Impact of corporate criminal liability reforms on private equity firms

• The new ‘failure to prevent fraud’ offence means that there is an increased risk of criminal enforcement against a large portfolio company whose employees, agents or other associated parties commit fraud to benefit the portfolio company. A fund could also be held criminally liable for failing to prevent fraud by a large portfolio company.
• Expansion of the rule on corporate attribution means that a portfolio company can now be prosecuted for a substantive fraud or other economic crime offence if committed by a ‘senior manager’ of the portfolio company (going further than the ‘directing mind and will’ test).
• A private equity firm can now be liable for a failure to prevent fraud committed by eg employees or agents of the firm, where the fraud is intended to benefit the firm.

New failure to prevent fraud offence

The new ‘failure to prevent fraud’ offence in s199 Economic Crime and Corporate Transparency Act 2023 will apply where a company (or partnership) fails to prevent an associated party from committing a fraud offence with the intention of benefitting the company/partnership or its clients. The fraud offences are broad; they include fraud by false representation, fraud by abuse of position, fraud by failing to disclose information (which can include conflicts of interest situations), cheating the revenue, false accounting, and fraudulent trading.

The new offence will only apply to an entity or group that meets two of the following criteria: more than 250 employees; over GBP18m assets; over GBP36million turnover. The criteria can be met by an individual entity or by a group.  A parent undertaking of a group can be caught by the new offence provided the group fulfils the size threshold. The offence catches UK and non-UK businesses but is particularly relevant where an element of the fraud occurs in the UK or where there is a loss or gain in the UK.  The new offence is likely to come into force mid to late 2024, with the only defence being having adequate procedure in place to prevent fraud.

Senior managers can now trigger corporate criminal liability

The changes to the ‘identification doctrine’ contained in the Act mean that a broader range of employees can trigger corporate criminal liability. It is no longer solely the ‘directing mind and will’; it also now includes senior managers.  This change came into force on 26 December 2023.

Portfolio company related risk

Risk for the portfolio company

A portfolio company that meets the size threshold would be in scope of the new failure to prevent fraud offence.  Fraud by an associated party of the portfolio company to benefit the portfolio company or its clients/customers could lead to liability for the portfolio company for failing to prevent fraud, unless the portfolio company can show it had reasonable procedures in place. 

Regardless of size, a portfolio company can now be prosecuted for a substantive fraud offence if a ‘senior manager’ of the portfolio company was involved.   

PE firms should build analysis of risk mapping for fraud/economic crime into target portfolio company due diligence, and review existing portfolio companies’ outbound anti-fraud controls/prevention procedures, if they are not already doing so.

Risk for a fund resulting from portfolio company misconduct

A parent undertaking (wherever incorporated) can be liable for a failure to prevent fraud by a subsidiary where the fraud is intended to benefit the parent or customers.  Even though the natural (and most likely) target for a prosecution would be the subsidiary, there is possible liability for a fund for failing to prevent fraud at a portfolio company which is intended, directly or indirectly, to benefit the fund.  An example might be where individuals at a portfolio company make misleading statements to gain investment for the company, win a contract or make sales.  If there are senior people at the portfolio company who have an interest in the performance of the fund, eg by way of investment performance or carried interest, then it is very likely that their decisions are being made to benefit the fund.  So if the fund doesn’t have adequate procedures in place to prevent fraud, it could be liable for a failure to prevent fraud by the portfolio company.

Firm risk

The new failure to prevent fraud offence would catch fraud, by employees, agents and others acting on behalf of the private equity firm, which is intended to benefit the firm or its clients, eg a dishonest valuation, misrepresentation of investment strategy or credentials (for example, on ESG) to win investment. 

Firms will want to make sure their internal compliance policies and training are up to date. Government guidance is expected on ‘adequate procedures’ late spring.