July 13, 2010
Bad, but not Otherwise Criminal: A review of the Honest Services law and guide for Management
On June 24, 2010 the United States Supreme Court’s decision narrowed the scope of the “honest services” law. The honest services law made it criminal “to deprive another of the intangible right of honest services”. Justice Ruth Bader Ginsburg said the law must be limited to the offenses of bribes and kickbacks. This article focuses on how government oversight has a limited effect on combating fraud and dishonesty as well as steps management can take to reduce fraud. Management has the responsibility to define, identify and react appropriately to ensure that dishonest acts do not have a negative impact on the business or not for profit entities (e.g. local, state and federal government, charitable organizations such as a 501(C)3, etc.). Any dishonest act is wrong, whether criminal or civil, and has negative effects on your business.
As Valerie Nixon stated in a 2006 article, honest services fraud refers to a 28-word addendum to 18 U.S.C §1345 (the federal mail fraud and wire fraud statute), added by the US Congress in 1988 (1). As detailed on the history section of Wikipedia, the 1987 Supreme Court ruling in McNally v. United States limited the mail fraud and wire fraud statues strictly to schemes to defraud victims of tangible property, including money. In another article Frank Razzano and Kristin Jones stated that he 1988 addendum was a direct response by Congress to McNally v. United States and created a platform for prosecutors to convict private individuals and public officials utilizing the vagueness of the honest services addendum (2). The law has been utilized differently in the public and private sectors. Honest services fraud by public officials included most unethical conduct, including briberies and a failure to disclose a conflict of interest, resulting in personal gain.
The honest services law has been used by the government to prosecute local, state and federal officials because it is easier to prove than bribery or extortion. Recent, notable convictions under honest services were against Jeffrey Skilling, Enron CEO, and Conrad Black, the newspaper mogul. It was Skilling’s appeal, which focused on the vagueness of the interpretations, to the US Supreme Court that led to the justices’ decision on June 24, 2010. In New Jersey the roundup by Federal Agents of approximately 40 politicians and government contractors was propelled by the use of the honest services law. Several of the New Jersey political corruption cases are on appeal and have the sentencing held pending this recent decision. Marcum’s PublicTrust Group has assisted many government entities combat fraud and dishonesty both proactively with establishment of policies and procedures as well as investigations when improper activity is suspected.
At the time of this article the Skilling and Black’s attorneys believe that the Justices’ decisions will lead to the convictions of their clients being overturned. Daniel Petrocelli of O’Melveny & Myers in Los Angeles who represents Mr. Skilling was quoted as stating, “This paves the way to completely exonerating Jeff Skilling”. He was later quoted as saying, “this has profound implications for every workplace in this country. All employees are now free from the risk of the government criminalizing behavior that does not clearly violate the laws.” Mr. Petrocelli’s comments should alert management to two things. First, the government and regulators do not prevent criminal or dishonest behavior from affecting businesses; only management can. Second, management must communicate to employees the consequences of committing dishonest acts.
The recent credit and subprime meltdowns were directly related to individuals’ greed; these individuals and entities focused solely on their personal benefit or bottom line. The driving force pushing individuals to commit fraudulent and dishonest acts is greed.
The Subprime debacle involved dishonesty by mortgage brokers, financial institutions, appraisers and others who knowingly arranged financing for individuals with no credit, steady income or an ability to pay. Neither regulators nor management recognized the potential affects these actions could have on an organization. As indicated in an Oct. 5, 2007 article “Subprime Hits as Second Bank Fails” in American Banker, members of the House Financial Services committee did not take the signs as an indication of the failures that would soon overwhelm the industry. Rep. Brad Miller, D-N.C., a member of the House Financial Services Committee said, "I don't have any information that makes me think that these two failures are a harbinger of more failures. I do think that the concern in the market for subprime mortgages does require Congress to reassure the marketplace by passing a reasonable set of regulations, and I hope to introduce that bill next week." House Financial Services Committee Chairman Barney Frank, D-Mass., said he has "not seen any sign that we are on the verge of a bunch of bank failures." (3) These comments show that financial debacles and other risks can go unnoticed. Management must take into account the potential for any risk, fraud included, that can affect their organization.
Laws and regulations do not protect organizations from fraud. It is up to management to evaluate and utilize resources such as forensic accountants to help them prevent, detect and combat fraud and dishonesty. Marcum professionals can help management identify these potential risks. Management must take the responsibility in preventing and detecting fraud as well as having the appropriate structure in place to avoid the commission of dishonest services. The government implementation of Sarbanes-Oxley (“SOX”), Foreign Corrupt Practices Act (“FCPA”), and other regulations as well as laws that try to prevent fraud and penalize perpetrators has done little to mitigate the risk. Fraud is still one of the most common and abrupt risks organizations and not for profit entities face. The financial cost coupled with the negative exposure can lead to negative financial and organizational effects.
Management must protect the assets and reputation of the organizations they are responsible for. It is also their responsibility to properly define what a dishonest service is to the organization as well as implement policies to define the consequences that go along with the dishonest service. Management must now ensure that the appropriate policy and procedures are well defined and employees are aware of them. For example, while calling in sick to go to a baseball game is dishonest your policies might define the punishment as minimal, if any. However, if the employee steals a computer or passes confidential information to a competitor there may be criminal ramifications. The dishonest service can include multiple scenarios and have various consequences. The proper notification of an organization’s policy can be a strong deterrent to mitigate fraud risk.
The most effective and proven way to mitigate fraud or other “dishonest” acts is to implement risk mitigation solutions. Risk mitigation solutions can encompass internal control, internal audit, anti-fraud programs and continuous monitoring. An effective risk mitigation program is tailored to the organization or not for profit by directly understanding and tailoring to the needs of the business.
The internal control program should rank risks to identify the significance and likely impact on the business.By ranking the likelihood and potential affect of risk, management can then implement an internal control structure to prevent, detect or correct the risk. It is important that management consistently test and monitor controls and risks. This allows them to identify potential frauds, new risks and make proactive changes. Testing regularly not only increases the likelihood of detection, but also shows employees that management is proactive in their prevention of fraud. Testing is a vital part of the continuous monitoring aspect.
Continuous monitoring includes internal control testing and encompasses such activities as video surveillance, surprise cash counts, analytic review, surprise audits and a variety of other techniques. It is important for management to implement effective solutions that fit their organization and needs. Internal Audit can assist management in providing internal control, risk management and continuous monitoring techniques. If the business does not have an internal audit department they can utilize an external, independent firm. This can lead to cost savings as well as independent thinking and best practice solutions. Marcum can assist with the external implementation of an internal audit department. Our professionals assist in implementing and providing management with a variety of continuous monitoring services.
Anti-Fraud programs consist of hotlines as well as procedures to investigate and criminalize reported fraud and should be designed to fit the needs of the specific entity. Anti-Fraud programs are also defined to assist management and internal counsel in appropriately dealing with possible criminal or civil violations. There are various fraud scenarios and it is important to be aware of them and know how to respond. Anti-fraud programs describe how investigations are handled, who is responsible for respective areas (i.e. legal, investigation, etc.) and how evidence is handled as well as other specific details.
Marcum professionals are skilled at assisting organizations and not for profits in implementing risk mitigation programs. Our Public Trust Group has assisted local, state and federal entities as well as organizations and not for profits in applying risk mitigation solutions. The use of an outside professional provides management with assurance that they have tailored their risk mitigation solutions to fit their business needs and contracted with professionals who can provide best practice solutions and ideas.
When a fraud has occurred management must take the proper steps to ensure recovery and prosecution, if applicable. The first step is to alert the organization’s legal counsel. Forensic accounting professionals can assist management and counsel in various aspects of their investigation. Marcum professionals provide forensic accounting and litigation services. Our professionals also assist in the recovery phase. Even if the act is not criminal, the organization may have a potential for recovery that is increased with the utilization of forensic accounting professionals. We can help determine the nature and severity of the crime by analyzing documents to determine if there is evidence of kickbacks or bribery. Marcum professionals can assist at quantifying the damage caused by fraudulent acts, whether criminal or civil . We utilize forensic accounting techniques and tools (i.e. computer forensics) to identify, analyze and quantify illegalities. We also assist counsel with litigation support and expert witness services. Our professionals frequently work with counsel to devise strategies as well as provide independent, expert witness services.
Management cannot rely on regulators or the legal system to protect their organization from fraud. No criminal ever thought of the honest services law before they committed a theft or dishonest act. Implementing risk mitigation solutions and hiring the right professionals can significantly reduce the negative impact of fraud and assist the business in the recovery process.
(1) Valerie D. Nixon (June 13, 2006). "Our Intangible Right To 'Honest Services' by Public Officials". North Country Gazette. http://www.northcountrygazette.org/articles/061306HonestServices.html.
(2) Razzano, Frank C.; Jones, Kristin H. (2009). "Prosecution of Private Corporate Conduct: The Uncertainty Surrounding Honest Services Fraud". Business Law Today 18 (3) http://www.abanet.org/buslaw/blt/2009-01-02/razzano.shtml.
(3) Adler, Joe; Blackwell, Rob (2007). “Subprime Hits Cited as a Second Bank Fails”. American Banker. http://22.214.171.124/article.html?id=20071004CBOUN1YG