Forum Finance 2021 and National Safety Council 1989: Everything old is new again

The recent publicity surrounding allegedly fraudulent equipment leasing transactions substantially funded by one of Australia’s major banks has echoes of a similar scandal thirty years ago involving a leading State government owned bank. In the recent case, many of the same sharp financial practices present in the previous scandal may be observed. Despite the monumental nature of the past chicanery, it seems that its lessons have been ignored or forgotten.

The National Safety Council of Australia (VIC branch)

In early 1989 the Victorian branch of the National Safety Council of Australia (NSCAV) collapsed, owing at least $300 million to its creditors, predominantly the State Bank of Victoria (SBV).

It later turned out that nearly 50 banks and financiers had lent in excess of $360 million to the NSCAV, a not-for-profit community services organisation that showed less than $100 million in assets on its books. The NSCAV’s key non-current assets (and hence a large part of the lenders’ security), were described as “containerised safety equipment”. The containers, purportedly packed with rescue equipment, were later found to be non-existent or empty. The organisation’s substantial body of trade debtors was also largely fictitious.

The NSCAV had been established in 1928 as a not-for-profit company limited by guarantee, so blame for the fiasco was subsequently attributed to lax regulatory oversight and inept governance from part-time or honorary directors. Supervision of CEO John Friedrich had been poor to non-existent, and consequently calamity ensued.  For example, the SBV had permitted its exposure to the NSCAV to balloon from an overdraft facility of $2.5 million in 1982 to cash advance and commercial bill lines totalling $67 million in 1988.

Further, the fact that the NSCAV was a perceived as a community-based organisation presumably beguiled the lenders into assigning a risk free profile to the organisation, believing that in the unlikely event of a worst case, they would be bailed out by government.

Forum Finance

In June 2021, a mid-market chattel financier called Forum Finance Limited (FFL), the borrowing arm of the Forum Group of Companies (FGC) was put into administration at the request of its major lender, Westpac Banking Corporation. It was found that FFL had borrowed upwards of $400 million from Westpac and other major banks and financiers. The loans were supposedly secured against equipment lease contracts which it or other members of FGC had purportedly arranged with large, credit-worthy lessees.

It was reported that Westpac’s Federal Court statement of claim had calculated its net exposure to FFL to be $294 million, a figure based on a portfolio of 100 lease transactions with a book value of around $341 million.  Other financiers had funded FFL in much smaller amounts, but also relied on the strength of similarly non-existent lease contracts.

Similarities

The similarities between the NSCAV frauds and FFL’s machinations are striking. They include:

• the aggregate amounts in question were nominally similar (though vastly different in “dollars of the day”);
• a lead perpetrator in the person of a charismatic CEO;
• lax verification and settlement procedures adopted by lenders;
• minimal or non-existent security; and
• unsigned or forged customer contracts.

The explanations given so far as to why FFL was able to facilitate the alleged misappropriations include the fact that the putative lessees procured by FFL had not signed the underlying lease documentation. Westpac and the other financiers presumably thought that the lessees, being large reputable groups, comprised its credit risk, and documentation was of a lesser concern. Yet it turned out that none of these customers was aware of the transactions the lenders had booked.

In the case of NCSAV, the frauds occurred during an era when a plethora of foreign banks had recently established themselves in Australia. This was the era of banking de-regulation, ushered in by the 1980s. When later asked how he had procured so much funding, John Friedrich replied that he “hadn’t had to ask, the lenders had simply come knocking on my door”.

Differences

Curiously the proceeds of the NSCAV financiers loans were not appropriated by John Friedrich for his personal benefit. Rather, they were invested in other items of rescue equipment or support, including aeroplanes, helicopters, a submarine, and satellite communications, as well as specially trained dogs, horses and pigeons. The operational component of the NSCAV’s 700 strong staff received smart paramilitary-style uniforms, in which they operated from ten rescue ‘bases’ around Australia. And, somewhat confoundingly, Friedrich and his family lived modestly on a small rural property near Sale, not far from the NSCAV’s main operational base.

On the other hand, the funding procured by the FCL CEO Bill Papas seems to have been largely disbursed on investments in real estate both locally and overseas, as well as exotic motor vehicles. Like Friedrich though, Papas also invested in his business (in the form of manufacturing ‘smart’ waste disposal equipment), and was reported to have been making timely loan repayments right up until the end.

Ultimately the undoing of both individuals can be attributed to the belated discovery of discrepancies in company documentation, whether at board level with the NSCAV, or with unsigned customer contracts in the case of FFL. Regardless, the fact that both scenarios had become Ponzi schemes would have meant their eventual exposure and demise anyway.

Risks for financiers

In the case of FFL, it appears to have exploited the vulnerabilities of the third-party funding model so commonly used in wholesale equipment finance. The long standing techniques of principal and agent and/or discounted receivables facilities rely on an outsourced sales team. The model offers great economies of scale for lenders who lack either the personnel or the animal spirits of the introducer firms to identify and close deals.

The key to the model’s rigour is the principal financier’s back office: equipment suppliers’ bona fides should be verified, documents checked, and the existence of the underlying equipment confirmed. Only then should money be permitted to flow, preferably direct to the supplier and not via a transaction’s introducer.

In the aftermath of the NSCAV debacle, a variety of deceptive techniques was identified:

• “fresh air” leasing (the equipment never existed);
• multiple leasing (same goods leased more than once);
• leasing of assets with uncertain or no value; and
• fictitious transactional accounting records.

Most of these techniques have been publicised in connection with FFL.

Further, suspicious indicators were identified in the NSCAV aftermath, but ignored at the time the loans were being made. These included things such as:

• goods invoices being provided by an unknown supplier;
• a supplier often being a company with nominal paid up capital;
• the assets financed not being new (sale & leasebacks require much more due diligence);
• delivery taking place to remote or inaccessible areas;
• difficulty in inspecting the goods; and
• the financed assets having rapid diminishing value.

In the case of the impugned FFL transactions, according to news media reports, the subject of the majority of the dubious lease contracts was equipment manufactured and supplied by a Greece based affiliate of FCG, called Iugus. Perhaps the eco-friendly nature of its ‘AI’ type industrial sale food digester machines obscured the need to ensure that false invoices, forged signatures and/or unsigned lease contracts could not slip through.

Additionally, it seems that lender funds were remitted to FFL’s bank account for intended disbursement to the goods suppliers. Payment direct to the suppliers would in hindsight have been prudent, although the involvement of Iugus would seem to have put even this risk mitigant in jeopardy.

Conclusion

The lesson for equipment financiers is that an outsourced sales model provides great scope for balance sheet volumes, but wholesale funding requires its own checks and balances. Resources not otherwise deployed in the ”front office” should be ploughed back into settlements and “back-office” departments. These functions assume even more importance compared to where the funder chooses to lend directly to a customer.