Allco board couldn't manage the conflicts

The picture of Allco Finance Group that emerged from the liquidator Ferrier Hodgson's examination of the failed company's executives and directors in the Federal Court last week is of a business that sailed close to the wind on risk-taking and related party activities, and relied on a fairly loose governance structure to keep it all under control.

When things got tough, that governance structure, which included a board-related party committee and a related party protocol, failed to protect shareholders.

According to former executive chairman David Coe, who made his appearance in court last Friday, it was normal for executives on either side of a related party matter to negotiate a transaction and leave it to the board's related party committee to review the deal.

Coe said the committee's role was to ensure that transactions of this kind were on terms that were arm's length and reflected commercial practice.

He said: "Any transaction that involved two entities where AFG was the manager would have to involve two teams."

However, those teams did not remain at arm's length. A record of emails passing between executives, which was detailed in the hearing, showed that there was no Chinese wall or anything even vaguely resembling one.

In August 2007 a fund managed by AFG, the Allco Principals Trust, started to receive margin calls on a geared holding of AFG shares. The investors in Allco Principals Trust were Allco executives.

Allco's solution to this problem was to lend APT $50 million in the expectation that a plan to list an investment fund in Singapore with assets seeded from APT would free up cash and solve the problem.

Negotiations over the loan took place between August and December, when the loan contract was executed. During that time Coe withdrew from board consideration of the deal but was in contact with members of both the Allco team and the APT team over aspects of the deal.

One of the issues in the negotiation of the loan was its term. It was originally to be short term, only four months, but there was a push to give APT greater security by extending the term to 12 months.

On December 4, a couple of weeks before the board signed off on the loan, Allco's head of funds management and an APT principal, Chris West, wrote in an email to Coe that "we have agreed to continue the facility."

Former Allco Finance Group deputy chairman Bob Mansfield said in his evidence that there were elements of the loan term that he did not see until after the loan was executed. Mansfield chaired the related party committee.

Another non-executive director Neil Lewis said he never saw the loan contract at all. In other words, the directors responsible for reviewing conflicts claim they were never in the loop.

Another email exchange between Coe and West on December 4 referred to discussion between West and Tom Lennox, Allco's company secretary, about the loan contract. West and Lennox were in separate "teams".

Coe said such an exchange was acceptable under the company's related party protocol because "it related to a simple factual question."

Allco deputy managing director Michael Stefanovski was concerned that Allco's position was becoming precarious and pushed for tough security conditions on the loan to APT.

Coe, who was supposedly not involved in the negotiation of the loan, wrote an email to Allco chief executive David Clarke on December 15 that said: "Stefanovski is conflicted."

In his evidence Coe said: "I sent this to Clarke because there was a conflict issue that had to be addressed."

In reality, Mansfield and the other non-executive directors had no real independence from this group of conflicted, over-indebted and highly politicised executives.

Mansfield said in response to questions about his oversight of the lending arrangements that as a non-executive director he took the view that the group made loans regularly and the executives were "well versed" in getting the best form of security.

At the time the loan was negotiated in December Allco had just $53 million of cash and if no deals were completed to bring cash into the business it would exhaust its available loan facilities by February.  This made it critical to get the terms of the loan right.

In answer to questions about Allco's financial position at the time, Coe said: "There was a significant amount of undrawn debt. That is available cash. The funding ability was $375."

Coe, like other executives, was working on the assumption that the Singapore listing would go ahead and the cash crisis would ease. As things turned out there was no Singapore listing and the cash crisis never eased.

The determination to push ahead and fund APT showed a lack of prudence that the board did nothing to check.