Richard Inder: Suing yourself is hardly effective

What is the point of suing if you are effectively suing yourself?

The answer is a no-brainer of course, but it is a question shareholders in carpet-maker Feltex and text messaging group Plus SMS are now asking themselves.

At issue is the continuous disclosure regime.

In the case of Plus SMS, the breaches of the regime were spectacular. It said it had exclusive control of many of the phone codes necessary to run global text message campaigns. These and other claims helped lift the share price as high as 80c, valuing the company at almost $280 million. But, unfortunately, the claims were wrong.

In the case of Feltex, its performance is less clear but it hardly has a stellar record. This week, the Business Herald reported the carpet company's debt had blown out to more than $140 million as suppliers demanded early payment amid fears that a rescue would run awry.

The story contrasted starkly with Feltex's earlier statements about the state of its balance sheet.

At the start of August, Feltex chairman Tim Saunders said he expected shareholders would get 9c to 12c a share if they accepted an offer from Australia's Godfrey Hirst to buy its assets for $141.8 million.

Shareholders and the media assumed that Feltex's balance sheet had not deteriorated as we did the sums to work to square the company's assertions with the figures.

Even at that point, the numbers did not add up. The difference between the company's June 30 debt burden of $128 million and Godfrey Hirst's offer price amounted to $13.8 million - the equivalent of just over 9c a share, some 3c less than the potential payout Saunders had promised.

So, if the debt was higher than $128 million, then Feltex would not even be able to pay out the minimum it expected from the Godfrey Hirst offer.

When Feltex this week confirmed at least the tenor of the Herald's story that its debt now stood at $135 million and would reach $143 million at the end of September, shareholders' worst fears were realised. A return of 9c a share was not pretty - especially for those who had bought shares at flotation at $1.70 a share.

Now shareholders were looking at a total loss because Feltex's debt was set to rise higher than Godfrey Hirst's offer - perhaps the most accurate valuation of the business at that date.

It is conceivable some investors took Saunders at face value and held on to shares that fell as the debt position emerged.

And, despite the the $55 million recapitalisation tabled yesterday by Auckland businessmen Graeme and Craig Turner, they still could suffer a loss.

This episode follows a $150,000 payout to the NZX to settle earlier allegations of breaches of the continuous disclosure regime and ongoing Securities Commission probe into Feltex's compliance with the regulations.

In the case of Plus SMS, shareholders may still have some recourse. Individual directors may fall foul of companies legislation.

But in the case of Feltex, if any breaches of the regime are found, only the company is in the firing line. Directors have a duty to ensure the company discloses all material information to the market. But they are sheltered, even if they are found wanting.

This hardly seems fair. If shareholders complain to the commission or the NZX calling for redress, they are only cutting off their noses to spite their face. Any sanctions - usually fines - imposed by the commission or the NZX in case of a breach are levied from the company.

The fines effectively come out of shareholders' back-pockets.

The problem is especially acute in cases such as Feltex. Shareholders, desperate for quality information, cannot take on management for not keeping them properly informed because it will only add to their already considerable losses.

It is hard to see a way around this problem.

One alternative may be making directors individually liable for breaches of the regime if they do not take all reasonable steps to ensure that material information is disclosed. The scrutiny of an insurance company - whose deep pockets would be a real source of funds even in the event of disasters such as Plus SMS and Feltex - may impose that extra level of discipline.

However, shareholders would still ultimately pay for the breaches as the new liability would be reflected in directors' insurance premiums - again usually paid for by the company.

Adding such sanctions would also lift the risks linked to taking on a directorship and may dissuade many from taking on what often can be a poorly remunerated and thankless and above all risky task.

The consequences of failure are severe. Will former Plus SMS chairman Jim Bracknell sit on another board?

The conundrum underscores the importance of companies finding directors who have the right set of skills for the task ahead of them. In hindsight, it is clear neither Feltex nor Plus SMS met this the most basic requirement, which in the end is the only insurance against poor performance.