Are shareholders paying for company’s crimes?

Rolls-Royce and the Serious Fraud Office settled on a £497m deferred prosecution agreement following an investigation into over two decades of corruption and bribery. But are the senior executives involved being held accountable? 
by Heather Connon


When Rolls-Royce and the Serious Fraud Office (SFO) announced in January 2017 that they had entered into a deferred prosecution agreement (DPA), it was not just the size of the agreement that broke records. The £497m payable in penalties, costs and disgorgement of profits was the highest ever achieved by the SFO, but the scope of the investigation was also unprecedented. It spanned 23 years and more than a dozen countries, involved the review of more than 30 million documents using the expertise of 70 members of the SFO’s staff – as well as a smart robot to analyse the documents – and was negotiated by a team of six legal counsel, including two queen’s counsel.

Yet even this scope and size of investigation did not stop criticism of the SFO for letting Rolls-Royce off too lightly by failing to prosecute either the company or individuals implicated in the widespread bribery and corruption uncovered by the investigation – despite Lord Justice Leveson’s comments in his judgment that it involved “the most serious breaches of criminal law in the areas of bribery and corruption (some of which implicated senior management and, on the face of it, controlling minds of the company)”.

Nor is there much evidence of executive salaries and bonuses being affected. While Rolls-Royce has introduced provisions allowing it to claw back bonuses when bad behaviour is uncovered, this was not until 2014 – after the period covered by the investigation – so no retraction of bonuses paid has been possible. The firm’s 2016 annual report says: “In cases where employees have been dismissed or resigned as a result of Rolls-Royce’s own internal investigation, shares and incentives have been cancelled in full as a consequence of the termination of their employment.” But it also reveals a notable hike in bonuses paid to chief executive Warren East, despite two profit warnings in the space of a year.
Putting things right Such criticism is not entirely fair, however. First, the SFO is continuing its investigation and individual prosecutions are still very much possible – indeed, that is the key reason that no specific names have been disclosed. Rolls-Royce has carried out significant remedial work itself, cleaning out its boardroom and removing all management involved in bribery and corrupt practices. The SFO is pursuing prosecutions of executives involved in the cross-border corruption uncovered during one of the other DPAs agreed so far – the main reason that the company involved has still not been identified.

Furthermore, there is no guarantee that a traditional prosecution would have uncovered the full extent of the fraud, nor resulted in the radical reform of the company’s behaviour. Indeed, a DPA can actually bring more wrongdoing to light. One of the key requirements for a DPA, rather than a prosecution, is that the company co-operates fully with the SFO – something that Rolls-Royce took almost to extremes, as evidenced not only in the 30 million documents provided, but in its frank reporting of areas of concern, including those which the SFO did not know about. Moreover, the company did not seek to influence the case, nor tip-off anyone involved. The judge himself acknowledged that there was little more it could have done to put things right.
What is a DPA?
A DPA is an agreement between an organisation and a public prosecutor that results in criminal proceedings being suspended, and subsequently discontinued, on condition that the organisation complies with the agreed terms. These may include the payment of a financial penalty, compensation, co-operation with future prosecutions of individuals and the implementation of a corporate compliance programme. 

It enables an organisation to avoid the full impact of a criminal conviction. DPAs must be approved by the Court and are only available to bodies corporate, partnerships and unincorporated associations, but not to individuals.

Self-reporting of wrongdoing is usually crucial, although, in the case of Rolls-Royce, the wrongdoing was first uncovered through anonymous internet postings about its businesses in China and Indonesia. 

In addition to Rolls-Royce, there have been a further two DPAs carried out in the UK to date:

Standard Bank: Relating to a fundraising exercise for the Tasmanian government. The bank immediately set out to put things right when the fraud was uncovered, and it co-operated fully with the review. This resulted in financial orders of $25.2m, and a further $7m payable to the Tanzanian government in compensation. 

XYZ Plc: The company has not been formally identified as prosecutions of executives are ongoing. Again, the company itself uncovered cross-border corruption, which it took immediate steps to correct. These issues were, however, so significant in relation to the company’s size that prosecution would undoubtedly have caused its collapse; the DPA allowed it to carry on in business. This resulted in financial orders of £6.5m.

Lois Horne, a partner in litigation and dispute resolution at Macfarlanes, says: “The prospect of being offered a DPA is the best way to encourage the company to self-report and co-operate with the investigation. Without that, the extent of the criminal act may never be uncovered. Rolls-Royce itself went above and beyond in its investigation, looking into every jurisdiction, not just the one where the initial problem was uncovered. If the SFO had been investigating on its own, it may never have uncovered the extent of the misconduct.”
Protecting the business DPAs can only be agreed with companies, not individuals. The penalties can be significant, directly affecting the wealth of its investors. However, Horne points out that these shareholders will also have benefited from the inflated profits arising from the criminal acts through dividends – and, in the Rolls-Royce case, the announcement of a settlement actually sparked a rise in the shares, which added more to the total value of the business than the cost of the settlement. 

For the public at large, Horne points out that a prosecution can threaten the very survival of a business, potentially impacting employees and supply chains. Rolls-Royce, for example, would have been barred from doing business in many jurisdictions had it been prosecuted; XYZ Plc, the unnamed company involved in one of the other two DPAs in the UK would have collapsed had the financial implications of the cross-border corruption it uncovered been made public. The DPA meant it was able to carry on in business, safeguarding not only its own jobs, but those of suppliers, and protecting its contribution to tax revenues and thus society as a whole.
Ensuring accountability Despite the lack of prosecutions so far, the Rolls-Royce DPA compares relatively favourably to the outcome of other scandals, such as the financial crash and market manipulation uncovered in its wake. While they were a record for the SFO, the scale of penalties imposed on Rolls-Royce is still dwarfed by the huge bills for market manipulation of LIBOR and other market indices during the financial crisis: banks across Europe and the US have paid more than $9bn for LIBOR manipulation and a further $5.6bn for fixing foreign exchange rates. So far, 20 prosecutions have been pursued in the UK and in the US, with the SFO securing four convictions – although charges on six others were quashed. There has also been criticism of the lack of accountability of senior executives at companies such as HBOS, Lloyds and Royal Bank of Scotland, which had to be rescued by the government. While senior executives such as Fred Goodwin and James Crosby were stripped of their knighthoods, and a number of executives have been banned from holding office, there have been no prosecutions.
Investors do, however, want to ensure that senior executives are accountable. Peter Montagnon, a corporate governance veteran and associate director of the Institute of Business Ethics, says: “Accountability for what has happened to a company must reside with the corporate leadership. This is not necessarily a legal issue, but it is certainly an ethical one. The evidence shows that companies where the leadership sets high standards and consciously projects a good example tend to have less incidence of wrongdoing.”

That requirement is effectively enshrined in the Senior Managers Regime (SMR) being implemented by the FCA, which puts the onus on individuals in financial services to demonstrate that they are taking reasonable steps to ‘do the right thing’. Horne notes that the common theme between this regime and the corporate offence of failing to prevent bribery is: “one of business ethics where those responsible for the acts of a company need to take direct responsibility for what is going on in their business”.

The ultimate aim is for companies to become more ethical, to hold themselves to account and to acknowledge that they are individually responsible for what occurs in the business. If DPAs and the SMR help to achieve this, society will have been well served.
Published: 06 Apr 2017
  • Integrity & Ethics
  • The Review
  • integrity and ethics
  • financial crime
  • FCA
  • crime

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