BENEFICIAL FINANCE - THE ORGANISATION, ITS DIRECTION-SETTING
AND PLANNING, AND THE MANAGEMENT OF CREDIT
CASE STUDY IN CREDIT MANAGEMENT: PEGASUS LEASING
TABLE OF CONTENTS
33.1.1 REFERENCE INFORMATION
33.1.2 BASIC CONCEPTS RELEVANT TO PEGASUS LEASING'S BUSINESS
126.96.36.199 The Nature of Pegasus Leasing's Leases
188.8.131.52 "Reverse Principal and Agency" Agreements
184.108.40.206 The Basic Premise of Beneficial Finance's Operating Joint Ventures
220.127.116.11 The Pegasus Leasing Joint Venture
33.2 THE FIRST JOINT VENTURE: AUGUST 1985 TO DECEMBER
33.2.2 INITIATION OF THE FIRST JOINT VENTURE
33.2.3 THE STRUCTURE AND MANAGEMENT OF THE FIRST JOINT VENTURE
33.2.4 THE BUSINESS ACTIVITIES OF THE FIRST JOINT VENTURE
18.104.22.168 The Nature of the Business
22.214.171.124 Reverse Principal and Agency Business
33.2.5 THE PERFORMANCE OF THE FIRST JOINT VENTURE
33.2.6 SUMMARY AND CONCLUSIONS
33.3 THE PEGASUS LEASING JOINT VENTURE: JANUARY 1988 TO
33.3.2 INITIATION OF THE PEGASUS LEASING JOINT VENTURE
33.3.3 THE STRUCTURE AND MANAGEMENT OF THE PEGASUS LEASING JOINT VENTURE
33.3.4 THE BUSINESS ACTIVITIES OF THE PEGASUS LEASING JOINT VENTURE
33.3.5 THE PERFORMANCE OF THE PEGASUS LEASING JOINT VENTURE
33.3.6 RESTRUCTURING OF THE PEGASUS LEASING JOINT VENTURE
33.3.7 SUMMARY AND CONCLUSIONS
33.4 PEGASUS LEASING AFTER MAY 1990
33.4.1 RESTRUCTURING OF THE JOINT VENTURE
33.4.2 TERMINATION OF THE JOINT VENTURE
33.4.3 THE LOSSES ARISING FROM PEGASUS LEASING
33.4.4 A HINDSIGHT REVIEW BY BENEFICIAL FINANCE
33.5 RELATED PARTY TRANSACTIONS
33.6 FINDINGS AND CONCLUSIONS
33.7 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
33.7.1 TERM OF APPOINTMENT A
126.96.36.199 Term of Appointment A(b)
188.8.131.52 Term of Appointment A(c)
184.108.40.206 Term of Appointment A(d)
220.127.116.11 Term of Appointment A(e)
33.7.2 TERM OF APPOINTMENT C
33.1.1 REFERENCE INFORMATION
||. Pegasus Leasing
||. Beneficial Finance
. Pegasus Securities Limited ("Pegasus Securities")
||. Bloodstock Leasing
and General Finance
. Debt Factoring
. Insurance Broking
|. Leasing finance
involving a large volume of transactions.
at 31 January 1991
. Pegasus Leasing
. Pegasus Securities
at 31 January 1991
. Pegasus Leasing
. Pegasus Securities
33.1.2 BASIC CONCEPTS RELEVANT TO PEGASUS LEASING'S
This Chapter reports the results of my Investigation of
Pegasus Leasing, a joint venture between Beneficial Finance and Pegasus Securities
Limited, a public company effectively controlled at all material times by Mr J A McGregor.
Established in August 1985, Pegasus Leasing was an
operating joint venture (as opposed to a project-specific joint venture) that carried on
business as a financier, principally to the bloodstock industry, until about December
1990. Beneficial Finance's involvement in the joint venture was regarded by it as an
extension of its core business activities into a new and specialised area. The rationale
of the joint venture was to combine the specialised bloodstock leasing experience and
expertise of Pegasus Securities with the financial resources of Beneficial Finance, to
grow a business from which both partners would profit.
Before reporting the results of my examination of the
Pegasus Leasing joint venture, it is necessary to briefly explain two important features
of its business, an understanding of which is fundamental to the events described in this
18.104.22.168 The Nature of Pegasus Leasing's Leases
First, it is important to appreciate that the leasing
carried on by the joint venture was, in substance, a form of lending.
Shortly stated, there are two types of leases, called
operating leases and finance leases. Operating leases are familiar to anyone who has ever
hired a car or paid rent. The asset is owned by the lessor, who lets the lessee use or
operate the asset, usually for a short period of time relative to the life of the asset,
in return for lease payments colloquially called rent. The lessor owns the asset, and
subject to special agreements, enjoys the benefits and runs the risks of the asset going
up or down in value.
In contrast, finance leases are a specialised form of
lending. Instead of a person borrowing money from a finance company to buy an asset, the
finance company buys the asset, commonly plant and equipment or motor vehicles, and leases
it to the person. The lease payments made by the lessee/borrower represent, in substance,
the payment of interest and part repayment of the principal amount of the
"loan". At the end of the lease/loan period, the lessee pays a
"residual" amount to become the owner of the asset. The residual is, in
substance, the unrepaid principal balance of the loan, and is not related to the actual
value of the asset at the time. Loans are structured as finance leases principally for
The leased asset usually provides security for the
"loan" represented by the finance lease, with the finance company's
"ownership" representing a form of legal mortgage over the asset. If the
lessee/borrower fails to make the lease payments representing interest and part repayment
of principal, the lessor/lender will "repossess" the asset to recover the
unrepaid loan amount.
In the case of Pegasus Leasing, the assets being leased
were principally thoroughbred horses. In evidence to my Investigation, Mr E P Reichert,
the General Manager of Beneficial Finance's Structured Finance and Projects division,
agreed that the leases granted by Pegasus Leasing were similar to motor vehicle leases,
and that the horses were the security for the loans.()
The value of the horses was not included in Pegasus
Leasing's balance sheet. Instead, Pegasus Leasing's assets were the amounts to be received
from the lessee/borrowers. The amounts were called "receivables", and were the
total of the lease payments (representing interest and part repayment of the principal),
and the residual (representing repayment of the balance of the loan), to be received by
Pegasus Leasing from its clients, the lessees/borrowers. In this Chapter, references to
leases should be thought of as being references to loans.
22.214.171.124 "Reverse Principal and Agency"
As well as carrying on business in its own right, Pegasus
Leasing made some loans, in the form of finance leases, as an undisclosed agent of both
Beneficial Finance and the State Bank, pursuant to what were called "Reverse
Principal and Agency" Agreements.
Although the terms of such agreements can be complicated,
their basic elements are simple. Instead of carrying on a financing business in its own
name and with its own managers and staff, a finance company (such as Beneficial Finance)
appoints an agent to carry on the business on its behalf. The loans are still loans of the
finance company, and will appear in its balance sheet. The loans are, however, arranged
and managed by the agent. Indeed, the borrower may not even be aware that the
"real" lender - the finance company bearing the credit risk of the loan not
being repaid - is someone other than the agent.
A finance company will enter into such an arrangement as a
means of expanding its business into new and specialised areas. The agent may have
particular expertise, and an established reputation and clientele, in the type of
financing that the principal wants to engage in, such as providing finance leases for
The agent will enter into the arrangement as a method of
growing its business beyond the limits that would apply if it had to rely on its own
The terms of a Reverse Principal and Agency Agreement can
vary widely. For example, the agent could be made liable to indemnify the principal for
some or all of any bad debts resulting from the loans. The agent might receive a
commission on new loans, a management fee based on the total loan portfolio, or a profit
share. Variations to these terms can affect the fundamental nature of the arrangement. For
example, if the agent is responsible for approving the loan and for any bad debts that
result, and receives a profit share, is it really acting as an agent, or is it in
substance making loans on its own account, funded by the finance company?
As I shall describe, this confusion arose in the case of
Pegasus Leasing, which provided leases as the sub-agent of Beneficial Finance under a
Reverse Principal and Agency Agreement between Beneficial Finance and the State Bank. That
Agreement was entered into as a result of a taxation ruling by the Commissioner of
Taxation in 1985 which effectively prevented finance companies from providing both finance
leases and operating leases to their clients. To overcome that restriction on its
business, Beneficial Finance provided finance leases ostensibly as the agent of the State
Bank. In legal form, Beneficial Finance was the agent of the Bank. In substance, however,
the Reverse Principal and Agency Agreement was simply a funding arrangement. Under that
Agreement, the Bank provided funds at an interest rate unrelated to the rate charged by
Beneficial Finance, did not pay any commission or management fee, had no input into or
control over the credit risk associated with Beneficial Finance's leases, did not keep any
record of the clients, and did not bear the credit risk. In short, for taxation reasons
the agreement had the legal form and effect of an agency agreement, but was in substance a
funding arrangement, and was treated as such by the management of Beneficial Finance. That
treatment eventually resulted in the State Bank, rather than Beneficial Finance, bearing
the losses resulting from the Pegasus Leasing joint venture's lease portfolio.
126.96.36.199 The Basic Premise of Beneficial Finance's
Operating Joint Ventures
Basic to the operations of the Pegasus Leasing joint
venture were the joint venturers' intentions in entering into the joint venture, and their
expectations of how it would operate.
Beneficial Finance's objective in entering into the joint
venture was to expand its business activities into new areas which, although they were an
extension of Beneficial Finance's own core businesses, were outside the scope of its
experience and expertise. Beneficial Finance was to provide the financial backing, and
Pegasus Securities the expertise, to carry on the joint venture business. In the words
of a Joint Venture Quarterly Report presented to the Board of Directors of Beneficial
Finance at its meeting on 16 December 1986, the joint venture was "seen as a
vehicle to pool the market knowledge and expertise on bloodstock leasing of Pegasus
Securities with the financial resources of Beneficial Finance."
Pegasus Securities' understanding of the responsibilities
of the joint venture partners was stated in the minutes of a meeting of that company's
Board of Directors held on 13 May 1985:
"Pegasus Securities would be responsible for
identifying and writing business, particularly in bloodstock leasing, to the extent of
between $1.75M and $2.0M per month.
Beneficial Finance is to be responsible for the
obtaining of wholesale funding at rates expected to allow a spread of up to 4 per cent per
annum. Beneficial to charge a guarantee fee of up to 1 per cent per annum where
This understanding was confirmed by Beneficial Finance's
letter dated 16 May 1985 to the directors of Pegasus Securities, which stated that Pegasus
Securities was to be responsible for sourcing business for the joint venture, and for the
granting of leases and the maintenance of the receivables portfolio. The letter was
co-signed by Mr Reichert, then Beneficial Finance's General Manager, Asset Acquisition and
A file note dated November 1986 prepared by Price
Waterhouse of a discussion with Mr G O'Brien, a Beneficial Finance executive who was a
member of the Joint Venture Management Committee, records Mr O'Brien's advice that:
"Pegasus Securities required funds for expansion,
which has resulted in Beneficial Finance becoming part of the business, as financier ...
Beneficial Finance are well aware of the opportunities that exist in such areas as
bloodstock leasing, however they are also conscious of the fact that they are not as able
to identify the value of such animals on their own. To enter into a venture on their own
would expose the possibility of significant losses being made."
This basis of the joint venture was common to most, if not
all, of Beneficial Finance's operating joint ventures. A Joint Venture Status Report dated
16 October 1989 prepared by Beneficial Finance's Management stated that "the
premise" of the joint ventures was that "Beneficial Finance has the
financial strength and the joint venture parties have the expertise". The Report
stated that Beneficial Finance often had total responsibility for funding the joint
"... the strong growth of some of the joint
ventures was not anticipated, and given that none of the joint venture partners have
the financial capacity to support the growth they were achieving through continual capital
injections to maintain gearing at acceptable levels, there has been an expectation
that Beneficial will provide the additional funding required. Whilst Beneficial can choose
to limit the funds lent, as there is no legal requirement to provide all funding, it is
our objective to not restrict profitable growth of the joint venture. However,
notwithstanding this objective, considerable difficulty is being experienced in attracting
non-recourse external borrowings with existing joint venture gearing levels."
In his submission to my Investigation, Mr D J Tucker, a
partner of Thomson Simmons & Co who was a director of Pegasus Securities and of
Pegasus Leasing, stated that Beneficial Finance facilitated all of the joint venture's
debt funding, either by direct loans or by guaranteeing third party loans, and accordingly
"it stood the commercial risk of any losses in the joint venture." Mr
Tucker's view is that Beneficial Finance effectively functioned as a non-recourse lender
to the joint venture:
"Although there were provisions (in the joint
venture agreements) contemplating loss sharing, it was clear to all parties that Pegasus
Securities' representation in the joint venture was through Lanceti Pty Ltd, which had a
paid up capital of $2."
The evidence of the Managing Director of Beneficial
Finance, Mr J A Baker, to my Investigation in respect of the Pegasus Leasing joint
venture, highlighted the reliance placed by Beneficial Finance on the expertise of its
joint venture partners, and the need for Beneficial Finance to carefully assess that
expertise. Mr Baker said:
"The philosophy was that the joint venture partner
would put up its equity and Beneficial would do so, but Beneficial really ultimately
understood that it would pick up any loss ... the Beneficial Board would have been quite
aware, with all the joint ventures, whether or not there was a guarantee from the other
party in relation to credit losses ... those people, we knew, could not stand up ... they
were small entrepreneurs but we were prepared to go into joint venture business with them
because they had skills and access to business. We weren't asking them to guarantee credit
losses." [Emphasis added]
In a submission to my Investigation(), the
former Non-Executive Directors of Beneficial Finance disputed Mr Baker's assessment of the
nature of the company's relationship with its joint venture partners. They said that:
(a) there was a standing direction from the Board of
Directors that all joint venture partners of Beneficial Finance were to provide guarantees
in respect of the liabilities of the joint ventures in which they participated; and
(b) Beneficial Finance's funding of any joint venture had
to be assessed using the same criteria, and subjected to the same policies and procedures,
as applied to its general lending business.
In his submission, Mr Baker disputed the suggestion that
there was such a standing direction, and no such direction has been found in any documents
provided to or reviewed by my Investigation, including minutes of Board of Directors'
meetings. Although I accept that the absence of any reference to the direction does not
necessarily mean that the direction was not given, the absence of any documentation of
such an important matter in the minutes, at the very least, reflects poorly on the Board's
reporting practices. The management of Beneficial Finance were unaware of any such
Whether or not such a standing direction was given, the
reality of the operating joint ventures in which Beneficial Finance participated was that,
in practical terms, the joint venture partners lacked the financial resources to meet
anything like one-half of the potential losses of the venture. The directors were told
that the rationale for the Pegasus Leasing joint venture was a partnership between
Beneficial Finance's financial strength, and its partner's business connections and
skills. That rationale was clearly stated in the submission for the establishment of the
Pegasus Leasing joint venture in May 1985.
Beneficial Finance did eventually obtain a guarantee from
Mr McGregor, who effectively controlled Pegasus Securities, and Pegasus Securities was
required to bear one-half of any losses of the Pegasus Leasing joint venture. The
Non-Executive Directors submitted to my Investigation that they were assured by Mr Baker
that Mr McGregor's assets were "substantial", and I accept that they received
that assurance. Even so, it should have been apparent to the directors that:
(a) Mr McGregor's personal wealth may have depended to a
significant degree upon the value of Pegasus Securities; and
(b) Pegasus Securities' net assets were nowhere near
sufficient to provide anything more than a small contribution to an exposure that came to
total $111.0M. Pegasus Securities' lack of financial strength was the very reason why it
entered into the joint venture.
In short, the Pegasus Leasing joint venture, like
Beneficial Finance's other operating joint ventures, was based on the premise that
Beneficial Finance bankrolled a small entrepreneur operating in a niche financial market
that Beneficial Finance perceived could, with financial support, build a profitable and
successful business. It would bear most of the financial cost of failure.
188.8.131.52 The Pegasus Leasing Joint Venture
Although the details of the Pegasus Leasing joint venture
are complex, there are a number of quite basic issues that are fundamental to
understanding the events that occurred.
First, it is useful to regard the Pegasus Leasing joint
venture as effectively having been established on 1 January 1988. A joint venture was
actually established with effect from 1 August 1985, and some aspects of that first joint
venture's operations are important to understanding the events that subsequently
transpired. I have described those important aspects in Section 33.2 of this Chapter. In
substance, however, the activities that resulted in significant losses for the State Bank
Group were conducted after 1 January 1988 by Pegasus Leasing Pty Ltd, a company jointly
owned by Beneficial Finance and its joint venture partner, Pegasus Securities.
Second, like Beneficial Finance's other operating joint
ventures, Pegasus Leasing was established on the premise that Beneficial Finance would
provide the financial backing needed to allow Pegasus Securities to grow a business from
which both participants would profit. Beneficial Finance's reliance on the expertise of
Pegasus Securities, and the certainty that it would bear the financial cost of the joint
venture's failure, meant that it was vital from Beneficial Finance's point of view that it
do two things:
(a) It must ensure that Pegasus Securities in fact had the
necessary experience and expertise to operate the business.
(b) It must ensure that if the joint venture business might
expand beyond the size or scope of that in which Pegasus Securities had experience and
expertise, Beneficial Finance would carefully monitor and control the joint venture's
activities. With the funding provided by Beneficial Finance, it was more likely than not
that the business would expand beyond the limits of Pegasus Securities' experience and
expertise. The expansion of the business was, after all, the basic reason for the joint
The first joint venture, which commenced business in
December 1985, was established as the result of an approach from Pegasus Securities. It
was essentially a partnership between Beneficial Finance and Pegasus Securities, with the
joint venture company, Pegasus Leasing Pty Ltd, acting as a nominee for the partners. The
first joint venture's business was largely limited to the granting of finance to the
thoroughbred horse industry, in the form of leases. The partners contributed $0.1M each as
capital to the venture, and were to share profits and losses equally. Those profits and
losses were calculated after payment of management fees to Pegasus Securities for
conducting the business, and of interest and guarantee fees to Beneficial Finance for
providing or facilitating funding for the venture.
As well as carrying on business on behalf of the partners,
Pegasus Leasing also granted leases as the sub-agent of Beneficial Finance under the
Reverse Principal and Agency Agreement between Beneficial Finance and the State Bank. The
leases granted as sub-agent were treated for accounting purposes as belonging to the State
Bank, and so were not shown in the accounts of the joint venture. Those leases were funded
by the Bank through loans to Beneficial Finance, which on-lent the funds to the joint
The first joint venture was not successful. From early in
1987, the Beneficial Finance Board of Directors expressed dissatisfaction with the
performance of the joint venture, and resolved that the venture should be terminated if
its performance did not improve.
In December 1987, the first joint venture was terminated.
It granted no new leases, and its portfolio of receivables was wound down, under the
management of Pegasus Leasing, over the following eighteen months. In July 1989, the
remaining receivables of the first joint venture were transferred to the new.
On 1 January 1988, however, Beneficial Finance and Pegasus
Securities entered into a new Pegasus Leasing joint venture. This was, in effect, the real
beginning of Pegasus Leasing. It was an incorporated joint venture, with Pegasus Leasing
Pty Ltd carrying on business in its own name, and not as nominee for the partners.
The new joint venture was established despite the
express recommendation of Beneficial Finance's Joint Venture Committee that it should not
be formed. No formal submission was presented to the Board of Directors of Beneficial
Finance in respect of its formation.
The new joint venture essentially took over the business
activities of Pegasus Securities. It purchased Pegasus Securities' insurance broking
business, and its debt factoring business carried on by a subsidiary of Pegasus
Securities, Rivlin Pty Ltd. Pegasus Leasing employed the staff of Pegasus Securities to
conduct the business, and used that company's accounting systems.
The business of Pegasus Leasing expanded very rapidly
over the following two years. Bloodstock Leasing operations were established in New
Zealand and the United Kingdom, and the venture acquired a 75 per cent interest in
Bloodstock Management International Ltd, a company carrying on business as manager of
bloodstock investment syndicates. It also invested in, and financed, two investment
syndicates, and acquired a number of other minor investments. Pegasus Leasing's total
assets grew from less than $1.0M in January 1988, to $85.0M in November 1989, an
The rapid expansion of Pegasus Leasing's portfolio was
funded entirely by Beneficial Finance with unsecured, ninety day loans. Although Pegasus
Leasing was established with capital of $0.4M in January 1988, subsequent losses meant
that, by 30 June 1989, the company had no capital whatsoever, with its liabilities
exceeding its assets. Nevertheless, its business continued to expand, funded by loans from
Beneficial Finance. As at June 1989 Beneficial Finance's unsecured loans to Pegasus
Leasing totalled $62.0M, and increased to $79.0M in November 1989, and $85.0M in February
1990. By January 1991, the State Bank Group's exposure to the joint venture totalled
$97.7M, with a further exposure to the Pegasus Securities group of $14.1M.
In August 1989, Mr Baker became concerned at the size of
Beneficial Finance's exposure to Pegasus Leasing. The efforts of Beneficial Finance to
reduce that exposure, or at least to take it off the balance sheet, eventually resulted in
the State Bank becoming the owner of Pegasus Leasing's portfolio of receivables. The
method suggested by the Chief General Manager of Beneficial Finance's Treasury and Capital
Markets division, Mr F R Horwood, was to refinance Beneficial Finance's loans to Pegasus
Leasing through the Reverse Principal and Agency Agreement with the State Bank. Mr Horwood
apparently regarded that arrangement as being little more than a funding mechanism for
Beneficial Finance's tax-based leasing business. In fact, however, the Agreement was an
agency agreement under which Beneficial Finance granted leases as agent for the State
Bank, with the State Bank owning the lease receivables. After almost a year of extensive
consideration and negotiations, it was eventually agreed that the State Bank would assume
ownership of all of Pegasus Leasing's portfolio of lease receivables.
In May 1990, a new joint venture was established between
Pegasus Securities and Beneficial Finance, which was a partnership of the type that
operated between 1985 and 1987. Pegasus Leasing's non-receivables assets were transferred
to the new unincorporated joint venture, which also managed the portfolio of lease
receivables then treated as owned by the State Bank.
Within three months Beneficial Finance decided to end the
joint venture. A series of adverse internal audit reports, a report from the external
auditors of Pegasus Leasing and Beneficial Finance, Price Waterhouse, and reports from
Beneficial Finance's own management, prompted Beneficial Finance to take control of the
activities of the joint venture, and to wind it up. Guarantees were obtained from Mr
McGregor and from Pegasus Securities in respect of the State Bank Group's loans to the
In late 1990 and early 1991, values of thoroughbred horses
fell dramatically. Many customers of Pegasus Leasing were unable or unwilling to meet
their obligations. In February 1991, a report from Ernst & Young, Chartered
Accountants, confirmed an estimate from Beneficial Finance's management that the losses
associated with the Pegasus Leasing business might total between $40.0M and $46.0M.
The fundamental failing of Beneficial Finance was to
provide essentially unlimited finance to a business that it did not adequately monitor,
and certainly did not control. Pegasus Securities may have had the experience and
expertise to conduct a modest thoroughbred leasing business, the company having total
receivables of $5.5M in 1985. With the finance provided by Beneficial Finance, however,
the business grew rapidly, unrestrained by any lack of funds. Without that restraint,
leases could be provided to borrowers who might otherwise have been excluded from
consideration. With ambitious growth budgets set, the downward pressure on credit
standards is obvious. In fact, even those growth budgets were exceeded.
The result was that credit standards fell, and the
business grew to a size and diversity beyond the experience or expertise of Pegasus
Securities. Inevitably, very large losses resulted, and the State Bank paid the bill.
33.2 THE FIRST JOINT VENTURE: AUGUST 1985 TO DECEMBER 1987
Established with effect from 1 August 1985, the first joint
venture carried on business from December 1985 until December 1987, when it ceased new
leasing and its portfolio of receivables was wound down. It was essentially a partnership
between a wholly-owned subsidiary of Beneficial Finance, Malary Pty Ltd, and a
wholly-owned subsidiary of Pegasus Securities, Lanceti Pty Ltd, with each company owning
one-half of the assets of the unincorporated venture, and being liable for one-half of its
The first joint venture made little direct contribution to
the losses eventually incurred by the State Bank Group. Some aspects of its activities
were, however, important in explaining the later activities of Pegasus Leasing.
33.2.2 INITIATION OF THE FIRST JOINT VENTURE
Pegasus Securities was a publicly listed company that
carried on business as a financier to the bloodstock industry, specialising in providing
loans in the form of leases over thoroughbred horses used by the lessees for racing and
In May 1985, Beneficial Finance was invited to acquire an
interest in Pegasus Securities when a shareholder and director had made a takeover bid for
the company. As a defensive move, the other directors of Pegasus Securities approached
Beneficial Finance to purchase a shareholding in the company. Beneficial Finance had
previously provided some loans to Pegasus Securities, and Pegasus Securities acted as an
agent for Beneficial Finance in writing some bloodstock leasing business.
A submission was presented to the Beneficial Finance Board
of Directors at its meeting on 21 May 1985, proposing that Beneficial Finance both
purchase 19.9 per cent of Pegasus Securities, and set up a joint venture with that
company. The purpose of the joint venture was to exploit fully the market potential of the
business of Pegasus Securities, and to provide Beneficial Finance with new business and
income. The submission stated:
"Pegasus Securities Limited is a relatively small
lease broker/financier specialising primarily in bloodstock leasing.
Formed in February 1982 by a number of South Australia
businessmen, it has grown to a receivable base of $5.5 million, although growth restraints
have meant that substantial volume has been handled on a brokerage basis to main stream
Beneficial Finance presently has an undisclosed
Principal & Agency Agreement in place, where bloodstock receivables total $1.53
million (11 accounts).
As well as banking lines, the company borrows on public
debenture issues, the most recent (No 2) in December 1984.
As of 1 May 1985, a shareholder/director, Mr Michael
Harrison, has made a takeover bid for the company, as he has plans to re-capitalise the
company and grow more quickly than is desired by the other directors. Accordingly, they
have sought Beneficial's assistance to buy him out, and set up this financing joint
venture to accommodate the growth."
In essence, the financial backing provided by Beneficial
Finance, principally in the form of guarantees, was to be combined with the business
expertise of Pegasus Securities to expand the bloodstock leasing business. The joint
venture would "enable Pegasus Securities to fully exploit their market potential,
as well as provide Beneficial with incremental finance volume and fee income."
The submission stated that the receivables portfolio of the
joint venture would be administered by Pegasus Securities, for which it would receive a
monthly fee of 1 per cent of the total end of month receivables. It was intended that
Beneficial Finance would provide as little debt funding for the venture as possible,
relying instead on third-party financiers whose loans would be guaranteed by Beneficial
Finance, for which it would receive a 1 per cent guarantee fee.
The credit submission included projections, prepared by
Beneficial Finance on the basis of assumptions agreed with Pegasus Securities, of the
joint venture's profitability, and of its assets and liabilities, over the three years of
operations to 30 June 1988. These projections made clear both dependence of the joint
venture on Beneficial Finance's financial backing, and the risk to Beneficial Finance of
any substantial losses. It was projected that, by 30 June 1988, the joint venture's total
assets would be $43.9M, with capital of only $0.2M. That represents a gearing ratio of
99.5 per cent, or a debt to equity ratio of 220:1. The credit submission stated that
Pegasus Securities' net tangible assets as at 31 December 1984 was only $1.1M, and that
part of its funding was in the form of debentures.
Although the submission was approved by the Board,
Beneficial Finance did not acquire any shares in Pegasus Securities, as a result of
written advice given to Mr Reichert by Pegasus Securities that another buyer had been
found for the shares. It did, however, enter into the joint venture.
On 4 July 1985 a new company, Pegasus Leasing Pty Limited
was incorporated to act as nominee for the proposed joint venture. The shareholders were
Malary Pty Ltd, an off-balance sheet company of Beneficial Finance, and Lanceti Pty Ltd, a
wholly-owned subsidiary of Pegasus Securities.
Beneficial Finance established a group of its senior staff,
called the `Pegasus Leasing Task Force', to assist Pegasus Securities in setting up the
business operations of the Pegasus Leasing joint venture as a financier to the bloodstock
33.2.3 THE STRUCTURE AND MANAGEMENT OF THE FIRST JOINT
The joint venture was unincorporated, which means that its
assets and liabilities were jointly owned by Beneficial Finance through its off-balance
sheet company, Malary Pty Ltd, and Pegasus Securities through its wholly owned subsidiary,
Lanceti Pty Ltd. In carrying on its business activities, Pegasus Leasing acted as nominee
for Beneficial Finance (Malary) and Pegasus Securities (Lanceti), the real owners of the
The joint venture was established with an initial capital
contribution of $0.2M, contributed equally by Pegasus Securities and Beneficial Finance.
The Joint Venture Agreement provided that Beneficial Finance and Pegasus Securities would
contribute equally to any additional capital needed by the joint venture, and that any
losses would be shared equally. Profits were to be distributed first to Beneficial Finance
at an effective rate of 25 per cent per annum on funds contributed by it, then to Pegasus
Securities at the same rate. Any remaining profits were to be shared equally.
A Management Committee, consisting of six members, with
three nominated by each of Beneficial Finance and Pegasus Securities, was responsible for
the management of the joint venture business. Beneficial Finance was to appointed the
Chairman of the Management Committee, who had the casting vote in the event of deadlock.
Although Pegasus Securities was responsible for performing all secretarial, managerial and
accounting functions for the joint venture, Beneficial Finance was entitled to nominate
the auditors and solicitors. Each joint venturer had the right to nominate two persons to
be directors of Pegasus Leasing Pty Ltd, the nominee company.
Authority to approve leases by the joint venture was to be
granted by the Management Committee. Initially, all leases of more than $0.1M were to be
approved by Beneficial Finance in accordance with its delegated loan approval authority
system. Leases of more than $0.75M required the approval of the Managing Director of
Beneficial Finance, or its Board of Directors. Leases of up to $0.1M were to be subject to
approval by the Pegasus Credit Committee, which was a committee of the Board of Directors
of the nominee company, Pegasus Leasing Pty Ltd.
Shortly after the joint venture commenced business,
however, authority was granted to the directors of Pegasus Leasing to approve all loans to
be granted by the joint venture. At a meeting of the joint venture Management Committee
meeting held on 24 March 1986, the delegated authorities were changed to require
transactions of more than $0.5M to be approved by three directors of Pegasus Leasing,
including both of the directors nominated by Beneficial Finance.
Most leases were for less than $0.5M, and a Joint Venture
Quarterly Report presented to the Beneficial Finance Board of Directors in December 1986
reported that loan approvals were performed by Pegasus Securities:
"There are no staff employed by the joint venture
and this minimises direct expenses. Loan approval (within limits approved by
Beneficial Finance) is performed by Pegasus Securities staff, as is the collection
on all accounts. Accounting and statutory records and subsequent financial reporting is
performed by Beneficial staff."
In March 1987, the Board of Directors of Beneficial Finance
directed management to impose a limit on Beneficial Finance's exposure to the joint
venture. An "Action Report" prepared by Mr B Barton, the company secretary of
Beneficial Finance, summarised a number of items requiring action as a result of
resolutions of the Beneficial Finance Board at its meeting on 27 March 1987. One of the
items for action required of Management by the Board was:
"An exposure limit is required in relation to the
bloodstock leasing on behalf of Pegasus Leasing."
I have found no evidence of any documented exposure limit
being established. The Non-Executive Directors submitted to my Investigation that they
received assurances from Mr Baker that the matter was being attended to, and Mr Baker said
in his submission that he had "an understanding" with Mr McGregor that
total receivables of about $100.0M was an appropriate level that would generate adequate
profits for the joint venture partners, and that the level of $100.0M was less than 5 per
cent of Beneficial Finance's total assets, and was therefore not, by itself, an excessive
exposure to bloodstock leasing. Beneficial Finance did, however, have other exposures to
the bloodstock industry, including its participation in another joint venture, Mortgage
Acceptance Nominees Ltd. An undocumented "understanding" is hardly an adequate
basis for managing Beneficial Finance's exposure, and did not address Beneficial Finance's
total exposure to the bloodstock leasing industry.
Although the 1987 Corporate Plan stated that the total
receivables of all joint ventures was limited to 20 per cent of Beneficial Finance's total
receivables, that is clearly inadequate as a limit on the exposure to the bloodstock
leasing of Pegasus Leasing because:
(a) it did not limit Beneficial Finance's exposure to the
bloodstock leasing industry, which might include exposures other than through joint
(b) it is unrelated to any measure of the financial
strength of the joint venture partners, and so is unrelated to their capacity to bear
one-half of joint venture losses.
One of the "action items" to be taken in
October 1990, as the problems associated with the Pegasus Leasing joint venture began to
fully emerge, was to finally establish a prudential limit for Beneficial Finance's
exposure to the bloodstock industry.
33.2.4 THE BUSINESS ACTIVITIES OF THE FIRST JOINT
184.108.40.206 The Nature of the Business
As noted, the joint venture carried on business as a
financier to the bloodstock industry, providing loans in the form of finance leases over
thoroughbred horses used by the lessee-borrowers for racing and breeding.
Although the horses provided security for the loans, it was
apparently regarded by Beneficial Finance as important that the credit worthiness of the
borrowers should be carefully evaluated, so that the joint venture would not be totally
reliant on the value of bloodstock for repayment of its loans. In evidence to my
Investigation, Mr Baker said that the "philosophy and thrust" underlying
the business was that loans should be provided only to "high net worth
The Beneficial Finance Lending Policy Manual, which was
used by the joint venture until a Credit Policy Manual was prepared specifically for
Pegasus Leasing in April 1990, stated that leasing business is "high risk"
because 100 per cent of the cost of the leased goods is being financed, and that
accordingly the credit assessment should:
"Give emphasis to applicants' financial strength.
It is essential that they can meet rental payments and residual, independent of expected
income from the animal. The value of our security depends upon the animal's continuing
health and performance, so verify its worth and fitness and ensure adequate insurance
cover is arranged."()
220.127.116.11 Reverse Principal and Agency Business
As stated in the credit submission proposing the
establishment of the joint venture, Beneficial Finance had, at the time, receivables of
$1.53M that were managed by Pegasus Securities as undisclosed agent for Beneficial Finance
pursuant to a Principal and Agency Agreement.
On 27 September 1985, Beneficial Finance and the State Bank
entered into a Reverse Principal and Agency Agreement, pursuant to which Beneficial
Finance was appointed as agent of the State Bank for the purpose of entering into lease
transactions involving "commercial goods". The arrangement was entered into
principally for the benefit of Beneficial Finance as a result of a change in the
interpretation of taxation law by the Commissioner of Taxation. Pursuant to a ruling of
the Commissioner of Taxation, having effect from 1 July 1985, finance companies were
required to treat all leases granted by them as either finance leases, or as operating
leases, for taxation purposes. By acting as agent for the State Bank, Beneficial Finance
was able to provide both types of leases to its customers without suffering any taxation
disadvantage which would adversely affect the price at which it could provide such
"loans". A report to the Board of Directors of Beneficial Finance in December
1986 stated that:
"The need for the Reverse Principal and Agency
Agreement arose because of the Taxation Department ruling, effective 1 July 1985,
restricting the use of both taxation methods of income reporting on lease transactions
within the same group of companies ... because of the unique tax paying position of the
State Bank (to the State rather than Federal Government) clearance was obtained from the
Taxation Office for Beneficial to use a different method from the State Bank. For those
leases that show a disbenefit using the operating lease method, the (so called) reverse
Principal and Agency Agreement is used.
The benefit of this arrangement to Beneficial Finance is
a presence in both tax based and non-tax based leasing markets. To our knowledge, none
of our competitors is able to match this dual presence."
The Report stated that the benefit of the arrangement to
the State Bank was "its ability to build a significant leasing portfolio with a
minimum of administrative overheads." In substance, however, the State Bank
neither enjoyed the benefits, or bore the risks, of the leasing portfolio. Although called
a Reverse Principal and Agency Agreement, the terms of the Agreement more closely
resembled a funding arrangement for Beneficial Finance's conduct of chattel leasing
business using the finance lease method of tax accounting. Beneficial Finance was
responsible for approving new leasing transactions, and was to bear the credit risk on
those transactions. The Agreement required Beneficial Finance to deposit with the State
Bank an amount equal to 0.25 per cent of the total receivables as a provision against
possible losses. The State Bank was to bear the credit risk only on leases of up to
$50,000 which were approved by the State Bank. Beneficial Finance was to manage and
administer the lease facilities, including the preparation of security documents, ensuring
that the leased equipment was adequately insured, collecting lease payments and keeping
the records of the lessees/borrowers. Under the arrangement, the State Bank made a loan
once a month to Beneficial Finance, at a fixed rate of interest, to reimburse it for the
advances made during the month. The interest rate earned by the State Bank was not related
to the rate earned by Beneficial Finance from the leasing business.
The Agreement authorised Beneficial Finance to appoint "such
other persons as it deems suitable ... to act as its own agents in relation to this
Agreement". On 9 April 1986, Beneficial Finance entered into a Sub-Agency
Agreement with Pegasus Leasing to transact business authorised by the Reverse Principal
and Agency Agreement. The Sub-Agency Agreement was endorsed by the State Bank. Although
the Reverse Principal and Agency Agreement was limited to "commercial goods",
Beneficial Finance obtained a legal opinion that bloodstock fell within the scope of the
Reverse Principal and Agency Agreement. In any event, Mr G J Yelland, General Counsel of
Beneficial Finance, said in a submission to me that State Bank, Beneficial Finance and
Pegasus Leasing appeared by their conduct to have accepted livestock as acceptable subject
matter of the Reverse Principal and Agency Agreement, and that the parties subsequently
formally agreed to accept the writing of leasing business in relation to horses as falling
within the Agreement.
The Sub-Agency Agreement provided that Pegasus Leasing was
to bear the credit risk in respect of all loans granted by it as the sub-agent of
Beneficial Finance under the Reverse Principal and Agency Agreement.
Perhaps because the terms of the Reverse Principal and
Agency Agreement resembled, in substance, a funding arrangement, the management of
Beneficial Finance quickly came to regard the Agreement as a cost-efficient method of
funding new leasing business. The Joint Venture Quarterly Report presented to the Board of
Directors at its meeting on 16 December 1986 stated in respect of the Pegasus Leasing
joint venture that:
"From July 1986, the joint venture has utilised
the SBSA reverse P&A as a more efficient method of funding its portfolio. Beneficial
charges an additional 0.5% above the State Bank rate to the joint venture as a
guarantee/facility fee. The National Australia Bank has refinanced $5.0M of the joint
Nevertheless, Beneficial Finance did separately identify
those lease receivables funded by the State Bank under the Reverse Principal and Agency
Agreement. The Joint Venture Quarterly Report stated that, as at September 1986, the lease
receivables funded by the State Bank totalled $57.3M, of which $4.2M were receivables of
the Pegasus Leasing joint venture.
The view of the auditors of Beneficial Finance and the
joint venture, Price Waterhouse, was that where leases were granted by the joint venture
under the Sub-Agency Agreement, the related receivables should not appear in the joint
venture's balance sheet. Rather, the receivables should be included in the State Bank's
balance sheet. An audit planning memorandum for the 1987 audit prepared by Price
"A number of the joint venture receivables are
written as SBSA deals. There exists a P & A arrangement with the State Bank which acts
as principal, and the joint venture as agent. Although these receivables do not appear in
the joint venture balance sheet, commission is earned on the deals."
In fact, the joint venture did not earn a commission in the
usual sense of that term. The joint venture received its profit in respect of leases
granted under the Sub-Agency Agreement in the form of the spread between the interest rate
it charged on the leases, and the interest rate paid to Beneficial Finance. By 30 June
1986, the total receivables relating to leases granted by the joint venture under the
Sub-Agency Agreement were $4.2M, comprised by forty separate leases. An analysis by Price
Waterhouse showed that in July 1986 the Reverse Principal and Agency business written by
the joint venture totalled $1.2M while its other business totalled $8.7M. In December
1986, Reverse Principal and Agency business totalled $5.8M, and other business totalled
The working papers of Price Waterhouse for the audit of the
joint venture for the year ended 30 June 1988 contains an analysis of receivables into
"SBSA Reverse Principal and Agency" receivables and other business. The analysis
identified an error in the allocation of receivables, in that the balance shown as
"SBSA Reverse Principal and Agency" receivables in the accounts of the joint
venture was shown as $13.3M, whereas it should have been $15.6M. The working papers
contain this explanation:
"These deals were incorrectly recorded as belonging
to Pegasus when they are SBSA Reverse P & A deals. Corrected in January. Correct
balances have been disclosed in balance sheets ... This problem was ... due to a keying
error by the client and so we can accept it as an isolated incident."
In a sense, so long as Beneficial Finance was liable to
bear the credit risk associated with leases granted under the Reverse Principal and Agency
Agreement, it was not of major significance to the State Bank if a particular lease was
incorrectly shown or not shown as having been made pursuant to that Agreement. In either
case, the risk of loss lay with Beneficial Finance, and not with the State Bank, which had
an indemnity from Beneficial Finance for the full amount of any losses. As noted, the
substance of the Reverse Principal and Agency Agreement much more resembled a funding
arrangement than an agency agreement. Similarly, so long as the joint venture was liable
to indemnify Beneficial Finance for any losses, a mis-allocation of receivables to the
Sub-Agency Agreement had no major credit risk implications.
The allocation of receivables to the Reverse Principal
and Agency Agreement could, however, have implications for Beneficial Finance's balance
sheet, and so for its gearing ratios and compliance with the terms of its debenture Trust
Deeds. Where leases were funded under the Reverse Principal and Agency Agreement,
Beneficial Finance's practice was to exclude from its balance sheet both the liability
represented by the loan from the State Bank, and the asset in the form of Beneficial
Finance's loan to the joint venture or the related lease receivables. The liabilities and
assets were simply netted off, reflecting Beneficial Finance's capacity as a mere agent,
or conduit to the sub-agent. As I shall describe, the Reverse Principal and Agency
Agreement was used in 1990 to move Beneficial Finance's exposure to Pegasus Leasing off
its balance sheet, with the result that the Pegasus Leasing receivables portfolio came to
be owned by the State Bank.
Even though the liabilities and assets related to the
Reverse Principal and Agency Agreement were not included on Beneficial Finance's balance
sheet, it was technically necessary for Beneficial Finance to show the full amount of the
receivables as a contingent liability in the notes to its accounts, because it was liable
to indemnify the State Bank for any losses in respect of the receivables portfolio. Such a
contingent liability could have implications for Beneficial Finance's debenture Trust
Accordingly, on 30 June 1987 Mr K S Matthews, Chief General
Manager of the State Bank, sent a letter to Beneficial Finance limiting Beneficial
Finance's obligation to indemnify the State Bank for any losses under the Reverse
Principal and Agency Agreement to a maximum of 10 per cent of the total receivables under
the Agreement. The purpose of the letter was to prevent Beneficial Finance having to
disclose in its accounts a contingent liability, essentially in the form of a guarantee,
for the full amount of all of the Reverse Principal and Agency receivables. In a
submission to my Investigation, the State Bank noted that such a contingent liability "would
not have been representative of the actual contingent liability or risk." ()
A file note dated 27 November 1990 from Mr A Parkinson, General Manager of Beneficial
Finance's Taxation and Corporate Planning department, stated that the risk borne by
Beneficial Finance was limited to 10 per cent because of the requirements of the trustee
for Beneficial Finance's debenture holders, and for "tax reasons". I understand
the reference to "tax reasons" to mean that, with the State Bank potentially at
risk in respect of the receivables portfolio, the terms of the Reverse Principal and
Agency Agreement would more strongly support the position that the receivables in
substance belonged to the State Bank. Subsequent Agreements expressly included a term
limiting Beneficial Finance's indemnity to the first 10 per cent of losses.
From the State Bank's perspective, such a limit would have
no implications provided that the actual losses realised in respect of leases written
under the Reverse Principal and Agency Agreement did not exceed 10 per cent of the total
receivables portfolio. If it did, the State Bank would be required to bear the loss. The
limitation of Beneficial Finance's liability to indemnify the State Bank to a maximum of
10 per cent of the total Reverse Principal and Agency Agreement lease receivables did not,
however, affect the position of the State Bank Group, since the indemnities obtained by
Beneficial Finance from its sub-agents were unaffected.
33.2.5 THE PERFORMANCE OF THE FIRST JOINT VENTURE
The Beneficial Finance Board of Directors expressed some
dissatisfaction with the profit performance of the joint venture from early in 1987. The
minutes of a meeting of the Beneficial
Finance Board on 27 March 1987 record that:
"... Concern was expressed at the poor results
achieved by Pegasus Leasing. This will be given a further 12 months and if the overall
performance is not improved, consideration will be given to discontinuing the
The audited financial statements of the joint venture for
the year ended 30 June 1987 showed an operating loss for the year of $0.12M. After a loss
of $31,405 for the period ended 30 June 1986, the accumulated losses to 30 June 1987 were
In April, a report informed the Board that sales for the
month had been "disappointing", and in May a report stated that a "disappointing
level of arrears ($1.27M at 31 March) has caused concern and steps have been taken to
substantially reduce the arrears outstanding". The minutes of the Board of
Directors meeting held on 29 May record that "forecast sales for 1987/88 for
Pegasus are $30.0 million, but there is concern at the continuing poor performance."
A joint venture report presented to the Beneficial Finance
Board of Directors' meeting on 31 July 1987 reported:
"Considering that Beneficial virtually assumes most
of the risks on receivables of $22.6M through guarantees to National Australia Bank and
through the State Bank Reverse P&A Arrangement, a return of:
(a) $27,000 being a 50 per cent share of profit, plus
(b) receipt of a management fee of $24,000 for the year;
(c) receipt of a guarantee fee of $70,000,
cannot, at this stage, be considered satisfactory. The
continued high level of arrears also reflects unsatisfactorily on the joint venture's
performance. The future operation of the joint venture requires careful review."
The minutes of that meeting record that:
"Concern was expressed at the poor performance and
possible bad debts of Pegasus Leasing. Mr Graham reported that the profit budget for
1987-1988 had been referred back for further review to seek ways of improving
profitability. This should be completed by 14 August. The Board considered the matter
should either be fixed to assure a profitable return to Beneficial, or the operation
should be dissolved over the next 12 months."
The audited financial statements of the joint venture for
the year ended 30 June 1987 showed an operating loss for the year of $0.12M. After a loss
of $31,405 for the period ended 30 June 1986, the accumulated losses to 30 June 1987 were
At its meeting on 25 September 1987, the Board was advised
by management that:
"... a new structure is being considered to embrace
a wider range of financing activities in conjunction with Mr Alistair McGregor. We are
continuing with the negotiations and will keep the Board advised."
The Board was also advised that the performance of the
joint venture was improving. The September report stated that the joint venture "continued
to be conducted to Beneficial Finance's satisfaction", and the October Joint
Venture Quarterly Report said:
"September saw a record result for Pegasus Leasing
where a profit of $54,000 was recorded ... Concentration on reducing the number and level
of arrears has been made over the past three months with total arrears reducing by 2.3 per
cent in the last two months."
The Report informed the Board that new terms for the
sharing of commissions on new joint venture business introduced to the joint venture by
the joint venture participants had been agreed between Beneficial Finance and Pegasus
Securities, and that those new terms " in the long run, should see Beneficial
Finance receive an adequate return from the joint venture (subject to adequate sales being
achieved)." The current level of sales was not considered adequate, with sales of
$1.06M since 1 August 1987 compared to budgeted sales of $5.28M.
On 27 November 1987, Mr Baker advised the Board that the
joint venture was to be restructured. The minutes of the Board meeting record that:
"The Managing Director advised that a Heads of
Agreement is being considered to form a new 50/50 joint venture operation and to acquire
the interests of Mr Alistair McGregor and the existing joint venture company. Price
Waterhouse is currently valuing McGregor's companies, including an insurance factoring
operation. A 20 per cent After Tax Return On Equity will be a minimum requirement for the
arrangement to proceed. Mr Baker was asked to discuss the final recommendation with Messrs
Barrett and Clark, or in their absence, other members of the Board to seek approval, if
For the six months ended 31 December 1987, the joint
venture reported a profit before tax of $32,000, which was $30,000 below budget. The Joint
Venture Quarterly Report stated that:
"Main savings appear in the area of losses (which
were nil for the half). However, the gross margin achieved of $0.253M is well behind
budget as a result of the lower than budget level of receivables ... Sales for the six
months reached only $5.1M, which was lower when compared to the same period for 1986, and
a large $10.4M lower than budget."
The minutes of the Board of Directors' meeting held on 29
January 1988 record that "it is reported that a new joint venture arrangement had
been entered into with Mr A McGregor, effective from 1 January 1988."
33.2.6 SUMMARY AND CONCLUSIONS
The first joint venture, which operated for two years until
December 1987, was essentially a partnership between Pegasus Securities and Beneficial
Finance, based on the premise that Pegasus Securities would manage and operate the
business, and Beneficial Finance would fund it. Profits and losses were to be shared
equally. Pegasus Securities received management fees for conducting the business, and
Beneficial Finance received interest and guarantee fees in respect of its funding of the
As well as conducting business on behalf of the joint
venture partners, Pegasus Leasing also granted leases on behalf of the State Bank, in its
capacity as a sub-agent of Beneficial Finance under the Reverse Principal and Agency
Agreement. The Principal and Agency Agreement was regarded by the management of Beneficial
Finance as a mechanism for funding its leasing business, and in economic substance it was.
That does not mean, of course, that the legal effect of the Agreement could be ignored.
Although the joint venture agreement provided Beneficial
Finance with joint control of the joint venture, and required that larger leasing
transactions be approved by Beneficial Finance, in my opinion the effective day-to-day
operation of the joint venture was controlled by Pegasus Securities. Pegasus Securities
had the responsibility for the conduct of the joint venture business, including the
introduction of new business, the approval of new leases, and management of the
More importantly, the fundamental basis of the joint
venture was that the specialised business would be conducted by Pegasus Securities.
Shortly stated, if Beneficial Finance had the experience and expertise to carry on a
bloodstock financing business, it would not have needed to enter the partnership with
Pegasus Securities. Fundamental to the arrangement was the understanding that Beneficial
Finance would rely on the experience and judgment of Pegasus Securities in the conduct of
the business. Similarly, if Pegasus Securities had the financial strength to grow the
business, it would not have needed to enter into an equity partnership with Beneficial
Finance. Pegasus Securities purpose in entering into the partnership was to obtain
financial support that would not otherwise have been available to it.
The Board of Directors of Beneficial Finance was
expressly told in December 1986 that Pegasus Securities was responsible for the
introduction of business, the approval of new leases, and management of the portfolio.
Despite the express direction by the Board of Directors,
no relevant limit was placed on Beneficial Finance's exposure to either the Pegasus
Leasing joint venture, or to the bloodstock industry generally.
The first joint venture was not successful, and in December
1987 it was terminated, and its portfolio allowed to run down, under the management of
33.3 THE PEGASUS LEASING JOINT VENTURE: JANUARY 1988 TO MAY 1990
Pursuant to Heads of Agreement dated 31 December 1987,
Beneficial Finance and Pegasus Securities agreed to enter into a new joint venture with
effect from 1 January 1988. The Heads of Agreement recited that Beneficial Finance and
"... now wish to wind up the operations of the
existing joint venture and to conduct the joint venture business and the business
presently conducted by Pegasus Securities either directly or through Rivlin, together with
such other business as they shall hereafter agree to conduct ... through a corporate
entity to be owned in equal shares by Pegasus Securities and Beneficial."
The proposal to change the structure of the joint venture
may be seen as a response to the criticism of the past performance of the joint venture.
It was, in effect, to be a fresh start. The portfolio of receivables of the first joint
venture would not be transferred to the new venture, but would instead be run down, under
the management of Pegasus Leasing.
The new joint venture was essentially based on the
business activities of Pegasus Securities, Beneficial Finance's partner in the first joint
venture. The joint venture company, Pegasus Leasing, was to purchase the existing
businesses of Pegasus Securities, employ that company's staff, and carry on the business
in its own right. Pegasus Leasing was owned in equal shares by Pegasus Securities and
Beneficial Finance. Again, however, the basic premise of the joint venture was the same -
a combination of the skills and expertise of Pegasus Securities, with the financial
backing of Beneficial Finance.
33.3.2 INITIATION OF THE PEGASUS LEASING JOINT VENTURE
In December 1987, Beneficial Finance's Joint Venture
Committee recommended against entering into the new joint venture. The Committee had
been formed in July 1987 to:
(a) review monthly results of each joint venture;
(b) review the risks associated with each joint venture,
and the returns to Beneficial Finance from participation in the joint ventures;
(c) review joint venture budgets and forecasts; and
(d) establish criteria for the assessment of new joint
The Joint Venture Committee was to approve any new ventures
prior to execution of documentation.
The minutes of the meeting of the Joint Venture Committee
in early December 1987 record:
"Pegasus Re-organisation. The Committee queried the
validity of the restructure and whether it was achieving its objective of lowering the
Joint Venture's borrowing cost. Some benefits would arise from the restructure namely
improved efficiency and improved relationships between the parties. The Committee felt
that the best course of action would be closure of the Joint Venture."
Despite this recommendation, Heads of Agreement were signed
by Mr Baker on behalf of Beneficial Finance, and by Mr McGregor on behalf of Pegasus
Securities, to form a new joint venture.
Further, the establishment of the new Pegasus Leasing joint
venture with effect from 1 January 1988 was not the subject of a formal submission to the
Beneficial Finance Board of Directors. As shown by the minutes of the Board of Directors'
meetings quoted earlier, however, the Board was informed of the intention to terminate the
first joint venture and to establish a new joint venture with a wider range of businesses,
and Mr Baker was asked to discuss the recommendation with Mr L Barrett and Mr T M Clark.
The evidence available to my Investigation is that the
new Pegasus Leasing joint venture was essentially the result of negotiations between Mr
Baker and Mr McGregor. The joint venture was established despite the recommendation of,
and without the approval or endorsement of, the Joint Venture Committee, and was not the
subject of a formal submission to, or review by, the Board of Directors.
The unsatisfactory nature of the procedures by which the
new joint venture was established hardly needs to be pointed out. Mr Baker's disregard of
the express and documented advice of the Joint Venture Committee displays a dangerous
distain for the professional judgment of others. The absence of a formal submission to the
Board of Directors bearing the recommendation of the Joint Venture Committee was equally
33.3.3 THE STRUCTURE AND MANAGEMENT OF THE PEGASUS
LEASING JOINT VENTURE
The principal elements of the Pegasus Leasing joint venture
were set down in the Heads of Agreement dated 31 December 1987. The terms of the
Heads of Agreement became binding, with effect from 1 January 1988, upon the execution of
a Deed on 29 January 1988.
The new joint venture involved the use of Pegasus Leasing
Ltd as the joint venture company to carry on business in its own right, and not as
nominee. (Pegasus Leasing Ltd became an unlisted public company in October 1988, and its
name was changed from Pegasus Securities Leasing Pty Ltd to Pegasus Leasing Ltd.)
In accordance with the Heads of Agreement, Pegasus
Securities and Beneficial Finance each contributed $0.2M of capital to Pegasus Leasing. As
under the first joint venture, Beneficial Finance and Pegasus Securities were to bear any
joint venture losses equally, in this case by contributing additional capital to the joint
venture company. Profits of Pegasus Leasing were to be paid to Pegasus Securities and
Beneficial Finance in the form of dividends, determined by its Board of Directors.
Beneficial Finance was to provide a guarantee of the indebtedness of Pegasus Leasing, for
which Beneficial Finance would be entitled to a guarantee fee of 1 per cent per annum.
The business of Pegasus Leasing was to be carried on from
the premises of Pegasus Securities. The initial directors of Pegasus Leasing were Mr
McGregor and Mr Tucker nominated by Pegasus Securities, and Mr Baker and Mr M Chakravarti
nominated by Beneficial Finance. Mr McGregor was Executive Chairman. Beneficial Finance
appointed one of its staff, Mr T Waller, to be the company secretary of Pegasus Leasing,
and provided the services of its internal audit department.
The Heads of Agreement provided that all lease approvals
were to be made by the Pegasus Leasing Board of Directors, subject to any delegations to
an appropriate committee.
The staff of Pegasus Securities were transferred to, and
subsequently employed by, Pegasus Leasing. The General Manager of Pegasus Leasing was Mr T
Knox, who had joined Pegasus Securities in 1983 after working for Beneficial Finance.
Beneficial Finance was entitled to nominate one of its staff to become a full-time
employee of Pegasus Leasing, and Mr J Gore, Beneficial Finance's Leasing Manager for South
Australia, was seconded to Pegasus Leasing. He subsequently became a full-time employee of
the joint venture. The Heads of Agreement provided that all accounting records were to be
maintained by Pegasus Leasing, using Pegasus Securities' accounting system. Beneficial
Finance was to review the Pegasus Securities accounting system and records, and "be
satisfied that adequate controls exist". The accounts of Pegasus Leasing were
audited by Price Waterhouse, the auditors of Beneficial Finance.
In practice, the day-to-day activities of Pegasus Leasing,
including the approval of leases, management of the receivables portfolio, and accounting
functions, were controlled by Mr McGregor and his Pegasus Securities staff. Mr G M Hewitt,
who became the General Manager of Pegasus Leasing late 1990 or early 1991, said in a
briefing paper() prepared for the Jacobs Royal Commission on behalf of
Beneficial Finance that, in practice, significant matters in the conduct of the business
of Pegasus Leasing were probably discussed by Mr McGregor with Mr Baker or other senior
managers of Beneficial Finance, or were raised at Board meetings of Pegasus Leasing.
The practical reality was, however, that the day-to-day
conduct of Pegasus Leasing's business was undertaken by Pegasus Securities personnel.
Beneficial Finance's control was essentially limited to its representation on the Board of
Directors of Pegasus Leasing.
Such an approach was consistent with the basic premise of
the joint venture that Beneficial Finance placed reliance on Pegasus Securities'
experience and expertise in the bloodstock industry. Beneficial Finance simply lacked the
relevant industry skills. Its role was to ensure finance for the joint venture.
In his evidence to my Investigation, Mr Reichert, who
was the General Manager of Beneficial Finance's Investment Banking division and was a
director of Pegasus Leasing from June 1988 to November 1989, said that he believes that "too
much latitude" was given to Mr McGregor in respect of the operations of the joint
venture, and that he "certainly believed at the time and still believed"
that "too much reliance was placed on Mr McGregor". Mr Reichert also said
that he did not believe that Mr McGregor had the "credentials" to
adequately manage the joint venture's business.()
Mr Reichert's evidence is a frank admission of
Beneficial Finance's failure to exercise effective control over the conduct of Pegasus
Leasing's business, and of his own failure to do so as a nominee of Beneficial Finance on
the Board of Directors of Pegasus Leasing. There is no evidence that Mr Reichert expressed
his concerns to the other directors nominated by Beneficial Finance, or took any other
action to impose greater control, even though he believed that Mr McGregor lacked the
necessary expertise and experience.
Beneficial Finance provided the debt funding for Pegasus
Leasing from its inception in January 1988, until early 1990 when the joint venture was
again restructured. The National Australia Bank's $5.0M loan to finance the old joint
venture, guaranteed by Beneficial Finance, was repaid in June 1988, after which Beneficial
Finance also funded that portfolio of receivables. By the end of 1989, Beneficial
Finance's unsecured loans to Pegasus Leasing totalled $79.0M.
The procedure for the drawdown of funds by Pegasus Leasing
was discussed at a meeting of that company's Board of Directors on 9 May 1988. The minutes
"The Board approved that Mr J Gilgen [the
Financial Controller of Pegasus Leasing] be authorised as a funding authority to
initiate drawdowns through Beneficial Finance in addition to Messrs McGregor and Knox. In
future, all drawdowns from Beneficial must be supported by a list showing either the deals
to be settled or deals that have been settled. Details should include date of settlement,
lessee and the amount to be financed. The list should be countersigned by an approved
In October 1989, Beneficial Finance took action to both
increase its control over its various joint ventures, and to reduce its funding commitment
to them. A draft letter dated 2 October 1989 prepared by the Investment Banking division
stated in part:
"On 1 July 1989, Beneficial Finance Corporation
implemented a top level restructure to provide stronger divisional focus in strategic and
major business areas.
A new division, Structured Finance and Projects, was
formed to control all of the company's structured facilities, overseas operations and
major property accounts. This division is headed by Erich Reichert.
The Investment Banking Division is now headed by Roger
Sexton and, inter alia, focus on Beneficial's strategic equity investments. The Investment
Banking Division is now responsible for strategic and policy issues relating to
Beneficial's Joint Ventures [JVs] while the Business Divisions are responsible for
the day to day operations of the JVs.
IBD has appointed an account manager for each JV. This
person will be involved in the strategic direction of the JV and will assist with policy
issues as they arise. Roger Sexton will be appointed to the board of each JV, with the
appropriate Account manager being the alternate board member."
A draft letter of the same date from Dr R N Sexton to the
Beneficial Finance personnel responsible for its various joint ventures stressed the need
to place greater emphasis on the monitoring and control of joint venture operations. The
letter identified a number of factors for "consideration and implementation":
"(a) One of the most critical areas that needs to
be addressed is Credit Standards. Attached is a summary of the Approval limits which apply
to your company, and it is essential that these limits are adhered to.
In particular, Group exposure to clients must be
closely monitored, and as a matter of procedure, no credit approval should be given
without first confirming the extent of Beneficial's exposure, if any, to the client.
The level of Beneficial exposure, or, if applicable, the
fact that no exposure exists must be included as part of the approval process. Information
concerning Beneficial's client exposures can be sourced through the joint ventures account
manager in the relevant Business Division.
(b) Any major variation in expenditure by the joint
venture outside of the approved budget, must be referred to the Board of the Venture.
(c) In order to ensure that Beneficial is fully informed
of the performance of each joint venture, and can therefore provide the necessary support,
it is essential that all financial and secretarial reports are prepared in a timely
It is appreciated that the responsibility for day to day
running of the business is that of the Joint Venture Manager. However, the level of
Beneficial's capital and funding commitment to the Venture necessitates the provision of
regular information to Joint Venture Accounting, the Business Divisions and Investment
banking Division. The provision of this information on a timely basis will assist in
Beneficial's continued support to the venture.
Secretarial matters should be referred to Beneficial's
Company Secretary, who is joint company secretary for all Joint Ventures.
There is no doubt that the financial climate has
changed, and that the successful companies will be those that adapt to the changing
environment and place more emphasis on monitoring and control.
Adherence to the above criteria will assist with the
continuing strength of our Joint Venture operations."
Despite this initiative, the effective control of most new
leasing of Pegasus Leasing, and the management of the portfolio, remained with Pegasus
Securities personnel. The minutes of the meeting of the Board of Pegasus Leasing on 25
October 1989 record that:
"After discussion, it was agreed that the Pegasus
Leasing Limited Board be substituted for the Beneficial Finance Credit Committee. Once
applications exceed that limit, they must then go to the Beneficial Finance Board for
approval. Mr O'Brien is to advise Mr McGregor of the limits and these will be circulated
with these Minutes. A resume is to be circulated to Board members giving relevant details
of all transactions."
Beneficial Finance's reliance on Mr McGregor or another
bloodstock leasing expert to run the joint venture business was expressly stated in
September 1990 by Mr F Piovesan and Mr Chakravarti, both senior managers of Beneficial
Finance who had been directors of Pegasus Leasing. In a memorandum dated 18 September
1990, they reported:
"We consider Beneficial Finance to have limited
expertise in the bloodstock industry, and therefore we will need to rely on Mr
McGregor or another independent authority to manage the investments, partnership accounts
and any problem loans involving decisions on the bloodstock held."
33.3.4 THE BUSINESS ACTIVITIES OF THE PEGASUS LEASING
The Heads of Agreement provided that Pegasus Leasing would
acquire from Pegasus Securities the business of Pegasus Insurance Brokers, and all of the
shares of Rivlin, a company that carried on a debt factoring business to the crash repair
industry. Debt factoring is a specialised form of lending based on the security of the
borrowers' trade receivables. On 29 January 1988, Pegasus Leasing and Rivlin entered into
an Agreement for Rivlin to trade as agent of Pegasus Leasing, and not upon its own
Although Pegasus Leasing acquired the businesses of Pegasus
Securities, it was not to purchase that company's receivables portfolio, or the existing
portfolio of receivables of the first joint venture. The Heads of Agreement stated that:
"None of the existing receivables in the existing
joint venture or Pegasus Securities are to be assigned or transferred to Pegasus Leasing,
which shall hereafter as agent and manager collect, account for and report to the joint
venture parties or Pegasus Securities their, respective receivables ..."
Despite this term in the Heads of Agreement, Pegasus
Leasing did purchase a portfolio of receivables from Pegasus Securities, and take over the
first joint venture's portfolio, in May and July 1989 respectively.
In about May 1989, Pegasus Leasing acquired a portfolio of
receivables totalling about $0.75M from Pegasus Securities. A letter dated 7 March 1991
from Kelly & Co, Solicitors acting for Beneficial Finance to Piper Alderman,
Solicitors acting for Pegasus Securities (Receiver & Manager appointed), stated that
the receivables were written into the books of Pegasus Leasing upon settlement of the
transaction, but responsibility for administration of the receivables, and for collection
of amounts due, remained with Pegasus Securities. A report prepared by Mr Hewitt stated
"Little information could be located with respect
to the sale of Pegasus Securities' receivables to the joint venture. It does not appear to
have received Board approval. The transaction in total was handled very poorly from the
Joint Venturers' point of view, with seemingly no documentation formally executed to
effectively assign the receivables to the Joint Venturers. Reconstruction of events have
indicated the intent of the transaction, however the Joint Venture has been disadvantaged
by the "deal" and its accounting."
On 1 July 1989, the assets and liabilities of the first
joint venture were transferred to Pegasus Leasing at book value, and the first joint
venture ceased to exist. The financial statements of Pegasus Leasing for the year ended 30
June 1989 said of the transfer that:
"The company also assumed the management of
receivables totalling $7.6M previously managed by the Joint Venture. The company also
assumed the liability for the funding of those receivables.
Since the year end a receivable in this portfolio of
approximately $2.0M has gone into arrears. The eventual outcome of this situation is
uncertain, however an adequate provision for any loss will have been made by 30 June
The reference to the managed portfolio of receivables of
$7.6M is apparently a reference to the leases granted by the old joint venture on behalf
of the State Bank as the sub-agent of Beneficial Finance under the Reverse Principal and
Agency Agreement. These receivables, which belonged to the State Bank, were not to be
shown in the joint venture's balance sheet. The reference to the need for a provision in
the accounts of Pegasus Leasing relates to the fact that Pegasus Leasing was required to
indemnify the State Bank for any losses arising from the managed portfolio.
The Heads of Agreement provided that the business of
Pegasus Leasing was to include:
(a) bloodstock and livestock leasing as previously
undertaken by the existing joint venture and Pegasus Securities;
(b) other leasing business, including the leasing of art
works and antiques and other types of specialist leasing business;
(c) the debt factoring business of Rivlin;
(d) leasing business of a type traditionally conducted by
Beneficial Finance, but only for established clients of Pegasus Leasing or as agent for
Beneficial Finance; and
(e) entrepreneurial finance business of such other
descriptions as Pegasus Leasing may initiate or develop.
The Heads of Agreement expressly authorised Pegasus Leasing
to carry on business in New Zealand and "elsewhere in the world as its Board of
Directors may from time to time determine". The directors' report accompanying
the financial statements of Pegasus Leasing for the year ended 30 June 1988 described the
joint venture's activities for the six months ended 30 June 1988 as follows:
"The company commenced trading on 1 January 1988 in
its own right in the finance industry providing funds mainly for bloodstock purposes.
Previously the company acted as nominee for Pegasus Securities Leasing joint venture which
is now in a run-down phase. Additionally, the company acquired an interest in Rivlin &
Associates Pty Limited, a crash repair factoring entity and also Pegasus Insurance Brokers
on 1 January 1988. The principal activities of the group during the course of the period
from 1 January 1988 were general finance, leasing, factoring and insurance brokers."
Over the period from January 1988 until June 1990, with
access to essentially unlimited funding from Beneficial Finance, the business of Pegasus
Leasing diversified and expanded in size very significantly, well beyond the limits of
Pegasus Securities' previous experience. In addition to bloodstock leasing in
Australia and the businesses acquired from Pegasus Securities, Pegasus Leasing's
operations after January 1988 included:
(a) bloodstock leasing in New Zealand and in the United
(b) ownership of a 75 per cent interest in Bloodstock
Management International Limited;
(c) ownership of an 87.5 per cent interest in Bloodstock
Trading International Limited, a United Kingdom bloodstock agent;
(d) participation in, and provision of finance to, two
thoroughbred investment syndicates, the North-South Thoroughbred Investment Parcel and the
Austral-Eire Thoroughbred Investment Parcel; and
(e) Various other investments and financing arrangements,
including loans, equipment leases and interests in other companies and a partnership.
At its meeting on 9 May 1988, the Board of Directors of
Pegasus Leasing resolved to commence leasing businesses in New Zealand and the United
Kingdom, and to set a target of $3.0M of new leases in Australia each month. The minutes
"In principal Pegasus Leasing are to proceed with
sourcing business in New Zealand. To enable business to be written, Pegasus Leasing are to
liaise with Beneficial's Treasury Department with a view to establishing a NZ $5M line
with the Bank of New Zealand. At this stage, business is only to proceed once a funding
source has been secured.
Currently, the draft budget shows a sales level of $2
million per month. The Board considered this level inadequate and that a target of $3
million per month of business sourced in Australia must be achieved. Beneficial pointed
out that its expectations for joint ventures were for a 20% profit and sales growth in
each year with a minimum return after tax of 30% on capital employed.
A separate budget is to be drawn up for the proposed UK
operations with the net result to be included in the Pegasus Leasing 88/89 budget as a one
line entry. This result should include an administrative fee to be charged by the
Australian Operations for work undertaken relating to UK sourced deals.
The Board approved that Pegasus Leasing are to be
involved in the UK subject to an appropriate funding source being organised. State Bank
are to be contacted with a view to arranging a funding line."
A dissection of Pegasus Leasing's receivables as at 30 June
1989 by Price Waterhouse showed both the diversity, and rapidly increasing size, of the
The "other loans" granted by Pegasus Leasing were
principally related to its promotion of the North-South Thoroughbred Investment Parcel.
Simply stated, the "Investment Parcels" were arrangements which allowed members
of the public to invest in thoroughbred horses, similar to the way in which public unit
trusts allow small investors to invest in commercial real estate. Each Investment Parcel
was divided into a number of "shares", and investors would lease a fractional
interest in the thoroughbred bloodstock of the Investment Parcel. The Investment Parcels'
activities were managed by a professional bloodstock management company.
A principal selling point of the Investment Parcels was the
income tax deductions that were said to be available to the investors. Since each investor
had a direct proportionate share of the bloodstock, the entire amount of the lease
payments were tax deductible to the investor. Typically, as with the North-South Parcel,
the investors would make an up-front payment of two or more years of lease payments,
enabling the bloodstock to be purchased. The full amount of the payment was said to be tax
deductible when paid. Further, some investors were able to borrow funds to make that
payment, with the result that investing in the Investment Parcel could actually provide
the investor with a cash benefit in the form of a taxation saving of up to half the amount
invested. Of course, the leases and loans eventually had to be repaid, but investors
relied on increases in value of the bloodstock, and income from breeding and racing, to
provide the necessary funds.
At its meeting on 9 May 1988, the Board of Directors of
Pegasus Leasing resolved to acquire an interest in a bloodstock management company, but it
was not until 15 December 1988 that Pegasus Leasing purchased a 75 per cent interest in
Bloodstock Management International Limited.
In October 1988, the Pegasus Leasing Board decided to
establish an Investment Parcel in South Australia, to be called the North-South
Thoroughbred Investment Parcel. Between October 1988 and April 1989 when the venture was
to commence, Pegasus Leasing entered into contracts to purchase thoroughbred horses to be
leased to the investors. The Investment Parcel was divided into forty shares, each with an
initial cost of $80,000 to meet lease payments on the bloodstock, and pay the costs of
maintaining the horses, for the first two years. Pegasus Leasing provided interest-only
loans to some investors to pay that initial cost, and underwrote the venture. In June
1989, Pegasus Leasing itself purchased sixteen of the forty shares that were offered to
investors. The North-South Investment Parcel was managed by Bloodstock Management
The Austral-Eire Thoroughbred Investment Parcel was a
breeding venture which held bloodstock in Ireland, Australia and New Zealand. It was
established in 1988, with Pegasus Leasing holding a 10 per cent interest. In December 1988
Pegasus Leasing increased its ownership to 20 per cent, and in September 1990 to 39 per
cent of the Investment Parcel. Pegasus Leasing also provided finance to Austral-Eire,
including a lease of $1.95M in December 1989 to fund new purchases of livestock.
The increasing complexity and diversity of Pegasus
Leasing's operations was accompanied by a rapid increase in its total assets and
liabilities. The joint venture was established with total assets of less than $1.0M,
represented by the businesses of Pegasus Insurance Brokers and Rivlin purchased from
Pegasus Securities. The audited financial statements of Pegasus Leasing for the year ended
30 June 1988 reported that, as at 30 June 1988, the company had total assets of $21.6M,
including receivables of $20.6M. Total liabilities were $21.3M, including loans of $18.0M.
By 30 June 1989, total assets had increased to $78.3M, an
increase of 263 per cent over the year. Receivables totalled $68.7M, an increase of 233
per cent. Pegasus Leasing's liabilities totalled $78.8M, or $0.5M greater than its total
assets. Its borrowings totalled $73.1M. When the joint venture was re-organised in May
1990, its total assets were almost $100.0M, including receivables of about $90.0M.
The management problems associated with the large and
diverse business operations were highlighted in a memorandum dated 18 September 1990 from
Mr Chakravarti and Mr Piovesan, who stated:
"The magnitude of the operation, ie
approximately $100.0M of receivables (over 50% of Beneficial Finance's South Australian
and Northern Territory receivables) dictates that any solution must be of a longer term
nature. In addition, the geographical spread further exacerbates our management
33.3.5 THE PERFORMANCE OF THE PEGASUS LEASING JOINT
Although the operating revenue of Pegasus Leasing increased
after January 1988 broadly in line with its increasing assets, the company incurred
increasingly large losses in each year.
The Joint Venture Quarterly Report presented to the Board
of Directors of Beneficial Finance in July 1988 reported that Pegasus Leasing incurred a
loss of $141,000 for the six months ended 30 June 1988, which was $6,000 worse than
budget. The Report stated:
"The loss includes a writeoff of goodwill of
$66,000 and given that the company has been trading for only six months this is an excellent
result. Future plans include an expansion into the UK and possible New Zealand.
Pegasus Insurance Brokers profit of $19,000 was $30,000
below budget. Gross premiums are better than budget by $417,000. The worse than budget
performance is due primarily to no profit share being received from Union Insurance due to
a large claim pending.
Rivlin profit is in line with budget and is primarily
due to savings in operating costs. Sales were below budget. The result is satisfactory,
given the level of accounts invoiced."
The audited financial statements of Pegasus Leasing for
Pegasus Leasing the year ended 30 June 1988 reported that the company incurred a loss of
$0.13M in the six months to 30 June 1988, leaving it with capital of only $0.27M.
(The audited financial statements for the old joint venture
for the year ended 30 June 1988 reflected the winding-down of its business activities.
Total receivables declined from $7.6M as at 30 June 1987, to $5.4M at 30 June 1988. The
old joint venture reported a loss of $0.13M for the year, and at 30 June 1988 its
liabilities exceeded its assets by $80,466. By 30 June 1989, the old joint venture's
receivables had declined to $1.2M. It recorded a loss of $89,404 in 1989, and its
liabilities exceeded its assets by $1.7M.)
Pegasus Leasing's operating revenue increased significantly
in the year ended 30 June 1989, due largely to a large increase in interest income.
Operating revenue for the year ended 30 June 1989 was $8.9M, compared to $1.0M for the six
months ended 30 June 1988, an annualised increase of 335 per cent. The major increase in
operating revenue was in interest receivable, which increased from $0.5M in the six months
ended 30 June 1988, to $7.5M in the year ended 30 June 1989. Although operating revenue
increased, so did Pegasus Leasings operating losses, from $0.1M in the six months ended 30
June 1988, to $0.8M in the year ended 30 June 1989.
Draft financial statements of Pegasus Leasing for the year
ended 30 June 1990 showed that the company's operating revenue and interest income
approximately doubled over the year from the amounts received in 1989. The draft accounts
disclosed, however, that the company incurred an operating loss of $5.5M for the year.
The key operating results of the Pegasus Leasing venture
from January 1988 to June 1990 can be summarised as follows:
30 June 1990
30 June 1989
30 June 1988
In summary, although Pegasus Leasing expanded and
diversified its operations rapidly after January 1988, it reported increasingly large
losses each year. Indeed, the joint venture recorded a loss every year from the time of
its formation in 1985.
That is not to say that the joint venturers did not derive
any profits from the provision of services to the joint venture. Pegasus Securities and
Beneficial Finance derived income in the form of management fees, commission, interest and
guarantee fees from the joint venture for providing management and financial services. A
report prepared by Mr Chakravarti and Mr Piovesan in October 1990 stated that each joint
venturer had received profits of about $1.1M over the life of the joint venture.
Nevertheless, assuming that the services were provided by the joint venturers on
commercial terms, the reported results of the joint venture strongly suggest an underlying
In 1989 and early 1990, some signs began to emerge that
Pegasus Leasing's business operations had outgrown the capacity of its internal management
information and accounting systems to cope.
In a memorandum dated 4 September 1990 from Mr J R
Devereaux to Mr Chakravarti, Dr Sexton and Mr G A Brown, Mr Devereaux reported that:
"In the monthly management report to the August
1989 Executive Committee meeting by the Finance, Credit & Personnel Division, a
reference was made in the Equity Accounting Section to Pegasus "maintaining its
chequered record" and further clarification has been requested.
From February, 1989 to August, 1989 we liaised with six
non-Beneficial Accountants, who were involved in the provision of financial data for
various entities, by specified deadlines, to enable preparation of Equity and Aggregate
Accounting statements for periods ending December 31, 1988 and June 30, 1989.
The performance by Pegasus was easily the worst and
we experienced none of the following problems with the other five entities:
1. No deadline was ever met, despite assurances they
could be complied with. This also applied to monthly financials for the period
2. Financials needed a number of alterations after we
3. On many occasions there was no response to our
Price Waterhouse provided accounting assistance for
the June 1989 accounts and I believe they had similar frustration."
At its meeting on 26 January 1990, the Board of Directors
of Beneficial Finance reviewed a summary of Internal Audit Report No 20, covering the
period October to December 1989. The Report stated that issues raised in the previous
audit report of Pegasus Leasing still had not been addressed; that deficiencies had been
found in the lending area, and that these related mainly to the fact that correct
approvals had not been obtained for transactions totalling $12.5M. Deficiencies were also
reported in the securities area. It was stated that the debt factoring business generally
lacked management and internal controls in both account management and administration. The
insurance broking division had failed to pay accrued taxes and duty totalling $0.13M.
There was a lack of account reconciliation between general and subsidiary ledgers, and
inefficiency and increased potential for error by utilising two different computer systems
to record and process information. The Report also severely criticised a wide range of
financial and managerial practices of Pegasus Leasing.
33.3.6 RESTRUCTURING OF THE PEGASUS LEASING JOINT
As I noted earlier, Beneficial Finance undertook an
analysis, in about September 1989, of both the control and funding of its various joint
ventures. A Joint Venture Status Report dated 16 October 1989, stated in respect of the
funding of the joint ventures, that:
"Currently, Beneficial provides the bulk of the
funds for most joint ventures, acting as Banker, achieving banker's margins but without
the benefit of bank cost of funds. The provision of funds has an opportunity cost
attached. A review of the shareholders' agreement for each of the joint ventures suggests
that Beneficial's original intention was only to interim fund. In addition, non-recourse
funding arrangements with external lenders are impacting on Beneficial/State Banks limits
in some instances.
The environment which prevailed when the joint venture
arrangements were first entered into has changed. While the premise that Beneficial has
the financial strength and the joint venture parties have the expertise has not changed,
the market requirements have since altered such that Beneficial's capital is now a scarce
resource. In addition, the strong growth of some of the joint ventures was not anticipated
and given that none of the joint venture partners have the financial capacity to support
the growth they were achieving through continual capital injections to maintain gearing at
acceptable levels, there has been an expectation that Beneficial will provide the
additional funding required. Whilst Beneficial can choose to limit the funds lent, as
there is no legal requirement to provide all funding, it is our objective to not restrict
profitable growth of the joint venture. However, notwithstanding this objective,
considerable difficulty is being experienced in attracting non-recourse external
borrowings with existing joint venture gearing levels ...
Our current efforts are being directed mainly towards
reducing Beneficial funding to joint ventures to the minimum required to secure
non-recourse funding, thereby maximising both the joint venture profitability and
Beneficial's overall ATROE from the joint venture involvement."
Even before that review, however, Mr Baker became concerned
at the large loan exposure that Beneficial Finance had to Pegasus Leasing, and expressed
that concern to Mr Horwood, Chief General Manager of Beneficial Finance's Treasury and
Capital Markets division. Mr Horwood's proposed solution seemed simple. He proposed that
the funding for Pegasus Leasing's business should be obtained from the State Bank through
the Reverse Principal and Agency Agreement. By borrowing funds from the State Bank under
that arrangement and on lending those funds to Pegasus Leasing, the loans would
effectively disappear from Beneficial Finance's balance sheet, because it was Beneficial
Finance's practice not to show in its accounts either the asset represented by its loan to
its sub-agent, or the associated liability to the State Bank. The "back-to-back"
loans were simply netted off.
A memorandum dated 28 August 1989 from Mr Horwood to Mr
"John Baker has noted that Pegasus has
approximately $62m of Beneficial direct loans, a rather high figure despite our
Trevor Waller advises that many of these loans could
have been set with the State Bank Reverse P&A Agreement but for various reasons were
The Reverse P&A costs Beneficial a premium of about
0.6 per cent (0.85 per cent less say 0.25 per cent margin on alternative Beneficial
Finance funding). For this we get off balance sheet assets; further there is no profit or
revenue leakage from a SBSA Group viewpoint. The allocation of provisions is likewise much
easier on Beneficial Finance.
It thus makes sense to switch a portion of these Pegasus
loans to the Reverse P&A; a figure of $30m to $40m would seem appropriate.
Could this be effected, with continuing advice to
Treasury as to likely settlement date(s)."
Attached to the memorandum was a summary of Beneficial
Finance's loans to Pegasus Leasing A hand-written annotation on the memorandum reads
In fact, only $20.0M of Beneficial Finance's loans were
refinanced at that time by the State Bank using the mechanism provided by the Reverse
Principal and Agency Agreement. A further $20.0M of Beneficial Finance's loans to Pegasus
Leasing were transferred to its off-balance sheet company, Kabani Pty Ltd, by way of a
journal entry. In a memorandum dated 28 November 1989, Mr Horwood advised Mr Baker that:
"You will remember your concern about Beneficial's
loans to Pegasus Leasing in the June 1989 accounts. At that stage we had $62.0M of direct
loans, by far our largest loan exposure.
Since then $20.0M has been refinanced via Kabani ... and
about $20.0M pushed through the SBSA Reverse Principal and Agency Agreement.
The balance of our loan to Pegasus, after reasonably
strong growth in receivables since June, is now around $40.0M.
Do you want to reduce this $40.0M figure further by
pushing more through the Reverse Principal and Agency Agreement? Should all new lending be
via the Principal and Agency Agreement?"
Mr Baker subsequently gave an instruction that Beneficial
Finance's loans were to be moved off its balance sheet, and that all new business by
Pegasus Leasing was to be funded under the Reverse Principal and Agency Agreement.
There is a fundamental problem with the
"solution" proposed and effected by Mr Horwood. The solution of refinancing
Beneficial Finance's loans to Pegasus Leasing by borrowing from the State Bank under the
Reverse Principal and Agency Agreement assumes that the Agreement was nothing more than a
funding mechanism. As I have said, the terms of the Agreement were such that, in
substance, it was a funding mechanism for Beneficial Finance's business, and Beneficial
Finance had regarded it as such since 1986.
In legal form and effect, however, the Agreement was not
a mechanism for funding Beneficial Finance's business. It was a Principal and Agency
Agreement appointing Beneficial Finance to conduct business as the agent of the State
Bank. That business, and the related receivables, belonged to the State Bank. The effect
of Mr Horwood's solution, if it were effective, was that the State Bank became the owner
of Pegasus Leasing's receivables to the extent of $20.0M. The problem was that no effort
had been made to identify which of Pegasus Leasing's receivables "belonged" to
the State Bank, or to the implications of an assignment of those receivables to the State
What followed was a series of meetings, discussions and
memoranda, almost Pythonesque in character, as the Management of Beneficial Finance and of
the State Bank tried to come to grips with the nature of the Reverse Principal and Agency
Agreement, and the implications of the action initiated by Mr Horwood.
Briefly stated, on 21 January 1990, Dr Sexton of Beneficial
Finance's Investment Banking division wrote a memorandum to Mr Baker in response to Mr
Baker's request for "confirmation that all new Pegasus Leasing business is being
booked through State Bank Reverse Principal and Agency Agreement". After noting
that Beneficial Finance had transferred $20.0M of its loans to Pegasus Leasing to each of
Kabani and the State Bank on 1 November 1989, Dr Sexton reported that since that time
Beneficial Finance had continued to provide funds to Pegasus Leasing to finance new
business. He wrote:
"It would appear that there may have been some
confusion as to your requirement with respect to how the Pegasus Leasing business was to
be written. At present, the total exposure to Pegasus Leasing stands at:
Dr Sexton reported that Pegasus Leasing business could not
be conducted under the Reverse Principal and Agency Agreement unless Pegasus Leasing was
able to identify particular leases that were being granted as an agent for the State Bank.
On 1 March 1990, Mr D Crichton of Beneficial Finance's Legal Services department noted
that the purported transfer of $20.0M of Beneficial Finance's loans to Pegasus Leasing to
the Reverse Principal and Agency Agreement could not be effective unless the particular
leases funded with that loan were identified as belonging to the State Bank. Mr Crichton
stated that the lack of identification of particular leases as belonging to the State Bank
was the major reason why the Reverse Principal and Agency Agreement had not been used to
fund Pegasus Leasing in the past.
In a memorandum dated 1 March 1990 to various officers of
Beneficial Finance and Pegasus Leasing, Beneficial Finance's legal officer, Mr Yelland
stated that before anything could be done to resolve the matter, the following action was
"1. Clarification of documentation of any Loan
Facility arrangements between Beneficial Finance and Pegasus Leasing prior to November
1989, eg minutes, letters, journal entries etc.
2. Identification of "securities" (if any)
backing that/those facilities.
3. Identification of separate advances and back to back
receivables which were purportedly "transferred" to:
(i) Kabani (November 1989)
(ii) State Bank (December 1989)
4. Identification of the terms of those transfers
whether they were with recourse to Pegasus/BFCL, the management of obligations transferred
with them, i.e. is Pegasus to continue to collect, were the receivables absolutely sold or
merely securitised, was the transfer notified to Pegasus, can it be deemed to be a new
loan directly from the assignees? Other matters to be resolved are Collection/Management
fees, terms of the loan which was transferred, yield thereon (query of guarantee) and
other similar information.
Note: The lack of information about the foregoing, is an
example of how badly neglected and/or casually this whole association has been treated in
the past. Hopefully, under concerted effort of the Investment Banking division the current
short comings will be remedied."
On 7 May 1990, Mr Yelland wrote to Mr M Dawes of the
State Bank's legal department, expressing his belief that the problems had resulted from "some
deplorable gaps in understanding/communication", and hoping that "we
lawyers can save the day". Simply stated, the solution proposed by the
lawyers was that:
(a) the State Bank would take over Beneficial Finance's
loans to Pegasus Leasing;
(b) Pegasus Leasing would then transfer its portfolio of
lease receivables to the State Bank in "repayment" of those loans; and
(c) Pegasus Leasing would then manage the portfolio of
lease receivables on behalf of the State Bank.
The legal mechanism to be used to effect this solution was
outlined in a memorandum dated 9 May 1990 from Mr Yelland to Mr Baker:
"The following will need to be submitted to the
Bank, for approval.
(1) That the Reverse P & A Agreement between
Beneficial and SBSA be ratified as extending to Pegasus Leasing as sub-agent of
Beneficial, and formally approved to allow bloodstock leasing and that all future deals
written by Pegasus Leasing be so written as agent for the Bank.
(2) That the Bank confirm its $20M "loan"
direct to Pegasus Leasing (backed by receivables of the same amount) -
"transferred" from Beneficial in December 1989, but since novated.
(3) That the Bank agree to accept a further $39.25M
worth of loans currently being funded by Beneficial to Pegasus Leasing (also backed by
(4) That the Bank agree to accept a further $20M worth
of loans currently being funded by Kabani to Pegasus Leasing.
(5) That instead of transferring the receivables
represented by the loans referred to in (3) and (4) above, from Pegasus Leasing to the
newly formed Pegasus (unincorporated JV); the Bank agree to take a transfer of these
receivables (subject to a limited "recourse" of some sort to Beneficial) from
Pegasus Leasing incorporated JV under a written offer/verbal acceptance arrangement direct
to the Bank. The consideration from the Bank being the balance owing under the loan to
Pegasus Leasing, now vested in SBSA.
(6) The end result of that exercise will be that:
(a) Pegasus Leasing will have no assets (receivables)
other than a few "repossessed" bloodstock.
(b) SBSA will have $79.25M worth of bloodstock
receivables written by Pegasus Leasing on its books.
(c) Beneficial will have a limited recourse obligation
to SBSA in respect of those leased bloodstock receivables.
(d) Pegasus Leasing will be engaged by SBSA to
"manage" the collection of these receivables and/or Beneficial will earn a fee
for a recourse exposure probably on a variable basis, equal to the gross yield of the
receivables less the Reverse P & A funding right.
(e) All future Pegasus Leasing transactions (i.e.
predominantly bloodstock leasing) fitting under the P & A will be written by Pegasus
Leasing as agent/sub-agent for SBSA and managed by them as in (b).
Beneficial Treasury has already anticipated the second
transfer of $45M worth of loans (see (3) above) and awaits SBSA internal approval before
allocation of the exact amount onto SBSA balance sheet."
The following handwritten note, dated 21 May 1990 and
signed by Mr Baker, appears on the first page of Mr Yelland's memorandum:
"... Graham Yelland - Proceed with assistance from
Rhys Horwood (if necessary) as regards SBSA Treasury."
A diary note dated 4 June 1990 by Mr S G Paddison, the
Chief General Manager of the State Bank's Australian Banking division recorded that on 1
June 1990, the Executive Committee of the State Bank, after consultation with Mr Clark and
Mr D W Simmons, approved a recommendation to the State Bank Board that the State Bank
should "refinance Beneficial Finance's portfolio" of bloodstock receivables
through the Reverse Principal and Agency Agreement.
In fact, the procedure outlined by Mr Yelland was not
implemented. Instead, the Management of the State Bank and Beneficial Finance agreed on a
simpler solution that amounted to a re-writing of history. On 27 September 1990, Mr
Parkinson, General Manager of Beneficial Finance's Taxation and Corporate Planning
department, made a file note recording an agreement between senior officers of the State
Bank and Beneficial Finance to treat all of the leases granted by Pegasus Leasing as
having been made as agent for the State Bank under the Reverse Principal and Agency
Agreement. Accordingly, Pegasus Leasing would not include the lease receivables in its
accounts because, being subject to the Reverse Principal and Agency Agreement, they were
owned by the State Bank. A subsequent memorandum from Mr Parkinson and Mr Yelland to
Mr J D Malouf (all of Beneficial Finance) stated that:
"8 November 1990 - After many discussions between
Beneficial, Pegasus Leasing and SBSA, the position that the receivables from Pegasus
Leasing were indeed SBSA receivables under the Reverse P&A was agreed. Draft
acknowledgment document for execution by SBSA/Beneficial and Pegasus Leasing was prepared,
ratifying the ownership of the receivables by SBSA and submitted for approval and
execution. The document has not been signed but receivables treated by all parties as
owned by SBSA not Pegasus."
This agreement appears to have been made in order to
clarify the treatment of the receivables and related loans in the accounts of Pegasus
Leasing, Beneficial Finance and the State Bank as at 30 June 1990. The memorandum by Mr
Parkinson and Mr Yelland noted that the accounting treatment agreed upon between all
parties did not accord with Pegasus Leasing's statutory accounts and taxation returns for
1988 and 1989. However, Mr Parkinson and Mr Yelland contended that the accounts and
taxation returns were incorrect, since:
"... such an analysis would mean that Beneficial
(SBSA) was effectively making unsecured loans to Pegasus Leasing.
In addition, if Beneficial was to be deemed to be the
so-called owner of the receivables or a lender to Pegasus Leasing, it may have breached
the 1960 and 1984 Trust Deeds gearing ratios in relation to assets and liabilities as at
30 June 1990."
On 23 November 1990, it was recorded in the minutes of a
meeting of the State Bank's Finance and Treasury personnel that, in May 1990, the Group
Executive of the State Bank had agreed to adopt, under the Reverse Principal and Agency
Agreement, all business written by Pegasus Leasing. A Deed of Acknowledgment of the
arrangements was forwarded to the State Bank by Mr Yelland on 16 January 1991.
33.3.7 SUMMARY AND CONCLUSIONS
The Pegasus Leasing Joint Venture effectively commenced
operations in January 1988. The business was conducted by a joint venture company, Pegasus
Leasing Ltd, which acquired the existing business of Pegasus Securities and employed that
The Pegasus Leasing Joint Venture was formed despite the
express and documented recommendation of the Joint Venture Committee of Beneficial Finance
that it should not be established. No formal submission was presented to the Board of
Directors of Beneficial Finance setting out in detail the terms and conditions of the new
Pegasus Leasing grew and expanded its business rapidly
after January 1988, funded by unsecured loans from Beneficial Finance. Its activities
became increasingly diverse and complex, and in the thirty months to 30 June 1990, total
assets grew by almost $100.0M. By June 1989, however, the losses incurred by Pegasus
Leasing had wiped out its capital, and the company's liabilities exceeded its assets.
Beneficial Finance's loans to Pegasus Leasing at the time totalled $62.0M, and by January
1990 were $85.0M. Signs began to emerge that Pegasus Leasing's operating and information
systems might have not kept pace with the growth and diversification of its business
In November 1989, Beneficial Finance sought to move its
loans to Pegasus Leasing off its balance sheet, by refinancing the loans by borrowing from
the State Bank under the Reverse Principal and Agency Agreement. This proposed solution,
however, ignored the legal effect of the Reverse Principal and Agency Agreement, which was
that the receivables portfolio of Pegasus Leasing would be owned by the State Bank. After
months of investigation and negotiation, the State Bank agreed to take over Pegasus
Leasing's receivables portfolio.
In my opinion, the growth and conduct of Pegasus
Leasing's business after January 1988 was not effectively controlled or monitored by
Beneficial Finance. In accordance with the basic premise of the joint venture, Beneficial
Finance relied on Pegasus Securities staff, and particularly Mr McGregor, to conduct the
business. Beneficial Finance provided unrestrained funding to Pegasus Leasing to finance
its rapid expansion. In his evidence to my Investigation, Mr Reichert said that despite
the fact that he had doubts regarding the credentials of Mr McGregor to carry on the
business, insufficient control was exercised over Mr McGregor in expanding Pegasus
In contrast to 1987, the minutes of the meetings of the
Beneficial Finance Board of Directors do not document expressions of concern regarding the
performance of the joint venture. This is despite the fact that the joint venture recorded
losses in each year, and that by 30 June 1989 its liabilities exceeded its assets.
33.4 PEGASUS LEASING AFTER MAY 1990
33.4.1 RESTRUCTURING OF THE JOINT VENTURE
In about April 1990, it was decided to restructure the
Pegasus Leasing joint venture, returning it to the form of an unincorporated partnership
of the type used between August 1985 and December 1987. There were a number of reasons for
(a) it facilitated the transfer of Pegasus Leasing's
receivables to the State Bank under the Reverse Principal and Agency Agreement;
(b) the direct ownership of one-half the joint venture's
non-receivables assets by Beneficial Finance would allow it to utilise any taxation losses
arising from those assets; and
(c) the restructure would result in the assets coming onto
Beneficial Finance's balance sheet, in accordance with its plans at the time.
On 29 May 1990, Pegasus Leasing transferred the majority of
its non-receivable assets to the unincorporated joint venture for a total consideration of
$8.0M. The joint venturers were Carcoar Pty Ltd, a wholly-owned subsidiary of Beneficial
Finance, and Lanceti Pty Ltd, a wholly-owned subsidiary of Pegasus Securities. The
recitals to the Joint Venture Agreement stated that Beneficial Finance and Pegasus
"... have agreed to constitute themselves into a
joint venture for the purpose of carrying on a business of inter alia arranging and/or
participating in operating finance leases and generally undertaking finance arrangements
in their own right or as agents for and on behalf of Beneficial as principal or as agent
or sub-agent for the State Bank of South Australia."
The directors of Pegasus Leasing in office at the time of
the restructuring were Mr McGregor, Mr Tucker and Mr Knox nominated by Pegasus Securities,
and Mr Piovesan, Mr O'Brien, and Dr Sexton of Beneficial Finance.
The terms of the new joint venture agreement dated 28 May
1990 were essentially the same as those of the first unincorporated joint venture. Pegasus
Leasing reverted to acting as a nominee for the joint venture partners. Capital was to be
contributed equally, and the partners would share profits and contribute equally to
losses. The Agreement provided that the joint venture could be terminated by either party
giving at least three months notice of its intention to terminate the venture.
33.4.2 TERMINATION OF THE JOINT VENTURE
Within three months of the restructure, however, Beneficial
Finance decided to wind up the joint venture.
In July 1990, the Beneficial Finance Board of Directors
decided to cease funding of all joint ventures, including Pegasus Leasing.
Beneficial Finance also moved to obtain a guarantee from Mr
McGregor and his companies for its existing loans to the joint venture. The minutes of the
Beneficial Finance Board of Directors' meeting on 27 July 1990 record that:
"The Board was advised that Mr A McGregor had
consented to give a guarantee with regard to the Pegasus Leasing joint venture. Mr
McGregor was currently overseas, but an exchange of faxes was to be arranged by 31 July
1990 to evidence a commitment to execute a guarantee."
At the same time, increasing evidence began to emerge of
the inadequacies of Pegasus Leasing's operating and information systems. An interim
internal audit report prepared in August by Mr A Kane and Ms B Holmes of Beneficial
Finance's Internal Audit department, found that the "systems, controls and
operations within the Pegasus Group are less than adequate," and noted
deficiencies particularly in the assessment and management of credit risk, including:
"(i) Absence of credit checks.
(ii) Nil or minimal financial analysis of applicant's
financial strength ...
(iii) Inability to confirm existence of current
insurance from information retained on file.
(iv) Other issues include cases of lack of formal
approval; absence of veterinarian's certificate confirming the identity and fitness of our
security; and waiving the requirement of insurance for the security."
In relation to Pegasus United Kingdom, the report referred
to a review of all files kept by Pegasus Leasing in Adelaide and noted that:
"a) Applications are not always signed for
b) No copies of supporting invoices on file to identify
or support finance security.
c) All documentation in relation to assignment of
security is located in UK.
d) Details of insurance cover is, at best, nominal.
e) Location of security is not always provided."
In August, Beneficial Finance began the task of
transferring the accounting functions of the joint venture from Pegasus Leasing's systems
to Beneficial Finance. Papers presented to the Board meeting of Beneficial Finance on 30
August 1990 record that:
"Pegasus Leasing's Management Information Systems
and Accounting functions have been transferred to Beneficial Finance and a general
provision of $1.5M against our funding lines has been raised as at 30 June 1990.
A thorough investigation of this joint venture is
continuing with a report to be completed by end November 1990. Any further provisions or
loss write-offs will be made progressively as identified.
In the meantime, funding of new sales has ceased and an
action plan to sell assets, minimise operating costs and wind up the operations as quickly
as possible is being implemented. This includes a restructure of the organisation with all
possible functions being absorbed by Beneficial by 31 December 1990. Group assets
currently under negotiation for sale are expected to net $1.1 million.
Total SBSA/BFCL exposure is $111.0 million and it is
expected that full realisation will take a minimum of three years."
The minutes of the meeting of the Beneficial Finance Board
held on 28 September 1990 record that "some difficulties were expected in the
winding up of Equus and Pegasus. The Board requested a detailed action plan for the
withdrawal from Pegasus to be submitted to the October Board meeting."
An Interim Management Report on the Pegasus Group dated 18
September 1990 was prepared for Beneficial Finance's Executive Committee by Mr Chakravarti
and Mr Piovesan, both of whom had been directors of Pegasus Leasing. The purpose of the
report was to provide a summary of the state of Pegasus Leasing's activities, and to make
recommendations to protect Beneficial Finance's exposure. The report began by noting that:
"The capital of the Joint Venture is $0.4M, $0.2M
from each partner, with returns since inception of $1.1M to each partner. The Joint
Venture is divided into the following individual operating entities:
|Australian finance operations
|UK/Ireland finance operations
|New Zealand finance
|Pegasus Insurance Consultants
|Rivlin $ Associates Pty Ltd
|(crash repair factoring)
|Investments, bloodstock held
& cash on hand
|Operations are currently
funded as follows:
|SBSA Rev. P&A
|SBSA (London) (guaranteed by
Rivlin and PIC are funded by Pegasus Leasing
The report went on to state that:
(a) "As a result of investigations to date by
Joint Venture Accounting, further losses of $1.2M required adjustment following various
accounting errors. It is anticipated that further negative adjustments will be necessary
as the accounting functions are undertaken by Beneficial Finance. It should be noted
that the Financial Controller of the Pegasus Group has resigned."
(b) "A recommendation for loss provisions on the
Pegasus Leasing Joint Venture receivables and investment loan accounts of $2.2M is
Beneficial Finance State Collections Manager is now
undertaking a full review of the receivables portfolio to ensure adequate collection
(c) "As a result of the accounting adjustments
abovementioned, the Joint Venture result to June 1990 is a loss in excess of $3.0M. To
July 1990, the Joint Venture and Pegasus Leasing Ltd. on a consolidated basis, reported a
loss of $0.21M. It is anticipated by Beneficial Finance that a smaller loss will be shown
In respect of the workout strategy, the report noted two
(a) first, the size and geographic spread of the business
meant that any solution to the problem had to be long term; and
(b) second, Beneficial Finance's limited expertise in the
bloodstock industry meant that it would need to rely on Mr McGregor, or another outside
expert, to manage the investments, partnership accounts and problem loans that involved
making decisions in respect of the bloodstock held.
The report identified a number of "Action Items"
that had been, or would be, taken to rationalise the Pegasus Leasing business. After
noting that the Sydney operations had already been closed, and that Pegasus Leasing was
not to enter into any new partnership ventures or acquire any investments without
Beneficial Finance's approval, the report stated that the following action was to be
(a) there would be no new funding of the joint venture. All
new transactions were to be undertaken by Pegasus Securities as agent for Beneficial
(b) all credit approval limits of Pegasus Leasing were to
be revoked, with all future transactions to be approved by Beneficial Finance in
accordance with its approval policies and procedures;
(c) all cheques written by Pegasus Leasing were to be
signed by at least one Beneficial Finance manager; and
(d) the New Zealand and United Kingdom operations were to
be closed, and the portfolios sold.
Further actions to be taken included:
(a) the establishment of a prudential limit for
Beneficial Finance's exposure to the bloodstock industry; and
(b) an assessment was to be undertaken by Beneficial
Finance of Pegasus Leasing's receivables portfolio, including the securities held and the
adequacy of insurance, to determine the feasibility of sale.
The report projected that an initial forecast, which
"needs to be refined", indicated that the joint venture could operate at a
profit over the following four years, after the payment of interest on funding provided by
In October 1990, Price Waterhouse, the external auditors of
Beneficial Finance and Pegasus Leasing, delivered a report severely criticising accounting
practices of Pegasus Leasing, and pointing out a number of transactions between Pegasus
Leasing and some directors and senior staff of both Beneficial Finance and Pegasus
Leasing. The report, which was given to Mr Baker at the request of Mr McGregor, stated
that an Assistant Manager from Price Waterhouse had spent approximately four weeks at
Pegasus Leasing, and to the date of the report had raised more than 150 adjustments to the
company's accounts. Price Waterhouse had previously pointed out problems in the quality of
accounting records of Pegasus Leasing in three management letters in the previous twelve
Price Waterhouse reported, among other things, that:
(a) The quality of accounting at Pegasus Leasing had
deteriorated since 30 June 1989.
(b) Accounting problems had not been resolved as they
arose. Instead, problems were left unresolved for months until specific requirements, such
as the annual audit, forced attention to be paid to them.
(c) Most of the adjustments that had been raised by Price
Waterhouse had reduced profit and net assets.
(d) The poor performance of Pegasus Leasing in the year
ended 30 June 1990 had been caused by a number of factors, including high interest rates,
additional provisioning on receivables, and write-downs in the value of bloodstock due to
a deflated market for horses.
(e) The information which had been produced for
management of Pegasus Leasing was so inadequate that the progressive deterioration in the
company's affairs was largely unidentified during the year.
(f) Price Waterhouse believed there was a general "hands-off
Pegasus" attitude amongst senior management of Beneficial Finance.
Minutes of the Board meeting of Beneficial Finance held on
26 October 1990 recorded that:
"The audit conducted on the Pegasus Joint Venture
had revealed significant accounting problems and errors. The Board was advised that the
joint venture operations had been wound down and would cease by 30 November 1990. Funding
had ceased and accounting and lending approvals were now being undertaken by Beneficial
The Board considered that Beneficial should take a hard
line in negotiations with Mr McGregor regarding his assistance in the management and wind
back of the existing receivables. Management was requested to submit details of the
further negotiations to the Board."
The review of Pegasus Leasing's securities and insurance
arrangements foreshadowed in the Interim Management Report was undertaken by Mr Yelland.
In a memorandum dated 25 October 1990, Mr Yelland reported the results of his review to Mr
Devereaux, who had been appointed by Beneficial Finance as its representative to work with
Mr McGregor to ensure that adequate controls were implemented, particularly in relation to
the collection of receivables and assessment of the values of investments. The review
covered about 40 out of 1,200 client files. Mr Yelland found that, although the
documentation was basically sound, the settlement procedures and security operations had
been undertaken by untrained personnel. Almost all files reviewed contained errors. The
memorandum stated that the major problems which had been encountered were:
". Failure to fill in blanks in Schedules i.e.
. Improper use of "Livestock Leases" for
leases of "shares" in livestock;
. Power of Attorney authorities post-date executions;
. Disregard for any interstate stamp duty liability;
. Failure to effect company, bankruptcy and other
essential credit checks;
. Pre and post-settlement conditions not followed for
. Omission or inadequacy of insurance covers;
. Veterinary verifications missing;
. Failure to obtain manager's signature."
A Status Report presented to the Beneficial Finance Board
of Directors in November 1990 stated that although no new leases had been approved since
the Board's directive on 26 October, Beneficial Finance's plans to take over full control
of the venture by controlling all bank accounts, retrenching surplus staff and running
down the insurance and debt factoring businesses were being resisted by Mr McGregor, who
(a) he gave his personal and corporate guarantees in August
1990 only because he was assured that the wind-down of the operations would not be so
precipitous as to adversely affect his interests; and
(b) in any event, the joint venture agreement required the
giving of three months notice for termination of the venture, which he would waive only if
Beneficial Finance agreed to allow him to operate some of his joint ventures activities in
his own right.
Beneficial Finance's legal counsel, Mr Yelland, advised
that Beneficial Finance's action in seeking to terminate the joint venture "may
well have been illegal", and that the "proper course would have been to
give the required three month's notice, followed by an orderly wind down".
Accordingly, the Status Report recommended that, in order to obtain Mr McGregor's
co-operation and release from any claims he may have against Beneficial Finance,
Beneficial Finance should:
(a) undertake not to enforce the termination of the joint
venture on a formal basis, but let it run down by natural attrition under the management
and control of Beneficial Finance;
(b) undertake not to appoint a receiver to any of Mr
(c) offer to sell Beneficial Finance's interest in the
insurance and debt factoring businesses to Mr McGregor at their total assessed value of
(d) engage Mr McGregor as a consultant to assist Beneficial
Finance in running down the joint venture's assets.
The Board of Directors approved the recommendations of the
A meeting was held on 7 December 1990 between Mr McGregor
and Mr Devereaux, Mr Piovesan and Mr Yelland to review the financial position of Mr
McGregor's companies. According to a report prepared in March 1991 by Mr Devereaux, Mr
McGregor advised the meeting that he required finance of about $1.0M or he would be forced
to put Pegasus Securities into receivership on 12 December 1990. His request was refused.
On the same day, a number of Pegasus Leasing staff were retrenched, and on 10 December the
files and records of Pegasus Leasing were transferred to Beneficial Finance's premises.
Mr McGregor took his own life on 11 December 1990. Pegasus
Securities was placed into receivership on 24 December 1990.
The papers for the December 1990 meeting of the Board of
Directors of Beneficial Finance documented the actions taken, and to be taken, by
Beneficial Finance with respect to Pegasus Leasing and Pegasus Securities as follows:
" . A Price Waterhouse report investigating the
Pegasus operations was commissioned in August 1990. The results of this report highlighted
a number of inconsistencies in the historical accounting of the joint venture.
. Given the performance of the joint venture, Beneficial
Finance advised the joint venture partner after the October Board meeting of the
Beneficial Finance Board of Directors that it would no longer fund the venture.
. The venture is being wound up with a number of staff
retrenchments already effected. The sudden death of the Joint Venture partner also has
resulted in Beneficial moving to take full control of the operation, and has substantial
ramifications for Beneficial as McGregor was to be an integral part of the Pegasus Leasing
. Following Mr McGregor's death, meetings have been held
with the remaining Director of the joint venture party [Lanceti Pty Ltd], who has
agreed to Beneficial taking control over the operations with Tim Knox, the general manager
of Pegasus acting as the day to day representative for Lanceti. The possibility of
purchasing Lanceti [for nominal cost] is also being examined so Beneficial has full
control of the venture. However, this is dependent upon analysis of the legal and tax
implications of this strategy.
. Knox is looking at the possibility of a MBO of part of
the insurance and leasing operations.
. Beneficial has appointed a manager for the Pegasus
operation. The manager, J Devereaux, has been closely involved in the winding up of the
operation for several months. Devereaux is retiring in March 1991 and has declined to
remain with Beneficial beyond this date. Consequently, a replacement will need to be found
prior to his departure.
. The Pegasus finance operation is being shifted to
Franklin Street and will be managed by Devereaux. The insurance operation will continue
under Knox's operation at Greenhill road until its future is determined. Beneficial has
organised the changing of the locks and access to the security system at Greenhill Road,
and tenants are being sought for the space.
. Rivlin has ceased advancing funds and the portfolio
will be wound down. The possibility of selling the operation has been investigated, but
interest only at a substantially discounted price was indicated. Hence it was determined
that running down the portfolio would result in the greatest return.
. Ernst & Young Equine division have met with AMCD
re the possibility of selling the Pegasus operations on a success fee basis only. Excel
Finance has also indicated preliminary interest in part of the operations.
. The full year profit/loss position of the year ended
30 June 1990 is yet to be finalised but is estimated at a loss of $4.5m. The fact that the
annual accounts have not yet been signed presents substantial problems as the Companies
Code requires disclosure of material changes which have occurred since balance date and
prior to signing hence finalisation of the accounts is being actively pursued.
. The forecast profit for 1990/91 is also being further
reviewed with a number of issues, including the level of general loss provisions being
(In a submission to me, Mr Knox denied that he ever
examined the possibility of a management buy-out of the leasing operations of Pegasus
Mr Piovesan, who had been appointed to the Pegasus Leasing
Board in May 1990, summarised in his submission to my Investigation the principal matters
of which he became aware after joining the Board:
(a) Beneficial Finance had no security for its loans to
Pegasus Leasing, and had been effectively capitalising interest on the loans by providing
further loans to pay that interest.
(b) Pegasus Leasing staff handled all accounting and
receivables management. There was a general "hands-off" attitude from senior
management in respect of Pegasus Leasing.
(c) Pegasus Leasing had failed to institute and maintain
proper procedures for the collection or write-off of receivables. As a result, there had
been very inaccurate reporting of receivables arrears by Pegasus Leasing. When the
transfer of the accounting and receivables to Beneficial Finance's computer system was
completed in September 1990, the level of arrears "blew out" dramatically.
Mr Devereaux made much the same point in a memorandum
dated 25 February 1991 to Mr Malouf, then the Managing Director of Beneficial Finance. He
"Mr McGregor, although using Beneficial's money,
had absolute control and autonomy over:
(i) approval standards of new lease deals;
(ii) the subsidiary receivables ledger; and
(iii) accounting records for the Joint Venture.
With this background it was inevitable that there
would be unsatisfactory delays in conveying adverse trends to middle/top management and
the Board of Beneficial."
33.4.3 THE LOSSES ARISING FROM PEGASUS LEASING
Generally, lease transactions written by Pegasus Leasing
did not begin to fall into default until the latter part of 1990 and into 1991, when there
were major reductions in the value of thoroughbred horses. As a result, without security
beyond the value of the horses, Pegasus Leasing became solely dependent on the propriety
and perceived financial strength of the lessees. Many lessees were unable or unwilling to
meet their obligations in declining economic conditions. In addition, some lessees sought
to avoid their obligations by taking advantage of faulty documentation, or alleging
misrepresentation by officers of Pegasus Leasing.
In a briefing paper dated 26 March 1991, the then General
Manager of Pegasus Leasing, Mr Hewitt, concluded:
"With the greater majority of the receivables
being secured by thoroughbreds, the ledger and its collectability is reliant on sales
prices being obtained. Further to this the "investment" portion of the general
ledger is directly reliant on the sales, particularly in respect of the involvement in the
Thoroughbred Investment Parcels.
Thoroughbred sales attended during February in Auckland,
New Zealand and Melbourne confirmed earlier trends of yearling falls in the 30% - 40%
range and broodmares up to 90%. These price falls have left many syndicates without the
working capital to continue and the participants either unable or unwilling to contribute.
More and more horses are having to be sold just to stop the on-costs of agistment,
servicing, vet expenses etc.
It is difficult to see the prices increasing for some
time, with many factors that promoted the price boost no longer evident, ie:
1. Non-bloodstock participants, having been caught with
poor investments, will not return to the markets.
2. Taxation benefits are in doubt, and the financial
viability of the structures do not measure up commercially.
3. Lack of players in the market to finance the
industry. Certainly it would be hard to envisage a financier getting involved to the
extent Pegasus and Excel achieved.
The general consensus within the industry is to
endeavour to maximise the return. However, selling is the best option to cut the ongoing
On 25 February 1991, Beneficial Finance sought an
independent report from Ernst & Young, Chartered Accountants, on a number of financial
issues concerning Pegasus Leasing. By letter dated 27 February 1991, Ernst & Young
provided a preliminary report, which concluded that the following factors had adversely
affected the business of Pegasus Leasing:
(a) the inability to the McGregor Group to meet its joint
(b) the depressed state of the bloodstock industry;
(c) doubt over the taxation status of bloodstock projects
(d) loss of popularity of syndication as a method of
attracting investors in bloodstock; and
(e) doubt as to enforceability of documentation of loans
and other transactions by Pegasus Leasing.
The report confirmed the estimate of Beneficial Finance's
Management that the losses associated with Pegasus Leasing would total between $40.0M and
$46.0M. The report provided the following details of the estimated losses:
losses to 31 December 1990
January and February 1991
Loss from the
portfolio of lease receivables
investments and bloodstock held
Austral-Eire investment and receivables
North-South investment and receivables
Loss on Rivlin
investment and receivables
managing the portfolios for 18 months
The review of Pegasus Leasing's exposure to the
Austral-Eire Thoroughbred Investment Parcel expressly stated that the loss estimate took
into account the nature of the investors that had borrowed from Pegasus Leasing:
"A review of the external investor files in Austral
Eire indicates that in most cases they were professionals who at the time of investment
were seen to be individuals of substance and with sufficient assets to cover the advances
made. We understand from Mr Knox that the advances were made based on the assessment of
the individuals net worth, and did not rely on the assets or income acquired by the
Given the above and the damage that could occur to their
professional status from any bankruptcy proceedings, a further return of $816,000 has been
estimated as the recovery to be collected from these individuals' personal assets. This
results in a loss to the Pegasus group of $2 million from these external receivables.
When combined with the loss on the Pegasus Leasing
investment, the total loss relating to Austral Eire is estimated at approximately $7
33.4.4 A HINDSIGHT REVIEW BY BENEFICIAL FINANCE
In November 1990, management prepared at the request of the
Board of Directors, an evaluation of the lessons to be learned from Beneficial Finance's
participation in joint ventures. The report included a summary of the "major
elements of weakness" in particular joint venture arrangements, identifying the "key
indicators which, whilst by no means exhaustive, clearly demonstrate where we went wrong
in each relationship". In respect of Pegasus Leasing, the report identified the
(a) "Top down" approval of the joint venture,
meaning approval by senior management without an analysis being undertaken at operational
(b) The joint venture agreement and related documents
advantaged Pegasus Securities at the expense of Beneficial Finance.
(c) Inadequate written procedures were established at
the commencement of the joint venture. There were high maximum credit limits that could be
approved without reference to Beneficial Finance, and those credit limits and/or approval
authorities were breached.
(d) Pegasus Securities was unable or unwilling to
contribute adequate capital to the joint venture. Indeed, Beneficial Finance had provided
financial support to Pegasus Securities.
(e) Pegasus Securities directly controlled the
management of the joint venture, and its accounting and receivables systems. There was
inadequate control by Beneficial Finance over the joint venture's cash receipts and
(f) The businesses of the joint venture were outside
Beneficial Finances "normal approved criteria", and some competed with the
businesses of other joint ventures.
(g) Within Beneficial Finance there were unclear, shared
and frequently changed account management responsibilities.
(h) The joint venture experienced high arrears, weak
collections of receivables, and significant loss write-offs.
I am satisfied on the basis of the information in this
Chapter that all of the points quoted from the Board Paper above are fair comments in
relation to the Pegasus Leasing joint venture.
33.5 RELATED PARTY TRANSACTIONS
In its report dated 16 October 1990, Price Waterhouse
listed a number of transactions that it had identified which "could be defined as
"related" by ASRB1017." They were:
30 June 1990
J A McGregor
("JAM") was the
Inte’l ("BMI") as
Trustee for AG McEwin Pty Ltd
Leasing Limited ("PLL")
BMI as trustee
JA McGregor & DJ Tucker
director of PLL
director of PLL
director of PLL
officer of PLL
director of PLL
director of PLL
BMI as trustee
for M Chakravarti
BMI as trustee
Director of PLL
for JA Baker
Pastrol & Co
Investments Pty Ltd
with JAM family
(The items marked * represent future lease payments due
from Bloodstock Management International to Pegasus Leasing where the individuals named
have paid to BMI all amounts due.
Thus, although a liability may exist between BMI and Pegasus Leasing, the individual has
met all his obligations to BMI).
Bloodstock Management International Pty Ltd, which was 75
per cent owned by Pegasus Leasing, was manager of the Austral-Eire and North-South
Thoroughbred Investment Parcels.
I have not located any statement of policy of Pegasus
Leasing with respect to loans to officers of Beneficial Finance, Pegasus Securities or
Pegasus Leasing. I consider that policies governing financial dealings by Pegasus Leasing
with related persons were not adequately documented. The failure to have in place
appropriate policies was, in my view, a serious administrative deficiency particularly
having regard to the amount of money involved. I would have expected Pegasus Leasing to
have had, and to have documented and enforced, a policy on financial dealings with its own
directors and employees and with the officers and employees of Beneficial Finance.
Furthermore, I have not found any evidence that the
Beneficial Finance Board had authorised and was monitoring transactions by Pegasus Leasing
involving Mr Baker.
In my opinion, finance transactions between a company
and its directors and senior employees involve issues of propriety and sensitivity. It is
important that prudent policies governing such transactions are established and strictly
enforced. I am of the opinion that, in relation to the Pegasus Leasing joint venture, such
policies were not established and, as a result, that the directors of Beneficial Finance
did not monitor and control financial transactions between Mr Baker and the joint venture.
I am also of the opinion that Mr Baker and officers of Beneficial Finance who entered into
financial dealings with the joint venture had potential conflicts of interest. Given that
ordinary formalities which should have been observed with all transactions were not always
carried out in transactions between Pegasus Leasing and the related parties mentioned in
the tables set out above, I consider that in relation to financial dealings with related
parties, directors of Beneficial Finance and officers of both Beneficial Finance and
Pegasus Leasing who were responsible for the administration of the affairs of the joint
venture failed adequately or properly to supervise, direct, and control, the operations,
affairs and transactions of respectively Beneficial Finance and of Pegasus Leasing.
Mr Reichert, Mr Knox, and Mr Martin have all submitted to
me that the transactions in relation to which they are mentioned in the particulars of
related party transactions set out above were all approved by Mr Baker and by the Human
Resources department, Beneficial Finance, and were on normal commercial terms.
Additionally, Mr Reichert and Mr Martin have submitted to me that
they were requested by Mr Baker and Mr McGregor to place
business with Pegasus Leasing rather than with one of its competitors.
I have not investigated each of the transactions identified
by Price Waterhouse involving the above-named persons, and so make no finding concerning
those transactions or the conduct of those persons.
The transactions described did, however, take place in the
absence of a sufficiently well-defined policy to govern transactions with the directors,
officers and employees of Pegasus Leasing and of Beneficial Finance.
The former Non-Executive Directors of Beneficial Finance
submitted, and I accept, that there were policies laid down for the granting of loans by
Beneficial Finance to its executives and staff from 1984. I have examined this matter
further in Chapter 43 - "Other Matters Investigated within the State Bank and
33.6 FINDINGS AND CONCLUSIONS
In essence, the important features of the Pegasus Leasing
joint venture are simple.
As with its other operating joint ventures, the fundamental
premise upon which the joint venture was based was that it would be a partnership between
the experience, expertise and reputation of Pegasus Securities in a specialised area of
finance, and the strong financial backing provided by Beneficial Finance. Beneficial
Finance hoped that, with its financial support, Pegasus Securities could establish a
significant portfolio of bloodstock lease receivables of about $100.0M, that would provide
a steady stream of profits for both partners.
With Beneficial Finance's financial backing, Pegasus
Securities could build a business of a size far beyond that which it could conduct from
its own financial resources. Pegasus Securities simply did not have the financial strength
to be able to borrow sufficient funds to grow a portfolio of receivables of $100.0M. It
could only do so by gaining finance from a joint venture partner. It necessarily follows
that Beneficial Finance's lending to the joint venture was not based on its usual credit
assessment policies and procedures, but was fundamentally influenced by the fact that
Beneficial Finance itself was joint owner of the borrower. Under those circumstances, it
was always going to be the case that Beneficial Finance would bear the cost of a failure
of the joint venture. The managing director of Beneficial Finance, Mr Baker, candidly
affirmed that this was the basis of the operating joint ventures of Beneficial Finance in
general, and of Pegasus Leasing in particular.
This reliance on its joint venture partner's expertise
required that Beneficial Finance do one of two things:
(a) First, it should have fully satisfied itself that
Pegasus Securities in fact had the experience and expertise to prudently and profitably
manage the business.
(b) Second, Beneficial Finance should have carefully
monitored the activities of the business, to ensure that the business did not diversify
and expand beyond the experience and capacity of Pegasus Securities to prudently and
profitably manage the business.
In my opinion, Beneficial Finance failed to do either of
Mr Reichert told my Investigation both that:
(a) insufficient control was exercised over Mr McGregor in
his conduct of the business; and
(b) Mr Reichert doubted Mr McGregor's credentials to
conduct the business.
Despite these concerns held at the time, Mr Reichert, who
was a director of Pegasus Leasing from June 1988 until November 1989, took no effective
steps to address that situation.
The very nature of the joint venture arrangement had the
effect that Beneficial Finance was forced to rely on Pegasus Securities to a considerable
degree. A basic premise of the joint venture was that it would conduct business in a
specialised area of finance in which Beneficial Finance lacked the necessary experience
and skills. If Beneficial Finance had had those skills, it would not have needed to enter
into a joint venture with Pegasus Securities. As late as October 1990, when the decision
was made to terminate the joint venture, Mr Chakravarti and Mr Piovesan, who had been
directors of Pegasus Leasing, expressed the view that Beneficial Finance still lacked the
necessary expertise to conduct the business, and that reliance would have to continue to
be placed on Mr McGregor or on another external specialist.
More importantly, the business activities of Pegasus
Leasing expanded to a size and diversity that was outside the experience of Pegasus
Securities, and beyond the capacity of its accounting and credit risk management systems
to cope. When the first joint venture was formed, Pegasus Securities had a total
receivables portfolio of only $5.5M. Between January 1988 and November 1989, the business
expanded rapidly to a receivables portfolio of $97.0M, including operations in New Zealand
and the United Kingdom, and participation in, and funding of, thoroughbred investment
This rapid growth of the business was made possible by
the apparently unrestrained funding provided by Beneficial Finance. No appropriate limit
was placed either on Beneficial Fiance's exposure to the bloodstock industry, or its
exposure to Pegasus Leasing. An inevitable result of the unrestrained access to funds was
a downward pressure on credit standards, since potential borrowers who might previously
been excluded from consideration by the need to ration available funds could now be
accepted as clients, in the pursuit of sales growth.
Even in August 1989, when Mr Baker expressed concern
regarding the size of Beneficial Finance's exposure to Pegasus Leasing, no action was
taken to restrain the growth of Pegasus Leasing's portfolio. Instead, the response of
Beneficial Finance Management was simply to try to pass the obligation to fund Pegasus
Leasing's business to the State Bank, through the Reverse Principal and Agency Agreement.
The end result of that attempt to refinance the lending to Pegasus Leasing was that the
State Bank assumed ownership of the receivables portfolio in 1990, and so bore the
In their submission to my Investigation, the former
Non-Executive Directors of Beneficial Finance said that there was a standing direction
that all joint venture partners must guarantee Beneficial Finance's loans, must be able to
contribute to one-half of any of the losses of the joint venture, and that Beneficial
Finance's lending to the joint venture must satisfy the normal criteria and policies
applicable to Beneficial Finance's lending business.
In my opinion, the Non-Executive Directors of Beneficial
Finance failed to appreciate the reality of the operating joint ventures, even though the
rationale for the joint venture was expressly stated to the Board of Directors on a number
of occasions. If the Non-Executive directors had brought an independent and analytical
mind to bear on the structure of the Pegasus Leasing joint venture, it should have become
apparent to them that the risk of financial loss lay with Beneficial Finance. An
examination of the joint venture's balance sheet would have shown that the joint venture
was wildly overgeared, and that in June 1989 it had no capital at all, with its borrowings
actually exceeding its total assets. Such a funding arrangement could not have been
satisfactory within Beneficial Finance's established lending policies and procedures.
The Non-Executive Directors did not appreciate the nature
of the risks being run by Beneficial Finance, and the actions that needed to be taken to
ameliorate these risks. The failure of the Non-Executive Directors to come to grips with
the basic nature of the joint venture amounted, in my opinion, to a failure to adequately
or properly supervise, direct and control Beneficial Finance's participation in the joint
In my opinion, the fundamental failing of Management of
Beneficial Finance was to fail to recognise the deficiencies in the joint venture
strategy. Reliance upon the experience and expertise of a joint venture partner within
that partner's business experience is one thing. To provide that partner with almost
unlimited finance, enabling it to expand and grow the business beyond the limits imposed
by normal commercial constraints, is an invitation to disaster. For this failing, the managing
director of Beneficial Finance, Mr Baker, must accept the heaviest blame. It was Mr Baker
who proceeded with the establishment of the joint venture despite the express
recommendation of the Joint Venture Committee not to do so. Many other of the officers
and employees of Beneficial Finance involved in the Pegasus Leasing joint venture could,
however, be subject to criticism, including those officers who served as directors of
Pegasus Leasing without exercising an adequate level of control, and those managers who
allowed funds to flow to Pegasus Leasing without limitation.
In my opinion, the fundamental strategy of the joint
venture was flawed. Providing a small, entrepreneurial business in a niche financing
market with unlimited finance to grow, uncontrolled by normal funding constraints,
involves taking an unacceptable risk that is tantamount to gambling. The use of the
Reverse Principal and Agency Agreement in 1990 to transfer the Pegasus Leasing receivables
portfolio to the State Bank simply meant that the State Bank paid the bill for Beneficial
33.7 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
33.7.1 TERM OF APPOINTMENT A
18.104.22.168 Term of Appointment A(b)
The processes which led the State Bank and Beneficial
Finance, a member of the State Bank Group, to engage in operations which have resulted in
material losses and in the State Bank and Beneficial Finance holding significant assets
that were non-performing include the processes described in this Chapter in respect of the
Pegasus Leasing joint venture and the Reverse Principal and Agency Agreement.
22.214.171.124 Term of Appointment A(c)
For the reasons described in this Chapter, those processes
126.96.36.199 Term of Appointment A(d)
The procedures, policies and practices adopted by the State
Bank and by Beneficial Finance, a member of the State Bank Group, in the management of
significant assets that are non-performing include those described in this Chapter in
respect of the Pegasus Leasing Joint Venture and the Reverse Principal and Agency
188.8.131.52 Term of Appointment A(e)
For the reasons described in this Chapter, those
procedures, policies and practices were not adequate.
33.7.2 TERM OF APPOINTMENT C
For the reasons described in this Chapter, in my opinion,
the operations, affairs, and transactions, of Beneficial Finance, a member of the State
Bank Group, were not adequately or properly supervised, directed and controlled by:
(a) the directors of Beneficial Finance; and
(b) certain officers and employees of Beneficial Finance as
identified in this Chapter.
(In making this finding in respect of the directors, I note
that, in addition to the usual qualifications in respect of the limited tenure of certain
of the directors, it was submitted to my Investigation on behalf of Mr K D Williams that,
as a director of Excel Finance Ltd, a company related to Pegasus Securities, Mr Williams "specifically
declared an interest on each and every occasion that Pegasus Leasing was brought to the
Beneficial Finance Board. On all those occasions, after declaring his interest, he took no
part in any deliberation or decisions in respect of Pegasus Leasing.")