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Feltex defence lawyers argue ‘rigorous’ due diligence went into 2004 prospectus

Lawyers for directors in the Feltex Carpets shareholder lawsuit have argued their clients went through a rigorous process of due diligence in preparing the prospectus for the failed company's 2004 share sale.

Alan Galbraith, on behalf of counsel for six of the seven directors, denied some 61 principal allegations and 80 related particulars in the lawsuit of Eric Houghton, who is suing former directors, owners and sale managers for $185 million on behalf of 3,639 former shareholders who say they were misled by the 2004 prospectus.

Galbraith said even if Houghton could establish that he relied on an untrue statement in the prospectus that caused loss, the defendants could raise a 'due diligence defence' under the Securities Act that they had reasonable grounds to believe the statement was true.

In opening submissions for the directors, who are the first defendants in the suit, Galbraith took the Wellington High Court hearing through a detailed account of the due diligence process in the months leading up to the IPO.

That included eight formal meetings of a due diligence committee made up of directors and executives, supported by legal and financial advisers, that met eight times between March 19 and May 4. Law firm Bell Gully oversaw interviews with 11 managers as part of the process, Galbraith said.

"That was a very, very vigorous due diligence process," he said.

Issues that arose included that the company might not meet its sales forecast for the year ended June 30. Former chief executive Sam Magill and chief financial officer Des Tolan advised the committee that the 2.8 percent shortfall wasn't material because Feltex still expected to meet its earnings forecasts.

This would be supported by two witnesses, Galbraith said. Former director Joan Withers, who only joined the board in April 2004, would say the process was "thorough, robust and at best practice level".

Rob Cameron, of Wellington investment bank Cameron Partners would give evidence in response to a range of the allegations, including the due diligence process.

He would also comment on the use of EBITDA as a performance measure in the prospectus, the use of normalised profit figures, the relevance of breaches of bank covenants between 2001 and 2003, an incentive plan for directors and managers, and disclosure of risks from rival imported carpets.

The first defendants plan to call 12 witnesses in all, including Tony van Zijl, professor of accounting at Victoria University, who would give evidence on allegations including Feltex's use of forward dating invoices to inflate sales, the recognition of SIP grants as income, the representation of goodwill and treatment of contingent liabilities.

Houghton, the plaintiff, bought 11,755 Feltex shares at $1.70 apiece, or $20,000, in the IPO, drawn to an investment that offered a gross dividend yield of 9.6 percent. All up, vendor Credit Suisse First Boston Asian Merchant Partners raised $193 million, selling 113.5 million shares, and Feltex raised a further $50 million to repay bondholders.

Within a year the stock was virtually worthless, thanks to a series of warnings that the company would miss its prospectus forecasts, and receivers were appointed in September 2006. Australian carpet maker Godfrey Hirst ended up buying the assets.

First NZ Capital and Forsyth Barr, which managed the IPO, are fourth and fifth defendants in the suit.

The case before Justice Robert Dobson is continuing.

(BusinessDesk)