CHAPTER 41
MANAGEMENT AND FINANCIAL INFORMATION REPORTING
TABLE OF CONTENTS
41.1 PURPOSE OF CHAPTER
41.2 PLAN OF CHAPTER
41.3 OFF-BALANCE SHEET STRUCTURE OF BENEFICIAL FINANCE
41.3.1 THE EXTENT OF THE OFF-BALANCE SHEET ENTITIES
41.3.2 REASONS FOR THE ESTABLISHMENT OF THE OFF-BALANCE SHEET STRUCTURE
41.3.2.1 Preamble
41.3.2.2 The Debenture Trust Deeds
41.3.3 ESTABLISHMENT OF THE OFF-BALANCE SHEET STRUCTURE
41.3.4 MEANING OF "SUBSIDIARY"
41.3.4.1 Thomson Simmons & Co 1985 Advice
41.3.4.2 Legal Definition
41.3.4.3 Subsequent Legislative Developments
41.3.4.4 Other Legislative Definitions of "Control"
41.3.4.5 Conclusion on "Control"
41.3.5 USE OF OFF-BALANCE SHEET STRUCTURES IN 1984-85
41.3.6 THE OFF-BALANCE SHEET STRUCTURE AND ITS OPERATION
41.3.7 THE ROLE OF THE AUDITORS AND THE TRUSTEE FOR DEBENTURE HOLDERS
41.3.8 CONCLUSIONS ON THE OFF-BALANCE SHEET STRUCTURE
41.4 INTERNAL MANAGEMENT REPORTING
41.4.1 DUTIES AND RESPONSIBILITIES OF THE BOARD
41.4.2 AGGREGATE ACCOUNTING
41.4.3 AGGREGATE ACCOUNTS - 31 DECEMBER 1988
41.4.4 AGGREGATE ACCOUNTS - 30 JUNE 1989
41.4.5 AGGREGATE ACCOUNTS - 31 DECEMBER 1989
41.4.6 AGGREGATE ACCOUNTS - 30 JUNE 1990
41.4.7 CONCLUSIONS FROM AGGREGATE ACCOUNTING
41.1 PURPOSE OF CHAPTER
This Chapter examines the arrangements concerning the off-balance sheet entities of Beneficial Finance for two quite distinct purposes. It reports on the investigation into the matters and events which caused the financial position of the Bank and the Bank Group, as publicly reported in February 1991. It also has relevance to my Investigation into the appropriateness and adequacy of the external audits of the accounts of the Bank, which are reported upon in other Chapters of my Report.
I am required by Paragraph A(a) of my Terms of Appointment to investigate matters and events which caused the financial position of the Bank and the Bank Group. In my opinion, "financial position" is a very wide concept, and goes beyond consideration of the contents of the published statutory reports of the Bank and the Bank Group. Paragraph A(a) requires me to investigate off-balance sheet matters which may be relevant to the financial position of the Bank and Beneficial Finance, as a member of the Bank Group, during the period from 1 January 1984 to 30 June 1990.
Paragraph B of my Terms of Appointment requires me to investigate the appropriateness and adequacy of the external audits of the accounts of the Bank and Beneficial Finance. As noted in Chapter 54 - "The External Audits of Beneficial Finance: Introduction", the Bank's published statutory reports included consolidated accounts of the Bank and what are called its subsidiary companies, including Beneficial Finance. As a matter of law, the Bank cannot have subsidiary companies in the usual sense, because this term is defined in the Companies Code in relation to companies governed by the Code. The Bank is not an entity governed by the Code. In respect of the accounts of the Bank, and the consolidated accounts of the Bank and its subsidiaries, published in respect of the period from 1 July 1984 to 30 June 1990, the external auditors reported that the consolidated accounts complied with the provisions of the Companies Code and gave a true and fair view of the state of affairs of the group at the relevant balance dates. Similar reports were issued by the external auditors of Beneficial Finance in relation to the consolidated accounts of Beneficial Finance and its subsidiaries.
I comment in Chapter 46 - "The External Audits of the State Bank: Background Information", on the relative responsibilities of the external auditors of the Bank and its subsidiaries other than Beneficial Finance, and the external auditors of Beneficial Finance and its subsidiaries. The Bank's auditors, KPMG Peat Marwick, have submitted that they were entitled to rely on the work performed by Price Waterhouse, as external auditors of Beneficial Finance and its subsidiaries, for the purpose of auditing the consolidated accounts of the Bank(). In my opinion, the work performed by Price Waterhouse formed part of the audit of the consolidated accounts of the Bank and its subsidiaries.
In my opinion, my Terms of Appointment consequently require me to investigate and report whether the above audit reports were appropriate and, specifically, whether adequate disclosure was made in the accounts of the results and affairs of the off-balance sheet entities of Beneficial Finance to ensure that the accounts gave a true and fair view of the results and affairs of the Bank and Beneficial Finance.
In any event, for the avoidance of doubt, my Terms of Appointment were amended on 23 December 1992 to make it clear that paragraph B of my Terms of Appointment extends to the external audit of the accounts of Beneficial Finance, which include the consolidated accounts of Beneficial Finance and its subsidiaries, and of such other subsidiaries of the Bank as I consider should be subject to investigation under paragraph B.
Paragraph C of my Terms of Appointment requires me to investigate and report, having regard to the matters in Paragraphs A and B, as to whether "... the operations, affairs and transactions of the ... Bank Group were adequately or properly supervised, directed and controlled by ... the Directors, officers and employees of the members of the Bank Group".
Paragraph E of my Terms of Appointment requires me to report on any matters which, in my opinion, may disclose any unlawful or improper activity, and whether in my opinion, such matters should be further investigated. My consideration of the questions arising, and recommendations as to matters which I consider should be referred for further investigation by the appropriate authority, are set out in this Chapter.
In this Chapter I examine two matters, concerning Beneficial Finance. They are as follows:
(a) The relationship between Beneficial Finance and its "off-balance sheet entities".
(b) The impact of the off-balance sheet structure on financial information prepared by the management of Beneficial Finance, during the period from 1 July 1984 to 30 June 1990, as a matter of internal management reporting to the Board.
I do not, however, examine and report in this Chapter on any information relating to Beneficial Finance prepared by officers of the Bank which may have been provided to the Bank Board.
41.2 PLAN OF CHAPTER
Off-Balance Sheet Structure of Beneficial Finance
This Section examines the development of the structure of entities known as Beneficial Finance's "off-balance sheet entities", and their status under the Companies (South Australia) Code. Transactions entered into by these entities were, in my opinion, matters and events which caused the financial position of the Bank and the Bank Group as reported in February 1991 by the Treasurer. Details of the off-balance sheet entities that were created in the period covered by this Investigation are set out in an appendix to Chapter 28 - "Overview of Beneficial Finance Corporation Limited".
Internal Management Reporting
This Section examines the information necessary for the Board and management of Beneficial Finance to properly and adequately supervise, direct, and control, the affairs and transactions of Beneficial Finance. Financial information presented to the Beneficial Finance Board is also examined and assessed.
Conclusion
This Section sets out my findings and conclusions on the above matters.
41.3 OFF-BALANCE SHEET STRUCTURE OF BENEFICIAL FINANCE
41.3.1 THE EXTENT OF THE OFF-BALANCE SHEET ENTITIES
At 30 June 1990, the operations of Beneficial Finance were conducted through a complex structure, both on and off-balance sheet, of trusts, companies, partnerships, and unincorporated joint ventures. At this date, prior to re-structuring, the assets held through off-balance sheet entities were in the order of $679.0M.() At this date many of the entities which had formerly been off-balance sheet were brought onto the balance sheet of the Bank, by being transferred to a subsidiary of the Bank, Southstate Corporate Holdings Ltd. The restructure proposed to reduce off-balance sheet assets to $425.0M(), and to leave off-balance sheet certain losses estimated at $9.7M before inter-company adjustments.() The above asset figures are before eliminating inter-company loans. The extent of the actual assets and losses of those entities which remained off-balance sheet for the year ended 30 June 1990 is discussed in Chapter 59 - "Review of the 1990 External Audit of Beneficial Finance".
41.3.2 REASONS FOR THE ESTABLISHMENT OF THE OFF-BALANCE SHEET STRUCTURE
41.3.2.1 Preamble
The creation of such a complex structure was the result of management proposals approved by the Beneficial Finance Board.
The structure of off-balance sheet entities was created principally to avoid restrictions imposed by the terms of the debenture trust deeds created, by law, to protect the interests of the debenture holders of Beneficial Finance.
The objective of conducting business of the Bank Group in a manner unaffected by the terms of the trust deeds, which Beneficial Finance regarded as being commercially restrictive, could have been achieved by the quite simple and proper expedient of creating "subsidiary" companies under the Bank itself, where there was no such deed. This was the method used in June 1990 to bring certain off-balance sheet entities onto the Bank Group's balance sheet.
41.3.2.2 The Debenture Trust Deeds
In a submission to me from certain former Non-Executive Directors of the Bank and Beneficial Finance, it is asserted that:
"The development of the off-balance sheet entities within Beneficial was a response to the provision of an overly restrictive Trust Deed and the demand for tax effective structured finance packages during the mid to late 1980's". ()
It is also asserted that the `complex corporate structure', to which I have referred, was not uncommon "and indeed characterised most Australian Banks and financial institutions at this time."
Price Waterhouse also have submitted that the use of off-balance sheet entities was not uncommon in the banking and finance industry in the 1980's.()
My Terms of Appointment require me to examine the operations and affairs of Beneficial Finance, as a member of the Bank Group. I consider that this requires me, in the context of the off-balance sheet entities, to examine the structure established by Beneficial Finance. I accept the evidence given to me by Mr G J Yelland, internal legal counsel of Beneficial Finance, and Mr D J Tucker, member of the firm of Thomson Simmons & Co, who advised on and established the structure, that they had no knowledge, when establishing the off-balance sheet structure, of the way in which other banks and financial institutions in Australia at the time may have structured their off-balance sheet entities.() In my opinion, evidence as to what may have been done by other banks and financial institutions in the 1980's would not assist me in determining the implications of Beneficial Finance's off-balance sheet structure.
The Companies Code provided, at all relevant times, that Beneficial Finance was a `borrowing corporation' for the purpose of Part IV Division 5, as it raised money from the public by means of issuing debentures as a security for loans made to it. Effectively, the Companies Code provides that a corporation which invites the public to subscribe for or purchase debentures shall enter into a Trust Deed appointing a trustee corporation to hold security over the corporation's assets, and/or monitor the maintenance of certain financial ratios that must be complied with by the corporation, on behalf of the debenture holders. The appointment of the trustee is designed to ensure that the borrowings from the public are subject to independent oversight by an entity that has a legal obligation to act in the interests of the debenture holders; the trust deed usually contains (and in Beneficial Finance's case did contain) a limitation on the amount that the borrowing corporation may borrow.
The trustee for the debenture holders of Beneficial Finance held security over Beneficial Finance's assets pursuant to a debenture Trust Deed, entered into in 1960, and an unsecured notes Deed, entered into in 1974. These Deeds were replaced by a further Deed, for both debenture stock and unsecured notes, entered into in March 1985. The replacement Trust Deed, although executed in 1985, did not become operative until September 1989, as it was not until then that the large number of debenture and note holders under the earlier Deeds could be contacted and have their borrowings discharged or transferred to the new Trust Deed.
The submission from certain former Non-Executive Directors describes the 1960 Trust Deed as being:
"... restrictive and even commercially unrealistic for the sophisticated financing transactions prevalent during the mid to late 1980s" ()
Beneficial Finance, however, was bound by each of the Trust Deeds. Beneficial Finance, set about finding ways to overcome their terms. The terms that caused particular concern were those which provided, firstly, that, where Beneficial Finance acquired a subsidiary company, the subsidiary had to become a guarantor of the whole of the liabilities of Beneficial Finance to the Trustee, and, secondly, the gearing requirements which imposed upon Beneficial Finance a minimum ratio of total liabilities to total tangible assets. Under the 1960 Trust Deed, this latter requirement imposed upon Beneficial Finance a maximum borrowing ratio of seven times shareholders funds, (which the 1985 deed changed to twelve times shareholders funds).
As to the requirement that a subsidiary become a guarantor of all of the liabilities of Beneficial Finance the submission on behalf of the former Non-Executive Directors states():
"It was a common practice amongst financiers in the mid to late 1980's for these financiers to in effect become equity participants in the projects which were being developed. Where a joint venture company was to be formed for the purposes of a particular project it was clearly commercially unrealistic to expect the joint venture partner to permit the joint venture vehicle to become a subsidiary of Beneficial guaranteeing liabilities of Beneficial quite unrelated with the joint venture. This, along with the taxation advantages available in structured finance packages was the principal reason for the use of "off-balance sheet entities". The off-balance sheet entity structure was conceived to allow Beneficial to enter into structured and tax effective joint venture and other transactions without the vehicles through which those transactions were being effected becoming subsidiaries within the definition of "subsidiary" contained in Section 7(1) of the Companies Code. The incorporation of off-balance sheet entities was a common practice amongst financial corporations at this time."
To place the establishment of the off-balance sheet entities of Beneficial Finance in context, I refer below to the debate in Australia concerning the off-balance sheet structures of certain corporations in 1984-85.
Certain reasons stated above for the use of off-balance sheet entities in the corporate structure, as developed by the Beneficial Finance Group in the period from 1986 to 1990, are confirmed by the Five Year Plan (1988 to 1993) of Beneficial Finance's Investment Banking Division, which states:
"... The existing Investment Banking Division structure involves a mixture of on and off-balance sheet activity. This situation has developed primarily as a result of Debenture Trust Deed limitations such as the inability to raise non-recourse prior ranking debt against assets owned by Beneficial, the requirement of minority shareholders in companies in which Beneficial owns greater than 50% to effectively provide guarantees to Debenture Holders and the lack of flexibility in buying and selling corporate entities."
and
"... for Beneficial to achieve optimum results in the next five years a new corporate structure was essential to overcome Trust Deed limitations on segments of the company's operations, minimise contingent liabilities and to expand into overseas markets."
In the late 1980's, Beneficial Finance sought to expand its markets and range of financial products. One of the strategies for achieving this expansion was to acquire an interest in other established operations. Sometimes when this occurred the original proprietors of the business retained an equity interest in the business so as to ensure that expertise and market links were not lost.
Beneficial Finance considered it to be commercially unrealistic for these operations to become subsidiaries as that would have required them to guarantee the liabilities of Beneficial Finance. Such a requirement was seen as a major obstacle to attracting or retaining external shareholders.
In the late 1980's, Beneficial Finance also acquired a controlling interest in various property development entities with external participants. For the reasons noted above, Beneficial Finance considered it commercially unrealistic for these entities to become subsidiaries of Beneficial Finance.
The Beneficial Finance Trust Deeds also precluded the pledging of specific assets as security in preference to the Trustee for debenture holders, which would have restricted the ability of subsidiaries to raise external finance.
For the reasons discussed above, Beneficial Finance sought to set up a structure such that:
(a) Beneficial Finance could acquire what amounted, in practice, to a controlling interest in another entity; and
(b) despite practical control being held by Beneficial Finance, the entity would not become a subsidiary of Beneficial Finance within the meaning of the definition of a subsidiary contained in the Companies Code.
41.3.3 ESTABLISHMENT OF THE OFF-BALANCE SHEET STRUCTURE
On 3 April 1985, Mr Yelland, Manager Legal Services of Beneficial Finance, wrote to Mr Tucker of Thomson Simmons & Co, solicitors for Beneficial Finance.
Mr Yelland's letter confirms instructions given to Mr Tucker in a meeting of 3 April 1985.
The letter sought advice as to a suitable structure for the acquisition by Beneficial Finance of the Centrelease Group of Companies.
In part, Mr Yelland's letter read as follows:
"... the major problem we have is selecting a suitable vehicle within or outside of our Group to acquire these interests.
The acquiring vehicle is seen as not only the appropriate receptacle for these interests, but also will be developed as the entrepreneurial [arm] of the Group. Hence, it is most desirable that that vehicle avoid the Trust Deed constraints as (to in particular) securing borrowings outside of the (new) Debenture Trust Deed constraints and that its assets (and liabilities) be off balance sheet ...
As we see it the alternative of acquiring vehicles open to us are ...
4. Through a company over which the Corporation would have unofficial control but which would not be a subsidiary ...
Given then that our directors can be satisfied with the control which Beneficial can exert over the arrangement covered in 4(a) in respect of both Board representation and sharing, it seems to be the most suitable way to go, provided the vendors can be persuaded to accept the profit-sharing contractual basis." [Emphasis added]
It will be seen from this letter that Mr Yelland was seeking advice from Mr Tucker as to a structure for the establishment of a new entity which would form part of the business operations of Beneficial Finance, over which Beneficial Finance would have "unofficial control", but which would not be a subsidiary of Beneficial Finance.
Mr Tucker replied with the memorandum of Thomson Simmon's & Co's advice dated 7 April 1985.
In the memorandum, Mr Tucker discussed various alternatives which, in his letter, Mr Yelland had proposed. One of those alternatives, noted by Thomson Simmons & Co in paragraph 5.5 was as follows:
"A company over which Beneficial would have unofficial control but which would not be a subsidiary, formed in one of the two following ways:
(a) With its shareholding held as to 48% both Beneficial and 48% by another entity of convenience which is not a subsidiary of, or related to, Beneficial. This entity would hold sufficient of its shareholding in the company as trustee for Centrelease to entitle Centrelease to beneficial ownership of 20% of the shares in [Joint Finance Company]. The remaining 4 per cent of the shares would be held by individuals nominated by, but not holding as trustee for, Beneficial. Beneficial would not appoint, or be able to appoint, more than one half of the directors of the company.
(b) As above but with the shareholding owned as to 48 per cent by Beneficial, 20 per cent by Centre Lease and 32 per cent by an entity unrelated to Beneficial."
In paragraph 12 of the memorandum Thomson Simmons & Co concluded:
"We therefore suggest use of a company, however for the reasons which follow we suggest a different share structure and board arrangements to those which have been proposed."
Mr Tucker then set out the provisions of Section 7 of the Companies Code. The memorandum continued in paragraphs 14 and 15:
"It is noted that it is control which lies at the heart of Section 7. If the company is not controlled by another company then it is not a subsidiary. But it has been observed in the proposal in paragraph 5.5, a company owned as to 50 per cent is not a subsidiary.
The terms of Section 7(1) are not impossible to overcome. We have considered several alternatives for structuring JFC so as not to bring it within Section 7(1)."
Mr Tucker then considered a series of alternatives in which company structures were proposed, but the shareholding of either Beneficial Finance, or any subsidiary of Beneficial Finance, was restricted to 50 per cent.
Thomson Simmons & Co recommended a structure using ordinary shares and redeemable preference shares, such that the voting power of the holders of the ordinary shares and of the redeemable preference shares were precisely 50 per cent each.
The memorandum concluded with the following paragraph 23:
"Establishment of JFC in the manner above advised will take it outside the disclosure requirements of the Companies Code and its liabilities outside of the range of liabilities to be included in calculations for the purpose of determining borrowing limits under Beneficial's Trust Deeds and is likely also to remove JFC from consideration under the Deeds relating to Euro Bond borrowings and any negative pledge arrangements which Beneficial may have.
Such companies are not uncommon but it will be apparent that skill has been employed to construct JFC in a manner calculated to have the above effect. Consideration must therefore be given to the perception of JFC if constructed as advised, in the context of the general commercial operations of Beneficial and its relationship with persons and groups who may be effected by the formation of such a company."
Mr Yelland gave evidence that he did not understand paragraph 23 as questioning whether the proposal was the sort of thing in which Beneficial Finance should be involved. () Nor did he regard it as his role within management of Beneficial Finance to oversee the advice obtained from Thomson Simmons & Co, or to question management whether Beneficial Finance should proceed with a proposal which Thomson Simmons & Co had advised was legal.
Following the advice of Thomson Simmons & Co on 7 April 1985, the proposal to establish the off-balance sheet structure, which became known as Kabani, was brought before a committee of the Beneficial Finance Board at its meeting on 15 April 1985. The proposal was approved, subject to a number of conditions being satisfied, including:
"(a) The proposed company structure to be submitted to Price Waterhouse to ensure they are satisfied from the point of view of the auditors. Price Waterhouse to be appointed auditors of the new company."()
The next meeting of the Beneficial Finance Board was held on 30 April 1985. It is recorded in the minutes that the conditions laid down in the minutes of 15 April 1985, for the formation of the off-balance sheet company, had been met. () In this matter, the Board was misled.
Mr A H Giles of Price Waterhouse gave evidence that Price Waterhouse were not asked to give an opinion on the proposed structure, and that the first they knew of the structure was in relation to Price Waterhouse's appointment as auditors in June 1985.()
The Beneficial Finance Board, on 30 April 1985, approved the establishment of the Kabani type structure and the immediate entering into of heads of agreement regarding the Centrelease transaction, with a view to settlement on 1 July 1985.
Price Waterhouse were appointed auditors of Kabani and Lagan, respectively, on 27 and 28 June 1985 (with effect from 1 July 1985), and, in later years, were appointed auditors of Malary (with effect from 1 July 1985) and Fortina (with effect from 1 July 1986).
Beneficial Finance established four groups of off-balance sheet entities. The holding company of each of these groups was owned by two discretionary trusts. These trusts held all the issued share capital in the following holding companies (the Kabani type companies):
(a) Kabani Pty Limited;
(b) Malary Pty Limited;
(c) Lagan Pty Limited; and
(d) Fortina Pty Limited.
Each of these holding companies had a capital structure comprising ordinary shares and preference shares. All of the ordinary shares in each of these companies were held by a trust which had been specifically created by Mr Tucker personally settling a sum of money ($10) upon trust, to be held by a trustee for that purpose. These trusts were known as, for example, the Kabani Ordinary Shares Settlement Trust. The trustee of each of the ordinary share trusts was Bondi Investments Limited, ultimately, a wholly owned subsidiary of Beneficial Finance.
Each of the ordinary share settlements was settled under a trust deed, which provided that any income derived from the assets of the trust, that is, its holding in the ordinary share capital of the four holding companies, would be distributed at the discretion of the trustee to a range of specified beneficiaries. All of these beneficiaries were members of the Beneficial Finance Group, with the exception of a beneficiary described as the National Heart Foundation.
The preference shares of each of the four holding companies were held by another four trusts. All the preference shares in a particular company were held by a particular trust. These trusts were known as, for example, the Kabani Preference Shares Settlement. The trustee of each of the preference share trusts was Thomson Simmons Nominees Pty Limited. These trusts were created by Mr Tucker settling a sum of money ($10) to be held by a trustee under trust deeds which were substantially similar to the trust deeds under which the ordinary share settlements were established. The preference share settlements were discretionary trusts, each having the same beneficiaries as the ordinary share settlements.
I will refer in this Chapter to the trusts holding shares in Kabani, Malary, Lagan and Fortina as the Kabani type trusts.
The preference and ordinary shareholders were each entitled to appoint one half of the Board of Directors of the Kabani type companies. Persons who were directors of Beneficial Finance were appointed to the board of each of the Kabani type companies (Kabani, Malary, Lagan and Fortina) at the date of incorporation. Half of the voting power for each company was initially held by Thomson Simmons Nominees Pty Limited, as trustee for the preference share settlement, but further preference shares were issued by the Kabani type companies on and after 6 May 1986, which resulted in Thomson Simmons Nominees Pty Ltd holding a majority of the voting power for each company. The further preference share issues were undertaken upon the advice of Thomson Simmons & Co, with the approval of Beneficial Finance.() This took the investment of the preference share trust in Kabani from an initial $10 to $121 by 30 June 1989. Nevertheless, the position upon, and after, such further preference share issues, was that the preference and ordinary shareholders continued each to be entitled to appoint one half of the Board of Directors of the Kabani type companies.()
The off-balance sheet entities operated and controlled through the Kabani type trust structures were not consolidated into the accounts of Beneficial Finance. Beneficial Finance took the view that those entities did not fall within the definition of a subsidiary contained in the Code. This view of the effect of the structures was supported by a number of legal opinions obtained by Beneficial Finance and the trustee of Beneficial Finance's Debenture Trust Deed, Austrust Limited, at various times between 1985 and 1991.() Many of these opinions fall outside the period under review, and could not have influenced matters in relation to the accounts for the years ended 30 June 1985 to 1990. Accordingly, I will not refer in detail to such opinions in this Report.
As noted in Chapters 57 - "Review of the 1988 External Audit of Beneficial Finance" to Chapter 59 - "Review of the 1990 External Audit of Beneficial Finance", management of Beneficial Finance resisted attempts by the auditors to provide disclosure of the results and affairs of the off-balance sheet entities, and insisted on disclosures being limited to the bare minimum. Management, in February 1989, obtained advice from Thomson Simmons & Co advising that disclosure was not required under ASRB1016 on Equity Accounting. Further advice was obtained from Thomson Simmons & Co in October and November 1990 that disclosure was not required under AAS24 on Consolidated Financial Statements, and confirmation of this advice was obtained from Mr M Robertson QC in September 1991 on AAS24 and the corresponding approved accounting standard ASRB1024.
41.3.4 MEANING OF "SUBSIDIARY"
41.3.4.1 Thomson Simmons & Co 1985 Advice
The view of Beneficial Finance and its legal advisers, Thomson Simmons & Co, was that the Kabani type companies fell outside the definition of "subsidiary" of Beneficial Finance as contained in the Code. The arguments for this were that Beneficial Finance:
(a) had no direct shareholding in any of the four holding companies;
(b) each Kabani type trust controlled only one half of the composition of the Board of Directors of each company;
(c) the shares held by trustees of the Kabani type trusts were to be disregarded in determining "control" by reason of Section 7(3)(a) of the Code, since the shares were held in a fiduciary capacity; and
(d) neither trustee had a majority voting power at company general meetings.
The 1985 advice did not go into detail about the discretionary trusts which were to hold the shares in Kabani. In fact, the trusts made Beneficial Finance the taker in default of appointment on vesting of the trust. This means that Beneficial Finance had a vested equitable interest in all the issued share capital of Kabani, subject to possible divestment by the trustee.()
The 1985 advice did not address the ordinary meaning of "control" as used in the definition of subsidiary, and the significance of the practical dominance over the affairs of the off-balance sheet entities exerted by Beneficial Finance, as a question of fact. Indeed, according to the evidence of Mr Tucker, he was aware that his client intended to exert practical commercial dominance over the Kabani type companies, but he took the view that he need not concern himself with these matters for the purpose of his advice.() Mr Tucker acknowledged that practical dominance in all matters appears to have been assumed by Beneficial Finance.() Because of the view he took on those matters, however, Mr Tucker did not consider whether "control" had a meaning beyond strict legal control, nor did he research any of the authorities on the meaning of control (other than the Keighery case, discussed below, which appears to support his view).()
I have received submissions from certain former Non-Executive Directors of the Bank and Beneficial Finance, from the external auditors of Beneficial Finance, Price Waterhouse, and from the solicitors who advised Beneficial Finance in connection with the off-balance sheet structure, Thomson Simmons and Co, that it is beyond my power to form a view whether any given company was or was not a subsidiary of Beneficial Finance under the Companies Code, or of the Bank as it used that expression, since this involves determining matters of law.()
While I have some reservations about these submissions, and I do not wish to be taken to have accepted them, for the reasons set out below, I do not propose to make a finding on whether the off-balance sheet entities were subsidiaries of Beneficial Finance or not. Further, I consider it is necessary to briefly examine the issue of control because I consider I must, pursuant to Term of Appointment E, consider whether any matters may disclose unlawful or improper activity.
41.3.4.2 Legal Definition
Section 7 of the Code contains the definition of a subsidiary which is set out below:
"... 7(1) For the purposes of this Code, a corporation shall, subject to sub-section (3), be deemed to be a subsidiary of another corporation if -
(a) that other corporation -
(i) controls the composition of the board of directors of the first-mentioned corporation;
(ii) is in a position to cast, or control the casting of, more than one-half of the maximum number of votes that might be cast at a general meeting of the first-mentioned corporation; or
(iii) holds more than one-half of the issued share capital of the first-mentioned corporation (excluding any part of that issued share capital that carries no right to participate beyond a specified amount in a distribution of either profits or capital); or
(b) the first-mentioned corporation is a subsidiary of any corporation that is that other corporation's subsidiary (including a corporation that is that other corporation's subsidiary by another application or other applications of this paragraph).
7(2) Without limiting by implication the circumstances in which the composition of a corporation's board of directors is to be taken to be controlled by another corporation, the composition of a corporation's board of directors shall be taken to be controlled by another corporation if that other corporation, by the exercise of some power exercisable whether with or without the consent or concurrence of any other person by that other corporation, can appoint or remove all or a majority of the directors, and for the purposes of this provision that other corporation shall be deemed to have power to make such an appointment if -
(a) a person cannot be appointed as a director without the exercise in his favour by that other corporation of such a power; or
(b) a person's appointment as a director follows necessarily from his being a director or other officer of that other corporation."
It will be seen that a corporation is a subsidiary of another if the other:
(a) controls the composition of the board of directors of the first-mentioned corporation;()
(b) is in a position to control the casting of more than one-half of the maximum number of votes that might be cast at a general meeting of the first-mentioned corporation; or
(c) holds more than one-half of the issued share capital of the first-mentioned corporation.
I will, for the moment, concentrate on the meaning of "control" (as used in the Code) of the composition of the board of directors in the following analysis, but the same reasoning would apply to (b) above.
Section 7(3)(a) provides that any power exercisable by a corporation in a fiduciary capacity shall be treated as not exercisable by it for the purposes of the above tests.() Section 7(3)(b) provides that any power exercisable by a bare trustee shall be treated as exercisable by the beneficiary.
Section 7(2) provides in part:
"Without limiting by implication the circumstances in which the composition of a corporation's board of directors is to be taken to be controlled by another corporation [it] shall be taken to be controlled by another corporation if that other corporation, by the exercise of some power with or without the consent or concurrence of any other person by that other corporation, can appoint or remove all or a majority of the directors ......" [Emphasis added]
The words in bold did not appear in the Companies Act 1961, and were added upon the introduction of the Companies Code in 1981.() I am advised that this represents a statutory extension of the ordinary meaning of "control".
I have also had regard to the requirement contained in Section 5A of the Companies and Securities (Interpretation and Miscellaneous Provisions) (South Australia) Code, which provides:
"... In the interpretation of a provision of a relevant Code, a construction that would promote the purpose or object underlying the relevant Code (whether that purpose or object is expressly stated in the relevant Code or not) shall be preferred to a construction that would not promote that purpose or object."
In my opinion, the purpose of requiring a holding company and its subsidiaries to prepare consolidated accounts is to truly and fairly represent the operations of entities under the same control in their relations with outsiders, and the meaning of "subsidiary" should be considered in this context.
The ordinary meaning of the word "control" is "to exercise restraint or direction upon the free action of; to dominate or command".() The concept of control does not appear to be limited by the means used to achieve it. I am aware of a number of authorities which adopt the dictionary definition in various legal contexts other that the Companies Code.()
Further, I am not aware of any authorities directly in point as to whether the meaning of "control" in the context of Section 7(1)(a)(i) -control of the composition of the Board - may cover situations where control is pursuant to commercial or practical dominance rather than pursuant to enforceable legal rights.()
There is a line of authority in the context of control of a company under tax and estate duty legislation that "control" means legal power to direct a majority of votes at a general meeting.()
Some recent Australian authorities, which were not available in 1985, suggest that the Courts may be prepared, in contexts other than the Companies Code, to give the word "control" a wide meaning.()
I have received submissions that "control" as used in Section 7(1) means control pursuant to legally enforceable rights, and that "power" as used in Section 7(2) has a corresponding meaning.() I observe that the Peat Marwick Accounting and Reporting Manual Update of February 1985, referred to below, also expresses this view, but does not cite any authority for it.()
Price Waterhouse submitted that there was no need to have recourse to Section 5A, quoted above, since the interpretation of Section 7(1) is "quite explicit, clear and unambiguous" on this point.() Price Waterhouse, however, acknowledge that there are no authorities directly in point.()
Price Waterhouse further submit that the word "control" must be construed in its context in the Companies Code as a whole, which is not limited to the context of the group accounts.() They point out that the definition of "subsidiary" is relevant in the context of a number of provisions, such as the prohibition on a company giving financial assistance in connection with the acquisition of its own shares, and the prohibition on a company making loans to a director, which carry criminal sanctions. Price Waterhouse submit that, in this context, it is unlikely that Parliament intended the tests for "subsidiary" companies to turn on inquiries into the existence of "control" in the sense of practical commercial dominance, rather it is likely that Parliament was contemplating a test of legal control which would be clear and easy to apply.() In my opinion, it would not be appropriate for me to attempt to determine which tests Parliament intended when Section 7(1) was enacted.
41.3.4.3 Subsequent Legislative Developments
In their submission dated 18 November 1992, Price Waterhouse submitted that the propriety of the use, in the 1980s, of off-balance sheet companies, not being subsidiaries under the law as it then stood, was recognised by subsequent reform of the law with the introduction of the concept of the controlled entity in the Corporations Law in 1991 and the introduction of AASB1024.
The provisions of the Corporations law were amended, effective from 1 August 1991, by the adoption of new provisions relating to the preparation of consolidated accounts for a company and its controlled entities. This is clearly something which occurred subsequent to the period under review in this Investigation. It is suggested by Price Waterhouse that the subsequent events throw light on the law applying in the period under review. I will examine the concept of "control" adopted in the new provisions, but first will examine the need for reform which had been identified by Parliament.
In his Second Reading Speech on the Corporations Legislation Amendment Bill 1991, the Federal Attorney-General said at pages 3 and 4:
"There have been widespread abuses of the existing company accounting and reporting requirements under which the true financial position of a group of companies has been able to be disguised by "off-balance sheet" reporting. This has enabled the financial statements of the company to be manipulated in such a way as to mislead investors and the market generally regarding the real level of liabilities or performance of a company or the group as a whole.
These abuses have been possible because company reporting requirements apply to companies and their "subsidiaries". The definition of "subsidiary" has a rather technical meaning in the Law which does not reach non-corporate entities. Further, group accounts have not been required to be consolidated, with the result that they can be very difficult to analyse.
One of the consequences of these practices has been a significant loss of investor confidence, both amongst Australian and overseas investors, in the reliability of corporate financial information in Australia.
To address these problems, the Bill provides for amendments to require that a company's directors must produce a single profit and loss account and balance sheet for all companies and other incorporated or unincorporated entities controlled by that company. The Bill will include a broad definition of control which focuses on the reality of control rather than technicalities."
In my opinion, the focus of the need for reform appears to have been non-corporate entities, which clearly could not have been subject to consolidation under the previous law since it applied only to "subsidiary" companies. Since, in the case of non-corporate entities, one could not refer to the traditional corporate indicia of control, it appears to have been thought necessary to base the relevant link for the purpose of preparing consolidated accounts upon the concept of "control" in a wider context than corporations.
The Attorney-General also refers to the feature of the law prior to 1991 that group accounts were not required to be consolidated, but could be constituted by presenting separate accounts for each company in the group. This change in the law does not seem relevant to the present issue.
I have also referred to the Explanatory Memorandum circulated by the Attorney-General on the Corporations Legislation Amendment Bill 1991. At page 68, the definition of control in AASB1024 was described as follows:
"... `control' - the capacity of an entity to dominate decision-making, directly or indirectly, in relation to the financial and operating policies of another entity so as to enable that other entity to operate with it in achieving the objectives of the controlling entity".
AASB1024 paragraph 9 defines the word "capacity" to mean:
"Ability or power, whether direct or indirect, and includes ability or power that is presently exercisable as a result of, by means of, or in breach of, or by revocation of , any of or any combination of the following:
(a) trusts;
(b) relevant agreements; and
(c) practices;
whether or not enforceable."
AASB1024 contains the following commentary on the term "control", which may be used as an aid to interpretation:
"... (xvi) any of the following factors would normally indicate the existence of control by one entity of another entity:
(a) the capacity to dominate the composition of the board of directors or governing board of another entity;
(b) the capacity to appoint or remove all or a majority of the directors or governing members of another entity;
(c) the capacity to control the casting of a majority of the votes cast at a meeting of the board of directors or governing board of another entity;
(d) the capacity to cast, or regulate the casting of, a majority of the votes that are likely to be cast at a general meeting of another entity, irrespective of whether the capacity is held through shares or options; and
(e) the existence of a statute, agreement, or trust deed, or any other scheme, arrangement or device, which, in substance, gives an entity the capacity to enjoy the majority of the benefits and to be exposed to the majority of the risks of that entity, notwithstanding that control may appear to be vested in another party....
(xx) The indicators of control outlined in the preceding paragraphs need to be distinguished from a circumstance where control of a particular entity is jointly held by two or more unrelated entities such that none unilaterally controls that entity. In this case none of the entities would qualify as the parent entity; however, it is important to consider the substance of the relationship between the entities which are deemed to have joint control of that other entity. For example, it is not unusual for an entity to be established to avoid recognising certain assets and liabilities in the accounts. While ownership interests and board representation of the new entity may be vested equally in the entity which sought to establish the new entity and in its financiers or legal advisers, this relationship may not constitute joint control as discussed above. To determine with whom control lies, it will be necessary to examine the manner in which major policy decisions are reached and the nature of the control over ongoing activities of the entity, rather than accepting that the nominal powers reflect the substance of the relationship." [Emphasis added]
Price Waterhouse have submitted that it can be inferred, from the words of the Attorney-General quoted above, that he was acknowledging that, prior to 1991, "control" in the definition of "subsidiary" was limited to control pursuant to legally enforceable rights, and excluded control from practical commercial dominance. ()
In my opinion, there is no clear statement that the new definition of control by reference to powers, whether or not legally enforceable, was intended to change the concept of control used in the previous law. In my opinion, the new definition and commentary now puts the matter beyond doubt.()
41.3.4.4 Other Legislative Definitions of "Control"
I have read the following definition of control in the Broadcasting and Television Act 1942, in relation to control of licences issued under that Act:
"91 (1) In this Division, unless the contrary intention appears-
`control' includes control as a result of, or by means of, trusts, agreements, arrangements, understandings and practices, whether or not having legal or equitable force and whether or not based on legal or equitable rights;"
The question is whether such a definition extends the ordinary meaning of "control", and whether the absence of such a definition in the Companies Code affects the interpretation of the term.
The definition has been construed by the full Federal Court, which held, in January 1987, that the definition does not widen the ordinary meaning of control:()
"... it was argued that s 91(1) cannot be relied on to broaden the concept of `control' in s 92D [control of a company]. That sub-section, it was said, defines control by reference to `control' itself, and says nothing of the content of the concept of control. It deals only with the means by which it is exercised, such as by trusts, agreements, arrangements, undertakings and so forth. I agree with the view that s 91(1) does not, of itself, widen the concept of control."
The same reasoning would appear to be applicable to the definition of control in AASB1024.
41.3.4.5 Conclusion on "Control"
It seems to me that the efficacy of the proposed structure to avoid the application of Section 7 of the Companies Code was a matter of opinion, on which there was no direct authority. I accept that the opinion Thomson Simmons & Co expressed in their 1985 advice was reasonably open to them to give, and the qualification they expressed in paragraph 23 as to the desirability of Beneficial Finance establishing the structure, was proper.
While such an interpretation may be queried, since it would appear to drive a coach and horses through Section 7 of the Companies Code, it is not for me to attempt to resolve any uncertainty in the law in this regard. Accordingly, I do not consider it appropriate for me to make a finding on whether the off-balance sheet entities were subsidiaries of Beneficial Finance or not.
41.3.5 USE OF OFF-BALANCE SHEET STRUCTURES IN 1984-85
In the September 1985 issue of "Abacus", an academic accountancy journal circulating in Australia, an article appeared written by Mr G Sullivan, lecturer in accountancy at the University of New South Wales(). The focus of the article was the use of unit trust off- balance sheet entities by six of the top one hundred Australian companies as revealed in an article in the Weekend Australian of 26-27 January 1985(). These structures appear to have been used as financing structures by borrowers.
According to Mr Sullivan's references, the use and accounting treatment of off-balance sheet structures had been under review by the accountancy profession for some time.() For example, in his July 1983 article in the "Chartered Accountant in Australia", Mr C Jackman, a partner in Price Waterhouse, Sydney, observed :
"The developing practice of off-balance sheet finance causes major distortions in the type of ratios examined by financial statement analysts. Fortunately some companies do provide the appropriate relevant information to adjust notionally amounts shown in the balance sheet, whether in accordance with statutory requirements (for example leasing commitments under the Companies Code Schedule 7, Clause 5 (2)(g); accounting standards; or in the overall interest of presenting a true and fair view.... Discussions between lawyers and trustee companies on the one hand and accountants on the other generally lead to the conclusion that the former belief that the accountants have the responsibility for determining the appropriate accounting treatment in these "off-balance sheet" financings while the latter are often strongly influenced by the legal form of the transaction...... The accounting profession and indeed the promulgators of corporate legalisation have only started to come to terms with the rapid change in and increasing sophistication of financing arrangements. However, it seems likely that future legislation will require financing to be placed "on" the balance sheet rather than "off" the balance sheet".
In February 1985, one of the accountancy firms who audited the Bank's accounts, Peat Marwick, published an update to their Accounting and Reporting Manual. The paper referred to recent examples of the use of off-balance sheet arrangements in the form of unit trusts and companies. The paper concluded with the following statement in relation to Peat Marwick's views on the accounting treatment of off-balance sheet entities()
"The following matters are relevant to a discussion on the firm's attitude to off-balance sheet companies:
1. There is currently no Accounting Standard, Exposure Draft or other guidance either in Australia or overseas which addresses this problem.
2. It is not yet considered appropriate for the Firm to come out strongly in either direction ie either to take a moral stance and insist that our clients consolidate such companies or alternatively actively to go out of our way to market such arrangements.
3. In essence the Firm does not condone the use of off-balance sheet arrangements purely and simply to enter into financing arrangements which would not be acceptable if they were in the company's own balance sheet. However, if clients are to enter into such arrangements then we must not only satisfy ourselves as to the legalistic matters covered in this paper but also as to the necessity for adequate disclosure.
4. It is recommended that clients entering into such off-balance sheet arrangements should clearly state in a note to their accounts that such an arrangement exists and where material the assets and liabilities of the off-balance sheet company should be disclosed as an abridged set of accounts within the note to the accounts. If the putative parent has guaranteed the borrowings of the off-balance sheet company then this would have a significant impact in relation to the contingent liability disclosure.
5. It is also important that the auditor makes reference to any off-balance sheet financing when submitting formal reports such as those normally required under debenture trust deeds."
The above paper recognises a view, current within the profession at the time, that off-balance sheet entities should be consolidated if necessary to ensure that the accounts of the putative parent company give a true and fair view. As mentioned in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance", this is a view which ultimately the National Companies and Securities Commission sanctioned, but believed it could not enforce under the law as it stood prior to 1991.
It appears from the press articles referred to in Mr Sullivan's article that the use of unit trust off-balance sheet entities by CSR and Entrad were the cause of some controversy in the national financial press in March 1985.()
In July 1992, Mr Giles and Mr D R Clark of Price Waterhouse were examined in relation to the external audits of Beneficial Finance. Both stated that they were aware in 1985 of the use of off-balance sheet entities(). While Mr Giles stated that he was not aware that there were differing views in the accountancy profession at that time as to how off-balance sheet entities should be treated, Mr Clark gave evidence that he was aware at that time that views differed on the accounting treatment(). The view expressed by Mr Sullivan in his article is that, accepting that the consolidated account provisions of the Companies Code do not allow the consolidation of unit trusts, disclosure of material transactions would be necessary to satisfy the requirement for true and fair reporting()
Mr Yelland gave evidence that he was not aware prior to this Investigation of any controversy in Australia in finance and accountancy concerning off-balance sheet structures.() I infer, however, from the instructions that were given to Thomson Simmons & Co on 3 April 1985, that management of Beneficial Finance were aware that off-balance sheet structures were being used in commerce in Australia. In my opinion, management should have known that the use of such structures by some Australian companies had given rise to some controversy with regard to the proper accounting treatment and disclosure.
In my opinion, Thomson Simmons & Co, in paragraph 23 of their advice dated 7 April 1985, were telling their client that use of an off-balance sheet structure could be perceived by persons dealing with Beneficial Finance as a contrived device to avoid the effect of Section 7 of the Companies Code, and that Beneficial Finance should consider whether it wished to risk commercial disapproval. In my opinion, Thomson Simmons & Co acted quite properly in the circumstances.
Mr Yelland submitted that he did not read paragraph 23 of the Thomson Simmons & Co advice in the above way.() Mr Yelland submitted that he now believes that Mr Tucker was referring to the relationship of Beneficial Finance's Treasury division with the capital markets, and that, accordingly, some confidential disclosures were made to the capital market lenders and ratings agencies on Beneficial Finance's involvement with the off-balance entities.
The Thomson Simmons & Co memorandum of advice, dated 7 April 1985, was not included in the Board papers for the meetings of 15 and 30 April 1985 at which the establishment of the first Kabani type structure was considered. Mr D W Simmons gave evidence that he had no recollection of seeing the advice, and if it was not in the Board Papers, then the Board would not have received a copy.()
I accept that the Board of Beneficial Finance was not informed of the possible controversial effects of establishing the structure, nor of the warning given by Thomson Simmons & Co in paragraph 23 of their advice dated 7 April 1985.
I have formed the opinion, on balance, that the matters concerning the establishment of the Kabani type companies do not disclose any unlawful or improper activity on the part of Beneficial Finance or the Board of Directors. I have not been able to establish whether management knowingly mis-informed the Board of the matters noted above, or if so, who was responsible. Accordingly, I make no recommendation that any of such matters be further investigated.
41.3.6 THE OFF-BALANCE SHEET STRUCTURE AND ITS OPERATION
The instructions of Beneficial Finance to Thomson Simmons & Co, and their advice, of April 1985 indicate that Beneficial Finance's commercial reason in establishing the off-balance sheet entities was to enable it to undertake business ventures without its interest in these ventures being subject to an obligation to give a guarantee to the trustee for debenture holders over the entire assets of the venture. Clearly such an arrangement would not have been commercially acceptable to prospective joint venturers.
Other effects of excluding such business undertakings from consolidation in the Beneficial Finance Group accounts would be to avoid the borrowing ratio restrictions in the debenture trust deed, and to avoid the disclosure of the earnings (or losses), assets (and the nature of the investments), and liabilities undertaken through off-balance sheet entities, which would otherwise be required under the Code if undertaken by Beneficial Finance or its acknowledged subsidiaries. While the impact on the borrowing ratio in early years was not such as to adversely affect compliance, even if the interests had been consolidated,() Beneficial Finance was apparently looking to the future when debenture trust deed limitations on borrowings might be of more concern.()
It is clear from the correspondence between Beneficial Finance and its solicitors, Thomson Simmons & Co, prior to the structures being established, that Beneficial Finance's instructions to Thomson Simmons & Co were that it desired to control the entities, but to avoid them being subsidiaries.()
I accept the evidence of Mr Yelland that the issue of accounting disclosure of the off-balance sheet entities was not considered by him, nor was it put to Thomson Simmons & Co, because the key issue was avoidance of subsidiary status.() Nevertheless, as mentioned above, management of Beneficial Finance subsequently resisted any disclosure relating to the off-balance sheet entities beyond the bare minimum.
In my opinion, the facts and circumstances set out in the next few paragraphs indicate that the affairs of the Kabani type companies were in fact controlled by Beneficial Finance and conducted for its own benefit and at its own risk pursuant to a variety of legal and practical commercial powers.
It follows, in my opinion, from the preceding finding above, that the affairs and results of the off-balance sheet entities of Beneficial Finance were relevant to the financial position of Beneficial Finance, and, if material, should have been disclosed in the accounts of Beneficial Finance and in the consolidated accounts of Beneficial Finance and its subsidiaries in order for such accounts to show a true and fair view. I am required by my Terms of Appointment to investigate and report whether the external auditors dealt with this issue appropriately and adequately.
Price Waterhouse have submitted, on the basis that no legal powers provided Beneficial Finance with `control' of the off-balance sheet entities, that no disclosure was required beyond that specified in Schedule 7 of the Companies Regulations in order for the accounts to give a true and fair view of the results and affairs of Beneficial Finance and the Beneficial Finance Group.() As noted above, I have formed the opinion that Beneficial Finance exerted control pursuant to a variety of legal and practical commercial powers. In my opinion, having regard to the accounting standards requirement to favour "substance over form" nothing should turn on that. I discuss the "true and fair" reporting requirement further in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance".
The facts and circumstances leading to my conclusions above are as follows:
(a) Beneficial Finance instructed its solicitors to set up the structure of off-balance sheet entities on behalf of Beneficial Finance.
(b) The structure was intended to be a permanent part, the "entrepreneurial arm", of the business structure of Beneficial Finance.() The off-balance sheet entities were integrated into the Beneficial Finance Group, and treated for management purposes indistinguishably from Beneficial Finance's acknowledged subsidiaries. It was certainly the case that those at Board level and at senior management of Beneficial Finance had no doubt that the entities were under the practical dominance of Beneficial Finance, and were run for the benefit of Beneficial Finance.() The Managing Director of Beneficial Finance at all relevant times, Mr J A Baker, had no doubt about the situation when questioned during my investigation:
"A: I don't know whether you can say it legally, but everyone just assumed that Kabani was Beneficial. It was just a corporate umbrella of some sort.
Q: What you are saying is that Kabani did what Beneficial told it to do?
A: Yes, there's no doubt about that.
Q: Kabani never met as a board, did it ?
A: No, all paper meetings." ()
(c) It was the intention of Beneficial Finance, in instructing its solicitors to establish the Kabani type trust structures, that they be so devised that Beneficial Finance would control the affairs and investment of those entities() Mr Baker gave the following evidence:()
"Q: Did Beneficial Finance have control over board representation and the exercise of shareholding, that is, voting power and so on, in Kabani?...
A: Well, I would think so.
Q: What leads you to think that Beneficial Finance did have that control?
A: We would not have utilised it if we could not control it, I do not think."
(d) Under the trust structures Beneficial Finance, at all times, had a vested equitable interest in all the issued share capital of the Kabani type companies, subject only to divestment if, upon termination of the trusts, the Trustee exercised its power of appointment in favour of some other beneficiaries.()
(e) The Directors of Beneficial Finance would not have been acting in the interests of Beneficial Finance, as they were legally obliged to act, if they had permitted business opportunities of Beneficial Finance to be exploited otherwise than for the benefit of Beneficial Finance.() It is clear from the minutes of the Beneficial Finance Board that business undertaken through the off-balance sheet entities, represented business opportunities of Beneficial Finance that were directed to the off-balance sheet entities, with the approval of the Beneficial Finance Board, on the understanding that the resulting benefits would be derived by Beneficial Finance.()
(f) The Kabani type trusts had no source of funds for commercial investment, and could not raise funds, without the trustees obtaining the prior written consent of Beneficial Finance. The consent of Beneficial Finance was required for many ordinary commercial steps by the trustees.()
(g) All funds of the off-balance sheet entities were either borrowed from Beneficial Finance or, obtained through a transaction in pursuance whereof the risk of borrowing was borne by Beneficial Finance.() Mr Yelland deposed that this was one of the means of "unofficial control" to which he was referring in his letter of instructions, dated 3 April 1985, to Thomson Simmons & Co.() On 30 November 1990, the Beneficial Finance Board passed the following resolution in relation to the Kabani type companies and other specified off-balance sheet entities, for the purpose, according to the agenda papers, of enabling the directors of those companies to sign the directors' reports for those companies for the year ended 30 June 1990:()
"It was resolved that Beneficial Finance Corporation Limited (Beneficial) support the associated companies listed below (the Companies) to the extent that it will provide such support as may be necessary to ensure that those companies are able to meet their debts as and when they fall due."
(h) The Kabani type companies were not joint venture companies, but holding companies for other business undertakings. There was no person commercially interested in the ownership of them other than Beneficial Finance. Mr Yelland gave evidence that this absence of "outside interference" was one of the means of "unofficial control" to which he was referring in his letter of instructions dated 3 April 1985 to Thomson Simmons & Co.() The only purpose of the Kabani structure was to prevent the Kabani type companies and their subsidiaries being or becoming subsidiaries of Beneficial Finance.()
(i) Directors of Beneficial Finance comprised the Kabani Board and the Boards of the other three similar companies established under the structures. In this respect, Beneficial Finance treated the off-balance sheet entities in the same way as the group's acknowledged subsidiaries.() There were no directors of the off-balance sheet entities other than those under some duty to Beneficial Finance. Mr Yelland gave evidence that this was one of the means of "unofficial control" to which he was referring in his letter of instructions dated 3 April 1985 to Thomson Simmons & Co:()
Q:I am at the moment putting to you the question that in deciding matters before the Kabani board, those persons chosen for the Kabani board would be expected to conform to the intentions of Beneficial finance, not by co-incidence but by design.
A: Well, from where I sat, I would have expected that, yes."
(j) Staff of Beneficial Finance conducted the day-to-day operations of the companies pursuant to service agreements between Beneficial Finance and each of the four companies.() Mr Yelland testified that this was one of the means of "unofficial control" to which he was referring in his letter of instructions, dated 3 April 1985, to Thomson Simmons & Co.()
(k) Accounts of Beneficial Finance for internal management purposes have, since December 1988, been prepared on the basis that the accounts of the off-balance sheet entities are consolidated together with Beneficial Finance and its acknowledged subsidiaries. (I examine the "aggregate accounting" exercise in detail in Section 41.4 below).
(l) Statutory accounts of Beneficial Finance for the year ended 30 June 1990 disclose the off-balance sheet entities as "controlled entities" pursuant to ASRB1017 (Related Party Disclosures).() Beneficial Finance's participation interest in Kabani was stated to be "100%".
(m) The ordinary share settlement trust, and the preference settlement trust, for the respective Kabani type companies, were established at the same time, with no commercial purpose other than to break the relationship of holding company and subsidiaries between Beneficial Finance and Kabani type companies. The only beneficiary nominated which was not a member of the Beneficial Finance Group was the National Heart Foundation. The evidence of Mr Baker and Mr Yelland was that Beneficial Finance did not intend to confer any benefit on the National Heart Foundation.()
(n) The business of the off-balance sheet companies was discussed, controlled, and directed, at board meetings of Beneficial Finance. Meetings of directors and annual general meetings of the off-balance sheet entities were constituted only by paper meetings arranged by Beneficial Finance.()
(o) The ordinary share settlement trust deed, and the preference share settlement trust deed, for each of the four companies, contained a number of terms which facilitated Beneficial Finance's control of the affairs of the Kabani type companies:
(i) The trusts were established by deed of settlement whereby the settlor, Mr Tucker, one of the members of the firm of lawyers who advised Beneficial Finance and acted on the instructions of Beneficial Finance to establish the companies and trusts, made a gift of $10 to be held upon the specified trusts for the benefit of Beneficial Finance and four of its subsidiaries, and a fifth beneficiary, the National Heart Foundation. At no relevant time was a body of that name in existence.() Mr Tucker deposed to the Investigation that he intended to refer to the South Australian arm of the National Heart Foundation. However, the National Heart Foundation of Australia (South Australian division) Incorporated was not contacted prior to being named in the deeds of settlement.
(ii) Under trust law, where the beneficiaries comprise a closed class they have the right to call on the trustee to vest the trust and transfer the assets to them or as they direct.() If the National Heart Foundation had not been included as a beneficiary, all the beneficiaries would be under the control of Beneficial Finance, which would therefore have a legal right to vest the trust assets. Mr Tucker acknowledged that this was the only reason for nominating the National Heart Foundation as a beneficiary.() Beneficial Finance could still exercise this power, but only with the concurrence of the National Heart Foundation.
(iii) The sole initial capital of each trust was the sum of $10, invested in shares in the Kabani type companies. The settlor foresaw that business opportunities would be limited with total capital of $10, and so provided the trustee with power to borrow notwithstanding that borrowings may exceed the value of the trust fund, provided the written consent of Beneficial Finance was first obtained.() In my opinion, this constitutes a legal power of Beneficial Finance which it used to control the affairs of Kabani type companies.
(iv) The trustee is permitted to invest in wasting and speculative assets, and to have the same powers of investment as if the trustee were the absolute beneficial owner.()
(v) The trustee may exercise his powers notwithstanding that he may have a personal interest in the outcome.()
(vi) The trustee may mix trust funds with other moneys.()
(vii) The trustee may, with the consent of Beneficial Finance, delegate all its powers under the trusts.()
(viii) The trustee shall not be liable for breach of trust unless due to deliberate bad faith, nor shall any director of the trustee incur any personal liability from the bona fide exercise of the trustee's rights powers and duties.()
(ix) The trustee may remove any person as a beneficiary.()
(x) The trustee may vest the trust early, at any time after one year from the date of establishment.() In the case of the trusts of which Thomson Simmons Nominees Pty Ltd was trustee, Beneficial Finance had the right to direct the trustee to vest the trust.() On vesting, unless the trustee otherwise exercises its discretion, the trust fund vests in Beneficial Finance.() Accordingly, at all material times, Beneficial Finance had a vested interest in the assets of the trust, subject to divestment if the trustee should, on the vesting date, exercise its power to appoint the assets to another beneficiary. The only beneficiary outside the Beneficial Finance Group was the National Heart Foundation.
(xi) In default of appointment by the trustee, both income and capital is to be held in trust for Beneficial finance.() Under trust law, a trustee must give due consideration to the position of the discretionary objects of its power of appointment, ie to all beneficiaries, including the National Heart Foundation.()
(xii) The trust deed purports to bind all persons claiming any beneficial interest in the trust fund to the clause excluding liability on the part of the trustee for breaches of trust unless due to deliberate bad faith.()
(p) Accordingly, the trustees of the Kabani type trusts must have known, at all relevant times, that the omission to exercise powers of distribution of income and capital, after sufficient consideration of the position of the National Heart Foundation to satisfy trust law, would have resulted in the entire income and capital of the trusts going to Beneficial Finance.
(q) The evidence of Mr Tucker was that Thomson Simmons Nominees Pty Ltd has no records relating to its appointment as trustee, or administration, of the Kabani type trusts of which it is trustee, and does not appear ever to have received notice of an annual general meeting of the Kabani type companies, or to have been notified concerning changes in the composition of the Boards of the Kabani type companies.()
(r) Since the establishment of the Kabani type trusts, all distributions of income have been made to the Ordinary Settlement Trusts and ultimately to Beneficial Finance through wholly owned subsidiaries, except for an interim dividend of $3,920 paid to the preference shareholders on 30 June 1989. This income was distributed to Beneficial Finance. As noted in paragraph (q) above, the trustee of the Preference Share Settlements, Thomson Simmons Nominees Pty Ltd, appears to have no record of playing any role in this distribution. The only documentation available to the Investigation concerning the preference share dividend of June 1989 is a set of accounts of the trust, for the year ended 30 June 1989, apparently prepared by Price Waterhouse (the auditors of the Kabani type companies appointed by Beneficial Finance) and signed by two directors of Thomson Simmons Nominees Pty Ltd. The audit report on the accounts for the year ended 30 June 1989 is dated 6 November 1991, which is considerably outside the period under review in this Investigation. The accounts mis-described Thomson Simmons Nominees Pty Ltd as manager of the trust. In the light of the evidence of Mr Tucker referred to in paragraph (q) above, it is not clear to me how the auditors were able to express the opinion that the accounting and other records of the trust had been properly kept.
(s) On 30 June 1989 additional preference shares were issued by certain Kabani type companies to Thomson Simmons Nominees Pty Ltd as trustee of the preference share trusts for the sole purpose of watering down the voting power held by the ordinary share trust to below 25 per cent. Beneficial Finance had provided guarantees and indemnities to third parties in respect of finance facilities provided by those parties to certain of the off-balance sheet entities.() Under the terms of Beneficial Finance's 1985 Debenture Trust Deed, Beneficial Finance had to include any such liability in its liabilities for trust deed purposes, and Beneficial
Finance believed that those provisions of the Debenture Trust Deed would not apply if the voting power of the ordinary share trusts were reduced to below 25 per cent.()
(t) In June 1990, distributions of income were made to Beneficial Finance through the Kabani Ordinary Share Settlement and the Fortina Ordinary Share Settlement, amounting in all to $6.1M, without there appearing to be any preference share dividend paid for distribution through the relevant Preference Share Settlements. This would have constituted a breach of the rights of the preference shareholder, Thomson Simmons Nominees Pty Ltd, as trustee of the Preference Share Settlements. It does not appear from any of the minutes of Bondi Investments Pty Ltd, as trustee of the ordinary share settlements, that any consideration was ever given to the position of the National Heart Foundation and the merits of any distribution of income to it.() The evidence of Mr Baker, former Managing Director of Beneficial Finance, previously referred to, and of Mr B D Barton, former Company Secretary of the Beneficial Finance Group, is that these meetings were never held, but would have been paper meetings.() The evidence of Mr Yelland was that the minutes of 30 June 1990 referred to above appear also to have been paper meetings.()
(u) On 27 June 1990, the trustee of the Kabani and Fortina Ordinary Share Settlements, Bondi Investments Pty Ltd, apparently exercised its powers, with the consent of Beneficial Finance, to add itself (Bondi) as a beneficiary of those trusts. The trustee then proceeded to distribute to itself the sum of $6.1M referred to above, without any apparent consideration of the interests of the National Heart Foundation. According to the evidence examined by the Investigation, Mr Yelland, on 4 July 1990, wrote to Thomson Simmons & Co seeking their advice on the addition of the trustee as a beneficiary. Thomson Simmons & Co's advice was given on 1 August 1990 that the trustee could be made a beneficiary. Minutes of Bondi, purporting to record a meeting of directors on 30 June 1990, record the tabling of the consent of Beneficial Finance to Bondi being made a beneficiary. This consent was in the form settled by Thomson Simmons & Co on 1 August 1990. The minutes do not, however, record any resolution of the trustee to add itself as a beneficiary pursuant to the powers conferred on it under the trust deeds. In evidence to the Investigation, Mr Yelland accepted that it was reasonable to infer that the minuted meeting never took place.() Further, the steps taken in June 1989 appear to have been directed by Beneficial Finance. It would be a breach of the duty by the trustee (Bondi) to have acted according to the dictates of Beneficial Finance, regardless of the interests of the other beneficiaries, which included the National Heart Foundation.()
(v) On 29 June 1990, a management proposal was approved by the Beneficial Finance Board for a corporate restructuring, the main thrust of which was to transfer certain off-balance sheet entities to a subsidiary of the Bank, to be called Southstate Corporate Holdings Ltd.() The Board Paper stated that the effect of the restructure would be to reduce off-balance sheet assets from $679.0M to $425.0M, and to leave off-balance sheet certain losses estimated at $9.7M before inter-company adjustments. The Kabani type companies and certain of their subsidiaries remained off-balance sheet. The transfer of the off-balance sheet entities was effected pursuant to a decision of the Beneficial Finance Board, without any indication that the Board needed the concurrence of any other person to implement the restructuring.
(w) Beneficial Finance understood that the trustees of the Kabani type trusts would act in accordance with its wishes, by virtue of the relationship between them. ()
(x) At 30 June 1990, after the reconstruction referred to above, there were assets in the order of $77.0M (after eliminating inter-company loans)() held through the Kabani type companies and remaining off-balance sheet entities. The value of the assets administered by the trustee of the Preference Share Settlements was by comparison nominal. For example, at that date, the accounts of the Kabani Redeemable Preference Shares Settlement showed assets of $121, against which a provision of $121 for diminution in value had been made, leaving zero net assets of the trust fund.()
41.3.7 THE ROLE OF THE AUDITORS AND THE TRUSTEE FOR DEBENTURE HOLDERS
Former director and Chairman of Beneficial Finance, Mr Barrett, accepted the legal advice that the avoidance of the trust deed requirements, by the off-balance sheet entities, was lawful, and he was given further comfort by his belief that the external auditors had also agreed that the use of Kabani type structures was quite acceptable(). Furthermore, in evidence to me, he stated that he understood that the management had consulted with the trustees, and that they were "happy and comfortable with the situation"().
In my opinion, the Board was misled by management as to these matters.
I accept the following matters raised by Price Waterhouse in their written submission to me dated 18 August 1992:
(a) Beneficial Finance provided Price Waterhouse with a copy of the Thomson Simmons and Co advice, dated 7 April 1985, and a further letter from Thomson Simmons, dated 19 July 1985, in which they repeated their conclusion that Kabani and Lagan were not subsidiaries of Beneficial Finance. This letter also concluded that the trustee for debenture holders need not be informed of the off-balance sheet entities.
(b) Price Waterhouse was of the view that the trustee for debenture holders should be made aware of the existence of the off-balance sheet entities, and the matter was brought up at a meeting between Mr Giles and Mr D R Clark of Price Waterhouse, and Mr Baker, the Managing Director of Beneficial Finance, on 23 April 1986.
(c) Subsequently Mr Baker and Mr Barton of Beneficial Finance held a meeting with Mr B Wood, the General Manager of the trustee, Elders Trustee and Executor Company Ltd on 27 August 1986; a copy of Mr Barton's file note of that meeting, which was made available to Price Waterhouse, and stated that:
"Mr Wood agreed that there appeared to be no restriction placed by the trust deed on this type of involvement (off-balance sheet operations)".
Although Price Waterhouse submitted that the matter of disclosure to the trustee was referred by Mr Giles to the Beneficial Finance Board on 29 July 1986, the Minutes of the Board Meeting contain no record of this matter being raised (which I accept does not mean the matter was not in fact discussed).
The Investigation observed that the audit files() contained a copy of Beneficial Finance's executives notes of the meeting held, on 27 August 1986, between Mr Baker, Mr Barton and Mr Wood which states in part that:
"...
(vi) Mr Wood was advised that Beneficial is undertaking off balance sheet operations in relation to Centrelease, Pegasus Securities, Allied Westralian, with the likelihood of other operations, in joint venture with groups which have a particular expertise. Any receivables being funded by Beneficial are shown as a tangible asset. The off balance sheet structure provided the opportunity to obtain outside wholesale funding by pledging particular assets without affecting Trust Deed requirements. Mr Wood agreed that there appeared to be no restriction placed by the Trust Deed on this type of involvement."
No-one from Price Waterhouse attended this meeting, and Price Waterhouse did not obtain direct confirmation from Elders Trustee (now Austrust Limited) that it accepted Beneficial Finance's view of the status of the off-balance sheet entities.
In my opinion, Price Waterhouse should have inquired of the trustee whether the apparent approval of the Kabani structure was based on due consideration of the matter in the light of adequate information. It appears that Price Waterhouse did not make any such enquiry, because Mr Giles thought it was not his place to pre-empt management's communication with the trustee. This was, nonetheless, a matter that was of potential significance, and, if necessary, Price Waterhouse could have arranged through Beneficial Finance management to confirm the position independently with the trustee.
A paragraph of Mr Wood's notes of the meeting of 27 August 1986, states that:
"9. Beneficial currently conducting off-balance sheet joint venture operations outside terms of trust deed. Currently loans to the joint ventures are made by Beneficial and therefore are assets under the Trust Deed. Long term intention is to have them self funding with borrowing from banks, not from public. This appears to be legitimate operation and not requiring trustee involvement."
On 27 August 1992, Mr Wood, the Managing Director of Austrust Limited (formerly Elders Trustee and Executor Company Limited), was examined.
The following questions were put to Mr Wood, and the following answers given:
"Q... What sort of information and explanations did [Mr Baker and Mr Barton] give you concerning these off-balance sheet operations?
A: Virtually none. Beneficial had for many years been involved in joint ventures, twenty years I guess, and joint ventures in Beneficial's parlance and in my parlance meant small land subdivisions. It was a situation where Beneficial would take some involvement in the management of the operations as well as advancing funds to improve their profitability. In the light of the improved land climate at the time, it seemed quite legitimate that they should be getting back into that type of operation.
Q: Did they expressly say that they were talking about land subdivisions?
A: No, they did not...
Q: But that is an inference you drew, based on your knowledge--
A: I drew that inference...
Q: [(vi) of the Beneficial Finance file note mentioned above was read to Mr Wood]. Now, my question is whether you believe that is a fair record of what was discussed?
A: Well, the preamble is obviously a far wider version of anything that I can recollect. The specific naming of groups and companies is something I have no recollection of whatsoever, nor the question of pledging assets of other groups do I recall that ever being discussed."
If Price Waterhouse had made direct enquiries of the trustee regarding its apparent approval of the Kabani structure it may have led to clarification of apparent inconsistencies between the Beneficial Finance and Elders Trustee records of the meeting of 27 August 1986.
In 1988, the trustee for debenture holders investigated the Kabani structure. On 3 November 1988, Beneficial Finance wrote to Elders Trustee enclosing a press release regarding the Beneficial Group acquisition of Campbell Capital Limited. That letter states:
"Campbell Capital Limited shares will be issued 49 percent to Beneficial Finance Corporation Ltd and 51 percent to Kabani Pty Ltd, and as such will not be deemed a subsidiary of Beneficial within the meaning of Section 7 of the Companies Code."
The press release which is attached to the letter is dated Wednesday, 3 November 1988. The first paragraph states:
"The Beneficial Group has acquired the investment bank, Campbell Capital Ltd."
and the last paragraph states:
"In joining the Beneficial Finance Group the team at Campbell Capital ..."
On 8 November 1988 an article appeared in the Adelaide "Advertiser" reporting that Beneficial Finance had taken a major stake in the national hotel and resort developer Pacific Rim. The same day, the trustee asked Beneficial Finance to advise ownership details of Pacific Rim Leisure, East End Co Ltd and Kabani Pty Ltd and whether or not they were deemed subsidiaries under the 1985 Trust Deed. Beneficial Finance replied the same day by facsimile that:
"BFCL and Kabani have essentially the same Board. However `control' is avoided (sec 7 (1)(a) and 7 (2)) by Kabani's Board being appointed since inception (ie not by BFCL)."
There were two attachments to the facsimile from Beneficial Finance, the third page is headed "Kabani Pty Ltd" and contains the following statements:
"1. Kabani is a trustee for Kabani unit trust...
5. Beneficial has been appointed formally manager, Kabani...
6. Kabani has the following wholly owned subsidiaries similarly constituted to itself, Malary Pty Ltd., Lagan Pty. Ltd., Fortina Pty. Ltd."
Based on the evidence examined by the Investigation, those statements are incorrect.
Mr Yelland submitted that point 5 may have been a reference to the agreement between Beneficial Finance and the Kabani type companies whereby Beneficial Finance would provide administrative, personnel, accounting, and general management services.() Notwithstanding the service agreement, in my opinion, point 5 was not a correct representation of the position.
On 10 November 1988, the trustee wrote in identical terms to its solicitors, Finlaysons, and to Price Waterhouse, seeking from both Finlaysons and Price Waterhouse advice and recommendations as to the action the trustee should take.
According to the terms of that letter, the abovementioned details provided to the trustee by Beneficial Finance concerning Kabani were forwarded to Price Waterhouse.
At the 27 August 1992, examination of Mr B Wood, the Managing Director of Austrust (formerly Elders Trustee), and the following questions were put to him and the following answers given:
"Q: Following that letter to Price Waterhouse [the letter of 10 November 1988], you have given us a hand written file note dated 23 November by Mr Wilson of your company which you have said seems to be the only recorded outcome of that correspondence. You have said that to the best of your recollection the suggested meeting [with Mr Giles of Price Waterhouse and Mr Tucker of Thomson Simmons & Co] did not eventuate because you wanted the benefit of Finlaysons advice before taking the matter further. Can you confirm if that is ---
A: That is absolutely correct. Yes.
Q: ... That means that Price Waterhouse did not respond with advice or recommendations either orally or in writing?
A: There is no record of that. I would expect that there would have been some conversations but they are not recorded."
The position regarding advice given by Finlaysons to the Trustee, Austrust Limited, is set out in Finlaysons' letter of 8 January 1991, which states in part:
"... set out below is a summary of the investigation undertaken by this firm and the advice given in late 1988 and early 1989.
1 On 10 November you wrote to us requesting advice in relation to whether Kabani Pty Ltd, Pacific Leisure Pty Ltd and Argus International Hotels Pty Ltd were subsidiaries of BFCL.
2 On 16 November 1988 we wrote to Mr G Yelland requesting certain information in relation to those companies.
3 On 14 December 1988 we received a partial response from Stuart Wright of BFCL.
4 On 22 December 1988 and 28 December 1988 we received further responses from Stuart Wright.
5 On 23 January 1989 we requested further information from BFCL and Peter Slattery wrote to you giving some preliminary views in relation to Kabani, Malary, Lagan, Fortina, Pacific Leisure Pty Ltd, First Pacific Mortgage Limited and First Pacific Insurance Brokers Limited.
6 On 24 January 1989 we received a response from BFCL.
7 On 2 February 1989 Peter Slattery wrote to you advising that on the information available Kabani was not a subsidiary of BFCL unless BFCL could influence the exercise of voting rights of shares in Kabani under the terms of the trusts pursuant to which the shares in Kabani were held.
8 On 2 February 1989 we wrote to Stuart Wright of BFCL requesting copies of the relevant trust deeds.
9 On 21 February 1989 Stuart Wright replied refusing to make the trust deeds available.
10 On 24 February 1989 Peter Slattery wrote to you informing you of this fact.
11 The trust deeds were made available, at least in relation to Lagan and on 7 March 1989, having reviewed the relevant trust deeds, Peter Slattery wrote to you setting out his opinion that on the basis that the trust deeds for Lagan, Malary, Kabani and Fortina were identical there was nothing in those trust deeds that made those companies subsidiaries of BFCL. His opinion was that unless there was some arrangement or understanding BFCL, in relation to composition of the board of directors of those companies, neither they nor First Pacific Mortgage or First Pacific Insurance Brokers were subsidiaries of BFCL.
12 On 13 March 1989 Peter Slattery wrote to you confirming that as Lagan, Malary, Kabani, Fortina, First Pacific Mortgage or First Pacific Insurance Brokers were not subsidiaries of BFCL it was not possible to require them to give guarantees pursuant to the terms of the 1985 trust deed. He also confirmed that he did not believe the trustee needed to make any further enquiries unless further information came to hand concerning the relationship between those companies and BFCL....
In essence, therefore, after reasonably lengthy enquiries we came to a view that, based on the information available and the assurance that each of the companies had been formed identically, that they were not subsidiaries of BFCL.
It must be emphasised, however, that at the time of giving our advice we may not have had access to all the relevant information in relation to the companies. Specifically if there were arrangements pursuant to which BFCL could control the composition of the boards of the companies or control the voting rights attaching to shares in the companies of which we were not aware, our opinion would have to be reviewed." [Emphasis added]
Mr Yelland made a statutory declaration, on 16 March 1989, to the effect that Beneficial Finance did not control the composition of the board of directors of Kabani, Lagan or Malary. That declaration was provided to Austrust. Mr Wood, Managing Director of Austrust, stated in evidence that he believed that the statutory declaration was obtained to satisfy his company that it was not necessary to pursue enquiries as to whether there was some arrangement of the kind referred to in Finlaysons letter of 7 March 1989.()
In evidence to the Investigation, Mr Yelland acknowledged that his statutory declaration was instrumental in the trustee accepting the status of the Kabani type companies.() Mr Yelland explained in evidence that the matters declared by him in the statutory declaration of 16 March 1989 represented his own conclusion based on his understanding of the legal effect of the structure and the advice that Beneficial Finance had obtained.() Mr Yelland added that the statutory declaration was made in response to a request, either from Austrust or Finlaysons, that he confirm by statutory declaration that there was no agreement or understanding concerning the composition of the boards of the Kabani type companies.(). In my opinion, the declaration made by Mr Yelland was unhelpful because he was deposing to a matter which was not a fact but an opinion as to a legal consequence, based on a view of the law which was not stated, of facts which were not stated. Mr Yelland submitted that the wording of the declaration was discussed with Austrust and Finlaysons.() I have been informed by Austrust that there is no record on Finlaysons' file that the form of the declaration was discussed with them.()
In their submission, dated 18 August 1992, Price Waterhouse stated that Mr Giles recalled having seen a copy of Finlayson's final advice in the matter, although Price Waterhouse had not kept a copy on their audit file. Price Waterhouse said that they had, however, retained on their audit file a copy of a Board paper prepared by Beneficial Finance's General Counsel, Mr Yelland, confirming that the effect of the Kabani structure was accepted by the trustee. This paper was tabled at the Beneficial Finance Board meeting on 31 March 1989. The paper, which was undated, stated in part:
"Kabani was established as an off-balance sheet company giving all of the desired managerial control but none of the assets/liability accountability by the Beneficial Group. Nor was Kabani subject to the Trust Deed constraints on gearing ratios....
The technique used, has been accepted for the past three years by both the Directors and Auditors, and now the Trustee. There is little doubt as to the legal efficacy of the technique used and it is not unique to the Beneficial Group".
In my opinion, the statement that the structure had been accepted by the auditors was speculative. Mr Yelland testified that, to his knowledge, the auditors had not expressly approved the structure, and that the statement was based on his inference, drawn, from the auditors' acceptance of the Beneficial Finance accounts in the years 1985-88 and their position as auditors of the Kabani type companies, that, they had accepted the efficacy of the structure.() Mr Yelland acknowledged that this inference could not be safely drawn because the auditors may simply not have questioned the efficacy of the structure or its disclosure on the grounds that it was not a material issue in those years. The auditors have submitted, and I accept, that the results and affairs of the Kabani type companies were not material to the results and affairs of the Beneficial Finance Group in the years 1985-87. For the reasons set out in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance", in my opinion the auditors failed to consider whether the results and affairs of the Kabani type companies were material in 1988.
In my opinion, management were not forthright in providing information to the trustee for debenture holders or the Board in relation to the Kabani type structure. I have, however, formed the opinion that the matters noted above concerning the enquiries made by the trustee for debenture holders in 1989, and the subsequent reporting by management to the Board on the outcome of those enquiries, do not disclose any unlawful or improper activity on the part of management.
41.3.8 CONCLUSIONS ON THE OFF-BALANCE SHEET STRUCTURE
Based on the evidence examined by the Investigation, and for the reasons set out in this Chapter and Chapters 57 - "Review of the 1988 External Audit of Beneficial Finance" to Chapter 59 - "Review of the 1990 External Audit of Beneficial Finance" of this Report, I have formed the opinion that:
(a) the affairs of the Kabani type companies were, in fact, controlled by Beneficial Finance, and such affairs were conducted for the benefit, and at the risk, of Beneficial Finance, pursuant to a variety of legal and practical commercial powers created under the off-balance sheet structure; and
(b) consequently, at all relevant times, the results and affairs of the off-balance sheet entities would, if material to the results and affairs of Beneficial Finance, be required to be disclosed in order for the accounts of Beneficial Finance, and the consolidated accounts of Beneficial Finance and its subsidiaries, to show a true and fair view in accordance with Section 269 of the Companies Code.
41.4 INTERNAL MANAGEMENT REPORTING
In my opinion, the establishment and conduct of operations through the off-balance sheet structure was one of the factors that contributed to the financial position into which Beneficial Finance had fallen by early 1991.
There are many indications that the directors of Beneficial Finance were having great difficulty comprehending the issues upon which they were constantly being asked to make decisions. Mr M G Hamilton, for example, considered that the board was simply overwhelmed by the amount of information which was delivered to them for each meeting. He said that:
"I think that it was extraordinarily difficult for some board members to comprehend the sheer complexity of a number of the issues they were being asked to approve".()
In his opinion, the Beneficial Finance Board and the management were progressively becoming unable to maintain control over the unwieldy structures, and the accounting section could not keep up with the paperwork generated by the multiplicity of entities involved.
"The joint ventures and the off-balance sheet activities were becoming so complex that Beneficial management was, I think, not totally in control of its own activities".()
Management accounts for selected off-balance sheet entities were regularly included in the monthly Board Papers received by Directors of Beneficial Finance. These accounts were prepared on a legal entity basis, and did not eliminate transactions and balances involving Beneficial Finance, its acknowledged subsidiaries, or other off-balance sheet entities, nor was the effect of such matters fully disclosed. Internal management accounts of the Beneficial Finance Group did not consolidate the results and affairs of the off-balance sheet entities. Accordingly, for most of the period under review, the Board of Beneficial Finance did not receive financial information clearly setting out the impact of the off-balance sheet entities on the financial position of Beneficial Finance. I refer below to attempts initiated by the Board to obtain consolidated financial information.
The submission to me from certain former Non-Executive Directors of both the Bank and Beneficial Finance confirms the problems created by the complexity of the structure.()
I accept the submissions that were put to me by the Bank in relation to the following matters:
(a) There was no co-ordinated approach to the creation of the off-balance sheet structure and it largely grew in an uncontrolled fashion.()
(b) Off-balance sheet entities were not created to hide non-performing assets - the assets acquired off-balance sheet were considered to be good investment or business propositions.()
(c) the majority of joint ventures, however, many of which were entered into through off-balance sheet entities, proved to be ill founded.()
(d) The Bank's present policy is that no new joint ventures of the type undertaken by Beneficial Finance will be entered into,() and that the off-balance sheet entities will be eliminated as soon as feasible.()
(e) All controlled off-balance sheet entities have been brought onto the accounts of the Bank Group since June 1991.()
(f) Beneficial Finance lacked adequate management information systems to provide basic balance sheet and profit and loss statement information concerning the assets under the control of Beneficial Finance's management, (which included off-balance sheet entities and joint ventures), and this contributed to the losses reported by Beneficial Finance.()
Whilst the extent of the growth of the company was itself a factor, the off-balance sheet structure meant, that at any given moment, it was difficult to know the true financial position of the Group. This position was obviously more acute amongst the directors than the management; Mr Baker himself professes to have been taken by surprise to find that off-balance sheet ventures were making losses.(). For the reasons set out in Chapter 35 - "Beneficial Finance - Prospectus 65", I am not prepared to accept Mr Baker's assertion in this regard. In my opinion, the complex off-balance sheet structure was a factor that contributed to the difficulties faced by the Board and management to assess and control the business of the Beneficial Finance Group.
The Board were concerned from an early stage to bring the off-balance sheet entities on to the balance sheet of Beneficial Finance, for management accounting purposes. Their concern appears to have been that they had too little knowledge of the true financial position of the Beneficial Finance Group.
The Beneficial Finance Board had, as early as 28 April 1988, expressed their concern about the need for equity accounting, and aggregate accounting, and a task force had been established to examine that issue. It was a slow affair, with steps gradually being taken to bring entities progressively on to the accounts of Beneficial Finance, but the report of the task force was not delivered until 1 March 1991. The earlier result of the investigations of the task force of Mr A Z Kane and Mr J R Devereaux pointed to the absolute necessity to resolve the whole matter quickly, and to bring all the operations on to the accounts of Beneficial Finance. The figures produced by the task force in February 1990 showed accumulated losses off-balance sheet of about $22.0M. The emergence of this result in January and February 1990 came as a surprise to the Board and Management.()
41.4.1 DUTIES AND RESPONSIBILITIES OF THE BOARD
I have examined the duties and responsibilities of the Board in Chapter 2 - "Reference Information on the Investigation" of my first Report. For the purposes of this Section, I will summarise those duties and responsibilities that relate to Beneficial Finance's internal management reporting.
One of the principal duties of a Board of directors is to supervise, direct, and control, the affairs and transactions of the company. To satisfy this duty, each director should receive such timely, adequate, and reliable, financial information as will enable the director to fully understand the following matters:
(a) Whether adequate systems and controls are in place to ensure that the company's assets are safeguarded from the risk of loss.
(b) Whether adequate systems and controls are in place to ensure that financial information produced by management and presented to the Board is of the required standard.
(c) The full extent of the company's exposure to, and risk of, financial loss.
In satisfying their duties in relation to matters concerned with a company's financial management, directors are required to:
"... exercise a reasonable degree of care and diligence". ()
In the context of this Section, I believe the standard expected of a director of Beneficial Finance, a company with consolidated total assets of $2,674.0M() funded by borrowings, much from the Australian public, of $2,436.0M() would be demanding.
41.4.2 AGGREGATE ACCOUNTING
"Aggregate Accounting" and "Aggregate Accounts" were terms used by Beneficial Finance to describe the notional consolidation of off-balance sheet entities into the consolidated financial statements of Beneficial Finance.
The need for aggregate accounting arose as a result of:
(a) Growth in the number of off-balance sheet entities and concerns of the Board to understand the impact of this growth on Beneficial Finance.
(b) Impending developments in accounting standards, which would eventually require greater disclosure in statutory financial statements of Beneficial Finance's off-balance sheet activities.
Certain former Non-Executive Directors of the Bank and Beneficial Finance have made the following submissions to me:
"... The growth in off-balance sheet activities, particularly in relation to joint venture projects occurred in Beneficial mainly during 1988. When it became clear to the Beneficial Board that the Group was undergoing unprecedented growth in that area it was quickly realised that the existing reporting mechanisms and statutory accounts were no longer suited to give the Board all necessary management information. It was then that the aggregate accounting and corporate restructure exercises were initiated." ()
The Board Minutes of 28 October 1988 recorded that:
"... Concern was expressed that financial information relating to off-balance sheet activities, which is not declared in the consolidated accounts, should be notionally grouped to ensure an understanding of their effect on group activities. It was agreed to produce six monthly, in February and August, a fully consolidated set of accounts which will include all off-balance sheet activities." ()
In January 1989, the Beneficial Finance Board considered a preliminary report on a proposal to restructure Beneficial Finance, and resolved that any change:
"... must result in the ability to report monthly to the Board on the total Group results including all off-balance sheet companies." ()
Mr Giles, Partner of external auditors Price Waterhouse, attended the January 1989 Board meeting. Minutes of that meeting record that he advised directors of:
"... the requirements for equity accounting standards for the accounts for the year ending 30 June 1989."
In January 1989, a number of changes to law and approved accounting standards were imminent. These changes had all been publicly foreshadowed during 1988. All would have the effect, when introduced, of compelling Beneficial Finance to make a greater disclosure than before of the activities of the off-balance sheet entities in its statutory accounts for external reporting purposes.
In March 1989, Special Submission 255 was presented to the Board at Beneficial Finance. SS255 directed the attention of the Board to the need for greater disclosure in the accounts of the Bank Group of the activities of Beneficial Finance's off-balance sheet operations on account of the matters already mentioned, and also because concern had been expressed by the Trustee for Debenture Holders as to the extent and increasing financial importance of Beneficial Finance's off-balance sheet operations.()
In response to these developments, Beneficial Finance established, in January 1989, a project team, comprising Mr Kane and Mr Devereaux, to report to the Beneficial Finance Executive Committee on the issues of Equity and Aggregate Accounting.()
The culmination of these events was the preparation of an "Aggregated Accounting Statement", the purpose of which was "... to provide further information to Management and the Board as to the extent of Beneficial's control and mix of assets and liabilities beyond that provided in its consolidated Group accounts." ()
Prior to the preparation of the first set of aggregate accounts, however, the project team prepared two illustrative equity accounting statements as follows:
(a) Accounts, as at 30 June 1988, were presented to the February 1989 Beneficial Finance Board meeting. The purpose of the exercise was acknowledged by the auditors to be mainly to present the format, rather than provide meaningful information.
(b) Accounts, as at 31 December 1988, were presented to the March 1989 Beneficial Finance Board meeting. These accounts stated also they did not include the off-balance sheet entities.
A report accompanying the aggregate accounts as at 31 December 1988 noted that:
"... A valuable lesson to be learned from the exercise was that accounts prepared by non-Beneficial Finance parties were not prepared on a consistent basis or format for Equity Accounting."
The report also stated that a further aggregate accounting statement, as at 31 December 1988, which would include all "the Kabani-type entities", was in process of preparation.
41.4.3 AGGREGATE ACCOUNTS - 31 DECEMBER 1988
The first set of aggregate accounts to include all the material off-balance sheet entities of Beneficial Finance was prepared in relation to the six month period to 31 December 1988, and was presented to the April 1989 meeting of the Beneficial Finance Board.
When compared with the statutory accounts published by Beneficial Finance, the aggregate accounts showed an increase in controlled total assets, after elimination of inter-company transactions, of $310.2M, with the main contributing factors being:
$M
(a) Outside borrowings including creditors and accruals 290
(b) Retained profits and reserves() 5
An attachment to these aggregate accounts identified twenty seven entities which had material assets greater than $1.0M, and provided a general description of the assets of those entities.
Some information was not readily available for inclusion in these accounts; therefore an amount of approximately $23.0M (1.1 per cent) of total assets was estimated by the project team as being assets attributable to those entities for which information was incomplete.() Accordingly, the aggregate accounts, prepared as at 31 December 1988, which comprised only a balance sheet, included certain estimates. They did, however, provide the Beneficial Finance Board with an indication of the effect of consolidating off-balance sheet entities into the statutory accounts of Beneficial Finance and its acknowledged subsidiaries.
In a report, dated 1 March 1991, the original aggregate accounting project team, Mr Kane and Mr Devereaux, commented upon the team's findings as a result of the preparation of the initial aggregate accounting statement. The report was addressed to the then newly appointed Managing Director of Beneficial Finance, Mr J Malouf. The team stated:
"... It was immediately apparent that the "known" structure of off-balance sheet entities was not only changing but that it was also incomplete. The first and essential task was to attempt to limit the growth of the off-balance sheet entities and to identify other entities which were not recorded on the corporate structure.
This was, in effect, the first occasion controls were to be introduced which would restrict growth in the Corporate Structure and identify all entities in which BFCL or any other entity in the Corporate Structure had an Equity position.
The problem of the structure was exacerbated by availability, quality and quantity of accounting information provided by the various entities."
Later in the same report the following observations were made:
"... Normal accounting and reporting standards were not evident."
and
"... Problems identified.
Initially, Aggregate Accounting was deemed necessary to provide Board and Management with an overall view of the asset/liability mix of the Group. The problems identified in achieving this aim related to:
. Dissection and disclosure of related party information in order that inter related transactions could be eliminated;
. Establish the extent of shareholding retained by BFCL or a related off-balance entity;
. Analysis of shareholders fund to clearly distinguish the interests of minority shareholders and pre and post acquisition profits;
. Analysis of liabilities to determine whether funding was derived from a mix of internal and external sources;
. Determine timing risks. Information may not correspond exactly to BFCL's accounting period, or information not finalised, or information not provided;
. Extent of contingent liability exposure that BFCL may have had in relation to the off-balance sheet entities;
. Lack of consistency of the accounting information prepared by other entities when compared with BFCL." ()
The following is a comparison of the aggregate balance sheet, as at 31 December 1988, with the statutory accounts of Beneficial Finance Group, as at the same date.()
|
Consolidated |
Aggregated |
||||
|
Current assets |
|||||
|
Receivables |
1,185.3 |
1,100.3 |
|||
|
Other |
25.8 |
40.2 |
|||
|
1,211.1 |
1,140.5 |
||||
|
Non-current assets |
|||||
|
Receivables |
568.8 |
744.4 |
|||
|
Inventories |
10.5 |
83.9 |
|||
|
Property, plant and equipment |
10.3 |
135.9 |
|||
|
Other |
31.5 |
37.7 |
|||
|
621.1 |
1,001.9 |
||||
|
Total Assets |
1,832.2 |
2,142.4 |
|||
|
Current Liabilities |
|||||
|
Creditors and borrowings |
921.8 |
1,101.5 |
|||
|
Provisions |
2.5 |
8.5 |
|||
|
924.3 |
1,110.0 |
||||
|
Non-current Liabilities |
|||||
|
Creditors and borrowings |
766.6 |
876.6 |
|||
|
Provisions |
7.3 |
8.8 |
|||
|
773.9 |
885.4 |
||||
|
Total Liabilities |
1,698.2 |
1,995.4 |
|||
|
Net Assets |
134.0 |
147.0 |
|||
The key points to observe from this comparison are:
(a) Total assets under the control of Beneficial finance were greater than those shown in Beneficial Finance's consolidated financial statements by $310.2M, of which $199.0M comprised non-monetary assets such as inventories and property, plant and equipment (property and construction assets).
(b) Beneficial Finance's non-consolidated entities had external borrowings of $289.7M which were not reported in Beneficial Finance's statutory consolidated financial statements.
(c) A measure of a company's liquidity is its ratio of current assets to current liabilities. The liquidity indicated by each balance sheet was materially different:
|
Consolidated |
Aggregated |
|
|
Current assets ("CA") |
1,211.1 |
1,140.5 |
|
Current liabilities ("CL") |
924.3 |
1,110.0 |
|
Ratio of CA:CL |
1.31 |
1.03 |
Beneficial Finance, through its controlled off-balance sheet entities, participated in a number of property development and/or construction projects, which were recognised as non-current assets in the aggregate accounts. The exposure of Beneficial Finance to these projects was recorded, in the consolidated financial statements of Beneficial Finance, as short term funding receivables. Accordingly, the aggregate accounting exercise revealed a much less favourable liquidity position than had appeared from Beneficial Finance's published consolidated financial statements, and highlighted Beneficial Finance's participation in property development.
41.4.4 AGGREGATE ACCOUNTS - 30 JUNE 1989
A more comprehensive set of aggregate accounts was completed in August 1989, in respect of the year ended 30 June 1989. These were presented to the Board of Beneficial Finance on 24 August 1989, and compared with the draft statutory accounts for the same period. An equity accounting statement was also prepared and presented to the Board of Beneficial Finance at the same time.
The aggregate accounts, presented to the Beneficial Finance Board in August 1989, disclosed a profit after tax for the 1989 financial year of $29.6M, compared with a reported profit after tax in the statutory accounts of $30.0M. These aggregate accounts also disclosed losses of $2.2M relating to off-balance sheet entities; $1.8M attributable to prior years and a current year loss of $0.4M.
The ratio of current assets to current liabilities in the statutory financial statements was 1.3 : 1.0 compared with a ratio of 1.0 : 1.0 in the aggregate accounts. This reinforced the result of the initial aggregate accounting exercise that there was a less favourable liquidity position disclosed by measuring current assets to current liabilities under aggregate accounting.
The report, of 1 March 1991, by Mr Kane and Mr Devereaux to Mr Malouf referred to above, states that some of the off-balance sheet entities included in the aggregate accounts, but not in the ordinary statutory accounts of Beneficial Finance, produced only unaudited financial information for the aggregate accounting exercise. Those entities were required to provide their best estimates of results for the 1989 year for preparation of the aggregate accounts.()
In August 1989, subsequent to the issue of 30 June 1989 statutory accounts, Mr Devereaux stated his concern to Mr M Chakravarti at the lack of regular and reliable financial information relating to off-balance sheet entities and inadequate monitoring of these results. The matter was referred to and discussed by Mr Devereaux and Mr Chakravarti with Mr Baker.()
In the course of my Investigation, Mr Baker has stated in evidence that, following discussions with Mr Devereaux and Mr Chakravarti, the following course of action was taken.
"... There was a joint venture accounting department set up headed by Dean Crichton and another - and a lady worked there too. I just can't think of her name. And so there was a lot more people power put into that accounting area to better monitor and - and control the joint venture accounts and I think most of those joint venture accounts were subsequently brought from third party locations and put into Adelaide head office, I think." ()
41.4.5 AGGREGATE ACCOUNTS - 31 DECEMBER 1989
Aggregate accounts were next prepared for the six month period ended 31 December 1989. The Beneficial Finance Board Minutes disclose that the results of this exercise were presented to the Board of Beneficial Finance on 23 February 1990.
The Beneficial Finance Board Minutes also disclose that the Beneficial Finance statutory consolidated accounts, for the six months ended 31 December 1989, were approved by the Beneficial Finance Board at a meeting of directors on 20 February 1990, just three days before the Board of Beneficial Finance was informed of the results of the aggregate accounting exercise.
The results of the aggregate accounting exercise, which had been presented to the Board of Beneficial Finance on 23 February 1990, was updated for the March 1990 Board meeting to take account of recently discovered information, including the recognition of tax benefits attributable to losses in certain subsidiaries.
An Attachment to the Aggregate Accounting Statement presented to the Board in February 1990 disclosed a loss attributable to off-balance sheet entities of $12.5M for the six month period to 31 December 1989, and an accumulated loss to 31 December 1989 of $22.1M.
The February 1990 Board Paper was prepared subsequent to preliminary calculations undertaken by Mr Kane and Mr Devereaux, which were the subject of comment in their report of 1 March 1991 to Mr Malouf. Their preliminary calculations were a loss for the six month period to 31 December 1989 of $12.8M and an accumulated loss to 31 December of $23.6M. Mr Kane and Mr Devereaux commented in their report, that upon examination, it was found that the cumulative losses from $2.2M (disclosed in the 30 June 1989 aggregate accounts) to $23.6M at 31 December 1989, was, in part, attributable to trading before 30 June 1989 - that is, the aggregate accounting results to 31 December 1989 included adjustments for revised results of off-balance sheet entities for the year 30 June 1989. The true performance of some of the off-balance sheet entities was worse than indicated by the figures which had been included in the 30 June 1989 aggregate accounts.
The Attachment to the February 1990 Board paper identified that the accumulated loss of $22.1M comprised, $9.6M loss for the year ended 30 June 1989 and a loss of $12.5M for the six months to 31 December 1989.
The understatement of losses for the off-balance sheet entities was attributed to the "... quality and accuracy" of the information made available to them when compiling the aggregate accounts. In the report to Mr Malouf, dated 1 March 1991, Mr Kane and Mr Devereaux have cited the following example:
"... This issue of accuracy can be demonstrated by reference to the accounts of Campbell Capital. The monthly report to the Board/Executive was showing a marginal profit as at 31 December 1989 of $0.1 million. In fact, the position as reported for Aggregate purposes was a loss of $1.2 million. The report to the Board only reported the profit position of the consolidated result of Campbell Capital, which did not include the losses being suffered on their Equity investments, which represented a substantial proportion of their business. It should also be noted that some of the financial results of these Equity investments were ranging from 6 to 18 months out of date depending on whether it was the June or December 1989 exercise."
Mr Kane and Mr Devereaux also commented in the same report:
"... This turnaround from a loss, which was seen to be within acceptable levels of materiality by the external auditors, to a loss which could offset 30% of the BFCL 30 June 1989 retained profits, might have been regarded as material by the auditors if they had known at the time."
41.4.6 AGGREGATE ACCOUNTS - 30 JUNE 1990
In a special presentation to the Beneficial Finance Board on 29 March 1990 by Mr S Spadavecchia, aggregate accounts for the off-balance sheet entities were tabled projecting the profit/loss for the off-balance sheet entities for the year to 30 June 1990.
This presentation forecast losses after tax attributable to all off-balance sheet entities, for the year ended 30 June 1990 amounting to $9.4M before inter-company adjustments. The Beneficial Finance Board Papers record that the forecast off-balance sheet losses in the presentation were expected to be covered eventually by increased property and investment values estimated to amount to $14.5M in the off-balance sheet entities. These expected gains would be unrealised at 30 June 1990. Nevertheless, it was stated in the presentation that the losses could be:
"... covered by Beneficial's unallocated provision for doubtful debts and still leave sufficient provisions to cover the on-balance sheet receivables portfolio." ()
The Beneficial Finance Board Minutes of 29 March 1990 recorded that:
"... It is intended to continue the Aggregate Accounting exercise on a monthly basis ..."
Notwithstanding this requirement by the Board, the next aggregate accounting statement, which forecast results to 30 June 1990, was not presented to the Beneficial Finance Board until 29 June 1990. The forecast aggregate profit after tax (for Beneficial Finance Group, entities to be restructured on to the balance sheet of the Bank, and entities which were to remain off-balance sheet) was $15.8M, to which the entities which were to remain off-balance sheet were forecast to contribute a $3.2M loss.
A further aggregate accounting statement was included in the Beneficial Finance Board Papers of 31 August 1990, which compared the actual results to 30 June 1990 with the forecast results to 30 June 1990 presented to the Beneficial Finance Board on 29 June 1990. The actual aggregate result (for Beneficial Finance Group, entities to be restructured on to the balance sheet of the Bank, and entities which were to remain off-balance sheet) was a loss of $14.4M, which was a turnaround of $30.2M. The entities which remained off-balance sheet contributed a loss of $5.4M to this result. The Beneficial Finance Group balance sheet result contributed profit of $5.8M to the aggregate result whilst a loss of $14.8M was attributable to entities to be restructured on to the balance sheet of the Bank.
The Beneficial Finance Board Papers commented on the reasons for the $30.0M turnaround which were principally:
"... provision for losses on receivables and investments being reassessed after the June paper was issued, profit forecasts not being achieved and the tax benefits of some losses not being achieved."
41.4.7 CONCLUSIONS FROM AGGREGATE ACCOUNTING
Based on the evidence examined by the Investigation and for the reasons set out above and in Chapters 57 - "Review of the 1988 External Audit of Beneficial Finance to Chapter 59 - "Review of the 1990 External Audit of Beneficial Finance, I have formed the opinion that:
(a) The results and affairs of the off-balance sheet entities of Beneficial Finance were such as to have a material effect on the financial position of the Beneficial Finance Group reported, at balance dates, from 30 June 1988 to 30 June 1990 (inclusive).
(b) Without accurate aggregate accounts, the Board and Management of Beneficial Finance was not properly informed as to the extent of the assets and operations under its control and responsibility. Accordingly, without such information, the Board and Management of Beneficial Finance were unable to, and did not, adequately or properly supervise, direct, and control the operations, affairs, and transactions, of the Beneficial Finance Group.
(c) By April 1989, when it received the first aggregate accounting figures, the Beneficial Finance Board was put on notice that the operations of the off-balance sheet entities potentially had a material effect upon the financial position of the Beneficial Finance Group.
(d) The aggregate accounts produced in respect of each six month trading period showed, as they became available, a deterioration in the financial position of Beneficial Finance, as a result of the activities of the off-balance sheet entities.
(e) The aggregate accounts which were presented to the Beneficial Finance Board on 29 June 1990, and which forecast aggregate accounting results to 30 June 1990, contained forecasts which were substantially inaccurate. The Beneficial Finance Board was not aware of the financial position or performance of the off-balance sheet entities under its control until August 1990 when further aggregate accounts were prepared.