his fiduciary duty and "foresaw or reasonably should have foreseen" that his actions could cause economic harm to his victim. The other, the "materiality" test, requires that the defendant possessed a fraudulent intent and made "any misrepresentation that has the natural tendency to influence or is capable of influencing" the victim to change his behavior.
"Reasonably foreseeable economic harm" test
In 1997, the United States Court of Appeals for the Sixth Circuit held in United States v. Frost that private individuals could be also convicted of honest services fraud. Two professors at the University of Tennessee Space Institute, Walter Frost and Robert Eugene Turner, were also president and vice president, respectively, of FWG Associates, a private atmospheric science research firm. Frost and Turner gave FWG reports to two of their students, one a doctoral candidate employed by the Department of the Army and one a master's degree candidate employed by NASA, allowing them to plagiarize an overwhelming majority of the reports for their respective dissertations. They also allowed another doctoral candidate, employed by NASA, to submit a dissertation which was mostly written by one of their employees at FWG. Their aim was to secure federal contracts with the agencies employing these students. All three students received their degrees, facilitated by Frost and Turner. In addition to many other charges, Frost and Turner were convicted of three counts of mail fraud for defrauding the University of Tennessee of their honest services as employees. On appeal, Frost and Turner argued that § 1346 did not apply to them because they were not public servants. The court disagreed, ruling that "private individuals, such as Frost and Turner, may commit mail fraud by breaching a fiduciary duty and thereby depriving the person or entity to which the duty is owed of the intangible right to the honest services of that individual."In 1998, the United States Court of Appeals for the D.C. Circuit upheld the wire fraud conviction of Sun-Diamond Growers of California for defrauding its public relations firm of the honest services of one of its agents, James H. Lake, in order to curry favor with the United States Secretary of Agriculture, Mike Espy. The corporation's vice president for corporate affairs, Richard Douglas, had acted in the scheme in such a manner that potentially could have caused economic harm to the public relations firm - he and Lake had illegally funneled contributions to a congressional candidate, Espy's brother. Sun-Diamond argued that those actions could not be criminal because there was no intent to do economic harm to the firm. However, the court ruled that an intent to do economic harm was not necessary to have committed wire fraud, affirming a pre-McNally decision in light of the 1988 statute:
In the private sector context, § 1346 poses special risks. Every material act of dishonesty by an employee deprives the employer of that worker's "honest services," yet not every such act is converted into a federal crime by the mere use of the mails or interstate phone system. Aware of the risk that federal criminal liability could metastasize, we held in Lemire that "not every breach of a fiduciary duty works a criminal fraud."... Rather, "here must be a failure to disclose something which in the knowledge or contemplation of the employee poses an independent business risk to the employer."... Sun-Diamond appears to confuse the requirement of an intent to defraud...with a requirement of intent to cause economic harm.
In 1999, the United States Court of Appeals for the Eleventh Circuit adopted a similar interpretation in United States v. deVegter. Michael deVegter was a financial advisor hired by Fulton County, Georgia, to recommend an underwriter for the county to hire. DeVegter accepted a payment of about $42,000 from Richard Poirier in exchange for influencing Fulton County to hire Poirier's investment banking firm for the job. DeVegter and Poirier were both indicted for conspiracy and wire fraud, with the latter including charges under the honest services statute. The district court dismissed the honest services charges for lack of evidence before the trial began; the government appealed. The court agreed with the government that there was sufficient evidence alleged in the indictment for the defendants to be charged with honest services fraud, because the allegations showed a breach of fiduciary duty and an intent to defraud in such a manner that "reasonably foreseeable economic harm to Fulton County" was a consequence of the scheme.
In 2001, the United States Court of Appeals for the Fourth Circuit recognized that there were two different tests that other circuit courts had generally used to determine whether honest services fraud had been committed; in United States v. Vinyard, it concluded that the "reasonably foreseeable economic harm" test was superior and applied that test to the case at hand. The defendant in the case, Michael Vinyard, had been convicted of fourteen counts of mail fraud and twelve counts of money laundering. His brother, James Vinyard, was an employee of the Sunoco Products Corporation who was charged with finding an independent broker to research recycled resins for their manufacture of plastic bags. The brothers instead created their own brokerage, "Charles Stewart Enterprises," and misrepresented it to Sunoco as a legitimate, independent firm that was supplying recycled resins at the lowest possible price. They purchased recycled resins from plastic vendors and, marking up the price, sold them to Sunoco, which eventually yielded $2.8 million in profits. The brothers funneled these profits from CSE to themselves through another entity in order to conceal their involvement with CSE on their tax returns. When the brothers were eventually indicted for mail fraud and money laundering, James Vinyard pleaded guilty and testified against his brother. Michael Vinyard appealed, arguing that his conviction of honest services fraud was wrongful because he did not cause harm nor did he intend to cause economic harm to the victim, Sunoco. Upholding his conviction, the court rejected this argument:
The reasonably foreseeable harm test is met whenever, at the time of the fraud scheme, the employee could foresee that the scheme potentially might be detrimental to the employer's economic well-being. Furthermore, the concept of "economic risk" embraces the idea of risk to future opportunities for savings or profit; the focus on the employer's wellbeing encompasses both the long-term and the short-term health of the business. Whether the risk materializes or not is irrelevant; the point is that the employee has no right to endanger the employer's financial health or jeopardize the employer's long-term prospects through self-dealing. Therefore, so long as the employee could have reasonably foreseen the risk to which he was exposing the employer, the requirements of § 1346 will have been met.
In 2006, the United States Court of Appeals for the Ninth Circuit treated the issue of whether private defendants could be prosecuted under § 1346 as settled law, citing the numerous other circuits which had affirmed the practice. In the case United States v. Williams, the defendant, John Anthony Williams, was an Oregon insurance salesman who had sold several annuities to an elderly rancher named Loyd Stubbs. When Stubbs liquidated his annuities, Williams deposited the resulting funds in a joint bank account he had opened in his and Stubbs' names. Williams proceeded to make massive cash withdrawals from the account, depositing the money in his own personal account and spending much of it; he also wired money to personal bank accounts he had in Belize and Louisiana. Williams was convicted of four counts of wire fraud, three counts of mail fraud, three counts of money laundering, and one count of foreign transportation of stolen money; the fraud charges stemmed from schemes to defraud Stubbs of money and of Williams' honest services as his financial advisor. On appeal, Williams argued that § 1346 did not apply to private commerce. The court disagreed, and, citing previous case law, ruled that within a fiduciary relationship the statute applied.