Australian Securities and Investment Commission v Atlantic 3 Financial (Aust) Pty Ltd & Ors [2006] QSC 132

SUPREME COURT OF QUEENSLAND CITATION: Australian Securities and Investment Commission v Atlantic 3 Financial (Aust) Pty Ltd & Ors [2006] QSC 132 PARTIES: AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION (applicant) v ATLANTIC 3 FINANCIAL (AUST) PTY LTD (ACN 056 262 723) (first respondent) and FREDRIC MICHAEL ACKER (second respondent) and GERILYN MARIE POLANSKI (third respondent) FILE NO: S4426 of 2003 DIVISION: Trial PROCEEDING: Application ORIGINATING COURT: Supreme Court of Queensland DELIVERED ON: 5 June 2006 DELIVERED AT: Brisbane HEARING DATE: 3 April 2006 JUDGE: Atkinson J ORDER: 1. The court declares that: a. In contravention of s 601ED(5) of the Corporations Act the second and third respondents operated unregistered managed investment schemes which were required to be registered pursuant to s 601EB of the Corporations Act. b. The second and third respondents, in operating the unregistered schemes prior to 11 March 2002, breached s 780 of the Corporations Law in that, not being an exempt dealer, they each carried on a securities business without holding a dealer’s licence. c. The second and third respondents, in operating unregistered schemes as from 11 March 2002, breached the provisions of s 911A of the Corporations Act in that they carried on a financial business without holding an Australian Financial Services Licence. d. In breach of s 727 of the Corporations Law and s 727 of the Corporations Act, the second and third -- 1 of 24 -- 2 respondents offered securities without a disclosure document in relation to the schemes. 2. And it is ordered that: a. The second respondent is disqualified from managing corporations for ten years from the date of this judgment. b. The third respondent is disqualified from managing corporations for eight years from the date of this judgment. CATCHWORDS: CORPORATIONS – MANAGEMENT AND ADMINSTRATION – DIRECTORS AND OTHER OFFICERS – application for declaration of contravention of sections 601EB, 601ED, 727 and 911A of the Corporations Act 2001 (Cth) and sections 727 and 780 of the Corporations Law – application for disqualification orders under s206E – where the directors engaged in irresponsible and deliberately misleading and deceptive behaviour – what period of disqualification should apply. Corporations Act 2001 (Cth) ss 206E, 727, 911A, 601ED, 601FA, 601FB Corporations Law ss 727, 780 ASIC v Sweeney [2001] NSWSC 114 ASIC v Vizard (2005) 219 ALR 714 Australian Securities and Investments Commission v Arafura Equities Pty Ltd [2005] QSC 376 Australian Securities and Investments Commission v Hutchings (2001) 38 ACSR 387 Australian Securities and Investments Commission v IP Product Management (2002] 42 ACSR 343 Australian Securities and Investments Commission v Parkes (2001) 38 ACSR 355 Australian Securities and Investments Commission v Pegasus [2002] NSWSC 310 Australian Securities Commission v Donovan (1998) 28 ACSR 583 Australian Securities Commission v Forem-Freeway Enterprises Pty Ltd (1999) 30 ACSR 339 Australian Securities Commission v Roussi (1999) 32 ACSR 568 Australian Softwood Forests Pty Ltd v Attorney-General (NSW) (1981) 148 CLR 121 Bishop Mar Meelis Zaia v David Tiglath Chibo [2005] NSWSC 917 Chapel Road Pty Ltd v ASIC [2003] AATA 660 Clout (Trustee) v Anscor Pty Ltd [2003] FCA 326 Corporate Affairs Commission v Transphere Pty Ltd (1989) 7 ACLC 205 Elliott v ASIC (2004) 48 ACSR 621 -- 2 of 24 -- 3 Leveraged Options Group Pty Ltd (2002) 41 ACSR 561 Karl Suleman Enterprizes v George [2003] NSWSC 544 Re Gold Coast Holdings Pty Ltd; Australian Securities and Investments Commission v Papotto (2000) 35 ACSR 107 Re HIH Insurance; ASIC v Adler (2002) 42 ACSR 80 Re Lawloan Mortgages Pty Ltd [2003] 2 Qd R 200 Re Strikers Management Pty Ltd; Australian Securities Commission v Dimitri (unreported, Fed C of A, Burchett J, No NG 3789 of 1996, 7 May 1997, BC9702133) Re Tasmanian Spastics Association; Australian Securities Commission v Nandan (1997) 23 ACSR 743 Rich v ASIC [2004] HCA 42; (2004) 78 ALJR 1354 Tobacco Institute of Australia LH v Australian Federation of Consumer Organisations Inc (1993) 113 ALR 257 Zipside Pty Ltd v Anscor Pty Ltd [2004] QSC 33 COUNSEL: P Morrison QC with S Brown for the applicant P Davis SC for the respondent SOLICITORS: Australian Securities and Investments Commission for the applicant Lynch & Co Solicitors for the respondent [1] The applicant, the Australian Securities and Investments Commission (“ASIC”), sought a number of declarations against the second and third respondents, Fredric Acker and Gerilyn Polanksi, as well as orders disqualifying them from managing a corporation for a period that the court considers appropriate (“disqualification orders”). [2] The declarations sought against the second and third respondents are for contraventions of the Corporations Law (the “Law”) 1 and the Corporations Act 2001 (the “Act”). The declarations sought are: 1. A declaration that in contravention of s 601ED(5) of the Act the second and third respondents operated unregistered managed investment schemes which were required to be registered pursuant to s 601EB of the Act; 2. A declaration that the second and third respondents in operating the unregistered schemes prior to 11 March 2002 breached s 780 of the Law in that, not being an exempt dealer, they each carried on a securities business without holding a dealer’s licence; 3. A declaration that the second and third respondents in operating unregistered schemes as from 11 March 2002 breached the provisions of s 911A of the Act in that they carried on a financial business without holding an Australian Financial Services Licence (AFSL); 1 Liability for contraventions under the Law are preserved by s 1400 of the Act: ASIC v Vizard (2005) 54 ACSR at [23]. -- 3 of 24 -- 4 4. A declaration that in breach of s 727 of the Law and s 727 of the Act, the second and third respondents offered securities without a disclosure document in relation to the schemes.” [3] The disqualification orders were sought pursuant to s 206E(1)(a)(i) and (ii) of the Act. Section 206E provides: “Court power of disqualification – repeated contraventions of Act (1) On application by ASIC, the Court may disqualify a person from managing corporations for the period that the Court considers appropriate if: (a) the person: (i) has at least twice been an officer of a body corporate that has contravened this Act while they were an officer of the body corporate and each time the person has failed to take reasonable steps to prevent the contravention; or (ii) has at least twice contravened this Act while they were an officer of a body corporate; or (iii) …; and (b) the Court is satisfied that the disqualification is justified. (2) In determining whether the disqualification is justified, the Court may have regard to: (a) the person’s conduct in relation to the management, business or property of any corporation; and (b) any other matters that the Court considers appropriate.” [4] The respondents accept that their contraventions warrant the court’s making the declarations sought and that a disqualification order for some period of time is inevitable. Nevertheless, in order to determine whether or not such declarations and orders are appropriate and, if so, the length of any disqualification order, the court must exercise its discretion. It is therefore necessary to set out the facts on which that discretion will be exercised. Except where specifically noted, those facts are not contested and are taken from a document entitled “Combined Schedule of Admitted Facts and Additional Facts” (the Schedule) which contains factual allegations admitted in the pleadings or in formal admissions which were made by the respondents a week before the matter was to be heard at trial. Those additional admissions obviated the need for cross-examination and for a trial of the matters which would otherwise have been in contest. That factor has operated to mitigate the penalty that would otherwise have been imposed. -- 4 of 24 -- 5 [5] The second respondent, Dr. Acker, was a director of the first respondent Atlantic 3 Financial (Aust) Pty Ltd (in liquidation) (“Atlantic 3”) from the time when it was incorporated on 27 May 1992 until it was wound up by this court on 25 November 2003. He was its secretary from 15 January 2002 and its managing director between 17 December 1999 and 17 July 2003. The third respondent, Gerilyn Polanski, was Dr. Acker’s de facto partner and a director of Atlantic 3 from 16 September 1994 until its winding up. Both the second and third respondents were also directors of a company which was incorporated on 21 March 2000, Atlantic 3 Funds Management Limited (Atlantic 3 FM”) which operated registered managed investment schemes pursuant to s 601EB of the Act and was a responsible entity within the meaning of s 601FB of the Act. However Atlantic 3 did not hold a licence pursuant to the Act, was not a responsible entity within the meaning of s 601EB and operated unregistered managed investment schemes as defined in s 9 of the Act. The unregistered schemes [6] Between 17 December 1999 and 17 July 2003, Atlantic 3 operated 15 investment schemes which were not registered pursuant to s 601EB of the Act (“the unregistered schemes”). The unregistered schemes were in relation to Mackay Leagues Club Limited (the “Mackay Leagues Club scheme”); Numinko Pty Ltd (the “Numinko scheme”); Sentry Alliance Pty Ltd (the “Sentry Alliance scheme”); Plymouth Greens Corporation Pty Ltd, Atlantic 3 Maryborough Mortgage Pty Ltd Advance (the “Maryborough scheme”); Clearview Properties Pty Ltd (the “Clearview scheme”); Bass Group Pty Ltd (the “Bass scheme”); Nathanial Barton; Yasmin McCarthy (the “McCarthy scheme”); Outback Cuisine Pty Ltd/Shannonville Pty Ltd/NAF (Rockhampton Property) Pty Ltd (the “NAF scheme”); All Seasons Resort Related Loans; Creevy Related Loans; Glen Kable Related Loans; Hallas Related Loans; Snadra Pty Ltd (the “Snadra scheme”); and Washington Developments Pty Ltd Related Loans (the “Washington Developments scheme”). Members of the public invested money in the unregistered schemes through Atlantic 3. [7] On 17 July 2003, Fryberg J found that the schemes were required to be registered and were operating in breach of s 601ED(5). Section 601ED provides: “When a managed investment scheme must be registered (1) Subject to subsection (2), a managed investment scheme must be registered under section 601EB if: (a) it has more than 20 members; or (b) it was promoted by a person, or an associate of a person, who was, when the scheme was promoted, in the business of promoting managed investment schemes; or (c) a determination under subsection (3) is in force in relation to the scheme and the total number of members of all of the schemes to which the determination relates exceeds 20. -- 5 of 24 -- 6 (2) A managed investment scheme does not have to be registered if all the issues of interests in the scheme that have been made would not have required the giving of a Product Disclosure Statement under Division 2 of Part 7.9 if the scheme had been registered when the issues were made. (3) ASIC may, in writing, determine that a number of managed investment schemes are closely related and that each of them has to be registered at any time when the total number of members of all of the schemes exceeds 20. ASIC must give written notice of the determination to the operator of each of the schemes. (4) For the purpose of this section, when working out how many members a scheme has: (a) joint holders of an interest in the scheme count as a single member; and (b) an interest in the scheme held on trust for a beneficiary is taken to be held by the beneficiary (rather than the trustee) if: (i) the beneficiary is presently entitled to a share of the trust estate or of the income of the trust estate; or (ii) the beneficiary is, individually or together with other beneficiaries, in a position to control the trustee. (5) A person must not operate in this jurisdiction a managed investment scheme that this section requires to be registered under section 601EB unless the scheme is so registered. (6) For the purpose of subsection (5), a person is not operating a scheme merely because: (a) they are acting as an agent or employee of another person; or (b) they are taking steps to wind up the scheme or remedy a defect that led to the scheme being de- registered. (7) A person who would otherwise contravene subsection (5) because an interest in a scheme is held in trust for 2 or more beneficiaries (see paragraph (4)(b)) does not contravene that subsection if they prove that they did not know, and had no reason to suspect, that the interest was held in that way.” [8] Section 601EB of the Act provides: “Registration of managed investment scheme (1) ASIC must register the scheme within 14 days of lodgement of the application, unless it appears to ASIC that: -- 6 of 24 -- 7 (c) the application does not comply with section 601EA; or (d) the proposed responsible entity does not meet the requirements of section 601FA; or (e) the scheme’s constitution does not meet the requirements of sections 601GA and 601GB; or (f) the scheme’s compliance plan does not meet the requirements of section 601HA; or (g) the copy of the compliance plan lodged with the application is not signed as required by section 601HC; or (h) arrangements are not in place that will satisfy the requirements of section 601HG in relation to audit of compliance with the plan. (2) If ASIC registers the scheme, ASIC must give it an ARSN. (3) ASIC must keep a record of the registration of the scheme. (4) For the purpose of determining whether subsection (1) is satisfied in relation to the scheme: (a) references in Parts 5C.3, 5C.4 and 5C.5 to a registered scheme are taken to include a reference to the scheme; and (b) references in those parts to the responsible entity of a registered scheme are taken to include a reference to the proposed responsible entity of the scheme.” Winding up the unregistered schemes [9] Fryberg J ordered that the unregistered schemes be wound up. On 27 November 2003, Mullins J wound up Atlantic 3 on the application of ASIC. Of the 15 unregistered schemes, 10 were smaller schemes which were ordered to be wound up by Atlantic 3 itself. The amounts involved in those schemes varied from $30,000 up to $420,000. The five larger schemes were ordered to be wound up by the liquidators Messrs Geroff and Maloney. Those five schemes were the Numinko scheme, the Sentry Alliance scheme, the Maryborough scheme, the Mackay Leagues Club scheme and the Clearview scheme. Lack of proper financial records [10] The moneys provided by investors in the unregistered schemes were provided on trust to be applied to the particular scheme in which they invested. Those moneys were not placed into separate trust accounts nor properly accounted for in relation to each scheme. Throughout the time when the unregistered schemes operated, all of the funds of the investors in the unregistered schemes and of Atlantic 3 were mixed in one bank account called a collections account. Moneys in the collections account were used to pay expenses of unregistered schemes, interest to investors, advances to borrowers and repayments to investors. -- 7 of 24 -- 8 [11] No proper financial records were kept. No general ledger was kept. No separate ledgers were kept for each scheme although spreadsheets and lists of investors were kept for each scheme. However, no financial statements such as profit and loss accounts, balance sheets, bank reconciliations, bank loan documents, investor ledgers, creditor records, deeds, mortgage loan files, transaction listings, cashbooks for each scheme, and for the collections account in respect of the unregistered schemes after September 2002, loan ledgers, sales/debtors records, asset registers and correspondence recording the unregistered schemes’ transactions, depreciation schedules or tax returns were maintained. Loss to investors from unregistered schemes [12] As a result of the lack of proper financial records, it has been difficult for the liquidators to determine the source and application of all of the funds. Large amounts of money cannot be accounted for. However, the liquidators have been able to come to the following conclusions about the solvency of, and potential proceeds to the Atlantic 3 investors from, the various unregistered schemes. In all of them, investors have lost significant amounts of money. [13] The Numinko scheme involved an investment of $968,984.25 from 33 investors. The liquidators have formed the view that no return of capital or interest will be made to the Atlantic 3 investors in the Numinko scheme. The whole of the investment has been lost. [14] Atlantic 3 provided finance to the Sentry Alliance scheme in May 1998 to discharge an existing mortgage debt of $199,067.68. Further sums were raised from investors. In May 2000, the loan to the Sentry Alliance scheme went into default. As at May 2002, $700,344 had been raised from investors for the Sentry Alliance scheme with $111,944 being used as repayments of capital to some investors leaving a balance of investors’ funds of $588,400. That sum well exceeded the security as the mortgage held by Atlantic 3 was only for $305,000. $294,333 of the investors’ money paid into the scheme is unaccounted for. The estimated return to investors of their capital from the Sentry Alliance scheme is 28.75 cents in the dollar. [15] The Maryborough scheme commenced when Atlantic 3 provided an advance to Plymouth Greens Corporation Pty Ltd (“Plymouth Greens scheme”). The loan went into default. Three of the properties over which Plymouth Greens scheme investors retained a mortgage were swapped for two properties in Maryborough with an additional $875,000 being paid by investors. On 28 November 1999, the sum of $1,329,823.32 was raised from 48 investors through another company established by the second and third respondents, Atlantic 3 Maryborough Mortgage Pty Ltd (“Atlantic 3 Mortgage”) to provide Atlantic 3 with the money it needed to pay the balance owing on the Maryborough properties. Only $955,000 was needed for that purpose. The difference cannot be accounted for. After 1999, the Maryborough scheme had insufficient cash flow to be able to meet payments of interest to its investors and yet investors’ money from the Maryborough scheme was used to pay investors in other schemes. The estimated return to the Maryborough scheme investors is 17.3 cents per dollar of the capital they invested. -- 8 of 24 -- 9 [16] $2,053,956.36 was invested by 63 investors in the Mackay Leagues Club scheme. The estimated return to those investors is 17.8 cents per dollar of the total amount of principal that they invested. [17] The Clearview scheme had a number of categories of investors. Eighty investors have been identified by the liquidators as providing a total amount of $3,404,063. It is estimated that they will obtain between nothing and 42 cents per dollar return of the capital they invested depending upon the priority within the different categories of investors. [18] As can be seen, as a result of the unlawful conduct of the unregistered schemes by the respondents, members of public who invested in them will lose significant amounts of money. Roles of the second and third respondents [19] Each of the second and third respondents had different roles within Atlantic 3. Their differing roles have an impact upon the length of the disqualification order which should be made with respect to each of them. Nevertheless each of them operated the unregistered schemes within the meaning of s 601ED(5) of the Act. That is so notwithstanding that the investments were channelled through Atlantic 3, a corporate vehicle under their control. The word “operate” has its ordinary meaning and is not limited to ownership or proprietorship “but rather to acts which constitute the management of or the carrying out activities which constitute the managed investment scheme.” 2 Both the second and third respondents in their capacity as directors of Atlantic 3 were the decision makers who determined the conduct of each of the unregistered schemes. [20] The second respondent, Dr Acker, was the managing director of Atlantic 3 from 17 December 1999 to 17 July 2003. He made determinations as to which loans would be made the subject of the unregistered schemes. He was responsible for sourcing investors for placement into the unregistered schemes and determining the number of investors to be placed into the relevant scheme. He was principally responsible for promoting the unregistered schemes to investors, including drafting the “write ups” (describing the investment and the suitability of the investment) which were provided to investors and he was responsible for maintaining the financial records of the unregistered schemes. [21] The third respondent, Ms Polanski, had a somewhat lesser role. She was an executive director of Atlantic 3 throughout the period when the unregistered schemes were operated. She made assessments of loans for the unregistered schemes and from time to time spoke to potential investors about investment opportunities in, and the investment performance of, the unregistered schemes. She was responsible for the management of the money and financial obligations in relation to the schemes and particularly for the calculation and payment of interest 2 Australian Securities and Investments Commission v Pegasus Leveraged Options Group Pty Ltd [2002] NSWSC 310 at [55]-[56]; (2002) 41 ACSR 561 at 574; Re Lawloan Mortgages Pty Ltd [2003] 2 Qd R 200 at 218; Australian Securities and Investments Commission v IP Product Management (2002) 42 ACSR 343 at 349; Australian Securities and Investments Commission v Arafura Equities Pty Ltd [2005] QSC 376 at [3]. -- 9 of 24 -- 10 to individual investors. She was involved in the day to day conduct of the schemes, and also responsible for maintaining their financial records. Knowledge of breaches of the law [22] In December 1999 as a result of changes to the Law made by the Managed Investments Act 1998 which introduced Part 5C into the Law, all unregistered schemes were required to be registered and the operator needed to be licensed. The second and third respondents became aware of that and knew from late 1999 that the unregistered schemes operated by Atlantic 3 did not comply with the requirements of the Corporations legislation and were being conducted unlawfully. [23] This knowledge is demonstrated by the fact that they received legal advice from a solicitor from the firm of Primrose Couper Rudkin to the effect that the schemes being operated through Atlantic 3 were managed investment schemes and that Atlantic 3 would therefore need to be licensed or to run out the old loan book or transfer the mortgages back to individual investors. As result, in late 1999 the second and third respondents gave instructions to Primrose Couper Rudkin to take steps to apply for a licence for a responsible entity within the meaning of the Law. A licence was obtained for a responsible entity, namely Atlantic 3 FM, but the second and third respondents did not take any steps to comply with the legal requirements in respect of the unregistered managed schemes operated by Atlantic 3 and continued to operate the unregistered schemes after that date. They did not transfer the unregistered schemes into Atlantic 3 FM. [24] At some time in or after March 2000, the second and third respondents became aware of the contents of ASIC policy 144 (the “policy”) with respect of managed investment schemes. The policy was issued on 2 March 2000. Significantly the policy set out that in order to operate a managed investment scheme, the operators must comply with Part 5C of the Law and explicitly said that schemes could not operate after 17 December 1999 unless they did comply. [25] On 6 November 2001, another firm of solicitors, CB Darvall & Darvall, gave further advice to the second and third respondents reiterating that the solicitor who had given advice from Primrose Couper Rudkin was concerned that the unregistered schemes did not comply with the Managed Investments Act, could not be registered as schemes under that Act and might be challenged as illegal. CB Darvall & Darvall told the second and third respondents that they agreed with Primrose Couper Rudkin that the unregistered schemes needed to be wound down as quickly as possible, that consideration should be given to bringing the Maryborough scheme within Atlantic 3 FM and that a concerted effort should be made to rationalise the unregistered schemes to reduce the total number of investors in each of them to less than 20, at which point they would not be required to be registered. [26] Nevertheless in breach of the Law and of s 601ED(5) of the Act, the second and third respondents continued to operate the unregistered schemes until 17 July 2003 when they were wound up by the Court. Between 17 December 1999 and 7 May 2003, investors put $5,283,122.35 into Atlantic 3 in respect of the unregistered schemes. It follows that the second and third respondents raised further moneys from investors and continued to promote and operate the unregistered schemes for -- 10 of 24 -- 11 three and a half years after that activity had been made unlawful and they well knew it had been made unlawful. The total loss of capital to investors in the five unregistered schemes which were wound up by the court appointed liquidators is between $7,868,013 and $8,608,711. The estimated return of capital is only in the order of 9.98 cents to 17.72 cents per dollar invested. Moneys raised from existing investors and new investors [27] After the respondents were aware that those schemes were being operated unlawfully, more moneys were raised from existing investors: for example the loans in the Bass scheme and the McCarthy scheme were extended in 2000. New investors were also introduced into the unregistered schemes. It was not disclosed to the new investors that the schemes were being operated unlawfully. [28] Dr Acker, for example, invited an investor who had funds in the registered scheme Atlantic 3 FM, to place $25,000 in the unregistered Maryborough scheme in April 2003 without informing her that the scheme was unregistered nor that it was experiencing negative cash flow. Atlantic 3 continued to receive new investments in relation to unregistered schemes even after the mortgages held by the schemes had gone into default. New investors were accepted into the Sentry Alliance scheme in April, November and December 2001, after the loan had gone to default and those new investors were not informed of the default. [29] An investor was introduced into the Mackay Leagues Club scheme in July 2000 even though the loan the subject of the scheme had gone into default in late 1998 and Atlantic 3 had entered into the property as mortgagee in possession. Another new investor was introduced into that scheme in April or May 2003 in spite of the fact that ASIC had already issued notices under s 30 of the Australian Securities and Investment Commission Act 2001 (the “ASIC Act”) to produce books about the affairs of the scheme. The investor was unaware that the purpose of the investment was to pay interest to existing investors due to insufficient funds in the scheme. Ponzi scheme [30] A scheme that operates in such a manner is often colloquially referred to as a Ponzi scheme. The US Securities and Investments Commission describes such schemes as follows: 3 “Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. Ponzi thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons. Ponzi told investors that he could provide a 40% return in just 90 days compared with 5% for bank savings accounts. Ponzi was deluged with funds from investors, taking in $1 million during one three-hour period – and this was 1921! Though a few early investors were paid off to make the scheme look legitimate, an 3 www.sec.gov/answers/ponzi.htm; accessed 05/04/06. -- 11 of 24 -- 12 investigation found that Ponzi had only purchased about $30 worth of the international mail coupons. Decades later, the Ponzi scheme continues to work on the ‘rob-Peter- to-pay-Paul’ principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses.” Unfortunately such schemes continue to attract and dupe innocent members of the public.4 [31] That moneys raised from investors for particular schemes were used to pay interest in other schemes, to pay interest to investors in a scheme after it had gone into default, and to pay moneys outside the scheme, can be inferred from the following examples. [32] Interest in the amount of approximately $123,650 continued to be paid to investors in the Sentry Alliance scheme until June 2003, after the loan the subject of the scheme had gone into default in May 2000 and no income was received for the rental of the property the subject of the scheme after that date. Atlantic 3 admitted investors into the Sentry Alliance scheme after the borrower had defaulted under the mortgage and after Atlantic 3 had entered into possession as the mortgage in 2001 without informing investors of Sentry Alliance’s default. This also had the effect of unlawfully diluting the interests of existing investors by conferring interests on new investors. The balance of funds that should have been approximately $160,000 in relation to the Sentry Alliance scheme at the time of the appointment of the liquidators was not provided to the liquidators nor have the liquidators been able to account for the funds. [33] Interest payments were made to investors in the Maryborough scheme between February 2000 and June 2003 in the sum of approximately $488,710 when there was a shortfall of income from the scheme of $390,753. On 29 January 2001, the second and third respondents permitted the Maestro Unit Trust and Jecarell Superannuation Fund, which were the investment vehicles of Dr. Jeffrey Carmichael, the third shareholder of Atlantic 3, to be paid the sum of $67,260.34 from the Maryborough scheme and caused three investors, who were not aware of the true financial situation, to be placed in the Maryborough scheme as substitute investors. The financial records of Atlantic 3 are so inadequate that the sum of $273,183 of estimated receipts and payments in relation to the Maryborough scheme cannot be accounted for by the liquidators. [34] The total amount of money received into the Mackay Leagues Club scheme was $2,043,956.36. The amount recorded in the sub-ledger for the period 16 July 1999 to 2 September 2002 and the Darvall and Darvall trust account as being received into the Mackay Leagues Club scheme was $1,079,504.13 with total investor deposits of $999,004. Of moneys paid by new investors into the Mackay Leagues Club scheme, $90,000 was paid to another scheme, the Jindabyne scheme, $12,060.93 was paid to Egerton as part repayment of principal; $24,000 was paid to 4 Zipside Pty Ltd v Anscor Pty Ltd [2004] QSC 33; Clout (Trustee) v Anscor Pty Ltd [2003] FCA 326; Chapel Road Pty Ltd v ASIC [2003] AATA 660; Bishop Mar Meelis Zaia v David Tiglath Chibo [2005] NSWSC 917; Karl Suleman Enterprizes v George [2003] NSWSC 544. -- 12 of 24 -- 13 an investor, Terry Mahoney; and $40,208.22 was paid to an investor known as “Wadsworth.” Investors were paid interest in the Mackay Leagues Club scheme until approximately June 2003 although the loan had gone into default in December 1998 and the scheme continued to have negative cashflow until June 2003. The shortfall in income received by the scheme as against the estimated interest of $874,122.11 paid to investors was $460,000.43. The liquidators have not been able to account for the sum of $850,615.20 in relation to the receipts and payments of the Mackay Leagues Club scheme. [35] Between 2001 and 2003 investors in the Clearview scheme were paid interest in the sum of $745,200 when no income was generated from the properties, the subject of the schemes, until after January 2003. Interest payments are recorded as having been made in the sum of $262,852 to three investors in the Clearview scheme when the epitomes of investment record that these investors were not to receive any interest payments until the development had finished. [36] Moneys raised from investors in the Maryborough scheme were used to pay interest to Plymouth Greens investors. $90,418.64 was paid to investors in yet another scheme, the Mergard scheme, from moneys raised from the Maryborough investors. Payments in breach of trust [37] In addition to the unauthorised payments referred to, the second and third respondents intermingled funds and caused Atlantic 3 to use moneys raised from investors for purposes other than those for which the moneys had been provided. Those payments were made in breach of the trust on which those payments were received. Some examples will suffice. Moneys raised from investors in the Mackay Leagues Club scheme were used to pay investors in other schemes and investors from other schemes were transferred into the scheme without payment. [38] Moneys raised from investors in the Sentry Alliance Scheme were used to repay $19,040 to an investor in the Clearview scheme and payments of $5,850 and $61,561.45 were made to Mr and Mrs Gilchrist from the Sentry Alliance scheme even though they were not investors in the scheme and there appears to have been no documentation to support the payments. [39] The Clearview scheme had four types of investors: the “Clearview Mahoney” and Clearview original investors; the Montville 2 investors (whose investments were made between October 2000 and March 2002); the Montville 3 investors (whose investments were made between November 2001 and October 2002); and the Montville or Clearview equity investors. Between 2001 and 2003 investors in the Clearview scheme were paid $745,200 in spite of the fact that no income was generated from the properties the subject of the scheme until after January 2003. [40] The financial records kept for the scheme were insufficient for the liquidators to determine the source and applications of all of the moneys in the scheme. However, the following irregular transactions show the misuse of funds into and from the unregistered scheme. $182,539.45 was recorded as a miscellaneous debit in the Montville 3 sub-ledger in the Clearview scheme to balance the accounts with another scheme, the Jindabyne scheme, when no record of payment having been -- 13 of 24 -- 14 made by Jindabyne was recorded. As a result, $182,539.45 raised from investors in the Clearview scheme was paid to investors in the Jindabyne scheme. $45,297.50 raised from investors in the Springfield Land Corporation scheme was paid to investors in the Clearview scheme to meet interest payments. The sum of $280,960 was transferred from another scheme operated by Atlantic 3, the Hinkler scheme, into the Clearview scheme. [41] The Sentry Alliance and Maryborough schemes were over-subscribed and the balance of funds raised cannot be accounted for in terms of advances made for the purpose of those schemes. [42] Non-cash investors were rolled into the Numinko scheme with interests of $11,165.20, $48,098 and $20,000 without any further payment into that scheme. New unregistered schemes commenced [43] In addition to continuing to operate unregistered schemes, Atlantic 3 commenced new unregistered schemes after 1999, when the second and third respondents knew that such schemes would be unlawful. It entered into the Washington Developments scheme in February 2000; a fifth loan to the Snadra scheme in September 2000; and a second Numinko scheme in October 2002. A second loan was made in the Clearview scheme in October 2001 and Atlantic 3 entered into a 10 year sale contract with NAF on 16 December 2002. [44] Far from running down existing unregistered schemes, in accordance with the legal advice they received, the respondents extended the terms of loans which were the subject of unregistered schemes. In August 2000, the loan which was the subject of the Bass scheme was extended until 27 July 2001, and in April 2001, the loan which was the subject of the McCarthy scheme was extended until April 2002. Investors misled [45] Not only did the respondents continue to operate the unregistered schemes, they misled investors as to the nature of the schemes. Some examples have already been given but there were many others. In relation to the Clearview scheme, for example, the “write-ups” and “epitomes of investment” indicated that investors would have a proportionate interest in the registered mortgage but there was no assignment or transfer of any interest in the mortgage with the result that no investor received a legal interest in any mortgage, and in the case of the third tranche of investors no mortgage in fact existed. The epitomes also indicated that moneys were to be paid into a trust account when Atlantic 3 had no trust account. [46] The Plymouth Greens investors in the Maryborough scheme whose investment predated the Atlantic 3 Mortgage investors in the Maryborough scheme were not told that those new investors gained a first mortgage over the properties owned by the Maryborough scheme and that therefore those investors had priority over them. -- 14 of 24 -- 15 [47] Investors were told loan to value shares were acceptable when in fact no valuations had been obtained or had been assigned. Nor were updated valuations obtained when Atlantic 3 was considering whether to extend loans. Carrying on a securities business without a licence [48] In breach of s 780 of the Law and s 911A of the Act, none of the respondents held a financial services licence or a dealer’s licence, nor was an exempt dealer. None was a responsible entity within the meaning of s 601EB, s 601FA and s 601FB of the Act. [49] Section 780 of the Law provided: “Dealers (1) A person must not: (a) carry on a securities business; or (b) hold out that the person carries on a securities business; unless the person holds a dealers licence or is an exempt dealer. (2) A dealer’s licence may authorise a person to do either or both of the following: (a) to carry on a securities business; (b) to operate: (i) a managed investment scheme; or (ii) managed investment schemes of a particular kind. Note: Only public companies that hold a dealers licence can be responsible entities for registered managed investment schemes (see section 601FA).” [50] Section 911A(1) of the Act provides: “(1) Subject to this section, a person who carries on a financial services business in this jurisdiction must hold an Australian financial services licence covering the provision of the financial services” No disclosure documents [51] Further, in breach of s 727 of the Law and of the Act, the second and third respondents offered securities without lodging a disclosure document with ASIC in respect of any offer to investors in the unregistered schemes. -- 15 of 24 -- 16 Declarations [52] The facts as set out herein show that the activities referred to are in breach of the relevant statutes. It is in the public interest that the declarations sought by the regulatory authority be granted to publicly expose and denounce on behalf of the community the unlawful behaviour in which the respondents have engaged and alert and inform investors as to what has occurred.5 It is therefore appropriate to grant the declarations sought. Disqualification Orders [53] It is clear that an order that the second and third respondents be disqualified from managing a corporation pursuant to s 206E of the Act for a period of time commensurate with protecting the public from activities of the type referred to in these reasons, is justified in the public interest. [54] In this case, the second and third respondents not only operated unregistered schemes, but also operated those unregistered schemes in breach of the duties which are set out in s 601FC. Those are the duties which responsible entities must exercise when they operate a registered scheme and should have been well known to the second and third respondents as directors of Atlantic 3 FM which operated registered managed investment schemes. [55] Section 601FC provides: “Duties (1) in exercising its powers and carrying out its duties, the responsible entity of a registered scheme must: (a) act honestly; and (b) exercise the degree of care and diligence that a reasonable person would exercise if they were in the responsible entity’s position; and (c) act in the best interests of the members and, if there is a conflict between the members’ interests and its own interests, give priority to the members’ interests; and (d) treat the members who hold interests of the same class equally and members who hold interests of different classes fairly; and (e) not make use of information acquired through being the responsible entity in order to: (i) gain an improper advantage for itself or another person; or (ii) cause detriment to the members of the scheme; and 5 ASIC v Pegasus (supra); ASIC v Sweeney [2001] NSWSC 114 at [30] – [31]; Australian Softwood Forests Pty Ltd v Attorney-General (NSW) (1981) 148 CLR 121 at 125; Corporate Affairs Commission v Transphere Pty Ltd (1989) 7 ACLC 205 at 209-214; Tobacco Institute of Australia LH v Australian Federation of Consumer Organisations Inc (1993) 113 ALR 257. -- 16 of 24 -- 17 (f) ensure that the scheme’s constitution meets the requirements of sections 601GA and 601GB; and (g) ensure that the scheme’s compliance plan meets the requirements of section 601HA; and (h) comply with the scheme’s compliance plan; and (i) ensure that scheme property is: (i) clearly identified as scheme property; and (ii) held separately from property of the responsible entity and property of any other scheme; and (j) ensure that the scheme property is valued at regular intervals appropriate to the nature of the property; and (k) ensure that all payments out of the scheme property are made in accordance with the scheme’s constitution and this Act; and (l) report to ASIC any breach of this Act that: (i) relates to the scheme; and (ii) has had, or is likely to have, a materially adverse effect on the interests of members as soon as practicable after it becomes aware of the breach; and (m) carry out or comply with any other duty, not inconsistent with this Act, that is conferred on the responsible entity by the scheme’s constitution. (2) The responsible entity holds scheme property on trust for scheme members. Note: Under subsection 601FB(2), the responsible entity may appoint an agent to hold scheme property separately from other property. (3) A duty of the responsible entity under subsection (1) or (2) overrides any conflicting duty an officer or employee of the responsible entity has under Part 2D.1. (4) The responsible entity may only invest scheme property, or keep scheme property invested, in another managed investment scheme if that other scheme is registered under this Chapter. (5) A responsible entity who contravenes subsection (1), and any person who is involved in a responsible entity’s contravention of that subsection, contravenes this subsection. Note 1: Section 79 defines involved. Note 2: Subsection (5) is a civil penalty provision (see section 1317E). -- 17 of 24 -- 18 (6) A person must not intentionally or recklessly be involved in a responsible entity’s contravention of subsection (1).” [56] The respondents assisted in the administration of justice by making admissions on the pleadings and agreeing to the Combined Schedule of Admitted Facts and Additional Facts at the trial of this matter. That assistance has operated to mitigate the penalty that would otherwise have been imposed. However it is important to recognise the limits of the co-operation offered by the respondents. That co- operation was not matched by co-operation during the investigation by ASIC. The respondents failed to respond fully or promptly to the notice issued by ASIC on 31 March 2003 pursuant to s 30 of the ASIC Act, and failed to comply fully with the order of McMurdo J made on 27 May 2003 to identify all of the investors in the Clearview scheme. [57] A number of cases have considered the matters which ought to be taken to account in determining whether or a not a disqualification order is justified and, if so, for how long. Those cases were conveniently reviewed by Santow J in re HIH Insurance; ASIC v Adler.6 One of those criteria has since been modified by a subsequent decision of the High Court. The factors which Santow J said were relevant, as so modified, include: 1. That disqualification orders are designed to protect the public from the harmful use of the corporate structure or from use of a corporate structure contrary to proper commercial standards.7 2. That a banning order is designed to protect the public by seeking to safeguard the public interest in the transparency and accountability of companies and in the suitability of directors to hold office. 8 3. That protection of the public also envisages protection of individuals who deal with companies, including consumers, creditors, shareholders and investors.9 4. That disqualification orders are protective against present and future misuse of the corporate structure.10 5. That disqualification orders act as personal deterrence. Santow J said that they were not punitive; however in Rich v ASIC, 11 the High Court held that exposure to a 6 (2002) 42 ACSR 80 at 97-99; [2002] NSW SC 483 at [56]. 7 Australian Securities and Investments Commission v Hutchings (2001) 38 ACSR 387 at 395; Australian Securities and Investments Commission v Pegasus Leveraged Options Group Pty Ltd (2002) 41 ACSR 561; Australian Securities Commission v Forem-Freeway Enterprises Pty Ltd (1999) 30 ACSR 339 at 349-350; Australian Securities Commission v Donovan (1998) 28 ACSR 583 at 602; Australian Securities Commission v Roussi (1999) 32 ACSR 568 at 570-571; Re Strikers Management Pty Ltd; Australian Securities Commission v Dimitri (unreported, Fed C of A, Burchett J, No NG 3789 of 1996, 7 May 1997, BC9702133); Re Tasmanian Spastics Association; Australian Securities Commission v Nandan (1997) 23 ACSR 743 at 751. 8 Australian Securities Commission v Roussi (supra) at 570; Re Gold Coast Holdings Pty Ltd; Australian Securities and Investments Commission v Papotto (2000) 35 ACSR 107 at 112. 9 Australian Securities Commission v Roussi (supra) at 570; Re Gold Coast Holdings Pty Ltd (supra) at 112; Re Tasmanian Spastics Association (supra) at 751. 10 Australian Securities Commission v Donovan (supra) at 603. -- 18 of 24 -- 19 disqualification order is exposure to a penalty and is therefore punitive, and not merely protective, in nature. 6. The objects of general deterrence are also sought to be achieved.12 As Finkelstein J observed in ASIC v Vizard: 13 “The sentence must be exemplary and sufficient so that members of the business community are put on notice that if they break the trust which is reposed in them they will receive a proper punishment … … the few [directors of publicly listed companies] that may be tempted to gain prestige, wealth and security by illegal means can be dissuaded from that course if the risk of detection and punishment is too great. … I am confident the fear of losing both their position from business life, as well as their good reputation, will be an effective deterrent in the case of many a director who is contemplating a dishonest course for gain. Few corporate crimes are spontaneous. There is always time to consider the consequences. The risk of a long period of disqualification … may well tip the scales.” Directors of companies involved in the securities business are likely to read the financial press and be aware of, and therefore in general likely to be deterred by, penalties given to other business people. 7. In assessing the fitness of an individual to manage a company, it is necessary that they have an understanding of the proper role of the company director and the duty of due diligence that is owed to the company. 14 8. Longer periods of disqualification are reserved for cases where contraventions have been of a serious nature such as those involving dishonesty. 15 9. In assessing an appropriate length of prohibition, consideration has been given to the degree of seriousness of the contraventions, the propensity that the defendant may engage in similar conduct in the future and the likely harm that may be caused to the public. 16 11 [2004] HCA 42 at [37]; (2004) 78 ALJR 1354 12 Australian Securities Commission v Donovan (supra) at 602; see also ASIC v Vizard (2005) 219 ALR 714 at [30] – [43]. 13 (supra) at [33] – [35]. 14 Australian Securities Commission v Donovan (supra) at 607. 15 Australian Securities Commission v Donovan (supra) at 605-607. 16 Australian Securities and Investments Commission v Pegasus Leveraged Options Group Pty Ltd (supra); Australian Securities and Investments Commission v Parkes (2001) 38 ACSR 355 at 386; Australian Securities Commission v Forem-Freeway Enterprises (supra); Australian Securities Commission v Roussi (supra) at 570-571. -- 19 of 24 -- 20 10. It is necessary to balance the personal hardship to the defendant against the public interest and the need for protection of the public from any repeat of the conduct. 17 11. A mitigating factor in considering a period of disqualification is the likelihood of the defendant reforming. 18 12. Santow J also referred with approval to the eight criteria governing the exercise of the court’s powers of disqualification set out in Commissioner for Corporate Affairs (WA) v Ekamper.19 It was there held that in making such an order it is necessary to assess: • the character of the offenders; • the nature of the breaches; • the structure of the companies and the nature of their business; • the interests of shareholders, creditors and employees; • the risks to others from the continuation of offenders as company directors; • the honesty and competence of the offenders; • any hardship to the offenders and their personal and commercial interests; and • the offenders’ appreciation that future breaches could result in future proceedings. 20 13. Factors which lead to the imposition of the longest periods of disqualification (that is, disqualifications of 25 years or more) were: • large financial losses; • high propensity that defendants may engage in similar activities or conduct; 17 Australian Securities Commission v Donovan (supra) at 607; Australian Securities and Investments Commission v Parkes (supra) at 386. 18 Australian Securities Commission v Forem-Freeway Enterprises (supra) at 351. 19 (1987) 12 ACLR 519. 20 Australian Securities Commission v Roussi (supra) at 570-571; Re Gold Coast Holdings Pty Ltd (supra) at 111. -- 20 of 24 -- 21 • activities undertaken in fields in which there was potential to do great financial damage such as in management and financial consultancy; • lack of contrition or remorse; • disregard for law and compliance with corporate regulations; • dishonesty and intent to defraud; • previous convictions and contraventions for similar activities.21 14. In cases in which the period of disqualification ranges from 7 to12 years, the factors which lead to the conclusion that these cases were serious though not “worst cases”, included: • serious incompetence and irresponsibility; • substantial loss; • defendants had engaged in deliberate courses of conduct to enrich themselves at others’ expense, but with lesser degrees of dishonesty; • continued, knowing and wilful contraventions of the law and disregard for legal obligations; • lack of contrition or acceptance of responsibility, but as against that, the prospect that the individual may reform. 22 15. The factors leading to the shortest disqualifications (that is, disqualifications for up to 3 years) were: • although the defendants had personally gained from the conduct, they had endeavoured to repay or partially repay the amounts misappropriated; • the defendants had no immediate or discernible future intention to hold a position as manager of a company; 21 Australian Securities and Investments Commission v Hutchings (supra); Australian Securities and Investments Commission v Pegasus Leveraged Options Group Pty Ltd (supra); Australian Securities Commission v Parkes (supra). 22 Australian Securities Commission v Forem-Freeway Enterprises (supra); Australian Securities Commission v Donovan (supra); Australian Securities Commission v Roussi (supra); Re Strikers Management Pty Ltd (supra); Re Gold Coast Holdings Pty Ltd (supra). -- 21 of 24 -- 22 • the defendants had expressed remorse and contrition, acted on advice of professionals and had not contested the proceedings. 23 [58] Many of the matters referred to reflect the factors which a court considers when sentencing offenders.24 When considering whether or not to impose a disqualification order and, if so, the length of the disqualification, essentially the court must consider the protective and punitive nature of disqualification orders in the circumstances and any mitigating or exacerbating factors which apply to the particular individuals against whom a disqualification order is sought. [59] The order should have the effect of positively discouraging others who might be tempted to engage in such behaviour, from yielding to that temptation. As Finklestein J said in ASIC v Vizard: 25 “A message must be sent to the business community that for white collar crime ‘the game is not worth the candle’.” Professor Arie Freiberg stressed the significance of general deterrence in his paper “Sentencing White Collar Criminals”:26 “General deterrence would seem to be particularly applicable to white-collar criminals who are likely to be rational, profit-seeking individuals able to operate Bentham’s hedonic calculus, weighing the benefits of committing the crime against the costs of being caught and punished. White-collar criminals also probably fear gaol more than others, having been less inured to its rigours than those who have come up through state homes and training centres. Secondly, sentences imposed on white-collar criminals are more likely to affect their peers, who, unlike some blue-collar offenders especially those under the influence of drugs, are more likely to read the press and become aware of the fate of miscreants in their midst.” The consequences of their corporate misbehaviour on people like Christopher Skase, driven into self-imposed exile, and Alan Bond, who was imprisoned, act as a general deterrence to others from abusing or misusing their position as company directors. This should not, however, be overstated. As commentators on the recent successful prosecution of Enron executives, Kenneth Lay and Jeffrey Skilling, have noted “incentives and greed” run counter to accountability and transparency in management and neither has disappeared.27 [60] The length of disqualification should reflect the following exacerbating circumstances of the offending behaviour which demonstrate that the second and 23 Australian Securities Commission v Donovan (supra); Re Tasmanian Spastics Association (supra). 24 Rich v ASIC (supra) at [49] – [52] per McHugh J; Elliott v ASIC (2004) 48 ACSR 621 at 658. 25 (supra) at [48]. 26 Paper presented at the Fraud Prevention and Control Conference convened by the Australian Institute of Criminology in association with the Commonwealth Attorney-General’s Department held in Surfers Paradise, 24-25 August 2000 at p 13. 27 Professor AP Brief of the AB Freeman School of Business of Tulane University quoted in Kurt Eichenwald “In Enron Case, a Verdict on an Era”, New York Times, 26 May 2006. -- 22 of 24 -- 23 third respondents should be considered unfit to manage corporations for a considerable period of time: (1) the respondents operated at least 15 unregistered schemes; (2) the moneys received from investors were pooled with other moneys and no proper financial records were kept; (3) some moneys were not accounted for at all and have simply disappeared; (4) investors have lost many millions of dollars. In the case of the five unregistered schemes where external liquidators have been appointed, that loss is approximately $7.8 million; (5) the respondents applied moneys provided to them for particular schemes for other purposes in breach of trust; (6) the respondents’ behaviour was contumelious in that they continued to operate unregistered schemes for three and a half years despite knowing that doing so was unlawful; (7) the respondents did not inform investors that the schemes were operating contrary to law; (8) knowing that it was unlawful to do so, the respondents: (a) put over $5,000,000 of investors’ money into Atlantic 3; (b) raised more moneys from existing investors; (c) introduced new investors into the unregistered schemes; (d) commenced new unregistered schemes; (e) continued to receive investments into unregistered schemes knowing that the schemes’ loans had gone into default; (f) used capital from some investors to pay interest to investors in other unregistered schemes; (g) misled investors as to the nature of the schemes and their financial viability; (9) The respondents breached ss 727 and 780 of the Act and ss 727 and 911A of the Act. [61] On the other hand, it is appropriate to have regard to the fact that there is no history of corporate misconduct by the respondents. While they were incompetent and irresponsible and deliberately engaged in misleading and unlawful behaviour it does not appear that their intention was merely, or even frankly, dishonest. Although there are moneys that cannot be accounted for, there is no allegation that the second or third respondents misappropriated the moneys for their own use. -- 23 of 24 -- 24 [62] In all of the circumstances, the appropriate period of disqualification in the case of Dr Acker is ten years and in the case of Gerilyn Polanski is eight years. Orders [63] The court declares that: 1. In contravention of s 601ED(5) of the Act the second and third respondents operated unregistered managed investment schemes which were required to be registered pursuant to s 601EB of the Act. 2. The second and third respondents, in operating the unregistered schemes prior to 11 March 2002, breached s 780 of the Law in that, not being an exempt dealer, they each carried on a securities business without holding a dealer’s licence. 3. The second and third respondents, in operating unregistered schemes as from 11 March 2002, breached the provisions of s 911A of the Act in that they carried on a financial business without holding an Australian Financial Services Licence. 4. In breach of s 727 of the Law and s 727 of the Act, the second and third respondents offered securities without a disclosure document in relation to the schemes. And it is ordered that: 1. The second respondent is disqualified from managing corporations for ten years from the date of this judgment. 2. The third respondent is disqualified from managing corporations for eight years from the date of this judgment. -- 24 of 24 --