The significance of a red flag — don't jump to conclusions too quickly

A short while ago, Jonathan Fisher QC gave expert  evidence in international arbitration proceedings on the significance of red flags in a large-scale corruption case.

The significance of a red flag — don't jump to conclusions too quickly

Although there is no universal definition of a red flag, there is a general recognition that a red flag is a risk indicator of potential illicit activity. However, a red flag does not provide evidence that illicit activity is taking place.

The presence of a red flag may constitute a reasonable basis for suspecting illicit activity, but this is a different matter.

The same is true where there is more than one red flag present. The inference of illegal conduct strengthens with the number of red flags which are flying, but it is does not necessarily follow that the inference is sufficiently strong to support a judicial finding to this effect.

A red flag is not a warning of danger but rather the risk of danger. This is not the same thing.

Classified in evidential terms, a red flag constitutes circumstantial evidence, or as the French know it, faisceau d’indices, from which evidence of illegal conduct can be inferred. But there is an important proviso.

The inference can be made only where there is no other reasonable explanation for the conduct.

This proviso is important to remember, especially where corruption, money laundering and tax evasion cases are involved, since it is easy to jump to the wrong conclusion. As Lord Normand  made clear in Teper v R [1952] AC 480 nearly seventy years ago, circumstantial evidence

• “must always be narrowly construed”.

Lord Normand warned that before drawing the inference of guilt from circumstantial evidence, it is necessary

• “to be sure that there are no other co-existing circumstances which would weaken or destroy the inference”.

These are strong words, and at a time when narratives of red flags permeate anti-corruption, anti-money laundering and anti-tax evasion policies and procedures, a reminder of Lord Normand’s strictures is timely.

The requirements that circumstantial evidence:

• “Must always be narrowly construed”, with the need
• “To be sure that no other co-existing circumstances”, are duly noted.

Therefore, before assessing the weight to be placed on a red flag which is present in commercial arrangements, the surrounding circumstances must always be considered with great care.

• In some types of business activity, the presence of a red flag, perhaps a lack of transparency, can be explained by a need for commercial secrecy.
• Similarly, whilst in some businesses payment of a large consultancy commission may trigger concerns, in other industries it remains the norm.

Each case turns on its own facts, and the significance of a red flag must be considered against this background.

Where commercial arrangements are tainted by a suspicion of unlawful conduct (typically, corruption, money laundering, tax evasion), parties have become more willing to raise the issue before a court or arbitration tribunal where a dispute between the parties has arisen.

Invariably, the issue is raised as a defence and is founded upon an argument that the contractual arrangements are unenforceable on grounds of public policy (See Patel v Mirza [2017] A.C. 467).

The difficulty with this line of argument is, of course, the question of proof.

Financial crimes are concealed crimes. Whilst a contracting party may suspect illicit activity, satisfying a judge or arbitrator is a different matter.

It is against this background that parties have placed increasing reliance on the presence of “red flags” said to be apparent in the circumstances of the commercial arrangement. The parties seek to infer from the red flag that some form of corruption, money laundering or tax evasion has occurred.

This begs two interesting legal questions, namely,

• What is a “red flag” and
• What degree of reliance may a judge or arbitrator place on it?

The Key Message

Whether for judges and arbitrators, or money laundering or compliance officers, is not to leap to conclusions.

In the face of a red flag, there may be other co-existing factors which explain the flag and limit the extent of any inference of illicit conduct which can be drawn.

by Jonathan Fisher QC - The quarterly magazine from Bright Line Law | Issue Two -  https://qm.brightlinelaw.co.uk/13/