Dispatch

• SEC gets flexible
• organised threat
• tribunal bins FSA judgement
• fraud rises

SEC gets flexible

Critics called the Sarbanes-Oxley Act uncompromising. But now the Securities and Exchange Commission seems to be choosing a more flexible course.

Taking a tough line is usually easier in principle than in practice. And after a troubled introduction of the 2002 Sarbanes-Oxley Act, the SEC appears willing to bend a little in the wind. With European, Chinese and Japanese companies all talking of either delisting from the New York stock exchange or reversing their intentions to list there, the SEC is adopting a more conciliatory tone.

'The SEC remains committed to a level playing field for all its issuers, foreign and domestic alike,' William Donaldson, the SEC chairman, told an audience at the London School of Economics. 'But we recognise that cross-border listings frequently entail issuers having to navigate duplicative or even contradictory regulations in different jurisdictions. While the SEC is unwilling to compromise where investor protections are concerned, some duplicative or contradictory regulations can compromise those protections and place an unnecessary burden on issuers, firms and investors.'

Days later, the SEC confirmed that it will consider limited exemptions to companies also listed oversees as part of a roundtable discussion of the introduction of the Act which it will conduct in April. This may lead to amendments to the reporting system, though the SEC is keen to increase pressure further on companies to improve their internal controls. This follows the revelation, made in Compliance Week in the US, that almost 600 listed US companies face investor lawsuits or increased borrowing costs arising from weaknesses or deficiencies in their filings to the SEC under the Act. The SEC is also seeking comments from auditors, companies and others on their experience of the Act, which will be posted on the SEC's website.

One likely result of the SEC's reflections is that overseas companies may not have to comply with Sarbanes-Oxley from July this year as planned. This would provide a breathing space in particular for European companies, simultaneously struggling with implementing IFRS.

But while the SEC's concessions will go a long way to resolving concerns in Europe, they are less likely to guarantee that major Chinese companies moving towards IPOs will list in New York. Scandals at China Life and China Aviation Oil have damaged confidence by outside investors in Chinese corporate governance practices and levels of disclosure. Within Chinese companies there are worries not only at possible tough enforcement practices by the SEC, but also that they could be subject to unpleasant class action suits by investors if the companies hit problems.

ACCA has endorsed the signs of flexibility from the SEC. Roger Adams, ACCA's executive director - technical, said: 'We welcome the proposals to relax the rules, or to provide more time.' However, he warned that other measures still being introduced by the SEC - such as stricter independence rules for auditors, particularly relating to tax advice - mean that there could still be damaging disparities between the approaches taken by regulators in the US and Europe.

'There is still some more progress to be made to ensure that rules-based independence standards don't bite too deeply,' added Adams, 'in particular, when they run counter to the principles-based rules on independence developed by the European Commission.'

However, moves by the European Commission to bring in their own equivalents of Sarbanes-Oxley and the Public Accounting Oversight Board, along with the adoption of IFRS, are adding to disquiet elsewhere. It is reported that several major Japanese companies are actively considering delisting on European exchanges, concerned by the cost of having to introduce international accounting standards in advance of any requirement to move to IFRS in Japan.

organised threat

Tough new measures to tackle international organised crime have been announced by the European Commission. Major crime gangs, many specialising in counterfeit goods and intellectual property theft, represent a growing threat to legitimate businesses.

Organised crime controls about 2% to 5% of world GDP, according to analysis conducted by the International Monetary Fund. Across the European Union there are about 4,000 organised criminal gangs containing probably 40,000 gangsters, the EU believes. The impact of just one element of their trade - the retailing of counterfeit and pirated goods - steals about 450bn euros from legitimate traders each year, says the World Economic Forum. International people trafficking alone is estimated to net between 8.5bn euros and 12bn euros, calculates the European Commission.

It is no wonder, then, that the EU is committed to tackling the growing crisis. Globalisation of legal trade has spawned globalised illegal transactions. Although the most widely traded counterfeit goods remain fashion items, CDs and DVDs, there has been stunning growth in the sale of counterfeit children's toys - production of which has risen by about 1,000% in two years. These represent serious health and safety risks - not just to children as consumers, with products not properly designed and tested, but also to those involved in manufacture. Often the factory workers are themselves children, sometimes abducted from their homes in parts of Asia.

Another worry is the close connection between organised crime and paramilitary warfare. One of those charged with the Madrid train bombing last year - an attack blamed on Al Qaeda - ran a business selling counterfeit clothes. Police who raided a counterfeit goods factory in Brazil run by Palestinian exiles found thank you letters for large donations from Hezbollah, the Lebanese based group dedicated to the destruction of Israel. And the IRA has been blamed by Northern Ireland's International Monitoring Commission for carrying out the £26m raid on Northern Bank.

A white paper has now been produced by the European Commission which would amend criminal law in several member countries. Changes include the harmonisation of definitions of a criminal organisation and a criminal conviction, providing the basis for an EU-wide database of convictions. The database should assist detection of crime, the monitoring of known criminals and enable courts to order more severe punishments where criminals have previous convictions in other member states.

Across the EU, leaders of criminal organisations could be imprisoned for 10 years, with five years' imprisonment for membership. The definition of a criminal organisation would be a structured association consisting of at least two members which, for material gain, commits crimes which are punishable with at least four years imprisonment. Examples of these offences include arms, drugs and people trafficking and money laundering.

It is hoped that the new EU-wide criminal law amendments can be in place by next year. Urgency is required because of the scale of the growing problem and the possible expansion of the EU to countries where organised crime is especially prevalent, including Bulgaria, Romania, Croatia and possibly Turkey and the Ukraine.

However, new EU member states have been amongst those most successful in tackling organised crime. Estonia, for instance, intercepted 11 ships of counterfeit clothing, while Hungary seized almost a third of a million counterfeit face and body lotions.

Professional advisers are warned to be cautious about approaches from people who may claim to be bona fide traders. 'Organised criminal groups are increasingly taking advantage of the benefits of legitimate company structures to conduct or hide their criminal activities,' concluded the 2004 Europol Organised Crime Report.

'If criminal gangs think that the EU has a soft touch on crime then they make a big mistake,' said Commission Vice President, Franco Frattini, commissioner responsible for justice. He added that his proposals would guarantee that 'criminals are brought to justice regardless in which member state they committed their crimes or fled to afterwards'.

tribunal bins FSA judgement

The UK's Financial Services Authority is to conduct a review of its enforcement procedures, following a highly embarrassing decision by the Financial Services and Markets Tribunal to reject processes used by the FSA to penalise Legal & General over alleged mis-selling of endowments.

L&G had mis-sold endowments between 1997 and 1999 to customers who should have been recognised as risk averse, agreed the Tribunal. But it rejected the FSA's use of a careful examination of a few cases to reach a generalised conclusion of mis-selling, justifying the penalty imposed by the FSA of £1.1m.

Moreover, the Tribunal decided that the FSA was wrong to have judged that L&G had failed to co-operate with its mis-selling inquiry, when the company rejected the methods used by the FSA. 'If L&G was not co-operating in securing a review which could be used effectively for enforcement, it was for the FSA to impose a suitable exercise,' ruled the Tribunal.

The FSA had relied in its working practices on a business review conducted by PricewaterhouseCoopers, which the FSA claimed justified making extrapolations on the number of total mis-sales on the basis of the cross-section examined in detail. But PwC told the Tribunal that its report was not intended to produce this inference.

While the FSA tried to put a gloss on the result by saying that its fundamental case of mis-selling had been upheld, the decision represents a major setback for the FSA. This has led it to set-up an enforcement review which will report to an FSA sub-committee advised by a barrister who specialises in banking law, Michael Brindle QC, and by David Pritchard, who retires as deputy chairman of Lloyds TSB in May.

The review will consider processes used in the FSA's inquiries, the role and involvement of senior management in these processes, the options for fair procedures with regulatory decisions made by people separated from the investigators and the accountability of decision-makers to the FSA board.

It is intended that the review will draw on expertise within the financial services sector, including practitioners and others with direct experience of the FSA's enforcement processes. But it will not explore options requiring changes to the Financial Services and Markets Act 2000.

John Tiner, chief executive of the Financial Services Authority, said: 'After three years of operating the existing arrangements for investigations and making enforcement decisions, and in the light of the Financial Services and Markets Tribunal's recent judgment in the Legal & General case, a review of their effectiveness is timely.'

The Association of British Insurers welcomed the review. Mark Allen, its legislation manager, said: 'The ABI believes it's important that the financial services industry has a strong regulatory framework and that robust enforcement processes exist within it. We were pleased that the FSA agreed to take on board a number of our suggestions during [a previous] review and we look forward to securing further improvements, particularly with regard to the conduct of investigations and the decision-making process, as a result of the planned review.'

But Which?, formerly the Consumers' Association, urged the FSA not to backtrack on its commitment to strong regulatory enforcement. Mick McAteer, principal policy adviser, Which?, said: 'While the decision that FSA processes were flawed is a worry for consumers, we hope the FSA won't be frightened off investigating other big companies and taking a tough approach where it's warranted. To restore consumer trust, the FSA needs to be a more robust enforcer than it has been so far. It needs to review its own procedures so that companies found to be guilty of mis-selling aren't let off the hook in future.'

Nor is the fight over endowment mis-selling the only conflict the FSA is involved in. Lloyd's of London has criticised the FSA for not taking a stronger stand in forcing disclosure of insurance brokers' commission. And the FSA's handling of the scandal of alleged mis-selling of split capital investment trusts has irritated both consumers and the industry. Without a speedy resolution of its problems, the FSA's credibility will be hard to sustain.

fraud rises

Fraud against businesses and consumers is on the rise in the UK, according to figures released by KPMG and by the Office of Fair Trading.

The incidence of fraud against businesses rose in the UK by 14% last year, the latest KPMG Fraud Barometer has found. KPMG's figures are reliable as they are based on cases reaching the Crown Court - 174 in 2004, to a total value of £330m. In one in three convictions, the fraud was committed by a company's employee. The majority of insider frauds were conducted by creating fake staff records for payroll processing, or the authorisation of bogus invoices. Other common frauds involved the theft and forging of company cheques.

Analysis by KPMG found that, in some cases, staff were able to succeed in their frauds for several years, eventually detected by accident rather than internal audit. But the total value of fraud has fallen because of Customs & Excise's success in tackling major VAT scams.

'The rise in the number of cases overall is bad news for UK businesses,' said David Alexander, fraud investigation partner at KPMG. 'Whilst the number of 'super-size' cases has fallen, more companies than ever are falling victim to fraud. Whilst our survey covers fraud cases over £100,000 we often find that losing even what may be relatively small amounts of money can disrupt cash flow and bring quite large businesses to their knees.' He recommends improved internal controls that would identify the most common frauds.

Consumers have also been warned about the growing threat from targeted fraud, through a month-long information campaign organised by the International Consumer Protection and Enforcement Network and, in the UK, by the Office of Fair Trading.

A 'top 10' of frauds targeted at consumers has been published by the OFT. Heading this is the telephone lottery scam, with individuals told by mail or phone that they have won a lottery prize - often naming actual lotteries in Spain or Canada. But 'winners' are told they must send money to pay for taxes or processing fees to gain their fictitious prizes. Similar swindles require 'winners' to claim prizes through premium rate phone numbers - the prizes either do not exist, or are not worth having. Other cold calls offer investments, which are dodgy or locked away in a jurisdiction where they cannot be recovered.

Pyramid schemes are still sold, promising financial returns based on signing up new recruits - but the schemes soon run out of cash. Related to this is the 'matrix scheme' offering free gadgets for persuading friends to sign up for a new product - such as a mobile phone signal booster. But only the first few respondents receive their gift. The OFT also warns of the risk involved in property investment schemes and work-at-home opportunities, which can be just an excuse for fraud.

The so-called 'Nigerian advance fee fraud' continues to be a serious problem. People are contacted and offered a big slice of a sum to be removed from Nigeria or other West African countries. Historically, these have claimed to be legacies which beneficiaries have been unable to export because of currency restrictions. But a new variant involves e-mails from people claiming to be bank managers who have committed fraud and are seeking to get their stolen funds out of the country.

The OFT calculates that the 10 most common frauds are together collecting £1bn a year from fooled consumers. OFT director of consumer regulation enforcement, Christine Wade, said: 'By exploiting the same routes to market as legitimate business, they damage not only individual consumers but the interests of fair trading businesses as well. As the global marketplace shrinks and communications systems become more sophisticated, the threat from rogue traders and scams that exploit consumers increases. Scammers are organised, manipulative and resourceful.'