2 He also pleaded guilty to one count on an indictment presented by the Director of Public Prosecutions for the Commonwealth charging that:
On or about 24 November 2000, being a director of HIH Investment Holdings Limited ("HIHIH") and of FAI Insurances Limited ("FAI"), was reckless and failed to exercise his powers and discharge his duties for a proper purpose in that he executed a series of documents concerning an application by HIHIH for shares in FAI which he knew had been backdated to 23 June 2000, and was reckless as to the consequences of signing those documents.
( Corporations Act 2001 s 184(1))
3 The agreed statement of facts in relation to the State offences was to the following effect:
" CONTRAVENTION OF CRIMES ACT 1900, S. 178BB
Cotesworth Letter of Credit - Pledged Assets
OVERVIEW
Cassidy's role in the HIH Group
1. The HIH Insurance Group came into existence in 1995, when CE Heath Casualty and General Insurance Ltd acquired the CIC Insurance Group. Terence Kevin Cassidy ("Cassidy") was the Group Financial Controller of CE Heath from the late 1970s until 1986, when he assumed the role of Managing Director (Australia). In 1995 he became the Managing Director (Australia) of the HIH Insurance Group, and he continued in that role until 2001.
2. Insurance business in Australia may only be carried on by a company authorised to do so under the Insurance Act 1973 ("the Act"). There were three main authorised insurers in 1999 within the HIH Insurance Group: CIC Insurance Limited ("CIC"), HIH Casualty and General Insurance Limited ("C&G") and FAI General Insurance Company Limited ("FAIG"). Cassidy was at the relevant times a director of each of these three authorised insurers. He had been a director of C&G since 1977, and became a director of CIC and FAIG upon the acquisition of those entities by HIH in 1995 and 1999 respectively.
3. In 1999 Cassidy, who held a Bachelor of Economics degree from the University of Sydney, possessed extensive experience in the areas of insurance and corporate finance and investments. He had a close working relationship with Mr Dominic Fodera ("Fodera"), Chief Financial Officer of HIH, and with Mr Ray Williams ('Williams"), Chief Executive Officer of HIH. Fodera and Williams were also directors of HIH, C&G and CIC.
4. An informal reporting process existed between Williams, Fodera and Cassidy, with contact often occurring on a daily basis. It was also usual practice for Williams, Fodera and Cassidy to meet and discuss issues prior to Audit and Board Meetings.
Acquisition of the Cotesworth syndicates
5. In October 1998 HIH acquired the Cotesworth Group Limited and its subsidiaries ("Cotesworth"), a Lloyd's of London managing agency and corporate syndicate based in the United Kingdom. Lloyd's of London required HIH to either deposit funds at Lloyd's or to arrange for banks to provide letters of credit to guarantee the obligations of the Cotesworth syndicates.
6. HIH made arrangements for letters of credit to be issued by Westpac and Societe Generale Australia Limited ("SG") to support the obligations of the Cotesworth syndicates. The letters of credit were secured by indemnities from companies within the HIH group, including the authorised insurers, and supported by securities owned by the authorised insurers. The effect of these financial arrangements was that the securities lodged by the authorised insurers were subject to charges in favour of Westpac and SG for the ultimate benefit of the Cotesworth syndicates.
7. By 30 June 1999 CIC had thus provided a total of $129 million (face value) in cash deposits and securities pledged to Westpac and SG to secure the obligations of the Cotesworth Group.
Regulation of authorised insurers under the Act
8. Under the system of regulation applicable in Australia in 1999, an entity's authorisation to carry on insurance business was subject under the Act to minimum solvency conditions. These conditions required that the value of the entity's assets should at all times exceed the amount of its liabilities by not less than the greater of $2 million, 20% of its premium income during its last financial year, or 15% of its outstanding claims provision as at the end of its last financial year - s 29(1)(b).
9. An authorised insurer was required by the Act to lodge quarterly returns and yearly accounts with the Australian Prudential Regulation Authority ("APRA") and the yearly accounts were required to be audited - s 44 and s 47. These accounts were to include a statement of assets and liabilities. The purpose of these accounts was to ensure that authorised entities complied with minimum solvency requirements.
10. Section 30(1) of the Act provided that some assets could not be counted by an authorised entity for the purpose of the minimum solvency calculations, including an asset "charged for the benefit of a person other than the body corporate to the extent that it is so charged" - s 30(1)(c).
CIC's Quarterly and Annual APRA returns for the period ending June 1999
11. On or about 24 August 1999, CIC's Quarterly APRA return for the three month period ending 30 June 1999 was lodged with APRA. Cassidy and CIC's company secretary, Mr Fred Lo ("Lo"), co-signed each page of the return on or about 19 August 1999. This return included Form 302 - a Statement of Assets and Liabilities encumbered or charged or subject to a floating charge or contingent liability.
12. The APRA return lodged by CIC and signed by Cassidy and Lo on or about 19 August 1999 was false in that Form 302 recorded the value of assets encumbered or charged for the benefit of third parties as nil. It did not disclose the $129 million in assets encumbered for the ultimate benefit of the Cotesworth syndicates.
13. On or about 22 November 1999, CIC's Annual APRA return for the period ending 30 June 1999 was lodged with APRA. Cassidy and Lo signed the Form 100 Certificate of Reporting Approach and Compliance on or about 22 November 1999.
14. The Annual APRA return included Form 102(i) (Minimum Solvency Requirements) and Form 103 - a Statement of Assets and Liabilities encumbered or charged or subject to a floating charge or contingent liability.
15. The Annual APRA return lodged by CIC and signed by Cassidy and Lo on or about 22 November 1999 was false in that the $129 million fixed interest securities that had been pledged by CIC to support the obligations of the Cotesworth syndicates had not been disclosed and excluded on Form 102(i).
16. Form 103 was also false in that it did not disclose the $129 million charged assets as statutory exclusions. As recorded on Form 103, the value of assets encumbered or charged was nil.
17. Had the $129 million in encumbered fixed interest securities been disclosed and excluded from the solvency calculations in Form 102(i), as it should have been, CIC would have recorded a deficiency of $111,861,000, rather than the surplus of $17,139,000 which it declared. Disclosure of the true (encumbered) nature of the assets pledged to support the Cotesworth syndicates would have resulted in CIC disclosing its failure to comply with the minimum solvency requirement.
CIRCUMSTANCES OF THE OFFENCE
Cassidy's knowledge of pledged assets, securities and the minimum solvency requirement
18. As Group Financial Controller of CE Heath from the late 1970s until 1986, Cassidy acquired considerable experience in financial transactions and securities, and was one of the persons responsible for signing the returns for all of the Group's licensed entities as required under the Act. The requirements of section 30(1) of the Act did not change between that period and 1999. Cassidy was familiar with and understood the provisions of the Act including the minimum solvency requirement, the need to lodge quarterly and annual returns and the need to disclose and exclude assets charged for the benefit of third parties.
19. The assets of CIC which had been pledged to secure the letters of credit were pledged via the system provided by Austraclear Limited. Cassidy was one of the Group's authorised signatories to Austraclear Limited ("Austraclear") for both CIC and C&G. He had co-signed C&G's and CIC's applications for Austraclear membership. Austraclear, a wholly owned subsidiary of the Sydney Futures Exchange, provides a service to members by which debt securities may be sold and on sold within the financial market. Austraclear holds those debt securities for its members, registers, encumbers and transfers those securities within the system, and provides a settlement procedure for transactions involving the transfer of those securities. Cassidy was also one of the Group's authorised signatories to the Reserve Bank Information Transfer System (RITS), which allows members to, inter alia, mortgage the assets deposited by corporate entities within the system.
20. Cassidy was experienced by 1999 in considering the effect of assets pledged to support letters of credit on an authorised entity's solvency margin. In 1989 he directed an employee to determine a method of pledging assets to secure letters of credit issued for C&G while protecting C&G's solvency margin. He subsequently authorised the pledging of assets by a New Zealand subsidiary to secure C&G's letters of credit, as New Zealand's then insurance legislation did not exclude for regulatory solvency purposes assets of a licensed insurer which were pledged to secure letters of credit. Cassidy reviewed the 1989 transaction in 1996.
21. In 1996 Cassidy was one of the persons appointed by the C&G Board to prepare, complete and execute the documentation on behalf of C&G to give effect to an agreement with Westpac to obtain letters of credit for C&G. On 6 November 1996 Cassidy signed a verification certificate on behalf of C&G, annexing minutes of a meeting of directors of C&G, which he had attended, at which it was resolved to accept the offer and to warrant the relevant matters. There is no evidence as to who in fact prepared the documents.
22. Cassidy was familiar with financial arrangements involving negative pledges and understood the characteristics of a negative pledge. He was involved in a number of financial transactions during the 1990s in which negative pledges were variously given over the assets of subsidiary companies or required by subsidiary companies over the assets of third party borrowers to secure loans provided by the subsidiaries.
Cotesworth letters of credit - negotiations and documentation
23. HIH commenced negotiations in early November 1998 with Westpac and SG to secure letters of credit to support the underwriting obligations of Cotesworth in the UK. As early as 4 November 1998, HIH had advised SG that it required an £88 million standby letter of credit.
24. The officers within HIH who had primary responsibility for negotiating the financial arrangements concerned with the issue of the letters of credit were Mr William Howard, General Manager Finance ("Howard") and Lo. Following discussions with these persons and with Fodera, Cassidy was aware that the financial arrangements involved with the letters of credit could have implications for the solvency requirements of the authorised insurers.
Westpac
25. Westpac advised HIH by letter of 23 November 1998 that it had approved the provision of a £60,000,000 letter of credit on behalf of the Cotesworth Group Limited. As well as requiring that the facility be secured by a pledge over at least £35,000,000 in cash or qualified securities to be held in Austraclear or RITS, Westpac required indemnification.
26. On or around 5 November 1998 in a then unrelated transaction, Cassidy and Lo had signed a guarantee and indemnity to Westpac on behalf of HIH Underwriting and Agency Services Limited and HIH, guaranteeing the obligations of HIH America Insurance Services Inc, HIH Underwriting and Agency Services Limited, and HIH. That guarantee and indemnity concerned a $US14,000,000 loan provided by Westpac to HIH America Insurance Services Ltd. Under the terms of the Cotesworth letter of credit arrangement, C&G was required to complete a third party indemnity specific to the Cotesworth transaction. Rather than creating new guarantees for the Cotesworth transaction, HIH Underwriting and Agency Services Limited and HIH agreed in writing to amend the earlier agreement so as to include a guarantee of C&G's liability under the Cotesworth indemnity.
27. Cassidy, as a director of HIH Underwriting and Agency Services Limited, signed the minutes of a meeting of its board of directors of 24 November 1998 regarding the proposed Cotesworth transaction. Lo and Fodera also attended that meeting (Fodera attending by telephone). The minutes record that the board resolved to authorise Cassidy and Lo to sign Westpac's offer letter of 23 November 1998 and to execute all relevant ancillary indemnity and guarantee agreements to give effect to the acceptance of the Cotesworth letter of credit and to enable the issue of that letter of credit.
28. Cassidy, as a director of C & G, signed the minutes of a meeting of its board of directors of 24 November 1998 regarding the proposed Cotesworth transaction. Lo and Fodera also attended that meeting (Fodera attending by telephone). The minutes record that the board resolved to authorise Cassidy and Lo to sign Westpac's offer letter of 23 November 1998 and to execute all relevant ancillary indemnity and guarantee agreements to give effect to the acceptance of the Cotesworth letter of credit and to enable the issue of that letter of credit.
29. Cassidy and Lo duly signed the relevant documentation, accepting Westpac's LOC offer and amending the 5 November 1998 guarantee and indemnity. The terms of this agreement were obviously inconsistent with the characterisation of the securities as being subject to a mere negative pledge.
SG
30. On 23 November 1998 SG wrote to HIH and offered it finance described as a performance guarantee facility for £30 million, comprising £15 million to be secured and £15 million unsecured.
31 The terms of the offer required HIH to provide acceptable security, defined as including Australian government or state government securities, or cash deposited with SG. In the event that HIH provided Australian government securities as acceptable security, SG required HIH to execute mortgage documentation in favour of SG. HIH was also required to execute a letter of deposit and set off, and pledge documentation in form and substance satisfactory to SG relating to SG's possession and control of the acceptable security. The offer could only be accepted by HIH delivering to SG a cheque representing the establishment fee, and documentation satisfying the conditions precedent. The provision of cash security was not an option for HIH.
32. Cassidy and Lo signed the letter of deposit and set off on 25 November 1998. Pursuant to that agreement, Cassidy and Lo agreed to establish an account and to deposit the initial deposit of £16 million by 27 November 1998. They further authorised SG to appropriate the whole or part of the deposit balance towards satisfaction of the liabilities. Liabilities were defined to include any liability or obligation owed to SG by HIH under the performance guarantee facility provided to the Company pursuant to the letter of offer of 23 November 1998. This documentation thus stated that SG was at liberty, in the event of a default, to apply the charged funds to discharge Cotesworth's liabilities. The terms of this document are obviously inconsistent with the characterisation of those funds as being subject to a mere negative pledge.
33. On 25 November 1998, Lo wrote to SG regarding the SG letter of offer of 23 November 1998 for a standby letter of credit for £30,000,000, and attached various documents including:
- duly signed deposit and set-off;
- duly signed issue notice;
- cheque for the establishment fee;
- company records as required by SG; and
- drafting amendments suggested by Minter Ellison.
34. Cassidy signed the issue notice on 25 November 1998, thereby giving SG notice that HIH required a letter of credit to be issued on behalf of Cotesworth Capital Limited on 27 November 1998 to the value of £30 million.
Pledging of securities in November 1998
Westpac
35. On 26 November 1998 HIH advised Westpac of the securities C&G and CIC had currently pledged to Westpac for existing letters of credit, and the securities it would pledge to Westpac for the Lloyds letter of credit. The amount of securities to be pledged to Westpac totalled AUD$53 million.
36 On 26 November 1998, CIC pledged $48 million of securities, encumbered in Austraclear, to Westpac for the Cotesworth letter of credit.
37. On 26 November 1998, C&G pledged $5 million of securities, encumbered in Austraclear, to Westpac.
38. On 27 November 1998, Westpac issued a standby letter of credit to Lloyds on behalf of Cotesworth to the value of £54,157,500.
SG
39. On 27 November 1998, CIC pledged a total of $36 million of fixed interest securities, encumbered in Austraclear, to SG.
40. As at 27 November 1998, CIC had pledged a total of $84 million of fixed interest securities, encumbered in Austraclear, to support the Cotesworth letters of credit.
41 Between December 1998 and June 1999, demands by Westpac for the amount pledged to be increased caused this figure to rise to $129 million.
HIH Board Meeting 2 December 1998
42. On 2 December 1998, Cassidy attended a Board meeting of HIH. The package of papers presented to each of the directors for this meeting contained a paper prepared by Lo entitled "Letters of Credit - Cotesworth Capital Limited". Lo's paper noted that letters of credit were issued by Westpac and SG on 27 November 1998 for and on behalf of Cotesworth, and that HIH needed to provide a performance guarantee in the event that the letters of credit were drawn down and Cotesworth was unable to indemnify the banks. Lo's paper set out the amount of securities secured to support the letters of credit from Westpac and SG. Lo's paper also noted "security on the secured commitment was provided through the pledge by HIH of a portfolio of government and semi--government securities acceptable to the issuing banks".
43. The paper contains a handwritten note made by Cassidy during the Board meeting that states: "Cash security on letters of credit". Cassidy was aware at 2 December that CIC and C&G had pledged the said securities.
44. The minutes of the 2 December 1998 Board meeting record that Fodera advised that letters of credit in favour of Lloyds totalling £84.16 million had been issued by Westpac and SG for and on behalf of the company and that the letters of credit were required as a security deposit to support Cotesworth Capital Limited's underwriting operation in line with its business plan. The Board resolved to ratify the action of management in securing the letters of credit.
Conversations with Lo and Fodera
45. Various HIH officers other than Cassidy had, at different times, adverted to the possible exclusion of assets of the authorised insurers which secured the Cotesworth letters of credit. On 4 November 1998, Howard sought legal advice from Stuart Johnson ("Johnson") of Minter Ellison about pledged assets and the regulator's solvency rules. Johnson provided oral advice to Howard later that day that, depending on the actual documentation, a 'charge' may include a pledge. This advice was not passed on to Cassidy.
46. On 20 November 1998, Lo sought legal advice from Johnson as to the difference between a pledge with a power of sale, and an equitable mortgage. Johnson provided oral advice to Lo later that day that there was no real difference between a pledge and an equitable mortgage, as a pledge effectively created a mortgage. This advice was not passed on to Cassidy.
47. In November 1998 Cassidy had conversations with Fodera and Lo and was told in each case that "the letter of credit is a form of negative pledge". Cassidy was surprised by the explanation. It was inconsistent with his own knowledge as to the security required by financial institutions for letters of credit and his understanding of the nature of a negative pledge, and it was inconsistent with the documentation which he had signed on behalf of HIH on 25 November 1998.
48. In registering surprise at these explanations, Cassidy adverted to the possibility that such advice may have been wrong. However, he chose to make no enquiries to satisfy himself as to the accuracy of these explanations.
49. In 1999, either when signing CIC's APRA Quarterly Return for the three month period ending 30 June 1999 (signed on 19 August 1999) or when signing CIC's APRA Annual Return for the period ending 30 June 1999 (signed on 22 November 1999), Cassidy was sufficiently aware of the possibility that the assets pledged by CIC had to be excluded for solvency purposes and were not a negative pledge to again ask Lo about the nature of that encumbrance. Cassidy was again told by Lo that the assets were subject to a negative pledge. Cassidy again registered surprise at that explanation. However, despite his advertence to the possibility that this explanation may have been wrong, and to the consequence that CIC's assets may not have been admissible for regulatory solvency purposes, Cassidy chose to make no further enquiries and proceeded to sign the APRA Returns.
Cassidy's state of mind in August and November 1999
50. In addition to Cassidy's state of mind identified in paragraphs 47 48 and 49, Cassidy was aware that at the time of signing the Quarterly and Annual returns that the proper classification of the securities pledged was critical to the licensed insurer's ability to meet the minimum solvency requirement. He knew that in each case there was no disclosure of and exclusion of assets pledged by CIC to support the Cotesworth, letters of credit.
51. Cassidy signed both the Westpac and SG documentation that imposed the requirement that securities be pledged in Austraclear to support the Cotesworth letters of credit. Cassidy knew that CIC and C&G had pledged securities in support of the letters of credit provided to Cotesworth by Westpac and SG.
52. Cassidy was aware that the pledges constituted the secured component of the transactions with Westpac and SG.
53. Cassidy appreciated that the exclusion of the pledged assets meant excluding assets to the value of at least £54 million or approximately $110 million; and that this was likely to affect the solvency of the company or companies pledging the assets.
54. Cassidy understood the annual return had a significant role in the assessment by the regulator of the long term viability of the licensed insurer.