Directors jailed for making misleading statement to the market

United Kingdom

On 7 October Gareth Bailey, former Financial Director, and Carl Rigby, former Chairman and CEO, of software company AIT Group Plc received custodial sentences of 2 and 3½ years respectively for releasing a misleading trading update to the market. The prosecution was instigated by the FSA and is the first time that the regulator has taken criminal proceedings under section 397 Financial Services and Markets Act 2000 (FSMA).

Under the section it is an offence for anyone to make a statement, promise or forecast that is designed to induce someone else to buy or sell shares if the person making the statement either knows it to be misleading, false or deceptive in a material particular or is reckless as to whether may be. On indictment, the maximum sentence is seven years imprisonment.

Since December 2001, when the FSA was given new powers under FSMA to prosecute companies and individuals for the 'civil' offence of market abuse, and to fine companies and directors for breaches of the listing rules, most cases involving misleading statements by listed companies have been brought under one or both of these heads. Because both are effectively civil offences policed by the FSA, they require a lower standard of proof than in criminal cases, but the maximum sanction in each case is a fine. In this instance, however, the FSA chose to instigate criminal proceedings under section 397.  

Although the two directors were acquitted on the charge of knowingly misleading the market (the 'dishonesty' offence), they were found guilty of making the statement recklessly. 

Mr Rigby was also disqualified from being a company director for 6 years, and Mr Bailey for 4 years.

The statement

On 2 May 2002 AIT (which was then listed on the Official List) issued a trading update stating that both turnover and profit were in line with expectations. However the forecast profit of £6.7m depended on the inclusion of £4.8m in revenue from three non-existent contracts in the 31 March 2002 year end results.

On 31 May 2002 an update stated that the 2 May 2002 statement was no longer accurate because one of the contracts had not been confirmed, resulting in a £1.1m shortfall in revenue and profit. The update also noted that short term cash requirements were unlikely to be covered by AIT's available borrowing facilities and other cash resources.

As a result, AIT's share price fell from 492.5p to 96.5p.

On 13 June 2002 AIT then announced that it would not publish preliminary results that day, as was previously expected, because of issues that had arisen in the company's audit. It also said that there would be a further shortfall in revenue and profit, partly because the company had failed to satisfy itself that the value of a license agreement worth £2.5m could be recognised in the year end results.

The share price then fell from 105p to 38.5p.

Sentencing

It seems clear that both the FSA and the court intended to make an example of AIT's directors. Passing sentence, His Honour Judge Elwen said:

"If investors, large and small, come to the view that they cannot trust the information companies announce to the market, they will avoid the market when making investment decisions. The health of the financial services industry which is a major contributor to the UK economy will suffer".

Margaret Cole, Director of Enforcement at the FSA, commented:

"Directors can expect to be held personally responsible for the announcements they make to the market, as these convictions have shown.  The sentences further demonstrate that the Courts take a serious view of this type of behaviour.  Before issuing a statement, directors must carefully consider their obligations and inform and consult their advisors early in the process."

Criminal offences policed by the FSA

As well as section 397 FSMA, the FSA is also primarily responsible for policing a number of other criminal offences which carry a maximum sanction of imprisonment, including:

  • carrying on a regulated activity in the United Kingdom without FSA authorisation – eg. accepting deposits; managing, advising on or arranging deals in investments; selling insurance (section 19(1) FSMA)
  • communicating in the course of business an invitation or inducement to engage in investment activity (a "financial promotion"), unless the promotion is approved by an authorised person (section 21 FSMA)
  • offering transferable securities to the public in the United Kingdom, or requesting the admission of such securities to trading on the Official List, without having first published a prospectus (section 85 FSMA)
  • operating or promoting an arrangement that constitutes a collective investment scheme within section 235 FSMA without FSA authorisation.

In each case there are various exemptions available, and directors should seek advice on how to take advantage of them.

The FSA's approach to enforcement

Although it will usually try to obtain information voluntarily, the FSA has extensive statutory powers of investigation, including powers to require the production of documents and to require persons to attend interviews. Failure to comply with an FSA-appointed investigator's notice requiring attendance for interview is likely to amount to a contempt of court. The FSA also has power to detain suspects for questioning in relation to certain offences. In addition, in August 2003 the FSA signed a memorandum of understanding with the City of London Police Fraud Squad formalising the powers of the police to arrest people, on the FSA's behalf, in cases of suspected market abuse, insider dealing, money laundering or illegal deposit taking.

In deciding whether to bring criminal proceedings or to refer the matter to another prosecuting authority, the FSA will apply the basic principles set out in the Code for Crown Prosecutors. In particular, it will consider whether:

  • there is sufficient evidence to provide a realistic prospect of conviction against the defendant on each criminal charge ('the evidential test'); and
  • having regard to the seriousness of the offence and all the circumstances, criminal prosecution is in the public interest ('the public interest test').

In considering the public interest test, the FSA will bear in mind that its four statutory objectives include maintaining market confidence and fighting financial crime.

Given its limited resources, the FSA's stated policy is to adopt a risk-based approach, under which it aims to prioritise and investigate only those cases which are significant. One of the things illustrated by the AIT case, however, is that it is not only the directors of the largest listed companies that the FSA may seek to make an example of: in this case the FSA appears to have regarded the offence as 'significant' even though the company's turnover, profit and net assets were relatively modest by comparison with many listed companies.