Financial Crime and Fraud Investigation: Historical Perspectives

Learning outcomes

Understand the historical context and perspective for business and financial crime

Appreciate the impact of an industrialised economy on business crime

Note the changing attitude of the judiciary to such crime

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Antiquity

Ancient Greek commercial crime is testified to by the fact that the Parthenon’s architect had to flee Athens to escape charges of embezzlement

Roman law decreed that dardanarii those who conspired to raise the price of grain, oil, bread, meat, or salt by the detention of vessels the suppression of provisions or similar practices were to be fined.

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Antiquity

Roman law foreshadowed today’s suspicion of corporate entities Rome’s rulers (according to Gibbons)

“viewed with the utmost jealousy and distrust any association amongst its subjects and .. the privileges of public corporations though formed for the most harmless or beneficial reasons were bestowed with a sparing hand”

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Middle Ages

The development of trade in Europe in the middle ages brought in a range of punishments to restrict fraudulent practices by the growing merchant classes

In 1469 Louis XI of France promulgated an act to curb fraud in the sale and delivery of market produce

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Middle Ages

Early English law decreed that any person who conducted business had to bring witnesses before the king’s deputy who could testify to the detail of the transaction

In the 13th Century rules were enacted into statute outlawing 3 specific marketplace actions: forestalling, regrating and engrossing

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Middle Ages

These were acts that tried to artificially raise the price of commodities

Spreading false rumours Buying and selling the same article in the

same market for a higher price Buying foodstuffs in the marketplace

before the specified time

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The acts outlawing these practices were repealed in 1767 as it was felt that they were restricting free trade

Adam Smith published The Wealth of Nations in 1776 a free market exponent his treatise was published at the dawn of the industrial revolution

Most frauds prior to this time were related to food products within the agrarian society. This changed with the expansion of trade

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Concern over increased fraudulent acts was expressed in 1602 by Sir Edward Coke who said,

“Fraud and deceit abound in these days more than in former times”

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Attitudes

The dominant position through the ages marked by the failure of the law to protect people against exploitation was expressed by an English judge in 1703

The case involved a man charged with obtaining money from a debtor by pretending that he was the agent of the man to whom the money was owed.

The judge was scornful “ Shall we indict one man for making a fool of another?” it was agreed that they should not

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Attitudes

Same indifference in an 18th century case where the defendant is charged with misrepresenting a purchase of 16 gallons of amber as 18 gallons

“what is it to the public whether Richard Webb has or has not his 18 gallons”

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Changing Times

In the years following the “Glorious revolution” of 1688 England experienced a revolution in public borrowing transforming the economy and creating opportunities for “swindlers”

The Bank of England was created in 1694 to finance the national debt and the government securities or funds issued by the bank and traded on the stock exchange became a source of investment for the wealthier classes. As a result they were also a source of white collar crime

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Changing Times

Sir Henry Furnese 17th Century director of the bank took part in a number of schemes for artificially lowering the price of the funds and then purchasing as much as possible at the lower price

In 1697 Parliament found that numerous stock brokers “unlawfully Combined and Confederated themselves together, to raise or fall from time to time the Value of such Talleys, Bank Stock, and Bank Bills, as may be most Convenient for their own private Interest and Advantage”

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Changing Times

New instruments of trade proved vulnerable to abuse. The first fraud in Exchequer Bills occurred within a year of their creation

In days of unreliable news false rumours could greatly affect the value of government securities and was a common fraud in the 18th century

In 1711 rumours of the death of Queen Anne caused a sharp fall in the funds allowing some to make good profits

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Attitudes

In Jonathan Swift’s Gullivers Travels of 1726

“ The Lilliputians look upon fraud as a greater crime than theft … honesty hath no fence against superior cunning … the honest dealer is always undone, and the knave gets the advantage.”

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Changing Times

In 1803 reports that the British and French had concluded a peace treaty caused a rise in securities though in this case the bargains were declared void and a reward offered to discover the perpetrators of the hoax

1814 Charles de Bereneger pretending to be a French colonel spread a rumour of French defeat by throwing pamphlets from his carriage in the City. Government funds rose quickly and de Berenger and his accomplices, including an MP, made a profit of £10,000

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Financial Markets

During the 18th century brokers conducted most of their business in Jonathon’s coffee house in Change Alley, little regulation

The “Wickedness” of speculation caused great anger

Daniel Defoe (1719) A System of Stock Jobbing “proving that scandalous trade as it is now carried on to be knavish in its private practice and treason in its public”

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Financial Markets

Samuel Johnson defined stock-jobbers in his dictionary as “ a low wretch who makes money by buying and selling shares in the funds”

Reputable dealers established the modern Stock Exchange at Capel Court in 1801

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In 1734 Sir John Barnard’s Act was passed

This measure sought to prevent the practice of “stock jobbing” and provided that wagers on the price of the stock were to be void and penalties were also levied on those who sold stock to which the vendor did not have possession or title.

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Corporate Structure

In 18th century joint stock companies were quite few only large organisations used this structure such as the East India or Hudson’s Bay companies

The South Sea Bubble 1720 showed how they could be fraudulently used

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South Sea Bubble The company was chartered in 1711 but did not

do much business just a little trade with the Spanish colonies this stopped when war with Spain started in 1718

The directors then devised a scheme for converting government funded debt into South Sea stock This would allow the government to reduce its debt while increasing the company’s capital and its prestige

Directors bribed MPs and court officials to instigate this and South Sea stock rose very high

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South Sea Bubble

This caused a multitude of other companies to start up of dubious background ie one advertised “ to carry on an undertaking of great advantage but nobody to know what it is”

The promoter opened his office and closed it on the same day running off with £3000 in deposits

The South Sea company was worried about competition and lobbied for the passing of the Bubble act of 1720 forbidding further company formation without Royal Charter or act of parliament

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South Sea Bubble

Shares in the South Sea company and others were over subscribed and as demands for further payments were called for, speculators who had borrowed to buy sold out, prices fell and the bubble burst

The crash brought ruin to thousand of humble investors, the directors fled abroad

This catastrophe caused a psychological restraint on joint-stock organisation for over a century

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Industrial Revolution

The industrial Revolution speeded up the pace of earlier financial developments

It was the joint stock company which provided the legal form through which business could be pursued

The Joint Stock Companies Act 1844 created a registrar of companies and the ability to start up quickly

Replaced the Royal Charter or Act route

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Industrial Revolution

The railways was Britain’s most ambitious capital project ever which had to be met entirely by private investment

Although not permitted to incorporate under the 1844 act

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Industrial Revolution

This need would require investments to reach a much expanded audience

This was achieved by offering higher returns than alternative government bonds

Thus emphasising possibilities for considerable personal wealth

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Railway Mania

Central to the 1840s boom was that a sequence of good harvests had flooded the market with surplus capital

Ensured promotions of new companies were met enthusiastically

The desperation of investors to make money promoted empty and asset led “bubble” companies alongside the legitimate rail schemes

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Railway Mania

In turn this encouraged the spread of “evil and plethoric speculative mania” (Evans 1859)

This ultimately precipitated the 1845 share market panic

In 1845 The Bankers Magazine warned that as many as 75% of investment opportunities were intended to “rob and delude the public … and swindle their subscribers”

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Railway Mania

This in turn placed pressure on legitimate schemes who had to overstate value on their own shares in order to entice investors

By October 1845 panic ensued and the market crisis loomed

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Railway Mania

With the coming of the railways big business fraud was here to stay, Railways transformed English finance.

The aristocracy and gentry became heavily involved as they were often given large tranches of shares as compensation for lines going across their land

This mania affected large numbers of the moneyed populous who held these shares

The phenomenal growth of the Victorian railways network and the corporations gave rise to numerous fraud possibilities

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Railway Mania

The company explosion started by the Railway Mania of 1845 was extended by the limited liability act of 1855 and the Companies Acts of 1856 and 1862

These acts set in train the vehicles for greater levels of business and financial crime

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Criminal Liability

Earliest manifestations of the perceived need became apparent from 1846 when some company directors became the subject of criminal investigation on account of their activities in the boom

These were “intrusions” into business dealings

Intrusions into “gentleman’s agreements”

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Criminal Liability

The private system of prosecution in 19th century Britain left victims of crime to pursue criminal proceedings

Within this private context there is evidence of involvement from “City interests” of a collective nature

This appears to have been a very powerful influence in determining responses to financial crime

A compact of landed aristocracy and capitalists

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Victorian Bank Crises

For most of the Victorian era the English banking system was riddled with fraud and mismanagement the financial crises of 1857 and 1866 and the collapse of the City of Glasgow bank in 1878 were high water marks in an age of widespread commercial dishonesty

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Victorian Bank Crises

1855 three London bankers Strahan, Bates and Paul were tried and convicted for the embezzlement of monies entrusted to them as bankers

Sentenced to 14 years transportation Straightforward criminal act ie

embezzlement

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Victorian Bank Crises

The Royal British Bank case 1858 This trial acknowledged by the judge as “the

first… of this nature” City of Glasgow Bank case 1878 Both banks’ directors were rumoured to have

made inappropriate loans and sought to cover them up by falsifying published balance sheets

All directors were convicted

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Victorian Bank Crises

The prosecutor in the Royal British case stated

“Wide-spread ruin has been scattered over the whole of the country, houses have been brought to destruction, families have been plunged from affluence to poverty, the hard earnings of industry, collected by long labour have been completely lost”

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Victorian Bank Crises

The defence of John Stapleton a Royal British director

Based upon his “good family” background That he was a “west end director” “Utterly ignorant in banking”

He was fined and discharged

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Victorian Bank Crises

The directors of Royal British received sentences of between 3 and 12 months

With the directors of City of Glasgow receiving between 12 and 18 months

Appreciation that the potentially criminal activity did not have deliberate dishonest intentions i.e. intent hard to prove

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Victorian Bank Crises

The way in which prosecutors and judges looked to men of commerce for guidance in the criminalization of business, suggests that City interests had a substantial hand in determining what amounted to acceptable business conduct

This pointed to an emerging culture of self-regulation

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Victorian Bank Crises

One could say that in the two cases mentioned Royal British and City of Glasgow the directors were considered outsiders

Contrasted with the collapse of Overend and Gurney in the 1860s

The directors were charged on almost identical charges in an identical situation

The directors were acquitted

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Victorian Bank Crises

Directors regarded as merely “careless” The collapse “unfortunate” The criminal proceedings were declared

by the judge to be vexatious and inappropriate

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Stock Market Frauds

A Committee of 30 formed in 1802 had the power to grant quotations on the exchange but not with a mind to the investing public

Therefore fraudulent firms found it easy Was termed “thieves kitchen” A number of fraudulent issues in 1860s and

1870s gave rise to parliamentary investigations

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Contemporary Perspectives The opportunity to commit white collar crime has

expanded in response to the globalisation of commerce and financial transactions

The extensive white-collar crimes of the 19th and 20th centuries resulted from the financial revolution that radically altered English finance during the early 18th century

The growth of a securities market and experiments in company organisation created a new world of opportunities for dishonest businessmen

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Contemporary Perspectives

The nature of global business is highly competitive and company officials may not interpret their actions as criminal.

Nelken states that people are “… caught out in serious offences quite often for behaviour which they did not expect to be treated as criminal, and for which it is difficult to secure a conviction”

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Contemporary Perspectives

Stuart Green “ What is interesting and distinctive about [white-collar crime] is that, in a surprisingly large number of cases, there is a genuine doubt as to whether what the defendant has alleged to have done was in fact morally wrong”

Suggests that this is because “act” or offence results from a course of conduct that is otherwise legal and even socially productive

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Some key texts Geis, G. (2007) White-Collar and Corporate

Crime, Pearson Prentice Hall. Johnstone, P. (1999) Serious white collar fraud:

historical and contemporary perspectives, Crime, Law & Social Change, Volume 30, 107-130.

Robb, G (2002) White-Collar Crime in Modern England: Financial Fraud and Business Morality, 1845-1929, Cambridge University Press.

Wilson, S. (2006) Victorian Experiences of Financial Crime, British Journal of Criminology, Volume 46, 1073-1090.

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Other Readings Evans, D.M. (1859) Facts Failures and

Frauds, Revelations Financial Mercantile Criminal, Groombridge and Sons

Green, S. (2004) Moral Ambiguity in White Collar Criminal Law, Notre Dame Journal of Law Ethics and Public Policy, Volume 18, 502-513.

Nelken, D. (1994) White Collar Crime, Dartmouth Publishing