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October 2010 Edition ----

Well its way past time but the Disciplinary Tribunal of the New Zealand Institute of Chartered Accountants has found a charge or two proven against Gordon Aud Fulton. There were several charges that were not proven but we think that they were just thrown in to make it look like he didn't do much wrong.

The charges related to a review Mr Fulton's firm Ernst and Young did of the half yearly accounts to 31.12.05 of Feltex Carpets Ltd, now called Exftx Ltd in receivership and liquidation.

The decision has got a bit of length. We will go through it and point out the bits that don't sound quite right to us.

As 1.2 says it was a referral from the Securities Commission. We say it took far to long to action but the judgment does not comment on that.

Then in Section 5 we come to the Australian involvement. 3.2 says Mr Fulton was the auditor in 2000, but the Feltex office moved progressively from Auckland to Melbourne (we did not realise that) and Mr Painter did most of the audit work from over there. In 5.5 we hear that "Mr Fulton stated that Feltex.s request of Ernst & Young to carry out the Review was made to Ernst & Young Australia". That is not quite the full story. Para 101 of MED v Feeney indicates that Mr Painter of E&Y Australia suggested to Feltex that they do a review of the half yearly accounts. Anyway as 5.5 says because the directors wanted to project a NZ flavour Mr Fulton signed the review report "(as with previous audit reports)" on NZ letterhead. Well firstly if the Feltex office was effectively in Melbourne we say it was deceit to go along with the directors and suggest otherwise although it was an NZ company subject to NZ law. We say that the Tribunal should have made an observation along those lines as well. We don't believe that that was the real reason for Mr Fultons involvement. We think it was to divide up the blame for the unqualified review so that with some luck neither party would get into trouble. Then we are sure that it was stated that Mr Painter had been the audit partner in recent times. Well if Mr Fulton was doing the signing he was carrying the can. He was the auditor.

Now we will jump to para 6.5 where for whatever reason Mr Fulton tells of Mr Painter phoning him saying that a restructuring is proposed and if it went ahead Feltex would breach its banking covenants unless the covenants are altered with ANZ's agreement. Well that is very specific and Mr Fulton has remembered it or chosen to say he did. Well we assert that any other involved person hearing this would say "its going to be interesting to see if the covenants are altered". Anybody else would be interested to know just how much tolerance the ANZ was prepared to give. Before the IPO Feltex had just one owner and that owner was probably rich and could manipulate Feltex's financial ratios as it wanted. That owner was completely gone now. None of the many new shareholders was going to come to the party with financing. It was a different ball game now.

In 6.6 Mr Fulton says his thinking was that it would make no sense for Feltex to enter into a revised loan agreement which it would breach two months later. This thinking does not make sense. Feltex's only hope no doubt was to get some more money to do some restructuring to get some viability back. It will breach its covenants and will be at the mercy of the bank. So what? Well the market might will not like that very much and the suppliers could withdraw their credit and close the company down but that is a risk that can be taken. He has said (7.9) that he recognised that Feltex was dependent on the ANZ. Its not such a big deal to make it official. We say this scenario of Mr Fulton's reasoning is not credible.

We say the likely scenario was that E&Y agreed not to notice that reporting of the bank loans in the accounts to 31.12.05 was not correct. It is probably a service rendered to the ANZ who no doubt wanted to keep up the market value of the company, and an aftermath of the IPO. Mr Fulton and Mr Painter apparently worked together on the IPO. They knew the ANZ had been worried about recovering its loans in 2002 and a $50m debenture which kept Feltex liquid was being replaced by funds from the IPO if successful. The knew there was no value in the shareholding for the invited $250m to buy. They may not have certified that it was a reasonably buy but that was not good enough. They knew that what was happening was a steal and they should have had nothing to do with it. The second last paragraph of the audit report with the prospectus suggests that the only reason they did not say they believed that the projected profit would be achieved was a reason that applies to all predictions of the future. That impression of course was wrong and we believe that they knew it.

It is obvious to us that they are in the business of meeting the wishes of big entities no matter how outlandish those wishes are. In this case it was to help the Government out with secret millions of cash for cheating to win some gold and silver medals at the Athens Olympic games.

Let us now go back to the case MED v Feeney and revisit the judgement. In paragraph 62 it is said "The previous standards, which had prevailed for many decades, favoured substance over form but NZIFRS, in respect of the standards relevant to this case, appear to favour form ahead of substance." Well this does not make much sense. Substance and reality go hand in hand. Then in para 64 the judge "explains" about of the previous standards "Therefore, regardless of the strictly applicable legal terms of the relevant facility, a company could still legitimately classify debt as non-current if it reasonably expected that the debt would not be called up in the next twelve months." She does not explain where she got this rubbish from. How subjective can you get. "Ooh Yea, we should be able to hang on for another 12 months".

We much prefer (would you believe it) Ernst and Young's version as given in paragraph 172 of the Securities Commission's report of 11 October 2007, where it says there was not a significant change in the requirements for the classification of debt from previous GAAP to NZ IFRS. The Commission in the following paragraph, 173, and later strongly disagrees with this claim but nowhere did it spell out what the difference was. Just because the new regime, NZ IFRS spells out what is patently obvious does not mean that there is a difference from the old regime. The Feltex directors were claiming that ANZ were not threatening to bring in the receivers which was the only excuse they had for not questioning the "non-current" description which the debt was given in the accounts to 31.12.05. Neither standard is about the attitude which the lender appears to be taking but somehow the impression is being given that the old standard did. The directors and most everyone else knows that a lender does not preserve wealth in a borrower company by saying it intends appointing receivers in a few days or weeks or months. That is just inviting the assets to disappear. The first a company knows about it is a receiver turns up, presents his credentials and says "I will take over now thank you". Until then the lender encourages "business as usual" so that as few people avoid doing business with the company as possible. The notice required to call up these loans was reduced from one year to one month. That is a good indication of what the bank was thinking. This change also suggests that it was prudent to check out what the requirements of debt classification are regardless of what regime is in place.

Changing of accounting standards is no good for justice. Always the new standards are perfect and not to be questioned but the old ones are "perceived" to have gaping holes. Accounting theory has been well understood for 50 years and there is nothing new to be learned about it. But always there are influential politicians and professionals who want some scandalous project to "get through". So a new set of rules are bought in and the argument presented that the offending was OK under the old rules. There is a belief that the new rules are now in place so its no use arguing about what the old rules were. Well this nonsense is not near good enough.

Well a court is just another forum even although its judgements have more consequences that most judgements. It appears that Judge Doogue has been "educated" by the Government into what the verdict should be. We dot not know what the huge time gap in the hearing was all about. It is contrary to good justice. Perhaps the educating was being done then. The MED, also under Government direction, has decided not to appeal the case so that is that.

As we have said before readers to financial accounts rely on the fact that two independent entities affirm the accounts, the directors and the auditors. It is critical that neither party relies on the other. If each of these two parties relies on the other the accounts have no credence at all. The directors would know this principle.

Its time to consider news and journalistic effort relating to the Feltex saga.

We have nothing but contempt for the press articles turning up in an attempt to sanitise the Feltex scandal. The latest on Stuff was on 29 Sept was "director believes in making a difference" or some such and was on Joan Withers. She sure has made a difference. She has dragged down the living standard of every NZer by a double digit percentage. The $250m she lured out of "Mum and Dad" investors to be squandered overseas is just the beginning. The lack of logic by which finance people have got into trouble have thrown the financial markets into turmoil and people are not inclined to use them any more.

Ms Withers asserts that she wouldn't have done anything any different with the benefit of hindsight. Well she is certainly not fit to be a director if that is the case. She is saying that she would not have checked out the prospectus before joining Feltex, and would not have refused to join based upon what she would have found. And she would not have warned the public that the IPO was fraudulent. The interview was with a female journalist of Fairfax, the company she was CEO of for 4 or 5 years. It is obvious to us that this company is supporting the Government by suppressing the Governments cheating exploits. They have got tied into it we suppose.

But the northern opposition, the NZ Herald, is no better. On 7 Sept published this piece by Susan Watson head of the Commercial Law at the Auckland Business School. This followed the acquittal of the Feltex five directors. The theme of much of the article was that some NZ directors were oh so ethical but oh so incompetent which could not be further from the truth. The reverse is the case. Directors are very competent but many are bent. Ms Withers is on the MBA advisory group of that school and of course Elizabeth Hickey the one time Ernst and Young technical expert who oversaw the $65m+ overstatement of the 1990 Bank of New Zealand profit as auditor is a professor at that school. Ms Hickey resigned from the Securities Commission shortly after another ex Ernst and Young partner, David Jackson did so. Mr Jackson resigned from the Commission because surprisingly it bit him. He was a director of this company, Nuplex, who did not keep the market informed of some happening so he is before the courts in due course.

Mr Jackson was chairman of Ernst and Young board of management from 1999 to 2002 it is said. He continued to have a senior role there and on the NZICA for some time after that we believe.

We would also like to mention John Judge. He was the CEO partner of E&Y over a similar time period we think. He left there and became chairman of the Accident Compensation Corporation which is audited by an E&Y partner. We thought the audit report for the ACC should have declared this connection with the chairman because it was not long ago that the chairman was the auditor's boss to a degree. We complained to the NZICA about that but they would not hear of it. Anyway there is an investigation going on at ACC at the moment over the renting of properties for its business premises. Some rents paid seemed rather high and the ACC employee responsible for this work got the sack for not following instructions. Its the sort of thing an auditor should be on the lookout for and perhaps they were involved in picking it up. But information supplied to the Minister of ACC seemed to have been the trigger.

Anyway we say these board of management people of E&Y should be having major developments with the cliental brought to their attention and we expect that they do. And we say that an IPO of the long established Feltex Carpets should have raised alarm bells. They should have known that the Australasian carpet manufacturing had considerable tariff protection that was being phased out. They should have wanted to see that prospectus before it is signed off. We think that they should have known what was going on and that it was improper.

The Dominion Post we think confirmed our suspicions that Mr Fulton had been chairman of E&Y NZ in comparative recent time. We thought that but then could not find any evidence of it. It was an attempt to frighten off any accusations we think. Now the National Business review seems to be saying that Mr Fulton is gone from E&Y but we can't be sure. You have to be a paying subscriber to get the information. Such information does not even go into their $10 newspaper. We think they are unfairly targeting the hapless Mum and Dad Feltex subscribers

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