Yes, Colluding With Russians to Interfere with the Election Is a Crime

The Special Counsel and several Congressional committees are investigating Russian interference with the 2016 election and the possible involvement of Trump campaign officials. The investigations are in their early stages, and it’s not yet clear whether any collusion took place. But some have suggested that even if it did, it would not be criminal.

Fox News commentator Brit Hume recently made this claim on Fox News Sunday. When one of the panelists noted that a grand jury in Alexandria, Virginia was conducting a criminal investigation, Hume interrupted:

But what crime? Can anybody identify the crime? Collusion, while it would be obviously alarming and highly inappropriate for the Trump campaign, of which there is no evidence by the way, of colluding with the Russians — it’s not a crime.

Hume was echoing a claim made by other Fox News pundits and supporters of the president. They imply the investigations must be politically motivated because collusion with Russians to interfere with our election, even if it did take place, would not be criminal.

No one knows yet what the various investigations will reveal. It’s certainly possible that no criminal misconduct will be found. But it’s wrong to suggest that criminal law is not even implicated here. If Trump campaign officials actively worked with Russians seeking to influence the outcome of the election, there are a number of potential criminal violations.

Collusion is like criminal conspiracy, a partnership in crime

The Most Likely Charge: Criminal Conspiracy 

Collusion is defined as a secret agreement to cooperate in some dishonest endeavor. This sounds a lot like criminal conspiracy, which prohibits agreements to pursue a criminal end. And indeed, the potential charge that most clearly applies to the Russian collusion allegations is the federal conspiracy statute, 18 U.S.C. § 371.

Section 371 prohibits two kinds of conspiracies: conspiracy to commit any offense against the United States and conspiracy to defraud the United States. Both theories potentially apply to any Russian collusion. The nature of a conspiracy charge makes it particularly appropriate for these allegations.

In a conspiracy case the offense is the agreement itself – the partnership in crime. A defendant must join the agreement with the intent to further its criminal objectives. But a defendant need not personally commit the crime that is the object of the conspiracy. In other words, it’s a crime to conspire to help another person commit an offense even if you don’t commit it yourself.

You also can conspire to help someone else commit a crime that you couldn’t possibly commit yourself – for example, because the statute doesn’t apply to you. The Supreme Court recently affirmed this principle in Ocasio v. United States, a case I wrote about here.

Finally, a conspiracy does not have to be successful. Conspiracy is a separate offense independent of the underlying object of the conspiracy. If the crime you conspire to commit is never carried out, for whatever reason, you can still be prosecuted for the conspiracy itself.

These features of conspiracy law have some obvious implications for any investigation of Russian collusion. For example, if Trump officials conspired to help Russians interfere with the election, they could be liable for conspiracy even if only the Russians did the actual interfering.

Similarly, if Trump officials conspired to help Russians violate bans on foreign involvement in U.S. campaigns, they could be liable for that conspiracy even though they were not foreign nationals and could not have committed the crime themselves.

Finally, because a conspiracy charge does not require proof that the conspiracy was successful, it would not require prosecutors to prove that any attempted interference actually impeded the election or affected the outcome.

Conspiracy to Defraud the United States

Section 371 prohibits conspiracies to defraud the United States “in any manner or for any purpose.” Typically, to defraud means to use dishonest methods to deprive someone of money or property. Using traditional mail or wire fraud to charge that the public was defrauded of its right to a fair election therefore would be problematic, because the intangible right to a fair election is not “property.”

But for purposes of Section 371 conspiracies to defraud the U.S.,  fraud has a different and broader meaning. In 1924 in Hammerschmidt v. United States  the Supreme Court held that conspiracy to defraud the U.S. includes schemes “to interfere with or obstruct one of its lawful government functions by deceit, craft, or trickery, or at least by means that are dishonest.” A conspiracy to defraud the U.S. under 371 does not need to result in a loss of money or property by the federal government.

This theory is often used to charge schemes that involve disguising transactions to evade some government regulatory program, or hiding assets to thwart the IRS. Individuals can be guilty of conspiracy to defraud the U.S. even if their underlying conduct, standing alone, would not be illegal. They can also be found guilty even if prosecutors can’t prove that the government lost money as a result.

Running a free and fair Presidential election is a core lawful function of the federal government. Any agreement to secretly and dishonestly attempt to interfere with a federal election would fall squarely within section 371’s prohibition on conspiracies to defraud the United States.

This theory has been used in election fraud cases in the past. For example, in the 1990’s there was a scandal involving China’s attempts to promote its interests within the U.S. government and potentially influence the 1996 presidential election. Charlie Trie, a Chinese-American with ties to the Clintons, was convicted for violating various campaign finance rules by exceeding legal contribution amounts and concealing the true identity of donors. Among the charges in his indictment: conspiracy to defraud the U.S. under Section 371 by impairing and impeding the legitimate functions of the Federal Election Commission.

Conspiracy to Commit an Offense Against the United States 

Section 371 also prohibits conspiracies to commit any offense against the United States. This applies to conspiracies to violate any criminal statute. The United States government does not need to be the victim of the intended crime.

Russian interference with the election reportedly involved hacking the Democratic National Committee computers and possibly other computer systems (including those run by state election officials). Breaking into computer systems without authorization violates 18 U.S.C. § 1030, the Computer Fraud and Abuse Act. The CFAA criminalizes a wide range of activities involving hacking or other unauthorized access to and theft of information from private and government computers. Any conspiracy to engage in such hacking could be charged as a conspiracy to commit an offense against the United States.

Suppose, for example, Trump campaign officials agreed to somehow assist Russian hackers who were gaining unauthorized access to the DNC and other computers. That agreement could constitute a conspiracy to violate the CFAA, and could be prosecuted under Section 371. Because the crime is the conspiracy, Trump campaign officials could be charged even if the Russians did all of the actual hacking. The Russians also could be charged with violating the CFAA itself, but both the Russians and the Trump campaign officials who assisted them could be charged with conspiracy.

Conspiracy to impede the FEC could violate 18 USC 371

Conspiracy to Violate Election Laws

Another possible conspiracy to commit an offense against the United States would be conspiracy to violate federal election laws. I’m no authority on election law so I’m not going to venture very far here. But if there is a potential criminal violation of election laws, then campaign officials could conspire with Russian individuals to violate that law.

Election law experts have suggested these facts could violate prohibitions on foreign contributions to our elections. For example,  52 U.S.C.§ 30121 outlaws election contributions and donations by foreign nationals. It may be that activities by Russian individuals, such as stealing and then releasing emails damaging to the Clinton campaign, could be characterized as contributing something of value to the Trump campaign.

If Russians violated the law against foreign contributions and Trump campaign officials conspired to help them do so, the campaign officials could be guilty of a conspiracy to violate that election law. Again, this is true even though they were not foreign nationals and so could not violate that law directly.

Aiding and Abetting

Title 18, § 2 of the U.S. Code provides that anyone who “aids, abets, counsels, command, induces or procures” the commission of a crime can be found guilty of committing the crime themselves. This criminal law theory of aiding and abetting is also potentially relevant to the Russian collusion allegations.

The theory would be quite similar to the conspiracy charge, but with less focus on proving the criminal agreement. If the evidence revealed that Trump or his campaign officials asked or encouraged the Russians to interfere with the election or assisted them in any way, they potentially could be charged as aiders and abettors. Potential charges could include aiding and abetting a violation of the CFAA or of federal election law.

Accessory After the Fact and Misprision

Suppose Trump campaign officials got involved with Russian hackers only after the hacking was already completed, and worked with them on things like timing the release of certain emails. Conspiracy to violate the CFAA might not be a viable charged, because you can’t conspire to commit a crime that is already completed.

At that point a couple of other options would come into play. Accessory after the Fact, 18 U.S.C. § 3, punishes anyone who knows a crime against the U.S. has been committed and then “receives, relieves, comforts or assists the offender in order to hinder or prevent his apprehension, trial or punishment.” Anyone who worked with Russian hackers to help them conceal their activities and avoid detection or apprehension could be considered an accessory.

A related charge, Misprision of a Felony, 18 U.S.C. § 4, punishes anyone who has actual knowledge of a felony that has been committed against the U.S. and “does not as soon as possible make known the same to some judge or other person in civil or military authority.” Again, if Trump campaign officials got involved with Russian hackers after the hacking was completed and cooperated with them rather than reporting the hacking, misprision would be a potential charge.

Yes, Collusion Can Be Criminal

Once again, for the record: I’m not saying any of these crimes took place. I’m not suggesting that anyone will be charged, or should be charged. As with any criminal case, everything is going to depend on the facts and what evidence the government can present. But it’s simply nonsense to claim there is no basis here for a criminal investigation.

Some have suggested this idea is being floated as a trial balloon by the Trump administration to gauge the public reaction. It’s akin to the argument that the president couldn’t obstruct justice because, well, he’s the president. The apparent implication is that no matter what went on with the Russians or any attempts to thwart the FBI investigation, the investigations are just a political “witch hunt.” Nothing criminal to see here, folks, move along now.

We don’t know what the investigation will ultimately reveal. But we should dispense with the idea that colluding with Russian individuals to influence the outcome of our Presidential election would not be a crime. If the evidence is there, federal prosecutors have plenty of tools with which to build a case.

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When Is Fraud Involving a Bank Not Bank Fraud? Shaw v. United States

Update 12/12/16: Today the Supreme Court unanimously ruled against Shaw and held that Section 1 of the bank fraud statute applies to a scheme to obtain deposits held by the bank even if the bank suffers no financial loss. The Court also affirmed that a bank does have a property interest in deposits that it holds, as both sides had basically ended up agreeing during oral argument. The Court sent the case back to the Ninth Circuit to consider the adequacy of the jury instructions, whether that issue was properly preserved, and whether any error in the instructions may have been harmless. See discussion below.

On the first day of arguments this term, the Supreme Court considered the scope of the federal bank fraud statute. The case, Shaw v. United States, involves complex questions concerning the definition of fraud and the nature of property rights. It’s a classic, nerdy white collar battle over statutory interpretation — and it was all completely unnecessary.

The federal bank fraud statute, 18 U.S.C. § 1344, makes it a crime to execute or attempt to execute a scheme or artifice:

1) to defraud a financial institution; or

2) to obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution, by means of false or fraudulent pretenses, representations, or promises.

Shaw involves the proper interpretation of clause 1 and what it means to defraud a financial institution. In particular, the issue is whether the defendant must intend to obtain property owned by the bank itself and cause the bank financial injury, or whether it is sufficient to show merely that the defendant intended to obtain property being held by the bank, such as customer deposits.

The defendant, Lawrence Shaw, was convicted for executing an elaborate scheme to steal money from a Bank of America checking account held by Stanley Hsu. After wrongfully obtaining Hsu’s bank statements and personal information, Shaw was able to open a PayPal account in Hsu’s name. He then repeatedly transferred money from Hsu’s checking account into the PayPal account and ultimately into other bank accounts that Shaw controlled. Shaw was able to siphon more than $300,000 out of Hsu’s account before Hsu, who was living in Taiwan, detected the losses.

Due to the operation of banking laws, Bank of America actually ended up suffering no financial loss as a result of the scheme. PayPal, which had allowed the phony account to be opened, ended up on the hook for about $100,000 of the loss. Hsu, who had failed to notify Bank of America about the fraud in a timely manner, personally lost nearly $200,000.

2000px-paypal_logo-svg

PayPal was left holding the bag

Shaw was indicted on multiple counts of executing a scheme to defraud a financial institution under clause 1 of the bank fraud statute. At trial and on appeal, Shaw did not deny his culpability. His defense was basically that the government had charged him under the wrong section of the statute. Clause 1, he argued, requires the government to prove that Shaw was targeting property owned by the bank itself and intended to expose the bank to a financial loss. Shaw maintained that his goal all along was simply to get Hsu’s money. He never had any intent to harm the bank, and the bank in fact did not suffer a loss. Accordingly, Shaw argued, his conduct, although fraudulent, did not constitute a scheme to defraud the bank within the meaning of the statute.

Shaw maintained that his scam should have been charged under clause 2, which covers schemes to obtain property of others in the custody of the bank – in this case, Hsu’s deposits. (This, of course, is not a very sexy or sympathetic defense; Shaw isn’t saying,“I didn’t do it,” he’s saying “Yeah, I did it, but you charged me the wrong way.” But sexy or not, if he prevails his convictions will be reversed. As I’m sure some famous football coach said once, an ugly win is still a win.)

The trial court ruled against Shaw and held the government was not required to prove that Shaw intended the bank to suffer any financial harm or to lose its own property. The judge instructed the jury that a scheme to defraud a financial institution required only proof that the defendant intended to deceive or cheat the bank somehow, but did not require proof that the defendant intended the bank to suffer any loss. The jury convicted Shaw on fourteen counts of bank fraud.

The U.S. Court of Appeals for the Ninth Circuit upheld Shaw’s convictions. The court of appeals reasoned that Congress could not have intended liability for bank fraud to turn on arcane banking rules and regulations about who will bear the loss. Requiring proof of intent to harm the bank itself, the court said, would make prosecuting bank fraud unreasonably difficult. Because the goal of the statute is to protect the integrity of the banking system, any scheme that deceives a bank will suffice, regardless of who ultimately is harmed. The court therefore agreed with the trial judge that clause 1 requires only proof that the defendant intended to deceive the bank, not that he intended to expose the bank itself to any financial loss.

Supreme Court

SCOTUS Agrees to Weigh In

The Supreme Court agreed to hear Shaw’s appeal, and the case was argued this past Tuesday. The courts of appeal are divided on the question presented in Shaw. The Ninth Circuit is in the minority; most courts agree with Shaw’s argument that clause 1 of the bank fraud statute requires the government to prove the defendant intended to expose the bank itself to a risk of financial loss.

As I discussed in my last post, to defraud someone usually means to deprive him of money or property through some kind of deception. The law generally draws a distinction between defrauding someone and merely deceiving them; a scheme to defraud typically requires not only a deception but also an intent to injure the victim by depriving them of their property.

Based on this understanding of fraud, the plain wording of the statute supports Shaw’s argument that the scheme must target the bank’s own property. The language “scheme to defraud a financial institution” suggests that the financial institution itself would be the victim of the fraud. This in turn would mean that the scheme to defraud would be designed to deprive the bank of money or property.

But then the question becomes what qualifies as “property.” Although (as the Justices somewhat testily pointed out) the government’s brief was not entirely clear on this point, during oral argument the government confirmed that it agreed a scheme to defraud a bank requires intent to deprive the bank of property and that merely deceiving the bank is not enough. The government disagreed with Shaw, however, about the nature of the property interests protected by the statute, and about whether depriving the bank of a property interest necessarily requires exposing the bank to financial harm.

The government agreed that the Supreme Court has consistently held that a scheme to defraud means a scheme to deprive a victim of money or property, but noted that the Court has always interpreted the term “property” very broadly. Fraud, the government argued, protects both tangible and intangible property, and protects property that is merely in one’s possession as well as property that one owns.

Under this broad definition of property, a scheme to obtain customer deposits is in fact a scheme to deprive the bank of its possessory property interest in those deposits. The same would be true of a scheme to steal other assets being held by a bank, such as customer valuables in a safe deposit box. There is no requirement that the bank actually own the property or suffer a financial loss; the law of fraud requires only that the scheme contemplated depriving the bank of its possessory property right in the assets it holds.

During oral arguments, Shaw’s attorney ultimately agreed with the government that the bank’s possessory interest in customer deposits could qualify as a property interest for purposes of fraud. A line of questions from Justice Kagan honed in on the fact that both sides now seemed to agree about the definition of “property.” Shaw’s attorney maintained, however, that the ordinary understanding of a scheme to defraud meant that to deprive the bank of that property interest required proof of intent that the bank would bear the ultimate financial loss. The Justices seemed more skeptical on this point, with Justice Alito in particular arguing that you could deprive someone of a possessory interest in property without necessarily causing them a personal loss.

But even if the Court ends up agreeing with the government that Shaw’s scheme deprived Bank of America of a property interest in Hsu’s deposits, Shaw may still prevail – because that’s not what the jury instructions said. During oral argument, several of the Justices suggested that the key issue in the case is really the jury instructions. Under questioning from Justice Sotomayor, Shaw’s attorney argued that even if Shaw loses on the interpretation of the bank fraud statute, his convictions must be reversed because the jury instructions were flawed. When the Assistant to the Solicitor General began his argument, the Justices immediately started peppering him with questions about the jury instructions and whether they adequately conveyed the requirements of fraud.

The jury instructions could be read to say that depriving the bank of property was not required, and that it was enough if Shaw merely intended to deceive the bank. The instructions thus arguably failed to distinguish between defrauding and merely deceiving a victim, which is usually critical to the law of fraud. At oral argument, Chief Justice Roberts pointed out that the Ninth Circuit’s opinion also said the bank only needed to be deceived – which seems to endorse the incorrect standard. There was some additional back and forth about the grammatical structure of the instructions, how the jury would have interpreted them, and whether the issue was properly preserved, so how the Court will come out on that question is unclear. But it’s very possible the government could win the legal fight over the definition of bank fraud and still lose the appeal based on flawed jury instructions.

The Implications of Shaw

Although Shaw has implications for banking law and the definition of fraud – and certainly has significant implications for Mr. Shaw — it does not really implicate broader interests about federalism or overcriminalization that are present in many white collar cases. There is no real universe of cases that will no longer be subject to federal prosecution if Shaw wins; Shaw himself admits he could have been prosecuted under clause 2 of the bank fraud statute.

The National Association of Criminal Defense Lawyers filed an amicus brief supporting Shaw on federalism grounds. It argued the bank fraud statute should be construed narrowly in order to limit the scope of federal prosecutions and allow the states to pursue such cases. But this argument doesn’t really hold water. Regardless of the outcome here, cases like Shaw’s will still be subject to federal prosecution, whether through other provisions of the bank fraud statute or through other laws such as mail and wire fraud. There are more than enough arrows in the federal prosecutor’s quiver.

But however it ultimately comes out, Shaw will be instructive in one more area: the importance of sound prosecutorial charging decisions. Clause 2 of the bank fraud law seems clearly to cover Shaw’s conduct. If prosecutors had simply charged Shaw under clause 2 in the first place, this entire issue could have been avoided. Prosecutors would have saved themselves a lot of headaches, time and money that had to be devoted to defending the convictions.

This isn’t a case of over-charging of the type that has caused the Court concern in recent years. There’s no question that Shaw’s conduct was criminal and deserved to be prosecuted. But by charging the case the way they did, prosecutors handed Shaw an issue for appeal that may well be successful. It’s what that football coach would call an unforced error.

Shaw should bring some clarity to the law of bank fraud. But the real lesson of Shaw for prosecutors should be a reminder of the importance of careful charging decisions and selecting the proper statutes when crafting indictments.

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The Definition of Fraud

Considering how important the offense of fraud is to white collar crime, you might expect the definition of fraud to be pretty clear by now. But a recent interesting case out of the 11th Circuit highlights the ongoing occasional uncertainty about what constitutes criminal fraud. It also highlights the risks of going to a bar with a stranger – but I digress.

Fraud is at the heart of much of white collar criminal law. White collar crimes, by definition, typically involve taking a victim’s money or property through some kind of deception rather than by force or violence. That same concept – wrongfully obtaining property of another through a trick or scheme – is also the essence of fraud. Any litany of the most common white collar offenses will include many with “fraud” in their title: mail and wire fraud, health care fraud, insurance fraud, securities fraud, real estate fraud, bank fraud, credit card fraud, and so on.

But fraud itself is not defined anywhere in the criminal code. As one federal judge helpfully observed: “The law does not define fraud, it needs no definition. It is as old as falsehood and as versatile as human ingenuity.” But of course we do need a definition, because human ingenuity also cooks up a lot of schemes that may be shady but are not criminal. Criminal law requires us to draw lines between conduct that actually amounts to fraud and conduct that may be merely dishonest or unethical — and sometimes those lines can be quite blurry.

Crimes such as robbery or homicide generally have pretty straightforward parameters. There may be defenses or mitigating factors in any particular case, but the facts that will establish the elements of the offense are usually relatively clear. If someone sticks a gun in your face and takes your wallet, there’s not much doubt there has been a robbery. If you come home to find your front door broken and all your valuables missing, there has been a burglary. But as I discussed in my last post, white collar crimes frequently involve more gray areas. The ancient crime of fraud is no exception.

In the absence of a statutory definition, the parameters of criminal fraud have been explored over the years in judicial decisions, with courts suggesting various formulations. The Supreme Court has said that to defraud typically means to deprive someone of property “by dishonest methods or schemes,” and typically involves “the deprivation of something of value by trick, deceit, chicane, or overreaching.” Another common formulation characterizes fraud as conduct that violates the sense of “moral uprightness, of fundamental honesty, fair play and right dealing in the general and business life of members of society.”

The trick, of course, is that not everyone will always agree on what constitutes “fair play and right dealing,” and mere “dishonesty” is generally not a crime. As I frequently remind my students, there is a lot of sleazy, rotten, immoral stuff that goes on in the world that is not criminal. White collar criminal law frequently involves trying to figure out the distinction.

Charles Ponzi: when it comes to the definition of fraud, the Ponzi scheme is a classic example

Charles Ponzi

The Textbook Example: The Ponzi Scheme

The textbook example of a fraud is the Ponzi scheme, named for its most famous practitioner, Charles Ponzi. In the 1920s Ponzi came up with an scam involving purported trading in International Reply Coupons (IRCs). IRCs were certificates that could be purchased in one country, enclosed in an international letter, and then be redeemed by the recipient in another country for the postage necessary to send a reply. Ponzi claimed that he could double investors’ money in just a few months by buying and selling large quantities of IRCs and taking advantage of differences in international postage rates and currency exchange rates. Early investors received substantial “returns” on their investment; word quickly spread and the money poured in.

In truth, of course, Ponzi was not investing in IRCs at all and was simply keeping the money. If any investors wanted to withdraw some of their funds, he would pay them off using money he had taken in from other investors – a central characteristic of what we now call a Ponzi scheme. Most investors, seeing the impressive returns they were supposedly earning, were happy to keep their money with Ponzi and to send even more. People mortgaged their homes and sent Ponzi their life savings. He made millions within the space of a few months. But ultimately the scheme collapsed, the investors were wiped out, and Ponzi was indicted and sent to prison.

Nearly a century later, Bernard Madoff was convicted for the largest single investment fraud in history, costing his investors billions of dollars. His New York company, Bernard L. Madoff Investment Securities, LLC, was simply one giant Ponzi scheme that he ran for decades. The classics never grow old.

Examples like Ponzi and Madoff are easy; no one doubts that their actions constituted fraud. They stole money from their investors by lying to them, harming their victims through a “dishonest method or scheme.” But some other cases are not so clear.

Suppose you walk into my electronics store wearing a Donald Trump t-shirt and a red “Make America Great Again” baseball cap. While you are looking at television sets, I point out a yuuge, 110-inch flat screen and say, “Guess what? This is actually the same kind of TV set that Donald Trump has in his private suite at Trump Tower!” Although it’s a perfectly good television set at a fair price, I actually have no idea whether Trump really owns it. If you buy the TV based on my statement, have you been defrauded?

Or suppose I’m a real estate agent showing you houses, and I tell you, “The houses in this neighborhood really hold their value. They should turn out to be great investments for the people who buy here.” In reality, I know the housing prices in the neighborhood have been declining and people are bailing out. If you buy, relying in part on my statements, have I defrauded you, even though you end up with a perfectly good, habitable house?

Or suppose I set up a website offering to sell $50,000 tickets on a private space flight to go visit the aliens who abducted Elvis. I get a few takers among rabid Elvis fans living near Graceland. If I abscond with their money is that a criminal fraud, even if no reasonable person could have possibly believed the offer was real? Or should the law say the victims should have known better and can simply sue me in civil court to get their money back? Does the answer change if the tickets were only $500? $5?

The Definition of Fraud

One well-known case exploring the parameters of criminal fraud is United States v. Regent Office Supply Co., decided by the U.S. Court of Appeals for the Second Circuit in New York in 1970. Regent sold office supplies through salesmen who solicited orders over the telephone. When they called a prospective customer, the salesmen would tell various lies about why they were calling; for example, they would falsely claim they had been referred by an officer of the customer, or that the salesmen had stationery they could offer at a good price because another customer had died. They used these false stories to “get their foot in the door;” to get past the receptionist who answered the phone and speak to someone who could actually place an order. Once talking to that person, however, there were no lies — the price and quality of the merchandise was honestly discussed, the products sold were perfectly good products at a fair price, and the products could be returned if the customer was not satisfied.

The government charged Regent with multiple counts of wire fraud, based on the phony stories told during the initial phone conversations. Prosecutors argued that the customers were deprived of the opportunity to bargain with all of the true facts before them. The agents deceived the customers about who they were and why they were calling, causing the customers to enter into the transactions under false pretenses. Were it not for the lies, the sales would not have taken place. The government argued that this amounted to a scheme to defraud. The trial judge agreed and found Regent guilty.

The Court of Appeals reversed the convictions. The court noted it did not condone the deceitful conduct, which it said was repugnant to “standards of business morality.” But simply because it was repugnant did not mean it was fraud. Although the customers may have been deceived, the court held, they were not defrauded.

The government’s position was that fraud could exist in a commercial transaction “even when the customer gets exactly what he expected and at the price he expected to pay.” The court was not willing to go so far. Fraud, the court said, requires that some actual injury to the victim be at least contemplated by the schemer, and that was missing here. The misrepresentations by the Regent salesmen did not go to the quality, adequacy, or price of the goods. When the deal was concluded the customers had gotten exactly what they expected.

To constitute fraud, the court held, it is not enough that there be some deception involved somewhere in the transaction. The deception must be coupled with a contemplated harm to the victim that relates to the very nature or heart of the bargain itself. Any intangible or psychological “injury” that may have resulted here from the customers being deceived about the reason for the sales call was not the kind of injury that would support a criminal fraud conviction. The sales tactics may have been sleazy and unethical, but they were not criminal.

nightclub-in-neon-108681294533967qk7

“Buy Me a Drink, Mister?”  United States v. Takhalov

This distinction between being defrauded and merely being deceived still rears its head in cases today. This past summer, the U.S. Court of Appeals for the 11th Circuit addressed it in United States v. Takhalov. The defendants in Takhalov were owners of several nightclubs in South Beach, Miami. The clubs hired Eastern European women to pose as tourists, locate visiting businessmen, and convince them to accompany the women into the bars owned by the defendants. The defendants did not deny this was taking place, nor did they deny that the women concealed their relationship with the clubs from the men – in fact, they argued this was a perfectly legitimate business model.

The parties differed about what happened once the men were inside the club. According to the defendants, the men simply purchased food and alcohol and had drinks with their female companions. The government, on the other hand, contended that once inside the club other misconduct took place, including concealing the true prices of drinks and food, forging the men’s signatures on credit card receipts, and secretly adding vodka to the men’s beer so they would get drunk faster. The defendants claimed that if any of that was going on, they knew nothing about it.

The legal issue in the case was right out of Regent Office Supply. The government argued the jury could have convicted the defendants of fraud based simply on the lies the women told the men to lure them into the bar in the first place, regardless of what happened after the men got there. Had the men known the women were actually club employees rather than simply friendly strangers, they would not have entered the club. Any business conducted in the bar, therefore, took place under false pretenses and amounted to fraud.

The defendants, on the other hand, argued that if all the government proved was that the men were tricked into entering the bar, then the men would have been deceived but not defrauded. Although the women might have concealed their relationship with the club, once inside the club the men ordered food and drinks off the menu and got exactly what they expected to get at the price they expected to pay.

The Eleventh Circuit agreed with the defendants. The Court noted that the wire fraud statute “forbids only schemes to defraud, not schemes to do other wicked things, e.g. schemes to lie, trick, or otherwise deceive. The difference, of course, is that deceiving does not always involve harming another person; defrauding does.” A scheme to defraud, the court said, must involve misrepresentations that go to the nature of the bargain itself – usually lies that go to either the value or the characteristics of the goods in question. But if the defendant lies about something else, such as the reason he is willing to enter into the bargain at all, those lies will not amount to fraud — even if the victim would not have entered into the transaction otherwise. The victim in such a case is not injured in a way the law of fraud will recognize.

Just as in Regent, therefore, even if the “customers” in Takhalov were misled about the reason for beginning the transaction (entering the bar), once there, according to the defense, the men got exactly what they expected – food and cocktails with attractive women — at the price they expected to pay. Any misrepresentations that took place when the women concealed their relationship with the bar did not go to the heart of the bargain with the bar itself. The defense was entitled to have the jury instructed that if this was all the defendants did, they were not guilty of fraud. Because the jury instructions failed to make this clear, the court reversed the convictions.

Other Upcoming Issues in the Law of Fraud

As Takhalov demonstrates, the exact parameters of the offense of fraud continue to be litigated. In fact, in its first week of arguments this term, the U.S. Supreme Court is going to consider two cases involving different aspects of fraud. Shaw v. United States involves the proof required to establish bank fraud, and Salman v. United States, a case I wrote about here, will examine the elements of insider trading, a particular variety of securities fraud. I’ll have more about those cases in future posts, as the law of fraud continues to evolve.

Stay tuned – and stay out of South Beach nightclubs.

(Update: since I wrote this post the Supreme Court has decided the Shaw and Salman cases. You can find my Shaw here post and my Salman post here .)

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White Collar Crime, Prosecutorial Discretion, and the Supreme Court

Does the Supreme Court still believe in prosecutorial discretion? A string of cases over the past few years has to make you wonder.

Prosecutorial discretion – the power to decide whether to bring criminal charges, who to charge, what crimes to charge, and how ultimately to resolve the case – is a fundamental component of the criminal justice system. The legislature enacts the laws but the executive branch enforces them, which includes making judgments about when and how to bring a criminal case.

On the macro level, this means setting national and local law enforcement priorities and making decisions about the deployment of finite prosecutorial resources. Different administrations at different times have declared areas such as health care fraud, narcotics, illegal immigration, or terrorism to be top priorities and have allocated resources accordingly. Such decisions necessarily mean other areas will not receive as much attention; a dollar spent fighting terrorism is a dollar that can’t be spent investigating mortgage fraud.

On the micro level, prosecutorial discretion involves deciding whether to pursue criminal charges in a given case and what charges to pursue. Factors such as the nature of the offense, strength of the evidence, the nature and extent of any harm, adequacy of other potential remedies, any mitigating circumstances or remedial efforts by the accused, and prosecutorial resources and priorities all may come into play.

For federal prosecutors, policies governing how they should exercise this discretion are set forth in the U.S. Attorneys’ Manual, and in particular in the Principles of Federal Prosecution. The Principles contain detailed guidance concerning when to bring charges, what kind of charges to bring, and how to handle criminal cases, in order to “promote the reasoned exercise of prosecutorial discretion by attorneys for the government.” USAM 9-27.110.

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Prosecutorial Discretion and White Collar Crime

Prosecutorial discretion is particularly important in white collar crime. With non-white collar, or “street” crimes, the parameters of the offense tend to be more clearly defined and charging decisions often are more black and white. If there is a body on the street with nine bullets in it, you pretty clearly have a homicide. If authorities can identify who did it, that person will almost certainly be charged. The prosecutor is not likely to say, “Due to our limited resources and other priorities, we’ll take a pass on this one and let the victim’s family file a civil suit instead” – not if the prosecutor wants to keep her job, anyway.

But white collar crime is full of gray areas. White collar prosecutors deal with sometimes nebulous concepts such as “fraud” and “corruption,” and white collar statutes are written in notoriously broad and general terms. As a result, it often falls much more to the prosecutor to determine whether something is a crime at all and to decide what kind of conduct merits a prosecution.

For example, suppose a hedge fund goes belly-up, and the investors who lost their money claim they were misled about their investment. Was it fraud, or was it merely aggressive – maybe even sleazy – sales tactics followed by incompetence, mismanagement, or just bad luck? Unlike a homicide, robbery, or drug case, at the outset it may not be clear that a crime has been committed. A prosecutor might well conclude, “If I investigated this for two years, perhaps at the end I would have a provable criminal fraud case – but perhaps not. Given my resources and priorities, I’m going to focus on other cases and let the SEC and private plaintiffs pursue civil and administrative penalties in this one.”

Given these potential gray areas, what’s the best way to deter and prosecute white collar crime? Imagine two different regimes. In System #1, Congress drafts broad statutes that proscribe conduct such as fraud in general terms, in order to encompass as much potentially criminal conduct as possible. It is left to the Executive Branch, through prosecutors, to enforce those statutes and determine which cases to pursue – with that discretion tempered, of course, by the oversight of the courts.

In System #2, Congress tries to write very precise and detailed statutes that are as specific as possible in defining the prohibited conduct. Such white collar statutes would leave fewer gray areas and less room for prosecutorial discretion – in other words, they would be more like street crimes. The downside of such a system would be that it necessarily creates loopholes: the more precisely you define criminal concepts like fraud, the greater the opportunity for individuals engaged in what should be criminal conduct to skirt the law’s prohibitions.

Historically, white collar criminal law has been closer to System #1: broad statutes prohibit things like fraud or corruption, and prosecutors are entrusted to exercise their discretion to determine how to apply those laws. But in a series of decisions over the past few years, the Supreme Court has signaled it is becoming increasingly uncomfortable with such a system. These decisions have limited several significant white collar statutes, moving us closer to System #2 – although with laws narrowed by the Court rather than by Congress. In the process, the Court has removed discretion from the hands of prosecutors while also making it more difficult to prosecute some criminal conduct.

The Supreme Court Limits Prosecutorial Discretion

The first such case was Skilling v. United States in 2010. Skilling involved the proper interpretation of 18 U.S.C. § 1346, which prohibits schemes to deprive another of the “intangible right of honest services.” Honest services fraud, a species of mail and wire fraud, has been around for decades. Most cases of honest services fraud have involved relatively straightforward allegations of corruption such as bribery, kickbacks, and conflicts of interest.

But prosecutors in some cases stretched the boundaries of the theory, using honest services fraud to prosecute, for example, a university professor who helped students plagiarize work to obtain degrees to which they were not entitled; an IRS employee who improperly browsed through certain tax returns but did nothing with the information; state officials who awarded public sector jobs based on political patronage; and a state official who failed to disclose a potential conflict of interest when state law did not require disclosure. Some of these schemes seemed wrong or dishonest but were far from traditional criminal corruption. The confusion over what actually qualified as a deprivation of honest services led Justice Scalia to argue in 2009 that the law was in a state of “chaos.”

The Supreme Court finally attempted to bring some order out of this chaos in Skilling. The defendant, former Enron CEO Jeff Skilling, argued that the honest services statute should be struck down as unconstitutionally vague, but the Court disagreed. Instead, it limited the law to what it deemed the core of honest services fraud: cases involving bribery and kickbacks.

The holding in Skilling dramatically narrowed the scope of honest services fraud. This successfully removed prosecutors’ ability to use the theory in innovative ways to charge more unusual schemes. But the limitation also created safe harbors for certain conduct, such as self-dealing by elected officials, that is plainly corrupt but may no longer be charged as a violation of honest services.

In 2014, the Supreme Court decided Bond v. United States. (Although not really a white collar case, Bond is instructive as part of the same trend at the Court.) In Bond a jilted wife tried to injure her husband’s lover by sprinkling some caustic chemicals on her mailbox and doorknob. The chemicals caused only a slight skin irritation on the woman’s thumb that was easily treated with cold water. Federal prosecutors subsequently charged Bond using a felony statute that prohibits the use of chemical weapons and carries a penalty of “any term of years” in prison.

The Court ultimately held that the statute did not apply to Bond’s conduct. But an undercurrent of the case was the Court’s obvious concern over the government’s decision to apply a federal law aimed at preventing the horrors of chemical warfare to such a trivial incident. During oral argument, Justice Kennedy told the Solicitor General that it “seems unimaginable that you would bring this prosecution.” Justice Alito remarked, “If you told ordinary people that you were going to prosecute Ms. Bond for using a chemical weapon, they would be flabbergasted.”

This trend continued in 2015 with Yates v. United States. Yates was a commercial fisherman working in the Gulf of Mexico. A fish and wildlife officer boarded his boat to conduct a routine inspection and ended up citing him for having several dozen red grouper on board that were slightly smaller than the legal limit – a civil violation. The officer told Yates to keep the fish until he returned to port, where they would be seized and destroyed. Once the officer left his boat, however, Yates instructed a crew member to throw the undersized fish overboard and replace them with larger ones.

When this ultimately came to light, prosecutors charged Yates with three crimes including obstruction of justice under 18 U.S.C. § 1519, a twenty-year felony. That law prohibits the destruction of “tangible objects” in an effort to obstruct a federal investigation. Captain Yates argued before the Supreme Court that fish were not “tangible objects” within the meaning of this statute. The Court ultimately ruled in his favor, but only by adopting what I believe was an unnatural and strained interpretation of the law.

But Yates is actually more significant for what it revealed about the Court’s views on prosecutorial discretion and charging decisions. During oral argument, the Justices were clearly disturbed by the application of a twenty-year felony to this fish-dumping episode. Justice Scalia asked what kind of “mad prosecutor” would charge Yates with a twenty-year offense, and sarcastically suggested perhaps it was the same prosecutor who had charged Bond with a chemical weapons violation. Later in the oral argument Justice Kennedy remarked, “It seems to me that we should just not use the concept [prosecutorial discretion] or refer to the concept at all anymore.”

The Court’s skepticism about prosecutorial discretion surfaced again this past spring in McDonnell v. United States. In reversing the corruption convictions of the former Virginia governor, the Court adopted a narrow definition of “official act” for purposes of federal bribery law. At oral argument and in its opinion the Court imagined federal prosecutors targeting elected officials for simply attending a lunch where a supporter bought them a bottle of wine, or for attending a ballgame as the guest of homeowners who earlier had sought the official’s help.

The narrow definition of “official act,” the Court concluded, was necessary to prevent politically-motivated prosecutions and the criminalization of routine political courtesies. But critics of the Court’s decision – including me – argue that the result is to shield a great deal of corrupt conduct that is precisely what the law of bribery aims to prevent.

The Future of Prosecutorial Discretion

In these recent cases, when faced with the interpretation of white collar crimes such as bribery, honest services fraud, and obstruction of justice, the Court’s approach has been to interpret the statutes narrowly and consequently to remove charging discretion from federal prosecutors. A moment during the Yates oral argument is particularly illuminating. The Justices asked Assistant Solicitor General Roman Martinez what guidance prosecutors followed when deciding what kind of charges to bring, and that led to this exchange:

MR.MARTINEZ:  Your Honor, the ­. . . my understanding of the U.S. Attorney’s Manual is that the general guidance that’s given is that the prosecutor should charge ­­once the decision is made to bring a criminal prosecution, the prosecutor should charge the ­­the offense that’s the most severe under the law. That’s not a hard and fast rule, but that’s kind of the default principle.  In this case that was Section 1519.

JUSTICE SCALIA:  Well, if that’s going to be the Justice Department’s position, then we’re going to have to be much more careful about how extensive statutes are.  I mean, if you’re saying we’re always going to prosecute the most severe, I’m going to be very careful about how severe I make statutes.

MR. MARTINEZ:  Your Honor, that’s ­­. . .

JUSTICE SCALIA:  Or ­­how much coverage I give to severe statutes.

MR. MARTINEZ:  That’s ­­– that’s not what we were saying.  I think we’re not always going to prosecute every case, and obviously we’re going to exercise our discretion. . . .

As Martinez attempted to point out, the real-world exercise of prosecutorial discretion is far more nuanced than Justice Scalia suggested. It’s true that the Principles of Federal Prosecution provide as a general rule – as they have for decades – that once a decision to bring charges is made a prosecutor generally should charge “the most serious offense that is consistent with the nature of the defendant’s conduct, and that is likely to result in a sustainable conviction.” USAM 9-27.300. But the Principles also recognize the need for prosecutors to consider the nature and circumstances of a particular case, the purpose of criminal law, and law enforcement priorities. What charges are “consistent with the nature of the defendant’s conduct” is also a matter of judgment and discretion. And of course considerable discretion also is involved earlier in the process, when deciding whether to bring charges at all.

But this exchange suggests the Court may believe it needs to interpret criminal statutes more narrowly because it cannot always trust prosecutors to exercise sound judgment when enforcing broadly-written statutes. As Justice Kennedy suggested during the Yates argument, it may be that the Court no longer thinks of prosecutorial discretion as a viable concept.

Of course, some critics of federal prosecutors will welcome this development and suggest it is long overdue. And some will point out that, for prosecutors, this may be considered a self-inflicted wound. The charging decisions in cases like Yates and Bond in particular may be what led the Justices openly to question whether prosecutors should continue to be entrusted with the same degree of discretion.

But it would be unfortunate if the Justices truly come to believe they cannot rely on prosecutors to exercise sound judgment in charging decisions. One can always argue about the merits of particular cases, but overall our system of broadly-written statutes enforced by the sound exercise of prosecutorial discretion has worked pretty well. If the Court continues to chip away at those statutes due to concerns about controlling prosecutors, it will continue to create safe harbors for some conduct that is clearly criminal.

It’s particularly inappropriate for the Court to limit these statutes based on hypotheticals that have no basis in reality, as it did in McDonnell. When we start seeing widespread prosecutions of politicians for accepting legal campaign contributions and attending Rotary Club breakfasts, then maybe we can talk about the need to curb prosecutorial discretion. But simply because we can imagine a parade of horribles based on the broad terms of a white collar statute does not mean that prosecutors are actually marching in that parade.

At the McDonnell oral argument, Justice Breyer noted that narrowing the definition of bribery might mean that a certain amount of corrupt conduct will go unpunished. Unfortunately, for now that appears to be a risk the Court is willing to take.

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The Impact of Justice Scalia’s Death on the Bob McDonnell Case

Justice Scalia’s death could end up spelling prison time for Bob McDonnell.

Scalia’s unexpected death over the weekend is a watershed in the legal community. Whether they agreed with him or not, few would deny that Scalia was a towering intellectual force on the Supreme Court for the past three decades. He was an aggressive and witty questioner from the bench, who almost single-handedly made Supreme Court oral arguments a lot more interesting. His elegantly-written and sometimes caustic opinions were eminently readable and could send many of us scurrying off to Google obscure terms such as “jiggery-pokery.” He had a tremendous impact on the Court and on the law.

But — this being Washington — Scalia’s body was not yet cold before people moved past the tributes and started debating the political and legal implications of his demise. President Obama and Senate Republicans promptly squared off over whether Obama should appoint a successor and whether the Senate would act on the nomination if he did.

There was also a good deal of commentary about how Scalia’s absence from the Court might affect the outcome of major cases pending in areas such as affirmative action, abortion, the Affordable Care Act, and the President’s powers on immigration and climate change. The loss of a single Justice can have a great impact because it opens up the possibility of a 4-4 tie. When that occurs, it is as though the Supreme Court case never happened. The lower court opinion stands and the Supreme Court’s decision has no value as precedent.

For former Virginia Governor Bob McDonnell, that’s a worrisome prospect. McDonnell and his wife Maureen were convicted on multiple counts of corruption back in September 2014. Prosecutors charged that the Governor and his wife agreed to use the power of his office to benefit a businessman, Jonnie Williams, by promoting his dietary supplement product within the state government. In exchange, Williams gave the McDonnells secret gifts and no-paperwork “loans” that totaled about $170,000. Following their convictions, Bob McDonnell was sentenced to two years in prison and Maureen was sentenced to one year and one day.

A panel of the U.S. Court of Appeals for the Fourth Circuit unanimously affirmed McDonnell’s conviction, and the full court declined to re-hear the case. But this past January, in a move that surprised at least some observers, the Supreme Court agreed to hear McDonnell’s appeal. The case likely will be argued in April and decided near the end of the Court’s term in June. (Maureen’s appeal in the Fourth Circuit is on hold pending the outcome of Bob’s case; the legal issues are virtually identical and whatever happens in his case will almost certainly determine the outcome of hers.)

A 4-4 Supreme Court tie in McDonnell’s case would mean the Fourth Circuit opinion upholding his convictions would stand – and that would mean the former Governor, and almost certainly his wife, would soon be heading to prison.

The McDonnell case, like all others currently pending, now faces this possibility of an equally-divided Court.  But when it comes to McDonnell, Justice Scalia was not simply one of nine Justices. If I had to pick the one Justice on the Supreme Court most likely to be sympathetic to McDonnell’s arguments, it would have been Justice Scalia. Whether in the majority or in dissent, it’s a safe bet Scalia would have had something to say about McDonnell’s case – and it’s almost certain it would have been good for McDonnell.

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Justice Scalia – A Likely Champion for Bob McDonnell

Justice Scalia was a leading voice on the Court in the area of white collar crime. He wrote the majority opinion in a number of important cases and powerful dissents in others. Consistent with his overall judicial philosophy, when it came to white collar crimes he typically argued for a strict interpretation of the statutory language and objected to any judicial “glosses” or expansive interpretations that arguably went beyond the literal words of the statute.

McDonnell’s “big picture” argument to the Supreme Court is that the government’s interpretation of federal corruption laws is too broad and potentially criminalizes a great deal of protected political activity. Justice Scalia’s overall approach to the law suggests he would have been sympathetic to this claim.

But even beyond issues of general judicial philosophy, Justice Scalia had previously staked out strong positions on the particular statutes McDonnell was convicted of violating — positions that would have directly supported McDonnell’s legal theories:

Official acts: From day one, a centerpiece of McDonnell’s legal defense has been the definition of “official acts” contained in the federal bribery and gratuities statute, 18 U.S.C. § 201. That statute defines an official act as “any decision or action on any question, matter, cause, suit, proceeding, or controversy” that may be pending or may be brought before the public official. McDonnell claims that favors he did for Williams, such as introducing him to other government officials or suggesting to state researchers that they study Williams’ product, were not “decisions” or “actions” on matters pending before McDonnell that would fall within this definition. Accordingly, he says, they cannot form the basis of a bribery conviction.

McDonnell was not charged with violating § 201, which generally applies only to federal officials. But he and his supporters have claimed that the language of § 201 governs all federal corruption laws, including those he was convicted of violating: the Hobbs Act and honest services fraud. I think this is wrong, for reasons that I’ve detailed in earlier posts here and here. But the claim remains the heart of McDonnell’s defense and is central to his Supreme Court appeal.

In support of their interpretation of the term “official act,” McDonnell and his supporters rely primarily on the Supreme Court’s 1999 decision in United States v. Sun-Diamond, which involved the appeal of Sun-Diamond’s conviction for paying gratuities to Secretary of Agriculture Mike Espy. In the course of its opinion, the Court discussed the definition of “official act” and pointed out that it was deliberately narrow. The Court noted that some routine political events, such as the President hosting a winning sports team at a White House reception, would not be “official acts” under this definition because they would not involve decisions or actions on matters pending before the President.

Sun-Diamond was not a bribery case and its discussion of “official acts” was not central to the Court’s decision.   Nevertheless, McDonnell and many other public corruption defendants routinely cite this portion of the Court’s opinion to argue that their conduct in a bribery case did not amount to official acts and thus cannot be punished.

And who was the author of the Sun-Diamond opinion? Justice Scalia. He also famously remarked in that same opinion that in an area as complex as public corruption, where there are many different statutes and regulations concerning the intersection of law and politics, “a statute . . . that can linguistically be interpreted to be either a meat axe or a scalpel should reasonably be taken to be the latter.” (He did know how to turn a phrase.)

Scalia’s view that the federal bribery statute must be narrowly construed would be directly in line with McDonnell’s position. McDonnell claims his conviction threatens all routine political interactions and that if it stands a politician could not attend a fundraiser (or host a team at the White House) without fearing a potential prosecution. He argues that fundamental First Amendment rights of political association and expression forbid this, and that the federal corruption statutes must be more narrowly tailored.

With his claim that all federal corruption laws should be interpreted by using a scalpel that would carve out a safe zone for his own actions, Governor McDonnell almost certainly would have found a sympathetic audience in Justice Scalia.

Honest Services Fraud: One of the two principal corruption statutes under which McDonnell was convicted is honest services wire fraud. In an honest services fraud case, a politician is charged with defrauding his constituents of their right to his fair and honest services by using his public office to line his own pockets.

In an important 2010 case, Skilling v. United States (involving the conviction of former Enron CEO Jeff Skilling), the Supreme Court addressed Skilling’s argument that the term “honest services” was so vague and amorphous that it rendered the statute unconstitutional. The majority disagreed. The Court held that honest services fraud should be limited to cases involving bribery or kickbacks, and that so construed the law was sufficiently clear. Because Skilling’s conduct involved neither bribery nor kickbacks, his convictions for honest services fraud were reversed.

Justice Scalia (joined by Justices Thomas and Kennedy) wrote an opinion agreeing with the final outcome but not with the analysis. Scalia agreed with Skilling that the phrase “honest services” is hopelessly unclear. He criticized the majority’s decision, arguing that narrowing the law to only bribery and kickbacks “requires not interpretation but invention.” Justice Scalia wrote that he would reverse Skilling’s convictions on the ground that the honest services law was unconstitutionally vague.

Bob McDonnell is arguing that honest services fraud requires proof of “official action” that goes beyond anything he did for Williams. But as an alternative, McDonnell claims that if honest services fraud is construed to apply to his conduct, then that law is unconstitutionally vague.

As noted above, Justice Scalia likely would have agreed with McDonnell about the need for a narrow concept of “official action” in a bribery case. But beyond that, Scalia had already written an opinion agreeing with McDonnell’s fallback argument that the honest services statute is so amorphous that it violates the constitution.

Justice Scalia was a long-standing and ardent critic of the honest services law. There’s little doubt he would have been solidly in McDonnell’s camp when it came to the challenges to McDonnell’s honest services fraud convictions.

Hobbs Act: The other corruption offense of which McDonnell was convicted was Hobbs Act extortion. As I wrote in an earlier post here, this is a somewhat unusual corruption law. The Hobbs Act applies to more traditional extortion by force or violence, but also to extortion “under color of official right.”

In the landmark 1992 case of Evans v. United States, the Supreme Court held that Hobbs Act extortion under color of official right requires only that a public official accept something of value knowing that it is being given in exchange for some exercise of official power. At common law, the Court said, extortion under color of official right “was the rough equivalent of what we would now describe as ‘taking a bribe.’”

Justice Thomas dissented in Evans – in an opinion joined by Justice Scalia. He argued that extortion and bribery are distinct crimes and that the majority’s opinion obliterated that distinction. Extortion under color of official right, he claimed, could not be committed by simply passively accepting a bribe; the public official had to induce or demand the payment under the wrongful pretense that he was entitled to it by virtue of his office.

Justice Thomas also argued that the Court’s interpretation of the Hobbs Act improperly opened up for federal prosecution a wide array of corruption crimes that traditionally had been prosecuted by the states. This federalism argument – that the federal government should not lightly assume jurisdiction over possible state and local corruption offenses – is also one of McDonnell’s claims, and is one to which Justice Scalia would have been sympathetic.

Last fall I attended the Supreme Court oral arguments in another Hobbs Act corruption case, Ocasio v. United States. Although it was not directly at issue in that case, I recall Justice Scalia, within the first few minutes, expressing his skepticism about the proposition that the Hobbs Act applies to routine state law bribery. When counsel noted that this was the holding of Evans, Scalia replied, to laughter, “I dissented, I assume.”

When it comes to the second pillar of McDonnell’s corruption convictions – Hobbs Act extortion – Scalia again was on record disagreeing with the prosecution’s legal theory. He almost certainly would have sided with McDonnell in his challenges to the Hobbs Act charges.

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Of course, there’s no way to know for certain what impact Justice Scalia’s absence will have on the final outcome in McDonnell’s case. It may be that McDonnell was going to lose anyway – it only takes four Justices to grant certiorari, but it takes five to reverse. Or it may be that he is destined to win or lose by a wider margin, where Scalia’s vote would not have tipped the balance.

But a 5-4 decision in McDonnell’s favor seemed like a real possibility. If that had happened, one of those almost certainly voting in the majority – and very possibly writing the opinion – would have been Justice Scalia. If that was destined to be the outcome, Scalia’s death means there will now be a 4-4 tie – which means the McDonnells will likely be going to prison.

The Supreme Court has lost one of its strongest, most consistent, and most articulate conservative legal voices. But the McDonnells have lost their most likely champion among the Justices. The impact on the outcome of their cases could be profound.

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The Ongoing Legal Saga of Martin Shkreli

When we last checked in on former pharmaceutical executive Martin Shkreli, he had just been indicted for securities fraud and related charges. Shkreli – a/k/a the “pharma bro” and “most hated man in America” – is best known for purchasing the rights to an anti-cancer drug called Daraprim and promptly raising the price by 5,000%. His defiant attitude in the face of the resulting outcry, along with his insult-laden Twitter feed, only heightened his notoriety.

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Pharma Bro Martin Shkreli

But Shkreli’s indictment last December had nothing to do with extortionate drug prices. The charges are based on Shkreli’s earlier conduct at two different hedge funds and at a company he founded called Retrophin. Shkreli allegedly defrauded his hedge fund investors by lying to them about their investments, and then defrauded Retrophin by wrongfully using company assets to settle claims from those hedge fund investors. An attorney who worked as Retrophin’s outside counsel, Evan Greebel, was charged with Shkreli in one count of conspiracy. (You can read a more detailed analysis of the indictment in my earlier post here.)

The criminal proceeding against Shkreli and Greebel is still in the early stages, but there have been a couple of interesting related developments in the past couple of weeks.

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Congressional Testimony – or Lack Thereof

Shkreli was subpoenaed to testify last Thursday, February 4, before the House Committee on Oversight and Government Reform. The committee was holding a hearing about skyrocketing drug prices, and the incident where Shkreli raised the price of Daraprim by 5,000% was Exhibit One.

Shkreli’s attorney made it clear in advance of the hearing that Shkreli would invoke his Fifth Amendment right against self-incrimination. That was no surprise. Even though the hearing was not specifically about Shkreli’s criminal case, there would be too much risk that something he said might end up facilitating his own prosecution. Almost any lawyer would likely give him the same advice.

Shkreli’s lawyer asked that his client be excused from attending the hearing, since he was not going to be able to answer questions. But Congress insisted that he appear, threatening him with additional criminal sanctions if he ignored the subpoena. And so, in a familiar Washington theater production, Shkreli sat before the committee, with his attorney in the “I am not a potted plant” seat directly behind him, and repeatedly invoked his right to remain silent in response to every question.

This type of scene unfortunately plays out quite regularly on Capitol Hill. In most legal proceedings, if a witness is going to take the Fifth it is relatively rare for him to be called to the stand. There may be a hearing before a judge to determine whether the assertion of privilege is valid, but if it is, the witness generally will not be forced to appear simply to assert the privilege over and over. For one thing, it’s a waste of everyone’s time if the witness is not going to answer. But more important, it is grossly unfair: repeatedly forcing a witness to assert his right to remain silent can’t help but lead to the impression he is hiding something and must have done something wrong. What should be a constitutional shield is turned into a bludgeon wielded to suggest the witness must be guilty of something – if not, why not answer the questions?

But Congress routinely compels witnesses to appear even when it is perfectly clear they are going to take the Fifth. Then they pepper the witness with speeches masquerading as questions, forcing the witness repeatedly to invoke his or her right to remain silent.

This is a tawdry business. Perhaps the reason it continues is that some Members of Congress are less concerned about actually getting answers and more concerned with trying to create a good video clip that will get replayed on cable news or social media. And indeed Shkreli’s brief appearance was a made-for-TV event, carried live on CNBC and elsewhere.

Shkreli didn’t do his image any good at the hearing. He smirked, rolled his eyes, and generally seemed annoyed that he had to be there. After he was finally excused, he sent out a Tweet calling the Members of Congress “imbeciles.”

But if Shkreli didn’t exactly cover himself in glory, neither did the Members of the committee. I’m no apologist for the pharma bro, but this practice of publicly pillorying a witness who is simply asserting his basic constitutional rights is pretty disgraceful.

Congress may be one of the few things in this country currently held in lower esteem than Shkreli. The spectacle before the House committee last week will do nothing to boost the approval ratings of either.

Attorney-Client Privilege – or Lack Thereof

In another development, we learned a couple of weeks ago that back in December U.S. District Judge Jack Weinstein ruled the grand jury investigating Shkreli could have access to emails that Shkreli and his former company had claimed were protected by attorney-client privilege.

One aspect of the fraud charged in Shkreli’s indictment relates to Retrophin, the pharmaceutical company he founded in 2011 and took public in 2012. The indictment charges that Shkreli defrauded Retrophin by using its assets to pay off debts that Shkreli incurred while running his hedge funds.

While acting as CEO of Retrophin and engaging in the alleged fraud, Shkreli had email exchanges with his outside counsel (and now co-defendant) Evan Greebel. Greebel, who is now a partner with Kaye Scholer LLP, was employed at the law firm of Katten Muchin Rosenman LLP at the time.

The grand jury subpoenaed documents from Retrophin, including copies of emails between Shkreli and Greebel. Retrophin produced the emails but redacted many of them, based on a claim by Shkreli’s attorney that the documents were protected by the attorney-client privilege.

Normally, of course, communications between attorney and client would be privileged and would not need to be produced. But the privilege is subject to something called the crime-fraud exception: if the client communicates with the attorney in furtherance of a crime or fraud, the law will not protect those communications.

The exception applies only if the communications are used to further an ongoing or future crime or fraud. If a client communicates with a lawyer about past criminal conduct, that of course is fully protected. Indeed, such communications are at the very heart of the privilege in the criminal context.

But a client will not be allowed to use an attorney’s services to help him commit a crime and then turn around and try to protect the very communications with counsel that made the crime possible. In other words, clients are not allowed to convert the shield of the attorney-client privilege into a sword that affirmatively helps them engage in criminal activity.

The crime-fraud exception can apply even when the attorney doesn’t know about the criminal conduct. I recall one case where I was arguing as a prosecutor that the crime-fraud exception applied to certain communications between a major corporation and its lawyers. Some of those communications were with a very distinguished former DOJ official who was now a partner at the firm. The firm brought him into the courtroom during the hearing to sit in the front row and glower at the judge, while the corporation’s lawyers expressed outrage at the suggestion that this gray-haired pillar of the bar might have been involved in any criminal activity.

It was all for show, of course — more theater —  because the attorney does not need to be involved. The client may be lying to his own counsel, just as he is to the victims of his fraud. If the attorney was deceived by the client and was assisting in the crime or fraud unwittingly, the privilege may still be overridden. The focus is on what the client intended, not on the intent or knowledge of the attorney.

In this case, of course, the government has done more than simply allege the attorney was involved – it has indicted the attorney, Greebel, as a co-defendant. Although it’s not legally required, that the attorney has been charged as a co-conspirator in committing the alleged fraud certainly bolsters the government’s argument for the crime-fraud exception.

The burden is on the government to establish that the exception applies. In support of its claim, the government submitted a 47-page affidavit from an FBI agent involved in the investigation. The affidavit alleges that the emails in question directly relate to fraudulent activities carried out by the co-defendants, including the backdating of documents to deceive the SEC and the creation of other phony documents used to defraud Retrophin.

In a December 3 order that was just recently unsealed, Judge Weinstein agreed with the government that the emails were not privileged. He noted first that to the extent the communications between Shkreli and Greebel related to Retrophin’s business, the privilege belonged to the company, not to Shkreli, and the company had already waived any privilege claims. But even if there were a personal attorney-client relationship, the judge ruled, “exchanges in redacted emails between the attorney [Greebel] and employee [Shkreli] were part of a scheme, conspiracy or fraudulent attempt to commit a securities fraud. The attorney-client relationship and privilege, if any, is voided by the criminal conduct.”

Accordingly, the unredacted emails were produced to the grand jury, were referenced in the indictment, and will undoubtedly play a major role at trial. There’s a reason prosecutors often say that “email” is short for “evidence mail” – it is frequently a rich source of incriminating information.

The fact that Shkreli was unable to shield his communications with his alleged co-conspirator attorney is not particularly surprising, but it nevertheless has to be considered a blow to the defense.

And in other news, Shkreli recently replaced his legal team with a celebrity lawyer who previously defended rappers Jay Z and Sean “Diddy” Combs. It appears this is only going to get weirder. Stay tuned.

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Supreme Court Agrees to Clarify the Law of Insider Trading

Update 12/6/16: As predicted below, today the Supreme Court unanimously upheld Salman’s conviction and rejected the Second Circuit’s standard in Newman.  I’ll have more on the case in a post next week.

Just three months after it refused to hear the government’s appeal in a landmark insider trading case from the Second Circuit, the Supreme Court announced last week that it will revisit the law of insider trading after all. The Court’s decision to grant review of the Ninth Circuit’s ruling in Salman v. United States may bode well for the government’s future prosecutions.

Both Salman and the Second Circuit case, United States v. Newman, involve the question of “tippee” liability for insider trading: when is a person who receives a tip of confidential information from a corporate insider prohibited from trading on that information? The two courts of appeal adopted apparently conflicting standards, and now the high court will weigh in.

The Supreme Court declined to take the appeal in Newman, where the government lost, and accepted the appeal in Salman, where the government won. At first glance that might suggest the Court’s decision to take Salman’s case is bad news for the government. But I think there’s a good chance the Court will use Salman’s case to clarify the law of tippee liability while affirming Salman’s conviction and rejecting the narrower legal standard adopted in Newman – an outcome that would favor the prosecution.

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The Law of “Tippee” Insider Trading 

Insider trading is buying or selling securities based on material, non-public information, in violation of a fiduciary duty or similar duty of trust and confidence. Trading on the basis of inside information alone is not a crime. In order to constitute securities fraud, there must be a breach of a legal duty in connection with the trading.

The most classic type of insider trading involves a corporate officer personally trading the company’s stock on the basis of corporate information not available to the shareholders. This violates the officer’s fiduciary duty to act in the best interests of the shareholders and to refrain from misappropriating corporate information for his or her own private benefit.

But the ban on insider trading would be pretty toothless if an insider could simply provide confidential information to a friend or family member who did not owe a duty to the shareholders and they were free to trade on that information. Thus the law has long recognized that, under certain circumstances, tippees who receive confidential information are prohibited from trading on it just as if they were corporate insiders.

The Supreme Court ruled on tippee liability in the 1983 case of Dirks v. SEC. Raymond Dirks was a broker who received inside information from Ronald Secrist, an officer with a life insurance company called Equity Funding. Secrist claimed there was massive fraud going on within Equity Funding and urged Dirks to investigate and make it public.

Dirks spent a couple of weeks investigating and trying to expose the fraud allegations. At the same time, he advised his clients and other investors about what he was finding, and some sold their shares. The stock price plummeted; ultimately the SEC began an investigation and Equity Funding collapsed.

The SEC thanked Dirks for his work in exposing the fraud by charging him with a civil insider trading violation. The SEC’s theory was that Dirks, as a tippee who received confidential inside information from Secrist, had an obligation to refrain from trading on that information or encouraging others to do so.

But the Supreme Court rejected the SEC’s position. The Court began by reaffirming the holding of its landmark insider trading case from three years earlier, Chiarella v. United States: insider trading is not established simply because someone traded on non-public information. To constitute securities fraud there must be a “manipulation or deception” involved, which means there must be a violation of a legal duty in connection with the use of the information.

The Court noted that not all disclosures of confidential information are done with a bad purpose.  For example, corporate officers frequently talk with stock analysts, whose job it is to ferret out corporate information and report it to investors. Even the SEC agreed such information flow is good for the markets. Such conversations may sometimes include matters not yet known to the public or to all shareholders, but that is not considered improper if done for the purpose of disseminating information about the company.

What matters is not the disclosure of inside information per se, but why it was disclosed: “[w]hether disclosure is a breach of duty . . . depends in large part on the purpose of the disclosure. . . . [T]he test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach [by the tippee].”

Accordingly, the Court held, a tippee is prohibited from acting on the inside information only if: 1) the tipper was violating a duty by providing the information; and 2) the tippee knew or should have know about that violation. Whether the tipper was violating a duty depends on the purpose of the tip and whether the tipper received any personal benefit in return.

The benefit to the tipper that will indicate a breach of duty is not limited to tangible monetary gains. The Court noted there also can be reputational or other intangible and indirect benefits to the tipper. In particular, the “elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend.”

Secrist had been providing information not in order to reap some personal benefit but to help expose widespread fraud within the company. Because Secrist himself therefore did not breach a duty, the Court concluded that Dirks did not inherit any obligation to refrain from using the information and could not be liable for insider trading.

Newman and Salman

 In 2014, more than thirty years after Dirks, the Second Circuit in Newman dealt a blow to the SEC and prosecutors by adopting a very narrow view concerning the benefit to the insider that must be established for tippee liability. (The Second Circuit includes New York and Wall Street, the venue for most securities fraud cases, so its decisions on these issues are particularly important.)

Corporate insiders in Newman disclosed confidential information to several securities analysts who passed the information along to others, including the defendants. After they were convicted for trading on that information, the defendants appealed and argued the government had failed to satisfy both prongs of the Dirks test: they claimed there was insufficient evidence that the insiders had violated a duty by receiving a personal benefit in exchange for the tips, and even if they did, there was no evidence the defendants knew about that violation.

The government argued it had presented sufficient evidence of a personal benefit to the tippers. One had received occasional career advice from an analyst to whom he leaked information. The other insider was a family friend of one of the analysts; they went to the same church and occasionally socialized together.

The court found this evidence of “personal benefit” was insufficient. Although the court agreed a benefit could arise from a tip to a relative or very close friend, the mere existence of a casual friendship was not enough. Proof of a personal benefit, the court held, requires evidence of a “meaningfully close relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”   The evidence in Newman did not meet that standard, and the Second Circuit reversed the convictions.

Salman, the case that the Supreme Court took last week, also raises the issue of what kind of benefit to the insider is required. Maher Kara, a Citigroup banker, passed confidential information to his brother Michael while knowing that Michael was likely to trade based on that information. Michael, in turn, shared the information with Salman. There was evidence that Michael and Maher had a very close family relationship, that Salman knew of that relationship, and that Salman knew Maher was the source of the information.

Salman argued the Ninth Circuit should apply the Newman standard and require the government to show that any benefit to Maher was “objective, consequential, and represented at least a potential gain of a pecuniary or similarly valuable nature.” He claimed there was no evidence of such a benefit to Maher and so Salman could not be liable as a tippee.

But the Ninth Circuit rejected Salman’s claim. The court held the case was a straightforward application of the holding in Dirks that an insider personally benefits from disclosing confidential information when he “makes a gift of confidential information to a trading relative or friend.”   Maher passed the information to his brother, with whom he had a close relationship – and that, according to the court, is all that Dirks requires. To the extent Newman went further and would require proof of a “consequential” or “tangible” benefit to the tipper even when the tip was to a close family member, the Salman court disagreed.

Supreme Court

What to Expect from the Supreme Court’s Decision

When urging the Supreme Court to take his case, Salman argued that the Second Circuit’s holding in Newman directly conflicts with the Ninth Circuit’s decision in his case. He argued that if a close family relationship between the insider and the tippee is enough to establish a personal benefit to the insider, as the Ninth Circuit held in his case, then Salman loses. But if there must be “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature,” as the Second Circuit held in Newman, then Salman should win.

The fact the Court agreed to hear the case may suggest it agrees there is a conflict between the circuits that it wants to resolve; resolving a circuit split is one of the main reasons the Court grants certiorari. But that doesn’t necessarily translate into good news for Salman.

It’s true the Court could have granted review in Newman if it disagreed with that court’s holding about personal benefit, but Newman was not a great vehicle to address that standard. Although the question of benefit to the tipper was important in Newman, there was a second big issue looming in that case: the defendants had received the inside information second or third hand and were several steps removed from the corporate insiders who made the initial tips. The Second Circuit was deeply troubled by this aspect of the case, and scolded the government for bringing prosecutions the court said have been “increasingly targeted at remote tippees many levels removed from corporate insiders.”

In other words, even if the Supreme Court had reversed the Second Circuit on the benefit issue, the defendants in Newman likely would have gone free anyway. The government had failed meet the second requirement of Dirks: proving that the remote tippee knew about the benefit received by the tipper and the corresponding breach of duty.

Salman, on the other hand, squarely presents the benefit issue, with no issue about Salman’s knowledge of the possible violation. But although the Court granted Salman’s appeal, it would be surprising if it reversed his conviction. As the Ninth Circuit recognized, leaking information to one’s brother is exactly the kind of tip that Dirks held would qualify as a benefit: providing information to a “trading relative or friend.”

Reversing Salman’s conviction would not only require effectively overruling Dirks; it would gut the prohibition on insider trading. Corporate insiders would be free to leak confidential information to friends, relatives, neighbors, or anyone, as long as they did not receive a direct tangible benefit in return. That would overturn decades of insider trading law.

Although predicting what the Court will do is always a risky exercise in reading tea leaves, I think it is far more likely that the Court will affirm Salman’s conviction while taking the opportunity to affirm and clarify the holding of Dirks – and in the process disagreeing, directly or indirectly, with the narrower Newman rationale.

Such a ruling could focus on the statement in Dirks that whether disclosure is a breach of duty “depends in large part on the purpose of the disclosure.” The focus should be more on the insider’s purpose and less on the nature of any benefit received.

The Court in Dirks was primarily concerned about sweeping within the insider trading prohibition the activities of corporate officers who were acting in the interest of the corporation by, for example, speaking with securities analysts. Even if inside information was inadvertently disclosed, the officers were acting with the purpose of fulfilling their duties and aiding the corporation, not for some improper personal purpose.

Similarly Secrist, who tipped Dirks, was acting not for some personal purpose but for the purpose of exposing fraud and wrongdoing within the company. Once again, the purpose behind the disclosure did not suggest a corporate officer breaching a duty by using corporate information for his own benefit.

An insider who tips to a family member, close friend, or golfing buddy is not acting for any proper corporate purpose. Whether or not the insider personally receives some “consequential” or “pecuniary” benefit, he or she is not acting to further the best interests of the company. Even if the benefit received is nothing more than the intangible pleasure of seeing a friend profit from the information, the disclosure violates the insider’s duty to refrain from using corporate information for some personal end.

Focusing on the purpose of the disclosure, rather than on the precise nature of the benefit, will better serve the goals of the ban on insider trading. If a corporate insider is not acting with the purpose of fulfilling his or her corporate duties, then they are likely acting with the kind of personal purpose that will result in the required personal benefit, tangible or intangible.

Focusing on the purpose of the disclosure also avoids hinging potential criminal liability on murky questions such as whether a particular friendship was sufficiently “meaningfully close” to find that the tipper benefited from the disclosure. That’s the kind of issue invited by the Newman standard.

The Newman court’s approach of requiring a more tangible kind of benefit may have been born out of that court’s frustration with the government’s “remote tippee” cases, but it seems misplaced. The tippers in Newman had no apparent legitimate corporate purpose for sharing the inside information, and so the benefit they received from sharing that information with friends or colleagues should have been considered sufficient.

It’s been more than three decades since the Court last addressed tippee liability. The Court in Salman has the opportunity to reaffirm that a tippee can be liable for trading on inside information, even if the benefit received by the tipper is not necessarily consequential or tangible. Although the government was denied review in Newman, it may still get the clarification of insider trading law that it sought when it tried to appeal that decision.

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