COMPLIANCE, corporate governance and the svp report
365 The Compliance Plan provided for the appointment of a Compliance Officer. The Compliance Plan provided that the Compliance Officer was responsible for, amongst other things, establishing an effective compliance culture, conducting an annual review of valuations of the Fund's assets, conducting a half-yearly review of valuation procedures and reporting the results of that review to the board, conducting a quarterly review of procedures relating to the payments out of the assets of the Fund and reporting the results of that review to the board.
366 City Pacific outsourced the position of Compliance Officer. It appointed Mr Stuart Russell and Ms Lisa Arnold of the firm Financial Services Consulting to provide compliance services to City Pacific. There was evidence that the Compliance Officer did furnish reports to the board. On one occasion, those reports referred to breaches of the Compliance Plan that had been identified by the Compliance Officer. As will be seen, however, it appears that the Compliance Officer failed to identify the compliance deficiencies identified by SVP. In particular, it appears that the Compliance Officer never identified any of the issues concerning the AGA facility.
367 Subsection 601JA(1) of the Corporations Act provides that the responsible entity of a registered scheme must establish a compliance committee if less than half of the directors of the responsible entity are external directors. The compliance committee is required to have at least three members, and a majority of them must be external members: s 601JB(1) of the Corporations Act. The functions of the compliance committee are to monitor to what extent the responsible entity complies with the scheme's compliance plan and to report to the responsible entity any breach of the Corporations Act or the scheme's constitution of which the committee becomes aware or suspects.
368 City Pacific established a compliance committee in accordance with the Corporations Act (the Compliance Committee). There is evidence that the Compliance Committee met, considered reports from the Compliance Officer, discussed breaches that had been identified and reported to the board. One minute of the Compliance Committee, dated 21 March 2006, referred to the AGA facility in the context of the policy in relation to related party loans. It does not, however, appear that the Compliance Committee identified any of the compliance issues that were identified by SVP. In particular, it does not appear that the Compliance Committee ever identified the specific issues concerning the AGA facility at any time during 2006.
369 Subsection 601HG(1) of the Corporations Act provides that the responsible entity of a registered scheme must ensure that at all times a registered company auditor, an audit firm, or an authorised audit company, is engaged to audit compliance with the scheme's compliance plan. Within three months after the end of a financial year of the scheme, the auditor of the compliance plan must examine the scheme's compliance plan, carry out an audit of the responsible entity's compliance with the compliance plan, and give the responsible entity a report that states the auditor's opinion in relation to compliance with the compliance plan: s 601HG(3) of the Corporations Act.
370 As already adverted to, City Pacific's compliance plan auditor was KPMG. There was some evidence that KPMG picked up various issues in relation to City Pacific's compliance in the course of its audits. For example, as has already been seen, in July 2006 KPMG raised some specific queries with Mr McCormick in relation to a number of City Pacific's loans, including the AGA facility. Mr McCormick's response to that query was revealing. The query raised by KPMG was whether a number of loans, including the AGA facility, were operating above their approved limit. Mr McCormick's response was not to fess up to KPMG that the AGA facility was, in fact, operating above its facility limit. Nor did he seek to justify that fact in any way. Rather, he created the misleading file note that suggested that approval had been given to increase the limit of the AGA facility to $26 million in late April 2006. It would seem that this was enough to satisfy KPMG. It was only when it subsequently appeared that the company conducting due diligence for the prospective purchaser of City Pacific's loan book sought to inspect the AGA loan file that Mr McCormick had to take the further step of preparing a backdated letter of offer to AGA to give the appearance that the loan had not operated above its approved limit. Mr Sullivan obliged and assisted the "tidy up" of the loan file by signing the backdated letter.
371 That evidence perhaps sheds some light on the question of how it came to pass that KPMG apparently failed to identify that the AGA facility was effectively operating outside its approved limit at virtually all times after late April 2006. KPMG was misled by Mr McCormick and Mr Sullivan. The available inference becomes even clearer when regard is had to the events of late December 2006 and early January 2007, when each of Messrs Sullivan, Swan, Donaldson and McCormick were prepared to sign a backdated loan proposal without demur or query. Plainly the intention was, once again, to give the appearance of regularity. It may be inferred that this was because Mr Sullivan and Mr McCormick, at least, were aware of the possibility that KPMG may conduct a year-end compliance audit.
372 The affidavit evidence of Messrs Sullivan, Swan and Donaldson contained some general evidence concerning the systems and structures in place at City Pacific to ensure compliance. They referred, in very general terms, to the roles of the Fund's compliance plan auditor, KPMG, the Compliance Officer, Mr Russell, and the Compliance Committee. Each of Messrs Sullivan, Swan and Donaldson maintained, in their defence to the alleged contraventions concerning the AGA facility, that they relied on KPMG, the Compliance Officer and the Compliance Committee, to identify and report to them any discrepancies or irregularities in relation to the AGA facility. Their evidence on that issue, however, was in very general terms and never extended much beyond mere assertion. They gave no evidence of specific instances of reliance on their part, or pointed to any documentary evidence that corroborated their claims of reliance. Given their evidence, considered in more detail later, concerning the cursory treatment they supposedly gave to the board papers, it was difficult, to say the least, for them to claim that they relied on any minutes of the Compliance Committee, or reports from the Compliance Officer, that may have found their way into the board papers.
373 There must also be real doubts about whether any of the respondents were able to simply rely on KPMG, the Compliance Officer and the Compliance Committee to identify potential breaches of the Compliance Plan arising from the AGA facility. Those doubts arise from at least three events. First, in the case of each respondent, doubts arise from the evidence concerning the SVP report and City Pacific's response to it. Second, in the case of Mr Sullivan and Mr McCormick, doubts arise from the evidence concerning the backdated file note and backdated letter of offer in relation to the $26 million facility. Third, in the case of each respondent, doubts arise from their knowledge of and involvement in the backdated proposal to increase the AGA facility limit to $44.87 million or $55 million in December 2006.
374 The evidence concerning the backdated approvals, or purported approvals, of the increase of the AGA facility limit to $26 million (in August 2006) and $44.87 million or $55 million (in December 2006) is considered in detail later. Suffice it to say here that it is difficult to see how the respondents could genuinely say that they relied on KPMG, the Compliance Officer and the Compliance Committee in circumstances where, by their complicity in backdating documents, they took steps to conceal breaches or discrepancies from external scrutiny.
375 As for the SVP report, the uncontested facts in relation to the SVP report, and the purported implementation of SVP's recommendations by City Pacific, have already been summarised. The specific findings and recommendations relating to the AGA facility have already been referred to. In addition to those specific findings and recommendations, the overall tenor of the SVP report was that there were a number of issues in relation to compliance at City Pacific. Amongst its general findings, SVP made the following observations concerning compliance at City Pacific:
While SVP considers that the Responsible Entity has had the interests of unitholders as a primary concern, the level of growth experienced by the Trust was not matched by a similar increase in the level of management required to ensure policies and procedures laid down by the Board were complied with and improved. The detailed comments made in this Part of the Report reflect that view.
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Generally, SVP's view is that loan administration procedures have been lacking.
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An integral part of the lending operations associated with the Trust is the valuation process. Although SVP's view is that in light of the values set out in valuations obtained by the Responsible Entity, and subject to a number of conditions as stated elsewhere in this Report, there appears to be adequate security for the loans as at 30 June 2005, the processes and procedures around the valuation activity require ongoing improvement. SVP identified some instances where it is unclear whether the Responsible Entity could or should rely on the valuations that were obtained. There were three occasions identified where valuation reports had been relied upon which had not been addressed to the Responsible Entity/Custodian. It will be noted that SVP has recommended updated valuation reports for a number of loans and that the the view expressed in the Report about the adequacy of security is subject in part to the outcome of those updated valuations; and to a full and recorded analysis of those valuation reports being undertaken.
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On many occasions, decisions appear to have been made without fully recording the reasons for them or the fact that they have been made. While acknowledging that part of the success of the Trust to date has been its flexibility, more structure is required as the Trust develops.
376 In relation to loan administration procedures, SVP made the following general findings:
SVP has identified non-compliance with policies, procedures and processes to varying degrees of materiality and which on their own, or in certain combination, should not be fatal to collection of a loan. SVP specifically mention documented analysis of valuations and the management of progressive loan draw down against development program (time) and a properly assessed "cost to complete" discipline. SVP is unable to predict if any combination of past decisions that do not comply with policy frameworks would have an adverse impact on the collection of a loan.
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For this reason the mortgage portfolio would benefit from applying the policy framework in a more disciplined manner than what has occurred in the past. SVP has observed this is now already occurring in practice.
377 SVP's general findings concerning compliance at the very least must have put City Pacific's management and directors on notice that City Pacific's own internal and external compliance bodies, personnel and procedures had not been particularly effective. In particular, City Pacific's existing compliance regime had failed to identify instances in the past, identified by SVP, where there had been non-compliance with the Compliance Plan or where loan administration procedures had been generally lacking.
378 There could be little doubt that the SVP report and recommendations became a major issue for City Pacific. The appointment of SVP was essentially forced upon City Pacific by ASIC. It became a condition of City Pacific's AFSL. The SVP report and City Pacific's response to it turned out to be an extremely costly exercise for City Pacific, and required extensive input from management and external lawyers and advisers. It was also a matter that plainly required attention and scrutiny at board level. Management and advisers gave the appearance of diligent concern and generated much sound and light. Various matrices setting out the SVP recommendations were prepared and circulated, as were matrices setting out City Pacific's proposed responses and plan of action.
379 It is, however, illuminating to consider exactly what was actually done in relation to loan administration procedures and the AGA facility in response to the SVP report. A number of points may be made.
380 First, SVP advised that, in its view, loan administration procedures at City Pacific had been lacking, in particular insofar as valuations were concerned. One of the major recommendations in that regard concerned the requirement for the lending manager to certify in the loan proposal that the valuation received by City Pacific in respect of the security property was acceptable. Certification by the lending manager required the lending manager, amongst other things, to review and analyse the valuation assumptions. The certification was required to be separate from the lending manager's sign-off of the lending proposal. It was required before approval was sought from and given by the Credit Committee. City Pacific agreed to act on that recommendation and eventually amended the Lending Manual to require such a separate certification.
381 Regrettably, however, as events transpired, the implementation of this recommendation was not given effect to in relation to the one AGA loan proposal that was prepared and submitted to the Credit Committee after the SVP report. That was the proposal that was put to the Credit Committee in December 2006, but backdated to suggest that it had been put to and approved by the Credit Committee in August 2006. That proposal contained no separate certification by the Lending Manager that there was an acceptable valuation. That may well have been because there was simply no way that the Lending Manager, Mr McCormick, could possibly have genuinely regarded the valuation assumptions in Mr Kogler's valuation to be even remotely acceptable. In any event, when the members of the Credit Committee approved the proposal, they did so without raising any query whatsoever about the absence of a certification.
382 In short, the SVP recommendation and the resulting amendment to the Lending Manual were essentially ignored by the Credit Committee.
383 The evidence of Messrs Sullivan, Swan and Donaldson in respect of that matter is addressed in detail later. Suffice it to say at this stage that their evidence concerning the absence of the certification in the proposal was most unsatisfactory. None of them gave an even remotely acceptable explanation for how they managed to ignore or overlook that deficiency in the proposal, given that it was the very deficiency that had so recently been the subject of a specific finding and recommendation by SVP.
384 Second, in that part of the SVP report that dealt with whether the Fund's loans complied with the Constitution and the Compliance Plan, the AGA loan was the one loan that was singled out as not complying. Whilst SVP's view that the AGA loan was "outside all current policy areas" appeared to turn, to an extent, on SVP's interpretation of section 5.8 of the Lending Manual, nonetheless it raised specific issues concerning the AGA facility. Perhaps more significantly, SVP made specific recommendations concerning the AGA facility. The recommendations were: first, that the loan be repaid or refinanced by 31 December 2005 if confirmation was not received that the Saddleback land could be included in the Urban Footprint of the South East Queensland Regional Plan; and second, that at the December 2005 review, a valuation be obtained from a different valuer to check the analysis of land values based on permitted uses.
385 It was an incontestable fact that neither of those recommendations were acted on by City Pacific. Confirmation that the Saddleback land could be included in the Urban Footprint of the South East Queensland Regional Plan was never received, let alone by 31 December 2005. Yet no steps were ever taken to require the repayment or refinance of the AGA facility. A different valuer was never retained to value the Saddleback land. All the valuations that were subsequently received in relation to the Saddleback land were obtained from the same valuer, Mr Kogler, and contained highly dubious assumptions concerning the permitted uses.
386 None of the respondents even attempted to explain how that sorry state of affairs came about.
387 Third, the immediate response to the SVP report by Messrs Sullivan, Swan, Donaldson and McCormick revealed that the concerns raised by SVP about the AGA facility had no apparent impact on them. Within a week of the receipt of the SVP report, they approved an increase to the AGA facility in circumstances where the supposed value of the Saddleback land referred to in the proposal was not even the subject of a valuation, let alone a valuation from a different valuer. Whilst Mr Swan noted that his approval was subject to the receipt of a valuation, he never took any steps to ensure that an acceptable valuation was received. Thus, SVP's concerns about the AGA facility and the valuation of the Saddleback land based on permitted uses apparently either fell on deaf ears, or were deliberately ignored by the Credit Committee.
388 Fourth, it was an incontestable fact that Mr Sullivan misled ASIC in relation to the implementation of SVP's recommendations concerning the AGA facility. Mr Sullivan's evidence in respect of that matter was manifestly unsatisfactory. As has already been observed, it reflected adversely on Mr Sullivan's credit generally.
389 The full progress report enclosed with Mr Sullivan's letter to ASIC dated 8 February 2006 had been the product of considered discussion and revision by management. In relation to SVP's recommendation concerning the AGA facility, the report stated that "[a] Draft valuation prepared by a different valuer … has been sighted at a substantially higher value". Someone made a considered decision to insert the words "by a different valuer" in the final draft of the report. That statement was unquestionably false, as Mr Sullivan ultimately conceded in cross-examination. No consideration was ever given to retaining a different valuer to value the Saddleback land. No draft report from a different valuer ever existed. Mr Sullivan was unable to provide any explanation, let alone a reasonable or plausible explanation, for how that manifestly false statement could be included in such an important report to ASIC. Given the seriousness of the issue, and Mr Sullivan's responsibility and involvement in the implementation of the recommendations concerning the AGA facility, it is extremely difficult to see how this could have been the product of mere oversight on Mr Sullivan's part.
390 Nor was Mr Sullivan able to give a reasonable explanation for how he came to report to ASIC that City Pacific held a legal opinion from an "eminent QC" that the 1989 rezoning approval was "valid" and that City Pacific had received advice that zoning gazettal is "a formality and is imminent". Mr Sullivan attempted to justify these statements on the basis that a barrister, Mr Stephen Fynes-Clinton, had apparently given advice at some stage to AGA (not City Pacific) about the status of the 1989 rezoning approval in relation to the Saddleback land. Mr Sullivan, however, could not recall ever reading that advice. Had he read it, of course, he would have appreciated that it said nothing about the gazettal of the rezoning approval being either a formality or imminent. There was simply no basis for that statement in the report to ASIC. Mr Sullivan must have realised this when, within a very short time after sending the report to ASIC, he became aware that the Council had refused to proceed to have the rezoning gazetted. Yet he made no attempt to correct the misleading statement made in the report.
391 The only reasonable inference is that Mr Sullivan either knew that the statements made to ASIC about the AGA facility were false and misleading, or was recklessly indifferent to whether they were accurate. The inference of mere oversight on Mr Sullivan's part is implausible. Either way, it is clear that as a result of the SVP report and the manoeuvrings involved in City Pacific's response to it, Mr Sullivan knew, at the very least, that there was a serious issue with the AGA facility. Yet rather than ensuring that SVP's recommendations were actually acted upon, which it was plainly within his power to do, Mr Sullivan chose to simply fob off ASIC by telling them what he believed it wanted to hear without any regard to the truthfulness and accuracy of the report.
392 How did Mr Sullivan manage to do this given that SVP's report and the implementation of its recommendations was a serious issue that was considered and discussed at board level? A copy of the report to ASIC was provided to Mr Swan and Mr Donaldson. What did they know and what did they do to satisfy themselves that the report was accurate? There are really only two possibilities: either Mr Swan and Mr Donaldson, were, like Mr Sullivan, prepared to mislead ASIC rather than actually implement SVP's recommendations concerning the AGA facility; or Mr Swan and Mr Donaldson provided no effective oversight or independent scrutiny in relation to that serious issue and simply left it to management. If the evidence of Mr Swan and Mr Donaldson was to be believed, it was the latter scenario. They effectively did nothing.
393 The overall effect of Mr Swan's evidence in relation to the implementation of SVP's recommendations was that, whilst the SVP report was a very serious issue that was considered and discussed at board level, he left it entirely to management to deal with. He himself made no inquiries to ensure that the recommendations concerning the AGA facility were implemented. Rather, he simply assumed that if there were any problems, the board would be informed. He effectively claimed to have no recollection of any discussions with management, or at board level, about that issue.
394 Mr Swan endeavoured to play down SVP's specific findings and recommendations in relation to the AGA facility on the basis that they were based on SVP's view that the loan did not "fit … into a category neatly" and that management had disagreed with that view. Mr Swan does not suggest that he gave any independent consideration to whether SVP's view was correct or not.
395 He also endeavoured to explain his lack of involvement with matters such as the implementation of the recommendations concerning the AGA facility on the basis that the greater concern for him and the board was the liquidity issue. The liquidity issue and ASIC's response to it was undoubtedly a serious issue that warranted attention at the highest level. It did not follow, however, that Mr Swan was entitled to turn a blind eye to other aspects of the SVP report and its implementation.
396 Mr Swan ultimately agreed that he was aware of SVP's recommendation that the AGA facility be repaid by 31 December 2005 if certain conditions were not met. He did not, however, consider that it was incumbent on him as a director (or a member of the Credit Committee who had recently approved an increase to the AGA facility) to inquire of management whether those conditions had been satisfied or if the loan had been repaid. Nor, it appears, did he turn his mind to that question when he received board papers, throughout 2006, that revealed not only that the AGA facility had not been repaid, but that further significant advances had been made to AGA.
397 In short, and to put the matter bluntly, on his version of events, Mr Swan himself did nothing whatsoever to satisfy himself, as a director of City Pacific, that SVP's recommendations had in fact been implemented. That appeared to be the case both in relation to the SVP recommendations generally, and the specific recommendations in relation to the AGA facility.
398 Mr Donaldson's evidence concerning his role or involvement in relation to the implementation of SVP's recommendations was much the same as Mr Swan's evidence. Initially, he effectively denied knowing about, or "registering", SVP's recommendations concerning the AGA facility. When it became obvious, from the documentary evidence put to Mr Donaldson in cross-examination, that the SVP report and City Pacific's responses to it had been discussed at board level, Mr Donaldson belatedly acknowledged that he "would have" become aware of the recommendations, including that a valuation from a different valuer be obtained, and that the loan be repaid if certain conditions were not met. Mr Donaldson did not, however, make any inquiries, or consider himself as being obliged to conduct any inquiries, about whether a valuation from a different valuer had in fact been obtained, or whether the conditions had been satisfied or the loan repaid. He maintained that those "matters were delegated to parties who were carrying these things out".
399 As with Mr Swan, the upshot of Mr Donaldson's evidence was that, despite the fact that the SVP report and recommendations were sufficiently serious and important to be considered at the board level, he did nothing himself to ensure that the recommendations were in fact acted on. He simply assumed that management "handled those matters correctly". When pressed, however, he effectively denied having any recollection about any actual discussions with management, including Mr Sullivan, in relation to the AGA facility and SVP's recommendations in relation to it.
400 The evidence of both Mr Swan and Mr Donaldson concerning the implementation of SVP's recommendations concerning the AGA facility was in many respects unpersuasive and lacked credibility. Nevertheless, assuming, for present purposes, that the evidence of both Mr Swan and Mr Donaldson in relation to the SVP report were to be accepted, were they justified in simply delegating responsibility for the SVP report and its implementation to management? Were they entitled to uncritically assume that management had properly responded to and implemented the SVP recommendations without any oversight or scrutiny on their part? Given the seriousness of the issues raised in the SVP report, the importance of the recommendations, the involvement of ASIC, the amount of money involved in the AGA facility alone, the position of City Pacific as a professional trustee in relation to the assets of the Fund, and the duties and responsibilities of Mr Swan and Mr Donaldson as officers of City Pacific, the answer to those questions must be "no". More was required.
401 The SVP report was impliedly, if not expressly, critical of aspects of City Pacific's loan administration procedures and compliance with the Constitution and the Compliance Plan. That amounted to a criticism of management. In all the circumstances, it was not sufficient for Mr Swan and Mr Donaldson to unquestioningly and uncritically rely on management to deal with those criticisms. Whilst it may not have been necessary for Mr Swan and Mr Donaldson to have had the "detailed direct involvement that is associated with operational responsibility", what was required was "a level of scrutiny as befits supervision": Vines v ASIC at [731].
402 Trilogy did not allege any breach of duty on the part of Messrs Sullivan, Swan, Donaldson and McCormick in relation to the response to the SVP report. Nevertheless, the evidence concerning the SVP report was significant for at least two reasons.
403 First, it revealed significant weaknesses in corporate governance at City Pacific. It revealed a management team, headed by Mr Sullivan, that was prepared to mislead ASIC rather than implement SVP's recommendations concerning a large loan that did not appear to comply with a number of City Pacific's loan administration policies and procedures. It also revealed, at best, an almost complete absence of any oversight or scrutiny of management by the independent or non-executive directors in relation to that issue.
404 Second, the evidence concerning the SVP report provided critical background and context in which to consider the events that occurred in relation to the AGA facility throughout 2006 and into 2007. In particular, the evidence concerning the SVP report must be considered in addressing the evidence of Messrs Sullivan, Swan and Donaldson to the effect that they did not know that advances continued to be made to AGA above its approved facility limit during 2006 and 2007, and had no reason to make inquiries, or even read the board papers, with a view to ensuring that the conduct of the AGA facility complied with City Pacific's lending guidelines and constituent documents. On any view, Messrs Sullivan, Swan and Donaldson must have known that the AGA facility was not just a regular loan amongst the many in City Pacific's loan book. Not only was it a large loan, but it was a loan that had been singled out by an independent expert as a non-complying loan. It had been the subject of specific and unequivocal recommendations.
405 It is unnecessary to discuss in any detail Mr McCormick's evidence in relation to the SVP report. The short point is that he was aware of the findings and recommendations concerning the AGA facility, but did nothing whatsoever to ensure that the recommendations were acted on. He never sought or obtained a valuation from a different valuer. He took no steps to have the AGA facility repaid or refinanced on or after 31 December 2005 when none of the conditions referred to in the SVP report were satisfied. He claimed that he had no recollection of any discussions with Mr Sullivan concerning those matters. Mr McCormick's only explanation for not doing anything regarding the SVP recommendations was that he believed that someone in "treasury" had a different view to SVP about what Lending Manual category the AGA facility fell within. That, of course, provided no good reason or justification for completely ignoring the recommendations.
406 Mr McCormick was also aware of SVP's recommendation that loan proposals contain a separate certification by the lending manager in relation to the acceptability of the valuation. He was aware that this recommendation was implemented by changes to the Lending Manual. Notwithstanding that, he ignored the recommendation and new procedure when it came to the AGA facility. He included no such certification in the backdated proposal to increase the AGA facility limit to $44.87 million or $55 million which he prepared in late December 2006. Given that he included the certification in other proposals he prepared at the same time, it can only be inferred that Mr McCormick deliberately ignored that procedure in the case of the AGA proposal.
407 It is difficult to escape the conclusion that Mr Sullivan and Mr McCormick acted together in deliberately ignoring, or taking no steps to implement, SVP's recommendations concerning the AGA facility. For whatever reason, they decided that they would not, or could not, require AGA to repay the facility. They deliberately chose not to retain a different valuer because they well knew that a valuation from a truly independent valuer would not support the size of the AGA facility. Those inferences are supported by the evidence that Mr Sullivan and Mr McCormick acted together in relation to the purported approval of the increase to the facility limit to $26 million in July or August 2006.