Four Merrill Lynch executives arranged in 1999 for their company to buy electricity-generating power barges from Enron that were moored off the coast of Nigeria. Enron would record $12 million of revenue and meet its earning goals. As part of the deal, Enron promised that Merrill Lynch would receive a return of its investment plus an agreed-upon profit in sixth months.

That win-win turned into a loser, however, when the government claimed that the deal improperly boosted Enron's earnings. The former Merrill Lynch executives were convicted of fraud in 2004 under the honest services provision (1346) of the mail and wire fraud statute, which makes criminal any “scheme or artifice to deprive another of the intangible right of honest services.”

Many defense attorneys are worried that the honest-services statute is too vague and allows prosecutors to charge executives with felonies for a broad spectrum of acts that might not constitute violations of any other criminal laws.

The 5th Circuit may have helped rein in that ambiguity in August when it overturned the convictions of the Merrill Lynch execs in U.S. v. Brown, and limited prosecutors' use of honest services. The decision may cause prosecutors to back off on bringing these types of claims.

“Any time a court of appeals strikes down the prosecution it causes the government to take a step back and say, 'Does this change the way we prosecute these cases in the future?'” says Barry Boss, office managing partner of Cozen O'Connor. “We'll see whether the 5th Circuit's decision changes the propensity of prosecutors to bring these charges.”

Clarifying The Law

The 5th Circuit said the charges against the executives relating to deprivation of honest services were “flawed,” because the prosecution failed to prove the executives acted solely for personal gain.

Judge Grady Jolly wrote that the executives “were driven by the concern that Enron would suffer absent the scheme” and that the “only personal benefit or incentive” for the executives “originated with Enron itself–not from a third party as in the case of bribery or kickbacks.” Therefore, the court held, the conduct of the Merrill Lynch executives fell outside the honest services statute.

In reaching this conclusion, the court cited the 2nd Circuit's 2003 decision in United States v. Rybicki, writing, “Rybicki concluded, and we agree, that cases upholding convictions arguably falling under the honest services rubric can be generally categorized in terms of either bribery and kickbacks or self-dealing.”

The decision is an important first step toward reining in prosecutors' use of the statute, which was originally used to charge politicians who engaged in on-the-job misconduct for personal gain. Prosecutors have taken advantage of the statute's vague language to apply it to acts by private individuals as well.

“1346 does not have limits [that define to whom it applies],” Boss says. “So it applies to people in private entities and private companies as well. It reaches a whole range of conduct that is much more amorphous than a theft of property or a false statement.”

This gives the government wide latitude in applying 1346.

“The reason prosecutors like [honest services] is because it encompasses almost any conduct that's dishonest,” says Jack Fernandez Jr., a partner in Zuckerman Spaeder. “The statute is limited only by the creativity of the prosecutor.”

Which begs the question: How far can the government cast its net? While the 5th Circuit's Brown decision tries to answer that question–limiting its use to individuals that commit fraudulent acts solely for personal gain–it may not be time to celebrate just yet.

“I'm not sure how big a 'win' this is for businesspeople in general,” says Charles Stillman of Stillman, Friedman & Shechtman, who represented Merrill Lynch during the government's investigation of the Enron deal. “Future prosecutors will look for ways to avoid the pitfalls the decision presents.”

A Supreme Solution

It's unlikely, therefore, that the 5th Circuit's decision will end prosecutors' use of honest services to prosecute a broad spectrum of acts. The ultimate solution will probably have to come from above.

“Until the Supreme Court does something, prosecutors will probably push the envelope,” says Joseph Mancano, shareholder at Buchanan Ingersoll & Rooney.

Another possible solution to the statute's ambiguity is clarification from Congress as to what acts and what individuals it intended for the statute to reach. It was, after all, a 1987 Supreme Court decision and Congress' reaction to it that muddied the waters in the first place.

In McNally v. U.S.–a case against a Kentucky public official for a patronage scheme–the Court held that the mail fraud statute didn't reach “schemes to defraud citizens of their intangible rights to honest and impartial government.” In response, Congress passed Section 1346, which provides that “the term 'scheme or artifice to defraud' includes a scheme or artifice to deprive another of the intangible right of honest services.”

However, that doesn't define intangible right of honest services.

“The answer is that Congress should amend the statute to identify clearly what it is that should be rendered illegal,” Fernandez says.