Can company directors be held liable for criminal liability? By Claire Gibson

Of the numerous duties and liabilities of company directors, their civil liability is often in the spotlight.

The potential liability of company directors to be declared by a court to be personally liable for the company’s debts, is significant, in terms of section 424(1) of the old Companies Act of 1973 (and it is notable that this section remains in force in circumstances where a company is wound up on the grounds that it is insolvent, even with the repeal of the Companies Act 1973) and the numerous provisions of the new Companies Act 2008 in terms of which a director can incur a liability in damages to the company, or to other persons.

There is an imperative difference between a director’s incurring personal liability for the company’s debts, and incurring personal liability for damages. This is due to the fact that with personal liability for damages, damages have to be proven and a causal link has to be shown to exist between the director’s misconduct and the damages in question.

Contemporary company law has moved away from criminalizing corporate delinquency and there are comprehensive reasons for this movement. Firstly, the movement of the criminal justice system is extremely slow. It can take years for a matter to come to court and by the time it does evidence has often been lost and witnesses at this stage may have died, disappeared or forgotten. Moreover, overworked prosecutors may well give more priority to crimes against the person, particularly crimes of violence, than to so-called “white-collar” crime. Furthermore, the onus of proof that rests on the prosecution in a criminal case is rather high compared to that in a civil matter. Lastly, many corporate suspects have the financial means to brief a driven legal team whose expertise and experience overshadow that of the prosecution.

It is worth considering, however, that “white-collar” crime can destroy peoples’ lives no less than physical violence, when people are misled into investing their life savings in hopeless companies, or are deceived into making other terrible investments.

The criminal prosecution of prominent business personalities is fairly rare in South Africa and in this regard the judgment handed down in The State v Levenstein case is presently a big discussion topic amongst most business communities.

In this case, Levenstein, a renowned businessman, was appealing against his conviction in the South Gauteng High Court on several counts, including common law fraud and breaches of the now-repealed Companies Act 1973. Levenstein’s appeal was partly successful, with his conviction on some counts being set aside, and on other counts confirmed. Levenstein’s appeal against sentence was also partly successful, with the sentence on certain counts being reduced. The effective sentence, as determined by the Supreme Court of Appeal, was one of eight years imprisonment, resounding the seriousness taken by the court of Levenstein’s misconduct. The charges against Levenstein, who is a qualified accountant and auditor, were all related to events that arose whilst he was an executive director of a bank and its holding company.

In 1995, Levenstein and his brother-in-law had founded a new company, Rand Treasury Ltd. Levenstein was the de facto chief executive officer of this new company, and the Reserve Bank had granted the company a banking licence. The company’s name was later changed to Regal Treasury Private Bank Ltd (“Regal”), which then became a registered bank. It was decided to found a group structure so as allow the banking business to be conducted in an entity separate from non-banking business. As of such, in February 1999 the holding company was listed on the Johannesburg Stock Exchange.

Regal’s troubles began in the financial year ended February 2000, when the company came into conflict with its auditors, Ernst &Young, with regards to the valuation of a certain unlisted investment held by Regal. The valuation of that investment was controversially published in Regal’s financial statements and then corrected a few days later. Additional audit problems arose in the following year. Levenstein was removed as the CEO of Regal, and within months he retired.

A cautionary statement was published regarding the holding company and this triggered a run on Regal, with the result that it was incapable of paying its depositors the money they had invested. Regal at no time recovered and in February 2004, it was placed into final liquidation.

In the preparation of Regal’s financial statements for the year, a valuation had to be made of a specific asset of the company, that is the company’s right to receive a percentage of the total issued shares of a company to which Regal had given a licence to use Regal’s brand name and trademark. The valuation of this asset, which Regal planned to adopt in its financial statements for the year, was an amount resulting from a valuation model that was grounded on potential rather than actual income. This flew in the face of what is usually known as GAAP (Generally Accepted Accounting Standards) which is the standard recognized by the Reserve Bank for banks under its supervision.

Ernst & Young were incapable of approving the value that Regal had arrived at by this method. The gulf between the two methods of valuation was considerable. Regal was pushing for a valuation of branding income for the year of R55 million, but Ernst & Young were not prepared to go beyond R5.5 million. Ernst & Young were of the opinion that, until the branding scheme actually grew income, it could not be taken into account in evaluating Regal’s profits. Ernst & Young indicated that if Regal did not alter its stance on the issue of valuation, they would qualify the company’s financial statements. Everyone involved realized that this could lead to a run on the bank, causing it’s collapse.

Levenstein instructed Regal’s Chief Financial Officer to redraft the company’s financial statements to reflect only R5.5 million as the value of Regal’s shareholding in the branding companies. However, in order to inflate Regal’s deceptive profits, Levenstein instructed the Chief Financial Officer to defer R6 million in expenditure for the year and to prepare the final financial reports on that basis.

Subsequently, the press statement was amended, at Levenstein’s instruction, to say that the company’s branding income had been deferred, with an additional statement to the effect that expenses of R18 million relating to the branding income had already been written off. This was incorrect, or at least an exaggeration.

The outcome was that Regal’s financial results were, on 16 May 2000, published in a form that had not been seen and approved by the company’s auditors, first on the Johannesburg Stock Exchange News System (“SENS”) and in the general press the subsequent day. The publication of Regal’s financial statements in this form brought an immediate and indignant response from Ernst & Young who demanded that a correction notice be published immediately, and this was done.

The publication of Regal’s financial results on 16 May 2000 in the form they were in was the basis of the charge against Levenstein. It was averred that the statement contained misrepresentations of fact that were not only factually erroneous but had been frequently made in order to persuade persons using the financials to act to their actual or potential prejudice. Untrue statements of fact had been made by Levenstein with conscious and deliberate dishonesty including the statement that the company’s results for the year ended 29 February 2000 had been audited, plus a false statement that roughly R18 million in branding expenditure had been written off.

The charge sheet averred that these false statements were to the prejudice or potential prejudice of Regal’s shareholders and other persons who made use of its financial statements.

In the judgment, the Supreme Court of Appeal made a point that

“Levenstein knew that the financial statements contained figures that did not bear the auditors’ approval. But that does not in itself justify a conviction of fraud. For that to result, he must have knowingly misrepresented the truth with the intention to induce persons embarking on a course of action to their actual or potential prejudice.”

The court acknowledged that Levenstein felt obstinate that his method of valuing the branding income was correct, that GAAP was inadequate for this purpose, and that Ernst & Young should have placed a far higher value on Regal’s branding income.

Nevertheless, the court pointed out that, Levenstein knew that Ernst & Young, as well as the other accountants and the Reserve Bank, firmly disagreed with his methodology and that Regal’s results had accordingly been manipulated. The Supreme Court of Appeal concluded by finding Levenstein guilty of fraud.

A fundamental principle, accepted worldwide, is that a company’s financial statements must give a true and fair view of the company. Accordingly, section 29(1)(b) of the South African Companies Act 2008 states that a company’s financial statements must present fairly the state of affairs as well as the business of the company.

However, this recognized principle conceals many problems. For example, in the case discussed above, Levenstein believed that the traditional way of valuing the prospective shares of the “branded company” that Regal was to receive from the agreement in terms of which Regal gave a licence to certain companies to use its brand name or trade mark, was insufficient for use, and that the value would be more precisely reflected by valuing potential income, rather than income already derived.

However, the court was able to circumvent any argument that Levenstein had not put forward a valuation that he knew to be false by focussing instead on the fact that he knew that the company’s auditors and the Reserve Bank disagreed with the methodology of his valuation and that he had knowingly manipulated Regal’s financial position by deferring R6 million in expenditure.

Levenstein’s conviction on this particular count was based on common law fraud. However it is noteworthy that, in terms of section 29(6) of the new Companies Act 2008, a person is guilty of an offence if he is party to the preparation or publication of any financial statements, knowing that those statements fail in a material way to present fairly the state of affairs and business of the company.

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