Business Financial Crime: Issues in Fighting Financial Crime

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Business Financial Crime Issues in Fighting
Financial Crime
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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

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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

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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)

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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

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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.

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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

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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

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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

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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 societys disapproval

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To regulate or control? Croall (2003)
Regulation Crime Control
Aims Securing and maintaining standards Securing compliance Protection prevention Prosecuting and punishing Deterrence Justice Moral condemnation
Strategies Persuasion Cooperation Self regulation Private remedies Prosecution Conflict External/state regulation Public justice and punishment
Arguments Persuasion and cooperation are More effective Offences complex Evidential difficulties Cost/resource factors Less effective because Low prosecution rates Regulatory capture Injustice
Assumptions The activities regulated are The regulated are Not really crime Willing to comply Really crime Amoral calculators
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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

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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

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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

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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

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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

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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

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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.

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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

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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

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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

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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

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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?

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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

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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

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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

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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

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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

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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 Braithwaites Enforcement
  Pyramid

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Enforcement Pyramid
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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.

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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

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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

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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

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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

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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

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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

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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

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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).

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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).

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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

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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

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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.

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