By James Chessell From Financial Review

As the head of investments for New Zealand’s $NZ35 billion Accident Compensation Corporation, Nicholas Bagnall is one of the country’s highest-paid public servants. According to the ACC’s 2016 annual report, which does not disclose the remuneration of individuals, it appears he earned as much as $870,000 – almost twice as much as the prime minister.

Helping ensure that New Zealand’s only provider of accident insurance coverage has enough money to pay out claims is an important and consuming job. Yet for a few days in early March, Bagnall found himself in the Cayman Islands being cross-examined by an eminent London silk about one of the ACC’s least significant holdings.

Unlike a typical Caymans visit, which should involve “sex, sun, rum and a little shopping” as John Grisham wrote in his bestseller The Firm, Bagnall’s stay was all business.

Confined to a small, windowless room on the second floor of the Caymans’ main courthouse, he spent three days fielding questions from John Wardell, QC, over the ACC’s minority share in a small private equity group called Torchlight Fund.

The cross examination covered a range of investments associated with Torchlight, including a stake in UK utility Thames Water purchased from investment bank Macquarie and a substantial shareholding in the ASX-listed Lantern Group, which has owned a portfolio of Australian pubs including the Dolphin in Surry Hills and the Commodore in North Sydney.

Each of these are high-profile investments in their own right and have been the subject of separate legal actions. But there is no escaping the fact they are of little importance to ACC, whose stake in Torchlight is less than 1 per cent.

“Look, I think one important point of context here is that this [Torchlight] investment was $NZ2 million roughly,” Bagnall said on the stand, according to transcripts of the hearing. “I am responsible for $NZ35 billion … If I allocated my time between investments and proportioned how big they are, I would give this about 10 minutes a year.”

It is an observation that poses an obvious question. Why did one of New Zealand’s most important investors spend more than a week in a Caribbean tax haven giving evidence against a little-known private equity firm that makes almost no difference to ACC’s performance?

Any explanation for Bagnall’s curious Cayman sojourn begins and ends with one man, George Kerr, the founder and chairman of Torchlight. Kerr is the reason Bagnall – and a small minority of Torchlight investors – are asking the Grand Court of the Cayman Islands to allow them to pull out their money early. He is also their primary target: they want to remove Kerr as the manager and wind up the fund altogether.

In order to withdraw money from a private equity fund before the agreed investment period expires, an investor must convince the fund’s principals to make an exception or prove the principals have broken the rules themselves. ACC and two other disgruntled investors have duly accused Kerr of a lack of probity and engaging in unethical behaviour.

But the reclusive Kerr, who has rejected the claims, is putting up a hell of a fight. The 50-year old has not just spent millions fighting the Caymans action – attending every day of the hearing personally – but has launched a counter-suit alleging the three investors are part of a co-ordinated campaign to damage his reputation.

The great, great, grandson of FH Pyne, who founded New Zealand stock and station empire Pyne Gould Guinness, Kerr is regarded as a shrewd investor by most people who have dealt with him.

But he is also a divisive figure in establishment business circles on both sides of the Tasman. Over the years he made plenty of money, fought numerous court battles and left a trail of frustrated former competitors as well as the odd-former associate in his wake.

Among these is John Grill, the former chief executive of Sydney-based engineering group WorleyParsons, who fell out with Kerr over a $NZ37 million loan made to Torchlight five years ago.

Kerr won the first round of a legal brawl; Grill the second. The matter remains before the courts.

Kerr, who has prevailed in 31 of his 32 legal battles, is an experienced litigant. When asked when a court action should end, he has been known to say “not until we win”.

“He’s regarded by everyone – friend and foe alike – as extremely intelligent, extremely sharp, someone who can run rings around normal people by putting deals together,” says one long-term observer of Kiwi business affairs who did not want to be named.

“The question people often ask about George is, ‘did he go too far?'”

Kerr’s reluctance to talk to the media has fuelled his portrayal as a shadowy figure in the New Zealand press. A former director of several blue-chip Trans-Tasman boards likens Kerr to “a worse version” of famed Kiwi corporate raider Sir Ron Brierley.

Those close to Kerr, who declined to comment, say this characterisation of him as a rule-bending opportunist is unfair. While acknowledging his personal style can be combative, they say he his in fact a traditional activist investor with a knack for identifying cheap assets.

Kerr’s friends describe a polymath with a deep interest in value investing who has been known to present new employees with a biography of British philosopher Nobel laureate Bertrand Russell. Torchlight’s investor updates are peppered with quotes from the likes of legendary US investor Benjamin Graham, author Tom Wolfe and the late NZ businessman Howard Paterson, who once observed “there is no profit in conflict”.

Kerr can be headstrong to the point of excluding others. “You can’t play chess by committee and you can’t invest by committee,” he once told an employee. Yet he is admired by many who have worked with him.

“He’s a professional colleague and a person I’ve watched with some interest and admiration his achievements during his working life,” Darryl Harford, a former colleague at Sydney investment manager IPAC, told the Caymans court in June.

Bagnall declined to comment for this story. Nevertheless, during his testimony, he made it very clear that there was no love lost between him and Kerr.

“You would regard him at least an equal on the intellectual front, wouldn’t you,” Wardell asked.

“I’ll grant you that,” replied Bagnall, who went on to explain that there were two things that gave him confidence about an investor – their skill and their trustworthiness. “My concerns with [Kerr] are 90 per cent around the trust.”

At one point, Bagnall even called Kerr a “crook”. It was a descriptor that earned him a rebuke from the judge who urged the witness to be “neutral in our language”. It wasn’t the only time Bagnall was told off for venturing into commentary his testimony.

At another point he was asked if he would apologise to Kerr if a key allegation in his affidavit was proven to be untrue. Bagnall replied without hesitation that he would not.

Kerr’s track record suggests he is more than rapacious opportunist.

He pulled off his first big deal in 1996 by convincing New York private equity firm Sterling Grace to back an $NZ4 million acquisition of the iconic Auckland wealth management business, Spicers. Five years later the business was sold to French financial services giant AXA for $229 million. Kerr, who was 35 at the time, got a cheque for $30 million.

After serving out his non-compete period on the ski fields of Europe he chaired another investment business, Brook Asset Management, before it was sold to Macquarie.

He is also the managing director of NZX-listed company called PGC – a financial services group that grew out of the old Pyne Gould Guinness and had run into problems before Kerr arrived. During the global financial crisis he has sufficient sway among investors to lead the recapitalisation and restructure of a busted non-bank lender called Marac.

Marac was split into a “good bank”, Heartland, which become NZ’s only listed bank. The “bad bank” was personally run by Kerr and became Torchlight.

Even during this period, however, Kerr did not escape controversy. PGC came under the scrutiny of the Financial Markets Authority – New Zealand’s equivalent of ASIC – for what the regulator alleged were unlawful related-party transactions. However, the judge who presided over the case, Justice Paul Heath, ruled against the regulator.

Quick of history

The Torchlight dispute has its roots in a quirk of history that meant the ACC – and another NZ government entity called Crown Asset Management – never chose be investors in the fund. Instead, the firms inherited their stakes after the global financial crisis thanks to the failure of South Canterbury Finance.

South Canterbury was a non-bank lender to property developers that couldn’t refinance its debt during the credit crunch. Torchlight arranged a $NZ75 million loan which Kerr worked out would be covered by at least a billion dollars of property.

When South Canterbury went under in 2010, triggering a $NZ1.6 billion government bailout, Torchlight was repaid its initial investment plus interest for a return of 26 per cent. Kerr was backed by one the worlds largest hedge funds, Fortress Investment Group, which is also an investor in Torchlight.

ACC and Crown Asset Management, which was established to manage the NZ government’s interests in failed finance companies, were exposed to the collapse. Their stakes were converted to investments in Torchlight.

From the beginning, the relationship with the government entities was uncomfortable. Crown had the job of liquidating its holdings into cash, which conflicted with the 10-year lock-up period of the Torchlight fund. Kerr offered to buyback Crown’s initial investment of $NZ30 million but was turned down, according to court documents.

ACC also lobbied for liquidity. It seems likely that having a minority position in a small private equity firm didn’t fit with its broader investment mandate either.

The conflict over liquidity meant the relationship with Kerr became fractious. In early 2015, the ACC, Crown and a third investor called Aurora Funds Management, which is linked to Macquarie, launched the legal action in the Caymans, where Torchlight had recently been registered.

The investors want the court to remove Torchlight as the manager and wind up the fund, adding “there has been a total breakdown of trust and ­confidence between the general partner and/or Mr Kerr and the petitioners”.

In their claim, the investors accused Kerr of a lack of probity and engaging in unauthorised related-party transactions, failing to properly update investors, and paying himself inflated management fees totalling $25 million.

Kerr believes the majority of Torchlight’s Limited Partners, such as Fortress, Daryl Harford and UK polling guru Lord Ashcroft, are happy with the performance of the fund. He strongly denies the allegations, telling The Australian in July 2015: “All claims are without merit in Torchlight’s opinion and will be vigorously defended or ­actioned by the fund.”

A source close to Kerr points out the three disaffected parties represent a small fraction of Torchlight’s total of 45 investors and failed to gather enough support to hold a meeting to discuss removing Kerr.

The problem for frustrated private equity investors – knowns as Limited Partners – is that they cannot simply pull out their money from a fund at a moment’s notice. Like the vast majority of funds, Torchlight locked in investors for a relatively long period of time, in this case 10 years. This structure is not unusual and allows the fund to invest in challenged assets that would take time to generate decent returns.

“If Torchlight allowed investors to dictate short-term liquidity we would be forced to sell assets early and in stressed circumstances – costing Limited Partners dearly,” Kerr wrote to investors March 2015, according to one LP who did not want to named.

Torchlight has invested about $250 million in assets such as former Babcock & Brown property group RCL, Lantern and UK regional newspaper business Local World.

Court documents suggest this contrarian approach has been successful. The fund has returned over 15 per cent per annum after all fees based on an expert valuation by Duff & Phelps that was commissioned by Torchlight. Torchlight made a return of five times its original investment on Local World and a total return of more than 50 per cent from Lantern. RCL is the largest remaining asset of Torchlight and is valued at over $350 million with more than 3500 residential building sites across NZ and Australia, according to Duff & Phelps.

Kerr, who clearly feels his methods have been misrepresented over the years, went on to conclude in his note to investors: “I am often accused of ignoring wider stakeholder interests when executing transactions. That is true. I am guiltily of focussing on Torchlight’s interests. These activists are promoting their own agenda, which is contrary to their fellow Torchlight Limited Partners.”

Counter claim

Kerr spends most of his time in London nowadays. According to his friends, he enjoys being away from the scrutiny that comes with living in NZ. His UK base also allows him to focus almost entirely on the Torchlight legal battle, which he is now trying to use to turn the tables on his accusers.

Earlier this year, Kerr filed his own $NZ200 million claim against ACC, Crown and Aurora, accusing them of being involved in an unlawful conspiracy aimed at removing him as the manager of Torchlight.

His counter-claim is based on the argument that Torchlight would have made greater returns from the Lantern hotels group had it been allowed to implement its own strategy. Instead, a 2015 shareholder coup ousted Torchlight’s representatives from Lantern’s board and instituted a new plan that led to a selldown of all the company’s hotels.

Lantern said in March it had realised $206 million from the asset sales in the previous 12 months, a 34 per cent premium to book value. Kerr believes the amount could have been as much as $400 million, based on a valuation report prepared by valuation Duff & Phelps.

Crown reacted angrily to Kerr’s lawsuit, with Crown chairman Gary Traveller telling the Auckland-based National Business Review the claim was “absolutely completely outrageous”. He added the case was “entirely meritless”.

Attempts to contact Traveller through the Minister of State Owned Enterprises were unsuccessful.

Adding to the acrimonious nature of the dispute is the involvement of Greg Marshall, a former Bain trader who runs a small Kiwi investment business, Logic Funds. Marshall was part of the coup to oust Torchlight’s representatives from the Lantern’s board and has backed ACC, Crown and Aurora’s attempts to wind up Torchlight even though he is not a Limited Partner himself.

Marshall and Kerr have a long history stretching back to 2004 when Kerr was an investor in Logic. Over the years, some Logic investors have moved their money to Torchlight, which some people close to Kerr claim has motivated Marshall to wage a campaign against him. Marshall was unavailable for comment.

The success of Torchlight’s cross-claim will largely depend on evidence and testimony accumulated during the original legal action launched against Kerr.

Throughout Wardell’s cross-examination of Bagnall, Traveller, Marshall and others, it appears the QC is trying to piece together the conspiracy case. Torchlight believes the dissident LPs have deliberately underplayed the performance of the fund and engaged in what they claim is a multi-faceted campaign to unseat Kerr, including lobbying regulators and auditors, breaching confidentiality, planting hostile stories in the media and even personal intimidation.

It remains to be seen if Wardell uncovered a smoking gun but he certainly succeeded in airing a range of serious allegations against the parties that want to wind up Torchlight including the conservative government entities.

The question of whether the aggrieved Limited Partners believed that Torchlight was underperforming is critical to the cross-claim.

In an affidavit explaining why Crown wanted to wind up the fund early, Traveller said: “I am worried there will be no return to the New Zealand taxpayer.”

However, the hearings in the Caymans revealed that Crown had commissioned an independent expert’s report from accounting firm Crowe Howarth in June 2014 that estimated the assets in the fund to be worth $NZ336-386 million and raised no concerns with Torchlight’s management. This valuation is broadly similar to the Duff & Phelps report.

Asked about how Crown could claim Torchlight was loss-making when the report suggested the fund had risen in value by between 37 per cent and 57 per cent, Sharon Burleigh, Crown’s former managing director, said it was possible. It is not clear from Burleigh, who went on to question some of the assumptions relied upon by Crowe, if the report was presented to the relevant minister at the time, Bill English, who is now Prime Minister.

For his part, Traveller was grilled about his loss of faith in Kerr. “I put it to you again I haven’t seen one document where there’s any suggestion of Mr Kerr saying something to you that wasn’t open or honest and you can’t point me to any can you,” Wardell asked.

“No I can’t. I just – it’s an impression I have that we were being led along,” Traveller replied.

The court also heard allegations that executives of Crown and ACC become personally involved in the case, sometimes approaching regulators and Torchlight’s auditors with the concerns about Kerr. An internal email sent by Crown board member Steve Smith that was read out in court even refers to a conversation he had with Justice Heath, who presided over the case involving Kerr and the NZ financial regulator.

Smith, who claimed to know Justice Heath “at a personal level”, wrote that the judge did “didn’t tell me much that wasn’t in the public domain” and indicated “there was more to come through court system”.

Wardell asked Traveller about Smith’s email. “Isn’t this a gross abuse of your position as a government entity, bending the ear of the auditors, the [regulator] and even approaching a judge who is the middle of trying a case?” Traveller replied: “I don’t think so.”

For his part, Bagnall was questioned about claims in his affidavit about supposedly failed property deal involving Kerr. Appearing to rely on a conversation with former Financial Markets Authority director Campbell Stewart, Bagnall claimed people that had invested alongside Kerr on the “Omaha Beach” project had lost every cent.

Only problem was that the project was called Te Arai and investors eventually got their money back, albeit later than expected and with lower than expected interest payments.

Throughout the hearing Wardell makes the argument that the real drivers of the case against Torchlight were Marshall and another small fund manager, Millinium Asset Services, which is run out of Sydney by Thomas Wallace. Neither were Limited Partners – and therefore could not agitate directly for Torchlight to be wound up.

However, it appears they were both instrumental in enlisting the more conservative government entities – Crown and ACC – to their cause. Their goal appears to be securing the lucrative Torchlight management rights if Kerr is rolled. Some observers sympathetic to Kerr believe it is an obvious attempt to grab Torchlight’s assets on the cheap.

Regardless of their motives, Wallace and Marshall are undoubtedly an interesting choice of allies for cautious government entities.

Wallace pulled out of the case the day before trial started and failed to turn up to court. His firm is currently in a legal dispute with Macquarie, which is also the responsible entity for Aurora.

Bagnall’s opinion of Marshall does not appear to be particularly high. He describes him as “part of a whole dodgy crowd [that included Kerr] where I have to treat things that they say with a degree of suspicion”. Nevertheless, he said it was “great” when Marshall and Wallace “showed an interest in trying to improve the [Torchlight] situation” by offering to oust Kerr.

Marshall’s emotional involvement was put under the microscope during his time in the witness box. (Marshall was not available for comment).

Wardell read out a statement Kerr gave to the New Zealand police in which he claims Marshall called and texted him to say that if he “didn’t get what he wanted commercially within 14 days then something would happen to me”. According to Kerr, who has three sons and one stepdaughter, Marshall then proceeded to say one his colleagues knew “some very bad Estonian people – make sure your daughter is nowhere near you”.

Marshall said the reference to the Estonians was simply to underling the fact “that he knew that we would go as far as we needed to trace him and the assets”. He denied making a threat, saying he was trying to tell Kerr “he could not run away from the investors he had treated so horribly”.

Kerr’s then wife, Kym Bamber, also received a call from Marshall which resulted in a complaint to the NZ police. Bamber claims Marshall told her husband was “in danger and our three sons shouldn’t travel to London to join my husband”. Marshall denies the phone call was threatening.

Despite questions about the conduct of both Marshall and Wallace, they continued to be regular contact with ACC and Crown over the Torchlight dispute. This included engaging with the regulator and making an approach to Torchlight’s auditor as well as sharing documents for the upcoming case.

“I have had serious concerns about Torchlight,” Bagnall told the court. “This was a small investment I didn’t want to spend a lot of time on. When Millinium and Marshall showed an interest in trying to improve the situation, I thought ‘that’s great – I’ll run on, you know, I’ll tailcoat them. I’ll let them do the work and try to get a better outcome for investors.”

It may have seemed like the easy thing to do at the time. But as the case rolls on, Bagnall could be excused for having second thoughts.

IMAGE: George Kerr is a divisive figure on both sides of the Tasman.

For more on this story go to: http://www.afr.com/business/banking-and-finance/financial-services/george-kerrs-cayman-island-legal-fight-shines-light-on-a-reclusive-figure-20170907-gyd6x0#ixzz4sCcOwv8w