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High Court of New Zealand Decisions |
Last Updated: 18 June 2012
THE NAMES OF ALL INVESTORS ARE PERMANENTLY SUPPRESSED.
IN THE HIGH COURT OF NEW ZEALAND TIMARU REGISTRY
CIV-2011-476-000642 [2012] NZHC 1216
IN THE MATTER OF THE CORPORATIONS (INVESTIGATION & MANAGEMENT) ACT 1989
AND IN THE MATTER OF THE STATUTORY MANAGEMENT OF FORRESTERS NOMINEE COMPANY LIMITED AND HUBBARD CHURCHER TRUST MANAGEMENT LIMITED
AND IN THE MATTER OF RICHARD GRANT SIMPSON, TREVOR FRANCIS THORNTON AND GRAEME CARSON MCGLINN AS STATUTORY MANAGERS OF FORRESTERS NOMINEE COMPANY LIMITED AND HUBBARD CHURCHER TRUST MANAGEMENT LIMITED
Hearing: 21 and 22 May 2012
Appearances: F B Barton and A Cunninghame for Applicants
P F Whiteside for Investors
A S Butler and P Smith for Mrs Hubbard and Estate Allan Hubbard
N A Till QC as Amicus Curiae
Judgment: 1 June 2012
RESERVED JUDGMENT OF CHISHOLM J
A The HMF assets are to be distributed in accordance with [113]. B Counsel are to take the further steps referred to in [114].
C General leave to apply is reserved in terms of [115].
D Costs in terms of [116] and [117].
FORRESTERS NOMINEE COMPANY LTD & HUBBARD CHURCHER TRUST MANAGEMENT LTD HC TIM CIV-2011-476-000642 [1 June 2012]
REASONS Table of Contents
Para No
Introduction [1] Background [7] Jurisdiction [16] The HMF operation [18] The investments [19] Annual investor statements [25] Reconciliations carried out by the statutory managers [30] Management of portfolios post statutory management [34] Issues [37] The primary issue [38] The PIP method [40] The first pooling method [41] Practicality [46] Earlier cases [47] Re Landbase Nominee Company Limited [48]
Re Ararimu Holdings Limited [51] Re Tricorp Investments Limited [53] Re International Investment Unit Trust [55] Principles emerging from these cases [58]
Survey of investors [61] The PIP method of distribution [65] Outline of the case in support [66] The case in opposition [72]
My conclusions [75] The two pooling
methods [92] Differences between the two methods [93] Conclusions
reached by the amicus [99]
My
conclusions [105]
Result [112]
Costs [116]
Introduction
[1] In their capacity as statutory managers of Forresters Nominee Company Limited (FNCL) and Hubbard Churcher Trust Management Limited (HCTML) the applicants hold assets relating to Hubbard Management Fund (HMF) on behalf of approximately 300 investors. They seek directions pursuant to s 58 of the Corporations (Investigation and Management) Act 1989 as to the appropriate method
of distributing those assets between the investors. An interim distribution of about
$9 million has already been made.1 Around $35.9 million remains to be distributed.2
[2] Initially Mr Whiteside was appointed by the Court to represent all investors. It became apparent, however, that this appointment was too wide because not all investors favoured the same method of distribution. At a pre-trial hearing on
3 February 2012 Mr Whiteside’s appointment was confined to investors favouring a pooling approach.3 It was implicit in this ruling that investors supporting the personal investment portfolios (PIP) approach4 advocated by the statutory managers would be represented by counsel for the statutory managers.
[3] Mrs Hubbard, who appears in both her personal capacity and as the administrator of Mr Hubbard’s estate, recognises the hardship faced by investors in having their investments tied up as a result of the statutory management. She wishes to assist the Court in determining the appropriate method of distribution, and I am grateful to her counsel for their submissions. Indeed, all counsel have provided invaluable assistance to the Court in resolving this difficult matter.
[4] It also needs to be recorded at the outset that a minute issued on 3 February
2012 stated:
[6] ... determination of the originating application should focus solely on the form of allocation and distribution of HMF and should not make any determination concerning:
(a) the composition of HMF, specifically whether or not particular shares, cash or other assets are the property of HMF;
(b) the legal consequences for Mr Hubbard’s estate or others, except for HMF or the investors, of representations made by, or alleged to have been made by, Mr Hubbard in respect of HMF; and
(c) otherwise Mr Hubbard’s estate’s liability to investors in
respect of HMF.
1 Pursuant to an order of this Court made on 9 March 2012.
2 This fluctuates depending on the value of the assets, mainly shares, at any given point in time.
3 This approach is explained at [41]-[45].
4 This approach is explained at [40].
This means that paragraph (a) of the originating application will not be pursued at this time and the hearing will be confined to the matters listed in
1(b).
Nothing in this judgment is intended to depart from that agreed approach. This judgment only concerns the appropriate method for distributing the HMF assets.
[5] Over 20 affidavits have been filed, with several deponents having sworn more than one affidavit. One of the statutory mangers, Mr McGlinn, gave viva voce evidence supplementing his five affidavits. He was also cross-examined.
[6] At the commencement of the hearing I made an order suppressing the names of all investors. Some investors have sworn affidavits. Given the suppression order I will not use their names when referring to their affidavits.
Background
[7] In 1953 Mr Hubbard began practice in Timaru as a chartered accountant on his own account. As partners were added the practice became known as Hubbard Churcher & Co. Mr Hubbard had a strong personal interest in share investments and soon after commencing practice he became a country member of the New Zealand Stock Exchange.
[8] Although the precise point in time when HMF came into existence is unclear, it seems that this would have been around 1998. The earliest records concerning HMF that the statutory managers have been able to access go back to that time. No formal documentation relating to the creation of HMF has been located. It is not incorporated.
[9] Initially Mr Hubbard began managing investments for a small number of his clients. Apart from the use of some Hubbard Churcher staff from time to time, the HMF operation does not appear to have involved the accounting firm. All investment decisions were made by Mr Hubbard.
[10] The primary focus of HMF was share investments, although at a later stage it also became involved in venture capital and private equity funds. Broadly speaking,
when investment funds were received by Mr Hubbard he would either allocate them to HMF or to Aorangi Securities Limited (ASL). ASL was a finance company used by Mr Hubbard for fixed return investments. It is also under statutory management.
[11] Until approximately 2004 HMF maintained numerous holder accounts with the relevant registries in the name of FNCL (or variations of that name). In 2004 there was a transfer of investments from various individual HMF holder accounts, including the FNCL holder account, into the name of HCTML. It appears that this consolidation was to reduce the administrative burden. From that time HCTML effectively held the assets in a trustee capacity. Funds relating to HMF continued to pass through the FNCL bank account.
[12] Each year Mr Hubbard provided individual investors with an annual statement as at 31 March. At this stage no statements have been located by the statutory managers for the years prior to 2000. Although the content of the statements varied, they generally record the original investment, additional funds introduced, funds withdrawn, and the overall gains/losses over the life of the investment/s.
[13] The most recent statements for 31 March 2010 were prepared by Mr Hubbard during June and July 2010, after the statutory managers had been appointed. Mrs Hubbard has deposed that they were prepared by Mr Hubbard “under intense pressure” and that she had heard him expressing frustration that he did not have all the information and material he usually had when preparing the HMF investor statements.
[14] The statutory managers were initially appointed in relation to the Hubbard related entities on 20 June 2010.5 At the time of the appointment it was not known by the appointers that HMF existed, and it was only after the statutory managers took possession of Mr Hubbard’s records that its existence became apparent. On
20 September 2010 the appointment was extended to include FNCL and HCTML.
5 ASL, various charitable trusts, and Mr and Mrs Hubbard personally, were placed in statutory management at that time.
[15] Unfortunately Mr Hubbard died last year after being involved in a road accident. The late Mr Hubbard and Mrs Hubbard were released from statutory management in November 2011.
Jurisdiction
[16] Section 58 of the Act provides:
58 Statutory manager may apply to Court for directions
(1) A statutory manager of a corporation may apply to the Court for directions concerning the business or property of the corporation, or the management or administration of any such business or property, or the exercise of any powers under this Part of this Act.
(2) On any application under subsection (1) of this section, the Court may give directions concerning the business or property of the corporation, or the management or administration of any such business or property, or the exercise of any powers under this Part of this Act, and every person shall be bound by any such directions.
[17] Although the application before the Court does not concern the property of FNCL or HCTML, I am satisfied that s 58 is wide enough to confer the necessary jurisdiction. The issue before the Court relates to powers the statutory managers are exercising under Part III of the Act. Section 58 is within that Part.
The HMF operation
[18] The information that follows has been largely derived from the following sources: the affidavits and evidence of Mr McGlinn; the affidavit of Mr Brand, a principal of HC Partners LP, formerly known as Hubbard Churcher & Co; the affidavits Ms Munro and Mr Linton, employees of HC Partners LP; and the extensive documentation before the Court.
The investments
[19] With some exceptions, investors provided funds to HMF for investment without specific instructions. The evidence indicates that investors would provide a cheque for investment monies or, in some cases, an automatic payment would be
established for payment into FNCL. In the majority of cases Mr Hubbard had total discretion as to the investment of funds. Occasionally investors would seek to transfer their investments from other associated entities such as ASL.
[20] Copies of 66 letters sent by Mr Hubbard to investors following the initial investment are before the Court. There does not appear to have been any standard letter or other form of document outlining the basis on which funds were received for investment. In one form or other 17 letters guaranteed return of the capital funds invested. Most of the letters are very brief and simply acknowledge the investment and forward a receipt.
[21] Over the course of a year Mr Hubbard would investment funds, often in consultation with stockbrokers. All decisions as to the type of investment and the allocation of those investments to particular investors were made by Mr Hubbard personally. Any enquiries about the investments that were not purely routine were referred to him. Allocations to particular investors were made by way of journal entries (usually retrospectively) in the HMF general ledger. It appears that Mr Hubbard bought investments in bulk and then allocated them to investors by way of journal entry.
[22] With the exception the general ledger, Mr Hubbard did not use a computer based-system for HMF. A manila folder contained all annual statements, correspondence, telephone messages, receipts, etc for each investor. From about
2008 there was also a manila folder for each investment which contained a summary of allocations of that investment to the investors for each year. Some folders are missing.
[23] Investors were charged an annual management fee and Mr Hubbard would determine the particular fee for each investor. Although in most cases the fee seems to have been based on 1.5% of the fund opening value, there were exceptions. In this respect there appears to have been an element of “tailoring” by Mr Hubbard for individual investors.
[24] From modest beginnings HMF experienced strong growth and the gains to investors over time were very good. This changed in late 2007 with the onset of the global financial crisis. It appears that over the life of the fund until the statutory managers were appointed, around 180-190 investors withdrew from the fund. They were paid out in cash, not by the transfer of shares that had been allocated to them. The same applied when investors reduced their investment.
Annual investor statements
[25] Each year investors received a statement recording their position as at
31 March. These statements, which were prepared by Mr Hubbard with the assistance of Hubbard Churcher & Co staff, were based on information contained in the HMF general ledger. A typical example of an investor statement is attached to this judgment as Appendix A.
[26] In the case of about 15 investors information is, however, incomplete or partially complete. And in the case of 11 investors information is completely missing. Some of the investors with incomplete or partially complete information had invested substantial amounts. Mr McGlinn is optimistic that in most cases information will be able to be recovered from the investors.
[27] The statutory managers have determined that Mr Hubbard did not carry out any reconciliation between the investments as reported to the investors in the annual statements and the cash and investments actually held at that time. This reflected the nature of the accounting process that was used by Mr Hubbard. According to Mr McGlinn the absence of investment management software to track actual investments held by HMF collectively, as well as each investor’s portfolio, was unorthodox for an investment business of this size.
[28] Until 2007 there does not appear to have been any significant discrepancy between the investments and cash reported to investors and the investments and cash actually held by HMF. However, that situation seems to have changed after the world equity markets suffered a downturn as a result of the global financial crisis in
late 2007. I will return to that shortly when discussing the reconciliations carried out by the statutory managers.
[29] During the course of their review the statutory managers noted that the investor statements over a number of years included references to “prior year adjustments”. In the earlier years up to and including 31 March 2008 the prior year adjustments were relatively infrequent. In the 31 March 2009 to 31 March 2010 financial years they noticed a significant increase in those adjustments, both in terms of the number and amount. For those years the total value of the adjustments exceeded $4.6 million.
Reconciliations carried out by the statutory managers
[30] The statutory managers carried out a reconciliation of HMF as at 31 March
2010. The purpose of this exercise was to compare HMF’s actual holding in
investments and cash with the summaries contained in the investor statements.
[31] Total funds reported to investors as at 31 March 2010 was around
$82 million, of which $76 million was in securities and $6 million was in cash. After allowing for adjustments and making provision for losses and charges against assets, the statutory managers concluded that there was a deficit of around
$31 million. Mr McGlinn cautioned, however, that movements in the value of markets over time mean that that figure is somewhat academic because it is only at the point that assets are actually realised that figures can be accurately determined.
[32] The statutory managers also attempted to undertake reconciliations for the period from 2007 to 2009. Again they were attempting to ascertain the extent to which the amount owing to HMF investors was matched by the underlying assets owned directly or indirectly by HMF. Similar issues to those noted as at 31 March
2010 emerged. In other words there was a shortfall of underlying assets. [33] Key findings of the statutory managers included:
a. The total value of the investments as reported on investor statements prepared by Mr Hubbard as at 31 March 2010 is significantly greater than the value of the underlying assets of HMF at that time.
b. The portfolio said to be held at a given time by an investor may not have been in fact what was held by HMF on their behalf.
c. Transactions that were reported as having occurred in the periods referred to in investor statements may not have occurred then, or at all.
d. The system operated by Mr Hubbard resulted in valuation errors in the investor statements.
The statutory managers also concluded that there was no easy way to align the assets owned by HMF with the related liability to investors for the assets that had been allocated to them by Mr Hubbard.
Management of portfolios post statutory management
[34] Following appointment on 20 June 2010, the statutory managers have not accepted any new investor funds.6 Following this Court’s order on 6 December
2010, the statutory managers have taken steps to reduce risk within the portfolio and to generate funds to meet margin calls.
[35] There has been significant movement in the value of the portfolio since the statutory managers were appointed. For example, as at 20 June 2010 the value of the fund was $47 - $48 million; by September it had climbed to around $56 million; and by 31 October 2011 it had dropped to approximately $43 million.
[36] When the $9 million interim distribution was made on 9 March 2012 the portfolio stood at around $44.9 million. Following interim distribution, approximately $35.9 million remains available for realisation and distribution. But, as recorded earlier, that is a fluctuating figure. It also depends on the actual value of
some HMF investments, including investments in ASL.
6 Payments received under automatic payments after 20 June 2010 were returned.
Issues
[37] It is not disputed that the Court should trace funds whenever possible: Re Landbase Nominee Company.7 At this stage assets totalling around $622,000 have been isolated (and removed from HMF) because there is the likelihood that they can be traced. Those assets (and any other assets that can be traced) are beyond the scope of this judgment.
The primary issue
[38] The primary issue is the appropriate method of distribution between investors. When considering that issue the Court should, as Mr Till QC succinctly put it:
...do justice between the investors, that is to be fair to them, by giving effect to the intentions of the investors, inferred if not express.
But as Williams J said in Re International Investment Unit Trust (In Statutory Management),8 what is required is a search for the “least unfair result for the investors” bearing in mind that no method of distribution will result in “perfect justice for all”. I will discuss the relevant cases shortly.
[39] Subject to any refinements that the Court might decide to adopt, three possible methods of distribution need to be considered: the PIP method; and two pooling methods, one advanced by counsel appointed to represent investors favouring pooling and the other by counsel representing Mrs Hubbard.
The PIP method
[40] In summary this method involves the following:
7 Re Landbase Nominee Company Limited (1989) 4 NZCLC 65,093 at 65,101.
8 Re International Investment Unit Trust (In Statutory Management) [2005] 1 NZLR 270 at [73].
(a) Taking the investor statements as at 31 March 2010 as the opening position. For each investor this shows a specific share portfolio together with the individual cash holding.
(b) Making adjustments to account for sale and purchase transactions between 1 April 2010 and 20 June 20109 so that as at 20 June 2010 each investor has a specific share portfolio and individual cash holding together with interest and dividends received up to that time.
(c) Dealing with shortfalls or excesses in particular assets and cash on a pro-rata basis.
(d) From 20 June 2010 there will be no further “tracking” of individual investment portfolios. All investments will be pooled and all investors will receive returns based on their updated pro-rata share of the HMF assets.
The PIP method (and also the two pooling methods outlined below) would ultimately require realisation of assets and the distribution of cash to the investors.
The first pooling method
[41] This is the pooling method advanced by Mr Whiteside and Mr Holderness, counsel representing investors who favour distribution by pooling. It is convenient to adopt their explanation:
8. The pooling method of distribution would involve:
a. liquidating all securities held by HMF;
9 Date of statutory management.
For the purposes of dividing the fund pro-rata, the entitlement of each investor would need to be established. This could be done in various ways, including:
a. the percentage of the total value of the fund attributed to each investor as per the 31 March 2010 investor statements;
b. the percentage of the total value of the fund attributed to each investor as at 20 June 2010;
c. the proportion of the total value of the fund contributed by each investor over time; this is what Mr Barton in his submissions on behalf of the statutory managers refers to as the “pari-passu” approach to pooling.
9. The pari-passu approach would require calculation of each investor’s total capital contribution, plus dividends and interest received, minus withdrawals...10
Of the three possible methods of dividing the fund pro-rata, there is a consensus that the pari-passu approach should be favoured. Under those circumstances I proceed on the basis that the first pooling method involves the pari-passu approach.
[42] The following formula illustrates how each individual investor’s entitlement
would be calculated under the pari-passu pooling method.
A – B x E C – D
Where:
A = the individual investor’s total cash contributions plus dividends and income
received as at 20 June 2010;
B = all funds withdrawn by the individual investor as at 20 June 2010;
C = total cash contributions to HMF plus dividends and income received by HMF as at 20 June 2010;
D = total funds withdrawn from HMF as at 20 June 2010;
10 Explanatory footnotes have been omitted from this quote.
E = total HMF funds to be distributed.
The second pooling method
[43] This alternative pooling method was advanced by counsel for Mrs Hubbard at a relatively late stage. That is not a criticism. By way of background to this method Dr Butler and Mr Smith explained:
3. ...following the interim distribution of $9.0 million or so at the end of March 2012...:
(a) HMF has assets available for distribution of approximately
$35.9 million.
(b) There are 220 investors with positive net cash investments in the aggregate of approximately $19.3 million. (The remaining investors have negative or zero net cash investments, indicating that they have already received back their cash contribution to HMF in full (and then some if the investors have a negative net cash investment)).
(c) Accordingly, the 220 investors with positive net cash investments can be paid in full.
(d) If these investors are all paid in full, that leaves a surplus of approximately $16.6 million remaining for further distribution to investors.
4. It is clear, then, that this case is not about allocating “shortfalls” or “losses”. Those descriptions are quite inapt. Rather, it is about determining the fairest distribution of assets among those who invested in HMF in circumstances where all investors can receive their investment back.11
Thus the first step under this method is a return of the capital investment to the investors.
[44] Following that the second step involves distributing the surplus according to a compound interest calculation that recognises the length of time that investors have had money invested with HMF. Preliminary indications are that the interest rate might be around 7.1%, but at this stage this can only be indicative, at best. The formula by which capital would be returned and the balance distributed is attached to
this judgment as Appendix B.
11 Explanatory footnotes have been omitted from this quote.
[45] The primary difference between the first and second pooling methods is that the second pooling method does not take into account dividends and other income received by investors from their HMF investment.
Practicality
[46] Each method suffers from the difficulty that there are missing records. However, the statutory managers accept that all of these approaches are capable of implementation. Depending on the approach that is selected there would be timing and cost differentials. For example, the PIP approach would be the most straightforward and cheapest, followed by the second pooling approach. The first pooling approach is likely to be the most time consuming and expensive.
Earlier cases
[47] Over the years the Courts have often confronted situations like this where there are insufficient assets to meet the claims of the investors. Counsel focused on four decisions and I will do the same.
Re Landbase Nominee Company Limited12
[48] Landbase held mortgages in trust for contributory mortgage investors. Prior to investing, potential investors had been given a brochure concerning the intended conduct of Landbase. Unfortunately those indications were not honoured in many respects: although investors held certificates naming the mortgage to which they contributed, the mortgage named was rarely the mortgage to which they contributed; in some cases investors were allocated to discharged mortgages; in other cases they were not allocated to any mortgages at all; and many of the mortgages were in arrears. There was a major shortfall and directions were sought as to the method of
distribution.
12 Re Landbase Nominee Company Limited (1989) 4 NZCLC 65,093.
[49] Eight factors indicating the desirability of pooling were recorded by Barker J. These included: the inability of the liquidators to trace interest to individual contributors; no matching of maturity dates of the investor’s investment with the mortgage maturity date; no reconciliation of the trust account with its individual components; in some cases investors were allocated to mortgages after the mortgage advance had been made; and deficiencies between the sums received from investors and the sums allocated totalling $3.2 million.
[50] Barker J concluded that the haphazard allocation of mortgages to investors precluded any chance of tracing and that “the only sensible, economical and equitable way of dealing with the trust moneys”13 was to distribute amongst all investors pro-rata. In response to the concern expressed by investors opposing pooling that their investment certificates mentioned a specific mortgage, Barker J noted that these certificates “often bore little acquaintance with reality”.14
Re Ararimu Holdings Limited15
[51] This company, which carried on business as a stockbroker, was part of the failed Equiticorp Group. Ararimu operated a scrip pooling system in which share scrip was held by a nominee company. Guidance of the Court was sought in relation to clients who were seeking to establish a proprietary interest in both money and scrip by tracing.
[52] Wylie J concluded that the buying client’s right to trace into scrip in the pool was dependent on the buying client establishing an identifiable proprietary interest in the payment which purchased the shares. Provided the allocation was complete, legal title was not essential to a buying client’s right to trace into scrip. That right depended upon establishing an identifiable proprietary interest in the particular
share.16
13 At 65,102.
14 At 65,102.
15 Re Ararimu Holdings Limited [1989] 3 NZLR 487.
16 At 502.
Re Tricorp Investments Limited17
[53] Tricorp held itself out as an investment consultant and private investment portfolio manager. It undertook investment of funds over a wide range of areas including real estate and shares. Its share trading operation resulted in very substantial losses, and the Court’s directions were sought in respect of funds where tracing was not possible (which represented the bulk of the shares and funds).
[54] After confirming that investors who established an identifiable proprietary interest could trace, Wylie J turned to the balance of shares and funds:
...the balance then remaining can only sensibly be regarded as being held on a global trust notwithstanding the documentation which would indicate specific trust for individual investments. The hopelessly inadequate records and the indiscriminate mixing of funds and pooling of share purchases renders a global trust the only practical way of recognising the proprietary rights resulting from the fiduciary relationship between Tricorp and its investors.18
He also commented that the situation before him was close to that confronted by
Barker J in Re Landbase Nominee Company Limited. Re International Investment Unit Trust19
[55] Although investors in this investment trust were promised high rates of return, they were not provided with any information about the specific investments that would be made. After statutory managers were appointed claims by investors exceeded $14 million and the assets were less than $5 million. The statutory managers sought directions as to the distribution of the assets.
[56] Having noted that collapses of this nature give rise to varying degrees of hardship for the investors as well as difficult legal problems, Williams J commented:
[73] To meet, as far as it can now be met, their common misfortune, what is required is a search for the least unfair result for the investors, bearing in
17 Re Tricorp Investments Limited HC Auckland M 2038/89 14 November 1990.
18 At [15].
19 Re International Investment Unit Trust [2005] 1 NZLR 270.
mind, that regrettably, no method of distribution will result in perfect justice for all.
Then the Judge set about determining the method that would be fairest for the greatest number of investors and the least unjust to the investors seen as a body.
[57] He concluded:
[81] ...the appropriate method must be pari-passu. It is the method chosen in other New Zealand cases cited earlier in this judgment. It is the method chosen in most of the comparable jurisdictions overseas. It is the method which all parties agree should apply to investments prior to
1 March 2003. It is the method recommended by Mr Waller [a chartered accountant] whose experience in this area and familiarity with the detail of IIUT’s financial position deserves respect. It is the method which is fairest and least unjust to the investors seen as a body. It is the method best suited to try and avoid undue disadvantage to investors according to the time of their investment and the way their funds were dealt with...
An order was made for the statutory managers to distribute the net proceeds of the investments to the investors on a pari-passu basis (after satisfaction of three proprietary claims).
Principles emerging from these cases
[58] Although every case depends on its own facts, there is a theme running through these cases that tracing of assets is always the starting point. Once the assets that can be traced have been identified and isolated, the Court will then determine how the balance of the assets should be distributed in the knowledge that there will not be any perfect method of distribution.
[59] When deciding upon the appropriate method the Court will endeavour to select a method that is fairest to the investors as a whole. In arriving at that decision it will take into account the expectations (express or implied) of the investors when they made their investments. The Court will also take into account the history of the fund, the reliability or otherwise of any documentation, and the practical realities of one method compared with another.
[60] It might also be added that in all of those cases a pooling approach was adopted. While that does not necessarily mean that a pooling approach should also be adopted in this case, it is nevertheless a significant factor.
Survey of investors
[61] Affidavits have been sworn by two members of the Investor Liaison Group (ILG). This group was set up in 2010 to provide a liaison between the statutory managers and the investors. There are six investors on the ILG.
[62] After the statutory managers announced that they favoured the PIP method of distribution, members of the ILG were concerned because, as one of the members of the group who is a deponent put it:
[20] ...we felt that, if Alan Hubbard had continued to manage HMF, investor statements as at March 2011 (and beyond) would not have been generated simply by “tracking” the performance of each investment as represented on the 31 March 2010 statements. The ILG felt that the PIP method was therefore inconsistent with the management style Mr Hubbard had employed and which investors were happy with.
[21] We thought that a pro-rata distribution would better reflect how Mr Hubbard ran the fund. However, we were not sure what the views of investors generally would be in regard to the most appropriate distribution method.
[63] In December 2011 emails or letters were sent to a total of 205 investors whose contact details were available. This did not purport to be a scientific survey and not surprisingly issues about its value as an accurate guide of investors’ views have been raised.
[64] Of the 75 investors who replied to the survey:
[24] ...almost all were in favour of pooling. Only two investors responded to say they favoured the PIP method.
[25] Comments made by the investors in response to the survey suggested that in most instances pooling was preferred because it was fairer, and better reflected the nature of HMF and the style of Mr Hubbard’s management of the fund.
Within the ILG all six investors initially favoured a pooling approach. However, one
member (who has also sworn an affidavit) subsequently changed his mind and now favours the PIP method.
The PIP method of distribution
[65] When considering this possibility I will begin by outlining the cases for and against. Then I will decide whether the PIP method is a viable possibility or whether it should be eliminated from further consideration
Outline of the case in support
[66] In July 2011 the statutory managers engaged Mr Eriksen, a very experienced actuary and professional investment advisor, to assist with various issues. In conjunction with the statutory managers Mr Eriksen reviewed the relevant HMF records and undertook sampling. Fifteen investors and seven HMF investments were selected at random.
[67] Mr Erikson concluded that HMF was never a pooled fund while it was under Mr Hubbard’s management. While there were common investment themes, at all times each investor held a “bespoke” portfolio. Returns enjoyed by each investor were not in any way related to the sale of units in a pool. As a result of “Mr Hubbard’s perception of each individual’s risk portfolio” investors enjoyed different rates of return over the same time periods.
[68] It was Mr Eriksen’s view that if HMF had existed in an ideal world the sums of all the specific investment assets identified in the investor statements would have matched the totals for each asset held in individual client portfolio accounts at the relevant registries prior to 2004 or in the HCTML account post 2004. Cash would have also been treated the same way with provision for tax, tax credits and accrued management fees. However, the reality was that in dealing with HMF Mr Hubbard only formally valued the funds and each investor’s position annually as at 31 March.
[69] Having received Mr Eriksen’s advice and considered various options, the statutory managers decided that they should support the PIP method for the following reasons:
a. This is consistent with the basis on which investors invested in the way in which Mr Hubbard was managing HMF.
b. While the method of allocation of investments was imperfect due to the manual system operated by Mr Hubbard, in our view, allocation of assets to individual investors did take place. Where those assets were not held by HMF at the time the investor statements were issued, the pattern we identified indicates that these would generally be purchased later to bring the statements into line with the actual holdings.
c. As statutory managers, we have managed HMF as a pool since our appointment on 20 June 2010. This reflects the reality that we did not have individual investor risk profiles as required to continue to manage portfolios individually. Additionally, we did not have any written individual investment plans and strategies, there were no written investment instructions from investors, there were no foundation documents or strategies to provide guidance, and the assets held by HMF did not agree with the aggregate of investor statements.
As earlier mentioned, this approach involves updating the investor statements to
20 June 2010 in a manner which the statutory managers consider would be consistent with the methods previously used by Mr Hubbard.
[70] By using computer software the statutory managers have been able to produce: a portfolio valuation as at 31 March 2010 which agrees with the statements produced by Mr Hubbard; a provisional portfolio event history report reflecting the transactions between 1 April 2010 and 20 June 2010; a provisional portfolio valuation report as at 20 June 2010 (subject to adjustment); and a provisional event history report for 21 June 2010. In other words, they are poised to go if the PIP method is approved.
[71] For the statutory managers Mr Barton and Ms Cunninghame submitted that the following matters favoured the PIP method of distribution:
(a) Pooling is not what Mr Hubbard had in mind for the investors. To the contrary he had personalised portfolios for each investor. Amongst
other things this is reflected by the differing interest rates and fees charged.
(b) There is sufficient validity in the investor statements as at 31 March
2010 for them to be relied on.
(c) The PIP approach would involve significantly less cost in terms of time and money. Given the investors’ need for a speedy outcome this is particularly important. The computer programme is in place and work could start immediately.
(d) The evidence indicates that the investors believed that they were investing in individual portfolios personal to them.
(e) Right up to 20 June 2010 the investors were being paid out in accordance with investor statement values.
(f) Whereas there would be an overpayment if either pooling method was adopted, this would not be the case for the PIP method.20
Counsel also submitted that given the basis on which the alternatives had been put to investors, the investor survey should receive little, if any, weight.
The case in opposition
[72] The PIP method was opposed by counsel appointed to represent the investors who favoured pooling, counsel for Mrs Hubbard, and Mr Till as amicus. Expert evidence in opposition was provided by Mr Haldner, a member of the executive board of a global firm with EUR 25 billion in investment programmes under management. He is also a member of the Swiss bar.
[73] Mr Haldner deposed that he would want to deliver a solution that seemed reasonable to the investors. He considered that the simplest method of distribution
20 I return to this issue of overpayment at [97] below.
would be to pool the assets, sell them, and then divide the proceeds of sale using the valuations in the investor statements as at 31 March 2010 to fix the proportion of the proceeds of sale to be paid to each investor. However, he refrained from expressing a view as to whether that approach should be adopted because he believed that it was a legal issue on which he was not qualified to comment.
[74] A summarised form of the arguments presented in opposition to the PIP
scheme follows:
(a) This was not a “bespoke” scheme. To the contrary, the investors intended to deposit their investment into a pooled fund from which individual profits would be derived from the overall performance of the fund. The intention of the investors would, therefore, be best reflected by a pooled distribution method.
(b) Given the unorthodox and unsatisfactory features of the individual investor statements as at 31 March 2010 those statements should, at best, be regarded as incomplete or ineffective and, at worst, as a complete sham. It could not be said that the money of individual investors had been used to purchase the particular shares attributed to such investors.
(c) HMF was not a personalised portfolio management scheme and it would be wrong for the Court to construe it as such by adopting the PIP method of distribution.
(d) The “tracking” exercise proposed under the PIP scheme after 31
March 2010 is inconsistent with the wide discretion exercised by Mr Hubbard. In particular Mr Hubbard made “arbitrary” allocations of investments to investors and also made “prior year adjustments”.
(e) Investors would not have expected their March 2011 statements to be based simply on the performance (or non performance) of the shares
in their “portfolio” as represented to them in the statement for
31 March 2010.
(f) The period from 1 April to 20 June 2010 is arbitrary. It is only created by virtue of the statutory management happening to commence on
20 June 2010.
(g) The PIP method is unfair because some of the investments represented in the statements for 31 March 2010 were not in fact held by HMF at all. Thus the results for individual investors under the PIP method would be a matter of pure chance.
(h) Without their knowledge or consent some investors were subscribed units in ASL and shares in Southbury Group Limited which are now said to be valueless. The PIP method would be unfair to them.
(i) Some investments held by HMF have, or are likely to have, maturity dates of 10 plus years. Investors who happen to have been allocated to such investments will suffer unless they wait for their maturity date. This presents a significant practical problem for the PIP method.
The crux of the opposition case is, therefore, that the PIP method of distribution would be unfair and a pooling method should be preferred.
My conclusions
[75] Support for, or opposition to, the PIP method reflects a fundamental divergence of views about how HMF operated. Whereas those supporting the PIP method believe that it operated as a personalised investment fund, those opposing that method consider that it operated as a pooled investment fund.
[76] Clearly the PIP method has distinct advantages over the two pooling methods in terms of expense and the speed of distribution. Computer models already in place would allow work on this method to get under way reasonably quickly and
indications are that it might be as much as $250,000 cheaper to implement than the first pooling option. There is also the advantage that under this method there would be no overpayment as a result of the interim distribution.21
[77] Counterbalancing those matters are factors which, in my view, rule out the
PIP method as a viable option.
[78] First, the expectation of investors. While there do not appear to have been any standard letters of instruction or other formal documentation accompanying the initial investment, there is nevertheless ample evidence from which inferences as to the investors’ expectations can be drawn. This includes the letters acknowledging receipt of the investment funds; the affidavits of the people who worked with Mr Hubbard on HMF matters; affidavits from some investors; extensive affidavit evidence from Mr McGlinn; and a wide range of documentary evidence.
[79] It can be safely inferred that most investors left Mr Hubbard with a virtually unlimited discretion as to the manner in which their funds were to be invested. No doubt there were instances where individual investors discussed their investments with Mr Hubbard before investment decisions were made.22 But I am satisfied that most of the investors simply deposited funds with Mr Hubbard without specific instructions and left it to him to decide how those funds should be invested. Their
expectation (consistent with Mr Hubbard’s reputation as a successful manager of investments) would have been that their investment would grow.
[80] One investor deposed that his major expectation was that Mr Hubbard would use his knowledge and experience in the sharemarket to achieve a reasonable profit on his investment; he expected to receive a portion, based on the amount of his investment, of the overall increase in value in the fund each year; he had no particular expectation as to exactly what the return on the investment would be; he did not know how much or how little risk Mr Hubbard was exposing his funds to;
and it never occurred to him that the funds might be exposed to a greater or lesser
21 This overpayment is discussed at [97] below.
22 One deponent has confirmed that this was the situation in his case. A letter from Mr Hubbard to an investor also indicates there had been a previous discussion about the nature of the investment in that case.
risk than the funds of any other investor. I am satisfied that this was typical of the majority of investors.
[81] There is evidence suggesting that Mr Hubbard designed a personal portfolio for each investor. Mr McGlinn deposed that he had a number of discussions with Mr Hubbard and that:
22. ...I discussed the nature of the fund and he was very clear that he was designing each investor’s portfolio to reflect his perception of their needs. He considered that the statements reflected the shares he needed to deliver to the investors and that each of the investors had beneficial ownership of the shares listed on the statement...
However, it is the expectation of the investors that is important. Regardless of Mr Hubbard’s perception of their personal needs, it can be inferred that each investor invested funds in the expectation that there would be growth, and left it to Mr Hubbard to achieve that outcome.
[82] In any event it is difficult to accept that Mr Hubbard’s perception of the needs of individual investors would necessarily reflect the expectations of those investors. For example, one deponent said that when she and her husband invested in HMF their expectation was that all funds would be put into shares. But they ended up with units in ASL (as well as shares).
[83] I therefore conclude that pooling would be more consistent with the expectation of investors than the PIP method.
[84] Secondly, the reliability of the investor statements as at 31 March 2010. Given that those statements are the starting point for the PIP method, they will obviously have a strong influence on the final outcome for individual investors. It follows that if the investor statements are unreliable the PIP method is flawed because it will not be based on sound information.
[85] It is clear that there are fundamental problems with the investors’ statements
as at 31 March 2010.23 There is a very large discrepancy between the reported
23 See [33] above for key findings reached by the statutory managers.
investments and the investments and cash actually held by HMF at that time. Given that allocations were often made retrospectively after shares had been purchased in bulk, some shares would not have been held by the particular investor as at 31 March
2010 and might not have even been held by HMF. Coupled with that there seem to
have been very substantial “prior year adjustments” in the 31 March 2009 and
31 March 2010 years.
[86] Those matters indicate that the 31 March 2010 statements could not provide anything like a sound foundation for distributing the HMF assets to the investors. Any other method which is capable of ameliorating those problems should be preferred.
[87] Thirdly, the PIP method would advantage or disadvantage investors according to whether they were allocated good or bad investments, or indeed, whether they had been allocated any investments at all. Examples of the anomalies that would arise have been provided. While I accept that no method is capable of avoiding all anomalies, I am satisfied that the pooling methods would reduce the extreme injustices and would thereby be fairer to the investors as a whole. To the extent that any reliance can be placed on the survey of investors, that also seems to be the view of a significant number.
[88] Fourthly, unlike the pooling approaches that have been proposed, the PIP method would not reflect an individual investor’s history with HMF. Had the fund not been in existence for such a long time this might not have been particularly significant. But given that it was operating for more than a decade with some investors having been in the fund for a long time and others for a short time, there should be some attempt to reflect the involvement of individual investors over time.
[89] Fifthly, the PIP method seems to equate individual investments as at
31 March 2010 with individual trusts in favour of particular investors. However, on my analysis that does not reflect the reality of the situation. As mentioned earlier,24 assets that are likely to be traced have already been isolated from the HMF pool.
Under those circumstances it is difficult to see how as a matter of law individual
24 At [37] above.
trusts for particular investors could arise. In my view the reality is that HMF
operated as a pooled investment fund, not a personalised investment fund.
[90] Finally, there does not seem to be any proper basis for distinguishing this case from the cases discussed earlier. Like most of those cases, this case involves a mismatch between reported investments and actual investments; unreliable records as to individual shareholdings; and a mixing of funds. Except for one case where the issue did not arise, pooling was directed in those cases.
[91] Having eliminated the PIP method I now turn to the two pooling methods.
The two pooling methods
[92] To a large extent both pooling methods are capable of eliminating most of the problems that led to the rejection of the PIP method. But they cannot provide a perfect solution. The issue is which of the two methods is the fairest for the investors as a whole.
Differences between the two methods
[93] As mentioned earlier, the primary difference between the two pooling methods is that while the first method takes into account dividends and income, the second method does not do so. The second method is based on the individual investor’s cash in and cash out during the period of the investment.
[94] The first method would require the statutory managers to reconstruct dividend and interest information. Given the accounting methodology that was used for HMF this will be a relatively difficult and time consuming exercise. That can be compared with the second method. During cross-examination Dr Butler put the following proposition to Mr McGlinn:
As the basis for cash in/cash out, you’d accept that for the vast majority of investors that information [the annual investor statements] would be sufficient to allow us to draw some conclusions about cash in/cash out, correct?
Mr McGlinn agreed with that proposition (provided the statements were available). He also expressed the view that it would be desirable for investors to have an opportunity to see the statutory managers’ calculation and to have an opportunity to come back with other evidence.
[95] The disadvantage of the first method is, therefore, that it would be more expensive and time consuming. Indications are that it might be $125,000 more expensive than the second method.
[96] A further difference between the two methods relates to taxation implications. To date each investor has paid tax year by year on the dividends and income allocated to that investor. Whereas there would appear to be no taxation issues under the first method, there are potential issues under the second method. Possible taxation implications were put to Mr McGlinn under cross-examination. Having emphasised that he is not expert in taxation matters, he suggested that taxation considerations should not drive the decision as to the appropriate method of distribution, and that in any event there should not be any issue if the growth was of a capital nature.
[97] Another factor that needs to be considered is the overpayment arising from the interim distribution. As I understand it, this situation has arisen because the second method had not been formulated at the time the orders as to the interim distribution of $9 million were made. It also appears to have reflected a misapprehension as to the first pooling method.
[98] Based on the modelling that the statutory managers have been able to undertake, it appears that under the second method 21 investors will have received around $1.6 million in excess of their entitlement. While I do not have any figures for the first pooling approach, my understanding is that there would also be an overpayment under that method, but that it is likely to be smaller. While the overpayment is unfortunate, it will have to be recovered whichever of the two pooling methods is used.
Conclusions reached by the amicus
[99] Mr Till supports the second pooling approach. He considers that the model underlying the first method is flawed because of its reliance on the investor statements. He submitted that it is illogical for counsel supporting the first method to criticise the investor statements as being largely fictional and possibly a complete sham when opposing the PIP method, and then to rely on the very same statements to support the second method.
[100] According to Mr Till, a pooling approach whereby investors receive their capital back before the gains are distributed would be fair. He also considers that distribution of the balance under the second method is fair because it makes an adjustment for those who have drawn more than their cash investment.
[101] Although a potential taxation disadvantage is acknowledged by Mr Till, he suggests that this is not an insuperable problem because investors would be able to rely on this judgment in support an application to IRD for the filing of amended returns. He also submitted that in the overall order of things, taxation should not be regarded as a major or pivotal issue.
[102] A further disadvantage noted by Mr Till is that a significant number of investors would not receive any distribution (at least at this stage). While he acknowledges that those investors would be disappointed, he notes that they would have already received a significant return on their investment (which is why they are not in a positive net cash position).
[103] A dramatic fluctuation of the HMF returns over the preceding 10 years concerns Mr Till. He raised the issue whether the formula involved in the second method would unjustly favour investors in poor years over those in good years. Mr Till has discussed that issue with the statutory managers who have accepted that an adjustment could be made to reflect the varying rates of return for each year.
[104] Finally, Mr Till raised the possibility of monthly rests as opposed to the annual rests contemplated in the second method.
My conclusions
[105] I am satisfied that the second pooling method should be preferred. Apart from the fact that it is favoured by counsel who has been appointed to assist the Court, there are three particular factors that I find persuasive.
[106] First, it would be cheaper and quicker to implement than the first method. I should also add that those considerations indicate that the model should not be altered to allow for monthly rests as opposed to annual rests. While monthly rests might arguably produce a slightly more refined result, that is outweighed by cost and delay. The investors should have their funds as quickly as possible without unnecessary costs being incurred.
[107] Secondly, I accept that there is merit in Mr Till’s point about the use of the investor statements. Under the first method the dividend return for individual investors would reflect the shares that they had been allocated. Thus the allocation of dividends would suffer from the same unreliability issues as the shares from which they were derived: refer back to the discussion at [84]-[86] above. The same is likely to apply to other income.
[108] Those issues do not arise if the annual investor statements are only used to determine the investor’s cash in and out. While some errors have been detected, my understanding is that there is no major concern on the part of the statutory managers about the accuracy of that component of the investor statements. There is also merit in the point made by Dr Butler that if there had been significant errors about an investor’s deposits or withdrawals during the course of a year it might be expected that the issue would have been raised and rectified after the annual investor statement was received by the investor.
[109] Thirdly, it is my view that the second method offers the greatest prospect of overall justice and fairness to the investors as a whole. It returns their capital which would probably have been the minimum expectation of the investors. It would also be in line with the guarantee that Mr Hubbard appears to have given to 17 investors. And it would reflect the history of individual investors with HMF.
[110] Naturally missing statements will present a problem, but this is the case regardless of the pooling method that is adopted. Over recent times the statutory managers have been successful in filling some of the gaps and Mr McGlinn seems to be reasonably confident that further progress can be made by obtaining information from the investors.
[111] Having said that, I accept that there is a total absence of investor statements prior to 2000. The possibility of taking 2004 or 2007 as a starting point was canvassed at the hearing. I am not attracted to either of those possibilities. On the other hand, it occurs to me that there might be merit in adopting the year 2000 as a starting point.
Result
[112] Given that there are still issues to be resolved it is only possible to provide interim directions, some of which might have to be revisited.
[113] The interim directions are:
(a) the statutory managers are to distribute HMF assets to the investors generally in accordance with the model advanced by counsel for Mrs Hubbard25 subject to:
(i) the variation proposed by the statutory managers to enable the level of return to any particular investor to reflect the level of return to the pool during the years in which, and to the extent of, the investor contributed cash for investment in any particular year;
(ii) any further refinements that might be directed by the Court;
25 The possibility of a Court direction as to what is meant by “cash” was raised at the hearing. I am
not inclined to provide any direction at this stage because I do not think that it is necessary. However, if particular matters arise they can be referred back to the Court.
(b) the statutory managers are to recover any overpayments resulting from the interim distribution;
(c) the statutory managers are to file and serve their response to the possibility of a 2000 starting point. If they favoured that modification, they should indicate how it should be expressed and no further explanation will be required. On the other hand, if they do not favour the modification, a brief explanation should be provided;
(d) other parties will then have a further seven days to file and serve their response to the information provided by the statutory managers under (c) above;
(e) before undertaking the distribution the statutory managers should:
(i) to the extent that they deem necessary, check the accuracy of any records they are relying on with the relevant investor/s;
(ii) correct any errors in the source information that are important
to the calculation of the investor’s entitlement;
(f) the statutory managers should endeavour to obtain missing records from investors as soon as possible. Depending on the outcome it will probably be necessary to determine what should happen in the case of investors with missing records.
[114] Once the steps referred to in [113](c) and (d) have been completed counsel are to confer about any further directions or modifications that might be required to the above directions. One matter on which I require further assistance is whether there should be a timeframe for the distribution. My initial inclination is that this would be undesirable because the statutory managers should have flexibility to realise assets under the most favourable conditions and in any event there could be a further application to the Court if concerns arose. If possible counsel should submit
a joint memorandum, following which I will, if necessary, convene a telephone conference.
[115] There is a general reservation of leave to apply further should the need arise.
Costs
[116] Counsel for the plaintiffs will, of course, be entitled to their costs from HMF. Mr Whiteside and Mr Till will also be entitled to costs from that source, and in the case of Mr Whiteside there will be an allowance for second counsel.
[117] My initial impression is that counsel for Mrs Hubbard should also be paid from the HMF fund. As is apparent from this judgment, their contribution has been very significant. However, I do not think that their costs (at least those payable by HMF) should exceed the costs of counsel appointed to support the pooling approach. Unless the Court is advised within 14 days that there is opposition to such an order, that will be the order of the Court.
Solicitors:
Anderson Lloyd, P O Box 13831, Christchurch
Wynn Williams, P O Box 4341, Christchurch
Russell McVeagh, P O Box 10-214, DX ZX11189, Wellington
N A Till QC, P O Box 252, Christchurch
Appendix 1
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