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July 2010 Edition ----

Well we write this on the fourth day of a hearing of the Disciplinary tribunal of the ICANZ where one Gordon Fulton is appearing on charges resulting from a "review" which his firm Ernst and Young did of the half yearly accounts for the six months to 31 December 2005 of Feltex Carpets Ltd (now known as Exftx Ltd in receivership and Liquidation). A verdict is expected later.

The hearing so far is almost devoid of the public or news media. A hearing had been advised for a month or more on the Institutes web site with little more details than time and place. The place, Wellington, is quite controversial. These tribunal hearings are very frequently held in Auckland but not in this case despite the defendant living and working there together with many other participants in the hearing. It made it harder to guess that Mr Fulton would be appearing and harder for the public closer to the action to attend.

Well the Institute has moved both its Auckland and Wellington premises recently and that might have something to do with it. It has rather nomadic tendencies. The new Wellington premises and hearing rooms are generally well appointed with fine decor, but sound proofing seemed almost non existent. Sounds of crockery collection in adjacent rooms and sirens outside' drifted in as if there was no barrier. Interior sound amplification was also needed. Some witnesses under cross examination were frequently asked to speak up and face the Tribunal (of five) when speaking. In this unrehearsed situation witnesses have to concentrate very hard and it is only natural to face the person asking the questions.

We think a little more attention could be given to indicating that the appeals are open ("unless the Tribunal decides otherwise"). Members of the public were not really expected. "What is your name?" she asked and then started looking for it on a list. The start time advised for the first day was 10am but the hearing did not start until 11.40. The large clock on the wall in the reception area where one had to wait at first appeared to have no numbers on it until one looked carefully at a certain angle when big numbers could be seen. Deceit involving numbers should be avoided by that institution at all cost.

Now to a bit of hearing content. Mr Fulton' defence was that it was really Ernst and Young Australia that did the job and he was (just) the signing partner although in that capacity he was obliged to keep his eyes open for anything that might have been amiss. If "he had had an inkling" that Feltex were in breach of their loan covenants or that the term of the bank loan had been reduced, then he would have investigated, but he did not so have. He had been told in October 2005 that Feltex was negotiating a further loan to finance the closing of an Australian plant and if this went ahead (which it did) then the company would record a loss which would put it in breach of one of its loan covenants with the bank as then existed. He "assumed" that as part of the negotiations for the additional loan Feltex would successfully insist that the covenants be adjusted so the breach would not occur. And he was unaware that this did not happen, and indeed Feltex's loans were reduced from a 12 month to a one month term, when he signed the "review" about 20 Feb 2006. Feltex seemed to have good surplus in its unused borrowing capacity which he thought would give it the power to remain as independent as it had been, which it would have exercised, ( although his firm recognised Feltex as being a high risk company). He was surprised when he eventually found out that that was not so.

Well we think it is a lot to expect the bank to be giving on both scores. He saw the one year term of the loan to be vitally important to Feltex. It seems inconceivable that he would not investigate to see how much rope the ANZ did give it, as he was entitled to do.

Mr Fulton had been the Audit partner for Feltex from 2000 to 2002. Feltex was a concern to its bank, the ANZ, during that time and the firm McGrath Nichol had been appointed by the bank to check matters out (as had also happened in 2005). Mr Painter, an Australian partner then become the audit partner although Mr Fulton was kept in the loop. Both partners worked on the audit of the 2004 prospectus the report of which shows Auckland as the address. As Mr Fulton related Feltex wanted this review report to 31.12.05 to emanate as coming from New Zealand as it wished to avoid the image of being effectively an Australian company, hence Mr Fulton's job as signing partner. We are not at all convinced. We produce here a copy of the final bit of the audit report for the 2005 annual accounts of Feltex which can be found on the online companies office records for Exftx ltd (in receivership and liquidation). It can be seen that the place of signing is purported to be Auckland NZ. There are no other instances of nationalistic flavour to be found in the audit report. The same is true for the 2004 audit report which we have also loaded down (with the annual accounts. According to Mr Fulton the audit partner and signer of this audit was Mr Painter who is based in Melbourne Australia. Whether he did the signing in Auckland we do not know. If it was not necessary to have an NZ signing partner to give the 2005 annual audit a NZ flavour why was it necessary to do so to give the review of the six months accounts to 31 Dec 2005 such a flavour? This mix up is similar to Ernst and Young's work with the 1990 Bank of New Zealand annual audit where Elizabeth Hickey the firm's then Senior Technical Partner seemed to take some major crooked decisions while the Audit Partner, Peter Garty took others. Whether these joint approaches actually happened at the time or were concocted when the firm was called to account is of course speculation.

We rather think if the review report purported to be coming from NZ then the review management should have been based there and had appropriate NZ qualifications.

The case against Mr Fulton said that no mis-conduct was deliberate. We say that improperly restricted the case against him. Although we do not yet know the verdict we are sure this Australia/NZ mix was a jack up by Ernst and Young to avoid a finding against any partner. Mr Painter was not before a tribunal and we did not hear any suggestion that that might be coming up. The Securities Commission complained to the NZ Institute of Accountants presumably because that is where the review report purported to come from. But the defence argument seemed to be if anyone is guilty it is the Australian partner. Mr Fulton was most reluctant to criticise his trans-tasman partner but finally ventured in his distinct UK accent "he could have done better".

Evidence was given that EY Australia had had questioned the $7,999 which was run up by Mr Fulton and his team and this is consistent with it being an Australian job at the time. EY took some time to advise who the Audit Partner was when we complained about the second last paragraph of the IPO audit statement (produced below) some time back. According to Mr Fulton, he and Mr Painter shared that task. Mr Fulton has been in the thick of the deceit and he has been obliged to come in and share the load when the writing was on the wall.

The expert witness for the prosecution was Martin Bloom from Sydney. Like the former Chief Financial Officer of Feltex, Des Tolan, Mr Bloom got his initial accounting experience in South Africa and has had an association with the multinational accounting firm Deloittes. Mr Bloom's association is since 2006 when Deloittes swallowed up the Sydney branch of the Horwath accounting group of which he was a senior partner leaving Horwaths with a Sydney "gap". Anyway although Mr Bloom was critical of Mr Fulton not taking a more pro-active role in the audit he did not place any emphasis on him being told in October 2005 that changes were being made to the banking facility and, as it was, if Feltex makes a loss a banking covenant would be breached. When the tribunal members came to question Mr Fulton however several of the questions were on this matter. This caused Mr Fulton's representative to be granted a break in proceedings for most of Thursday afternoon, while they researched the matter. He argued that that had not been part of the prosecution case.

It shows something of the limitations of accounting when if a company takes generally accepted appropriate action to maintain its long term health it records a loss for the year but if it puts its head in the sand and ignores the needed action it makes a profit. We rather think that if a segment of a business is making a loss and a recovery to profit is unlikely the company should be required to make a provision for the cost of closing that segment down. Perhaps that is the case.

The "prosecution" case was presented on behalf of the Professional Conduct Committee by Michael Reed QC the successful defender from mass murder accusations of David Bain. Mr Reed "conceded" that the alleged offences were unintentional and that we can all have sympathy for Mr Fulton but professional standards needed to be upheld. This we assert is not an appropriate stance for him to take.

The true story which Mr Reed was obliged to put regardless of the instructions of the Institute's Professional Conduct Committee, is that Ernst and Young have been in the thick of this Feltex scandal to raise founds to cheat NZ into medal success at the Athens Olympics. They knew Feltex was in financial trouble in 2002. A $50m injection to alleviate this was not going to last long especially when the company started paying big dividends on its huge shareholding. The auditors were not required to give an opinion on how realistic the assumptions used in the prospectus were but because they were manifestly ridiculous professional persons were obliged to have nothing to do with that IPO whatsoever. Not that we are in anyway inferring that these EY accountants are professional people but that is what the "profession" purports them to be. Given the situation with Feltex in October 2005 the likelihood is that the ANZ did not want it released that Feltex were at the mercy of the bank or trade creditors of Feltex might close up shop bringing the business to a halt and the Bank probably wished it to remain an operating concern while it looked for a buyer. It no doubt was EY's function to this big ANZ business. That is the way it gets its work. These people have got to be locked up.

Our review of the hearing ends here in the meantime.

We think the time is right to revive our condemnation of the second last paragraph of the Audit Report of the May 2004 Feltex Carpets IPO prospectus. This is it:

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 the failure to give the most relevant reason, if a reason is given, amounts to corruption and that should be amongst the charges against the auditor. That paragraph as quoted gives a very reassuring impression to investors. It tends to say "the only reason why we do not say that we think the projections will be met is a reason which applies to any projections".

We think some earlier audit reports for other IPOs advised that the auditors did not give an opinion as to whether the forecasts and projections would be achieved without reason or qualification. This is fair but we believe it was seen as putting people off the investment and so this "reason" was devised. We don't believe that this reason is genuine and auditors are quite happy to get involved in forecasting the future when it suits them. Predicting the future is an important aspect of most fields of endeavour.

We are of course convinced that the auditors along with Feltex directors and administrators, Government representatives, the vendors promoters and brokers of the Feltex offer, and the Securities Commission and its retained expert and the Feltex liquidaters were all party to this bent prospectus to fund improper preparation to enable certain NZ athletes to win medals at the 2004 Athens Olympic Games. This fact needs to be made clear to any court dealing with the Feltex collapse.

Allan Hubbard FCA is a "fellow" of the Institute of Chartered Accountants of NZ. He does not seem to have a public practice certificate but probably he does not need one for what he does. Possibly he has had one in the past. The Institute has run courses in succession planning which claimed it was the responsibility of all those in business. At the age of 82 Mr Hubbard needs a stand in substitute but he does not appear to have one. We think he should not have the "fellow" status on that score. Humans never go on forever and often go a bit wobbly before they conk out.

The chair of the establishment board for the Financial Markets Authority, Simon Botherway, is not a member of the ICANZ apparently. He has a B.Com and is a member of the Financial Planners Assn. We are inclined to think that these planners need comprehensive accounting knowledge. The FPA seem to put much less emphasis on academic qualifications. It seems to be hours of experience which counts with them but who would or should offer this experience to unqualified people seems to be a bit of a mystery.

I seems that when the FMA is established its establishment board will constitute its board but we have not seen anything which says that.

In contrast to Mr Botherway's qualifications the chair of the Securities Commission, Ms Diplock, has qualifications "AO BA (Hons), LL B, DipEd (Sydney), Dip Int Law (ANU), FIPAA, FNZIM". Then we have a Commission member Keitha Dunstan , who has qualifications: PhD (QLD), M Bus (QUT), Grad Dip Mgt (UCQ), B Com (QLD), CA, FCPA . These Commission members both hail from Australia and the new female prime minister over there should be able to find good places for them.

But we are not at all satisfied with the composition of the FMA establishment board. We believe that it is designed to continue the concealment of serious corruption in the Feltex IPO prospectus.

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