Butler and Anor and Australian Prudential Regulation Authority
[2009] AATA 570
•31 July 2009
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2009] AATA 570
ADMINISTRATIVE APPEALS TRIBUNAL )
) Nos 2007/0968
GENERAL ADMINISTRATIVE DIVISION ) 2007/1794
Re John Leonard Butler
Alan Parsonson
Applicants
AndAustralian Prudential Regulation Authority
Respondent
DECISION
TribunalJustice Downes, President
Date31 July 2009
PlaceSydney
DecisionThe decisions under review are affirmed.
.....................[sgd]......................
Garry Downes
President
CATCHWORDS
FINANCIAL REGULATION - Australian Prudential Regulation Authority - disqualification – whether applicants are fit and proper to be or act as directors or senior managers of a general insurer - whether transaction was true insurance - whether there was actual transfer of risk - whether accounting treatment was appropriate - scheme to remove debt from balance sheet - insufficient disclosure by applicants – applicants disqualified.
Insurance Act 1973 (Cth)
Administrative Appeals Tribunal Act 1975 (Cth)
Briginshaw v Briginshaw (1938) 60 CLR 336
REASONS FOR DECISION
31 July 2009
Justice Downes, President
Summary
1. Commencing in 2000 Zurich Australian Insurance Ltd (Zurich Australia) was involved with a number of reinsurance transactions. The transactions appeared to reduce its liability under a large general insurance portfolio. Its balance sheet was improved by $60 million. However, if risk under the portfolio passed to a third party insurer, the risk ultimately rested with an associated company, Zurich Insurance Company of Switzerland (Zurich Switzerland). Moreover, there was an arrangement that Zurich Australia would ultimately assume the liability. The sole object of the transactions was to improve Zurich Australia’s balance sheet. They were not motivated by any purpose of writing insurance business for profit. The transactions did not justify any material change in Zurich Australia’s balance sheet. Zurich Australia senior management did not adequately inform its board, the regulator (Australian Prudential Regulation Authority), its auditors (Pricewaterhouse Coopers) or the ratings agency, Standard & Poors, of the full nature of the transactions. Both applicants were materially concerned in the devising, implementing and using of the transactions. Their involvement was such that, notwithstanding their otherwise good reputation, they should be disqualified from holding any senior management position with a general insurer.
The Scheme
2. Zurich Australia is a general insurer. As at 31 December 1999 its accounts disclosed $254 million in outstanding claims provisions. Zurich Australia needed additional capital to ensure a prudent level of solvency and to fund a proposed strategic change program. This required an improvement in its balance sheet of some $60 million. Carry forward tax losses meant that profits of that amount would not attract income tax.
3. Zurich Australia managed to achieve the desired improvement in its financial statements during the year ending 30 December 2000. It did this through the following transactions.
4. The primary transaction had the effect of transferring a significant loss portfolio to General and Cologne Reinsurance Australasia Ltd (GCR). By this transfer (“the loss transfer”) (actually a reinsurance because it operated by way of indemnity) GCR indemnified Zurich Australia for $254 million of losses in excess of $10 million for a premium of $137.75 million. As accounted for, the transaction improved Zurich Australia’s financial position by more than $60 million and solved its immediate requirements for further capital. The reinsurance contract was executed on 28 September 2000 with respect to losses incurred on policies issued prior to 31 December 1999.
5. The evidence establishes that the premium for the reinsurance was not commercial. The outstanding claims provisions, even when adjusted for discounting and prudential margins, were some $215 million against a premium of $137.75 million. The evidence suggests that an appropriate premium would have been of the order of $199 million.
6. GCR was protected from its adverse position by a retrocession of the loss transfer to Cologne Reinsurance Company (Dublin) Limited (Cologne Dublin). Cologne Dublin indemnified GCR for $254 million in excess of $134 million for a premium of $500,000. This retrocession was executed in October 2000. It left GCR with liability for a certain $134 million against a premium of $137.5 million, so that it effectively earned a fee of $3.5 million, $500,000 of which was passed on to Cologne Dublin.
7. On 11 December 2000 Zurich Australia entered into a stop loss reinsurance agreement with Koelnische Rueckversicherungs Gesellschaft AG – Australian Branch (Cologne Australia). The reinsurer agreed to pay losses in excess of 100% of net incurred loss ratio up to 10% of net premium, if investment income was smaller than 7% of net premium, up to $45 million for any year. The policy was for twelve months from 1 January 2000. A minimum and deposit premium of $7.66 million was payable. The actual premium was 1% of third party business and 2% of other business. This policy was renewed and continued with different premiums. The policy was broadly similar to stop loss reinsurance policies which had previously been written between Zurich Australia and Zurich Switzerland.
8. The stop loss reinsurance was also retroceded to Cologne Dublin by Cologne Australia by an agreement made in early 2001 but effective from 1 January 2000. The premium and conditions were similar to the stop loss reinsurance except that Cologne Australia was left with $100,000 as a fee.
9. On 15 December 2000 Cologne Dublin retroceded to Zurich Insurance Company – Bermuda Branch (Zurich Switzerland (Bermuda)) what was described as Pool Z which incorporated both the loss portfolio retrocession and the stop loss retrocession. The policy commenced from 1 January 2000. Pool Z was a fund used to accumulate the premiums under both the loss transfer and the stop loss for investment by Scudder Investments Australia Limited. The pool was used to meet claims made under the loss portfolio.
10. The effect of these transactions was to move ultimate liability for the loss transfer from Zurich Australia to Zurich Switzerland through its Bermuda branch. At the same time, Zurich Switzerland assumed the rights and liabilities under the stop loss.
11. Four addenda were entered into to the stop loss by Zurich Australia and Cologne Australia. The first, made in 2001, made the agreement continuous, subject to termination on three months notice. The second (2001), third (2001) and fourth (2003) varied the minimum deposit premiums from $7.66 million to $6.75 million, $7.60 million and $12.5 million respectively.
12. There were three addenda to the stop loss retrocession. The first and second followed the first and second addenda to the stop loss. With effect from 1 January 2003 the stop loss maximum liability was varied, by the third addendum, to $50 million and the premiums altered to 1.4% for third party business and 2.8% for other business. From the same day the retrocession from Cologne Dublin to Zurich Switzerland (Bermuda) was varied to a retrocession direct to Zurich Switzerland and not the Bermuda Branch. It is not clear that this variation had anything other than accounting consequences. It may be that, in law, the same entity, Zurich Switzerland, was always the retrocessionaire.
13. Material before me is relied upon to support an allegation that it was always intended that Zurich Australia would bear the ultimate cost of the loss portfolio and that the stop loss reinsurance and retrocession was the primary means to achieve this. The triggers for the stop loss reinsurance would be unlikely to be satisfied so that the premiums would convert to profit. The circumstances surrounding this assertion are complicated and I will need to address them in detail.
14. I will call the totality of the above arrangements, “the scheme”.
The Players
15. Zurich Financial Services Australia Ltd (Zurich Financial) is the non-operating Australian holding company of a general insurance company and a life insurance company. The general insurance company is Zurich Australia. Zurich Financial is a subsidiary of Zurich Financial Services, a Swiss corporation. It is frequently referred to within the Zurich Group as “Home Office”. Other Zurich Group companies carry on insurance in Switzerland including Zurich Switzerland. In these reasons, unless distinction is necessary, I will refer to Zurich Australia and the general insurance arm of Zurich Financial almost interchangeably. This seems to reflect the way the two companies were treated within the Zurich Group. There seems also to be a similar lack of distinction in the evidence between Zurich Switzerland and Zurich Home Office.
16. John Leonard Butler was an employee of Zurich Australia and Zurich Financial throughout the period covered by the transactions described above. He was an accountant with substantial audit experience, including in the insurance industry. At first Mr Butler was the Chief Financial Officer reporting to the Chief Executive Officer. He was General Manager, General Insurance and Head of Production from November 1999 to October 2001 and Chief Operating Officer for both companies from October 2001 to March 2002. He became Chief Executive Officer of both companies in March 2002 and held that position until his resignation in July 2004. He was located in Australia.
17. Alan Parsonson was an employee of Zurich Switzerland. Until October 2000 he was Regional Manager, Asia/Pacific. From November 2000 to October 2001 he was Strategic Performance Manager. From November 2001 to August 2003 he had a diverse role which still involved management of the Asia/Pacific Region. Until November 2001 he was a director of Zurich Australia.
18. The Australian Prudential Regulation Authority has disqualified both persons from being or acting “as a director or senior manager of a general insurer (other than a foreign general insurer), or a senior manager, or agent in Australia… of a foreign general insurer, or a director or senior manager of an authorised NOHC [Non Operating Holding Company]”. It did so pursuant to s 25A of the Insurance Act 1973 (Cth) as it was in February 2007. That authorised APRA to “disqualify a person if it is satisfied that the person is not a fit and proper person to be or to act as someone referred to in” provisions of the Act identifying, amongst other roles, the positions which Messrs Butler and Parsonson have been disqualified from holding. Messrs Butler and Parsonson unsuccessfully sought internal review of the decisions. They now seek review of the decisions in this Tribunal.
The Task
19. In these applications I must:
(i)analyse and assess the transactions described above in the context in which they were executed;
(ii)determine what involvement the applicants severally had in devising, implementing and using the transactions;
(iii)determine whether that involvement, in the context of their general character and conduct, renders them not to be fit and proper persons to be or act as directors or senior managers in the insurance industry as described in more detail above; and
(iv)determine, in the exercise of my discretion, whether they should be disqualified.
20. When these proceedings were commenced there were two other applicants, Florian Salzgeber and Malcolm Jones, seeking review of similar disqualifications. Because there were common issues of fact in each matter the Tribunal determined to hear the matters concurrently. All parties adduced evidence relevant to the common issues and also adduced evidence relating to individual applicants. In the case of the applicants, the evidence they adduced relating to the conduct of individuals was concentrated on their own conduct. During the currency of the hearings the applicants Salzgeber and Jones came to an accommodation with APRA and the proceedings relating to them came to an end. That left the proceedings brought by Messrs Butler and Parsonson. After the other applicants’ proceedings came to an end evidence was given by Messrs Salzgeber and Jones, at the request of APRA, in the remaining proceedings. All representatives were permitted to cross-examine all witnesses called on behalf of all parties.
Summary Analysis
21. The nub of APRA’s case is that the transactions under consideration were not true insurance transactions. They were motivated by a desire to remove liabilities from a balance sheet. They achieved that goal, it is said, without any real change in the circumstances of Zurich Australia. The transactions were carried out in circumstances in which it was always intended that Zurich Australia would bear the ultimate cost of the loss portfolio. The circumstances surrounding this claim will need to be carefully considered. Zurich Group companies, through their employees, were involved in this conduct, it is said, and, in effect, relied upon it to support a misleading balance sheet generally and, in particular, to mislead Zurich Australia’s board, PricewaterhouseCoopers, APRA and Standard & Poors. Fit and proper employees would not engage in this conduct and the involvement of the applicants was sufficient to require their disqualification.
22. Against these claims the applicants draw attention to the fact that insurance is concerned with contractual relations. They say that the loss portfolio reinsurance was valid reinsurance which transferred risk from Zurich Australia and passed ultimate liability for the loss portfolio to GCR. The balance sheet entries were correct and no one was misled. They go further and say that the transactions were of a kind APRA would have approved. They accept that there is some material which anticipated that Zurich Australia would accept ultimate liability, but they say that this was merely an expectation, and nor an obligation, and would have yielded to adverse developments within Zurich Australia. They say that legal liability was at all times removed from Zurich Australia even if it ultimately rested with Zurich Switzerland. The applicants also challenge the degree of knowledge which APRA says they had, particularly of any proposal for Zurich Australia ultimately to bear the loss.
Summary Conclusion
23. This is a very complicated matter. It will require careful analysis of the facts and arguments. However, I can say here that my review of the evidence and the submissions has caused me to conclude that the applicants are not fit and proper to hold the offices under consideration. They should be disqualified. I have come to these conclusions from an assessment of the facts at two levels. First, I consider that the whole transaction, driven, as it was, by a purpose of fixing Zurich Australia’s balance sheet, was a transaction which called for people in the position of the applicants to be extra vigilant to be satisfied that it was proper. Even if there was a transfer of risk, the purpose remains one of correcting a balance sheet. I consider that the proposal called for significant disclosure to the board, Pricewaterhouse and APRA, as well as Standard & Poors. This is not a case in which it was sufficient for those involved to form, on balance, their own view on propriety, and act on it, without first discussing it fully with the very persons whose role it was to act as policy maker, auditor, regulator and financial assessor. Secondly, I consider that careful assessment of the conduct of the transactions, of the details of the discussions and meetings, of the details of the correspondence and emails, confirms the impropriety of what was done. The applicants’ involvement was such as to attract a sufficient level of impropriety to warrant disqualification. Their otherwise distinguished careers and reputation do not sufficiently redeem them, particularly in the circumstances that they continue to maintain the propriety of their conduct although accepting that, with hindsight, it might have been done differently.
24. It was urged upon me that the case against the applicants was based on hindsight, using the standards of commercial propriety which might today apply, after the collapse of the HIH Insurance Group, without recognising that the transactions took place at an earlier time, when standards were different. I do not agree. I do not consider that the standards which applied to the conduct I am dealing with are ephemeral. I think greater disclosure was called for at the time, just as much as it would be now. Indeed, I think that it is the applicants’ argument that depends on hindsight, or perhaps a microscopic reconstruction of the transactions, while an overview of the transactions, the way they were developed and the purposes by which those involved were motivated, shows their commercial immorality. By analysing the detail, the brushstrokes, of the individual transactions, and pronouncing each aspect and each contract, or each brushstroke, to be justifiable, and not without precedent, the applicants’ miss the whole canvas. It is the whole canvas, and not the sum of the brushstrokes, which matters.
The Scheme Through Some Critical Documents
25. The first step towards assessing the propriety of the transactions and the involvement of Messrs Butler and Parsonson in them is an examination of the objective record of the events surrounding the transactions with particular emphasis on their involvement.
26. Early in 2000 Zurich Australia needed further capital. There was a concern it would not comply with its solvency obligations. APRA had tentatively refused to approve its reinsurance proposals. These could be varied, but the whole problem could be avoided by an injection of further capital. Zurich Australia also needed further capital to embark upon a business program it wished to implement.
27. On 22 February Peter McCarthy, the head of underwriting in the general insurance division of Zurich Australia and Richard Mayo, actuarial and reinsurance manager of Zurich Australia, met Tore Ellingsen, John Byrne and other representatives of the Cologne Group to discuss a possible reinsurance solution. A further meeting took place the following day.
28. On 24 February Mr McCarthy sent an email to John Stanbridge, the Chief Financial Officer of Zurich Australia, with a copy to John Butler headed “GCR and the Objectives”. It cited “two main objectives”:
“utilise our tax losses
cap our reserves (and therefore future losses) on the ZIA [Zurich Australia] liability portfolio for accidents up to December 1999 or better still transfer the whole risk of the portfolio off our balance sheet”.
The email noted what “these two will enable us to achieve:”
“improve our capital position – increased $ solvency (i.e. increase net assets).
reduce the required minimum statutory solvency (by doing 2).
increase possible profits in 2000.”
The author invited recipients to “agree with the above objectives?”
29. On 30 March 2000 Mr Mayo sent an email to Mr McCarthy describing progress on the proposal. A copy was sent to Mr Butler. It described “the problem… as follows:”
“• Zurich currently holds $247m in Outstanding Claims Provisions (undiscounted, before prudential margins) for ZIA liability and $215m after discounting and prudential margins. While the prudential margin is sizeable, there is a good chance that it may prove to be inadequate in the long term, possibly significantly so. Therefore, it may be desireable (sic) to purchase some kind of cap on this potential.
•Zurich currently holds around $100m, of tax losses which are not on the balance sheet. It is desireable (sic) that these be used up as soon as possible.
•Zurich needs additional capital in the next few years in order to provide a prudent level of solvency, and to fund the change program. Our target level of capital is about $62m more than we have now.
•It would be very beneficial if we could improve our results this year and manage them in to the future (without ‘adjusting’ our reserves).”
It described “the gist” of the GCR solution in two scenarios. Dealing with the second scenario, it said:
“• This can be extended to being a full Loss Portfolio Transfer (Scenario 2).
In this case the entire portfolio of $270m is transferred to GCRA, at a premium of $150m. The premium goes into an experience account on which interest is earned. Claims are paid from the experience account. GCRA protects the experience account by buying an Adverse Loss Development cover of, say, $110m excess of $160m from CRD [Cologne Dublin] who in turn buy a similar cover from a Zurich Group company.”
In the email Mr Mayo made the following comment on the proposals:
“In all these scenarios, there is basically no risk transfer outside the Zurich group. The losses are moved from us to a company within the group that either has a more favourable tax environment, or is making excess profits and can afford the loss.”
He described one of the issues as:
“• How much are we prepared to pay for genuine risk transfer, if we want it?”
30. This email was forwarded by Mr Mayo to Robert Stevenson, who was head of group reinsurance within the Zurich Group. He was based in Zurich. Mr Stanbridge was proposing to visit Zurich and wished to discuss the proposal.
31. On 3 April 2000 a meeting took place between Messrs Mayo, McCarthy, Stanbridge and Butler. Mr Mayo summarised the meeting in an email of the same date, headed “GCR deal”, to Messrs Butler, McCarthy and Salzgeber:
“It was agreed at today’s meeting to go ahead with the discussions with GCR. Our primary objective will be to increase our capital by as much as is feasible in 2000 (about $150m) while at the same time limiting our potential losses from ZIA liability runoff. The Loss Portfolio Transfer option is considered the best option.”
32. On 27 April Christopher Grohe, who worked for Mr Stevenson in Zurich, sent an email to Mr Mayo headed “GCR deal”. Copies were forwarded to Mr Stevenson and Mr Parsonson. This is the first relevant email received by Mr Parsonson. The email says:
“We would appreciate if you could keep us informed on your discussions with GCR next week and take it that we will receive a proposal for the whole transaction from Z – Australia in good time for final approval.”
33. On 28 April Mr Grohe forwarded to Mr Parsonson a string of email correspondence including Mr Mayo’s email of 30 March. Mr Parsonson attached this string to an email to Mr Jones dated 8 May headed “GCR Proposal”. The email proposed “an open dialogue between all 3 parties (G&C, ZRe, ZA) with ZRe [in] a consulting role”. It referred to a potential need to “free up solvency at short notice”. This email and the string was forwarded to Mr Butler on 9 May.
34. It follows that by this time both Mr Butler and Mr Parsonson had been informed of the proposed “GCR deal” and had received Mr Mayo’s email of 30 March. Indeed, Mr Butler had been sent it on two occasions.
35. On 11 May Mr Butler responded to the 9 May email querying the involvement of Zurich Re. The email referred to “the risk transfer/balance sheet restructuring that we have been evaluating”.
36. On 18 May Mr Butler received an email sent by Mr McCarthy which referred to the fact that “Bob [Stevenson] does not what (sic) the risk to end up in Home Office R/I”. On the same day Mr Butler received an email from Mr McCarthy the purport of which was that Zurich Australia would not need stop loss reinsurance if the loss transfer went forward “(ie we will not get anywhere near the loss ratio when [the] stop loss kicks in unless the whole world falls in)… Even if we have a few cat[astrophie]s we will not get any where near the loss ratio trigger”. Another email of the same date, also received by Mr Butler, says: “Alan Parsonson has been in discussions with Ralf Juergens about Stop Loss”.
37. On 31 May Mr Mayo signed a letter from Zurich Financial to APRA enclosing “a copy of the placing slip for a reinsurance contract entered into with General & Cologne Reinsurance Australasia Limited with effect from 1st January 2000”. The document enclosed was a draft of the loss transfer in a different form to the agreement as subsequently signed. The transfer had not, at the time, been approved by Zurich Switzerland. No reference was made to any further transactions or retrocessions. The reinsurance, as outlined, was subsequently approved by APRA.
38. Also on 31 May Mr Stevenson sent an email, copied to Mr Parsonson. The email included the following reference to the loss transfer:
“We all know that the G&C Re pricing is under Burning Cost. G&D (sic) Re know that as does Australia. It has been made equally clear that we will not subsidize Australia, either directly or indirectly. The ultimate performance of this contract is their responsibility. What we will do is help give them time to breath (sic), although again the economics have to work. For Australia they will essentially be funding the performance of this cover from future earnings. The presence of this cover, at whatever pricing is agreed, is intended to improve their Solvency Surplus with immediate effect, a financial pre-requisite for the potential success of their future financial strategy. However we construct it, Z – Aus own the responsibility for the performance of this cover.”
39. Another email to Mr Stevenson in the string which includes this email confirms the evident meaning of “Burning Cost”: “The scenarios given by Z Australia and also the LPT [loss transfer] structure from G & C Re use far too low premiums (below BC)”. The email describes the loss transfer as “a guaranteed looser” (sic).
40. On 5 June Mr Stevenson informed Mr Parsonson of a meeting with Mr Ellingsen in the following words:
“I believe I gave him and his colleagues a clear picture of our expectations. Any arrangement is to be self-standing, there is to be no subsidy of Australia, either directly or indirectly although we would provide speed of settlement cover to facilitate the closing of the transaction. Any deficit incurred by the reinsurer under this cover is the responsibility of Z-A for repayment, ideally from future earnings. In effect this transaction gives them time, time to improve the solvency margin, time to return to profitability and time to repay their debts, it does not exonerate them from repayment. This has been made very clear and is understood.”
The email referred to “the price” of the loss transfer as “driven by the desired Solvency margin”.
41. Emails from around this time suggest that Mr Parsonson was taking a considerable interest in the proposal. He discussed the proposal with Mr Stevenson. He prepared a spreadsheet exploring the issue.
42. On 20 June 2000 Mr Stevenson sent Mr Parsonson an email which included the following: “The open question for me at the moment is a) the final shape and structure of both steps LPT and the ‘Governance’ Stop Loss…”. This appears to be the first reference to the involvement of stop loss reinsurance. There had been a governance stop loss previously in place with Zurich Switzerland.
43. In late June, Mr Parsonson and Mr Stevenson came to Sydney. The proposal was discussed in meetings they attended. On 27 June, there was a meeting between representatives of Zurich Australia, including Messrs Parsonson and Stevenson, and the Cologne Group. Broad agreement was reached although some details were finalised in the following days. It is unlikely that stop loss reinsurance was discussed.
44. On 28 June Mr Ellingsen circulated an email within the Cologne Group he headed “SWISS CHAMPAGNE”. The email suggests agreement had been reached. It refers to agreed “pricing” of $3.5 million.
45. On 30 June Mr Ellingsen sent an email to Messrs Parsonson and Stevenson. The email refers to two legs. The email includes the following:
“Further to this, you can expect to receive a full wording from John and myself for Leg 2, Tuesday morning (July 4) Zürich time.
We would appreciate if you can support us with the name of the reinsurer who will back up this leg, and communicate any suggetions (sic) for change asap thereafter.
The idea is to have leg 2 signed by the end of next week, this will put us in the position to have Leg 1 in place at the same time.
John and myself will make sure that all documentation from our side will be finished before we leave AU.”
It is apparent that leg 1 is the loss transfer and leg 2 is the passing of the risk of this transfer from GCR. Leg 1 is effectively made contingent on leg 2.
46. An attachment to this email describes the whole transaction:
“1.Zurich Australia buys a reinsurance cover of A$254m x/s A$10m for a premium of A$137.75m from GeneralCologne Re in respect of its corporate liability.
2.The reinsurance cover also provides Zurich with 2 mutually exclusive options to provide flexibility in the event that the book develops adversely- firstly to purchase an extra A$60m excess of A$264m for a premium of A$15m or alternatively to purchase an extra A$30m excess of A$264m for a premium of A$10m. This option expires on 30 June 2003.
3.After payment of the premium to GeneralCologne Re, GeneralCologne Re will enter into an investment management agreement with Scudder to manage this fund. Zurich will determine the investment benchmarks for the fund.
4.Claims payments will be met from the fund every 6 months.
5.Based on the expected payout pattern of the claims and a return of 7% per annum, it is expected that the fund will have a shortfall of A$XXm. This shortfall is expected to occur in 2005.
6.GeneralCologneRe will secure its position with a retrocession A.N. Other Reinsurer. In the interim, Zurich Australia will fund this shortfall by purchasing an out of the money stop loss cover from Home Office. This surplus premium plus related investment income will be used to fund and meet any shortfall on the run off of the corporate liability book.”
Point 6 anticipates both the retrocession and the funding of any short fall through stop loss cover, describing it as an interim means to protect GCR from risk, at the cost of Zurich Australia.
47. The proposal was required to be approved by Zurich Switzerland. The person with authority to make the ultimate decision was Frank Schnewlin, an executive board member of the Zurich Group. Mr Schnewlin approved the proposal early in July. It was Mr Parsonson who sought and received the approval by Mr Schnewlin.
48. On 4 July Mr Stanbridge sent an email to Mr Parsonson. It stated that when telephoning Standard & Poors to inform them of the loss transfer, Standard & Poors disclosed that it was proposing to downgrade Zurich Australia from A+ to BBB+ which was a downgrading of three notches. Mr Stanbridge indicated that Zurich Australia would rely on the loss portfolio transfer to see if this decision could be reversed.
49. On 5 July Mr Parsonson sent an email to Mr Salzgeber with a copy to Mr Stanbridge. This was in reply to an email from Mr Salzgeber relating to the audit of Zurich Australia and to a conversation he had had with Richard Deutsch, the lead audit partner at Pricewaterhouse who handled the Zurich Australia account. Mr Salzgeber expressed the view that the whole profit from the loss transfer could be brought to account in 2000. He enquired whether Mr Parsonson supported this view. The reply included a statement “that this reinsurance deal would pass the transfer of risk test and so it would be possible both in statutory and IAS [International Accounting Standards] to take credit for the reinsurance premium and claims transfer in 2000 rather than to defer these…” Mr Parsonson added the caveat that “I AM NOT AN ACCOUNTANT AND SO I COULD BE SEVERELY CHALLENGED ON ALL OF THIS!”.
50. On 6 July Mr Parsonson sent an email to Mr Jones and Mr Stanbridge. A copy was sent to Mr Butler. The email followed a meeting between Mr Parsonson and Mr Schnewlin. The email contained the following:
“1. General & Cologne Loss Portfolio Transfer
Frank has agreed to this proceeding – albeit that he would prefer for the deal to be executed with an initial single premium sufficient to cover the full claims trail and payment of an ADC [Adverse Development Cover] premium. From my discussions he appreciated the need to optimise the approach in order that enough Solvency could be released from the exercise.
He would like to ensure that the final deal allows us to fund the “Gap Claims” through the payment at any time of a further single premium to top up the accumulated additional Stop Loss premiums. From my knowledge of the deal, I did not think that this would cause any problems.
I have had Bob Stevenson confirm that the deal would pass the Risk Transfer test and so, I assume, that the deal will be reflected in IAS reporting as a full reinsurance treaty.”
On 9 July Mr Butler forwarded this email to Mr McCarthy.
51. On 7 July Mr Deutsch sent an email to Mr Salzgeber. The email required assurances relating to the loss transfer. They were ultimately given in a slightly different form.
52. On 4 July Mr Stevenson had sent an email concerning the Stop Loss to Mr Mayo saying that he “would prefer to see some additional premium being paid now because of how we will route the Stop Loss”. Mr Mayo replied the same day:
“Following discussions with John Butler and Peter McCarthy, we would like to propose that, while we realise that the Stop Loss needs an increased premium to fund the payback we would like to defer this increase to 2002. We are happy to pay the expiring rate for 2000 and 2001.”
The “expiring rate” was the last rate under the prior stop loss with Zurich Switzerland. A reply on the same day indicated Mr Stevenson’s preference “to see some additional premium being paid now because of how we will route the Stop Loss”. These two emails were forwarded to Mr Butler on 7 July. Mr Mayo followed this up with Mr Butler on 13 July who replied on 16 July. There were further emails on the topic of whether an increased premium should be paid on the stop loss immediately. Both Mr Parsonson and Mr Butler received copies of two relevant emails of 17 July and 18 July respectively. On the same day a copy of the draft agreement virtually in its final form was emailed to Mr Parsonson.
53. On 20 July Mr Stanbridge wrote to Standard & Poors describing the loss transfer. No mention was made of any proposal for its retrocession, nor was there any mention of the proposed stop loss reinsurance.
54. On 31 July Mr Parsonson sent an email to Mr Stevenson seeking his approval to finalise the loss transfer. Mr Stevenson replied the same day saying he could see “no reason why the contract with GCR cannot be signed”.
55. On 4 August Mr Salzgeber sent an email to Mr Butler concerning the investment strategy to be employed for the funds provided by the premium for the loss portfolio transfer.
56. Zurich Australia made the representations sought by Pricewaterhouse on 14 August in a letter signed by Messrs Jones and Stanbridge. The representations were as follows:
“Reinsurance contract with General & Cologne Re. Australia Limited (‘GCRA’)
Specifically in relation to the non-life reinsurance contract with GCRA entered into during July 2000 (“the transaction”) we represent:
·that the Zurich Financial Services Australia Limited group has not entered into any associated or related contracts to the transaction with GCRA;
·that the Zurich Financial Services Australia Limited group will not receive any recharges of other expenses from other Zurich Financial Services group companies related to this transaction or any related transaction;
·that there is no present commitment or intention to mutually terminate the contract with GCRA on terms which would negate the benefit of the contract to the Zurich Financial Services Australia Limited group;
·that there is no present commitment or intention to mutually terminate the contract with GCRA, and enter into another transaction with GCRA on different terms which in substance would have the effect of negating the benefit of the contract to the Zurich Financial Services Australia Limited group;
·that the Zurich Financial Services Australia Limited group has received clearance from APRA that its approval given in a letter dated 27 June 2000 remains valid following management explaining the incorrect information provided to APRA in the letter dated 31 May 2000; and,
·that all documentation pertaining to the proposed transaction with GCRA has been provided to you.”
57. On 22 August Mr Parsonson sent an email to Mr Stevenson stating that it was imperative that the loss transfer “can satisfy the Risk Transfer test”. He went on to say “if there is an element of the deal which has circularity back to GHO this will not be the case and would not release the full solvency in the current year and, hence, would not permit the funding of the strategy spend as envisaged”. Mr Stevenson responded the same day with an email containing the following:
“General Cologne Re in Australia is not retroceding the same risk as they are assuming from Z-Australia. The exposure they are reinsuring can essentially be characterized as timing risk. However, if we want to make this more opaque, the (sic) what we should do is establish “Portfolio Z” with General Cologne Re Australia. Portfolio Z will consist of several transactions, including for 2000 at least a share of the current Stop Loss, and for the future, shares of Z-Australia treaties with low frequency potential (Property Cat) that would otherwise have been ceded into the open reinsurance markets. Portfolio Z will ultimately be self-supporting, in that premium flows from future contracts will offset any losses incurred under the LPT (in theory). We would provide protection to General Cologne Re based on the exposure they have under Portfolio Z. This exposure will essentially be a combination of actual risk exposure and timing risk, but it can be demonstrated that it does not apply specially to the LPT.”
This proposal was subject to further consideration in an exchange of emails involving Mr Parsonson on 28 August.
58. On 28 September Pricewaterhouse wrote to Mr Stanbridge at Zurich Financial concurring “with management’s view that for local statutory reporting purposes any gain arising on entering the transaction with GCRA can be taken to income up front in the year ended 31 December 2000”. The transaction referred to was described in the letter and did not involve any proposal other than the loss transfer.
59. On 5 September Mr Stevenson sent an internal email which was copied to Mr Parsonson relating to “Z-Australia Stop Loss”. It contained the following:
“I have strongly suggested that the ZIC share should in fact be ceded to GCR Australia, if they can handle it and used to immediately start to offset the LPT.”
60. On 12 September Mr Parsonson sent an email to Mr Stevenson asking this question:
“Do I understand that the proposed Stop Loss of 1% compulsory + 2% is to cover both governance AND 2nd leg??”
Mr Stevenson replied the same day:
“That was my original plan… I thought we had gained a fundamental agreement from all parties that if we routed the premium through the same channel as the LPT, the standard rate level, 1%, would flow through to CRM [Corporate Risk Management] and the “excess” would serve to fund a little of the gap.”
61. The issue of the additional stop loss premium, which was raised in July, had apparently not been decided by the beginning of October. On 3 October 2000 Mr Stevenson sent an email to Mr Mayo with copies to both Messrs Butler and Parsonson headed “Governance Stop Loss”. The email was in the following form:
“We do not consider that we have had a definite response from Z-A on this subject. Our firm proposal remains to increase the premium payable and modify the attachment point under the Stop Loss to the levels previously discussed (and included within draft contract language). We really need to start Z-A to start the process of closing the gap in the LPT arrangement with GCR this year. I’d prefer not to put the mechanics of the process in writing at this time, but will walk Alan Parsonson through it so that he can add his blessing to the proposal.”
Mr Parsonson responded to the email, suggesting further discussion, the same day.
62. On 30 October Ralf Juergens, from Zurich Switzerland, sent an email to Mr Mayo and others, with a copy to Mr Parsonson, as follows:
“…[P]lease go ahead and prepear (sic) the Stop Loss contract for 100% share between Zurich Australia and GCRA and the retrocession between GCRA and ZIBB [Zurich Insurance Bermuda Branch] at terms agreed.”
63. On 17 February 2001 Mr Butler sent an email to a number of persons in Zurich Australia. Attached was a document which Mr Butler stated in the email he had received. An entry against “GHO Stop Loss Premium” in this attachment directed attention to note (d) which was as follows:
“Stop Loss premium increased from 1.5% per budget to 2% of GNPI, this increase is directly related to LPT. The total of 7.8m stop loss is now set aside for LPT therefore budget of 5.8 is assumed when calculating the net impact of stop loss transfer. The original stop loss budget of 5.8m was consistant (sic) with 1999 rates and agreed to GHO.”
64. On 2 April 2001 Mr Salzgeber prepared a memorandum on Zurich Financial headed paper addressed to Messrs Jones, Butler and Stanbridge. The copy in evidence is not signed. Mr Stanbridge and Mr Jones gave evidence that they received it. Mr Butler denied receiving the document. I am satisfied that Mr Butler did see the document. I accept Mr Salzgeber’s evidence that he remembers dispatching it to Mr Butler. The memorandum contains the following paragraph:
“As you are aware, the premium we paid GCR for the transfer of our ex-ZIA portfolio will not suffice to cover all the liabilities transferred. The gap is about $67m. We will accumulate a fund in Dublin for GCR to be in a position to keep paying our claims once the premium we paid them last year has been used up. That wan’t (sic) be the case for 5 to 6 years.”
The memorandum concluded with the following paragraph:
“If you agree with the strategy proposed above, please sign of (sic) on this letter and send it back to me or give me a ring. Please do not keep any files on this.”
65. On 27 February 2002 Mr Parsonson sent Mr Stevenson an email including the following:
“The initial premium was A$137.50 of which 3.5m. was in respect of GCRA’s fee.
Since then Australia have paid A$87,374,876 in 2000 and A$7,965,710 as Stop Loss premiums in 2000 and 2001, respectively. Of these amounts GCRA have forwarded A$3.25m. in 2000 and A$3.00m. in 2001 in respect of Governance Stop Loss. Their net retained Contribution over the 2 years is A$9.091m. compared to the A$7.23m. which they have reported as retained by them.
I am unaware of the Scudder performance and have to take their word for it.”
The email concluded with reference to two “areas of concern”:
“1. The amount withheld by GCRA, and
2.The need to review the Stop Loss premiums given the acceleration of claims payments.”
66. On 11 March 2002, after the disclosures of the HIH Royal Commission, APRA wrote to Zurich Australia seeking reassurances as part of a process of reauthorising each insurer. The letter sought information relating to alternative risk transfer (ART) arrangements:
“We are now seeking additional information on financial reinsurance or ART contracts where the financial and strategic motivations of the reinsured take precedence over the risk transfer needs. In particular, we are interested in contracts that:
·impose an obligation on the insurer to repay the reinsurer even if the insurer were to cease business (ie enter into insolvency or liquidation).
·involve a high ratio of premium to maximum potential recovery – that is, a ratio of 65 per cent or greater; and/or
·are subject to unusual conditions or other restrictions that limit the reinsurer’s liability.”
Zurich Australia replied with a letter dated 26 April 2002 signed by the Chairman and Mr Butler. The letter contained the following:
“• The Approved Actuary and the Approved Auditor have been given unfettered access to all information concerning Zurich Australian Insurance Limited’s (ZAIL’s) reinsurance arrangements; and
•ZAIL has no contracts that fall into the three categories described in the request.
The company has in place a loss portfolio transfer contract which was entered into in 2000. It was reviewed and approved by APRA at the time. In the interests of good disclosure, we have included a summary of the principal details as an attachment.”
The summary of the loss transfer made no mention of its retrocession or of the stop loss reinsurance.
67. Further representations were made to Pricewaterhouse in a letter dated 22 March 2002. This time the letter was signed by Mr Butler as a director. It included the following representations:
“In relation to non-life outwards reinsurance contracts in force at any time during the year ended 31 December 2001 we represent that:
·the complete contracts have been made available to you (including any revisions to original contracts);
·there are no associated or related contracts or side agreements to these contracts;
·that the Zurich Financial Services Australia Limited group will not receive any recharges of other expenses from other Zurich Financial Services group companies related to these contracts or any related contracts, other than the normal charges related to being part of the Zurich Financial Services group (these charges do not negate or effect the reinsurance contracts in any way);
·that there is no present commitment or intention to mutually terminate any of these contracts on terms which would negate the benefit of the contracts to the Zurich Financial Services Australia Limited group;
·that there is no present commitment or intention to mutually terminate any of these contracts and enter into other transactions on different terms which in substance would have the effect of negating the benefit of the existing contracts to the Zurich Financial Services Australia limited group;
·all contracts have operated as expected throughout the year and all payments to the Zurich Financial Services Australia Limited group required under the contracts have been made on a timely basis.”
68. Similar representations were made in a letter dated 19 March 2003 relating to the year ended 31 December 2002. The letter was again signed by Mr Butler.
A Simple Analysis
69. In the material before me the transactions are variously, and confusingly, described as having two or three parts. As the case before me has proceeded there are claimed to be three parts. This is how I propose to deal with the transactions. The three parts are as follows:
Part 1:The reinsurance of the loss portfolio by GCR for an uncommercial premium.
Part 2:The retroceding of the risk of that reinsurance ultimately to a Zurich company.
Part 3:The taking of steps by Zurich Australia to assume responsibility for the shortfall between the reduced premium passed on to the Zurich retrocessionaire and the claims paid.
As the matter proceeded before me it became clear that the applicants did not challenge the correctness of asserting a series of dealings satisfying these descriptions. The real issues lay, first, in whether Part 3 had a sufficient level of obligation to affect the validity of Part 1 as risk transferring reinsurance and, secondly, in what involvement the applicants had in the matter.
70. Notwithstanding the absence of any real issue as to whether there was a transaction with three parts it is nevertheless necessary to examine with care the documentary and other evidence on the topic and to form a view about them. This is because the real question relates to knowledge and motives as revealed by the documents as much as it relates to the legal effects of the documents. However, in assessing these matters an important starting point is the objectively ascertainable material contained in contemporaneous documents the authenticity of which is not in doubt.
71. Assuming for the moment that the applicants at least read emails sent to them, even though they may not now recollect reading individual emails, the objective material set out above shows that the dealings incorporated each of the three parts and that the applicants not only were aware of them but were knowingly concerned in achieving them.
72. From the time he saw the 30 March email Mr Parsonson was aware that there “was no risk transfer outside the Zurich Group”. On 5 June he was informed “there is to be no subsidy of Australia” and that “any deficit… is the responsibility of Z – A for repayment”. On 31 May, when he was informed that the loss transfer “pricing is under Burning Cost”, he was also told that “Z – Aus own the responsibility for the performance of this cover”. He learned that the stop loss was to be a vehicle on 20 June and more clearly on 30 June when he read: “Zurich Australia will fund this shortfall by purchasing an out of the money stop loss cover from Home Office”. On 6 July he learned that Mr Schnewlin wanted “to ensure that the final deal allows us to fund the “Gap Claims” through the payment at any time of a further single premium, to top up the accumulated additional Stop Loss premiums”. He was even privy to a proposal to increase premiums under the stop loss before the end of 2000. On 3 October he received an email relating to the “Governance Stop Loss” asserting that “We really need to start Z – A to start (sic) the process of closing the gap in the LPT arrangement with GCR this year”.
73. At the latest Mr Butler learned of the broad proposal from an email on 24 February 2000. On 30 March he learned that a favoured proposal would transfer the entire portfolio to GCR and that risk would be protected by GCR purchasing adverse development cover which would be matched by “similar cover from a Zurich Group company”. The author concluded that “there is basically no risk transfer outside the Zurich group”. Mr Butler received an email of 4 July stating that “the Stop Loss needs an increased premium to fund the payback…”. He received the 6 July email on the same topic as well as the email of 3 October.
74. The emails suggest that neither Mr Butler nor Mr Parsonson were interested bystanders. They suggest that they were concerned with the developing and implementing of the transactions for the purpose of holding Zurich Australia out as having an improved balance sheet. The detail of the transactions as finalised was not identical to the proposals originally being considered, but the substance did not change. It is the broad proposal which concerns me, not the minutiae of how it was achieved. As will appear, I find that both Mr Butler and Mr Parsonson read and understood all the emails sent to them. I find that they were aware of all three parts of the scheme.
75. Objective evidence, such as the emails, is usually the most reliable evidence in discovering the facts surrounding commercial transactions and the relatively few documents to which I have referred may alone give a sufficient picture to fairly and finally determine this case. That is not, however, the way the case proceeded.
The Case As Presented
76. The Tribunal was furnished with documents filling nearly 40 leaver arch files. These included multiple copies of many documents. The Tribunal heard evidence from 17 witnesses. The hearing occupied 25 days. The fact that originally there were four applicants had its affect on the length of the proceedings. However, 25 hearing days, with a transcript covering 1,998 pages, and nearly 40 folders of documents seems disproportionate. This Tribunal has a statutory obligation to be “economical, informal and quick” in addition to “fair [and] just” (Administrative Appeals Tribunal Act 1975 (Cth) (s 2A)). It has an obligation to conduct proceedings “with as little formality and technicality, and with as much expedition”, as the case permits (s 33(1)). It will be necessary in the future, in similar cases, to bear these statutory obligations squarely in mind. Directions will need to be given which ensure that any hearing is limited to sufficient significant matters to enable a proper determination to be reached without extending to detailed analysis of peripheral matters as was the case here. Administrative decision-making, which is what the Tribunal is engaged in, needs to be proportionate.
77. The Tribunal has a wealth of material before it. This includes the evidence of the applicants. Inevitably, I have had in mind my assessment of this evidence in all that I have said so far, but it now falls to me to address that material directly.
The Witnesses
78. The following witnesses gave oral evidence, for the parties indicated:
APRA
Richard Mayo, Actuarial and Reinsurance Manager of Zurich Australia.
John Stanbridge, Contractor assisting Chief Financial Officer and later CFO of Zurich Australia.
Warwick Churche, Zurich Switzerland Regional CFO for Asia/Pacific from early 2001.
Richard Deutsch, Lead Audit Partner for Zurich Australia from Pricewaterhouse Coopers
Ian Hammond, Audit Review Partner for Zurich Australia from Pricewaterhouse Coopers.
Thomas Karp, Executive General Manager of the Diversified Institutions Division of APRA.
Nancy Milne, Non-Executive Director and later Chairman of Zurich Australia and Zurich Financial.
John Byrne, Underwriter with and later Chief Executive Officer of Cologne Dublin.
Malcolm Jones, CEO of Zurich Australia and Zurich Financial until March 2002.
Florian Salzgeber, Manager, Capital Management of Zurich Australia and Zurich Financial.
Alan Parsonson
Alan Parsonson, Zurich Switzerland Regional Manager Asia/Pacific, later holding other positions.
Eric Chalmers, Former Assistant Commissioner, General Insurance of Insurance and Superannuation Commission.
Gregory Taylor, Consulting Actuary.
John Butler
John Butler, CFO and later CEO of Zurich Australia and Zurich Financial.
Peter Standish, Chartered Accountant specialising in insurance.
Cathy Manolios, General Counsel of Zurich Australia and Zurich Financial from April 2002.
APRA
Nicholas Hullah, Chartered Accountant and Auditor.
APRA’s Evidence
79. APRA called evidence from a range of witnesses, primarily employees of Zurich Australia during material periods. Their evidence was very extensive and took up a great deal of time. Mr Stanbridge, for example, gave oral evidence in chief over more than two days. The bulk of this evidence involved the identification of documents not in issue. The evidence he gave about discussions was limited. He was cross-examined, including cross-examination on behalf of Messrs Jones and Salzgeber, who were still actively involved in the proceedings at the time, for most of a day. I did not find this evidence particularly assisted me in my task. I will, however, refer to some parts of it. There were other witnesses whose evidence also did not assist me. I will not, accordingly, expand these reasons by reference to evidence which did not assist me in any particular manner, but I will refer to some pertinent aspects of it.
80. Richard Mayo was employed by Zurich Financial as Actuarial and Reinsurance Manager of Zurich Australia. He was responsible for the purchase and administration of reinsurance and the annual process of valuing outstanding claims. He reported to Mr McCarthy who reported to Mr Butler. Mr Butler reported to Mr Jones who, in turn, reported to Mr Parsonson. Mr Salzgeber was head of capital and financial management and reported to Mr Stanbridge. He reported to Mr Jones. All these people were senior to Mr Mayo. Mr Mayo gave evidence about the background to, and the development of, the transactions. He did so largely by reference to contemporary documents, particularly emails. He also gave evidence about some relevant conversations he had had, particularly with Mr Butler. I accept Mr Mayo’s evidence which I have set out below.
81. Mr Mayo gave evidence about conversations with Mr Butler relating to the third part of the transactions. He said that on more than one occasion in 2002 and 2003 Mr Butler said words to the following effect to him: “any information about the Stop Loss or the second leg of the link between contracts is only to be revealed to people with my permission” and “if anybody asks questions about the retrocession of the LPT and any link with the Stop Loss refer them to me”.
82. In early July Mr Mayo was informed by Mr Stevenson that the stop loss premium would need to be increased to fund the payback. Mr Mayo spoke to Mr Butler who suggested that the increase should be deferred. Some of this is referred to in emails extracted above. It is apparent that Mr Butler was closely associated with the issue of whether a proposed increased premium for the stop loss should be delayed.
83. On 17 July Mr Mayo sent Mr Stevenson an email headed “Stop Loss”. Mr Stevenson’s reply was copied to Mr Butler. Mr Mayo says the email captures the essence of what Mr Butler had said. The email says: “His view is that it is disadvantageous to the group for us to be paying this increase in premium at a time when we are not in a tax paying position. It would be more efficient to wait a year until we are in a tax paying position, so the additional premium is deductible in Australia”.
84. In cross examination Mr Mayo accepted that he could not recollect any conversation with Mr Butler to the effect that the proposed increase in premiums was to cover the adverse claims experience of the loss transfer. This, of course, stands against emails which clearly identify this. Moreover, one asks what other understanding Mr Butler, an experienced insurance executive, had of the reason for the proposed increase?
85. John Stanbridge is a chartered accountant although he resigned his membership of the Institute of Chartered Accountants in 2008. He began working at Zurich Financial in June 1999 as assistant to Mr Butler. He became CFO in January 2000. He left Zurich Financial in November 2001.
86. Mr Stanbridge primarily reported to Mr Jones after his appointment as CFO but continued to report to Mr Butler with respect to existing business. He dealt a lot with Mr Parsonson who was his contact in Switzerland. He spoke to him frequently on the telephone.
87. Mr Stanbridge met with representatives of Cologne Group on 23 February 2000. This was one of the earliest discussions. He briefed Mr Butler on the meeting. Thereafter Mr Stanbridge was significantly involved with the proposal. His evidence, however, did not materially add to what is shown by the correspondence.
88. Warwick Churche is an actuary by training. He worked for the Zurich Group between at least 1997 and 2004. From April 2001 he was CFO of the Asia/Pacific Region. He was a director of Zurich Australia and Zurich Financial from November 2001 until June or July 2004.
89. Mr Churche gave evidence that he dealt frequently with Mr Butler and on occasion with Mr Parsonson but that he was not informed of the details of the scheme.
90. There was a good deal of accounting evidence before me. Richard Deutsch, the lead audit partner dealing with Zurich Australia, gave evidence. So did the audit review partner, Ian Hammond.
91. Messrs Deutsch and Hammond audited Zurich Australia’s 2000 accounts. They gave the accounts an unqualified audit certificate although a debt of $60 million had been removed because of the loss transfer. However, in 2004, after reviewing further material, Pricewaterhouse concluded that the 2000 accounts contained a fundamental error. The accounts for 2004 were prepared to reflect this. Essentially, Pricewaterhouse concluded that there was a “constructive obligation” on Zurich Australia to repay the shortfall and this meant that the effect of the $60 million debt should have been retained on the balance sheet.
92. Richard Deutsch was first informed about a proposed reinsurance with GCR in May 2000. This was in a conversation with Mr Stanbridge. During May Mr Deutsch saw documents describing the proposal as an “Alternative Risk Transfer Solution” and referring to Zurich Australia’s need for additional capital. This alerted him to the possibility that the proposal involved financial reinsurance. Mr Deutsch raised the question of whether there was risk transfer. Mr Deutsch had a further meeting with Mr Stanbridge on 21 June 2000. During that meeting Mr Stanbridge expressed the view that Zurich Australia would carry all of the gain from the proposed GCR transaction to account in 2000. This was inconsistent with the advice Pricewaterhouse had given up to that time. Mr Stanbridge pressed his view at a meeting on 3 July 2000.
93. At no time was Mr Deutsch informed of the stop loss contract. If he had been he would have investigated further. He raised with Mr Salzgeber the difference between what he then understood to be a premium of $124 million and cover of $254 million. In reply Mr Salzgeber referred him to Mr Byrne or Mr Ellingsen of Cologne Group. Mr Deutsch met with Mr Byrne and Mr Smith of Cologne Group. Based on what he was told Mr Deutsch says he was satisfied that there was risk transfer. Mr Deutsch made a note of the conversation in which he wrote that GCR expected to make a loss on the contract but that the deal was being “looked at in the context of the overall relationship between GCRA and Zurich globally”. He was told that Mr Parsonson and Mr Stevenson were the relevant Zurich officials Mr Byrne was aware of. Mr Byrne also suggested that there was “some fat in the prudential margin” which might also qualify the apparent difference between the premium and the cover.
94. Mr Deutsch was prepared to act on this basis, but his prior concerns caused him to require assurances from Zurich Australia. On 4 July Mr Deutsch sent an email to Mr Salzgeber, copied to Mr Butler, summarising Pricewaterhouse’s “current position in relation to the required accounting treatment… [for the] proposed contract with GCRA”. Three issues were raised. The second was Pricewaterhouse’s requirement for written representations relating to the proposed contract.
95. On 25 July 2000 Mr Deutsch sent an email to Mr Butler. He referred to a discussion “a few weeks ago” and said he “would like to come and talk (say for an hour) to you as part of our half year review…”. One of the matters he mentioned was “Accounting for GCRA contract: Home Office & local statutory reporting”. It does not seem that this meeting took place. However, it did provide Mr Butler with an opportunity to give Mr Deutsch an explanation of the transactions.
96. On 18 August 2000 Mr Deutsch attended a Zurich Financial board audit committee meeting. Mr Parsonson was present at the meeting. Mr Parsonson neither took the opportunity to discuss with him the wider scheme nor to refer at all to the stop loss. The “GCRA contract” is mentioned in the minutes of the meeting and Mr Deutsch spoke about it at the meeting. It was, however, treated by Mr Deutsch as a single transaction.
97. In February 2001 Mr Deutsch and Mr Hammond, from Pricewaterhouse, attended a meeting with Messrs Jones, Butler and Stanbridge to discuss the Zurich Australia audit for the year ended 31 December 2000. The agenda included discussion of the “GCRA contract treatment”.
98. Mr Deutsch met Mr Parsonson on more than one occasion at board audit committee meetings. He may have attended a meeting on 17 August 2001. There was discussion at the meeting of “the GCRA contract”.
99. In April 2004, an investigative section in Pricewaterhouse was engaged by some Zurich Australia directors to investigate transactions with the Cologne Re Group. As a result of this investigation Pricewaterhouse notified the board of Zurich Australia and Zurich Financial that it considered that there was a fundamental error in the Zurich Australia accounts. As lead audit partner Mr Deutsch was responsible for Zurich Australia’s accounts for 2004. These accounts recognised a fundamental error and brought to account the accumulative financial effect of the error in those accounts.
100. Ian Hammond is a chartered accountant. He has an honours degree in arts from Macquarie University. He has been a member of the Australian Accounting Standards Board where he was concerned with developing standards for the insurance industry. He has 15 years experience of auditing companies in the insurance industry. He became the review partner for Zurich Australia in Pricewaterhouse in 1999.
101. Mr Hammond knew both Mr Parsonson and Mr Warwick Churche, who was a member of the board of Zurich Financial and concerned with Zurich Switzerland’s regional management in the Asia/Pacific. He learned about the GCR transaction from Mr Deutsch in May 2000. He was never informed during this period of any stop loss.
102. During 2000 and 2001 Mr Hammond attended some board and board audit committee meetings of Zurich Financial at which Mr Parsonson was present.
103. In August 2000 he discussed the GCR transaction with Mr Parsonson in which the favourable terms to Zurich Australia of the contract were referred to. Mr Parsonson said that the global relationship between GCR and Zurich should be borne in mind. Mr Hammond attended the board audit committee meeting of 18 August 2000.
104. In June 2003 Mr Hammond had a meeting with Mr Churche in which Mr Churche informed Mr Hammond about much of the circumstances surrounding the loss transfer. He was informed about the stop loss, although not about any direct relationship between the stop loss and the loss transfer. Mr Hammond was concerned to know, and was informed, that the stop loss premiums were commercial. He did this to satisfy himself that the risk was not being transferred back to Zurich Australia. Reassured that the stop loss was a standalone commercial transaction Mr Hammond did not suggest that there was any error in the accounts.
105. On 15 April 2004, Mr Churche telephoned Mr Hammond to inform him that APRA had commenced an investigation into the loss transfer. On 19 April Mr Churche informed him that a group of executive directors of Zurich Financial wanted to engage the Forensics unit of Pricewaterhouse to investigate. This investigation preceded Pricewaterhouse’s advice that there was a fundamental error in Zurich Australia’s accounts.
106. Evidence was given by Thomas Karp, who retired this year as Executive General Manager of the Supervising Support Division of APRA. In 2000 he was Executive General Manager of the Diversified Institutions Division, a position which he held until August 2004. Mr Karp’s evidence was directed to the attitude which APRA would have taken if the scheme had been disclosed in full. Mr Karp’s evidence is seized on by the applicants because it does not categorically say that APRA would have declined to approve the scheme as reinsurance. He said APRA’s attitude would have hinged on whether there was ultimately a “liability” for the local company: “That is, was there some ultimate obligation on [Zurich Australia] to pay some part, or all of, the claimed “profit” component of the transaction (or conversely, to pay the gap component)”. He concluded that “APRA would likely have viewed the transaction as a desperate action”.
107. It would, of course, have been difficult for Mr Karp to say what the final attitude of APRA would have been. Any such expression of opinion would no doubt have been objected to. The real question is, however, whether the scheme should have been reported to APRA, not what hypothetical response APRA might have made, if it had. Mr Karp’s evidence, at its lowest, discloses that APRA would have taken the matter seriously and would have disapproved the scheme or reinsurance if there was an obligation to repay.
108. Evidence was given by Nancy Milne. She was a non-executive director of both Zurich Australia and Zurich Financial from September 1999. She became Chairman of both companies in March 2004.
109. Ms Milne was aware of the GCR contract and even that it was very beneficial. She learned this from Mr Deutsch who said he was carefully investigating it. Ms Milne was never informed of the wider scheme. She was told nothing about the retrocession of the loss transfer to another Zurich company or that Zurich Australia was involved in covering the gap. If she had been she says she would have requested an investigation. When she learned that Pricewaterhouse had approved the accounts she was satisfied that the accounts were correct.
110. She was troubled that no concerns had been raised with the board when APRA first made its inquiries in 2002 and Mr Churche made an investigation. She ultimately learned about the issues in March 2004.
111. Ms Milne was party to the decision to raise the matter with APRA and to instruct Pricewaterhouse to investigate. She voted in favour of the accounts being restated after the report was received.
112. John Byrne is a chartered accountant. He had been an audit manager for KPMG. In 1998 he went to work for Cologne Dublin. The business of Cologne Dublin was mainly financial reinsurance. It carried on an alternative solutions business which wrote reinsurance “where the client’s primary driver is not the transfer of traditional insurance underwriting risk”. In June 2000 Mr Byrne became deputy chief executive of Cologne Dublin and, in 2001, chief executive.
113. On 27 June Mr Byrne, Mr Ellingsen and Mr Smith from Cologne Group attended a meeting with Messrs Stevenson, Parsonson, Mayo and Baker from Zurich Australia. Mr Byrne says that Mr Ellingsen explained the proposed structure which involved risk moving to GCR and then being retroceded, ultimately to a retrocessionaire which would carry the risk. There was discussion about the fee GCR would be paid to provide the facility. He does not recall any discussion about the stop loss.
114. Malcolm Jones was CEO of Zurich Australia until March 2002. He gave evidence after an accommodation had been reached with APRA. His evidence was not particularly extensive. The main point, for present purposes, is that he said that he saw the memorandum of 2 July 2001 and telephoned Mr Butler to discuss it.
115. Florian Salzgeber completed a doctorate in business administration in Zurich in 1988. He went to work for Zurich Switzerland. In January 1999 he came to work for Zurich Financial, in Australia, where he stayed until May or June 2003. At first he was in charge of finance for Zurich Australia and subsequently for capital management and investment. At first he reported to Mr Butler as CFO, but this changed to Mr Stanbridge when he became CFO.
116. Mr Salzgeber gave detailed evidence of the scheme and particularly the investment of the funds. His evidence included reference to the 2 July 2001 memorandum. He said the memorandum recreated his proposals relating to the investment of the Dublin account represented by the loss transfer and stop loss premiums. He said he remembered having the memorandum delivered to Mr Butler. I find that he did.
The Evidence on Behalf of Mr Butler
117. John Butler is qualified as a chartered accountant. He held a number of positions prior to joining Zurich Australia. For a time he was an audit partner at Ernst & Young. His work focused on the insurance and financial services industries.
118. Initially as CFO of Zurich Australia Mr Butler was asked to work at strengthening reserves. He became aware that a claim had been made under the stop loss agreement Zurich Australia had with Zurich Switzerland in that year. As CFO he was responsible for the financial aspects of the operation of Zurich Australia. He was involved with the strategic change program.
119. As CFO Mr Butler reported to the CEO, Mr Jones. His dealings respecting Home Office were with Mr Parsonson, as manager of Australian and other Asia/Pacific businesses. He also dealt with Frank Schnewlin, who was a member of the Zurich Global Executive Board. Both Mr Parsonson and Mr Schnewlin were directors of Zurich Financial.
120. Mr Butler had a role of understanding and overseeing Zurich Australia’s reinsurance arrangements.
121. When Mr Butler was promoted to the position of General Manager, General Insurance and Head of Production for Zurich Australia he became responsible for all general insurance operations. He became more aware of losses that had occurred in the 1990’s and a deteriorating situation in 1999. Seeking to understand the cause of the problem was an important part of his work. This was associated with a continuing central involvement with the strategic change program.
122. Throughout 2000 and 2001 Mr Butler divided his time, more or less equally, between general insurance responsibilities, the strategic change program and other executive responsibilities. Mr Butler had eight to ten people reporting to him. These included the head of portfolio management, Peter McCarthy, to whom the reinsurance manager, Mr Mayo reported. Mr Salzgeber was also a part of the team which ultimately reported to Mr Butler.
123. Upon his appointment as COO in October 2001 Mr Butler became responsible for all Zurich Australia’s business from an operational perspective. On his further promotion to CEO in March 2002, upon the resignation of Mr Jones, he was appointed to the boards of Zurich Financial and Zurich Australia. Upon his appointment as CEO he was informed that Zurich Australia must rapidly improve its return on equity or it would be sold.
124. In his affidavit, Mr Butler explained that his various roles with Zurich Australia kept him very busy. He says that in 2000/2001 he worked an average week of 70-80 hours. He received 40 to 50 emails per day. He said that if an email was addressed to him he “scanned it to see whether it required any action of me. If it did not then, depending on my time constraints, I generally did not read the email in any detail”. If the email was copied to him, “I generally only scanned the email and may not have read it at all”. His normal practice was not to read the emails in a chain.
125. Mr Butler addressed the significant emails which were sent or copied to him in connection with the loss transfer and associated transactions in his affidavit.
126. For the year 2000, when the scheme was devised and largely implemented, he refers to about 25 emails he received or sent. The emails include the emails extracted above. For virtually every email received by him Mr Butler said that he either did not recall receiving it or did not recall reviewing it. He accepted that he had read the email of 6 July, although not recalling it, because he subsequently forwarded it to Mr McCarthy with a comment. He did not, however, recall this action.
127. It is unusual for a businessman to assert such a complete failure to have read or understood extensive correspondence as Mr Butler has done. I am conscious of the fact that the use of emails, as a tool of business correspondence, and the ease with which copies can be sent, has generally very significantly increased the correspondence which businessmen receive, but my comment stands. However, I need to address what involvement Mr Butler had in the relevant events of 2000.
128. First I note that Mr Butler held senior executive positions in Zurich Australia at all relevant times. Until the beginning of 2000 he was the CFO, a position which directly involved the accounting treatment of significant transactions. In 2002 he became CEO. In the meantime, for 2000, he was general manager of general insurance before becoming chief operating officer.
129. From the perspective of its significance within Zurich Australia the scheme was primarily directed towards an improvement of $60 million in Zurich Australia’s balance sheet. In 1999 it would have been directly relevant to Mr Butler’s role. However, notwithstanding his promotion, in 2000 he still had a vital interest in any general reinsurance. Messrs Mayo and Salzgeber, who worked on the scheme, generally reported to him, although he says that this was not so with the scheme because it was not conventional reinsurance.
130. The emails which Mr Butler says made no impact on him were not routine emails relating to general reinsurance. They were significant emails relating to a matter of great importance to the future business of Zurich Australia. They were of the kind that anyone receiving copies, would read. This is particularly so in the case of a senior executive who had previously had a significant role with respect to Zurich Australia’s performance and its financial accounting. The emails generally had headings showing that the subject was significant.
131. I also note the regularity with which Mr Butler received emails and copies. There is no suggestion that he ever asked that they not be sent. The fact that he was sent so many emails does suggest an interest in the subject matter.
132. Mr Butler was extensively cross-examined, particularly about his involvement with the scheme in 2000 and the emails that were sent by him. I did not think that his denials of awareness of emails that were sent to him was convincing. He was much more aware of the significant transactions which were to shore up Zurich Australia’s balance sheet and become the foundation of the strategic change program than he was prepared to admit. As I have already pointed out, if he had read the emails he would have understood, almost from the outset, all of the aspects of the scheme which are criticised and which form the basis for the action taken against him. I find that he did. I am not satisfied that Mr Butler did not study or understand any of the emails. I have no doubt that he was retaining a close interest in every aspect of the scheme, reading carefully all relevant emails and discussing the issues with others. I find that he had full knowledge of all the emails received by him. In making this finding I take into account the seriousness of the matters before me and the need to take that into account in determining whether I am sufficiently persuaded in accordance with the principles originally enunciated in Briginshaw v Briginshaw (1938) 60 CLR 336. However, when I take into account all the factors I have considered and which are adverted to in these reasons, I have no doubt that Mr Butler read and understood all the relevant emails he received. The proof of this is not, to my mind, indefinite or inexact.
133. The precise way the scheme was carried out is not, of course, ultimately relevant, if it is the basic scheme itself which attracts the approbation. There are, however, two issues raised at the hearing that require comment. The first is what knowledge Mr Butler had of an association between the loss transfer and the stop loss. The second is whether he received Mr Salzgeber’s memorandum of 2 April 2001.
179. I begin by saying that as I read the circular it had no operation in circumstances such as those I am dealing with. Treating the loss transfer separately, I do not read the circular as addressing an uncommercial reinsurance contract which appears, on its face, to be a conventional reinsurance, at all. The circular is concerned with particular types of arrangement, mostly annual. The closest of these arrangements to the present is described as follows:
“Reinsurance Facility – an insurance arrangement involving payment of a premium to transfer portion or all of a risk to the reinsurer.
·Premium charged in line with risk exposure
·Agreed payment if the Event occurs
·No commitment to repay the claimed amount
·May be limited exposure by reinsurer
·Pay back of a claim over future years may be intended but is not contractual
·The policy has an agreed time frame, usually a year.”
180. I do not think that the loss transfer, whether considered alone, or in its context, falls into this category. In particular, the premium was not in line with risk exposure. Nor does the stop loss seem to be within the spirit of the circular.
181. I also note that the circular contains the following:
“… However, if there is uncertainty as to whether risk has been transferred the ISC would have to treat the whole arrangement as financial, not as reinsurance.
If an arrangement appears to have been specifically structured to circumvent this test, the ISC will have no option but to disallow the arrangement as reinsurance… .”
I do not think that the circular, which does not, in any event, seem to have played any part in Zurich Australia’s consideration of the scheme, offers the applicants any assistance. On the contrary, I consider that it supports the proposition that the scheme should have been fully disclosed to APRA.
Consideration
182. A significant issue in the case, which I have already dealt with, related to the knowledge of the transactions which Messrs Butler and Parsonson severally had. Mr Butler, in particular, did not accept that he was aware, at the time, of much of the material. He did not accept, for example, that he knew of any arrangement to use stop loss premiums to fund losses on the loss transfer. Nevertheless, Mr Butler accepts that there was an arrangement, which is referred to in his submissions as a “payback arrangement” and could be described as an “expectation”. The arrangement admitted is that “[Zurich Switzerland] expected [Zurich Australia] to payback any monies [Zurich Switzerland] paid out on the [loss transfer] and its retrocessions”.
183. I have concluded that both Mr Butler and Mr Parsonson were aware, at the time, of the relevant material in the emails they received, whether they were addressed to them or sent as copies. I do not doubt that nine years later Mr Butler might not be able to remember the content of particular emails. However, that is not the point. If he read and understood them at the time then he was aware of their importance at the time. I am satisfied that Mr Butler, and Mr Parsonson, were so aware. I also find that both of them are still aware of sufficient detail at the time to have a continuing recollection of the pertinent aspects of the scheme and its development, even if that recollection is a lot less clear than it was. What is most important, however, is what they knew at the time, not what they remember now, although the latter is a relevant tool in seeking to discover the former.
184. The applicants raised a number of common defences to APRA’s claims. One of the most significant defences was that there was a transfer of risk resulting from the loss transfer. This alone justified removing the loss portfolio provision from Zurich Australia’s balance sheet.
185. As a matter of the law of contract it may be that the effect of the loss transfer was that Zurich Australia could look to GCR for indemnity with respect to all claims exceeding the $10 million excess. It was never intended, however, that GCR would actually bear this inevitable cost. It was intended, in the first place, that, until exhausted, claims would ultimately be met from earnings of the fund represented by the premium. In early discussions this was to be through “an experience account” (30 March 2000 email) and later through “an investment management agreement with Scudder” (30 June email). Ultimately, it was the Dublin fund. It was not anticipated that any shortfall would occur until 2005 or later. The working out of the understanding with GCR made it very clear that this shortfall would be borne by a Zurich entity. I find that both Mr Butler and Mr Parsonson were fully aware of this.
186. The thrust of the arrangement was always that GCR would not bear any ultimate loss. To be frank this was clear to all the parties involved from the outset. Realistically, no one at Zurich Australia would have offered or even contemplated an arrangement with GCR under which there would be a known substantial loss. This reality is clear, at the least, from the email of 30 March and must have been obvious, and hardly necessary to be mentioned, to all of the persons at the 27 June meeting.
187. The reality is that the dealings between Zurich Australia and GCR were not fundamentally concerned with a precision of contracts. Certainly, GCR wanted contract documents to protect their position. Their insistence on leg 2 being in place before leg 1 could operate (30 June email) makes this clear. The parties were more concerned, however, with an overall outcome and not with the negotiation of separate and independent transactions.
188. It is apparent from the email exchanges that one element of the overall management was to reinsure “timing risk” (email of 22 August 2000). Zurich Australia would be ultimately liable for the loss but its present liability would be reinsured and, in consequence, that liability could be removed from its balance sheet. It is important to note, however, that actual liability was always some time off. The full amount of the provision was brought to account in the 1999 accounts even though it was not expected that many of the claims would be payable for many years and may not have been paid even now. What is important is that Zurich Australia must have considered that the whole of the liability needed to be shown in its accounts in 1999.
189. Although the expert evidence did not cover this, and I do not make it a basis for my decision, I note that the extra timing reinsurance provided by the scheme does not seem to have offered any real benefit to Zurich Australia, that the delays in claims themselves would not have provided, except the possibility that it might permit the liability to be taken off balance sheet.
190. It seems that, in fact, the fund represented by the loss transfer premium was running out by 2003 because of the very substantial uplift in the stop loss premium at that time. Had there been no loss transfer and the premium had not been paid it would seem that Zurich Australia would not have been in any materially different position, so far as timing was concerned, except that it would have retained provision for the whole of the loss on its balance sheet.
191. There are two flaws in the argument that the loss transfer represented a transfer of risk at law. First, such a transfer would be a technical legal transfer which did not represent the substance of the arrangement even if it represented its form. Secondly, although the question of whether there was transfer of risk is a relevant factor it is far from the most important factor. I am concerned with commercial morality in business tested by whether Messrs Butler and Parsonson are “fit and proper” to undertake senior insurance executive roles, not with determining technical legal questions and using the result of those determinations to found judgments on commercial morality.
192. Some emphasis was placed by the applicants on the practise, in the insurance industry, of insurers and reinsurers evening out bad claims experiences, particularly for single year policies, by increasing premiums in subsequent years. It was suggested that this, in some way, justified the third part of the present scheme. They relied, particularly, on the evidence of Mr Chalmers.
193. The evidence of this practise was not extensive, but, to my mind it bears no relationship to the present scheme. First, it was a scheme, it was not an ad hoc reaction in a later year to an adverse claims experience not originally anticipated in an earlier year. Secondly, the loss was known in advance. Thirdly, the premium was never calculated in the belief that it would result in anything other than a loss. Not only does this practice not assist the applicants, but, because the present situation lies outside the practice, it leads to the inference that the present scheme was outside ordinary insurance norms. It is not without relevance that no evidence was put before the Tribunal of a scheme similar to the present scheme, with a view to inviting the inference that, for that reason, the present scheme was within the norm.
194. Much of the hearing addressed the question of how that part of the scheme which involved the making up of the shortfall should be described. Both applicants accepted that there was some arrangement. They could hardly do otherwise. In the written submissions filed on behalf of Mr Parsonson the following appears: “In his evidence Mr Parsonson accepted that he [understood] throughout 2000 that there was an expectation that via the stop loss premiums there was an expectation that [Zurich Australia] would fund the gap claims (albeit the premiums were still commercial and the stop loss could be cancelled)”. Mr Butler was less forthcoming, although, as I have said, he accepted the existence of some proposal although not admitting any particular knowledge of it. I find that both Mr Butler and Mr Parsonson understood the obligation as I have found it to be.
195. In his submissions, Mr Parsonson suggests that the fact that the accountants adopted different approaches “defeats any contention that it must have been obvious to all concerned in 2000 that the transaction did not involve any transfer of risk”. Even if that were true, rather than the uncertainty relieving those involved from responsibility for inquiry, it seems to me that it increased the obligation on those involved in the Zurich Group, particularly the more senior of them, to make careful inquiry to discover the position. It must be remembered that the important question was not whether the transactions were permissible, but how they should be accounted for. This is why it is no answer for those involved to seek to excuse their involvement by saying they were not actuaries or experienced in insurance. The real question is whether it was proper for these transactions to be put forward as yielding a profit of $60 million and whether the balance sheet should be prepared on this basis. This was a question more for senior management and financial officers than for those writing insurance.
196. Much of the applicants’ submissions address particular aspects of the steps in implementing the scheme. This is particularly so of the case that the board, the auditors, APRA and Standard & Poors were misled. Evidence is pointed to that, if accepted, shows that one or other of the two were not present at a meeting, or did not see a particular email, or, if present at a meeting, made no incorrect statement, or relied upon someone else at the meeting disclosing anything relevant.
197. I do not see this as the way this case should be disposed of. Plainly, Messrs Butler and Parsonson were not involved at every step. However, that is not the point. What they were required to do, as all the senior executives involved were, was to ensure that the whole scheme was put before, particularly its auditors, to enable the scheme to be evaluated. It was not appropriate for these executives to stand by while the transactions were selectively disclosed and it was not for them to leave it to others to decide what should be disclosed.
198. The essence of what should have happened in this matter was put by Mr Deutsch at the end of his evidence:
“HIS HONOUR: … Let me ask you to assume, Mr Deutsch, that there was no constructive obligation here. That in fact the accounts in 2000 were correctly prepared. What do you say about whether the persons in Zurich, who were instructing you, should have done about the other transactions, ie, contracts 2, 3, 4 and 5? Should they have told you about them, so that you could form a view, or were they entitled, because they were right, not to show them to you?--- President, the answer to that is very clear and that is that they should have told me. They failed in their duties to the board and they failed in their duties to the auditor and they make that worse and they repeatedly compounded it by signing representation letters to us that they’d given us all the information that was relevant and they clearly did not and so this morning for me has actually been quite frustrating, because when you’re forming a view as to what was done correctly here and what was not, that last 10 seconds of discussion is as relevant in my mind, if not more, than the actual intricacies of the accounting.
…
MR SMITH: The answer you gave, may I suggest that you’re failing to give any weight to the proposition that you’re being asked to assume, for the purpose of answering these questions that the arrangements that you were not told about did not have any effect on the financial position of the entities whose accounts you were auditing. Do you agree with that proposition?--- And I’m saying the stop loss contract between ZAIL and GCRA, I think, was a relevant contract under the period and was relevant to the 31 December 2000 accounts and I was not told of its existence.”
199. As with much of this case the applicants concentrated on the detail of the components of the scheme, enquiring about risk transfer and the like. In response, APRA sometimes adopted a like approach. However, that is not really what this case is about. It is about whether there was an adequate disclosure of a scheme the essence of which was removing very substantial debt from a balance sheet for little return other than delay in liability most of which delay was present in any event.
200. What Mr Parsonson and Mr Butler should have done, was to give the board and the auditors a thumbnail sketch of what was happening. It could have been done in a few minutes. Then it would have been up to the auditors to make enquiries. They might ultimately have approved the balance sheet as it was prepared. That may be unlikely in the circumstances that they ultimately insisted that the entries be corrected. However, they might have approved. That this is a possibility, is not, however, really to the point. What Messrs Parsonson and Butler should have done was to fully explain the scheme so that the auditors could consider how it should be treated. Similarly, they should have given the board an opportunity to consider the whole transaction.
201. I am less concerned about the position with APRA. Clearly, there should have been further disclosure to APRA. However, prior disclosure to the board and auditors was appropriate. That would inevitably have changed what was proposed. The Financial/Finite Insurance Circular did not protect the transaction. Again, perhaps APRA would have approved it. The problem is that they were not given the chance. Standard & Poors should not have been misled, but I do not find that Mr Parsonson or Mr Butler were implicated in that.
202. It is true that Mr Parsonson wrote emails to the effect that it was important for there to be risk transfer and that he did not have the training to know whether there was risk transfer. However, this was not enough for someone in the position of Mr Parsonson. It might have been enough for one of the persons lower down the chain such as Mr Salzgeber, but it was not enough for someone as senior as Mr Parsonson. Nor was it enough for him to ask the question or raise the issue. His duty was to find out the answer from someone whose opinion he could accept. He did not do this. I repeat that it was not, in any event, simply a question of whether, as a matter of the law of contract, a contract such as the loss transfer involved a transfer of risk. What was required was a disclosure of the whole scheme and the question was, how should it be treated in Zurich Australia’s balance sheet? This is a very different question.
203. Mr Parsonson was, at the time the loss transfer was negotiated and entered into, a director of Zurich Australia. He should have raised the detail of the scheme, as he understood it, for consideration by the audit committee of the board and the board itself. This was, after all, a transaction which was calculated to have a significant effect on the balance sheet of Zurich Australia.
204. He should also have raised the transaction very directly with the auditor. In his evidence Mr Parsonson refers to discussions with both Mr Deutsch and Mr Hammond. He says he asked them whether they were satisfied with the disclosure they had received. This was not good enough. How could the auditors know that disclosure had been satisfactory if they did not know that the whole scheme had not been disclosed?
205. Mr Parsonson frankly admitted that he was always concerned about circularity. He appears to suggest that his original concern was allayed by his belief that there was risk transfer. As I have said risk transfer is not really the question, or, at least, only part of the question. There could be risk transfer with transfer back. In any event, the question was what was the appropriate accounting treatment, not what the law of contract provided. Mr Parsonson returned to his concern about circularity in 2002. There was an enquiry by a London accountant, Mr Taylor. There was a factual debate as to whether an inquiry had been undertaken by the London auditor, Mr Stooke. None of these seemed to me to provide an answer to Mr Parsonson’s plain obligation in both 2000 and at all times later to frankly put the essence of the transaction before Zurich Australia’s auditors for consideration.
206. In substance, the position of Mr Butler is no different. He knew all the relevant details of the scheme. He had the opportunity to disclose it, yet he did not. After he became CEO his obligation became even clearer, yet he signed misleading letters to both the auditors and APRA.
207. One way of testing this case is to ask what would have happened if the whole scheme, including the payback proposal, had been declared to the board, the auditors, APRA and Standard & Poors? It would be difficult to explain the three parts of the proposed scheme to auditors without the auditors immediately suggesting that it would leave the level of debt on the balance sheet unchanged. The reality is that this is no doubt why it was not so explained.
208. This was a scheme to remove debt from a balance sheet for virtually no benefit except, possibly, time, most of which was available in any event. One can query even that, in the light of the insistence as early as July 2000 upon steps being taken to cover the gap. Pricewaterhouse would have insisted, as they ultimately did, that although the entries on the balance sheet might change, the debt would remain.
209. In any event they should have been told. Fit and proper senior insurance executives such as Mr Butler and Mr Parsonson would have queried the scheme and sought independent advice as to its accounting treatment. They would not have relied on others. They would not have relied on their own conclusions.
210. It follows that I am satisfied to the requisite extent, having regard to the seriousness of both the allegations and the consequences of disqualification, that Mr Parsonson and Mr Butler were not fit and proper senior insurance managers between 2000 and 2004. However, the question for me is whether they are now fit and proper. To my mind the failures of Mr Parsonson and Mr Butler were serious. They were not fleeting or transient. They persisted over a substantial period of time. Although both of them said, to an extent, that they would now do things differently this does not cause me to think that they have sufficiently changed. Both of them have sought to defend their conduct. Their undoubted good character and reputation in the industry does not cause me to consider that they are fit and proper. In saying this I take into account the character evidence tendered on behalf of Mr Butler and Mr Parsonson.
Result
211. I find that Mr Parsonson and Mr Butler are not fit and proper persons to act as directors or senior managers of a general insurer or to act in the other positions from which they have been disqualified. In all the circumstances I consider that they should, in the exercise of my discretion, be disqualified pursuant to s 25A of the Act. Once I find that it is appropriate that they be disqualified, I have no discretion relating to any term of the disqualification. The disqualification is protective. It is not for a term. It is open to both Mr Parsonson and Mr Butler to seek to have the disqualification lifted by the Federal Court of Australia in the future.
212. The decisions under review will be affirmed.
I certify that the two hundred and twelve (212) preceding paragraphs are a true copy of the reasons for the decision herein of Justice Downes, President
Signed: ...............................[sgd]...........................................
Claire Doherty, AssociateDate/s of Hearing: 11-15, 18-20 August 2008
9-12, 16, 18-19, 23-27, 30-31 March 2009
1-3 April 2009
Date of Decision: 31 July 2009
Solicitor for the Applicants: Mr Butler: Freehills
Mr Parsonson: Thompson Eslick SolicitorsCounsel for the Applicants: Mr Butler:
Mr R Smith SC, Mr J SmithMr Parsonson:
Mr R Beech-Jones SC, Ms A Horvath
Solicitor for the Respondent: Sparke Helmore Solicitors
Counsel for the Respondent: Mr N Cotman SC, Ms M Fisher, Ms J Gleeson
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