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Presentation by Paul O'Neil to the Competition and Law Policy Institute of New Zealand

Regulatory prosecutions – the experience so far

Introduction

I have been asked to speak about the FMA’s experience of bringing criminal proceedings in a commercial context and offer some insights that may be of relevance to this audience given the incoming criminalisation of cartel conduct. 

Certainly, whilst we are still a young organisation in relative terms,  the FMA has had its fair share of such experience with several prosecutions brought under the Crimes Act, Securities Act, Companies Act and Financial Reporting Act since our formation in 2011.  Of these, probably the greatest profile has been afforded to the series of prosecutions that the FMA brought against finance company directors in the aftermath of the global financial crisis.  The finance company investigations have now concluded and whilst some of these matters remain before the Court, this chapter of New Zealand’s regulatory history is almost closed.

On that basis, the timing for me speaking is somewhat interesting given that through the new Financial Markets Conduct Act 2013 the FMA is now (at least in theory) moving away from criminalisation towards a more civil based model of enforcement.  I say in theory because of the course the FMA is responding to a dynamic market and, in some ways that I will discuss, criminal conduct has moved towards us. 

I’ll start by discussing the current state of the FMA’s regulatory focus, just to provide some context for the observations I’d like to make and as part of that I’ll talk about some of the perimeter actives that have fallen with the scope of the FMA’s criminal mandate. 

I’ll then talk about the decision making process the FMA goes through when it is determining whether civil or criminal proceedings may be the appropriate response.

Finally, and I intend this to be the focus of the discussion, I’ll make some observations around the FMA’s experience of bringing criminal proceedings from a legal, procedural and practical perspective.

Current regulatory environment for the FMA

The Financial Markets Conduct Act

The new FMC Act adopts a system of de-escalating levels of liability and introduces a new set of regulatory powers and infringement offences, increasing the emphasis on civil liability for contraventions.   Under the Act, serious criminal offences, which may result in imprisonment, are now reserved for the most serious violations of the law.  This is a shift from the regime under the Securities Act where, for example, section 58 of that Act provided for criminal prosecution for what was effectively a strict liability offence.

A key focus of the new regime, with the expanded regulatory toolbox, is to ensure that the regulatory response to actual or potential misconduct is proportionate to the contravention.  As part of this new regime, the FMCA confers on FMA the power to make a range of administrative orders including Direction Orders which direct compliance with the Act and stipulate steps that must be taken to comply, and Stop Orders which prohibit certain action. These orders are designed to enable FMA to proactively and swiftly respond to threats of harm to the market across a wide range of regulated activities by means other than Court action.  This goes much wider than simply choosing between litigation options.  The FMA now has an extremely broad range of tools to select from when deciding how it should respond to misconduct.

While shifting away from an emphasis on criminal liability, the FMC Act provides a broader range of civil penalties and remedy provisions where market participants contravene the law.  In pursuing a civil claim, FMA can apply to the High Court for orders including declarations of contravention, civil pecuniary penalties, and compensation orders.  These civil liability provisions are strict liability in that a person who contravenes a civil liability provision is liable unless they make out a defence. Persons involved in a contravention may be liable if they were an intentional participant in the primary contravention and had knowledge of all essential facts. The FMC Act provides robust defences for those who have good corporate governance structures and due diligence processes and procedures in place. 

What all this means in practice is that criminal liability is now reserved for the most egregious misconduct involving knowledge or recklessness.  By way of example, and to tie it back to our finance company experience, directors would now only be criminally liable if an offer document was issued with their authority, permission or consent and they knew or were reckless about whether there was a defect in disclosure.

Finance company cases

That said, whilst it is tempting to talk about the decriminalisation of certain behaviour under the new Act, there is more to it than that.  The finance companies that were the subject of these prosecutions raised money from the public pursuant to prospectuses which were registered under the Securities Act 1978.  The charges brought under s58 of the Securities Act were premised on the contention that the prospectus contained statements which were untrue in a number of respects. In each of the cases brought by the FMA, the Judge concluded that there were untrue statements and once this determination was made, and the directors were not able to establish they had reasonable grounds to honestly believe that the prospectus was true, the criminal offence was complete.

The charges were therefore very close to strict liability and so you had the relatively unusual situation (both in the New Zealand legislative context and overseas) where notwithstanding a potential finding of honesty (or an absence of dishonesty), there was still criminal liability in the form of a maximum potential penalty of five years imprisonment, or fines of up to $300,000.  Now this has changed under the FMC Act and some commentators (and indeed some of the defendants themselves) have talked about this conduct being decriminalised. [mention Lombard]  

Whilst there is something to this comment, I would make two general points in response:

  • First, in many of the Finance Company cases brought under s58, the FMA (through the Crown) reached the evidential standard it needed to reach under the Act.  If it had been required to reach a standard of say recklessness, then it would have sought to do so and in many of these cases may have succeeded.  So whilst the evidential standard might have changed, the conduct may still have been criminal under the new regime.
  • Secondly, it is somewhat misleading to apply a retrospective lens to past s58 breaches and say that this conduct is no longer criminal.  The reality is that Parliament had a set of penalties that responded to a certain disclosure regime that was in place at the time.  Arguable that regime was less rigorous, but it was met by severe penalties under s58.  We now have a very robust, stringent and different disclosure regime under the FMC that responds to breaches with what in most cases will be a civil response.  However, the important point is that the regime is intended to lessen the likelihood of such conduct occurring in the first place. You can’t look simply at the penalties and say that they have changed without acknowledging that the whole regime has changed with it.   

I make these points with an awareness that the legislative scheme for cartels is very different, but also with the important footnote that it is often overly simplistic to say in a black and white way that conduct has moved from non-criminal to criminal or vice versa. 

Perimeter behaviour

I also want to briefly address some of the less mainstream aspects of the FMA’s mandate to deal with criminal conduct.  What we have seen on some recent occasions is market participants using the language of the FMC Act regime, for example purporting to offer investment management services, financial advice as well foreign exchange, gold bullion and share trading services, as a pretext for conduct that may be simply fraudulent.

The question of whether the FMA’s oversight does in fact extend to these activities is a separate one, but for the purposes of his conversation the important point is that some individuals and entities can use the language of financial markets as a means to give credibility to their conduct.  For example, taking public funds in on the basis that it will be invested in certain ways, but where in fact no investment is taking place – in such cases you are left with pure theft rather than a nuanced financial markets offence.

Indeed, this raises the interesting regulatory question of whether it’s financial markets misconduct at all, if no financial markets activity ever took place.  It has been suggested by some that this is pure crime which falls outside what the FMA should be looking at.  On the other hand, the FMA has a real stake in preventing the language of financial markets being used to facilitate criminal activity. 

However, regardless of where you fall on this somewhat esoteric debate, the conduct can’t be allowed to continue, so where appropriate we have acted, using the FMA’s statutory powers and have worked jointly with the SFO and Police in the investigation of this type of conduct.  This engagement has ensured this activity doesn’t slip through the cracks.

The lesson – particularly when considering the criminalising of cartel conduct – is that a stronger statutory mandate (which the FMA has in the form of its new Act) makes some things clearer.  But it also can highlight – for the regulator, and for those who would breach the law – where you don’t have authority.  Some individuals and entities will capitalise on that.  It also underlined for the FMA the need for strong regulator-to-regulator relationships – they allow you to ensure coverage of a bigger area than you can cover on your own. In the FMA’s case, our MOUs with other agencies means we are able to co-operate closely, ensuring perimeter activity is the subject of enforcement action even if ultimately not by us.

The appropriate regulatory response

The question of whether to bring criminal or civil proceedings, or indeed to use on the array of new tools provided to the FMA under the new Act is not straightforward.  The Solicitor-General guidelines for prosecutors sets out in great detail the test that must be met both in terms of evidential sufficiency and public interest and I don’t propose to detail that today.

However, there are some policy questions, which  I think are of general application, which assist the FMA as a risk based regulator to makes its decision in terms of what regulatory response it might choose and I think its useful just to touch on some of those:

  • The seriousness of the conduct – is it intentional, reckless, grossly negligent or simply negligent?  Is it merely a technical breach or are there any other aggravating or mitigating circumstances such as an abuse of trust or authority, vulnerable victims, or history of recurring misconduct?
  • Market impact or detriment  - has the offence resulted in serious financial loss and is the behaviour likely to have significant and ongoing impact on financial markets?
  • Public policy - Would a decision not to commence or continue enforcement action likely undermine public confidence in the regulation of the financial markets?
  • Deterrence - Will enforcement action modify the behaviour of others by demonstrating or explaining the consequences of failure to comply?
  • Maintenance of law - Would enforcement action contribute to the performance of FMA's statutory mandate and its strategic objectives?
  • Compensation – is there an opportunity to take action that a return for investors?

These factors cannot be viewed in isolation, can never be exhaustive, and one does not necessarily trump the other.  It’s a balancing act and one that becomes decidedly more difficult when criminal action – the most serious of regulatory responses – gets placed on the table.

Practical issues

One of the issues for the FMA to consider when it is evaluating the appropriate regulatory response to misconduct is the question of what resources it’s appropriate to devote to the matter.  Bringing proceedings is time consuming and expensive and the FMA, as with any regulator, does have to pause before it spends public money to head down this route.  On top of this, criminal proceedings, at least in theory, are more resource intensive than civil proceedings.

As a general proposition, criminal investigations will need to be conducted to a higher standard than civil investigations as there are greater possible consequences in criminal proceedings of getting it wrong.  Specifically, the Evidence Act applies only to criminal proceedings, so the factors used to assess whether evidence has been improperly obtained do not explicitly apply to civil proceedings. 

However, the reality is that if evidence was clearly unfairly obtained, it is still unlikely that a Court in civil proceedings would permit such evidence to be used.  Instead the Court is likely to resort to one of the following options:

  • It may find other means to exclude the evidence, such as through s8 of the Evidence Act, or simply reduce the weight that s given to the evidence;
  • The High Court Rules provides for situations where the Court may strike out all or part of a pleading.  The grounds for strikeout include an abuse of process.  Arguably this acts as a catch all to cover all instances of misuse of the Court’s process.

In other words, the consequences of not following proper process when it comes to evidence are ultimately likely to be equally impactful on the outcome of the proceedings whether it’s criminal or civil.

In any event, the reality for the FMA has been that at the investigation stage, it is usually not possible to adhere to a lesser ‘civil’ standard.  This is because at this stage it will generally not be possible or appropriate to pre-judge whether the conduct (and the evidence) will lead to bringing either civil or criminal proceedings.

As noted earlier, the choice between the two is often finely balanced.  As a consequence, therefore the FMA’s practice has been to conduct its investigations to a criminal standard to preserve that option.  That begs the question, what does that that higher standard look like in practice? 

For present purposes, it’s probably best to look at it in 3 phases being the pre-interview phase, the interview itself and prior to the laying of charges:

Prior to interview:

The FMA’s practice is that written notice will be provided to a witness or a suspect.  Each investigation approach will differ, but typically the FMA will, where possible and appropriate, outlining the following information:               

  • the right to be accompanied at interview by a lawyer;
  • the general purpose of the interview;
  • the general factual subject matter; and
  • the type of allegations the suspect might face.

There is no requirement to set out a full list of the questions to be asked in advance of interview, nor is there a requirement to provide further disclosure of the case against the suspect.  Indeed doing this may affect the integrity of the investigation process.    However, the FMA invites interviewees and their lawyers to engage in relation to information that will assist the interview to operate more effectively.  If we are in a position to give that information without prejudicing the investigation process, then we will consider doing so.

At interview:

The FMA will always ensure that any person being interviewed understands their right to have a lawyer present.  It is no one’s best interests that evidence is gathered in circumstances where they are not aware of their legal rights.

At the interview, a person should be advised of their rights, regardless of whether the interview is voluntary or compulsory.  A witness should also be given their full rights (including the right against self-incrimination) if there is a possibility they may become defendants in the same proceedings.  The FMA has taken a cautious approach to this as again, the value of evidence given when a person is under a misapprehension as to the liability they might face down the track, is limited. 

As part of the same approach, whilst the FMA will often interview people on a voluntary basis, if criminal proceedings are in play we will tend to do this under formal compulsory notice, so that the basis for the interview can be set out explicitly and there can be no doubt about the circumstances in which evidence was taken.

There is a base expectation in the case of evidential interviews that if a person is questioned about other statements or evidence, the substance of the statements or evidence must be fairly explained.  Again, the FMA is realistic about the complexity of the commercial matters it investigates so it will endeavour to provide as much detail as it can in advance of the interview, or otherwise to give direction around the documents or material the person might consider so they are properly prepared.

Another consideration that has become very important for the FMA is the confidentiality of its investigations and in particular the interviews it conducts.  The FMA experience has been that the issue of confidentiality orders in criminal investigations is often best practice.  The effect of the orders is that the subject of the interview cannot discuss its content with any other party (except for acknowledged exceptions in relation to legal advisers) including those about to be interviewed or members of that person’s organisation. 

This protects the integrity of the interview process in that people can’t simply share information in advance in order to “get their story straight”.  It also provides a protection for those who are the subject of the interview as it means that they have a legal basis for resisting the inquiries of employers or other parties who ask them for information.   

Post interview:

In the context of criminal prosecutions, the FMA has generally provided a right to be heard prior to being charged or proceedings being filed.  This approach does not reflect a hard and fast rule, but the FMA does consider it important to make reasonable efforts to give a suspect the opportunity to explain their case and any possible defence.

If a suspect does raise a possible defence, due consideration as to the merits of that defence will be given by FMA.  At that point, the FMA may also consider whether or not it is able to reach a non-ligation solution.  In the context of civil proceedings, the FMA is able to have a robust commercial discussion and try to reach a deal.

In the context of possible criminal proceedings this ability is somewhat constricted by the fact that obviously the threat of criminal proceedings cannot be used to broker a deal.  At the same time the Solicitor-General guidelines do envisage an ability to negotiate and provided a solution is reached on the basis that it represents an appropriate and proportionate alternative to a prosecution – as opposed to an outcome that has been achieved through the undue pressure of potential criminal proceedings – then that ability to negotiate is there. 

The parties do also need to remember that there is no ‘without prejudice’ privilege operating in the context of criminal law.  However, there is still the ability to carry out confidential discussions and the Courts have tended to treat this in very much the same way.  

Management of evidence

Aside from process, there are also some practical considerations that arise from conducting criminal prosecutions.  In the FMA’s experience, a secure central evidence location, an experienced team of evidence coordinators and an established evidence movement process is crucial.  The FMA’s enforcement team contains a core of former police and agency staff who have vast experience in implementing and observing the proper procedures and processes to ensure these expectations are met.

By their nature, the prosecutions the FMA has brought are document intensive.  Typically, the core documents in a large prosecution will number in the tens of thousands.  The documents themselves will consist of hard copies, emails, pst files, hard drives, memory sticks, clones and smart phones.  These documents (in all of these forms) need to be centrally stored in a single secure location.  By secure, I mean that all parties (staff, experts, external counsel) that might have access to those documents in whatever form they exist should be known and the circumstances in which they have that access will be known and documented. 

Ultimately, the FMA experience is that these documents also need to be stored using appropriate litigation software that allows the documents to be categorised, coded, reviewed and disclosed.  There are a number of tools on the market, but crucially, whatever tool is used, the source of the document needs to be clearly identified and traced through its journey from its provision to the regulator to its advancement as piece of evidence. 

The other point around clear identification of source is allowing certain sensitive documents to be isolated and treated separately.  The FMA receives information (which can then become evidence) from a wide range of sources.  This includes protected disclosures, privileged material, material from overseas regulators and other enforcement agencies.  This means that such material can have a certain character of confidence or protection around it which will mean it has to be stored separately and treated differently.  Again in order to maintain confidence in its processes and to respond to any challenges around the appropriate use of such evidence, particularly in the context of criminal proceedings, the ability to isolate and store such material in a consistent and documented fashion is key.

The other aspect of such document intensive cases is the facilitation of defendant’s access to this material.  In the context of criminal prosecutions, the fair trial rights of defendants are rightly seen as paramount.  What this has meant in practice is that the FMA, the Courts and defendants have on occasions had to work together to reach a practical solution to ensure that those facing criminal prosecutions involving vast numbers of documents are not at a disadvantage when it comes to understanding the case against them.  This area of our prosecution work is probably the most quickly developing and we expect advancements in this area – followed by a need for both regulators and Courts to adapt to any perceived technological imbalance – will continue.

Media

As a starting point, the FMA as a public regulator has an obligation to be open and transparent about its enforcement actions including the criminal prosecutions it brings.  What that means is that, (with some very limited exceptions) public statements will accompany this action being taken.

Against this the FMA is subject to the Media Protocol for Prosecutors, which does influence the form those statements might take.  In terms of key points:

  • The FMA will generally seek to offer the defendant the right to seek name suppression before any initial public statement is made.  If the intention to seek suppression is signalled, then the FMA will respect that right and not name the individual or entity until the position is resolved.
  • The FMA is conscious of the need to strictly observe the restrictions around sentencing indications.  It is a criminal offence to disclose the content or even the fact of a sentencing indication taking place.  The FMA prefers not to commit its own criminal offences. 
  • Unless exceptional circumstances apply and comment is required, the FMA will typically not comment on proceedings while they are ongoing.  Whilst as part of its requirement to be open and transparent about its enforcement action, the FMA will typically publically acknowledge pleas, or verdicts, it will typically only offer substantive comment about the actual conduct once the sentencing process has been completed.
  • The FMA is also conscious that in cases where there are several defendants that are charged with the same conduct, it needs to be aware of making substantive comments about a resolution where there remain defendants still to face charges.  Again fair trial rights are paramount.

Conclusion

There are certainly practical and process driven challenges presented by bringing criminal prosecutions in a commercial context.  It places a real onus on the decision makers to get things right and requires a heightened awareness of procedure and the development of systems that ensure cases are fairly and properly brought and the fair trial rights of those affected remain intact. 

At the same time, these disciplines should be equally applicable to any regulatory action that is taken by a state funded entity (criminal or otherwise) and in many ways, whilst the legal landscape may change – in the form of a move to criminalisation by the Commission, or a move toward a more civil based regime by the FMA – the standards of regulatory investigations and conduct of proceedings it might bring can and must remain at the same high level.