Working with Lawyers on a Fraud Investigation

David Debenham, Partner  – McMillan LLP

“Fraud” is a legal conclusion. A “fraud investigation” should not presuppose that conclusion is true, only that it might be true. A fraud investigation is really a misnomer because the complainant seeks legal remedies for a perceived wrong, whether that wrong is ultimately called “fraud” or not. Therefore the investigation is really about whether a wrongdoing has occurred, and if so, what remedies are available to the complainant as a result of that wrong. Lawyer and investigator alike have to be able to identify the wrongdoing on any particular set of facts, the evidentiary threshold for proving that wrongdoing, and whether the legal remedy afforded the victim of the wrongdoing effectively remedies the wrong. Therefore the fraud investigation is really an iterative process between investigator and legal counsel in which legal tests are matched with the state of the evidence in what should be a continuous dialogue from discovery of the wrongdoing until the verdict at the trial. A few examples should suffice to make the point.

We start with a complaint based on a first iteration of “the facts”, some evidence, and some notion that some form of wrongdoing has occurred. From this we need to establish a framework for analysis for an investigation.

Let us start with the remedy being sought by a private complainant. Is the suspect insolvent? If not, a personal remedy against the suspect as a contract breaker, tortfeasor, or in restitution due to unjust enrichment may suffice. In such a case the investigation is not a fraud investigation at all, it is simply an investigation that requires proof of the particular wrongdoing and the amount of compensatory damages. However even if the suspect is solvent, the complainant may not be seeking compensatory damages, but an accounting for profits, or rescission of a contract and tracing an asset, in which case the investigation must extend to considering whether actual or constructive fraud has occurred. If the suspect is insolvent, then one must consider whether there is sufficient evidence to support a propriety claim to trace property and to make arguments based on constructive and resulting trusts, fraudulent conveyances and the like. One may also consider whether the personal claim is one that will survive the suspect’s bankruptcy under s. 178 of the Bankruptcy and Insolvency Act, and whether there are personal claims against third parties for conversion, conspiracy, knowing assistance, knowing receipt or some other form of liability that will satisfy the complainant’s desire for an effective remedy. Finally, the availability of remedies under the criminal and public welfare statutes may afford the private complainant the desired remedies, and therefore the statutory pre-requisites to the desired relief under any potentially applicable statutes may be explored in the course of a private investigation.

In the case of public authorities, the public complainant must review the availability of the full panoply of statutory and common law remedies to determine which potential remedies are available, and which the complainant wishes to pursue. In the case of both private and public complainant, the desired remedy to the complainant cannot be lost sight of, although pursuit of the complainant’s goal cannot be confused with the task of the investigator and counsel to have a fair and balanced investigation that will meet and exceed all legal and professional standards in uncovering what has actually occurred. The complainant and suspect have a right and reasonable expectation to a fair and balanced investigation conducted with due care and due diligence, and not a particular result or outcome. The remedy that the complainant has in mind sets the parameters and scope of the investigation, not its result.

The investigator now reviews the documents and interviews witnesses with potential remedies in mind because that determines what has to be proven or disproved, and how convincing the level of proof must be. Let us take the level of knowledge required of a suspect or accessory. Depending on the claim the court may require proof of (i) actual knowledge, (ii) willful blindness, (iii) willfully and recklessly failing to make such inquiries as an honest and reasonable person would make, (iv) knowledge of such circumstances which would indicate the facts to an honest and reasonable person, or (v) knowledge of circumstances which would put an honest and reasonable person of the need to inquire further1. Levels of knowledge may lead to conclusions about levels of dishonesty, and therefore whether the suspect or accessory is liable for actual or constructive fraud.

Levels of knowledge may determine questions of intention. For example, the tort of intentionally inducing the breach of a contract between two other parties requires both knowledge of that contract, and an intention to induce its breach. What kind of knowledge is required in this context? As one judge put it, “even if they did not know the actual terms of the contract, but had the means of knowledge—which they deliberately disregarded—- that would be enough. Like the man who turns a blind eye. So here, if the officers deliberately sought to get this contract terminated, heedless of its terms, regardless of whether it was terminated by breach or not, they would do wrong. For it is unlawful for a third party to procure a breach of contract knowingly, or reckless, indifferent whether it is a breach or not.”2

In tort, recklessness and intention are equivalent. In the law of fiduciaries, a failure to inquire when the facts would suggest that an honest and reasonable fiduciary would enquire, may constitute doing an act with “guilty” knowledge sufficient to constitute conscious wrongdoing3. Thus the answers to the investigator’s question as to what someone knew, and when they knew it (“the Watergate Questions”), may be decisive to the claim being asserted and the remedy that may be awarded by the court. As the answers to the Watergate Questions may change as the state of the evidence unfolds during the course of the litigation, pleadings may have to be amended right up to, and during, the trial to match the nature of the claim and the defences being asserted to match the current state of the evidence. For that reason alone, timely communication of the state of the evidence between counsel and investigator is key, particularly in the run up to the trial.

Let us consider a commercial fraud involving a supplier presenting false invoices to a firm that is paid by the company bookkeeper. If the company bookkeeper and the supplier both are part of the scheme, the claim may be against both under the tort of conspiracy (personal claims), or it may be as constructive trustee and knowing assistance (also personal claims), or it may involve a claim to a constructive trust as a result of tracing for a proprietary remedy. Where the requisite guilty knowledge on the part of the bookkeeper is not proven, the supplier may be liable for dishonest assistance, or if that level of knowledge is not proven against the supplier, then the supplier may be liable for knowing receipt so long as the supplier benefited. If the bookkeeper was negligent, then the issue would be whether the employer can sue the employee for negligence or breach of the employment for such negligence, or if the employer wanted to dismiss the employee, whether the conducted amounted to grounds for dismissal without notice. If the supplier induced the bookkeeper to pay an invoice he should not have, can the conduct be said to have intentionally induced the bookkeeper to breach her employment contract (eg her obligation of fidelity to her employer), without rising the level of dishonest assistance? If the supplier is a corporation, it may be that proving fraud may give rise to a defence that the individual acting for the supplier was acting so far outside the scope of their duties as to be acting “on a frolic” of their own4 , whereas the allegation of inducing breach of contract to get an invoice paid may attract vicarious liability on the supplier corporation’s part. Thus proof of fraud against the bookkeeper may be a requirement for the employer’s fidelity policy, while proof of fraud on the part of the supplier’s representative may hurt one’s claim to hold the supplier’ corporation vicariously liable. Most cases turn on not only what the investigator is able to prove, but what the complainant wants to prove in the context of a desired remedy. For this reason the forensic investigation is a constant re-visiting of the state of the evidence and the remedies that they may present themselves as a result. Does the complainant want to pursue a remedy against the bookkeeper? What if the supplier goes bankrupt? Does the complainant’s position on the appropriate remedy change? With that in mind, it is no wonder that legal counsel, faced with a two year limitation period, sues everyone for everything, to preserve the complainant’s options pending the conclusion of the investigation at the end of the pre-trial discovery process. As a result, the scope and breadth of the investigation may change, and preserving evidence thought to be trivial at one stage may be critical later on. The investigator and legal counsel alike must be wary of trying themselves to one theory of the case at too early a juncture— fraud investigations are for the highest stakes involving the most sophisticated participants, and must be conducted accordingly.

How should the investigator approach the collection, preservation, collection and presentation of evidence? That is largely a matter of style. However all approaches should keep the investigator’s evidence toolkit in hand at all times.

The Investigator’s Evidence Toolkit

  1. Evidence is admissible is admissible if its probative value is greater than its prejudicial effect.
  2. Evidence is prejudicial if its effect is to excite passions or emotions such that it is given undue weight, or it causes confusion, or takes up too much time or otherwise distracts the trier of fact.
  3. The probative value of evidence is a function of its relevance and material bearing on the issues to be decided.
  4. Relevance means that the evidence has some tendency to make some proposition more likely to be true or false as a result of its introduction.
  5. Material means the extent to which the proposition that is being advancing by the evidence is important to the issues in the case. Materiality therefore is a function of the legal requirements of a particular cause of action or defence.
  6. Credibility means the strength of the evidence in proving a particular proposition.
  7. Evidence is credible if its source is believable with respect to a primary fact, and the strength of inferential force that this primary fact is. The inferential power of a primary fact is a function of how much it reasonably allows the trier of fact to logically revise his belief in the direction of a particular secondary derivative fact.
  8. Reasons for a decision are usually based on a series of derivative facts, more commonly described as inferences from primary facts. Findings of the trier of fact with respect to the primary facts form the foundation of the derivative facts.
  9. The decision of the trier of fact is a conclusion based on a finding of mixed question of fact and law. A finding of mixed fact and law means the application of legal definitions to various derivative facts. Examples include a finding of negligence, fraud, breach of trust.

Let us use Robin Hood as an example. Robin is charged with stealing gold from Prince John. The defence calls Maid Marion to testify that Robin Hood is really Robin of Locksley, a noble who was fought in the Crusades. How can we judge this evidence? Consider:

  1. Is Maid Marion to be believed in that she only heard of Robin’s alleged nobility from Robin himself?
  2. If she is believed, does this lead reasonably to an inference that Robin has a lesser propensity to steal from King John? In other words is Robin’s status as a noble relevant to his propensity to steal?
  3. If it is relevant to his propensity to steal, is that propensity material to this case where Robin may have taken Prince John’s gold but not consider it stealing, as Robin believes he was justified in doing so under a higher authority above the arbitrary and unjust laws of the Kingdom?
  4. If it is material, is it prejudicial as the trial of a noble by a jury of common people is likely to cause them to fear the personal repercussions should they convict a member of such a powerful family?
  5. If it is prejudicial, does the time necessary to prove Robin’s status, and the undue weight it will have on the outcome, outweigh its probative value since it is more or less likely to result in a “true” verdict? Looked at in this way, a negligent investigation can be judged by the same criteria as an unreasonable verdict. Was undue weight placed on Maid Marion’s evidence despite the fact she was madly in love with Robin Hood and would say anything to free him? Was an unjustifiable inference made by finding that Robin did not steal the gold because of the primary finding of fact that Robin was a noble? Is the conclusionary finding that Robin did not steal Prince John’s gold stand in the face of the testimony of several eye witnesses, including Friar Tuck. Little John and Will Scarlett, all of whom confirmed that Robin was their leader in a conspiracy to steal Prince John’s gold? Did the jury misunderstand or ignore the legal definition of theft, or find derivative findings of fact unsupported by the evidence such that the conclusionary finding that Robin did not steal Prince John’s gold is a perverse one, and that any investigation that resulted in the same conclusion was conducted negligently, or in bad faith.

How does this apply to a claim for deceit and in particular proof of an intent to deceive? There can be admissions against interest by the fraudster, but this form of direct evidence is rare. Therefore one has to have evidence of other factors from which one can either infer a fraudulent intent or which leads to a contrary interference. Consider the following circumstantial evidence checklist for a claim that the suspect fraudulently induced the plaintiff into signing a contract that the suspect never intended to perform:

Circumstance surrounding original promise More likely a lie less likely a lie Evidence in this case
The fact of breach The promise was easily kept Performance was difficult and therefore more susceptible to a reasonable explanation for non-performance
The number of attempts at performance Few or with a little effort suggests a lack of intention in the first place Several efforts or concerted and costly effort suggests bona fides of original promise
The promisor’s awareness of conditions likely to prevent his performance or make that performance unprofitable at the time of the promise At the time of the promise, the promisor knew that conditions or circumstances were such that fulfillment of the promise was unlikely The promisor was unaware that the circumstances were such at the time the promise was made that conditions would laterhe could not perform the promise when the time came
The promisor’s capacity to fulfill the performance or attempts to acquire the means of performance The promised return was unlikely, unprecedented in the marketplace, or required more skill or resources than were available to the promisor The promisor was simply ignorant of his ability to fulfill his promise
Similar promises and similar incidents of non-performance Went unperformed and even went unattempted, and completion was unprecedented in the promisor’s experience The promisor had never attempted performance before,  or had succeeded on previous occasions
Whether there were any changed circumstances between the time of promise and the due date of performance beyond the promisor’s control No excuse for non-performance May excuse non-performance
Continued promises in circumstances when it became apparent that performance would be unlikely suggests the original promise was a lie In circumstances where continuing to attempt performance may suggest that promisor’s original promise was made in good faith
Other representations Lying about qualifications, past experience and the like suggests that the original promise to perform was also intentionally deceptive If other parts of the story check out, they lend credence to the idea that the promisor was being truthful about his intentions as well
motive to lie— Receipt of advance fee or deposit or other benefit that made promise in itself more likely to be deception no benefit to the promisor resulting from the lie, only damage to the promisee
  1. Baden v. Societe Generale [1993] 1 W.L.R. 509.
  2. Emerald Construction Co, v. Lowthian [1966] 1 W.L.R. 691 , at 700-701 (H.L.)
  3. Manifest Shipping Co. Ltd. v. Uni-Polaris [2003] 1 W.L.R. 469.
  4. Dubai Aluminium v. Salaam [2002] 2 AC 366;Balfron Trustees Ltd v. Petersen [2002] WTLR 157