Brian Gaynor: Probe into Feltex shows watchdog out of touch

The Securities Commission would be lucky to score one out of 10 for its investigation of the Feltex prospectus. Its low rating is mainly due to the process, rather than the outcome, of the review.

In an environment where public issuers have demanding disclosure and transparency requirements, the commission remains incredibly secretive and uncommunicative. It didn't reveal it was undertaking an investigation nor did it give frustrated shareholders an opportunity to present their point of view.

One of the commission's main objectives is to "help build confidence in New Zealand's securities markets" yet its one-page press release on the Feltex investigation had the opposite effect. It gave the clear impression the commission is out of touch with investor sentiment and hopes the Feltex debacle will vanish from the headlines.

One problem with the commission is that it sets itself lofty goals but doesn't always adhere to these.

Its recent annual report lists several roles and functions as part of its objective to strengthen confidence and investment in the capital markets. These include:

* To keep under review practices relating to securities and to comment on these.

* To keep under review securities market activities and to comment on these.

* To promote public understanding of the law and practice of securities.

Feltex was one of the biggest IPOs in the past 15 years yet the commission hasn't made any substantive comments on the group's failure to achieve its prospective financial information, to fully disclose directors' interests or its dismal share-price performance.

Surely these issues warranted a review and substantive comment? Surely the commission needs to go farther than a one-page press release stating "no further action will be taken in regard to this matter". Why hasn't it used the Feltex disaster to promote public understanding of the law and practice of securities?

Key aspects of the Feltex prospectus were the financial predictions for the June 2004 and June 2005 years. As it was dated May 5, 2004, the results for the June 2004 year were fairly predictable but the June 2005 year result was much more uncertain.

The prospective financial information for the June 2004 year was called forecasts and for the June 2005 year projections. There is an important distinction between forecasts and projections.

According to earlier commission reports, prospective financial information in a registered prospectus should be prepared in accordance with Financial Reporting Standard 29 Prospective Financial Information (FRS-29).

FRS-29 says this prospective financial information can be presented as forecasts or projections. A forecast must be based on reasonable and supportable assumptions, whereas projections must be reasonable but do not have to be supportable.

According to FRS-29, "a forecast reflects the most probable outcome or the outcome within a range, given expected conditions and actions; projections reflect a range of possible outcomes based on varying assumptions about the conditions that might exist".

In other words, investors can derive far more confidence from forecasts, compared with projections, in offer documents. For this reason, FRS-29 requires that all disclosed prospective financial information shall be labelled clearly as either a forecast or a projection and "the distinction between a forecast and a projection shall be made clear in any prospective financial information being presented".

A key aspect of the Feltex prospectus, and most offer documents, was the summary pricing table. This was a full page at the front of the Feltex prospectus highlighting the prospective price/earning multiple and gross dividend yield based on prospective June 2005 year information. This June 2005 year information was labelled "projected" but the distinction between a forecast and a projection was not made clear as required by FRS-29. The summary pricing table gave the clear impression that the prospective price/earnings multiple was based on realistic and supportable assumptions, whereas it was based on less robust criteria.

Why didn't the commission comment on this? Surely it should take every opportunity to point out the difference between a forecast and a projection, particularly as one of its main objectives is to promote public understanding of the law and practice of securities.

The difference between the two isn't clearly understood, even by leading stockbrokers. First NZ, one of the joint lead managers to the Feltex IPO, published a number of documents at the time of the issue. Prospective June 2005 year financial information was referred to as projections in some places and forecasts in others.

The Securities Commission made no reference to forecasts or projections in its latest press release. Maybe this is because it hasn't done an adequate job of educating the public about this important difference.

The commission also investigated the disclosure of directors' interests and found "no evidence of breach of any disclosure obligations".

This may be technically correct but, once again, the commission could have given a much fuller explanation of its decision.

Most of the disclosure requirements in New Zealand relate to voting securities. Disclosure requirements are far less onerous for securities that have no voting rights and these instruments are being increasingly used to avoid disclosure.

All the original Feltex directors, except Joan Withers, were participants in a long-term equity plan that gave them a non-voting economic entitlement to Feltex shares. As highlighted in this column on July 1, these directors were effectively major sellers of Feltex shares into the IPO but the specific details didn't have to be revealed because these entitlements were non-voting.

The regulations require full disclosure of directors' interests but Feltex was able to avoid this because its directors effectively owned securities that had no voting rights.

Why hasn't the commission taken the opportunity to explain this to investors? Is the commission happy with the non-voting securities disclosure loophole and, if not, what does it propose to do about it?

There is little doubt that some investors might have reconsidered their participation in the Feltex IPO if they had known that the directors were major sellers into the offering.

As one of the commission's roles is to review and comment on practices relating to securities and securities market activities, it is extremely disappointing it decided to have an "investigation", rather than an "inquiry", into Feltex.

Once again we are dealing with definitions as a Securities Commission "investigation" is short and secretive, concluding with a brief press release, whereas an "inquiry" is more detailed with a comprehensive report available to the public. These reports are extremely useful as they give an insight into securities market practices and offer guidelines for promoters and directors of future IPOs.

The commission's skimpy press release is in deep contrast to the improved transparency of public issuers and the willingness of the Takeovers Panel to be open and communicative. The panel gives a detailed explanation of most of its decisions, which is highly valuable to market participants.

The Securities Commission has an important role to play in boosting investor confidence in the country's capital markets.

This role would be enhanced if it gave detailed reasons for its decisions, even if investors do not welcome these decisions.

The future of Feltex remains unclear and the Shareholders Association has organised a meeting at 10am on Monday at the Ellerslie Convention Centre. Interested parties should attend as shareholders have a number of voting options at the coming special meeting.