Brian Gaynor: Regulations, not personalities, count

Photo / Sarah Ivey

It is difficult to write about Allan Hubbard and the Government's decision to place him, his wife, Aorangi Securities and seven charitable trusts into statutory management.

This is because Hubbard is a very likeable person as well as being one of the country's most highly regarded individuals due to his business acumen, generosity and humility. Consequently he enjoys enormous support, particularly in the South Island.

There is widespread belief that the Government's move is unjustified because investors haven't lost any money. Ironically, the same people have also argued that our regulators should have moved earlier with the failed finance companies, before investors suffered losses.

The response to Hubbard's statutory management clearly demonstrates that investors need to sort out two important issues:

* Do they want regulators to move on poorly managed companies before investors lose money or do they want the regulators to wait until losses have occurred?

* Should individuals who are generous - and make large donations to charity - be exempt from securities regulations and best practice business standards?

The issues regarding Hubbard are quite simple; should Aorangi Securities have issued a prospectus, were its funds lent without adequate security and should any of this money have gone to Hubbard and his wife Margaret?

On Sunday afternoon Commerce Minister Simon Power issued a press release revealing that Hubbard, his wife, Aorangi Securities and the charitable trusts had been placed into statutory management. He also said a number of issues had been referred to the Serious Fraud Office.

Power said that the main objectives of the move were "to prevent fraud and reckless company management, to protect investors and to enable the orderly administration of a company's affairs".

A diagram of Aorangi Securities, which is the main company in the statutory management structure, was attached to Power's press statement. The diagram is reproduced here.

Aorangi Securities, which was formed in 1974, is owned by Allan and Margaret Hubbard and they are the only directors. It was a contributory mortgage company but seems to have been transformed into a finance company, raising funds from investors and on-lending these funds to investors.

As the diagram shows it borrowed around $98 million from over 400 investors in Otago and Canterbury and this was supposed to be on-lent on a first mortgage security basis.

One of the first issues is the absence of a prospectus. This seems to be inconsistent with securities regulations which require a prospectus to be issued when an offer is made to the public. As far as debt securities are concerned the issuer must also "appoint a person as a trustee in respect of the security" and that person must "sign a trust deed relating to the security".

Aorangi doesn't appear to have either a prospectus or trust deed.

According to Power's diagram an undefined proportion of this money was lent to commercial interests, some of which was secured, and the remaining went to the Hubbards on an unsecured basis.

According to Power's fact sheet many of the loans made by Aorangi:

* Are inadequately documented by way of term loan contracts or loan agreements.

* Appear to be unsecured.

* Appear to be made contrary to instructions given by investors that their deposits be lent under the security of a first registered mortgage.

If this is correct then unsecured loans to Hubbard and his wife are inconsistent with the instruction to lend this money on a first registered mortgage secured basis.

This is an important matter and was the main issue in the huge $45 million settlement reached between ING (NZ) and ANZ National Bank with the Commerce Commission, which was announced this week.

The commission was more concerned about where monies in the ING Diversified Yield Fund and ING Regular Yield Fund were invested, and the misrepresentation of risk, than the amount of money lost by investors.

According to the Commission: "It is important that consumers are able to make properly informed decisions, based on clear and accurate information. Investors decide where to invest their money based largely on their appetite for risk. Throughout our investigation investors have told us that they would not have invested in these funds if the actual risk had been represented accurately."

The same should apply to Hubbard. If investors were told that their Aorangi money would be invested on a first registered mortgage security basis then that is where it should have gone and not into unsecured loans to the company's directors.

The day after the statuary management decision Hubbard released a statement with the following Aorangi figures:

* Aorangi has $88 million of depositors' money, not the $98 million released by the Commerce Minister.

* The company had $126 million of loans, $2 million of cash and equity of $40 million.

The announcement didn't say how much of the $126 million of loans was to directors but Hubbard promised that if investors were not paid in full then he would meet any shortfall "provided it is within my resources" to do so.

The Hubbard issue is somewhat similar to the controversy over politicians and the use of their credit cards for personal expenditure.

It is wrong for politicians to use ministerial credit cards for personal expenditure, even if they pay the money back, as it is inappropriate for company directors to access money on a unsecured basis, when the funds are supposed to be secured, even when they intend to pay it back.

The Securities Commission and Serious Fraud Office seem to be concerned with Hubbard because he took money from Aorangi on an unsecured basis, with inadequate documentation and security, and this is a misrepresentation of risk as far as investors are concerned.

Would the major trading banks allow their directors to take money out of client accounts on the basis they would be able to pay it back? This is a ridiculous suggestion yet there seems to be widespread support for this sort of behaviour at Aorangi.

What would be the outcome if something happened to Hubbard? Would his beneficiaries be prepared to meet his promises to Aorangi? What would happen if Hubbard ran out of money and was unable to meet any shortfall? Hubbard argues that none of his investors have lost money but South Canterbury Finance, which had a large number of related party loans, had total losses of $362 million for the 18 months ended December 2009.

The company would probably have failed without its government guarantee.

The issue here is whether Hubbard's indiscretions are little more than oversight and laxness, as John Kidd of McDouall Stuart has argued, or it is more serious than this.

Timaru lawyer Edgar Bradley, a long time friend of Hubbard, told the media: "If a sometime criticism of Allan is a lack of documentation then it must be remembered he is a product of days when trust was more important than paperwork. Sadly the reverse is now the case."

Bradley's view is misguided because trust and documentation are both vitally important in the modern era and the former has not replaced the latter.

The clear message from the Hubbard's statutory management and Serious Fraud Office investigation is that regulators believe that he has obtained funds from Aorangi on an unsecured basis when investors have been told that their money would be secured.

Regulators cannot condone this behaviour on the basis that Hubbard, or anyone else in the same situation, promises to meet any shortfall.

* Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management.