Fraudulent financial reporting is still a crime
The much-awaited ruling by the Joint Divisions of the Italian Supreme Court on the subject of fraudulent financial reporting and false corporate statements had the final say in the controversial case that has triggered interpretative disputes and academic differences.
By Flavia Giuliani
With judgment no. 22474, the Joint Divisions have definitively expressed their opinion on the age-old jurisprudential and academic question which had caused much confusion among criminal law scholars and financial experts on the subject of fraudulent financial reporting.
It all began with the legislative amendment of the art. 2621 of the civil code introduced by art. 9 par. 1 of law no. 69 of 27 May 2015. Compared to the previous formulation referred to in the 2002 reform, the subject of false statements in the new wording has been reduced from ‘material facts albeit subject to valuation’ to ‘material facts.’
This reduction has created a lively debate between two opposing schools of thought: those who considered the so-called offence of fraudulent accounting decriminalized (Crespi judgment of 16 June 2015) and those who believed instead that the exclusive reference to ‘material facts’, i.e., the subject of fraudulent reporting, did not rule out valuations from the scope of criminal repression, which valuations, conversely, could be defined as false if they clashed with technically or legally undisputed evaluation criteria (Giovagnoli judgment of 12 January 2016).
The fifth criminal division referred the question to the Joint Divisions, which stated that ‘the crime of fraudulent corporate statements exists with regard to representing or omitting material facts albeit subject to valuation if, given the valuation criteria established by law or generally accepted technical criteria, the perpetrator consciously deviates from these criteria without giving adequate supporting information in a way that is apt to mislead the recipients as to these corporate statements.
Legal collected the views of acknowledged experts in tax law regarding this complex subject matter at the round table “Fraudulent financial reporting: tax issues and criminal liability”, moderated by Angela Maria Scullica, editor-in-chief of Le Fonti financial publications. The debate was attended by Vincenzo José Cavallaro of Stufano Gigantino Cavallaro & Associates; Ignazio La Candia of Pirola Pennuto Zei; Gianluca Ferri of CBA law and tax firm; Luigi Isolabella of the Isolabella law firm; Carlo Baccaredda Boy of Carlo Baccaredda Boy; Giuseppe Scozzari of S&R Scozzari and Rutigliano; Riccardo Lucev of Orlando & Fornari; Piero Magri of R&P Legal, and Andrea Orabona of Orabona law firm.
Before arriving at the last ruling by the Supreme Court, how did the law on fraudulent accounting evolve?
Scozzari: Three judgments have been passed on the subject, which are bound to pose an interpretative question, which will ultimately become the central issue, i.e., whether or not accounting estimates should have any criminal relevance within the crime of fraudulent statements and, as such, punishable. In other words, the problem is to establish – in the light of the reform introduced with law no. 69/15 – whether the crime of fraudulent accounting still exists.
A first judgment, the so-called Crespi judgment (no.33774/15) embraced a line that is more consonant with the literal wording of the law (art. 2621 of the civil code) and therefore more restrictive with respect to its applicability. Against a broader background of fraudulent bankruptcy, it excluded accounting valuations from the remit of this criminal offence.
This partially abrogative interpretation of the provision in question has aroused strong criticism from some legal scholars who did not share this restrictive interpretation since, according to this doctrinal line, it would go against the will of the legislator, which is instead aimed at broadening the scope of punishment. The Crespi judgment was followed by the Giovagnoli judgment (Supreme Court law no. 890/15), which resulted in the opposite interpretation, in the belief that removing the phrase “albeit subject to valuation’ is inconsequential, and by adopting instead an interpretation based on voluntas legis, while bringing accounting estimates back into the scope of criminal penalties with the result of voiding the new reform.
Some commentators have criticized this decision because it did away with a series of constitutional principles at a stroke, placing in the hands and arbitrariness of the judge the possibility of considering certain conducts punishable, thus desecrating the principle of legality,
a key principle in our penal system. Judgment no. 6919 of 2016 has recently overturned the principle established by the previous judgment, leading back perhaps to the underlying rationale set forth by lawmakers, while entrenching the nature of legality where lawmakers aimed to prevent approximate valuations – which cannot be defined with absolute logic and objectivity – from being subjected to punishment and consequent criminal conviction.
La Candia: First off, one thing must be considered from a comparative viewpoint and taking into account the international context in which companies operate: the regime of financial crimes, and in particular that of fraudulent accounting, as contemplated in other jurisdictions seems to be less strict than in Italy. In France, imprisonment is up to 5 years; in Germany from 1 to 3, in the United Kingdom imprisonment can be up to 7 years for listed companies; in Switzerland imprisonment can reach a maximum of 3 years, while in Portugal imprisonment is up to one year. Thus, the amended Italian regime seems to be quite strict, with the exception of the United States. I wonder if the picture, as outlined, can be considered consistent with the principle of proportionality vis-à-vis criminal offences. On the one hand, penalties have been overall stiffened, while on the other hand, valuations, which permeate financial statements throughout, have been expunged from the law.
What is your opinion on the rulings issued?
Scozzari: I believe that the Crespi ruling, i.e., the first ruling, may be the one that best obeys the will of lawmakers, who wanted to simplify the regulatory framework. The elimination of the penalty thresholds set out in the 2002 reform, which causes uncertainty and varying decisions from one trial to the next, had actually watered down the crime of fraudulent accounting, leading to punishment only in extremely particular cases. I believe that the Crespi ruling gave a correct interpretation of the reform that had been advocated by our lawmakers. Of course, this interpretation may be criticised at least on one account: if, on the one hand, legislators wanted to eliminate the valuation aspects from the criminal remit, on the other hand, by introducing non-liability to punishment per 133 bis, it has envisaged a scenario of possibilities by placing the onus on the shoulders of the judges, thus considerably affecting the principle of legality within which criminal law should be able to freely operate. I believe that the Crespi judgment and law no. 6919 adhere more closely to what lawmakers had in mind and to this reform as contemplated in law 69 of 2015.
Ferri: I mainly deal with tax litigation and I have carefully read the three judgments which have come with all the innovations on the subject of fraudulent accounting, I must admit I can’t go along with the restrictive tendency of the Crespi judgment, despite it being more protective, which were recently confirmed by decision no. 6916 of 22 February. If we read judgment no. 890/16 carefully, I believe that this is the most correct interpretation. In my view and from a more substantive perspective – fraudulent accounting still occurs in the preparation of financial statements, and the reason why I think that this judgment is right is that I have to create a balance sheet according to what is laid down in the civil code and based on both EU directives and international accounting standards, while also abiding by accounting policies. If someone intentionally depart from these parameters, thus failing to prepare a balance sheet on the basis of these principles, then, I’m afraid, it means that fraudulent accounting is still quite prevalent.
La Candia: Following the latest changes, the law has in some ways become quite ‘innovative’ compared to the previous wording, with the result that the Supreme Court must necessarily conform to the literal meaning of the law. One hopes that judges won’t fall prey to the ‘anxiety’ of interpreting the law in a manner that is not in keeping with its formulation. In practical terms, valuations assume greater importance in transfer pricing. In this respect, a number of legal scholars seem to ‘refrain’ from affirming and consolidating some principles, many of which are currently being debated. This recalcitrance has caused many challenges and short-circuited supranational regulations (e.g., amicable dispute resolutions or arbitration procedures).
Orabona: In my opinion, legislators have moved closer to abrogating cases of ‘false accounting’. They have indeed proceeded to eliminate the parenthetical element ‘albeit subject to valuation’ from the text which defines fraudulent corporate communications offences, thus expunging from the same provisions any reference to punishing manipulated accounting valuations found in financial statements. I can only agree with the reading of the provisions in question recently offered by Professor Lanzi, in that it emphasizes the criminal irrelevance of ‘false accounting’ in addition to the multiple comments on the unconstitutionality underlying the application of this unfavourable stance adopted by the jurisprudence. One hopes that the Joint Divisions will ultimately uphold the irrelevance of ‘false accounting’ in all cases of erroneous statements that are in violation of either the accounting standards set forth in the civil code or international accounting standards as well as cases of erroneous statements occurred notwithstanding the same provisions of law.
Cavallaro: To determine the criminal relevance of accounting valuations, and for the purposes of establishing the criminal offence of fraudulent accounting, it is essential to indicate in the documents attached to the financial statements the accounting criteria that underlie the assets and liabilities and the actual compliance with these accounting principles. Only the violation of these criteria could give rise to punishable facts. This is the case, for example, of tax offences where, to establish the offence of fraudulent tax return, art. 4 of legislative decree 74/2000 does not take into account the incorrect classification of existing assets or liabilities, in relation to which the criteria that have actually been applied have, in any case, been indicated on the balance sheet or in other relevant documentation required for tax purposes.
Isolabella: In my opinion, the issue it is not so much all-encompassing penalties as penalties that are often not strident enough. Lawmakers feel the need to intervene in a certain area and do so in unclear terms because what leads them to deal with that specific legislative area is often heterogeneous. In other words, lawmakers are not so strong as to be able to afford clarity and yet – and there is no doubt about it – the law must necessarily be clear. Let’s analyse, however, the specific case that concerns us: what were lawmakers thinking of as they were wording this law? Did they want to bring the Supreme Court to a standstill? Could they imagine all the pages that would be written and the hours spent trying to interpret the legislative text which, as a result, were taken away from the administration of justice? I’m obviously being provocative here because of the countless hours spent understanding the law. Logic is the rationale behind law. Dialectics – as we witness on a daily basis – is an element that can stifle logic. Dialectics is fundamental, language is what brings logic to the surface, but langauge can also stymie and distort logic.
Dialectics, which is a fundamental component of law, can transform itself and assume perverse connotations. If it is true that fraudulent accounting, or rather, the concept of valuations, can fall under the category of fraud, and if it is true that the new law has focused on a specific aspect to be protected, i.e., transparency, it is foolish to think that fraudulent accounting can be extrapolated from the new punitive model. So, let’s get away from the logic that’s behind the law. While it is true that the parenthetical element ‘albeit subject to valuation’ has been done away with, it is equally true that, because that element had been added to the previous law, it may very well have had a meaning. However, it is true that the concept of material fact also includes any valuation aspects. Removing that parenthetical element – especially if we consider the principles that inspired the reform – does not have, in and of itself, a definitive or crucial meaning. It is merely a lexical fact, which risks engulfing us in dialects once again. Let’s focus instead on the role of the legislator. The concept of liability is fundamental for all of us, though our legal system is not particularly focused on the principle of duty and objective truth. What we’re talking about is fraudulent financial reporting, a law that is specifically geared towards protecting the truth, and yet – on the whole – our legal system is reluctant to deal with the duty to truth – if not sporadically. The punitive paradigm identifying objective truth as a category to be protected is in fact quite limited.
Lucev: After a decade of ineffectiveness in dealing with fraudulent financial reporting, lawmakers have brought the law back to levels of effectiveness and punitive response as a result of a clear criminal policy. This didn’t use to be the case under the 2002 law, which had relegated fraudulent accounting to being a ‘Cinderella’, which we criminal lawyers seldom encountered: with prosecution upon complaint and a shortened statute of limitations due to art. 2621 being a fine, we rarely have had to tackle defensive arguments. This positive view on the reform seems to therefore jar with the apparent 2015 legislative debacle, which fuelled the debate on this variously persistent criminal relevance of fraudulent financial reporting. There is no doubt that this is where the weak point of the reform is, because – as a result – we are faced with two equally authoritative but clashing jurisprudential theses today. This will necessarily have to reach a solution because companies and their management must carry on with their business knowing where they stand vis-à-vis the law.
I find the thesis supporting the continued criminal relevance of fraudulent accounting convincing. Yet, I also believe that leaving out a portion of text cannot be read as neglectable by legal experts. The wording ‘albeit subject to valuation’ was there yesterday and it’s gone today.
This is a fact and it’s only fair to ask whether lawmakers had meant to change something in this case, since elsewhere, e.g., art.2638 of the civil code, this phrasing is still used. A systematic reading seems to suggest that this parenthetical element is indeed meaningful. Likewise, its absence must be meaningful, too. At first sight, it seems to me that a restrictive thesis – whereby fraudulent accounting has been expunged from criminally relevant conducts – is preferable also in terms of protection of the accused. That said, we’re all waiting for some clarification from the Joint Divisions.
Baccaredda Boy: This law is dogged by the problem of understanding what is fraudulent and what is not. Fraudulent accounting cannot be found in the literal wording of this law, which is sacrosanct in our criminal law system, where the principle of legality is effective. Three legislators have intervened in this matter: in 1942, in 2002 and today. The laudable 1942 text referred to ‘facts’; the 2002 law specified ‘material facts’ to narrow down the scope, while adding the parenthetical element ‘albeit subject to valuation’, which has since been eliminated in the current legislative intervention. In my opinion, it is clear that if this parenthetical element has been eliminated, the principle of legality requires that fraudulent accounting should not be considered. One wonders then how the much-heralded repressive goal set by the 2015 law could be explained given the decriminalization of fraudulent accounting. On the other hand, the problem of fraudulent accounting aside, the rule presents some clarity issues on technical grounds, giving judges a wide margin of discretion. This aspect is plainly evident if we take into account the three legislative texts. The 1942 law was written in a simple and linear manner and was applied correctly until the ‘Mani Pulite’ era. From that moment on, that law was unreasonably expanded. Faced with the greater power wielded by magistrates, the subsequent intervention in 2002 by the Berlusconi government certainly aimed to establish significant ceilings to circumscribe the discretionary powers of the magistrates. It subsequently brought about an actual non-application of the law, also due to the presence of the prosecution on complaint condition. On balance, it seems to me that the new text today has, once again, granted dangerously and unreasonably discretionary powers to the judges.
Magri: It goes without saying that the literal wording of the law is very important. The provision ‘albeit subject to valuation’ is no longer there and, as such, valuations should no longer be important. However, what I’d like to stress is that criminal lawyers will increasingly need to rely on corporate lawyers. Teamwork will need to be put in place because criminal lawyers may well look into the existence of fraudulent accounting, but only corporate experts can ultimately ascertain the accuracy of accounting valuations. Indeed, the ruling by the Supreme Court goes back to the Crespi judgment, which groups criminally relevant facts into ten categories: falsely increased revenues, non-entered costs, false statements regarding the existence of bank accounts, recognition of invoices issued for non-existent transactions, recognition of enforceable receivables, recognition of assets derived from fictitious contract, etc.. The criminal offence of fraudulent accounting will be increasingly applied, for example in cases in which tax offences fail to constitute a criminal offence at a subjective or objective level. In such cases, false accounting then becomes a very effective and powerful tool in the hands of prosecutors.
How does this law affect the preparation of financial statements?
Cavallaro: What is, after all, a balance sheet if not a set of valuations? If the legal system attributes criminal value to the conduct of those providing false corporate statements because the choices of a number of stakeholders can depend on those statements, it is clear that punishable facts must depend on valuations – if valuations are the medium that provides such false information to third parties. Financial statements are nothing more than a set of valuations, an aggregate of assets and liabilities represented by numerical quantities behind which are valuations. If the criteria for these valuations are compliant and fully explained, it follows that no sanctionable facts can derive from valuations. However, if corporate directors want to provide false corporate statements through manipulated valuations, then these conducts must clearly be criminally relevant, thus constituting fraudulent financial reporting.
Isolabella: The old law referred to ‘material facts albeit subject to valuation’. This wording clearly incorporates – by definition – what is subject to valuation into the concept of material fact. Therefore, even if I leave out the parenthetical clause, the material fact still includes valuations. If I leave only the wording ‘material facts’, the concept of valuations is still included in it. This is indisputable as is the rationale behind the law, which – however bad it may look – still requires transparency including by punishing fraudulent accounting. It’s about going into the details of individual cases in an effort to fully understand when a specific wording can constitute a significant material fact. However, ruling out that valuations may be at the root of fraudulent statements means reducing to the bare minimum what the new law aims to protect, which is in stark contrast with what inspired the law in the first place.
Ferri: In my opinion, the law must also be interpreted a little more boradly, so that it can strike more offences and not only affect, for example, the use of fictitious invoices or the failed recognition of earnings.
Magri: In my opinion, the fundamental issue is to provide a correct interpretation of material facts and valuations. In other words, we cannot accept a thesis whereby a balance sheet is merely an aggregate of valuations. We must understand – and this is where criminal lawyers need corporate lawyers and tax lawyers – when it is a significant material fact and when it is a mere valuation.
Baccaredda Boy: While it is true that this law risks becoming meaningless in its application – because there are cases of false financial statements that are not valuation-based, these are a small minority and are less serious as a whole in the complex communications of large corporations. Thus, it is clear that the lawmaker’s hope which aimed to broaden the scope of criminal offences while exacerbating the punishment was ultimately dashed. If the intent is really to punish more, then this is absolutely antithetical to decriminalizing false accounting. Against this background, lawmakers could step in to fix the error, as they are already doing in other matters relating to corporate criminal law, instead of leaving it to the jurists to decide.
La Candia: As mentioned earlier, a much-debated issue concerns the valuation fact and the issue of transfer pricing in multinational groups. In the past – in a few cases – false accounting was inadequately debated by some courts on the assumption that transfer-pricing policies adopted by companies had not been deemed adequate or compliant with the provisions laid down by national regulations and, in some cases, the OECD.
While this is a complex and not easily solved issue, I hope that the new law will bring about a radical change in the mindset of both technical and legal experts.
Scozzari: With this reform, lawmakers aimed to create an equitable balance between what can and what cannot be considered a criminal offence. The adverb ‘consciously’ – repeated several times in the revised regulations under scrutiny here – clearly defines what dolus eventualis is: an unconscious conduct that subsequently triggers a behaviour that incorporates both consciousness and willingness. The fact that lawmakers have urged us to exercise caution because an offence must have a specific intent since the ultimate goal is to gain an advantage – and as such cannot be unintentional – I believe that it is consistent with the interpretation found in the Crespi judgment. If the jurisprudence excludes manipulated valuations, i.e., if I manipulate the existence of a loss-making checking account, or if I artificially devalue the shares of a company when I shouldn’t, then in these cases, of course I’m engaging in a conduct aimed at intentionally creating a profit while damaging specific individuals. Then, there, of course, that’s where criminal liability can be traced.
Orabona: However, I hope that the courtrooms will take on board the restrictive interpretation of the subjective element of false financial statements, since the existence of wilful misconduct in disclosing false facts or figures in financial statements is now required for establishing the same criminal offences. Therefore, the punishment of corporate management for fraudulent financial reporting should be automatically ruled out in all cases of erroneous or negligent representation within these statements of material facts, which can be attributed to the mere violation of the accounting preparation criteria required by national and EU law currently in force.
Lucev: Discussing balance sheets without including the concept of ‘valuations’ is impossible and even a criminal lawyer must take note of it. However, if the concept that ‘a balance sheet is an aggregate of valuations’ is acceptable, this does not mean that the criminalization of fraudulent financial reporting based on an unclear incriminating rule must be accepted. In particular, I find it difficult to accept that false accounting continues to constitute an offence on the basis of an incriminating rule that used to maintain that it was an offence, but it no longer does.
In the hope that the Joint Divisions untangle the matter soon, it seems to me that a reasonable approach would set out the rules of the game plainly from the outset.
If financial statements are the sum total of valuations – and punishing fraudulent statements is certainly expected – then the valuation criteria followed each time should be clarified in explanatory notes. That said, in my opinion, room for criminal penalties should apply only to cases of fraudulent deviation from stated valuation criteria.
