Pioneer Mortgages and Columbus Capital battle over fees, fraud in Fed Court

The ongoing dispute between non-bank financial institutions Pioneer Mortgage Services and Columbus Capital has begun in earnest in the Federal Court, with a full day's evidence and argument yesterday, and the prospect of more today and tomorrow.

At stake is the right to manage part of the estimated A$2.2 billion pool of mortgages from the Origin wholesale mortgage origination business, sold by ANZ to the Malaysian-backed Columbus Capital in September 2012.

Pioneer was one of around 20 mortgage companies that were funded under ANZ's Origin program. Management fees were shared in line with what has become a legacy agreement comprising, in part, of a margin over the funder's average cost of funds plus a profit margin for the funder.

Columbus has been trying to unwind many of these agreements, for example by unilaterally increasing its margins on the mortgage managers' funding costs.

As the parties spilled into the courtroom both sides are accusing the other of misleading or deceptive conduct under consumer protection legislation - for different reasons.

One important aspect not disputed by either side is that one of Pioneer's senior managers allegedly misused her position to commit a series of fraudulent mortgage drawdowns, directing the funds into her own bank account. Once discovered, the loss highlighted a number of shortcomings in Pioneer's internal controls, risk management approach and post payment review processes.

However, whether the level of fraud was sufficient to allow Columbus to rescind its management agreement - a legacy of the arrangement with ANZ which sold the portfolio of mortgages to Columbus in 2012 - is at the heart of this dispute.

Columbus is arguing that the fraud represents such a severe breach of conduct, and a failure to act in good faith, that it is within its rights to refuse to pay management fees to Pioneer, and indeed can demand that Pioneer buy back the mortgages in question.

For this, Columbus is relying on a clause in the management agreement that Pioneer must manage the mortgages in a businesslike manner, irrespective of any default by the bank (originally ANZ, since substituted by Columbus Capital).

For its part, Pioneer has been arguing that actions by a rogue employee are not so serious as to constitute an act of default under the main contract.

The manager in question, who is not named directly in court lists, was called to give evidence after both main protagonists parties and the Court agreed that doing so would likely resolve many outstanding points of objection. But she was not present in the building, however, and did not have legal representation.

Irrespective of the fate of its errant manager, Pioneer has countered with further allegations (also made under consumer protection laws)  over a letter sent by Columbus on 14 November 2014, advising borrowers that they would be subject to a new $399 "facility fee", ostensibly to compensate the mortgage providers for the extra cost of providing the loan, while referring to a "customer loyalty offset".

A further bone of contention is that the Columbus letter named Pioneer as responsible for the fee being introduced, and the Columbus call centre operators did not follow instructions to offer to waive the fee for borrowers who rang to complain.

Pioneer said this letter and subsequent behaviour by Columbus caused it reputational damage and cost it at least one borrower, and maybe more, who were motivated to "decamp" as a consequence.

In the forensic examination of witnesses - a mix of mid-ranking to senior professionals and managers - to determine what damage, if any, had been done there was a concession by Columbus's in-house lawyer that at least two borrowers had paid out their loans and moved on.

However, none of the witnesses were able to show they had indulged in any deep and forensic examination, beyond following in-house manuals and interpreting and organising whatever information had been provided to them by other parts of their respective businesses.

Nicole Pryde, chief operating manager for Pioneer Mortgages, was the first witness cross-examined. It emerged that there was undoubtedly a flaw in Pioneer's post-payment checking process, in that redraws of $10,000 or less were not reviewed other than by one of the firm's senior employees, assisted by a clerk.

Pryde further conceded that, as she and her clerk only reviewed redraws where paperwork was in order, if no paperwork was created it was unlikely the fraudulent transaction would be identified.

Pryde also relied to some extent on initial checking by the manager of Pioneer's client support service who, it has since emerged, is allegedly the person behind the fraudulent redraws.

One of the expert witnesses called by Pioneer, Warren Williams, a former employee at the large non-bank originator RAMS (now RHG Mortgages), who now describes himself as "a self-employed consultant", said he'd formed the view that the redraw review process "wasn't working" but would not go so far as to say that doing more than a yearly quality assurance test was needed. He certainly rejected the suggestion that there was a need to review every redraw.

(CORRECTION: An earlier report had stated Mr Williams was a witness for Columbus Capital. That was incorrect; he was called to the stand by Pioneer to explain his analysis on their behalf.)

He did note, however, that allowing a single employee to carry out the entire drawdown and payment process "was not standard business process", and that the shortcoming of the system was that there were only two levels of user authorisation in the Pioneer system - very limited or full authority.

Also, the IT system, developed by ANZ, and taken over by Columbus when it acquired the Origin mortgage book, allowed the user to input any bank account details they chose, unlike a modern system which would have such details stored.

(CORRECTION: We previously incorrectly reported this was Pioneer's system - more accurately, it was developed by ANZ, and then used by Pioneer under licence from Columbus, until the whole Origin mortgage book was transferred to the modern Columbus platform in 2013.)

Also under dispute is the initial reaction by Columbus when told of the fraud by senior Pioneer staff. That is yet to be fully tested, but is one crucial piece of a circumstantial argument.

The case continues on Thursday 23 July, starting with video evidence from Melbourne.