White Collar Crime - Essay Example

White Collar Crime 1. Introduction: Crime and criminal acts have been existing is human societies all the time. Over the years, the nature of crime has changed in tune with the developments in the society and they include murder, theft, arson and cheating to name few. Acts of crime committed by the wealthy and even influential people show that poverty is not the prime reason for committing crimes. Even though such acts have been carried out over the years, it was given a proper name seventy years ago in 1939. The term white collar criminal was coined by sociologist Edwin H Sutherland while speaking to the American Sociological Society. This paper is a review of white collar crimes in an Australian context and will specifically address the collapse of the HIH Insurance Group, considered to be one the biggest corporate failures ever in the country. The study will cover the crime/misbehavior, regulatory failure, the existing literature relevant to the area of crime and regulation, and provide a case analysis, explaining how and why the failure of regulation occurred. 2. The concept of white collar crime: According to Suthrland, “white collar crime may be defined approximately as a crime committed by a person of respectability and high social status in the course of his occupation” (The evolution of white collar crime, n.d.). The book, Encyclopedia of white-collar & corporate crime states that Sutherland implicitly makes it clear that crime results not just out of poverty, but due to other reasons as well. Sutherland developed the theory of differential association primarily to state that criminality includes “the social and business influences that caused persons of high status to violate the law through occupation” (Salinger, 2005, p. 775) One of the earliest among similar researchers was Edward Alsworth Ross, who coined the term criminaloid, intentionally done to sound familiar with words like asteroid, crystalloid or anthropoid. Ross feels that such acts were not seen as serious by the general public and the perpetuators themselves. (Geis, 2006, p. 26). Ross adds that there is a ‘shocking leniency’ by the public towards such crimes and the people who perpetuate or are a part of the crime. What is interesting is that the article which originally appeared in The Atlantic Monthly was written in 1907. Over the years, the term white collar crime has come to be primarily associated with business alone. Hartung undertook a study on violations in price control of wholesale meat in Detroit in 1950. According to him white collar crimes are those committed by a firm or its agent by violation of statutes and regulations (Wong, 2005). Vilhem Aubert is of the opinion that such crimes are symptomatic of the social structure that is present in a region or country (Geis, 2006, p.175). Yeager referring to other studies provides several reasons why companies resort white collar crimes. They include fall in profits, corporate greed, and existence of certain statutes. For example, “laws designed to protect consumers, the environment, and employees restrict management autonomy at the point of production rather than simply in market relations, and can impose costly regulatory and liability requirements on companies” (Yeager, 1992, p. 9). The author also mentions that large corporations (Fortune 500 companies) are more prone to commit such crimes with regard to product safety, labor, and protection of the environment. On the other hand smaller companies are more likely to commit crimes like tax evasion, and other finance related laws. The following are the most common white collar crimes according to HG.org, an organization that operates an online portal for law and government related areas. They include “antitrust violations, computer and internet fraud, credit card fraud, phone and telemarketing fraud, bankruptcy fraud, healthcare fraud, environmental law violations, insurance fraud, mail fraud, government fraud, tax evasion, financial fraud, securities fraud, insider trading, bribery, kickbacks, counterfeiting, public corruption, money laundering, embezzlement, economic espionage and trade secret theft” (White Collar Crime Law - Guide to White Collar Crime Law, n.d.). The next section will review the specific instance of HIH Insurance. 3. The background and history of the collapse of HIH Insurance: According to the Report of the Royal Commission on the HIH collapse, there is no apparent “fraud or embezzlement to be behind the collapse” (Some key findings, 2002). The real reasons behind the collapse will be reviewed after a brief history of the company. The HIH Insurance Group had a complicated past with regard to its history. The company, originally known as MW Payne Liability Agencies Pty Ltd, was started in 1968 by Ray Williams and Michael Payne. It later changed its name to CE Heath International Holdings and then to CE Heath Plc. What started off as an underwriting business, expanded over the years, primarily through acquisitions of companies like CIC Insurance, Utilities Insurance and FAI Insurance (Facts about HIH Insurance, 2001). The company is now referred to as the HIH Insurance Group. At the time of bankruptcy, the company had presence in UK, USA, New Zealand, some markets in Asia, and Argentina. The collapse of the company appears to be caused by many factors which ultimately snowballed and could not be controlled by it. A per the Royal Commission, the company made a series of poor business decisions which included expansion plans and acquisitions. The 1999 hailstorm in Sydney actually became a factor which put considerable strain on HIH and other insurance companies in the country. According to the Bereau of Meteorology, Government of Australia, the loss due to the hailstorm may exceed $1.5 billion (The Sydney hailstorms, 1999)! Auditors either failed to spot or report problems with the company’s finances even though it was apparent in the accounts. The company was having problems with cash management by the end of the 1990s. The company could not generate the financial outcomes that it expected from its acquisitions, expansions and general business. The regulatory authorities in the country failed to take notice of the situation and did not act in time to control the activities and decisions of the company. The board of directors also did not perform their duties in terms of diligence and skill. The specifics of the collapse are now given below. Due to poor acquisitions and management practices, both its US and UK operations did not prove profitable, one of the reasons that led to the collapse. This was especially more acute in the UK. For example, Winterthur auditors “identified problems in provisioning data, the lack of a consistent underwriting approach and coherent business philosophy in relation to inwards reinsurance, and the insufficiency and poor quality of the financial information” (Emerging problems, n.d. .7). Another major contributing factor that the company paid too much in its haste to acquire FAI Insurance. Mr Adler who sold his and the family shares to HIH admits that Ray Williams was obsessed with the acquisition and the price paid was nearly 100 million above the market value. It is reported that Williams wanted HIH to be the biggest general insurer in the country (Adler denies HIH blame, 2003). Practically every article or book related to the collapse state that HIH did not undertake due diligence when valuing FAI Insurance. According to Gup, even though HIH paid nearly 300 million AUD for the acquisition, the actual value of FAI was a negative 105 million AUD (Gup, 2004, p. 203). Other serious drawbacks and failings also became apparent prior to and after the collapse. The company annual accounts prior to the collapse did not reflect the true worth of the company.  Armstrong and Francis in their article in the Journal of Business Systems, Governance, and Ethics, state that “the Annual Report following the acquisition of FAI reported a 112% rise in profits in the first half of 2000. The reported increase in profits were said to be the due to the generally accepted, but dubious, accounting practices” (Armstrong & Francis, 2008, p.9), According to Campbell and Houghton, “another major problem with HIH was that it didn’t set aside enough reserves to cover future insurance claims and overvalued some assets” (Campbell & Houghton, 2005, p.169). Another factor that made this inadequacy all the more serious was that the company specialized in long tail insurance. This term used in general insurance refers to policies where claims may arise long after the premiums have been paid. The problem with such insurance is that companies need extra reserves for contingencies and claims arising out of such policies. The Royal Commission has also noted that the company did not care to review its management and corporate governance policy and change it suit modern market trends in the insurance industry. For example, the Commission states that internal auditors did not take the factor of risk assessment seriously, concentrating on accounting, thereby underestimating the risks actually facing the company. The company filed for bankruptcy in March 2001. White collar crime affects various stakeholders and this will be discussed in the next section. 4. Consequences of white collar crime and bankruptcy: The steps followed by the government and regulatory authorities are not sufficient according to Dignam. “Successive waves of corporate collapse in every decade of Australia's history suggest that there is a significant unresolved corporate governance problem in Australia. Corporate collapse has been followed by reform but with little effect on the overall pattern of collapse and reform every decade” (Dignam, 2009). The following sectors, other than shareholders and creditors would have been significantly affected by the collapse if the Federal and state governments had not come up with compensation packages. They are policy holders in areas like personal, worker compensation, business, and sports insurance (Who is affected? 2001). Some of the policy holders fared better. According to an article in the defunct company website, “Many former policyholders of the HIH Insurance Group were provided with alternative insurance arrangements with Allianz, IAG (formerly NRMA) and QBE Insurance, via the completion of a number of transactions following the appointment of the provisional liquidators in March 2001” Background financial information, 2007). One way to tackle such acts is to bring in more statutes or make the existing ones more effective. 5. Statutes, duties and responsibilities: Armstrong and Francis, state five crucial duties or responsibilities that are essential for office bearers. The first thing that such people who hold high offices, especially in large corporations is that they hold a position of trust to all the stakeholders. The authors add that each of these five duties was effectively breached by the office bearers, and directors of both Enron and HIH. (Armstrong & Francis, 2008, p. 4) They have a duty to act honestly and in good faith to the best of their abilities and take decisions that are in the best interests of the company and its stakeholders. In the case of HIH, the major stakeholders are the policy holders, the shareholders, the employees, and its creditors. This requirement is specifically stated in section 181 of the Corporations Act in the country. Section 184 states that it is a crime in case there is a breach of this duty (Tomasic, Bottomley & McQueen, 2002, p.368). Making an official statement that is false or misleading is considered to be a breach of trust. Acting recklessly without thinking about the consequences is also considered to be a crime. In this case, the acquisition of FAI and expanding into the highly competitive US and UK markets can be considered to be reckless in nature. Secondly the directors of a company have a duty not to vote on matters where personal consideration or interest is involved. In case there is interest or consideration, they must disclose the fact to the board. Such directors who have an interest or consideration should preferably be absent from meetings where the matter is discussed because their presence might influence others and act in his or her favor. These are covered in sections 191 and 195 of the Act. In this instance, Ray Williams appeared to have a personal interest in the acquisition of FAI due to the fact that the company was purchased above cost and without due diligence. Another director, Charles Abbott was found guilty of conflict of interest, improper conduct, and conducting business after being aware of the need for insolvency by the Royal Commission (APRA makes further disqualifications in relation to HIH, 2005). The Commission also found Trahair, an officer of FAI, guilty of non-disclosure that his company too was under-reserved. Thirdly, officers of the company are not make improper use of company information that will, in any way become damaging or detrimental to the company. They should also not disclose any information which is considered to be confidential to anyone not authorized to receive it. Directors and officers should be diligent and should exhibit their skill when carrying out their duties and responsibilities (section 180). Here HIH did not undertake due diligence in acquiring FAI. Moreover, their overvaluation of the company also indicates a lack of skill on the part of the directors. Lastly, directors should not conduct business once a company becomes or is sure to become insolvent. There appears to have been some serious steps taken by the government and regulatory authorities regarding prevention of white collar crimes in Australia. 6. Reforms and existing statutes: Some of the provisions of law that existed prior to and introduced after the collapse are reviewed here. A prominent national legislation introduced in 2003, was the Proceeds of Crime Act 2002. Till this time many individual states had acts similar to it primarily aimed at confiscation of property/assets obtained by illegal means. Section 5 of the national act provides that the state has the power to confiscate property obtained through offenses against the government and commercial exploitation. Its provisions are also aimed at deterrence to take part in a criminal act and also provide the power to law enforcement and other agencies to take action against offenders as per the provisions of the Act. It should be noted that the word ‘commercial exploitation’ was not present in the Proceeds of Crime Act 19897 and its subsequent amendments. This inclusion can deter future fraudsters and law breakers because the gains they made by illegal means may end up becoming the property of the state. Section 17 also gives the power to restrain in disposing of a property or a situation where the property can be disposed only in the way stated in the order. The APRA, as of May 2008, has the power to apply to a Federal Court disqualifying an individual from holding a post in the industry (Powers, n.d.). If the authority has proof that if an individual officer in a company is misusing his powers in any way, it can resort to this provision. The APRA also states that individual and group companies should maintain the minimum capital requirements adequate to cover its local and overseas operations. So, for companies incorporated in Australia, assets must exceed liabilities by not less than $A2 million, 20 percent of premium income, or 15 per cent of outstanding claims, whichever is greater” (Insurance solvency supervision, 2002, p.63). This figure of two million has been raised to five by APRA. Every company should compulsorily evolve a risk management strategy. It includes factors like disproportionate representation by a shareholder, non-executive chair, audit committee, clear job description for officers and advisors etc. The directors will also have to provide in writing, that the regulations are being complied with. With regard to reinsurance, there should be a well established management strategy which should be approved by the APRA. The country has also adopted the International Financial Reporting Standards (IFRS) as a part of the Corporations Act, referred to as AIFRS. According to the Financial Reporting Council, this is essential to maintain quality of reporting which in turn will help investor protection and increase market confidence. (Adoption of International Accounting Standards in Australia, 2005). 7. Solutions in preventing white collar crime; It is quite clear that white collar crime is still a reality even today. This is evident from a talk given by Christopher Craigie, the Commonwealth director of Public Prosecutions in October 2008. He states that the nature of corporate white collar crime has changed over the years and it is now possible for a single individual (rogue trader) or a small group of people to commit crimes. Some of them were of such high magnitude that large multinational corporations became insolvent or incur huge losses. The collapse of Bearing Bank and the French bank Societe Generale were given as examples. According to him, “During the last 10 years or so the opportunity for corporate crime has increased exponentially” (Craigie, 2008). The solution is to maximize penalties, and introduce strict laws to prevent or at least bring down further occurrences in the future. Big penalties are important because the probable benefit derived by an office bearer or director or office bearer who has committed fraud is worthwhile even if the person undergoes a prison term. 8. Conclusion: In spite of the massive reminder of the HIH failure, Enron, and other major scandals, white collar crime is still a reality. It is true that statutes, laws, and regulations have come up in order to tackle this menace. One specific example is the Sarbanes-Oxley Act in the United States set up after the failure of Enron. It is seen that the Australian government is also serious about tackling such crimes in the country. There have been many developments especially with regard to regulations by the APRA. But the country and its government should probably look for a legislation that is similar to the Sarbanes Act in order to tackle such crimes. In the Australian scenario, the best example is the failure of HIH Insurance. The company acted on behalf of the whims and fancy of one or two or several influential directors without any mechanism for questioning or objections. In the era of globalization, organizations need to be flexible, but this factor should not come in the way of individual or corporate greed. Ultimately, it is a combination of statutes, cooperation, transparency, and self-restraint that can form a real and lasting solution to this menace. It may mot be possible to wipe out the occurrence of white collar crime altogether in a particular region, country or market, but strong government intervention and cooperation from the diverse players in the market can definitely help in controlling its occurrence. References Adler denies HIH blame. (2003). The Age, Retrieved August 23, 2009, from http://www.theage.com.au/articles/2003/01/21/1042911381770.html Adoption of International Accounting Standards in Australia. (2005). Australian Government – Financial Reporting Council, Retrieved August 23, 2009, from http://www.frc.gov.au/reports/other/letter.asp APRA makes further disqualifications in relation to HIH. (2005). Australian Prudential Regulation Authority, Retrieved August 23, 2009, from http://www.apra.gov.au/media-releases/05_13.cfm Armstrong, A. & Francis, R. (2008). Loss of Integrity – the true failure of the corporate sector, Journal of Business Systems, Governance and Ethics, 3(3), Victoria University, 1-13 Background financial information. (2007). HIH Insurance, Retrieved August 23, 2009, from http://www.hih.com.au/financial_background.html Campbell, T., & Houghton, K. A. (2005). Ethics and auditing (p. 169). ANU E Press. Craigie, C. (2008). Director’s speeches, Retrieved August 23, 2009, from http://www.cdpp.gov.au/Director/Speeches/20081010cc.aspx Dignam, Alan J. (2009). The Role of Competition in Determining Corporate Governance Outcomes: Lessons from Australia's Corporate Governance System. Retrieved 24 August 2009, from Social Science Electronic Publishing, Inc: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=785445 Emerging problems. (n.d.). A brief Corporate History of HIH (extracted from pages 51 – 64 of Volume I of the HIH Report), Retrieved August 23, 2009, from http://www.oecd.org/dataoecd/24/10/19217174.pdf Facts about HIH Insurance, (2001). HIH Insurance Group Collapse, Retrieved August 23,2009, from http://www.aph.gov.au/library/INTGUIDE/econ/hih_insurance.htm Geis, G. (Ed.).(2006). White-collar criminal (p. 175). Aldine Transaction. Gup, B. E. (2004). Too big to fail (p. 359). Greenwood Publishing Group. Insurance solvency supervision. (2002). Insurance solvency supervisión (p. 63). OECD. 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Hg.org – Worldwide legal directories, Retrieved August 23, 2009, from http://www.hg.org/white-collar-crime.html Who is affected? (2001). HIH Insurance Group collapse, Retrieved August 23, 2009, from http://www.aph.gov.au/library/INTGUIDE/econ/hih_insurance.htm Wong, KC. (2005). From White-Collar Crime to Organizational Crime: An Intellectual History. Retrieved August 23, 2009, from http://www.murdoch.edu.au/elaw/issues/v12n1_2/Wong12_1.html#1.1.%20The%20discovery%20of%20white-collar%20crime_C Yeager, PC. (1992). The limits of law – The public regulation of private pollution, Retrieved August 23, 2009, from http://assets.cambridge.org/97805213/65352/sample/9780521365352ws.pdf Read More