Following the advent of the credit crunch, the past seven years have not been kind to the world’s corporate governance guardians and financial watchdogs. Still heavily armed with powers they once failed to use, regulators have beefed up their manpower and are taking bolder steps to explore company wrongdoing and make their presence felt.
According to research by financial services consultancy Kinetic Partners, between 2006 and 2013, the U.S. Securities and Exchange Commission (SEC), the U.K. Financial Conduct Authority (FCA) and Hong Kong Securities and Futures Commission (SFC) increased their numbers of employees by around 22%, 53% and 51%, respectively. During that same period, these agencies also increased their overall expenditures by 62%, 48% and 120%.
As regulators seek to improve their investigations and prosecutions records, there are worries that this more proactive approach may sometimes be too heavy-handed. There have been instances of regulators “over-reaching” in pursuit of a prosecution, and even some examples of outright abuse of power to try to secure convictions.
The most obvious examples of such behavior are in emerging markets, where the degree of corruption can be more endemic: stories abound of Russian tax authorities carrying out politically motivated investigations, for example, while the U.S.-China Business Council said this September that China’s antitrust regulators strong-arm companies not to use lawyers during probes and to “admit guilt” and “make statements without being informed of the grounds for investigations.”
Cases of improper regulatory conduct also occur in developed markets. Furthermore, lawyers say there may be many more cases that are unreported because the firms being investigated may not have been aware of their own legal rights or that the regulatory and enforcement agencies were exceeding their authority.
Examples of companies or individuals successfully taking on a regulator or prosecuting authority are rare. Companies usually just settle—hopefully without admitting liability—or maybe win on a procedural technicality, but they seldom receive an apology or, even less likely, any money. As a result, very few companies bother complaining.
For example, the Tribunal, the primary method of challenging enforcement decisions of U.K. financial services regulator FCA, has upheld only 13 out of 81 (16%) challenges brought since 2003, according to research by law firm Freshfields Bruckhaus Deringer. For regulated firms, while 907 disciplinary enforcement notices were issued between the regime’s introduction in 2001 and May 2014, there have only been 17 challenges in the Tribunal, of which a mere four were successful. The last victory was in 2008.
“The statistics highlight how infrequently firms are willing to take on the financial regulators and how difficult it is to overturn regulatory decisions when firms or individuals do so,” said Simon Orton, a dispute resolution partner in Freshfield’s London practice.
There have been some notable victories, however. In October 2011, a Manhattan federal appeals court ruled that Wall Street regulator the Financial Industry Regulatory Authority (FINRA) did not have the right to take its members to court to enforce disciplinary actions. The ruling came after a 14-year fight waged by Fiero Brothers, a small penny-stock brokerage firm, and owner John J. Fiero. The regulator had accused the firm of short-selling, fined it $1 million and barred Fiero from the market. When the company refused to pay, FINRA tried to collect the money in federal court—a move that the U.S. Court of Appeals for the Second Circuit ruled exceeded its powers.
In April 2008, the U.K.’s Office of Fair Trading (OFT—now part of the Competition and Markets Authority) agreed to pay supermarket chain Morrisons £100,000 ($151,400), plus legal costs, to settle a libel action after the competition regulator had named the company as part of its investigation into an alleged milk cartel. Morrisons denied the allegations.
The OFT—which had the capability to fine guilty parties up to 10% of global turnover—admitted that it incorrectly suggested that Morrisons had been the subject of a provisional finding of infringement in relation to milk, cheese and butter pricing between 2002 and 2003, and that the supermarket had previously been warned by the OFT against anti-competitive behavior. In fact, the OFT had not made any such finding of infringement against Morrisons, nor had the chain been accused of any price-fixing activity after 2002 or been warned about any such practices.
Such a remedy is unlikely to be available now. Under the terms of the new U.K. Defamation Act 2013, companies must prove that a “serious financial loss” has occurred as a direct result of the defamation before even bringing a case. Companies in other countries face similar barriers when trying to bring a defamation claim as regulators and enforcement agencies are usually given immunity from legal claims in the pursuit of their work.
Victories Against the Regulators
Not all regulatory actions come down in favor of the regulator. In some instances, organizations have found success by fighting back:
Last summer, the U.K.’s Serious Fraud Office (SFO) agreed to a combined £7.5 million ($8.3 million) civil settlement with property tycoons Robert and Vincent Tchenguiz. The brothers were targeted by the SFO in a March 2011 raid over the running of holding company Oscatello, one of Icelandic bank Kaupthing’s largest debtors when the bank collapsed. It was later revealed that the search warrants relied heavily on documents provided by accountants Grant Thornton, whose liquidators Steve Akers and Mark McDonald were representing Oscatello. SFO director David Green said, “The SFO deeply regrets the errors for which we were criticized by the High Court in July 2012,” adding that “the SFO has changed a great deal since March 2011.”
In 2008, the Australian Pesticides and Veterinary Medicines Authority (APVMA) enlisted the Australian Federal Police to raid agricultural chemical company Imtrade Australia’s Perth premises after the company gave a fictitious name and address in China as the manufacturer of certain active constituents in its products. The company claimed it did not want the information made available to its competitors, but the regulator threatened criminal sanctions, plus cancellation of the approval of the active constituents and products associated with the false information. Two weeks later, the APVMA imposed a compulsory recall of 47 of the company’s products, and notified Imtrade that the items were no longer registered because they were affected, procured or induced by fraud.
However, the Australian Federal Court later found that the APVMA had acted unlawfully by removing the products from the approved products register, and subsequently ordered their reinstatement. False information had not been relied upon to approve the products, it said, but was merely collected as required. Simply providing incorrect information did not give the regulator the right to recall the products the way it did, the Court ruled.
In 2010, the European Court of Justice (ECJ) ordered the European Commission to pay French electrical equipment manufacturer Schneider Electric compensation for costs directly incurred as a result of a merger investigation. The ruling showed that the Commission could be held liable for damages for losses caused as a result of mergers that are unlawfully blocked. The victory was a pyrrhic one, however: the company was originally looking for €1.7 billion ($2.6 billion) in damages and costs, but it received just €50,000 ($75,000).
While these examples illustrate that the regulators acted incorrectly, they do not show that the agencies acted with malice or any deliberate attempt to entrap. Yet there are instances of such misconduct occurring as well. In April 2003, Pan Pharmaceuticals was a listed company worth about AUS$350 million ($285 million) when it collapsed after Australian regulator the Therapeutic Goods Administration (TGA) ordered a recall of its products. The company sued the government for misfeasance and was awarded AUS$55 million ($44.7 million) in damages in 2008. The court was told of one meeting where a TGA officer said it should “go for the jugular” when investigating the company. In 2011, customers, distributors and retailers of Pan products whose businesses had been affected by the recall won a class action settlement for AUS$67.5 million ($54.9 million) against the government and TGA.
In March 2013, the U.K.’s former financial services regulator, the Financial Services Authority (FSA), was forced to apologize to U.K. oil broker PVM Oil Futures after FSA Complaints Commissioner Sir Anthony Holland found that the regulator’s markets and supervisory staff misled the company about the purposes of a meeting the previous year so that it could obtain evidence to support an enforcement case.
Furthermore, the FSA demanded the removal of its lawyer, Sara George, a regulation and commercial litigation partner at international law firm Stephenson Harwood who had worked as a FSA lawyer herself from 2002 to 2006, so that it could continue questioning PVM without her present. The regulator also exerted pressure on PVM to withdraw a truthful and accurate account of events and to concede supposed wrongdoing, threatening staff with jail even though no criminal offense had been committed.
PVM and George complained to the FSA, but the regulator’s initial investigation exonerated the staff involved and criticized George’s behavior. Consequently, George and PVM decided to refer the matter to the FSA’s complaints commissioner. Holland reversed the decision after reading email conversations among the FSA staff that the first investigation did not see, concluding that the regulator’s conduct was “unprofessional and lacked integrity” and upholding all aspects of the complaint. He also found that the FSA’s evidence came “perilously close” to “bad faith,” a concept that is defined as an act designed to deceive or mislead in order to gain advantage. “We were clearly the subject of bullying and unethical behavior by a regulator,” said PVM Managing Director Robin Bieber.
The FSA said in a statement, “We believe that the decision to not disclose the dual purpose of the meeting was a mistaken judgment in this case, [but] we do not believe the judgment was the result of a lack of integrity.”
George was unimpressed, however, and warned companies—and their lawyers—not to take a regulator’s inquiries at face value. “You don’t need to be legally qualified to know that you can’t lie to people and deliberately try to entrap them,” she said. “If clients do not have legal representation, who knows how far a regulator may go to make an example of them? My experience has taught me not to trust anything that a regulator does with regard to a client. Lawyers need to ask questions regarding the reason for any interview or investigation, and how that process is being conducted. Don’t just rely on a regulator’s ‘goodwill’ to do the right thing; be aware of your legal rights and use them.”
“You need to work with the regulator, rather than against it,” said Philippa Hann, financial services litigation partner at law firm Clarke Willmott. “If you attempt to be difficult, you will soon find out that the regulator has more power than you do. However, this does not mean that you simply stand back and let it take charge—you use your legal rights to the full extent and ask questions. But you need to engage rather than stonewall.”
While regulators may be taking on a more obvious and proactive investigative role, many experts believe cases of regulators over-stepping the mark are still rare. “Regulators around the world are taking more of an interest in how companies are complying with their rules, and that is welcome,” said Andrew Peddie, partner and head of the corporate team at U.K. law firm Pitmans. “However, the more proactive a regulator can be, the greater the fear that they may exceed their powers. Actual cases of this are rare, but the perception that this may happen is certainly present.”
“Let us not forget that, for years, regulators around the world—particularly in the U.K.—rarely flexed their muscles to stem corporate abuse,” said Monique Melis, partner and global head of consulting at financial services consultancy Kinetic Partners. “It almost came to a point that you had to ask, ‘what the hell do you need to do to actually go to prison?’ It makes sense that regulators are now more proactive and that they are not afraid to use their powers, but the approach needs to be consistent and followed correctly.”
Part of the fear that regulators may be deliberately strong-arming companies comes from the feeling that the watchdogs are trying to improve their credibility by coming down heavily on any instance of abuse. In such circumstances, it is more amenable for companies to settle quickly, given the option of reducing legal costs, time and reputational damage.
But lawyers on both sides of the Atlantic are also questioning whether regulators and enforcement agencies are being inappropriately incentivized to pursue companies and individuals, as some are awarded a share of any financial penalty—and making even more if a company self-reports wrongdoing or agrees to a settlement. Indeed, the Manhattan Institute for Policy Research suggests that there is a “shadow regulatory state” in which U.S. federal prosecutors are extracting large amounts of shareholder cash from the world’s biggest corporations—and assuming sweeping regulatory powers—without ever having to prove their case in court.
One of the key weapons is the “deferred prosecution agreement.” Introduced by President Bill Clinton in 1993, federal DPAs have ensnared more than 300 American and foreign businesses in the past decade. Hefty financial penalties are imposed under DPAs—pharmaceuticals firm GlaxosmithKline was handed a $3 billion penalty, while banks HSBC and UBS agreed to pay $1.91 billion and $1.52 billion, respectively, in recent years. Such settlements also often require companies to overhaul compliance and training programs, review sales and incentivization practices, and even fire key personnel, all of which can be expensive and time-consuming.
The U.K.’s primary investigatory agency, the Serious Fraud Office (SFO), also receives a bigger share of the spoils if a company “self-reports” and agrees to a settlement. According to Dick Gould, deputy head of investigations in the proceeds of crime division, under the Asset Recovery Incentivization Scheme (ARIS), the SFO would retain 50% of funds received in any civil cases that it lead with the Home Office retaining the other 50%. However, in the case of confiscation orders (net of payments to victims) the Home Office would again retain 50% of the net receipt, but the remaining funds are split 12.75% to Her Majesty’s Courts and Tribunal Service, 18.75% to the prosecuting agency and 18.75% to the investigation agency. Therefore, the SFO receives less “income” from confiscation than civil recovery.
“It is very difficult to predict what income the SFO will secure over the coming year,” Gould said, but “the SFO is no longer dependant on ARIS and it can therefore not form any basis of a decision to prosecute or not to prosecute.”
There appears to be little doubt that regulators have the upper hand in any investigation and, as a result, companies are more likely to continue to choose the less painful option of paying civil settlements rather than face lengthy legal battles. But experience suggests that, when a company’s entire business and reputation is at stake, sometimes a legal fight may just pay off.