Download 2. The definition and elements of fraud

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666946/1/CWT - note-accounting fraud
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Private and Confidential
Legally privileged
MEMORANDUM
ACCOUNTING FRAUD
1.
Introduction
1.1
We have been requested to advise on certain aspects of the offence of fraud
and, in particular, accounting fraud.
1.2
In this note, we firstly briefly discuss the definition and elements of fraud,
before considering a number of cases which are relevant to accounting fraud.
2.
The definition and elements of fraud
2.1
"Fraud" has been defined as "the unlawful and intentional making of a
misrepresentation which causes actual prejudice or which is potentially
prejudicial to another" (CR Snyman Criminal Law 4th ed (2002) at 520; see
also J Burchell and J Milton Principles of Criminal Law 2nd ed (1997) at 579).
2.2
The four elements of fraud are thus:
2.2.1
a misrepresentation;
2.2.2
prejudice or potential prejudice;
2.2.3
unlawfulness; and
2.2.4
intention.
We briefly consider each of these elements in turn.

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2.3
2.3.1
a misrepresentation
A misrepresentation is "an incorrect statement of fact or law made by one
person to another" (Burchell at 581);
alternatively this has been
expressed as "a perversion or distortion of the truth" (Snyman at 521).
2.3.2
A misrepresentation usually takes the form of words (either written or
oral), but may also take the form of conduct.
Furthermore, a
misrepresentation may be express or implied (Snyman at 521).
2.4
2.4.1
prejudice or potential prejudice
In order for a court to find that fraud has been committed, the perpetrator
must have caused harm to a third party. This harm is termed "prejudice"
(Snyman at 523; Burchell at 585).
2.4.2
Prejudice may be either actual (i.e. real) or potential. Potential prejudice
arises where the misrepresentation, when considered objectively, is likely
to prejudice the third party or involves some risk of prejudice to the third
party. A possibility of prejudice is sufficient (i.e. it is not necessary to
show a probability of prejudice), however, it must be a reasonable
possibility (i.e. it should not be so far-fetched that a reasonable person
would not believe that prejudice will be suffered).
Furthermore, it is
irrelevant whether or not the party to whom the misrepresentation was
made, was in fact misled by that misrepresentation (Snyman at 524-525).
2.4.3
Prejudice may also be proprietary or non-proprietary. "Non-proprietary
prejudice takes the form of prejudice to interests such as reputation or
dignity.
More importantly, it exists where some aspect of public
administration is materially inconvenienced" (Burchell at 585).
2.5
unlawfulness
Certain misrepresentations will not be unlawful (for example, exaggeration of
the qualities of goods in an advertisement). Other examples include that a
misrepresentation of love or affection will not be prosecuted as fraud (Burchell
at 580-581).
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2.6
2.6.1
intention
An intention to defraud has two elements, namely: (i) an intention to
deceive; and (ii) an intention to defraud. In other words, "X must have
made the representation knowing or foreseeing that it might be false"
(Burchell at 588).
2.6.2
Snyman at 527 explains this as follows: "X can be said to be aware that
her representation is false not only if she knows that it is false but also if
she has no honest belief in its truth, or if she acts recklessly, careless as
to whether it is true or false. She can even be said to know that her
representation is false if, although suspicious of their correctness, she
intentionally abstains from checking on sources of information with the
express purpose of avoiding any doubts about the facts which form the
subject-matter of the representation".
2.6.3
The following statement made by Buckley J in Re London and Globe
Finance Corporation Limited [1903] 1 Ch 728 is of relevance here:
"To deceive is to induce a man to believe that a thing is true which is
false, and which the person practising the deceit knows or believes
to be false. To defraud is to deprive by deceit; it is by deceit to
induce a man to act to his injury. More tersely it may be put that to
deceive is by falsehood to induce a state of mind, and to defraud is
by deceit to induce a course of action."
2.6.4
We also note that the following statement made by Lord Lane CJ in R v
Grantham [1984] 3 All ER 166 (CA) at 171b:
"… a person is guilty of fraud if he intends by deceit to induce a
course of conduct in another which puts that other's economic
interests in jeopardy, even though he does not intend that actual
loss should ultimately be suffered by that other."
2.6.5
Importantly, negligence, and even gross negligence regarding the truth of
the statement, does not amount to intention for purposes of this element
of fraud.
Motive, however, is immaterial to the presence of intention
(Snyman at 527-528).
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3.
3.1
Specific examples of accounting fraud
We now consider a number of cases in which the courts have found that
fraud, particularly related to fraud in respect of accounting records, was
committed.
3.2
Perhaps the most well-known recent decision in relation to accounting fraud is
that of Squires J in S v Shaik and Others [2005] JOL 14601 (D). The second
charge laid against Shabir Shaik by the State related to incorrect journal
entries which had been made in the financial statements of Shaik's
companies. In particular, three loan accounts in the books of Kobifin (Pty)
Limited ("Kobifin"), which included directors' remuneration and a loan
indebtedness to Proconsult (Pty) Limited, in the total amount of R1 282 000,
were written off on the false pretext that they were expenses incurred in
setting up a polyester driver's licence card project with the Department of
Transport (the Prodiba project).
In this case, the "misrepresentation
concealed the true nature of the writing-off of these loan accounts, which was
to extinguish the debts owed by [various] persons to Kobifin, which debts
included R268 775.69 of the money paid to or on behalf of Jacob Zuma up to
that year, month and day and the action concealed that fact from
shareholders, from creditors of the group, including the bank that provided the
overdraft facilities, and from the Receiver of Revenue" (at 4).
3.3
In this case, Shaik accepted that a number of journal entries in Kobifin's
books were incorrect and that a false explanation of these entries had been
given in the company's financial statements. However, Shaik argued that this
was done on the initiative of his accountant and Kobifin's auditors who had
prepared the statements, and that he had no knowledge of their wrongfulness
nor that the effect of such false statements may be unlawful (at 7). The court
was thus required to consider whether Shaik "was a party to the false journal
entries and the plan to write off the three identified loan accounts against the
upwardly revalued assets and the representation that the loans being so
written off were costs incurred in the development of the Prodiba polyester
driver's licence project" (at 12).
3.4
Squires J held Shaik's defence was implausible and that he was, on the facts,
a party to the decision taken to make false representations in relation to the
loan accounts (at 71).
Accordingly, Shaik was convicted of fraud on this
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count (at 100). This conviction was upheld by the Supreme Court of Appeal
in Shaik and Others v The State (an unreported decision handed down on
6 November 2006 under case number 248/06) at para 35 of the judgment.
The matter is currently on appeal before the Constitutional Court.
3.5
It is clear from this case that an intentional representation in journal entries
and financial statements that amounts are for a stated purpose, whereas in
fact such amounts are being used for a different purpose, constitutes fraud.
3.6
Other cases which pertain to a conviction for fraud on the basis of a failure to
keep accurate accounting records, include S v Kamfer [1998] JOL 3916 (T)
and NBS Bank Limited v Cape Produce Co (Pty) Limited and Others 2002 (1)
SA 396 (SCA).
3.7
The NBS case involved the keeping of two sets of books, which is "one of the
stock devices employed by frauds". NBS Bank Limited ("NBS") had
implemented a procedure in terms of which an official accepting a fixed
deposit would record his or her acceptance electronically, so that both the
receipt of the money and the identity of the depositor would be reflected in the
bank's accounting system (at para 1).
3.8
Mr Vito Assante, while branch manager of the Kempton Park branch of NBS,
contrived a scheme to circumvent the above procedure. In return for deposits
made by investors, he would issue a type-written letter to the depositor,
purportedly undertaking that NBS would reimburse the depositor with interest
on a stated day. Assante maintained a set of books which correctly recorded
NBS's receipt of the deposit and the name of the depositor.
However,
Assante carried this set of books with him at all times (at para 2).
3.9
Assante then maintained a second set of books for NBS which correctly
recorded the debit to the account where cheques issued by investors were
deposited into NBS's bank account.
However, this second set of books
contained no recordal of the depositor as NBS's creditor. Instead, Assante
had arranged for a credit to be passed into a 'corporate saver account' held at
NBS by Nel Oosthuizen & Kruger attorneys ("NOK"). In this instance, NOK's
books of account did not reflect a credit in the name of the person who had
issued the cheque, but instead reflected a credit in the name of a developer
nominated by Assante (at para 3).
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3.10
In this case, Cape Produce Co (Pty) Limited ("Cape Produce") instituted
proceedings against NBS claiming that NBS was responsible for the loss
suffered by Cape Produce under Assante's scheme. While this portion of the
judgment is not relevant for our purposes, the court accepts that Assante's
scheme was fraudulent (at para 7).
3.11
In Kamfer, the accused was charged with fraud in circumstances where she
had been a director and shareholder in Fundstrust (Pty) Limited
("Fundstrust"). Fundstrust was held out in marketing publications to be an
entity which would arrange for the placement of client's funds with approved
institutions such as banks and "undoubted blue chip corporations" (at 2-3).
The following quotation from the judgment of van Niekerk J at 3-4 describes
the activities carried on by Fundstrust:
"In their money market operations Fundstrust engaged in accepted
money broking transactions by effecting money lendings between
depositors, banks and acceptable institutions in the name of the
depositor as well as traditional money broking where the depositors'
cheques were merely handed over to banks or institutions.
However, deposits from the public were also banked in Fundstrust's own
account and then lent out to various non-bank borrowers. Excess funds
were placed with banks in Fundstrust's name. Fundstrust's money
market operations thus included the carrying on of the business of a bank
or deposit-taking institution. Funds were received on a principal basis
from members of the public and then advanced to borrowers, unknown to
each other, and Fundstrust acted as principal to both parties.
Funds raised via the money market were banked in Fundstrust's own
account and then on-lent to the capital market operations of Fundstrust in
order to finance capital projects. Depositors' funds received on a 'call'
basis were invested in long term property development projects, often
without the depositor's knowledge.
The money market operations also included the so-called rolling of funds,
in that as funds received on a 'call' basis and advanced on a medium or
long term basis were not always available to repay depositors, new
deposits were raised to repay existing depositors.
Fundstrust also received deposits on a 'call' basis then invested these
funds, often without the knowledge of the depositors, with a bank or
deposit-taking institution for a fixed term, thus acting as a principal
deposit-taker with its own account. To repay these new deposits were
used causing further rolling. The difference between the 'call' rate paid
by the depositor and the fixed deposit rate paid by the bank/[deposittaking institution] was retained by Fundstrust."
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3.12
The accounting records and financial statements of Fundstrust were not
accurate and kept up-to-date. The accused was charged with fraud on the
basis of a wrongful and unlawful failure to disclose to Gilbey Distillers and
Vintners (Pty) Limited ("Gilbey") how Fundstrust was dealing with Gilbey's
funds.
In particular, "[a]t the end of September 1991, and just before
Fundstrust was provisionally liquidated a total of R45 million of Gilbey's funds
had been fixed for two years and placed in a long term property development,
contrary to Gilbey's wishes" (at 5-6). Kamfer was convicted of fraud, which
included a conviction under section 284(1) of the Companies Act, 1973 that
she had failed to keep proper books and records for Fundstrust.
4.
4.1
Conclusion
Accounting fraud is merely an incidence of fraud, and the four elements of
fraud must be met to secure a conviction in circumstances where a person
has made a false representation in accounting records or financial
statements.
4.2
Please do not hesitate to contact us should you have any queries arising out
of this advice.
PETER GREALY / CAROLYN YOUNG
WEBBER WENTZEL BOWENS
21 DECEMBER 2006