Upping the ante on fighting fraud

How Germany’s proposed Association Sanctions Act may force companies to investigate themselves

Heralded as long overdue by some legal commentators and criticised as superfluous by others, there is a growing agreement that it has the potential to fundamentally change Germany’s approach to prosecuting fraud in the private sector. If implemented in its current form, associations headquartered in Germany – including corporations and enterprises – will, for the first time, be subject to criminal prosecution as legal persons. German lawmakers, it would appear, are finally joining their American and British counterparts in accepting that it is not just individuals, but also the culture and larger structural failings of a company that can produce malfeasance.

In a further change of tack, the draft act also allows for significantly more painful sanctions to be imposed on those who fall foul of the law. Whereas current legislation caps penalties for fraud and other “administrative offences” at €10m, corporates will soon be liable for up to 10% of their worldwide annual turnover, provided it exceeds €100m. On top of that, the worst culprits may also face forced dissolution. However, the latter is likely to be abandoned, since the draft Act is still under review and might see some late adjustments.

Collaboration is the key

Though where there is shadow, there is also light. Mitigation measures set out in the draft Act let associations all but guarantee their survival and, in a further alignment with common practice in the US, reduce penalties by up to 50% through full collaboration with the authorities. However, rather than conducting the investigations themselves, prosecutors are now seeking to outsource all investigation work – and thus the majority of the costs – to potential wrongdoers. In other words, to qualify for lower penalties, companies will be required to conduct, or alternatively retain third parties to conduct, their own internal investigations. Whole internal departments or contracted private sector investigators will effectively be compelled to act as auxiliary officers of the state.

Major challenges to future internal investigations?

This step change in the investigations process gives rise to major challenges and changes in how internal investigations are conducted.

Firstly, under the provisions of the draft Act, employees interviewed as part of the investigation will be read their legal rights and may choose to be accompanied by a lawyer or representative of the workers’ committee. Faced with a risk of separate prosecution under criminal law, interviewees – whose collaboration is often key to uncovering wrongdoing – may opt to make use of their right to remain silent. This limits the potential success and thus the utility of the investigative process.

Secondly, there will be no such thing as legal privilege between the association, effectively the client, and the investigator. Not only the final investigation report, but also all supporting documentation and working files on which it is based will be subject to review by the prosecution authorities. If in doubt, they reserve the right to reperform the work. Comprehensive and meticulous documentation of the investigation – in German – is thus paramount to avoid delays, dawn raids and disappointment.

Finally, associations will likely commission a competing, legally privileged investigation outside of the draft Act’s constraints. While the state’s auxiliary officers are also required to pursue potentially exonerating lines of enquiry, companies in the crossfire and their legal counsel – who act as the defendant in court – will hardly want to rely on this alone. This will result in a duplication of costs and disruptions to day-to-day operations.

It remains to be seen if the investigation format proposed under the draft Act does not in fact defeat its purpose. In view of the above, associations may try to fend off sanctions by building a thorough defence through their own investigations. At worst, this will mean making no, or only token efforts to support the prosecution authorities’ auxiliary officers. Investigators reporting to the state may therefore find information less than forthcoming, laconic witnesses in interview and other frustrations.

No place to hide for German businesses

For associations’ top executives, there is a further threat lurking in the draft Act. A failure to exploit its full mitigation potential to minimise possible fines constitutes a breach of their duty of care, making executives personally liable for compensation, e.g. under the German Stock Corporation Act. Cooperating with the authorities by commissioning an internal investigation can therefore become tantamount to a legal obligation.

In sum, besides sending shivers down executives’ spines and causing headaches for legal counsel and investigators alike, the draft Act places heavy demands on associations. Most of them, especially Germany’s illustrious medium sized businesses, do not have the tools or resources to meet these alone. For those with operations abroad, the scope for additional complications is huge. Cross-border investigations may find themselves frustrated by arguments over jurisdiction and competing legal principles, even within the European Union.

While we do not expect material changes to the final version of the Act (besides ruling out the prospect of the forced dissolution), the many discussions it has started within the legal community are likely to be considered in the ongoing intragovernmental consultation phase. And there is time for many more: nobody expects the Act to be implemented before mid 2020.