ROBERT REGINALD STITT and AUSTRALIAN PRUDENTIAL REGULATION AUTHORITY
[2009] AATA 601
•14 August 2009
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2009] AATA 601
ADMINISTRATIVE APPEALS TRIBUNAL )
) No 2007/4414
GENERAL ADMINISTRATIVE DIVISION ) Re ROBERT REGINALD STITT Applicant
And
AUSTRALIAN PRUDENTIAL REGULATION AUTHORITY
Respondent
DECISION
Tribunal The Hon B J M Tamberlin QC, Deputy President
Mr S E Frost, MemberDate14 August 2009
PlaceSydney
Decision The decision under review is set aside.
..............................................
The Hon B J M Tamberlin QC
Deputy President
CATCHWORDS
INSURANCE LAW – disqualification – fit and proper person – director of a general insurance company – diligence – competence – significance of evidence as to competence and character – lack of evidence as to standards against which Applicant’s behaviour should be judged – decision under review set aside.
Relevant Act
Insurance Act 1973 – ss 2A, 3, 24, 25A and 63
Citation:
Re Slee and Australian Prudential Regulation Authority [2006] AATA 206
ABT v Bond (1990) 170 CLR 321
Re Abbott and Australian Prudential Regulation Authority [2008] AATA 641
Vines v Australian Securities and Investments Commission (2007) 63 ACSR 505
Kamha v Australian Prudential Regulation Authority (2005) 146 FCR 24
REASONS FOR DECISION
14 August 2009 The Hon B J M Tamberlin QC, Deputy President
Mr S E Frost, Memberbasic facts
1. This is an application under s 63 of the Insurance Act 1973 (“the Act”) to review a decision made on 14 August 2007 by a delegate of the Australian Prudential Regulation Authority (APRA) which confirmed an earlier decision to disqualify Robert Reginald Stitt from being or acting as the holder of a senior insurance role pursuant to s 25A(1) of the Act.
2. The delegate decided that Mr Stitt was not a fit and proper person to be or act as a director or senior manager of a general insurer under s 24(1) of the Act.
3. APRA is the prudential regulator of the financial services industry and oversees, among other things, banks, credit unions, general insurance and reinsurance companies and life insurance companies.
4. On 29 August 2005, a delegate of APRA issued a show cause notice on Mr Stitt because it had formed a preliminary view that he should be disqualified on the basis that he was not a “fit and proper person” to act in the position of senior manager or director of a general or other insurer.
5. On 1 June 2007, Mr Peter Kennedy, as delegate of APRA, disqualified Mr Stitt as referred to above. An application was made to APRA for reconsideration, and Mr Kennedy’s decision was confirmed by another delegate, Susanne Tongue, on 14 August 2007. The decision under review is that of Mr Kennedy as confirmed by Ms Tongue.
6. The broad issue on this review is whether, at the time of hearing before the Tribunal, the correct and preferable decision is that Mr Stitt should be disqualified under s 25A on the ground that he is presently not a fit and proper person to be or act in a senior management position under s 24(1) of the Act.
Background
7. Between January 1992 and 15 March 2001, Mr Stitt was a non-executive director of HIH Insurance Limited (HIH) and its predecessors, which included CE Heath Underwriting Ltd and Insurance (Australia) Pty Limited (CE Heath). The HIH group was comprised of HIH and a number of subsidiary companies, and the main activity of the group was general insurance underwriting. Mr Stitt was also a member of the board audit committee from 1992, when he joined CE Heath, and on 22 October 1998 he also became a director of HIH Investment Holdings, a subsidiary of HIH.
8. On the application for review before the Tribunal, counsel for APRA, Mr Stevenson, stated that APRA’s submissions to a significant extent reflect the reasons of the first delegate, Mr Kennedy, whose conclusions as to fitness and propriety were as follows:
…
166.The conclusion that I have reached is that your conduct demonstrates a consistent pattern of failures to perform your duties as a director of HIH with the requisite degree of due care and diligence. You were involved in a number of decisions and resolutions by the board that were not subject to appropriate levels of scrutiny and ultimately contributed to HIH’s eventual collapse. The consistent pattern of conduct and failure to adequately perform your duties as a director demonstrate that you lack competence for the purposes of my assessment of fitness and propriety under the Insurance Act.
167.The evidence discussed above demonstrates your failure to fulfil your duties in relation to a number of key aspects of HIH’s governance and decision making. In particular, you:
167.1failed to consider major transactions appropriately through failing to require appropriate analysis by either management or external consultants to inform your approval of the following transactions:
a. the CareAmerica re-acquisition;
b. the acquisition of FAI;
c. the Allianz joint venture;
167.2failed in your duty as a member of the audit committee by agreeing to the authorisation of a misleading note to the financial report for the year ended 30 June 2000;
167.3failed to place yourself in a position to adequately understand and consider provisioning issues for HIH including a failure to consider the report of HIH’s external actuary on this issue.
168.In addition, you failed to perform appropriate duties in relation to your position as a director of HIH Investment Holdings Ltd.
169.I have concluded that you fell below the standard of what is to be expected of a director of a general insurer. In particular, you failed in a number of instances to consider matters for your decision with the degree of due care and diligence required of a director in your position. As noted at paragraph 5 above, competence in the performance of your business duties is one of the criteria for fitness and propriety under the Insurance Act. As you were a director of HIH, my assessment as to whether you fulfilled your duties as a director with the requisite degree of due care and diligence is fundamentally relevant to your competence, and thereby to my assessment of your fitness and propriety under the Insurance Act. Accordingly, I consider that you fail to meet the criteria for fitness and propriety of competence in the performance of your duties as a director. These matters demonstrate that you have failed to meet standards of fitness and propriety under subsection 25A(1) of the Act on the basis of your failures to abide by the duties to consider matters for the decision of the board with due care and diligence.
9. The conclusions of the later delegate, Ms Tongue, confirming the decision of Mr Kennedy, were as follows:
...
39.Based on the material above, I find that your conduct demonstrates a failure to adequately consider three significant transactions, namely the re-purchase of CareAmerica, the acquisition of FAI, and a joint venture arrangement with Allianz, prior to HIH entering into these transactions. I also find that, as a member of the HIH audit committee, you authorised the inclusions of misleading material in the financial reports for the year ended 30 June 2000; that you failed to take steps to understand and consider the provisioning of outstanding claims liabilities; and that you failed to discharge your duties as a director of HIH Investment Holdings.
40I consider that your conduct demonstrates that you failed to fulfil your duties as a director with the requisite degree of due care and diligence, and that this conclusion is fundamentally relevant to your competence and thereto the assessment of your fitness and propriety pursuant to section 25A of the Insurance Act.
41On the basis of my concerns as to your competence, I find that you are not a fit and proper person to be or act in a section 24 position. Accordingly, I confirm Mr Kennedy’s original decision to disqualify you from being or acting in a section 24 position, pursuant to section 25A of the Insurance Act.
The Substance of the Case for APRA
10. The gravamen of the case for APRA is that Mr Stitt was insufficiently diligent in performing his duties as a director and as a member of the audit committee of HIH, and that if he had been less trusting of management and more diligent in enquiring into the detail of the matters coming before him, the governance of HIH would have been more effective and some of the mistakes that the company made in the last years of its operation would have been avoided. APRA also contends that the present fitness of Mr Stitt is to be judged by his conduct whilst a director and member of the audit committee of HIH, and regard should be paid to whether his competence to act has changed in the intervening years since he ceased to be a director. In order to determine this, consideration must be given to the question whether his subsequent actions, including his submissions to APRA and his evidence to the Tribunal and his cross-examination thereon, indicate that he has learnt from the events of 1996 to 2001.
Hearing
11. During the hearing, Mr Stitt filed affidavits from a broad spectrum of eminent professional persons from the legal world, and from prominent members of the insurance industry with whom he has been associated over many years and, in some cases, over decades. These affidavits testify as to his general high level of diligence, competence, integrity and experience in both the legal profession and in relation to the insurance industry. None of this evidence was challenged by the Respondent by way of cross-examination or otherwise, and there was no suggestion made that such evidence should not be accepted and given appropriate weight.
12. Whilst there is no challenge to Mr Stitt’s character, integrity, or lack of propriety, the evidence referred to above as to his character is of significance in determining whether, at the time of this hearing in 2009, Mr Stitt is presently a fit and proper person to perform the roles from which he has been disqualified, and we will refer later in some detail to the substance of this body of evidence.
13. Mr Stitt has filed a detailed affidavit in which he responds extensively to the incidents relied on by APRA in this proceeding. Exhibited to this affidavit are five large files of documents to which he also refers. At the hearing, he gave oral evidence in chief and he was extensively cross-examined on his affidavit, on the detailed material furnished by him and on numerous other documents. Mr Stevenson for APRA relies on the documentary material and on the cross-examination to make out his case for a finding that Mr Stitt is not a fit and proper person to perform the functions of a director or a senior manager.
14. This hearing took place in the broader context of a long-standing investigation of the affairs of the HIH group and the reasons for its failure, and there has been a comprehensive report following the Royal Commission into the affairs of the HIH group and associated companies conducted by Justice Owen. The observations, findings and conclusions of that inquiry are not binding on this Tribunal, but are referred to by APRA by way of general background to furnish a broad understanding of the context in which the incidents relied on by APRA are said to show lack of diligence.
15. The task of the Tribunal is to reach a conclusion on the evidence presented to it as to whether, at the present time, Mr Stitt is not a fit and proper person, such that he should be disqualified. There is no onus of proof and the Tribunal must reach a conclusion on all of the evidence before it at the conclusion of the hearing.
Observations
16. The conduct of Mr Stitt which, it is said, indicates that he is not a fit and proper person does not include any adverse view as to his integrity, moral turpitude or any blame-worthy aspect of his character. It goes to the question of competence, and the need to protect the community from persons in the insurance business, at a senior level, who have been shown to have failed to exercise due care and diligence. Another matter to note is that no expert or insurance industry witness has been called by APRA. No oral testimony was provided by APRA to spell out, in the particular type of circumstances present in this case, the types of specific conduct or action which should be taken by an experienced competent person occupying such a position in the insurance industry. That is not to say that such evidence would be determinative but, in this case, it would have been useful in evaluating the level of competence which should be applied in considering the conduct of Mr Stitt.
17. Mr Stitt was not an executive director and was therefore not involved in the everyday management of the business. The information provided to the board of HIH by executive directors, and senior management particularly, in relation to some of the matters relied on by APRA, was not frank and open, and did not disclose all matters necessary for a proper examination of the business before the board. The Supreme Court of New South Wales has found that Messrs Ray Williams, Rodney Adler and Dominic Fodera breached the duty imposed on them under the Corporations Act and breached the relevant duty of care at common law in relation to the affairs of HIH. In addition, criminal prosecutions arising out of corporate misfeasance and non-performance of duties as directors and officers of HIH has since led to sentences of imprisonment in the case of Messrs Williams, Adler, Fodera and Terrence Cassidy. Senior officers, Mr William Howard and Mr Robert Kelly, pleaded guilty as did Mr Fred Lo to charges brought against them in relation to their conduct at HIH. The evidence does not disclose that any of this misconduct was known or ought to have been known by Mr Stitt, such as would place him on notice or arouse suspicion requiring closer scrutiny of the activities and recommendations of management. It is also to be noted that the former chairman of HIH and the audit committee, Mr Geoffrey Cohen, has now given an undertaking to APRA and has acknowledged breaches of duties by him in respect of the conduct of the audit committee. In his acknowledgment, Mr Cohen accepted that he did not competently and diligently carry out his duties and responsibilities in relation to the conduct of meetings and other procedural matters and also in relation to the Allianz transaction and in relation to the financial viability and consequences of proceeding with the joint venture arrangement. He accepted that with the benefit of hindsight, and what has since transpired, he should have acted differently in relation to a number of these matters, and he regretted the consequences that arose.
18. APRA referred to the fact that Mr Stitt had at one point proffered an undertaking to it and, while it had refused to accept the undertaking, it sought to use this offer of an undertaking as an indication that Mr Stitt accepted that he had failed to exercise due care and diligence. However, Mr Stitt gave evidence that he has reconsidered his position after APRA had refused to accept the undertaking, and he said that the undertaking was only given by him in order to avoid the expense, delay and enormous stress which would be caused by a full hearing as to the incidents in question. We accept this explanation by him as being reasonable and do not draw any adverse inference against him as a consequence of the proffering of his undertaking.
Conduct and Character Evidence
19. An important consideration in this case is the cogent, consistent and uncontradicted body of evidence as to the professional competence, experience and diligence of Mr Stitt, both in the legal profession and in relation to the insurance industry specifically. No contrary evidence was led and there was no cross-examination on any of this material. This evidence provides a framework within which the fitness and competence of Mr Stitt, as a person who performs the functions in question, must be assessed. This evidence includes sworn statements from prominent senior persons in the legal profession giving evidence as to competence and character, which, when taken with the background and professional experience of Mr Stitt as detailed by him, leads to the conclusion that he was a diligent, competent and experienced professional. In particular, one very senior person who has known Mr Stitt over many years expressed the view that any lack of care, attention and diligence would be quite foreign to the character of the person known to the deponent. Also, there was evidence from a Mr Gregory Waters, General Manager of Internal Audit for HIH, who had the opportunity of seeing Mr Stitt during audit committee meetings, which indicated that Mr Stitt would ask questions in relation to material and proposals which were under consideration at the meetings, in his capacity as non-executive director and member of the audit committee. Mr Waters was not called for cross-examination. His evidence was detailed and said that Mr Stitt had a deep appreciation of his responsibilities, specifically in relation to insurance matters, and that he was well-versed in claims management. He says that Mr Stitt was an active member of the audit committee, and was always willing to test and question management, the external auditors, his fellow members and the internal auditor, and that he was persistent and probing. This is verified by the Minutes referred to in the course of these reasons. He was considered to be well prepared, informed, diligent and competent and demonstrated a profound knowledge of audit committee obligations and directors’ duties. Other witnesses gave evidence as to Mr Stitt’s experience and diligence in preparing and conducting legal cases. What we take from this body of evidence, which we find to be particularly impressive, is that the failures alleged against Mr Stitt in this hearing, even if they were to be substantiated, would be out of character.
20. A further observation we make at the outset is that APRA relies on five discrete matters which do not demonstrate any pattern of conduct, but are rather separate isolated incidents where Mr Stitt is said to have failed to exercise due and proper diligence, which range over a considerable period of time. This is not a case where it can be said that there has been any pattern of careless conduct.
Legal Principles
21. The Insurance Act has as its main object the protection of the interests of policy holders and prospective policy holders under insurance policies in ways that are consistent with the continued development of a viable, competitive and innovative insurance industry: see s 2A. This protection is to be achieved by restricting persons who can carry on insurance business in Australia by requiring general insurers, directors and senior management to meet suitability requirements.
22. Under s 25A, as it was then, APRA could disqualify a person from being a director or senior manager of a general insurer if APRA was satisfied that the person was not a “fit and proper person” to be or act in such a position. On 1 June 2007, the delegate of APRA decided that Mr Stitt was not a fit and proper person to be or act as a director or senior manager of a general insurer. A senior manager is defined in s 3 of the Act as a person who has or exercises any of the senior management responsibilities for the insurer or agent.
23. The expression “fit and proper person” calls for a general overall assessment taking into account the person’s competence, character, diligence, honesty, integrity and judgment to perform properly the duties of director or senior manager. In this case, the Tribunal is concerned with the position as director of a general insurance business. Some useful guidance in the present case can be obtained from the observations of Deputy President Purvis and Senior Member Ettinger in Re Slee and Australian Prudential Regulation Authority[2006] AATA 206 where they said at [113]-[114]:
[113] … The manner in which the Applicant undertook his work was devoid of the appropriate degree of care. He made significant errors that should not have been made. He failed to identify those errors thus demonstrating not only a lack of reasonable care in the performance of his work, but a deficiency in his work practices. The Applicant failed to exercise the professional care and diligence expected of a reasonable and competent actuary.
[114] It is to be noted that there is no attack upon the integrity of the Applicant. It is to his competence that APRA directs the attention of the Tribunal. There is no attack upon his honour or character but upon his competence, his skill and ability to carry out the responsibilities and obligations of an actuary. Compliance with professional standards is relevant and a pre-requisite to such an assessment. It is not only that the Applicant was negligent or made an error or mistake. He displayed a gross disregard for his professional obligations. He was aware or should have been aware of the instances of his incompetence. A lack of awareness would be further evidence of such lack of competence.
24. After observing that the “fit and proper person” concept carried no precise meaning, but took its meaning from the context and the activities in which the person was engaged and the end to be achieved by those activities, Gaudron and Toohey JJ in ABT v Bond (1990) 170 CLR 321 at 380 observed:
The concept of “fit and proper” cannot be entirely divorced from the conduct of the person who is or will be engaging in those activities. However, depending on the nature of the activities, the question may be whether improper conduct has occurred, whether it is likely to occur, whether it can be assumed it will not occur, or whether the general community will have confidence that it will not occur.
25. In considering conduct that took place on specific occasions, looking back over a period of up to 13 years, it is necessary to bear closely in mind the dangers that can arise from what is described as “hindsight bias”. That is to say the distortion that can occur when evaluating conduct which arises when matters subsequent to the carrying out of the conduct emerge, and when the consequences are seen clearly. The difficulty is that once that later information is known, it is difficult to prevent that knowledge affecting an understanding of past events. The problem has been referred to by courts in many areas, including patent law, in cases when considering the question of “obviousness” of an invention; the evaluation of conduct as negligent, having regard to reasonable care standards; and the valuation of shares and land. Courts and tribunals are aware of the tendency to consistently, and on occasions, unconsciously, exaggerate what could have been anticipated with foresight at the time, thereby giving rise to the perception that what in fact happened was inevitable and also must have appeared clear beforehand.
26. In Re Abbott and Australian Prudential Regulation Authority [2008] AATA 641 at [179], Senior Member Taylor said:
Conduct that occurs without the benefit of hindsight must be evaluated with a proper and realistic regard to the subjective knowledge, belief and intentions of the persons involved.
27. In Vines v Australian Securities and Investments Commission (2007) 63 ACSR 505, there is a detailed consideration by the New South Wales Court of Appeal of the question whether a person is a fit and proper person. At [61], Spigelman CJ emphasised that findings of past contraventions do not of themselves create any presumption against a person as to fitness and propriety which needs to be rebutted in order to meet the allegations. While evidence of past contraventions is significant and must be weighed when considering a person’s fitness and propriety, the contraventions are not determinative. In this case, it is not necessary for Mr Stitt to satisfy the Tribunal that he has become a fit and proper person. This is because it is not to be presumed that he was not a fit and proper person. The only question is whether he is now fit and proper, taking into account any past contraventions in the context of the whole of his conduct, including subsequent and preceding events. The main object of the Act, as referred to above, is directed to the protection of policy holders and, therefore, it is important to evaluate the present character and future conduct of the person under consideration when carrying out the role of director or senior manager: see Kamha v Australian Prudential Regulation Authority (2005) 146 FCR 24 at 32 [25].
APRA’s Case
28. Specifically, APRA bases its case that Mr Stitt is not a fit and proper person on alleged past demonstrations of conduct which manifests lack of fitness to hold office as director or senior manager in relation to the following transactions and matters:
1.The re-purchase of CareAmerica;
2.The acquisition of FAI Insurance Ltd (FAI);
3.The entry into the joint venture with Allianz;
4.The failure as a member of the audit committee to investigate the accuracy of a note to the account; and
5.The failure to understand or consider the provisioning made by HIH for outstanding claims.
We now turn to each of these matters.
The Reacquisition of CareAmerica
29. HIH had established a workers’ compensation underwriting operation in California in 1987. In time, apparently, that business became very profitable, and in 1994 HIH sold the business to a U.S. purchaser.
30. Some time in 1996, the U.S. owner wanted to dispose of the business and for that purpose it started looking for potential purchasers. One such potential purchaser it identified was HIH. It seems that, on becoming aware of this opportunity, HIH engaged Hambros Corporate Finance Limited, described in Board minutes as HIH’s ”financial adviser”, to provide it with advice on the possible acquisition of the business.
31. Hambros duly prepared a “briefing paper” which was tabled at the HIH Board meeting on 13 December 1996. Much of the information in the briefing paper had been provided to Hambros by senior management of the current U.S. owner of the business, and it is this fact that has been central to much of the criticism that APRA has levelled at Mr Stitt. The complaint against him, dealt with in detail later in these reasons, is that the decision to reacquire CareAmerica was based largely on information provided to HIH by the vendor of the business and that the information was not checked or verified by HIH or any of its professional advisers.
32. The briefing paper contained a one-page “Executive Summary” and then a report of 17 pages made up of a combination of narrative commentary and various tables of financial information. At the end of the main paper were three appendices. Appendix I set out historical financial information for CareAmerica from 1992 to 1995 (plus estimates for 1996). Appendix II set out forecasted financial information from 1996 to 2000. Appendix III comprised three graphs dealing with historical movements in premium levels for workers’ compensation in, respectively, the American States of Illinois, Michigan and Minnesota. The relevance of these figures was said to be that each of those States had, like California, moved from a “regulated” workers’ compensation insurance environment to one that was deregulated. The graphs showed how premium levels had moved in those States after deregulation. In broad terms, they had dipped slightly over a period of two to three years, and then recovered to the pre-deregulation level. Overall, the graphs presented a reasonably favourable picture of premium levels for those three States, based on actual historical information. It was implicit that similar trends could be expected in California. A note at the foot of each of the graphs sourced the information in them to A. M. Best & Co, described by Mr Stitt in cross-examination as “probably the most influential and significant insurance analysts in the world”. Mr Stitt, according to his evidence, placed significant reliance on the trends depicted in those graphs.
33. The Hambros briefing paper explained the scope of and limitations in the work that the firm had undertaken for HIH. On several occasions, it noted that certain financial information had not been “audited” or “verified”. The briefing paper, and the “Summary of Offer Letter” appended to it, made four separate references to the need, perceived by Hambros, for some sort of “due diligence” to be undertaken if HIH planned to proceed with the purchase of CareAmerica:
(a)It noted that “[t]he information contained [in this paper] has been sourced, primarily from an Information Memorandum produced by Dean Witter Reynolds Inc. (“Dean Witter”) and from discussions with management. It has not been independently verified. Should this transaction proceed further full due diligence will be required.”;
(b)It referred at page 4 to a five-year profit and loss forecast produced by senior management (of the vendor), and noted that the forecasting model “[had] not been audited or verified. Should this opportunity be progressed further due diligence will be required on it.”;
(c)On the first page of the “Summary of Offer Letter”, Hambros proposed that HIH not require a reserve indemnity from the vendor, noting that “full due diligence will be performed on the loss reserves”; and
(d)On the second page of that letter Hambros noted that “[a]ny offer which may be made will be conditional on … full due diligence”.
34. In the face of those statements, APRA complains that Mr Stitt was involved in the decision to reacquire CareAmerica without the due diligence that Hambros had recommended, or at least foreshadowed. As explained in APRA’s statement of facts and contentions at paragraph 34:
…
In relation to the CareAmerica reacquisition the principal complaint against the applicant is that he was a member of the Board which approved the reacquisition notwithstanding that there had been no due diligence of CareAmerica, that HIH had not negotiated a reserve warranty from the vendors and that there had been no actuarial valuation of the likely risks of the reacquisition.
…
35. The statement continued at paragraph 49:
…
It should have been apparent to a reasonably diligent director in the applicant’s position that the full due diligence recommended by Hambros had not occurred. This ought to have raised concerns in the applicant’s mind as to the risk being taken by HIH in the transaction. He, and the other members of the Board, ought not to have permitted the transaction to proceed without the completion of the recommended due diligence, including a full review of reserves.
…
36. At paragraph 52 the statement said that Mr Stitt:
… did not satisfy himself that the due diligence, which Hambros had emphasised was a condition of entering the transaction without a reserve warranty, had been performed. … The applicant … fail[ed] to exercise prudence and diligence in the performance of his role as a director of HIH.
…
37. Mr Stitt’s position is explained by the following extract from the transcript, at pages 23-24:
MR STEVENSON: All right. So they’re the - I’m suggesting they’re the four references that Hambros made to a due diligence of some kind. Now, is your position that a full due diligence was performed, or that it was not performed?‑‑‑Well, it depends on what full due diligence means in this context. It was my understanding that a due diligence had been performed by both the actuaries and the auditors.
The actuary is Mr Perr, P-e-r-r?‑‑‑No, Milliman & Robertson, which was the major actuary in California, and that was confirmed by Timothy Perr.
But ‑ ‑ ‑?‑‑‑We retained both of those actuaries, and I understood they’d done their job.
Milliman & Robertson were the vendor’s actuaries, weren’t they?‑‑‑But they were also our actuaries. We’d retained them over the years when we were in California with Heath Cal. They were a highly reputable actuary.
But they weren’t retained to produce a report for consideration by the HIH board in relation to this reacquisition, were they?‑‑‑They produced a report which was produced to our board by Colin Richardson as a part of the material that we had. I think I dealt with it in my affidavit, if I can go to that.
I’m asking you about it, but didn’t you understand that the report of Milliman & Robertson which Mr Perr reviewed was the report they had made to their client, the vendor, not to HIH, the prospective purchaser?‑‑‑Well, it was a report about the - it was an actuarial report about the business. Whoever actually prepared it, it was, presumably, accurate and truthful. It was prepared by reputable actuaries.
My question was, did you understand that a full due diligence report had been performed, and as part of your answer, that you thought so far as reserves is concerned, it had been, by Milliman & Robertson?‑‑‑And by Timothy Perr, yes. The answer to your question is yes.
And I think you also mentioned the auditors, and that’s Arthur Andersen?‑‑‑They did a financial audit.
Did you understand that to be a full due diligence by them?‑‑‑I understood that was to be directed to the question as to whether or not the financial figures were accurate on which we were operating. That’s what Arthur Andersen were retained to do.
38. Since APRA’s complaint rests squarely on Hambros’ recommendation that due diligence be undertaken, and the claimed failure of the HIH Board to insist on that process, it is surprising that APRA called no-one from Hambros to explain:
(a)that the recommendations relating to due diligence were genuine and serious, attuned to the particular circumstances of the proposed transaction, and not simply a standard, albeit somewhat tailored, set of disclaimers routinely included in Hambros’ advice letters;
(b)exactly what processes Hambros had in mind when making the due diligence recommendations; or
(c)how, and why, proceeding without due diligence would amount to a lack of prudence.
39. We do not think that it is for us to determine, in the absence of any relevant evidence, what are the proper standards of behaviour of a non-executive director on a board faced with an acquisition opportunity and an essentially favourable briefing paper from a company’s financial adviser. Must a board always insist on due diligence when an adviser recommends it? And if it must, what does “due diligence” actually mean? Mr Stitt clearly thought that at least some of the work that was done, and reported to the Board, amounted to “due diligence”. APRA conceded that some due diligence was done, but it did not amount to “full” due diligence. We are then left wondering: how does “full due diligence” differ from “due diligence”? And when Hambros recommended “full due diligence”, did it really mean to encompass every facet of the CareAmerica business – legal, regulatory, taxation, financial, actuarial? Would anything less than “due diligence” in respect of each of these facets, and perhaps more, have satisfied the “full due diligence” that was recommended?
40. Whatever might be the answers to those questions, Hambros was HIH’s financial adviser. It was not the decision-maker. It was not for Hambros to specify that any offer would be conditional upon full due diligence; whether that would be a condition was a decision for the Board. Hambros might, of course, reasonably make such recommendations, but it does not follow that the recommendations that Hambros made were the only reasonable and prudent recommendations that could have been made in the circumstances. (It should not be forgotten that this was a business that had been out of HIH’s hands for something less than three years; the directors were entitled to take that fact into account.)
41. We are left with a series of complaints about Mr Stitt’s “prudence” and “diligence”, but no objective yardstick, or legal standard, against which his actions (or inactions) are to be measured. We do not have the benefit of any testimony from the authors of the Hambros briefing paper. We do not have any experts telling us whether Hambros’ “due diligence” and “full due diligence” recommendations were appropriate and reasonable. We do not have any evidence of the true meaning of those expressions and we do not have any evidence that full due diligence would have been, and anything less than that would not have been, prudent and diligent in the particular circumstances of the case.
42. Instead, we have evidence that Mr Stitt relied on:
·a report from Milliman & Robertson, a respected firm that was one of HIH’s actuaries;
·a report from Arthur Andersen, HIH’s auditors; and
·trend graphs sourced to A. M. Best & Co, regarded by Mr Stitt as “probably the most influential and significant insurance analysts in the world”.
43. Mr Stitt thought that taking into account information of this nature amounted to the exercise of “due diligence” by the HIH Board. APRA has not demonstrated that that is not the case.
44. We are satisfied, on the evidence presented as a whole, that in the circumstances Mr Stitt did not act in a manner other than one which was competent and diligent in relation to the reacquisition of CareAmerica.
Acquisition of FAI
45. APRA’s submission is that Mr Stitt, and the directors of HIH, on 22 September 1998 took a decision to acquire FAI when there was not sufficient information to allow the board to be confident that it was a prudent commercial decision. It says that the decision amounted to speculation with the assets of HIH leading to a disastrous outcome for policy holders and that the conduct of the board demonstrated a willingness to simply “rubber-stamp” the position and conclusions of management and take unacceptable commercial risks with the company’s assets. It contends that the directors should have asked for more time and information so as to ensure a proper informed evaluation be made of the proposal, and that it demonstrated such a degree of lack of diligence required of a director or senior manager so as to demonstrate that Mr Stitt is not a fit and proper person to act as a director or senior manager. It is contended that Mr Stitt should have said that he was not in a position to make a properly informed decision and should have not allowed the acquisition to proceed.
46. APRA refers to the following circumstances.
47. From 1995, HIH regularly reviewed the possibility of acquiring FAI. Consistent with similar analyses which had been performed in earlier years, HIH examined FAI’s 1998 annual accounts released on 9 September 1998.
48. On 22 September 1998, a notice was circulated for a Board meeting that day. A number of directors were not present. Mr Stitt participated in this Board meeting by telephone, and without access to the Board papers. Three other directors, including the chairman, attended via video. The meeting was told that there were other parties interested in acquiring a shareholding in FAI and a decision had to be made as a matter of urgency. It was in that context that the meeting proceeded to consider the acquisition.
49. The only detail of the proposed acquisition presented to the Board was the Hambros’ “Project Vitamin Financial Model” which contained an assessment of the value of FAI’s assets. Mr Stitt did not have access to this document during the meeting. In that document, Hambros:
·assessed the earnings effect of the proposed FAI acquisition as “dependent on the accuracy of the forecasts used for [FAI] and the level of synergies”.
·concluded that that takeover synergy benefits would need to be of the order of $25 million pre-tax to justify the acquisition financially.
·estimated that the takeover at 75 cents per share would reduce HIH’s earnings per share by 9.5% on an undiluted basis and by more than 11 per cent, taking into account the dilution effect of HIH’s convertible notes on issue.
50. It is conceded by APRA that there is no suggestion Mr Stitt knew that the basic problem with FAI was that it was chronically under-reserved as a consequence of a series of fraudulent insurance transactions that FAI had entered into. There is no evidence or suggestion that anything could have been done by Mr Stitt to have discovered this fraud. Nor is there any suggestion of moral turpitude or lack of integrity on the part of Mr Stitt. Furthermore, there is no suggestion that as at 22 September 1998 Mr Stitt knew that other members of the board and senior management of HIH were otherwise than trustworthy, and it is accepted that he in fact trusted their integrity.
51. By the time the approach was made by FAI, it was the commercial conclusion of both HIH management, and the board of directors, that it was sound commercial policy to expand the business of HIH to develop a “critical mass” in its business to survive in the changing insurance market of the 1990s, and that there would be many complementary business advantages in the acquisition of FAI
52. Mr Stitt, in his affidavit, has dealt at length with this matter.
53. Mr Stitt emphasised that HIH had considered the acquisition of FAI since about 1995. It was not a spur of the moment decision on 22 September 1998. HIH and its advisers had kept the affairs of FAI under review, including the consideration, from time to time, of financial and public business information. It regularly received advice from Hambros as to the position and performance of FAI. The possible acquisition had been assigned the name of “Project Vitamin”.
54. The evidence of Mr Stitt details the extensive history considered by the board of the benefits of the acquisition of FAI in part or in whole, including numerous perceived synergistic benefits, as well as efficient management, branding advantages and broadening of distribution channels. The evidence was that Mr Stitt had previously considered this information. There were many other reasons which made the acquisition of FAI a significant commercial attraction, so far as HIH was concerned. Mr Stitt refers in his evidence to the numerous reports from 1995 through 1998 of Mr Colin Richardson of Hambros as to the FAI assets. He refers to Minutes of board meetings between 1996 and 1998 at which reports from Hambros were considered in relation to the acquisition of FAI, and at which Project Vitamin was discussed. He sets out the reasons why he saw FAI as a desirable acquisition in that period. In addition, he refers to meetings prior to 1998 at which specific share prices for acquisition were discussed. Also, his affidavit sets out in detail the history and depth of the examination by himself, the board, management and the advisers in relation to this acquisition.
55. Mr Stitt also gave details of his familiarity with and experience in relation to the role and function of a due diligence committee. He had been appointed a standing member of the due diligence committee of HIH in February 1998.
56. The above evidence relating to the earlier examinations, the perceived advantages and consideration of the acquisition of FAI was not contested in any significant respects by APRA.
57. The evidence of Mr Stitt, which we accept, is that on 22 September 1998, he was connected by telephone with a link-up of directors, some of whom were present by video-link. He was informed of the proposed sale by Mr Rodney Adler of Mr Adler’s stake in FAI the following day, and he took into account the statement made by Mr Williams that there were other potential purchasers in the market. He was told by Mr Williams that a decision had to be made immediately as to price. There was also present during part of the meeting a legal adviser, Mr Atanaskovic. Mr Stitt asked whether due diligence should be performed and he was informed that Mr Adler would not open the books to HIH as a direct competitor, and that the accounts which had been lodged recently with the Australian Stock Exchange were accurate and could be relied on.
58. There was some discussion about due diligence. Mr Stitt considered, as did the others present, that the board had a good and sufficient background knowledge of FAI, and that the acquisition had been discussed in sufficient detail in the past to make a decision on an urgent basis.
59. Mr Williams pointed out that Arthur Andersen, who were the auditors of both HIH and FAI, had signed-off on FAI’s accounts, and that FAI’s actuaries, PricewaterhouseCoopers, were reputable and could be relied on, particularly as to the adequacy of claims reserves. The fact that there were common auditors gave Mr Stitt some comfort. He also says that in reaching a decision he took into account and gave weight to the commercial judgment of other members of the board as well as his own.
60. Mr Stitt gave evidence that there were discussions of FAI’s financial statements, which showed FAI to have been profitable and to have had a good past performance. In forming a view as to price, Mr Stitt relied on the commercial experience of other experienced directors, who concluded that a range of share prices was appropriate in which the price of $0.75 eventually paid was assessed as reasonable.
61. Mr Richardson was present at the meeting and he supported the acquisition at a price of $0.75 per share. Mr Stitt says that he relied on Mr Richardson’s long-standing experience. He states that the board had been presented with a document concerning the “Project Vitamin Financial Model” by Hambros which contained an assessment of the value of FAI assets. Mr Stitt recollected that there was discussion of the topics set out in that model at the meeting.
62. Criticism was levelled against the conduct of Mr Stitt because he did not attend the meeting in person, when it would have been possible for him to do so, and to the fact that the meeting was conducted partly by video with some directors and by telephone with others, including Mr Stitt. There was no evidence that personal attendance would have made any difference, or that any disadvantage was caused by discussion of the acquisition taking place between parties who were not physically present at the meeting.
63. Mr Stitt also relied on the fact that before a takeover could be finalised, a Part A statement would be issued by HIH, and a Part B statement would be issued by FAI, which would entitle HIH to withdraw its acquisition offer if it had to do so. Mr Stitt said:
This was a transaction which was being done within the framework of the Corporations law, within the framework of the Stock Exchange regulations, within the obligations of continuous disclosure. To talk of it as a gamble is absolute nonsense. Any takeover is a risk, but to say it was a gamble is just patently absurd. We had to put in a Part A statement. They had to put in a Part B statement. I was on a due diligence committee for our Part A statement. ... If there was any material alteration, we could have pulled out.
64. In deciding whether there was a contravention of the fit and proper person standard in relation to the FAI acquisition, it is also appropriate to take into account several other matters.
65. APRA has called no oral evidence as to what a company director should have done in circumstances such as these. There is no evidence from any witness from APRA as to what would constitute due diligence or as to a proper course of conduct in the particular urgent circumstances having regard to the past history of examination and consideration of the affairs of FAI. In other words, the “content” of the requirement for due diligence has not been spelt out by APRA. Considerable weight must be given to the particular context and circumstances in this case and to the commercial urgency of the transaction and the need for an immediate commercial decision.
66. There is much more to be considered in relation to this allegation than the board meeting of 22 September 1998 taken in isolation. The examination of the conduct of Mr Stitt in this case calls for a careful consideration of the entire history of the commercial context in which the decision was reached to enter into the acquisition. When seen in its full context, the acquisition does not show, or in our view disclose, any conduct which departs from the standard of due care or diligence. The decision to acquire FAI called for an immediate commercial judgment, involving a degree of commercial risk due to time pressures, the existence of competitors according to the information given to Mr Stitt in relation to a business, which had been targeted for a period of three years and which had been the subject of regular financial examination.
67. We are satisfied, on the evidence presented as a whole, that, taking into account the above circumstances, Mr Stitt did not act in a manner otherwise than as a director who was competent and diligent in relation to the acquisition of FAI, and that his conduct in this respect does not reflect adversely on his present fitness to be a director or senior manager.
Allianz – Joint Venture
68. On 13 September 2000, HIH entered into a joint venture agreement with Allianz Australia Insurance Limited (Allianz) in relation to insurance business that HIH had acquired through FAI.
69. The joint venture agreement provided for Allianz to transfer its personal insurance and compulsory third party insurance business to the joint venture. Each participant would contribute to a claims reserve trust to fund the insurance liabilities of the joint venture. At that time, HIH was in urgent need of funds. The transaction involved a payment by Allianz to HIH to compensate for the sale of its insurance business to the new joint venture.
70. The joint venture was to be under the management of Allianz, and was to operate on the basis of a 51 per cent ownership by Allianz and a 49 per cent ownership by HIH.
71. It is not disputed that the cash-flow impact on HIH of this transaction was partly the cause of the liquidity problem of HIH as a result of which a provisional liquidator was appointed on 15 March 2001.
72. APRA’s criticism of Mr Stitt is that he did not properly inform himself in relation to the nature of the transaction and did not understand its impact on cash-flow and the way in which it was to be implemented, and that he did not postpone consideration of the acquisition so that there could have been a closer examination of the arrangement.
73. Specifically, APRA says that Mr Stitt failed to appreciate that the joint venture agreement dated 13 September 2000 provided for premiums to be paid to a trust, and that he did not acknowledge the significance of this. The claim against Mr Stitt is primarily related to the board meeting of 12 September 2000, at which a draft agreement to form the Joint Venture was tabled but not distributed to board members. The board decision took place after an audit committee meeting which took place on the same day at which Mr Stitt was present.
74. APRA says that on its proper construction, if read with due care, the draft agreement as tabled by Mr Fodera, an executive director of HIH, on 12 September 2000, provided that premium income after deduction for reserves would only be paid to HIH at quarterly intervals, whereas the share of Allianz was to be paid within seven days. Mr Stitt, it is said, failed to appreciate this and its consequences on cash flow.
75. APRA has called no oral evidence on this matter and Mr Stitt has dealt with it in considerable detail in his affidavit.
76. Mr Stitt first became aware of a joint venture proposal on 5 September 2000, at which stage the proposal had been well advanced by management. He was concerned to learn that management had advanced the joint venture proposal without informing him. He considered, and stated at that meeting, that it was essential to obtain further information, analysis, and evaluation of the transaction, and he insisted on having a detailed proposal presented to the HIH Board concerning the proposals together with statements of the advantages and disadvantages of such a transaction. The board minutes record that he did not let the meeting proceed and insisted on an adjournment. At the resumed meeting on 8 September, a document entitled “Strategic Options” and a paper were presented providing an evaluation of the proposals and an analysis. There was extensive discussion at that meeting of those documents. One of the options was favoured by the board at that time, namely the proposal by Suncorp-Metway.
77. That meeting was adjourned to 12 September 2000. On that date, there was an audit committee meeting and further discussion of the strategic restructure proposals. There were some disadvantages of the Suncorp-Metway proposal mentioned at that time, and the Allianz proposal was then presented as the favoured alternative.
78. The audit committee meeting commenced at 3.20 pm on 12 September 2000 when Mr Fodera referred to the joint venture arrangement with Allianz, into which the company would transfer its retail division for an upfront payment by Allianz of $200 million. He produced a pro forma balance sheet, and explained that the effect of the Allianz transaction was to introduce cash of $200 million, as well as receivables of $200 million.
79. The Allianz joint venture was proposed as having substantial benefits as regards its impact on cash-flow. The independent adviser from Hambros, Mr Colin Richardson, was strongly in favour of the Allianz proposal and Mr Stitt took this into account. There was no mention, at any stage, that under the proposed joint venture agreement the premium income covered by the agreement could be directed into the trust provided for in the joint venture, and effectively ‘quarantined’ for several months with the consequent adverse impact on HIH cash-flow.
80. At 8.30 pm, Mr Fodera tabled a draft agreement for the joint venture. After discussion, it was agreed that it was in the best interests of HIH to enter the agreement in the form of the draft. Messrs Williams and Fodera, both executive directors of HIH, were authorised to effect minor and incidental changes to the draft agreement. An agreement was executed the following day.
81. Mr Stitt initially recalled that he had not seen the agreement tabled at that meeting. At the hearing, he amended this statement, by way of evidence in chief, to say that if the draft agreement tabled at the meeting on 12 September 2000 was in the same form as the final agreement executed on the following day, then he would have read it. The draft agreement was tabled late in the meeting and he did not have an opportunity to take a copy away and read it, and was not able to consider it in great detail. He did not consider that he needed to. The final executed joint venture agreement is in evidence but the draft is not. In view of the information given at the meeting, there is some doubt as to whether the document as executed was in the identical form as the draft. Given the later disclosures as to the deceptions on the part of some of the executive directors and senior management, it is possible that there may have been some significant variation.
82. Mr Stitt did not at that time, and still does not consider that, on his reading, this agreement disclosed the ‘quarantining’ of the funds to be paid to HIH under the joint venture agreement.
83. The agreement is far from clear in relation to times for payments and accounting for premium income. Assuming that the draft was identical with the joint venture agreement executed the following day, the provisions as to when moneys were to be paid to HIH are complex in the extreme. Mr Stitt says that he would have read the document as not disclosing any “quarantining” of the funds by delaying the payments. He refers to the provisions which refer to Allianz paying two hundred million dollars to the group and to the manager accounting for the group at the end of each month after setting off the reserves and to the requirement that payment was to be made within seven days. Mr Stitt refers to the repeated emphasis in the agreement to payment.
84. In relation to the trust provisions, Cl. 13.10 refers to the establishment of the trust into which monies equal to the reserve amount for the purposes of the Insurance Act were to be paid. It refers to the release of monies to HIH at the end of March, and subsequent quarters in the event that the total value of money and assets in the trust exceeds the total reserve amount. It is this provision which provides for delayed payment which Mr Stitt is said to have not considered, or failed to understand, as regards its cash-flow implications.
85. Mr Stitt says that when reading this provision, and taking into account what he had been told by Mr Fodera at the audit committee meeting, he did not understand that the moneys would be “quarantined” but rather that they were to be paid or accounted for without delay.
86. The joint venture agreement in evidence is opaquely drafted, and it is not, on its face, clear as to whether the money would be quarantined. The repeated emphasis in the agreement on payment and accounting for monies could reasonably give rise to the impression that the moneys were to be accounted for or paid immediately or within a short period.
87. This agreement raises real and difficult questions of construction, and given the assurances from management as to the immediate benefits to cash-flow, the consensus of all directors, and the limited time available to consider the document, it was not unreasonable for Mr Stitt not to be alerted to the “quarantining” of the excess premium income above reserves and its consequences. With the benefit of hindsight, and after detailed consideration, and being alert to the potentiality of dishonesty or incompetence of management, it may now be perceived that there was a “quarantining” of the funds, but these matters were not known in September 2000.
88. To his credit, Mr Stitt was the only director who raised basic concerns and sought detailed analysis, evaluation and explanation of all the options at the meeting of 5 September. This drew attention to the need for further examination at a later meeting, which occurred on 8 September.
89. Having regard to the foregoing, we do not accept APRA’s submission that Mr Stitt misunderstood or was not diligent in relation to the Allianz joint venture. To adopt what is later seen to be an incorrect but open construction of a complex legal document does not amount to lack of care or point to incompetence, or lack of fitness.
90. Although not in its Statement of Facts and Contentions, APRA also sought to raise a question as to whether Mr Stitt exercised proper diligence in relation to the payment of the cash amount of $200 million. Since this matter was raised for the first time during cross-examination and submissions were made after the conclusion of the evidence, we do not consider that APRA should be permitted to rely on this point.
91. In any event, we do not consider there is any substance in the point because Mr Stitt has explained that he was not made aware of the delayed payment of the $200 million cash amount until after an amendment agreement making such provision had been executed by senior management.
92. Without the knowledge of Mr Stitt, an amendment agreement had been made on 24 November 2000 which provided for payment of the fixed amount of $200 million to the trustee of the trust, which in turn meant that it would also be quarantined or paid on a delayed basis.
93. It was submitted for APRA that because at a meeting on 31 October 2000 there was a line in a document tabled, which referred to Allianz cash of $200 million as being a trust liability, this ought to have been then appreciated by Mr Stitt, and he should have understood that there was a change proposed to the payment arrangements for this amount and in failing to do so, he failed to exercise due care.
94. In our view, no such conclusion should be drawn. Mr Stitt was clear in his uncontradicted evidence that at no stage was his attention directed to any possibility that the $200 million would not go to HIH directly. His evidence was that he considered this was directly contrary to what he had been told by Mr Fodera on 12 September 2000, as confirmed in the presentation to the audit committee. He was not present at the meeting of 29 November 2000 when the matter was considered, and did not receive a copy of or read the minutes until the subsequent board meeting.
95. Having considered the submission, we do not consider that it reflects in any significant adverse way on the fitness, propriety or competence of Mr Stitt to occupy the office of director or senior manager.
National Indemnity – Note in 2000 Accounts
96. Before its acquisition by HIH, FAI had entered into a re-insurance contract with National Indemnity Inc (NI), a subsidiary of Berkshire Hathaway Inc (Berkshire). In 2000, a dispute arose as to the extent of cover available to FAI under this contract. Berkshire claimed that the maximum recovery available to FAI was $50 million, and HIH claimed that it was $80 million, a $30 million difference. In the 2000 accounts HIH declared the $30 million as an asset.
97. APRA’s claim is that Mr Stitt, as a member of the audit committee of HIH, at a meeting on 12 October 2000 and thereafter at a directors’ meeting, showed lack of diligence, in that he failed to correct a misleading note to the accounts in relation to this disputed amount. Mr Fodera, an executive director, had expressed confidence to the board that FAI would recover the $30 million and the audit committee concluded that the prospects for FAI recovering the amount were strong.
98. The Minutes of the 12 October audit committee meeting record that Mr Buttle of Arthur Andersen advised, amongst other things, that there should be an amendment to the financial report referring to the fact that normal commercial disputes and actions were included in contingent liabilities. This was to be by way of a Note 37 to the accounts.
99. This amendment was accepted by the board at the meeting, but Note 37 in its final form, as implemented by management, did not come before the board. The note in the accounts was as follows:
Contingent Liabilities
Members of the consolidated entity are engaged in normal commercial disputes and actions which individually are not considered but which if taken together may have a material impact on the consolidated entity. The directors, supported by appropriate professional legal advice, consider the possibility of a material consequence to the consolidated entity, arising from these disputes or actions, to be remote. (Emphasis added)
100. Mr Stitt does not know who the author of the Note was, or who drafted or settled it, in its final form. He was not consulted about it and he would not have expected to have been asked to draft or settle the Note.
101. APRA says that the Note was misleading because there was no legal advice in relation to the estimate of $30 million recovery, and that Mr Stitt failed to exercise diligence and was incompetent in not checking to ensure that the Note was adequate.
102. Mr Stitt acknowledged that as a member of the audit committee he should accept responsibility. He said in cross-examination, however, that he was not thereby admitting personal breach of duty. He points out that the audit committee comprised six other members who were experienced auditors, including the chairman, Mr Geoffrey Cohen.
103. APRA says that the acknowledgement is a personal admission of lack of diligence by Mr Stitt, and supports the conclusion that he is not a fit and proper person to be a director or occupy a senior management position or an insurer.
104. In response, Mr Stitt refers to several matters. The first is that it has not been shown that the amount of $30 million was outside any reasonable range of estimation in an area where reasonable minds could differ in predicting the likely outcome of a court proceeding or arbitration.
105. Second, Mr Stitt says it was not unreasonable to rely on the estimation of his fellow audit committee members, who were experienced auditors, when considering the estimate or examining any subsequent note to the accounts to ensure that Note 37 in its final form was accurate. It has not been shown that, as an individual, it was prudent for him personally to “second guess” the views of the experienced members and to check the note in its final form.
106. Counsel for APRA accepts that this matter taken alone is not of “momentous importance”.
107. The Note is not specifically directed to the NI dispute, but it is a general note which refers to commercial disputes generally.
108. Mr Stitt also says that he was entitled to assume management, whom he had no reason to mistrust, would draft an appropriate note to the accounts to accurately reflect the decision of the audit committee, and it was not incumbent on him to ensure that it do so, or to pursue the matter beyond the Committee’s decision.
109. Whilst Mr Stitt has dealt with this matter extensively in his affidavit, and has been subjected to detailed cross-examination, we note that no testimony was led by APRA as to what a prudent and responsible member of an audit committee might be expected to do in such a situation, in order to prevent the Note, as finally included, from being in the form in which it was framed.
110. The evidence of Mr Stitt was that there was no discussion at the meeting of any specific level of any recovery under the NI contract, and that the meeting terminated on the basis that each of the amendments in the form of notes would be drafted and vetted by Arthur Andersen.
111. Having regard to the entire context in which the Note came to be formulated, and the evidence before us, we are not persuaded that the circumstances relating to the Note, either when taken alone or cumulatively, provide any significant support for a conclusion that Mr Stitt is not a fit and proper person for the purposes of the Act.
Claims Provisioning
112. APRA’s concerns in this area are set out in paragraphs 76 to 78 of its Statement of Facts and Contentions (“RSFC”) , as follows:
76.The so called ‘provisioning issues’ relate to the circumstances of three separate issues which were the subject of findings by the delegate in relation to the applicant’s fitness and propriety. They are:
76.1failure to consider or take steps to understand the external actuary’s reports in respect of outstanding claims;
76.2failure to properly consider a prudential margin; and
76.3failure to ask questions about previous provisioning levels.
77.These issues are related, and together demonstrate the failure of the applicant to demonstrate even the most basic level of curiosity as to the integers of the single most significant item on the HIH balance sheet. At no stage (at least from 1997 to 2001) did he call for or review one of Mr Slee’s reports. Nor did he ask to meet Mr Slee, or have him attend a Board or audit committee meeting.
78.As a direct result, he allowed himself to be misinformed as to the true state of the Group’s provisioning.
113. Mr Stitt was a member of the HIH Board audit committee. He acknowledged that the outstanding claims provision was the largest liability item on the HIH balance sheet. He explained that two or three times a year the HIH auditors, Arthur Andersen, would provide to the audit committee various pieces of information, including, in tabular form, a set of figures which sought to show the adequacy of HIH’s claims reserves. A table of this nature would typically show, by reference to the various lines of HIH’s business, the liabilities in relation to outstanding claims, as estimated, in turn, by HIH management; by HIH’s external actuary; and by the auditors. The auditors would express their estimates as a range from “low” to “high”. Mr Stitt explained that he always paid close attention to the figure estimated by the actuary, because, as he put it, the actuary was the “independent umpire”.
114. He also explained that neither he nor any other members of the audit committee had ever asked to see any of the actuary’s reports. He had never thought it necessary. As he said in cross-examination (Transcript, pages 80-81):
MR STEVENSON: And you never called for them?‑‑‑Well, why should we?
When I say “you”, I mean, members of the audit committee ‑ ‑ ‑?‑‑‑Well, why should we? I mean, if you can’t trust these sort of people, then you might as well not be in business. I mean, it’s ‑ ‑ ‑
Well, can I suggest it’s not just a question of trusting whether or not the auditors have accurately conveyed to the audit committee the actuaries’ view. Did it not occur to you that the actuary might have, in his reports, expressed views relevant to matters concerning, amongst other things, outstanding claims provision that it would be important or useful for the audit committee to have a look at?‑‑‑The actuary expressed his view as to outstanding claims provision by giving a figure in respect of each class of business in respect of each geographical area throughout the world and that that was the figure which we were given. That was the figure which we were to operate on. I mean, it would be intolerable if we had to go behind every statement of figures to say, “Well, what did you – how did you assess the great states, how did you assess California, how did you assess Argentina, how did you assess China”? I mean, we just simply couldn’t do that.
Did it not occur to you that in the reports prepared by Mr Slee he might have been expressing general views about the adequacy of claims provisions or qualifications to the views that would be useful for the audit committee to see?‑‑‑No, it did not occur to me that that would be the position. I would expect if you have management which is – which has integrity, if you have management which is competent and if you have management which you trust, you would expect management to draw your attention to anything that was unsatisfactory …
115. APRA suggested that the state of affairs in relation to HIH’s outstanding claims provision should have led Mr Stitt to call for the actuary’s reports. That state of affairs was said to be that HIH had “persistent problems in relation to under reserving” (RSFC, paragraph 90), in that the accounts for 31 December 1996, 31 December 1997, 30 June 1999 and 30 June 2000 showed that there had been under reserving in each of those years. Mr Stitt, however, saw things differently, as the following extract from the transcript (pages 72-73) shows:
MR STEVENSON: Doesn’t the fact that there's a reassessment in one year of account of the provision made in previous years of account, show that the provision made earlier was inaccurate?‑‑‑No, not at all. That's a fundamental misconception. It doesn’t understand the way the insurance business works. Let me just give you a simple example to say what I’m saying is correct. You have a crane collapses on a worksite in Chicago and there's people killed and injured, property damaged, loss of profits, business opportunity; all kinds of class of business would, or could fall under a policy that you have with that exposure. You’ve then got to sit down and work out what is this claim likely to be worth. How many of these people will ultimately claim and in what amount. In one year - in the first year nothing would have happened, the American lawyers wouldn’t have even commenced proceedings, so you’ve got to make an assessment on all of those things. You might say 20 million or 200 million, whatever it is, that's enough. But then the next year the claims start to come in and you say it’s not 20 million, it’s got to be 50 million or 100 million. Let me give you another example. The aircraft that went into the World Trade Centre, I was - I’m still on syndicates in that aviation syndicate in Lloyds. They still haven’t worked out whether there's one claim or two claims or four claims since the World Trade Centre in 9/11. Now that's an example where each year there has to come back somebody to say well, yes, we said last year was 100 million, this year we’re saying it’s 200 million. It doesn’t mean that we got it wrong, it just means that it changes and that it alters.
And surely it can reflect, can’t it, adverse development in various portfolios?‑‑‑Of course it can, and you might settle a claim that you thought you’re going to pay 500 million and you settle it for 20 million, so you’ve had a benefit. I mean it goes up and down.
Isn’t it the case that the documents you saw, or the director of HIH showed that there had been a decline in the adequacy of claims provisions throughout the late 1990s?‑‑‑No. All that there was a decline in was that there were more claims being made; that's all. But all that meant was that we had to bump up our reinsurance treaties, the extent of our cover.
116. This extract also introduces one of the fundamental disagreements between APRA and Mr Stitt as to the approach to provisioning. APRA insists that prudence dictates a “prudential margin” in the outstanding claims provision, so as to cover those risks that cannot be catered for in the standard actuarial calculation. On the other hand, Mr Stitt says that the critical issue is to have a reliable calculation of the provision, and then cover the liability by entering into appropriate reinsurance treaties. He referred to this approach as “reinsurance to close”, an approach on which, he said, Lloyds of London had operated for hundreds of years.
117. Towards the end of the first hearing day, for the first time, Mr Stitt was shown the reports written by Mr Slee, the actuary, in relation to the periods ending 31 December 1999 and 30 June 2000. The first of those reports noted at page 6 of the executive summary:
I point out that for the past 3 years the result with the benefit of hindsight has shown that in fact the reserve was inadequate. When reserves are fully discounted and only have a 50% probability of adequacy, the company does run high risks and therefore one would expect to see a solvency margin well in excess of the legal minimum requirement.
I would suggest that prudence would suggest that the solvency margin be at least 20% of the net discounted claim reserve, that is $533,000,000 excluding goodwill as an asset.
118. In the second report Mr Slee said at page 8:
Given the fact that the legal requirement is for the solvency margin to be available at all times (not just on balance date), and given the exposure to uncertainty, I would suggest that prudence would dictate that the solvency margin be at least $500,000,000 excluding goodwill as an asset.
119. It is now clear that management of HIH concealed those reports from the Board, and possibly also from the auditors. As a result, all the audit committee saw when the auditors made their regular presentations to the committee was the figure estimated by the actuary, but without any reference to the qualifications that he expressed in his reports. The question is whether, at any time from March 2000 (when Mr Slee made the first of these particular reports) to October 2000 (when he made the second of them), the circumstances should have alerted Mr Stitt to the need to require production of Mr Slee’s reports, or at least to require Mr Slee to attend and provide information to the audit committee. We are satisfied, on the basis of Mr Stitt’s explanations, that there was no reason, at that time, for Mr Stitt to take either of those courses.
120. We are also satisfied with his explanations in relation to APRA’s assertions that:
·a “prudential margin” should be included in the outstanding claims provision; and
·there had been “persistent” under reserving over a period of years.
121. As to the first of those assertions, the decision not to include a prudential margin had been made as a matter of principle by the HIH board as a whole, some years earlier. Against that background, Mr Stitt, as a member of the audit committee, considered the claims provisions every six months, by comparing the estimates made by management with those made, first, by the actuary and, second, by the auditors. APRA has not demonstrated any shortcoming in that approach, which seems to us to be an entirely reasonable one. From Mr Stitt’s perspective, there was a further layer of prudence applied to the exercise by ensuring that the outstanding claims provisions were covered by appropriate reinsurance treaties. On the information available to him at the time, and especially in light of management’s concealment of the actuary’s warnings from the audit committee, Mr Stitt’s actions are not open to reasonable criticism.
122. As to the second assertion, we agree with Mr Stitt’s point that an increase in provisions for prior years’ claims from one year to the next does not lead to a conclusion that the earlier year’s provision was inaccurate. Not only is there no congruence between the “prior years” referred to in the first year and those referred to in the second year; it is also the case that the estimates of liability are made one year apart. For that reason, they should be expected not to remain constant, but to move both up and down, and sometimes even significantly, from one year to the next, depending on the facts known as at the balance date. No adverse inference against Mr Stitt is justified merely on the basis that he took no action in relation to the increase in the provision over several consecutive years.
123. We are satisfied, on the evidence presented as a whole, that in the circumstances Mr Stitt did not act in a manner other than one which was competent and diligent in relation to the quantification of outstanding claims provisions.
Acknowledgement of Error
124. APRA submits that the fact that Mr Stitt adheres to the position that he would not have done anything differently, even with the benefit of hindsight, indicates that he is not a fit and proper person to be or act as a director or senior manager of a general insurer. However, this submission depends on whether there were contraventions, and we are not persuaded that any contravention of the standard of diligence, competence and experience has been made out. Moreover, the position of Mr Stitt is that he did not think he would do anything differently because what he did was based on the best analysis he could bring to bear on the information with which he was provided at the time. This indicates that his approach to the questions raised was to do his best, given the information available.
125. Finally, we note that Mr Stevenson SC submits that the Tribunal, when deciding whether Mr Stitt is a fit and proper person, should look at what has happened in the past eight years to see whether his fitness for office has changed in any positive way. Over that period, there have been a Commission of Inquiry and two examinations by APRA of his conduct. The decisions of APRA resulted in Mr Stitt’s disqualification as a director and a senior officer. It is to be reasonably expected that subjection to such detailed scrutiny over the past eight years would serve to closely focus Mr Stitt’s attention on the need to exercise great caution in the performance of the role of director or senior officer. This incentive would operate to lessen the possibility of any contravention of his obligations in performing such functions in the future.
DECISION
126. We conclude that the decision of Mr Kennedy as confirmed by Ms Tongue should be set aside and that the correct and preferable decision is that Mr Stitt should not be disqualified from being or acting in a s 24 position pursuant to s 25A of the Insurance Act 1973.
I certify that the one hundred and twenty-six (126) preceding paragraphs are a true copy of the reasons for the decision herein of The Hon B J M Tamberlin QC, Deputy President, and Mr S E Frost, Member.
Signed: .................................[sgd]............................................
AssociateDate/s of Hearing 1-3 June 2009
Date of Decision 14 August 2009
Counsel for the Applicant Mr B Walker SC and Mr R Carruthers
Solicitor for the Applicant Mr S Morris and Ms K Banton, Piper Alderman
Counsel for the Respondent Mr J Stevenson SC and Mr P BrahamSolicitor for the Respondent Ms D Dinnen, Australian Government Solicitor
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