"The Collapse of Enron and the Narrowing of 'Honest-Services' Fraud"

By Dana M. Grimes, Esq.

Published: December 2010 "Trial Bar News"

The Enron Trial: The Collapse of a House of Cards

During his admissions interview for Harvard Business School, when former Enron CEO Jeffrey Skilling was asked if he was smart, he supposedly replied, "I'm f--king smart."  And that certainly appeared to be true while Skilling ran the seventh largest revenue-grossing company in America.  His intelligence, however, was no match for his greed - in 2001 Skilling resigned shortly before Enron's scandalous and devasting collapse.  Skilling and other high level executives were charged inter alia with conspiracy to commit "honest-services" wire fraud, in violation of Title 18 U.S.C. §§ 371, 1343, and 1346, by depriving Enron and its shareholders of the "intangible right" to their "honest-services."  [Skilling was also charged with more than 25 counts of securities fraud, wire fraud, making false representations to auditors, and insider trading.]

The "honest-services fraud" statute, Title 18 U.S.C. § 1346, was enacted in 1988 by Congress in an attempt to overturn a 1987 Supreme Court ruling, McNally v. United States (1987) 483 U.S. 350, which held that the wire fraud statute did not encompass intangible services cases.  The McNally court had noted in its ruling: "if Congress desires to go further, it must speak more clearly."  Ibid., p. 37.  Indeed, Congress desired to go further, and did so by enacting Title 18 U.S.C. § 1346, which includes the language Skilling challenged as unconstitutionally vague: "For the purposes of the Chapter of the U.S. Code that prohibits, inter alia, mail fraud . . . and wire fraud . . . the term 'scheme or artifice to defraud' includes a scheme or artifice to deprive another of the intangible right to honest-services."

The Government's theory was essentially that Skilling and other top Enron executives committed honest-services fraud by conspiring to deceive investors by exaggerating public reports of the company's fiscal health - thereby artificially inflating its stock price - and that they subsequently profited greatly through salary, exorbitant bonuses, and the sale of Enron stock.  At trial, there was no evidence that Skilling solicited or accepted brides.   One of the principle government trial witnesses was former Enron CEO Andy Fastow, whose cooperation resulted in a sentence of only 6 years in prison.

The Verdict

After a four month trial, the jury found Skilling guilty of 19 counts, including the honest-services fraud conspiracy charge, along with securities fraud, making false statements to accountants, and one count of insider trading.  He was acquitted of nine insider trading counts.  He was sentenced to 292 months of imprisonment and $45 million in restitution.

Skilling's lead defense lawyer, Dan Petrocelli, had never previously handled a criminal case.  Petrocelli became famous when he made the wise career choice to represent Ron Goldman's father pro bono and sue O.J. Simpson.  According to newspaper reports, Skilling placed $23 million into a trust to pay his legal bills; Petrocelli's firm received $17 million more from the insurance companies that provided Enron with liability coverage.  Petrocelli says his firm is owed $30 million more, bringing the grand total to $70 million, which would be a pricey defense even for a lawyer with previous criminal experience.  [The price of this defense certainly covered the cost of the cowboy boots the L.A. lawyer reportedly wore to the Texas trial, which were likely not a staple in his wardrobe prior to this case.]

The Appeal

Skilling raised two issues on appeal: (1) that pretrial publicity and community prejudice prevented him from obtaining a fair trial (thousands of Houston residents lost their jobs, and many lost their life savings, when Enron collapsed), and (2) that the jury improperly convicted him of conspiracy to commit honest-services wire fraud.  The United States Court of Appeals for the Fifth Circuit affirmed the trial court, and the Supreme Court granted certiorari in May of this year.  Skilling v. United States (2010) 561 U.S. ____.

The Jury Pool (of Enraged Houstonians)

The Supreme Court accepted that the Enron trial occurred in a city full of resentment toward Enron executives.  However, the Court rejected Skilling's claim that his entire trial was unconstitutionally unfair because of the hostile environment in which it was tried in Houston.

Justice Ginsburg's majority opinion finding that Skilling suffered no "actual prejudice" at the trial was supported in whole or significant part by the Chief Justice and Justices Alito, Kennedy, Scalia and Thomas, who supported the findings of the Houston trial judge.  A former trial court judge herself, Justice Sotomayor dissented, joined by Justices Breyer and Stevens.

Justice Sotomayor questioned District Court Judge Lake's methods as follows:

The majority understates the breadth and depth of community hostility toward Skilling and overlooks significant deficiencies in the District Court's jury selection process.  The failure of Enron wounded Houston deeply.  Virtually overnight, what had been the city's "largest, most visible, and most prosperous company," its "foremost social and charitable force," and "a source of civic pride" was reduced to a "shattered shell."  Citing App.11, 13, pp. 649a-650a, 1152a.

One potential juror (who was not seated) reportedly lost about $50,000 as a result of Enron's collapse; Justice Breyer noted the judge overruled the defense motion to dismiss that particular juror for cause.  Skilling pointed out that his voir dire only lasted five hours.  By contrast, the criminal trial of Martha Stewart involved six days of juror selection, and that was a case in which there was not evidence of strong anger and resentment among jurors as was the case in Houston after the collapse of Enron.  [In fact, while people may joke that Martha Stewart learned to fashion a shiv out of a lamb shank whilst in prison, her popularity has grown since that time, and her company, MSO, is fiscally stronger than before her trial.]

Skilling's main argument was that prospective jurors, whether or not they had been exposed to negative media coverage about Enron, had personally felt or seen the damage caused by Enron's collapse by virtue of living in Houston and they therefore would not feel comfortable returning to their community with "not guilty" verdicts.  The majority pointed out that this argument was weakened by the fact that the jury apparently felt comfortable enough to return not guilty verdicts on nine insider trading counts.

The Court held that the district court did not err in denying Skilling's request for a venue transfer due to pretrial publicity.  This ruling may make it more difficult for criminal defense attorneys in high profile cases to appeal convictions that were reached in a community that was hostile to the defendant.  The High Court indicated it would vacate verdicts impaired by hostile jury pools only in "the extreme case."

Honest-Service Fraud is Now Applicable Only to Bribes and Kickbacks

The Skilling Court affirmed in part, reversed in part, and remanded in their 9-0 opinion by Justice Ruth Bader Ginsburg.  And while the Skilling opinion purports to be unanimous, its 105 pages reflect a wide array of differing opinions by the Justices.  With a different pattern of voting among the Justices than in the holding regarding the jury pool issue, the majority saved the honest-services fraud statute with a limiting construction.

With respect to Title 18 U.S.C. § 1346, Skilling v. United States narrows the "honest-services" portion of the federal fraud statutes and will deter prosecutors from bringing mail and wire fraud charges against corporate executives whose conduct did not involve the receipt of bribes or kickbacks.  This marks a major change in federal corruption law, since for the past few decades, United States Attorneys have used Title 18 U.S.C. § 1346 broadly and now the statute is applicable only to bribery or kickback schemes.  The Court suggested that Congress may want to tinker with the statute to broaden its reach while keeping in mind constitutional restraints on doing so.

Justice Ginsburg, writing for the majority, "acknowledge[d] that Skilling's vagueness challenge has force," but rejected Skilling's contention that the honest-services statute was unconstitutional, pointing to the fact that since the 1940's, Courts of Appeals have consistently construed the mail and wire fraud statutes to prohibit not only frauds in which the offender profits financially from the victim, but also frauds in which the victim loses intangible rights.  The loss of intangible rights prosecutions historically involved the bribery of public officials and eventually expanded to include the bribery of private employees in breach of their allegiance to an employer, as in Shushan v. United States (1941) 117 F.2d 110.

The majority rejected the Government's argument that the law should proscribe "self-dealing," (i.e., not disclosing that an action creates personal gain or not disclosing conflicts of interest).  The Court found such a reading of the statute would be unconstitutionally vague, since it would provide insufficient specificity regarding what conduct was forbidden.  (To satisfy due process, "a penal statute [must] define the criminal offense [1] with sufficient definiteness that ordinary people can understand what conduct is prohibited and [2] in a manner that does not encourage arbitrary and discriminatory enforcement."  Kolender v. Lawson (1983) 461 U.S. 352, 357.)  The Skilling Court concluded that the statute is amenable to a limiting construction under which it is narrowed to apply only to "fraudulent schemes to deprive another of honest-services through bribes or kickbacks supplied by a third party who had not been deceived."

Such a limitation is what the majority identified as the "core" of the pre-McNally honest-services jurisprudence.  With respect to the facts of Skilling's case, the majority concluded that because there was no evidence Skilling solicited or accepted kickbacks or bribes, he could not be convicted of violating Title 18 U.S.C. § 1346 as charged.  However, since the conspiracy included other fraud such as securities fraud and conventional "money-or-property" wire fraud, the Court remanded the case to the Fifth Circuit on the issue of whether the error was harmless.

Not All Nine Agree

Justice Scalia has never liked the honest-services statute, and would have "reverse(d) Skilling's conviction under § 1346 on the ground that it fails to define the conduct it prohibits."  Justice Scalia, with the support of Justices Kennedy and Thomas, indicated that of all of the lower court rulings applying that law in specific cases, "not one is limited to bribery and kickbacks.  That is a dish the Court has cooked up all on its own."  Justice Scalia disagreed with the majority's limiting construction, which he considered a rewrite of the statute without support in a fair reading of its language.

The Aftermath of Skilling v. U.S.

Post-Skilling, honest-services cases must be proven with evidence that the defendant solicited or accepted bribes or kickbacks.  The Court's holding raises issues regarding retroactive application to prior convictions in honest-services fraud prosecutions, in which the evidence relied on to support the convictions did not involve kickbacks or bribes.  The Skilling Court vacated two other such convictions.  Thus, lower courts will likely vacate cases that were based upon the older, broader application of the honest-services fraud statutes.

The Skilling Court held, "It is therefore clear that, as we read § 1346, Skilling did not commit honest-services fraud" and cited Yates v. United States (1957) 354 U.S. 298, for the proposition that "because the indictment alleged three objects of the conspiracy - honest-services wire fraud, money-or-property wire fraud, and securities fraud - Skilling's conviction is flawed."  However, the Court went onto say, this "determination does not necessarily require reversal of the conspiracy conviction . . . errors of the Yates variety are subject to harmless-error analysis."

In other post-Enron collapse news, investors in the company were represented by none other than Bill Lerach, whose fees make Petrocelli's fees look diminutive.  So far, Lerach's firm is credited with obtaining settlements in excess of $7 billion from companies such as Citigroup, CIBC, and JPMorgan Chase.

As to smart Mr. Skilling himself, the Supreme Court affirmed the Fifth Circuit's ruling on Skilling's fair-trial argument, vacated its ruling on his conspiracy conviction, and remanded the case for the Fifth Circuit to "take a fresh look at the parties' harmless-error arguments."  Thus, whether the "Government can show that the conspiracy conviction rested only on the securities-fraud theory, rather than the distinct, legally-flawed honest-services theory" is a question for remand.

UPDATE-4/15/2011

As the Supreme Court noted, "All of his convictions, Skilling contends, hinged on the conspiracy count and, like dominoes, must fall if it falls." However, when US 5th Circuit Court of Appeals disagreed with Skilling's argument when they reviewed the case again, in early April of 2011.  The court ruled that since the trial jury had been presented with "overwhelming evidence" that Skilling had conspired to commit fraud, the verdict would have been the same even if the honest service fraud theory had not been presented.    The court affirmed Skilling's 24 year sentence.    

Update 4/6/2013 The Department of Justice announced it is considering entering into an agreement with the defense to re sentence Skilling.   This would result in a lower sentence, if the trial judge approves it.  Skilling has served  about 6 years of his sentence, and it is not know how much of a reduction will be recommended.   

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