5 May 2020
Introduction
While the restrictions on movement and remote working made necessary by the COVID-19 pandemic have had a significant practical impact on the way government authorities go about their work, it is clear is that the appetite for enforcement is undiminished by the crisis. Indeed, a number of regulators and enforcement agencies in key markets have signalled their intent, through strongly worded statements (and, in some cases, high-profile enforcement action), to respond decisively in cracking down on misconduct at a time of unprecedented volatility and distress across global markets.
What is also very clear is that the enforcement landscape in Asia and beyond will look notably different in the wake of this global pandemic. The combination of new ways of working and challenging market conditions will give rise to additional risk factors for companies and financial institutions, and lead to increased scrutiny in certain areas from regulatory and enforcement authorities.
We have provided a brief summary of some of the key areas of risk and will be providing further guidance on some of the specific issues at play over the coming weeks.
Bribery and corruption
The World Economic Forum last week warned of the need to guard against corruption in the rush to respond to COVID-19, asserting that while the response to the global pandemic should focus primarily on the health and socio-economic consequences, the “principles of transparency, justice and good governance need to underpin all measures at all times”.
Extreme pressure on financial performance across many industries is likely to be a catalyst for corruption issues, as businesses and their employees struggle to meet revenue targets and are motivated to consider improper payments or benefits to increase sales or secure contracts. At the same time, increased public spending on recovery measures and economic stimulus potentially gives rise to increased opportunities for inducements to government officials in relation to public tenders but also more generally in the context of increased interaction between companies and government authorities.
Market abuse
The uncertainty surrounding COVID-19 has given rise to extreme volatility in securities and commodities markets worldwide. Such volatility, combined with disruption to routine governance processes (e.g. filing annual reports, shareholder meetings) creates fertile ground for market abuse in the form of insider trading, as well as algorithmic trading activities, such as spoofing, aimed at manipulating markets.
In recent weeks, market regulators worldwide, including the US Securities & Exchange Commission, the UK Financial Conduct Authority and the Hong Kong Securities & Futures Commission, have issued firm reminders to market participants of their obligations to comply with regulations on illegal securities trading. In the coming weeks and months, we can almost certainly expect to see enforcement focus in Asia and globally directed towards conduct aimed at taking advantage of market disruption, making this a key area of risk management for public companies (and individuals associated with them), as well as investment advisers and asset managers.
Anti-money laundering
The Financial Action Task Force (an intergovernmental AML and terrorist financing watchdog) has warned financial institutions and other businesses to be particularly vigilant to emerging AML risks, highlighting an increase in risk presented by criminals “taking advantage of the COVID-19 pandemic to carry out financial fraud and exploitation scams” and also warning that “criminals and terrorists may seek to exploit gaps and weaknesses in national AML/CFT systems while they assume resources are focused elsewhere.”
As acknowledged in a circular issued by the HKMA on 7 April, the COVID-19 pandemic poses unprecedented challenges to the normal operation of AML and counter-terrorism financing systems and processes for financial institutions. These challenges include weakened controls due to remote working and disruption to processes, and delays to approvals due to technology constraints.
Fraud
Accounting fraud was one of the most significant areas of focus for enforcement authorities globally in the wake of the 2008 financial crisis and we can expect that trend to be repeated in the aftermath of the COVID-19 outbreak. Challenging economic conditions can give rise to an increased incidence of accounting fraud, as businesses come under pressure to understate the impact of market conditions on their financial position. Companies need to consider carefully how they report COVID-19 related impacts and be aware of the potential for misconduct within their organisation, for example department heads under pressure to show robust financial performance, or sales teams engaging in channel stuffing or other fraudulent revenue recognition practices in order to meet sales targets or quotas.
The extensive nature of government aid and stimulus packages in the wake of COVID-19 creates another potential area of risk. Companies seeking to benefit from government assistance should ensure that they comply fully with the relevant application processes and maintain a record of all communications with government authorities. Companies adjudged to have fraudulently benefited from funds intended for struggling businesses or employees (e.g. furlough schemes) are likely to face severe penalties, not to mention potentially significant reputational damage.
As businesses look at ways of reducing costs to withstand challenging economic conditions, there may be pressure on legal and compliance departments to compromise on compliance, increasing the potential for misconduct to occur (and reducing the likelihood of detecting such misconduct in a timely way so as to mitigate enforcement impact). As the above summary shows, it is more important than ever for businesses to be aware of the risks and to take a proactive approach to ensuring compliance. The cost of not doing so could be severe, as enforcement agencies are likely to respond forcefully to COVID-19-related misconduct, particularly in instances where individuals or businesses have benefitted financially from their misconduct.
For further information, please contact:
Jeremy Birch, Herbert Smith Freehills
jeremy.birch@hsf.com