Part 7: Our concluding comments

7.1
We have commented on Delta's decision-making process at each stage of the Luggate Park and Jacks Point investments and how the investments fared. In this Part, we give our overall findings on the investments, and then focus on lessons learned for Delta, for the holding company, for the Council, and for other local authorities and council-controlled organisations.

Delta's decision-making process for investing in Luggate Park and Jacks Point

7.2
We have set out Delta's decision-making process for the Luggate Park and Jacks Point investments in detail, to give an independent description of what happened and to provide assurance about the process followed. The investments have been of interest to the Council and residents of Dunedin since they were made, but some of the facts were not widely known or well understood. Our report should help to correct some misinformation and fill some gaps in people's knowledge.

7.3
We have identified some positive aspects and some deficiencies on the part of Delta, the holding company, and the Council. We consider that there are lessons to be learned for all involved, and for other local authorities and their council-controlled organisations. Some of our findings will contribute to the Auditor-General's broader governance study, in particular because that study is considering commercial decision-making by council-controlled trading organisations.

Our overall findings

7.4
The directors approached these investments cautiously and made careful decisions based on financial estimates and generally supported by good information. The directors were well supported by Delta staff in making their decisions. In turn, legal and tax advisors supported Delta staff. Governance and oversight arrangements were appropriate and worked well.

7.5
We found no evidence of:

• the investments being entered into for inappropriate reasons or because of personal connections with the other parties involved;
• poor management of conflicts of interest adversely affecting either investment; or
• Delta not being paid for contracting work and this being a motivation for entering the investments.

7.6
Despite these positive findings, we did identify some aspects in which Delta met neither good business practice nor the expectations we have of public entities.

7.7
Delta failed to engage appropriate expertise to consider the Luggate Park investment despite a recommendation from its tax advisor to do so. This was particularly important because this was a new area for Delta, and its most experienced director in property development, Mr Coburn, was perceived to have a conflict of interest. Delta's main manager advising the board had an acknowledged lack of expertise in the area.

7.8
Because of the money involved, it would also have been useful to seek an independent view of the price sought for the Jacks Point land and the financial projections for the project.

7.9
Other problems we noted are:

• In general, Delta focused too much on the potential benefits and not enough on what might go wrong.
• The directors of Newtons breached the Local Government Act by making decisions without a statement of intent.
• Delta paid for unconsented as well as consented land at Luggate at the start of the joint venture.
• Delta used artificial business structures to avoid public accountability.
• Delta's directors did not meet all the requirements of the Companies Act for the consultancy arrangement with Mr Coburn for project management work at Jacks Point. The directors did not resolve that the arrangement was fair to the company or disclose the details of the arrangement in the company's interests register.
• There was a lack of questioning or oversight of the investments by the holding company because of the common directors.
• Delta and the holding company did not communicate effectively with the Council about the Luggate Park investment, and the holding company did not communicate effectively with the Council when the Jacks Point investment breached the company's $10 million spending authority.
• The Council wanted more cash from the holding company subsidiaries but did not have adequate governance and oversight arrangements in place to support that demand, and had not made clear how much risk the Council was willing to take on.

Lessons to be learned

7.10
Delta directors and staff regarded both investments as learning experiences for the company. Because of the losses involved, they proved to be expensive lessons. When we asked about lessons learned or what they would do differently for the Luggate Park joint venture, several directors and staff said that they would focus more on termination arrangements or an "exit strategy" to protect their position if the project did not deliver the expected benefits.

7.11
Delta identified this as a risk early on, but we did not see any detailed consideration of it apart from some advice on the tax position of the joint venture parties if the venture lost money.

7.12
One director said that, with hindsight, he would have held out for more "downside safeguards", but noted that when the board considered the Luggate Park proposal the benefits to each side looked "fairly even". He was clear that the main reason for both investments was to get work for Delta's workforce in Central Otago.

7.13
When the expected tax credit is taken into account, Delta's loss from the Luggate Park joint venture was about $4.4 million. Several of those we talked to thought the decision was reasonable at the time, but was affected by the global financial crisis and its unforeseen effect on the property market. However, Mr Polson, the former chairman of the joint venture subcommittee and Delta, told us that, in hindsight, he thinks the Luggate Park investment was a mistake.

7.14
We saw no consideration by Delta's staff or directors about whether Delta had enough property development expertise to enter the Luggate Park joint venture. Because of Mr Coburn's declared conflict of interest, and managers' acknowledged lack of experience, it would have been prudent to consider getting advice on the business case for the proposal and the property market from someone with property development expertise.

7.15
Having a strategy to grow a business means taking some risks, but when entering a new area it would have been better to get independent scrutiny of the risks.

7.16
The Luggate Park joint venture had complex legal and funding arrangements that were challenging for Delta's first venture of this nature. The complexity, and managing the joint venture relationship, added to Delta's costs in terms of management time and legal and tax advice. However, despite the parties' best efforts, the investment turned out to be a bad one.

7.17
Delta had more control at Jacks Point. It was a more straightforward arrangement than Luggate Park, and the loss will be less. Although Delta has not made the profits it expected, there is less scope for lessons learned there.

Communication

7.18
Good communication between council-controlled organisations and their parent councils is fundamental to good governance and effective relationships of trust between councillors and the directors of council-controlled organisations.

7.19
We did not see any evidence of any direct communication with the Council about Luggate Park at the time of the investment in 2007, although Delta's efforts to expand into Central Otago as part of its growth strategy would have been known to the Council from 2006 or earlier. Delta was sensitive about its Luggate Park investment at the time and was keen to maintain a low profile about it. However, it would have been better for the holding company to have let the Council know that one of its subsidiaries was departing from core business and was getting into a riskier venture. Because of their demands for extra dividends from the holding company group, it would have been useful for councillors to understand this.

7.20
There was more communication for the Jacks Point investment in 2009. This was higher value and nearer the holding company's spending authority of $10 million, so there was more reason to tell the Council about it. However, the Council should also have been told when it became clear that the $10 million threshold would be breached.

7.21
The Council's approval was not required for the Luggate Park or Jacks Point investments when they were made. However, the holding company's policy of telling the Council about certain investments below the threshold for the Council's approval was sensible. A "no surprises" approach is a significant part of good relationships between parent and subsidiary organisations. It would clearly be preferable for a councillor to learn about the investments from Delta or the holding company than from the media.

7.22
The arrangements between the Council and the holding company were effective in keeping a group of senior staff, the Mayor, and another councillor informed, but the system relied on that small group deciding the appropriate information to share with the wider Council. We do not know to what extent they did this. The Larsen review drew attention to the need for better communication practices within the Council group.

7.23
In the report, Mr Larsen noted that:

• important information was often held by a few people and not shared appropriately;
• communication within the Council and with its investment companies needed to improve, with formal reporting structures between the holding company and the subsidiary companies, and between the holding company and the Council;
• part of the blame for communication problems lay with councillors because of their poor attendance at important meetings about holding company matters; and
• councillors needed to show more trust and capability in handling confidential information.

7.24
We consider that the communication weaknesses that Mr Larsen identified in his review were present to some extent during the Luggate Park and Jacks Point investments. However, the Council and the holding company have since taken steps to improve these matters.

Effect of the loss on the group of companies and ratepayers

7.25
Adding the Luggate Park loss and the projected Jacks Point loss together gives an overall loss of about $6.4 million. This does not include all costs incurred and will increase by up to $2.3 million if the expected tax credits are not realised.

7.26
Delta has continued to increase its turnover and assets in the period of the investments and has managed the loss within its overall operations. Delta has continued to pay dividends to the holding company over the period of the investments, but would have been able to pay more had the Luggate and Jacks Point investments been successful. In essence, the net worth of the Council has decreased by about $6.4 million because of the Luggate Park and Jacks Point investments. The loss has affected Delta's overall operations and reputation.

The Council has improved governance structures

7.27
The Larsen review identified problems with how the Council governed and managed the organisations it controls. We are satisfied that the Council is taking appropriate steps to address those problems. Therefore, we have not made any specific recommendations for the Council, the holding company, or Delta.

Lessons for councils and council-controlled organisations

7.28
When we agreed to carry out this inquiry, we expected that there would be lessons learned for local government as a whole. We finish this report by commenting on more general lessons for the Council and for local government about risks and confidentiality.

Being clear about risk

7.29
Delta made the investments at a time that the Council required more dividends from the holding company group. Had the investments succeeded, they could have helped to meet that requirement when profits were realised.

7.30
We consider that the Council bears some responsibility for the investments. The governance regime it had in place failed to provide any guidance or oversight to the holding company or Delta for the investments, and the Council had not specified its risk appetite for the activities of its trading organisations. Its main focus at the time seems to have been on how much money it could get from its trading organisations and not so much on what they were doing.

7.31
As governors of a public entity, Delta's directors were responsible for prudent stewardship of Delta's assets and funds but were also trying to expand the business to generate more profits for the shareholder. The inevitable tension between careful stewardship and shareholder requirements for more money was not helped by the absence of guidance from the Council or the holding company on risk.

7.32
Local authorities with commercial entities should actively consider their risk appetite from time to time, and be explicit about this with those entities. The annual statement of intent process should provide a basis for those discussions. If a local authority gives primary responsibility for governance of council-controlled organisations and other commercial entities to a holding company, the holding company should seek the council's agreement to its approach to managing risks.

Confidentiality

7.33
For council-controlled trading organisations, there can be a tension between open communication and commercial sensitivity. There will often be a good reason for a council-controlled organisation to protect or withhold information during commercial negotiations,⁹⁰ including when the council-controlled organisation considers that there is a risk of leaking confidential information that might affect those negotiations.

7.34
However, when decisions have been made, confidentiality considerations should become less important, and council-controlled organisations need to decide then how best to communicate with their shareholding councils. Private sector entities dealing with council-controlled organisations should be aware of this, and that the situation is more complex when dealing with a public entity.

7.35
We will be exploring governance and communication matters between council-controlled organisations and councils in more detail in the study mentioned earlier. In the meantime, we trust that this report will provide some useful guidance for all other local authorities – especially those with council-controlled trading organisations.

90: Under the Local Government Official Information and Meetings Act 1987.