VOLUME TWO REFERENCE INFORMATION

CHAPTER TWO
REFERENCE INFORMATION ON THE INVESTIGATION

TABLE OF CONTENTS

2.1 INTRODUCTION
2.1.1 THE PURPOSE OF THIS CHAPTER

2.2 BACKGROUND TO THE INVESTIGATION AND REPORT
2.2.1 STATUTORY POWERS OF THE INVESTIGATION
2.2.2 THE CONDUCT OF THE INVESTIGATION
2.2.2.1 Resources and Extent of the Investigation
2.2.2.2 Approach and Methodology
2.2.3 The Requirement of Confidentiality
2.2.2.4 Conclusions of Fact

2.3 EXAMINATION OF THE BANK AND BANK GROUP

2.4 THE "FINANCIAL POSITION" OF THE BANK AND BANK GROUP
2.4.1 THE FINANCIAL POSITION AS REPORTED BY THE BANK AND THE TREASURER
2.4.2 THE SOURCES OF THE BANK GROUP'S LOSSES

2.5 COMPARISON WITH OTHER BANKS AND FINANCIAL INSTITUTIONS

2.6 THE STANDARD OF CONDUCT APPLIED TO THE BANK'S BOARD OF DIRECTORS, MANAGEMENT AND EMPLOYEES
2.6.1 THE OBLIGATIONS AND DUTIES OF THE BANK'S BOARD OF DIRECTORS
2.6.1.1 The Commercial Charter of the State Bank
2.6.1.2 The Governance of the Bank
2.6.1.3 Other Aspects of the State Bank of South Australia Act 1983
2.6.2 ASPECTS OF THE LAW OF DIRECTORS' DUTIES
2.6.2.1 Introduction
2.6.2.2 The General Law of Director's Duties
2.6.2.2 Reliance by the Board of Directors upon Management
2.6.2.3 The Particular Role and Duties of the Managing Director
2.6.2.4 The Obligations of the Board of a Parent Corporation for the conduct of the Affairs of a Subsidiary Corporation
2.6.2.5 The Role and duties of Common Directors on the Boards of Parent and Subsidiary Corporations
2.6.2.6 Do Directors Increase their duties by doing work that might in another Company be done by Employees?

2.7 THE RELATIONSHIP BETWEEN THE STATE BANK OF SOUTH AUSTRALIA 1983 ACT AND THE GENERAL LAW
2.7.1 THE POWERS AND DUTIES OF THE BANK, THE BOARD, AND THE DIRECTORS

2.8 CONCLUSION

2.1 INTRODUCTION

2.1.1 THE PURPOSE OF THIS CHAPTER

In the course of my Investigation I have had to consider a wide variety of legal issues relating both to the conduct of the Investigation, and to its substantive content.

Principal among these were:

(a) the precise scope and requirements of my Terms of Appointment;

(b) the principles of law relevant to my Terms of Appointment; and

(c) the standard that should be applied to the Bank Group's Board of Directors, management and employees in the conduct of the Bank's business.

The purpose of this Chapter is to describe the approach I have taken to these issues.

2.2 BACKGROUND TO THE INVESTIGATION AND REPORT

2.2.1 STATUTORY POWERS OF THE INVESTIGATION

My Investigation was established by the Governor under Section 25 of the State Bank of South Australia 1983 Act ("the Act"), which is the constituent Act of the Bank. Section 25 empowers the Governor to appoint the Auditor-General (or some other suitable person) to make an investigation and report under the Section.

Section 25 was substantially amended on 28 March 1991, and again on 3 December 1992, to facilitate my Investigation. Sub-section (7) makes clear that for the purposes of my Investigation, I had the same powers as those provided by Division III of Part III of the Public Finance and Audit Act 1987, including the power to inspect documents and places, require the giving of written and oral evidence on oath, and by summons to require the appearance of any persons or the production of any documents. Sub-section 25 (7)(a) and sub-section (7)(b), that were added to the Act in December 1992, empowered the Supreme Court to order persons to provide information and to answer questions. These amendments were necessary, notwithstanding the existing sub-section 25(8) that provided that a magistrate could issue a summons requiring a person to appear before me to answer questions, or to produce documents, provided that the magistrate was satisfied that there were reasonable grounds to believe that the person had relevant knowledge or control of relevant documents. The failure to comply with the order of a Magistrate was a fine or imprisonment, but did not overcome the possibility that there could be a continuing failure to produce documents and delay the Investigation. The December 1992 amendment provided a procedure pursuant to which information could, subject to the Order of the Supreme Court, be obtained quickly with the Court being in a position to assess the merits of the claims of both the investigator and the person against whom the order was being sought. The failure to comply with an order of the Supreme Court would be a contempt of the Court with appropriate remedies being available to the Court to ensure compliance with its Orders.

Sub-section 25(4) of the Act authorised me to make public statements as to the nature and conduct of the Investigation, and to invite and receive information or submissions as to any matter relevant to the Investigation, as I saw fit. In the early stages of the investigation I placed an advertisement in the `Financial Review' and the `Advertiser' advising the public of my investigation and invited submissions from persons who considered that they had information that was relevant to my Terms of Appointment. I have received several submissions.

2.2.2 THE CONDUCT OF THE INVESTIGATION

2.2.2.1 Resources and Extent of the Investigation

My Investigation has brought in a significant number of contracted external experts who have examined, in great detail, all relevant aspects of the operations of the Bank and of Beneficial Finance, these being the two corporations in the Bank Group which incurred almost all of the Group's losses.

Those experts can be conveniently classified as comprising five separate groups:

(a) officers of the Auditor-General's department, who, under my supervision have spent long hours planning, controlling, and managing, the Investigation;

(b) a number of individual consultants, with particular expertise in banking, and legal matters, were engaged to investigate and advise on particular aspects of the Bank Group's operations;

(c) accounting and audit professionals from three national accounting firms (Coopers & Lybrand, Deloitte Ross Tohmatsu and Ernst & Young) were engaged to investigate and report on particular aspects of the operations of the Bank and Beneficial Finance;

(d) the Adelaide law firm, Norman Waterhouse, acted as solicitors to my Investigation; and

(e) a number of legal counsel, including Queens Counsel, were briefed to review and advise on aspects of the Investigation, and to review draft Chapters of this Report.

2.2.2.2 Approach and Methodology

A four staged approach characterised the Investigation process, comprising an initial planning phase, preliminary investigation phase, specific investigation phase and report writing phase.

Initial Planning Phase

This phase of the investigation process involved the following: a detailed analysis of the Terms of Appointment; an initial determination of the scope of the review and the level and mix of resources required to effectively undertake the Investigation; the establishment of the Auditor-General's Investigation Office; and the arrangements for administration and systems infrastructure.

It was clearly apparent from the analysis of the Terms of Appointment that the Investigation to be undertaken would cover a wide spectrum of the commercial and management problems of the Bank and Beneficial Finance, over a period of seven years. The size and specialist nature of the Investigation required the contracting of a banking expert, and professional accounting and audit members of the three national accounting firms. It was the responsibility of these professionals to undertake the substantive investigation work that was planned, directed, and controlled, by my officers and me.

Preliminary Investigation Phase

The substantive investigation of the Bank Group commenced with the conduct of a preliminary survey of the operations of the Bank and those related entities that comprised the Bank Group over the period 1984 to March 1991.

This phase of the Investigation was directed to providing me, as soon as was practicable, with:

(a) a sound understanding of the Bank Group organisation and principal management, and financial and accountability arrangements, that existed within each of the entities within the Group;

(b) an appropriate evidentiary basis for the planning and performance of specific investigation tasks relative to the Terms of Appointment; and

The preliminary investigation phase principally entailed the performance of overview assignments of the Bank and Beneficial Finance Corporation Limited. The overview assignments encompassed information gathering, documentation and initial commentary and analysis in respect of the following:

(a) organisation, and management structures of the Bank Group entities;

(b) financial status of the Bank Group entities;

(d) critical management, financial accounting, and information systems, of the Bank and Beneficial Finance Corporation;

(e) credit risk management policies and procedures, prudential controls, delegated lending authorities, and major client credit facilities of the Bank and Beneficial Finance Corporation;

(f) Internal/External Audit arrangements; and

(g) significant events in the history of the Bank since its inception in 1984, and of Beneficial Finance in the period 1984-1991.

In this phase, my Investigators were directed to search for, and collect documents and other evidentiary material from the many sources that could possibly have a bearing on those subjects on which this Report was to be submitted. This search for material continued throughout the Inquiry. As the material was gathered it was necessary to analyse co-ordinate and collate the growing volume of documents, transcripts of interviews etc.

Working report documents were prepared that formed the basis for the planning and conduct of subsequent specific lines of inquiry relative to the Terms of Appointment. Copies of the report documents were provided to the Royal Commission and my Terms of Appointment were specifically amended to make this matter clear.

Specific Investigation Phase

The working report documents produced at the completion of the preliminary investigation phase were analysed, and their preliminary findings and suggestions were used to structure the conduct of specific investigation assignments.

Specific investigation assignment plans were developed to cover all matters referred to in my Terms of Appointment. The specific investigation assignments covered matters related to the Bank, Beneficial Finance Corporation, and External Audit of the Bank Group.

The `Index of Investigation Report' included in each volume of this Report, not only serves to summarise the structure and contents of the Report, but also generally reflects the specific investigation assignments that were undertaken in respect of the Bank during this phase of the Investigation. Specific investigation assignments undertaken in connection with Beneficial Finance Corporation and External Audit will be examined in later Reports.

Report Writing Phase

At the completion of the specific investigation assignments draft reports in relation to each topic heading outlined in the `Index of Investigation Report' were produced.

The draft reports (draft `Chapters' of the Investigation Report) were prepared on the basis of information obtained during the course of the preliminary and specific investigation phases. This included information drawn from such sources as: material contained in a large number of Bank Group records and files; evidence obtained through formal transcript interviews of past and present Directors and officers of the Bank Group entities; and evidence presented to the Royal Commission.

The draft Chapters were released for `natural justice' purposes, to persons or legal counsel acting on behalf of persons who, it was considered, might be affected by the preliminary investigation findings and conclusions contained in the Chapters. Written and oral submissions were received from interested parties during the `natural justice' period. The drafts were reviewed and where necessary evidence taken, so that I could determine whether or not and the extent to which provisional conclusions should be revoked, varied or confirmed.

2.2.2.3 The Requirement of Confidentiality

The conduct of my Investigation was, to some extent, complicated by the need to ensure the confidentiality of information regarding both the Bank's continuing operations, and the Bank's customers. Respecting that confidentiality was of course essential to ensure that the Bank did not suffer any commercial disadvantage in respect of its on-going business, and that the Bank's customers could continue to deal with the Bank without fear that any commercially sensitive information might be disclosed to unauthorised parties. The Terms of Appointment expressly directed me to conduct my Investigation, and to Report, with regard to the continuing commercial needs of the Bank.

The need for confidentiality was addressed in my Terms of Appointment in a number of ways.

In respect of the conduct of my Investigation, Term of Appointment J directed me to "avoid as far as practicable prejudicing or interfering with the on-going operations of the Bank and the Bank Group".

In respect of the confidentiality of information of the Bank and its customers, Term of Appointment I required that, so far as practicable, I was to:

"(a) in any information provided or report made ... protect the confidentiality of information which could properly be regarded as confidential information of the Bank or of a member of the Bank Group or of a customer or person dealing with the Bank or a member of the Bank Group;

(b) in any report ... when it is necessary in my opinion to disclose or refer to such information, to present the report in a manner which enables the findings and recommendations in the report to be considered separately from the confidential information, the confidential information where practicable being presented in a separate report or appendix".

Term of Appointment H required me "so far as practicable to avoid prejudicing pending or prospective criminal or civil proceedings, and to report in part by way of confidential report" if I consider it appropriate.

Finally, in accordance with sub-section 25(5) of the Act, I am required to present to the President of the Legislative Council and the Speaker of the House of Assembly only those reports presented to the Governor that I consider "need not remain confidential".

In summary then, considerations of confidentiality have been relevant to:

(a) the conduct of my Investigation, in that I have sought to limit my requirements of the Bank and Bank Group to that information which I judged to be relevant to and necessary for answering my Terms of Appointment; and

(b) the reporting of the results of my Investigation, both to protect the commercial confidentiality of the Bank and its customers, and to avoid prejudicing any pending or potential civil or criminal proceedings or further investigations.

In respect of the conduct of my Investigation, all persons involved signed an Undertaking of Confidentiality requiring them to keep confidential, and to safeguard, any documents or other information made available to or read by them as a result of their involvement.

In determining whether any parts of this Report were to remain confidential, I sought to balance public interest considerations having regard to:

(a) the right of the public to be informed of the reasons and responsibility for the financial position of the Bank Group; and

(b) the public interest in protecting the continuing commercial operations of the Bank, and in ensuring that actual and potential future legal actions are not prejudiced.

Achieving this balance has meant that I have disclosed in this Report information which is reasonably necessary to support my conclusions and findings, and in respect of which the interests of disclosure override those of confidentiality.

2.2.2.4 Conclusions of Fact

My Investigation is, as its name implies, an investigation into the matters specified in my Terms of Appointment, and is not a judicial or quasi-judicial proceeding. As stated by the Full Court in its judgment on 25 September 1992, the:

"... appointment of an Auditor-General to investigate and report on the sort of matters referred to in the terms of appointment, does not suggest the conduct of an inquiry of a judicial or curial kind ... The report of the defendant may affect reputations but it cannot affect legal rights nor can it result in the imposition of penalties. If there are subsequent proceedings, either civil or criminal, arising out of the report, the plaintiffs will have their opportunity to cross-examine witnesses and to test the evidence against them" (p 22-23).

Nevertheless, it is clear that any conclusions of fact drawn by me will have significant implications, particularly as they may affect the reputations of parties that are the subject of findings in this Report. Accordingly, in reaching conclusions regarding issues of fact, I have kept firmly in mind that all such conclusions must be well founded, having regard to the whole of the material before me. Accordingly, in arriving at the conclusions contained in this Report, I have not regarded facts (including inferences and matters of degree) as being established unless I was satisfied, on the whole of the material before me, that the conclusions of fact I have recorded should be reached.

In this respect, it is important to appreciate the relationship between the general conclusions I have reached in this Report, and the particular evidence on which those conclusions are based.

My Investigation is required to reach some quite general conclusions regarding the causes of the losses of the Bank and Bank Group, and the adequacy of the supervision of the Bank's and Bank Group's affairs.

By their very nature, these findings are general conclusions only. They may not apply in all cases. Not all of the Bank Group's loans resulted in losses, and not all loans were badly evaluated and managed. All that can be done is to review all the evidence and reach a conclusion, based fairly upon the evidence, as to the real and effective causes of the Bank Group's financial position, and of the adequacy or otherwise of the supervision and management of its affairs.

The general finding of the causes of the Bank Group's financial position, and the adequacy of supervision and management is based on both particular and general evidence, including:

(a) detailed evidence received in respect of a whole range of the Bank Group's business activities;

(b) evidence of the general operation of the Bank's and Beneficial Finance's businesses, including their marketing philosophy, business plans, the nature of their businesses, the nature of their assets, the nature of their funding, and the management of those assets, liabilities and of the risks associated with their businesses; and

(c) the opinion evidence of experts who have reviewed and evaluated the Bank's and Beneficial's business operations, including reviews undertaken by those corporations themselves.

The principles that I have outlined in Chapter 1 - "Conclusions, Findings and Recommendations of the Investigation" can and have been applied by me in respect of particular transactions examined in the course of my Investigation. The consistent features of those transactions, together with evidence of the operation of the Bank's and Beneficial Finance's credit evaluation systems and the opinions of experts, allowed me to reach conclusions regarding the real and effective causes of the Bank's and the Bank Group's financial position, and the adequacy of the supervision and management of their business activities.

2.3 EXAMINATION OF THE BANK AND BANK GROUP

As noted, the Terms of Appointment require me (inter alia) to investigate and report on the reasons for the financial problems of the Bank and of the Bank Group, as reported by the Bank and the Treasurer in public statements on 10 February 1991 and in a Ministerial Statement by the Treasurer on 12 February 1991. Pursuant to sub-section 25(13) and sub-section (14) of the Act, the "Bank Group" includes all companies in which the Bank had an interest of more than 25 per cent of their issued capital.

Having regard to the contents of the statements of 10 and 12 February, I took the view that it was neither necessary, nor possible, within reasonable limits of time and expense, to examine the business activities of all of the various companies which, together with the Bank, constituted the Bank Group. As the statements of 10 February and 12 February 1991 make clear, the financial position of the Bank Group was primarily the result of losses associated with the corporate and property loan portfolios of the Bank and of Beneficial Finance, and to some lesser extent with the acquisitions of certain companies by the Bank.

Accordingly, the approach I have adopted in conducting my Investigation has been to treat the subsidiaries of the Bank, other than the Beneficial Finance group of companies, as being assets of the Bank, the relevance of which is limited to the processes by which the Bank came to acquire those subsidiaries. In other words, my Investigation has focussed on:

(a) the reasons for the losses recognised by the Bank in respect of its loan portfolio;

(b) the processes by which the Bank came to acquire certain subsidiary companies which can reasonably be regarded as "non-performing" assets of the Bank; and

I have not examined the internal management or operations of other subsidiaries of the Bank, such as Oceanic Capital, Executor Trustee, Ayers Finniss or United Bank. The acquisition of Oceanic Capital Corporation Limited and United Bank Limited are the subject of separate Chapters of this Report, ie Chapter 17 - "Case Study in Acquisition Management: The Oceanic Capital Corporation" and Chapter 18 - "Case Study in Acquisition Management: The United Building Society".

2.4 THE "FINANCIAL POSITION" OF THE BANK AND BANK GROUP

2.4.1 THE FINANCIAL POSITION AS REPORTED BY THE BANK AND THE TREASURER

My Terms of Appointment require me to investigate and report on the causes of and responsibility for the financial position of the Bank and Bank Group "as reported by the Bank and the Treasurer in public statements on 10th February 1991 and in a Ministerial Statement by the Treasurer on 12th February 1991".

The "financial position" as described in those public statements can be summarised as follows:

(a) The Net Present Value of the difference between the book value of the Bank Group's loans and related assets, and the realisable value of the principal amounts of those loans and assets, was estimated to be $990.0M.

(b) An internal analysis of the Bank Group's loan portfolio disclosed that non-accrual loans, predominantly those accounts which were in arrears, could reach $2.5B.

(d) As a result of the Government's financial support arrangements, the Bank reported a profit, for the half year ended 31 December 1990, of $20.0M, and achieved a risk-weighted capital adequacy ratio on that date above the Reserve Bank's minimum requirements.

2.4.2 THE SOURCES OF THE BANK GROUP'S LOSSES

The source of the losses which have contributed to the financial position of the Bank and Bank Group can be broadly seen from the details of the use of the State Government's Indemnity by the Bank, as provided in the Bank's Annual Report for the year ended 30 June 1991, and in its submission to my Investigation:

Entity	Indemnity Use
	$M	%
State Bank of South Australia
Provisions for loan losses	980	45
Provisions for subsidiary companies
Oceanic Capital Corporation	101	5
United Banking Limited	87	4
Others		5
Property Asset Writedowns	65	3

	1238	56

Beneficial Finance Group
Provisions for loan losses	726	33
State Bank provisions on equity holdings	99
Taxation effects	57	3
General and Other Provisions	882	40
	81	4
	2200	100

Source: State Bank Submission to the Investigation. Minor discrepancies in addition due to rounding.

The significance of the losses related to the property and corporate sectors of the Bank loan portfolio were identified in an analysis of the Bank's portfolio undertaken by JP Morgan (as at 31 December 1990), and by the Bank (as at 30 June 1991).

An analysis of the Bank's interest earning assets as at 31 December 1990 was prepared by JP Morgan in April 1991. By excluding those interest earning assets having a risk weighting of 20 per cent or less, the profile of the Bank's loan portfolio as at 31 December 1990 (those assets involving substantive credit risk) was:

Loan Portfolio	Proportion of Loan Portfolio	Proportion of Non-Performing Loans
	%	%
Australia:
Housing	14.7	2.0
Retail Personal and Business	13.0	13.0
Corporate	37.6	60.4

New Zealand:
Housing (United Banking)	7.6	1.2
Corporate	9.9	11.6

Other International:
Housing	0.5	-
Corporate	16.8	11.9
	100.0	100.0

As can be seen, the Bank's housing loans accounted for only 2.0 per cent of its non-performing loans. The worst performed sector of the portfolio was corporate loans within Australia, which represented 37.6 per cent of the portfolio, but accounted for 60.4 per cent of the Bank's non-performing loans.

The Bank's 1991 Annual Report provided the following summary of the Bank Group's loan portfolio classified by industry exposures as at 30 June 1991:

Industry	Total Exposures	Non-Accrual Exposures
	%	%
Finance	25.8	12.8
Property	22.4	51.9
Construction	7.7	12.5

Exposures to the property and construction industries totalled 30.1 per cent of the Group's portfolio, yet accounted for 64.4 per cent of non-accrual exposures. According to a Media Release by the Bank in respect of these exposures, the Finance sector "also includes some property exposures".

2.5 COMPARISON WITH OTHER BANKS AND FINANCIAL INSTITUTIONS

In examining the losses of the Bank and Bank Group, I have not forgotten that they were not alone among financial institutions in realising significant losses in the aftermath of the 1980s. The experience of losses was shared, to varying degrees, across the spectrum of financial institutions, including the licensed banks, finance companies, merchant banks, and other State Banks.

I have concluded that it is neither possible, nor helpful, to attempt to compare and contrast the losses reported by the Bank with those of other financial institutions. Any such comparison faces serious difficulties and distortions associated with differences in the recognition and reporting policies and practices adopted by financial institutions in respect of non-performing and non-accrual loans, asset value write-downs, provisioning and bad debt write-offs.

Nevertheless, in evaluating the adequacy and reasonableness of the actions of directors, managers and staff according to the standards prescribed by law, I have kept firmly in mind the fact that, as testified by the losses realised, mistakes and errors of judgment were made in many financial institutions in the difficult economic environment of the 1980s.

2.6 THE STANDARD OF CONDUCT APPLIED TO THE BANK'S BOARD OF DIRECTORS, MANAGEMENT AND EMPLOYEES

2.6.1 THE OBLIGATIONS AND DUTIES OF THE BANK'S BOARD OF DIRECTORS

Term of Appointment C requires me to investigate and report whether the "operations, affairs and transactions of the Bank and the Bank Group were adequately or properly supervised, directed and controlled by:

(a) the Board of Directors of the Bank;

(b) the Chief Executive Officer of the Bank;

(d) the Directors, officers and employees of the members of the Bank Group."

Term of Appointment D requires me to investigate and report whether the information and reports to the Bank's Board of Directors were "adequate", and sufficient to enable the Board to discharge "adequately" its functions under the Act.

Term of Appointment A(h) requires me to investigate and report on such of the following matters as, in my opinion, I should investigate and report:

(a) any possible conflict of interest or breach of fiduciary duty or other unlawful, corrupt or improper activity on the part of a director or officer of the Bank or a subsidiary of the Bank; or

(b) any possible failure to exercise proper care and diligence on the part of a director or officer of the Bank or a subsidiary of the bank.

Sub-section 25(2)(a) of the Act, added to the Act on 23 December 1992 with retrospective application from 28 March 1991, provides express statutory authority for Term of Appointment A(h).

In answering these Terms of Appointment, it is necessary to establish some criteria by which the direction and control by directors, officers and employees can be said to have been "adequate" and "proper". By what standards will the performance of, for example, the non-executive directors, be measured to determine whether it was "adequate" and "proper"?

(One possible standard can be rejected immediately - that is the standard of success or failure. In one sense, the fact that the Bank and Bank Group have suffered significant losses implies that their activities were not "adequately" or "properly" supervised, directed, and controlled. In other words, the view could be taken that the supervision was necessarily inadequate because the Bank and Bank Group suffered significant losses. Such a "standard" must be rejected because:

(a) the losses may have been caused wholly by external factors that could not reasonably have been foreseen or managed; and

(b) the losses may have been the fault of one group - the directors, or management or employees - to a greater extent than another.)

In respect of the Directors, officers, and employees, of Beneficial Finance, the requisite standards are clear. Beneficial Finance was a finance company incorporated under the Companies Code, and all of the provisions of the Code, and the general laws of director's duties, clearly apply. The legal position of Beneficial Finance and its directors, officers, and employees, was no different to that of any other commercially operating company.

The situation of the Bank was, however, quite different. The Bank was (and is) a statutory corporation, established by a special act of Parliament (the State Bank Act) as an instrumentality of the Crown. The provisions of the Companies Code (1981) - in particular, Section 229 regarding the duties of directors - do not apply to the Bank and its officers, since the Bank is not a "corporation" for the purposes of the Code.

It should also be noted that the Act provides a statutory immunity from liability for Directors and officers of the Bank. Section 29(1) of the Act provides that:

"(1) No liability attaches to a Director or other officer of the Bank for an act or omission done or made, in good faith, and in carrying out, or purporting to carry out, the duties of his office.

(2) Any liability that would, but for subsection (1), attach to a Director or other officer of the Bank shall attach instead to the Bank."

This statutory immunity from liability does not mean, of course, that no judgement can be made as to whether the Board of Directors and the officers of the Bank performed their functions properly and adequately. Nor does it mean, in my opinion, that they had no obligation or duty to do so. The statutory immunity means only that, if they fail in their duties or to meet their obligations, they are - provided they acted in good faith - immune from any civil liability for that failure or breach. The liability attaches, instead, to the Bank.

Despite the fact that the Bank is a statutory corporation and an instrumentality of the Crown, I am of the view that the obligations and duties of the Board of Directors, officers, and employees, of the Bank are those established by the general law applicable to such persons in companies generally. In other words, in evaluating whether the Board of Directors and officers of the Bank "adequately" or "properly" supervised, directed and controlled the Bank's operations and activities, and whether the Directors and officers of the Bank exercised "proper" care and diligence, the standards to be applied are those of the common law generally applicable to company directors and officers.

In Phipps v. Boardman (1967) 2 AC 46, it was said that the ambit of the duties of persons holding a statutory office depended upon the nature of the office and all other applicable circumstances. Applying that test to the Bank, I have concluded that the Board of Directors was - as the Board itself expressly stated at its first meeting on 28 June 1984 - to be regarded in all respects as a Board of a commercial, competitive corporation carrying on the business of banking. The duties of the Board are no more or less than those of any Board of a commercially operating company.

2.6.1.1 The Commercial Charter of the State Bank

Of particular significance to my conclusion that the adequacy of the Bank's Board of Directors' and of Management's discharge of their functions is to be judged according to the established law applicable to commercial enterprises is the essentially commercial charter of the Bank.

Section 19 of the Act provides that the Bank "shall carry on the general business of banking", and vests the Bank with all such powers as are necessary for that purpose. Sub-section 19(2) expressly provides that the business may be carried on both within and outside South Australia.

The particular objectives of the Bank in the conduct of its banking business are stated at sub-sections 15(1) and (2) of the Act, in the form of directions to the Board of Directors regarding the exercise of its powers in the administration of the Bank's affairs. These objectives are both commercial - to administer the Bank's affairs "with a view to achieving a profit" - and non-commercial - to act with a view to promoting "the balanced development of the State's economy" and the "maximum advantage to the people of the State", paying "due regard" to the importance to each of the "availability of housing loans".

A review of the minutes and correspondence of the Merger Advisory Group which advised the Government on the formation of the new Bank in 1984 and which was an important influence in drafting the Act, and of the Hansard report of the Parliamentary debate accompanying the introduction of the Act, shows that it was expected that the Bank would operate first and foremost as a commercially competitive financial institution. The Merger Advisory Group stated in a paper dated 17 October 1983 titled "Draft Legislation: The Competitive Position of the New Bank", that it favoured structuring the Bank along "mostly commercial" lines because:

"- It will require the Bank to be more entrepreneurial;

- It will impose a stronger commercial discipline on the Board and Management;

- At the same time it ensures that community interests are not entirely discarded as a factor in decision making, and Government is left with an opportunity to influence the Bank's policies;

- It will give the Bank the best possible structure with which to grow and at least maintain its position in the increasingly competitive environment."

In his second reading speech in respect of the Act, the Premier and Treasurer, the Honourable J C Bannon, stated that the Bank would have wide powers in relation to financial transactions. He expressed the view that the Government was determined to ensure that the Bank would have "the flexibility necessary to operate effectively in a rapidly changing financial environment", and envisaged that it would be "an engine of economic growth". The then Leader of the Opposition, Mr J Olsen, who supported the Act, described the many areas in which the new Bank could compete, including corporate banking, loan syndication, investment services and portfolio management. The tone of the debate was optimistic about the opportunities for an expanded range of services to be provided by the new bank. Mr J C Bannon said that the geographic operation of the Bank was to be "a matter for judgement of the Board", which while it was to be exercised within the parameters of Section 15 of the Act, was to be "done on a commercial basis".

The Board's and Management's interpretation of the Bank's charter placed particular emphasis upon the need for the Bank to be commercially competitive and profitable. This interpretation did not ignore the Bank's social obligation to the economy and people of South Australia, but rather it regarded the competitive strength and profitability of the Bank as being essential prerequisites to the fulfilment of those obligations. The Bank's interpretation of the charter contained in sub-sections 15(1) and (2) of the Act can be fairly summarised as follows:

(a) the principal requirement of the Bank was that it operate as a competitive, commercial financial institution with a view to earning a profit;

(b) the objectives of promoting "the balanced development of the State's economy" and "the maximum advantage to the people of the State" were to be achieved, in part, by maximising the financial strength and profitability of the Bank;

(c) the commercial imperative was to be balanced by a sense of social responsibility to South Australia, particularly in regard to housing loans. The Bank's social responsibilities could not be met, however, unless the Bank was commercially successful; and

(d) the Bank's responsibility to act in accordance with proper financial principles in all its operations is reaffirmed by sub-section (2) of Section 15 (see below).

This interpretation of the Bank's objectives was clearly expressed in the Bank's 1989 Annual Report. In a "Message to our Owners", the Chairman and Group Managing Director stated:

"In 1983, both major political parties in South Australia supported a decision to launch State Bank with a commercial charter - a mandate to operate under accepted principles of financial management with a view to achieving a profit.

It was agreed the charter would be balanced by a sense of social responsibility to the Bank's South Australian home base, particularly in regard to housing."

The expansion and diversification of the Bank to become a "regional bank in Australasia", pursuing "profitable opportunities in global markets by developing as a niche player in key financial centres such as New York and London", was perceived as important to providing the Bank with the capacity to meet its social obligations.

The 1989 Annual Report stated that the Bank's ability to provide low-cost housing loans was possible:

"... because of the great financial strength it possesses from pursuing a commercial charter. Under it's constitution, the Bank has generated growth and profits from a wide range of operations in many different markets.

Activities by the Bank and its subsidiaries, such as corporate lending, merchant banking and funds management, provide the strength to make home lending decisions which, in periods of high interest rates, are often more social than commercial in nature."

2.6.1.2 The Governance of the Bank

My conclusion that the adequacy of the Bank's Board of Directors' and Management's discharge of their functions is to be judged according to the established law applicable to a commercial enterprise is reinforced by the essentially commercial nature of the arrangements for the governance of the Bank. As noted above, the Merger Advisory Group recommended that the Bank be established on a "mostly commercial" basis.

The Act provides the statutory framework for the governance of the Bank, and the general thrust of the Act is to seek to place the Bank on a principally commercial footing broadly similar to the private banks.

In a very real sense, the Act operates as the Memorandum and Articles of Association of the Bank. It specifies the objectives of the Bank, and establishes arrangements for the governance of the Bank by allocating rights and responsibilities to the shareholders (the State represented by the Treasurer), the Board of Directors, and Management.

Being a statutory corporation, the Bank does not have issued shares, or shareholders with the rights usually granted to shareholders (acting in meeting or otherwise) by company law. Instead, the Bank essentially operates as an agency of the Crown, with the powers and objectives specified by the Act. Sub-Section 6(3) provides that the Bank "holds its property for and on behalf of the Crown", and the Treasurer guarantees the liabilities of the Bank (sub-section 21(1)).

The Act provides for the State to exercise certain powers, within defined limits, in respect of the conduct of the affairs of the Bank. In a very broad sense, these powers are a substitute for those available to the shareholders of companies registered under the Companies Code. In particular:

(a) The directors of the Bank are appointed by the Governor.

(b) The Bank is prohibited from acquiring more than ten per cent of the issued shares of a company without the approval of the Treasurer (sub-section 19(7)).

(c) The Treasurer may initiate consultations with the Board in relation to "any aspect of the policies of administration of the Bank", and the Board is obliged to consider any proposals made by the Treasurer in relation to the administration of the Bank's affairs and, if requested, to "report to the Treasurer on any such proposals" (sub-section 15(4)).

(d) The Treasurer has power to require the Bank to pay a dividend of such amount as he considers "appropriate" having regard to the Bank's profitability and capital adequacy, after giving "due regard" to a recommendation of the Board. Any divergence between the recommendation of the Board and the determination of the Treasurer is to be reported in the Annual Report of the Board (Section 22). (The Annual Reports do not disclose any such divergence of opinion.)

In terms of the Bank's capital, the Treasurer is authorised by the Act to advance, from moneys provided by Parliament, funds by way of "grant or loan" (sub-section 20(1)). Grants are to be treated as capital contributions, and once made cannot be withdrawn without approval of both Houses of Parliament (sub-Section 20(3)). This arrangement can be regarded as being broadly similar to that applying to private sector companies: shareholders can contribute additional capital in response to a rights issue by the company, but cannot withdraw the capital once contributed (shareholders looking to recover their investment can, of course, sell their shares).

As a statutory corporation, with its liabilities guaranteed by the State Government, the Bank is, in a real sense, disconnected from some of the market forces and commercial costs which apply to private sector banks. The Act makes provision for these factors in a number of ways:

(a) First, the Bank is subjected to taxation. The Bank is expressly made liable for "rates, taxes and other imposts under the law of the State", despite the Bank's status as an instrumentality of the Crown (sub-section 6(4)). Further, the Bank is obliged to pay to the Treasurer an amount equal to the income tax for which it would have been liable if it were subject to Commonwealth income tax (sub-section 22(1)(a));

(b) Second, the Treasurer may, after consultation with the Board, impose a charge for the guarantee provided by the Treasurer in respect of specified liabilities of the Bank, although no such charge can be levied in such a way that it relates "in effect, to all the liabilities of the Bank" (sub-section 24(4)). The absence of a general charge is intended to negate, in an approximate way, the implicit tax imposed on the Bank by its obligations to conduct its business with "due regard" to non commercial matters, such as the "availability of housing loans".

The Act establishes the Board of Directors as the governing body of the Bank (sub-section 14(1)), subject to a requirement to consult with the Treasurer when requested (sub-sections 14(3) and (4)). The Board may delegate any of its powers or functions under the Act (sub-section 18(1)).

The Chief Executive Officer is, subject to the control of the Board, responsible for the "management" of the Bank (sub-section 16(2)). The Chief Executive Officer may delegate any of his powers or functions under the Act (sub-section 18(2)).

The division of corporate governance functions between the Board of Directors and the Chief Executive Officer is not materially different than that generally adopted by private-sector companies; particularly as described in clauses 66 and 79-82 of the model Articles at Table A of the Companies Code (1981). Two particular aspects of the allocation of responsibility provided by the Act should be noted:

(a) the Act makes the Chief Executive Officer responsible for management of the Bank, "subject to the control of the Board". Clause 66 of Table A provides that "the business of the company shall be managed by the directors".

(b) the delegation by the Board or Chief Executive Officer of any of their powers or functions is expressly stated to "not derogate from the powers of the delegator". Clause 81(2) of Table A allows directors to confer on the managing director any of their powers, and such a conferring may be "to the exclusion of" the powers of the directors.

At its inaugural meeting on 28 June 1984, the Board of Directors approved the following description of the "Proceedings of the Board" as drafted by its Chairman, Mr L Barrett:

"... the role of the Board is as its name implies, viz. a Board of Directors, and, in considering the proceedings of the Board, emphasis is to be placed on determining and directing matters of policy. The execution of this policy is the role of the Chief Executive Officer and the staff of the Bank.

The Board is not to be seen as a "rubber stamp" to endorse all actions and recommendations of Management without question.

A procedure will be developed by which the Board will be able to assess the efficacy of Management and control any delegation of its powers or functions."

At the same meeting, the Board approved arrangements for the "Functioning of the New State Bank Board and Delegation of Powers to the Chief Executive Officer", intended "to indicate the manner in which the new Bank Board will control the affairs of the Bank through the Chief Executive". Those arrangements provided for regular Board meetings, the form of operating reports to the Board, and various delegations to the Chief Executive (including, for example, limited authority to approve capital expenditure, and to write-off loans) and established a system of delegated loan approval authorities. The arrangements included a system for the Board to review and approve strategic plans and budgets:

"Annually, about March, the Directors will be asked to approve a 5-year strategy plan. This would probably require the afternoon of a Board day and would focus on where the Bank wants to be 5 years from then. When the Board has discussed, amended and approved the 5-year strategy plan, Management would then start preparation of the annual profit plan for approval by the Board at the July Board meeting (again a special afternoon should be set aside)."

2.6.1.3 Other Aspects of the State Bank of South Australia Act 1983

Since the tenor of the Act is that the Bank was to pursue commercial objectives in a competitive environment, it seems naturally to follow that the standard of conduct required from those responsible for managing the Bank - the Board of Directors and Management - is that imposed by the general (non-statutory) law regarding the duties of directors and managers of companies generally. Consistently with that view of the Bank, the arrangements established by the Act for the governance of the Bank are, in essence, wholly analogous to those of a company's Memorandum and Articles of Association. There are, however, some other aspects of the Act which require particular mention.

As noted, I am of the view that Section 14 and Section 15 of the Act do not qualify or limit the obligations of the Board under the general law. In particular, they do not require the non-executive directors of the Bank to perform executive or managerial functions over and above those required by non-executive directors of companies generally. While it is true that Section 15 refers to the Board of Directors "administering" the Bank's affairs, that should not be read as requiring the non-executive directors to engage in the day-to-day administration and management of the Bank. Clause 66 of Table A, for example, provides that "the business of the company shall be managed by the directors". Further, Section 18 of the Act expressly authorises the Board to "delegate any of its powers or functions under this Act". Such delegation may, presumably, be express or implied.

2.6.2 ASPECTS OF THE LAW OF DIRECTORS' DUTIES

2.6.2.1 Introduction

Having concluded that the appropriate standard of conduct to be applied to the Bank's Board of Directors and Management (and, of course, to Beneficial Finance's Directors and Management) is the law applicable to directors and officers generally conformably with the Act, especially with Section 15, it is appropriate that I set out first some of the general principles of that law that I have applied in the course of my Investigation. The particular application of these principles to particular situations, including the allocation of functions within the corporation, is described in the relevant Chapters of the Report. I shall consider later the relationship between the Act and the general law and how the two work together in mutual compliance and re-inforcement

2.6.2.2 The General Law of Director's Duties

The general obligation of a director is to apply reasonable care and diligence in the performance of his functions and the exercise of his powers. In determining "reasonable care and diligence", the generally acknowledged leading case is Re City Equitable Fire Insurance Company Ltd. [1925] Ch 407. The principles laid down in that case were restated in modern terms by Mr Justice Rogers in AWA Limited v. George Richard Daniels t/as Deloitte Haskins & Sells (1992).

The existing law does not contain an explicit statement in detail of what is expected in every particular situation. A prescription to meet every possible set of facts is beyond the power of any lawmaker. In Commonwealth of Australia v. Friedrich (1991) 5 ACSR 115 at 125 Tadgell J said:

"What constitutes the proper performance of the duties of a director of a particular company will be dictated by a host of circumstances, including no doubt the type of company, the size and nature of its enterprise, the provisions of its articles of association, the composition of its board and the distribution of work between the board and other officers: Byrne v. Baker [1964] VR 443 at 450."

Nevertheless, there are a number of important propositions regarding the standard of performance required of directors and managers that can be stated, at least in broad terms.

First, in respect of non-executive directors, there is no objectively-determined standard of skill which must be attained by non-executive directors in meeting their obligation of reasonable care and diligence. As stated by Rogers J in the AWA Case (at p 255):

"... there is no objective standard of the reasonably competent company director ... The very diversity of companies and the variety of business endeavours do not allow for a uniform standard ... What constitutes the proper performance of the duties of a director of a particular company is considered to be dependent:

(a) upon the actual knowledge and experience of the individual director;

(b) the nature and extent of the corporation's business;

(c) on the distribution of responsibilities in the particular corporation.

Conventional wisdom held that a director need not exhibit, in the performance of duties, a greater degree of care, skill and diligence than may reasonably be expected from a person of his or her knowledge or experience (Re City Equitable Fire Insurance Co Ltd [1925] Ch.407, 428); when the opportunity presented itself to reassess this approach it was declined (Byrne v Baker [1964] VR 443, 450)."

In other words, it is for the shareholders - in the Bank's case, the Governor acting on advice of the Executive Government - to determine what skills they want on the Board, and to appoint appropriate directors accordingly. The law does not require non-executive directors to display a level of skill and experience that they do not possess. If, however, a non-executive director does have particular skills, he or she must utilise them in the performance of their functions as a director.

In respect of executive directors, however, the law requires that a person must perform his functions with an objectively determined level of skill. Full-time employees of a company who accept appointment to a particular office in a company for which recognised skills are required impliedly promise that they have those skills than may reasonably be expected from a person of his or her knowledge and experience. As stated by Rogers J in the AWA Case:

"Usually the Chief Executive is employed under a contract of service which will either include an express term or, in the absence of an express term, an implied term, that the Chief Executive will exercise the care and skill to be expected of a person in that position. The degree of skill required of an executive director is measured objectively" (p 25).

Second, it is clear that the standard of reasonable care and diligence that is required of directors -both non-executive and executive directors - is higher now than it was when some of the earlier court decisions regarding the obligations of directors were made.

The prospect that the obligation imposed by law may change over time has long been recognised. In Blyth v. Birmingham Waterworks Co. (1856) 11 Ex 781 at 784, Alderson B said:

"Negligence is the omission to do something which a reasonable man, guided upon those considerations which ordinarily regulate the conduct of human affairs, would do, or doing something which a prudent and reasonable man would not do."

The "considerations which ordinarily regulate the conduct of human affairs" must necessarily change as new practices are adopted in society. This is as much applicable to directors as to users of the highway. Hence in the application of the objective element of standard of care - the standard of the hypothetical prudent person - consideration is given to changes in community standards.

So in 1959 Sir Douglas Menzies of the High Court, speaking extra-judicially and in respect of a director of a life assurance company by way of example, said (33 Australian Law Journal 156 at 164):

"It can properly be demanded that he should have or obtain at least a general understanding of the business of life assurance, that he should know or learn something about the investment of large sums of money in a changing economy, that he should concern himself with important staff problems and that he should bring an informed and independent judgment to bear upon the various matters that come to the board for decision. Any life insurance company appointing a director would expect all this of him; any person accepting office as a director would expect to do as much and, to repeat myself again, what is expected is the best indication of the content of the duty of care that rests upon an office holder."

In Friedrich's case at 126 Tadgell J relied on that statement and developments in legislation and the views of the courts in supporting his statement that:

"As the complexity of commerce has gradually intensified ... the community has of necessity come to expect more than formerly from directors ... In response, the parliament and the courts have found it necessary in legislation and litigation to refer to the demands made on directors in more exacting terms.

In particular, the stage has been reached when a director is expected to be capable of understanding his company's affairs to the extent of actually reaching a reasonably informed opinion of its financial capacity."

The changing content of the obligation of care and diligence was referred to by Rogers J in the AWA Case:

"Of necessity, as the complexities of commercial life have intensified the community has come to expect more than formerly from directors whose task is to govern the affairs of companies to which large sums of money are committed by way of equity capital or loan. The affairs of a company with a large annual turnover, large stake in assets and liabilities, the use of very substantial resources and hundreds, if not thousands of employees demand an appreciable degree of diligent application by its directors if they are to attempt to do their duty. To some extent this has been recognised by the fact that the compensation paid to non-executive directors has changed from a modest honorarium to a sum which bears a measurable relationship to the work expected of a director. Indeed it has led to a number of professional non-executive directors" (p 248-249).

Third, of particular importance in determining the required standard of care and diligence is the division of responsibility within a particular company between the non-executive directors and management. As stated by Rogers J, the "responsibility" of the non-executive directors needs to be examined in the light of the proper division of functions between directors, management and auditors" (p 250). Rogers J continued:

"A Board's functions, apart from statutory ones, are said to be usually four fold:

1. to set goals for the corporation

2. to appoint the corporation's chief executive

3. to oversee the plans of managers for the acquisition and organisation of financial and human resources towards attainment of the corporation's goals, and

4. to review, at reasonable intervals, the corporation's progress towards attaining its goals ...

The Board of a large public corporation cannot manage the corporation's day to day business. That function must by business necessity be left to the corporation's executives. If the director of a large public corporation were to be immersed in the details of day to day operations the director would be incapable of taking more abstract, important decisions at board level ...

The directors rely on management to manage the corporation. The Board does not expect to be informed of the details of how the corporation is managed. They would expect to be informed of anything untoward or anything appropriate for consideration by the Board. In the context of the present case directors rely on management:-

(a) to carry out the day to day control of the corporation's business affairs,

(b) to establish proper internal controls, management information systems and accounting records,

(c) reduce to writing if appropriate and communicate policies and strategies adopted by the Board,

(d) implement the policies and strategies adopted by the Board,

(e) have a knowledge of and review detailed figures, contracts and other information about the corporation's affairs and financial position and summarise such information for the Board where appropriate,

(f) prepare proposals and submission for consideration by the Board,

(g) prepare a budget,

(h) attend to personnel matters including hiring and firing of staff and their terms of employment ...

A director is justified in trusting officers of the corporation to perform all duties that, having regard to the exigencies of business, the intelligent devolution of labour and the articles of association, may properly be left to such officers (Dovey v. Cory) [supra] 485-486, 492-493; in re Brazilian Rubber Plantations & Estates Ltd [supra] 438; Huckerby v. Elliott [1970] 1 AER 189, 193, 195). A director is entitled to rely without verification on the judgment, information and advice of the officers so entrusted. A director is also entitled to rely on management to go carefully through relevant financial and other information of the corporation and draw to the Board's attention any matter requiring the board's consideration. The business of a corporation could not go on if directors could not trust those who are put into a position of trust for the express purpose of attending to details of management (American Law Institute "Principles of Corporate Governments, Analysis and Recommendations" p 175,176). Reliance would only be unreasonable where the director was aware of circumstances of such a character, so plain, so manifest and so simple of appreciation that no person, with any degree of prudence, acting on his behalf, would have relied on the particular judgment information and advice of the officers (In Re City Equitable Fire Insurance Co [supra] 428). A non-executive director does not have to turn him or herself into an auditor, managing director, chairman or other officer to find out whether management are deceiving him or her (Graham v. Allis-Chalmers Manufacturing Co 188 A 2nd 125, 130)."

Finally, the law recognises that conducting a commercial enterprise involves some risk-taking, and will not hold a director or officer to have breached his or her duty for mere errors of judgement. As stated in the explanatory memorandum to the Corporate Law Reform Bill (at para 87):

"The courts have in the past recognised that directors and officers are not liable for honest errors of judgement: Ford's Principles of Company Law (6th ed, 1992) at p 528-9. They have also shown a reluctance to review business judgements taken in good faith. Thus, in Harlowe's Nominees Pty. Limited v. Woodside 121 CLR 483 at 493, the High Court said:

`Directors in whom is vested the right and duty of deciding where the company's interests lie and how they are to be served may be concerned with a wide range of practical considerations, and their judgment, if exercised in good faith and not for irrelevant purposes, is not open to review in the courts.'"

It is important to keep this principle in view when evaluating the performance of the Board of Directors and management of the Bank in particular. Although it is a statutory corporation guaranteed by the people of South Australia, the State Bank is a commercial enterprise, and so, of necessity, a risk taker to some degree.

2.6.2.2 Reliance by the Board of Directors upon Management

Pursuant to sub-section 14(1) of the Act, the Board of Directors is the governing body of the Bank. Sub-section 16(2) provides that, "subject to the control of the Board", the Chief Executive Officer is "responsible for the management of the Bank".

Sub-section 16(3) provides that the Chief Executive of the Bank "shall be appointed by the Board", to whom the Board "may delegate any of its powers or functions" under the Act (sub-section 18(1)). The Chief Executive may also delegate any of his powers or functions (sub-section 18(2)). The Board may also appoint such other officers "as it thinks necessary for the effective operation of the Bank" (sub-section 17(1)).

In exercising the power to appoint a managing director, and in conferring powers on the appointee, the directors are required to act with reasonable care and diligence. However, having made the kind of appointment that could be made by a reasonable board and having made the delegations that could be made by a reasonable board, the Board of Directors are then entitled to rely on the managing director, and upon management generally, until such time as the Board were put on enquiry as a result of events that had previously occurred which would require the Board to begin to question management or the Managing Director more closely.

Reliance by the Board of Directors upon management will not remain permissible once there are circumstances known to the Board which would put a reasonable Board of Directors (allowing for the subjective element) on enquiry.

Further, as noted by Rogers J in the AWA Case, the Board of Directors has a duty to monitor the affairs of the company. It is axiomatic that persons charged with an obligation for the administration of large amounts of money cannot simply make a delegation under authority and then be unconcerned as to the results of the delegation. In modern conditions, a Board is expected to set up a system of checks by which the use of the authority given by the delegations can be monitored. The practice of setting up internal audit procedures is an example. The practice of conducting reviews of management is another. The Board has the responsibility of satisfying itself that adequate checks exist. In the process of approving a system of checks the Board is expected to deploy whatever relevant skills its members possess. If they lack the necessary skills, the Board is expected to obtain professional assistance at a level and cost consistent with the scale of the company's operations and resources.

The managing director would be obliged to keep the board informed in relation to matters which need the Board's attention.

In summary, provided the Board of Directors acts reasonably in the appointment of a managing director, delegates within reasonable limits and institutes the necessary checks, the Board can rely on the managing director to act properly within the scope of the powers delegated to him or her. Whether the Board has so acted as to reach the point where it can so rely depends on whether the Board has done what a reasonable Board could have done. So far as reliance on other executives is concerned, this will depend on similar considerations, bearing in mind that there may be sub-delegations from the managing director.

2.6.2.3 The Particular Role and Duties of the Managing Director

The managing director occupies two positions. In his or her role of managing the company the managing director is acting as an employee of the company. In the role of a director as a member of the Board the managing director will participate in the collective activity of making Board decisions.

The role as an employee will be governed by the contract of employment between the company and the managing director. It will be an implied term of the contract of employment that the managing director will perform his or he duties with proper care and will act up to the standard of a reasonably competent managing director of the kind of company in question: Lister v. Romford Ice and Cold Storage Co. Ltd. [1957] AC 555 at 572-3 per Viscount Simonds, at 586 per Lord Radcliffe, at 592 per Lord Tucker, at 598 per Lord Somervell. In other words, in the role of managing the company contemplated by the contract of employment the standard of skill, care and diligence is an entirely objective one. The appointee to the post of managing director is taken to have promised to act up to an objective standard of a hypothetical reasonably competent managing director. If the company in question is a bank, the person appointed managing director warrants that he or she has the capacity to manage a bank up to the standard of a reasonably competent manager of a bank of the type and size in question.

2.6.2.4 The Obligations of the Board of a Parent Corporation for the conduct of the Affairs of a Subsidiary Corporation

The obligations to be considered will be obligations of two kinds: first, obligations in general and, secondly, obligations in banking activities under requirements of the Reserve Bank of Australia.

The Board of a parent corporation such as the State Bank is responsible for directing the management of the parent corporation. Some oversight of the subsidiary corporation, such as Beneficial Finance, is part of that responsibility.

The parent corporation as shareholder will have power to appoint directors of the subsidiary corporation. If that power is exercised by the parent's Board, the members of the parent's Board are under a duty at common law to exercise a reasonable degree of care and diligence in making an appointment. The composition of the subsidiary's Board as a whole taking into account qualifications and knowledge of all directors is a further relevant responsibility of the parent company.

Directors of the subsidiary corporation having been appointed, the parent corporation's directors may leave the direction of the management of the subsidiary corporation to its Board. If the directors of the parent have power to make the appointments and have made proper appointments but the directors of the subsidiary do not perform their duty, the directors of the parent corporation are, in general, not liable for that default. However, directors of a parent corporation would be under a duty to consider results of the subsidiary corporation's operations and to take action to try to improve the performance of the subsidiary if it produces unsatisfactory results.

In summary, the directors of a parent corporation are under no duty to act as if they were directors of the subsidiary corporation. Nor do their legal obligations, in general, extend to giving directions on matters of management to the Board of the subsidiary. They have power to invite the Board of the subsidiary to consider acting in a particular way and the subsidiary Board may have power to adopt the suggestion. The parent's Board has an obligation to exercise reasonable care and diligence in constituting the Board of Directors of the subsidiary, and to monitor the results of the subsidiary corporation.

The guidelines promulgated by the Reserve Bank of Australia in Prudential Statement G1 bear upon the relationship between a parent bank and its subsidiary corporation.

Prudential Statement G1 provides:

"A bank should not give a general guarantee of the repayment of liabilities issued by its non-bank associates and should ensure that an associate does not, in an attempt to upgrade the status of its liabilities, seek to give the impression that the bank's financial resources stand generally behind, or (could be ) called upon to stand behind, its operations.

Insofar as a bank feels implicit responsibility for its associate, it should exercise that responsibility by ensuring that its associate has sound and prudent management which is aimed at achieving undoubted viability within the capital resources of the associate itself.

A bank should ensure that the size of its subsidiaries does not become unduly large relative to the bank itself and that there should not be a proliferation of a bank's associations, particularly in the same broad area of financial markets."

A parent bank could by appropriate provisions in the articles of association of a subsidiary arm itself to give a wide range of directions about the management of the subsidiary. Even in the absence of such provisions the legal powers possessed by a parent bank to achieve compliance with those guidelines would normally include the power to change the composition of the Board of a subsidiary and the power to invite the Board of a subsidiary to act in a particular way which is in the interests of both the parent and the subsidiary. It is the responsibility of the Board of the parent bank to consider using those powers.

If failure to comply with the guidelines could cause prejudice to or, even worse, destruction of the parent bank, a failure by the Board of the parent to use whatever powers it had in relation to the subsidiary could, depending upon the circumstances, amount to a failure to exercise a reasonable degree of care and diligence.

2.6.2.5 The Role and duties of Common Directors on the Boards of Parent and Subsidiary Corporations

The reason for having common directors on the Boards of a parent and its subsidiary corporation is to facilitate the parent's monitoring of the performance of the subsidiary viewed as a resource belonging to the parent.

The common law gives very little recognition to the practice of common directorships in groups of companies. So far as their duties are concerned they do not differ from other directors. The common director will owe a set of duties to each corporation. He or she will be obliged to act in the interests of the parent corporation when acting as a director of the parent, and to act in the interests of the subsidiary when acting as a director of the subsidiary corporation. Where the subsidiary is wholly-owned the common director when acting in each corporation will be acting properly if he or she has an honest belief that the interests of the parent and the subsidiary correspond.

2.6.2.6 Do Directors Increase their duties by doing work that might in another Company be done by Employees?

As was noted earlier, the particular obligations of directors and management of a company will depend upon the allocation of responsibilities within that company. The particular circumstances in which the business of a company is conducted can impose additional duties on the directors, particularly in respect of the necessary skills that the directors must exercise in performing some specialised functions. This may well be the case where directors are involved in approving complex credit submissions. By undertaking that role, the directors bring upon themselves a duty to bring to the company the skill and experience necessary to fulfil that role. In approving large loans, the directors undertook an essentially executive task, giving rise to an obligation to exercise the needed degree of skill in credit evaluation demanded by that function.

2.7 THE RELATIONSHIP BETWEEN THE STATE BANK OF SOUTH AUSTRALIA 1983 ACT AND THE GENERAL LAW

2.7.1 THE POWERS AND DUTIES OF THE BANK, THE BOARD, AND THE DIRECTORS

General principles operate according to particular circumstances. It should be first and firmly emphasised that the State Bank of South Australia was not engaged in just a business; it was engaged in a particular business the business of banking. In some measure, and whatever the law may say, banks, generally, are affected with a public interest; they provide a service to the public that is crucial to the commercial and personal welfare of the community; and any flaw in that service will adversely affect that welfare.

Further, the SBSA was not just any bank: it was the State Bank; and annexed by Statute to its actual and potential assets were certain unique financial advantages that were coupled with, and that directly or indirectly affected, the material welfare of every citizen in the State.

The liabilities of the Bank were guaranteed by the Treasurer, who could, from General Revenue (duly appropriated), satisfy debts payable under the guarantee; and the Treasurer could, out of moneys duly appropriated, make advances to the Bank, which were to be treated as subscriptions of capital, and were not repayable except upon resolution of both Houses (Sections 20 and 21 of the Act). Those financial advantages stood as a constant reminder to the Bank and its Board of Directors that, as a matter of commercial probity, rather than of law, they were subjected to corresponding responsibilities to the citizens of this State.

Section 20 and Section 21 of the Act put the Directors - especially the Chief Executive Officer - and senior managers on ample notice that, as responsible and fair-minded officials, it required them to exercise their statutory powers, in strict conformity with the Law. They could not have failed to realise, moreover, that, whatever their position was according to strict legal analysis, they were dealing with the public's money.

The SBSA Act did not have either Memorandum or Articles of Association. The Act was, and is, the Bank's Charter: it legally created it; it conferred on it its rights and powers, and imposed on it, and placed limits on, its functions, responsibilities, and duties; it set its policy; and it regulated the administration of its affairs. Ordinary trading banks, operate under and pursuant to the general law; the State Bank operates, as well, under and pursuant to the Act.

The governing authority of the Bank, which is given "full power to transact any business of the Bank": (Section 14(1) of the Act), is a body named "the Board". The Board is to be constituted by officials called "Directors" (Section 7(1)), who must number not less than six, nor more than nine; and the Directors are to be appointed by the Governor (Section 7(2)) which means by the Governor, on the Advance, and with the Consent, or the Ministers of the Crown, meeting as and in Executive Council. The responsibility of making such appointments is a serious one. The Directors' functions, policies, powers, and duties, are set forth clearly in Division IV of Part II of the Act; and the Ministers of the Crown who tender advice to the Governor no doubt have Division IV of Part II and Part III clearly in mind when recommending appointees. In doing so, they cannot be unaware of what the Act thus demands from the Board, nor are they likely to overlook that, according to Section 12(3), one half the total number of Directors forms a quorum empowered to transact the business of the Board. Section 12(3) thus insists on quantity, but says nothing about quality; any mix of Directors may make up a quorum. Accordingly, it would, at all relevant times, have been apparent to Ministers in Executive Council that every Director recommended for appointment would need skill, knowledge, and experience, commensurate with the task laid upon him or her by the Act. The significance of Section 12(3) is reinforced by Section 12(6) which enables the Board to pass a resolution without the advantage of going to a Board meeting to do so. What seems to be contemplated by Divisions II and III of Part II of the Act is that any quorum of the Board, however constituted, and whether at a formal meeting or not, should be capable of discharging the Board's statutory responsibilities. The Chief Executive Officer, in particular, would have been aware of that.

The Board's Statutory position, with respect to the outside world, and within the organisation of the Bank, is defined by Section 14: the Board is to be the governing body of the Bank, and has full power to transact any business of the Bank (sub-section (1)); anything done by the Board in the administration of the Bank's affairs is binding on the bank (sub-section (2)). The passage "anything done by the Board in the administration of the Bank's affairs" impliedly defines what is binding on the Bank; it is not to be supposed that the Board would be authorised to do anything ostensibly in the way of the Bank's business that would not be so binding.

Section 15(1) takes up the expression "the administration of the Bank's affairs", and uses it to declare what are to be the policies of the Board in the course of that administration. The Board is instructed to act, "in its administration of the Bank's affairs", with a view to promoting the balanced development of the State's economy, and the maximum advantage to the people of the State, and to pay due regard to the further matter there particularised -the importance to the State's economy, and to the people of the State, of the availability of housing loans.

By Section 15(2), the previous two references to "administration of the Bank's affairs", as the criterion of what is binding on the Bank, and as the vehicle of its policies, are rounded off and given their full import: the Board is "to administer the Bank's affairs in accordance with accepted principles of financial management, and with a view to achieving a profit". The objective form "in accordance with accepted principles of financial management", contrasts with the "expression", "with a view to achieving a profit".

The Honourable the Premier, in his second-reading speech on the SBSA Bill, stated that the Bank was established with the specific objective of becoming "an engine for economic growth". It seems to me to be, to the highest degree, improbable that the Premier would have expected to be understood as exhorting the Bank to achieve its objective by abandoning, where it was simply thought expedient, prudential policies and sound principles of banking.

I have accordingly, proceeded upon the view that, in the understanding and application of Division IV of Part II, the critical sub-sections (1) and (2) of Section 15 must be read reciprocally, so that they interact with one another: the policies denoted by sub-section (1) `shall' be pursued by the Board in and through the administration of the Bank's affairs (by implication, only in that way); and the Board "shall administer" those affairs "in accordance with accepted principles of financial management and with a view to achieving a profit" (sub-section (2)). It is necessarily implied that acts done "with a view to achieving a profit" must be done in accordance with accepted principles of financial management. Conversely, I read the Act as insisting that the administration of the Bank's affairs shall not be directed to policies that do not accord with those specified by Section 15(1).

I should add this further comment. Whatever may, in strict law, have been the precise measure of the Board's responsibility for laying down policies and seeing to their implementation, there is nothing in the Act or, so far as I am aware, in the general law, that would have released the Board from taking ordinary, down-to-earth, measures to discharge that responsibility. It is neither unfair nor unrealistic to expect the Directors, faced with the plain demands of the law, including Section 15, to have insisted on finding out from the Chief Executive Officer and senior staff alike, and, accordingly, to have determined

(1) what were their responsibilities in law; and

(2) what were sensible policies, the installation and pursuit of which ought reasonably to have led to the discharge of those responsibilities.

In order to further those policies, it was not beyond the capabilities of even what may be termed the lay Directors to take commonsense measures, and to stand no nonsense.

To be blunt, there is nothing esoteric about asking questions, seeking information, demanding explanations, or extracting further and better particulars; there is nothing unduly burdensome in expecting each Director, to the best of his ability, to insist, even at the risk of becoming unpopular, on understanding what was laid before him.

Section 15(2), in every day parlance, was an express admonition to the Board to kept its collective feet on the ground. It reaffirms, in the circumstances pertaining to the operations of the Bank, the core of the general law.

Section 15(2) does not, in other words, set up a separate and higher standard for the Bank Board. But it emphasises with respect to the Bank directors, the responsibility that is annexed to every director in the commercial world not to be led astray by passing exuberance, fashionable risk taking, or the careless and irresponsible assessment of security but in all things, to act in accordance with accepted principles of financial management, mindful of the particular circumstances in which he is called on to act.

2.8 CONCLUSION

This Chapter has provided, together with some essential background to the Investigation, a summary of the important legal issues that are central to both the conduct of my Investigation, and to the conclusions I have reached as explained in this Report.

This summary can, of course, do no more than provide the framework and broad principles within which particular circumstances and actions must be evaluated.

In the Chapters which follow that constitute the substance of this Report, I have described in detail the factual basis upon which the particular conclusions and finding made in each Chapter are based. Where necessary, I have sought to explain the application of the broad legal principles set out in this Chapter to the particular facts as found by me.

In one sense, the facts as described in the following Chapters are more important than my findings. Each reader of this Report will, no doubt, have his or her own standards to apply to the actions, inactions, and particular circumstances, that together conspired to cause the financial of the Bank.

Nevertheless, I am constrained, in my findings of adequacy and appropriateness, to apply the standards of the law.

CHAPTER TWO REFERENCE INFORMATION ON THE INVESTIGATION