US Supreme Court to Decide Fate of Honest Services Fraud, Linked to Duty of Loyalty

Senior corporate officers have gained Supreme Court review of their convictions that were partially based on a scheme to deprive the company and its shareholder of their right to honest services. The trial court explained that to show guilt under the honest-services theory the government had to prove that the senior officers misused their positions for private gain by knowingly and intentionally breaching their fiduciary duty of loyalty. Black v. US, 08-876. The case is due to be argued before the Supreme Court in December. The Court has also agreed to review another case that questions the constitutional vagueness of the honest services statute. Skilling v. US, 08-1394.

Section 1346 of the US Code prohibits schemes to deprive another of the intangible right of honest services, thereby defining a fraud offense in the deprivation of the right to honest services. The government’s merits brief pointed out that honest services fraud requires a breach of the duty of loyalty, carried out with an intent to deceive, on a material matter. The jury instructions in this case embodied those requirements, said the brief, because they required an intentional breach of the fiduciary duty of loyalty, committed with intent to defraud and involving material omissions or misrepresentations.

Under Delaware law, the duty of loyalty requires that a corporate fiduciary act with undivided and unselfish loyalty, with no conflict between duty and self-interest. The duty of loyalty mandates that the best interest of the company and its shareholders take precedence over any interest of an officer or director.

Properly construed, argued the government, the elements of Section 1346, breach of duty of loyalty, intent to deceive, and materiality, limit its application and provide intelligible bounds. Honest services fraud bleeds into money or property fraud when disclosure of a breach of duty of loyalty would lead the principal to seek a more advantageous financial deal. In this case, noted the brief, had the senior officers disclosed to the company’s audit committee and board of directors that the recharacterization of management fees would net the defendants a higher after tax income, the committee or the board might have decided that this increase in the value of the fees to them warranted a reduction in the size of the fees.

By limiting actionable honest-services schemes to those involving undisclosed breaches of the duty of loyalty, said the government, Congress ensured that Section 1346 does not criminalize all manner of dishonesty. For example, the statute does not cover the employee who phones in sick so he or she can go to a ball game. Instead, the statute criminalizes only schemes in which an employee or public officer secretly takes official action to further their own interests while pretending to act in the interests of those to whom they owe a duty of loyalty.

The petitioning senior officers argued in their brief that the jury was allowed to convict even if it found that they sought a lawful tax benefit in another country, with no contemplated detriment to their employer, but in the process fell short of complying with their Delaware-law duty of loyalty to the company. That anyone could even consider such conduct to be a federal crime, said the brief, is the unfortunate consequence of Congress’ decision some twenty years ago to expand the definition of a scheme to defraud to include the vaguest of terms: encompassing any plan to deprive another of the intangible right of honest services. According to the corporate officers, the government has stretched this malleable phrase, unknown in the common law, far beyond the public corruption context that gave rise to its enactment, treating the statute as an invitation for federal courts to develop a common-law crime of unethical conduct.

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