updated on 24 November 2020
QuestionWhat impact might covid-19 have on civil fraud law?
We've all been warned to watch out for an overwhelming wave of online and offline scams as criminals take advantage of overstretched systems (and people) in the wake of the pandemic. At the height of the first lockdown, there was more than 6,000 times the normal amount of spam. The Serious Fraud Office also expects a deluge of pandemic-related fraud and economic crime.
However, it's not just criminal fraudsters who are making the most of the distraction and disruption of covid-19. Litigators are also anticipating a surge in civil fraud cases as a result of the economic downturn.
What's civil fraud?
Civil fraud generally involves fraudulent misrepresentation or deceit. It encompasses everything from Ponzi schemes to skinny-dipping. Only joking: that’s a veiled reference to Warren Buffett's famous saying that "you only find out who's swimming naked when the tide goes out". In short, his quip means that fraudulent behaviour is often revealed in times of economic hardship.
When businesses fail, past bad behaviour can be uncovered when stakeholders try to salvage what's left of their money. Studies after the 2008 financial crash showed that the amount of money lost through fraud increased by approximately 20%.
There are various theories about why fraudulent behaviour tends to increase during recessions. One is along the lines of Buffett's theory as above; some people (dishonestly) made the most of the good times and their fraud was exposed when said good times came to an abrupt halt. The most famous example is Bernie Madoff's fraudulent investment scheme. Despite a comprehensive report to the Securities Exchange Commission by Harry Markopolos, a certified fraud examiner, in 2005, Madoff's extensive fraud was not exposed until the financial crash in 2008.
In times of financial hardship, the risk of fraud can increase as businesses fight for survival. On the criminal side, directors might strip companies of their assets on insolvency, and it is feared that many companies have fraudulently taken advantage of the furlough scheme, for example.
However, not all fraudulent behaviour will be caught under criminal or regulatory regimes. Company directors might falsify company accounts to give a better impression of the company's financial position or executives might mislead clients to enter into risky transactions to get hold of valuable commission. Such misrepresentations, if they cause someone to suffer loss, might result in a civil fraud claim.
Give me some examples
Remember the film The Big Short? After the 2008 financial crisis, investors discovered that they had been fraudulently sold debt investment products known as Collateralised Debt Obligations (CDOs). Buyers of CDOs suffered vast losses due to the collapse of the US housing market, which contributed to the global financial crash. This prompted a wave of misrepresentation claims against the banks and financial advisers who mis-sold CDOs and against the ratings agencies that overstated CDOs' investment grade, among other allegations and prosecutions.
Back in England and Wales, misrepresentation claims for mis-selling financial products pre-2008 have also formed part of the work of civil fraud lawyers for the past decade. High-profile cases include UBS v KWL, which also involved the infamous CDO.
CDOs and CDon'ts
In UBS v KWL, UBS and a financial adviser called Value Partners were counter-sued for fraudulent misrepresentation after they sold a specific type of CDO to a municipal water company in Leipzig (KWL) without proper regard for their client's interests. UBS and Value Partners had arranged that Value Partners would encourage municipal clients to buy these CDOs regardless of whether it was in their clients' best interests.
In relation to one particular CDO, it was alleged that UBS executives misrepresented the actual risk of the transaction to get internal approval and agreed with Value Partners that it would not give independent advice to KWL on the likely risks. Value Partners also bribed one of the managing directors of KWL, who then made a fraudulent misrepresentation to UBS that the transaction was bona fide, of which UBS was aware and was held to have dishonestly assisted.
Due to this corrupt arrangement between the financial adviser and the bank, the court said that the pair of them drew KWL into an unfair transaction where it was exposed to huge financial risk, but the financial adviser and UBS would receive significant financial gain.
Civil fraud cases can sometimes involve groups of people conspiring together like in UBS, or it can involve a rogue individual fleeing justice, as in the case JSC BTA Bank v Ablyazov below.
Goodbye Mr A
Mukhtar Ablyazov was the former chairperson of JSC BTA Bank, the largest retail bank in Kazakhstan at the time. He was accused of embezzling around $6 billion-worth from the bank between 2005 and 2009 when the Kazakh authorities audited the bank after the financial crash and discovered a gigantic black hole of missing funds.
However, Ablyazov said he had his reasons. Ablyazov claimed that the president of Kazakhstan tried to gain control of the bank in 2009 as part of a long-running attempt to "destroy" him. The bank was nationalised in 2009 and Mr Ablyazov was removed from office, so he sought asylum in the UK. Before his departure, Mr Ablyazov allegedly started to squirrel away the bank's cash in various locations around the world.
What happened next? The lawyers threw on their capes and saved the day?
Calm down: they're called robes, not capes. The lawyers and the English courts did kick into action, though. In late 2009, the English court granted a worldwide freezing order over Ablyazov's assets. The value of his various properties and investments ran to several billion dollars and involved more than a thousand companies worldwide in which he held a financial interest. The bank also obtained search orders in England and Wales and Cyprus to find out whether Ablyazov was surreptitiously shuffling his assets out of reach of enforcement.
Three years later, the English court found that Ablyazov had not fully disclosed his assets, uncovering a haul of new assets and undisclosed companies which weren't covered by the worldwide freezing order. It sentenced him to 22 months in prison for contempt of court and, when deciding the main claim, ordered Ablyazov to pay sums of more than $£4.6 billion to JSC BTA Bank.
Less encouragingly, Ablyazov's whereabouts are still unknown, so we can only wonder if JSC BTA Bank will get its money back.
What about poor KWL? Does Leipzig still have running water?
Thankfully, the UBS v KWL case has found its happy ending and the Leipzig population's personal hygiene was saved. Lawyers reviewed huge volumes of electronic and hard-copy documents, sourced from nearly 50 locations, and presented 28 witnesses. Despite the bribe received by its managing director, KWL was entitled to rescind its transactions with UBS. Rescission meant that the transactions were cancelled and KWL was put back in the same position that it was in before it had entered into them.
What a relief
The Ablyazov and UBS cases neatly demonstrate what clients need from their lawyers in fraud scenarios. Claimants want compensation for their losses or, if assets have been misappropriated, to get their property back. They need lawyers to help them to investigate what's happened and pursue the fraudsters.
Like in Ablyazov, lawyers must sometimes take preventative action before a potential defendant gets wind of proceedings and hides evidence or conceals its ill-gotten gains. Freezing injunctions are often used to prevent defendants from dissipating their assets, while search orders are useful to stop defendants from destroying key evidence.
Civil fraud lawyers need a firm grasp of a wide range of commercial issues and areas of law; they might have to untangle complex financial products as in UBS, unpick a web of linked companies with hidden beneficial owners like Ablyazov or understand complex trust structures.
As we saw in Ablyazov, civil fraud claims often span multiple jurisdictions so it's a wise choice of specialism if you want an international element to your work. There are numerous cases where high net-worth individuals and investment schemes chose to house their funds in tax-efficient jurisdictions, such as Jersey, Guernsey or the British Virgin Islands (BVI). Lawyers also might have to bring claims in multiple jurisdictions if, say, a fraudster funnelled stolen funds out to Cyprus, the BVI and the Seychelles (as Ablyazov did).
Don't distract me with glamourous holiday destinations; what were you saying earlier about all of us being defrauded in lockdown?
Don't worry. Unless you're an international business magnate you're unlikely to find yourself in the kind of sticky commercial situations that we've seen in the English courts after the 2008 financial crisis. Ablyazov and UBS are perfect examples of civil fraud being prompted by and revealed in the aftermath of economic turmoil.
If you're applying for training contracts, observe and analyse the changing levels of fraudulent activity and economic crime as the economy fluctuates over the next few months, and keep an eye out for juicy civil fraud cases popping up in the English courts over the next few years.
If you've already started your legal career, getting involved in civil fraud as a paralegal, trainee or junior lawyer can be stimulating and formative for your skillset. If Ablyazov and UBS are anything to go by, you won't have a dull moment.
Becky Baker is a trainee solicitor at RPC.