On April 24, 2012, the U.S. Court of Appeals for the Ninth Circuit, sitting en banc, held in United States v. Milovanovic, No. 08-30381, — F. 3d —, 2012 WL 1398647 (9th Cir. Apr. 24, 2012) (en banc), that independent contractors who take bribes or kickbacks, but who have no formal fiduciary relationship with the government, nonetheless can be prosecuted for honest services fraud based on a breach of “a comparable duty of loyalty, trust, and confidence.” Id. at *5. The ruling significantly broadens the scope of potential criminal liability for government contractors accused of some kinds of wrongdoing.
The facts in Milovanovic were straightforward. The primary defendants were an employee of a private translation service that had contracted with the State of Washington to provide translators for the written portion of the State’s commercial driver’s license (CDL) test and an individual who contracted directly with the State to administer the driving skills portion of the test. Id. at *2. Both accepted bribes from test-takers to falsify test results and subsequently mailed fraudulent documents in support of those falsified results to the State agency responsible for issuing CDLs. Id. The defendants were indicted for honest services mail fraud in violation of 18 U.S.C. §§ 1341 and 1346, which prohibit use of the mails to further a scheme to defraud another of the “intangible right of honest services.” Id. at *3. They challenged the indictment on the grounds that the Supreme Court held in Skilling v. United States, 130 S. Ct. 2896 (2010), that breach of a fiduciary duty is an essential element of honest services fraud, and that as independent contractors, they did not owe such a duty to the State of Washington. Id.
The Ninth Circuit ruled that while breach of a fiduciary duty is an element of honest services fraud, the term “fiduciary” in this context encompasses not only a formal, or “classic,” fiduciary relationship but an informal fiduciary relationship – that is, “a trusting relationship in which one party acts for the benefit of another and induces the trusting party to relax the care and vigilance which it would ordinarily exercise.” Id. at *7. The Milovanovic indictment, the court said, “sufficiently alleges a breach of a position of trust both to honestly and fairly administer tests and to truthfully certify to the State applicants residing in Washington who are qualified to be commercial vehicle operators.” Id. Therefore, it stated an offense for honest services fraud.
This holding could have notable consequences for contractors. First, the Ninth Circuit’s formulation of an informal fiduciary relationship, the breach of which could trigger criminal liability for honest services fraud where the alleged fiduciary takes bribes or kickbacks, is extremely broad. Arguably, every government contractor is in a “trusting relationship” in which it “acts for the benefit of” the government and, by its promised performance of the contract, induces the government to “relax the care and vigilance which it would ordinarily exercise.”
The Ninth Circuit noted in passing that the defendants in Milovanovic argued that interpreting the honest services fraud statute to apply to informal fiduciaries would make any party to a contract subject to prosecution. But it dismissed that concern, relying on a concurrence in a pre- Skilling Second Circuit case, United States v. Rybicki, 354 F.3d 124, 148-55 (2d Cir. 2003) (Raggi, J., concurring). That case reasoned that “not every breach of an employment contract or service agreement will support a federal fraud prosecution.” Id. at 153. Rather, according to the Rybicki concurrence, an honest services fraud prosecution will lie only where “the value of the particular services at issue largely depends on their being performed honestly, that is, without fraud or deception.” Id. That standard is quite vague, however, and does not seem to place a practical limit on potential liability.
Second, the Ninth Circuit’s opinion arguably makes even subcontractors susceptible to prosecution for honest services fraud; as noted above, one of the defendants in Milovanovic did not contract directly with the State, but rather contracted with a private translation service that in turn contracted with the State.
Finally, the Milovanovic case does not appear to be limited to government contractors. The honest services fraud statute criminalizes any scheme to deprive another – not necessarily the government – of honest services. For example, in the Enron scandal, the government successfully prosecuted a number of company executives for depriving the Enron shareholders of their right to the executives’ honest services. Therefore, it appears that a party to a private contract who accepts bribes or kickbacks, and thereby breaches the vague informal fiduciary duty described in Milovanovic, also would be subject to a prosecution for honest services fraud.
Given the expansive reading of the honest services fraud statute in Milovanovic, a petition to the Supreme Court for a writ of certiorari may be forthcoming. Therefore, the long-term effect of the case remains to be seen. For now, however, parties to a contract in the Ninth Circuit must take into account that Circuit’s extremely broad interpretation of the statute, and should conform their conduct accordingly.