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We recommend to shareholders and recent ex-shareholders of Exftx Ltd (in liquidation), previously called Feltex carpets Ltd, that they take a group action against the 2004 auditors of that company, especially if they have subscribed for shares in that company after having read its May 2004 prospectus including the audit report, or after consulting an adviser (official or unofficial) who had done so.

The auditors are not necessarily the worst or most culpable players in the fiasco but they are probably easiest to form a case against, the case requiring the presentation of limited evidence. Such action does not preclude further action against others at any later date prior to or after this recommended action is completed. Don't be led on by people or associations who claim to be investigating remedies for shareholders but won't give details about what they are working on. It is far too easy for these people or groups to have lucrative associations with liable parties and play shareholders along giving the impression that they are doing something on their behalf until too much time has elapsed.

The action we recommend centres on the second to 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. "

The full text of the audit report is given here and auditors' comments with respect to the paragraph are available here.

We say that this paragraph deliberately and unjustifiably comforts potential investors who have concerns about the forecasts and projections by implying that the auditors have investigated the possibility of there being more sinister and unacceptable reasons for them not expressing the opinion referred to and found such reasons not to exist. Other evidence indicates that they had done no such investigations.

We say that the word "expected" in the first sentence refers to substantially honest, sincere, genuine expectations and not speculatively optimistic or fraudulent statements of expectations which could exist in a particular situation. Obviously the latter statements of expectation will frequently or invariably turn out to be wrong so there is no need to say so. Although the variations from expectations referred to by the auditors can be quite profound they are variations of the market economy involving market forces and imperfections beyond the ability of anyone to monitor or control and are part for the environment that all investors in company shares have to accept. The implication is that speculative or fraudulently optimistic expectations have been found by the auditors not to be present in the specific Feltex forecasts and projections. However it can be shown that the auditors were not required to make such a finding and they have elsewhere said or implied that they had not done so.

There should be no need to show that projections or forecasts were reckless or fraudulent and this led to the shareholders' losses. It should be only necessary to show that the shareholder's concerns were unjustifiably negated by this paragraph of the audit report and this possibly or probably led to them to investing and so suffering loss.

Reasons for concern are easy to find in the prospectus and it can be shown that almost all readers would have found them. Here is a table from page 19 of the prospectus.

Summary Financials (adjusted for one-off items)

(EBITDA = Earnings before Interest, Taxation, Depreciation and Amortisation.)

It can be seen that the "anticipated" improvement in profit is colossal as is the 1% assumption upon which it is based (page 91).

We have had a look at some other audit reports forming part of prospectuses containing forecasts or projections around that time and found that despite a different audit firm in some cases, a similar paragraph appears in them all. We suspect that the practice continues to the present. In some cases however the second sentence refers only to forecasts and projections in general and not to the specific forecasts and projections contained in the prospectus concerned. This possibly makes the paragraph acceptable because readers can see that the paragraph applies to all audits regardless of how suspicious the genuineness of the forecasts and projections in the prospectus concerned might be. But also the deception occurs only where there is cause for concern about the genuineness of any of the forecasts or projections and probably for many offers this is not so. Also such deception is probably only able to be cause for an action where there has been a shareholding loss.

Commentators did profit and dividend yield calculations based upon these forecasts and projections and compare the results with forecasts and projections were reliable enough to make this acceptable. Probably this assumption was fuelled by this paragraph in the audit report which we quote. Potential investor might therefore have been unfairly influenced via this channel as well. The forecasts and projections are not treated as figments of someone's imagination and issues surrounding them are most relevant.

While listed companies which are not making share issues are obliged to keep the public informed of their expectations as to profit and significant related matters it seems to be generally done in such a way that the auditors do not get involved. But for share issues the regulation require that the assumption upon which the predicted profitability is based to be declared and that the derivation of revenue and profit from these assumptions be audited. Auditors are thus involved and it is necessary for extent of the involvement to be made quite clear. We suspect that someone with some authority was insisting that a disclaimer along the lines of the second sentence of the paragraph we quote, minus the word "accordingly", be included in audit reports. But probably companies making share offers were unhappy with such a sentence because it might tend to suggest that the auditors had concerns about the particular forecasts and projections. This could have been overcome with a sentence saying that it was standard practice for auditors to make such a disclaimer. But someone has made up this paragraph which implies that the assumptions have been checked over and it is only the ever present risks of the commercial environment that investors have to worry about. But auditors have to take full responsibility for what they say (which invariably is very little) and that they followed on from what was in previous prospectuses is no excuse. .

The claim by the auditor concerned that the first sentence was a "note of caution" we say is an attempt to confuse the issue by considering the interpretation of the sentence in isolation. The sentence is not presented in isolation. It is presented as being the reason for what is said by way of the second sentence, and this is the only relevance accorded it. The first sentence can be assumed to have a true meaning in its own right and readers are free to examine it in isolation as much as they like for all the information which can possibly be gleaned from it. But in isolation the message is not what the writer is communicating to the reader. It is incidental to that. And most if not all readers are only interested in taking in what a particular writer has got to say. They are not interested in passing away the time of day by examining information which comes their way incidentally for anything of value it might hold. But anyway the first sentence of the paragraph only advises of risks that are always inherent in owning shares and it is necessary override such warnings in order to get the potential benefits of being a shareholder.

We invite solicitors to offer their services for such a joint action.

---- You are invited to participate in a survey on the matter by clicking here

The following is the text of the audit report.

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