Read the fine print that was the judge’s message to three Sydney investors who have lost millions and now had $44 million in damages awarded against them.
The clock was ticking towards midnight on June 30, the last day of the 1997 financial year, and there was pandemonium in the Canberra offices of Mallesons, Stephen Jacques, one of Australia’s top-gun law firms.
It was, said a Supreme Court judge, “a frantic, unsightly, and ungainly late evening that can only be described as a madhouse of frantic efforts by all who participated under the most considerable time pressure imaginable”.
At stake was a deal worth $72 million to the New Zealand promoters of a high-tech investment scheme and tax deductions worth tens of millions, plus promised profits of up to $2 billion for an elite group of Australian investors.
There had been a last-minute decision, based on advice from an eminent Sydney tax silk, to change the documentation. But if the deal was not signed and sealed by midnight, the 30 investors, who included prominent lawyers, accountants and businessmen, would not be able to claim tempting tax deductions of $1 for every 15c invested.
Said Justice Clifford Einstein, in a recent Supreme Court judgement: “the investors were so concerned with obtaining the immediate tax benefits held out, as to well and truly relegate to the side careful consideration of the transaction. Care was well and truly thrown to the wind.”
Despite their efforts, by 4am the following morning, when the team of weary lawyers finally turned out the lights, there was what the judge agreed had been a “stuff up” in the documentation. Some documents were not signed, others which were signed were incorrect.
And some of the investors were to pay dearly for what the judge described as their failure to investigate the real nature of the business only one even visited New Zealand to inspect the premises at which the high-tech devices were supposedly developed, and none commissioned any independent reports, or properly read the documentation.
As a result, at the end of a marathon six-week trial, controversial New Zealand investment banker John Reid has been cleared of claims of misleading and deceptive conduct in promoting the scheme, and three of the investors have been ordered to pay $44 million in damages, among the highest ever awarded by an Australian judge.
The big losers are self-made multi-millionaires Geoffrey Morgan of Balmoral and Andrew Banks of New York founders of head-hunters Morgan and Banks, whose two investment companies have been ordered to pay $20 million in damages, interest and costs and Alan Ian McLean, an electrical engineer, whose companies are up for $24 million.
As well, the tax department has now ruled that the scheme was for tax minimisation and not a valid investment, and has billed all the investors for the millions of dollars they saved on tax.
Justice Einstein warned against describing the court decision as a “Pyrrhic victory” for Reid, because the Morgan/Banks companies were $2 shelf companies which the court was told would be unable to pay. McLean was too ill to attend court, and could not be contacted.
The debacle had its genesis in 1996 when Reid was introduced to Gary Urwin, then a partner in Horwath & Horwath one of the world’s top 10 accountancy firms and managing director of its entrepreneurial subsidiary Horwath Corporate.
Reid was keen to sell intellectual property rights to some “cutting edge” devices invented by New Zealand software company Digi-Tech principally a device called a terminal adaptor which would accelerate internet access speed.
Urwin agreed to find some Australian investors Horwath Corporate was to get $3.9 million commission for this.
The investors were reassured by the fact that Horwath was promoting the scheme, and by other credible endorsements, particularly the fact that Chris Kelliher, the former boss of Microsoft in Australasia, was a big investor and agreed to head the Digi-Tech operation in Australia.
Deloitte Touche Tohmatsu, the New Zealand arm of the world’s second-largest accountancy, produced a report endorsing claims that gross profits of the Australian venture could total $1.9 billion within five years, although a qualifier to the effect that they were merely checking Digi-Tech’s arithmetic was never shown to investors.
Finally, tax law guru Ian Gzell, QC, now a Supreme Court judge, said that, in his opinion, the deal would comply with Australian tax laws if it were restructured.
Each unit of $12,500, provided it was subscribed before the June 30, 1997, deadline, would generate $83,333 in tax deductions a 300 per cent return on investment for people on the top marginal tax rate, even if Digi-Tech never made a cent.
The investors say they believed they were buying into a ready-to-sell product, which was about to sign multi-million-dollar contracts with Telstra and companies such as Reuters. However, the products failed to materialise, demands were made for more money to complete R&D, and the investors cancelled the contract claiming they had been sold “vaporware”.
Reid, however, convinced the court that all he had been selling was “intellectual property rights”, and that no such representations had been made.
The judge found him convincing, but did not accept the evidence of some of the investors, particularly Urwin, of whom he said: “In my opinion, he was a most unreliable witness who did not hesitate to produce a version of events consistent with his own interests.”
He said of the investors: “They are doubtless extremely unhappy with the net effect of the rulings of the Commissioner of Taxation.
“They are extremely angry at what they now regard as unfair and unseemly conduct [by Reid].” But he stated that they were unusually sophisticated investors, and, as such, should have checked out a high-risk, tax-driven investment such as this more carefully.
All sides have lodged appeals: Morgan, Banks and McLean against the $44 million judgement, and Reid against the remaining investors who were held not liable for breaching their contract.
Back in Auckland this week, Reid said the judgement had vindicated his stance that he had not misled the investors, but that he was not celebrating.
“The reality is that this has left scars on everybody,” he said. Reid said that his once high-flying investment bank, Milloy Reid Wong, had not been able to snare more than five fee-paying jobs in the four years since the Digi-Tech scheme fell apart, and he hoped the litigation would not drag on for years longer.
He said that he had already settled out of court with more than one of the investors and others had agreed to settle, but reneged.
“When you are dealing with sensible commercial people, sensible commercial settlements can be achieved,” he said.
Reid would not comment on criminal proceedings launched against him in New Zealand following the collapse of another tax-driven scheme also involving Digi-Tech.
In this case, a total of 110 investors, said to include “the cream of the New Zealand investment community “, have lost more than $200 million and are being pursued by the tax office for another $83 million.
In March, Reid and three other people were charged with money-laundering and conspiracy to defraud the Inland Revenue.
Reid has strenuously denied the charges, and the trial is expected to begin late next year.
Pub: Sydney Morning Herald
Pu bdate: Saturday 26 October 2002
Word count: 1500
Geographic area: Australia
Drawing: By Michael FitzSimons
Caption: Life smiles of the rich and famous … Banks and Morgan are now less than amused with the Digi-Tech damages ruling.