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February 2015 Edition

We wish to commemorate Waitangi Day with a condemnation of Justice Goddard in relation to her decision in the civil case Hedley v Kiwi in the year 2000.

Our condemnation been triggered by the recent appointment of Justice Goddard to leading an UK sex abuse enquiry. We do not believe Justice Goddard is a suitable person for that role because of her conduct in Hedley v Kiwi. We accept that the Hedley v Kiwi case is a now a little historic but this UK sex abuse enquiry is going back to the 1940s and hence is far more historic.

We don’t know whether Judge Goddard is resigning to take up this appointment but we suspect the appointment is going to be treated as a secondment.

Hedley v Kiwi concerns the merger of the co-operative dairy companies Kiwi Co-operative Dairies and Tui Milk Products about the year 1996.

A merger proposal was put to the Tui Milk Products Ltd shareholders about 1996 and it failed to get the required 75% majority to proceed. Certain of the Tui directors then arranged for certain reports to be prepared for the shareholders including one from Ernst and Young and for the proposal to be put to the shareholders a second time. This time it passed and the merger went ahead. Several hundred Tui shareholders lead by Mr Hedley took an action concerning the fairness of this second vote and how it was arranged and in 2000 Justice Goddard ruled against them. Our complaint concerns the Ernst and Young report to the Tui shareholders and Justice Goddard’s reaction to it.

The Ernst and Young report stated that it was using Net Present Value analysis to derive the monetary gain to be obtained by the Tui shareholders should they agree to the merger. When presenting its Net Present Value figure however the report did not make it clear whether this 89 cents per Kg of milk solids “for the years 1996 to 2015” was for each kg of milk supplied for those 20 years or was a notional up front payment for the supply of one kg of milk solids for each of the 20 years. Indeed only if one had a good understanding of what Net Present Value was all about would one tend to think it was the latter, based upon the grammar used.

We claim that this was a deliberate misrepresentation of the Net Present Value in order to mislead shareholders as to what the true financial benefits might be and vote for the merger. We accept that it was not a complaint of the complaining shareholders that shareholders had been mislead over the nature of these claimed financial benefits. Shareholder would say they all knew that 89 cents extra for each kg of milk solids was “too good to be true” and would not wish to insult one-another by claiming that some of them would believe it. However shareholders do sometimes increase their wealth several times over as the result of a company merger. But our main point here is that shareholders had relatively little to gain through voting against the merger. It would mainly revolve around loss of local identity as factories close, and then perhaps schools etc as a result. Although they might not have really believed they would get an extra 89 cents for each kg supplied for 20 years many would not wish to risk turning down such wealth through failure to believe in it.

We claim Ernst and Young deliberately reduced the value of the Net Present Value “payment” to make it more credible that this payment was received every year for every kg supplied. An interest rate of 13% was adopted probably with the excuse that this was the typical rate paid by farmers on their bank overdrafts at that time. But the 13% rate would include an element of compensation for inflation or a short term penalty to dampen inflation. The higher the interest rate the less the net present value. Ernst and Young assumed that the benefit that their models calculated for year 4 of the merged companies would continue each year indefinitely and they did not progressively increase this annual benefit for inflation. They also made an arithmetic “mistake” to suit their purposes which we are happy to explain if I were given a copy of the report. We have lost the one we had.

Justice Goddard’s lengthy decision does not comment at on the Net Present Value calculations contained in the Ernst and Young report although the report had been complained about by the plaintiffs. We submit that she had a duty to read the report and understand the calculations made and how they were presented. We submit that having done so she has improperly failed to take this deception into account in her decision.

Our main complaint however concerns the last sentence of paragraph 226 of the Hedley v Kiwi decision. It perhaps needs to be explained that the merger agreement provides for the former Tui suppliers to have certain deductions from their payments for milk which was referred to as the “differential”. The plaintiffs were particularly critical of the existence of the differential. Also an expert witness appointed by the defense was Mr John Hagen. This sentence in 226 is the only use of the Net Present Value figures in the written decision as far as we are aware. The figures are being used to advance the view that the Tui shareholders were doing very well out of the merger and hence a little bit of rough justice in the detail, if such existed, was acceptable. The sentence reads “he [Mr Hagen] said that EY’s analysis showed that, without the differential, Tui shareholders were projected to be approximately 141c per kilogram of milk ahead of their stand-alone position and even after the differential approximately 90c ahead.” We say that Justice Goddard knew that this 90c was not an extra 90 cents for every kilogram of milk solids supplied after the merger indefinitely into the future; but was the equivalent extra payment received then (up front, one 90c payment only) for supplying one kilogram for each of the next 20 years. It may have been acceptable for her to paraphrase Mr Hagen and say he said that the EY analysis indicated that they stood to do well out of the merger, but once she introduced the amounts of 90 cents and 141 cents into the sentence she had a duty to make it quite clear what she (and he and EY) was/were talking about ie exactly what those amounts in cents represented.. Doing so would bring into question how well the shareholders understood the EY analysis and whether this rather unusual concept for farmers had been fairly presented. The decision makes no mention of farmers possibly getting misled by it. Also the effect of this sentence was to take away any sympathy readers of the decision may have had for the plaintiffs. It is not plausible that she did not know what she was doing.

We have come to the conclusion that like the 2014 hearing of Houghton v Saunders, in this year 2000 case Hedley v Kiwi the plaintiff management was in fact working for the defendants and the action was brought so that a genuine action would not be mounted. We say Justice Goddard well knew this and went along with it.

‘ We wish to comment further on paragraphs 321 to 323 of Justice Dobson’s High Court decision in Houghton v Saunders. It is in fact a gross understatement to say “Feltex was meeting it EBTA, EBITDA and NPAT forecasts”. EBIT for instance was forecast to be $26.385 in FY2004 in the May 2004 prospectus but in fact turned out to be $33.565m according to the 2004 annual accounts. We wish to make two points in this regard:

1 1t is not acceptable to allot subscribed monies as shares when the prospectus contains material variances in sales and various profit figures from that which was known to be the best estimate of what would eventuate. At para 321 Justice Dobson says that sales were materially below that forecast. It is not a valid argument to say these variances don’t matter much because the declared profit is going to be better than that shown in the prospectus. All figures in the prospectus need to be consistent with the best estimates at the time of the allotment. The prospectus showed the best estimate of sales figures to be: FY2003 $314m, FY2004 $335m, and FY2005 $348m. Potential investors would think the 2004 figure should be substantially accurate and the 2005 figure represents a rise over the previous year similar to that for 2004. If the 2004 figure was shown as $329m as was largely known by the directors at the time of the allotment, the 2005 sales figure would have been far more likely to be questioned. Justice Dobson should have found that the allotment was not proper and the directors were consequently liable.

2 The huge reduction in production costs per unit of carpet sold for the FY2004 over that forecast in the prospectus needs to have been explained and Justice Dobson should have insisted upon an explanation. It is not credible to say or imply that this is made up of a host of little things. The only credible explanation is that there has been a cash injection (ie big payment credited to the sales account for little or no carpet) by the vendor of the company. There is little or no cost to making such “sales”. Genuine sales might have been say $307m (consistent with the falling sales trend) and the genuine EBIT might have been about $11m in which case a cash injection of $22m would increase sales to the reported $329m and EBIT to the reported $33m. The $22m would come out of the perhaps $150m received by the vendor leaving plenty to be applied to other agreed purposes. In 2005 sales have fallen with the trend to $300m and this $48m reduction over that projected has caused the EBIT to fall from $41m projected to $26m. It would be understandable for the vendor to wait to the last moment to get assured that the huge payment was coming its way before forking out the injection. Possibly it was made after the IPO proceeds had been received. That the directors have been complicit in failing to declare this injection will have been obvious to Justice Dobson and his decision needed to say what was going on and rule against the directors. This injection has given the impression that the company had turned the corner with respect to sales and profitability.

We have previously said that the time for the directors to take special care is prior to the prospectus being printed and for practical purposes we still say that that is the case. However it seems that for legal purposes the bulk of the responsibility is before the allotment. If the best estimates at that time differ materially from the figures given in the prospectus, the allotment must not proceed and presumably it is necessary to refund the monies. .

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