Most experienced contractors have a healthy fear of the various types of fraud claims: False Claims Act, federal and state wire and mail fraud, common law fraud, etc. They know that enforcement authorities are always looking for ways to swing the hammer against a contractor they suspect is fleecing the government. Fraud claims arise when a victim (sometimes the government) contends that the defendant lied about the goods or services offered in order to induce the victim to voluntarily transfer property to the defendant in an exchange. Where the victim parts with much for nothing in return, the fraud analysis is easy—the defendant’s intent to wrongfully steal property or to inflict a pecuniary loss is obvious. But in cases where the victim receives from the defendant goods or services of real value, whether the defendant intended to harm the victim or deprive them of their property becomes a more difficult question.

Last week, the US Supreme Court took an important step in Ciminelli v. United States to narrow the scope of the federal criminal mail and wire fraud statutes and reject the “right to control” theory of wire fraud, under which a defendant could be convicted solely on the basis of scheming to deprive a victim of valuable economic information needed to make a discretionary economic decision with their money or property. Speaking for a unanimous court, Justice Clarence Thomas declared, “In sum, the wire fraud statute reaches only traditional property interests. The right to valuable economic information needed to make discretionary economic decisions is not a traditional property interest. Accordingly, the right to control theory cannot form the basis for a conviction under the federal fraud statutes.” This holding offers important and clarifying guidance both to contractors and to state and federal procurement officers.

The broad language of the mail and wire fraud statutes imposes criminal penalties on “‘[w]hoever, having devised or intending to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises’ uses the mail, 18 U.S.C. § 1341, or wires, [18 U.S.C.] § 1343, for such purposes.” Nearly 100 years ago, the Supreme Court held in Hammerschmidt v. United States, 265 U.S. 182, 188 (1924), that for a scheme to fall within the mail or wire fraud statutes, mere deceit is not enough—there must be an actual pecuniary harm to the victim that deprives them of money or property. Over time, however, the basic elements of fraud became blurred and diluted in cases where, without proof of any actual intent to cause financial or pecuniary harm to the victim, the government prosecuted defendants who may have engaged in questionable or deceptive conduct.

In this regard, perhaps no doctrine has proven more potent to prosecutors than the so-called right to control theory of property. It holds that one’s right to control his or her assets qualifies as “property” such that even if a defendant did not intend to steal or inflict pecuniary harm, the defendant may still be convicted if they deprived the victim of the right to control the victim’s assets by withholding from the victim “potentially valuable economic information” that might have informed how the victim might use those assets. This theory was sometimes used by prosecutors who used the fraud statutes to set standards for contractors and state officials with respect to disclosures on the theory that they deprived the public of its intangible right to “honest services.”

The Ciminelli Case

In 2012, New York Governor Andrew Cuomo launched a $1 billion campaign to develop the greater Buffalo area in a project known as “Buffalo Billion.” The Fort Schuyler Management Corporation, a nonprofit entity affiliated with the state university system, was in charge of allocating the Buffalo Billion funds. Fort Schuyler’s board of directors would eventually award a $750 million development contract to a Buffalo firm led by Louis Ciminelli.

Unbeknownst to the Fort Schuyler board, Ciminelli had been working with state insiders to shape the Buffalo Billion allocation process in his favor. Rather than having firms bid for specific projects, the program adopted a proposal process that allowed firms to bid to become a “strategic development partner.” A strategic development partner would be first in line to negotiate with Fort Schuyler. State officials and insiders then promoted and implemented selection criteria that favored Ciminelli’s firm, such as a requirement that the firm be based in Buffalo and that the firm use software that the insiders knew Ciminelli’s firm already used. After the board selected Ciminelli’s firm as a strategic development partner, that firm was at the head of the line to negotiate with Fort Schuyler. The board subsequently negotiated a $750 million contract with Ciminelli’s firm.

Here, the alleged fraud was not a straightforward case of theft: Ciminelli did not personally run off with $750 million. Construction of the development project did occur. Rather, the prosecutors noted that Ciminelli’s firm received significant compensation for its management role, contrasting Ciminelli’s management fees with the lower fees charged by competitors. But those fees were agreed to by the Fort Schuyler board during the negotiation process—they could have rejected Ciminelli and negotiated with an alternative bidder. The trial court did not admit evidence discussing the quality of Ciminelli’s development management services, thus precluding the jury from considering whether the increased quality of Ciminelli’s management work might have justified the higher compensation.

Nor was this a classic “deprivation of honest services” type of case. Twelve years ago, in Skilling v. United States, the Supreme Court held that fraudsters could criminally deprive victims of not only money or property, but also the intangible right the public has to “honest services.” (Citizens have the right to honest services from civil servants, and an unscrupulous government employee accepting a bribe to favor one candidate over others might deprive citizens of those honest services.) Under this theory, prosecutors do not have to show how the government lost money as a result of the unscrupulous behavior. Prosecutors rather must show that the defendant participated in illegal bribes or kickbacks. In the Ciminelli case, prosecutors could perhaps show an undisclosed conflict of interest, but they were unable to produce any evidence linking Ciminelli to the payment/receipt of any bribes or kickbacks.

Instead, the prosecutors focused on the alleged deprivation of Fort Schuyler’s and the state’s right to control the Buffalo Billion funds: Ciminelli and the state insiders with whom he coordinated were accused of engaging in a deception that deprived the Fort Schuyler board of its right to control the state’s funds and the associated allocation process. Fort Schuyler’s board allegedly lost its interest in a proper, competitive bid process because it did not know about the state insiders’ undisclosed conflict of interest and efforts to put Ciminelli’s firm at the head of the line to negotiate. The trial court explained this right to control theory to the jury, and the jury found Ciminelli guilty of wire fraud. The US Court of Appeals for the Second Circuit upheld Ciminelli’s conviction, which he appealed to the Supreme Court.

Ciminelli argues that the right to control theory of deprivation is an improper workaround against the “honest services” decision in Skilling: State insiders may well have had an undisclosed conflict of interest because they were working to favor Ciminelli, but undisclosed conflicts of interest alone are insufficient to prove fraud. If prosecutors could not prove any bribery or kickbacks, they had to prove that Ciminelli intended that the Fort Schuyler board and the state lose or be deprived of some amount of money or property. Ciminelli argued that his actions did not deprive Fort Schuyler of any such money or property. The alleged bid-rigging only affected the first stage of the selection process: determining which firm would be first to negotiate with Fort Schuyler. Thus, there was no deception in the project negotiation itself. If board members were dissatisfied in their negotiations with Ciminelli regarding the $750 million project, they could have moved on to negotiate with a different firm—but they still chose to award the project to Ciminelli’s firm. And there was no evidence that they received anything less than what they bargained for and agreed to.

This case raises important questions of federalism and overcriminalization. How much autonomy should Fort Schuyler’s board and New York State authorities have over procurement before federal authorities intervene? And where precisely do federal authorities draw the line between a federal crime and a sharp business practice to gain an advantage over competitors? Was Ciminelli really on notice that his coordination with state insiders to get an inside track on open negotiation was, in fact, wire fraud?

Certainly the government has a vested interest in maintaining fairness and honesty in the government contracting process. But which forms of deception are serious enough to merit criminal sanctions under the fraud statutes? While collusive price-fixing behavior among the contractors bidding for business is both improper and illegal, some level of insincerity and sharp elbows is expected in any commercial negotiation. In Ciminelli’s case, the main wrongdoing appears to be his “sneaking to the front of the line” in the negotiation process. Should that really lead to criminal sanction and prison time?

A healthy fear of the government’s anti-fraud arsenal remains an important survival instinct for all contractors. But they can breathe just a bit easier knowing that the Supreme Court told prosecutors to reconsider whether and how a fraud was actually committed before bringing charges against a defendant for an inchoate “crime” in the absence of any harm.

[View source.]