The substantive provisions of the Fraud Act 2006 will come into force on 15 January 2007.
This Briefing has two main objectives, namely:
a. to provide an overview of the new Act; and
b. to explain some of the consequences of the new Act for financial institutions, particularly in the context of their anti-money laundering obligations.
Overview of 2006 Act
Oddly enough, until the 2006 Act was introduced, English criminal law did not include a general offence of "fraud", nor did it include a specific definition of that term. Instead, a series of separate offences (e.g., "obtaining property by deception", "obtaining a money transfer by deception", "obtaining a pecuniary advantage by deception", "procuring the execution of a valuable security by deception", "obtaining services by deception" and "evasion of liability by deception") sought to cover the same ground.
This patchwork quilt of highly specific offences gave rise to a number of difficulties in practice. In particular, conduct which would generally be regarded as dishonest or fraudulent might not fit neatly into one of the specific offences. This very detailed legislative approach also tended to promote defences of a highly technical - and frequently unmeritorious - character.
The 2006 Act was passed in order to simplify the law and, in line with the Government's intention, to enhance the prospects of successful prosecutions in future fraud cases. Those prospects will perhaps be further enhanced if the current Fraud (Trials without a Jury) Bill becomes law. The purpose of that Bill is obvious from its title, but it is unnecessary to discuss it in the present context.
Against this brief background, it is necessary to examine the new offences created by the 2006 Act and to examine commercial situations to which the new statutory provisions could apply.
The new offences
In broad terms, the 2006 Act seeks to classify fraud into three general categories. First of all, it creates an offence of "positive" fraud, i.e., where the defendant makes a statement designed to make a gain or to cause a loss. Secondly, a "negative" fraud offence is created, which criminalises the deliberate withholding of information with a view to securing a gain or inflicting a loss. Finally, the Act creates an "abuse of position" fraud which affects those who seek to take advantage of a position of trust or confidence.
Fraud by false representation
Under section 2 of the 2006 Act, a person commits an offence if:
a. he dishonestly makes a false representation; and
b. in doing so, he intends to make a gain (for himself or anyone else) or to cause a loss to another person (or to expose that person to a risk of loss).
The scope of the offence is defined and explained by the 2006 Act and existing case law as follows:
a. a representation may give rise to the offence if it is a statement as to a matter of law or fact, or as to the opinion of any person. A false statement as to one's intentions or state of mind may thus be "fraudulent" for these purposes;
b. a representation is "false" if it is untrue or misleading and the person making it knows it is, or might be, misleading. A representation may thus be treated as "fraudulent" for these purposes if the defendant was reckless as to the accuracy of his statement (i.e., he did not know or care whether or not his representation was true);
c. the representation may be express or implied, (that is, the representation may be made in writing or by word of mouth, or it may be inferred from conduct). For example, if the defendant presents a document to be relied upon by another party in the knowledge that its contents are untrue, then he impliedly and falsely represents that the document is authentic and accurate;
d. a representation is dishonest if (i) it would be viewed as objectively dishonest according to contemporary standards and (ii) the defendant himself realised that his acts were dishonest;
e. a representation is made even though it is submitted through an electronic system designed to receive or respond to communications (i.e., it is not necessary that the representation should be made to an individual). This overrules the earlier view that a representation has to be made to a person, because a machine cannot be deceived. As a result, a person who uses an ATM card without the consent of the true user will commit an offence under this heading. By entering the PIN, he makes a false representation to the machine to the effect that he is entitled to use the card;
f. the offence is committed if a false representation is made with a view to making a gain or inflicting a loss. It is not necessary to show that a gain or loss was actually made or incurred;
g. a "gain" includes not only the receipt of money or property, but also the retention of money which ought to have been paid to another party;
h. likewise, the victim may suffer "loss" if he is deprived of his existing funds or if he does not receive funds which he is otherwise entitled to receive; and
i. in each case, it does not matter whether the gain or loss is permanent or only temporary.
The "fraud by false representation" offence may have consequences for borrowers seeking to raise loan facilities from their banks, and for the individuals involved in those negotiations. Some typical situations may help to illustrate the point. In order to enable it to draw funds under a standard loan agreement, the borrower will be required to confirm some or all of the following matters:
a. that it is not in default in respect of any of its other borrowing arrangements (essentially a question of fact);
b. that no official consents are required in order to enable it to perform its obligations under the loan agreement (essentially a question of law); and
c. that there has been no material adverse change in its financial position since the date of its most recent audited financial statements (essentially a question of opinion).
In accordance with the provision outlined above, the borrower and the officers in charge of the negotiations on its behalf may commit the "fraud by false representation" offence if (i) to their knowledge, any of these statements are, or might be, untrue and (ii) the statements are made dishonestly with a view to ensuring the drawdown of the loan. As noted above, the existence of dishonesty involves a partly objective and a partly subjective test. But it may well be possible to prove dishonesty in such a case; it would be objectively dishonest to obtain funds from a bank in this way, and those working in the borrower's treasury or finance function would be aware of that fact.
Fraud by failing to disclose information
Under section 3 of the Act, a person commits an offence if:
a. he dishonestly fails to disclose to another person information which he is under a legal duty to disclose; and
b. he intends thereby to make a gain (for himself or any other person) or to cause a loss to another person (or to expose that person to a risk of loss).
The offence created by this section is potentially very broad, given that it creates a sin of omission, rather than commission. At first sight, this risk appears to be mitigated by the reference to information which a person is under a legal duty to disclose. Yet legal duties can flow from many diverse sources, including legislation, contracts, relationships of trust and agency and obligations of utmost good faith. The section is apparently not limited to statutory or regulatory disclosure obligations.
It is at this point that the breadth of the "failure to disclose" offence becomes apparent. Examples - which may not have amounted to criminal offences under the old law - include the following:
a. a borrower fails to disclose to a lender the occurrence of adverse events which may entitle the lender to terminate the facility, knowing that the provisions of the loan agreement require notification of such matters. It may be argued that the borrower thereby exposes the lender to the risk of loss (or greater loss) because the borrower's financial position may deteriorate further before the lender discovers the true situation; and
b. similarly, a borrower might neglect to inform a lender of an occurrence which might entitle the lender to charge penalties or increase the margin on the loan. In such a case, the borrower may have deprived the bank of funds which it was otherwise entitled to receive.
In each of these cases, if the loan agreement required the borrower to provide the relevant information and the borrower deliberately refrained from doing so, then it seems that the borrower would commit an offence, because it has deliberately inflicted a loss on the lender, or exposed it to the risk of loss.
It is true that, in such cases, dishonesty must be proved, but deliberate non-disclosure may be sufficient evidence of that element.
Fraud by abuse of position
As shown above, section 2 creates a fraud offence by reference to a positive act, whilst section 3 creates an offence of fraud by omission. Section 4 provides a further variation, and creates an offence which may be committed by act or omission. The section is not concerned with conduct which creates or leaves a misleading impression. Rather, it addresses the dishonest abuse of a position of trust. Under the terms of that section, a person commits an offence if:
a. he occupies a position in which he is expected to safeguard (or not to act against) the financial interests of another person;
b. he dishonestly abuses that position; and
c. he intends thereby to make a gain for himself (or any other person) or to cause loss to another person (or to expose that person to the risk of loss).
Once again, a person can abuse his position either by positive act or by omission. It is not difficult to envisage that this offence could be committed in a number of cases where a fiduciary relationship exists. For example, in the past, a company director who diverted a business opportunity to himself could be subjected to civil proceedings to recover the benefit, but he would not generally have committed a criminal offence. Now, if the requisite element of dishonesty can be proved, he could be prosecuted under the "abuse of position" offence created by section 4.
Extent of criminal liability
Private individuals may, of course, commit any of the new fraud offences in their personal capacities.
In addition, and although the required element of dishonesty is necessarily a human (rather than a corporate) failing, the offences may be committed by companies and other legal entities. In that event, a director, manager, secretary or similar officer is also guilty of the same offence if it was committed with his "consent or connivance". As a result, a corporate official may be liable for a fraud offence in two types of case, namely:
a. where he is the person who dishonestly makes a false representation, withholds information or abuses the company's position (as the case may be); or
b. where he is not the officer directly responsible for the primary criminal act but is aware of, and consents to, the intended commission of that act by a colleague.
Relevance of new offences for banks
It is apparent that the 2006 Act broadens the scope of the offence of fraud as that term is generally understood. Nevertheless, it is tempting to ask - what relevance does this have for the banking fraternity? A bank may occasionally have grounds for believing that a borrower has misrepresented its financial position, or may have failed or delayed in providing material information required under the terms of the loan agreement, and that this may have prejudiced the bank in some way. Yet, in the normal course, such matters would be dealt with through negotiation. The lender, having discovered the truth, may demand additional security or other measures. Criminal law issues would arise only in the most extreme and obvious cases. This position may now have to change, given that the Fraud Act 2006 must be read in conjunction with the bank's anti-money laundering obligations under the Proceeds of Crime Act 2002.
Anti-money laundering implications
As is well known, sections 327 - 330 of the Proceeds of Crime Act 2002 create various offences involving the proceeds of crime. Although any of these offences could become relevant in this context, section 330 is the most wide-ranging provision and it is thus proposed to concentrate on that section.
Under section 330, an individual working within a bank will commit an offence if (i) in the course of his work he acquires information which leads him to suspect (or ought to lead him to suspect) that someone is engaged in laundering the proceeds of crime and (ii) he fails to report that suspicion to the bank's Money Laundering Reporting Officer. The MRLO may, in his turn, be obliged to report that suspicion to the Serious Organised Crime Agency.
Money laundering involves the acquisition, concealment, use or transfer of property which represents the proceeds of any crime or "criminal property". For these purposes, "criminal property" means a person's "benefit" from criminal conduct. Clearly, if a borrower receives funds from the bank as a result of a "false representation" offence, then those funds will represent such a benefit and the relevant moneys will accordingly constitute the proceeds of crime. But the expression "benefit" is also taken to include the retention of funds which ought to have been paid to a third party. Thus, if as a result of a deliberate misrepresentation or non-disclosure, a borrower has retained funds which it might otherwise have had to pay to the lender (e.g. by way of default interest or as a result of the operation of a margin ratchet), then the borrower may be in possession of the proceeds of crime to that extent. In each of these cases, the relevant employees of the bank will be obliged to make a report to the MLRO in order to avoid the commission of an offence under section 330. The Fraud Act may thus compel banks to report their own borrowers under these circumstances.
As a practical matter, it may often be very difficult for a bank to decide whether a report should be made. For example, it will not always be easy to decide whether a borrower genuinely believed that there had been no material adverse change in its financial position since the date of its latest audited statements, since this clearly involves a significant element of opinion and value judgement; it may equally be difficult for the bank to determine whether the borrower has acted dishonestly. Yet it is not the offence with which the bank is concerned, for it is required to report the mere suspicion of an offence. As a result, banks will no doubt exercise caution and will lodge reports in cases which may be regarded as unclear.
It should be emphasised, however, that a reporting obligation can only arise if the bank suspects that the borrower is in possession of funds which represent the proceeds of crime. Thus, if a borrower submits a drawdown notice but the bank refuses to respond to it (whether because it suspects the fraud or for any other reason), then drawdown will not occur and the borrower will not come into possession of any criminal property. Although the borrower may have committed an offence by dishonestly making a false representation with a view to obtaining the funds, no reporting obligation is imposed on the bank in such a case.
Likewise, if, with a view to ensuring that the bank does not terminate the facility and/or enforce its security, the borrower dishonestly withholds information which the loan agreement requires it to provide to the bank, then the borrower may commit the "failure to disclose" offence because it thereby exposes the bank to a risk of loss. On the whole, it seems that there would be no need to report such a situation under section 330 because the borrower does not receive any criminal property as a result. Nevertheless, it must be said that this point is not entirely clear. It could be argued that (i) the bank loses the right to accelerate the facility as a result of the non-disclosure, (ii) the borrower thereby retains funds which it would otherwise have to repay to the bank and (iii) the resultant benefit to the borrower constitutes criminal property. If that analysis is supportable then a bank may wish to consider making a section 330 report in that type of case.
The Fraud Act 2006 is in many respects to be welcomed, in that it simplifies a formerly complex area of the law and may help to avoid the use of technical defences which have no real merit. Yet the law may well have unintended consequences. The breadth of the new fraud offence criminalises a broader range of conduct, with the necessary result that a wider range of property may constitute the proceeds of crime. In the past, the anti-money laundering obligations of banks have focused primarily on the source of the customer's own funds. The Fraud Act may widen those duties, and banks may have to consider whether customers may have committed criminal offences in the context of loan negotiations or transactions with the bank itself. Failure to do so may involve bank employees in the commission of an offence under section 330 of the Proceeds of Crime Act 2002.