Tuesday, August 3, 2010

The path to the failure of Feltex lined with good Intentions

The finding in the district court yesterday that 5 former directors of failed company Feltex Carpets, Tim Saunders, Peter Thomas, Peter David Hunter, John Michael Feeney and , Hagen were found not guilty of charges under the Financial Reporting Act is not surprising, simply because laws surrounding possible breaches by them under the act specify intention rather than the actual results of any perceived misconduct by directors and management at Feltex. Lawyers for the prosecution, engaged by the Registrar of Companies, clearly took the wrong tack here, if there was any tack to take at all.

The charges laid against the "Feltex Five" related to information provided in the company's December 31, 2005 half-yearly financial statements in that they failed to disclose a breach of its banking covenants and did not properly classify its debt.

The judgement by Judge Jan Doogue, in the Auckland District Court today indicated lack of intention to mislead might be a leading factor in the not guilty decision and that Feltex Accountants, Ernst & Young were solely responsible for informing the Feltex Five of the company's financial reporting breach's:

"There is overwhelming evidence that these directors are all honest men and that they conducted themselves at all times with unimpeachable integrity. There is not one skerrick or evidence to suggest any intention by them to mislead the regulatory authorities, market, shareholders, potential investors or any other person.

If E&Y had performed the review to a proper professional standard as the directors were entitled to expect they would have identified and advised Feltex and the directors of the need to classify the bank debt as a current liability and to refer to the covenant breach in the explanatory notes.”

I would argue though that although intent to mislead was not the case, this lack of intent was on a lesser part of the roles of the Feltex Five to take responsibility themselves to make sure investors knew the true nature of what they were investing their money in and that possible irregularities or perceived risks were made known to the investing public as part of being responsible and experienced directors and professional managers.

For very experienced business people to not have the responsibility of informing investors of the true nature of a companies books cannot be mitigated by placing blame for non disclosure of financial breaches on Ernst & Young, even though the accountancy company clearly needed to disclose such breaches and seriously erred by not doing so.

Interestingly, after the 2004 IPO the Securities Commission also concluded that the 2004 Feltex Prospectus was not misleading but that:
  • FTX failed to disclose certain material information to the market concerning changes to its facility agreement with ANZ in October 2005;
  • FTX failed to disclose the breach of its banking covenants in its 31 December 2005 half-year financial statements; and
  • FTX did not properly classify its debt in its 31 December 2005 half-year financial statements.
I would argue that pre the 2004 IPO and Prospectus issuance and during the 2 short years the company traded there must have been inaccurate numbers presented to Feltex investors. Often talked about (by my good self) Pro-Forma figures used in IPO Prospectus and subsequent comparisons in bookwork made after an IPO, do not give investors a clear picture of the financial health, or otherwise of any business - debt levels at the Prospectus issuance were very high but were they clear? This debt ultimately led to the demise of the company. A class action is being taken against the Feltex Five for poor disclosure in the 2004 Prospectus.

The Feltex Five are defiant in their innocence after the verdict but can we really trust 5 men who after an IPO and two short years they run a business into the ground costing investors a quarter of a billion dollars and the only people who made serious money from the IPO were these five?
What conclusions can we make from this not guilty verdict?

Well what we can clearly say is that the Financial Reporting Act lacks a broader umbrella that allows abdication of responsibility for those that are charged with having it when they manage and operate a public company. We can also assume that specifically the act also lacks the ability to hold individuals accountable for sloppy and careless operation of a business that might unintentionally lead to the loss of that business and the loss to investors of their moola.

This decision also opens a loophole for other directors that will or are about to go before the courts for similar charges and that surely puts investors on the back foot yet again where they cannot trust company management to operate a business in a prudent manner because the penalties for financial misdemeanors are either non-existent or meaninglessness.


Analysis of 2004 IPO & Prospectus
Securities Commission

Financial Reporting Act 1993
Timeline of Feltex Decline

Tim Saunders/Feltex @ Share Investor

Tim Saunder's independence in question
2004 Feltex Prospectus

c Share Investor 2010

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