Regulator turns prospectus forecasts into dirty words

By Mike Ross

Friday 28th March 2003

After the abuses of the dotcom bubble, the Securities Commission is warning promoters against talking up growth prospects without commenting on the downside risk.

Its report into Vertex concludes directors misled investors in last year's initial public offering (IPO) when they highlighted the potential growth of two business units, Technical Injection and Securefresh, while not giving equal emphasis to material risks. At the time of the IPO, the business was undergoing significant structural change and no settled pattern had emerged.

Technical Injection evolved from an injection moulding business formerly owned by Carter Holt Harvey Plastic. Securefresh uses specialised machinery to deliver wrapped meat trays to supermarkets for immediate display, cutting out the need for supermarkets to have inhouse butchers preparing meat cuts for sale.

Just two months after listing, Vertex directors revised forecasts published in the prospectus to state that revenues for the six-month period spanning the IPO were expected to be down 10%, with earnings before interest and tax down 15%. Poor performance in the Technical Injection and Securefresh divisions were blamed.

This news, coming hot on the heels of an IPO touting the potential strengths of both these business units caused more than a minor flutter in the capital market the market price of Vertex shares dropped nearly 30%.

The Stock Exchange queried the accuracy of forecast financial information published by Vertex in its prospectus. The market surveillance panel and the Securities Commission were asked to investigate.

The panel recommended no action be taken, after finding Vertex had breached listing obligations requiring the supply of relevant information to the market. The commission found the prospectus was misleading. For prospectuses, the commission has a power of investigation only. It has no power of enforcement.

It had no criticism of the general business risks disclosed by Vertex in its IPO prospectus. But it criticised the lack of specific risk disclosure about Technical Injection and Securefresh.

In marketing the IPO, these business units received special attention as the main contributors to future company growth. In the year post-float, 50% revenue growth was anticipated for Technical Injection, 100% for Securefresh.

Before the shares were allotted, Vertex directors were having second thoughts about these revenue predictions. Major customers were slow in placing firm orders. But the directors remained confident delayed orders would be picked up in the second half of the year.

The commission says the likelihood of information influencing a reasonable investor is determined in part by the emphasis given to that section of the business when marketing the offer. Where one part of the business is highlighted as offering good growth prospects, then the offer document must also emphasise the risks associated with that part of the business.

Often high-growth ventures carry particular risks that differ from those facing an established business. A failure to disclose these risks misleads investors, the report says.

With disclosure, investors are given the opportunity to assess for themselves the soundness of the business judgment and the possible effects of that judgment on the investment.

The report also highlights confusion within the Vertex board over the difference between forecasts and projections and further confusion over PricewaterhouseCoopers' role. Its engagement letter made it clear it was not required to verify the accuracy of prospective financial information in the prospectus.

There was evidence not all directors were aware of the terms of the engagement letter, with (now resigned) Vertex chairman Jon Hartley telling the commission his understanding was that PWC did undertake a rigorous review of the forecasts.

The commission found there were misunderstandings over the distinction between forecasts and projections. The difference is significant.

Intending investors read forecasts as being based on supportable best-estimate assumptions. Projections are hypothetical possibilities.

The commission states the anticipated revenue and earnings before tax for Technical Injection and Securefresh should have been described as projections rather than forecasts. The figures were based on customer information about likely order levels and inherently this was highly uncertain.

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