B&B auditors missed dividend source

Neither Ernst & Young partner Mark O'Sullivan, who was in charge of the audit, nor any member of his team, realised that B&B was distributing money to its shareholders that it had not earned in the half and full-year periods in which the distributions were made.

Under questioning by Peter Wood, counsel for B&B's liquidators, Deloitte, Mr O'Sullivan accepted the dividends were not being paid out of profits as stipulated by the Corporations Act and that the distributions constituted an "unauthorised reduction" in the company's capital.

B&B was able to cover the dividends that it handed to shareholders between 2004 and 2008 only thanks to the share of the wider group's profits made by its main operating arm, the privately run Babcock & Brown International Pty Ltd (BIPL).

The two companies B&B was the parent through its majority shareholding in BIPL shared the same financial year (to December 31), the same directors and virtually the same management team.

B&B acted as a holding company but all its operating assets were housed in BIPL, from which the group earned its profits. Apart from retained earnings, B&B's own profits were tiny compared with the actual huge sums it declared for the 2005, 2006 and 2007 financial years.

That structure had been set up before B&B floated on the ASX six years ago and was approved by the listing authorities, including the Australian Securities and Investments Commission.

But a consequence of that structure was that B&B could not declare what it would hand back to shareholders until BIPL had decided the sum it would pay as a dividend. That was initially 40-50 per cent of profits it earned and later 30 per cent of the total.

Mr O'Sullivan told the court that it "never occurred" to him to question the method under which B&B received the money. That was despite the fact he had attended several of the special meetings of the two-man BIPL and B&B board committees that had agreed to the dividend payments and signed off the accounts.

He also confirmed that members of his audit team had seen and checked the trail of documents through which the distributions were recommended and then approved.

But they too had not realised the significance of what was happening or referred it to Mr O'Sullivan.

The hearing continues today in Sydney.