Business Financial Crime: Issues in Fighting Financial Crime

1. Business Financial Crime: Issues in Fighting Financial Crime

2. Impact of financial crime • Most recent report on fraud in UK by NERA (National Economic Research Associates) 2002 put the annual cost of financial crime at £14 billion

3. Impact of financial crime • Financial crime is low risk high reward for the criminal • For example armed robbery and drug crime usually attract greater penalties • A £500,000 robbery offender will net 15 years • Fraud of the same value may not result in a custodial sentence

4. To regulate or control? When applied to business the term regulation refers to “use of the law to constrain and organise the activities of business and industry” (Hutter, 1997) 4

5. To regulate or control? • Financial regulation is • Directed at the control of fraud , and • At the regulation of standards in the market and in business and financial services • Can be distinguished from social regulation which incorporates such areas as health and safety, food safety and quality, environmental health, pollution and consumer protection 5

6. To regulate or control? Regulatory approach associated with form of law and enforcement developed in the 19th and early 20th centuries. Criminal laws considered necessary to protect the public from dangers they could not protect themselves from Criminal sanctions were justified as deterrents. 6

7. To regulate or control? Difficulties in proving intent led to development of strict liability with regulatory offences being considered mala prohibita (wrong as prohibited) rather than mala in se (wrong in itself) Or not really crime but technical offences This developed into a discretionary enforcement style where criminal prosecution is used as a last resort 7

8. To regulate or control? • A regulatory approach is therefore associated with a minimal use of criminal sanctions • The debate hinges on which regulatory or criminal law can and should be used to control the activities of business • Involves a range of theoretical and political positions • Summarised as conservative, liberal and radical 8

9. To regulate or control? • Conservative is based on laissez faire and free market principles • Minimal regulation as market forces provide sufficient protection • Liberal views accept that regulation is necessary • Seeks a balance between regulatory and criminal sanctions • Radical takes the view that law and regulation are limited by the influence of business interests • Therefore criminalisation is necessary 9

10. To regulate or control? • Advocates of each, place differing emphasis on the aims of legislation • To regulatory approaches the main aim is to secure and maintain high standards of business and commerce • Enforcement therefore should be a balance between industry interests and public protection • Crime control approaches emphasise prosecution and punishment • To deter or incapacitate offenders • To secure justice and show society’s disapproval 10

11. To regulate or control? Croall (2003) 11

12. To regulate or control? Regulation incorporates self regulation Crime control stresses state regulation Regulation includes compensation, negotiation and out of court settlements Criminal justice deals with “punishment” and “justice” which is seen to be done. In practice regulators adopt a range of styles more a continuum 12

13. To regulate or control? • Arguments • Persuasive and cooperative strategies are said to promote good relationships based on mutual respect between business and regulators • Critics would say that such styles can lead to sympathy between the parties and “regulatory capture” (ie domination by vested interest who “capture” decision makers) • Approach of compliance rather than crime may undermine the symbolic role of criminal law • Leads to a class of offenders being treated more favourably 13

14. To regulate or control? • Arguments • Cooperative approaches assume that the majority of businesses are willing to comply and can be persuaded • Whereas others suggest that businesses are rational “amoral” calculators in the pursuit of profit 14

15. Financial regulation and crime control • Incorporates elements of both crime control and regulatory approaches • Many areas of financial regulation have shifted from self regulation to state regulation • Financial Services Act 1986 • Creation of Serious Fraud Office in 1988 • Creation of Financial Services Authority in 2000 • Seen as necessary to encourage investors and to protect them from the risks of a more open market

16. Aims of regulation • Laws covering serious fraud emphasise crime control but also reflect a wider concern with standards • “provide a regulatory framework within which commerce can function” Levi (1987) • Aims of the SFO are defined as “investigate and prosecute serious and complex fraud and maintain confidence in the probity of business and financial services in the UK” • This is similarly reflected in the objectives of the FSA ie “market confidence”

17. Strategies of regulation • Agency strategies reflect elements of regulation and crime control • SFO and the police in fraud cases stress detection and prosecution • In general however, most financial crime control is compliance based with arrest and imprisonment as subordinate • For example HM Revenue and Customs rarely prosecutes and uses out of court settlement and fines • The FSA also follows a similar approach

18. Respective merits • The government established the Fraud Trials Committee, an independent committee of inquiry, in 1983. • Chaired by Lord Roskill, it considered the introduction of more effective means of fighting fraud through changes to the law and to criminal proceedings. • It was the impetus for introducing the Criminal Justice Act 1987 and creating the SFO • Known as 'the Roskill Report' published in 1986.

19. Respective merits • Following this, discussions on the regulatory and crime control approaches stress high expertise needed in fraud detection and the evidential difficulties. • Consequent high cost of “risky” prosecutions • Makes regulatory sanctions attractive

20. Respective merits • Contrast situations: • Where evidence of serious dishonesty and high level of public concern for punishment. • The nature of the offence requires strong criminal deterrence • Regulatory action is more appropriate where the offence is seen as technical or in a “grey area”

21. Respective merits • Rosalind Wright (ex head of SFO) underlined the significance of criminal sanctions along with their moral and symbolic dimensions “… can provoke fundamental changes in attitudes and practices amongst businessmen and their advisers”. • Especially so of accountants and solicitors

22. Respective merits • Use of regulatory strategies in some areas has attracted widespread criticism • Low rates of prosecution and “scandals” such as pensions mis-selling • This undermines the moral and symbolic role of law • Suggests class bias along with a tolerance of activities such as lying cheating or stealing

23. Contested moral status of activities • While many forms of fraud are unambiguously criminal • Offences involving market regulation are often regarded as “technical” • However, what distinguishes “mis-selling” or “mis-description” of goods in fraud • What degree of deception is criminal? • Do regulatory offences not involve morality?

24. Contested moral status of activities • Moral ambiguity gives offenders a justification for resisting regulation • Insider dealing is an example where in court defendants argue “technical” nature and that they are following normal business practice

25. Effective regulation Regulation is generally agreed to work better where: • There is agreement between regulators and those regulated over the objectives of regulation • Where regulated are morally committed to compliance • Contentious legislation creates resistance and leads to unacceptable compliance ie letter and not spirit complied with

26. Effective regulation • A mixture of strategies and sanctions is available and used • Range of formal and informal sanctions • Regulators avoid “capture” • Pension mis-selling industry persistently denied wrongdoing • There is a single regulator with power over one industry • The US Federal Drugs Agency is regarded as very effective for this reason

27. Effective regulation • Within corporations, objectives are clearly communicated and structures support compliance • If compliance officers or internal audit are below status of sales department then profits are priority rather than standards • Paying commissions can also be problematic eg insurance mis-selling • “Incentivises lying as well as selling”

28. Does deterrence work? • The deterrent effect of criminal law is assumed to be greater in financial corporate and white collar crime • Potential offenders are assumed to be rational, making decisions by calculating costs of compliance or offending against costs of prosecution and sanction • ie Amoral calculators

29. Sources of consensus • Generally a broad agreement that control of crime in business requires a combination of approaches incorporating instrumental and moral dimensions • Suggests utility of Braithwaite’s Enforcement Pyramid

30. Enforcement Pyramid

31. Enforcement Pyramid • Defection from cooperation is likely to be a less attractive proposition for business when it faces a regulator with an enforcement pyramid than when confronted with a regulator having only one deterrence option. • This is true even where the deterrence option available to the regulator is a powerful, even cataclysmic, one. • It is not uncommon for regulatory agencies to have the power to withdraw or suspend licenses as the only effective power at their disposal. • The problem is that the sanction is such a drastic one that it is politically impossible and morally unacceptable to use it with any but the most extraordinary offences.

32. Different offences different approaches • Different levels of complexity and visibility • Different kinds of offenders • Those with “respectability” may be more deterred by public exposure • Others by threats to profits • Those attracted to the “thrill” are less amenable to deterrence • Amoral offenders • Stress moral unacceptability

33. Different offences different approaches • Large corporations present problems as they may be able to impede the work of external regulators and influence regulatory agendas by exercising influence over the law making process • “regulatory capture”

34. Moral or Amoral Calculators • Research has shown high standards of ethics amongst intending business persons • However, moral standards can be subverted within the corporate environment • Managers not “bad people” they can become “amoral chameleons” (Punch, 1996) • As employees they may face dilemmas in prioritising business interests over professional ethics in situations where they are expected to “find ways around the law” • Business may have differing moral codes and cultures of compliance

35. A range of sanctions? • The arguments suggest effective regulation requires a wide range of strategies and sanctions • Incorporating regulatory and crime control strategies • Takes account of instrumental and moral dimension • Some self regulation effective but must be backed by full range of sanctions which must be used

36. A range of sanctions? • Certainty of detection is a major feature of deterrence • Law is undermined if detection rates are low • Suggested (eg Rosalind Wright ex SFO) more resources for policing of fraud required • Need for central fraud agency • Lack of public stigma could be addressed by more publicity • Contrast with the developing US approach

37. Current Issues • Financial crime does not figure in government crime objectives • The formation of the Assets recovery Agency and the Proceeds of Crime Act 2002 have started to redress the balance • Creation of the Serious Organised Crime Agency in April 2006 will have a positive impact on reducing financial offences

38. Current Issues • Investigating financial crime has also been impeded by the absence in the UK of a statutory offence of fraud • The Fraud Act 2006 introduced in January 2007

39. Current Issues • The Act repeals all the deception offences in the Theft Acts of 1968 and 1978 and replaces them with a single offence of fraud (Section 1) which can be committed in three different ways by: • false representation (Section 2); • failure to disclose information when there is a legal duty to do so (Section 3); • abuse of position (Section 4).

40. Current Issues • The Act also creates new offences of possession (Section 6) and making or supplying articles for use in frauds (Section7). • The offence of fraudulent trading (Section 458 of the Companies Act 1985) will apply to sole traders (Section 9). • Obtaining services by deception is replaced by a new offence of obtaining services dishonestly (Section 11).

41. Current Issues • UK Fraud Review recommendations • National Fraud Reporting Centre • Increases in fraud related sentences • Formal system of plea management • Avoiding lengthy trials and resource expenditure

42. Global Approach • Financial Times December 12 2007 • “UK First for Price Fixing Charges” • There oil industry executives face first ever UK criminal prosecution for price fixing under a US deal. • Will plead guilty in Texas before travelling to UK to arrested and charged under the 2002 Enterprise Act • Global crackdown on cartels and price fixing

43. References Bowron, M. and Shaw, O. (2007) Fighting Financial Crime: A UK Perspective, IEA Economic Affairs, March. Croall, H. (2003) Combating Financial Crime: Regulatory Versus Crime Control Approaches, Journal of Financial Crime, 11(1). Hutter, B. (1997) Compliance: Regulation and the Environment, Clarendon Press, Oxford. Nakajima, C. (2007) Issues in Fighting Financial Crime, IEA Economic Affairs, March Punch, M. (1996) Dirty Business: Exploring Corporate Misconduct, Sage, London. 43