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Mitigating fraud risk ahead of the UK’s corporate governance reforms and economic crime bill

Key reforms in corporate governance requirements are part of the UK Government’s response to various major corporate failures that stemmed from material control weaknesses.

The UK has witnessed significant escalations in both the frequency and sophistication of economic crime in recent years. Organisations are exposed to many types of fraud, internally and externally, with the digitalisation of society only increasing vulnerability.

In response to this rising threat, the Government is introducing legislative changes that place the onus on UK companies to take proactive measures for preventing fraud. It is important organisations are aware of the implications of the reforms and establish the necessary fraud prevention and risk mitigation strategies required.

Corporate governance reforms

Key reforms in corporate governance requirements are part of the UK Government’s response to various major corporate failures that stemmed from material control weaknesses.

Last year, the UK Government published a series of proposed corporate governance reforms in response to the Department for Business, Energy, and Industrial Strategy’s policy paper, Restoring Trust in Audit and Corporate Governance. Published in 2021, this document was in response to various investigations into major corporate collapses and failures. The reforms proposed focus on legislative changes to strengthen UK companies’ corporate governance and internal controls.

Significantly, enhanced statutory reporting requirements will be applicable to large private companies with over 750 employees and an annual turnover in excess of £750 million (new public interest entities (PIEs) classification). Additionally, new fraud risk management reporting requirements instruct PIEs’ directors to report on fraud prevention and detection actions they have taken.

Economic Crime and Corporate Transparency Bill

The Economic Crime and Corporate Transparency Bill, which follows the Economic Crime (Transparency and Enforcement) Act of March 2022, is primarily designed to tackle the growing problem of money laundering in the UK. It allows the Government to impose sanctions more quickly, better support law enforcement investigations, and counter foreign criminal gangs through the creation of the Register of Overseas Entities.

The Bill requires directors and persons with significant control to improve corporate transparency through enhanced registration and verification. Furthermore, the “failure to prevent” either fraud, false accounting, or money laundering for commercial organisations — with the exception of SMEs — will be an offence.

Consequently, commercial organisations and their senior managers can be prosecuted if “reasonable” or “adequate” controls to prevent economic crime are proven absent. The Bill has already passed its third reading in the House of Lords, with discussions progressing into the latter half of 2023.

Managing fraud risk

Beyond the legislative requirements to implement fraud risk management processes, there is a compelling business case for combatting fraud, given its potential impact on reputation, business continuity, culture, and even share price.

Marsh research from 2018, examining the impact of disruptive events on share prices, found accounting fraud the type of event most difficult to recover from. The average share price of public companies who suffered a fraud event remained approximately 20% below the pre-event level 240 days after the incident. Organisations dealing with fraud risks can opt for risk transfer or risk mitigation — or a combination of both. 

Risk transfer can include the purchase of commercial crime policies, for example. Such policies provide protection from financial losses stemming from business-related crime — including theft by employees, forgery, robbery, and electronic crime. A directors and officers (D&O) policy can also be used for risk transfer by protecting a company’s directors and key managers against alleged wrongful or negligent acts that resulted in fraud. However, while D&O coverage provides protection against third-party losses, organisations with this insurance will still suffer the losses resulting from the incident of fraud.  

While the D&O market experiences favourable conditions, the commercial crime market is currently seeing high premiums and deductibles, as well as, tightened capacity. These market conditions may lead some organisations to focus on risk mitigation rather than risk transfer.

Risk mitigation strategies can include investing in risk management services, testing procedures already in place, and improving internal controls that help detect and prevent fraud. Before offering coverage, insurers will always analyse what steps a company has already taken to address existing control weaknesses that resulted in incidents of fraud. This is a critical step for insurers determining coverage feasibility.

Next steps

It remains to be seen whether implementation of the proposed changes will result in heightened litigation. However, a more forensic approach by companies and their directors — fully cognisant of the potential threats — should see appropriate risk frameworks established to protect themselves. 

To aid organisations seeking to proactively mitigate their risk ahead of the passing of new legislation, Marsh has developed a comprehensive fraud risk management proposition. This suite of services provides measures for strengthening internal controls, identifying areas of improvement, and ensuring regulatory compliance for better preparedness. 

To find out how to safeguard your organisation against fraud and manage risks arising from the reforms, please contact your Marsh adviser.

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