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September 2009 Edition ----

We will start perhaps with a few updates similar to last months edition.

Joan Withers has finally made it onto the board of Mighty River Power. Her appointment was announced in May at the same time as that of Keith Smith, the chairman of The Warehouse where Ms Withers was also a director. As the story goes Ms Withers gave up that appointment as well as one on Feltex Carpets (now Exftx Ltd in receivership and liquidation) and perhaps several others to become Chief Executive in New Zealand of Fairfax the News Media owners. That is not a step which many directors with a extensive portfolio of companies choose to make. And indeed we say that if one has been a director of a company for only a year or two and the company is under stress then it is not a step which one is entitled to make. Most especially if as in this case all the shareholders in the company when she left the company ,Feltex, were not there when she joined it. All the shareholders were there as a result of a prospectus which had her photo in it as a newly appointed director. They were entitled to think that she would be there for some time and would not leave the company if its success was under threat. Not unsurprisingly many of these shareholders were "Mum and Dad" ones where probably Mum was impressed that there was a women director of some standing and/or Dad was keen to keep in Mum's good books. Feltex went belly up during Ms Wither's tenure. It was not promoted as a high-risk investment. Why should anyone think that she can still be a good director? Well perhaps she went in there at the request of people she should have been able to trust. But those people should have to own up and take some responsibility for the Feltex collapse. Directors have got to live with their judgements. The buck has to stop with them.

Mighty River has had a good year and apparently has contracted with a lot of new power consumers in the South who had been customers of the listed company Contact Energy. As a fine weather director Ms Withers is off to a good start. The mighty river, which inspired the SOE's name, is we think the mighty Waikato where Mighty River owns a string of power stations. Southerners might think the only mighty river is the Clutha which has more water than the Waikato and where Contact has two big dams and is looking at constructing several more. Mighty River also generates geothermal power and is developing in this area. It now has nine directors, four of which are female including its chairperson.

Feltex's chairman during Ms Withers tenure there was Tim Saunders. Mr Saunders was a member of the Contact Energy board until he got charged with offences as a director of Feltex. Contact expressed confidence in him and soon after he resigned from there. Its a funny world. .

Next update concerns the Feltex liquidators, McDonald Vague, not exactly that firm but sort of. They have gone into the red with a new appearance for their web site which now contains their sixth report on Feltex. There are two interesting bits. On page 2 and item 4, under the heading Investigation and Legal Issues - Legal Issues the liquidators say "they are pleased to advise two significant events which assist in advancing recovery proceedings". They then announce the numbered first of these events thus "1 Directors Breach of Duty and Negligence" and proceed to name the five directors they are taking action against and a little bit of information. It does not involve the IPO as we understand it. It says resolution is not expected before 2011. The report then moves on to item number 5, Dividends. Where is the second significant item which they were supposed to be having pleasure in announcing?, we ask. Accounting can be a complex subject but we think being able to keep track of thinking up to the count of two (2) should be within their capability.

A bright spot is that they have not made any any decisions on shareholders claims relating to the IPO. A bit of reconsideration might be going on we think.

Two of the liquidators have signed the report. Perhaps it is the one who knows the implications of the word "two" who is missing.

We believe the liquidators have neglected their duty in failing to make the shareholders register available to the public.

We mentioned things last month without providing as much evidence as we might.

Firstly we provide Sue Newberry's take on the Feltex affair. We mentioned Ms Newberry as being a far better choice for Securities Commission chairperson.

Then we referred to a statement made by Warren Allen, the Ernst and Young partner who was a long time chairman of the Education committee of the International Federation of Accountants who has for some time been a board member of that organisation. Mr Allen is a past chairman of the Institute of Chartered Accountants of NZ who helped see off the old Society so that those who offended when under its jurisdiction could not be got into trouble by it. We referred to Mr Allen's denial in 2001 of Ernst and Young's unqualified audit report for the 1990 Bank of New Zealand annual accounts having been held to be inappropriate by anyone of consequence, particularly the Securities Commission. Here is the page of the document concerned. It is his item 8 which is clearly a mistruth. Here is the paragraph of the Securities Commission report, which disproves it. The full report is available here.

15.154 E & Y gave an unqualified audit opinion with respect to a set of financial statements for the BNZ for the year ended 31 March 1990 which did not, in our opinion, present a true and fair view of the results of the Bank for that period.

We say that action by Mr Allen should have him struck off all membership of any accounting organisation for good. This SC report was prepared when he was a Wellington branch audit partner of Ernst and Young. It is inconceivable that he would not take an interest in an 273 page ((plus appendices) report into aspects of the annual accounts and their audit by his fellow partners.

A discussion of Ernst and Young is warranted by the appointment of ex E&Y CEO John Judge as chairman of the Accident Compensation Corporation.. While we are in that 1993 report let us have a look at paragraph 15.158.

15.158 In our view E & Y should have included an income overstatement of at least $15.9 million on account of the Bank's incorrect treatment of the capital notes. The omission of such an adjustment was an unfortunate error.

We reject the validity of the final sentence of that paragraph and say it was a deliberate "mistake" made to go along with the wish of the government and influential shareholders such as Michael Fay for the bank to report a reasonable profit regardless of the facts. The "incorrect treatment" was revealed by a statement of Elizabeth Hickey supplied at paragraph 15.141 of the report thus:

15.141 E & Y looked at this issue in 1990. In Hickey's file note of 11 May 1990 she describes the capital notes but does not indicate an awareness of the zero coupon bond. She acknowledges that the Bank is using a straight-line basis rather than a yield to maturity basis but concludes:

Because the interest rate is a floating one based on LIBOR, it is not possible to calculate the reduction in the perpetual capital notes on a yield to maturity basis. Accordingly, the Bank's adopted straight-line basis is accepted.

Well a floating interest rate would make it equally difficult to spread interest by either the Yield to Maturity or the Straight Line method. She would have been naturally interested to see how the Straight Line calculation had been achieved. Presumably one would have to make some assumption about what the LIBOR interest was likely to be on average and use that. This was a case of debt defeasance where a debt and an asset which offset one another at maturity was put in the books for the net amount which in this case was a debt. Ms Hickey purports to have thought that it was all debt. Well she would not have thought that if she understood the Straight Line calculation which we are sure she did. They had told the bank board that they were "looking into the notes". That indicates that they had suspicions about them. Just because there was some difficulty about applying YTM (as they erroneously claimed) is no reason to revert to an invalid method. They had a duty to see that a fair amount of interest on this net debt for the year and to qualify their report if this was not done. We are sure the "mistake" was a put up job and the Commission had no evidence for declaring that it was a mistake. Ms Hickey is back on the Securities Commission again and needs to be put off it as soon as possible. Presumably both senior partners were looking into it. They were entitled to get bank staff to explain it to them. There was no excuse for a mistake and a mistake as such did not happen. YTM had had extensive promotion as the only method of interest apportionment between accounting periods. In 1988 the IRD adopted as the only apportionment method for tax purposes and taught it to tax practitioners throughout the country saying that it had long been a requirement for financial reporting purposes and they, IRD, were just catching up. The Securities Commission refused to entertain the possibility that these two auditors deliberately went along with the profit overstatement which was undoubtedly the case.

Soon after the release of the 1990 BNZ annual accounts Peter Garty, the audit partner "somehow" realised that YTM should have been used and also realised that Straight Line interest was no longer appropriate for the Bank's other large zero coupon bond known as the "Insurance Policy". But he purportedly still did not get it right because he purportedly continued to think that the apportioned interest on the Capital Notes was interest payable and not interest receivable. This was very convenient because in his purported mind the two overapportionments of interest offset one another so purportedly he did not need to be concerned about a significant profit overstatement.

Mr Garty now appears to be the Group General Manager of the Ministries Trust of The Sisters of Mercy in New Zealand. For a period he was financial controller at the besieged St Lawrence finance group.

Mr Allen has used this misconduct of his high paid colleagues to punish low paid accountants for misconduct and force them out of the Institute for alleged ignorance. Ms Hickey was one of the people producing high priced courses some of which needed to be attended to retain membership. She gets good appointments from politicians on the cover-up.

Well a spell on Ernst and Young misachievements is not complete without mention of their mishandling of a report to the shareholders of Tui milk Products prior to them voting for a second time on whether to merge with Kiwi Cooperative Dairies in 1996. E&Y did some "net present value" analysis and said the shareholders would be better off from merging by "$1.41 per kg milk solids for the years 1996 to 2015". They did not say this was the result of NPV analysis. What they say they meant was that the shareholders would receive the equivalent $1.41 per kg of annual milk solids supplied as a once only up front payment provided they continued to supply the same annual quantity at least until 2015. We say that what they said was the shareholders would get $1.41 extra for each kg of milk solids supplied up until 2015. They would no doubt argue that no shareholder would believe that that would be possible. We say industrial mergers frequently do produce 30% greater benefits to shareholders. We say shareholders are not going to turn down the possibility of such a large increase regardless of how sceptical they may be. They would say that all shareholders who asked were made fully aware of what was meant and there were meetings which gave them plenty of opportunity to ask. We say many shareholders would not have availed them themselves of this and chose to say out of the discussion and just studied the paperwork prior to voting. A small drop in the yes vote would have stopped the merger. We also say the calculation was wrong. They calculated the first four years independently. Then instead of doing a bulk calculation for the years 5 to 20 they did it for the years 3 to 18. The shortened time has a big effect with an 11% interest rate.

We understand Mr Judge defended this work. We do not think he is a suitable chairman for ACC. He has already criticised ACC's reserves by comparing them to that required by an insurance company. But ACC is not an insurance company and it was never intended that it be one. Building up reserves is just an invitation for corruption as we have alluded to with its National Mail and Feltex share purchases.

The main purpose of this edition was to decry the words on page 37 (page 39 of the pdf file) of the Feltex IPO " In the period from 1993 to 2003, the size of the Australian carpet market has averaged approximately 50 million square metres per annum and the compound average growth rate of the carpet market has been 1.7% per annum"

We say that that statement may be true in its own right but is irrelevant to a proper analysis of what previous years' market sizes suggest future ones might be. The statement takes into account just two of the previous year's market sizes and gives a 50% weighing to one of them, 1993, which is so long ago as to be barely relevant. The years 1994 to 2002 are all more relevant than 1993 but they are ignored. We say the only reason the statement is there is to mislead prospective investors and as such it is fraudulent. The difference between the market size for 2005 as they calculated it and as per least square analysis of the 10 most recent years is sufficient to account for Feltex's collapse. Feltex chose to assume that its market size would grow from its known 2003 size by 1% pa. And it stated that this was below the average growth for the past 10 years. This was not so. The average growth of the latest 10 years of figures was a line which if projected to 2005 was some 3% below the 2003 figure. The 2003 figure nevertheless had a very strong influence in putting a positive slope of about 0.5% p.a. on this line. But there was a considerable possibility that the 2005 figure would come in 5% below the 2003 figure since in general actuals must go as far below the average line as they go above it. We think that is a 7% projected revenue overstatement that could equate to a $15m projected profit overstatement.

At the top of page 91 of the prospectus under the heading of Industry conditions Feltex say they assume the size of their market will grow by "approximately 1% which is below the average growth of the past 10 years". It is reasonable to assume that they are referring to their 1.7% statement on page 37. A correct statement would have been "approximately 1% which makes the 2005 projected size some 7% above what the latest 10 years of historic data would indicate a prudent figure for 2005 to be".

We cannot identify who was responsible for producing the statements but the directors at the time must take responsibility for them. We can however be more specific about review authorities who have chosen not to cite this issue in there reports of investigations which they have claimed to have taken into the IPO. The three liquidators are all members of the Institute of Chartered Accountants of NZ. They apparently don't care a toss about how analysis of historic data is undertaken. "Chose a low year on the left and a high year on the right and so project a line up into the sky" seems to be good enough for them. Then there is Mr Kevin Simpkins, an ICANZ member and also we think an ex Ernst and Young employee or partner who was "retained" by the Securities Commission to look into this IPO. He probably claims to be very skilled in the interpretation of historic data as all such members are supposed to be. Well Feltex said their adopted increase was below the average of the last ten years and what they say is good enough for him. He would not like to get his eyes dirtied by looking at the data and drawing an average line himself. The chairman of the ICANZ Professional Conduct Committee says the matter is of an insufficient nature. $250m is apparently chicken feed to him. As at 10 Sept they had no more professional misconduct hearings scheduled. Only one case seems to have been heard since two were dealt with on 3 March. You would think things would be heating up in that department with a recession being on.

We referred the matter to the Serious Fraud Office. Their reply, which we intend to publish did not give a clue as to where the complaint fell down. They say they only deal with serious of complex fraud. Is $250m not big enough for them? They do not say. Or is least squares of similar analysis not complex enough or is it too complex. They give the impression that only they know what fraud is and it is too complex to tell it to anyone else, and fraud can only be ascertained by some massive investigation. Well that might be sometimes the case. One gets the impression that they "choose" their cases and that is their prerogative. They have no obligation to demonstrate any fairness. Their job is only to get "undesirables", or some such expression that might exclude the ruling classes, into trouble.

Well a date has been set for the trial of the accused five from the Exftx board and management for a couple of indiscretions that allegedly occurred after the board first announced a downward revision of it 2005 profit expectation. Strangely not all the board is being held to be accountable. That is in early April 2010. We understand a defence is that they were relying upon other people to do the jobs properly for them. We understand those other people might be or include the auditors which will make it interesting. Mr Fordon Fulton was supposed to be before ICANZ over this issue but it has not happened. However nobody will be going to prison as a result of the court case. .

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