The report weÆve all been waiting for

In the March issue of FinanceAsia magazine we once again called for the publication of the report into the demise of Peregrine. Finally, the Hong Kong government has published it.

A long-awaited report into the rise and fall of Peregrine Investment Holdings, the forerunner of BNP Prime Peregrine, has finally been released. Its contents, however, will disappoint those who had expected a hard-hitting expose of financial finagling at its worst.

The report, produced by an independent investigator at the behest of Hong Kong's financial secretary, has been under wraps for more than a year pending the result of a police and Department of Justice investigation into Peregrine's collapse.

Last month, FinanceAsia called for the release of the report, and speculated that it would likely contain embarrassing information about some of Hong Kong's leading financiers.

As it turns out, the report, authored by Richard Farrant, former chief operating officer of Britain's Financial Services Authority, states that investigators found no evidence of fraud or dishonesty by any of Peregrine's directors, managers or advisers. What failings they did find were “failures of performance rather than intention”.

Far from being the flaming indictment many had anticipated, Farrant concluded that five former Peregrine directors – Alan Mercer, John Lee, Peter Wong, Andre Lee and Philip Tose – were guilty, simply, of conduct that "fell below the standard of competence which should have been shown, and who thereby breached their duties of skill, care and diligence." He recommended that the Financial Secretary and Official Receiver apply to the court to have four of the directors (not Mercer) disqualified from ever managing a company again.

The report is unlikely to be welcomed by former Peregrine shareholders such as Cheeroll Ltd, which is suing Peregrine's directors for “negligent misrepresentation”. The company claims it lost $27 million after it decided not to dispose of its Peregrine shares because of Peregrine's upbeat comments and its publication, shortly before its collapse, of a statement in the South China Morning Post saying that “rumours of losses by Peregrine running into hundreds of millions of US dollars and of Peregrine's financial demise are completely false.”

Farrant's report addresses this issue only in passing, and then makes clear he thinks the statements were made without malice: “It is necessary to separate what [the directors] thought was the financial position of the companies from what I believe was a more realistic judgment of their positions. My investigations have not unearthed evidence that the directors knowingly failed to disclose facts to shareholders they knew to be true.”

Shareholders disagree, and they are receiving some support in court. Earlier this year, appeals court Justice Anthony Rogers ruled that it was “clearly arguable” that Peregrine's directors should be held individually responsible for the company's public denial of losses. The directors had tried to argue that the statements were made on behalf of the company, not any single individual.

Whether or not shareholders win their civil case, the directors are in the clear as far as the government or the Hong Kong police are concerned; a police spokeswoman says the report was finally released once a criminal investigation failed to uncover evidence of wrongdoing.

Criminal no, but certainly careless. Management's “attention to risk mitigation was very sloppy,” Farrant states. “Its intentions were often good, but were sometimes not translated into practical benefit through inattention to essential detail.” In other cases, Farrant says, management “did not consider how its risk might be mitigated if the unexpected happened, and probably missed opportunities to contain its risk. Overall, it did not behave in a credit-risk conscious manner.”

Peregrine and its subsidiary, Peregrine Fixed Income Limited (PFIL), collapsed in January 1998 under $400 million of debt following a series of failed investments in Burma, Vietnam and Bangladesh and a bad $265 million loan to PT Steady Safe, an Indonesian taxi company with links to the Suharto family. The plunge of the rupiah during the Asian financial crisis made it impossible to recoup the loan, which represented a quarter to a third of Peregrine's capital.

“I believe Steady Safe was the straw that ultimately broke the camel's back,” Farrant concludes.

While conceding that Asia's financial crisis contributed to Peregrine's collapse, Farrant maintains that prudent management could have saved the company. He particularly criticizes Peregrine for exposing itself so heavily to Steady Safe and another Indonesian company, Sinar Mas/APP.

“In my view, the Steady Safe commitment was a fundamental mistake, going far beyond a simple error of business judgment,” Farrant says. “Too many of Peregrine's eggs were in one basket. The Group would not have survived as a business if these two exposures went seriously wrong, even if there had been no Asian market crisis.”

Peregrine began dealing with Steady Safe in October 1996. In April 1997, its president suggested to Peregrine that it finance a merger with Cita Marga Nusaphala. Peregrine planned to issue three tranches of debt, worth about $350 million, with maturities of up to five years.

Until the debt could be arranged, Peregrine agreed to make temporary loans, backed by short-term promissory notes it hoped to sell into the market. The transaction committed Peregrine to supply funds over several months, but gave no chance for Peregrine to back out of the deal unless Steady Safe failed to meet its basic obligations.

Farrant places most of the blame for the Steady Safe debacle on PFIL managing director Andre Lee, whom he describes as “a demanding and abrasive manager, combining an acute ability to observe developments and identify strategies to exploit business opportunities with the ability to communicate them fluently, and a considerable capacity to handle detail.”

Such people, he says, "easily become arrogant and contemptuous of less articulate, quick thinking or self-confident colleagues." Andre Lee, he says, had too much power for the company's own good. Lee's close relationship with Peregrine chairman and founder Philip Tose “made him a daunting prospect to challenge”, Farrant says.

Tose's fault, Farrant claims, was in relying excessively on Lee. “That over-reliance may have unduly exposed Peregrine to Andre Lee's blind spots,” he says. “Andre Lee's influence with Philip Tose may have weakened the ability of others to extend better risk management into PFIL.”

The “blind spots” Farrant refers to stemmed from Lee's background at Lehman Brothers, a much larger and more diversified investment bank than Peregrine. Farrant maintains that Lee was unable to adjust the risk appetite of a large organization such as Lehman to a small operation like Peregrine.

Andre Lee, though, is not the only one chastised for incompetence. Philip Tose, Peter Wong and John Lee were also accused of “incompetence of a very high degree.”

Tose, Farrant argues, was guilty of failing to ensure that risk management controls over Peregrine's fixed income business were in place and operating properly. He blames Tose's lack of oversight as “at the heart of the most serious aspect of mismanagement within Peregrine.” The consequences of that lack of oversight manifested themselves most severely in the case of Steady Safe. Since Tose failed to personally restrain Andre Lee's commitment to the loan, there was no system of control at any other level of the group that could reign Lee in.

Another director to come in for criticism was Peter Wong, who was effectively the group's chief operating officer. Wong failed to establish centralized, independent risk management covering the fixed income business, Farrant reports. He also mishandled the fixed income internal audit report and wrongly described the scope of credit control in the 1996 Annual Report. Farrant claims the description was over-optimistic and inaccurate. The mis-description would have misled shareholders, Farrant says, and contributed to the delay in improving fixed income credit procedures.

Finally, Farrant criticizes John Lee, who came from Lehman Brothers to join Peregrine as group treasurer. He was responsible for the group's credit risk management, including putting in place credit risk controls ahead of the Steady Safe commitment. According to Farrant, Lee failed to put controls in place in time, and failed to alert Tose that the controls were not in place. Lee also badly handled a requirement to make provisions against bad and doubtful exposures.

In short, the report presents a picture of an informally managed group with unclear reporting lines where individual directors had a good deal of unsupervised autonomy. In such an environment, many issues that should have been dealt with fell between the cracks.

The one director who comes out of the mess unscathed is Francis Leung, who co-founded the business with Tose in 1988 and was effectively its co-chief executive. Leung headed the deal origination and corporate finance side, Tose handled sales and distribution and Peter Wong, whom Leung recruited from Citicorp, was supposed to make sure everything worked. Today Leung is group vice chairman of BNP Paribas Peregrine.

Another director who received relatively light criticism was Alan Mercer, who joined Peregrine from the Securities & Futures Commission and was in charge of legal affairs and compliance. Mercer was also not among those Farrant recommends be included in any application to the court for disqualification. He is, however, accused of incompetence for failing to sufficiently pursue and ensure completion of the company's 1997 internal audit of PFIL.

Despite Farrant's insistence that his investigation found no evidence of dishonesty, he comes, at times, within a hair of contradicting himself. In connection with Peregrine's combined exposure to Steady Safe and Sinar Mas/APP, he says the position could have caused the investment bank to collapse if the loans went sour. Yet Peregrine gave no warning of such a risk to investors.

“I do not believe the shareholders and creditors of the Group had any reason from Peregrine's Annual Reports or other public statements to expect that Peregrine's management would expose the Group to that possibility even if it was unlikely, nor do I think they would have found it acceptable,” he says.

Litigious creditors and shareholders will no doubt ask a court to examine the fine line between "negligent misrepresentation," which Cheeroll claims is an actionable offense, and the non-criminal “breach of common law duties of skill, care and diligence,” of which Farrant accuses Philip Tose, Peter Wong, John Lee, Andre Lee and Alan Mercer.

For creditors the difference is immaterial. One way or another, they lost large amounts of money. At the time of its collapse Japanese brokerage Nikko Securities held nearly Y11 billion ($93.7 million) of Peregrine bonds. Nikko had lead-managed two Peregrine bond issues in Japan, each worth Y10 billion and maturing in 2000. Peregrine defaulted on the bonds, costing Nikko's clients millions.

In Germany, Commerzbank AG is seeking to recover DM73.2 million ($34.4 million) on a currency swap it made just before Peregrine went bankrupt. Commerzbank, which has taken its complaint to court, maintains that Peregrine knew it was about to collapse and must therefore have known it couldn't return the $40.1 million due to Commerzbank under the transaction.

The whole sorry affair does little to burnish Hong Kong's image as a leading financial centre. Peregrine's standards of disclosure do not meet global financial centres’ regulatory requirements. The only good that can come of the saga is if the Peregrine Report spurs Hong Kong’s authorities to match global corporate governance best practices, rather than be content to merely be better in Asia.