A ghastly mess!

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Tom Cockroft explores the need for a new offence of failure to prevent fraud.

“A British bank is run with precision/ A British home requires nothing less/ Tradition, discipline, and rules must be the tools/ Without them – disorder! Chaos! Moral disintegration!/In short, we have a ghastly mess!”

(“The Life I Lead”, Mary Poppins)


The exploits of the professional shoplifter pale in comparison to the damage that corporations can wreak to the economy. The general consensus remains to steer away from affixing corporate criminal liability as a response to corporate fraud. Prosecution is still seen as reserved for individuals against whom there is direct evidence of fraud and those individuals who aid or abet them (section 12 of the Fraud Act 2006); the corporations meanwhile face regulatory fines. The question remains: does this approach provide the public with the protection they need? And where an individual stealing a loaf of bread can be prosecuted but a corporation stealing billions cannot is there truly “equality before the law”?

Damage caused

Of course, much of the financial crisis had nothing to do with fraud. However, there were undoubtedly large bets being made and risks being taken which ultimately caused enormous losses, and the structural incentives made such risks rational at the time.

What is the loss to the taxpayer? The answer is to be found in the concept of “implicit subsidy”: the value of the implicit subsidy is estimated at somewhere between £30-120bn per annum. This figure represents the subsidy that taxpayers give to British banks just by virtue of being available to bail them out (see Donald MacKenzie’s 2013 article in the London Review of Books). To tackle risk-taking and reduce the subsidy there needs to be, principally, effective regulation. Where exceeding risk limits is proscribed, it is fraudulent to disguise such behaviour as legitimate business risk.

However, regulation can only take us so far. What protection is afforded against the corporations which tacitly encourage such risk-taking? The Government must tread carefully, however: corporations, most notably investment banks, may disguise their fraud in labyrinthine instruments. It then costs huge amounts of time and money to prosecute the case, time and money which might otherwise be dedicated, say, to thousands of prosecutions for burglaries and assaults. But the scale of damage uncovered by a long and complicated fraud trial often dwarfs that of the typical “ABH” and perhaps begs the question: where will our economy go if people are no longer equal before the law?

Regulatory fines

Regulatory fines, as a means of tackling banking misconduct, are in vogue. Such fines are increasing. By way of example, Lloyds Banking Group set aside £1.4bn for delayed PPI compensation. In the LIBOR case, RBS and Barclays faced considerable fines and media scrutiny for their roles in the Libor manipulation scandal.

UBS were fined £27.9m for their part in the £1.4bn trading fraud committed by one of its employees, Kweku Adoboli. This was described as a failure: i. “to adequately supervise the GSE business with due skill, care and diligence – reported desk limit breaches were not adequately acted on by line management; ii. to put adequate systems and controls in place to detect the unauthorised trading in a timely manner – insufficient co-operation between front and back offices – level of understanding of the trading activities led to a lack of sufficient enquiry and accountability between functions; and iii. to have adequate focus on risk management systems and to sufficiently escalate or take sufficient action in respect of identified risk management issues.”

However, fines alone do not work. Neither can they hurt the pockets of those to blame. Nor can they saddle them with the stigma of a finding of dishonesty. The money received in government bail-outs is used to pay the penalties. In addition, the corporation, a virtual entity, is tainted rather than the individuals responsible.

Civil claims

Seemingly more promising are claims in negligence or under section 213 of the Insolvency Act 1986, where a company knows or firmly suspects that fraudulent trading is taking place. (See Bank of India v Morris [2005] EWCA Civ 693, para 14.) Recourse to traditional notions of negligence and vicarious liability is superficially attractive. However, an award of damages will at best put the parties in the position that they would have been in to begin with; it will not serve to punish. This is because claims in tort will usually generate compensatory damages only due to the common law’s reticence to allow for punitive damages in civil claims. (See the responses to the Law Commission Consultation Paper 195 Criminal Liability in Regulatory Contexts, paras 1.1028 and 5.84-5.91. To the Law Commission, the concept of vicarious liability is equally nebulous as that of “directing mind and will”.)

Corporate criminal liability

Corporate criminal liability is still tied to the out-dated notion of the “directing mind and will” of the organisation. Arguably, the concept fails to reflect the reality of modern-day large corporations, where organisational structures can easily be disguised, where e-mail chains rarely go above a certain level and where an ethos or culture of impropriety can develop quite independently of the controlling officers.

Possible solutions

As the Director of the Serious Fraud Office (SFO) suggested in a recent speech, a better way to tackle failure to prevent fraud may therefore be by means of a statutory offence, parallel to that in section 7 of the Bribery Act 2010. Section 7 criminalises the failure of a commercial organisation to prevent bribery by an associated person – which essentially amounts to its employees – unless it has adequate procedures in place to prevent such conduct. Section 7(2) reads as follows: “But it is a defence for [the organisation] to prove that [it] had in place adequate procedures designed to prevent persons associated with [it] from undertaking such conduct.” The statute thus places a positive obligation on organisations to maintain such controls at the risk of being liable for the offences of its officers.

To adopt this approach in relation to fraud would be a step in the right direction but on any view section 7 and the accompanying principles offer much clearer guidance.

Guidance from the Ministry of Justice recommends that procedures put in place to prevent bribery be informed by the following six principles: clear, practical and accessible policies; commitment from the top level; rigorous risk assessments; due diligence checks on employees; communication and training; and monitoring and review. (See commentary on the guidance by Stephen Gentle in the 2011 Criminal Law Review.)

In this sphere at least, the Australians are leading the way: criminal liability is imposed if the corporation failed to create and maintain a corporate culture requiring compliance with the contravened law (Part 2.5 of the Criminal Code 2002, section 51).

The fault element is taken to exist if the corporation expressly, tacitly or impliedly authorises or permits the commission of the offence.

Some have criticised the Australian approach as excessively draconian on corporations, arguing that it is unfair to fix them with criminal liability for simply failing to maintain an appropriate “corporate culture”, which is an amorphous concept.

Two reasons can be given as to why it is not draconian or unfair. Firstly, the offence still requires a fault element which is only satisfied if the corporation in some way allowed the offence to occur, for which it should be liable. Secondly, the concept of corporate criminal liability is not equivalent to personal criminal liability, in that no one’s liberties are at risk, and thus we should not be needlessly worried about levels of culpability.

Outside the area of bribery, the closest the United Kingdom has come is in section 8(3) of the Corporate Manslaughter and Corporate Homicide Act 2007. This section allows the jury to aggregate the fault of different people at different levels in the organisation. Here, a jury may have regard to general systemic failings when considering the issue of whether a company is in breach.

The need for a parallel provision in relation to fraud is twofold: firstly, to reflect the reality of systemic failings and tackle the broader culture fostered by organisations as a whole; and, secondly, to act as a sufficient deterrent to continuing misconduct.

A factor in favour of regulatory rather than criminal response might be where the balance of public interest is in achieving reparation for victims, the likelihood of a criminal prosecution damaging the prospects of this due to bankrupting the corporation.

Although there is no public interest in destroying a corporation to the detriment of innocent stakeholders, it is only the deterrent and PR nightmare of a conviction – with the help of deferred prosecution agreements – that is likely to encourage banks to identify and clear out the top offcials responsible, to prevent recurrence of fraud and clean up any tainted image. (See Schipani’s article in the 2011 Company Lawyer.)

Quantum

To penalise corporate officials, it is only fair that damages be ascribed proportionately to income. The higher you go up the corporation, the bigger the punch. Remember the case of the Swedish millionaire who was handed down a speeding fine of $290,000 in Switzerland for repeat offending in his Ferrari.

Deferred Prosecution Agreements

Deferred prosecution agreements (DPAs) represent a new approach to the issue of combatting corporate crime, and involve the prosecutors reaching an agreement with the corporation – criminal proceedings are suspended as long as the corporation meets certain conditions, such as a disgorgement of profits, the paying of a financial penalty and cooperating in implementing compliance programmes and reporting offenders etc.

A new code on DPAs has been issued by the Directors of the CPS and SFO. The most important principles are transparency, self-reporting by corporate wrongdoers and judicial involvement. DPAs will involve co-operation with prosecution authorities. They should provide evidence that offenders have been dealt with, that individual offenders will not be tolerated, that they are no longer part of the corporation, and evidence of compliance, a promise of future good behaviour.

Judicial involvement is crucial, because unlike in the US, a corporation cannot just come to court and ask for the judge’s agreement to a DPA. In England and Wales, the judge will be involved in most stages of the process. He will have an impact and will refuse to allow the DPA if he believes it is contrary to the interests of justice.

The SFO has emphasised that prosecution remains the preferred option for corporate criminality but where the effect of a DPA is to clear out bad management and put a warning mark to their name, this approach has much to commend it. There is one thorny issue, however – the DPA may make provision for a financial penalty and/or confiscation. On this issue, prosecuting authorities would do well to take heed of the note of caution in the case of R v Innospec. In that case, the Director of the SFO accepted the view that the court should determine whether to impose a fine in preference to a confiscation order.

Why was the Director right? As HH Geoffrey Rivlin QC made clear in submissions on the topic of DPAs to a meeting organised by Transparency International on 5 August 2012, it is very important as a deterrent that a large fine is imposed and is seen to mark the conduct. The offending must be punished irrespective of whether it has produced a benefit. The deprivation of any benefits obtained follows, but that is simply an additional consequence.

For the Director to have preferred confiscation to a fi ne, in circumstances where Innospec Limited was unable to pay both, would have given rise to a conflict of interest incompatible with the independent duties of a prosecutor: although the proceeds obtained from a confiscation order are paid to HM Treasury, the amounts received are distributed by them in accordance with an agreed procedure, with 37.5% going to the SFO (as the investigatory and prosecuting body) – the Treasury retains 50% but passes 18.75% to the prosecuting authority and 18.75% to the investigating authority and the balance of 12.5% to HM Courts & Tribunals Service.

The temptations placed in the way of prosecuting bodies which are stretched financially – to achieve a large pay out – may be great, or they may certainly be perceived to have influenced the shape of the plea agreement, as Lord Justice Thomas made plain in R v Innospec.

“But even beyond that, it could also be argued that it is difficult indeed for a prosecutor, when deciding whether to prosecute or not, to act as a Minister of Justice if it is anticipated that this may well be coupled with an order for confiscation – for this too could be perceived, very probably wrongly, as a decision calculated to have the effect of contributing to its own funding.”

It is therefore to be hoped that others will follow the lead of the Director of the SFO in ceding decision-making on this issue to the courts.

Of course, part of the reason for DPAs is to avoid companies not having an immediate conviction where it is not necessarily fair to tarnish the corporation’s name. Under European and some US regulations or provisions (see for example 2014/18 EC), if a corporation is convicted, it is automatically excluded from the competition for any public contracts and that is why the US has DPAs, and that is where the DPA comes into its own: in short, the DPA can save good corporations from the consequences of having a few bad apples in the barrel which might otherwise spell disaster – bankruptcy and thousands of redundancies.

Conclusion

In R v Innospec, Lord Justice Thomas (as he then was) said at paragraph 38 of his sentencing remarks: “it would be inconsistent with the basic principles of justice for the criminality of corporations to be glossed over by a civil as opposed to a criminal sanction.”

What then is preventing the Government from introducing such an offence? Would it discourage entrepreneurial risk taking?

Would it simply lead companies to outsource threatening risks? Is the risk better met by co-operative methods of regulation than by waspish prosecutions? (See Robert Baldwin’s article in the 2004 Modern Law Review.)

These questions are all open to debate, but if clear guidance on risk management is given, as it has been in relation to bribery, such an offence should not unduly concern corporations. Rather, the incentives created by such an offence would make for more stable and cleaner markets and, in fullness of time, restore investor confidence, whilst ensuring that the wild excesses of recent years are brought to an end.

With thanks to HH Geoffrey Rivlin QC and Nicholas Rimmer for their comments.

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Tom Cockroft

Tom is a barrister, currently on secondment to the CPS Special Crime and Counter-Terrorism Division. In September he takes up a Pegasus Scholarship in Paris.