In a recession, there is normally an increase in financial crime and an increase in the discovery of financial crime. The former is a result of the worsening economic climate; for example, individuals' personal financial needs and companies' desire to 'cut corners' to meet difficult targets. Additionally, countries may seek to recover the proceeds of crime in order to improve their own cash flow. With an inevitable increase in insolvencies and audits brought on by financial difficulties, crimes are uncovered which may have been previously hidden–companies are under no general reporting obligations.
1. Financial Crime Trends
According to KPMG Forensic's Fraud Barometer1, more than £1.1 billion of fraud was dealt with by UK courts in 2008; the highest level recorded since 1995 and the second highest in the twenty-one year history of the survey. Fraud by professional gangs remained at the extremely high levels seen in previous years (£800million in 2008) but there was a marked increase in fraud by individuals. Taken together, company managers, employees and customers were tried for some £300million of fraud last year- this is three times the value seen in 2007.
KPMG warns that the worst is yet to come. The bulk of the fraud committed since the credit crunch began in August 2008 is unlikely to be discovered or prosecuted in the near future. The Fraud Barometer's records show that after the last UK recession of the early 1990s, the height of prosecutions being dealt with by the courts was not reached until 1995.
In a positive economic climate it is far easier to commit crimes of dishonesty. When credit is readily available and lenders are vying with each other for business there is an inevitable relaxation of lending criteria. In the extreme examples, this is potentially disastrous- the US subprime mortgage crisis and the troubles of Fanny Mae and Freddie Mac.
2. Regulation
In the first Reith Lecture, the political philosopher, Michael J Sandler said "Almost everybody agrees that we need to improve regulation, but this moment is about more than devising new regulations. It's also a time, or so it seems to me, to rethink the role of markets in achieving the public good."2
In March 2009, the chairman of the Financial Services Authority (FSA), Lord Turner, released a report on the future of regulation in the banking and financial sectors. It offered an exhaustive list of enhancements and enlargements of the FSA's operations3. There was already a trend to increase regulation in the UK as evidenced by legislation such as the Regulatory Enforcement and Sanctions Act 2008.
Regulatory Enforcement And Sanctions Act 2008
The Regulatory Enforcement and Sanctions Act (the Act) 2008 is a result in part of the Government's commitment to implementing the Hampton agenda. It received Royal Assent on 21 July 2008.
The aim of the Act was to "provide consistent enforcement and increase the effectiveness of risk-based regulation across the country and ease the burden for business".
The Act reflects an increasing shift away from prosecutions and towards regulatory compliance. It offers regulators a range of new sanctions which can be imposed directly by the regulator without any judicial intervention. There are four categories.
A Fixed Monetary Penalty can be imposed where the regulator is satisfied beyond reasonable doubt that a relevant offence has been committed. The fines are at a low level and are intended for minor regulatory non-compliance (normally capped at £5000). Unpaid fines will be enforced through the civil courts.
Discretionary Requirements can be imposed such as Compliance Requirements, which can be used to ensure that steps are taken to rectify a compliance breach, and Restoration Requirements, which can be used to ensure a business deals with the consequences of the offence.
A Stop Notice can be imposed which will prohibit the activity within the notice until any requirements specified in the notice have been complied with. In order for such a notice to be imposed, the regulator must reasonably believe that the activity presents a significant risk of serious harm to human health, the environment or the financial interests of consumers and is, or is likely to be, an offence. Failure to comply with a Stop Notice is a criminal offence.
Enforcement Undertakings are agreements made between a business and a regulator whereby the business agrees to undertake specific actions, for example, to ensure that a payment of compensation to those affected by the breach will be paid. Such undertakings may be used when the business itself has brought the issue to that regulator. Breach of an undertaking may result in an alternative sanction or criminal prosecution.
Each of these new civil sanctions allows the regulator to broaden its remit of powers without encouraging an increase in criminal prosecutions. A large number of regulators are able to use these powers.
3. Difference Approaches: To Prosecute Or Not To Prosecute?
Regulation v Criminal Liability
When an investigation is launched, it may not be clear whether it will result in a criminal prosecution, civil sanction or regulatory enforcement. In many instances, there is more than one of the above options available to the investigating agency.
The Financial Services Authority And The Serious Fraud Office
The FSA is increasingly focusing on insider dealing and market abuse and has already secured its first criminal prosecution for insider dealing4 and is continuing to initiate investigations and bring charges in such cases. The SFO is increasingly considering imposing civil sanctions; for example, in the Balfour Beatty case, the SFO used the civil recovery powers made available to it under the Proceeds of Crime Act 2002 for the first time5.
The Financial Services Authority And The Office Of Fair Trading
The FSA and OFT now have powers under FSMA to initiate criminal proceedings under sections 401 and 402 Financial Services Markets Act 2000 which overlaps on the powers of the SFO to prosecute financial crime. They have always had a focus on preventative measures, advice and slap-on –the –wrist sanctions for companies that come clean. However, there are now more criminal investigations being conducted and the OFT is dealing with its second prosecution for cartel conduct.
4. International Cooperation
States appear to be making a unified, global effort to introduce regulatory standards and legislation that are workable and compatible.
Fraudsters have exploited loopholes in the global financial system; for example, tax arbitrage was once encouraged by the desire for inward investment by developing countries, island communities and some developed countries e.g. the Netherlands.
State Parties are beginning to make a unified effort against tax evasion, the increase in multi-lateral and bi-lateral tax treaties and agreements, mutual legal assistance and international moves to increase regulation. Countries like Switzerland are being named and shamed, along with Liechtenstein, Monaco, and even Jersey, Guernsey and the Isle of Man.
Unsurprisingly, increased global cooperation will mean a closing of the loopholes traditionally used by offenders to evade tax and commit fraud, as well as an increase in enforcement.
Tax Havens
The economic crisis has led various states to declare a global war on tax evasion and avoidance with a particular focus on tax havens. This is obviously partly aimed at boosting tax revenues during the recession.
On 2 December 2008, the UK Government announced that an independent review would be done by Michael Foot, covering the areas of "financial supervision and transparency; taxation, in relation to financial stability, sustainability and future competitiveness; financial crisis management and resolution arrangements; and international cooperation."
A progress report of the Foot Review, setting out its scope and issues for consultation, was published on 21 April 2009 and stated as follows:
"First, financial regulators everywhere face the prospect of substantial additional demands on their resources to implement wide-ranging changes to international regulatory standards. Meeting regulatory standards is not only important for the integrity of the financial system, but also for attracting financial services business from centres which are unable to do so. Second, the financial centres will need to review their current legal structures to ensure that they have the legal framework and institutional infrastructure in place to deal with major shocks. Some of the financial centres already have depositor, policyholder and investor compensation schemes in place to provide a 'safety net'. Those that do not will need to consider the extent to which such safety nets are considered vital for the business proposition. All will need to consider the funding implications of a major call on a compensation scheme and the range of tools available to deal with the local consequences of the failure of a major firm in their jurisdiction.6"
5. Reporting Requirements
Despite the proposals in The National Fraud Strategy for a new National Fraud Reporting Centre7 there is, as yet, no general statutory or common law obligation for companies to report fraud.
Professionals in certain fields are however, under obligations to report suspicion or knowledge of financial crime, for example, section 330 Proceeds of Crime makes failure to disclose knowledge or suspicion of money laundering an offence for all those who work in the regulated sector. Suspicious Activity Reports are made to the Serious Organised Crime Agency reporting suspicion of a host of criminal activities including tax evasion and drug smuggling.
Another example is the Charity Commission, who subject trustees to reporting requirements in the case of fraud. If a trustee has even a suspicion of fraudulent behaviour, he or she must report it to the Commission and to the police.
Insolvency Practitioners are also subject to various reporting obligations under the Insolvency Act 2000.
6. Eastern Europe
Yukos Case – Political Risk
Corporate Raiding Using Prosecutions – Economic Risk
"Corporate raiding in Russia is criminal by nature. Russian billionaires who made fortunes in corporate raiding should be locked up, instead of posturing at the top of Forbes rankings8".
"Raiders" are business groups that specialise in taking over firms against their will. They organise and execute the aggressive 'capture' of a target company. In recent years Russia has experienced an unprecedented wave of these hostile takeovers.9 Gennady Gudkov, head of a parliamentary Working Group examining the issue, stated in 2006 that the Group knew of about 1,000 cases a year, but that the real scale of these attacks was probably closer to 10,000 or 15,000: "this problem is almost impossible to solve in a corrupt state.10"
Footnotes
1. Fraud nears record levels in 2008 – and worst to come, says KPMG, 2 February 2009.
2. 'Reith lecture: a price for everything but at what cost?', Michael J Sandler, The Times, 13 June 2009
3. More regulation can't be right, Sunday Times, 22 March 2009
4. 'FSA wins first conviction for insider dealing, The Times, 27 March 2009
5. Serious Fraud Office successfully obtains first ever Civil Recovery Order involving major plc', SFO Press Release, 6 October 2008
6. Progress report of the independent Review of British offshore financial centres, Michael Foot, April 2009
7. The National Fraud Strategy, 19 March 2009
8. Herman Gref, Russia's Minister for Economic Development
9. 'A Survey of Corporate Governance in Russia,' Centre for Economic and Financial Research (CEFIR), June 2007, Lazareva et al
10. 'In Russia, Corporate Thugs Use Legal Guise,' The Washington Post Foreign Service, 20/04/2006
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
