14 October 2014

Sth Canterbury Finance: R. v. Sullivan, White & McLeod

While Allan Hubbard, the autocrat controlling South Canterbury Finance, developed a sainted reputation as benefactor for good causes his finance company was desperately hiding the extent of problem loans by window-dressing its balance sheet.  By moving problem loans off balance sheet prior to balance date and taking them back later, South Canterbury presented a healthier picture than justified.
Mr Hubbard died in September 2011 following a car crash.  He left behind a finance company under government control following a $1.6 billion bailout and criminal prosecutions against former directors of the company and its chief financial officer.  Poor lines of control within South Canterbury Finance and weak accountability caused evidentiary problems for prosecutors trying to sheet home criminal liability.  A single director, Edward Oral Sullivan, was convicted. On a charge of deception in relation to a 2006 transaction, he was held to have deliberately misrepresented who was the end purchaser of shares in a Hellaby Holdings subsidiary in order to defeat operation of the Takeovers Code.  He was also convicted of Securities Act offences for material non-disclosures of related party lending.
The most serious criminal charge faced by directors was an allegation that they used false financial statements to get a 2008 government guarantee of South Canterbury investors’ deposits.  This charge was dismissed when there was no proof that the government actually relied on the financial statements when admitting South Canterbury to the guarantee scheme.
The then Labour coalition in New Zealand was blindsided in October 2008 when the Australian government suddenly announced a federal guarantee of depositor’s funds.  This was designed to calm investors’ nerves in the face of worldwide banking instability and the threat of a run by depositors on banks.  Two days later, the Labour government announced a similar guarantee scheme for New Zealand deposits to prevent a flight of investor funds to Australia.  Within 48 hours South Canterbury applied to join the scheme.  Approval was given three weeks later.
The High Court was told South Canterbury provided copies of its most recent audited financial statements in support of its application.  It was alleged that the figures had been massaged.  There was evidence that South Canterbury management had a history of window-dressing its balance sheet to hide the extent of asset impairment.  The prosecution described methods used as being “purposefully structured to hide high risk lending” and moving “beyond the cavalier to the dishonest”.  One internal South Canterbury finance memo talked of “cheque-swapping at balance date” and the creation of a “façade”.
Evidence was given that South Canterbury’s parent company, Southbury Group, would acquire problem loans from South Canterbury shortly before balance date.  This removed any need to disclose the impaired loan which was now replaced in South Canterbury’s records with the injection of new funds to replace the non-performing debt.  After balance date the transaction would be reversed.  Asset impairments were understated as a result.  Management had no incentive to manage non-performing loans when they were being hidden from analysts and investors.  Any complaints within South Canterbury about the practice were waved away in autocratic fashion by Mr Hubbard.  Attempts by the auditor to keep tabs on what amounted to related party lending proved ineffective.
One example of window-dressing described in the High Court was false accounting entries made ten days before balance date in 2009 recording a fictitious transaction between Southbury, South Canterbury and Kelt Finance Ltd.  South Canterbury supposedly was advancing $10 million to Kelt Finance which in turn lent $10 million to Southbury which in turn paid $10 million to South Canterbury.  The effect of this fictitious money-go round was to misleadingly reduce related party indebtedness between Southbury and South Canterbury by $10 million and hide the fact that South Canterbury was in breach of loan limits with Southbury.
Justice Heath ruled that even if the financial statements used to obtain a government guarantee of investors’ funds were false, there was no evidence that the government relied on these financial statements before granting the guarantee.
There was evidence that in October 2008 there were such grave concerns about a total financial collapse that finance companies were being admitted to the scheme with minimal prior checks.  Government did not decide which financial organisations would be given a guarantee; that decision was delegated to the secretary of the Treasury.  The court was told applications were sent to the Reserve Bank for analysis.  Bank analysts gave a “negative assurance” in respect of South Canterbury’s application: they had no reason to believe it should not be approved.   The final decision remained with Treasury and was at the discretion of the secretary of the Treasury.  Evidence was given that there was no written record of reasons why the secretary of the Treasury gave approval for South Canterbury to be admitted.  He was not called to give evidence at the trial.
R. v Sullivan, White & McLeod – High Court (14.10.14)
14.047