Month: February 2019

On February 21, the United Kingdom Ministry of Justice published its Criminal Justice Statistics quarterly report for England and Wales for the year ending September 2018.  The report stated that while the conviction ration for court prosecutions increased to 87 percent – the highest such ratio in a decade — the total number of defendants prosecuted fell 4 percent to 1.37 million.

The report also observed that the 4 percent decline in overall prosecutions (compared to the preceding year ending September 2017)

is primarily driven by a 12% decrease in defendants prosecuted for indictable offences, continuing the downward trend seen since 2011. Compared to the previous year, there have been decreases in prosecutions for all indictable offence groups except possession of weapons, where there was a 2% increase.

It also reported that 1.19 million offenders were convicted during the 2017-2018 reporting period, reflecting a 3 percent fall from the previous year.  It noted that “[a]s with prosecutions, this decrease is driven by a fall in convictions for indictable and summary motoring offences (down 12% and 2% respectively) and there have been decreases in convictions for all indictable offences apart from possession of weapons, which continue to show an increasing trend.”

What this report does not clearly state is that, as The Times reported, “the number of suspects dealt with [via prosecution] fell to its lowest since records began almost 50 years ago,” while “recorded crime in England and Wales rose by more than 8 per cent to 5 million offences in the same period.”  It also does not make clear the practical consequences of rigid and sustained dedication to austerity.

Last October, the then-outgoing head of the Crown Prosecution Service (CPS), Alison Saunders, said that “the CPS and police were failing to investigate thousands of cases efficiently – from rape to fraud to modern slavery – and were critically short of the skills and resources required to combat crime.”  In particular, she noted that she “had to lose a third of her workforce as a result of funding cuts of more than 25%.”

Such drastic and sustained reductions in force cannot help but diminish the quantity and complexity of fraud cases that prosecutors can bring.  According to data that the auditing and consulting firm BDO gathered, in 2018 only 525 reported cases for fraud exceeding £50,000 were brought in the United Kingdom – a decrease from 577 in 2017.  A BDO executive characterized that 2018 total as “the tip of the iceberg . . . Cases are rarely being brought against individuals for fraud.  Given the amount of frauds we see out there, the amount of prosecutions at a corporate and individual level is tiny.”

In 2018, the United Kingdom Parliament’s Home Affairs Committee issued a report declaring the proportion of fraud cases investigated “shockingly low,” in comparison to the calculated total of 1.7 million offenses a year, adding: “It appears highly unlikely that more than one in 200 victims ever sees their perpetrator convicted.”  The likely effects of this continuing drain of prosecutive capacity include not only a general decline in public confidence about the criminal justice system, but a risk of high-value complex fraud, as the BDO executive opined, “increasingly being dealt with [‘]outside the judicial system’ as companies attempted to avoid reputational damage.”

At a time when large-scale external or internal fraud schemes can involve a billion pounds or more,  regulators, as important as their work is, should not be expected to be the sole public authority to protect the public as well as the public fisc.  Criminal prosecutors and regulatory enforcers can work effectively and in close coordination to meet those critical needs – but only if they are adequately resourced to do so.

On February 26, the U.S. Department of Justice announced that it would be repatriating a total of $6 million to the Kyrgyz Republic related to the corruption and theft of government funds by the family of former Kyrgyz President Kurmanbek Bakiyev, including Bakiyev’s son Maxim Bakiyev.  To mark the successful cooperation of both countries in the repatriation, senior Kyrgyz Finance Ministry and U.S. Department of State officials participated in a joint public event.

The repatriation stemmed from a $6 million forfeiture order entered in a successful money-laundering prosecution in the U.S. District Court for the Eastern District of New York.  In October 2018, the Department of Justice granted a Petition for Remission that the Kyrgyz government had filed with the Department’s Money Laundering and Asset Recovery Section (MLARS).  The Kyrgyz government asserted that that the funds subject to the forfeiture order “traced back to monies stolen by Maxim Bakiyev from Kyrgyz state authorities and other banking institutions.”  Prosecutors in MLARS’s Kleptocracy Asset Recovery Initiative assisted in the investigation that connected these funds to the corruption offenses in Kyrgyzstan.

As of February 26, the Department of Justice stated, approximately $4.5 million of the funds had been collected and would be available for repatriation to the account of the Kyrgyz government.  It also said that both the U.S. and Kyrgyz governments would make additional efforts “to try to locate and return the remainder of the stolen assets in the forfeiture order.”

The Department of Justice also reported that the repatriated assets would “be used for the benefit of the Kyrgyz people, with a focus on social projects and anti-corruption and transparency.”  Those projects reportedly include:

• Healthcare: “Improving public access of the rural population to the healthcare system by buying and installing medical equipment (X-ray, diagnostics equipment, etc.) for regional hospitals to deliver better medical services to the rural area population”;
• Water: “Construction of water supply facilities in order to expand access  to clean drinking water for the rural population through upgrades of drinking water systems and expansion of the scope of ongoing construction of large-scale water supply facilities (water pipes, water pumps, water purification facilities) currently under way with financial support of the World Bank and other International Financial Institutions;” and
• Anti-Corruption: “Strengthening Kyrgyz institutions responsible for anti-corruption programs and promoting the transparency of court proceedings and financial integrity of state organs, including the purchase and installation of audio and video equipment for projects in district courthouses to increase transparency and public control in the justice sector.”

Note: This case marks another significant (if comparatively small) success in international cooperation to locate and repatriate assets stolen by kleptocratic regimes.  In contrast to some other countries with high bribery and corruption risks, such as Equatorial Guinea, where the prospects of repatriated funds being used for the benefit of the general population are vanishingly small, the Kyrgyz Republic, despite its low ranking in the current Corruption Perceptions Index (132nd out of 180 countries), appears to represent a genuine opportunity for repatriated funds to meet everyday needs of Kyrgyz residents.

The Justice Department announcement does not specify how the use of the repatriated funds to support the announced projects will be monitored and audited.  Organizations and experts focused on anti-corruption and kleptocracy issues should therefore make a sustained effort to track and report publicly on what happens with these funds, and how successfully these funds have been used to support the identified projects.  More countries are likely to join in efforts to find and repatriate kleptocrats’ assets if they have confidence that recipient countries’ mechanisms for using repatriated funds for public benefit are both transparent and effective.

Recent reporting in the Washington Post and the Huffington Post has drawn attention to Absher, an e-government portal and general services software for the Saudi Arabian Interior Ministry that allows male guardians of women in Saudi Arabia to track and control the movement of those women, and to the fact that Google and Apple offer Absher for downloading through their app stores.

Although Absher, according to the Post, “allows Saudi citizens to process a host of personal status issues such as getting a passport, a birth certificate or vehicle registration,” human rights advocates have said that it also facilitates Saudi Arabia’s system of male guardianship by restricting travel by women:

It remains illegal for women in Saudi Arabia to travel without permission from a so-called male guardian. Under this system of laws and practices, women in the kingdom need the approval of a “guardian,” typically a male relative, for a range of decisions and actions, including marriage, employment with private companies, certain types of health care and release from prison, said Adam Coogle, a Middle East researcher at Human Rights Watch.

Using Absher, Saudi men can restrict the travel of Saudi women by first allowing or disallowing them to leave the country, and the men can also limit the dates and places women are permitted to travel.

Business Insider’s coverage of Absher included screenshots of the app that show the male guardian can input a woman’s name and passport number, specify the number and duration of trips the woman may take, and cancel any travel authorizations for that woman.  In addition, Insider reported that the male guardian

can also enable an automatic SMS feature, which texts them when a woman uses her passport at a border crossing or airport check-in. . . . [A woman] would have little chance of escaping from within Saudi Arabia, where borders are integrated with the Absher alert system.

Any attempt to leave would be blocked as soon as her passport was checked at an airport. Even if she were to make it out, she would leave a digital trail making her easy to find.

Various human-rights activists and Members of Congress have decried Absher and called on Google and Apple to stop offering it through their app stores.  The creation of Absher, however, itself raises a fundamental ethical question: does Absher, or any software whose primary purpose or necessary effect is to violate human rights, violate any software-engineering or general corporate codes of ethics?

The general answer for both appears to be no.  With regard to the software-engineering industry, in 1997 two of the leading professional organizations in that field, the Association for Computing Machinery (ACM) and the Institute of Electrical and Electronics Engineers (IEEE) Computer Society, jointly promulgated a Software Engineering Code of Ethics in 1997.  That Code is organized around eight generic keyword principles (product, public, judgment, client and employer, management, profession, colleagues, self), each of which contains statements of aspiration, expectation, and demand for software engineers.  Consistent with that framework, however, the Code does not directly proscribe the writing, installation, or use of code that directly violate criminal or human-rights law.  As a commentary on the Code explained:

The code is not a simple ethical algorithm that generates ethical decisions. In some situations standards may  conflict  with  each  other  or  with  standards  from other  sources.  These  situations  require  the  software engineer  to  use  ethical  judgment  to  act  in  a  manner that  is  most  consistent  with  the  spirit  of  the  code  of ethics, given the circumstances.

Similarly, corporate codes of ethics, even of information-technology companies, do not appear to prohibit in specific terms the writing, distribution, installation, or use of code that could violate criminal or human-rights laws.  For  example, Microsoft has an elaborate and integrated set of ethical policies and standards.  These include a general Standards of Business Conduct that articulates the company’s commitment “to respecting and promoting human rights to ensure that technology plays a positive role across the globe.”  In particular, its Global Human Rights Statement states that Microsoft strives to ensure that our technology, business activities, and employment practices “are respectful of the human rights of all individuals and empower every person to achieve more, consistent with the relevant human rights” defined in several United Nations treaties that include the Convention on the Elimination of all Forms of Discrimination Against Women.  Neither of those corporate documents, however, specifies that the company opposes and prohibits the creation, installation, distribution, or use of code that would violate the terms of such international conventions or related laws.

What, then, should professional organizations and companies do about applications such as Absher?  Certainly organizations with broad membership from the software-engineering community, like the ACM and IEEE, should revisit their codes of ethics and add language barring the creation, distribution, installation, or use of software that violate specific criminal or human-rights laws.

Because it may take substantial time for revision of such industry-wide codes, in the short term individual companies should review their codes of ethics and decide whether to amend those codes directly or issue internal directives that bar the creation, distribution, installation, or use of such software by company employees.  In addition, given the widespread acceptance of Bring Your Own Device (BYOD) in corporate functions, companies can prohibit the installation or use of software like Absher, whose primary purpose and necessary effect is to deny well-defined human rights, on company-owned or BYOD devices.

The debate over Absher is certainly part of a much larger public debate about various practices that are asserted to contravene human-rights norms, ranging from artificial intelligence to uses of big data to government surveillance programs.  Each of those topics is broad and complex enough for reasonable minds to debate the proper scope of restriction or prohibition on those practices.

But some software, as conceived and written, is so inherently directed at the suppression of fundamental freedoms, such as the right to travel, that public- and private-sector organizations should treat it as a clearcut violation of the Universal Declaration of Human Rights as well as national constitutions and statutes.  If companies can issue codes of conduct that prohibit conduct such as anticompetitive practices or bribery that violate the law, they can make clear that those prohibitions extend to software that necessarily violates human-rights laws.

On February 20, The Times reported that more than 50 senior bankers from Royal Bank of Scotland (RBA) “had large chunks of their annual bonuses tied to targets set by a government agency,” HM Treasury’s Asset Protection Agency (APA).  For example, multiple bankers in RBS’s controversial Global Restructuring Group (GRG) had 70 per cent of their 2010 annual bonuses evaluated against APA-established “performance targets.”  They included former GRG head Derek Sach, former GRG finance director Declan Hourican, former GRG UK head Laura Barlow, former GRG head of recoveries and litigation Joy McAdam, and the heads of GRG’s Ireland, Asia Pacific, and Americas divisions.

Although GRG was reportedly designed to help business customers of RBS in financial difficulty, the United Kingdom’s Financial Authority commissioned an investigation by Promontory Financial Group of RBS’s treatment of certain small and medium enterprises by GRG.  That investigation “found that between 2008 and 2013 GRG had focused on extracting money from thousands of companies.  Many business owners handled by the unit claim that RBS damaged their livelihoods.”

The 50 RBS executives who received exceptionally high incentive-based bonuses per the APA targets also included officials outside GRG.  Stephen Hester, then the RBS Chief Executive Officer, had 28 per cent of his bonus tied to APA-established targets.

The APA, which ended operations in 2012, exercised this authority in connection with its operation of the United Kingdom’s Asset Protection Scheme (APS).  The APS was designed

to support the stability of the UK financial system, increase confidence and capacity to lend, and thus support the UK economy by protecting financial institutions participating in the Scheme against exceptional credit losses on certain portfolios of assets in exchange for a fee. . . . The APS was designed, in effect, to isolate problem assets in a virtual “bad bank”. The toxic assets were insured but stayed on the balance sheet of the bank, which continued to be the first line of management for the assets in question. The insurance cover acted as a substitute for equity capital as it was recognised by the FSA as regulatory capital for the purposes of capital adequacy assessments.

Under the APS, RBS — the only financial institution participant in the APS after November 2009 — got the benefit of having problem or “toxic” assets isolated in a virtual “bad bank.”  This arrangement provided insurance for those assets, while leaving the toxic assets on RBS’s balance sheet and RBS serving as first- line of management for those assets.

The Times report, however, stated that “[i]t was not clear what agency targets had to be met for bonus conditions to accrue, but the agency’s goals included pushing the bank to ‘seek and identify potential disposals’ of customer assets.”

Note:  In the wake of the 2008 financial crisis, RBS management undoubtedly faced what the APA characterized as an “extremely challenging task” in turning RBS around and restoring its viability.  But it is highly troubling that a temporary agency, with no experience in setting executive compensation, apparently saw fit to make incentive-based compensation a significant (in some cases dominant) component of RBS executives’ bonuses, without any clear criteria for awarding of those bonuses or sustained oversight of the bonus-award process.

Both before and after the financial crisis of 2008–2009, as one expert consultant put it, “there have been numerous examples of incentive compensation programs motivating behaviors and activities that resulted in unintended consequences that damaged company reputations, financially harmed companies and their shareholders, and culminated in employee and executive terminations.”  On the basis of that hard-won knowledge, no company – and certainly no government agency – should  adopt any employee incentive-compensation arrangements unless they address the following points:

1. Clear statements of the targets for particular levels of incentive compensation. In response to the Times’s reporting, an RBS spokesman stated: ““Compliance with the asset protection scheme was a key objective for the bank. The pay of senior executives and other relevant employees was aligned to ensure the bank met this objective.”  With respect, compliance with the APS was not just “a key objective” for RBS, but a minimum requirement for RBS to obtain the benefits that it did from the APS.  Stating that senior executives’ pay was aligned to ensure that RBS complied with the APS implies that executives were given substantial bonuses for doing what they were obligated to do under any circumstances, rather than for superior performance.
2. Specifying the performance criteria for such targets. While the Promontory investigation did not discuss the particulars of RBS executives’ compensation, other incentive-compensation programs have foundered when performance criteria were not specified and subordinates were made to understand that their compensation was dependent on making “the numbers” that senior management dictated.  In GRG’s case, RBS’s training aids included a memorandum that told GRG employees, “Sometimes you need to let customers hang themselves. You have then gained their trust and they know what’s coming when they fail to deliver. . . . Missed opportunities will mean missed bonuses.”
3. Conducting regular incentive-compensation risk assessments. In the United States, since 2010 the Securities and Exchange Commission has required that publicly traded companies conduct risk reviews and make proxy statement disclosures if the “features of a company’s compensation policies and practices have the potential to incentivize its employees to create risks that are reasonably likely to have a material adverse effect on the company.”  While no company, absent extreme circumstances, would ever choose to make such a disclosure, the SEC standard should prompt companies to engage in periodic risk assessments of their incentive-compensation programs – at the least, to minimize the possibility that any of those programs would come close to creating such risks.  Those risk assessments, like other types of risk assessments, should take pains to identify a company’s inherent risk, evaluate existing controls to mitigate that risk, and determine residual risk
4. Actively managing the risks that particular incentive-compensation arrangements may create.  Moreover, once that residual risk has been determined, companies must take specific steps to address and manage those risks on a continuing basis.  Merely identifying the risks without further action will do nothing to protect the company in the event that the compensation program with which those risks are associated later leads to regulatory enforcement or reputational damage.

Last week, in Balmoral Tanks Ltd  v. Competition And Markets Authority, [2019] EWCA Civ 162 (February 15, 2019), the Civil Division of the England and Wales Court of Appeal dismissed an appeal by a Scottish tank design and manufacturing company, Balmoral Tanks (Balmoral), from a ruling by the Competition Appeal Tribunal (CAT) that Balmoral had violated section 2 of the Competition Act 1998 (1998 Act) and article 101 of the Treaty on the Functioning of the European Union (TFEU).

Between 2005 and 2012, according to the Court’s decision, four firms that “were parties to a cartel relating to the supply of [cylindrical galvanized steel tanks (“CGSTs”)] in the United Kingdom”  participated in bid-rigging, price-fixing, and market-sharing.  When Balmoral entered the market for the supply of CGSTs in late 2011, three of the cartel participants, perceiving Balmoral as a threat to their cartel, “sought to persuade Balmoral to join it.”  That led to a meeting on July 11, 2012, involving managing directors of two of those three cartel participants and of Balmoral.  In that meeting, the Court of Appeal noted, the Balmoral managing director “resisted the attempts to recruit Balmoral Tanks to the cartel” and made clear, in the CMA’s words, “that his company was not prepared to take part in the pre-existing customer allocation arrangements; that Balmoral was keen to be seen as a competitor in the sector and would be competing with the other suppliers to win bids for CGSTs.”

With regard to the four cartel members, the Competition and Markets Authority (CMA) issued a decision in 2016 that the companies had “participated in an agreement and/or concerted practice which had as its object the prevention, restriction or distortion of competition in relation to the supply of CGSTs in the UK,” and thereby infringed provisions of the 1998 Act “and/or” TFEU Article 101.  In relation to that decision, the CMA reached settlements involving financial penalties against the three firms (and/or their parent entities) that had participated in the May 11 meeting with the Balmoral representative.  (The fourth firm took advantage of the CMA’s leniency policy and alerted the CMA to the cartel’s existence in the spring of 2012, and so received no financial penalty.)

Even though the CMA explicitly recognized that Balmoral “was not a party to the main cartel infringement, refusing to join the cartel despite facing significant pressure from the other parties to do so,”  it issued a second decision in 2016 that conduct in the July 11 meeting had given rise to infringement by Balmoral and the three penalized firms of the 1998 Act and the TFEU.  The CMA imposed a financial penalty of £130,000 on Balmoral and its parent entity, Balmoral Group Holdings Ltd (Balmoral Group).

“[E]vidently indignant at their treatment by the CMA,” as the Court of Appeal put it, Balmoral and Balmoral Group appealed to the CAT, but the CAT dismissed that appeal.  On appeal to the Court of Appeal, Balmoral offered four grounds for its appeal from the CAT: (1) inconsistency between the CAT’s initial decision on the other cartel participants and its decision on Balmoral; (2) the CAT’s use of an impermissibly strict approach in its test for infringement; (3) failure “to undertake necessary analysis on uncertainty reduction”; and (4) error in law by the CAT in “impos[ing] a fine on Balmoral, and only Balmoral, for its role in the information exchange infringement.”  The Court of Appeal concisely rejected each of these arguments and dismissed the appeal.

Note:  Companies operating in the United Kingdom should take note of this decision for two reasons.  First, it sends a strong message that even “casual discussions about price” at a single meeting between competing firms can lead to liability under the 1998 Act and the TFEU.  Notwithstanding that Balmoral’s representative ultimately declined to join the cartel, the Court of Appeal cited extensive passages from the recorded conversations in the July 11 meeting, which showed in detail, among other things, that –

1. The Balmoral representative “shar[ed] [Balmoral’s] views on what pricing should be for specific tanks and that prices should move upwards”;
2. The Balmoral representative “volunteered the current prices at which Balmoral Tanks” was selling two types of tanks;
3. The meeting attendees “provided each other with information about what their prices would be if asked to quote” for a particular type of tank in the future;
4. Attendees discussed “price bands” for a particular type of tanks going forward;
5. The attendees discussed price bands for another type of tanks; and
6. The attendees discussed future bids for contracts with a particular tank head manufacturer.

Second, companies should take note that in this case, the CMA covertly recorded and transcribed the July 11 meeting, which apparently occurred after one of the cartel participants defected and reported to the CMA.  Those transcripts provided the CMA with verbatim statements by each of the meeting’s participants, including Balmoral’s, from which the CMA and the Court of Appeal liberally quoted in their respective decisions.  Accordingly, any company tempted to have even a “casual discussio[n]” about price with a competitor must recognize that it runs the risk of creating self-inculpating evidence that the CMA can use against it.