Any good fraudster knows they must ensure the proceeds of their deception are not easily identified. An ill-informed investigator typically gives-up after asset searches on the wrongdoer produces a negative result. A good fraud investigator, however, will know the process of tracing may provide an effective means of securing a positive outcome for victims of fraud.

As a starting point, it is important to note that ‘tracing’ assets is different from ‘following’ assets. The distinction was explained in a seminal case in the United Kingdom’s House of Lords. ‘Following’ is the process of following the same asset as it moves from hand to hand. Tracing is the process of identifying a new asset as the substitute for the old. Where one asset is exchanged for another, a claimant can elect whether to follow the original asset into the hands of the new owner or to trace its value into the new asset in the hands of the same owner. (Foskett v McKeon [2001] 1 AC 102, 128 (Millet LJ)

Equitable tracing pre-supposes “the continued existence of the money as a separate fund or as part of a mixed fund or as latent in property acquired by means of such a fund.” (Re Diplock [1948] Ch 465 at 521)

To illustrate the tracing process, consider three hypothetical examples:

  • Simon is the trustee of a family trust. Simon misappropriates trust property by withdrawing cash from the trust’s bank account and uses those funds to purchase shares in his own name. In this case, the process of tracing could seek to establish that beneficiaries of the trust have an equitable interest in the shares. Where the value of shares has increased, Simon must also account to the beneficiaries for the profit made.
  • Cassandra works in the accounts department of a large retail company. Cassandra creates a false invoice to deceive her employer into paying money into her friend’s legitimate farming business bank account. There were existing funds in the friend’s bank account before the total balance was withdrawn to purchase livestock. Even with a mixed fund, the process of tracing could allow Cassandra’s employer to seek a charge over the livestock.
  • Omar is a financial advisor. Omar’s client gives him directions to liquidate all the client’s shares and to purchase gold bullion. Instead, Omar uses the proceeds of the sale of the shares to pay off his own secured car loan. In this scenario the process of tracing could allow the client to be subrogated to (that is, standing in the place of) and assume the rights of, the lender over the car.

In all these examples, tracing is not a claim against another party – but a method for identifying property. In each of these examples, a fiduciary relationship exists between the wrongdoer and the victim (e.g., trustee, employee, and professional adviser). Such a relationship is a precondition to equitable tracing. Accordingly, the claim will often be framed as an equitable action for breach of fiduciary duty. The remedies may include an account of profits, a charge, a lien, or a constructive trust. Ultimately, the question of the specific claim that is brought and the specific remedy that is sought will depend on what is appropriate in the unique circumstances of each case.

The rules are of tracing are complex. Tracing will be complicated by factors such as bankruptcy, insolvency or death. There are also some limitations. For instance, the property must be identified – so where funds have been used to pay for services already rendered or perishable goods, as just two examples, tracing will not assist. Nevertheless, tracing may provide a way of obtaining a positive outcome where misappropriated funds have already changed hands.

In practical terms, in a fraud investigation it is not enough to simply do an asset search on the wrongdoer. A fraud investigation should be directed to revealing all relevant facts and circumstances of the wrongdoer’s dealings with the proceeds of their fraud. Oftentimes, such matters are only fully known following discovery and the production of documents by non-parties under subpoena. This is hard work and can be tedious. But the rewards can be well worth the effort.

Note: this article is for information purposes only and is not legal advice. If you wish to obtain advice about a particular matter, please contact Duxton Hill.

By Andrew Tragardh and Dr Aaron Lane, Duxton Hill