(Fortune Magazine) -- When it comes to fighting white-collar crime, the sharpest arrow in the federal prosecutor's quiver is a law most nonlawyers have never heard of, known as the "honest-services fraud" law.
In essence, the law extends the concept of fraud beyond classic cases, like a Bernie Madoff Ponzi scheme -- where a crook uses deceit to take money from his victims -- to situations where wrongdoers cheat their victims of something less tangible.
If a judge or governor accepts bribes, for instance, he is not necessarily stealing money from anyone, but he is depriving the public of the "honest services" they have a right to expect from him. Likewise, if a corporate purchasing officer accepts secret kickbacks from vendors, he's depriving his employer of his "honest services."
"Look around at all the high-profile cases today," says Richard Craig Smith, a former federal prosecutor now with the law firm Fulbright & Jaworski. "Ninety-five percent of them are charged under honest-services fraud. That's not just an accident."
In fact, recent defendants in such cases compose a white-collar rogues' gallery for our times, featuring such tarnished luminaries as former governor Rod Blagojevich of Illinois; former U.S. congressman William Jefferson of Louisiana; newspaper magnate and former Hollinger International CEO Conrad Black; lobbyist Jack Abramoff; and former Enron CEO Jeff Skilling.
Yet this potent weapon is now in peril, as are scores of convictions obtained under it. The U.S. Supreme Court has chosen to hear no fewer than three cases this term -- including Skilling's and Black's -- that pose the question of whether prosecutors are applying this law too broadly, and indeed, whether the law must be struck down as unconstitutional.
Two cases, involving prosecutions against Black and former Alaska state legislator Bruce Weyhrauch, were argued on Dec. 8, while Skilling's will be heard March 1. Rulings are expected by next summer. (Black and Skilling are in prison after convictions. Weyhrauch's case is still at the pretrial stage. All the defendants maintain their innocence.)
The feature that prosecutors love about honest-services fraud is precisely what critics say dooms it constitutionally: its nearly infinite adaptability. "There's almost no fact pattern that cannot be fit around 1346," says Smith, referring to the section of Title 18 of the U.S. Code that defines the offense. Read literally, it seems broad enough to catch any deceit at all. If so, then who among us is not guilty?
In constitutional terms such a law would violate due process, because it would fail to give businessmen and public officials fair notice of what is and isn't a crime before they unwittingly commit one. A vague law also lends itself to abuse: If everyone's guilty of it, then those few singled out for prosecution are targeted arbitrarily and discriminatorily.
The law's fiercest critics are weighted toward both ends of the political spectrum. Liberals object to it on due process grounds, while conservatives say it violates principles of federalism.
The law "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," wrote U.S. Supreme Court Justice Antonin Scalia last February when he dissented from the Court's refusal to hear yet another honest-services fraud case. "Carried to its logical conclusion," he continued, it "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; a mayor's attempt to use the prestige of his office to obtain a restaurant table without a reservation; [or] a salaried employee's phoning in sick to go to a ball game."
In reality, Scalia's list of penny-ante peccadilloes wouldn't lead to prosecutions because each federal appeals court has assumed that the broad language of the honest-services statute, enacted by Congress in 1988, must be read in light of certain implied limiting principles.
The trouble is that each court's limiting principles differ from the next's, and that none of these principles are explicit in the text of the law that Congress passed. Worse still, some of these limiting principles were actually written into competing "honest-services fraud" bills that were considered by Congress in 1987 and 1988 -- but were rejected!
In any event, Scalia's central point is indisputable: The law is most indispensable to prosecutors where criminality is fuzziest. "If you defraud someone out of money," explains Susan Necheles, a white-collar defense lawyer at New York's Hafetz & Necheles, "there's clearly a crime, and there are plenty of statutes that cover it. When the government resorts to honest-services fraud, on the other hand, it's almost always because there's a real question whether this was a crime or just aggressive business behavior."
Unfortunately, as we'll see, the government has often outsmarted itself, tossing this backup, catchall charge into indictments where old-fashioned, unassailable legal theories would have sufficed -- Skilling's being a prime example. In the mistaken belief that they were playing it safe, prosecutors may have rigged their cases with time bombs, now poised to detonate.
The U.S. Constitution does not give the federal government direct power to punish fraud, which is a topic left instead to the states to grapple with. It does, however, give the federal government power to regulate the U.S. mails and interstate commerce. Accordingly, Congress -- beginning in 1872 for the mails and in 1952 for telephone, wire, radio, and television transmissions -- passed criminal laws to keep these media free of fraud.
The mail and wire fraud laws forbid "furthering" a scheme to defraud by using the mails or wires (now including e-mail, of course). In practice, the role played by the mailing or phone call can be pretty minor, and in modern society it will be an extremely rare fraud that does not at some point involve the use of mail, telephone, or e-mail.
The mail and wire fraud statutes are worded in an identical two-pronged way. They forbid schemes "for obtaining money or property by means of false pretenses," but they also forbid, alternatively, "schemes to defraud."
Judges reasoned that each prong must address itself to slightly different conduct, and that it therefore must be possible to have "schemes to defraud" that don't involve "obtaining money or property" from the victim. This interpretation turned out to be useful when prosecutors and courts were confronted with schemes involving thefts of intangible rights, like, say, a voting-fraud scheme in which defendants steal an election by mailing in phony write-in ballots.
Eventually some nameless prosecutor hit upon the theory that a fraud to deprive the public of "honest services" should also be considered one of those thefts of intangible rights that's covered by the "scheme to defraud" prong of the law. Though isolated instances of its use can be found as early as 1949, it ascended into prominence in the 1970s.
It proved particularly valuable when federal prosecutors sought to prosecute corrupt state officials, since federal bribery laws did not then apply to most of them. But even when federal bribery laws could have been used, federal prosecutors soon preferred to use the honest-services-fraud concept, because it didn't require them to prove a quid pro quo.
Suppose, for instance, a judge was caught red-handed accepting bribes. He could always claim that the bribes hadn't influenced his judgment. Disproving his claim beyond a reasonable doubt -- required under the bribery laws -- was always challenging. On the other hand, for a judge to accept secret payments from a litigant cheated the public of his honest services, and that in itself was enough to prove honest-services fraud. Proving quid pro quo became superfluous.
The theory was a smashing success. As professor John Coffee of Columbia Law School later wrote, it was "an exotic flower that quickly overgrew the legal landscape in the manner of the kudzu vine until by the mid-1980s few ethical or fiduciary breaches seemed beyond its reach." It was used in successful prosecutions of state governors, state party chairmen, state and federal judges, and innumerable smaller fry, including private-sector kickback-takers and self-dealers.
By 1980 the honest-services theory had so juiced up and turbocharged the mail fraud law that the chief of the business crimes unit of the U.S. Attorney's office (now U.S. District Judge), Jed Rakoff, referred to it in a law review article as "our Stradivarius, our Colt .45, our Louisville Slugger, our Cuisinart -- and our true love ... It understands us and, like many a foolish spouse, we like to think we understand it. To ask us to explain it ... however, is quite another matter."
In 1987, alas, the U.S. Supreme Court did ask prosecutors to explain the honest-services concept, and it didn't like what it heard. In a case called McNally v. United States, a 7--2 majority dealt the U.S. Justice Department a stunning rebuke, rejecting the concept and upending scores of convictions. Though the concept had until then been endorsed by every federal appeals court to consider it, an unusual alliance of liberal and conservative justices (including William Brennan Jr., Thurgood Marshall, William Rehnquist, and Scalia, then in his first term) now scrapped the prosecutors' most treasured tool.
"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," the majority wrote, "we read [the mail and wire fraud statutes] as limited in scope to the protection of property rights. If Congress desires to go further, it must speak more clearly than it has."
Desperate to reverse the damage, prosecutors pleaded with Congress to give them back their precious weapon. Less than a month after the ruling, a bill to do so was introduced, followed soon by others. Each bill took a stab at addressing the Supreme Court's concerns over the concept's amorphousness by inserting some language to cabin its outer limits. None went anywhere, however.
Finally, shortly after midnight on the last day of the congressional session in October 1988, the terse language of today's honest-services fraud law was tacked onto a mammoth drug bill, and it passed a couple of hours later without debate. It declared simply that from then on, a "scheme ... to deprive another of ... honest services" would be a considered a "scheme to defraud." It clearly overruled McNally, yet it addressed none of the Court's constitutional concerns -- vagueness, federalism, and separation-of-powers issues.
Once the law took effect, courts resurrected their inconsistent pre-McNally precedents and then groped their way forward on an ad hoc basis. Today some federal circuits require that, to prove honest-services fraud, the defendant must be shown to have also "contemplated economic harm" to the victim.
That's the element Conrad Black claims wasn't proven in his case. Other courts don't care about that requirement but do demand that the defendant be shown to have violated some state law. That's the sine qua non that Bruce Weyhrauch claims is missing from the charges against him. Still other courts say no, violating a state law is unnecessary, but they want to see something else.
Behind all these questions of statutory interpretation lurks the big enchilada: Do any of these stopgap judicial improvisations really save the law from unconstitutionality? That's one of the issues teed up in Jeff Skilling's case.
Unless the Justice Department pulls off a dazzling hat trick -- winning all three cases in every respect -- dozens of convictions will be overturned and hundreds more thrown into question. In fact, because of the ripple effects set in motion whenever an important criminal precedent falls, the repercussions will extend even to convictions based on other statutes involving unquestionably solid legal theories.
Skilling's appeal provides a mind-bending illustration. Only one of the 19 counts of which he was convicted -- the first one, charging criminal conspiracy -- actually alludes to honest-services fraud.
Nevertheless, his lawyers are arguing that if that count falls -- the "anchor count for the entire indictment," as his counsel Dan Petrocelli of O'Melveny & Myers refers to it in an interview -- the other 18 must fall with it. He'll argue that the tainted count and all the others were inextricably linked in the court's jury instructions and in the prosecutors' closing arguments, requiring that outcome.
Petrocelli's argument is not mere lawyer's guff. In 2006, immediately after Skilling's conviction, an appeals judge hastily reviewing Skilling's emergency bail application found that if the honest-services theory fell, at least 14 of the 19 counts against Skilling would have "serious frailties." Similarly, if Conrad Black's honest-services fraud conviction is overturned, his lawyers have arguments for why Black's other conviction, on an obstruction-of-justice charge, must also be reversed.
At oral arguments in the Black and Weyhrauch cases last month, at least three justices -- Chief Justice John Roberts Jr., Scalia, and Stephen Breyer -- appeared highly skeptical of the law's constitutionality. Justice John Paul Stevens, on the other hand, who dissented in the McNally case 22 years ago, still seemed to see nothing wrong with it.
Freshman Justice Sonia Sotomayor looked to be searching for ways to salvage the law, which would be consistent with her track record. In 2003 she participated in a rare sitting of the entire U.S. Court of Appeals for the Second Circuit when it heard a challenge to the constitutionality of the honest-services fraud law. She joined the 7-4 majority that upheld the law, while finding a disarmingly plausible way to rein in its boundlessness.
In an opinion written by Judge Robert Sack, that court pored over the case law on honest-services fraud as it stood in 1988, when Congress enacted the law, searching for whatever consensus existed then among the various federal appeals courts. In other words, it tried to identify the schemes that all courts would have agreed were covered by the law and the general principles that characterized those cases.
Sack concluded that (at least in the private-sector cases, which happened to be the category in which the dispute arose) kickback and bribery cases always seemed to be covered, while self-dealing cases (e.g., where a corporate officer directed corporate business to a company in which he had an undisclosed private interest) were covered only if the transactions were also provably unfair to the corporation. Henceforth, that court decided, it would recognize such uses of the law, but no others.
Sensible resolution, right? Sensible, at least until one realizes that this interpretation lets Skilling fall through the cracks. Skilling made his zillions from his ordinary Enron salary and stock holdings. Those were, of course, vastly inflated because of false statements in earnings reports, auditor reports, and analyst conferences, but still, as his counsel Petrocelli says, there was indisputably "no bribery, kickback, or money on the side." Accordingly, any honest-services fraud charges against him would have to be reversed.