Practice Areas Review: Labor

Corporate Fraud. Improper Conduct/Misconduct of Company Management



Attorney-at-Law, Partner, VB PARTNERS



Attorney-at-Law, Partner, VB PARTNERS



Business Center Bashnya No.5, 22 Rybalska Street, Porch 13,
Kiev, 01011, Ukraine
+380 44 581 1633
+38 0 44 581 1533

Ukrainian law firm VB PARTNERS was founded in 2005 and in that time our firm has acquired a reputation of highly-qualified specialists in various areas of law.

The firm provides comprehensive legal assistance and business consulting services to national and foreign investors all over Ukraine.

Over the last 8 years VB PARTNERS has gained deep expertise in such areas as corporate, M&A, litigation, white-collar crime, taxation, competition and antitrust, investments and real estate.

VB PARTNERS is considerably good in the retail, real estate and construction, media & entertainment, tobacco, alcohol, energy, oil and gas sectors.

It provides effective and accurate legal advice regarding:

— Full legal assistance to foreign investors on the territory of Ukraine;

— Litigation and arbitration;

— Legal representation at state authorities;

— Disputes with the state as to taxation, antimonopoly and customs legislation;

— Protection of property (corporate, investment and privatization disputes, protection and recovery of penalty on real estate, securities and other assets);

— Comprehensive legal assistance to the energy, oil and gas industries;

— Qualified legal representation in criminal cases, etc.

In the last 3 years VB PARTNERS has been in the TOP 50 of the best domestic law firms in Ukraine.  Our firm’s partners are consistently placed on the list of leading Ukrainian specialists of the country's legal market by the most authoritative international and Ukrainian market reviews.

Confidentiality compliance, trustworthiness and immediate response to challenges posed by clients and demands constitute an integral part of the firm’s operating philosophy.

We are proud to be described as an effective and dynamic law firm.


Legal Methods of Combat

Economic crimes affect companies all over the world. No sector of the economy can be fully protected from its undesirable consequences. In addition to direct losses, economic crimes can seriously impair a company’s image or its reputation.

Some 59% of domestic companies have become victims of economic crimes in the last two years. This is higher than the world average (43%).

Ukraine occupies 6th place in the ranking of countries in terms of corporate fraud (45%); Russia — 1st place (71%), South Africa — 2 (62%), Kenya — 3 (57%), Canada — 4 (56%), Mexico — 5th place (51%)1.

The real disaster for Ukrainian businesses is massive embezzlement by top managers. This accounts for 50% of all identified factors.

Even foreign companies with a developed system of corporate compliance procedures and policies face this negative phenomenon in practice. But no appropriate measures are taken against every one in five employees who has committed an economic crime in the organization.

Today, fraudsters have a wide range of techniques, while internal investigation experts are only starting to develop prevention and detection mechanisms. The economic recession has led to reluctance on the part of organizations to invest in such services as internal audit or internal financial investigations.

But the owners and managers of companies aimed at ensuring sustainable development, should be interested not only in preventing economic crimes, but also in eliminating their effects.


Types of internal corporate fraud:

1. Related-party transactions;

2. Direct and indirect embezzlement;

3. Creation of “parallel” business;

4. Appropriation of intellectual property;

5. “Theft and sale” of commercial information.

Reasons for their occurrence:

— lack of internal corporate procedures and policies of compliance;

— building of relationship with key managers on the principles of “trust” rather than formal relationship;

— lack of clear and transparent system of bonuses;

— lack of an effectively working Internal Auditing Department in the company;

— work in industries related to high risk, and commitment to high-risk operations;

— presence of relatives of officials in management working in sector;

— agreements with sister companies;


Some signs of fraud on the part of management:

— unexplained changes in the balance sheets;

— unusual or large bargains at the end of the reporting period;

— special relationship with third party partners;

— lack of fixed-capital assets;

— increased revenues while cash account turnover is decreased;

— increased stocks while accounts receivable are decreased;

— unexplained changes in the balance sheets;

— unexplained increase in the number of court cases;

— unexplained drop in turnover in a growing market;

— growth in expenses is faster than the growth in income, etc.

The key problem in proving the commission of fraud is the lack of a direct link between the actions of management and the negative consequences for the company. Also, it is difficult to prove such a link and losses.

This link and availability of losses may be proved using both the auditors/experts conclusions and criminal legal methods (interrogations, explanations of third parties, economic examination).

Detection of Fraud and Creation of the Original Body of Evidence

1. Internal investigation of a potential act of fraud, which should be carried out by means of internal or external auditors, in order to create a high-quality body of evidence. It is auditors who carry out the analysis that confirms the fact of illegal actions.

2. Drawing of audit conclusions. These conclusions will form the basis of the expert examination, action demand or crime commission statement.

3. Receipt of conclusion of certified court expert based on auditor’s conclusion.

4. Questioning of the participants to the act of fraud by a lawyer, compiling of relevant protocols.

Possible Actions of Elimination and Compensation for Losses

The purpose is a complete/partial compensation for losses, the creation of conditions under which the former employee will be forced into a “voluntary settlement agreement” and full or partial compensation for damages.

Bringing a dishonest employee to responsibility will significantly reduce the risk of fraud in the future. The fact of responsibility actually incurred is the best protection.

Mechanisms of bringing dishonest managers to responsibility:

1. Criminal legal mechanism.

2. Civil legal mechanism.


Criminal Legal Mechanism

1. Obtaining information from the audit service.

2. Internal investigation of the potential fact with involvement of internal/external auditors.

3. Creation of body of evidence. Forensic examinations.

4. Initiation of criminal proceedings.

5. Active legal proceedings. Filing requests for conducting investigations aimed at disclosing the intent and proving certain actions of the fraudsters.

6. Initiation of the arrest of property/items obtained by illegal means.

7. Commencement of civil action within criminal proceedings.

8. Filing accusation / voluntary settlement agreement.

Successful implementation of this mechanism depends on the quality of the primary analysis by the audit services and the proactive procedural position of lawyers. The current Code of Criminal Procedure allows lawyers to initiate and often independently conduct proceedings aimed at collecting evidence.

If a high-quality body of evidence of illegal actions will be an argument, this will make the fraudster actually acknowledge the fact of improper conduct and compensate for losses.

Companies should not be afraid to use criminal procedure methods. Their effectiveness is often much higher than the claims of a civil legal nature.


Civil Legal Mechanism

A number of amendments came into force on 1 June 2014, including amendments to the Labor Code, which strengthened material responsibility of company officials (Directors, Chairman, members of the executive body and the Supervisory Board, Chairman of the Audit Committee).

Now these persons are financially liable for damages in full instead of the amount of the average monthly wage as was the case before.

Thus, there is a real opportunity to fully recover from the directors the damages caused by them.

Due to the amendments, companies have effective tools to combat misconduct by directors.

Damage caused by directors may result from the following:

— gross violations of internal documents, compliance policies and procedures;

— non-compliance with procurement procedures, tenders or financial borrowings;

— creation of “parallel” business, making of related-party transactions and other conflicts of interest;

— making of obviously unprofitable transactions;

— dissipation of assets;

— corporate fraud;

— appropriation of intellectual property, databases, customers, suppliers, and others.

Forms of Impact and Compensation for Damage

In order to prevent these violations by officials, it is necessary to do the following:

1. Bring the Charter and internal company documents into conformity with laws (compliance policies, procurement procedures, and tenders);

2. Amend labor contracts in terms of stepping up the responsibility of officials;

3. Sign pledge agreements with officials to secure possible compensation claims for damages.

In case of misconduct by officials, we propose to recover the damages caused by them by judicial means, namely:

1. Form the body of evidence;

2. Prepare and submit an action for damages;

3. Arrest the director’s property before making a decision;

4. Recover damages on the basis of a court ruling.

Earlier, full recovery of the damages caused by the director was possible only after bringing him to criminal responsibility, which had ambiguous meaning both for the company and for top managers.

This mechanism is a new one. Currently, its practical application has not been established. If the company does have clear regulations and policies, these provisions create the potential opportunity of compensation for losses caused by improper actions carried out by officials.

1According to the study Economic Crime during Economic Recession by PwC