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Feltex directors found not guilty

Monday 2nd August 2010

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Directors of Feltex have been found not guilty of misleading investors under the Financial Reporting Act after the collapse of the iconic New Zealand carpet-maker in 2006 because their accounting advisers, Ernst & Young, failed to advise them adequately.

The decision in the Auckland District Court will come as a blow both to the Registrar of Companies, who brought the actions, and to Feltex investors who lost money when Feltex was placed in receivership and then liquidation in 2006, just two years after raising $250 million from the public and floating on the NZX. 

However, the judgment suggests directors in other high profile cases of alleged negligence, such as the suits brought against Nuplex and Lombard finance company directors, may also have grounds to anticipate dismissal of charges against them.

Judge Jan Doogue found no evidence that the five directors - Tim Saunders, Peter Thomas, David Hunter, John Feeney and John Carlasw - had attempted to mislead the financial markets, shareholders or any other person.  

"There is also overwhelming evidence that these directors are honest men," the judge said of the actions taken by the Feltex directors, all of whom are, to varying degrees, scions of New Zealand corporate life. 

All five directors faced two charges each relating to the way an ANZ debt facility was disclosed in the company's financial statements for the six months to December 31, 2005. 

Judge Doogue said the case was not about "what went wrong internally within Ernst & Young that led to their failure to adequately advise the directors", but noted the E&Y was "completely wrong" in the way it characterised amendments to the classification of liabilities and had "made none of the obvious inquiries" into a breach of debt covenants by Feltex, of which it was aware. 

She was satisfied that E&Y was not only aware of the documents disclosing a breach, but that "they failed to review it or understand its terms, or understand the implications as far as the reporting standards were concerned".

"Had the review been undertaken competently and thoroughly, it would have identified the issues currently before the Court and the directors would have received advice accordingly.

"Having engaged E&Y to act as the company's IFRS advisers the directors could legitimately expect that the review would pay particular attention to ensuring that the IFRS requirements were met," the judge said. 

Questions asked by members of the Feltex board's audit committee demonstrated this, as did the fact that the express purpose of the IFRS review sought by Feltex was "restoring Feltex's credibility in the market as recommended by E&Y".

"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." 

Chapman Tripp partner Roger Wallis said the verdicts would provide "some welcome and timely comfort to directors who acquit their duties honestly and diligently".

The judge had found that directors were entited to rely on the professional advice they received in complex technical areas such as financial reporting.

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