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Well hot off the press we have advice of an Institute of Chartered Accountants of NZ Professional Conduct Committee decision involving a complaint on an aspect of the audit report forming part of the 2004 prospectus of the Feltex Carpets Initial Public Offer. Acceptance of this public offer by way of a subscription resulted in financial loss to most everyone who partook, many to the full extent of their subscription, as things stand at the moment. It cost the country around $200m.

We trust that this advice, which we say shows the committee have buried their 12 odd heads deeply in the sand, can be accessed by clicking here and the response to the committee of the auditor concerned can be accessed by clicking here. In the meantime at least we have suppressed the names of the principal people involved but not the firm name.

The complaint centers on the second last paragraph of the audit report which reads as follows "Actual results are likely to be different from the forecast and projected financial information since anticipated events frequently do not occur as expected and the variation could be material. Accordingly we express no opinion as to whether the forecasts for the year ending 30 June 2004 and projections for the year ending 30 June 2005 will be achieved. "

We say that the word "accordingly" implies that the substance of the first sentence of this paragraph is the reason for declining to express an opinion as explained in the second sentence. We claim that the auditor (Institute member) confirms this in the auditor's response where it says in the second last sentence of the 4th dotted paragraph " i.e. to provide assistance to the reader, we are explaining why we do not provide an opinion".

We believe that this reason is not "the" genuine reason because:

a: Very few if any readers would not be well aware of the inherent risks of owning shares as explained in the first sentence of the paragraph complained about and the auditor would be well aware of this. To the extent that need to provide "a note of caution" could be valid it would be far more effective to advise those new to investing in shares to seek professional advice or take an educational course on the subject before getting involved. But the prospectus itself is riddled with such warnings, we suspect so any potential complainants know they will be greeted with "don't say we didn't warn you that you could lose you money", so there was no need for the auditors to jump on this bandwaggon as well. They should have been concentrating on explaining the scope of their audit and what they found in carrying it out. They are one of the few sources the investor has for what is going on inside a company. Many more people are qualified to comment on a company's external environment and the pitfalls which it might contain, and do.

b: A far more substantial reason would be that in order to responsibly express the opinion the auditor would have to fully evaluate each of the assumptions upon which the projections and forecasts were based (henceforth called "the assumptions") by obtaining all relevant knowledge of how they were adopted as known to Feltex. This would be a difficult and onerous task which would not have been contracted for and hence would not be paid for. Indeed putting such an opinion in their report would possibly constitute a breach of contract. Feltex might not have been amenable to the auditors expressing such an opinion at the time the contract was entered into as Feltex would not know what the opinion would be and they might have decided to approach other accountants to do the work without expressing such an opinion. The forecasts and projections can only be as good as the assumptions so the validity of the assumptions is highly critical to the expression of this opinion. We say that these considerations are far more relevant to the decision on whether to express the opinion than the reason given.

We claim that the true reason for the first sentences of the paragraph complained about was to effectively negate the effect of the disclaimer which comprises the second sentence when the word "accordingly" is omitted. This is because far more people will be inclined to subscribe to the offer when they are lead to believe that the only reason a positive opinion was not expressed was because of the inherent uncertainty of dividends and future share value that all shareholders in all companies must face up to. Without the reason the disclaimer is very stark and invariably gives the impression that in dealing with the assumptions as they have to, the auditors have developed grave concerns about the validity of the assumptions, wish to have as little as possible to do with them, and wish to somehow convey that. But the reason as contained in the first sentence not only neutralises the stark effect, it negates the whole disclaimer and turns it around.

It would be a lot fewer words and a lot more meaningful to just say in the second sentence "accordingly we do not express an opinion on whether any forecasts or projections in any prospectus will be achieved" but instead the auditor makes a point of applying it to the Feltex forecasts and projections only so giving the false impression that they had determined that there were no others reasons not to give a positive such opinion in this particular case.

We believe that the disclaimer has been forced upon the auditors by some authority, official or unofficial, and the reason has been appended to the to give the opposite message to the disclaimer to keep in good with the clients. The disclaimer of course is not really a piece of new information. It merely confirms what most people will have observed. Its usefulness is in saying that if you are looking for the expression of opinion referred to you should probably give up, and if you think you saw such an expression you should check it out again because you probably were mistaken.

We say that the "note of caution", which the first sentence complained of is said to contain' will not be taken aboard by investors anyway because they will correctly see it as a reason for what is stated in the second sentence and not a message in its own right. It is true that the cart somewhat becomes before the horse. But there can be good reasons for doing this and with the correct harnessing and wording it works near enough. When one sees the cart coming around the corner one might jump to the conclusion that it is travelling by way of its own motor ie is a message in its own right, but then when one sees the horse one realises that both horse and cart retain their normal functions and things are not that much different. The initial idea of a cart with its own motor is forgotten about because a sound explanation has been found.

In preliminary discussions the Institute suggested that in earlier audit reports relating to share offers of other companies these to sentences had appeared but with the word "accordingly" omitted. They were thus two sentences on two different topics. Then someone got the idea of linking the two. The Institute suggested that there was nothing wrong with just linking them. Well there are hundreds of words and phrases which might be used to link such sentences so that the narrative flows better but one has to be chosen which does not change the meaning and "accordingly" is not such a one. We suggest the phrase "We also advise that" would have filled the bill. We say that when the word accordingly was added the message applying to each sentence disappeared and a new message about the relationship between the two was substituted. We believe that the Institute had probably dug out some evidence to support their contention. The contention does explain the cart before the horse situation and is in general most credible. The auditor's response does not support this contention however as can be seen. We suspect that this explanation was probably held up the auditors' sleeve and they were considering responding if need be "sorry about that Chief but a junior staff member thought the sentences would be better linked like that and it just got through". They always like to have a "bungling" explanation on hand as it is far better to be perceived as being a bungler than as being a cheat. In 1993 the Securities Commission found that this audit firm made a large number of "unfortunate " mistakes and misjudgments in their 1990 work papers which resulted in the Bank of New Zealand getting an unqualified audit despite a $55m profit overstatement. They were suspicious of the incorrect accounting treatments right from the start of their audit but then just "happened" to make a series of blunders. Certainly the claim by this prospectus auditor "we are explaining why we do not provide an opinion" does not ring true for reasons previously given and the fact that they probably had no reason to consider whether to provide such an opinion because they would not have been asked to do so.

We say that there is nothing wrong with a company telling prospective investor how they expect the company will perform by way of forecasts and projections. Indeed it is highly desirable that they do so so that everyone who might like to subscribe gets a feel for the envisaged future performance. But such communication is highly subjective and needs to be taken with a grain of salt. On one level the auditors seem to be saying that they have formed the opinion that all forecasts and projections in prospectuses should not be allowed because they are too subjective and they will have nothing to do with them. But because they refer to the particular Feltex forecasts and projections and not forecasts and projections in general the untrue inference is that they checked out these particular forecasts and projections and found them to be soundly based, but they cannot say so because of this policy that they have which applies to all prospectuses. The assumption to be derived from the paragraph is that if they had been unsure about the validity the assumptions it would not be appropriate to give this always applicable fall back reason as the reason for their disclaimer. A disclaimer with a reason for it is a qualified disclaimer and so is possibly not a disclaimer at all. It invites the reader to speculate what would be the case if the reason did not exist or is igored.

We say that readers of the prospectus, before they read the audit report, had good reason to be highly wary of certain assumptions such as a one percent increase in market share when the company was 80 years old and its market was increasingly being opened up to low cost foreign competition. They also had cause to be wary of the huge increase in the projected 2005 profit over that forecast for the previous year. It is our opinion that by way of their "reason" in the first sentence complained about the auditors have effectively said that there was no need to be wary of the validity of those specific declarations and the only thing to be concerned about was inherent uncertainties applicable to the owning of shares in general. Yet they have elsewhere indicated that they have not checked out the validity of the assumptions, in line with not being required to do so. The effect of the paragraph is to negate reader discrimination between share offers as to the validity of claims made and we say that such discrimination is most essential to minimise fraud.

We believe that people who subscribed to the issue after having read the audit report, or had an adviser who read the audit report have good cause to seek redress.

But we wish to go on and further rubbish the claim in the auditor's response that "Collectively, these two statements caution the investor that actual results may vary from the projections and forecasts". We say no. The paragraph takes the form "[Statement A] is the reason for [Statement B]" which has been expressed "[Statement A] accordingly [Statement B]". The writers, the auditors, are in what they said in this paragraph not asking the reader to take on board either or both A or B as independent statements. Their only message is that A is the reason for B. Obviously one has got to know what A and B are to make sense of the message but the two statements are not messages in themselves. One is only being asked to absorb the fact that A is the reason for B and the implications that that might have and we say that most or all readers are disciplined enough to observe this. They have been conditioned by hype to believe in such auditors and to follow what the auditors are in fact telling them and not to get side tracked. Neither A or B in their own right will be news to the great majority of readers anyway, "A" being basic knowledge to all investors, and "B" having been already established because no such opinion had been encountered, so the temptation to get side tracked is minimal. It is true that readers are free to study A and B as intensely as they like and perhaps get some education from the exercise. The great majority of people to not have the time to study everything they stumble across however and are only interested in what people they assume are reputable put up to them. The readers will thus be all attention to what the auditors are actually telling them (not what the auditors later say they are telling them) and will have the expectation that it will be told accurately. l

To illustrate that A and B are not to be considered as messages in their own right given the way that the paragraph has been expressed, should anyone not be convinced, consider the following paragraph in the same form.

" I had soiled myself and was in much need of a shower. Accordingly I took off all my clothes."

Let us assume the context was such that the writer was present in a place where it was rather or most inappropriate to go naked.

Now a realistic scenario is that the writer desperately wants every reader to ignore completely both Statement A and Statement B as independent statements and to forget both of them if that is possible. Both statements are highly embarrassing to him. The reason he disseminated the statement is possibly that he believes that he has been seen naked and he wishes everyone to know that he has a relatively innocent explanation so that perhaps then they will not take action against him. Hence it can be seen that when one says "A is the reason for B" there is no assumption that the writer or speaker wants you to take note of A in its own right, nor is there an assumption that you are wanted to take note of B in its own right.

We say that what is said in an audit report is highly important. We say this auditor is feeding the Institute this nonsense and the Institute knows it but is unprepared to take action.

While the paragraph, which is claimed to cautionary effect, does in fact encourage investors by implying that investments pertaining to all prospectuses where the paragraph is used check out well and only some peculiar principle stance of the auditors prevents them from endorsing the projections, such general encouragement might have its good points.

On average public company shares have generally yielded well in the past and it is a commonly held view that they will continue to do so. There are some potential share investors who are deterred by the inherent uncertainties and a little deception to get them on board is potentially good for them. We reject such a practice however, widely use as it might be, because deception is evil and once you start it where will it end.

However the greatest evil of the paragraph in question is that it negates investors perceptions of which public offers are worth the risk and which are not. The whole purpose of a prospectus is to assist investors to come to such a conclusion and be right as much as possible. But the paragraph effectively says: "Any fears you have on this investment are unfounded. The only reason we don't endorse the projections is inherent uncertainty relating to all shares which you know about."

We end this particular discussion (the issue will not end with an analogy to the legend of Lady Godiva.

We expect that that a reporter of this event may well have attempted to convince a censor that the substance of the tale was that the lady had ridden on a white horse through the city and hence the focus was on the fashionableness of white horses at the time. Similarly this auditor is saying that the paragraph focused on the genuineness of the dangers of investing in company shares, which is equally pathetic.

The Godiva tale would likely have lured the populous to be present at the fine lady's next public outing, although their hopes or expectations for this next event might not have been fulfilled as they would have wished. Similarly the NZ investing populous will have had their disquiet over the Feltex projections dispelled by the auditors effectively saying that their failure to publicly agree with the projections is only because of uncertainty which is applicable to earnings of the shares of all companies. They thus were lured to use their cheque books to unload themselves for expectations that had no hope of being achieved.

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