In 'Kousisis,' the DOJ Once Again Pushes the Limits of Federal Fraud Prosecutions
Can the government bring criminal fraud charges for a transaction where the alleged victim obtains the goods or services for which they paid? On Dec. 9, 2024, the U.S. Supreme Court heard oral argument in Kousisis v. United States to help answer this question. The case is the latest in a series of opinions that confront—and largely limit—the reach of federal criminal statutes.
While the justices presented a myriad of hypotheticals to the attorneys, they did not give a clear indication of the direction that the court is likely to take. Regardless of the outcome, the case is sure to further impact the way federal prosecutors in a new administration use the mail and wire fraud statutes.
For decades, prosecutors, defendants, and the courts have litigated the reach of the federal criminal law. It has been a smoldering debate of cyclical expansion and contraction, particularly under the mail and wire fraud statutes, in which prosecutors seek to extend the reach of the law by bringing charges on novel sets of facts and theories of criminal culpability.
The Supreme Court steps in to call foul, prompted by defendants and other interested parties such as civil rights defenders. Prosecutors then review other untested areas of questionable commercial conduct, eventually identifying a case they believe warrants criminal prosecution under an expanded theory of liability.
As Justice Samuel Alito put it during oral argument, this background looms like “a cloud or a fog” over Kousisis, where the court is now confronted with the so-called “fraudulent inducement” theory, which is based on Learned Hand’s famous dictum: A man is none the less cheated out of his property, when he is induced to part with it by fraud, because he gets a quid pro quo of equal value.
In other words, even where the alleged victim received the benefit of the bargain, if the bargaining itself was infected with misinformation, the bargain would be deemed fraudulent because the alleged victim “lost the chance to bargain with the facts.”
Now the court must decide whether deception to induce a commercial exchange can constitute mail or wire fraud, even if the defendant did not intend to cause economic harm, and the alleged victim received the goods or services for which it paid.
Background
Kousisis involves a bid for a federally-funded contract to repair two bridges in Philadelphia. Defendant Alpha Painting and Construction Co., Inc. (“Alpha”), under the supervision of its project manager Stamatios Kousisis, was the lowest bidder and won the contract. This contract was subject to the federal Disadvantaged Business Enterprise program, under which contractors are encouraged to ensure that 10% of their spending benefits small businesses owned by members of historically disadvantaged groups ("DBEs").
There was no dispute that Alpha delivered high-quality bridge repairs, and did so at a discount relative to the competing bids. In doing so, however, Alpha evaded regulatory and contractual goals for participation by DBEs, according to government allegations. As alleged, Alpha would direct a certain percentage project spending would be directed to DBE suppliers, but the suppliers were mere pass-throughs to non-DBE suppliers. This was a contractual requirement whose breach was expressly singled out as a “material breach” and could result in its termination.
In affirming the conviction, the Court of Appeals for the Third Circuit observed that Pennsylvania’s Department of Transportation (PennDOT) received the repair services that it bargained for, but it did not achieve its policy goals of fostering economic opportunities for minorities. It held that PennDOT was deprived of “the benefit of its bargain when it paid the full contract price because of a false pretense.”
Another case challenging the “fraudulent inducement” theory, United States v. Porat, is in the certiorari stage at the Supreme Court. In that case, which also arises from the Third Circuit, prosecutors brought wire fraud and related charges against the former Dean of Temple University’s Fox Business School, Moshe Porat, for making false submissions to U.S. News to inflate the school’s standing in the U.S. News rankings. Among other things, Mr. Porat was accused of inflating the percentage of students that had taken the Graduate Management Admission Test (GMAT).
The prosecution’s theory in Porat is that students elected to enroll in the school’s MBA program at least in part because of the school’s rankings, which were based on false information. And while students obtained the education and the degree for which they paid tuition, once the false responses were exposed, Fox Business School ended up ranked at a lower level. While any loss of reputational value was intangible, according to the prosecution students were induced to enroll based on misrepresentations and as a result they were induced to part with their tuition money, thus justifying a conviction for wire fraud.
Skepticism of Expansion
Beginning in the 1970s, prosecutors and lower courts had expanded the definition of the “defraud” clause in the mail and wire fraud statutes. Courts no longer required the prosecution to show that a defendant had caused a tangible loss of property; instead, prosecutors could rely on the loss of certain “intangible rights,” such as the citizenry’s right to good government, or the honest and loyal services of its governmental officers.
This expansion movement was tentatively halted by the Supreme Court in the late 1980s by limiting the statute to schemes to defraud victims of property rights. As a result, prosecutors then began to frame various interests as “property rights,” such as the U.S. interest in regulating foreign resales of arms, video poker licenses, and even the George Washington Bridge in New York.
The “fraudulent inducement” theory underlying the Kousisis and Porat prosecutions reflected a similar expansion of the mail and wire fraud statutes, and it comes on the heels of recent pushback against other expansive theories of mail and wire fraud. In 2023, the Court decided Ciminelli v. United States, a case arising out of a large government-facing development project in upstate New York.
In Ciminelli, the court specifically rejected the “right to control” theory of fraud, under which a defendant could be guilty of criminal wire fraud for depriving someone of “potentially valuable economic information” necessary to “make discretionary economic decisions.” It reaffirmed that fraud prosecutions can proceed only where the victim is deprived of a “traditional property interest.” Justices criticized the theory for attempting to “vastly expand federal jurisdiction without statutory authorization,” making a “federal crime of an almost limitless variety of deceptive actions traditionally left to state contract and tort law.”
Although during oral argument the Government minimized this trend, skepticism towards expansive federal jurisdiction is not limited to fraud prosecutions alone. Earlier this year, the Court handed out a similarly spirited decision in Snyder v. United States, where it limited the reach of the Federal Program Bribery statute (18 U.S.C. §666) to exclude gratuities paid to public officials for performing an official act.
The oral arguments and the decision in that case show a court concerned with drawing a line between conduct that rises to the level of a federal crime, and conduct best left to state and local policy judgments about “when gifts expressing appreciation to public officials for their past acts cross the line from the innocuous to the problematic.”
Kousisis and Porat both raise questions about the line between federal crimes and conduct that should be addressed through the contractual bargaining process and, as needs arise, through civil contract or tort litigation. When questioned about the criteria used to differentiate between civil and criminal fraud, Kousisis pushed for the justices to establish a clear line based on the common law injury requirement, and hold that there can be no mail or wire fraud conviction in the absence of harm to a traditional property interest.
The government, conversely, argued for a materiality standard, under which the fraudulent conduct could encompass other subjective preferences by the victim of which the defendant has constructive knowledge, for which there would be “no one size fits all” definition or jury instruction.
Potential Impacts
The theory underlying Kousisis v. United States could have significant implications for how businesses prepare for risk. While evaluating and controlling for civil legal risks is routine, the consistent attempt by federal prosecutors to reach into areas of traditional civil liability is cause for concern. Criminal liability under federal law and carries significant reputational, financial, and operational risks. Especially if the Court rules in favor of expanding the statutes’ application to include fraudulent inducement, businesses could face criminal liability for using “white lies, puffery, and other fraudulent promises” in areas where before they faced at most civil exposure.
For example, if a company engages in puffery in advertising a product’s benefits, that could potentially lead to criminal charges under fraudulent inducement theory. Companies that rely on ethical or environmental certifications to market their products, such as “ESG” branded financial products, “fair trade” coffee, and “free range” eggs could also face exposure to mail and wire fraud liability if their adherence to these standards differs from the expectations of federal prosecutors.
The line between genuine fraud and routine commercial disagreements could become blurred, and companies would need to be far more cautious about their marketing practices and contractual representations. The ruling could also impact practices in contract negotiations and require more diligence in representations and warranties that are made beyond the scope of the actual exchange, such as overly optimistic delivery timelines or asset valuations.
Under a broader interpretation of the mail and wire fraud statuses, even though no tangible property was lost, and the purchaser still obtains the products they paid for, the misrepresentations could be seen as a fraudulent inducement, depriving the supplier of its “right to bargain” with full knowledge of the facts and triggering fraud charges. This would expand prosecutorial reach into business transactions that were traditionally handled in civil court.
Takeaways
However the court decides Kousisis v. United States, the fact that the fraudulent inducement theory is even on the table has far-reaching consequences, not only for the scope of federal fraud prosecutions, but also for the way businesses operate and communicate with consumers, investors, and counterparties. If the court rejects the “fraudulent inducement” theory, that will provide some comfort on the subject of criminal exposure, and could present an incentive for prosecutors to pursue other theories, such as prosecuting certain misconduct under more specific federal statutes (e.g., a false statement charge under 18 U.S.C. section 1001), or civil remedies short of criminal prosecutions.
It would also be directionally consistent with expectations that the incoming Trump administration will reign in prosecutors and focus on more traditional criminal prosecutions involving street crime, immigration, and fraud cases involving actual monetary loss such as Ponzi schemes.
But regardless, the fact that the case is being reviewed means there is considerable force to the view that businesses that engage in fraudulent inducement must pay a price, even where they provide the bargained-for goods or services to the alleged victims. As a result, the rights to intangible values such as diversity goals and reputational status are likely to remain subjects of contractual commitments and civil litigation, and companies would be wise to attend to that growing risk.
Solomon Shinerock is a partner at Lewis Baach Kaufmann Middlemiss PLLC. He previously served as an assistant U.S. attorney in the Northern District of New York and an assistant district attorney in the Manhattan District Attorney's Office Major Economic Crimes Bureau. Eloisa Yang is a foreign associate at Lewis Baach Kaufmann Middlemiss. Her practice focuses on white collar defense and internal investigations.
Reprinted with permission from the December 12, 2024 edition of The New York Law Journal © 2024 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or asset-and-logo-licensing@alm.com.