Overstated Company Profits and Financial Conduct Authority - Assignment Example

Over d company profits Number Department Over d company profits Company directors are legally responsible for processing the Company Financial Statements in line with the relevant statutes and regulations. Chapter II of The Companies Act 2006, for example, obligates the directors to process annual Financial Statements with due diligence. By virtue of the statutory provision, the Topsell directors who have overstated the Group Financial Statements by £250 million have acted in breach of the law and other complimentary regulations such as the International Financial Reporting Standards (IFRSs) as ratified by the European Union. The Group and Company Financial Statements are regulated by law to provide an accurate and fair financial position of the corporation. In processing those financial reports, the directors are expected under Sections 170 to 175 of the Companies Act 2006 to: choose appropriate accounting options and then implement them in a consistent manner; draw financial conclusions and projections which are attainable and rational; indicate that the Group Financial Statements are in line with IFRSs as ratified by the EU; that relevant United Kingdom Accounting Standards have been adhered by including accompanying statements; develop the company financial reports on a continuous basis unless it is proper to believe that the company will be affected by business changes, in which case supporting evidence or qualifications should be provided. Any confirmation of compliance with the regulations means the company has taken practical steps to adhere to the provisions as well. Overstating company profits is therefore regarded as a deviation from the acceptable norms and is therefore actionable under civil and criminal justice processes (Denise, & Twigg, 2013). The directors have the responsibility to maintain effective accounting statements that reveal with due accuracy at all times, the financial status of the corporation and to enable them confirm that the preparations and eventual release of the financial reports are in line with Article 4 of the Companies Act 1985, which involves IAS Regulation. As such, overstating the company financial reports may be viewed as deviating from the solemn duty to protect the company’s assets upon which unsuspecting investors have reasonable expectations of success. The malpractice, whether mistaken or not, fails to meet the reasonable tests for the avoidance and revelation of scams. Therefore such actions may expose the directors to criminal proceedings on the grounds of fraud and misrepresentation, on the one hand and civil proceedings by the shareholder claims for the damages occasioned by the overstated profits on the other hand. Financial Conduct Authority The Financial Conduct Authority (FCA) has tremendous authority, including the discretion to regulate behavior of organizations dealing with promotion of financial products. The oversight body has the capacity to enforce minimum standards and requirements on the commodities. It has the authority to open investigations into the activities of a company and individuals handling finances such as the company statements and seek court actions against it whenever there is adequate evidence to sustain a trial (Denise, & Twigg, 2013). Additionally, the FCA is mandated to embargo financial products for a period of one year, while carrying out investigations that may lead to the indefinite ban of the products. This way, the FCA has the authority to direct companies to immediately withdraw or adjust financial promotions which it establishes to be inaccurate, and to release such decisions. However, modifying financial statements is only possible where the disparity is immaterial. In this case, the £250 million error is likely to be actionable by prosecution because it constitutes a material loss. The recent case of FCA v African Land [2014] EWHC 144 (Ch) best underscores the regulatory authority of the FCA in achieving restraining orders against inappropriate financial programs. In the case, the FCA brought charges against two directors seeking injunctive relief to ban the continuing advertisement of an investment program. The primary issue is the case was whether the financial scheme was a joint investment scheme under the provisions of section 235 of Financial Services and Markets Act 2000 (FSMA). The case was one of the initial suits in which the English common law factored the interpretation of different elements of the definition of a collective investment scheme (CIS) under section 235 of the Act (Denise, & Twigg, 2013). The case is similar to Topsell in that the shareholders have a collective investment in the company by virtue of their shares. The court granted the FCA’s prayers in its ruling that two investment schemes, advanced by Capital Alternatives and several other firms constituted CIS. The programs were undertaken and run without the approval of the FCA. In light of this decision, the FCA can sue Topsell directors for breaching its regulations and even seek an injunction on the preparation of the prospective financial reports, pending audits of the overstated profits. Financial Reporting Council The Financial Reporting Council (FRC) is another regulatory body in the UK, whose mandate extends to the Republic of Ireland. The independent body is responsible for promoting effective corporate governance and publication of reports to enhance investment and in this case meet the needs of the shareholders. The setting up of the Financial Reporting Review Panel (FRRP) in 1990 was geared towards complimenting the mandate of the UK’s Financial Reporting Council. The FRRP’s primary mandate is to make sure that the publication of financial statements by companies is done in line with proven accounting requirements as specified under section 235 of the Companies Act 1985 (Sandbu, 2012). True and Fair In safeguarding the integrity of the financial reports, the basic rule upon which the body relies is making sure the statements are ‘true and fair.’ The doctrine has been an important part of English law and financial management practices in the United Kingdom for a long period of time. Although, the doctrine is yet to be codified in law, ‘true and fair’ basically means ensuring that the reports are thoroughly screened to weed out any material discrepancies that may arise therefrom. Since the 1980s, when the doctrine became prominent in then English law, there have been remarkable transformations of accounting standards and the management of companies’ financial statements in the country. As such, the overstatement of Topsell’s profits violated FRC’s “true and fair” doctrine, which generally regulates the preparation of relevant company accounts, governance reports and finance audits. The Companies Act 2006, under section 393 obligated the Topsells board of directors not to publish financial statements unless it was sure that they presented a true and fair picture of the company’s financial position. The directors breached this cardinal rule, however. In addition, the FRC’s clarification that the introduction of International Financial Reporting Standards (IFRS) in the United King did not alter such basic requirement despite their seemingly slight difference in their application places another liability upon the company directors (Sandbu, 2012). In particular, issues have been raised in respect of the application of the doctrine and whether it should practically override common accounting rules under the IFRS, with some people arguing that the absence of “prudence” in the rule makes it lesser in accounting reporting (Sandbu, 2012). However, the regulator notes that, whilst there can be differences in terminology under the international regulation the “true and fair” doctrine outweighs prudence. However, Topsell directors were neither true and fair not prudent in their actions. As such, the FRC would argue Topsell were not factually accurate, possibly because they did not process the accounts according to relevant reporting guidelines; and the serious omission led to substantial misstatements which apparently misled shareholders and the public in respect of Topsell’s financial standing. In this case, misstatements may be the outcome of substantial errors or double entries of transactions and balances in the reports, which should be actionable (Sandbu, 2012). The report is not fair because the directors have not presented it in a faithful manner. As such, the statement reeks of partiality and it does not reflect the economic value of transactions or the legal justification of the error. The Serious Fraud Office Unlike the FCA and the FRC, which are mainly concerned with civil cases against rogue companies and directors, the Serious Fraud Office (SFO) is an independent body charged with investigating and bringing serious criminal charges of fraud and bribery against the suspects. The body operates under the Attorney General’s office and has jurisdiction over cases in England, Wales and Northern Ireland. SFO prosecutes different cases some of which are committed outside of the country (Fearnley, Beattie, & Hines, 2011). The SFO may, under the Criminal Justice Act 1987, section II, exercise its special compulsory discretion to compel the company’s directors to provide justification for the overstated financial statements and any other relevant reports irrespective of their confidentiality. The SFO may also invoke the Bribery Act 2010 in Topsell case if it so established that the overstating of the financial reports had to do with bribery of investors to invest in the company at the expense of ensuring proper corporate governance. The regulator is mainly concerned with ensuring that the UK provides an appropriate environment for all investments. According to Section 19 of the Theft Act 1968, overstating of profits constitutes fraud, which is defined as misuse of position or misrepresentation of fact or jeopardizing a party’s rights for individual gain (Sandbu, 2012). In this case, the company directors are individually liable for publishing misleading accounts. Publishing false financial reports is a kind of fraud executed when a party creates, abolishes, hides or falsifies a financial report which consciously misleads consumers about the organization’s financial position. The SFO would need to carry out investigation on the issue, however, in order to establish whether the primary intention of the company overstating its profits was to mislead shareholders and creditors. Overstating profits can be decided the same way R v Bright & Others (2007) was expended. The case involved serious fraud allegations leveled against Independent Insurance for misrepresenting financial reports. Earlier on when Independent Insurance made public its financial reports for the year 2000, it projected £900 million in spare market value. The asset value was more than £300 million and it had registered £22 million in profits by the end of the financial year.  The financial position of the company was seen as positive and closely similar to the overstatement of the profits in this case. Within a few months of publishing the reports, the company collapsed, triggering a suspension of its share trading. More than one thousand employees lost their jobs and even more investors lost their shares (Sandbu, 2012). At trial, the executive director Michael Bright, his deputy and the chief financial officer were found to have concealed details of insurance dues from the organization’s reports. It was also established that the chief executive and the finance chief made partial disclosure of a number of risky contracts with the firm’s re-insurers. In determining that these commissions and omissions constituted criminal fraud, the court removed the corporate veil to give the directors prison sentences ranging from three to seven years in addition to a 12-year ban from holding similar position. Misrepresentation In the English law of contract, tortious misrepresentation involves a circumstance where an individual is enticed to give in to a contract wholly or partially by inaccurate affirmation of fact given by a party to a contract. If a misstatement of fact is part and parcel of the terms of contract, it definitely constitutes grounds for claims of violation of contract. The victim of misrepresentation may legally rescind the contract and or benefit from the resulting damages. In this case, the shareholders can validly claim a breach of their contract with the directors by the latter party and seek compensation from the provable damages resulting from the actions and omissions of the board. Topsell shareholders can claim misrepresentation on the grounds of fraud, negligence, or non-negligence. If misstatement of the account is proved, the directors can be liable for false declaration that creates harm by jeopardizing the reasonable expectations of a rise in the share value. In this case, the English contract law regulating the duties and obligations of the directors to the shareholders would kick in, in which case, the directors would be denied the opportunity to bargain because they gave a true consent of the misrepresentation of the accounts. Ground for true consent exists in this case because without it, the directors would not have released the statements in the first place. In the Topsell case, any acts of misrepresentation had been made by the directors by the time they published the financial reports and thus they had completed their side of the bargain. As such, the misrepresentees in the shareholders do not have the option of seeking an injunction in respect of damages because they have already occurred. As Sandbu (2012) noted, the misrepresentation may not void the contract between the company through the shareholders and the directors as it generally happens in unconscionable or fraudulent contracts, rather it voids the contract only where the misrepresentee has clearly expressed their intention to that effect. Remedies which the shareholders of Topsell stand to get are partly controlled by the Misrepresentation Act 1967. English law usually permits unwinding of contracts where misrepresentation suffices, so that both sides are taken back into the status before the violation had occurred. In cases where the misrepresentation was included among the contractual terms, so as an option, the shareholders can press for the subsistence of the contract and seek lost expectations. In this situation, Topsell shareholders can equally bring claims for compensation as if the overstating of the profits had been correct. The shareholders may also clai reliance damages due to losses triggered by the misrepresentation of accounts. In Edgington v Fitzmaurice (1885) 29 Ch D 459, company directors dispatched a prospectus to the shareholders inviting investments in debenture bonds. The report said finances would be used to change their buildings, buy them property such as horses, cars and increase the supplies. In reality, however, the company’s primary intention was to settle the liabilities facing the company. The plaintiff mistakenly believed that he would obtain the benefits specified by the company if he purchased the bonds. The court decided that the statements contained in the prospectus amounted to actionable misrepresentation because they substantially influenced the shareholder’s actions. Despite the high probability that the directors of Topsell will be guilty of criminal fraud by misrepresentation and liable for the damages arising from their actions, the shareholders may encounter difficulty carrying the burden of proof. This is especially true because the court denied claims of misrepresentation in Howard Marine and Dredging Co Ltd v A Ogden & Sons (Excavations) Ltd [1978] QB 574 on similar grounds by holding that under the Misrepresentation Act 1967 s 2(1), there was no reasonable premises to believe that the mistaken registration process was done improperly. Conclusion Generally, directors owe their respective companies the duty to be truthful and fair in processing financial statements. This implies the need to adhere to the relevant accounting standards and statutory laws in the processing and presentation of the accounts. Overstating the accounts means the directors deviated from their solemn duty of ensuring truth and fairness when preparing the reports. The conduct of Topsell directors is therefore actionable under the tort law and under criminal law of fraud as well as under misrepresentation of fact. References Denise, W., & Twigg, J., 2013. Cayman target director duties in the spotlight. International Financial Law Revie, 32(5), pp.74. Fearnley, S., Beattie, V., & Hines, T., 2011.Reaching Key Financial Reporting Decisions: How Directors and Auditors Interact. New York: John Wiley & Sons, 2011 Journal of Business Ethics, 109(1), pp.97-107. Sandbu, M., 2012. Stakeholder Duties: On the Moral Responsibility of Corporate Investors. Read More