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 A charge of false accounting against ex-SCF CFO Graeme Brown was withdrawn in August 2013.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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19 Comments

So was that the genius - no accounting records.

Whereas Fortex kept records and one could see loan cash incorrectly marked as sales/profits

"On several occasions Justice Heath appears stunned at the unorthodox and old fashioned business practices of SCF driven by Hubbard. "

whereas anyone who has actually done business with (or worked for) people like Mr Hubbard, or many older business people, won't be surprised in the slightest.

Very very few people actually run accounts like the Courts and Judges expect.  This is because successful business people cannot afford to think or operate like a judge/court expects - they would be drowned and bankrupted in paperwork and unprofitable actions before their first few years.   I wish the courts could understand that...but I suppose that's what makes them regular paid employees of a guaranteed payroll (and not business folk)

You conveniently overlook several things
 
SCF was an entity that solicited and accepted deposits from the public. As such it was required to keep proper records and operate double entry accounting systems and was subject to audit
 
SCF used an artifice of shifting related party loans around the group just before and after balance date in order to hide them, and never disclosed them, even though Company Law requires them to be disclosed
 
SCF was audited. How the auditor ever audited non-existent accounts is beyond belief
How the auditor was able to issue unqualified reports is equally astounding

not conveniently overlooking anything.

put in all the requirements you like, its going to be a lead balloon.  (try it a see)

and as you see the loans were minuted, and the guy involved clearly prefer the related party loans - which again is very normal for a smaller operation where the business owner tends to have to be light on their feet to keep everything running.

The auditor would have looked at the accounts presented to them. and approved them.

The auditor would consider it beyond their duties to check whether the senior staff who were implimenting the public funding side were also properly applying the Company Law side of things.   However NZ employment law says that those employed in roles aren't personally responsible, and it lay entirely at those employees feet, that they were still operating public side when _clearly_ the business owner/boss was not willing to transition to the public model.

Sorry Cowboy.  Thats doesn't stand up.  These people took a lot of money from the public, then with vast arrogance did very self directed things with it, with a viewpoints similar to yours that it was ok for them to do that.  Just shocking behaviour.
The government bailed it out for about $1.5 billion.  Money of yours and mine which we would have had better purposes for.  $1.5 billion.  Which alternatively could have been lost by investors.
There are reasons for these requirements, tedious as they are on a daily basis.  Think a little harder about it please.

your "facts"  don't seem to fit the processes involved in developing a business structure - please elaborate how the details of your comment relate to how a business is setup, run and transition.

Still waiting for you to elaorate.

Or is it one of those rules that only exist until examined?

.. so the government should bail them out , it was the government who destroyed SCF , not the late Alan Hubbard ...

Remember reading some speculation at that time that SCF was rescued, nothwithstanding the bad book keeping, etc to actually rescue the rich people who had sunk their money into it and preserve that vote bank...any truth to that ?

Leetle story to add some context here. Went to SCF many moon-turns ago to try to sell 'em some electron-shufflement wizardry.
 
Talked to some of the top brass.  Came away empty-handed.  Later, in the debrief, we were mystified by the fact that, when we had talked about sticking a straw into their systems and re-casting the data there to be gained, in the Interests of Better Things, they seemed a bit vague as to what 'systems' existed, and where we would insert the straw.
 
Well, we know now, hey.
 
Hard to run a data pipe into an IBM selectric....

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.
And.
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.
No wonder he wasn't called.  Such a casual look at the state of affairs when signing off $1.58 Billion of tax payer funds is not believable.  Perhaps a cross examination under oath may have disclosed some embarassing reasons? 

I'd love to know how much money flooded into SCF after they got the government guarantee tick....

NZ Herald reported yesterday that Mr Hubbard had given away millions of dollars to charity out of his OWN POCKET.
You would now have to question wether it was out of his own pockets as reported.

Sure, it was a direct subsidy to the good people of Timaru, ultimately paid for by the long-suffering taxpayer.  No wonder they worship him down there.

What makes my blood boil in all this is that Treasury happily guaranteed all this on behalf of the taxpayer, without the slightest apparent attempt at surveillance.  Subsquently losing the taxpayer over $1 billion.  During this time, their main concern was to try to increase the number of children in schoolrooms.  They had time to be educational experts, but not accounting/finance ones.  I think they should be the ones on trial, not the directors of SCF.

The problem was I believe that if a guarantee wasnt given then the withdrawl of finance to small businesses was seen as being catestrophic.
Really what you pint to is a close the gate after the horse has bolted, ie this should sector have been "policed" years ago to stop the ponzi schemes....but oh no lets not do taht it costs toomuch and we dont like to do that sort of answer.
So yes some ppl should be on trial, but really for letting so much happen without curbing it.
regards
 

Oh yes, I can see the point to providing the guarantee, to keep the oils of commerce and finance oiled. 
 
However, having given it, wouldn't you consider it wise to protect the taxpayers' interests, thru a process of monitoring and reporting?  Especially when you consider the colossal size of the risk?  Doesn't "risk management" mean anything to the experts at Treasury? 

Treasury are right wing, free market ideologues, and hence no "monitoring and reporting" is needed as its all "self-correcting" and will work well in a free/unregulated market.
Again there are 2 sides, colossal loss from pouring money in and colossal loss from a collapsed economy from not.
You and I could give Treasry the benefit of the doubt that they decided the biggest risk of biggest loss was not pour money in aka allow a Lehmann moment. Frankly though Id sack the lot, too wrong too often.
regards
 
 
 
 

Unfortunately, I think you have hit the nail on the head - blinkered by ideology.