GONE WITH THE WAND

THE opening questions appeared innocuous enough. You were the managing director of Babcock & Brown? Yes.

Between 2004 and 2007, you were variously described in Babcock & Brown annual reports as its managing director, chief executive officer and group chief executive? Yes.

But when former Babcock & Brown chief Phil Green fronted a liquidator's hearing in the Federal Court into last year's $3 billion corporate collapse, it took just minutes to strip away appearances and reveal the private reality of what had been a very public face.

Question: Was there ever a formal resolution to appoint you MD? Answer: I don't recall.

Were you ever employed by Babcock & Brown Ltd? My employment contract was

with Babcock & Brown International.

Was it a written contract? I believe so. Now that you mention it, I may have been employed by Babcock & Brown Australia. But I was group CEO.

Over two days, Green would effectively admit that very little about Babcock & Brown was as simple as it appeared.

Peter Wood, counsel for liquidator Deloitte, put to Phil Green that Babcock (B&B) was nothing more than a "filter" for a subsidiary, a private vehicle called Babcock & Brown International Pty Ltd (BIPL).

Green agreed that appeared to be the legal position.

B&B was a holding company, a conduit used to raise money from the public markets to fund the activities of a privately held company that housed the group's assets.

It raised $550 million in a public float, then gave the money to the private company BIPL to invest.

It raised millions more in a notes issue, then gave it to BIPL.

It received dividends from BIPL to pay its shareholders.

Wasn't this structure unusual? I don't believe so.

Why was it done like that? For the capital gains tax purposes of major international investors.

From a $5-per-share float in 2005 dubbed by Macquarie Equities as the "IPO of the century", B&B's share price hit $34 amid billion-dollar infrastructure deals loaded with debt.

Its stellar float delivered millions in advisory fees to broker UBS and its rise led to comparisons with Australia's largest investment bank, Macquarie Group. But as the ripples of the global financial crisis spread in late 2007, a slow train wreck began to unfold that is only now being fully detailed in public.

At the heart of the structure sat Green: B&B managing director, director of the private company pulling the strings and a member of the two-man subcommittee that decided how much in dividends BIPL should pay to B&B, of which Green was one of the largest shareholders. B&B's collapse led to an astonishing loss of face for Green removal from the board of the prestigious Sydney Cricket Ground Trust and resentment from within the wealthy eastern suburbs community over lost money.

And now, as BusinessDay can reveal, watching Green's evidence from the gallery were officials from litigation funder IMF Australia, which is considering a Babcock & Brown class action.

THAT exchange over Green's job status speaks volumes about the structure on which the Babcock & Brown empire was built.

From hours of court testimony emerges a fascinating picture of corporate life within a major Australian company where the most important board decisions were effectively the province of the chief financial officer and were delegated to a two-man special committee that approved matters such as dividend payments and year-end accounts in meetings lasting little more than 10 minutes.

Here was a business with an executive chairman based in California and with a large chunk of operations in the US and Europe being run out of Sydney by a chief executive whose personality dominated those around him.

Phil Green embodied B&B, publicly and privately. Inside B&B, the man who shunned ties for casual wear could do no wrong. He was one of two directors, the other being ASX Ltd director and former senior partner at Price WaterhouseCoopers Michael Sharpe, who sat on that "special-purpose" board committee that took the major decisions.

In fact, it was two committees in one a structure that mirrored how the Babcock group had been set up and operated. Like their fellow board directors at B&B, Green and Sharpe were also on the BIPL board.

But in the witness box over two days, dressed in dark suit and tie, Green rejected repeated suggestions from the liquidator's counsel that he had any conflict of interest.

Green and Sharpe were also the two men on a special-purpose committee of the private company that decided dividend policy and signed off on the company's accounts.

Every six months they would act on the half-year finance report from chief financial officer Michael Larkin and recommend what dividends be paid. Normally, that would be done at the behest of the board of a publicly listed company. But in the case of Babcock, the power lay in BIPL because it earned the money and B&B was just the recipient of whatever the privately run business chose to hand over.

As revealed in court this week, BIPL and its subcommittee would decide the profit figure, declare its own dividend and then hand B&B's share to the listed holding company.

Wood picked away at Green until the true picture emerged of how Babcock determined its dividends. The listed company would close its books on the half-year and full year.

Some weeks later, the private vehicle would declare a dividend to pay to the public vehicle. The public vehicle would then declare a dividend at its results. But, crucially, it was from money that had not been booked in the relevant period.

As first Green, and then a severely embarrassed Ernst & Young auditing partner, Mark O'Sullivan, acknowledged to the court, the Corporations Act required dividends to be paid from profit.

But that small issue seems to have escaped the boys at B&B and BIPL and its auditors, who failed to pick up on what had become established practice.

As for the outside world, investors, regulators, advisers and many analysts were none the wiser since what they were presented with was the public face of the Babcock empire, albeit one that mirrored the private one.

And to all intents and purpose they were one and the same. Then it all started to unravel.

IT WAS late 2007, and tensions were growing in the Babcock & Brown camp. From his California bunker, chairman Jim Babcock fired off an email to Green.

The long-term partnership between Green and Babcock, central to the business, was fracturing.

Babcock was becoming more cautious and conservative, in the threat of a global recession, suggesting there were better, smarter uses of the company's money.

Green, who had only months earlier outbid Macquarie for the assets of Perth energy company Alinta, had also seen a preliminary proposal to buy collapsed Allco Finance Group, allowing it a face-saving exit.

He didn't share Green's concerns that the global situation was "scary".

Babcock also emailed deputy chairman Elizabeth Nosworthy and Green, expressing concerns about Green's links to margin-lending broking specialist Tricom, although Green told the court he could not recall Nosworthy raising it as an issue with him.

Outside, it remained business as usual.

In profit guidance in February 2008, Babcock & Brown assured the market that its "conservative low-risk" business model would serve it well in challenging times. It forecast a $750 million full-year profit.

The liquidator's hearings this week have provided the first opportunity to compare what was happening inside the company with what the market was being

told.

In the background, tension and discontent was growing.

While Green remained optimistic that the Babcock group would weather the growing financial storm engulfing the world, the signs were already there that the good times for B&B were over.

Jim Babcock's warning in December 2007 of a global recession was to prove somewhat prophetic.

The tight squeeze and then disappearance of cheap credit cut off a large proportion of B&B's lifeblood, leaving it without finance to acquire assets and, more importantly, depriving would-be buyers of its assets cash to fund their purchases.

Another consequence was that the price of assets started to crash good news if you had money to buy but bad if you needed to sell.

And B&B, which relied on deal-making and asset-churning to lighten the load on its balance sheet and bring in the profits, was now a seller.

The first sign that B&B was in trouble came not long after, at the end of March.

Wood asked Green if B&B's guidance from February had not been "wildly optimistic".

The 2008 financial year did not start well, with B&B making a first-quarter loss $21 million but Green was not that concerned, as he said in court this week.

The push to complete deals by the December-year end always meant that the immediate quarter afterwards was a lot quieter, he said.

Despite the growing problems on financial markets and B&B's sliding share price, activity picked up enough in the second quarter to persuade Green and his colleagues that the 2008 year would still turn out to be good.

Jim Babcock and Green publicly reaffirmed their profit guidance of another record result at B&B's annual meeting on May 30.

"We remain absolutely confident in our basic business model, which is supported by strong global dynamics and prospects in all of our core business areas," boasted Babcock in his address.

"Therefore I am happy to reaffirm that B&B remains on track to deliver net profit after tax of at least $750 million."

However, the second quarter, and the first-half result which was not due to be declared for several weeks did not make such attractive reading, even though the group had by the end of June returned to profit.

By then, Michael Larkin was reporting likely net earnings of $251 million, which left a lot to do in the last six months of the year, although that was traditionally B&B's stronger half, given the previous rush to get deals done and the profit in the door.

Green felt at the time that the result would put the group well on the way to $750 million.

The key to a better second half was going to be the sale of the group's wind farm business in Europe, for which it was looking to make a $650 million gain on its investment.

The team handling the sale was confident it would pull off the deal, and this optimism was enough to persuade an increasingly jittery Green in early June that the company should not retract or qualify its profit forecast.

With the financial crisis in full swing and some of Wall Street's biggest investment banks teetering, Green sent an email to his most senior managers on June 13.

"Given the dramatic turn of events over the past few days, we need to go into a trading halt or withdraw our profit guidance," he wrote.

B&B also needed more headroom on its financing. Its sliding share price was close to triggering a breach in the market capitalisation clause in its banking covenants. If such news was made public it would put more pressure on its stock, particularly in light of the troubles being experienced by another highly leveraged financial engineer, Allco, and hit confidence.

But the wind farm sales team was adamant it would meet its planned deadline and get a good price.

Despite his concerns, Green opted to say nothing publicly about the profit forecast. Instead, B&B issued a market update to investors on June 16, seeking to alleviate their concerns about "incorrect and misleading" comments about B&B's debt facility and a decision the previous week by ratings agency Standard & Poor's to downgrade the company's credit rating.

Asked by Wood why nothing was said until the shock statement to the ASX in early August announcing a full-year profit downgrade and a poor first-half result, Green said senior B&B executives in fact qualified guidance in a presentation to a UBS conference on June 25.

But again that was opaque. The group's present performance was summarised on one page of a 40-page presentation and that page contained just three short bullet points.

Of those, one dealt with discussions with the group's banking syndicate about its debt facility, which were said to be "progressing well", while a second point baldly stated that the full-year profit guidance had only been reconfirmed at the annual meeting less than a month before.

The comments about the forecast contained the normal caveats and at the time weren't considered by investors to be anything out of the ordinary, particularly considering the rather extraordinary events that were affecting the world's financial markets. "The 2008 guidance is subject to the resolution and impact of current discussions around our corporate debt facilities, market conditions and outcomes of the asset sale program," the brief update said.

Little more than six weeks later, shareholders learnt how badly B&B's world had imploded.

Not only would the company report a half-year profit as much as 40 per cent below the $250 million of the corresponding period a year before, but it would also miss its planned annual target by at least $100 million.

The reason: a significant write-down in the value of its equity investments and its core assets, which was to be the first of many and was to culminate in a $4.6 billion impairment charge in the final 2008 accounts that led to a $5.6 billion loss.

"The volatile global capital market conditions have made and continue to make business conditions uncertain and forecasting in the short term difficult," said Green in a statement.

Those words signalled the beginning of the end. He was asked to resign, and on August 21 he quit and was replaced as chief executive by Michael Larkin while the group's co-founder, Jim Babcock, resigned as executive chairman, to be replaced by his deputy, Elizabeth Nosworthy. So, too, did Green's close ally, non-executive director Michael Sharpe, chairman of the board's audit and risk management committee, who stood down for health reasons.

Green stayed as a non-executive director. But within a month he had left a decision he now says he took because of an increasingly difficult standoff with his former colleagues over attempts to save the group.

Green wanted to bring in an equity partner and sell the company. But Nosworthy, Larkin and the remaining directors were opposed, preferring to bunker down and, with the help of the group's bankers, try to trade their way out of trouble and emerge smaller but alive.

There was no going back, for them or Green, who chose to exit completely.

As Green retreated to his Point Piper mansion, B&B first tottered and then, in a painful and excruciating seven-month slow death involving talks with its bankers, toppled into administration.

Among the final indignities, the outside world then learnt that B&B had agreed not to wind up its subsidiary, BIPL, to recover the $600 million debt that is now the subject of the liquidator's hearings. This allowed BIPL's lenders to recover their money from the operating business they were keeping on life-support and now run by Michael Larkin.

ONE line of inquiry from the liquidator more than any other questioned the use of B&B funds as the company tottered on the brink.

In February 2008, Green rejected reports that some B&B staff held extensive margin loans over their shares. "This is total nonsense, it's market rumour and it's absolute rubbish", he said.

It was another factor weighing on the B&B share price, because those stakes held by staff and executives risked liquidation in the case of a margin call.

Following B&B's 2007 Alinta acquisition, questions were asked about Green's links to Tricom boss Lance Rosenberg.

When Tricom struggled in the market rout, Green recommended B&B help out the company a move that he said this week was aimed at recovering B&B's shares and so avoid further downward selling pressure on its stock, which had been targeted by short-sellers.

Until this week, Green's personal holdings at risk in Tricom had never been revealed.

As emerged in court, Green held 800,000 B&B shares and other investments totalling $15 million inside Tricom, which were used to secure a further $22.5 million in margin loans to two of Green's family companies.

The fact remains that as B&B wobbled, its boss recommended a $35 million financial lifeline for a broker in which he had $15 million in assets trapped.