Most of the media attention on the South Canterbury Finance High Court decision has been on the failure of the Serious Fraud Office to obtain more convictions.
However, Justice Heath's 258-page judgment deserves far more scrutiny than this because it is an extremely well written document that covers a wide range of important governance issues.
Justice Heath did not conduct an inquiry into the collapse of South Canterbury Finance (SCF) but "found it necessary to make findings on the way in which SCF's business was conducted so that I have a factual basis against which to determine what knowledge each accused may have had on a particular topic at any time". These findings paint a bleak picture of the governance of the country's largest finance company.
The High Court judge assessed SCF on the following basis; board dynamics, Allan Hubbard's role, accounting systems, loan authorities, related party lending, board delegation, prospectuses and financial statements.
The first point to note is that SCF was 100 per cent owned by Southbury Group, which was controlled by the late Allan Hubbard and his wife Margaret. Southbury had three directors - the Hubbards and Andrew Borwell - but it had "few (if any) formal meetings of directors with discussions between Mr Hubbard and Mr Borwell about its affairs taking place irregularly, either in person or by telephone".
The SCF board, which comprised Hubbard, Edward Sullivan, Robert White and Stuart Nattrass, met every two months but the company's governance was more like "a closely held company than one that solicited funds from the public".
Hubbard was chairman, the controlling shareholder and the dominant board member. Hubbard was "ungovernable" according to one of his fellow directors and he appointed Lachie McLeod as chief executive in 2003 without any consultation with the board.
On August 20, 2008 the SCF directors passed the motion: "That the board have no confidence in the chair."
Hubbard, who was 81 at the time, refused to resign and threatened to fire some of his fellow directors.
Justice Heath wrote: "By allowing Mr Hubbard to continue to operate as he had historically done, they (the directors) contributed to SCF's downfall, as the existing governance structures were unable to cope with the problems that surfaced."
Allan Hubbard's role
The High Court judge wrote that he did not believe Hubbard or any of the accused set out to defraud investors but the corporate governance standards that Hubbard insisted on maintaining and "the inability of his co-directors to influence a change in his attitude directly contributed to the failure of the company, and the losses suffered".
SCF accounting systems were a mix of computerised and antiquated handwritten cashbooks, journals and typed ledger cards. The company had three separate ledger systems with Hubbard having complete control over the largely handwritten B Stock Ledger, from which he also made loans.
It was extremely difficult to prepare SCF's financial statements because Hubbard was reluctant to disclose the contents of the B Stock Ledger, particularly the related party loans to Southbury. A number of the B Stock Ledger loans had not been approved in accordance with SCF's guidelines, they had no security or the security had expired.
SCF had relatively robust loan authority limits but these were not applied to many related party transactions. The major issue was that Hubbard "had an ingrained reluctance to disclose related party lending", partly because some of these exceeded the loan authority limits.
Related party lending
SCF's group accountant, its auditors and trustee continually raised the issue of the inadequate disclosure of related party transactions. These transactions were with Southbury and companies associated with the SCF directors.
In July 2007 the directors presented a memorandum to Hubbard proposing that he pass control of the B Stock Ledger to the company's chief executive and that all loans must comply with the company's loan authority limits.
However, related party loans, and their disclosure, continued to be a problem and Justice Heath had this to say:
"The problem with corporate governance, loan authorisations, disclosure of related party transactions and credit management were intertwined. The related party and credit management concerns were symptoms of the corporate governance malaise.
"The root cause was Mr Hubbard's belief that related party lending was more secure for investors because he had greater control over it. He also wished to maintain the historically close links between the governance of Southbury and SCF.
"One of the ways in which those views manifested themselves was his reluctance to hand over information in a timely fashion."
SCF's group accountant told the court that Hubbard's attitude towards related party lending was: "Trust me, I know what I am doing". Justice Heath's response to this evidence was: "I agree (with the group accountant's statement)."
The judge's comments on board delegation are important in relation to his decision to find the accused not guilty on 13 of 18 charges. He said that the directors delegated responsibility for preparation of the half-yearly financial statements and the narrative of each prospectus to executives and "the more that has been delegated and the less knowledge that a director may have acquired, the less likely it is that any guilty intent may be proved on Crimes Act charges".
Prospectuses and financial statements
Justice Heath said that as none of the accused elected to give evidence he was required "to determine their state of knowledge of the relevant financial statements and the narrative from the available pool of evidence".
He wrote: "That evidence demonstrates an almost cavalier approach to the issue of prospectus documents, and to the reading of them."
Evidence provided to the court showed that prospectuses were presented to the board in their final form and were signed without discussion. It appears that the directors signed the prospectuses on the basis that Hubbard and Robert White had discussed them with the auditors.
The judge criticised the auditor, who was from a small firm in Ashburton. He wrote that the auditor "effectively retracted his evidence" and "I do regard it (his evidence) as unreliable".
Justice Heath's judgment is an excellent, but depressing, document that makes most rise-and-fall books look tame by comparison.
SCF was a hopelessly run organisation, mainly because of Hubbard's stubbornness and his close ties with the other directors. They were either long-time business associates of Hubbard or owed their SCF position to the chairman.
According to Justice Heath: "The extraordinary degree of loyalty shown by the four men (the three other directors and CEO) in the face of Mr Hubbard's stubborn refusal to change provides some explanation for the failure of their constant efforts to modernise SCF's business practices."
The SCF debacle clearly demonstrates the need for continuous board refreshment, strong independent directors, younger directors and female directors. A number of independent female directors might have had a better chance of convincing Allan Hubbard to adopt modern governance standards than his longstanding male Timaru-based directors.
Another issue at the Timaru trial was the inclusion of SCF in the Crown's Guarantee Scheme in late 2008. This protected investors' deposits and has cost taxpayers in excess of $800 million as far as SCF is concerned.
The Crown argued that SCF would not have been accepted into the scheme if full disclosure of a number of related party transactions had been included in the company's October 2008 prospectus.
Justice Heath determined that the Treasury gave priority to the public confidence factor when approving SCF's inclusion and "I am not persuaded beyond reasonable doubt that the Crown would inevitably have refused SCF's application to enter the Guarantee Scheme had the alleged false information been disclosed."
Justice Heath was surprised that the Crown didn't require the former Secretary to the Treasury to give evidence in support of its cases.
The non-appearance of the country's most important public servant has added another bizarre twist to the extraordinary South Canterbury Finance saga.
• Brian Gaynor is an executive director of Milford Asset Management.