January 19, 2012 Should shareholders be forced to pay back dividends?
The Serious Fraud Office (SFO) has won an order in the High Court that a shareholder must pay back a dividend of £131,201. The dividend was derived from the proceeds of corruption but the SFO accepted that the shareholder had no knowledge of the corruption. Nevertheless the SFO (and the court) considered that the shareholder had failed to exercise proper control and diligence over its subsidiary and so should be forced to pay it back.
Mabey Engineering (Holdings) Limited was the parent company of Mabey and Johnson Limited (M&J) a manufacturer of modular bridges. M&J was found guilty to charges of corruption and breaches of United Nations sanctions as part of its work in Iraq and was convicted at Southwark Crown Court in September 2009. The SFO then successfully traced the proceeds of this corruption to the dividend paid to the parent company and won an order that it should be paid back under Part 5 of the Proceeds of Crime Act 2002 (POCA).
The law surrounding Part 5 of POCA is complicated and this article is not the place for the detail. Suffice it to say that this was a civil case and POCA gives the SFO the power to trace the proceeds of crime and reclaim it. The SFO broadly had to show that, on the balance of probabilities, the profits were property obtained by unlawful conduct and that the dividend payments ‘represented’ this property. Then, in certain circumstances’ they could force it to be repaid.
Now, before going any further, it is only fair to point out that M&J (which is part of the Mabey Holdings group) self reported the incident to the SFO and is now a very ethical company. In fact, Richard Alderman, director of the SFO also said that they “have been impressed by [M&J’s] attitude and the clear commitment of the new management to ethical trading”. It is also likely that without M&J’s cooperation the SFO would have been unable to show that the dividend payments represented the profits of unlawful conduct and therefore recoverable.
This though does still leave the fact that a shareholder was forced to pay back dividends because of the action of the subsidiary. So what does mean for other shareholders?
Scope of the decision
In the press release given by the SFO, Director Alderman made two key messages [our emphasise]:
First, shareholders who receive the proceeds of crime can expect civil action against them to recover the money. The SFO will pursue this approach vigorously. In this particular case, however, the shareholder was totally unaware of any inappropriate behaviour. The company and the various stakeholders across the group have worked very constructively with the SFO to resolve the situation, and we are very happy to acknowledge this.
The second, broader point is that shareholders and investors in companies are obliged to satisfy themselves with the business practices of the companies they invest in. This is very important and we cannot emphasise it enough. It is particularly so for institutional investors who have the knowledge and expertise to do it. The SFO intends to use the civil recovery process to pursue investors who have benefitted from illegal activity. Where issues arise, we will be much less sympathetic to institutional investors whose due diligence has clearly been lax in this respect.
These are quite bold statements from the SFO and not sentiments that many shareholders would have considered true before this case. It makes clear that institutional shareholders at least should carry out due diligence on their targets not just to make sure they can deliver the financial returns that are desired, but that they are also operating legally.
This statements have caused a little bit of controversy with some commentators believing that the SFO has gone too far. Yesterday though Director Alderman not only confirmed the breadth of this decision, but potentially widened it when he said [our emphasise]:
Institutional shareholders are not just passive recipients of dividends; they also have regular discussions with the management of the businesses in which they hold shares. I am going to have discussions soon with representatives of institutional shareholders. I am going to ask them whether any of them have asked management if they are satisfied that their companies have adequate procedures under the Bribery Act. If they have not asked that question, I shall want to know why not. After all, we all know that a corruption investigation can have a devastating effect on the share price of a company. If institutional shareholders are not concerned about that, then it seems to me that they are not living up to their ownership responsibilities and are not doing what society expects from them.
This last sentence suggests that institutional shareholders owe responsibilities to the wider society and not just to themselves. Though many politicians would presumably love this to be the case, this isn’t what has previously been accepted. Since the introduction of the Companies Act 2006, directors have been under an express duty to consider the impact of the company’s activities on the community and the environment[ref]Companies Act 2006, section 172[/ref] but no such explicit duty exists for shareholders.
Perhaps this is the way things will start to move; the government is hoping that shareholders will be able to keep executive’s remuneration under control; and institutional groups such as the ABI have long been advocates of high levels of corporate governance. However, this is a long way from saying that shareholders should act as watchdogs of the companies they invest in, not for their own benefit, but for the benefit of the wider world. We will have to wait and see how things progress.