It is important to engage external solicitors, able to provide advice on multiple legal disciplines, at an early stage. This will maximise the chances that the next steps of your investigation will be protected by legal professional privilege and that appropriate action is taken to protect the position of the firm and its clients.
A trusted employee blowing the whistle and informing you that your fellow partner has been stealing from the firm or its clients by making unauthorised payments is every law firm partner's worst nightmare. Our suggested best practice will allow you to investigate and respond appropriately to the allegations, while minimising disruption to your firm and maximising the chances of getting your firm's or your client's money back.
The initial investigation
Your first port of call is to notify the firm's compliance officer, who can help to investigate the whistleblower's concerns.
If help is required from other employees, only inform them of the whistleblower's concerns on a need to know basis. Do not tell the potential fraudster that they are under investigation or call the police. These steps come later.
You should conclude the initial stage of the investigation quickly. It should not be an extensive investigation as you need only do the minimum necessary to establish that the whistleblower's concerns are potentially valid. You only need to establish that the unauthorised payments have been made and that it is not obvious why - for example, from a brief review of the electronic files.
Decide on your strategy
Your external solicitors will assist in preparing your strategy for resolving the problem.
Your objective is to identify as much information as possible about the fraud, as quickly as possible. This maximises the chances of recovering any misappropriated funds from the fraudster.
It may be appropriate to apply to the court for interim remedies such as freezing orders and search and seize orders. You may also wish to apply for disclosure orders, without notice to the suspected fraudster, to allow you to identify cash flows through various accounts.
As a victim of fraud, it is also important to obtain a proprietary freezing order where possible. This type of freezing order means that the stolen monies generally cannot be used by the fraudster to fund his or her defence. In many instances, it is therefore better to delay going to court until the evidence is so compelling that a proprietary freezing order will be granted.
The importance of privilege
Privilege has been a hot topic recently, following the Court of Appeal's judgment in SFO v ENRC.
Getting it wrong regarding privilege can have disastrous consequences. Although your firm is the victim of the fraud, there is a real risk that you could be sued by clients if client funds have been taken. The firm may also be investigated by third parties such as the Solicitors Regulation Authority (SRA) or HMRC, with potentially serious consequences including the SRA intervening, closing down the practice.
Bear in mind that legal advice privilege does not apply to advice given by accountants. Therefore, any analysis prepared by an accountant could be disclosable to third parties in proceedings. Best practice is to use your external solicitors to instruct accountants, maximising the likelihood that litigation privilege will apply.
In circumstances where the law firm is the victim of the fraud, it should be straightforward to demonstrate that litigation is in reasonable contemplation. However, your external solicitors should record why they consider that litigation privilege is engaged. This will be helpful evidence if the privileged status of a document is later challenged.
Documents created during your investigation are also likely to contain confidential and privileged client information. This privilege will belong to each client and is something that you, as a firm, cannot waive. While the SRA and other regulators have certain powers to access privileged client information, you should consider such requests carefully and ensure that the appropriate formal procedure is used.
Your regulatory responsibilities
You need to carefully consider your professional obligations. You will have specific reporting obligations to the SRA in the event of misconduct by partners or staff, and in the event of financial assurance concerns which may have been caused by the fraudster's actions. The SRA will take a hard line on firms or individuals who fail to self-report such material issues promptly. It is important to consult with your external legal advisers about self-reporting. Solicitors with significant regulatory experience, and who hold the SRA's confidence, will be able to draft the self-report to ensure that the right messages are sent, and will provide the SRA with reassurance that the issue is being properly managed.
The SRA's main concern will be whether you moved quickly to replenish any deficit in client funds. Partners will be aware of their duties to rectify any shortfall "promptly upon discovery" under the SRA Accounts Rules (SARs), and all partners are jointly and severally liable for any SARs breaches. This means that if a shortfall is identified in your client account and is not replaced immediately, using all necessary means, the SRA may take regulatory action against all partners. The duty to replace client monies promptly applies regardless of whether you have recovered that money from the fraudster or insurers.
You have a professional obligation to inform clients if you discover an act or omission, including a fraud, which could give rise to a claim by them against the firm. You will also wish to demonstrate to clients that you are taking appropriate steps and start rebuilding their trust. Your external solicitors may draft these essential client communications on your behalf.
Professional indemnity insurance
Get in touch with your insurers on day one of the investigation. You will have to comply with the notification requirements in your policy. From a cash flow perspective, it is also beneficial if insurers will replenish any client account deficit at the outset rather than the firm having to do this out of its own funds and then seek reimbursement from insurers. However, this will be dependent on the timescales of the insurer making funds available and your regulatory duties to replenish promptly upon discovery.
The sooner insurers confirm coverage, the sooner you will be able to sleep a little easier. However, insurers can take time to confirm that the firm is insured for the loss. This is particularly the case in relation to professional indemnity insurance for law firms which is written on the SRA's 'minimum terms', as insurers will wish to be satisfied that there are "innocent" partners involved so the fraud exclusion in that cover does not come into play.
Your external solicitors should carefully consider your insurance coverage, advising on any gaps in cover which may potentially expose the firm and as to the scope of your cover, such as the extent to which you are or are not covered for internal investigation costs. They should also be able to tell you how to maximise the likelihood that coverage will be confirmed, and make you aware of the obligations which continue after notification to insurers. They can also liaise with your insurers on your behalf - particularly important if insurers may take an adverse position.
Your insurer might wish you to use one of its panel solicitors' firms. However, it is important that you instruct who you think has the relevant expertise to advise you in this business critical situation. Many policies will allow the managing partner of the insured firm to determine which firm is instructed.
The objective is obviously to get coverage confirmed as quickly as possible. Once the insurer confirms coverage, you should seek an interim payment from them in respect of any client funds you may already have had to replenish.
Criminal or civil recovery?
Your first instinct might be to report the fraudster to the police and let justice take its course. However, corporate victims of fraud may be underwhelmed by the police response to a crime report, due to resourcing issues and the police's priorities focusing on other types of crime. If the police do take an interest, response time is likely to be months and weeks rather than hours and days. By that time, the fraudster will have probably dissipated the money, ruining your chances of recovery.
There is an array of civil recovery options available to target a fraudster. The most draconian are freezing orders and search and seize orders. However, there is a high evidential burden that must be discharged to obtain these orders. Sometimes it is worth biding your time and building up this evidence.
Seek disclosure orders against third parties such as banks to find out where the fraudster has deposited your money, and investigate the fraudster's assets. Maintaining the advantage of surprise is crucial at this stage - otherwise, the fraudster could dissipate the cash and even flee the jurisdiction.
Maintaining the confidentiality of any civil court proceedings is also often necessary. Your external solicitors will be able to take the requisite steps to maintain your firm's confidentiality, and indeed your clients' privilege. These steps can include redacting client names in evidence, having hearings heard in private, getting the court file sealed and obtaining press reporting restrictions.
Learning lessons for the future
It is important to reflect on whether any changes to policies and procedures should be made to try to avoid similar situations arising again in future, or to put your firm in a better position to tackle them if they do.
For example, were there 'red flags' which should have alerted the firm that the partner in question was a fraud risk? Was the partner highly protective or his or her work; did they take little annual leave? If so, do you need to change policies to address this: for example, by introducing mandatory annual leave or revisiting remuneration or supervision structures?
Do your financial systems need to be made more robust to make frauds harder to perpetrate or quicker to detect? Are there ways in which your investigation could have been made more effective? Did you have adequate types and levels of insurance in place to cover this type of situation, or should you buy additional cover, such as crime cover, in future? Reflecting in this way will ensure that your business is stronger in future as a result of the difficulties you have had to work through.
Alan Sheeley is a civil fraud and asset recovery expert, and Samantha Palmer a professional practices expert at Pinsent Masons, the law firm behind Out-Law.com. Michael Reading is a litigation and regulatory expert at Pinsent Masons.