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Lombard convictions an own goal

  • February 24th, 2012

I see nothing in the conviction reasoning to comfort anyone, though burnt investors may see justice of a kind – until the the non-prison penalties to come.

I draw some slight comfort from a discreditable schadenfreude. When Sir Douglas Graham was Minister of Justice I presented the NZ Law Society's submissions on what became the Companies Act 1993. I was also heavily involved in the debate over whether we should have a takeover law like Australia's, or more like the USA or Switzerland (we got mostly Australia's dopey model). I had several meetings to lobby the Minister on both. I recall his indifference to our warnings that the law was casually eroding the balances of shareholder and director powers, rights and freedoms. Puffing smoke rings high in the air as he looked at the ceiling (yes Veronica in those days cigars were common in the Beehive) he told me he thought I was getting a bit carried away, and that he was sure the courts could ensure that uncertain new provisions would be applied sensibly.

But that memory is unworthy. It is far overshadowed by genuine sympathy for the plight of him and his fellow directors.

When honest men share the criminal dock with crooks the crook is comforted,  the boundary between the crooked and the straight becomes obscure and obedience to criminal law becomes a matter of cynical calculation. Instead of being an unquestionable standard for all decent citizens, adherence to criminal law becomes mere risk balancing. The risk of being caught becomes just like other business risks, balanced against the returns. This is even more so when the law renders criminal some acts that the director (as potential criminal) has no practical way to stop.

All healthy legal systems rely on an active consensus of the law abiding to uphold the rules, and to assist in detecting and punishing offenders. That in turn depends on the social mechanisms like shame and disgrace that enforce the consensus.

Our company and securities law is busy trashing that consensus.

Paragraph 10 of Dobson J's Reasons for Verdict explains it.  He did not make the law. He must just apply it:

"In the relevant respects, the law has created criminal liability for what may be no more than a material misjudgement about the accuracy and adequacy of the description of the state of financial health of the company, as directors authorise it in offer documents".

The judge's reasoning highlights how mechanical the law is. I think there were ways in which he could have mitigated the reach of this law, but even if he had, when circumstance emerge that make an offering statement untrue the statutory defences are flimsy. Evidence of honesty, diiigence, compliance with accepted governance principles, reliance on trusted management and reliance on accounting standards may all be immaterial.  

I will think no less tomorrow of the Lombard directors than I did two years ago. I would welcome these convicts to my house. I give them still as much respect  for their achievements as before. I would appoint at least one of them to positions of responsibility. So in this respect criminal law has lost its power to brand. It has lost its power to draw distinctions that are vital for the effective functioning of commercial morality when the policeman or the regulator is not around, or is too busy.

The disjunct between commercial morality or ethics and the criminal law now means that when I do not have personal knowledge I am likely to sympathise with defendants, and assume that they are just losers in a liability lottery,. Criminal law should be invoking in its support the powerful social sanctions of exclusion and disgrace. Now senior directors all over the country have another reason to shudder "there but for the grace of God go I". For if they are any good at all they will often have made decisions with inadequate information, relying on their intuitions about others, juggling risks, applying their best efforts for the company, knowing that it could go wrong.

This is not to say that I do not judge those responsible for losing investors' money. Nor does it say I respect these particular directors for their sagacity as the long bull market in property neared its end, and it became ever more inevitable that the mezzanine financiers of developments would lose their money. They were foolish optimists, in hindsight. I  would not have made the same decisions as them. But perhaps I am more risk averse, and had been through the 1980s as a senior commercial lawyer, 

But I draw a huge distinction between misjudgment (as the judge called it) or foolish optimism on the one hand, and dishonesty on the other. There are plenty of dishonest directors to hound. When the law squanders scarce enforcement millions on foolishness it sends millions more into the pockets of the  lawyers now feeding off the corporate desperation for back-covering records of conspicuous diligence. None of my million dollar per year professional colleagues will be helping make any commercial boats go any faster, though many will be earning more in a year than any liability most of their clients would ever have.

But risk aversion has far higher costs. The flight of people from public markets to private equity and direct investment could waste most of the millions more the government is pouring into securities law, and trying to revitalise the moribund share market. Yet without an active local share market for medium size companies, our successful local business people will continue to sell to foreign capital when they need more, or want to start spreading their personal investment risks.,

Criminalising foolishness is foolish, but if we are now set on it there are many classes of foolishness to criminalise before a failure to warn even more strongly than they did, investors looking for the returns from calculated risk.

What about the politicians who ordered the guarantees for finance companies that have lost us all billions. What about the city planners and the heritage lovers whose aesthetic preferences blocked replacement of old brick buildings that have killed scores of people? What about the boilermakers union leaders who have killed by making it impossible to build steel framed building in New Zealand for decades so that instead we had concrete pillared buildings imitating the slenderness of steel.? What about those who designed or implement the parole laws that enable known violent risks to kill innocent New Zealanders every year?

A couple of years ago, commenting on the charging of Rick Bettle I summarised the likely outcome of convicting honest and diligent but unwise or unlucky directors as follows;

"The deterrent of the prosecutions could see the birth of  impeccable candour among company directors, ushering in a new age in which fear of prosecution makes it  possible to take at face value nearly all public commercial discourse, assuming statements have been checked to exhaustion for possibly misleading inferences. The resulting public confidence will see a flood or renewed saving and direct  investment by the newly trusting "mums and dads".

Or we could be watching a dramatic acceleration of the great decline in  opportunities for direct public investment, as promoters directors and major shareholders decide that the compliance costs (and risks) of public offering far outweigh any lowered costs of capital. On that scenario there will be little that the NZX can do to reverse its decline in significance. The power and revenue of private equity and other "wholesale" market intermediaries will surge, and whatever their 'financial literacy' or newly refreshed trust, for "kiwi mums and dads" there will be declining choice for direct investment."

Another post summarised the effect on the returns investors might expect from share investment, of imposing asymetric liabiliities on directors:

" if shareholders want the upside of good faith judgment when it proves right and want the blood of directors when that same good faith judgment proves to have been unwarranted, then the shareholders will find that the directors will demand a goodly part of the return that the shareholders are expecting. If directors pick up the downside risk for shareholders they will want the return to justify it."

Another contribution to widening inequality.



I found your post very interesting and thought provoking. I am not certain as yet that I agree with all your comments, which I will need to think further on, but a I do think greater attention needs to be given to the issues you raise

  • Mark Hubbard
  • February 25th, 2012
  • 8:43 am

A very good post. Risk is essential to a prosperous economy, and free lives, because what Western social democracies are proving is, the bigger the State, the more the movement, for whatever reasons, to try and eliminate risk, and because that is impossible, the unintended consequence is damned near police states in the powers that have been given to bureaucracy, and the stifling of the vibrancy needed for well working free markets (and free lives).

I think only a philosophy that encompasses limited government (classical liberalism) can turn this, but the will for that is the minority, and the biggest fault of democracy, is it’s majority rule. I dont see any solution coming, just a quickening decline into the Big State. I find that deeply frightening.

Indeed, a good analogy of how bureaucracy, by trying to eliminate risk is killing economies, on the micro-level, CAPCHA’s that are appearing on all blogs now, to eliminate the risk of bots or spam, are killing blogs because I can’t get through over half of them and end up often giving up. Third try to post this.

  • barry
  • February 25th, 2012
  • 9:33 am

Steven – this case is again a reminder  of the myth about the separation of governance and management.
Often a bit of common sense helps a lot.  So I liken the running of a company to running a cruise liner.  As the captain you direct that the boat be sailed in a certain course. You need to check that this is in fact happening, and if it isn’t happening you need to take over the steering wheel yourself and get the thing running properly. It is not acceptable for the captain to say “But I told the helmsman to steer this heading, but he didn’t and I didn’t do anything about it so as to save the ship”.  As we have all seen the captain of the Costa Concodia (aka the Costa-lota) is the guy in the gun – the helmsman wont be in any sort of trouble at all.
Corporate leadership in NZ has a dismal history – as we can all see in the performance of the share market. Several years ago I challenged the then Governor of the Reserve Bank about his pleading with the general population to stop buying houses and instead buy shares.  I dug out the performance of the top 20 (I think – it could have been the top 10) over the previous 15 years (the longest I could find) and found that if Id bought a share in each of them 15 years ago it would have cost me $39, but now 15 years later if I sold them I would have obtained $35 – of course that doesn’t account for the dividends.  “But what dwelling over 15 years losses that sort of value” I asked him (– leaving out the rental income). He had to agree, but offered the usual platitudes about ‘the long term’ and ‘some do better’ etc.
Of course the reason they do so badly is the appalling abilities of the directors and the management of most public companies in this country. They lack a basic understanding of their role and their responsibilities.
One of the reasons they do so badly is that they believe this myth about “governance is governance and management is management and never the two shall cross”
This is where the Lombard directors (and many others) went wrong. They thought that as directors they didnt have to know what was going on in any detail at all, they thought that those sort of details were managements problem. But they forgot that as directors they had simply delegated the responsibility to run the place to management, but that they still had responsibility and liability for the running of the company. We heard the same sorry story recently from the Blue Star lot – “management didn’t tell us the truth”.
Directors run and manage a company on behalf of its shareholders and that means they have to know whats going on and they have to be aware of whats happening so that if the company isn’t running as they have directed it to, then they can make adjustments. 
Only a fool would think that management is going to fess up to the directors about their (managements) inabilities and short comings.
 Yes – these guys at Lombard might be nice people who simply made some foolish mistakes – but that’s because they forgot that they had a responsibility to know what was going on in the company – it was a job they were paid to do.

  • Tony
  • February 25th, 2012
  • 12:16 pm

Barry, I agree.  I have worked with Boards in the public sector for many years and have found many of them mesmerised by the separation between management and governance.
Sure, Board interference with management can be a major problem but so too can Board detachment in the face of obvious problems.  I regard the separation of the two as a necessary fiction to be discounted when circumstances demand.  It's all art not science.


 Stephen, says v we should treat Graham special and privileged.
I don't think so Stephen. pal. I would hang with  along side Eric Watson and the others.
This son of a bitch ruined people's lives.

  • Stephen
  • February 26th, 2012
  • 9:09 pm

I agree with you and Barry on the dopeyness of slavish adherence to the governance/mamagememt distinction, but only to the extent that the directors are on notice that they need to know more than management might be volunteering

  • Ivan
  • February 27th, 2012
  • 10:06 am

I agree with peterquiote's comments 100 percent. We are to soft on these type of crims in New Zealand. The only type of crim that gets hammered in this country is the low income one.


I hesitated to come in here again.  Many old peoples lives were ruined by idiots like fucking Douglas  Maori Graham.
You are a criminal Graham Douglas .like other previous Ministers of State. NZ NAT
Stephen should welcome the fact that he is not a Minister or in Parliament . Stephen, you know you are a genius, and we are fools.
We revile these Douglas Graham people. We want justice. Our fathers and our Mothers suffered. 
Some of my fathers and mothers are  left with nothing.
How many fucking Fay and Richwhite and Watson do we need before I get the chance to hang them upside down .
Excuse me Sir Michael fucking Richwhite , Eric Watson, Hotchins, give me permission on this siter Stephen to shoot them, hang upside down.
Come on intellectuals and lawyers, tell me why it is it ok to ruin my Mother"s life
peter quixote  

  • Brendan
  • March 2nd, 2012
  • 5:56 pm

Good analysis.
From public companies and financial institutions we need financial transparency, and honest representation.  Anything short of that is a breach of trust and sanctions apply.
Directors have a duty of care to be informed on both counts.
Ignorance is hardly an excuse.

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