R v Sullivan
[2014] NZHC 2501
•14 October 2014
IN THE HIGH COURT OF NEW ZEALAND TIMARU REGISTRY
CRI 2011-076-1948 [2014] NZHC 2501
THE QUEEN
v
EDWARD ORAL SULLIVAN, ROBERT ALEXANDER WHITE and LACHIE JOHN McLEOD
Hearing: 12, 13, 17, 18, 19, 21, 24, 25, 26, 27, 31 March 2014
1, 2, 3, 4, 7, 8, 9, 14, 15, 16, 28, 29, 30 April 2014
1, 2, 5, 6, 7, 8, 9, 13, 14, 15, 22, 26, 27, 28, 29, 30 May 2014
3, 4, 5, 6, 10, 11, 12, 17, 18, 19, 20, 24, 25, 26, 27 and
30 June 2014
21, 23, 24, 28, 30 July 2014
5, 6, 7, 8, 12, 13, 14, 15, 16 and 18 August 2014Counsel:
C R Carruthers QC, N F Flanagan, P W Gardyne and
E Rutherford for Crown
P H B Hall QC, M A Corlett and K H Cook for Mr Sullivan
R B Squire QC for Mr White
J H M Eaton QC for Mr McLeodVerdicts:
14 October 2014
Reasons:
14 October 2014
REASONS FOR VERDICTS OF HEATH J
Solicitors:
Serious Fraud Office, PO Box 7124, Wellesley Street, Auckland
Meredith Connell, PO Box 2213, Auckland
Gresson Dorman & Co, PO Box 244, Timaru
Rhodes & Co, PO Box 13444, Armagh, ChristchurchDuncan Cotterill, PO Box 5, Christchurch
Counsel:
C R Carruthers QC, PO Box 305, Wellington P H B Hall QC, PO Box 3750, Christchurch R B Squire QC, PO Box 10157, Wellington
J H M Eaton QC, PO Box 13868, Armagh, Christchurch
M A Corlett, PO Box 4338, Shortland Street, Auckland
R v SULLIVAN [2014] NZHC 2501 [14 October 2014]
Contents
1. Verdicts [1] 2. Structure of reasons [8] 3. Reasons for verdicts – legal requirements [12] 4. South Canterbury’s business environment: 2004–2010
(a) A culture of concealment?
[15]
(b) Rapid growth: 2004 – mid 2008 [18] (c) Effect of financial crises: mid 2008–2010 [23] 5. Governance and management
(a) Introduction
[26]
(b) Board dynamics [27] (c) Mr Hubbard’s role [46] (d) Accounting systems [52] (e) Loan authorities [59] (f) Related party lending [64] (g) Delegations from directors to management [81] (h) “Knowledge” of prospectuses and financial statements [85] 6. The Trust Deed [99] 7. The Guarantee Scheme
(a) The reasons for the Guarantee Scheme
[108]
(b) South Canterbury’s application to enter the Scheme [117] (c) South Canterbury’s processes [128] (d) An attempt to amend the Guarantee Deed [138] (e) The final form of the Guarantee Deed [140] 8. The transactions
(a) The Shark transactions
(i) Shark 1 [143] (ii) Shark 2 [164] (b) The Woolpak transaction [179] (c) The Hyatt transactions (i) Introductory comments [220] (ii) The Hilltop transaction [226] (iii) The Quadrant transaction [277] (d) The Dairy Holdings transaction [297] (e) The Kelt transaction [314] 9. The $150 million banking facility [355] 10. Debt impairment [358] 11. The financial reporting environment [362] 12. The indictment and its particulars
(a) The form of the indictment
[373]
(b) The prospectus charges: Counts 1–5 [378] (c) The “theft” charges: Counts 6–8 [387] (d) The “deception” charges: Counts 9 and 10 [391] (e) The false accounting charges: Counts 11 and 12 [396] 13. Relevant rules of practice and evidence
(a) Onus and standard of proof
[399]
(b) Accused not giving evidence [401] (c) Circumstantial evidence and inferences [403] (d) Expert evidence [406] (e) Separate trials [415]
14.
(f) (g) (h) Sympathy and prejudice
Lies
General
[417] [418] [420] The prospectus charges: Legal principles (a) The regulatory regime [421] (b) The offence [430] (c) Elements and legal principles (i) “Making or concurring” [432] (ii) Material falsity [437] (iii) Knowledge, recklessness and intent [446]
15. The “theft” charges: Legal principles
(a) The offence [454]
(b) Elements and legal principles
(i) What must be proved? [456] (ii) Control [459] (iii) The “obligation” [465] (iv) Requirement – Trust Deed [467] (v) Requirement – Guarantee Deed [470] (vi) Specific and general “requirements” [477] (vii) “Knowledge” [483] (viii) Intention [484]
16. The “deception” charges: Legal principles [487]
17. The “false accounting” charges: Legal principles [491]
18. Count 1: 18 November 2004–27 October 2005: Prospectus 55
(a) The charge [500]
(b) Outcome [502] (c) Shark 1 – materiality [503] (d) Shark 2 – materiality [508] (e) Conclusion [513]
19. Count 9: 26 May 2006: Deception
(a) The charge [514]
(b) Materiality and inducement [519] (c) Knowledge and falsity [521] (d) Conclusion [542]
20. Count 6: 1 June 2006: Theft [544]
21. Count 11: 1 June 2006: False accounting [554]
22. Count 2: 28 September 2006–16 October 2007: Prospectus 57
(a) The charge [565]
(b) Omission of the Woolpak lending
(i) Material falsity [571] (ii) Knowledge [579] (iii) Intention to induce [584]
(c) Omission of the Hyatt lending [586]
(d) Conclusion [594]
23. Count 3: 14 October 2007–25 October 2008: Prospectus 58
(a) The charge [595] (b) Omission of the Woolpak lending [602] (c) Omission of Hyatt lending [603] (d) Conclusion [608]
24. Count 10: 14 October 2008 and 3 November 2008: Deception
(a) The charge [609]
(b) Inducement
(i) Background [612] (ii) Witnesses [614] (iii) Documentary evidence [620] (iv) Analysis [626]
(c) Conclusion [639]
25. Count 4: 23 October 2008–22 September 2009: Prospectus 59
(a) Introduction [640]
(b) Woolpak lending [642] (i) Mr Sullivan [644] (ii) Mr White [648]
(c) Omission of the Hyatt lending [657]
(d) The $150 million bank facility
(i) The charge [661] (ii) The statements in Prospectus 59 [664] (iii) The Syndicated Agreement: Interpretation [666] (iv) Relevant background [678] (v) Analysis [694]
(e) Conclusion [700]
26. Count 7: 1 May 2009: Theft
(a) The charge [701]
(b) The circumstances of the alleged offending [703] (c) Knowledge of the obligation and requirement [710] (d) Breach of requirement
(i) Relevant dates [712]
(ii) Analysis [714]
(e) Conclusion [721]
27. Count 8: 30 June 2009: Theft [722]
28. Count 12: 20 July 2009: False accounting
(a) The charge [726] (b) Background [729] (c) The Crown’s allegations [740] (d) Analysis [745] (e) Conclusion [750] Count 5: 19 October 2009–10 February 2010: Prospectus 60 (a) Introduction [751] (b) Woolpak [757] (c) Quadrant [760] (d) Dairy Holdings [768] (e) Kelt [774] (f) Debt impairment [784] (g) Conclusion [806]
29.
1. Verdicts
[1] South Canterbury Finance Ltd (South Canterbury) was incorporated as a private limited liability company on 10 February 1926. Its head office was in Timaru. From 1976, South Canterbury began to take deposits from members of the public. This was done by making offers of debt securities through prospectuses and investment statements. This method of raising capital continued until February
2010. On 31 August 2010, South Canterbury was put into receivership. At that time, there was a deficiency to investors of about $1.6 billion. When the receivers were appointed, South Canterbury was the largest finance company in New Zealand.
[2] An investigation by the Serious Fraud Office followed South Canterbury’s demise. On 8 December 2011, Mr Edward Sullivan, Mr Robert White and Mr Lachie McLeod were each charged with offences involving dishonesty, arising out of their participation in the management and affairs of South Canterbury.1 At relevant times Messrs Sullivan and White were directors of South Canterbury, and Mr McLeod its Chief Executive Officer.2 The offending is alleged to have occurred between 18 November 2004 and 9 February 2010. Pleas of not guilty were entered to all charges.
[3] There were two other directors of South Canterbury for most of the period covered by the alleged offending. They were Mr Allan Hubbard, the chairman of the board, and Mr Stuart Nattrass. On 2 September 2011, Mr Hubbard died from injuries sustained in a motor vehicle accident. Mr Nattrass was not charged. He gave evidence as a Crown witness at trial.
[4] When informations were laid, two other executives of South Canterbury were charged. They were Mr Graeme Brown, Chief Financial Officer, and Mr Terence Hutton, Group Accountant. Both faced false accounting charges. The charges against Mr Brown were withdrawn on 6 August 2013. That was done by an
amendment to the indictment that removed Mr Brown from it.3 Mr Hutton received
1 The offence of theft in a special relationship, in respect of which three of the twelve counts are brought, does not require proof of dishonesty.
2 The periods during which each held those positions are set out in para [27] below.
3 R v Sullivan (Minute 16) HC Timaru CRI-2011-076-1948, 6 August 2013 at paras [1] and [2].
More generally, see R v Sullivan (No 11) [2014] NZHC 1312 and R v Sullivan (No 13) [2014]
a discharge on the charge brought against him when the Crown indicated, on 2
December 2013, that it did not propose to offer any evidence on it.4 Both Messrs
Brown and Hutton were called on behalf of Mr Sullivan to give evidence at trial.5
[5] On 14 October 2014, following a trial over 71 sitting days between 12 March and 18 August 2014, I delivered the following verdicts in open Court:
(a) Count 1 – false statement by promoter
Mr Sullivan Not Guilty
Mr White Not Guilty
(b) Count 2 – false statement by promoter
Mr Sullivan Guilty
(c) Count 3 – false statement as promoter
Mr Sullivan Guilty
(d) Count 4 – false statement as promoter
Mr Sullivan Guilty
Mr White Not Guilty
(e) Count 5 – false statement as promoter
Mr Sullivan Guilty
NZHC 1365 (reasons).
4 R v Sullivan (Minute 25) HC Timaru CRI-2011-076-1948, 2 December 2013 at paras [1] and [2].
5 During the course of the hearing, before Mr Brown was called to give evidence, the Crown characterised him as an “unindicted co-conspirator” for the purpose of arguing that the rule of evidence known as the co-conspirators’ rule applied in respect of each accused. In oral remarks in open Court when my verdicts were delivered, I offered views on that suggestion, in the context of my assessment of Mr Brown as a witness: see R v Sullivan (Verdicts) [2014] NZHC
2500.
(f) Count 6 – theft by person in a special relationship
Mr Sullivan Not Guilty
(g) Count 7 – theft by a person in a special relationship
Mr Sullivan Not Guilty Mr White Not Guilty Mr McLeod Not Guilty
(h) Count 8 – theft by a person in a special relationship
Mr McLeod Not Guilty
(i) Count 9 – obtaining by deception
Mr Sullivan Guilty
(j) Count 10 – obtaining by deception
Mr Sullivan Not Guilty Mr White Not Guilty Mr McLeod Not Guilty
(k) Count 11 – false accounting
Mr McLeod Not Guilty
(l) Count 12 – false accounting
Mr McLeod Not Guilty
[6] These are my reasons for returning those verdicts. While the verdicts were returned in the order set out in the indictment, I analyse each of the counts in chronological sequence.
[7] During the course of their closing addresses, counsel for the accused reminded me on a number of occasions that my function was to determine whether particular charges brought against each accused had been proved beyond reasonable doubt. They counselled me not to undertake an inquiry into the reasons behind South Canterbury’s failure. While I agree with that submission, I have found it necessary to make findings on the way in which South Canterbury’s business was conducted so that I have a factual basis against which to determine what knowledge each accused may have had on a particular topic at any given time, and the intentions
that may have been formed as a result of decisions that were made.6
2. Structure of reasons
[8] The Crown case is based primarily on a consistent failure to disclose the true extent of related party lending between 2004 and 2010. To support that contention, the Crown relied on seven transactions into which South Canterbury entered between
18 November 2004 and 9 February 2010. Two, in 2004, involve a company called Shark Wholesalers Ltd (Shark): the Shark 1 and Shark 2 transactions.7 Another two were linked with (what can neutrally be described as) South Canterbury’s interest in the Hyatt Hotel in Auckland. They occurred between 2006 and 2009: the Hilltop and Quadrant transactions.8 The remaining three are discrete in nature and were entered into in 2006 (the Woolpak transaction)9 and 2009 (the Dairy Holdings10 and Kelt
transactions11) respectively.
[9] These transactions have been characterised by the Crown as related party lending that ought to have been disclosed to members of the public who invested on
the faith of five prospectuses issued in the period between 2004 and 2010.12 The
6 For example, see paras [15]–[25] and paras [85]–[98] below.
7 See paras [143]–[163] (Shark 1), [164]–[178] (Shark 2) below.
8 See paras [220]–[275] (Hilltop) and paras [277]–[296] (Quadrant) below.
9 See paras [179]–[219] below.
10 See paras [297]–[312] below.
11 See paras [314]–[354] below.
12 Prospectuses 55, 57, 58, 59 and 60.
Crown also relies on alleged misrepresentations in one of the prospectuses about a bank facility of $150 million13 and a failure to disclose the true extent of impaired debt14 in another.
[10] In order to explain the verdicts I have returned, it is necessary to understand the way in which the board of South Canterbury functioned, the roles that the various directors performed at particular times, the extent of their contemporary knowledge of the transactions in issue and at the time that prospectuses were issued, the way in which they delegated various managerial and accounting functions to members of the senior management team, and the way in which functions were divided among them.
[11] I have written these reasons in 29 parts. That has enabled me to provide the factual context in which each of the charges requires consideration, before analysing them in turn. After explaining the legal requirements that I must follow in giving my reasons for verdicts,15 I deal with those issues as follows:
(a) First, after considering and responding to the way in which the Crown put its case,16 I set out the factual context against which I have considered the charges.17
(b)Second, I discuss the governance and management arrangements adopted by South Canterbury.18 I do this by reference to board dynamics,19 the particular role of Mr Hubbard,20 the accounting
systems used,21 the loan authorities given,22 related party lending,23
13 See paras [355]–[357] below.
14 See paras [358]–[361] below.
15 Part 3, at paras [12] and [13] below.
16 A brief summary of the Crown case is set out at para [15] below.
17 Part 4, at paras [15]–[45] below.
18 Part 5, at paras [27]–[98] below.
19 Part 5, at paras [27]–[40] below.
20 Part 5, at paras [46]–[30] below.
21 Part 5, at paras [52]–[92] below.
22 Part 5, at paras [59]–[63] below.
delegations from directors to management24 and the knowledge of directors about the content of prospectuses and financial statements.25
(c) Third, I identify the nature and terms of key documents on which the Crown rely to prove some of the charges against each accused. The first is a debenture trust deed (the Trust Deed) in respect of which the company now known as Trustees Executors Ltd was appointed (and remained) as trustee (the Trustee).26 The monies advanced by depositors were secured by the Trust Deed over the undertakings of South Canterbury and its charging subsidiaries. The second is a deed of guarantee (the Guarantee Deed) into which the Crown and South
Canterbury entered on 19 November 2008 under the “Non-Bank
Retail Deposit Takers’ Scheme” (the Guarantee Scheme).27
(d) Fourth, I summarise each of the seven transactions on which the
Crown relies.28
(e) Fifth, I provide background to the alleged misrepresentation about a “committed” bank facility of $150 million29 and the asserted deliberate under-reporting of the level of debt impairment in the financial statements for the year ended 30 June 2009.30
(f) Sixth, I outline the financial reporting environment in which financial statements contained in the prospectuses were prepared.31
(g)Seventh, I explain the form of the indictment and its particulars,32 as well as the legal rules of practice and evidence that I have applied in
reaching my decisions.33
24 Part 5, at paras [81]–[84] below.
25 Part 5, at paras [85]–[98] below.
26 Part 6, at paras [99]–[76] below.
27 Both the Guarantee Scheme and the Guarantee Deed are explained in Part 7, at paras [108]–
[141] below.
28 Part 8, at paras [143]–[163] (Shark 1), [164]–[178] (Shark 2), [179]–[219] (Woolpak), [220]–
[284] (Hilltop), [285]–[296] (Quadrant), [297]–[312] (Dairy Holdings) and [314]–[354] (Kelt).
29 Part 9, at paras [355]–[357] below.
30 Part 10 at paras [358]–[361] below.
(h)Eighth, I set out the elements of each of the offences charged. I do this by reference to the provisions under which the charges have been brought. They can be grouped into four categories:
(i) the prospectus charges34
(ii) the “theft” charges35
(iii) the “deception” charges36
(iv) the “false accounting” charges37
(i)Ninth, I analyse the counts in respect of each accused in chronological sequence, and explain why I returned verdicts of guilty or not guilty on particular charges.38
3. Reasons for verdicts – legal requirements
[12] I conducted this trial without a jury.39 In R v Connell, the Court of Appeal
explained the extent of the reasons that should be given for a trial Judge’s verdicts.40
Generally, all that is required is a statement of the ingredients of each charge, any relevant rules of law or practice, a concise account of the facts, and a plain statement of the essential reasons why the verdicts have been returned. When the credibility of witnesses is involved and important evidence is either accepted or rejected, that too should be stated explicitly.41
[13] Despite what was said in Connell, I consider that this is a case in which I
should give fulsome reasons for my verdicts. The prosecution is of public interest. It is important to both the public and the accused. South Canterbury was, at the time
32 Part 12, at paras [373]–[398] below.
33 Part 13, at paras [399]–[420] below.
34 Part 14, at paras [421]–[453] below. Crimes Act 1961, s 242.
35 Part 15, at paras [454]–[486] below. Crimes Act 1961, s 220.
36 Part 16, at paras [487]–[490] below. Crimes Act 1961, s 240.
37 Part 17, at paras [491]–[499] below. Crimes Act 1961, s 260.
38 Parts 18–29, at paras [500]–[807] below.
39 R v Sullivan (No 2) [2013] NZHC 2058 (reasons).
40 R v Connell [1985] 2 NZLR 233 (CA).
41 Ibid, at 237.
of receivership, the largest finance company that had operated in New Zealand. Losses to public investors amounted to approximately $1.58 billion. A payment of that sum from the public purse was required under the Guarantee Scheme. One of the receivers, Mr Black, gave evidence that distributions by them (from the realisation of assets) had totalled just under $820 million.
[14] Because the evidence was voluminous and closing addresses comprehensive, even fulsome reasons will necessarily be incomplete and selective in nature. Nevertheless, I consider that it is important to explain the basis on which I entered the verdicts as fully as possible.42
4. South Canterbury’s business environment: 2004–2010
(a) A culture of concealment?
[15] The Crown case against Messrs Sullivan, White and McLeod is based on the proposition that “the directors and management of South Canterbury ignored or evaded important controls that should have regulated how the company operated”, over the whole of the period of the alleged offending. Mr Carruthers QC, for the Crown, submitted that this “approach to the management of the affairs of the company moved beyond the merely cavalier to the dishonest” and “materially contributed to the company’s collapse”. He added that “the hallmark of the offending was a series of related party transactions that were purposefully structured to hide high risk lending”.
[16] In my view, the Crown’s suggestion of (what amounts to) an underlying culture of concealment does not withstand scrutiny. The conduct of which complaint is made is more readily explicable by reference to two market phenomena and the way in which South Canterbury was governed and managed. It is unrealistic to expect that an examination of seven transactions over a period of a little over five years can provide an accurate foundation for an allegation of continuous
concealment of information from the public. One only needs to read the
42 See also R v Eide (Note) [2005] 2 NZLR 504 (CA) at para [21], R v Wenzel [2010] NZCA 501 at paras [39]–[40] and R v Banks [Reasons for verdicts] [2014] NZHC 1244, [2014] 3 NZLR 256 at paras [7]–[9].
prospectuses to realise what a small part of South Canterbury’s business was represented by the seven transactions. To illustrate the point, two transactions were entered into in 2004,43 yet the next one to be impugned as a deliberate concealment did not begin until 31 March 2006.44 At least in the period between 2004 and mid
2008, a more benign explanation for the behaviour exhibited by those transactions exists.
[17] I have identified two relevant market phenomena, both of which had a significant impact on the way in which South Canterbury was governed and managed over the period covered by the alleged offending.
(b) Rapid growth: 2004 – mid 2008
[18] The first was a period of rapid growth, between 30 June 2004 and 30 June
2008. Corporate governance procedures that were used by South Canterbury during that time proved inadequate to deal with the need to manage a significant increase in the public moneys available for investment. In this period, South Canterbury moved from being a company with total assets of about $750 million as at 30 June 2004, to one with almost $2 billion by 30 June 2008. The absence of both a robust loan authorisation process and a casual approach to the need to impair debt45 were contributing factors to the problems that South Canterbury faced when the financial downturn happened in 2008.
[19] The corporate governance procedures adopted by South Canterbury during this period (and, indeed, beyond) were more nearly analogous to those of a closely held company than one which solicited funds from the public. That was due to Mr Hubbard’s influence over the company’s affairs. South Canterbury’s parent company, Southbury Group Ltd (Southbury) was owned and controlled by interests associated with Mr Hubbard. Despite attempts from other directors to change his ways, Mr Hubbard was unable or unwilling to grasp the need to adapt existing governance and management procedures to the contemporary business environment
in which South Canterbury was operating.
43 The two Shark transactions: see paras [143]–[163] below.
44 The Woolpak transaction: see paras [179]–[219] below; in particular at para [183].
45 See paras [20] and [21] below.
[20] It was common practice for Southbury to acquire “problem loans” from South Canterbury shortly before balance date. This had the effect of either removing or minimising the need for South Canterbury to provide for impaired debt, as the accounting records showed an injection of new funds by Southbury to replace the non-performing debt. Often, however, moneys advanced by Southbury would be repaid after balance date. That meant that the true nature of the inter-company
advances was not transparently reported to investors.46 Indirectly, the way in which
Southbury acquired “problem” loans operated as a disincentive for South Canterbury
to manage non-performing loans rigorously.
[21] There was a special relationship between South Canterbury and Southbury. That manifested itself most clearly in lending arrangements by which Southbury could obtain finance almost at will from South Canterbury. Apart from an unusual reference in a document registered with the Companies Office to a “debenture”
having been granted in favour of South Canterbury,47 no documentary evidence was
produced to record the terms on which South Canterbury would lend money to its parent. Such a document may or may not have existed. While there were deficiencies in the investigation of the Serious Fraud Office that could have resulted in any document of this type not being located, the preponderance of evidence satisfies me that the directors and management of South Canterbury acted on the basis that Southbury had the right to draw down to (at least) 35% of shareholders
funds, without prior approval from the board or a credit committee.48 That
percentage was fixed by reference to the Trust Deed, as the maximum single entity exposure.49
[22] In the period between 2004 and 2008, the two Shark transactions, the
Woolpak transaction and the Hilltop transaction was undertaken. For reasons I give later, I am satisfied that no dishonest conduct was involved in relation to either the
46 In a memorandum to directors dated 6 January 2009, Mr McLeod referred to a practice of “cheque swapping at balance dates” and the need to eliminate the “total façade”. See also, paras [64]–[80] below.
47 I call this “unusual” because, as at the date of the document, what had previously been called
“debentures” were known as “general security agreements”, after the Personal Property
Securities Act 1999 came into force.
48 I say “at least” because, on one interpretation of the Trust Deed, Southbury may well have been entitled to borrow more than that amount, without any breach of the Trust Deed by South Canterbury. See para [107] below.
49 See cl 16.1(d) of the Trust Deed, set out at para [104] below.
Shark or Hilltop transactions. There was dishonesty involved in the Woolpak transaction, but the circumstances in which that occurred are unrelated to the corporate governance concerns I have identified in relation to the period of rapid growth.
(c) Effect of financial crises: mid 2008–2010
[23] The second arose from the impact on South Canterbury’s fragile business model of a downturn in the property market around mid June 2008, and what became known as the global financial crisis from about September 2008. On 24 July 2008, Mr McLeod was reporting to the board that only three finance companies were doing “limited lending” at that time, one of which was South Canterbury.
[24] When property values fell in mid to late 2008, it had an adverse effect on both Southbury and South Canterbury. Mr McLeod reported on 24 July 200850 that one of the “current challenges” for South Canterbury was “surviving”. Not only did the downturn it impact on the value of securities taken for particular loans, but consequential problems for borrowers meant that many were rendered illiquid and were unable to maintain principal and interest payments. The ability for regular inter-company advances to be made from Southbury to South Canterbury,51 was also compromised. On Mr Hubbard’s own figures, prepared at the end of October 2008, South Canterbury needed to raise capital of something in the order of $90 million to survive.52 The events of 2008 and beyond exposed the fragile capital structure on which South Canterbury had operated and drove the directors to respond to difficult problems in a “knee-jerk” fashion, rather than by the development and application of a coherent strategy.
[25] The Quadrant, Dairy Holdings and Kelt transactions all took place in the period between December 2008 to July 2009. They can all be linked to South
Canterbury’s need to address problems arising out of the economic downturn.
50 This was the same meeting at which Mr McLeod had noted that only three finance companies
were doing “limited lending”: see para [23] above.
51 See paras [130] and [131] below.
52 See para [130] below.
5. Governance and management
(a) Introduction
[26] This part of my reasons deals with questions of corporate governance and management, in relation to the affairs of South Canterbury. As foreshadowed earlier,53 I regard the need to analyse how the board and management interacted as necessary to the decisions I must make about the state of knowledge of each accused at any particular time, and the intentions that lay behind particular decisions that they made.
(b) Board dynamics
[27] At material times, the board of South Canterbury consisted of: (a) Mr Hubbard - from 23 April 1990 until 28 May 2010. (b) Mr Sullivan – from 23 April 1990 until 31 May 2010.
(c) Mr White – from 10 February 1993 until 28 August 2009. (d) Mr Nattrass – from 19 May 2002 until 28 August 2009.
(e) Mr Baylis – from 20 October 2009 until 1 September 2010. (f) Mr Shale – from 20 October 2009 until 1 September 2010. (g) Mr McLauchlan – from 20 October 2009.
[28] The board of directors of South Canterbury met every two months.54
Generally, all directors attended formal meetings. On almost all occasions, Mr McLeod was present. During their respective tenure, Messrs Brown, Peter Bosworth (Chief Operating Officer), Nigel Davenport (Corporate Lending
Manager) and Kevin Gloag (who dealt with issues involving public depositors)
53 See para [7] above.
54 Meetings of a more informal character were also held, particularly in late 2008.
would attend regularly, at least for those parts of the meetings at which their reports were presented. Later, Mr Andrew Borwell (a director of Southbury) attended meetings as an “advisor”,55 at the request of Mr Hubbard.
[29] Mr Hubbard was (in substance) the controlling shareholder of Southbury from the date on which it was incorporated, 31 May 1991. At various times Messrs Sullivan, White, Nattrass and McLeod were also shareholders in Southbury. Mr Hubbard and his wife, Mrs Jean Hubbard, were directors of Southbury throughout. Mr Borland was a director of Southbury between 1 September 2007 and
30 June 2009. In evidence, Mr Borland explained that the business of Southbury was to monitor its subsidiary companies, the largest of which was South Canterbury. Mr Hubbard tended to run Southbury in an autocratic manner. There were few (if any) formal meetings of directors, with discussions between Mr Hubbard and Mr Borland about its affairs taking place irregularly, either in person or by telephone.
[30] Mr Hubbard used Mr Borland as a trusted sounding board, in relation to the various companies in which he had an interest. Mr Hubbard had recruited Mr Borland to be a director of Southbury and arranged for him to attend meetings of the board of directors of South Canterbury regularly. South Canterbury’s board minutes describe Mr Borland as “an advisor”. It is clear that Mr Borland was alive to the difference between a role as director and one as advisor. Mr Borland’s primary role (as Mr Hubbard’s confidante) was to respond to comments made by directors in relation to areas within his expertise, to raise any issues he thought appropriate, and to undertake specific project work at the direction of the board.
[31] While Mr Nattrass described Mr Hubbard as something of a “silent” chairman, other witnesses suggested strongly that Mr Hubbard was the dominant member of the Board. However often he may have spoken, or in what tone, it is clear that Mr Hubbard’s voice held significant sway. Although in his late 70s and early 80s during the relevant period, Mr Hubbard remained the public face of, and
driving force behind, South Canterbury’s business activities.
55 See para [30] below.
[32] Mr Nattrass considered that Mr Sullivan was the person who tended to set agendas, control meetings and, in conjunction with Mr McLeod, deal with “action points” arising out of the directors’ deliberations. He viewed Mr Sullivan as acting in a manner akin to an executive director, particularly in relation to his dealings with “problem” loans. I accept that assessment of Mr Sullivan’s role.
[33] Mr Nattrass acknowledged that, over a period of about seven years when they worked together as co-directors, Mr White applied himself diligently to his tasks but was undermined by Mr Hubbard’s behaviour. Mr Nattrass considered that Mr White had high ethical standards and was an honest man. There was a considerable body of other evidence from witnesses who attested to Mr White’s honesty, integrity and conscientious work ethic.
[34] Mr Nattrass said that he was surprised about Mr McLeod’s appointment as Chief Executive Officer, in October 2003. It had been arranged by Mr Hubbard without any consultation with the board as a whole. While acknowledging that Mr McLeod was well-versed in the “asset side” of finance company work, through his prior experience as a rural sector banker, Mr Nattrass considered that he did not have the same experience when dealing with liabilities, particularly “problem debts”. He described Mr McLeod as a “hard worker” but with a “referee” mentality; noting that in business it is not possible to “blow the whistle and reset”. That comment was made in the context of a career choice that Mr McLeod faced at about the time of his appointment as Chief Executive Officer. He was considering an alternative career as a professional rugby referee. Even though Mr Nattrass was beginning to think that Mr McLeod was out of his depth towards the end of his time on the board, he accepted that he trusted and was prepared to rely on Mr McLeod.
[35] It was rare for the board of South Canterbury to obtain external legal advice. Generally, Mr Sullivan was the sole repository. Raymond Sullivan McGlashan (RSM), the firm of solicitors of which Mr Sullivan was a partner, acted for South Canterbury on most of the prospectuses that were issued, in conjunction with Bradley West, another firm of solicitors from Timaru. Another firm, Bell Gully, provided advice in respect of Prospectus 60.
[36] As his evidence progressed, it became clear that Mr Nattrass regarded Mr Hubbard as “ungovernable”. This view was reflected (albeit in different words) in evidence given by members of the senior management team. Mr Nattrass referred to Mr Hubbard as being “outcome” driven, whereas he regarded Mr White as more keenly appreciative of questions of process and detail. Mr Nattrass said that it was common knowledge that Mr Hubbard referred to Mr White as “Handbrake Bob”, because of his tendency to counsel caution in transactions with which Mr Hubbard wished to proceed. That description of Mr White fits with his decision to resign office as a director contemporaneously with Mr Nattrass, once he learnt of discussions that had taken place at Mr Hubbard’s home on the evening of Wednesday
26 August 2009.56
[37] I am satisfied that, over time, Messrs Sullivan, White and Nattrass made sincere attempts to convince Mr Hubbard to change his ways. They were unsuccessful. By allowing Mr Hubbard to continue to operate as he had historically done, they contributed to South Canterbury’s downfall, as the existing governance structures were unable to cope with the problems that surfaced when the market turned against South Canterbury in mid to late 2008.
[38] Why were the other directors and the Chief Executive Officer unable to achieve change? For a long time, Mr White and Mr Hubbard had been partners in a firm of chartered accountants in Timaru, known as Hubbard Churcher. Mr Sullivan and Mr White had been close associates of Mr Hubbard for many years. As a result of their business and personal relationships, Messrs Sullivan and White were loyal to Mr Hubbard. So too were Messrs Nattrass and McLeod. They owed their positions at South Canterbury to Mr Hubbard. The extraordinary degree of loyalty shown by the four men in the face of Mr Hubbard’s stubborn refusal to change provides (at least at a human level) some explanation for the failure of their constant efforts to modernise South Canterbury’s business practices.
[39] In opening, the Crown suggested that there was a “board within a board”,
based in Timaru. There were two rationales for that proposition. The first was that
Messrs Hubbard, White and Sullivan were all located there. The second was the
56 See paras [41]–[42] below.
lengthy personal and business relationship that Messrs Hubbard, Sullivan and White enjoyed. While Mr Nattrass did not say that he had ever been denied material information, he did suggest that a “board within a board” existed. However, his view was that it consisted of Messrs Hubbard, Sullivan and (though not a director) Mr McLeod. Mr Nattrass deliberately excluded Mr White from those who made up that inner sanctum.
[40] While I acknowledge readily that, because of their common location and personal history, the Timaru based directors (and Mr McLeod) had a greater opportunity to discuss contemporary issues informally, I do not accept that there was any “board within a board” of the type asserted by the Crown. There was no evidence to suggest that Mr Nattrass was excluded from significant decision-making.
[41] By mid August 2009, the position had been reached whereby Mr Nattrass considered that a vote of no confidence in Mr Hubbard should be passed by directors. A motion to that effect was put at a meeting held on 20 August 2009. It was seconded by Mr Sullivan. Mr Hubbard, Mr White and Mr McLeod were also present at that meeting. The minutes record:
3. Board Chairmanship
Discussion regarding the future Chairmanship of the Board ensued, during which it was noted that there appeared an imminent need to address the issue due to the noted expectations of the parties with whom the Project Team were in current discussion. Although in earlier informal discussion there appeared to be agreement with the Chairman on the need for change, Mr Hubbard expressed the view, particularly in regard to his proposal to float the Southbury Corporation Limited concept, that change at this time was inappropriate.
At the conclusion of discussion on the motion of Mr SJ Nattrass, seconded
Mr EO Sullivan, the following motion was duly carried:
• That the Board have no confidence in the Chair.
[42] Subsequently, Mr Hubbard made it plain that he would not resign. Before announcing his position, he regained Mr Sullivan’s support, but not Mr White’s. Mr Nattrass gave evidence that he was told, at Mr Hubbard’s home, that he would be “fired”, or he could “offer his resignation”. Mr Nattrass said that he also received a
telephone call from a firm of solicitors in Auckland representing Mr Hubbard. They
advised him to stop “harassing pensioners”.
[43] Notwithstanding the resignations of Messrs White and Nattrass on 28 August
2009, South Canterbury continued to carry on business as normal, with Mr Hubbard and Mr Sullivan at the helm. Although for a short period of time South Canterbury voluntarily decided not to take depositors’ money on the faith of Prospectus 59, Prospectus 60 was issued on 20 October 2009. Three independent directors, Messrs Baylis, Shale and McLauchlan were appointed on the same day. In February 2010, at about the time they had become familiar with South Canterbury’s business, Prospectus 60 was withdrawn from the market. By the end of May 2010, both Mr Hubbard and Mr Sullivan had resigned as directors.
[44] By late August 2010, South Canterbury could no longer carry on business. As a result, on Tuesday 31 August 2010, the directors requested the Trustee to appoint receivers of South Canterbury and its 13 charging subsidiaries. At the time of receivership, South Canterbury remained in the Guarantee Scheme. That was the result of an extension granted in late 2009.
[45] The Trustee appointed Messrs Downey and Black as receivers on the morning of 31 August 2010. As a result of discussions before the appointment of receivers, the Crown immediately nominated the Trustee as the “eligible creditor”, under the terms of the Guarantee Deed. Thereafter, the Trustee made a claim on behalf of holders of all debt securities issued by South Canterbury. A sum of approximately $1.58 billion was paid by the Crown to the Trustee on 31 August
2010, in full and final settlement of the Crown’s obligations.
(c) Mr Hubbard’s role
[46] A number of criticisms were made about Mr Hubbard’s business practices during the trial. Many are relevant to the context in which the accused’s alleged offending occurred. I am conscious that, having died before charges were laid, Mr Hubbard has not had the opportunity to answer allegations made against him. Having said that, the evidence tended to paint a consistent picture of Mr Hubbard’s business practices. The findings that I make about Mr Hubbard’s conduct reflect my
assessment of the evidence of relevant witnesses, taking into account Mr Hubbard’s
inability to testify to rebut their allegations.
[47] Mr Hubbard enjoyed good personal relations with investors. He was seen as someone who was frugal in his private life and philanthropic in outlook. Mr Hubbard once famously said that he “would rather live in a tent” than have any of the public depositors lose money. I do not believe that Mr Hubbard (or any of the accused) set out to defraud investors. But, unfortunately, the corporate governance practices that Mr Hubbard insisted on maintaining, Mr Hubbard’s view of the greater
security of related party lending,57 the lack of transparency in publicly available
documents about the extent and nature of such lending, and the inability of his co- directors to influence a change in his attitude directly contributed to the failure of the company, and the losses suffered.
[48] Mr Hubbard also insisted on the maintenance of antiquated bookkeeping processes that were used in conjunction with computerised systems, known as Sovereign and Great Plains.58 In the context of a company that, as at 30 June 2006, boasted total assets of over $1 billion, I found it astounding that one month before that balance date a cheque was drawn by Mr Hubbard and Mr Sullivan in the sum of
$25 million, entered in a handwritten outwards cash book, and posted to physical ledger cards, on which entries were typed through an electric typewriter.59
[49] Mr Hubbard maintained (what was known as) the B Stock Ledger,60 which was largely referable to the handwritten system. It is clear from evidence given by those concerned with the preparation of financial statements for South Canterbury that this method of recording transactions had the potential to cause significant errors. It was necessary for specific inquiries to be made of Mr Hubbard before financial statements were finalised. Often, he was dilatory in providing the information, or failed to disclose fully what related party business had been transacted. In particular, there were frequent problems in ascertaining the true state
of the inter-company debt between South Canterbury and Southbury.
57 See para [80] below.
58 See para [54] below.
59 In relation to the Hilltop transaction, see paras [246]–[248] below.
60 See para [55](b) below.
[50] On some occasions, Mr Hubbard exercised Southbury’s right to draw funds from South Canterbury without reference either to other directors or senior management.61 This had the potential to cause serious problems when South Canterbury’s half-yearly financial statements were being prepared. For example, while particular “advances” from South Canterbury to Southbury were coded to the latter in South Canterbury’s books, the actual amount payable at any given time by Southbury to South Canterbury could not be determined without a manual search of the Southbury ledger card, searches of other ledger cards maintained by Mr Hubbard,62 and (often) a direct personal inquiry of him. Mr Hutton accepted that I might not find the amounts stated to be due from Southbury to South Canterbury at any particular balance date to be reliable.
[51] Mr Hutton explained the practical difficulties inherent in this unhappy state of affairs. On his evidence, this method of accounting led to the omission of a sum of approximately $30 million from amounts disclosed as “related party” transactions in Prospectus 59.63 That was a significant sum, and one in respect of which the Crown alleged dishonest concealment from investors, in connection with the Hilltop transaction.
(d) Accounting systems
[52] South Canterbury’s half-yearly financial statements were prepared primarily by Mr Hutton. Initially, he was employed by Hubbard Churcher. Mr Hutton regarded Mr White as his mentor and would generally consult him if difficult issues arose in relation either to the financial statements or the Trust Deed. Later, he became South Canterbury’s Group Accountant.
[53] The preparation of the accounts was overseen by Mr Brown, after he joined South Canterbury in August 2007. There were no formal arrangements for the accounts to be discussed with directors before they were settled for audit purposes.
The evidence suggests that Mr Brown and Mr Hutton had delegated authority to
61 See para [20] above.
62 See paras [54]–[56] below.
63 As to Prospectus 58, see para [595] below.
finalise preparation of the financial statements in conjunction with the auditors, and to answer questions raised by them as the audit process progressed.
[54] As late as 2006,64 South Canterbury’s financial record keeping was characterised by the partial use of handwritten cashbooks, journals and typed ledger cards. While two computerised accounting systems (known as Great Plains and Sovereign) had been installed a few years earlier, not all of the loans were recorded in them. Mr Hubbard preferred old-fashioned records that he could touch as well as read.65
[55] I am satisfied from the evidence that three separate ledger systems were maintained, known as the A, B and C Stock Ledgers. I find:
(a) The A Ledger represented most of South Canterbury’s loans, for example financing arrangements for houses and cars. The A Ledger was maintained by Mr Tim Underdown, whose wife Jill was one of the administrators responsible for writing up entries in South Canterbury’s books.
(b)The B Ledger was overseen by Mr Hubbard. Few, if any, employees had access to the cards. It was often difficult for those employees who were charged with the preparation of South Canterbury’s half yearly financial statements (and the auditors) to gain access to those records to ensure all loans were properly recorded.66
(c) The C Ledger was originally under the supervision of Mr McLeod.
When Mr Davenport commenced employment with South Canterbury in October 2005, he took over responsibility for the this Ledger from him. Mr Davenport reported to Mr McLeod. Nevertheless, in respect of borrowers with whom he had close connections, or loans of a more complex nature, Mr McLeod retained oversight. Although
Mr Hubbard had no formal responsibility for the C Stock Ledger, I am
64 See paras [48] and [49] above.
65 More generally, see paras [49]–[51] above.
66 See also paras [56]–[58] below.
satisfied that he did take an interest in a number of accounts that were recorded in its cards.
[56] Ms Gregan was employed by South Canterbury from May 2007 to December
2010 as an analyst working with Mr Davenport and the Rural Loan Manager, Mr Ellis. She gave evidence about her knowledge of the B Stock Ledger.
[57] Ms Gregan said that “up until 2007 Mr Hubbard was the sole manager of the loans recorded in the B Stock Ledger”. She said that she and other employees only gained access to the B Stock Ledger cards in 2007, when a “mirror set” was entered into the Sovereign system. From that time, attempts were made to ensure that the handwritten and computerised systems were synthesised.
[58] Once access was gained to those ledger cards, it became apparent that there were a number of loans with no security, or where security had expired. Sometimes, interest on these loans was being charged on a non-compounding basis. In many cases there was little or no documentation to demonstrate that the loan had been approved in accordance with usual practice. It was not until December 2009, when Mr Nigel Gormack replaced Mr McLeod as Chief Executive Officer, that the B Stock Ledger cards were placed physically in the possession and under the control of accounting staff.
(e) Loan authorities
[59] So far as arms’ length transactions were concerned, South Canterbury had relatively robust loan authority limits in place throughout the period in issue. The amounts that could be advanced on the authority of one or more persons were spelt out in clear terms by resolutions of the board of directors. However, those authority limits were not applied to many related party transactions.
[60] Mr McLeod took up his position as Chief Executive Officer of South
Canterbury on 1 October 2003. He was introduced to the board at a meeting held on
9 October 2003. In the course of the 9 October 2003 meeting, the board amended
existing “lending limits”, so that:
(a) The Chief Executive Officer (with authority to delegate in appropriate circumstances) could authorise loans up to $500,000.
(b)The Chief Executive Officer and one director could authorise loans up to $1 million.
(c) The Chief Executive Officer and four directors could authorise loans up to $5 million.
The minutes did not address the possibility of loans being made in excess of
$5 million.
[61] The “lending limits” were reviewed again at a meeting of directors held on
25 March 2004. On this occasion:67
(a) The Chief Executive Officer could authorise loans up to $500,000.
(b)The Chief Executive Officer and one director could authorise loans between $500,000 and $1 million.
(c) The Chief Executive Officer and three directors could authorise loans between $1 million and $5 million.
(d) The Chief Executive Officer and all directors could authorise loans
$5 million and over.
[62] Further revisions were made to loan approval authorisations at a meeting of the board held on 7 March 2005. On this occasion:
(a) The Chief Executive Officer, one director, or the Chief Operating
Officer could authorise loans between $250,000 and $500,000, with only one signature required.
67 In each case, in the absence of the Chief Executive Officer a director was required to authorise the loan on his behalf.
(b)The Chief Executive Officer, one director, or the Chief Operating Officer could authorise loans from $500,000 to $1 million, with two signatures required.
(c) The Chief Executive Officer or the Chief Operating Officer could, together with two directors, could authorise loans from $1 million to
$5 million. Alternatively, such authorisation could be given by three directors.
(d)The Chief Executive Officer and the Chief Operating Officer, in conjunction with three directors, could authorise loans in excess of
$5 million.
[63] Modifications were made to loan approval arrangements at a meeting of the board held on 25 September 2008. This meeting was held shortly before the Government announced that the Guarantee Scheme would be established. They were:
(a) The Chief Executive Officer, Chief Operating Officer, National Credit
Manager or one director could authorise loans up to $500,000.
(b)The Chief Executive Officer or Chief Operating Officer or National Credit Manager, together with one director, could authorise loans from $500,000 to $1 million.
(c) The Chief Executive Officer or Chief Operating Officer or National Credit Manager, together with two directors, could authorise loans from $1 million to $5 million.
(d)The Chief Executive Officer or Chief Operating Officer or National Credit Manager, together with three directors, could authorise loans of and over $5 million.
While the board resolved to re-examine authority levels within three months, that review did not take place before the company was put into receivership on
31 August 2010.
(f) Related party lending
[64] In 2004, the advances to and from Southbury represented the bulk of related party lending. As time moved on, both Woodnorth Myers & Co (the auditors) and the Trustee began to express concerns about the way in which inter-company advances were being accounted for and reported.
[65] Mr Hutton gave evidence about the processes followed when he sought to identify related party lending for the purposes of disclosure in financial statements. There were three types of related party disclosure in South Canterbury’s accounts; those related through directorship, shareholding and control. Originally, the auditors assumed responsibility for identifying those loans which were to be disclosed as related party advances. Later, Mr Hutton, who had no personal visibility of entities that might be related, established a process to enable the accounting staff to identify such lending.
[66] The first step involved undertaking a search of the Companies Office database, by reference to the names of the four directors, Messrs Hubbard, Sullivan, White and Nattrass. Another search would also be made to ascertain the companies in which Southbury had an interest, so that could be compared with those to which South Canterbury had lent money. A list of potential related parties would be circulated to the directors of South Canterbury, who were asked whether any should be deleted or added. Given that Mr Hutton’s methodology would not identify all companies over which directors of South Canterbury exercised control or significant influence, this step enabled the directors to draw such companies to his attention, by adding them to the list. A deletion may have been required if, for example, Mr Sullivan held shares in another company as trustee for a client of RSM.
[67] Particular problems arose in the finalisation of the list, in relation to
Mr Hubbard’s interests. Mr Hutton explained that Mr Hubbard was a director of a
large number of companies, meaning that the exercise of identifying them and seeking information from Mr Hubbard could take some time.
[68] After the list had been finalised, Mr Hutton would check if South Canterbury had any exposure to the identified entities. If so, whatever amount was owing, Mr Hutton would include it within the table of related party advances disclosed in a prospectus. It is apparent that this system was reliant on accurate information being provided to Mr Hutton by the directors. In that context the evidence establishes that
Mr Hubbard had an ingrained reluctance to disclose related party lending.68
[69] The auditors had raised the topic of related party loans in a number of management letters sent after completion of the half-yearly audits. There were recurring themes. Two examples, taken from successive audits, will suffice for present purposes:
(a) In a management letter dated 10 November 2006, they said:
… that there were a number of loans advanced to companies during the [financial year ended 30 June 2006] where a Director of South Canterbury ... was also a Director of that company. Not all of the loans to such companies were identified as related parties for disclosure purposes.
(b) Similar observations were made in a letter of 30 April 2007:
… that there were a number of loans advanced to companies during the [financial year ended 31 December 2006] where a director of South Canterbury . . . was also a Director of that company. Not all of the loans to such companies were originally identified as related parties for disclosure purposes.
Save for the addition of the word “originally”, the terms of the April 2007 letter are the same as that sent in November 2006. A recommendation that followed, to establish a register of directorships, was couched in the same language in each letter.
[70] These issues were also exercising the minds of the directors during 2007. Mr Nattrass gave evidence that Mr Sullivan prepared a memorandum to
68 By way of illustration, see para [73] below.
Mr Hubbard, which was sent with the approval of both Mr Nattrass and Mr White. The memorandum, dated 25 July 2007, began:
Directors are concerned that there are issues that are not properly being addressed particularly with the need to have higher standards arising from:
• Standard & Poor’s.
…
• Auditors upgrading their requirements.
There is concern because of available time issues, your health, and the need for better governance that more appropriate structures to be adopted.
These include:
1. Stock B ledger- 32 out of 55 loans that need to be resolved before
auditors “sign off”.
2. Loan and drawdown authorisation.
3. Cheque signing authorisation.
…
6.Single entity exposures - adherence to cumulative advances to one party.
7. No advances without security being in place before advance made.
8. Related party advances
…
[71] In their memorandum to Mr Hubbard, the directors proposed a number of solutions to the problems they had identified. They included responsibility for the B Stock Ledger69 being transferred to Mr McLeod; the need for adherence to the company’s credit policy, through existing management systems; ensuring that loan authorisation and cheque signing authorities were honoured; having all securities in place before advances were made; and requiring the “appropriate level of approval of
Directors/staff for related party advances”.
[72] In November 2008, at a time proximate to the provision of information to
Treasury in respect of the Guarantee Scheme, South Canterbury had been in
69 The nature of the A, B and C Ledger cards is explained at para [55] below.
discussions with the Trustee about (among other things) the company’s corporate governance practices and related party transactions. Against the backdrop of both the Guarantee Scheme and pending changes to the law to allow the Reserve Bank of New Zealand (the Reserve Bank) to take a regulatory role in respect of non-bank deposit takers, representatives of the Trustee,70 in a letter dated 17 November 2008,71 identified a number of concerns; in particular:
(a) Due to the “significant size and growing reputation” of South Canterbury, the company needed to “consistently demonstrate it adheres to best practice corporate governance policies”.
(b)Concern was expressed about a particular transaction in respect of which there had been a material error in Note 2 to the financial statements for the half year ended 31 December 2007 which, as a related party transaction, “was a significant departure from best practice standards”.
(c) In light of the expected assumption of regulation of deposit takers by the Reserve Bank, increased scrutiny was likely to be placed on all related party transactions.
(d)Concerns were expressed about transparency, in the context of the absence of any published accounts from Southbury. The inability of an investor to review such accounts meant that no “objective assessment of the financial capability of the parent company” could be undertaken.
(e) Reference was made to “a number of related party transactions between” South Canterbury and Southbury having been undertaken “over the years”. Specific mention was made of one, in the sum of
$51 million, made in July 2008. With the likelihood of “increased
70 See paras [73] and [137] below.
71 The relevant parts of this letter are quoted to evidence the concerns communicated by the Trustee, at that time. There is evidence to suggest that the directors may not have seen this letter until late March 2009: see para [74] below.
regulatory oversight of the Reserve Bank”, a suggestion was made that South Canterbury review the manner in which those transactions were managed.
[73] Mr Yogesh Mody, the Southern Regional Manager of the Corporate Trust division of the Trustee, gave evidence that the letter of 17 November 2008 was sent by email to Mr Brown and Mr McLeod at 10.17am that day. He said that Mr McLeod acknowledged receipt of the email at 1.57pm but “dismissed our observations as they applied to the loans provided to senior managers for the purpose of acquiring shares in Southbury”. In the course of his response, Mr McLeod expressed his belief that there should be “more [South Canterbury] senior management in Southbury.” He added:
… It drives them harder to succeed and makes these people make sound decisions. They would not favour other Southbury Companies – as [South Canterbury] is Southbury!
[74] Eventually, an interim response was received, by letter dated 16 February
2009. In the letter of 16 February 2009, Mr Brown, “as requested by [Mr McLeod] and Mr Hubbard” acknowledged the Trustee’s point about corporate governance. So far as related parties were concerned, Mr Brown stated:
Whilst one acknowledges the potential negative sentiments held by some to related party transactions the nature of the related transactions for [uncompleted sentence]
Mr Mody responded by suggesting that the sentence dealing with related party lending was incomplete but he received no further comment on that.
[75] An expanded response was sent by South Canterbury on 12 March 2009. This letter did not deal with related party transactions. Instead, it dealt with the proposed regulatory regime under the Reserve Bank Amendment Act and credit management issues. In relation to the former, Mr Brown expressed the view that:
The board considers that it meets the requirement for two independent directors in Stuart Nattrass and Edward Sullivan.
[76] Mr Mody said that during the course of a telephone discussion with Mr White on 25 March 2009, he formed a clear view that Mr White was unaware of this
correspondence. At that stage, Mr Mody forwarded copies of the Trustee’s letter of
17 November 2008 and the two responses to Mr White. I proceed on the basis that
the directors of South Canterbury did not see the Trustee’s letter until after 25 March
2009.
[77] The problems identified by both the auditors and the Trustee persisted. In a management letter dated 8 April 2009, the auditors referred to the absence of “a systematic method for identifying related parties both in respect of lending and investments”. They observed that while a register had been provided to them, it had “been found to be incomplete in a number of areas”. The auditors gave emphasis to this issue as a result of reviews of failed finance companies that had been undertaken by the Securities Commission, and comments by the Reserve Bank and the Companies’ Office when approving prospectuses. They made it clear that it was “essential that the [South Canterbury Group] introduces improved systems to identify its related party transactions”. The auditors identified as the most important measure “improved disclosure at boardroom level with minutes specifically noting the related party status of the material transactions approved”. The auditors stated plainly both that the directors needed to improve this area of their responsibilities substantially and that if there were any doubt about whether a particular transaction needed to be disclosed as a related party item then advice to that effect should be given to a member of the accounting team for advice.
[78] In their letter of 8 April 2009, the auditors referred specifically to inadequate
accounting for the “problem loans” that had been sold to Southbury. They said:
Recording of loans sold to Southbury Group
These loans are in the most part recorded in the Sovereign advances ledger. The amount purchased by Southbury has been recorded as a payment received. This means that Sovereign will calculate arrears taking this payment into account. Should the agreed terms of this loan not be met by the borrower, Sovereign will not record that the loan is in arrears as the lump sum payment already made will be treated as a payment rather than being treated as a reduced sum advanced. The recording of arrears on these loans needs to be reviewed on a regular basis.
[79] The Trustee continued to express concerns. On 5 May 2009, following a meeting with South Canterbury’s board of directors on 30 April 2009, the Trustee wrote to draw attention (among other things) to the status of related party loans:
…
2. Status of Related Party Loans
At 31 December 2008, related party loans totalled $170m, as against $54m as at 30 June 2008. Included in these related party transactions was the security sharing agreement, whereby the parent company, Southbury Group (i) acquired non-performing loans with a carrying value of $89.6m from SCF in consideration of a transfer of assets for full value and (ii) took a subordinated position (behind the debenture holders). Whilst we acknowledge and understand the commercial rationale for this transaction, we reiterate that in this increased regulatory oversight environment, all related party transactions now come under much closer scrutiny from the regulators who are looking for ‘transparency’ in all such transactions. Having discussed at length this transaction, we remain unclear as to whether the farm assets to be acquired by SCF have actually been acquired or still remain an undertaking to transfer on behalf of Southbury Group.
…
[80] The problems with corporate governance, loan authorisations, disclosure of related party transactions and credit management were intertwined. The related party and credit management concerns were symptoms of the corporate governance malaise. The root cause was Mr Hubbard’s belief that related party lending was more secure for investors because he had greater control over it. He also wished to maintain the historically close links between the governance of Southbury and South Canterbury. One of the ways in which those views manifested themselves was his reluctance to hand over information in a timely manner for the Chief Financial Officer and the Group Accountant to incorporate into the half-yearly accounts. Mr Hutton acknowledged in evidence that Mr Hubbard’s attitude towards related party lending was one of: “trust me, I know what I’m doing”. I agree.
(g) Delegations from directors to management
[81] In many small companies, directors fulfil the dual roles of governance and management. In larger enterprises (such as South Canterbury), the functions are
divided.72 Directors establish the policy or rules that are to be implemented by
72 Companies Act 1993, s 128.
management and put systems in place to ensure their instructions are carried out. In
Dairy Containers Ltd v NZI Bank Ltd,73 Thomas J expressed this idea as follows:74
It should not be necessary to restate that it is the fundamental task of the directors to manage the business of the company. Theirs is the power and the responsibility of that management. To manage the company effectively, of course, they must necessarily delegate much of their power to executives of the company, especially in respect of its day to day operations. Although constantly referred to as “the management”, the executives’ powers are delegated powers, subject to the scrutiny and supervision of the directors. Responsibility to manage the company in this primary sense remains firmly with the directors.
[82] Although those obligations are cast on directors, both s 2B of the Securities Act 1978 and s 138 of the Companies Act 1993 recognise that, in certain circumstances, a director may rely on information from others. Neither s 2B nor s 138 create a defence to a criminal charge. Their relevance is to the adequacies of the inquiries actually made, the information on which the directors relied and the
reasonableness of any such reliance.75 By way of illustration, in the context of a
prosecution of directors under the Financial Reporting Act 1993, Judge Jan- Marie Doogue, in Ministry of Economic Development v Feeney,76 used s 138 to assist her inquiry into whether directors of a company took all reasonable and proper steps to ensure that its financial statements complied with that Act.
[83] In a company such as South Canterbury, it is inevitable that senior management will be delegated responsibilities by directors. Also, particular directors will be asked to deal with specific tasks.77 Subject to adequate monitoring of management by the directors or anything that may put a director on notice of the need for further inquiry,78 reliance on information provided by management in their
delegated areas of authority will generally be appropriate. But every reliance inquiry
73 Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR 30 (HC).
74 Ibid, at 79. This passage was referred to with approval by the Court of Appeal in Mason v Lewis
[2006] 3 NZLR 225 (CA) at [115].
75 In Paape v Fahey (2005) 9 NZCLC 263,813 (HC) at paras [90] and [91], Ellen France J accepted that s 138 could inform the steps taken by directors in the context of obligations imposed by the Securities Act 1978.
76 Ministry of Economic Development v Feeney (2010) 10 NZCLC 264,715 (DC), at paras [23],
[24] and [34]. This decision was discussed in some detail in Australian Securities and Investments Commission v Healey [2011] FCA 717, (2011) 278 ALR 618 at para [151] and following.
77 See Companies Act 1993, s 130(1).
78 Securities Act 1978, s 2B(1) and Companies Act 1993, s 138(2)(b) and (c).
will be fact specific, taking into account both the obligations and responsibilities of particular directors and the nature of the tasks delegated to members of the management team.
[84] The directors of South Canterbury delegated responsibility for preparation of both the half-yearly financial statements and the narrative of each prospectus to Mr Hutton and Mr Brown. In the context of charges that involve proof of dishonesty the fact that directors may not have exercised supervisory functions over those to whom tasks have been delegated is not relevant when considering the actual knowledge that a director had at any particular time. Indeed, the more that has been delegated and the less knowledge that a director may have acquired, the less likely it
is that any guilty intent may be proved on Crimes Act charges.79
(h) “Knowledge” of prospectuses and financial statements
[85] In determining whether either Mr Sullivan or Mr White had knowledge of any specific fact that the Crown says ought to have been disclosed in the prospectuses, it is necessary to consider the issue at two levels. The first is the way in which prospectuses were dealt with by the board, and the information available to the directors when each was signed. The second is the specific knowledge held by a particular director.
[86] In this segment, I deal with knowledge at a generic level. Relevant evidence was given by Mr Nattrass, Mr Brown, Mr Hutton and Mr Pearson, the auditor. That evidence was directed to the circumstances in which a prospectus, an extension certificate, or an amendment to the prospectus may have been signed.
[87] Mr Nattrass said that while all directors signed the prospectus, only Mr Hubbard and one other director signed the financial statements. Having said that, he accepted that the accounts were approved by the board. So far as the prospectuses were concerned, they were brought to a meeting in final form. Mr Nattrass could not
recall any discussion about them at any meeting before they were signed.
79 See paras [87]–[98] below.
Mr Nattrass understood that prospectuses were prepared by executives, with a degree of oversight from Mr White.
[88] Mr Hutton took primary responsibility for preparing the prospectuses. He was responsible for the final content of both the narrative and the financial statements. Mr Hutton said that if he had doubts or questions about any particular issue, he would generally raise them with Mr White. My impression is that Mr White’s role was limited to dealing with specific questions raised either by Mr Hutton or Mr Brown.
[89] Mr Brown was involved with Mr Hutton in the preparation of the prospectuses. His involvement was more with the financial statements than with the narrative. Mr McLeod was responsible for co-ordinating the work of the executives on the prospectuses, as opposed to exercising oversight.
[90] I am not confident that the directors read the draft prospectuses carefully when they were referred to them for consideration before the board meeting at which they would be signed. For example, Mr Nattrass admitted that he signed Prospectus
59 without reading the statements about the $150 million banking facility. His evidence was that he “signed the prospectus on the basis of the sub-committee having overseen it” and that “those responsible for putting the prospectus [together] were comfortable with it”. Mr Nattrass considered that Mr White had a greater involvement in the preparation of the prospectuses than I have indicated.
[91] Mr Pearson, the audit partner who was responsible for the half-yearly audits of South Canterbury’s financial statements, gave evidence that he had few personal interactions with directors about the financial statements, whether for the year ended
30 June or the six months ended 31 December. He drafted representation letters for the directors to sign. There is no evidence of any substantial input from directors into the terms of those letters, on which auditors are entitled to rely in expressing their opinion about the truth and fairness of relevant financial statements. Further, although there were criticisms of aspects of South Canterbury’s business practices in the management letters that were sent to the board after each audit had been completed, Mr Pearson did not attend any board meetings to discuss them.
[92] After Mr Pearson had concluded his evidence, I had real concerns about his veracity in relation to contact with directors about problems identified in management letters. It seemed to me inherently unlikely that someone in Mr Pearson’s position, a partner of a relatively small firm of chartered accountants in Ashburton who was charged with the responsibility of auditing, on a half-yearly basis, one of the largest and fastest growing finance companies in New Zealand, did not speak to directors about concerns identified in management letters. As partner in charge of the audit of both the June and December financial statements, Mr Pearson accepted that he spent approximately 90% of his time dealing with South Canterbury audit issues. The audit report would generally be completed at the same time that the prospectuses were signed. The auditors drafted a representation letter which appears to have been signed by the directors without much, if any, inquiry.
[93] In his evidence in chief, Mr Pearson deposed that, subject “to timeframes, there would be a meeting between the auditor and some of the directors for [a] final audit sign-off of the financial statements” and that ordinarily Mr Hubbard and Mr White represented the directors at those meetings; at least until Mr White resigned as a director. In answering questions from me, Mr Pearson sought to dilute the impact of that evidence.
[94] Mr Pearson explained the “final sign-off” meetings as ones that were not intended to resolve queries, but rather to ensure the letter of representation and financial statements would be signed. He said that “we wouldn’t necessarily even discuss any of the points that we’d come up with during the audit” because “we would have already covered off and been comfortable with the areas that … we may have raised during the audit”. Mr Pearson effectively retracted his evidence about “final sign-off meetings” with Mr Hubbard and Mr White, telling me that those sorts of meetings did not take place in respect of each audit and, in any event, were very short and did not deal with much more than “sign here”.
[95] Like a number of witnesses from the South Canterbury geographical area who were called by the Crown, Mr Pearson exhibited no desire to volunteer evidence that might paint the accused in a poor light. While, on reflection, I do not consider that Mr Pearson’s evidence lacked veracity, I do regard it as unreliable.
Nevertheless, even though it is much more likely that Mr Pearson did have the type of discussions with the directors to which he referred in his evidence in chief, I have reached the conclusion that it is better to leave his evidence to one side than to speculate on what might or might not have been said at the “final sign-off” meetings.
[96] Mr Brown gave evidence that the management letters were discussed at board meetings. While any discussion about them does not appear to have been minuted, Mr Brown said that he recalled quite heated discussion about the corporate governance issues raised by the auditors. His evidence was that (in particular) Messrs Sullivan and White “called for change and . . . for Mr Hubbard to provide in a more timely manner, information”. Mr Brown described their protests as “very loud and long”. He said that he saw “red faces after [he] left the boardroom when [the directors] exited at the end of the day” and that he knew “people were exasperated in terms of their endeavours to corral Mr Hubbard” to provide information in a timely manner. I accept Mr Brown’s evidence on this topic.
[97] As the accused elected not to give evidence, I am required to determine their state of knowledge of the relevant financial statements and the narrative of the prospectuses from the available pool of evidence. That evidence demonstrates an almost cavalier approach to the issue of prospectus documents, and to the reading of them. While I take the view that Mr White is likely to have read the prospectus and the accounts more closely than his fellow directors, primarily because of his reputation for being both conscientious and cautious, I consider that the safest course is to determine the actual state of knowledge of Mr Sullivan and Mr White of facts that are relevant to proof of particular charges brought against them.
(a) the reasons for the withdrawal of Prospectus 59 and the status of investor funds being held in trust,
(b) the circumstances that had required a peer review of the company’s
auditors
(c) the reasons for the resignations of Messrs White and Nattrass and the steps being taken to secure replacement directors.
[756] The minutes of the meeting of 17 September 2009 were received and confirmed at the next board meeting held on 27 October 2009, at which both Mr Hubbard and Mr Sullivan were present. The information contained in both Mr McLeod’s report and in the minutes of the 17 September 2009 board meeting provide evidence of Mr Sullivan’s knowledge about the position of South Canterbury at the time he and Mr Hubbard signed Prospectus 60, on 20 October 2009. When issued, Prospectus 60 contained an audit opinion on the financial statements included
in it, and a letter from the Trustee. Both were dated 20 October 2009.515
(b) Woolpak
[757] As at 30 June 2009, despite the payments totalling $3,132,860.02 having been made by Plum Duff on 26 March and 18 May 2009,516 the amount outstanding from Woolpak to South Canterbury was $6,323,681.58. By the financial year ended
30 June 2009, not only did Mr Sullivan have the knowledge acquired when the Woolpak transaction was first undertaken in the period between April 2006 and September 2006, but he had also arranged for South Canterbury to give an indemnity to Woolpak and Mr Lund on 21 May 2009.517
[758] There is no doubt that, as at 30 June 2009, Mr Sullivan was aware that the Woolpak debt was a material related party transaction that should have been disclosed in Prospectus 60. In addition to the reasons given in respect of counts 2, 3
and 4, given the difficult circumstances that South Canterbury was facing by the end
515 As to the terms of the audit report, see paras [802] and [803] below.
516 See para [211] above.
517 See para [214] above.
of June 2009, I infer that Mr Sullivan knowingly failed to disclose the material lending to Woolpak in order to induce subscription to debt securities offered in Prospectus 60.
[759] I find this particular of count 5 proved beyond reasonable doubt.
(c) Quadrant
[760] The circumstances in which Quadrant took over debts previously owed by Hilltop Hotels and shares in Regency have already been explained.518 In particular, I refer to the two loan agreements of 4 May 2009 that led to a sum of $39,281,629.14 being advanced to Quadrant on 1 May 2009.519
[761] In relation to Prospectus 60, the allegation is that Mr Sullivan knowingly concurred in the making of a materially false statement by omitting the lending that occurred in May 2009 to Quadrant, with intent to induce investors to subscribe for debt securities in South Canterbury.
[762] I am satisfied beyond reasonable doubt that, as at 20 October 2009 when Prospectus was signed, Mr Sullivan knew that the loans to Quadrant had been made in May 2009. Mr Sullivan had been instrumental in arranging for his brother-in-law, Mr Symes, to be inserted as a director and shareholder of Quadrant. I consider that had been done to avoid market perception that that company was linked to South
Canterbury.520
[763] In the circumstances in which South Canterbury found itself in October 2009, when Prospectus 60 went into the market, it would have been disastrous for South Canterbury if members of the investing community had known that South Canterbury effectively owned a hotel in Auckland and that money was being advanced to a related company to avoid the need to disclose that.521 The suggested
explanation of an attempt to avoid a perception of a forced sale does not answer the
518 See paras [285]–[296] and [703]–[712] above.
519 See paras [703] and [704] above.
520 See paras [286]–[294] above.
521 Generally, see paras [708]–[708] above.
point. The letter from Mr Sullivan to Mr Symes of 4 December 2008 evidences the true purpose.522
[764] On any view, both the ownership of the Hyatt Hotel and the advance to Quadrant of almost $40 million were material to potential investors who were advancing funds on the basis of the information contained in Prospectus 60.
[765] I do not see any inconsistency between my finding that this particular has been proved beyond reasonable doubt and the verdict of not guilty which I returned on the charge of theft in a special relationship arising out of the “loan” of about
$39 million made by South Canterbury to Quadrant on or about 1 May 2009. The latter is referable to knowledge of the terms of a requirement contained in the Guarantee Deed and whether it had been breached. The former depends upon whether Mr Sullivan had knowledge that disclosure of the Quadrant lending would have added significantly to the mix of information available to a potential investor
and could have led to a different investment decision being made.523
[766] There was no dispute between Mr Graham and Mr Hagen that Quadrant was a related company of South Canterbury. The lending to Quadrant was both significant in dollar terms (the advance of over $39 million represented over 1% of South Canterbury’s total assets as at 4 May 2009) and related to the ownership of a hotel by a company associated with South Canterbury.
[767] For those reasons, I found this particular proved beyond reasonable doubt.
(d) Dairy Holdings
[768] Mr Graham and Mr Hagen disagreed on whether the advance made to Mr Armer524 was related party lending. Mr Graham’s approach was to link South Canterbury’s desire to make available a facility to Dairy Holdings and the channelling of the money through Mr Armer to avoid a breach of its Trust Deed.
Mr Graham opined that the “back to back arrangement” whereby Mr Armer agreed
522 See para [708] above.
523 See paras [437]–[445] above.
524 The general background to this transaction is set out at paras [297]–[312] above.
to make the facility available to Dairy Holdings demonstrated that he received the money as no more than a conduit. For that reason, he took the view that the lending ought to have been treated as a related party advance to Dairy Holdings.
[769] Mr Hagen’s opinion was that the loan was made personally to Mr Armer, on the basis that it was designed either to keep South Canterbury’s exposure to Dairy Holdings to within the Trust Deed limits, or to obtain better security for its advance. The security offered by Mr Armer would not otherwise have been available to South Canterbury. He also expressed the view that Mr Armer’s personal liability to pay the debt negated any argument that the loan was a related party advance. Mr Hagen relied on the fact that Mr Armer personally paid approximately $3 million to the receivers of South Canterbury to satisfy the debt to demonstrate that there was no interdependence between Mr Armer and Dairy Holdings.
[770] I am not persuaded that the Dairy Holdings transaction should be regarded as a related party advance. Although there is some evidence that Mr Hubbard intended that the accounts be redrawn after 30 June 2009 to show the debt as being owed by Dairy Holdings rather than Mr Armer, there is nothing to show that Mr Armer or Mr Sullivan was aware of such an arrangement.
[771] In my view, albeit reluctantly, Mr Armer entered into a personal transaction with South Canterbury, at Mr Hubbard’s request, to secure funds for the benefit of Dairy Holdings in circumstances where South Canterbury could not have advanced those moneys to Dairy Holdings without breaching both the Trust Deed and the
Guarantee Deed.525
[772] Although the transaction between South Canterbury and Mr Armer enabled Dairy Holdings to receive moneys that it could not obtain directly from South Canterbury, there was no pretence about it. Mr Armer well understood that he was accepting personal responsibility for the loan. Despite the fact that he arranged to funnel moneys from Dairy Holdings (rather than himself) directly to meet repayments to South Canterbury his assumption of personal liability is amply
demonstrated by his payment of some $3 million to the receivers of South
525 See paras [306]–[309] and [312] above.
Canterbury when they called upon him to pay.526 There is no reason why he should have made that payment if there were some artifice about the transaction that meant that South Canterbury could only pursue Dairy Holdings. The fact that Mr Armer had given security over personal assets adds weight to that finding.527
[773] I am satisfied that the Dairy Holdings transaction was not a related party loan. For that reason, the particular of count 5 based on this transaction has not been proved beyond reasonable doubt.
(e) Kelt
[774] The circumstances in which the Kelt transaction arose have been summarised previously.528 The issue in respect of count 5 is whether Mr Sullivan knew, or was reckless as to whether, the $10 million owed by Southbury to South Canterbury was omitted from Prospectus 60, and whether he intended to induce an investor to subscribe for securities on the faith of that prospectus by a material omission.
[775] Mr Sullivan’s knowledge must be assessed as at the date on which Prospectus
60 was issued: 19 October 2009. Before that date, there had been a meeting of the board of directors of Kelt Finance, of which Mr Sullivan was chairman, and a question was asked whether the “advance” from South Canterbury to Kelt Finance of
$10 million was made appropriately.
[776] Mr Sam Kelt was a director of Kelt Finance. Mr Sullivan, Mr McLeod and Mr Bosworth were South Canterbury’s representatives on the board. The other Kelt Capital representative was Mr David Nancarrow. After Mr Sam Kelt had discovered an increase in the amount owed to South Canterbury as at 30 June 2009, he raised the issue immediately. Initially, he sought answers to his concerns from Mr Sullivan and Mr Bosworth, who were present at a meeting of directors of Kelt Finance held on 1 October 2009. The minutes of that meeting record that, at the request of
Mr Sullivan (as chairman of the board), discussion on this topic was not minuted. In
526 See paras [307]–[313] above.
527 See para [310] above.
528 See paras [314]–[354] and [726]–[739] above.
evidence, Mr Sam Kelt indicated that he did not receive any explanation but that
Mr Sullivan promised him that he would investigate matters further.529
[777] Some three days after Prospectus 60 was issued, on 22 October 2009, Mr Sam Kelt wrote to Mr Sullivan in an endeavour to obtain more information about the “loan”.530 I am sure that Mr Sullivan’s state of knowledge was the same on
23 October 2009 as it had been when he responded the following day, 19
October 2009.531
[778] I find Mr Sullivan’s response disingenuous and deliberately misleading in
two respects:
(a) He did not “extract” a copy of the term loan agreement from Mr Brown, in the pejorative sense in which that term appears to have been used in the letter; and
(b)The transaction was not a “manipulation” by Mr Hubbard. It was a “manipulation” by the board of South Canterbury for the purpose to which Mr Sullivan alludes: to avoid breaching the Trust Deed provisions in respect of Single Entity lending.
[779] In fairness to Mr Sullivan, his letter accurately recorded that:
(a) Kelt Finance’s board had not approved the “transaction”,
(b) Kelt Finance had not executed a term loan agreement and
(c) the transaction was not only “unusual” but did not “seem to have much integrity”.
[780] Mr Sullivan placed some reliance on the fact that the Kelt transaction had been examined by the auditors but not queried by them. There are two reasons why I
529 More generally, see paras [340]–[347] above.
530 Mr Sam Kelt’s letter is set out in full at para [348] above.
531 The terms of Mr Sullivan’s letter are set out in full at para [349] above.
place no weight on what was done by the auditors. The first is that Mr Sullivan has acknowledged that he knew the transaction did not “have much integrity”. The second is that the auditors conducted their examination on the premise that, even though the accounting entries were made after balance date, and backdated, there had been an actual agreement entered into between Kelt Finance and South Canterbury in close proximity to balance date. That assumption was wrong, and Mr Sullivan knew that.
[781] I am satisfied that the Crown has proved beyond reasonable doubt that Mr Sullivan knew that the Kelt transaction had been undertaken in an endeavour to ensure that the Single Entity ratio of the Trust Deed was not breached and that it was not disclosed as a related party loan for that reason.
[782] Mr Sullivan, as a director of both South Canterbury and Kelt Finance, had full knowledge that the transaction had not been approved by Kelt Finance. It was deliberately not disclosed. In my view, the non-disclosure was material, known by Mr Sullivan to be such, and was made to induce investors to advance money to South Canterbury, in the knowledge that had it been reported the breach of the Single Entity ratio as a result of the Southbury borrowings would have required full disclosure.
[783] I find this particular proved to the required standard.
(f) Debt impairment
[784] Mr Sullivan is alleged to have made a materially false statement in Prospectus 60 about the level of debt impairment. The Crown’s starting point is a letter of 5 May 2009, by which the Trustee advised the directors of South Canterbury about its concern over the level of debt impairment.532
[785] The Trustee wrote:
Further to our meeting with the SCF Board on 30 April 2009, we now formally request further details on the following three key issues discussed:
532 This is the same letter in which the Trustee expressed concerns about related party lending: see para [79] above.
1. Impaired Assets
Over the 9 month period from June 2008, the Company has experienced a significant increase in its level of impaired assets, up from approx $61m in June 2008 to approx $180m in March 2009. We note however, that notwithstanding the substantial deterioration in the loan book over this period, the level of provisioning (approx. $22.5m at 31 December 2008) has remained reasonably static, which suggests to us that the Company remains confident being able to realise full value for the majority of these impaired assets.
We request further details as to how the Company satisfies itself as to the adequacy of the provisioning levels and for all loans over $5m a schedule (reconciled as at 31 March) containing:
the name of the borrower, the nature of the advance, the amount outstanding,
the payment overdue profile (0-30 days/30-90 days or 90 days +)
the specific provision, and
ashort commentary as to the basis for the provision raised and remedial actions planned
We also ask why, under an IFRS environment, there is no collective provision being made.
More generally, given on-going adverse market conditions, we seek your views as to what strategies the Board has in place to mitigate further potential losses arising from increasing delinquent loans.
[786] The Crown relies on the increase in provisioning between the financial statements for the year ended 30 June 2009 and the six months ended
31 December 2009. Compared with the allowance of $77.9 million as at
30 June 2009, the provision was increased to $244.2 million as at 31 December
2009. Mr Graham’s evidence was that such a significant increase in the amount allowed for impairment was highly unlikely to have resulted only from deterioration of the underlying debt securities between 30 September and 31 December 2009.
[787] In particular, the Crown relies on evidence from Mr Thompson. He was employed by South Canterbury as Head of its Asset Management Unit on
1 April 2009.533 Mr Thompson made his first report on 15 May 2009. In that report,
533 Generally, see paras [358]–[361] above.
Mr Thompson summarised his view on provisioning in respect of various accounts which were under the control of the Asset Management team. There were other debts that had not been referred to Mr Thompson for management, for example the one owed by Quadrant.
[788] Attached to Mr Thompson’s report was an “Executive Account Summary”. As at 15 May 2009, there were 25 loans listed as being under the Asset Management team’s control, with a further four being identified as likely to be referred to the team. Mr Thompson assessed that provision had been made only for an amount of
$1,479,490 but that, in his view, there was an additional “At RISK” amount of
$11,034,000. In fact, that amount reflected an arithmetical error in calculating the total of the additional amount for risk that Mr Thompson had identified. The true total was $18,934,000.
[789] On 16 June 2009, a credit committee was formed to consider loan applications. Messrs McLeod, Borland and Bosworth comprised that committee. Even though the relevant resolution stated that the committee would include “one Director and Mr Borland operating under best practice”, they rarely, if ever, met to discuss applications. Generally, they would consider each independently and advise their views. Until that process was put into place, it appears that Mr McLeod saw all loan applications before they were granted, save (perhaps) for those that were made on behalf of Hubbard related entities.
[790] Mr Brown’s response, when asked about a report that he prepared to the board on 10 June 2009 in which he had suggested inaccurate reporting in the past, was that Mr Hubbard’s practice of acquiring “problem” loans before they were impaired on South Canterbury’s books, meant that the company’s impairment assessment was lower than would otherwise be the case.534
[791] The Crown contended that explanation was insupportable on the evidence. While it does offer a valid reason why provisioning was so low up to 30 June 2008, Mr Brown’s evidence lacks plausibility in relation to the period from 1 July 2008 when Southbury (in particular) no longer had the means of supporting South
Canterbury in that way. In that regard, I refer to the problems identified by
Mr Hubbard about the need for recapitalisation in his memorandum of
30 October 2008.535
[792] Mr Thompson prepared a further memorandum, dated 8 July 2009, for a meeting on 13 July 2009. The report was distributed to Mr Hubbard and Mr Sullivan (as directors), Messrs Borland, McLeod, Baxter and Bosworth. By this time, the Asset Management team consisted of Mr Thompson, Mr McGillivray, Mr McCosh and Mr Ramano.
[793] The schedule for the July 2009 meeting takes on some significance as it was available to both Mr Hubbard and Mr Sullivan before the financial statements for the year ended 30 June 2009 were finalised and audited. The amount shown as being the subject of a provision remained $1,479,000. Mr Thompson’s “additional at risk” figure as at 21 May 2009 had increased to $23,063,000.536 However, no provisioning decisions were made at this meeting. Also, Mr Thompson, apart from some discussions with the auditors, took no part in the decision-making process, whereby the amount of a particular provision was assessed.
[794] Although detailed correspondence took place after the meeting on
13 July 2009, there is no evidence that Mr Sullivan participated in it, or in any decision-making that would impact on his knowledge of the correct level of impairment required after that time. Most of the correspondence involved Mr McLeod and Mr Borland.
[795] Mr Thompson was questioned closely on the various reports that he prepared for South Canterbury directors and management; in particular by reference to specific loans. Significantly, Mr Thompson asserted that Mr McLeod and Mr Sullivan had agreed that the risk assessed by him in his May 2009 report
accurately reflected the impairment involved – a figure that actually totalled
535 Relevant parts of this report at summarised or set out at paras [130]–[131] above; see also
Mr White’s response to Mr McLeod of 30 October 2008, set out at para [132] above.
$18 million.537 Mr Thompson held to that view notwithstanding a challenge from
Mr Corlett in cross-examination.
[796] Mr Thompson’s assessment of the minimum amount of any provision that
Ernst Young (an accounting firm appointed to review the work of the auditors for the
30 June 2009 audit) might accept for the purposes of impairment in the June 2009 financial statements are relevant to the position taken by the Crown. Mr Thompson sent an email to Mr McLeod and Mr Borland on 10 October 2009: In summary:
(a) Reference was made to a telephone conference call the day before the email. Mr Thompson said that “some question marks exist” about how the final provisioning was reached. He indicated that Ernst Young wanted to review the relevant files, and that they already had reports undertaken by KordaMentha and the auditors.
(b)Mr Thompson referred to an instruction to “minimise” the provision for the 30 June 2009 audit. He did not consider that the amount for which provision had been made was adequate, given the analysis which he and his team had undertaken.
[797] KordaMentha had been appointed by South Canterbury on the instigation of both Treasury and BNZ, to undertake an investigation into the adequacy of provisioning, for the year ended 30 June 2009. That is the firm of which Mr Graham is a partner. While Mr Graham was involved, the lead partner in the impairment review exercise was Mr Brendan Gibson. He was not called to give evidence. When reporting, on 4 September 2009, KordaMentha advised that the total allowance for debt impairment could range between $174 million and $209 million. That report was sent to South Canterbury on 7 September 2009, for comment.
[798] While an increase in provisioning of $166.3 million between the amounts shown in the financial statements as at 30 June 2009 and 31 December 2009
respectively is significant and of concern, it represents only prima facie evidence that provisioning may have been under-stated in the earlier accounts.538
[799] Quantification of a provision for debt impairment is an art, rather than a science. It is plain from the original KordaMentha report to Treasury of 4 September
2009, the response subsequently sent by South Canterbury and KordaMentha’s reply of 23 September 2009, that there were differences in opinion about the level of impaired debt as at 30 June 2009. Each view was supported by relevant information from which it had been formed.
[800] Generally, in the context of a finance company, the final figure for impairment is reached after input from senior executives with responsibilities for loan performances, people who deal with the borrowers “on the ground”, valuers who can provide an adequate valuation of security provided for the loan, and accounting staff who are required to report provisioning decisions in accordance with relevant financial reporting standards. No two companies will undertake an assessment of impairment in the same way. In almost all cases, there will be a considerable range in the amounts for which provisioning must be made, dependent upon the judgment of those involved in the process. An informed reader of financial statements will ordinarily expect the provisions to be expressed at the lower end of the available range. Potential investors should be taken to realise that no company wishes to under-report profits, or to over-emphasise losses.
[801] Prospectus 60 was put into the market on 19 October 2009, nine days after Mr Thompson sent his email to Mr McLeod and Mr Borland. There is no evidence that Mr Sullivan knew of the content of Mr Thompson’s email to Messrs McLeod and Borland before Prospectus 60 was issued. When Mr Sullivan signed Prospectus
60 he knew that the auditors had not questioned the amount allowed for impairment in those accounts. Whatever the true position may have been, I cannot exclude the reasonable possibility that Mr Sullivan honestly believed that the level of impairment had been stated as an amount which was within a range that reasonable people might accept.
[802] To support that conclusion, I refer also to the auditors’ views. They were aware of the critical nature of the impairment judgements that management was required to make. In the notes to the financial statements for the year ended 30
June 2009, South Canterbury had included comments about the assessment of debt impairment, in the context of revisions to the interpretation of standards to give effect to the new international model that had been adopted for New Zealand. That Note, which formed part of the accounts that were audited, states:
E CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS
The preparation of the financial statements requires the use of management judgements, estimates and assumptions that affect the reported amounts and the application of policies.
Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.
The Company makes estimates and assumptions concerning the future. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below.
a) Impairment Losses on Loans and Advances
The Company reviews its loan portfolios to assess impairment on a monthly basis. In determining whether an impairment loss should be recorded in the income statement, the Company makes judgements as to whether there is any observable indication that there is a measurable decrease in the estimated future cashflows from individual loans within a loan portfolio. This evidence may include an adverse change in the payment status of borrowers. Management uses its knowledge gained from historical loss experience for assets with credit risk characteristics and objective evidence of impairment when scheduling its future cash flows. The methodology and assumptions used for estimating both the amount and timing of future cashflows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. The assessment of the level of impairment could potentially be understated if factors affecting the judgements made change.
In compliance with NZ IAS 39 paragraph 63 the company is required to calculate, for those impaired assets as described in paragraph 63, a provision based on the Net Present Value (NPV) of future cashflows net of anticipated holding and realisation costs. This calculation is based on estimates. The company is required to estimate the value it anticipates to realise from these assets, when the cashflows will be received and the expected holding and selling costs. Changes in market conditions could result in an increase or decrease in the estimated provision which would impact the company's financial results.
….
(Emphasis added)
[803] Despite reporting some concern about the fundamental “going concern” assumption for the 30 June 2009 financial statements, the auditors expressed an unqualified opinion in Prospectus 60, in respect of them. In their letter of
20 October 2009, which was included in that prospectus and in which they expressed their audit opinion, the auditors said:
Basis of opinion
An audit includes examining, on a test basis, evidence relevant to the amounts and disclosures in the financial statements. It also includes assessing:
•The significant estimates and judgments made by the directors in the preparation of financial statements; and
…
Unqualified opinion
We obtained all the information and explanations we required. In our opinion:
•Proper accounting records were kept by the Charging Group as far as appeared from our examination of those records;
•The financial statements on pages 44 to 71 that are required by clauses 16 to 31 of the Second Schedule of the Securities Regulations 1983 and that are required to be audited:
- comply with these regulations;
-subject to these regulations, comply with New Zealand generally accepted accounting practice;
-give a true and fair view of the financial position of the Charging Group as at 30 June 2009 and the results of its operations and cash flows for the year ended on that date.
Our audit was completed on 30 September 2009 and our unqualified opinion was expressed as at that date. We have not undertaken any procedures from the date of completion of our audit.
(Emphasis added)
[804] It may have been wiser for Mr Sullivan to await a review by Ernst Young. However, I am not prepared to condemn Mr Sullivan for relying on figures prepared
by members of South Canterbury’s senior management team which were not the subject of adverse comment by the auditors, notwithstanding the strong views to the contrary expressed by Mr Thompson and KordaMentha. There is a reasonable possibility that Mr Sullivan had an honest belief that the amount shown for debt impairment was within the available range, albeit at the very lowest end.
[805] For those reasons, I do not find this particular proved beyond reasonable doubt.
(g) Conclusion
[806] I find proved beyond reasonable doubt that there were material omissions in Prospectus 60 that Mr Sullivan knew ought to have been disclosed and which were not in order to induce investors to subscribe for securities in South Canterbury. I find particulars relating to the Woolpak,539 Quadrant540 and Kelt541 transactions proved to that standard. I do not find proved beyond reasonable doubt the particulars relating to the Dairy Holdings542 transaction and debt impairment.543
[807] For those reasons, I found Mr Sullivan guilty on count 5 of the indictment.
P R Heath J
539 See paras [757]–[758] above.
540 See paras [760]–[764] above.
541 See paras [774]–[780] above.
542 See paras [768]–[773] above.
543 See paras [784]–[805] above.
7
4
0