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Skilling’s “Honest Services” Argument Fails in the US Supreme Court

Enron Redux

You remember the Enron failure. It ushered in a sustained period of financial statement fraud where earnings restatements totaled in the billions. It has been estimated that financial statement fraud caused a decrease in market value of stock of approximately 500 to 1,000 times the amount of the fraud so that, for example, a $10 million fraud might cause a $5 billion loss in market value.

The perpetrator of the Enron fraud was Jeff Skilling, the former CEO of Enron. Skilling blessed the off-balance sheet, special-purpose entities (SPEs) set up by its financial wizard, Andy Fastow. This maneuver enabled Enron to keep billions of debt off its Balance Sheet and shift it to the entity. Many of these entities were shells set up to hide debt. In return for cash received by Enron from bank loans made to the SPEs, these entities agreed to accept unwanted assets on Enron’s books.  In some cases Enron even recorded a gain on the exchange thereby boosting income because the cash received from the SPE was greater than the book value of Enron’s asset transferred to it.

On October 23, 2006, Skilling was sentenced to 24 years and 4 months in prison and fined $45 million. That means he wouldn’t get out until 2030. By then he’d be 74 years old.

Skilling has filed a serious of appeals of his sentence. On April 3, 2008, Skilling’s defense attorney argued with government prosecutors that Skilling’s trial and the conviction itself was based on “honest services fraud” that he said did not apply to Skilling.

Honest services fraud refers to a 28-word sentence of 18 U.S.C. Section 1346 (the federal mail and wire fraud statute), added by the US Congress in 1988, which states: "For the purposes of this chapter, the term, scheme or artifice to defraud includes a scheme or artifice to deprive another of the intangible right of honest services."

The statute has been applied by federal prosecutors in cases of public corruption as well as in cases in which private individuals breached a fiduciary duty to another. In the former, the courts notably have been divided on the question of whether a state law violation is necessary for honest services fraud to have occurred. In the latter, the courts notably have taken differing approaches to determining whether a private individual has committed honest services fraud – a test based on reasonably foreseeable economic harm and a test based on materiality.

The statute, which has been a target of criticism, was given a narrow construction in the case of Skilling v. United States. In order to avoid finding the statute to be unconstitutionally vague, the Court interpreted the statute to only cover "fraudulent schemes to deprive another of honest services through bribes or kickbacks supplied by a third party who ha[s] not been deceived."

Skilling’s basic argument was that even though he committed illegal financial maneuvers, he did so in order to save the company and did not profit from it. This sounds to me like a “delusional” defense approach.

On January 6, 2009, the US Court of Appeals for the Fifth Circuit affirmed Skilling’s conviction, but vacated the sentence and remanded for resentencing. I believe there were procedural errors in the original trial that led to the decision.

On October 13, 2009, the Supreme Court agreed to hear the appeal. A key question was whether the federal “honest service” fraud statute required the government to prove that Skilling’s conduct was intended to achieve “private gain” rather than to advance the interest of his employer, and, if not, is the statute unconstitutionally vague.

Let’s not forget our Enron history. On May 25, 2006, Skilling was found guilty of conspiracy, insider trading, making false statements to auditors, and securities fraud. It seems to me Skilling’s motivation for the fraud was both to advance the company’s interests and increase his own individual wealth. It’s a common theme that ran throughout the many frauds at the time including Enron, WorldCom, Tyco, and Global Crossing.

On April 16, 2012, the Supreme Court left intact Jeffrey Skilling’s conviction for leading the Enron Corp. accounting fraud, refusing to grant a second hearing to the imprisoned former chief executive officer. Let’s hope it stops right here and right now. Skilling should accept responsibility for his actions and not look for loopholes in the law to escape serving his sentence. He was a main contributor to the fall of the 7th largest company in the US back in 2001.

A long time ago Sophocles, one of three ancient Greek writers of tragedy said: “It is a painful thing to look at your own trouble and know that you yourself and no one else has made it.”

Blog posted by Steven Mintz, aka Ethics Sage, on April 20, 2012