15 September 2014

Feltex: Houghton v. Saunders

The over three thousand disgruntled Feltex investors who joined a class action demanding compensation after the 2004 public float were left bereft after a High Court ruling that the float prospectus was not materially misleading as to content or omissions and that even if it were no compensation would have been payable since the share price did not drop noticeably immediately after the float.
Shareholders buying into Feltex in 2004 saw the share price drop by two-thirds over the next two years, with Feltex then going into liquidation.  A class action followed, claiming investors were misled when investing.
The 2004 public float enabled Credit Suisse First Boston to sell down its interest in carpet manufacturer Feltex.  While the prospectus identified numerous risks facing the business it generally portrayed an improving financial position for the company.  The issue price at $1.70 per share implied a gross dividend yield of 9.6%.  Six months after the float, directors reported trading results that were up on the previous period, announcing an interim dividend 15% higher than the interim dividend projected in the prospectus.  Then two months later, directors warned of a profit downgrade.  The quoted share price all but halved over the next two days trading.
Not surprisingly, investors considered they had been stung: the company’s prospects had been oversold in the float prospectus.  The Securities Commission investigated.  In a 2007 report, it concluded that the Feltex prospectus was not misleading in any material respect.
Justice Dobson reached the same conclusion after an eleven week hearing in the High Court.  In their class action, investors alleged the prospectus was misleading under a number of broad headings: undisclosed adverse trading trends; misstatements or omissions as to business risks; misleading or unreasonable assumptions as to future financial performance; misleading presentation of financial data; misstatements regarding management’s equity incentive plan; discrepancies between descriptions of how the final price would be set and how the book build did take place; and misrepresenting share value by painting Feltex in a more positive light than was justified.
Justice Dobson said the test as to whether a prospectus is misleading is through the eyes of a prudent non-expert who at least has a basic understanding of the narrative.  A prudent non-expert who does not understand a material part of any prospectus is obliged to get clarification before proceeding.  Content does not have to be “dumbed down” for less sophisticated readers.  The Feltex prospectus was 148 pages long.
There is some sympathy for investors where cautionary signals and descriptions of risk are buried near the end of a long document, His Honour said, but this was not such a case.  The Feltex prospectus signalled potential risks upfront.
In the investment statement headed “What are my risks?” Feltex included an extensive disclaimer cautioning potential investors not to place undue reliance on forward-looking statements.  Justice Dobson said this disclaimer removed the basis for any claim that investors were entitled to rely on prospectus projections.
While there were justifiable criticisms of some content in the prospectus, he said, none of the criticised content was material.
Relying on expert evidence regarding efficient market theory, Justice Dobson said no damages would be payable even if there had been material misstatements or omissions in the prospectus.  Efficient market theory stipulates that the market price for publically traded shares will quickly assimilate the price effect of new information.  Once a less than fully informed market becomes fully informed, the impact of new information is very quickly reflected in the share price.
Feltex said since the share price exhibited no significant drop post-float until nine months after the prospectus was issued then any misstatement or omission in the prospectus was, nine months later, no longer relevant to the market price.
Investors had the opportunity to sell into the market at any time, rather than waiting until Feltex went into liquidation and then attempt to recover the price paid.
Houghton v. Saunders – High Court (15.09.14)
14.042