Company Law: Illegalities

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1 Wrongful Trading

• Previous law extended by Insolvency Act 1986

• Previously, directors could only be liable for company’s debts where they were guilty of fraudulent trading – difficult to prove

• I.A. 1986 designed to give creditors increased protection

• An example of lifting the veil

• Directors (and sometimes others too) may be held liable when:-

  • Company has commenced insolvent liquidation

  • They knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation or administration

  • They held a position of power (director)

• On the office-holder’s application, the court may order a contribution to the company’s assets

• A director avoids liability by taking every step that ought to have been taken to minimise potential loss to creditors

2 Fraudulent Trading

• two offences under the name “fraudulent trading”

• a criminal offence under the Companies Act 2006, and

• a civil offence under the Insolvency Act of 1986

• the criminal offence applies to the situation where an entity has been set up

• or allowed to continue trading specifically with the intention of defrauding creditors

• penalty is a fine and/or imprisonment up to 10 years

• the civil offence applies when an entity is being liquidated

• where it becomes apparent that an entity has continued trading with the intention of defrauding creditors, the liquidator can take action against anyone who was knowingly a party

• if found liable, the Court may direct that those persons liable shall contribute to the shortfall in the entity’s assets in such amounts as the Court thinks fit

• The essential difference between Fraudulent Trading and Wrongful Trading is in the words ‘intent to defraud creditors’. In Wrongful Trading, there is no such intent whereas with Fraudulent Trading …

3 Money Laundering

• A process whereby the proceeds of criminal activity are converted into assets appearing to have a legitimate origin

• Usually involves 3 distinct phases

  • Placement of the funds into legitimate business activity

  • Transfer of money from business to business (or place to place) to conceal its original source

  • Integration – the money takes on the appearance of having come from a legitimate source

• Proceeds of Crime Act 2002 seeks to control money laundering by the creation of 3 categories of criminal activity

  • Laundering (maximum 14 years prison and / or fine)

  • Failure to report (maximum 5 years prison and / or fine)

  • Tipping-off in the regulated sector (maximum 2 years’ imprisonment and/or a fine)

• The offence of failure to report relates only to individuals acting in the course of business – for example, accountants

4 Policies, procedures and controls in relation to money laundering

Abbreviations in general use in the area:

AIM Alternative Investment Market

FATF Financial Action Task Force

FCA / PRA Financial Conduct Authority / Prudential Regulation Authority

JMLSG Joint Money Laundering Steering Group

MLRO Money Laundering Reporting Officer

5 Assessing risk for money laundering purposes

• Money Laundering Regulations require the accountancy profession to adopt a risk-based approach when considering the issue of money laundering

• the Regulations identify 4 types of risk arising from the

  • firm’s client profile – determines the sort of client activities that the firm’s personnel will be watching for

  • potential of new clients being involved in money laundering or terrorist financing – determines the level of initial customer due diligence work to be undertaken

  • ongoing activities of clients – affects the level of ongoing monitoring that will need to be applied to a client

  • firm’s internal procedures – affects the firm’s training and record keeping policies

• it is highly unlikely that the high-street practice in a small market town in the UK will encounter clients or business contacts involved in terrorist financing

• but it is equally likely that at least one of that firm’s clients is involved in tax evasion, fraud or theft (all are examples of money laundering)

• a firm’s policies and procedures should be sufficient to ensure that all members of the firm’s staff are aware of the sort of money laundering activities that they are likely to encounter

Examples of obvious instances where clients:

• deliberately fail to take action where their own customers have overpaid in the hope that that customer fails to notice their error (theft)

• falsify accounting information in order to obtain finance from a bank or money lending organisation (fraud by misrepresentation)

• such as solicitors or surveyors ‘borrow’ their clients’ money for their own purposes (fraud by abuse of position)

• fail to disclose information where required – for instance failure to provide all relevant information to an insurance company (fraud by failure to disclose)

  • tax evasion, theft and fraud are the three forms of money laundering most likely to be encountered by auditors / accountants

  • but firms should ensure that all members of staff are aware and alert to other types of potential laundering activities

• (It is increasing the case that police with production orders are visiting accountancy firms seeking information about clients that are suspected of serious criminal activity)

  • firms need to consider the nature of the client base. It is highly likely that a firm will have clients with geographical connections with other countries and this will affect the level of risk assessment for those clients individually

  • but where a firm has multiple clients from a particular country or area, this would affect the entire risk assessment policies and procedures for the firm

  • FATF monitors the effectiveness of the anti-money laundering regimes in countries across the World and publishes a list of non-cooperating countries and countries with weak controls

• FATF lists change frequently: consult the current official high-risk and increased-monitoring lists rather than memorising a frozen list

• Current high-risk jurisdictions: consult FATF’s current official list

The list changes regularly and dated country examples should not be treated as current

Jurisdictions under increased monitoring: consult FATF’s current official list

FATF updates its lists after each plenary

Use the current official list when assessing geographic risk

Historic examples should not be treated as current

Country risk remains one factor in the overall risk assessment

6 Initial client risk assessment

• different clients, even operating within the same field, will present different risk profiles

• consider the case of 2 clients operating as charities

  • the first, a small local charity funded largely by government grant, will pose little risk from a money laundering point of view

  • the second, a large charity collecting money from street collections and door-to-door collectors ready to send that money abroad to help relieve the suffering of people caught up in natural disasters – therein lies considerable opportunity for money laundering and even terrorist financing

• JMLSG has issued Guidance referring specifically to three levels of due diligence:

  • simplified due diligence

  • standard due diligence

  • enhanced due diligence

• JMLSG acknowledges that, where a firm has a client base that is substantially homogenous with only a restricted range of products and services, it could be appropriate to use a simple risk assessment model

• where this simple approach is not appropriate, many firms are adopting a risk assessment process that classifies their clients into high, normal and low level risk

• Guidance sets out specific instances where low level / simplified due diligence can be applied

  • instances include:

    • stock exchange listed companies including AIM listed

    • financial institutions

    • credit institutions

    • FSA registered clients

• at the other extreme, Guidance identifies situations where enhanced due diligence is mandatory

  • instances include:

    • clients that are politically exposed

    • clients that use products, services or entities that provide anonymity

• whereas most firms will not have politically exposed people in their client list, it is important to remember that political exposure relates not just to clients as individuals but includes also:

  • spouse

  • partner

  • children and their spouse

  • parents

  • known close associates such as business partners

• with reference to ‘anonymity’ mentioned above, this relates for example to people involved in offshore trusts in places such as the British Virgin Islands

• enhanced due diligence would be appropriate where the local regime is specifically designed to provide anonymity as in the BVI

• but even with enhanced due diligence, the Regulations are absolutely clear … if you don’t have adequate customer due diligence, you can’t act for that client

• Non-face-to-face contact and geographic links are risk factors assessed in context; apply enhanced due diligence where the Regulations make it mandatory or the assessed risk requires it

• it would seem appropriate when assessing risk for a new client to assume a standard level of due diligence unless circumstances would justify either a simplified level or an enhanced level

7 Record keeping and monitoring

• risk assessment is applicable not just at the stage of initial assessment of a new client – the initial risk assessment noted earlier

• it’s a continuous process

• subsequent ongoing monitoring should be a part of the assignment planning process to ensure that all assigned staff is aware of the money laundering risk

• even where initial assessment was simplified due diligence with no requirement to check the identity of individuals that manage or own the client entity, ongoing monitoring is still necessary

• this ongoing activity then links directly to a duty to report any abnormal suspicious activity

• how can we determine what is ‘normal’ and therefore what is ‘suspicious’?

• from the ‘know your client’ information collected on the audit client permanent file!

  • for example, for a client that has numerous customers in The Cayman Islands, regular and frequent trips to the Caribbean tax haven could be considered to be ‘normal’ activity

  • but for a client that owns a building supplies business, regular and frequent trips to Grand Cayman would more likely be viewed justifiably as ‘suspicious’

• still within the ‘know your client’ area, certain business activities carry with them an increased inherent risk

  • a client’s business may involve the purchase of used vehicles. These could be acquired for the purposes of being used as a source for spare parts, could be sold in the country of origin or could be exported

  • but what was the source of the vehicles that the client has acquired? Motor vehicle theft in the UK is not an unusual occurrence! And a stolen vehicle bought for cash can soon be stripped of its identity

• Regulations do not require additional steps of an accountant, but it is a requirement that accountants are aware of the potential for money laundering and terrorist financing opportunities

• that awareness then requires an accountant to consider whether the transactions inspected as part of normal work appear consistent with the accountant’s expectations, given knowledge of the client

• and, where the accountant comes across any activity that lies beyond those expectations, there is a positive duty to report it

• important to realise that the findings from initial risk assessment could well require amendment as circumstances change and this, in turn, may require a reconsideration of the level of due diligence that is appropriate together with the extent of ongoing monitoring

8 Exposure of the profession

• many regulations that face the profession tend to be routinely followed

• but, unlike most other regulations, the Money Laundering Regulations have the potential for criminal sanctions to be taken against the accountancy firm and its members in addition to them facing regulatory action from the ACCA

• criminal sanctions are relatively rare

• but action from the regulatory bodies and particularly the FSA appears to be increasing with substantial fines being levied against regulated entities and, in some cases, against individual MLROs

• firms should have appropriate and risk-sensitive policies and procedures designed to prevent the firm’s services being used to launder money

• remember, this includes tax evasion, theft and fraud

• Regulations specifically include the requirement to provide staff with ongoing training

• in the area of monitoring compliance with, and the internal communication of, the required policies, controls and procedures, firms should be able to answer these self-assessment questions positively:

  • if asked, would your staff know who is the MLRO, what are the firm’s procedures and where may these be found?

  • could you demonstrate that all staff have been trained on the regulations and given ongoing training on the recognition and dealing with suspicious transactions?

  • if you were to select a number of client files at random, would they all have a risk assessment and adequate customer due diligence for the entity, management and beneficial owners?

  • if you were to analyse the pattern of reporting of suspicious transactions, would it identify potential issues – for example would it identify where individuals or departments appear to have unusually high or low levels of reporting when compared with other individuals or departments with similar client fee bases?

• it must be tempting simply to buy a manual and treat that manual as the firm’s policies and procedures

• JMLSG Guidance states that the use of such a standard proforma would likely reflect adversely on the level of seriousness with which the firm’s management is dealing with the issue of money laundering and terrorist financing

• yes, accepted that a manual could very well be helpful

• but the policies and procedures contained within the manual should be tailored to the specific risks faced by the firm

• and who bears the responsibility for the firm’s compliance?

• initially, that responsibility is borne by the MLRO

• but legally it is the collective responsibility of all the principals within the firm

• and the consequences of failure adequately to assess risk and monitor effectively?

• there is considerable regulatory risk where a firm falls foul of the Regulations in addition to considerable reputation risk for both the firm and for the principals within that firm

9 Insider Dealing

• Insider – a person who has a business connection with a company as a result of which they may acquire relevant information

• Dealing – buying or selling shares or securities in a company

• Inside information is specific or precise, non-public information relating to qualifying securities or issuers

• There is no six-month age condition

• If made public, it would be likely to have a significant effect on price

• An insider in possession of unpublished price – sensitive information should not deal

• An offence is also committed if the insider encourages another person to deal

• A person dealing as a result of that encouragement, and believing the source to be an insider, is also committing an offence

• Disclosure of inside information, other than in the proper course of employment to an authorised person, is also an offence

• Some defences are available to be claimed

10 Bribery

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• Bribery Act 2010 targets both bribery and corruption

• 4 offences

  • bribing another person

  • receiving a bribe

  • bribing a foreign public official (FPO) (see next page)

  • commercial organisation failing to prevent bribery (see next)

• bribing = offering financial or other advantage to perform a relevant function or activity improperly

• relevant function or activity:

  • any function of a public nature

  • any activity connected with a business

  • any activity performed in the course of a person’s employment

  • any activity performed by, or on behalf of, a group of persons

• these “relevant functions or activities” may be anywhere in the world

11 Bribing an FPO

• offence to offer, directly or indirectly, a financial or other advantage to an FPO intending to influence them in gaining business or an advantage in connection with business

• an FPO holds an administrative, legislative or judicial position outside the UK

• commercial organisation failing...

  • a company or partnership is liable if an agent, employee or subsidiary bribes another person intending to gain a business advantage

• Defence - if a company can show that it had adequate procedures in place, appropriate to the level of risk

  • “adequate procedures” based on six guidance principles

12 The Six principles

• proportionate procedures

  • proportionate to risks faced and size of company

• top-level commitment

  • risk assessment

• due diligence

  • the company should apply due diligence procedures in respect of company personnel who are at greater risk of offering bribes

• communication

  • to ensure all employees / connected persons are aware of the company’s culture and attitude

  • includes training and education procedures

• monitoring and review

  • procedures should be regularly reviewed and improved as necessary

• “adequacy of procedures” is a matter for a court to decide

• NB “hospitality” that is reasonable and proportionate is acceptable, ie is it not prohibited by the Act.

13 Penalties

• an individual who is found guilty faces imprisonment up to 10 years

• a guilty company is liable to an unlimited fine

• but, in addition, there is reputation loss...

• ... and potentially, civil claims against the directors for failing to implement adequate procedures

14 First conviction

• Munir Patel found guilty of accepting £500 to suppress a driving conviction from court records. Serving a 3 year prison sentence

15 Facilitation of Tax Evasion

• Under the Criminal Finances Act 2017, ‘relevant bodies’ (including firms of accountants and auditors) may be held liable if they fail to prevent individuals associated with them from facilitating tax evasion. So, if an employee or agent of, say, a firm of accountants engages in actions that are designed to help others to evade taxes, the accountancy firm itself can face legal consequences.

• The defence is that reasonable prevention procedures were in place, or that it was not reasonable in the circumstances to expect such procedures

• Failure to prevent fraud — under the Economic Crime and Corporate Transparency Act 2023, a large organisation is liable where an associated person commits a specified fraud intending to benefit it, unless it had reasonable prevention procedures or it was unreasonable to expect them. Large means meeting at least two thresholds: more than 250 employees, more than £36m turnover and more than £18m total assets

16 Summary

• In summary, companies must exercise vigilance in their operations and management in their efforts to prevent the occurrence of all the above six fraudulent activities. Failure to be so vigilant may lead to severe legal consequences for both the organisation itself as well as for the offending individuals.