Legal Briefing

Will it be a Happy New Year for your company?

The In-House Lawyer Logo

Crime, fraud and licensing | 01 February 2010

The year-end audit process can bring headaches for in-house lawyers. With the financial year for most companies ending on 31 December, the first few months of the New Year bring the deepest scrutiny by external auditors of a company’s transactions and dealings, in addition to year-end procedures being run by internal audit. This increased scrutiny can lead to the discovery of evidence pointing to improper or even illegal conduct by employees or management during the financial year.

Although such issues can emerge at other times throughout the year, the problem at the year-end is the impact they could have on the financial reporting timetable. This condenses the time available for a thorough internal investigation, often necessary to ensure that any issue does not impact materially on the company’s financial statements or on the integrity of senior management signing off on the financial statements.

In-house lawyers can find themselves required to give urgent advice to the board and the audit committee to help board members recognise the risks facing the company in conducting an investigation, the potential liabilities, and the regulatory reporting and disclosure obligations.

WHITE-COLLAR CRIME AND RECESSION

During an economic downturn, companies and individuals often take greater risks. They may be tempted to engage in fraud, bribery or cartel activity to protect their own positions or their company. Pressure, opportunity and the ability to rationalise illegal behaviour (eg everyone is doing it) all come into play.

Warren Buffett, the American investment guru, succinctly summed up the effect of a recession when he said: ‘You never know who is swimming naked until the tide goes out.’ Well, the tide is on its way out now and we are sure to see a lot more ugly stuff left on the beach.

What happens if the audit process uncovers a black hole in the accounts, evidence of irregular payments or manipulation of accounts? Companies need to deal with these issues promptly before someone blows the whistle and reports matters to the authorities, yet many remain unprepared to do so.

WHAT ARE THE RISKS?

With economies around the world struggling to get to grips with the recession, it is inevitable that some individuals will be tempted to use underhand and illegal tactics to keep ahead of competitors. It could be a manager or an employee manipulating accounts or paying bribes to win desperately needed new business. Fear often drives such activity: fear of the company breaching financial covenants, fear of the individual losing their job or fear of the company going into liquidation.

In its 2009 survey, ‘Occupational Fraud: A Study of the Impact of an Economic Recession’, the Association of Certified Fraud Examiners reported that there has already been a significant rise in detected fraudulent activity. And more is to come: 35.7% of respondents expect an increase in financial statement fraud and 25.6% expect an increase in corruption during 2010. In-house lawyers can, and should, play an important role in ensuring companies react in the best possible way.

With increased pressure from politicians on regulators and prosecutors to investigate and prosecute those responsible for wrongdoing, companies need to take immediate action or risk serious consequences. Prosecutors have a wide range of tools and laws at their disposal to investigate and prosecute both individuals and companies. Recent developments in UK fraud and corruption law are aimed at making prosecutions easier and quicker.

FRAUD ACT 2006

The 2006 Act creates a single offence of fraud (s1) that can be committed in three different ways:

  • false representation (s2);
  • failure to disclose information when there is a legal duty to do so (s3); or
  • abuse of position (s4).

Particularly relevant to senior executives is the offence of fraud by abuse of position. A person commits this offence if they occupy a position in which they are expected to safeguard, or not to act against, the financial interests of another person. Prosecutors will find this charge particularly useful in cases where there are allegations that senior executives have acted dishonestly, and to the detriment of their company and its stakeholders. Examples include concealing or failing to reveal the true financial position of the company to protect their own salaries, pension contributions, share allocations and bonuses.

In-house lawyers need to ensure that boards, senior executives and employees are fully aware of their obligations and responsibilities, and the wide scope of activities covered by the 2006 Act.

BRIBERY BILL

After years of committees and consultations, a new Bribery Bill (the Bill) is finally making its way through Parliament and should become law in 2010. This will significantly increase the risks for UK companies paying bribes to win new business.

Naturally, individuals and companies who overtly engage in corrupt activities will commit offences. However, a somewhat controversial aspect of the Bill is the proposal to create a strict liability corporate offence of failing to prevent bribery. More companies could be prosecuted in future where it can be established that someone has paid a bribe to further a company’s business interests. Companies can no longer simply blame the individual concerned.

The only defence available to a company in these situations will be to show that it had ‘adequate procedures’ in place to prevent bribery. The Serious Fraud Office’s (SFO) early view on what adequate procedures might look like includes:

  • a clear statement of anti-corruption culture and a Code of Ethics;
  • principles that are applicable regardless of local laws or culture;
  • individual accountability;
  • policies on gifts, hospitality, facilitation payments, advisers/third parties and political contributions;
  • training for staff at all levels;
  • regular checks and auditing;
  • a helpline for employees to report concerns; and
  • appropriate and consistent disciplinary processes.

There should be no doubt that the consequences of fraud or corruption can be extremely serious: unlimited fines, imprisonment (up to ten years), disqualifications, procurement bans and confiscation of assets. With these new laws in place, senior executives and companies could become more vulnerable to prosecution.

GROWING IMPORTANCE OF INTERNAL INVESTIGATIONS

A prompt and effective internal investigation that gets to the heart of the matter could help avoid or mitigate a criminal investigation or prosecution. The benefits are obvious. Internal investigations can establish if there has been any wrongdoing by individuals or the company, provide an early warning of imminent problems, identify control failure, demonstrate good corporate governance, and facilitate early engagement with regulatory and prosecution authorities.

But once a decision has been made to conduct an investigation, steps need to be taken to ensure that it is managed appropriately. There are many pitfalls for the unwary or unprepared, and getting it wrong can affect the whole outcome; individuals may be able to cover their tracks, evidence may be lost or destroyed, employees could be (or may feel) unfairly treated, and personal data could be illegally accessed and reviewed. Furthermore, if an internal investigation is not thorough enough, and fails to uncover all improper activity and all wrongdoers, there is an increased likelihood that someone might blow the whistle externally, either going to the media or the authorities.

The fruits of a competent and thorough investigation can be invaluable, particularly in allowing a company to make a full voluntary disclosure to the authorities. However, the best results can only be achieved if the investigation team has the right skills, is familiar with the likely outcomes and consequences, and can advise on disclosure issues. When so much is at stake, this is not the time or place for enthusiastic amateurs to be leading the investigation.

EARLY DISCLOSURE AND CO-OPERATION

Arguably, the internal investigation has become even more important in recent times. Enforcement authorities around the world are looking increasingly to companies to self-investigate and to disclose voluntarily any breaches of regulations or law. The Department of Justice and the Securities and Exchange Commission in the US have encouraged and rewarded self-reporting for some time. Several UK regulatory authorities, including the Office of Fair Trading, the Financial Services Authority and HM Revenue & Customs, have also been offering incentives for early disclosure and co-operation. The latest UK regulator to go down this route is the SFO.

In the past year or so there have been some notable cases that resulted from companies self-reporting to the SFO. Balfour Beatty and AMEC were dealt with by way of Civil Recovery Order, rather than full criminal prosecutions, for ‘accounting irregularities’. Mabey & Johnson pleaded guilty to criminal charges of corruption and sanctions busting after entering into a plea agreement (another new process introduced in 2009 for serious fraud/corruption cases). The way in which these matters are disposed of can be crucial to the company’s business, particularly if the company works in the public sector, where a criminal prosecution could lead to disbarment from public contract tenders.

So where does the internal investigation fit into this scheme? In the case involving Mabey & Johnson, a great deal of credit was given by the sentencing judge for the quality of the internal investigation, which had been conducted by an external legal team. Documents relating to the internal investigation were provided to the SFO, including copies of privileged notes and internal interviews of certain employees. The SFO regarded this approach as ‘meriting specific commendation’. It now expects this level of openness from all companies or it ‘…will not regard the co-operation as a model of corporate transparency’.

BE PREPARED

To quote Warren Buffet again: ‘It takes a lifetime to build a reputation and five minutes to ruin it.’ Companies should be prepared to deal with all types of crisis situations. With the economic downturn increasing pressure on management, and with greater regulatory activity and more potent laws, companies and their in-house lawyers must be ready to deal appropriately with allegations of fraud or corruption and to set up thorough, reliable internal investigations.

A crisis management plan is essential. However, even more important than ensuring that a company is well-prepared to respond is the need for all companies to take prudent steps to protect themselves by investing in proactive and comprehensive fraud and corruption prevention programmes. In-house lawyers have a key role to play in developing an effective legal risk culture, in helping to set a good tone from the top, and in ensuring that adequate resources are available to ensure that the profits being generated by their companies are being made in compliance with all laws and regulations. This way, there will be far less chance of auditors picking up evidence of any improper behaviour when reviewing the actions of the company in the past year.

Important points to remember when setting up an internal investigation

Consider the resources available: Do you have enough people with the right range of specialist skills within the company? Are they sufficiently independent from the matter and the people who are, or could be, under investigation?

External assistance may be required: The more serious the problem, the more likely it is that you should engage specialist external advice and an independent investigation team. It is easier for independent investigators to interview senior members of staff and avoid conflicts of interest. An independent investigation carries more credibility with regulators, prosecutors and stakeholders.

Preserve the evidence: It is usually crucial to prove who knew what and when. Instructions on document preservation (including e-mails and other information held on computers) must be issued as soon as a problem comes to light. However, do not forget such issues as privacy and data protection.

Consider legal professional privilege: If preserving privilege is important, consider engaging external advice and assistance from a law firm, rather than keeping the matter in-house or instructing accountants. Privilege in the context of investigations is a complex issue but the best opportunity to preserve privilege comes from instructing external legal advisers.

Involve HR: Suspensions or associated disciplinary hearings may be required or already be underway. However, the company should investigate in a way that minimises the possibility of substantial compensation claims from aggrieved employees or ex-employees for wrongful or unfair dismissal further down the line.

Interviews: Consider carefully when to interview senior management. Often, it is sensible to postpone interviewing senior management until the facts and documents have been gathered and analysed. Junior employees are likely to be more accessible and flexible during the early stages. Do not conduct interviews too early in the process. You may reveal gaps in the investigation or give too much away.

Keep the scope of the investigation under constant review: The objective should be clear but the scope of an investigation can change as more facts and evidence emerge. What appears at first to be a one-off case of bribery may escalate across numerous contracts and require a review of systems and controls across the business.

Consider disclosure obligations: If the company is publicly traded, it may be necessary to make an announcement to the market. There may be disclosure obligations within existing contracts. It may be necessary to inform regulators, the police, auditors, banks, etc. It may also be prudent to keep the company’s staff and investor/media contacts up-to-date with the progress of the investigation. This will allow them to respond to adverse publicity resulting from required disclosures and to ensure that no incorrect statements are issued, eg denials of wrongdoing before an investigation is completed.

Informing insurers: Consideration should be given at the earliest opportunity to informing directors and officers liability insurers of the possibility that there may be a regulatory investigation of insured directors and officers that could lead to criminal prosecutions and/or civil claims to ensure that cover is not voided.

One point of contact with regulators/prosecutors/media: A large investigation may involve many people. When engaging externally one central point of contact minimises the risk of inappropriate disclosure or conflicting information.