Loading Up The SFO

Be careful what you wish for....

On the 29th November the SFO let out the worst kept secret in town. They have been investigating Hanover Finance. This investigation has been on-going for three months apparently.

The downfall of Hanover has been done to death by repeaters, reporters and commentators. I had a good slash at their failure as well here but it must be time a year on to bring in Allied and their complaint to the SFO. My emphasis in bold below. According to the SFO on their own website.

"Mr Feeley said that having considered the Securities Commission report and the complaints of a number of persons, including Allied Farmers, the efforts of the SFO investigation was best focused on several key areas relating to the payment of dividends and other transactions occurring immediately prior to announcement of the moratorium proposal, and debt restructuring involving the transfer of assets to Allied Farmers.

We will be interviewing a small group of key Hanover staff and professional advisers to seek explanations of these transactions.

Mr Feeley said that the even with a tightly focused investigation, the scale of the task was such that the SFO would be engaging significant external resources.

In addition to a large internal team, and collaboration with the Securities Commission and Registrar of Companies, we have engaged a number of New Zealand’s senior legal counsel and leading forensic accountants to assist us.”

The investigation has been elevated to a Part 2 where:

“the Director has reasonable grounds to believe that an offence involving serious or complex fraud may have been committed…”

Again leave aside the history of Hanover for one moment, given that you could put any 12 men and women on a jury for anything including a murder of the most vicious gang member in the country right now and Hotchin and Watson would be found guilty of it, such is the public bias that the media, industry and commentators have built against them.

I wish to look at the conduct of Allied. This apparent “victim” of a serious fraud.

Allied as a “victim” of fraud

From Feeley's release above what we now know for sure about the SFO investigation pending is that:

- Allied are a complainant against Hanover
- They are looking specifically at dividends and transactions before the moratorium proposal
- They are also looking the transfer of assets to Allied
- This investigation will take “significant” taxpayer resources, including external experts.

My issue with Allied complaining about Hanover's conduct is quite simple. The taxpayer is now paying big money for investigating aspects of the transaction that Allied should have undertaken before they conducted the transaction in the first place with Hanover.

I liken it to a house purchaser buying a leaky home, knowing it was leaky as the media and financial community had reported it extensively, buying “as is”, using their own experts in conducting a full inspection on the house so they knew precisely what was wrong with it when they paid a reduced purchase price – and now running to the authorities such that the taxpayer has to assist them in prosecuting the seller of the leaky home that everyone knew leaked.

That is analogous to Allied making a complaint against Hanover for fraud. It is a good analogy as Hanover was a property finance company. It is even better as Hanover investors voted for the proposal as did Allied shareholders.

Jane Diplock, in a rare move went to the bother of putting out a "cheat sheet" if you like about the Allied/Hanover transaction. Most telling is this answer to her own set of questions.

If the proposal goes ahead and you hold on to your shares then you are taking a risk on the ability of the Allied board and management to get more value out of Hanover's assets than Hanover managed to. The Allied board believes that it can do this.

Allied are in plain language, failing to do this and need someone to pin it on.

Hanover turned tits-up because they took funds, onlent to persons who didn’t pay them back and to companies that failed or are slow paying. Simple. So who are the villains in the piece? Those who set up the financing or really those who made promises to pay and then couldn’t so didn’t, sending the finance company to the wall in the first place.

Worldwide in the past few years, trillions of dollars of assets have been written-down, written-off and binned. Thousands of hedge funds are now worth zero, ditto share certificates. Most without any fraud at all and all due to the GFC (global financial crisis). In New Zealand those who borrowed money to build houses for New Zealanders to buy, New Zealanders all with the hit and hope strategy of making a tax-free capital gain, went to the wall. Property developer scalps are littered all over New Zealand unable to repay the finance companies who lent them money to buy properties that New Zealanders were meant to buy. On figures available New Zealanders were going to keep buying. So where is the fraud in any of this? A large market tank of commercial and second property (beach property) seems the simplest explanation looking at the Allied assets taken from Hanover. Failing at business when you have vulture scalped the "best" assets of a failed company doesn't necessitate a fraud inquiry.

When things are going well, no one notices what is happening in a company because no one has to my knowledge, ever complained to the SFO about making too much money have they? When there is an economic downturn people look for someone to blame for their money being lost.

Dividends

Some of the lending and other transactions in Hanover were inter-related. At one time when the company had assets on the book of $1,025b, only $199m or around a fifth of that was inter-related and at some point this increased to around a third. Some of this was to Hotchin and/or Watson’s own companies but ultimately their success or failure depends on demand for their developments and profitability of their businesses. If property was sold they would have succeeded. It didn’t, they lost money and everyone else did as well.

Much is made of this inter-related lending but it was a fraction of the issue. As are the dividends paid. Related party transactions

$45.5 million was paid in Hanover’s last gasp as dividends. Much has been made of this.

Even if we took that $45 million and crudely spread it like a Socialist over the 17,000 “investors” each would receive the paltry sum of $2,647.06.

Even in the life of one of those foolish old-aged pensioners paraded as victims of this alleged “fraud” that sort of sum isn’t going to make a flying bit of difference to that person eating or not is it? No one has listened to the cry at the time from Hanover that all this money according to reports was all tipped back into the company plus another $25 million. Don’t want to know do they? It is far easier to report the villainous side of the story.

Bernard Hickey gasped at $5 million paid to Hotchin and Watson and demanded it be paid to the “investors”. Spread over the 17,000 “victims” that’s $294.12. Or less once you took administration costs off distribution to 17,000 parties. Allied haven't paid it and Hanover are now taking them to court.

Is this all fraud? To go to top tier legal firms and get their precise expert legal advice on point of when you can declare a dividend and ensuring that to the letter of the law at the time its capital adequacy ratios are maintained? Hardly. It is prudent business practice to ask for expert opinion and as long as Hanover directors did this, I cannot see the problem.

Anytime a dividend was proposed I cannot imagine Hanover not going to its lawyer and accountants and asking for specific advice on the transaction. Commentators know this and have therefore skipped over the point and whinged that legally they may have been able to do it but what about the morality of it? When attackers cling to morality in justification for publicly hanging a corporate, you know the attacker has lost. A Nation's laws at the time are its morality.

There is no room for morality at all in an argument where you wish to have someone charged with a criminal fraud which is what the investigation has moved on to. At best the dividend issue is a civil legal matter and again – not something that the SFO should be spending taxpayer money investigating.

I took it upon myself to contact Roger Wallis at Chapman Tripp with this question and specifically a couple of others as I advised him I was going to write a blog post regarding, asking him to release a copy of the specific legal opinion on which these dividends were paid. With the SFO investigation entering Part 2, he’s wrapped up tighter than a nun’s **** presently by law and so emailed back promptly with:

“Unfortunately I am not going to be able to comment at all at this stage”.

The “unfortunately” is careful legal speak for – “this is a load of **** but we cannot defend ourselves now as we are under investigation”. A common position and a legal strategy in tying your opponents up while you continue to publicly pound the life out of them in the court of public opinion.

As reported in a Fran O’Sullivan column, one of many she has crafted on the issue of Hanover and Hotchin, Wallis has in the past eventually answered concerns from an investor in a reasonably direct fashion so appears to wanting to answer even if no one is actually listening to and taking on board his points because again no one wants to listen to the opposing arguments. They aren't sexy and are often difficult to comprehend. Remember these detractors in many instances threw their life-savings at Richard Long. They are not necessarily the sharpest knives in the drawer and at this point are so desperate they will support Hotchin and Watson being attacked for anything in a form of mass Hanover Utu.

Again the dividend issue is little stuff in the scheme of things and based on the classic New Zealand “Kiwi” attitude that because someone is richer than you are, then they should bare the load of any loss in a commercial venture, because, you know, they are richer than you, drive a nicer car and can afford it.

It is not something that the SFO needs to be dealing with and if Allied are a part of that as a complaint then they have no grounds to be as it is none of their business how dividends were paid prior to their interest in the company a they should have known what was happening. For reasons I bring up later.

Dividends and inter-related lending didn’t bring down Hanover. Lending to those who invested in property did. You know, those developments that one day you as a New Zealander may be living in, trying to buy low and sell high, just like everyone else…driving demand for more development, rental properties and more requirements to have second tier lending when the banks say no. Those developments that worldwide have suffered slumps and wiped off asset portfolios everywhere. It is not a New Zealand unique problem.

Debt Restructuring and Allied Transfer

This is where Allied’s complaint would most likely have centred.

Rob Alloway has previously accused Hanover of forgiving substantial loans in the weeks before Allied bought the Hanover portfolio for $396.2 million.

Allied Dobbed Hanover to Regulators and that they did.

The comments from the want-away Managing Director Rob Alloway in this article from the NBR are quite astounding when read in conjunction with his comments of around a year ago when he was selling the deal:

“We were quite shocked at some of the activity that took place prior to our acquisition of the assets and immediately moved to alert regulators.

We feel that the actions of the Hanover Board and management while under moratorium have had a significant impact on the value of the assets, and investors deserve to have this investigated.

These comments indicate that Allied’s due diligence was either non-existent or failed and there were no or hopeless warranties relating to material transactions. Remember again Allied weren’t acquiring a blue chip company with a brilliant track-record of profitability, they were buying one of the most written about, vilified companies in New Zealand’s recent history. Hanover was already in a DRP (debt restructure plan) and failing to make payments. The writing was on the wall.

Again, Allied weren’t just buying a leaky home, but a leaky home with signs outside with proof of the leaks. Some have called Hanover a “lame elephant”. That’s the understatement of the century, Hanover was a three legged elephant that was being asked to carry sumo wrestlers round the jungle. Everyone knew it, so what made Allied think they could either a) turn it around or b) that they knew something everyone else didn’t about how they could grow a fourth leg for the elephant.

Most journalists and business commentators sat on the fence regarding Allied’s proposal for Hanover investors. Financial advisors ducked for cover under their furniture knowing they'd made such a porkie with Hanover in the first instance and referring their clients into other finance companies. Even investor friendly-Bruce Sheppard threw his rag at “investors” who wanted advice. Leaving them to the hounds on the basis of being stupid in the past. But Grant Samuel went as far as stating Hanover investors had no choice but to accept the offer.

Business involves managing risk and here a thorough due diligence and agreements with massive warranties on sale should have been executed by Allied.

In Allied's own recent 2010 report they confidently discuss due diligence head on:

Allied Farmers has been the centre of much criticism around its due diligence processes surrounding the acquisition however, it appears to have been conveniently forgotten that these same assets were audited, overseen by an independent Trustee and the subject of review by other third parties on numerous occasions, with a valuation not too dissimilar to the attributed acquisition value of $396.2 million.

Really? In other words if this is really the case, Allied should be trotting off to court and suing those parties listed above who looked at the numbers. The ones they hired that is. They must have "conveniently forgotten" that when crying off to the Regulator.

The SFO Complaint

Nowadays litigation is so expensive and elongated to get an outcome that one way of effectively burying your competitor for free and attempting to absolve yourself publicly of any fiscal responsibility is to accuse them of fraud. Fraud is nasty as it is criminal and takes a very long time to investigate. Any major loss of value on what the Allied deal was executed for was always going to result in a fraud allegation because Allied shareholders were going to run at their own Board for recommending the deal. And like little puppets for fiscal losers, the SFO have run with Allied’s complaint rather than telling them to go to other avenues they should have gone to. And paid for themselves.

The SFO may throw charges everywhere but they will have a major job in convicting anyone in Hanover on the dividends and inter-related loans as it would all have been driven under extensive legal advice from the likes of Wallis and big four firms. These opinions and advice are extensive documentation. Allied would have received their own legal opinions. Even Jane Diplock recently threw her hands up when attacked regarding finance companies and bit back with :

"Many of the prospectuses had been extremely well drafted by the best lawyers in the country, Diplock said".

Indeed, and if the prospectuses and the ensuing activity and decisions of the finance company followed the law as drafted, there is little Diplock could do because what was happening was perfectly legal. Losing other people's money in poor market conditions is not a crime, else most NZX company directors would at some point be serving a stint in the Big House.

No one seems too concerned that behind every prospectus distributed were financial advisors who charged clients to manage their financial affairs but were acting predominantly as retail salesmen and women. Financial advisors who necessarily didn't read prospectuses and a load of people too darn cheap to get another lawyer to pick apart the prospectuses and find out what most of these finance companies were actually investing in. A general problem of most "unsophisticated" "Ma and Pa" investors - their advisors are either idiots or on the take themselves. They don't seek pricier independent legal counsel so in my view get what they deserve if they sign up to often 30 or 40 page prospectuses without understanding what they sign up to. You can't legislate to protect that and neither should you.




In November 2009, this man, Rob Alloway sold the Allied/Hanover deal of $400m of assets (now worth $94.3 million and sliding) to Hanover investors with this pitch:

"This isn't some rumpety transaction to create some paper company. We have the vision to create a solid rural services and financial services company with plenty of equity and very little debt," he said. "We want to grow a business which is high-performing and delivers equity growth and earnings growth in the future."

Mr "Rumpety Transaction" resigned as MD in September 2010, but has been re-instated for six months. Under what circumstances is anyone's guess.



John "Bolter" Loughlin had already scurried from Allied Finance Unit as Chairman in September 2010. Tradition says that Chairmen stay for the benefit of shareholders. Obviously he saw Allied had stuffed up enough that the money wasn't worth the effort and so he fell on his sword.

In their press release of 30 June 2010, Allied stated they wouldn't pay Hanover the $5 million and listed some reasons why Hanover breached agreements:

• to administer its assets in the usual and ordinary course;
• to consult with Allied Farmers in relation to proposed transactions;
• not to dispose of any Finance Asset without the prior consent of Allied Farmers;
• not to terminate or adversely vary or fail to enforce the terms of any Hanover contract assumed by Allied Farmers;
• not to enter into any abnormal or unusual transaction which adversely affected its assets; and
• to apply cash generated after 30 June 2009 only to specified costs or pay it to Allied Farmers.

Hanover is now going the correct route - to the courts to battle this one out.

This release does however point to the sort of issues Allied must have alleged of Hanover to stick in an SFO complaint. Civil matters, dealt with in the courts.

Allied also released this to their shareholders on 20 November 2009 representing to their shareholders the following:

Extensive due diligence was carried out by Allied and its advisors to arrive at the agreed net asset value figure of $396.2 million. However, an adjustment mechanism formula will be applied in June 2011 which will adjust the original share allocation formula/ratio between existing shareholders and the incoming Hanover and United investors. This is to ensure fairness should the amount recovered from the assets be less than the amount we will pay for them. To achieve this, existing shareholders will be issued Bonus Securities. A review of recoveries received up to June 2011 will be made, together with a reassessment of the value of any finance assets we still hold and, if that total is less than $396.2 million, the Bonus Securities will result in your holdings of ordinary shares being increased so as to restore the appropriate relativity. If the total is greater than $396.2 million, no shareholding change occurs and all shareholders will benefit from that uplift.

The Allied team sold the transaction so well to their shareholders that at the Special Meeting of Shareholders on 8 December 2009, almost 90% of Allied shareholders approved the Hanover deal.

Allied Farmers Annual Report 2010

What we can see is that Allied negotiated in a commercial "adjustment mechanism formula" in June 2011. This formula is discussed on page 14 of Allied's Annual Report:

The Exchange Agreement provides that a “Shortfall” will exist if in respect of the period up to 30 June 2011 the total amount achieved from the realisation of any finance assets and the total value of any such assets still held by Allied Farmers Investments Limited or any on-transferee of such assets (in each case, determined on a consistent basis with the price allocated under the Exchange Agreement) is less than the $396.2 million price attributed to those assets under the Exchange Agreement. This calculation will be made as part of the audit of the Company’s financial results for the period ended 30 June 2011 and is expected to be announced at the time the audited financial statements are released.

So due to their negotiated assessment of the downside risk for their own shareholders using the adjustment mechanism formula, Allied therefore do not necessarily need to worry so much about the valuations or Hanover's prior conduct, they are really just using the SFO to counter-balance criticism of their own shortcomings. Their MD resigned and came back, their Chairman walked out on the shareholders and now they pawn Hanover off on the SFO. Where is their responsibility in this? The Directors who backed the deal and sold it to the shareholders? The shareholders themselves for buying that proverbial "leaky home"?

New Zealand however doesn't seem to be a country for responsible informed and educated investing, people want upside reward without accepting and manning-up to downside risk. It doesn't want to be a country where loses are taken as part of business. It doesn't want to be a country where questions can be asked really if some people are just too stupid to have money to be allowed to choose their own investments.

It's easier to put your complaint on the grand pile at the SFO and have those you hate subjected to a criminal investigation.

The New Zealand Way..........

All at the taxpayers expense.