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visit www.theexpgroup.com. Good luck with your F4 studies. ACCA Paper F4 Corporate and Business Law For

ACCA Paper F4

Corporate and Business Law

For exams in 2010

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ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

Chapter 16

Criminal Activity in Company Management

Law Chapter 16 Criminal Activity in Company Management The examiner has stated that in the exam,

The examiner has stated that in the exam, you may be required to (all at the application level):

Recognise the nature and legal control over insider dealing.

Recognise the nature and legal control over money laundering.

Discuss potential criminal activity in the operation, management and winding up of companies.

Distinguish between fraudulent and wrongful trading.

Insider Dealing

Insider dealing is the illegal activity of using non-public (ie privileged) information to make a personal gain or avoid a personal loss.

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

It causes a loss to other shareholders, since other shareholders will have bought shares at an unfairly high price, or will sell at an unfairly low price, when compared with what the insider knew.

There are lots of rules about insider dealing in different jurisdictions in the World. In the exemplar of the UK, insider dealing is defined and regulated by Part V of the Criminal Justice Act (1993).

The UK Criminal Justice Act (Section 52) provides a succinct definition of how insider dealing can happen and it is probably the best tool to remember it for exam and practical purposes.

The Offence of Insider Dealing

An individual is guilty of insider dealing if they have information as an insider and deal in price-affected securities on the basis of that information. Dealing also includes refraining from a planned deal or discouraging another to hold off before buying or selling the securities in question.

An individual who has information as an insider will also be guilty of insider dealing if they encourage another person to deal in price-affected securities in relation to that information.

An individual who has information as an insider will also be guilty of insider dealing if they disclose it to anyone other than in the proper performance of their employment, office or profession.

Dealing

Dealing is defined in s.55 CJA, amongst other things, as acquiring or disposing of securities, whether as a principal or agent, or agreeing to acquire securities. Section 52 makes it clear that only such activity in a regulated market is covered by the Act.

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

Inside Information

Inside information is information that:

relates to particular securities, and

is specific or precise, and

has not been made public, and

is likely to have a significant effect on the price of the securities.

This means that general impressions about the future prospects of a company cannot be insider information.

Insiders

Section 57 states that a person has information as an insider only if they know it is inside information and they have it from an inside source. The section then goes on to consider what might be described as primary and secondary insiders.

The first category of primary insiders covers those who get the inside information directly through either:

being a director, employee or shareholder of an issuer of securities, OR

having access to the information by virtue of their employment, office or profession.

The second category of insiders includes those whose source, either directly or indirectly, as a primary insider, as defined above.

This means that directors, senior management and auditors are at considerable risk of being insiders. They must therefore be very careful not to accidentally commit the offences of insider dealing.

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

ExPedite Notes ACCA F4 Corporate and Business Law EXAMPLE Discussion Point How do you think that

EXAMPLE

Discussion Point

How do you think that directors of publicly listed companies might defend themselves from accusations of insider dealing when they buy or sell shares in their company?

A Victimless Crime?

Some people have suggested that insider dealing is a victimless crime and possibly even a perk of being a director. This is an unsustainable argument!

Whilst some would argue that insider dealing is a victimless crime, in that no one is forced, or tricked, into buying or selling shares: the shares in question are, after all, bought „at arms length‟ on the stock exchange. Nonetheless such activity is treated as criminal. The underlying justification for this would appear to be that those who engage in the activity gain an unjustified return based in their access to price sensitive information that is not available to the general public. In addition it is recognised that the existence of insider dealing tends to undermine the integrity of the share market generally as the public may exhibit reluctance to participate in a market that is being, at least in part, run to the benefit of a few individuals with privileged access to such information.

Stock Exchanges with the strongest rules against insider dealing, the best mechanisms for detecting it and a record of prosecuting those suspected of indulging in insider dealing will be more successful than those with those with a reputation for tolerating unfair returns from those with inside information.

Defences

Somebody accused of insider dealing may defend themselves only by proving that the offence has not been proven beyond reasonable doubt. These defences may therefore be possible:

They were not an insider

The information was too general to be inside information (eg personal opinion)

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

The information was publicly available, or the accused had good grounds to believe it was publicly available (eg had been announced to the Stock Exchange)

There was no expectation that the person receiving the information would deal in securities

Etc.

receiving the information would deal in securities  Etc. EXAMPLE Discussion Point In groups, spend five

EXAMPLE

Discussion Point

In groups, spend five minutes thinking of situations in which directors or members of an audit team may come across the risk of accidental insider dealing and how they can defend themselves against this. Note that ignorance of the law or carelessness are not defences!

Past Real Exam Question Paper 2.2 GLO, June 2004 Question 12 Ken lives with Lena.

Past Real Exam Question Paper 2.2 GLO, June 2004 Question 12

Ken lives with Lena. Lena is on the Board of Directors of Megatelevision plc, which has been considering a take-over from Night TV plc. One Friday, Lena tells Ken that she has to attend a very important board meeting of Megatelevision plc, the outcome of which could have a crucial impact on the future of the company. At the Board meeting it is agreed that, subject to some final negotiations to be carried out by the Managing Director of Megatelevision, the take-over bid should be accepted. That evening the Managing Director phones Lena and leaves a message on the answering machine confirming that the negotiations have been successful and that the take- over bid will therefore be accepted. When Ken comes home, before Lena, he hears the message.

The following events subsequently take place:

(i)

Ken buys shares in Megatelevision plc;

(ii)

Ken tells his friend Nat about the likelihood of the take-over and Nat buys shares in Megatelevision plc;

(iii)

Nat in turn passes on the information to his friend Owen who also buys

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

shares in Megatelevision plc;

(iv) At a dinner party Ken, without actually telling him about the take-over proposal, advises his brother Pete to buy shares in Megatelevision, and Pete does so.

Required:

Consider the position of the various parties under the legislation regulating insider trading.

(10 marks)

Money Laundering

Definition

Money laundering is the process by which the proceeds of crime, either money or other property, are converted into assets, which appear to have a legitimate rather than an illegal origin. The aim of the process is to disguise the source of the property, in order to allow the holder to enjoy it free from suspicion as to its source.

The process usually involves three distance phases:

Placement is the initial disposal of the proceeds of criminal activity into apparently legitimate business activity or property.

Layering involves the transfer of money from business to business, or place to place in order to conceal its initial source.

Integration is the culmination of the previous procedures through which the money takes on the appearance of coming from a legitimate source. This stage is the goal of the money launderer.

Note that money laundering includes tax evasion (ie disguising funds or income that have already crystallised a liability to tax, as distinct from tax avoidance, which is planning one‟s affairs to avoid crystallising a liability to tax). This places accountants and tax advisors at considerable risk of observing money laundering.

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

Money laundering was first made a criminal offence in the United Kingdom under the Drug Trafficking Offences Act 1986 and is now regulated by the Proceeds of Crime Act 2002 together with the specifically anti-terrorist legislation, the Terrorism Act 2000 and the Anti- terrorism Crime and Security Act 2001.

The European Commission has issued a number of rules on money laundering, which all member states must enact. This includes the third directive on money laundering, which contains the core offences.

Offences Relating to Money Laundering

The Proceeds of Crime Act 2002 seeks to control money laundering by creating three categories of criminal offences in relation to the activity.

Offence 1: Laundering

The first category of principal money laundering offences relates to laundering the process of crime, or assisting in that process and is contained in ss.327329. Under s.327, it is an offence to conceal, disguise, convert, transfer or remove criminal property from England and Wales, Scotland or Northern Ireland. Concealing or disguising criminal property is widely defined to include concealing or disguising its nature, source, location, disposition, movement or ownership or any rights connected with it. These offences are punishable on conviction by a maximum of 14 years imprisonment and/or a fine.

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

Offence 2: Failure to report suspicion

The second category of offence relates to failing to report a knowledge or suspicion of money laundering.

Under s.330 it is an offence for a person who knows, or suspects, that another person is engaged in money laundering not to report the fact to the appropriate authority.

However, the offence only relates to individuals, such as accountants who are acting in the course of business in the regulated sector. The offences set out in these sections are punishable on conviction by a maximum of five years imprisonment and/or a fine.

Offence 3: Tipping off

The third category of offence relates to tipping off and is contained in s.333, which makes it an offence to make a disclosure, which is likely to prejudice any investigation under the Act. The offences set out in these sections are punishable on conviction by a maximum of five years imprisonment and/or a fine.

Wrongful and Fraudulent Trading

The criminal offence of fraudulent trading

Section 993 of the Companies Act 2006 establishes the criminal offence of fraudulent trading, which applies whether or not the company has been or is in the course of being wound up. A party found guilty of fraudulent trading is liable on indictment to seven years‟ imprisonment and/or an unlimited fine, or on summary conviction to six months‟ imprisonment and/or a fine of up to the statutory maximum. This does not just apply to fraudulent trading in relation to creditors, and as was held in R v Kemp (1988) if a company is used for any kind of fraud, those liable may be liable to be convicted under this law. In R v Grantham (1984) the Court of Appeal held that a jury had not been misdirected that dishonesty and an intention to defraud might be present if they determined that a defendant charged under what is now s.993 obtained or helped to obtain credit or further credit, knowing that there was no good reason for thinking funds would be available to pay the debt when it fell due or shortly afterwards. It was not necessary for the prosecution to prove

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

that the defendant knew that there was no reasonable prospect that the creditor would ever be paid. In R v Lockwood (1986) the Court of Appeal required the same standard of dishonesty applied in other criminal cases to be applied to fraudulent trading there was not to be one standard for criminal cases in general and a separate, more restricted, one for cases involving commercial fraud.

Civil liability for fraudulent trading

Under s.213 of the Insolvency Act 1986, if in the course of a winding up it appears that any business of the company has been carried on with intent to defraud creditors or for any fraudulent purpose, the court may on the application of the liquidator order any persons who were knowingly parties to the carrying on of the business to make such contributions, if any, to the company‟s assets as the court thinks proper.

This is one of the examples of “lifting the veil of incorporation”, since the barrier between directors and the company itself has been deliberately lifted in order to make the directors personally liable.

In Re William C Leitch Brothers Ltd (1932) the controlling director of a company ordered goods at a time when he knew that the company could not pay its debts. The court held that if a company continued to carry on business and to incur debts at a time when there was to the directors‟ knowledge no reasonable prospect of the creditors receiving payment of debts it may be inferred that the company is carrying on business with intent to defraud, and the director may be held liable for fraudulent trading.

However, fraudulent trading under s.213 of the Insolvency Act 1986, and its predecessors, has been notoriously difficult to establish because of the high burden of proof involved in demonstrating dishonesty. In order to establish liability for fraudulent trading under s.213 the prosecution must actually demonstrate an intention to defraud which must be proved by showing that the person had the requisite knowledge. The difficulty in establishing such an intention led to the introduction of s.214 if the Insolvency Act 1986, which relates to the lesser category of wrongful trading.

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

Wrongful Trading

Section 214 of the Insolvency Act 1986 states that a person is guilty of wrongful trading if:

the company has gone into insolvent liquidation, and

at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, and

that person was a director of the company at that time.

Wrongful trading has the same civil liability attached to it as fraudulent trading, though the criminal penalties are lesser.

There have been considerably more successful prosecutions for wrongful trading than for fraudulent trading. Where fraudulent trading can only be proven if a jury is satisfied that the accused wilfully intended to defraud others, wrongful trading can be proven if the jury is satisfied that loss was unreasonably suffered by others as a result of the negligence or recklessness of a director who continued to trade when there was no realistic expectation that the company would be able to meet its debts.

Wrongful trading is therefore a greater risk to honest directors than fraudulent trading.

Both wrongful trading and fraudulent trading are immediate grounds for disqualification from holding a UK directorship under the Company Directors Disqualification Act 1996.

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

Want to Know More?

You can read the full text of the Insolvency Act 1986 by following this link:

http://www.statutelaw.gov.uk

You can download a free full copy of the Companies Act 2006 at

Past Real Exam Questions

Done Revised

Insider dealing

Q12 June 2004

Q12b June 2005

Q12 June 2006

Q10 F4 GLO pilot

Q10 June 2008

Money laundering

Q5 June 2004

Q12 December 2004

Q8 December 2005

Q12 December 2006

Fraudulent/ wrongful trading Q12 June 2005

ExPedite Notes ACCA F4 Corporate and Business Law

ExPedite Notes

ACCA F4 Corporate and Business Law

Solutions to real past exam questions

Examiner’s solution to Question 12, June 2004 Paper 2.2 GLO

(i) Ken is an „insider‟ as he receives inside information from a primary insider, i.e. the MD of

Megatelevision plc. The information fulfils the requirements for „inside information‟ as it relates to: particular securities, the shares in Megatelevision; is specific, in that it relates to the take-over; has not been made public; and is likely to have a significant effect on the price of the securities. On that basis Ken is clearly guilty of an offence under s.52 when he

buys the shares in Megatelevision plc.

(ii) When Ken tells his friend Nat about the likelihood of the take-over he commits the

second offence of disclosing information he has as an insider. Nat then becomes an insider

himself and is guilty of dealing when he buys shares in Megatelevision plc.

(iii) This situation is similar to that in (ii) in that when Nat passes on the information to his

friend Owen he is also guilty of disclosing information he has as an insider and equally Owen becomes an insider himself and is guilty of dealing when he buys shares in Megatelevision plc.

(iv) When Ken advises his brother Pete to buy shares in Megatelevision plc, he commits the

third offence under s.52 of encouraging another person to deal in price-affected securities in

relation to inside information. Pete on the other hand has committed no offence for the reason that, although he has bought shares in Megatelevision plc, he has not received any specific information and therefore cannot be guilty of dealing on the basis of such information.