Porridge for business leaders

If prison is a good deterrent to business crime why don’t we use it more?

This article first appeared in Aimzine.

Although I regard myself as very tech-savvy I’m not an avid Facebook user. Therefore I rely on old-fashioned techniques such as email and the telephone to keep in touch with what friends are up to. Recently though, one of my best friends from school was the subject of an article in the Evening Standard, which at least saved me a phone call. I say school friend but it will become apparent why I now need to refer to him as an acquaintance or even just someone I vaguely knew. “Oh, him. Yes I think I spoke to him once or twice”, I’ll have to respond when people question me about our secondary school friendship.

The reason is that he, let’s calls him PS, was in a crown court recently facing charges of fraud. It seems that his persona of being a successful property developer turned out to be a house of cards. The stunning home he and his wife owned (albeit partly with a fraudulently obtained mortgage) in the Guildford countryside, along with the obligatory Porsche and Land Rover parked outside, were funded mostly by asking parents from his children’s exclusive independent school to invest in his property empire that never was. Many “investors” put in six figure sums and actually those amounts were invested in property but it’s just that they were invested into his Guildford home. So, fair enough that PS is now serving time at Her Majesty’s pleasure and I daresay he’s probably not enjoying it, unless of course he’s discussing plans for a new business with two ex-directors of a Torex Retail subsidiary.

Last month, Edwin Dayan and Christopher Ford previously directors of XN Checkout which supplied software for shop tills to the likes of McDonald’s, Argos and Homebase were sentenced to prison for falsifying invoices to create the impression that XN had made £1.65 million more profit than it really had. Sentencing the two, the judge said ‘such sentences may seem harsh on a personal level, but a strong deterrent is needed’. Again, it’s difficult to argue with that conclusion.

These two stories received a fair bit of coverage in the daily press, but of equal interest is the story of someone not going to prison.

Not going to prison
During the month, The Insolvency Service announced that it had applied to the High Court to disqualify all of the former directors of Farepak and its parent company EHR. You may remember that in 2006, just weeks before Christmas, Farepak went into administration. The company collects monthly payments from its customers then distributes vouchers back to those customers for use over the Christmas period. During that time it builds up substantial cash balances and had loaned £35m of those balances to another EHR group company which also went into administration. Savers, many of whom are from the poorest parts of society, lost out entirely that Christmas and only much later did they recover around a third of what they had saved. The Insolvency Service said that the directors’ conduct made them “unfit to be concerned in the management of a company”.

Something that doesn’t seem to have been addressed clearly enough though is the directors’ obligations under the Companies Act 2006. The Act, CA2006, was the largest piece of legislation to ever go through Parliament and codified much of what had previously been case law; you’d think therefore that it would be effective. One obligation it places on directors is that they use reasonable care, skill and diligence in exercising their duties. The extent of their obligation is related to the experience and knowledge they possess. Therefore a director who has more experience, knowledge and skill will have a higher threshold in discharging this duty. You’d think then that Sir Clive Thomson, chairman of EHR at the time, who has served on the boards of six FTSE companies, and ran Rentokil for two decades might have had some expectation on him as to his thinking during the Farepak crisis and a high threshold as to how he discharged his duties.

Independent judgement
Another obligation on directors is to “exercise independent judgement”. It’s not clear whether the directors of Farepak fulfilled that responsibility when they agreed to loan £35m of their customers’ cash to another group company. A degree of independence might have led them to question whether the credit risk was good and whether they would have made a loan to a third party in a similar situation.

However, we will never know as apparently CA2006 doesn’t allow investigations such as the one into the circumstances around Farepak’s collapse to be made public. We therefore have to trust the government and its agencies that their priorities are correct and that there are no other factors for stronger action not to have been taken.

From my layman’s position I find it hard to differentiate between someone who took other people’s money to invest in his own house, and a group of directors who took other people’s money from a savings plan to prop up another company that they were directors of.

The judge in the Torex case had it spot on when he sought to give a sentence which would act as a deterrent but of course for judges to do that the government and its agencies have to ensure that people with a case to answer do actually appear in the dock in the first place. The history of business misdemeanours over the last thirty years seems to indicate that government agencies whether the Serious Fraud Office, or the City of London Police or others have been either too indifferent or too incompetent to address this failing.

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