The New "Failure to Prevent Fraud" Offence.

The New “Failure to Prevent Fraud” Offence

On 11 April 2023, the Government published a factsheet and further clause amendments which set out the new proposed offence of “failure to prevent fraud”. The new offence will be included in the Economic Crime and Corporate Transparency Bill (more info HERE and HERE). The Bill is presently going through Parliament and has reached the Committee stage in the House of Lords.

The Government’s intention behind the new failure to prevent fraud offence is to make it easier to prosecute larger companies (described as organisations) where an employee or agent commits one of a specified group of criminal offences for the benefit of the business. This new measure has been debated for a long time and been the subject of a Law Commission Report. It is a further example of the Legislature’s use of the reverse drafting technique seen in the existing failure to prevent offences in the Bribery Act 2010 and to prevent tax evasion. It represents a further step ina the Government’s desire to reform corporate criminal liability in the UK. As the draft clauses in the Bill and accompanying factsheet set out, the new offence is designed to protect victims by driving a change in company culture by introducing fraud prevention procedures that hold companies to account if they profit from the criminal actions of their employees. The new offence does not change the position of individuals, like directors, who can still be prosecuted for any criminal offence they have committed.

The prosecution authorities, and specifically the Director of the SFO and the DPP, have long called for an amendment to the law to assist in proving criminal offences committed by companies. Naturally, this development has been welcomed as a further and important tool in fighting corporate fraud. Lisa Osofsky, the outgoing Director the Serious Fraud Office the principal prosecuting authority for serious business crime, regards the proposed change as being a “game changer for law enforcement – bringing the law on fraud in line with bribery” which will help them “crack down on fraudulent enterprises”.

Why the need for Change?

There has always been significant debate about how and when a company can be held to be criminally liable. Establishing a company’s criminal liability is handled differently in different jurisdictions around the world. At present in England & Wales, before a company can be convicted of a criminal offence the prosecution must be able to prove that the company committed the offence through the act of a human being (usually a director although it can be any individual) provided they are identified as being the controlling mind or directing will of the company. This is known as the identification principle. It has been an established principle of English law since 1972 and the Court of Appeal judgment in Tesco Supermarkets Ltd v Nattrass [1972] AC 153, [1971] 3 WLUK 144. In recent years, and specifically after the SFO’s very public loss in the Serious Fraud Office v Barclays [2018] EWHC 3055 QB [2020] 1 Cr.App.R. 28, the prosecuting authorities have expressed increasing frustration that they have not been able to identify individuals with sufficient control to successfully prosecute larger companies. This is often because in larger companies, management functions are frequently devolved, or complex management structures are in place that result in a more diffuse management arrangement, leaving no one individual having full oversight. As a result, it has been argued that the law should be changed so that larger companies can be held to account overcoming the apparent ‘hurdle’ that the ‘identification principle’ was said to have caused. This lobbying has now proved partially successful.

Key features of the new offence

Helpfully the Government has published a factsheet on the proposed new offence and below are the key features.

A. The Offence

• An organisation will be liable where a specified fraud offence is committed by an employee or agent, for the organisations benefit and the organisation did not have reasonable fraud prevention procedures in place to prevent the fraud.

It is important to note:

• A company can commit a criminal offence and be liable even where the company’s management did not order or know about the fraud, where it has not put in place adequate fraud prevention procedures.
• The proceeds of any criminal offence (criminal property) are also very likely to engage other criminal provisions, and specifically money laundering offences. However, the Government has deliberately altered its original draft clause and as of 11 April 2023 declined to include the principal existing money laundering offences. This is said to be because the suite of principal criminal offences in the Proceeds of Crime Act 2002 are working sufficiently well that the new offence does not need to capture them. No doubt they have also not been included because if a predicate criminal offence is committed by the company, including the new failure to prevent offence, the existing money laundering offences become relevant and may also be committed. Although the new clause in the Bill now excludes money laundering, the Bill itself does propose further amendments to money laundering offences (which are beyond the ambit of this present piece and require separate consideration).

The offences presently proposed in the draft Bill and factsheet that will be in scope for failing to prevent include:

• fraud by false representation (section 2, Fraud Act 2006)
• fraud by failing to disclose information (section 3, Fraud Act 2006)
• fraud by abuse of position (section 4, Fraud Act 2006)
• obtaining services dishonestly (section 11, Fraud Act 2006)
• participation in a fraudulent business (section 9, Fraud Act 2006)
• false statements by company directors (Section 19, Theft Act 1968)
• false accounting (section 17, Theft Act 1968)
• fraudulent trading (section 993, Companies Act 2006)
• cheating the public revenue (common law)

B. Which Companies will it Apply to?

Although the prosecution authorities and police have consistently argued that any proposed new offence of failing to prevent fraud should be of general application to all companies, at present the Government has clearly rejected that plea, and the proposed new offence is not so wide. The implication of the Government’s amended draft clause is that the problems associated with the identification principle said to have been present in investigations and prosecutions of larger corporations do not appear to have caused similar problems in smaller companies and SMEs. No doubt this is because in smaller companies and SMEs management structures are usually flatter, and the individuals responsible for making decisions sufficient to bind the company are more readily obvious. Consequently, the identification principle has not caused similar problems.

The Bill proposes that the offence is limited to larger organisations in the following way: It will only apply to an organisation that meets two of the three following criteria:

• More than 250 employees
• More than £36 million turnover
• More than £18 million in total assets

The accompanying factsheet states that the impact of the offence will be kept under review and the threshold at which companies are to be excluded can be amended through secondary legislation if required.

C. Jurisdictional Application

• The new offence will apply across the UK with equivalent offences in Scotland and Northern Ireland.
• The new offence will have extraterritorial reach. This means it can be committed by an overseas organisation (and the employee if overseas) where the employee commits a relevant fraud offence under UK law or targets UK victims.

D. Penalties

• A company convicted of this offence may receive an unlimited fine.
• A company, if convicted, may also be liable, under the present draft of the Bill, to a Serious Crime Prevent Order under the Serious Crime Act 2007.
• As per the other failure to prevent offences, this new offence will be one which is prone for a company to agree to as part of a deferred prosecution agreement (‘DPA’) under Schedule 17 to the Crime and Courts Act 2013.

The new offence will come into force when the Economic Crime and Corporate Bill receives Royal Assent.

E. Essential Guidance

The Government recognises that once the Act is in force it will need to publish guidance on what amounts to ‘reasonable fraud prevention procedures’ as it has done under the Bribery Act 2010. Such prevent procedures may in time require further consultation and refinement, but it will only be after the guidance is published that the offence will be enforced.

Once in law, the new offence and associated guidance, which is openly designed to bring about change in corporate culture, will become a vital consideration for boards. It will require every company caught by the ambit of the new offence to have in place an overarching policy aimed at the prevention of financial crime. To many large corporations and PLCs this will mean a revision or extension of their existing ABC and anti-financial crime policies. To some companies however, this change will create a new challenge, requiring a review of existing structures and compliance response. It is of note however, that all boards (whether of a large or small company) should be aware that if a company has an effective and proactive corporate compliance programme in place now aimed at the prevention of financial crime, that is a factor which the SFO already considers when assessing whether a company should be charged with a criminal offence. The argument that all boards should actively consider how they protect the company against the acts of their employees or agents affecting the company, if they have not already done so to date, now becomes even more compelling.