Feltex Carpets Limited
IPO Prospectus, Financial Reporting and Continuous Disclosure

The Commission has inquired into the 2004 IPO Prospectus of Feltex Carpets Limited (in Liquidation) ("FTX"), and FTX's compliance with financial reporting and continuous disclosure obligations in the period between its listing in 2004 and the appointment of liquidators to the company in late-2006.

The Commission's inquiry has concluded that:

• the prospectus was not misleading in any material particulars;
• FTX failed to disclose certain material information to the market concerning changes to its facility agreement with ANZ in October 2005;
• FTX failed to disclose the breach of its banking covenants in its 31 December 2005 half-year financial statements; and
• FTX did not properly classify its debt in its 31 December 2005 half-year financial statements.

The Commission has determined that it should report on the findings of its inquiry. It has found a failure to disclose material changes to the banking facility in October 2005, a failure to disclose the breach of banking covenants, and a failure to properly classify the company's debt in the December 2005 half-year financial statements. These matters variously raise issues about the governance of the company by the FTX Board and about the conduct of FTX's auditors, Ernst & Young.

FTX is now in liquidation and its shares are no longer trading on the NZSX. As liability for continuous disclosure breaches lies only against the issuer concerned, there is no realistic chance of taking enforcement action in these circumstances. Under the law in force in 2005 directors and officers of companies could not be held liable for continuous disclosure breaches. Therefore, no question arises of action against any individuals.

In late 2005 it was widely known that FTX was in difficulty. At that time FTX was dependent upon the continued support of its bank, ANZ. It appears that the FTX directors failed to comprehend the significance of changes made to the debt facility agreement that were designed to protect the position of the bank, and so failed to adequately inform the market of these.

The FTX board's failure to disclose the breach of FTX's banking covenants in its 31 December 2005 half-year financial statements raises questions of compliance with the Financial Reporting Act 1993. Certain defences may be available to the directors, including that they "took all reasonable and proper steps to ensure that the applicable requirement of this Act would be complied with." The Commission found that the directors did take certain steps, as described herein. Nevertheless, the Commission is of the view that the FTX board failed to pay sufficient attention to the breach and failed to consider whether there were financial reporting obligations arising from the breach. The Commission refers this matter to the Registrar of Companies.

Questions of liability under the Financial Reporting Act arise only in regard to the conduct of the directors of a company. Therefore, the Commission is not able to refer this matter to the Registrar of Companies in regard to the conduct of FTX's auditors, Ernst & Young.

FTX's failure to properly classify the debt in its 31 December 2005 half-year financial statements has highlighted that the classification of debt in interim financial statements is not expressly addressed by an applicable financial reporting standard. The Commission refers this matter to the ASRB to consider whether any guidance or other action is necessary.

The improper classification of debt was a breach of New Zealand Generally Accepted Accounting Practice ("NZ GAAP"), but it was not a breach of an applicable financial reporting standard. Questions of liability under FRA arise only where there is a breach of an applicable financial reporting standard. Therefore, the Commission will not refer this matter to the Registrar of Companies in regard to the debt classification issue.

The Commission is of the view that the work undertaken by Ernst & Young New Zealand in relation to the review of the December 2005 financial statements failed to meet the standards required for such an engagement. The Commission refers this matter to NZICA.

While the issues referred to above raise questions about the performance of the FTX Board and its auditors, the Commission is not suggesting that these issues are the reason that FTX failed. The Commission has heard from witnesses that the collapse of FTX was due to a combination of factors. Such factors included the high fixed costs inherent in the carpet manufacturing industry and those particular to FTX, the need for restructuring, the decline in the Australian housing market, and the competition from Asian carpet manufacturers. It is the Commission's view that the FTX collapse was not caused by securities or financial reporting matters, and accordingly, the Commission will not comment on the FTX collapse.