A warning issued by the UK’s Serious Fraud Office (SFO) yesterday has left investors quaking in their boots. As reported in the Financial Times today, the SFO has for the first time won a Civil Recovery Order under The Proceeds of Crime Act (POCA) allowing it to confiscate shareholder dividends paid by a company convicted of a criminal offense.
This case involved concerned Mabey Engineering Holdings who, according to a press release on the SFO website, has agreed to repay the £131,201 dividend it received from its subsidiary Mabey & Johnson, which built bridges in Iraq and admitted corruption and breaches of UN sanctions in 2009, but the SFO acknowledge that its parent company, Mabey Engineering Holdings, was totally unaware of any inappropriate behavior at Mabey & Johnson.
Small Change, but Big Implications
While the amount involved may be small, the potential implications are huge with the SFO pledging to pursue similar cases “vigorously.” In the official press release, Richard Alderman, Director of the SFO, said:
Shareholders who receive the proceeds of crime can expect civil action against them to recover the money. The SFO will pursue this approach vigorously…
What the landmark Mabey Engineering case means is that Civil Recovery Orders can be sought against entirely innocent shareholders who have received dividends as a result of illegal activities in which a company may have been involved and of which they had no knowledge. In principle this could apply to big institutional investors of listed companies.
Due Diligence Defense Won’t Stick
The SFO used the opportunity to emphasize the importance of the need for all investors to undertake the necessary due diligence as to the business practices of the companies in which they invest, saying:
Shareholders and investors in companies are obliged to satisfy themselves with the business practices of the companies they invest in. This is very important and we cannot emphasize it enough. It is particularly so for institutional investors who have the knowledge and expertise to do it. The SFO intends to use the civil recovery process to pursue investors who have benefited from illegal activity. Where issues arise, we will be much less sympathetic to institutional investors whose due diligence has clearly been lax in this respect.
Unfortunately, due diligence will not constitute a legal defense to an application for a Civil Recovery Order in respect of paid dividends.
Directors Could Be Left Holding the Can
We have heard a lot about the implications of the UK Bribery Act but less attention has been paid to date to the indirect costs and dangers associated with illegal corporate activity.
The real threat here lies in the interaction between activity which can be characterized as criminal and the very wide-ranging remedies available to the UK prosecuting authorities under POCA. (Bear in mind that this case predates the inception of that Act!)
It is not so much the fear of direct prosecution which should keep directors awake at night as the risk that shareholders may seek to hold directors to account if the share price of their company is depressed by concerns about the company’s business practices. This ruling must increase that risk to the extent that shareholders now have to factor in the risk that they may be called upon to disgorge their dividends to the authorities.