Ministry of Economic Development v Feeney and Ors Dc Ak

 
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IN THE DISTRICT COURT AT AUCKLAND

CRI-2008-004-029199

Between
Ministry Of Economic Development
Informant
and
John Michael Feeney
John Carlaw Hagen
Peter David Hunter
Timothy Ernst Corbett Saunders
Peter Thomas
Defendants
Counsel:

B Dickey and S Symon for the Informant

A Galbraith QC, D Cooper and S East for the Defendants Saunders, Hunter and Hagen

P Davison QC and R Woods for the Defendants Feeney and Thomas

RESERVED DECISION OF JUDGE J M DOOGUE
INDEX

page

Introduction And Summary Of Conclusions

4

Financial Reporting Act 1993 And The Charges

6

Sections 36A and 40

6

Charges

7

First Charge

8

Second Charge

8

The Law

9

The relationship between the FRA and the Companies Act 1993:

Are the directors entitled to rely on s 138 of the Companies Act 1993?

9

Common law principles

15

Assistance from Australia

18

Material conclusions from the authorities

19

Material Background Facts

20

Importance of temporal context in which the statement was prepared.

20

ANZ Bank facility

23

Feltex's expectations of ANZ at material time

24

Reasonable and Proper Steps to ensure compliance:

What Steps Did The Feltex Directors Take?

26

• Placed reliance on a qualified, competent and well resourced management team

27

• Established a comprehensive transition process from GAAP to IFRIS

29

• Engaged a highly reputable accounting firm (Ernst & Young) to prepare an IFRS assessment report identifying key areas issues that needed to be addressed in the transition

31

• Created and established a steering committee comprising Feltex's own financial management and supervised by Ernst & Young

32

• Engaged Ernst & Young to conduct a review of the Feltex half year accounts to 31 December 2005

33

• Obtained declarations by the CEO and CFO in relation to Feltex's compliance with the FRA which certified that the company's internal financial controls were adequate and effective

34

• Used an appropriately constituted audit committee whose responsibilities extended to overseeing the integrity of the financial reporting and control process

41

• Messrs Thomas and Feeney relied on the recommendation of the audit committee

43

Additional Steps The Informant Submits The Directors Should Have Taken

44

Fundamental question: Did the directors have to do it themselves?

45

Were the directors:

• themselves required to engage in a study of the accounting standards and the way they applied to Feltex?

• themselves required to engage in a study of the interim financial statement to satisfy themselves that the statement complied with the standards?

Specific steps advanced by informant

51

• They themselves should have looked at the standards

51

• They should have specifically asked of Ernst & Young if the classification of the ANZ facility was correct or not

51

• They should have asked Ernst & Young for an opinion on the impact of the ANZ facility on the reporting requirements

51

• They should have ensured Feltex's financial management team knew how to properly deal with the implications of the ANZ facility on the reporting requirements

51

• They should have asked management for an opinion on the impact of the ANZ facility and the reporting requirements

52

• They should have known to report the breach of covenants within the facility

52

• They could and should have asked ANZ for a written waiver in anticipation of the breach of covenants as at balance date

52

• They should have ensured that Ernst & Young had all the all the relevant documents and information to perform the review

52

• Messrs Feeney, Thomas, Saunders and Hunter should have asked Mr Hagen to interpret the standards

53

Ernst & Young's Failures

54

Conclusion

59

Schedule

6

New Zealand Institute of Chartered Accountants Web Page

New Zealand Equivalents to International Financial Reporting Standards

INTRODUCTION AND SUMMARY OF CONCLUSIONS
1

The defendants (“directors”) were directors of Feltex Carpets Ltd (“Feltex”), a company listed on the New Zealand Stock Exchange (NZX). Each of the directors faces two charges under s 36A of the Financial Reporting Act 1993 (“FRA”). In short, it is alleged that a statement containing interim financial information for the half year ended 31 December 2005 failed to comply with applicable reporting standards required by the FRA and that the directors have failed to prove that they took all reasonable and proper steps to ensure that the applicable requirements of the FRA would be complied with.

2

Feltex announced its half year results and issued the statement on 20 February 2006. The statement was approved by Feltex's Audit and Risk Management Committee (“audit committee”) and recommended to the board for adoption at the audit committee's meeting of 16 February 2006. The board approved the statement at its meeting on 19 February 2006.

3

The directors all accept that the statement failed to comply with the applicable reporting standards. The issue I have to determine is whether the directors did or did not take all reasonable and proper steps to ensure that the applicable requirements of the FRA would be complied with.

4

As at December 2005, New Zealand was in a transition period from its previous accounting standards (“GAAP”) to the adoption of the New Zealand equivalent of International Financial Reporting Standards (“NZIFRS”). Feltex chose to adopt NZIFRS as early as it could. Its 31 December 2005 interim financial statements were its first financial statements prepared under NZIFRS. Feltex was one of the first New Zealand companies to report under IFRS.

5

Feltex's directors knew that the new standards were complicated and voluminous and that they had to be worked through with an eye for the detail and any significant changes. They resolved it was necessary for the company's credibility to position the company to be able successfully to effect the initial transition to utilisation of IFRS and to secure their successful ongoing utilisation. So they set up comprehensive processes and procedures to ensure that these outcomes were attained. They took these steps not because they were seeking to protect themselves but in order to promote the interests of the company by ensuring compliance with the FRA in this new and challenging accounting standards environment.

6

One of the charges relates to a failure of the financial statement to disclose breaches of which the directors were aware of certain financial covenants contained in an ANZ Bank facility agreement. The other concerns a failure to classify the ANZ liability as a current liability. Some readers of this judgment might think — if directors know there has been a breach of a financial covenant in a facility agreement, it follows that the breach should be disclosed in the financial statement; and if directors know that a breach of a financial covenant, or some other circumstances, permits the lender to call up the loan, it follows that it should be classified as a current liability. That is a logical view to take of matters at first blush. Somewhat surprisingly for the uninitiated, those were not the requirements under the previous accounting standards which favoured a substance over form approach — to be contrasted with the more prescriptive, form over substance, approach of the new standards. Under the substance over form approach of the previous standards which had prevailed during the professional lives of these directors up until this point, they were entitled to form a view based on expectations of what the lender would actually do, irrespective of the lender's strict legal rights. The evidence concerning the dealings between the company and the ANZ Bank demonstrated that during the material time Feltex's directors and management, and indeed their specialist accounting advisers Ernst & Young, were entitled to and did hold the view that ANZ would not be relying upon its strict legal rights and would be providing continuing support for the company. This state of affairs meant that the financial statement complied with the requirements of the previous standards. But it was insufficient to meet the requirements of the new standards.

7

As will appear from the body of the judgment, the IFRS standards are highly complex and presume in-depth knowledge of accounting principles. Those applying them and advising in relation to them have usually undergone specialist training because their interpretation and application requires highly specialised expertise within an already specialised field. Specialist auditors look to technical directors for assistance on their interpretation and application. These directors were entitled to seek and rely upon specialist advice. Ironically, it seems clear that the company's specialist advisers were themselves judging the financial statement by reference to the requirements of the previous standards rather than the requirements of the new standards. That is the single most important reason why the directors have ended up having to face this prosecution.

8

Having considered the evidence, the legal principles applicable and the respective submissions of the Crown and Defence, I find each of the directors not guilty of the charges laid. I find that they did take all reasonable and proper steps to ensure that the applicable requirements of the FRA would be complied with. My detailed reasons are contained in the body of this judgment.

9

There is also overwhelming evidence that these directors are all honest men, and that they conducted themselves at all times with unimpeachable integrity. There is not one skerrick of evidence to suggest any intention by them to mislead the regulatory authorities, market, shareholders, creditors, potential investors, or...

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