CHAPTER 35
BENEFICIAL FINANCE - PROSPECTUS 65
TABLE OF CONTENTS
35.1 INTRODUCTION
35.2 OFF-BALANCE SHEET LOSSES
35.3 AUSTRALIAN RATINGS DOWNGRADE
35.4 REVERSAL OF SHOCK PROOFING AND UNDERLYING PROFIT
35.5 REPORTED DECLINE IN FORECAST PROFIT
35.6 NON-PERFORMING LOANS AND OPERATING PROFIT - APRIL, MAY AND JUNE OF 1990
35.7 WITHDRAWAL OF PROSPECTUS NO. 65
35.8 CONCLUSIONS
35.9 REPORT IN ACCORDANCE WITH MY TERMS OF APPOINTMENT
35.9.1 TERM OF APPOINTMENT A
35.9.2 TERM OF APPOINTMENT C
35.9.3 TERM OF APPOINTMENT E
35.1 INTRODUCTION
In this Chapter, I report on the events surrounding the issue and subsequent withdrawal of Beneficial Finance's Prospectus No. 65 of 7 August 1990. I consider whether the Directors of Beneficial Finance and, in particular, Mr J A Baker, failed in their respective obligations including their obligation to promptly advise the Corporate Affairs Commission of a number of matters which came to their knowledge with respect to the financial condition of Beneficial Finance. I also consider whether Prospectus No. 65 should have been withdrawn from the public prior to 7 August 1990.
I have done so under Terms of Appointment A(h), C and E.
Under Term of Appointment A(h) I am required to investigate and inquire into and report on such of the following matters:
"(i) ...
(ii) any possible failure to exercise proper care and diligence on the part of a director or officer of the Bank or a subsidiary of the Bank."
Under Term of Appointment C, I am required to:
"... investigate and inquire into and report ... whether the operations, affairs and transactions of [member of] the Bank Group were adequately or properly supervised, directed and controlled by:
(a) ...
(b) ...
(c) ...
(d) the Directors, officers and employees of the members of the Bank Group."
Under Term of Appointment E, I am also required having regard to the material considered by me in respect of the matters set out in paragraphs A to D of my Terms of Appointment to report on any matters which in my opinion:
"... may disclose a conflict of interest or breach of fiduciary duty or other unlawful, corrupt or improper activity and ... report whether ... such matters should be further investigated."
Prospectus No. 65 was the last prospectus issued by Beneficial Finance during the period under review.
The issue of that prospectus (as with all others) to the public was governed by various provisions of the Companies and Securities Law. Section 97 of the Companies Code provided that a corporation must not invite or offer the public to subscribe for, or purchase, debentures in that Corporation unless, inter alia, a copy of a prospectus in relation to the invitation, or offer, has been registered by the Corporate Affairs Commission.
Section 110 (12) of the Companies Code prohibited a company allotting or issuing shares or debentures on the basis of a prospectus after the expiration of six months from the date of issue of the prospectus. Beneficial Finance Prospectus No. 65 was issued on 2 November 1989. Pursuant to the provisions of Section 215 C (2) of the Companies Code, Beneficial Finance applied on 27 October 1989 to the Corporate Affairs Commission to be exempted from compliance with Section 110 (12) of the Code in order that debentures could be issued under Prospectus No. 65 for a period of twelve months from the date of issue.
The Directors of Beneficial Finance provided a written undertaking to the Corporate Affairs Commission in support of their application for this "extended life prospectus". The Directors undertook, inter alia:
"..... (b) That the directors of the company, will immediately inform the Commission's delegate of
(i) Any material deterioration in their [Beneficial and its subsidiaries] financial condition; and
(ii) Any occurrence which may result in the prospectus containing or omitting any information that is false in a material particular or materially misleading in the form and context in which it appears;
(c) That the directors of the company will comply with a demand by the Commission or its delegates to withdraw the prospectus immediately where the Commission or its delegate becomes aware that the prospectus is or has become false in a material particular or materially misleading in the form or context in which it appears. Failure to comply with the demand would have the effect that the exemption would be revoked." [Emphasis added]
On 2 November 1989, the Corporate Affairs Commission granted an exemption pursuant to Section 215 C (2) of the Code to enable Beneficial Finance to allot or issue debentures pursuant to the prospectus for a period of twelve months after the date of issue. The notification of exemption granted on 2 November 1989 contained certain conditions, including the following:
"... (d) Within two weeks after the expiry of six months from the date of an extended life prospectus,() there is submitted to the Commission a report by the directors of the company:-
(i) Dealing with the matters which would be required to be dealt with in a report under Clause 21() of Schedule 4 to the Companies (South Australia) Regulations to be included in a prospectus in relation to the debentures to which the prospectus relates, which was registered six months after the prospectus; and
(ii) Stating whether after making all reasonable inquiries they are of the view that any material statement which has been included in the prospectus is untrue or misleading in the form and context in which it appears or whether any material matter has been omitted from the prospectus.
(e) The directors or members of the governing body, as the case may be, of the company promptly advise the Commission:-
(i) Of any material deterioration in the financial condition of the company; and
(ii) If the prospectus contains material that is, or has become untrue or misleading in a material particular in the form and context in which it appears." [Emphasis added]
Section 98 of the Code governs the contents of prospectuses. The prospectus issued by Beneficial Finance which contains the matters required by Section 98 is referred to as the "long form prospectus". Beneficial Finance also issued a "short form prospectus" which contained a summary of the matters referred to in the long form prospectus. That short form prospectus was required to, and did, state that the Company would provide any person with a copy of the long form prospectus within a reasonable time of receiving a request at any of the Company's places of business.
In addition, on 2 November 1989 the Directors reported, in both prospectuses that, after due inquiry by them in relation to the interval between 30 June 1989 and 26 October 1989, they had not become aware of any circumstances which, in their opinion, materially have affected or will affect the trading or profitability of the company or its subsidiaries or the value of the assets of the company or its subsidiaries.
The long form Prospectus No. 65 contained the following statement concerning profitability:
"Beneficial Finance has operated profitably each year since its inception in 1960. For the twelve months ended 30 June 1989 the Beneficial Group's after tax operating profit amounted to $30M compared with $17.4 million for the 12 months ended 30 June 1988. The company and guarantor subsidiaries' after tax operating profit amounted to $29.2 million ...
SUMMARY OF GROUP OPERATIONS FOR 12 MONTHS ENDED 30 JUNE 1989
Operating profit, after tax, was 72% higher at $30 million (June 1988 $17.4 million)...
SUMMARY OF OPERATIONS FOR THE COMPANY AND GUARANTOR SUBSIDIARIES FOR 12 MONTHS ENDED 30 JUNE 1989
Operating profit after tax was 65% higher at $29.2 million (June 1988 $17.7 million)"
The short form Prospectus No. 65 contained the following statement concerning profitability:
"Summary of Operations for the twelve months ended 30 June 1989
. Operating profit after tax was 65% higher at $29.2 million (June 1988 $17.7 million) ... These figures are consistent with the details of the company and guarantor subsidiaries in the Investigating Accountants' Report in the full Prospectus."
An investigating accountant's report was annexed to the long form prospectus which set out the 1989 financial results of Beneficial Finance.
Prospectus No. 65 was eventually withdrawn by Beneficial Finance by letter dated 6 August 1990 to the Corporate Affairs Commission. That letter stated:
"Further to our discussion in your offices this morning, I wish to officially notify you that Prospectus No 65 will be voluntarily closed effective 5pm August 7 1990.
This action is pursuant to Clause 12(b) of NSCS Policy Statement 158 issued August 1989 relating to the Companies Act and Code Section 215(c) and sub-section 168(2). It is the directors opinion that matters have occurred which may be interpreted as representing a deterioration in the financial condition of the company and the prospectus may be now interpreted as materially misleading in some areas."
Prior to withdrawal of the Prospectus, the Directors of Beneficial Finance provided a report (in accordance with condition (d) referred to above) to the Corporate Affairs Commission on 27 April 1990 in the following terms.
"The directors report that after due inquiry by them in relation to the interval between 30 June 1989 and 27 April 1990:
(a) they have not become aware of any circumstances which in their opinion materially have affected or will affect the trading or profitability of the corporation or of its subsidiaries or of the value of the assets of the corporation or of its subsidiaries ...
(c) the directors after making all reasonable enquiries are of the view that there is not anything in or omitted from the Prospectus which could result in it being false in a material particular or materially misleading in the form and context in which it appears."
I set out hereunder for the purposes of examination, the following matters which, in my opinion, were particularly relevant to the financial condition of Beneficial Finance in the context of the respective obligations of both the Board and Mr Baker during the life of Prospectus No. 65. These matters are:
(a) The off-balance sheet losses disclosed in the aggregate accounting exercise reported to the Board in February and March of 1990.
(b) The downgrade of Beneficial Finance's debenture rating by Australian Ratings reported to the Board in February of 1990.
(c) The deteriorating operating profit of Beneficial Finance evident to Mr Baker as at December 1989.
(d) The reported decline in forecast profit as reported to the Board in monthly Board Papers.
(e) The increasing extent of non-performing loans and their effect upon profit before tax as disclosed in the Board Papers particularly in April, May and June of 1990.
(f) The need for a provision of some $22.0M to be raised in respect of the Somerley loan which was apparent to Mr Baker, at least, in February 1990.
35.2 OFF-BALANCE SHEET LOSSES
I have considered whether the level of the off-balance sheet losses reported to the Board in February and March 1990 resulted in a material deterioration in the financial condition of the Company which should have been reported to the Corporate Affairs Commission.
The off-balance sheet losses were reported internally within Beneficial Finance, but these internal reports did not form part of the published financial statements of Beneficial Finance. Losses sustained by the off-balance sheet entities could, however, impact upon the financial condition of Beneficial Finance itself. This impact on Beneficial Finance was a result of the fact that Beneficial Finance was the major financier of most of the off-balance sheet entities, and also had equity in many of them.() Indeed Beneficial Finance found it extremely difficult to find third parties to fund the off-balance sheet entities. On most occasions any such third party funding was supported by a guarantee or letter of comfort from Beneficial Finance.()
Accordingly, the off-balance sheet losses were likely to affect the value of Beneficial Finance's investments, and assets in the form of loans, to those entities. The losses sustained by the off-balance sheet entities made it likely that the profits of Beneficial Finance needed to be written down as a result of provisioning being made for those losses.
Mr D W Simmons gave the following evidence when asked whether the Board was concerned that there could be a flow-on effect from the off-balance sheet losses to the on-balance sheet profit.
"Yes, that was why the aggregate accounting exercise was being done, yes." ()
In 1988 an "Equity Accounting Committee" was set up consisting of Mr J R Devereaux and Mr A Z Kane. Mr Devereaux and Mr Kane were, at that time, working in the Special Projects division within Beneficial Finance. That committee, which reported to Mr S Spadavecchia was set up to oversee the implementation of the equity accounting standard and was also given the task of preparing the aggregate accounts of Beneficial Finance.()
The exact terms of the equity accounting standard can be found in Australian Accounting Standard No 14. Mr Spadavecchia stated in evidence that the effect of the standard was that an investor company was required to show, by way of a note to its accounts, its share of a profit or loss of a company in which it had an investment and exercised significant influence. The extent of loss in any one company was limited to the amount of the investor company's shareholding.() "Aggregate accounting" was a term that was developed within Beneficial Finance. Aggregate accounting consolidates in one set of accounts the results of all entities over which Beneficial Finance exerted significant influence without regard to legal structure or shareholding. The intent was to develop in-house a net position for the Beneficial Finance Aggregated Group.() In February 1989, the Beneficial Finance Board decided that the preparation of the aggregate accounts should take priority over the preparation of the equity accounting statements.()
The first aggregate accounting exercise was performed in June 1989. The aggregate accounts as at June 1989 disclosed an accumulated off-balance sheet loss of $2.2M, comprising post acquisition losses of $1.8M and a current year loss of $0.4M.()
The aggregate accounting exercise continued throughout the first half of the 1990 financial year. () In January of 1990, Mr Kane and Mr Devereaux produced the first draft of that aggregate accounting exercise. Their first draft showed that the accumulated aggregate loss had increased from $2.2M to $23.6M as at 31 December 1989.()
The accounts finally produced by Mr Kane and Mr Devereaux in February 1990 disclosed an accumulated aggregate loss of $22.1M.() The accumulated aggregate loss of $22.1M was divided into two periods. The period to 31 December 1989 had resulted in a loss of $12.5M in the off-balance sheet entities. In addition, retrospective adjustments made to the 30 June 1989 results disclosed an increase in the previously reported off-balance sheet losses from $2.2M to $9.6M as at that date.()
Those figures were provided to Mr E P Reichert, Manager of the Structured Finance Projects division in Beneficial Finance. On, or about 22 February 1990, Mr Reichert confirmed to Mr Kane that the aggregate accounting statement was representative of the current position. He also confirmed that the projections for the period to 30 June 1990 were representative of current expectations.() A copy of the aggregate accounts was also provided to Dr R N Sexton in Beneficial Finance who did not challenge them. He endorsed the forecasts for the period to 30 June 1990() in a written note to Mr Kane.
On, or about 22 February 1990, the final aggregate accounting figures were provided by Mr Kane and Mr Devereaux to Mr Spadavecchia and Mr M Chakravarti. Mr Chakravarti immediately took those documents to Mr Baker.() At the Board meeting on 23 February 1990, the off-balance sheet loss of $12.5M for the period ended 31 December 1989 was disclosed to the Board.() The discussion paper presented to the Board does not, however, refer to the additional off-balance sheet loss not recognised at 30 June 1989. That loss of an additional $7.4M is, however, disclosed in the aggregate accounts attached to that paper.() In short, the body of the discussion paper did not draw out the fact that an additional loss had been incurred and moreover this matter would not have been apparent without a close analysis of these accounts.
The half yearly accounts of Beneficial Finance for the period ended 31 December 1989 had been approved by the Beneficial Finance Board and signed on 20 February 1990, three days earlier.() These accounts disclosed a half yearly profit of $14.3M. According to Mr Baker, the Board was "agitated and upset" about the information provided to it at the Board meeting on 23 February 1990.() After that meeting, Mr Baker expressed fears that he might be dismissed as a result of the aggregate accounting results.() At that Board meeting, when questioned by the Board, Mr Baker advised the Board that the extent of the off-balance sheet losses was being reviewed and he believed that the figures presented were not correct, that the losses would be far less than those presented, and that they would be manageable.()
Mr Devereaux has given evidence to this Inquiry that he was told by Mr Spadavecchia that he (ie Mr Spadavecchia) had informed Mr Baker of the extent of the aggregate losses in January of 1990 prior to the accounts of Beneficial Finance being signed.() Mr Spadavecchia has, however, denied that such a conversation between he and Mr Baker took place. Mr Baker has denied that he knew of the extent of the aggregate losses until 22 February 1990.() He has given evidence that he recalls no such conversation with Mr Spadavecchia.()
Both Mr Kane and Mr Devereaux asked Mr Spadavecchia to advise Mr Baker of the draft aggregate accounting results in January of 1990.() Mr Kane has given evidence that he was advised in January or February by Mr Devereaux that Mr Spadavecchia had told him that he had discussed the draft results with Mr Baker.() I can see no reason why Mr Devereaux would have told Mr Kane of his conversation with Mr Spadavecchia if it did not occur.
In all the circumstances, I am not satisfied that Mr Baker did not know of the draft aggregate results in late January 1990 or early February 1990. Indeed, I would find it surprising that information of this nature would not have been passed on to Mr Baker immediately.
I also note that, in October 1989, Mr Baker was provided with an aggregate accounting statement showing that the off-balance sheet losses to 30 June 1989 had increased to $9.4M and projecting total losses of $11.6M through to June 1990.() In my opinion, it was not appropriate for Mr Baker to sign off on the half yearly accounts, on 20 February 1990, when he knew that the aggregate accounting results were about to be published and, in particular, when he knew that individual off-balance sheet entities, which had their results reported in those accounts, had suffered substantial losses.
I find that Mr Baker failed to satisfy himself that any reported off-balance sheet losses would not materially affect the on-balance sheet reported profit of Beneficial Finance. I also find that Mr Baker failed to satisfy himself that the reported on-balance sheet result was consistent with the Group Aggregate result and to reconcile discrepancies between the results.
Mr Baker has conceded both to this Inquiry and to the Jacobs' Royal Commission that had the true aggregate losses been known at the time when the December 1989 accounts were signed off that further provisioning `on-balance sheet' would have been required.() Mr Kane gave the following evidence to the Inquiry regarding the potential significance of the extent of the off-balance sheet loss disclosed in the draft result that he had prepared in January 1990:
"Mr Devereaux and I considered this would have had significant impact on the taking up of provisions in the books of Beneficial since in looking at that list Beneficial was a major financier to most of those entities, and from that basis we thought it important to get a rough draft, and it ended up being a rough draft of this document to Mr Baker as soon as practicable." ()
The Investigation has not sought to identify the exact effect that the off-balance sheet losses would have had on these accounts. The effect, however, would have been significant given the size of the off-balance sheet losses as stated in the "Aggregate Accounting Statement as at 31 December 1989" presented to the Board on 23 February 1990.
In March 1990, a further paper on the aggregate accounting exercise was presented to the Board.() The $7.4M loss not accounted for in the 30 June 1989 aggregate accounts, was not referred to in that paper. That paper showed that the off-balance sheet loss for the half year to December 1989 had been reduced from $12.5M to $7.3M as a result of more up to date information and some tax benefits.() The paper also referred to asset revaluations which would increase the asset values of the off-balance sheet entities by $14.5M by 30 June 1990. The paper forecast an off-balance sheet loss for the full financial year of $9.4M. Mr Spadavecchia presented the paper to the Board reporting on the above matters on 29 March 1990.()
Mr Simmons' diary note of 29 March 1990 records the following:
"At the Beneficial Board meeting on 29 March there was a presentation on aggregate accounting.
What is not apparent in real terms is that there has been losses made. These losses have been quite substantial. It is thought that the losses could be offset by an increase in assets but this is not realistic as the assets that have been increased are property assets which rely upon the market improving. The market may not improve. In real terms there has been a substantial loss taken in the off-balance sheet companies."
Mr Baker gave the following evidence to the Jacobs Royal Commission regarding the asset revaluations:
"It is no real comfort but it was regarded as some comfort, it certainly wasn't good enough comfort to book it into the financials." ()
Mr R P Searcy also gave evidence to the Jacobs' Royal Commission that he stated his "disregard" for the re-valuation of assets,() notwithstanding that some of the other directors may still have held the view that a measure of reliance might be placed on asset re-valuations. I am of the opinion, that there was little hard evidence on which any of the directors could reasonably have relied upon the asset revaluation as a factor ameliorating the effect of off-balance sheet losses.
Having regard to the extent of the reported off-balance sheet losses, the information provided to the Board at the Board meetings in February and March of 1990, in my opinion, disclosed that provisioning for these losses would have to be made on the balance sheet. The quantum of such losses has not been assessed by this Investigation. Nevertheless in light of the extent of the reported losses, I am of the view that the level of provisioning required was significant, and was a matter warranting special attention by the Board in view of the approaching statutory report which it was required to provide to the Corporate Affairs Commission in April 1990.
35.3 AUSTRALIAN RATINGS DOWNGRADE
Prospectus No. 65 contained the following statement regarding the investment rating of Beneficial Finance:
"At the date of this prospectus, the debenture stock of Beneficial Finance is rated by Australian Ratings Pty Ltd as AA- having a very strong capacity to meet debt obligations. Australian Ratings have 18 different ratings between AAA (the highest) and C (the lowest). AA- is the fourth highest rating available."
In February 1990 Australian Ratings notified Beneficial Finance of a downgrade in its rating of the debenture stock of Beneficial Finance from "AA-" to "A+".() I have considered whether the notification of this downgrading should have been notified promptly to the Corporate Affairs Commission and whether it was a factor which should have resulted in the Prospectus being withdrawn from the market by Beneficial Finance.
The Beneficial Finance Board was concerned with improving or maintaining its rating by Australian Ratings from as early as June 1986. Equity was provided by the Bank specifically for the purposes of upgrading or maintaining the Company's rating on three occasions between 30 June 1986 and 30 June 1990.
At a Board meeting on 26 May 1989 the Board discussed the possible downgrading by Australian Ratings of the debenture rating of Beneficial Finance from "AA-" to "A+".() The Board accepted that the debenture rating by Australian Ratings was an important matter for the purpose of a debenture issue.() Mr Baker gave evidence to this Inquiry that a higher interest rate might have to be offered by the Company on such an issue to offset the effect of a downgrade.()
The Beneficial Finance Board was also aware that a downgrade in the rating was something which was likely to affect the cost at which Beneficial Finance could obtain its funds.()
In or about November 1989 the Beneficial Finance Board was first advised of a proposed downgrading of the debenture rating of Beneficial Finance from "AA-" to "A+" and the corporate rating from "A+" to "A".() The Board directed Mr Baker to write to Australian Ratings expressing its concern and disappointment at the proposed downgrade.() A letter was written by Mr Baker to Mr G J Lee, the Director of Australian Ratings, on 20 December 1989.() On page 2 of this letter Mr Baker wrote:
"We find this situation [the proposed downgrade of the debenture rating] quite ludicrous and in no small way alarming given the implications for trustee status in some states, our competitive position in the corporate bond market and finally for our competitive position in domestic retail markets where soon to be announced concessions on discrete application forms for public prospectus have a minimum rating criteria."
Mr F R Horwood and Mr Baker confirmed the importance of the preservation of the existing rating in their evidence to this Inquiry.()
On 15 February 1990, Australian Ratings issued its report which downgraded the debenture rating from "AA-" to "A+".() This downgrading meant that Beneficial Finance had the fifth highest rating available rather than the fourth.
This change in rating was not reported to the Corporate Affairs Commission until 14 May 1990. It was reported to the Commission by Mr T D Auld when Mr Horwood was overseas. Mr Auld wrote to the Corporate Affairs Commission arguing that the downgrading did not make the prospectus misleading. The copy of the letter retained by the Corporate Affairs Commission dated 14 May 1990 is annotated:
"... No action is required."
On 31 July 1990 the Corporate Affairs Commission requested a meeting with Mr Horwood to discuss the ratings report.() At that meeting Mr Horwood expressed concern that the Commission might review whether the prospectus should remain on issue, given the February 1990 Australian Ratings Report, the level of contingent liabilities, and deteriorating profit performance.()
Mr Horwood has given evidence that he does not consider that the downgrading of the rating was a material matter in relation to the prospectus, but cannot recall whether he considered at the time whether it was a matter which might be material in relation to the prospectus.()
Mr Baker has conceded to this Inquiry that the downgrading ought to have been reported to the Commissioner for Corporate Affairs promptly to comply with the conditions of the exemption.
He said in evidence:
"It is probably something that should have been brought to the attention of the Corporate Affairs Commission. I would have thought, yes." ()
I have formed the opinion that the downgrading of the debenture rating was (when viewed in conjunction with the off-balance sheet losses subsequently reported to the Board in February and March 1990) a significant matter. The downgraded debenture rating made the reference to the debenture rating of Beneficial Finance in the prospectus no longer accurate in the form and context in which it appeared. Whilst the downgrade of itself may not have warranted withdrawal of the prospectus, nevertheless it stood out as one of a number of early warning signals in relation to the financial condition of Beneficial Finance.
35.4 REVERSAL OF SHOCK PROOFING AND UNDERLYING PROFIT
"Shock proofing" was a means used by Beneficial Finance to build up reserves, which might be used later in less profitable periods to smooth out the level of reported profits.() This practice had been taking place within Beneficial Finance since 1987.() Funds were shock proofed by various methods including fees kept in suspense, general provisions, the Managing Director's contingency fund, the profit participation fund, and prudent accruals.()
In March 1989, Beneficial Finance, at Mr Baker's direction, started to use the provisions it had built up, by shock proofing, to increase its reported profit.() This use of shock proofing provisions was a response to a perceived deteriorating profit performance by Beneficial Finance.()
In September 1989, Mr J D Suter (Senior Manager Planning and Reporting) provided a report to the Executive Committee of Beneficial Finance outlining the discrepancy between the profit reported by Beneficial Finance and what he described as its "underlying profit" between March and August of 1989.() When Mr Suter used the term "underlying profit" he meant "the profit which will be generated as such so it is generated from normal day to day transactions".() To arrive at the underlying profit of Beneficial Finance, Mr Suter eliminated adjustments to the profit by the use of shock proofing reserves and the effect of one off up front fees being brought to account in one month.()
The September 1989 report of Mr Suter disclosed that the reported profit of Beneficial Finance was substantially higher for the months April, May and June of 1989 than the underlying profit. Most of the difference between the underlying profit and the reported profit for that period can be attributed to the reversal of shock proofing.() The document was shown to the Executive Committee during a verbal presentation by Mr Suter in September of 1989.() Mr Baker was the only member of the Board who was present at Executive Committee meetings although another member of the Executive Committee, Mr M G Hamilton was an alternate director.
On 22 January 1990 the General Manager, Strategic Management Services, Mr A G Parkinson, sent a memorandum to Mr Baker, Mr Chakravarti, Mr Horwood, Mr J D Malouf, Mr G L Martin, Mr G O'Brien, Mr Reichert, Mr Sexton and Mr G J Yelland regarding the underlying profit of Beneficial Finance. That report showed that although the reported profit to December 1989 for that half year was $14.021M, the underlying profit was only $10.18M.() I am satisfied from that document, in the absence of any other evidence, that the term underlying profit was being used in the same way as Mr Suter used it.
The report also disclosed that the underlying profit for the month of December 1989 was a mere $0.359M compared to the reported profit of $2.54M. The report also stated that "there will be limits to the company's ability to continue reporting above the underlying trend." Neither of the two reports was forwarded to the Board.()
Mr Baker gave evidence to the Royal Commission that he agreed that core profitability (being the profit on a month to month basis without any large one-off abnormal type items) was an indication of the health of Beneficial Finance.() In a submission to my Investigation, however, Mr Baker submitted that the Executive Committee considered the January report, but did not consider that a major problem existed. I do not agree. The contents of this report were important and should have been conveyed to the Board.
Furthermore, the information provided to Mr Baker relating to the underlying profit of Beneficial Finance, in September of 1989 and later in January of 1990, should have indicated to Mr Baker that there had been a material deterioration in the financial condition of the company which should have been reported to the Corporate Affairs Commission.
Mr Spadavecchia gave evidence that the underlying profit of Beneficial Finance continued to decline throughout the second half of the 1990 financial year. It should be noted that to calculate underlying profit, Mr Spadavecchia eliminated shock proofing entries only, and not `one-off' front end fees. Mr Spadavecchia gave evidence indicating a difference between "underlying profit" (as he used the term) and "reported profit".()
The reported profits for March, April and May 1990 were tax effected profits. The Company reported a net loss before tax for these periods. Mr Baker was aware of the continued discrepancy between the underlying profit and reported profit and the continued deterioration in the underlying profit because the adjustments were made at his direction.() There is no evidence to suggest that either Mr Spadavecchia's calculations or the earlier two reports regarding the downward trend in underlying profits were reported to the Board.()
The two reports regarding underlying monthly profit disclosed a downward trend in the profits made by the Company's operating activities. This downward trend was significant, and Mr Baker failed in his duty to disclose the contents of those reports to the Board.
The continuing deteriorating underlying profit performance of Beneficial Finance throughout the second half of the 1990 financial year reinforced the matters that should have been apparent to Mr Baker at the end of December 1989. I am of the opinion that this trend was significant and, it could have indicated a significant deterioration in the financial condition of the Company, which should have been reported to the Corporate Affairs Commission and which might have influenced the withdrawal of the prospectus.
35.5 REPORTED DECLINE IN FORECAST PROFIT
The forecast profits of Beneficial Finance for the 1990 financial year gradually, but consistently, declined between November 1989 and July 1990. These profit forecasts were prepared by the Strategic and Planning division and were normally included in the monthly Board Papers.
The forecast profit provided to the Board for Board meetings during the life of the prospectus is set out below.()
|
|
1990 Forecast |
|
24 November 1989 |
$35.0M |
|
24 December 1989 |
- |
|
26 January 1990 |
$33.0M |
|
23 February 1990 |
$30.0M |
|
29 March 1990 |
- |
|
27 April 1990 |
$27.0M |
|
25 May 1990 |
$24.0M |
|
29 June 1990 |
$21.3M |
|
27 July 1990 |
$20.6M (draft actual figures) |
|
3 August 1990 |
$4.4M (audited figures) |
In April of 1990 concern was raised at the Board meeting that the profit forecasts were too optimistic.() Prior to the May 1990 Board meeting Mr Simmons told Mr Baker to advise the Board that Beneficial Finance would not make the forecast level of profit.() Mr Baker told the Board at that meeting that:
"... Things were getting worse and the outlook was not good, and while we still expected to make a profit, profit was going to be substantially below budget and we were going to have a real task in handling our non-performing loans, but we had taken action to reorganise management, different people in different seats, we were putting the expertise where the problems were." ()
The forecast profit deteriorated from $35.0M as at November 1989 to $24.0M at May 1990 and $21.3M at June 1990. The net profit after tax reported by Beneficial Finance and its subsidiaries in the previous financial year to 30 June 1989 was $30.0M. In my opinion, the forecast profit of $24.0M and $21.3M, in May and June 1990 respectively, showed that Beneficial Finance was expected to be materially less profitable in the 1990 financial year than the 1989 financial year.
Given that Beneficial Finance reported an on-balance sheet profit of $14.3M to the half year 31 December 1989 the deterioration in Beneficial Finance's profit performance throughout the first half of 1990 was made even more evident by the profit forecasts of May and June of 1990. Once again, combined with other indicators the continuingly deteriorating trend in profit forecast could have provided no comfort for the Board.
35.6 NON-PERFORMING LOANS AND OPERATING PROFIT - APRIL, MAY AND JUNE OF 1990
The Board Papers for the 27 April 1990 Board meeting disclosed that on-balance sheet non-performing loans had increased during the month of March 1990 from $111.3M to $183.4M and accounted for 7.6 per cent of average net receivables. This represented an increase from $31.2M at 30 June 1989 and $75.0M at 30 November 1989. Off-balance sheet non-performing loans at 31 March 1990 were an additional $49.9M. The April 1990 Board Papers also disclosed that the Company had suffered a net loss before tax of $0.601M for the month of March. Mr Simmons' diary note dated 24 April 1990 records the following matters:
"Telling John Baker that I would like to get together with you on Thursday after the Bank Board meeting to go through the Beneficial papers. I said I didn't see anything unusual but I was very concerned about the non-accruals. Baker saying that the non-accruals was such that he thought the Bank might have to help. This is the fear that I had before."
Mr Simmons' diary note dated 27 April 1990 records the following matters:
"At the Beneficial Board on 27th, a great emphasis was placed on the status on the company. It is becoming apparent to me that with a write-up of $75 million in non-performing loans, Beneficial has a real problem. This write-up of non-performing loans is not the be all and end all as there are other non-performing loans that will come out in the wash. When we went through the accounts, it became apparent that the provisioning was not tight enough and this would be a real problem. I am concerned with these provisions as they could wipe profits substantially. The Board was concerned with the fact that Beneficial was showing a profit but the profit was not a trading profit. It was a profit generated by the treatment of tax loss."
Mr Simmons later made a further diary note on 27 April 1990, which records the following matters:
"Attendance on John Studdy.
John Studdy had met with me the night before. He raised with me the problems regarding Beneficial. I told him that the major problems with Beneficial was the non-accrual loans. I said that the non-accrual loans were about $200 million over budget which was $30,000. At the Beneficial Board meeting this matter was discussed in detail. Subsequently I spoke to Clark in the afternoon and he said that the figure could be as high as $400 million. At $400 million, that is $60 million short fall without any write-offs."
Pursuant to the condition (d) of the exemption for the extended life prospectus a report to the Corporate Affairs Commission, dated 27 April 1990, was presented to the Directors to be signed at this meeting.
Report Dated 27 April 1990
On 27 April 1990 at that Board meeting the Directors signed the report in the following terms:
"The Directors report that after due inquiry by them in relation to the interval between 30 June 1989 and 27 April 1990:
(a) They have not become aware of any circumstances which in their opinion materially have effected or will effect the trading or profitability of the Corporation or of its subsidiaries or of the value of the assets of the Corporation or of its subsidiaries ...
(c) The Directors after making all reasonable inquiries are of the view that there is not anything in or omitted from the prospectus which would result in it being false in a material particular or materially misleading in the form and context in which it appears."
The report was signed by Mr Simmons, Mr K D Williams, Mr Baker, Mr T M Clark, Mr R D Malcolmson, Mr K S Matthews, Mr Searcy, Mr J D Studdy and Mr A G Summers.
The report contained a further undertaking by the Directors to immediately inform the Commission's delegate of:
"1. Any material deterioration in their financial condition; and
2. Any occurrence which may result in the prospectus containing or omitting any information that is false in a material particular or materially misleading in the form and context in which it appears."
The report was provided to the Board for signing as an attachment to a letter dated 20 April 1990 addressed to the Directors from the Corporate Secretary.() In a submission to my Investigation on behalf of the Non-Executive Directors as at February 1991, it was asserted that at the 27 April 1990 meeting there was considerable discussion amongst Board members concerning the state of Beneficial's financial health, being a discussion which took place against the background of the undertakings which were to be discussed and signed. The Board then sought and received assurances from management that nothing material had occurred to Beneficial which would prevent them from executing the undertakings that were sought. In addition Mr Simmons required that Mr Yelland, as the General Counsel for Beneficial, `sign off' each month thereafter on the undertaking and list such `sign off' as a Board Agenda item each month because as chairman he regarded the question of materiality as substantially a legal question and wanted the monthly assurance of General Counsel that it was appropriate that the undertakings remain current. (In fact the Board did not require Mr Yelland to `sign off' at the May Board meeting. I will have more to say about this issue below.) Mr Baker in evidence to me did not deny that assurances were sought and given. In my opinion, any such assurances were entirely misplaced and could well have misled the Board.
Nevertheless, whilst I accept the submissions on behalf of the Board as accurately reflecting the concerns expressed by the Board at the time of executing the undertakings, I reject the conclusion which the Board submitted of necessity followed, namely that "it was entirely appropriate for the Board to adopt a wait-and-see attitude" on the direction in which Beneficial was heading and for that reason it was in order for the undertakings to be signed.
By the 27 April 1990 alarm bells must have been ringing loud and clear in the Board's corporate ear. In my opinion it was high time for the Board to say "enough is enough", delay signing the undertakings and call in an investigating accountant for a report.
In response to this (at the time tentative) view, which I expressed during the natural justice process, the Board sought and obtained just such a report from a Mr B Morris of Edwards Marshall & Co, Chartered Accountants. Mr Morris was instructed to examine the relevant reports made available to the Board for the meeting of April 1990 and report as to whether or not this material should have put the Board on notice of a material deterioration in the trading or profitability of Beneficial, such as would have required the Board to notify the Corporate Affairs Commission pursuant to its undertakings.
Mr Morris' opinion was that:
"... on the basis of the Board's understanding of the profit that had been achieved by Beneficial during the nine months to 31st March 1990 and the forecast continued profitability of Beneficial for the remaining three months of the 1989/90 financial year ... the answer ... is no." [Emphasis added]
However, Mr Morris also commented on some of the material which was fundamental to the decision which the Board was required to make, namely Beneficial's "problem exposures".
Mr Morris listed the exposures and then made the following observations:
"As a general rule the submissions [with respect to these exposures] were brief. I found the submissions unhelpful in that they failed to communicate to me the salient issues, the extent of the risk and the impact upon the financial position and prospective financial position of Beneficial". [Emphasis added]
I pause here to observe that his description of these submissions as "unhelpful" is perhaps the kindest of all possible constructions.
His report continued:
"I have formed the opinion that in respect of a number of projects there existed a potential for Beneficial to incur further losses above those which had been provided for in respect of the specific exposures. I was, however unable to conclude on the facts before me whether the potential further losses needed to be provided for at the time or whether general/unallocated provisions were adequate for the purposes".
If the Board had (as circumstances demanded of a reasonable Board) sought and obtained an investigating accountant's report in terms even remotely similar to that produced by Mr Morris, it would not have executed the undertakings. It would have been forced to seek from management, reports which would properly inform it as to Beneficial Finance's true financial position. Instead despite having echoed the concerns expressed in Mr Simmons diary notes for the 24 and 27 April 1990 the members of the Board too readily accepted assurances from management which then comforted them in executing the undertakings.
In my opinion, in all the circumstances the members of the Board who signed the undertaking failed to exercise proper care and diligence.
In this regard, Mr Baker who was an Executive Director is in a different category. He was in a better position than the Non-Executive Directors to better appreciate the deteriorating financial condition of Beneficial Finance. He was privy to information indicating this possible deterioration as early as the beginning of 1990. He was also, as Managing Director, responsible for the "unhelpful" submissions being put to the Board in relation to the "problem exposures".
During the natural justice process, he reaffirmed his confidence, as at 27 April 1990, about the financial viability of Beneficial Finance. Notwithstanding this, I am of the opinion, that having regard to all of the material considered by me, Mr Baker's conduct relating to the matters set out above, namely, withholding important information from the Board and in executing undertakings in the circumstances outlined, may disclose unlawful, or improper, activity and should be further investigated.
May and June 1990
On 8 May 1990 Mr Simmons met with the Premier and advised him that the present level of non performing assets was increasing each month and could reach $300.0M.() Mr Simmons had been provided with a model by Mr J T Hazel which suggested that, with sustained non-performing loans at this level, the Company would make no profit, even without making specific provisions for losses.() In his evidence to the Royal Commission, Mr Simmons agreed with the proposition that the level of non-performing assets in terms of the level of Beneficial Finance's assets is "a pretty dramatically poor picture".()
Mr Simmons' diary note dated 23 May 1990 records that Mr Simmons said to Mr Baker that:
"In my view Beneficial would be in a situation where it would be intolerable next year. The Bank would support Beneficial but it has had no option but to find out exactly what the situation was."
Mr Simmons' diary note dated 25 May 1990 states the following:
"Attendance on John Baker. I went around to see Baker before the Board meeting. I told Baker that I was very concerned with how things were going. I said that as Chairman and friend I believed that he should take things up front and deal with things himself before the meeting started. I said that I had a real problem in this regard. I said that I believed that he should say how badly things were going, how disappointed he was with some of the information he had received and how poor Pier Cairns was. I said I would highlight the situation right up front otherwise there would be enormous problems with the directors. I said the directors were becoming very concerned. I was becoming very concerned because in real terms the non-accrual loans were at a level which meant that Beneficial Finance was not profitable. I said this was a real concern to me. I said that the major thing to be done was to allay the fears of the directors and be positive as to what was happening. The meeting went through that way."
That diary note also records the following:
"At the Beneficial Board meeting it became apparent that Beneficial was travelling a great deal worse than people had thought. The problems that emerged were:
1. The non-accruals were $285 million;
2. There was a cash flow which showed that Beneficial was breaking at a loss.
3. Mindarie Keys was a problem.
4. Pacific Rim was a problem.
5. We alluded to the Pier Cairns transaction.
6. On the cash flow there was a shortage."
At the Board meeting on 25 May 1990 Mr Baker expressed pessimism about the future of Beneficial Finance to the Board.() The Board Papers disclosed that non-performing loans as at 30 April 1990 had risen to 8.3 per cent of average net receivables. There were $205.0M of non-performing loans on-balance sheet and total group non-performing loans of $265.0M.
The information before the Board at that meeting regarding the extent of the non-performing loans and the continued trading losses made by Beneficial Finance showed that there had been a significant deterioration in the financial condition of the Company.
Furthermore, having specifically required (presumably because of the importance it attached to the matter) that Mr Yelland, as General Counsel for Beneficial, sign off each month on the undertakings, the Board failed to ensure that a certificate was signed by Mr Yelland at its May meeting.
No explanation (other than the matter was overlooked) for this failure was provided to my Investigation.
The Board Papers for the Board meeting of 29 June 1990 disclosed that non performing loans at 31 May 1990 remained at 8.3 per cent of average net receivables and the total value of on-balance sheet non-performing loans had increased by a further $6.2M. The papers also disclosed that Beneficial Finance had suffered a net loss before tax of $4.9M for that month. The information provided in the June 1990 Board Papers served only to confirm the significant deterioration in the financial condition of the Company.
Mr Baker has conceded to this Inquiry that as at May 1990 he would agree that the financial condition of Beneficial Finance had deteriorated from October 1989.() He conceded that if he had turned his mind to the matter in May or June of 1990 he would have considered that he should have advised the Corporate Affairs Commission of the deterioration in the financial condition of the company.() He also conceded that in April - May 1990, he was "not focusing on the problems" of Beneficial Finance as well as he should have.() Such a 'concession' rings hollow when viewed against the background of a Managing Director who had failed on a number of occasions to disclose vital information to the Board.
Mr Simmons has conceded that in April, May and June of 1990 that he had a number of matters brought to his attention which raised a degree of concern regarding the financial condition of the Company.() Mr Simmons also gave the following evidence to the Inquiry regarding the deteriorating financial condition of Beneficial Finance.
"As I said it was a very rapid deterioration really from March, April and May but the Board was always working a month behind itself so certainly in your position, looking at this, you could say; well, yes, I would have done something but in my position it is not quite as easy as that and that is one of the problems that I think a Board has in a situation like this, is that because there is a discrete topic which you are looking at you take into account - you look at it very carefully. The Board is not looking at that carefully. It is looking at a variety of matters. I think in - as a matter of interest in August of that year I had 180 separate matters I was dealing with at the bank at that time so it is just not possible to look at it like you would look at something if you were asked to advise in a legal practice, for example. You would sit down. You would look at it very carefully. You can weigh it all up. You come to a different conclusion than if you were on the hop trying to run a business which has got immense problems, both in the political sense and in the corporate sense and this is just one item that you are concerned with.
It is very difficult to give that the degree of attention that you give it now and, you know, a Director must be able to rely upon management who are meant to be competent to highlight things otherwise it just does not work." ()
Mr Simmons gave similar evidence earlier in his examination.
"If you have one single object to do and that is to look at the prospectus, go through it very carefully, consider whether or not on all this information now you should have considered doing something the answer might well be yes." ()
Whilst I can understand the difficulties of Mr Simmons and the Board in this regard they provide insufficient justification for failing to seek an investigating accountant's report in April or to notify the Corporate Affairs Commission in May.
Provisioning
One particular non-performing loan, namely the Somerley loan, was a major concern to the Beneficial Finance Board and especially to Mr Baker.() Beneficial Finance had an exposure of approximately $22.0M to this project which went into default with its financiers in early 1990.() Beneficial Finance held a second mortgage over the project which at the time the problems arose was no more than a "hole in the ground".()
Mr Baker has given evidence to this Inquiry that on the matters which were known to him as at February 1990 a provision should have been made at that time for the entire potential loss.()
Mr Baker gave evidence that:
"We really should have bitten the bullet on it in February instead of saying we did not know what it was going to be."()
"Price Waterhouse were there and it was discussed and I suppose in retrospect, if you look back on it, it was really this, the desire to keep the profits up and keep the profitability of the whole State Bank Group up that the Board as a Group, including myself, did not face up to the potential realities of that problem." ()
Special Submission No. 297 presented to the Board on 20 February 1990, on the day the 31 December 1989 accounts were signed, adverted to the possibility of a projected loss to Beneficial Finance on this account of $10.5M. The accounts were signed without any provision being made. Mr Simmons in his evidence suggested that various propositions were put to the Board in relation to recovering the amount owing on the Somerley loan in support of his contention that the Board was entitled not to make a provision.() I am not convinced that this was a reasonable view to take. There is, however, no evidence on which I could find that the Directors, (other than Mr Baker), did not genuinely believe that a provision was not needed.
On 10 April 1990 the external auditor Mr A N Giles wrote to Mr Baker regarding the audit of the consolidated accounts of Beneficial Finance and its subsidiaries for the six months ended 31 December 1989.() This letter notes that the unallocated provision of 1.15 per cent as at 31 December 1989 might not be sufficient. The letter also recommends that even uncertain deals ought to be specifically provided for. Mr Baker did not advise the Board that he had received this correspondence.() In fact, the recommendations in the letter were not carried out by Mr Baker and senior management within Beneficial Finance. In particular, in June of 1990 the unallocated loss provision had decreased to 0.8 per cent and no specific provision had been raised in respect of the Somerley account.()
Mr Baker was asked during the course of this Inquiry for an explanation for not advising the Board of the external auditor's letter of 10 April 1990. Mr Baker responded:
"I do not know why I would have not brought the Board's attention to that, I just cannot have a reasonable answer to that." ()
This was important information that Mr Baker ought to have disclosed to the Board. His failure to do so when viewed against the background of the other reports undisclosed to the Board is explicable only in terms of a managing director acting in blatant disregard for his duties to the Board.
For its part, in light of my findings surrounding the execution of the April undertakings and the marked change in attitude adopted by Mr Baker at the May meeting I am of the opinion that steps should have been taken by the Board immediately following the May Board meeting, to notify the Corporate Affairs Commission. In failing to do so the Board again failed to exercise proper care and diligence.
35.7 WITHDRAWAL OF PROSPECTUS NO. 65
Ultimately, by letter dated 6 August 1990, Beneficial Finance wrote to the Commissioner for Corporate Affairs, advising him that the prospectus would be voluntarily closed, effective from 5.00pm 7 August 1990. The letter stated:
"It is the Directors' opinion that matters have occurred which may be interpreted as representing a deterioration in the financial condition of the company and that the prospectus may now be interpreted as materially misleading in some areas. It is the company's intention to proceed immediately in the preparation of a new prospectus, no. 66 using financial data for the year ended 30 June 1990."
The letter was written as a result of the losses for the year ended 30 June 1990 disclosed in the Price Waterhouse report which was received in early August 1990. The withdrawal was not discussed at Board level. Mr Hamilton and Mr Simmons both discussed the matter with Mr Horwood.() At the direction of Mr Simmons, Mr Hamilton, who had become Managing Director of Beneficial Finance following the resignation of Mr Baker, instructed Mr Horwood to close the prospectus.()
The papers I have obtained from the Corporate Affairs Commission do not indicate any notification from Beneficial Finance to the Corporate Affairs Commission in accordance with the condition imposed by Section 215 C (2) of the Companies Code other than the letter of 6 August 1990, the notification of the Australian Ratings downgrade of 14 May 1990, and the report of 27 April 1990.
In my opinion, the advice from Beneficial Finance to the Corporate Affairs Commission on 6 August 1990 was far too late. For the reasons that I have set out in this Section, I believe the prospectus should have been withdrawn earlier.
35.8 CONCLUSIONS
As a result of my investigations and on the basis of all the evidence before me, I have made the following findings and conclusions.
Beneficial Finance Prospectus No. 65 was issued on 2 November 1989. On 27 October 1989 Beneficial Finance applied to the Corporate Affairs Commission pursuant to Section 215C(2) of the Companies Code to be permitted to issue debentures under the prospectus for a period of twelve months from the date of issue.
In support of that application, the Directors of Beneficial Finance stated in a written undertaking to the Corporate Affairs Commission, inter alia,:-
"(b) That the directors of the company will immediately inform the Commission's delegate of:-
(i) Any material deterioration in their [Beneficial and its Subsidiaries] financial condition;
(ii) Any occurrence which may result in the Prospectus containing or omitting any information that is false in a material particular or materially misleading in the form and context in which it appears."
Pursuant to Section 215C(2) of the Companies Code, the Corporate Affairs Commission permitted Beneficial Finance to allot or issue debentures pursuant to the prospectus for a period of twelve months after the date of issue. This exemption contained certain conditions, inter alia, that:-
"(d) Within two weeks after the expiry of six months from the date of an extended life prospectus there is submitted to the Commission a report by the directors of the company ...
(ii) Stating whether after making all reasonable enquiries, they are of the view that any material statement which has been included in the Prospectus is untrue or misleading in the form and context in which it appears or whether any material matter has been omitted from the Prospectus.
(e) The directors or members of the governing body as the case may be of the company promptly advise the Commission:-
(i) Of any material deterioration in the financial condition of the company; and
(ii) If the Prospectus contains material that is, or has become untrue or misleading in a material particular in the form and context in which it appears."
At the Beneficial Finance Board meeting of 23 February 1990 the Board was advised of an off-balance sheet loss of $12.5M for the half year ended 31 December 1989. Aggregate accounts attached to the papers presented to the Board also disclosed that there was an additional $7.4M off-balance sheet loss for the period ended 30 June 1989, which had not been previously recognised. Therefore, the total previously undisclosed off-balance sheet loss was $19.9M.
In March 1990, a further paper was presented to the Board advising that the off-balance sheet loss for the half year ending December 1989 had been reduced from $12.5M to $7.3M as a result of more up to date information and tax benefits. The paper also referred to asset re-valuations which would increase the asset values of the off-balance sheet entities by $14.5M by 30 June 1990.
The Directors of Beneficial Finance did not report the off-balance sheet losses disclosed to them at the Board meetings in February and March of 1990 to the Corporate Affairs Commission.
In February 1990 Australia Ratings downgraded its rating of the debenture stock of Beneficial Finance from "AA-" to "A+". The Directors of Beneficial Finance failed to advise the Corporate Affairs Commission of the February 1990 Australian Ratings "downgrade" until May of 1990.
The April, May and June 1990 Board papers disclosed a sustained increase in the non-performing loans of the Company. The Board papers for 27 April 1990 Board meeting disclosed that on-balance sheet non-performing loans had increased during the month of March 1990 from $111.3M to $183.4M and accounted for 7.6 per cent of average net receivables. This represented an increase from $31.2M at 30 June 1989 and $75.0M at 30 November 1989. Off-balance sheet non-performing loans at 31 March 1990 were an additional $49.9M. The April 1990 Board papers also disclosed that the company had suffered a net loss before tax of $0.601M for the month of March 1990.
At the Board meeting of 27 April 1990 the Directors signed a report pursuant to Condition (d) of the exemption for the extended life prospectus in the following terms:-
"That the directors report that after due enquiry by them in relation to the interval between 30 June and 27 April 1990:-
(a) They have not become aware of any circumstances which in their opinion materially have affected or will affect the trading or profitability of the corporation or of its subsidiaries or of the value of the assets of the corporation or of its subsidiaries ...
(c) The directors after making all reasonable enquiries are of the view that there is not anything in or omitted from the Prospectus which would result in it being false in a material particular or materially misleading in the form and context in which it appears."
The report was signed by Mr Simmons, Mr Williams, Mr Baker, Mr Clark, Mr Malcolmson, Mr Matthews, Mr Searcy, Mr Studdy and Mr Summers.
At the Beneficial Finance Board meeting on 25 May 1990, the Board Papers disclosed that non-performing loans as at 30 April 1990 had risen to 8.3 per cent of average net receivables. There were $205.0M of non-performing loans on balance sheet, and total group non-performing loans of $265.0M.
The Board Papers for the Board meeting of 29 June 1990 disclosed that non-performing loans as at 31 May 1990 remained at 8.3 per cent of average net receivables and the total value of on-balance sheet non-performing loans had increased by a further $6.2M. The papers also disclosed that Beneficial Finance had suffered a net loss before tax of $4.9M for that month.
The Board Papers for the June 1990 meeting forecast an after-tax profit for the second half of the 1990 financial year of $7.0M. This represented a marked downturn in the financial performance of the Company.
The Directors did not advise the Corporate Affairs Commission of the level of and the sustained increase in the non-performing loans of the Company reported in the April, May and June 1990 Board Papers. The Directors did not advise the Corporate Affairs Commission of the trading losses incurred by Beneficial Finance during April, May and June 1990. The Directors did not advise the Corporate Affairs Commission of the forecast downturn in financial performance shown in the June 1990 Board Papers.
The Corporate Affairs Commission was advised by Beneficial Finance on 6 August 1990 that Prospectus No. 65 would be withdrawn. The Corporate Affairs Commission received no other advice other than the notification of the February Australian Ratings downgrade in May of 1990.
The half year accounts of Beneficial Finance to 31 December 1989 disclosed an on-balance sheet profit of $14.3M. Mr Baker signed off on the 31 December 1989 accounts in February of 1990. At the time of signing off on those accounts, he was aware of substantial losses in individual off-balance sheet entities which were not recognised in those 31 December 1989 accounts. I am of the opinion that he was aware of the full extent of the off-balance sheet loss because he had been earlier advised by Mr Spadavecchia of the draft figures produced by Mr Devereaux and Mr Kane disclosing extensive losses in the off-balance sheet entities. These figures also showed that the Beneficial Finance on-balance sheet profit would be offset by the off-balance sheet losses. Mr Baker did not take any steps prior to signing off the accounts to ensure that the difference between the $14.3M on-balance sheet profit and the off-balance sheet losses was reconciled by appropriate explanation. He did not take action to ensure that the off-balance sheet losses did not materially affect the reported on-balance sheet profit.
Mr Baker received reports in September 1989 and January of 1990 disclosing that the true underlying profit of Beneficial Finance was well below the reported profit of the Company. The reports disclosed that the level of reported profit was being bolstered by the use of shock proofing provisions. Mr Baker failed to disclose the contents of these two reports to the Beneficial Finance Board. By his actions he withheld important information from the Board.
In April 1990 Mr Baker received correspondence from Beneficial Finance's external auditors recommending that the Company adopt more prudent provisioning. Mr Baker failed to disclose this advice to the Board. In failing to do so he withheld further vital information from the Board.
Nevertheless, by the meeting of 27 April 1990, the Beneficial Finance Board had received sufficient information to put it on notice as to the declining state of the financial health of Beneficial Finance.
In the circumstances it was inappropriate for the Board to rely upon the assurances from Mr Baker and management and thereafter proceed to execute the undertakings asserting that there was no material deterioration in the Company's financial condition. Rather than continuing to rely on such assurances the Board should, at that stage, have called for a report from an investigating accountant.
In accordance with my Term of Appointment A(h) I am of the opinion that the Board failed to exercise proper care and diligence, in relation to matters leading to its execution of the undertakings, it was required to provide to the Corporate Affairs Commission.
By the time of its meeting in May 1990, the Board was clearly on notice of a significant deterioration in Beneficial's financial condition. Immediately following this meeting the Board should, in my opinion, have notified the Corporate Affairs Commission, in accordance with its undertakings, and taken steps to withdraw the prospectus.
In accordance with my Term of appointment A(h) I am of the opinion that in failing to notify the Corporate Affairs Commission and withdraw the prospectus the Board again failed to exercise proper care and diligence.
On the basis of all the facts, I am of the opinion that Mr Baker, in failing to take any action prior to signing off the accounts for December 1989 to reconcile the on-balance sheet profit and off-balance sheet losses by appropriate explanation, and in failing to disclose the existence and contents of reports in September 1989 and January 1990, and the correspondence of April 1990, failed to exercise proper care and diligence.
35.9 REPORT IN ACCORDANCE WITH MY TERMS OF APPOINTMENT
35.9.1 TERM OF APPOINTMENT A
(a) As to Term of Appointment A(h), I am of the opinion that for the reasons given in this Chapter the Board of Directors of Beneficial Finance, ie Mr Simmons, Mr Williams, Mr Baker, Mr Clark, Mr Malcolmson, Mr Matthews, Mr Searcy, Mr Studdy and Mr Summers failed to exercise proper care and diligence:
(i) in relation to the matters leading to the execution of the undertakings it was required to provide to the Corporate Affairs Commission for Prospectus No. 65; and
(ii) in May 1990 by failing to immediately inform the Commissioner's delegate of a material deterioration of the financial condition of Beneficial Finance.
(b) As to Term of Appointment A(h), I am of the opinion that for the reasons given in this Chapter the Managing Director, Mr Baker failed to exercise proper care and diligence in that in late January or early February 1990 he failed to take any steps prior to signing off the accounts for December 1989 to reconcile the on-balance sheet profit and off-balance sheet losses by appropriate explanation and further, in September 1989, January 1990 and April 1990 he failed to disclose to the Board the contents of important reports and correspondence relating to the financial condition of Beneficial Finance and in so doing withheld vital information from the Board.
35.9.2 TERM OF APPOINTMENT C
As to Term of Appointment C, I am of the opinion that for the reasons given in this Chapter the operations, affairs and transactions of Beneficial Finance were not adequately or properly supervised, directed and controlled by the Directors, officers and employees of Beneficial Finance.
35.9.3 TERM OF APPOINTMENT E
I report that I am of the opinion, having regard to the material considered by me in respect of the matters set out in Terms of Appointment A and C, the actions of Mr Baker in failing to inform the Beneficial Finance Board of the contents of the reports and correspondence in September 1989, January 1990 and April 1990 and having regard to information available to him about the financial condition of Beneficial Finance at the date of the execution of undertakings in that regard to the Corporate Affairs Commission may disclose unlawful or improper activity on his part, and accordingly I recommend that this matter should be further investigated.