When a business discovers possible fraud or corruption in its organisation, there will often be questions about why this had not been revealed in previous audits. Amongst the difficult considerations the business will need to take into account, as to its potential liability and whether it needs to self-report, a Court of Appeal case gives welcome guidance as to who may, or may not, be liable for certain offences relating to the provision of information to auditors.
What was this case about?
In late 2011, a $1.7bn fraud by camera maker Olympus Corporation came to light when the British Chief Executive investigated the accounts and reported what he thought was stolen money. In fact, it transpired that the company had hidden losses in its accounts for 13 years.
The Japanese authorities investigated and the company was convicted in both regulatory and criminal proceedings. Three directors were also convicted, one of whom was also a director of subsidiary company Gyrus Group Ltd, a UK company. The Serious Fraud Office was not able to bring a prosecution against the directors in the UK, as they could not be extradited from Japan. However, it brought a prosecution against the two corporate entities (Olympus and Gyrus), relating to documents that had been provided by the director of Gyrus to its auditor.
What was the alleged offence?
Gyrus and Olympus were charged various counts of making a statement to an auditor which was misleading, false or deceptive, contrary to section 501 (1) of the Companies Act 2006 (the “Act”).
Though the facts were admitted, the two companies argued that s.501 (1) only applies to certain categories of persons who may be required to give information to auditors, which did not include them. Those categories of persons are set out in section 499 (2) of the Act.
Section 499 gives auditors a general right to access a company’s books, accounts and vouchers, and stipulates that an auditor may require such information or explanations as he thinks necessary for the performance of his duties. Subsection (2) provides that this information can be obtained from the following persons:
“(a) any officer or employee of the company;
(b) any person holding or accountable for any of the company’s books, accounts or vouchers;
(c) any subsidiary undertaking of the company which is a body corporate incorporated in the United Kingdom;
(d) any officer, employee or auditor of any such subsidiary undertaking or any person holding or accountable for any books, accounts or vouchers of any such subsidiary undertaking;
(e) any person who fell within any of paragraphs (a) to (d) at a time to which the information or explanations required by the auditor relates or relate.”
The parties agreed that the court should be asked to determine as a preliminary question the meaning of “person” in s.501 (1) of the Act.
What did the court decide?
The High Court judge Eder J, found that the definition of “person” was limited to the category of persons listed at s.499 (2), and therefore did not include the company itself, because:
- the more natural construction is that s501 (1) refers back to s.499, since it refers to providing information that “the auditor requires, or is entitled to require, under section 499”;
- section 501 (3) states that “A person who fails to comply with a requirement under section 499 without delay commits an offence unless it was not reasonably practicable for him to provide the required information or explanations.” It would be odd if this subsection had a different scope and meaning to subsection (1);
- the heading of the section makes it clear that s.501 is intended to prescribe the offences that may be committed in relation to the auditor’s rights to information; these rights are set out in s.499;
- this interpretation is consistent with the overall scheme of, and pattern established throughout, the Act. As Eder J held: “this responsibility is enforced with criminal sanctions which attach, not to the general population, but to the same, specified categories of persons with whom the duty rests.” He added that, “Where the intention is to make the company…responsible for a particular obligation, this is explicitly stated. Where the intention is to impose criminal liability on the company for default [of] those obligations, this is explicitly stated too.” (Paragraph 23 (v) and (vi), judgment); and
- the various pre-Companies Act 2006 iterations of the right of auditors to the information, and the corresponding offence, supported the defendants’ case.
This decision was appealed to the Court of Appeal, which upheld the High Court’s decision on this issue.
Did the information supplied amount to a “statement” under section 499?
As an alternative to its primary argument, the two companies argued that the director’s report and financial statements that had been supplied to the auditors, and on which the Crown based its prosecution, did not amount to a “statement” within section 499. This was because section 499 enabled the auditors to obtain information in order to be able to report on the company’s annual accounts: they argued that section 499 did not, therefore, apply to the annual accounts themselves.
In the event, the High Court did not need to decide this issue, as it had determined that Gyrus could not be convicted under s.501 (1). However Eder J addressed the point anyway: he was not persuaded by Gyrus’ argument that the director’s report and financial statements could not as a matter of law be caught by section 499. He held that whether the documents in question did fall within s.499 would depend on the particular facts and fall to be decided at full trial.
This point was also appealed to the Court of Appeal, which again agreed with Eder J’s first instance decision. It held that, for example, information contained in a marginal or covering note might qualify as information that the auditor would be entitled so seek, so bring that document within the scope of section 499, but that it would need to be decided on the facts whether this was indeed the case.
What did this mean for the prosecution?
Eder J in the High Court had concluded that the “prosecution is inevitably doomed as a matter of law“. As a result of its appeal being dismissed, on 10 November 2015 the Serious Fraud Office offered no evidence against the Defendants, and the charges were dropped.
There are other offences that a company might feasibly be convicted of where it has given misleading information to its auditors (for example under the Theft Act 1968). It is not clear why alternative offences were not brought in the present scenario – perhaps because the Crown could not prove a gain or loss arising from the offending conduct.
What does this mean for companies?
The fact that a company cannot be convicted under section 501 for providing misleading information to its auditors will give a degree of comfort to business that uncover what appears to be an historical fraud. However, this is far from the end of the story. Depending on what is revealed, other offences may have been committed, which may carry much larger potential sanctions.
The most important thing will be to obtain clear advice early on of the risks presented, so that all of the options, including self-reporting and potentially seeking a Deferred Prosecution Agreement, can be considered while they remain viable.