Articles : Scams and Scoundrels

Ben, the skeleton man in the rocking chair, surveyed proceedings as his skeleton dog lay at his feet, a skeleton cat chased a skeleton rat down its hole in the wainscot, and a skeleton canary sat glued to the perch of its cage.

All in all, the Skeleton Room of Sydney's Australian Museum was the ideal setting for Horwath & Horwath, one of the world's largest accounting firms, to launch its new fraud deterrence and investigation service a crack team of accountants and former police dedicated to protecting corporate coffers from criminals and con men.

As the 80-odd guests sipped chardonnay and nibbled on canapes, Horwath chairman Claude Jugmans declared that fraud was costing Australian business about $3.5 billion a year. With police and the Australian Securities and Investments Commission overwhelmed and understaffed, Horwath was looking for a place in the front line of the fight against white-collar crime.

That launch last month of Horwath as an anti-fraud specialist its biggest assignment so far is the international hunt for $130 million missing from Karl Suleman's collapsed Froggy.com investment scheme would have been greeted with a wry smile by a group of 35 Australian investors, including accountants, prominent businesspeople and other professionals.

On Monday they will front up to the NSW Supreme Court for a marathon six-week trial in which the role of Horwath and other heavyweight corporate advisers in the promotion of one of the most disastrous schemes of the dot com boom a "black box" developed by a tiny New Zealand company called Digi-Tech will come under intense scrutiny.

The scheme had rolled-gold credentials. A Horwath subsidiary pitched it to the firm's clients. The world's second-largest accounting firm, Deloitte Touche Tohmatsu, signed projections stating that the scheme could generate windfall profits of hundreds of millions of dollars. One of Australia's most eminent tax experts, Ian Gzell, QC, said that in his opinion the highly lucrative tax advantages complied with the law.

But within 30 months it had all collapsed in tears and recriminations.

Not a single black box was ever sold in Australia and investors lost the lot more than $3 million. The tax office disagrees with Gzell who is now a Supreme Court judge and is trying to claw back as much as three times this amount in disallowed deductions.

And now the Australian investors and Digi-Tech are suing each other. The investors claim they were misled; the New Zealand promoters, principally Auckland merchant banker John Reid, say investors defaulted on their contract and should cough up the balance owing, $NZ75.6 million ($62 million).

On top of everything else, another scheme involving Digi-Tech in NZ has collapsed, leaving 110 investors said to include "the cream of the local investment community" facing a tax bill of $100 million. In March, the New Zealand Serious Fraud Office charged Reid and three other businesspeople with money laundering and conspiracy to defraud.

You would think a man like Chris Kelliher would be the last person to fall for what Digi-Tech's Australian manager would later describe as "a classic piece of vapourware". Kelliher, a 45-year-old New Zealander, had been the long-time managing director of Microsoft in Australasia, an executive in the world's largest company and its greatest digital success story.

It was autumn 1997 and Kelliher was leaving Microsoft to go into business for himself.

"I wanted to get involved in start-ups, and I wanted to be my own boss," he says. The phone call, from an accountant/friend named Gary Urwin, came to the right man at the right time.

Urwin, a 52-year-old fellow New Zealander, is a former partner at Horwath, specialising in putting together business financing deals. By 1995 he was managing director of a company called Horwath Corporate Pty Ltd, which was majority owned by 13 of Horwath's NSW partners, and whose three other directors were a Horwath partner, the firm's chief executive and a former partner turned adviser.

The name Horwath added a credible brand to Urwin's pitch, says Kelliher. The firm is, after all, the local arm of one of the world's top 10 accountancy firms, with branches across Australia and in 90 other countries. In NSW alone, Horwath has 28 directors, 220 staff and turnover of $30 million a year.

Its Web site proclaims: "Horwath [is] dedicated to one objective the success of our clients. Our diligent approach reassures our clients [that] they will always receive the high level of service and advice they should expect ... we are proud of our reputation."

The proposition Urwin put to Kelliher was investing in a licence to the Australian rights to a piece of high-tech equipment called a terminal adaptor in layman's terms, a $400 gadget to give a computer high-speed Internet access using existing phone

lines (ISDN).

The technology had been developed by a small, unknown Wellington company called Digi-Tech, and Horwath had been appointed "to assist in establishing operations in Australia and procure joint investment partners". Their fee was to be 3.1 per cent of the money invested more than $2 million.

In a confidential "information memorandum" sent to potential investors, including clients of the firm, Horwath said the gadget represented "state-of-the-art tools and technology", and that it was "leading-edge software [that] would enable Digi-Tech to benefit from the explosive growth expected in the tele and data communications industry throughout the '90s and into the next century".

Kelliher was well aware from his time at Microsoft that "the Internet was exploding and there was going to be huge demand for high-speed access, particularly ISDN".

He saw Digi-Tech as "an opportunity to get a stake in the ground" and did not dismiss extravagant claims about its potential: "It could have been another Netcom or a Sirius with a 60 or 70 per cent market share."

Kelliher said that as a reality check he visited Digi-Tech's premises in New Zealand: "It was only a two-hour smell test, but they seemed to have good people, and there were products on the bench with lights flashing and so on. I really never suspected the thing did not exist [as it was marketed to us]."

Adding credibility to the investment pitch was a report by the NZ branch of Deloittes, which had been commissioned by Digi-Tech. The Horwath memorandum cited that report to support predictions of gross profits of $267 million over five years in the Australian business marketplace, with "total potential gross profits increasing to $1.94 billion should Telstra extend ISDN to private homes".

Investors say they were told lucrative deals with Telstra and Reuters were soon to be signed. In fact, Kelliher says Reid told him specifically that Telstra would order 15,000 of the gadgets a deal worth around $6million within a fortnight. Reid denies this.

The icing on the cake was the advice from tax-law guru Gzell circulated to investors that the juicy tax-minimisation strategy which Horwath was promoting would comply with Australian tax laws. According to court documents, the deal was structured so that the first payment of $12,500, which was due on the last day of the 1997 financial year, would carry a tax deduction of $83,333 effectively a return of 333 per cent for a one-day investment.

"I had a million things on my mind," says Kelliher. "Deloittes [and Horwath] ... are very conservative, very careful. When I saw their name on the study it absolutely impressed me. They did a sanity check on the numbers and a sanity check on the thinking. At the end of the day it was their seal on it ..."

Kelliher says he committed himself to investing $300,000 a year for the five-year life of the scheme $1.5 million. And his decision encouraged other investors to jump on board.

"If it was good enough for the boss of Microsoft, it's good enough for me," said one. The bandwagon had begun to roll.

The list of investors, many of whom are now both plaintiffs and cross-defendants in the Supreme Court litigation, contains many names well known in the Sydney investment community: Andrew Banks and Geoff Morgan, founders of the Morgan and Banks recruitment agency; accountant and investor Graham Brand; Ian McLean, electrical engineer and boss of McLean Tecnic; and Robert Chambers, a Woollahra investor.

All of them were experienced in business "sophisticated investors", as Horwath describes them. But none of them knew much about digital technology, and no-one could predict the dot com crash which, within three years, would dynamite tens of billions of dollars of investors' money, blowing away 80 per cent of the value of New York's high-tech Nasdaq stock index almost overnight.

Says Chambers: "The market was pretty pumped up about black boxes and gizmos and dot coms. I'm not a technical person ... you do rely on professional advice [and] they were all relatively blue chip organisations you could rely on. [If this] little black box had gone where the Deloittes valuation suggested, I'd be living in the Bahamas now on a 100-foot yacht."

The investors paid the first instalment of the $72.5 million price that Deloittes had put on the Australian rights to the Digi-Tech black box on the last day of the 1996-97 financial year and sat back to wait for the promised profits to roll in.

However, within a few months it became apparent it was going to take a wee bit longer than expected to reap that $2 billion windfall. First the Telstra deal fell through; then came unexpected demands from NZ for more money to complete the research and development of the gadget.

The investors are adamant they believed they were investing in a ready-to-market product. Chambers claims that Urwin told him "this is not an R&D exercise the software has been developed".

However, Reid has a very different take on it."We sold them intellectual property rights," he said in the first interview since his arrest. "That's not a product. At the very worst, [in] layman's terms it can be an invention. It's not a [market-ready] product that's ready to be sold to every Tom, Dick and Harry."

The Australians handed over another $800,000 before they finally baulked at the apparent lack of progress from NZ in developing the all-important software to support the Digi-Tech black box. Eventually they were told that not only were there no contracts, the terminal adaptor was "only 20 per cent functional" and did not even meet Australian technical protocols.

As the scheme began to fall to bits in early 1999, Robert Bridger, an Optus high-flyer brought in to be chief executive of the Australian Digi-Tech investors' company, Digi-Tech Software Pty Ltd, reported bluntly to the board: "Competing in the generic terminal adaptor market would not be viable. This market was highly competitive and dominated by a number of well-established competitors."

Says Bridger: "We never [even] got to the stage where there was a finished product we could evaluate. It was really the emperor's new clothes. They [the investors] had been sold something which didn't exist [as a ready-to-market product]. It was a classic case of vapourware."

In March 1999, pre-empting any action by the Australian investors who were by now more than $3 million down the drain, Reid terminated the agreement, claiming that the Australians had defaulted by failing to provide proper audited accounts a claim the investors dispute. When they sued him, Reid promptly countersued for the outstanding $62 million.

And those highly paid advisers began to distance themselves.

Horwath's partners had by now sold out of Horwath Corporate to Urwin, chairman Jugmans claiming that "we were not happy with the direction he [Urwin] was taking the company with this aggressive tax scheme".

Jugmans later emailed, retracting his use of the word "aggressive", and saying that Horwath and Urwin had parted company "because we were unable to agree ... about the future direction of Horwath Corporate and the expansion of its consultancy activities".

He was unable to clarify just why it took from June 1997 until March 1999 for Horwath to identify Digi-Tech as a tax-driven investment, other than to strongly deny that the firm baled out when the scheme began to look shaky.

As for taking responsibility for the disaster, Jugmans says: "Horwath actually doesn't take responsibility for that, because [that] information memorandum was prepared for sophisticated investors ... able to invest more than $500,000. [They were] told right up front that they must make their own decisions on this, and they must conduct their own due diligence. The print wasn't fine, believe me."

Equally, Deloitte Touche Tohmatsu takes no responsibility for that $2 billion profit projection the company says it was relying on information provided by Reid and its only role was: "We checked the arithmetical accuracy of the projections and have found no arithmetical errors."

The firm's NZ chairman, John Hagan, was prepared to agree that Deloittes had lent the Digi-Tech pitch credibility. But its report "says quite clearly that ... `in no way do we guarantee or otherwise warrant the achievability of the forecast. Forecasts are inherently uncertain ... they are based on assumptions, many of which are beyond the control of Digi-Tech and their management."

Justice Gzell, as he is now, did not respond to an invitation by the Herald to explain his role in the affair. No doubt he would say that he may yet be proved right if the investors who relied on his advice decide to fight the tax office's assessment in court and, in any case, what more can any expert be expected to do than give his honest opinion?

Urwin, the man who imported the Digi-Tech idea from New Zealand and who devised the tax scheme, is now portraying himself as one of Reid's victims, though for reasons he would not explain, he is not a party to the current litigation. He says it is "totally erroneous" to suggest (as everyone else associated with the scheme does) that the black box did not work.

Question: Everyone lost all the money they put in now what responsibility do you take for that, being the man who promoted it?

Urwin: "These are clearly matters before the court."