UK: The Final Whistle on Fraud

Last Updated: 15 March 2004
Article by Mark Surguy

Corporate fraud is big news once again with Parmalat and the claim against the Bank of England arising out of the collapse of BCCI. The "whistle-blowing" legislation (the Public Interest Disclosure Act 1998) provides protection to an employee if he chooses to report an internal fraud and as a result suffers victimisation or loses his job. In the case of dismissal, it is automatically unfair as the legislation confers protection on employees who choose to blow the whistle. However does the law ever oblige an employee to report a fraud?

If the answer is Yes, then it raises all sorts of issues. Firstly what happens if, as an employee, you don’t report it? And if you are obliged to file a report, to whom should it be made - the police, the company's lawyers, the auditors or to the company itself? Secondly, do you have a duty of confidentiality? Is reporting a suspected fraud a breach of confidence? If so, could that be a defence to a claim that you should have reported but didn’t?

You could be forgiven for fearing that if you make a report of suspicious behaviour, which then proves capable of innocent explanation, your job prospects and working relationships will be damaged. On the other hand, if there is a duty to report and you don’t, could you be sued for the loss to the company caused by someone else's dishonest behaviour?

The case of RGB Resources (in liquidation) v. Rastogi & Ors [2002] EWHC 2782 (Ch) has helped shed some light on these difficult questions. This case concerned a certified accountant who was employed as a financial controller of an unlisted public limited company. He was not on the board. The chief executive officer, deputy chief executive officer and a third executive director were all implicated in the misappropriation of several hundreds of millions of dollars of loan capital. The company (through liquidators) took action against the directors and against the financial controller for the recovery of the misappropriated funds.

The financial controller's case was that he had not been involved in any of the unlawful activities of the others and had been unaware of what was going on. The company's position was that as a senior executive, the financial controller was subject to a duty to make enquiries about the suspicious conduct of the other directors and should have taken steps to prevent dishonest activities affecting the company. The company also claimed that the financial controller was liable to disclose these activities both internally and externally and had failed to do so.

If such duties were held to exist, then it was not disputed they had not been complied with. Accordingly, depending on the court's ruling, this senior employee's personal assets could be exposed to very substantial claims.

Whilst stating that there is no universal duty to investigate suspected fraud, the court said that there may be such a duty in particular cases. Its existence will depend on the contractual duties of the employee in question. The court suggested that a general manager would be under a duty to investigate whereas a more junior employee may not necessarily be under such a duty. The court held that based on the facts of RGB, the financial controller was liable to investigate, because he was akin to an internal auditor with contractual duties to monitor the business, to prepare audit files for the external auditors, and to liaise closely with those auditors. When such a duty to investigate arises, there is also a corresponding duty to investigate promptly.

The court also clarified that it would not be a breach of confidence for one employee to report the wrongdoing of another.

Following this case there are a number of factors which will point towards the duty arising:

  • The more senior the reporting employee, the more likely the duty will arise.
  • The more senior the employee whose conduct is under suspicion, the more likely the duty will exist.
  • The more serious the conduct in question, the more likely it is that the law will uphold the existence of a duty.
  • The more serious the adverse effect on the company, the more likely it is that the duty will arise.

This duty to report a fraud clearly extends to reporting on superiors as well as on inferiors, though it is plain that to be caught by the rule, the employee must have some kind of supervisory function. Managers clearly cannot stand by and take no action. Internal auditors are likely to be treated in the same way.

As to whom to report the fraud, the court's ruling was that there should be a report to the board or at least to an honest member of the board. If financial wrongdoing is suspected (which will almost always be the case with a fraud), a report has to also be made to the company's external auditors (the auditor is of course an officer of the company) and if necessary to the police.

In summary, whether a duty to report and investigate exists will depend on your client's role within the organisation, the nature of the suspicious conduct, and the identity of the perpetrator. Your client may be obliged to monitor the deceptive activities, make an internal report and possibly to involve one or more outside bodies. Failure to comply promptly with these duties could be costly. A client could be caught up in legal proceedings, which could render him unemployable until the proceedings have been resolved and their personal assets exposed as a result of doing nothing.

In such a tricky area the safest course of action for a client is to have recourse to the confidence of legal advice, where full and frank discussion can take place and appropriate decisions can be reached after careful reflection of the factual evidence and consequences. Such advice would be privileged and would remain so even if adversarial proceedings in relation to the offending conduct were not in contemplation.

(As recently published in New Law Journal)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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