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KEY TAKEAWAYS
1. Directors of a Singapore company may be legally liable for any financial losses incurred by a company if proper care is not taken to investigate the financial irregularity red-flags or fraud allegations.
2. Directors could consider commissioning an independent forensic investigation to determine the severity of the issues and limit their legal liability exposure.
3. The benefits of an independent investigation include resolving issues, remediating the situation, and assuring stakeholders that proper governance is deeply entrenched within the company, which ultimately would preserve or enhance the reputation of the company.
What should a director do when they come across financial irregularity red flags, or even more concerning, allegations of fraud within the company?
There are possibly three options to take. The first is to ignore, the second is to request management to explain, and the third is to investigate independently.
Directors are bound not just ethically, but also by relevant rules, regulations and laws to address the crux of the matter. Some of the questions arising could include: Did management know about the issue, and what actions have they taken to prevent and remediate the situation?
Legal obligations of the director as an individual
In January 2024, a High Court ruling in Singapore in the IPP case sent a strong warning to directors to be good stewards of the businesses in their care, highlighting that they can face severe liabilities under the Companies Act if they do not do so.
In this instance, the Judge found that a director failed to act on “several red flags” that emerged and “an honest and reasonably diligent director would have persisted and probed further… [and] that on the balance of probabilities, the fraud [of the company] would have been discovered.” This resulted in a ruling in favor of the company, which claimed more than US$146 million (S$196 million) against the director for the financial losses incurred.
Additionally, directors of issuers on the Singapore Exchange (SGX) have duties under the SGX Listing Rules. These duties include:
- Act in good faith and in the best interests of the company.
- Avoid conflict of interest.
- Exercise due care, skill and diligence.
The Singapore Exchange Regulation states that any breach of duties may result in possible criminal and civil actions.
Financial red flags and fraud allegations
When faced with financial red flags and fraud allegations, the logical option for directors is to conduct an independent investigation into the financial irregularities and fraud allegations. This demonstrates that they have acted in good faith, in the best interests of the company, and exercised due care, skill and diligence in discharging their duties.
This investigation should remain free from management’s participation, with explanations given directly to the directors so that the actual root causes of the issues are not biased in favour of the management.
Hence, the directors should consider commissioning external advisors to conduct the investigation and report directly to them. External advisors, such as forensic investigators and white-collar crime lawyers, can support the directors in driving the investigation and provide practical advice.
Working as a team, the lawyers would advise the directors on their legal obligations and the implications of the results. Forensic investigators (including accountants, computer forensics technicians, data technologists and corporate intelligence specialists) can then focus on holistic reviews of the company’s books and records.
Through this collaborative effort, external advisors enable directors to navigate the investigation promptly and confidently, recognising that key stakeholders (shareholders, auditors, regulators, bankers, and others) eagerly await the investigation’s findings.
Benefits of an independent investigation
The benefits of conducting an independent investigation are multifaceted, with the obvious one being to limit a director’s potential exposure to legal liabilities.
Other benefits of an independent investigation include ensuring key stakeholders that proper corporate governance is entrenched within the company. Directors can maintain oversight and remain independent from management. Ultimately, the independent investigation can enhance the integrity, reputation and value of the company. At the end of the investigation, the directors will obtain a factual account of the issues, addressing critical questions such as:
- Were the financial irregularities or fraud allegations substantially proven?
- How did they happen?
- What was the financial loss?
- Who was involved; more importantly, was management involved in the fraud?
- Are the perpetrators still with the company?
- Are there any other similar fraudulent transactions?
The factual account will provide directors with a basis on whether to terminate any business relationships with business partners and/or employees, including management, and to put in place measures to remediate the issues at hand. The benefits of conducting an independent investigation are multifaceted, with the obvious one being to limit a director’s potential exposure to legal liabilities.
Upholding corporate Integrity
Directors often have to weigh the cost and benefits of conducting an independent investigation, considering whether to accept management’s responses or ignore the financial irregularities or fraud allegations.
Conducting an independent investigation benefits not only the directors personally (i.e., to limit exposure to legal liabilities) but also for the company.
Even if the investigation does not produce any hard evidence of wrongdoing, it sends a powerful message to employees, management and key stakeholders that the directors hold corporate integrity and reputation in the highest regard.
Source: This article first appeared in the Q2 2024 issue of the SID Directors Bulletin published by the Singapore Institute of Directors (accessible via membership only).
1 https://www.straitstimes.com/business/directors-in-breach-of-fiduciary-duties-can-face-severe-liabilities
2 https://www.straitstimes.com/business/former-ipp-director-goh-jin-hian-liable-for-us146m-losses-suffered-by-company-high-court
3 https://eoasis.rajahtann.com/eoasis/lu/pdf/2022_05_SGX_Elaborates_Directors_Duties.pdf
