Company History

In 1968, Ray Williams and Michael Payne formed CE Health International. As a result of a merger in 1995 between CE Heath and the Swiss based insurer Winterthur Insurance Company, the company HIH Winterthur was established. In 1998 the name of the company was changed again, this time to HIH Insurance Limited. This last name change had been brought about by the withdrawal of Winterthur from the operations. Winterthur had become increasingly nervous about the operations of the company and consequently had sold its shares. HIH continued to expand its insurance ventures with the purchase of FAI Insurance, World Marine and General Insurance and Cotesworth, which had direct links with Lloyd's Insurance. However, FAI had been purchased in 1998 at a premium from Rodney Adler (Non-Executive Director of HIH) and without either board consultation or the completion of a due diligence report. Accordingly, in September 2000, HIH was forced to write off its investment in FAI for $400 million.

The insurance arenas entered into by HIH included the high-risk areas of marine, aviation, natural disasters and film financing insurance, in addition to the highly competitive workers' compensation insurance market in California. HIH experienced considerable losses due to its exposure to these high-risk areas. Such losses included:

• $100 million from film losses
• Considerable damages claims from the major hailstorm in Sydney (from the takeover of FAI)
• Large losses from the 1999 Florida typhoon
• Extensive workers' compensation claims as a result of the industry deregulation in California. The Californian courts had altered the award scale for benefits, which resulted in a dramatic increase in the cost of claims to insurance companies such as HIH.

Background

Mr Williams was sentenced after pleading guilty on 15 December 2004 to three criminal charges:

• that he was reckless and failed to properly exercise his powers and discharge his duties for a proper purpose as a director of HIH Insurance Limited when, on 19 October 2000, he signed a letter that was misleading
• that he authorised the issue of a prospectus by HIH on 26 October 1998 that contained a material omission
• that he made or authorised a statement in the 1998-99 Annual Report, which he knew to be misleading, that overstated the operating profit before abnormal items and income tax by $92.4 million.

ASIC's HIH investigation has already led to criminal prosecutions of 9 former senior executives, including directors, of FAI, HIH and associated entities on 31 Corporations and Crimes Act charges. These criminal prosecutions include:

• On 23 December 2003, Mr William Howard, a former General Manager of HIH Insurance Limited, was sentenced to three years' imprisonment, fully suspended on the basis of on-going assistance to the HIH investigation. Mr Howard had pleaded guilty to two counts of criminal misconduct, namely that he dishonestly received from Mr Brad Cooper approximately $124,000 in return for facilitating payments by HIH directly or indirectly in favour of Mr Cooper. Mr Howard also admitted facilitating a payment of $737,000 to a company associated with Mr Cooper knowing that the payment obligation had already been discharged.

• On 22 October 2004, Mr Bradley Cooper was committed for trial on six charges of corruptly giving a cash benefit to influence an agent of HIH Insurance Limited, namely Mr Howard, and seven charges of publishing a false or misleading statement with intent to obtain financial advantage. The trial is set down to commence on 1 August 2005.

• On 20 April 2004, Mr Charles Abbott, the former Deputy Chairman of HIH Insurance Limited, was charged with dishonestly using his position as a company director. The committal hearing is set down to commence on 30 May 2005.

• On 19 July 2004, Mr Timothy Maxwell Mainprize was committed for trial on charges of failing to act honestly in the exercise of his powers and discharge of his duties as an officer of FAI General Insurance Company Limited. He was also committed on one count of providing false and misleading information. His trial is set down to commence on 5 September 2005.

• On 19 July 2004, Mr Daniel Wilkie was committed for trial on charges of failing to act honestly in the exercise of his powers and discharge of his duties as an officer of FAI General Insurance Company Limited. He was also committed on one count of providing false and misleading information. His trial is set down to commence on 5 September 2005.

• On 19 July 2004, Mr Stephen Burroughs was committed for trial on charges of failing to act honestly in the exercise of his powers and discharge of his duties as an officer of FAI General Insurance Company Limited.

• On 16 February 2005, Mr Rodney Adler pleaded guilty to four charges, two of disseminating false information that was likely to induce people to buy HIH shares, one of making and publishing false statements and one of being intentionally dishonest and failing to discharge his duties in good faith. Mr Adler was sentenced on 14 April 2005 to four-and-half years' jail with a non- parole period of two-and-a-half years.

• On 24 March 2005 Mr Terry Cassidy pleaded guilty to two charges of recklessly making false statements and one charge of recklessly failing to discharge his duties as a director for a proper purpose. There will be a sentencing hearing commencing on 19 April 2005.

Question 1- Legal Liability

Sydney solicitor Bruce Dennis will be coordinating a class action for some 600 HIH shareholders against the auditors - Andersen's (as the firm is now known). In addition, HIH's liquidator, Tony McGrath of KPMG is also likely to seek to recover funds for HIH creditors.

a) Identify and discuss in detail THREE (3) relevant legal concepts which are related to the collapse of HIH. In your answer, explain why these principles are relevant.

b) What conditions need to exist for a negligence action to be upheld?.

Question 2 - Ethics

The HIH board of directors includes three former partners of the audit firm Arthur Andersen. In the past decade, Andersen's has earned more than $8 million from auditing HIH books and $7 million for other services.

a) Why would HIH have wanted to hire prior members of its external audit team?

b) What are the advantages of having the same firm provide both the auditing and consulting services?

c) Indicate whether these circumstances represent a violation of ethical standards and give reasons for your answer.

d) Outline the primary recommendations for audit reform proposed by the introduction of CLERP 9. What impacts do you feel these changes will have on the practice of auditing?

Attachment:- HA 3032 A1.pdf