The “Do Something” Approach to Corporate Misconduct: Is law enforcement shutting the stable door after the horse has bolted?

Thursday, December 29, 2016 - 13:32
David N. Kirk

David N. Kirk

The past eight years since the global financial crisis have seen law enforcement in most jurisdictions trying to “do something” about the misconduct that got us all into such an economic mess. The bankers have been blamed by media, politicians and the public. There have been attempts to seek retribution, but little has been achieved. The public wanted to see wealthy bank directors strung up, or at least pilloried, for failing to spot the danger signs in the levels of toxic debt on their balance sheets, and for otherwise profiting from their egregious recklessness. Yet, in the United Kingdom, no one has been prosecuted. Will it be different next time?  When the next banking failures hit the economy, will there be criminal laws in place to punish the guilty?

The debate continues over who is guilty. Is it only the bankers or is it also the politicians who rode high on the illusory wealth of the nation, propped up by unsustainable debt? Is it the investors who were demanding – and enjoying – ever higher dividends? Or did we, ordinary members of the public, play a part in condoning and encouraging reckless banking while we borrowed beyond our means? By putting blame aside, it is perhaps instructive to see what measures authorities have put in place since 2008 to prevent it from happening again.

In the UK, the Parliamentary Committee on Banking Standards (PCBS) looked into all this in 2012 and had no doubt that the bankers were a bad lot who needed to be held to account. Accountability, indeed, has become the name of the game. The Senior Managers Regime (SMR) is in the process of being rolled out by the regulator across the financial services sector, with senior managers having to take a direct line responsibility for compliance issues. How this will work in practice remains to be seen, but early indications are that the regime is causing much soul-searching and concern at the board level and is having a deep impact on management behavior.

Another outcome of the PCBS’s deliberations was the introduction of Section 36 of the Financial Services (Banking Reform) Act 2013: “Offense relating to a decision causing a financial institution to fail.” If you are a senior banker of a regulated firm who makes a decision that causes the bank to fail, or fails to stop such a decision being taken, knowing that there is a risk that the decision will cause the bank to fail, you are guilty of a criminal offense.

It seems highly unlikely that such an offense will ever be charged and, if charged, that a conviction would result. The nature of decision making at senior levels in a bank is not a solitary occupation. There will be teams of internal and external advisors, as well as fellow board members, who will play their part in reaching a decision, and the analysis of that process will almost certainly be difficult to characterize as reckless. In addition, it is hardly likely that a large financial institution will fail because of a single internal decision: Failure will also be caused by external factors, including unforeseen changes in the economy.

The banks that built up dangerous levels of toxic debt in the run-up to the financial crisis were all following a policy that, at some stage, had seemed like a very good idea. Just as with the Libor scandal, it was not an isolated bank that made a reckless decision. On the contrary, all the major banks were marching to the same tune. At what point can you say that the joint thinking of many European and U.S. senior bankers that went unchallenged by regulators, and which, for some time, appeared to produce profits while supporting home ownership ambitions that governments have championed, has breached the section?

While it is not difficult to predict that this offense will never be successfully prosecuted, it is also fair to say that the existence of the offense will create an additional column in the risk register: Which senior board members will want to take the risk that their decisions will be judged to have been reckless? In providing an opportunity to review risk, like the SMR, it will remind senior directors of their duties.

Although the UK Bribery Act 2010 was not in any way a response to the financial crisis, it was introduced at a time when businesses probably thought they had enough on their plates. Not only was the economy limping along from the crisis but now a new piece of legislation refocused attention on the thorny topic of international corruption and made it even more difficult to do business in many parts of the world. The law enforcement fanfare that greeted the Bribery Act was considerable, and the UK has been congratulated for taking a bold step in the international war on bribery. In particular, Section 7 of the Bribery Act represents a step change in the approach to corporate misconduct by creating an offense of failing to prevent corruption. This was a wholly new concept in criminal law terms. It represented a move away from the traditional approach to corporate criminal liability of the “Identification Principle,” in which the directing mind and will of a company has to be identified with misconduct committed by or on behalf of a corporation. It has prompted companies to review their procedures and to ensure that they have adequate systems in place to prevent bribery. In other words, the Bribery Act has created a climate for better business ethics.

On the back of this new offense, the Criminal Finances Bill 2016-17, currently making its way through the legislative process, has introduced a similar offense of failing to prevent the facilitation of tax evasion, and attempts are being made to add an amendment to the bill creating another offense of failing to prevent economic crime. The UK Serious Fraud Office could have used such a law against the banks that permitted, and possibly encouraged, benchmark manipulation in relation to Libor and Forex. However, it was forced to decide that it could not take action under the “Identification Principle” because evidence of senior management knowledge of misconduct did not exist.

At the same time, a new way of dealing with the failure to prevent offense – and, indeed, other corporate offenses – has been introduced: the Deferred Prosecution Agreement. The DPA, which is a form of alternative dispute resolution imported from the United States, punishes corporate wrongdoing without creating the risk that the punishment will destroy the company and harm innocent third parties, such as employees, investors and creditors. It is also another way to improve corporate conduct by convincing companies that reporting their own misdemeanors to authorities demonstrates good governance and contrition and is a sensible alternative to burying their heads in the sand.

The problem with the “corporate offense approach to fraud is that companies cannot go to prison. The only possible sentence is a fine which can be said to have little or no impact or deterrence, which is an essential part of the criminal process. The public is unlikely to think that a company that receives a reduced fine and no conviction after negotiating a DPA has been punished. Individuals run companies, and individuals should be punished. A fine is just a cost of doing business. At the same time, the process of bringing a DPA before the court is cumbersome and time-consuming, meaning there is little benefit for law enforcement in terms of cost reduction and freeing up resources for other investigations.

What effect has this legislative and procedural activity had on the business community?

The combination of the SMR, DPAs, “failure to prevent” corporate crimes, and well-intentioned (but unprosecutable) offenses may be said to amount to a package of measures that might improve conduct over time while reducing the risk of serious damage to the economy and a consequent recession. Undoubtedly, there has been an increase in focus on the systems and controls of large businesses. Senior management has been forced to concentrate on governance and compliance issues. There are new approaches to anti-money-laundering processes. The private sector is working more closely than ever with law enforcement, to the positive benefit of both sides.

Will all this prevent another recession that is largely caused by the familiar combination of corporate greed and misconduct but which will inevitably be different in scale and scope from any predecessor? 

The idealistic fervor that accompanied efforts to “do something” about bad bankers is already being met by the inevitable counter argument that businesses must be allowed to take risks unbound by the regulatory red tape that prevents creative thinking and profit making.

David N. Kirk is a partner in the Government Investigations and White Collar Litigation department of McGuireWoods London LLP and former chief criminal counsel to the UK Financial Conduct Authority. He can be reached at