A look at the complex area of fraud

Press, 6 July 1988, Page 37

A look at the complex area of fraud

Fraud is an emotional subject. Anyone who has lost money through the sharemarket crash or in some dubious business deal feels, quite understandably, that they have been defrauded.

But fraud, especially corporate fraud, is a very complex area. The inclusion of fraudulent conduct in the criminal law requires a legal system of some sophistication. As late as 1704 the Chief Justice of England held that it was not stealing where the defendant obtained £2O from the complainant by pretending that he was collecting it on behalf of some other persons. The Chief Justice asked: “Shall we indict one man for making a fool of another?”

After a few decades the question ceased to be rhetorical. In 1757 Parliament created the statutory offence’ of obtaining property by false pretences. That offence survives in its. substance in New Zealand’s Crimes Act.

Over the years many more statutory offences have been created, largely in response to changing ways of doing business.

This is an area where the legislature cannot be proactive. It needs to know what is happening in the marketplace, and to define what is unacceptable in light of that information. If it does not do this, it will end up passing irrelevant laws or, worse, laws which are so widely drawn that they stifle all business activity, the legitimate as well as the illegitimate. The first problem then is the legal definition of unacceptable commercial conduct. This is a continuous process, requiring an ongoing examination of commercial conduct.

The other problem is of enforcing the laws which are made. The enforcement of laws against fraud raises very special problems. In a sense the two problems, that of legal definition and of enforcement, are intertwined. A policeman on the beat witnesses an assault. It is immediately apparent to him that an offence is being committed. He arrests the offender and later on he will give evidence in court about the incident. Cases of fraud are very different. There is usually no particular, easily recognised act which is outlawed. It is the way or the manner in which the act is carried out that is prohibited.

In fraud we are concerned with an apparently legitimate commercial operation being used for illegitimate purposes. In many situations it is very difficult to unravel operations and transactions to discover the fraud. Fraud is often a subtle activity and this calls for innovative laws.

In this area legislators must proceed with great

care to ensure that acceptable commercial activity is not criminalised or stopped. Otherwise we run the risk of throwing out the baby with the bathwater.

At present, the law attempts to distinguish the acceptable from the unacceptable. In the definition of false pretences in section 245 of the Crimes Act, there is the following provision: “Exaggerated commendation or depreciation of the quality of anything is not a false pretence unless it is carried to such an extent as to amount to fraudulent misrepresentation of fact.” Now sales talk is a natural and . inevitable phenomenon of the marketplace. It would be a sad society that penalised salesmen for articulating “untruths” such as: “This is the car of your dreams.” On the other hand, the provision recognises that sales talk can amount to fraud. The law has to find a cut-off point to distinguish talk which should be tolerated in a free society from deception which cannot be tolerated. The test which judges have adopted is whether the falsity can be proved as a positive fact or whether it can only be proved by the opinion given by an expert, in which case it will not be a false pretence. For example, someone who knowingly claims that a ring has diamonds in it, when the stones are only cut glass, would be guilty of a false pretence. The statement can be proved on the facts to be false. But a statement that a certain article is as good as another is usually a matter of opinion and as such would not be a false pretence. If someone borrows money with no intention of repaying it, that is a false pretence. But that does not mean that people who cannot or will not repay their debts are all fraudulent. The Crimes Act makes this quite clear: “Where the representation is in the form of a promise, the existence of an intention not to perform the promise shall not be inferred from the fact alone that the. promise is not performed.” What has to be shown is

that the borrower had no intention of repaying the loan at the time it was taken out. That intention needs to be proved beyond reasonable doubt, that is by the generally applicable standard of proof in criminal cases. If that were not so, our prisons would be filled with people who cannot meet their commitments, many of whom would be totally innocent. How then should legislators get on top of fraud without turning the country into a police state and without shutting down the marketplace? There are already signposts in our law that we can follow.

The first point is that we can specifically aim provisions at companies and at business people. We are perfectly entitled to expect higher standards from the business community. It is a matter of setting the standard with optimal specificity. This means that every player knows what the rules are, but that the provisions are not so detailed that people spend their time looking for loopholes. The Fair Trading Act, 1986, contains a general rule that no person, in trade, shall engage in conduct that is misleading or deceptive. A contravention of this norm does not by itself constitute an offence. It is too general for that. But those who have been harmed by contravening conduct have a civil remedy. It is not unreasonable to impose higher standards on companies and officers of companies. The limitation of personal liability is a privilege conferred by the State. Its abuse by dishonest or reckless conduct should attract sanctions and, in proper cases, the complete withdrawal of the privilege. The other road ahead is greater reliance on civil, rather than criminal sanctions. In part this is a consequence of setting a higher standard of conduct for the business community. Reliance on the civil law is desirable because there should only be a limited number of crimes of recklessness; and crimes of negligence should be very few.

Taking civil action also ensures that many more cases are brought to a successful conclusion. Criminal trials of difficult company fraud cases are very time consuming. They often take years to prepare and months to run. This is because they are not concerned with a simple act but with a series of transactions each of which has to be proved to the appropriate criminal standard, and to a jury without any background in business matters.

I am not saying that we should not run such trials. They have their place. Three major company fraud trials in recent years, JBL. Pacific Syndi-

cates and Universal, all secured convictions. What I am saying is that we cannot exclusively rely on them to contain corporate fraud.

Under the Companies Act former officers of a company being wound up can be ordered by the court to assume personal responsibility for the company’s debts where they were: • Knowingly a party to the carrying on of any business of the company in a reckless manner. , • Knowingly a party to the carrying on of any business of the company with intent to defraud creditors or for any fraudulent purpose. 0 Knowingly a party to the contracting of a debt by the company and did not, at the time the debt was contracted, honestly believe on reasonable grounds that the company would be able to pay the debt when it fell due. The sanction of personal liability is potentially powerful. It has been applied on several occasions in recent years. It may be possible to make it considerably more effective by having a “reverse onus” provision. Where investigations revealed that a former officer’s conduct was fraudulent, as understood by the Companies Act, the officer would then be required to establish why he or she should not assume personal responsibility. This may sound draconian. But it is consistent with requiring high standards from the business community and with using alternative remedies to the criminal law, which is of limited help in this area.

It is not acceptable for former officers of companies to walk away from their companies, investors, and creditors and to do nothing other than challenge the authorities to prove matters which are peculiarly within the knowledge of those company officers. They should be required to co-operate actively with the investigating authorities. The way to get on top of commercial fraud is to monitor the market place and to review the laws to ensure that they are adequate,. not occasionally, but continuously. We are doing this. This year there will be legislation:

0 To provide remedies against insider trading; 0 To require disclosure of the true ownership of listed shares by nominees;

0 To provide a regulatory framework for trading in futures contracts; OTo provide regulations for contributory mortgage schemes. At the same time the Companies Act is being reviewed by the Law Commission. The Justice Department is producing a new Crimes Act. In this way we are keeping our laws up to date and effective.