Opinion: Why the Feltex debacle must never happen again: NZX couldn't withstand another credibility hit like this

Scourge of the NZX. Now there's final confirmation Feltex shareholders won't get a cent back, the FMA must prevent anything like this from ever happening again.

By Gareth Vaughan

Ahead of the National Party's plans to float stakes in state owned enterprises on the sharemarket after November’s election, "ma & pa" retail investors have been handed an unfortunately timed reminder that the sharemarket can be a wild west with little or no accountability for hundreds of millions of dollars worth of investor losses.

It comes in the form of Feltex, the scourge of the NZX and one of the most high profile initial public offerings of the past decade. Amid little fanfare, Feltex's liquidator McDonald Vague has settled a legal spat with five former directors of the failed carpet maker.

Feltex is a cautionary tale of wealth destruction that Sean Hughes, CEO of the government's new super financial markets regulator the Financial Markets Authority (FMA), and his troops must never let happen again.

Many ma & pa investors old enough to remember the 1987 crash have not gone near the sharemarket since. And as JBWere strategist Bernard Doyle has pointed out, the sharemarket has now slumped to the point where it's "ceasing to be relevant to the economy" and leaving a hole for what an equity market normally does such as providing businesses with capital to employ people and invest in growth.

Doyle recently noted the NZX's market capitalisation as a percentage of Gross Domestic Product  has tumbled to just 29%,  leaving us sandwiched between Ireland at 28% and Greece at 30%. It's down from 52% in 1997. Doyle has also pointed out the average daily turnover on our sharemarket has "oscillated around a flat trend" for 15 years, and at about NZ$60 million per day, is the same as in 1997.

And the latest ASB Investor Confidence Survey suggests New Zealanders have little interest in the sharemarket. According to the survey, term deposits are the most popular investment product  with 19% support, followed by rental property at 15%, KiwiSaver and bank savings accounts equal third at 12%, managed Investments/unit trusts/superannuation next with 10% support, and finally investing directly in shares in listed companies bringing up the rear with just 6% support.

Hughes has been tasked with restoring retail "ma and pa" investors' confidence in the financial markets after the demise of dozens of finance companies (see our Deep Freeze List here for full details). He has acknowledged his task  is a tough one and he isn't helped by the full implications of the Feltex debacle.

Liquidator's settlement removes hope of shareholders getting any money back

There's always investment risk and companies will continue to fail. But Feltex's story is a particularly grisly tale that could have been avoided. Feltex was a household name, had been around for donkeys' years, and its shares were peddled to retail investors by sharebrokers as a safe, high yielding investment opportunity.

Witness June Goldstein. A Christchurch widow then in her eighties, Goldstein told me in 2006 she had invested NZ$15,000 in Feltex after a Forsyth Barr adviser (Forsyth Barr was co-lead manager of the Feltex float with First NZ Capital) convinced her Feltex was a "long time, reliable firm" and a better bet than children's clothing retailer Pumpkin Patch which she had planned to invest in.

Within 27 months of its June 2004 IPO that raised  NZ$254 million at NZ$1.70 a share, Feltex was gone,  brought down by too much debt and, in my opinion, dismal management.

The McDonald Vague case was supposed to start a three week High Court trial this week. The liquidator had included shareholder claims worth about NZ$9 million stemming from Feltex breaching NZX continuous disclosure rules in its action against the five directors.

But the settlement means shareholders have now almost certainly lost their last realistic chance of getting any money back. There is still a separate live case, led by ex-Fay Richwhite staffer Tony Gavigan. A class action type case, this is seeking compensation from parties associated with Feltex's IPO on behalf of investors. However, the prospectus was cleared by the Securities Commission and most in legal circles believe this case has a particularly hard row  to hoe.

The liquidator's settlement comes without the five - former chairman Tim Saunders, ex-CEO Peter Thomas, and ex-directors Peter Hunter, Michael Feeney, and John Hagen  who have always denied any wrongdoing- admitting any liability. It's a confidential deal McDonald Vague describes as "modest and pragmatic" and reached on a “costs saving” basis.

Why should the terms of a settlement relating to a publicly listed company be confidential?

If we leave aside the issue of how a major dispute involving claims worth the thick end of NZ$40 million involving the liquidator and directors of a publicly listed company can be settled confidentially, it appears safe to assume there’ll be nothing in the deal for investors. Nothing.

The receivership has seen secured creditor, and in my opinion highly justified plug-puller, the ANZ, recoup all bar A$2.9 million (plus interest) of the A$119.5 million it was owed. But shareholders, who thought they were buying into a long standing and safe business, have got nothing.

And this is after a Securities Commission investigation concluded, among other things, that Feltex failed to disclose a breach in its banking covenants with the ANZ and that the company classified about NZ$100 million of debt as non-current when it should have been classified as current, and due for repayment within 12 months.This meant Feltex - according to McDonald Vague and based on the Securities Commission's report  - was in breach of NZX continuous disclosure rules for 10 months - until the breach was finally disclosed to the sharemarket in June 2006.

The directors, meanwhile, allowed firstly Talley's Group (famed for fishing) and Sleepyhead owners Craig and Graeme Turner (famed for making beds) to do due diligence on Feltex in opposition to a deal with fellow carpet maker and rival Godfrey Hirst that would have secured all ANZ's money and 12 cents per share for shareholders. According to McDonald Vague, the directors weren't taking justified business risks.

Godfrey Hirst walked away from that deal only to return to pluck Feltex out of receivership in a second deal that - compared with its initial offer - saw Godfrey Hirst take over the cost of only 625, or about half of Feltex's staff.

It saw Feltex trade creditors lose NZ$5 million, left ANZ with a NZ$14 million shortfall and saw staff lose out on NZ$523,204 worth of pay, and shareholders dip out completely.

Little accountability for the misleading of investors 

If Feltex was in breach of NZX continuous disclosure rules that means investors were misled. And they weren’t misled over a minor issue. They were misled over Feltex’s debt, the very issue that ultimately brought the company down.

So where’s the accountability?

NZX, whose hierarchy told the parliamentary select committee overseeing the FMA establishment before Christmas there have been no regulatory failures on the sharemarket, stung Feltex for NZ$150,000 in an earlier settlement of an alleged continuous disclosure breach, this one over a profit downgrade. That’s Feltex. Not its directors or advisers. So that NZ$150,000 came out of shareholders funds rather than benefiting them as key victims.

The Securities Commission's report referred Feltex's auditor Ernst & Young and responsible partner Gordon Fulton to the New Zealand Institute of Chartered Accountants (ICANZ) in November 2007. This came after the watchdog concluded work done by E&Y in a review of Feltex's December 31, 2005 half-year accounts wasn't up to scratch.

Three years later, in 2010, ICANZ fined Fulton NZ$150,000. So again, no money for Feltex's shareholders who were the victims of the company's erroneous debt classification.

And in a criminal case taken against the same five directors McDonald Vague targeted by Registrar of Companies Neville Harris over the undisclosed banking covenant breach, District Court Judge Jan Doogue ruled the directors took all reasonable steps to comply with the rules and blamed E&Y. The Crown (read taxpayer) was ordered to cough up NZ$952,111 worth of legal costs that the directors ran up successfully defending the charges. The Crown is appealing.

How can investors be sure this won't happen again?

So without suggesting any of the SOEs the government might float will collapse, let alone in the fast and spectacular manner of Feltex, where's the assurance to ma & pa that this type of debacle won't happen to a listed company again?

Well, a law change in 2008 means the FMA can now take action directly against company directors in relation to an alleged breach of continuous disclosure as the Securities Commission did against Nuplex directors over that company's continuous disclosure. In that case Nuplex coughed up NZ$3 million for shareholders.

Then there's the FMA's new Australian Securities and Investment Commission (ASIC) style powers. Here, the new watchdog has the ability to act against the likes of company directors, auditors and trustees where there is significant public interest to do so, over - for example - an alleged breach of directors' duties. This could mean, for example, the FMA following a similar route to that taken by ASIC in a successful case against auditor KPMG and directors of failed property finance group Westpoint. ASIC recouped up to A$67.5 million for Westpoint investors.

So should another Feltex type situation emerge, Hughes & Co have the tools to do something about it , - for the benefit of shareholders. And they must do so because the sharemarket, should the SOE floats breathe some life into it, may not be able to withstand another Feltex type blow.

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13 Comments

Incredible. The NZX and the NZ Institute of Chartered Accountants get money from fines charged to Feltex. The lawyers make a killing and the poor investors get nothing.

And the NZX says the system worked.

No wonder there was a boom in investments in rental property after 2006.

Let's hope the FMA does a much, much better job and that the NZX lifts its game.

cheers

Bernard

Mark Weldon is still running the NZX as if it is his personal plaything ... . Don't  hold your breath waiting for him to lift  its game , Bernard .

The NZX obviously doesn't really want Kiwis to invest in the share market.

NZX are gone! credibility shot leaving the finance industry in tatters.

They well have to re-invent themselves with a independant Goverment guarantee or Caveat Et Emptor.

Where law ends peril begin :)

Ho Hum, whats new. Been watching all the smart arses in suits taking suckers money all my life. God damn it they even sucker stupid politicians lots of the time. Its always going to be better from now on and wont happen again. I dont think so! Cheers

Bobby's bang on...and it's on to the next rort and scam...the so called new policeman in charge will prove to be as useless and the last...any crims that do trip over themselves will get a smack on the wrist and be told not to get caught again. Look at them living it up on home detention....what a joke.

 

To be fair to June Goldstein, tor lawn, her instincts were pretty good. What she told me more fully was that she wanted to buy Pumpkin Patch shares (its IPO was at about the same time as Feltex's)  because she believed parents would buy clothes for their children before they spent money on themselves.

Her adviser however said she'd be better off buying into a "long-time, reliable firm" Feltex.

"I let myself be talked into it," she said "I can't really afford to lose nearly NZ$15,000 and it's a lesson to me. I have to be much more careful."

Pumpkin Patch has had its ups and downs but done a hell of a lot better than Feltex.

And Bobby and Wolly, the thing is this time around the FMA - given its new powers - won't have any excuses like previous toothless (and in some cases gutless) regulators who failed. Whether things improve remains to be seen but I certainly have some hope they will.

Here's Chapman Tripp on the FMA v Bernard Whimp:

FMA sinks teeth into Whimp

18 May 2011

Page Content

Bernard Whimp has provided the Financial Markets Authority (FMA) with an easy first scalp in Financial Markets Authority v Carrington Securities LP1 and in the exercise of its new powers to deal with predatory low ball offers. 

This is a good result for the FMA as it seeks to win public confidence in the new regulatory regime.

The context

The litigation related only to the most recent offers made by Whimp.  These offered a price higher than the current share price but with payment spread over ten years in equal annual instalments.  During that time, any dividends would go to Whimp.

The offered price was headlined at the front of the offer together with a favourable comparison to the recent market price on NZX and emphasis on the ‘first in first served’ limited period for the offer.  Other important terms (including the spread payments) were set out in much smaller print on the reverse side of the document.

An earlier interim court order had required Whimp to send notices to all accepting shareholders requesting that they affirm their agreement to sell.  Seventeen affirmations were received by the FMA and 132 by Whimp (notwithstanding that the order required that they be sent to the FMA).

In addition to the court proceedings, the FMA also used its new power under section 49 of the Financial Markets Act to require Whimp to disclose to potential ‘investors’ specific warning notices issued by the FMA in any future unsolicited offers. 

The FMA’s second cause of action in relation to misleading aspects of low-ball offers sent by Whimp before Christmas has been adjourned for later determination.

The case

The FMA argued that the deferred payment offers breached section 13 of the Securities Markets Act 1988.  Section 13 prohibits conduct, in relation to any dealings in securities, that is misleading or deceptive or is likely to mislead or deceive. 

It is not necessary to prove either that the deception was deliberate or that anyone was actually deceived by it (although the Court was clear that both were manifestly present in this case).

The Judge, Gendall J, found that the offers were misleading because they created the impression that full payment would be made immediately or promptly and that the offer price exceeded the current share trading price.  Further, the offer document did not convey clearly:

“that the consideration for the acquisition of the shares was, to the extent of 9/10ths an unsecured loan to Limited Partnerships about which no information was given”.

The Judge drew heavily on the Australian decision in National Exchange Pty Ltd (ACN 006 079 974) v Australian Securities & Investments Commission2, noting that Whimp must have based his strategy on the offers at issue there (from David Tweed, Whimp’s Australian equivalent) so similar were they in structure.

Orders were granted against Whimp and those limited partnerships he used in the offers restraining them from making any like offers in the future.  In relation to the offers already made, and except where the shareholders had affirmed their intention to proceed, the Court voided the sales by:

  • cancelling the contracts
  • directing the return of any shares that had been transferred, and
  • restraining the registration of any shares acquired.

The defendants were also required to produce copies of the affirmations they had received so that the FMA could make further inquiries to confirm their validity.

The FMA’s new powers

Although the Government has decided against introducing a “proper purpose” test for access to share registers for the moment, recent changes to the Securities Markets Act should inhibit future unsolicited offers.  These include:

  • the FMA’s power to require that offerors include a warning statement from the FMA at the beginning of unsolicited offer documents.  Such statements will typically suggest questions which investors should consider (How much will you receive per share?  When will you get paid?  Who is making the offer?) and will warn them that, if they accept the offer, they may receive less than if they sold the shares through a sharebroker, and
  • the power to make regulations.  The Government has not yet used this regulation-making ability but could use it to set rules such as requiring that the market price be quoted in the offer document, or a fair estimate of value for an unlisted security, and requiring a ‘pause period’ before acceptances can take effect.

Whimp’s announcement of his “retirement” within days of these new provisions being passed into law suggests that the FMA has the tools to put him and others like him out of business.

I absolutely agree. This behaviour even goes on within the Police.

The only way the FMA will really have any teeth is if they bring in investigators from offshore contracted on a case by case basis. 

Outerspace calling. Haven't you humans learn't anything? Can see those Blue Chip boxes of documents and didn't get them! Hotchy's in his mansion. Just filling "gung ho" pockets. You mere mortals should ask us for help!!!! Poor Bernard -     by b17 May, 6:17pm.     

Earth to Outerspace....you were breaking up.! message unable to be understood ..! Please repeat message...!..CCCCCCCCHH..over.!

Hi Earth, Bridgecorp: Solvent = inhouse, insolvent = distributed to public. Refer NBR "Sweeping Bridgecorp ruling kept secret"!!!!!!!!!!!

 

 

Hey Outerspace, I don't have access to their paid content, but how do they know it's a sweeping ruling if it has been kept secret?