Fran O'Sullivan: Ministry must front up over Feltex

(L to R) Feltex Directors John Hagen, Peter Thomas (CEO), Tim Saunders (Chairman), Peter David Hunter and John Feeney. Photo / Sarah Ivey

Registrar of Companies Neville Harris is maintaining his silence over the failure of the high-profile criminal action the Ministry of Economic Development's national enforcement unit took against the "Feltex five".

Harris threw the book at former chairman Tim Saunders, former chief executive Peter Thomas, John Hagen, Peter Hunter and John Feeney, charging that they breached section 36A of the Financial Reporting Act (1993) by failing to disclose in Feltex's December 31, 2005, interim accounts the company had breached its loans facilities with the ANZ and had failed to properly reclassify term debt as current debt.

The directors later conceded the details were not disclosed in the interim financial statements. But maintained that at the time the accounts were signed off they were in receipt of professional advice that led them to believe they had complied with relevant laws.

When it came to show-time in the Auckland District Court, the five gave evidence that they had relied on a review by Feltex's auditor Ernst & Young to ensure the accounts complied with new accounting standards.

Judge Jan Doogue accepted the directors' submissions that they had taken all "reasonable and proper" steps to ensure compliance with the FRA by relying on advice sought from Ernst & Young.

"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 of evidence to suggest any intention by them to mislead the regulatory authorities, market, shareholders, potential investors or any other person," said Doogue.

Doogue's categorical comments are what are typically referred to as a "comfort statement" in legal circles. She clearly felt the Feltex directors' reputations had been unfairly trashed.

Her comments are intended to redress some of the damage the directors have felt as some of their former acquaintances treated them like pariahs at public places like the Koru and Northern Clubs (something I have observed).

In internet chatrooms, Doogue's judgment has been lambasted by some (in too many cases anonymous) "former investors" as a nod to the "old boys' club" but drilling down into the 62-page judgment it is easy to see how Doogue reached her conclusions.

While she doesn't say so directly, it is obvious Doogue felt some of the evidence laid against particular directors was risible.

For example, she devotes considerable comment to claims that Hagen - a former chairman of Big Four accounting firm Deloitte - should have been able to pinpoint the breaches by virtue of his own professional skills and position as chairman of the Accounting Standards Review Board at the time the International Financial Reporting Standards were introduced.

Hagen retired from that post in February 2003. While the Accounting Standards Review Board had announced in December 2002 it proposed the adoption of the new IFRS standards from January 2007, the process of reviewing and considering those standards did not occur until 2004 and 2005. He thus had no detailed knowledge on this score.

Even more to the point, Hagen's own expertise was not as an auditor. He worked on corporate advisory while at Deloitte.

The notion that as a director of Feltex he should in effect be doing Ernst & Young's work was fanciful to say the least. The reality was that Hagen's role on the Feltex board was to be a director - not the company's auditor.

It is these sort of rank misperceptions on the ministry's part that underline why five directors now want Harris to front-up and explain why the MED took the case in the first place.

At the heart of this is why such issues were not thrashed out behind the scenes instead of proceeding to a lengthy court case which has cost all involved considerable time to defend - on top of the reputational damage and opportunity cost in having to resign other directorships to concentrate on their own vindication.

Hagen is particularly piqued.

He told this columnist that Harris had called upon him three times in the past to give an expert opinion on whether to take action against particular directors.

It is pertinent that MED did not call a single expert witness for the Feltex case - who was skilled in governance or a highly-regarded director in his/her right - to substantiate why the board should have been in the firing line in this instance.

The directors' insurance ought to cover their costs for defending the action. What it won't cover is the "opportunity cost" they have suffered from having to defer other work while defending their reputations.

It is also difficult to see how the ministry could find any avenue to appeal against the Doogue decision.

The disciplinary panel of the Institute of Chartered Accountants (ICANZ) is this week expected to release the results of its own inquiry into Ernst & Young's performance. Ernst & Young NZ partner Gordon Fulton has attracted some criticism. But in fact it was a Melbourne player who had been in charge of this phase of the company's audit process.

Former Feltex directors will be hoping it's a case of "one down, two to go" after Doogue threw out the criminal action brought against them.

McDonald Vague, who were appointed Feltex's liquidators on December 13, 2006, have alleged reckless trading and negligence against the Feltex five.

The liquidators maintain Feltex was "balance sheet insolvent" for at least 11 months before the receivers took the reins after ANZ - which was by then owed A$119.5 million - pulled the plug on Feltex; and that they breached sharemarket continuous disclosure laws.

The five say they followed Bell Gully's legal advice, Ernst & Young's advice on sharemarket disclosure rules and Deloitte advice on Feltex's solvency. A three-week trial is set down starting May 16, 2011. But Doogue's judgment that directors are entitled to rely on professional advice will undercut the liquidator's case.

The more interesting aspect of this case - if it is pursued - is the decisions the board took as Feltex came under increased pressure.

McDonald Vague alleges the directors were "inherently against" selling Feltex to Australian rival Godfrey Hirst and "unreasonably biased" towards Sleepyhead owners Craig and Graeme Turner or Talley's Group.

In many respects this claim drives more towards the heart of the real issue: why Feltex fell over less than two-and-a-half years after its IPO.

The IPO is the subject of a separate class action. Hagen and Thomas are not among the previous Feltex directors facing that claim.