Judge's verdicts in SCF fraud trial raise spectre of the late Allan Hubbard not wanting the company to enter Crown guarantee scheme

By Gareth Vaughan

The Judge in the South Canterbury Finance (SCF) fraud trial has suggested the firm's late chairman Allan Hubbard would've preferred SCF hadn't entered the Crown retail deposit guarantee scheme, which its investors ultimately received a $1.58 billion taxpayer funded payout through following the company's collapse.

Verdicts were delivered yesterday following the lengthy trial earlier this year of former SCF directors Edward Sullivan and Robert White, and ex-CEO Lachie McLeod. The three were charged following a Serious Fraud Office (SFO) investigation. Justice Paul Heath acquitted McLeod and White on all charges. However, Sullivan was found guilty on five of the nine charges he faced. Sullivan has been remanded on bail and will be sentenced on December 12.

SFO director Julie Read said the SFO was considering the Judge’s reasons for the decisions.

SCF collapsed into receivership on August 31, 2010 triggering a $1.58 billion taxpayer funded payout to 35,000 investors under the Crown guarantee. A total of 21 charges were initially laid by the SFO against five men in December 2011 after a 14 month investigation into SCF in what was alleged to be New Zealand's biggest white collar crime. A charge of false accounting against ex-SCF CFO Graeme Brown was withdrawn in August 2013. The SFO also withdrew two charges of false accounting against SCF's former accountant Terrence Hutton in October 2013. Hubbard died in a car crash in September 2011.

The SFO alleged persons associated with SCF unlawfully obtained the benefit of the Guarantee Scheme for SCF by failing to disclose to the Crown that the company had entered into related party lending. The SFO estimated the total value of the allegedly fraudulent transactions at $1.7 billion.

However, all three defendants were acquitted on the charge relating to the Crown guarantee scheme.

In written reasons for his verdicts Justice Heath raises the "apparent preference" of Hubbard to not enter the guarantee scheme, which was hastily thrown together by government officials in October 2008 at the height of the Global Financial Crisis during the 2008 election campaign, following Australia's implementation of its equivalent scheme. SCF was accepted by Treasury into the Crown guarantee scheme on November 19, 2008, and then into the extended guarantee scheme on April 1, 2010.

On several occasions Justice Heath appears stunned at the unorthodox and old fashioned business practices of SCF driven by Hubbard. However, Justice Heath also notes John Whitehead, the Secretary of the Treasury, made the decision to allow SCF to enter the guarantee scheme but was not called by the Crown to give evidence.

"In those circumstances, I was obliged to determine whether the Crown had proved the element of 'inducement' beyond reasonable doubt on the basis of relevant documentary evidence and the oral evidence of Mr Park, a Treasury official who was not involved in the decision to allow South Canterbury into the scheme.  In deciding that I could not exclude the reasonable possibility that the Secretary would have signed the guarantee deed that day regardless," Justice Heath said.

See more on Treasury's oversight of the scheme here and here.

'Jail before lunch time'

Justice Heath's written reasons feature an email sent by White to McLeod in response to a memorandum from Hubbard on October 30, 2008 about options to deal with problem loans. The Hubbard memorandum came after White and Sullivan had identified existing SCF business practices - especially related party lending - as a potential impediment to entry into the Crown guarantee scheme.

"In today's climate I cannot see how we could tell the market that we are going it alone without the Crown Guarantee," White wrote.

"We would be dead in the water in no time flat, and equally, any suggestion that we should contemplate backdating any of Allan's proposals would see the lot of us in jail before lunch time."

Justice Heath notes the last sentence in White's email above should be read in context.

"Plainly Mr White was concerned about Mr Hubbard's apparent preference not to enter the Guarantee Scheme. This is clear from his observation that, in the prevailing economic climate, he could not see how South Canterbury could inform the market that it was not going to enter the Guarantee Scheme without risking imminent demise," Justice Heath wrote.

The Judge also said he didn't believe 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, 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," Justice Heath said.

No robust loan authorisation process and a 'less than orthodox' approach to debt impairment

In broader comments Justice Heath painted a picture of the Crown failing to prove its case of an underlying culture of concealment at SCF between 2004 and 2010.

"The Crown based its allegations on seven transactions and three other events. I do not consider that an examination of the seven transactions over a period of a little over five years can provide a safe foundation for an allegation of continuous concealment of information from the public," he said.

Justice Heath pointed out during a period of rapid growth from June 2004 until June 2008, when it more than doubled total assets to almost $2 billion, SCF's corporate governance and management procedures proved inadequate.

"The absence of a robust loan authorisation process and a less than orthodox approach to debt impairment were contributing factors to the problems that South Canterbury faced when a major financial downturn occurred in mid to late 2008," Justice Heath said.

SCF's corporate governance procedures were more suitable for a closely held company than one which solicited money from the public due to Hubbard's influence over the company's affairs, the Judge said. Despite attempts by other directors to change his ways, Hubbard was unable or unwilling to grasp the need to adapt existing governance and management procedures to the contemporary business environment SCF was operating in, the Judge added.

"As one witness confirmed Mr Hubbard regarded related party loans as the safest of all because he had more control over them," Justice Heath said.

'Removing or minimising the need for South Canterbury to provide for impaired debt'

Justice Heath continued: "I have mentioned a 'less than orthodox' approach to debt impairment. It was common practice for South Canterbury's parent company Southbury (which was controlled by Hubbard) 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."

"As a result, the true state of the inter-company account was not transparently reported to investors. Indirectly, the way in which Southbury acquired 'problem' loans operated as a disincentive for South Canterbury to manage non-performing loans rigorously."

An electric typewriter & the 'B Stock Ledger'

Justice Heath also made detailed reference to Hubbard's insistence on the maintenance of "antiquated" bookkeeping processes that were used in conjunction with computerised systems, known as Sovereign and Great Plains.

"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," Justice Heath said.

"Mr Hubbard maintained (what was known as) the B Stock Ledger, 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."

"On some occasions, Mr Hubbard exercised Southbury’s right to draw funds from South Canterbury without reference either to other directors or senior management. 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, 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."

The majority of the charges brought by the SFO against Sullivan, White and McLeod related to specific transactions entered into by SCF involving allegedly undisclosed, related party lending. The charges Sullivan was found guilty of were one of a false statement by a promoter, three of false statements as a promoter, and one of obtaining by deception. All three men were found not guilty of charges of theft by a person in a special relationship, and McLeod was found not guilty on two charges of false accounting.

Here's the shorter of two documents covering Justice Heath's  written reasons for his verdicts.

Here's a video interview with then-SFO boss Adam Feeley on the investigation into SCF in 2010.

And here's former Finance Minister Michael Cullen blaming then-Australian Prime Minister Kevin Rudd for the wide ranging New Zealand retail deposit guarantee scheme.

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