Criminalizing Corporate Governance Failures - Essay Example

?Criminalising corporate governance failures is a step too far. Discuss Introduction The significance of criminalising corporate governance failures is actually obvious. The idea should be simple and obvious for all stakeholders to understand. The issue of criminalising corporate governance failures is not a simple one. Keep in mind that while there is a need to compel corporate officers to protect their fiduciary duties through criminal proceedings, there is yet one more aspect which looks at criminalising corporate governance failures as a step to severe. There are legitimate considerations about criminalising corporate governance failures, mainly from social pressures related to protection of public interest or the protection of minority rights, as well as considerations that adopt the rhetoric of deterrence through harsh legal sanctions, signalling deterrence to directors who may think of being in breach of fiduciary duties. To begin with, it was established in Salomon v. Salomon and Co. Ltd that a registered corporation is a legal person, separate from its members. This principle may be referred to as the veil of the incorporation. Therefore, the law will not evade this rule and go behind the separate personality of the corporation to the members.1 So many reason exist for corporate officials to hind behind the veil2; one which is to commit fraud, another many be to “confuse and conceal”3 But there are exceptions to the rule in Salomon’s Case where the veil is lifted, or pieced and the law disregards the corporate entity and pays regards instead to the economic realities behind the legal facade, that is, where the facts supersede form. The exceptions should however be classified between those provided by statute and those provided by law4 Why must the courts lift the veil of the corporation? The sole reason is because maintaining it will cause many problems to criminalize corporate governance failure. Reference should be made to Bank Voor Hnadel en Sheep v. Slatford5 where Lord Devlin also said “the legislature can forge a sledge hammer capable of cracking open the corporate shell”. With regards to the nature of lifting the veil, LCB Gower states that “In cases where the veil is lifted, the law either goes behind a corporate personality to the individual members or ignores the separate personality of each company in favour of the economic entity constituted by a group of associated companies”6 The courts have adopted a more generalized approach based of the interest of justice as being the guiding light. Thus, Lord Denning M. R was prepared to lift the veil in Wallersteiner v. Moir7. Instead of relying in the interest of justice approach, the Court of Appeal in Adams v. Cape Industries plc8 had applied the test as stated by Lord Keith in Woolfson v. Strathclyde Regional Council9 that the veil would only be pieced where special circumstances exist indicating that it is a mare facade concealing the true facts. Therefore, there must be some improprietory before a veil can be lifted10 such as fraudulent trading11 or wrongful trading12. Instead of relying in the interest of justice approach, the Court of Appeal in the Adams case had applied the test as stated by Lord Reid in the Scottish case of Woolfson v. Strathclyde Regional Council above, that the veil would only be pieced where special circumstances exist indicating that there is a mere facade concealing the true facts. The case, like Adams concerned the issue as to whether a group of companies ought to be looked upon as a single company for the purposes of instituting legal proceedings. The court’s position is therefore even becoming clearer. There must and forever be some evidence of imporprietory. On the other hand, where the existence of some improprietory cannot be established, the courts will never lift the veil. Therefore, and in such cases, the company cannot be criminalized. This approach was taken by Toulson J in Yukong Line Ltd v. Rendsburg Investment Corporation13. A similar approach was also taken in the case of Ord v. Belhaven Pubs Ltd14. On facts similar to Creasey v. Beachwood Motors ltd, the Court of Appeal refused lifting the veil. After looking at the particular facts of the case, the courts decided that it would be best to resort to statute. This merely suggests that the courts will be prepared to treat every fact of the case as being different. But the general position still remains that the courts can criminalize corporate governance failure because the company will be acting through human minds. The legal or statutory duty of care of directors or corporate officials have been put be put on a legal basis, just at par with what is held by the Trustee Act 2000. Although corporate officials are not trustees in the strict sense of the word, they are nevertheless treated to run the company like trustees for the benefit of shareholders as well as other corporate stakeholders. Therefore, they can appropriately be covered by the scope of the Trustee Act 2000. In relation to corporate responsibility for crimes committed by corporate officials, corporate officials are required to act as any ordinary prudent person would act in managing similar affairs. But corporate officials are afforded a much higher duty of care than ordinary trustees. This is for the sole reason that corporate officials are paid for their services. In Re Waterman’s Wills Trust15, Harman J made a clear distinction between ordinary trustees and people paid to work as trustees. He said “I do not forget that a paid trustee is expected to exercise a higher standard of diligence and knowledge than an unpaid trustee and a bank which advertises itself larger in the public press as taking charge of administration is under a special duty”. Perhaps, the same standard of care applies to corporate officials. Remember that corporate officials are treated as fiduciaries so far as the law does not permit them to make profit, by taking advantage of their office unless the articles permit this or the consent of shareholders. The leading case on this is the case of Regal (Hastings) Ltd v. Gulliver16. The decision was to the effect that it is an illegal activity of a company director to use his position to make something of personal profit and he is liable to account for this, either in tort or company law or even in a criminal suit. This is applicable even if the corporate official acted bona fide and this “in no way depends on fraud or absences of bon fides”. It should be recalled that there should be no possibility of talking about the board trying to later approve that acts of corporate officials. Keep in mind that attempting to later ratify their acts, so as to let the corporation stand to gain from the illegality, may become an infringement to the principle that corporate officials should never have their interest conflicted with that of the company. A leading case on this is Guinness plc v Saunders17. What is known about this case is that corporate officials should not be able to exploit what should originally be that of their corporations to benefit economically18, else this may amount to theft which will call for criminalization. The significance of this is that corporate officials have exploited corporate opportunities for their benefit. Therefore, holding corporate officials liable for any criminal act that may arise from this would not be a step too far. But there are cases in which courts have had a more benign attitude towards acts of corporate officials which the company may consider illegal and the courts have considered it a step to far to hold corporate officials liable. A typical example is the case of Queensland Mines Ltd v. Hudson19. Corporate officials will not be prosecuted either in tort of criminal law if their act out of the scope of their activities and make personal gains as long as the corporate opportunity which they benefit from has been expressly or implicitly rejected by the corporation; or if the present state of affairs of the corporation takes its business out of the scope of corporate opportunity. However, this decision causes some sort of difficulties because it may contradict that decision in the Regal case. Keep in mind that Lord Reid left open the question of effect of a board rejection. It is generally suggested that corporate officials should be punished severely for their failure even if the company can redeem its finances or if the company does not stand to lose financially. Lord Templeman20 pointed out that issues such as bribes cause loss and damage to the principal, although it may not be quantifiable, as in the present case, where quantifiable harm to the administration of justice had been done. This decision should be welcomed today for the reason that it will go a long way to prevent illegal acts of corporate officials. Perhaps corporate officials should be forewarned of the consequences of their acts ahead of instituting criminal liability on them. More recently, the courts have decided that criminalizing corporate governance failure should not be taken to mean a step too far. In Wellerstiner v. Moir, Lord Denning pointed out all circumstances for lifting the veil. The case of Gilford Motor Co Ltd v, Home21 shows that even though fears may be raised as to the extent to which corporate governance failure should be criminalized, the courts will overlook this to go ahead on criminalize corporate governance failure because the courts will not want situations where a company can be used as a device to mask the real activities of corporate officials. The criminalisation of corporate governance failures should not be considered as a step too far. One thing is clear. There is an urgent need of a more holistic, integrated accounting of the corporations’ activities. Legally sanctioning a corporation is a good way to reduce corruption. Keep in mind that corporate governance controls and trims down financial as well as non-financial risks by pushing in reliability, transparency in addition to accountability within a corporation. Maintaining corporate governance is considered as one of the best means to guarantee that board members, managers, employees and shareholders take care of and run the firm to give appropriate outcomes, fair to the expectations of shareholders as well as other stakeholders. Additionally, it provides a structure to protect assurance of investors, enhance contact to capital markets and encourage expansion. Corporate ineffectiveness and the ‘shambling journey towards oblivion’22 always call for criminalization of corporate governance failure. It therefore goes without saying that bad management in addition to poor accounting are the sole reasons why corporations fail23. Remember that bad management within corporate culture amounts to deceit24. For these reasons, stakeholders must always hold corporate officials responsible and one of the best means to get at this is to make sure that they are furnished with information that is of utmost and paramount interest to their stakes. But the problem is not just having access to information, but having access to appropriate and wholesome information.25 A typical example of the case of deceit was reported by the Royal Commission Report on the failure of HIH, in which the Commission noted that systems at HIH ‘left much to be desired’, so much so that management was ‘often flying blind’26. The bad side of it was that, ‘there was a filtering of information such that, on occasions, bad news reached the board only if it could not be avoided’27. …: ‘put bluntly, HIH management recognized that the group was under-performing at a level that could not be sustained … it used and relied on questionable transactions giving rise to doubtful accounting entries, which disguised the seriousness of the situation … the process was fatally flawed’. Therefore, there is always a need for criminal liability to take care of corporate governance failures. Under the above normal circumstances, should it not be right to say there is and will forever be a need to criminalising corporate governance failure? The obvious answer is YES. Criminalising corporate governance failures should act as deterrence to subsequent criminal behaviour. This idea of criminalising corporate governance failure must be kinked to the objective which it ought to achieve. A surely and highly rated reason for criminalising corporate governance failure is to prevent future offences as well as to deter initial offences. A Case for Criminalising Corporate Governance Failures It can be right to state that criminalising corporate governance failures is a step to far. If we take for granted all predispositions to criminalise corporate governance failure, we should also take into consideration how criminalising corporate governance failure should be practical. The case that criminalising corporate governance failures should not be regarded as a step too far is a theoretical one. If we rests this case on an optimal fine theory along with the assumption that the rates of deterrence are low and for these reasons, sanctions (especially pecuniary sanctions) ought to be extremely high if deterrence should take effect. But what if enormous fines, as punitive sanctions, do not prove workable? The alternative is to resort to the necessity for jail for individuals. Why Criminalising Corporate Governance Failures Is a Step Too Far Again, recourse to criminal (or civil) sanctions may prove wanting because certain hurdles may surmount justice. The principal question of civil as opposed to criminal liability is equally a procedural and political one and a correct answer to this will possibly depend upon how severely an individual is of the view that a corporation ought to be dealt with as if it is suspected to have carried out its dealings in an improper manner. This will again be impossible to be answered properly without an iota of bias because corporate officials will on no account prefer criminal liability while victims of corporate misconduct will always elect for tougher sanctions. At one time, Smith, noted that, “The necessity for corporate criminal liability awaits demonstration”. Today, the problem of corporate governance failure is on a rapid increase, it becomes increasing clear for tougher (criminal) sanctions to replace fines. It was recently stated that “With such power must come responsibility. Just as individuals owe a duty not to harm or injure others in society without justification, so too do companies owe a duty not to poison our water and food, not to pollute our rivers, beaches and air, not to allow their workplaces to endanger the lives and safety of their employees and the public, and not to sell commodities, or provide transport, that will kill or injure people”28 Despite the fact that this would seem as stating what is obvious and to be practical, it would seem it is now common place to impose criminal liability on corporations. The courts have even upheld this view of holding a corporation liable for manslaughter29. So many obstacles would appear to obstruct the imposition of criminal sanctions on corporations. Some of these include: 1. The Problem of Corporate Personality This particularly relates to how the issue of corporate personality is perceived by the courts. There as so many ways to humanize a corporation. This can either be done by lifting the veil of the corporation (to prosecute individuals responsible for corporate misconduct)30 or where senior corporate officials are made to function in the minds of the corporation (also known as the Identification Doctrine) sometimes known as the alter ego doctrine, this is the antithesis to the doctrine of separate corporate personality as first laid down by the House of Lords in Lennards Carrying Co. v. Asiatic Petroleum31 and later developed in Tesco Supermarkets Ltd v Nattrass32; and where a corporation decides to operate as a legal fiction with its individual opinion (often illustrated in its internal as well as external documents). Although these make it feasible to impose criminal responsibility on a corporation, practically, the courts will be taking a step too far to lift the veil. This will not be possible where a series of illegal acts will have to be combined to give rise to a cause of action for one illegal act33, although it is today held that such rejection was premature34. In thinking about corporate illegality, there is gradual but steady recognition that a corporation should be treated in the same manner as an individual as illustrated be James Gobert “When a crime occurs in the course of business, it is likely to be the result of a breakdown in more than one sphere of the company’s operation. Policies may be misguided in conception, inadequately supervised, and incompetently carried out. To capture the full extent of a company’s wrongdoing would require an aggregating of these failures”35. The problem with this is that criminal liability can be imputed on smaller companies than bigger ones36. This is probably because the complexity involved in management of bigger company males it difficult for investigators to get to the truth about illegality. But a solution to this should be found in assessing the nature of the corporation. Celia Wells puts it this ways “Corporate liability is thus dependent on an anthropomorphic view of company structure.”37 by referring to the court’s decision in Tesco Supermarkets Ltd v Nattrass where illegal acts of top corporate officials were construed to include actions of the entire corporation by construction of the word “manager” in S. 20 of the Trade Descriptions Act 1968 to mean person managing the business of the corporation, rather specific (branch) manager. More barriers facing the establishment of mens rea on a corporation has been explained by CMV Clarkson to the effect that “.If the corporate culture permitted or encouraged the wrongdoing, it may be easy to infer that the corporate body itself must have foreseen the possibility of the harm occurring. Or that it has created an obvious and serious risk of the wrong resulting. Or that the consequence was virtually certain to occur from which intention may be inferred38. The unpleasant lack of consensus to convey the criminal law requirement of mens rea only goes a long way to illustrate that criminalizing corporate governance failures is a step too far. As rightly put by James Gobert, a corporation is beyond doubt a personification of the bad man for the simple reason that it complies with the law exclusively through a wish to steer clear of the consequences that may happen to him and not for the reason that it is doing what it normally thought of as correct39, then such a corporation is preferably suited to preventive measures for example; as imprisonment and fines. Theoretically, we find it impracticable to imprison a corporation. It has been remarked that a corporation has “no soul to be damned and no body to be kicked”40 2. Right of Entry into a Corporation For The Purpose Of Getting Information To criminalize corporate governance failure, there should be efficient access to information. Most corporations possess documents in which access by the public ought to be restricted. Access to information may also strain the relationship between lawyer-client and accountant-client. Remember that to access a corporation’s files, it may also mean access to files of lawyers and accountants41. This will raise an issue of serious worries to existing and potential clients. But this can become possible because most corporate misconduct are said to stem from lawyers and accountants42. Permitting this would raise a probability in the future that lawyers and accountant will never report illegal activities of their clients because they fear loosing rich clients. What is more to this is that to closely supervise the activities of lawyers and accountants has never been a popular issue and this will make the idea of criminalizing corporate governance failure a step to far. Laura Cox QC equally states that “corporate lawyers will also be affected because corporations have human rights too… (and)….increasing levels of regulation of financial and other markets penetrate ever more deeply into the affairs of both individuals and corporations”43. As soon as information is categorised as confidential, the revelation should be governed by certain principles. Sometimes, solicitors and accountants will never want to constitute themselves in a position of being in breach of their duty of confidentiality with the employers. For the purposes of company law, information that is guarded against disclosure in corporate spheres must not be embodied in any official writing or reduced to any material form. Information is barely what has been fused in the minds of those operating within the corporate sphere. To find information confidential, the information ought to be somewhat surreptitious, even though it need not be new or original. It must not be a thing which is public knowledge. All that is obligatory, though, is qualified, and not absolute. Keep in mind that information that is often kept secret between corporate officials and their lawyers or accountants is always information, the disclosure of which the company is of the view that it would be detrimental to such officials or of benefit to the interest of shareholders, partners or even the interest of justice. The duty to reveal confidential information can be made obligatory by law. Although the courts will rely on the rationale of Megarry J in Coco v. A. N Clark [Engineers] Ltd44, the law of confidentiality will however not be applicable here because the information which is the subject matter is hidden so as to obstruct justice. 3. Hurdling By Parties to Criminal Prosecution The very first of such hurdle is the cost of instituting and completing not just a simple criminal proceeding, but a criminal proceeding against a large corporation. Even those who are extremely rich would be afraid of incurring enormous costs. Perhaps, this is the reason why there are few cases instituted against corporations over the years45. On its part, the administration may be slow to institute criminal actions on corporations. This is partly due to the contribution which such corporations make to its national welfare. James Gobert is of the view that an administration cannot despise to finding the middle ground its in attempt to jeopardize it financial position by criminalizing corporate governance failure46. Keep in mind that the administration is fearful of deterring potential investors as well as discourage existing investors. Sarbanes-Oxley Act and Its Effects on Corporate Governance Failure The Sarbanes-Oxley Act was voted for in July 2003 and this has developed to be the most inclusive regulation touching corporate governance. The Sarbanes-Oxley Act is an omnibus bill regulating a great scope of areas in corporate law. The main idea behind the Sarbanes-Oxley Act is that it is meant to encourage corporate conscientiousness, support disclosure of information from solicitors or other agents of the company, advance sufficient and enough financial reporting, establish an out of the ordinary auditing supervision board, save the neutrality of security analysts from harm in addition to making stronger, punishment for corporate governance failure. Despite the fact that the Sarbanes-Oxley Act assumes a lot of proposals meant for protect corporate governance failure, it is doubted if this is going to be very effective. Perhaps, nothing will change from what the courts have practiced in the earlier days for the following reasons: This is a high requirement that corporate officials must make obvious evidence of the good behaviour. However, corporate officials have not been stripped of their powers as well as the incentives that will compel them to act ultra vires or engage themselves in future criminal activities that will further plunge their corporations into total mess. Although the Sarbanes-Oxley Act prescribes punishment for errant corporate officials, the nature of punishment will never act as a deterrent to corporate governance failure. The requirements of the Sarbanes-Oxley Act may be counterproductive or impractical. Keep in mind that they will call for thorough compliance efforts. These provisions have particular relations to the US market. Therefore, when foreign corporations find these burdensome, they may be forced to withdraw themselves from US markets and some US corporations may decide relocating their corporations to markets or countries with less complex and friendlier corporate atmosphere. The Sarbanes-Oxley Act also assumes criminalizing corporate governance failure but may discourage corporate officials from investing reasonable time in thrusting their corporations in the direction of success. Keep in mind that more time will be spent on accounting and compliance instead of efficiency or productivity. Reporting of important information may hypothetically make way for good trading environment, but may be the occasion of an obscuring storm of inconsequential disclosures on the part of corporations preferring compliance to disclosure. The Sarbanes-Oxley Act further withdraws powers from corporate boards and confers them on public magistrates. Such boards, out of disapproval, may be forced not to reflect on good corporate governance because the law forces them into positions of absolute compliance. This may be thought of as codifying ethical standards and using them as law. Before the advent of Sarbanes-Oxley Act 2003, corporate officials had acted on the benefits of corporate governance as a means of survival. This reform has a very high price tag and there is no assurance that it will deter corporate governance failure. Therefore and for every reasonable corporate governance scholar, it would seem the best way is to go back to the law and criminalize corporate governance failure. Conclusion There is a variety of practical questions to which answers must be provided on the subject of criminalizing corporate governance failures. Because laws are made by the people and meant for the people, it is necessary to investigate how the public will agree or disagree that criminalizing corporate governance failures is either a step too far or not to far; and if possible, the sort of corporate governance failure that would be criminalized. There is no denying in that fact that the law is gradually evolving and as many will identify “Modern companies can be regarded as having both bodies and souls that, through the censure and stigma of punishment, can be kicked and damned in the hope of inculcating corporate conscience”47. What obtains today is that there is a growing tendency to surmount the entire hurdles that criminalizing corporate governance failure will bring. It should be noted that from whatever angle criminal proceedings emanate, it should be to the just and equitable interest of the company as well as the interest of the public. It cannot be found enough to get corporations hiding behind governance failures simply because the prosecution will consider it a step to far to criminalize corporate misconduct. One more approach can be a welcomed initiative. This should however be a more collective move whereby the whole corporation or part or it is criminalized on behalf of the entire corporation as in Re Express Engineering Works Ltd48 where the decision of all the shareholders was held to be the decision of the company. Alternatively, fines or punitive damages could be imposed as an act of deterrence. Far from the imposition of fines, one more alternative is to assail on the corporate image of the corporation at fault. This will provide severe consequences that no corporation would want to experience. Other forms of sanctions are always feasible to imagine and think about the effects, as long as this will prevent a corporation from being caught by the law for corporate governance failure. What should be the way forward? The law should be applied and not complied. We should look at the compliance side of the law, than the frail side. Howard (1994), expresses this worry about human judgment, when he states that:“…rules, procedures, and rights smothering us are different aspects of a legal technique that promises a permanent fix for human frailty. Dictates are so precise that no one has the chance to think for himself. Procedural layers do away with individual responsibility. Rights are absolute so that choices among conflicting groups never need to be addressed much less balanced. Law be cleansed of human input. All tough choices, and indeed all choices, must be predetermined”49 One thing should be clear, if the public is not given the chance to understand the coercive part behind laws and their applicability, we may at the final end, lose the very concept which the law ought to be. Therefore, law must be complied to and be regarded as instruments of accomplishment. For this reason, legal compliance should be distinguished from ethical compliance and law should be applied for the common good for all. If this role of the law is not adhered to, the failure to criminalize corporate governance failure would act as one of the most probable threats to the future of a corporation. What ought to be advocated in today’s corporate world is the legal behaviour of companies. We can only achieve effective corporate governance is the law is applied. Every corporate entity must adhere to the low if the purpose of it having a reputational value is envisaged. For this reason, effective corporate governance can be achieved by adopting a set of principles and best practices and best practices means strict compliance with the law. While requiring strict compliance to the law, we should also take note of the fact that there is equally an urgent need to put together law and ethics, with the intention to find the way to go through the grey areas that criminalizing corporate governance will pose as well as continue on the is proposition of the law – that is, what the law is and not what the law ought to be. Ethics is beyond doubt an indispensable constituent for corporate success and corporate ethics will carry on to serve up as the outline for corporate success, this 21st century. We must not relate in a corporate atmosphere where we can only experience the breeding of corporate officials who find themselves irresponsible and who are stepping down from their conscientiousness to think with awareness in view of the ethical dimensions that their actions might constitute. Conceivably, it will be inappropriate to conclude without making reference to the following observation which in a few words, incorporates that whole idea of merging law and ethics when the issue of criminalizing corporate governance failure is brought under consideration: “An adequate corporate strategy must include non-economic goals ... An economic strategy is humanized and made attainable in a living organization by deciding on the character the company is to have, the values it espouses, and its relationships to its customers, employees, communities, and shareholders. The personal values and ethical aspirations of the company leaders, though probably not specifically stated, are implicit in all strategic decisions … Although codes of ethics, ethical policy for specific vulnerabilities, and disciplined enforcement are important, they do not contain in themselves the final emotional power of commitment. Commitment to quality objectives – among them compliance with law and high ethical standards – is an organizational achievement. It is inspired by pride more than the profit that rightful pride produces. Once the scope of strategic decision is thus enlarged, its ethical component is no longer at odds with a decision right for many reasons”50. Bibliography Andrews K. ed, (1989), “Ethics in Practice: Managing the Moral Corporation”, Harvard Business School Press, Boston, Massachusetts. pp 10/11 Celia Wells in .Manslaughter and Corporate Crime. 139 New Law Journal Pt II, at p 931 CMV Clarkson, Corporate Culpability. 1998, 2 WebJCLI CMV Clarkson in .Kicking Corporate Bodies and Damning their Souls. in 59 Modern Law Review 1996 at page 557. Ed Charles and Trevor Murphy, ‘Bad company’ (2002) 72(7) Australian CPA 6. Edward, First Baron Thurlow . referred to in .No Soul to Damn: No Body to Kick: An Unscandalized Inquiry into the Problem of Corporate Punishment. Coffee J . 1981 79 Michigan Law Review 386. Grania Langdon-Down, The Lawyer, .Not-so-private investigations, 11/02/97 Howard, P. (1994), “The Death of Common Sense: How Law is Suffocating America,” Random House, New York. James Gobert, .Corporate Criminality: New Crimes for the Times. . Criminal Law Review 1994 Kite and Ors, Only one prosecution for Corporate Manslaughter. The Independent, 9/12/94 Laura Cox QC, Take a step in the rights direction. The Lawyer . 22/11/99 LCB Gower, (1992) Principles of Modern Company Law Royal Commission Report, ‘The integrity of information sources’. Ruthven, Lifting the Veil of Incorporation in Scotland, 1969, Judicial Review, p 1 VS Khanna, Corporate Criminal Liability: What Purpose Does it Serve? in 109 Harvard Law Review, May 1996, 1477. Statute Insolvency Act 1986, S. 214 Insolvency Act 198, S. 213 Read More