Auditors, trustees, directors, CEOs savaged in official report on finance companies 'operating like Ponzi schemes'

A report on finance company failures by the Companies Office said it understood a number of the failed companies were operating in a similar manner to ponzi schemes, where funds received from new investors were used to repay maturing deposits. "It is our understanding that a number of the failed finance companies were in the end acting in a similar manner to Ponzi schemes," the Registrar of Companies Neville Harris said in the report to Parliament's Commerce Committee said. The full report is here as Appendix B starting on Page 8. "In many cases, funds received for investment from new investors were used to repay the maturing loans of existing investors. In these circumstances the companies continued taking in funds many months after their position was irreversible, thus exposing investors to immediate losses," the report said. The report also hit out against "second-tier" accounting firms, such as BDO Spicers, Staples Rodway and Hayes Knight, used by many of the finance companies. It questioned these firms' capabilities and experience to audit the companies with due diligence.

"Issues arose as to whether they had sufficient capability and experience to conduct the initial due diligence for the assignment and to audit such complex and elaborate company and business structures," the report said. Auditors hammered "As a general observation, the audits of many of these finance companies lacked the rigour and analytical depth one would expect for entities managing substantial public investments. There is a view among receivers that if they had been rigorously audited, it is unlikely many of the failed finance companies would have continued in business for as long as they did." The report noted that the 'big four' accounting firms (Deloitte, Ernst & Young, Pricewaterhouse Coopers and KPMG) "were not particularly interested in finance company audit appointments," with KPMG seemingly the only one of the four to act as auditor for more than one finance company. Third party debacle Lending practices were called into question, with a focus on related party lending for the benefit of directors of the finance companies. Concentration of loan risk was also labeled as an issue. "A number of the finance companies engaged in excessive related-party lending with investors funds, often in circumstances where funding for the particular venture could not be sourced from conventional funding sources. In some cases, the only objective of entering into one of these transactions was to benefit one of the directors (or interests associated with the directors) or prop up a poor performing investment," the report said. "The largest finance companies often had significant reliance on the success of one industry and/or a very small group of borrowers. By way of example, the loan books of Bridgecorp and Lombard Finance Limited were heavily weighted to the speculative end of the property market. The exposure of these finance companies was such that they had no choice but to continually roll over poor performing loans until the borrower's development project could be completed." Directors useless A "key factor" in the "failure of the finance company industry" was the quality of corporate governance of the companies, the report said. "In a number of cases, these companies were dominated by a chief executive who was the principal architect of the company's modus operandi. The boards tended to lack the breadth of experience and skills required to oversee the scale, complexity and characteristics of financing operations. Too often directors were not adequately informed, misled or failed to take sufficient interest in the affairs of the company. There is also a pattern of the company's CEO or directors having been involved in previous financial industry failures." Perpetual and Covenant criticised Trustee companies, Perpetual and Covenant, were earmarked for their apparent lack of "adequate understanding of the risk profile of finance company lending, to deal effectively with what turned out to be widespread failure within their finance company client list." Some of the trust deeds between the trustees and finance companies were "too weak", given the activities many of the companies were engaged in, and they "did not appear to have enough sufficiently experienced staff" to deal with their client lists, the report said. "In our view, Covenant and Perpetual were slow to detect adverse financial issues developing and they responded too timidly to circumstances where investors' interests were being put in jeopardy," it said. 'No regulation of moratoria' Finally, the report looked at the issues surrounding finance companies now operating under moratorium, saying: "There is no regulatory oversight of these moratoria, matters being left with the companies, their trustees and the affected investors," the former two having been placed under the spotlight earlier in the report. "The various moratorium proposals have been the subject of some criticism, however investors have agreed to delayed repayment plans approved by the company's trustee so there is no reason or room for a regulatory agency to intervene. Some observers have expressed concern that moratoria avoid the accountability and inquiry that directors and others may face in a receivership or liquidation situation. There is an emerging trend of a number of moratorium proposals failing to meet the forecast expectations on which they were offered to investors." See our definitive Deep Freeze List of failed finance companies in New Zealand, how much they owe, and the main people involved, including Trustees. Also, see our Deep Fees List containing information on receivership costs and legal fees charged to failed finance companies that are in receivership, and how these relate to the expected payouts to investors.