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Insight: FSA’s first scalp

In addition to his jail sentence, Bailey, former finance director of
fully-listed software company AIT, was disqualified from being a company
director for four years. His sentence followed his conviction by jurors of
recklessly making a statement, promise or forecast which was misleading, false
or deceptive.

AIT’s former chairman and chief executive, Carl Rigby, was sentenced to three
and a half years imprisonment and disqualified from being a director for six
years for the same offence. Both also face proceedings to confiscate their
assets to pay the costs of the Financial Services Authority, which prosecuted
the case, and possibly to compensate affected shareholders. A third defendant,
Alistair Rowley, AIT’s former sales director (who was not on the board), was

This was the first criminal action taken by the FSA under s397 of the
Financial Services and Markets Act (FSMA) 2000. Section 397 sets out the
criminal offences of making a misleading statement and engaging in a misleading
course of conduct for the purpose of inducing another person to exercise or
refrain from exercising rights in relation to investments. Conviction carries a
maximum sentence of seven years imprisonment and/or a fine.

On 2 May 2002 Rigby and Bailey, as directors of AIT, issued a statement via
the regulatory news service that stated both turnover and profit were in line
with expectations. The forecast profit of £6.7m depended on the inclusion of the
revenue from three contracts worth a total of £4.8m in the March 2002 year end
results – a £1.1m contract with Centraal Beheer, a £2.5m contract with Datapoint
and a £1.2m contract with St James’s Place. The prosecution proved its case that
the announcement of 2 May was rendered misleading, false and deceptive because
these contracts did not exist. AIT had given all three companies backdated
agreements and secret side letters explaining that the agreements would be
nonbinding. The side letters were withheld from AIT’s auditors and from the
non-executive directors.

On 31 May 2002, the company issued an update stating that the 2 May statement
was no longer accurate because a contract (Centraal Beheer) had not been
confirmed. It also noted that shortterm cash requirements were unlikely to be
covered by AIT’s available borrowing facilities and other cash resources. The
statement caused the share price to fall by around 80%, from 492.5p to 96.5p.

On 13 June, a further statement was issued announcing that AIT would not
publish preliminary results that day because of issues that had arisen in the
company’s audit. It also said there would be a further shortfall in revenue and
profit, partly because the company had failed to satisfy itself that the value
of a license agreement (Datapoint) worth £2.5m could be recognised in the year
end results. The share price fell again, from 105p to 38.5p. The truth about the
third contract emerged later, after new management had taken over.

AIT survived the crisis – just. The company, which renamed itself Portrait
Software plc in June this year, completed a refinancing in August 2002. It
subsequently cancelled its listing on the main market and moved to AIM, where
its shares are now trading at around 18p – but following a 25-for-1
consolidation, that’s the equivalent of 0.72p in the old form, a 99.85% fall
from 30 May 2002.

Following the sentencing, the FSA’s director of enforcement Margaret Cole,
commented: “Directors can expect to be held personally responsible for the
announcements they make to the market, as these convictions have shown. The
sentences further demonstrate that the Courts take a serious view of this type
of behaviour. Before issuing a statement, directors must carefully consider
their obligations and inform and consult their advisors early in the process.”

This is a point emphasised by Richard Burger, senior solicitor with the
regulatory team of Mills & Reeve. “If you are a director of a listed company
you do need to be careful when making statements to the market,” he says.

“If in any doubt, you should rely on your advisers. Directors have to take
the decisions, but the use of a sounding board – a corporate adviser, accountant
or even a lawyer – can be helpful for clarification.”

For Bailey, the whole episode must seem like a nightmare. He had only stepped
into AIT’s top finance role at the end of December 2001. Then in his early 30s,
this was his first appointment as finance director of a listed company.

However, while it is possible to feel sympathy for Bailey, his circumstances
do not reduce his responsibility. “FDs have to understand the components of
their earnings and financial statements very quickly,” says Martin Harty, senior
consultant in the financial services practice at international law firm Crowell
& Moring. “They have to understand where the earnings come from and that
they are solid. Ignorance is no defence.”

In other words, a defence of being out of your depth will not cut much ice at
trial when investors have lost substantial sums.

Although the FSA has chalked the case up as a victory, the regulator failed
to get a conviction on a more serious count. Bailey and Rigby had also been
charged with making a statement to the market knowing it to be misleading, false
or deceptive in a material particular, again under the FSMA’s s397.
Nevertheless, it seems inevitable that the FSA will pursue similar charges in
future, given the powerful message that a custodial sentence sends to the City.

Harty suggests that directors of AIM companies could be more vulnerable to
successful criminal prosecutions than their larger listed company counterparts.
“In an AIM company the FD is more clearly at the centre of the responsibility
for the integrity of the financial statements and reporting,” he says.

“There may not be dispersal of authority with audit committees and risk
management that you have in a larger company. So in an AIM company the FD might
be much more exposed and not have the support mechanisms around him that he
would have in a larger company.”

At the same time, Harty notes, there are some chief executives with very
strong personalities and who may have a strong interest in the numbers the FD is
being asked to agree to. AIM convictions may also be easier to achieve in a
trial by jury because the figures tend to be “easier to understand”, Harty adds.
The materiality of the sums in question may seem more obvious than in the
larger, multibillion-pound, global businesses.

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