Smith v Australian Prudential Regulation Authority
[2017] FCA 807
•19 July 2017
FEDERAL COURT OF AUSTRALIA
Smith v Australian Prudential Regulation Authority [2017] FCA 807
File number: NSD 1909 of 2016 Judge: NICHOLAS J Date of judgment: 19 July 2017 Catchwords: INSURANCE – application to revoke or vary disqualification under s 26 of the Insurance Act – whether disqualification continues to be justified – relevant considerations – length of disqualification to date – applicant’s remorse and recognition of wrong-doing – APRA’s assessment of future prudential risk and whether applicant likely to pose a prudential risk in the future – disqualification revoked with effect from date of order Legislation: Insurance Act 1973 (Cth), ss 25A, 26(1)(a)
Financial Sector Legislation Amendment (Review of Prudential Decision) Act 2008 (Cth)
Cases cited: Australian Broadcasting Tribunal v Bond (1990) 170 CLR 321
Burroughs v Australian Prudential Regulatory Authority (2016) 246 FCR 38
Date of hearing: 15 March 2017 Registry: New South Wales Division: General Division National Practice Area: Commercial and Corporations Sub-area: Commercial Contracts, Banking, Finance and Insurance Category: Catchwords Number of paragraphs: 51 Counsel for the Applicant: Mr S Rushton SC with Mr A Byrne Solicitor for the Applicant: Clyde & Co Counsel for the Respondent: Mr PS Braham SC with Mr BK Lim Solicitor for the Respondent: Mr Ben Carruthers ORDERS
NSD 1909 of 2016 BETWEEN: JOHN ANDREW SMITH
Applicant
AND: AUSTRALIAN PRUDENTIAL REGULATION AUTHORITY
Respondent
JUDGE:
NICHOLAS J
DATE OF ORDER:
19 JULY 2017
THE COURT ORDERS THAT:
1.Pursuant to s 26(1)(a) of the Insurance Act 1973 (Cth) (“the Act”) the decision made by the Australian Prudential Regulation Authority on 5 October 2004 that John Andrew Smith is a disqualified person pursuant to s 25A of the Act (as it then stood) be revoked with effect from 19 July 2017.
2.There be no order as to costs.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
REASONS FOR JUDGMENT
NICHOLAS J:
INTRODUCTION
Before me is an application by the applicant, John Andrew Smith, seeking an order pursuant to s 26(1)(a) of the Insurance Act 1973 (Cth) (“the Act”) revoking a decision made by the Australian Prudential Regulation Authority (“APRA”) on 5 October 2004 pursuant to s 25A of the Act (as it then stood) disqualifying Mr Smith from acting as (inter alia) a director or senior manager of a general insurer (other than a foreign general insurer) or as a senior manager, or agent in Australia for the purposes of s 118 of the Act, of a foreign general insurer.
APRA is the sole respondent to this proceeding. Senior Counsel for APRA made both written and oral submissions in relation to Mr Smith’s application which make clear that APRA does not oppose Mr Smith’s application in so far as any revocation order made will have prospective operation. Of course, it is ultimately necessary for the Court to be satisfied that it is appropriate to make the order sought by Mr Smith.
THE EVIDENCE
The affidavit evidence in support of the application comprises two affidavits made by Mr Smith and an affidavit made by Mr John Richardson OAM. Mr Smith also gave some oral evidence-in-chief relating to his dealings with a Mr John Byrne in 2001 and the summary termination of his employment in 2005 which I refer to in more detail later in these reasons. Neither Mr Smith nor Mr Richardson was cross-examined.
APRA relied on an affidavit of Ms Jennifer Balding, a Senior Manager in the Specialised Institutions Division of APRA. She was not cross-examined. Annexed to her affidavit were a number of documents including:
·a copy of the current version of Prudential Standard CPS 520 Fit and Proper (“CPS 520”) which came into effect on 1 January 2013;
·transcripts of telephone conversations produced to APRA in 2001 including a transcript of a telephone conversation between Mr Smith and Mr Byrne on 14 June 2001;
·a copy of Mr Smith’s application for review of the decision of 5 October 2004 that was filed with the Australian Appeals Tribunal (“AAT”) on 20 December 2004.
THE RELEVANT PRINCIPLES
Section 26(1) of the Act, in its current form, provides as follows:
A disqualified person, or APRA, may apply to the Federal Court of Australia for:
(a)If the person is a disqualified person only because he or she was disqualified under section 25A – a variation or a revocation of the order under that section; or
(b)Otherwise – an order that the person is not a disqualified person.
The provision was enacted in 2008 by the Financial Sector Legislation Amendment (Review of Prudential Decision) Act 2008 (Cth) which, among other things, removed APRA’s power to disqualify insurance practitioners and conferred on the Federal Court new powers directed to the same end.
The construction and operation of s 26 was considered for the first time in Burroughs v Australian Prudential Regulatory Authority (2016) 246 FCR 38. It is not necessary to repeat the history and objects of the Act, or the constitutional character of the revocation power, explained in detail by Allsop CJ in that decision: see at [50]-[64]
In applying s 26(1)(a), consideration needs to be given to the surrounding statutory context of the provision, including the current disqualification regime under the Act: Burroughs at [57]
Section 25A(1) of the Act, in its current form, provides that, on application by APRA, the Court may disqualify a person from being or acting as a director or in other senior managerial roles set out in subsection (2) if the Court is satisfied that:
(a)the person is not a “fit and proper person” to be or act as a such a person; and
(b)the disqualification is “justified”;
Section 25A(3) sets out the matters that the Court may take into account when determining its satisfaction as to a person’s fitness and propriety. They include any matters set out in the regulations, any criteria for fitness and propriety set out in the prudential standards, and any other matters the Court considers relevant. Section 25A(4) then sets out the matters that the Court may take into consideration when determining its satisfaction as to whether a disqualification is justified, namely: the person’s conduct in relation to the management, business or property of any corporation, and any other matters that the Court considers relevant.
As stated by Allsop CJ in Burroughs (at [61]):
The length of disqualification under s 25A is for a period that the Court considers to be ‘appropriate’. An ‘appropriate’ length of time will be one that best serves the protective purposes of the Act. The Court must make a value judgment on the length of time that must pass before a person is no longer a prudential risk to the insurance industry. The regime is not essentially punitive. However, in setting an ‘appropriate’ disqualification period, the Court will consider the seriousness of a person’s wrongdoing as part of its inquiry and in so doing send a clear message of deterrence to others in the insurance industry.
As his Honour also explained, the task for the Court is to determine whether (at [67]):
a disqualification continues to be justified or whether it should be revoked or varied. The Court’s analysis will have regard to previous conclusions pertaining to an applicant’s fitness and propriety (be they made by APRA prior to 2008 or by this Court after 2008) and whether these continue to be sufficiently justified to warrant the revocation or variance of the disqualification. This formulation avoids the Court’s having to make a positive finding of a person’s fitness and propriety in the nature of a jurisdictional fact and yet continues to be guided in its content by the considerations found in the current s 25A of the Act.
The term “fit and proper” derives its meaning from its statutory context, the activities in which the person is or will be engaged, and the ends to be served by those activities: Australian Broadcasting Tribunal v Bond (1990) 170 CLR 321 at 380. Section 25A(3) also requires the Court to consider any relevant criteria set out in the prudential standards.
Prudential Standard GPS 520 includes, as a criterion of fitness and propriety for holding a position of responsibility within APRA-regulated institutions, that:
it would be prudent for a regulated institution to conclude that the person possesses the competence, character, diligence, honesty, integrity and judgment to perform properly the duties of the responsible person position.
In the case of the insurance industry, a senior manager’s or director’s level of diligence and competence must be very high, particularly given that the purpose of prudential supervision is to prevent corporate failure by ensuring that risk is well-managed: Burroughs at [73]).
A further aspect of the meaning of “fit and proper” is that s 26(1)(a) of the Act requires the Court, in considering a revocation application, to assess whether the conclusions concerning the applicant’s fitness and propriety at the time of their disqualification continue to be sufficiently justified, at the time of the revocation application, to warrant the revocation of the disqualification. Section 25A(4) provides that, in deciding whether a disqualification is justified, the Court may have regard to the person’s conduct in relation to the management, business or property of any corporation, and any other matters the Court considers relevant. Since the Act imposes primary responsibility for protecting the interests of policyholders on directors and senior management of general insurers, the likelihood of a person being a prudential risk is a relevant consideration: Burroughs at [80]).
THE RELEVANT FACTS
Mr Smith was employed by General & Cologne Reinsurance Australasia Limited (later known as General Reinsurance Australia Ltd) (“GCRA”), a subsidiary of General Cologne Re, between 1998 and 2005, first as an underwriter in the Treaty Department, and, from December 1999, as the Chief Treaty Underwriter. In 1998, companies within the FAI group negotiated a financial reinsurance transaction with GCRA which included an aggregate excess of loss contract (“AXOL contract”). Mr Smith was involved in negotiating and documenting the contract.
The AXOL contract, and the circumstances of its negotiation and documentation, were addressed at the Royal Commission into the failure of HIH Insurance Limited, and, in the report handed down in 2003 at the conclusion of the Royal Commission, Justice Owens found that the AXOL contract was a sham. His Honour made adverse findings about various people involved in the transaction including Mr Smith.
The circumstances giving rise to Mr Smith’s disqualification, and Justice Owens’ and APRA’s findings in relation to those matters, are set out in an attachment to APRA’s Disqualification Decision dated 5 October 2004 (“Disqualification Decision”). The following summary is based upon that document.
During 1998, Mr Smith was employed by GCRA as an underwriter in the Treaty Department, and was the Australian representative of the General Cologne Re Alternative Solutions Business Unit. From December 1999, he held the position of Chief Underwriter at GCRA.
In 1998, companies in the FAI group negotiated with GCRA the AXOL contract, first made in May 1998 (“first AXOL contract”) and renegotiated in June 1998 (“second AXOL contract”). The first and second AXOL contracts formed part of a larger transaction involving GCRA (“GCRA transaction”).
The first significant meeting between GCRA and FAI concerning the GCRA transaction was on 18 March 1998. Mr Smith did not attend but received a report on it and was told that FAI was under-reserved on certain books of business. Shortly after, Mr Smith was copied on an email sent by a colleague at GCRA indicating that FAI wanted a solution by which it could take up reserves over three years totaling $65m and that knowledge of the transaction would be restricted to certain people at FAI and GCRA including Mr Smith.
On 24 March 1998, FAI wrote to GCRA confirming that the “expected run-off losses” for two accounts over the following three years were $25m, $20m and $20m, and Mr Smith passed that letter on to others at GCRA including Mr Ellingsen of GCRA. On 25 March 1998, Mr Smith received an email from Mr Ellingsen including a draft slip indicating that the GCRA transaction would include the following elements.
(a)it would include a slip (which would be cashless and contain an offset clause), but it would not be apparent at “first glance” how the slip worked;
(b)the slip contained three sections of cover (year 2000 risk, professional indemnity and non-recoverable reinsurance) with an overall aggregate limit of $65m; and
(c)the “basic premium”, payable over five years and totalling $55m, was to be held on deposit by the reinsured on behalf of the reinsurer until 1 July 2002 and GCRA was not to be obliged to make cash payments before that date.
The $10m “gap” apparent on the face of the draft slip was to be made up by other profitable (for GCRA) reinsurance business to be written at the time, and it was envisaged that this “other business” was to be risk bearing. Without the offset clause, GCRA would have been exposed to a known loss of $10m on the contract. It was because of the “other business” that the structure of the transaction was not apparent at “first glance”.
On 26 March 1998, Mr Smith met with Mr Mainprize of FAI and explained the “bare bones structure” of the proposed transaction. On 16 April 1998 Mr Smith sent a facsimile to Mr Burroughs at FAI with a revised draft slip and stated that it shows the “bare bones structure as promised.” The slip was very similar to what had been shown to Mr Mainprize.
In early April 1998, GCRA conducted a due diligence of FAI’s underwriting and claims files, and Mr Smith was involved in that process. A report was produced, and it concluded that FAI had substantial shortfalls in a number of portfolios, totalling about $110.78m. After the due diligence, Mr Smith attended a meeting at GCRA at which Mr Ellingsen stated that the transaction would not proceed unless there was an “arrangement of $12.5m additional premium that ... would not be affected by claims”.
In late April 1998, Mr Smith and Mr Burroughs attended meetings at which they identified the types of cover which would not ultimately be included in “other business” under the AXOL contract and types that would be included. Mr Smith told the Royal Commission that he knew, at least by mid April 1998, that the gap was $10m, the fee was $2.5m and it was anticipated that this would be made up under the “other business”. Mr Smith was involved in revising the draft first AXOL contract.
Around this time, Mr Smith prepared and signed six 1 May 1998 contracts, which, on their face, provided for the different types of cover Mr Smith had agreed with Mr Burroughs. In total, the six contracts provided for payment of $12.5m by way of premiums in two equal instalments of $6.25m on 1 May 1998 and 1 July 1998. On 6 May 1998, FAI accepted the cover provided for in the six 1 May 1998 contracts.
A 1 May 1998 side letter became the means of ensuring the six 1 May 1998 contracts remained claims free. It was addressed to the Managing Director of GCRA and stated that “Despite the contractual intention of the [six 1 May 1998 contracts], unless mutually agreed by both parties, FAI will not seek reinsurance recoveries [under those contracts].” At the Royal Commission, Mr Smith acknowledged that the letter appeared to take away any underwriting risk for GCRA which would be apparent on the face of the six contracts.
On 6 May 1998, Mr Smith (and Mr Self of GCRA) attended the FAI offices to execute the first AXOL contract. Mr Smith backdated the contract to 16 March 1998. Also on 6 May 1998, a letter was prepared by GCRA and sent to FAI stating:
Following our discussions in your offices and by phone, we hereby agree that should the performance of the [AXOL contract], made between our companies, be prohibited or rendered inoperable in consequence of any law or regulation which is in force in Australia then we will suspend the cover provided under those contracts set out in your letter dated 1 May 1998 and return in full any premiums already paid thereunder less any claims paid or due for payment.
On 23 June 1998, FAI requested that GCRA provide further reinsurance cover for $40m. Mr Smith prepared a redraft of the existing slip, and it was emailed to others at GCRA on 24 June 1998. The slip contained two additional sections: one for General and Products Liability written prior to 1 June 1998 and the other for Professional Indemnity business written prior to 1 June 1998, with an additional $20m of cover ($10m per section). The total cover in aggregate was $85m with a premium of $75m.
During the negotiations for the second AXOL contract, GCRA and FAI agreed on a fee payable to GCRA of $2.25m and that agreement manifested itself in section 6 of the second AXOL contract (premium of $2.25m payable in five instalments of $450,000 over four and a half years). The inclusion of section 6 conveyed the misleading impression that GCRA was providing insurance cover under section 6.
On 26 June 1998 Mr Smith and Mr Self met with Messrs Wilkie and Mainprize of FAI, and, at the meeting, the second AXOL contract was signed by Mr Smith and Mr Self on behalf of GCRA. Shortly after, Mr Smith and Mr Self received from FAI a side letter dated 26 June 1998 stating: “Despite the contractual intention of Section 6 in the [AXOL contract], unless mutually agreed by both parties, FAI Insurance Group will not seek reinsurance recoveries under this section of this reinsurance contract”. The letter conveyed the misleading impression that GCRA was providing insurance cover under section 6, and disguised the fact that $2.25m in related “premium” was a fee.
On 29 May 1998, GCRA received $6.25m in aggregate premium due under each of the six 1 May 1998 contracts. On 9 July 1998, GCRA received a further $6.25m. The premium of $12.5 million comprised the $10m “shortfall” resulting from the provision of cover of $65m under the first AXOL contract for premium of $55m, and a $2.5m fee. GCRA was entitled to a further fee of $2.25m under the second AXOL contract.
Dr Darryl Roberts, the APRA delegate who made the Disqualification Decision, made the following findings in the Disqualification Decision.
(a)The AXOL contract was not a genuine contract of reinsurance, but a sham disguising a transaction between FAI and GCRA pursuant to which there was no transfer of risk;
(b)Mr Smith was involved in negotiating and documenting the transaction, and realised:
(a)the transaction was being pursued by FAI for the purpose of transferring claims losses, of which FAI was aware, into future reinsurance premium so as to stage an increase in its reserves over time;
(b)although one element of the transaction involved the AXOL contract, which on its face suggested risk transfer to GCRA, overall the transaction did not involve any risk transfer;
(c)the transaction was documented for the purpose of enabling the officers of FAI to present only the AXOL contract to FAI’s auditor and hide those elements that removed risk transfer;
(d)FAI proposed to account for the AXOL contract as a contract of reinsurance by booking a substantial profit under the contract for the year ended 30 June 1998, and, to do so, FAI would have to withhold from the auditor the “six 1 May 1998 contracts”, the fact of their connection with the AXOL contract and the “1 May 1998 side letter”; and
(e)the GCRA transaction was financially detrimental to FAI in that it involved payment of more premiums and fees than possible total recoveries with no legitimate commercial benefit being conferred on FAI under the transaction.
Dr Roberts concluded that Mr Smith:
(a)was aware that the GCRA transaction was improper and yet facilitated it;
(b)knew that the transaction was documented to enable the officers of FAI to present only the AXOL contract to the auditor of FAI and hide those elements that removed risk transfer;
(c)facilitated the GCRA transaction to enable FAI to make a significant profit which it would not have made unless the transaction had been documented in that form;
(d)did not demonstrate, by his involvement and role in the GCRA transaction, integrity in the conduct of business duties; and
(e)was not a fit and proper person to hold a “section 24” position under the Act (in its then form).
By reason of the Disqualification Decision, Mr Smith was designated a “disqualified person” for the purposes of the Act, and, accordingly, became prohibited, pursuant to s 24, from acting as:
(a)a director or senior manager of a general insurer (other than a foreign general insurer); or
(b)a senior manager, or agent in Australia for the purposes of s 118 of the Act, of a foreign general insurer (that is, a foreign company authorised under section 12 to carry on insurance business in Australia); or
(c)a director or senior manager of an non-operating holding company of a general insurer or insurers authorised under s 18 of the Act.
In April 2004, a short time after the HIH Report was handed down by his Honour Justice Owens (and against the background of the findings in the report), Mr Smith voluntarily provided to ASIC a written Enforceable Undertaking:
(a)to undertake a professional development program with the St James Ethics Centre encompassing ethical decision-making and leadership, with the program to be approved by ASIC; and
(b)not to engage in certain conduct related to the provision of financial services for at least 12 months.
Mr Smith completed the program with the St James Ethics Centre in 2004 and complied otherwise with the Enforceable Undertaking.
By way of summary of relevant events since 2005:
(a)In 2005, Mr Smith and his family moved to France, and Mr Smith was employed as a treaty underwriter by AXA Re, a reinsurance company that in 2006 became Paris Re following its sale to private investors;
(b)In 2007, Mr Smith’s role at Paris Re was moved to Zug in Switzerland, and so Mr Smith and his family moved to Switzerland;
(c)In 2009, Paris Re was taken over by Partner Re, and, following an interview, Mr Smith was employed as a senior treaty underwriter in the catastrophe underwriting department of Partner Re with effect from July 2009;
(d)In 2011, Mr Smith’s family returned to Australia, and he returned to Australia in April 2012. Since May 2012, Mr Smith has been employed at Guy Carpenter & Co in Sydney, first in treaty placements; since June 2012, as head of broking; and since August 2014 as chief risk officer in the Sydney office.
The circumstances of Mr Smith’s summary dismissal from GCRA were addressed in correspondence between Mr Smith’s solicitors and APRA in 2016, prior to commencement of this proceeding. As noted in that correspondence:
(a)Mr Smith’s employment was terminated on the basis of conduct of Mr Smith in 2001 in connection with a notice to produce issued by ASIC;
(b)in that context, Mr Smith engaged in telephone discussions, in 2001, with an employee of a related entity of GCRA about whether particular documents should be produced;
(c)the other employee suggested that certain documents should be removed from GCRA’s files (and, it follows, not produced to ASIC);
(d)Mr Smith contemplated that suggestion, but came to appreciate that it would be inappropriate and raised this issue with a more senior colleagues at GCRA; and
(e)Mr Smith accepts that his having engaged in those discussions and having considered removal of documents from a file demonstrated (in 2001) poor judgement.
The relevant telephone conversations were recorded and a transcript of them is in evidence. In April 2005, some four years after those conversations occurred, Mr Smith prepared a document which sets out his recollection of the context of the conversations and his reasons for making various statements in the course of them. In that document Mr Smith acknowledges his error of judgment and expresses his regret. I should emphasise that the relevant telephone conversations that eventually led to Mr Smith’s summary dismissal occurred in 2001, approximately three years before this disqualification.
CONSIDERATION
There is no doubt that the wrongful conduct that gave rise to Mr Smith’s disqualification was serious and dishonest. In short, he facilitated a sham transaction that enabled FAI to deceive its auditors. He now accepts that what he did was dishonest and that APRA’s decision to disqualify him was correct. He has expressed considerable remorse, and also demonstrated a genuine appreciation of the hardship that many innocent people suffered as a result of the collapse of HIH.
Since his disqualification, Mr Smith has continued to work in the insurance and reinsurance industry in France, Switzerland and Australia. His roles have included treaty underwriter and senior treaty underwriter although he has not had individual underwriting authority and has not had others reporting to him. Since 2012 he has been employed by Guy Carpenter & Co in various capacities including, most recently, as chief risk officer in the Sydney office, under the supervision of Mr Tony Gallagher, the Chief Executive Officer.
Mr Smith’s attitude to his previous conduct is now very different to what it was in January 2005 when, at the time of discontinuing his application for a review of the disqualification decision, he “emphatically denied” behaving in a dishonest manner. Further, as I already mentioned, Mr Smith has undertaken a number of ethics and compliance courses. These have enabled him to learn about, and reflect on, various ethical issues, and he has endeavoured to apply what he has learnt in these courses in his employment.
Mr Richardson, the Executive Chairman of Guy Carpenter, with whom Mr Smith has worked since 2012, has deposed to Mr Smith’s competence and character. Mr Richardson says that Mr Smith adopts a stringent approach to ethical and corporate governance issues, and that he regards Mr Smith as a person of honesty and integrity.
The views of APRA will usually carry significant weight in a case such as this. In Mr Smith’s case, Senior Counsel for APRA stated that his client does not consider that there is any real and not remote chance that Mr Smith will pose a prudential risk if his disqualification is revoked.
The conduct which gave rise to Mr Smith’s disqualification occurred around 20 years ago, and the length of his disqualification thus far has been approximately 12 years and eight months. He has had a significant period of time in which to reflect on his previous wrongful conduct.
I am satisfied that Mr Smith is not likely to pose a prudential risk in future. Given the lengthy period during which he has been disqualified, his manifest remorse, and his acknowledgment and understanding that his previous conduct was serious, wrong and dishonest, I am satisfied that the continuation of his disqualification is not justified.
DISPOSITION
There will be an order pursuant to s 26(1)(a) of the Insurance Act 1973 (Cth) (“the Act”) that the decision made by the Australian Prudential Regulation Authority on 5 October 2004 that John Andrew Smith is a disqualified person pursuant to s 25A of the Act (as it then stood) be revoked with effect from 19 July 2017.
There will be no order as to costs.
I certify that the preceding fifty-one (51) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Nicholas. Associate:
Dated: 19 July 2017
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