Why white collar crime just got harder to battle

skilling.gi.top.jpg By Roger Parloff, senior editor


FORTUNE -- The U.S. Supreme Court's ruling in the criminal case against Enron CEO Jeff Skilling yesterday addressed two crucial and frequently recurring controversies that come up in white-collar criminal cases: What is the precise meaning of the federal statute that criminalizes schemes to defraud someone out of "the intangible right to honest services." And, two, when is a jury likely to have been so personally impacted by a crime, or so emotionally inflamed by pretrial publicity and adverse local sentiment, that the only way for a defendant to get a fair trial is to have his case moved to another location? Skilling raised both issues in challenging his convictions, which were handed down by a federal jury in Houston in 2006 and for which he is serving a sentence of 24 years imprisonment.

While the Court's decision sharply cut back on federal prosecutors' ability to bring certain types of honest-services fraud cases -- we'll explain what those are in a moment -- prosecutors also dodged a couple bullets today. On balance, as we'll see, things could have been a lot worse. Specifically, the Court rejected Skilling's claim that trying him before a Houston jury -- ground zero for Enron's catastrophic implosion -- had denied him a fair trial, and it also rebuffed his argument that the honest-services fraud law was unconstitutional and had to be struck down entirely.

Justice Ruth Bader Ginsburg wrote the Court's opinion, with each part of her ruling reflecting a 6-3 majority, though the composition of that majority was different for each issue. Three generally conservative justices (Justices Antonin Scalia, Clarence Thomas, and Anthony Kennedy) would have struck down the honest-services law rather than simply narrowing it, while three generally liberal justices (Justices Sonia Sotomayor, John Paul Stevens, and Stephen Breyer) would have granted Skilling a new trial because of the prejudice that could be anticipated among jurorin Houston.

Skilling's case was actually one of a trio of high-profile honest-services cases decided yesterday, including those of Canadian newspaper magnate Conrad Black, who is in prison after having been convicted of an "honest-services fraud" in 2005, and former Republican Alaska state legislator Bruce Weyhrauch, who has not yet gone to trial.

I will try to address the key questions readers likely have in a Frequently Asked Questions format.

What's the bottom line? Will Skilling walk?

It's conceivable, but unlikely. To explain why, we first have to discuss what honest-services fraud is.

Okay, what's honest-services fraud?

The term refers to a subcategory of both wire fraud and mail fraud in which the defendant doesn't steal money directly from the victim, the way he would in a classic, Bernie Madoff-style fraud; instead, the defendant deprives the victim of an intangible right of some kind. The classic examples are bribes paid to public officials or secret kickbacks paid to corporate officers. If I secretly bribe a state governor (or a corporate procurement officer) to award me a contract that I might not have won on merit, I've definitely defrauded the public (or the corporation) of the honest services of its employee, though I haven't necessarily defrauded the public (or corporation) out of money or property. (For an in-depth explanation of the concept and its history, see The Catchall Fraud That Catches Too Much.)

That doesn't sound so controversial.

Well, the problem is that no one knows precisely where the concept ends. Prosecutors have also applied it, for instance, to undisclosed conflicts of interests, breaches of loyalty, or candor that we might not admire but that we might not have realized were crimes, let alone federal felonies. Former legislator Weyhrauch, for instance, was charged with having continued to work on legislation that impacted the Alaska oil industry after he had applied for a job with a company in that industry, and without disclosing that fact to the public.

"Carried to its logical conclusion," Justice Scalia claimed in a 2009 case, the honest-services law "also renders criminal . . . a salaried employee's phoning in sick to go to a ball game." Prior to yesterday's ruling, the federal courts of appeals had reached conflicting conclusions about precisely what the law covered and what it excluded.

Prosecutors like the law because of its amorphousness and flexibility, but that amorphousness is the source of its legal dubiousness. In constitutional terms, an overly vague and broad criminal law violates due process, because it fails to give us fair notice of what is and isn't a crime before we 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. Skilling's lawyers argued that the honest-services law was, in fact, void for vagueness.

How did the Court rule on the honest-services statute?

The majority found that the law did need to be interpreted in a narrower fashion than it has been in the past, but that, when narrowed in that fashion, it could pass constitutional muster.

What does the law, as narrowed, now cover?

It can still be used to prosecute kickback and bribery schemes, but not any of the murkier, borderline cases. This was a loss for the government, which had hoped to shoehorn in at least one more fairly amorphous category of conduct, which it described as "undisclosed self-dealing by a public official or private employee -- i.e., the taking of official action by the employee that furthers his own undisclosed financial interests while purporting to act in the interests of those to whom he owes a fiduciary duty."

The court also ruled unambiguously that the honest-services fraud that Skilling had been charged with was an invalid theory -- one that fell outside the newly defined, acceptable perimeter. Though the jury could have found that Skilling committed conventional wire fraud (depriving victims of money or property, rather than intangible rights) and securities fraud, he could not have committed honest-services fraud because he hadn't accepted any bribes or kickbacks. (His profits came only from his salary and stock holdings. Both of those were wildly inflated by fraud, but by conventional wire fraud and securities fraud, not honest-services fraud.)

So was it stupid for the government to have charged Skilling with honest-services fraud in the first place?

In retrospect, it was a mistake, yes. At the time, it probably seemed like the safe thing to do. Prosecutors would have thought: If the jurors have any trouble with our conventional theories of fraud, they can still convict him on the honest-services theory.

If the Court ruled in Skilling's favor, then why won't Skilling walk?

Skilling was convicted of 19 counts in all, including one count of conspiracy, 12 counts of securities fraud, five counts of making false representations to auditors, and one count of insider trading. Only the conspiracy charge made any explicit reference to the honest-services fraud crime.

Here's where it gets tricky. That conspiracy charge actually accused Skilling of conspiring to commit three different federal crimes: honest-services fraud, conventional wire fraud, and securities fraud. While the jury only had to find that the defendant conspired to commit one of those three crimes in order to convict him, we can't get inside the jury's mind now and figure out which one or ones it did find he committed. If, in fact, the jury thought he had conspired to commit only honest-services fraud, but not the other two, then he was wrongfully convicted.

Notwithstanding that shadow hanging over the conspiracy count, the Court did not, interestingly enough, dismiss it. Instead, it sent the case back to the U.S. Court of Appeals for the Fifth Circuit to decide whether the conspiracy count should be dismissed or if, on the other hand, the problem with the "honest-services fraud" language might have been "harmless" under all the circumstances.

How can an invalid legal theory be harmless?

The government has argued that, because the jury convicted Skilling of 12 substantive counts of securities fraud -- whose definition was never in question -- the jury must have also believed that Skilling conspired to commit those crimes. If so, any error as to honest-services fraud might be harmless.

Still, the logic is not airtight -- conspiracy charges have elements of proof that substantive charges don't have -- so a court might dismiss the count. And if it does, the next question is whether "spillover prejudice" and confusion generated by that tainted count require dismissal of some or all of the remaining 18 counts too.

Skilling's counsel Dan Petrocelli has asserted in the past that the conspiracy count is the "anchor count for the entire indictment" and that all the others were inextricably linked to it in the court's instructions to the jury and in the prosecutors' closing arguments. (In 2006, immediately after Skilling's conviction, an appeals judge hastily reviewing Skilling's emergency bail application did find that if the honest-services theory fell, at least 14 of the 19 counts against Skilling would have "serious frailties.")

Still, the bottom line is that even after yesterday's victory, Skilling has not yet succeeded in knocking out even the conspiracy count, let alone the 18 others.

What's happening to Conrad Black and Bruce Weyhrauch?

Their cases also go back to lower courts for interpretation of how the Skilling ruling will apply to them. Black's situation is somewhat analogous to Skilling's. He was convicted on one count of fraud that had included both an honest-services theory and a conventional wire fraud theory, with no way to tell now which theory (or theories) the jury accepted. He was also convicted on a separate obstruction of justice count, and so, again, the lower courts will have to decide whether spillover prejudice from the tainted count dooms the other one too.

Weyhrauch's lawyer, Don Ayer of Jones Day, asserts that the Skilling ruling unambiguously rejects the only honest-services theory the government has articulated against his client. But it is not yet clear what position the government will take.

What was the ruling on pretrial prejudice?

Skilling was tried in Houston, an unquestionably difficult environment for an Enron defendant, given, as Justice Sotomayor wrote in her dissent to this portion of the ruling, "thousands of the company's employees lost their jobs and saw their retirement savings vanish. As the effects rippled through the local economy, thousands of additional jobs disappeared, businesses shuttered, and community groups that once benefited from Enron's largesse felt the loss of millions of dollars in contributions."

Nevertheless, Judge Ginsburg and the majority justices were deferential to U.S. District Judge Sim Lake's judgment that he could adequately winnow out prejudiced jurors using questionnaires and conventional jury selection procedures.

Ginsburg stressed that the jury was drawn from a city of 4.5 million, rather than from a small rural community; that "although news stories about Skilling were not kind, they contained no confession or other blatantly prejudicial information of the type readers or viewers could not reasonably be expected to shut from sight"; that more than four years had elapsed between the Enron bankruptcy, in December 2001 and the start of the trial in January 2006; and, finally, that the jury in this and other Enron-related cases conducted in Houston seemed to render discerning verdicts, acquitting on some counts while convicting on others. (Skilling himself was acquitted of nine insider-trading counts.)

Of course, if the Court had had found that Skilling's jury trial had been tainted, his convictions on all 19 counts would have been tossed out and the government would have had to start over from scratch -- a expensive prospect of doubtful feasibility nearly a decade after the events.

Given that the government avoided this fate by only a 6-3 vote, I think prosecutors can count themselves pretty lucky. To top of page