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A Report on aspects of the initial public offering of Wakefield Hospital Limited in 2001 [2002] NZSecCom 9 (7 August 2002)

Last Updated: 7 November 2014

A Report on Aspects of the Initial Public Offering of Wakefield Hospital Limited in 2001
7 August 2002

TABLE OF CONTENTS

• Summary of Conclusions
• Background to this Report
• Placement
• Securities Commission's comments and opinion

Securities Commission
12th Floor, Reserve Bank Building
2 The Terrace
PO Box 1179
Wellington

GLOSSARY OF ABBREVIATIONS

SUMMARY OF CONCLUSIONS

1. This is a report on a review by the Securities Commission of aspects of the initial public offering of shares (IPO) in Wakefield Hospital Limited (WHL), a company incorporated in New Zealand.
2. The Commission has considered three broad questions in its review:
   1. whether the offer document for WHL's IPO adequately described the risk factors associated with the share offer;
   2. whether the prospective financial information in the offer document properly set out the principal assumptions on which it was based; and
   100. the process followed by the directors of WHL in preparing for the IPO.
3. The Commission has formed the view that:
   1. the offer document for the IPO was misleading because it failed to adequately describe the risks faced by WHL relating to subcontracting of publicly funded cardiac surgery;
   2. the prospective financial information in the offer document was misleading because it failed to state that the prospective financial information was based in part on an assumption that WHL would receive significant revenue from publicly funded cardiac surgery in the 2001/02 financial year;
   100. the prospective financial information was, by the date of allotment of shares following the IPO, also likely to mislead investors because it was presented as a forecast when, by that date, a significant assumption underlying that information was more properly described as a hypothetical rather than a "best-estimate" assumption;
   4. the directors of WHL did not undertake adequate financial due diligence to examine the risks and uncertainties concerning publicly funded cardiac surgery underlying the prospective financial information, in order to ensure that the offer document properly informed investors of:
      • the key risk factor in this regard;
      • the basis for the business judgement they had made in relation to that key risk factor, and how that judgement affected the prospective financial information.

The inadequacy of the financial due diligence process may have contributed to the misleading nature of the offer document;

5. in preparing the offer document, and at the time of allotment of shares, the directors of WHL held an honest but mistaken belief that subcontracting with Capital and Coast District Health Board (CCDHB) for the provision of publicly funded cardiac surgery would re-commence in the 2001/02 year. The directors of WHL believed that the risk statements and assumptions were not misleading by reason of omitting references to the risks associated with the contracting situation with CCDHB.

BACKGROUND TO THIS REPORT

4. WHL made an offer of shares to the public in a combined investment statement and registered prospectus dated 6 August 2001 (the "offer document"). Following the IPO, the shares were allotted on 5 September 2001 and WHL listed on the New Zealand Stock Exchange on 6 September 2001.
5. Just over 2 months later, on 16 November 2001, WHL announced its half-year results for the period from 1 April 2001 to 30 September 2001. The results showed a profit after tax that was about 60% lower than the previous year. The company attributed this to:

"a reduced amount of cardiac surgery done under contract to public sector healthcare organisations".

6. At the same time the Chairman of the company, Mr John Calder, released a statement saying that WHL's "full-year earnings are likely to be about 50% of the profit forecast when the company floated".
7. On 17 December 2001 the Market Surveillance Panel announced the outcome of an investigation into compliance by WHL with the continuous disclosure obligations of the NZSE Listing Rules. The Market Surveillance Panel's investigation looked at the period between the release of the offer document on 6 August 2001 and the announcement by WHL on 16 November 2001 of its half-year results.
8. The Market Surveillance Panel concluded that WHL had inadvertently breached Listing Rule 10.1 in failing to make timely disclosure of relevant information to the market, namely a known decline in publicly funded cardiac surgery. WHL accepted the Panel's findings.
9. In addition to its formal findings the Panel's decision concluded:

"The Panel's investigation necessarily involved some consideration of the soundness of the Prospectus forecasts themselves. The determination of this matter does not fall within the jurisdiction of the Panel, but it will be referring this question to the Securities Commission for its consideration"

10. The matter was referred to the Securities Commission on 17 December 2001.

THE COMMISSION'S REVIEW

11. In early 2002 the Commission decided to conduct a review of WHL's public share offer and offer document. This review has been carried out under section 10(c) of the Securities Act 1978, which provides that it is a function of the Commission to "keep under review practices relating to securities, and to comment thereon to any appropriate body".
12. Terms of Reference for this review were settled on 12 March 2002. The Terms of Reference are set out in Appendix A.
13. The Commission's review focussed on the matters set out in paragraph 2.
14. The Commission considers that the matters under review raise issues of securities law and practice upon which it is appropriate for the Commission to comment. The Commission has decided to comment by way of this report.
15. This report has been prepared by a quorum of Commission Members comprising Jane Diplock (Chairman), Colin Beyer, Falcon Clouston, Annabel Cotton, Elizabeth Hickey, and Lloyd Kavanagh. The Commission was assisted by counsel.

Procedure

16. The Commission determined the procedures for this review. The Commission heard evidence from the following:
    • Mr John Calder, Chairman of the Board of WHL, Orthopaedic Surgeon;
    • Mr Richard Barnes, General Manager and Director of WHL;
    • Mr John Aburn, Director of WHL;
    • Mr Michael Morris, Director of WHL;
    • Mr Andrew Carpenter, Finance and Administration Manager of WHL;
    • Mr John Riordan, cardiothoracic surgeon, Alternate Director of WHL until July 2001 (and thereafter User Representative at Board meetings); Clinical Leader Cardiothoracic Unit, CCDHB.
    • Ms Margot Mains, Chief Executive Officer, CCDHB;
    • Ms Elizabeth McLean, Business Manager, CCDHB;
    • Ms Louise McKenzie, Legal Adviser, CCDHB;
17. The Commission received affidavit evidence from Mr Bruce Wattie, a partner at PricewaterhouseCoopers (PwC).
18. In addition the Commission received documents and information from:
    • Buddle Findlay, Barristers & Solicitors;
    • PricewaterhouseCoopers, Chartered Accountants;
    • Forsyth Barr Limited & Forsyth Barr Frater Williams Limited, Members of the NZSE;
    • Horsley Christie, Solicitors.
19. Confidentiality Orders were in place throughout the review. WHL was represented by counsel throughout the hearing of evidence. No right of cross- examination was afforded. Documentary evidence considered by the Commission was provided to WHL. Oral evidence was recorded, and transcripts provided to WHL.
20. After receiving evidence the Commission prepared a confidential consultative report and invited comment from affected parties. These parties were given a full opportunity to respond with submissions and to provide further evidence to the Commission. In addition to considering written submissions on behalf of WHL, the Commission re-convened to hear oral submissions from WHL's counsel.
21. The Commission has carefully considered all evidence and submissions before publishing this report.

THE BUSINESS OF WHL - CARDIAC SURGERY

22. WHL operates Wakefield Hospital, a private hospital in Wellington. WHL was incorporated in 1988 by a consortium of medical specialists to purchase the Wellcare Hospital. WHL provides specialist surgical and medical services. It provides these services to private patients and, under contract, to regional and government agencies.
23. One such specialist area is cardiac procedures. These comprise both cardiology and cardiothoracic surgery. The offer document recorded that cardiac procedures generated "a significant portion" of WHL's revenue in the 2000/01 financial year, and disclosed that 44% of WHL's revenue in 2000/2001 came from cardiac procedures. In the 1999/2000 year these procedures provided almost 50% of clinical revenues.
24. This report is concerned with WHL's contracting arrangements for the provision of cardiothoracic surgery to CCDHB. This does not include cardiology. Cardiothoracic surgery refers to both heart surgery and thoracic surgery. In this report the term "cardiac surgery" is used as a generic term to refer to any cardiac or thoracic surgery (but not cardiology). No distinction is made by WHL between cardiac surgery and thoracic surgery for accounting and reporting purposes.
25. The offer document for the IPO described WHL as the sole private provider of facilities for cardiac surgery in the central New Zealand region. According to the offer document, 35-45% of cardiac surgery in this region was performed at Wakefield Hospital. Fees from cardiac surgery have made up a significant part of the revenue of WHL since 1999.
26. Since February 1999 surgeons at Wakefield Hospital have carried out cardiac surgery both for private patients and for patients referred to WHL for treatment by CCDHB (and its predecessor agency, Capital Coast Health Limited, a Hospital and Health Service). Cardiac surgery provided on referral from CCDHB is described in this report as "publicly funded cardiac surgery".
27. The role of district health boards is set out in the New Zealand Health Strategy 2000 (NZHS), as follows:

"District Health Boards will carry out health needs assessment with their local communities"

"District Health Boards will agree on the specific areas on which they will focus in funding agreements entered into with the Minister of Health. Those funding agreements will contain clear, measurable performance indicators that will allow progress to be measured."

"District Health Boards' strategic plans will have to be consistent with the New Zealand Health Strategy..."

28. The NZHS identifies priority health and service delivery objectives, and states that:

"These priorities will provide a direction for action on health. Selecting priorities ... does mean increased emphasis will be placed on action on these priorities over time: an evolutionary rather than revolutionary process. The importance of these priorities will be recognised in ... the Minister of Health's funding agreements with District Health Boards, and District Health Boards' funding agreements with providers."

29. In setting its annual plans CCDHB must have regard to the Government's objectives set out in the NZHS. The NZHS identified the reduction of the incidence and impact of cardiovascular disease as a health priority. This strategy also stated, as a key priority in the area of service delivery, that "District Health Boards will need to place priority on reducing elective waiting times...". Key objectives for access to elective services are:
    • a maximum waiting time of 6 months for first specialist assessment;
    • a maximum waiting time for surgery of 6 months for patients who are offered publicly funded treatment; and
    • delivery of a level of publicly funded service which is sufficient to ensure access to elective surgery before patients reach a state of unreasonable distress, ill health, and/or incapacity.
30. The NZHS also identified strategies for district health boards to achieve the objectives for access to elective services, including:
    • increasing the supply of elective services.
    • improving the capacity of public hospitals.
31. It is in the context of these performance and accountability arrangements that CCDHB contracted with WHL to perform various medical and surgical services. While CCDHB had adopted the objective to provide all its cardiac surgery "in-house" from 30 June 2001 (as stated in its 2000/2001 Business Plan), it also subcontracted cardiac surgery to WHL during 2000/2001. This was required in this period to overcome limitations in the operational capacity of its own hospitals.
32. Mr John Riordan is a cardiothoracic surgeon who provides surgical services to both CCDHB and WHL. He was also an alternate director of WHL until mid-July 2001, when he resigned as a director. Mr Riordan told the Commission that CCDHB and its predecessors viewed the ability to contract out surgery as "a great facilitator" for helping to reduce waiting lists, and to ensure that the district health board would secure future funding for similar levels of cardiac surgery.
33. The Commission was informed that publicly funded cardiac surgery accounted for around 15% of clinical revenues of WHL in 2000/01. Since 1999 the number of publicly funded cardiac cases had grown steadily (1999: 24; 2000: 168; 2001: 254).

The Agreements with CCDHB

34. Prior to 2000 cardiac services were provided by WHL to Capital Coast Health Limited (CCH) under a series of individual agreements. In January 2000 WHL and CCH settled an agreement called "Contract for the Purchase and Provision of Health Services and Supplies for the Period Beginning 1 September 1999". The introduction to this agreement set out that:
    • CCH was contracted by the Health Funding Authority to provide medical services;
    • CCH was entitled to sub-contract for the provision of those services under certain circumstances;
    • WHL had agreed to provide a range of these services on behalf of CCH "as specified from time to time in the Second Schedule (if any)";
    • the parties were entering into the agreement "to record the terms upon which the services will be provided with the intention that the agreement would continue so long as there are services to be provided and contained in the Schedules hereto, as replaced, added to, or varied from time to time".
35. The agreement set out a framework for the provision of services (and payment for those). This agreement expressly stated that it did not commit either CCH or WHL to provide any services or pay any money except as set out in Schedules to the agreement, which could be amended from time to time.
36. When this agreement was signed in January 2000 it had a Schedule that referred to cardiothoracic surgery. In this Schedule CCH estimated that it would need to purchase around 20 cardiothoracic procedures per month from WHL until the end of June 2000 in order to meet obligations to the Health Funding Authority. The Schedule set out the various procedures that WHL might perform and the prices at which this work would be done. The agreement recorded in this Schedule expired in June 2000. A second part of this Schedule was added in April 2000, covering the provision of services for more complex cases.
37. The 1999/2000 Schedule was rolled over for the 2000/2001 financial year, with periodic amendments to the terms and conditions of the Schedule for the continued supply of cardiac surgery up until 30 June 2001. These arrangements were concluded between WHL and CCDHB in a series of letters dating through 2000 and 2001. The extended contracting arrangements expired on 30 June 2001.
38. No Schedule was agreed for the period after 30 June 2001. The effect of this was that at the time of WHL's IPO it had no active contract in place to provide any cardiac services to CCDHB.
39. At the time of the public offer the contractual relationship between WHL and CCDHB could at best be described as a "Heads of Agreement". It was described by Ms Mains, the Chief Executive Officer (CEO) of CCDHB, as an "evergreen contract". The January 2000 agreement provided a framework for the performance of any services provided by WHL to CCDHB. A further contractual agreement, such as that put in place for the 2000/01 year, was needed to activate this framework.
40. WHL advised the Commission that referrals from CCDHB had in the past often been informal and conducted on a "good faith basis", in that the arrangements would be made by telephone, and only later formalised in writing. Mr Aburn, a director of WHL, described the practical operation of the CCDHB contracting arrangements as follows:

"My recollection of the whole arrangement with Capital and Coast Health is that there is ... an evergreen contract, ... and schedules appended to it for work to be done....

The experience that we had during the previous year..., was that sometimes the paperwork followed the patient being treated and this would be in the case where there would be severe or serious or critical patients that had to be dealt with and had to be dealt with quickly.

My understanding of the arrangement that we had with Capital Coast Health was that although it might not have been totally pure and bullet proof from the point of view of the paper trail, that it seemed to work and there was good understanding on both sides and, more importantly, the clinical procedures were completed."

41. Mr Morris, a director of WHL, also gave evidence describing the CCDHB contracting arrangements as follows:

"In respect of the contracted cardiac surgery, there was a background over the previous two to three years of fluctuating demand with requests for procedures often made at short notice in a way which was, at times, quite disruptive of the hospital's ability to provide surgery to its private patients."

42. The Commission received evidence to indicate that such informal arrangements for delivery of services was not an unusual situation in the public health sector. The directors of WHL judged that the lack of a Schedule for cardiac surgery in July 2001 was a temporary and not unusual situation, having regard to the public health sector contracting environment.
43. In contrast with the CCDHB contracting arrangements, at the time of the public offer WHL had two contracts to provide services to the Accident Compensation Corporation (ACC), each running until 31 October 2002 (with a right of renewal). Under these contracts WHL provided elective surgical and clinical services to ACC.

Policy Changes at CCDHB

44. CCDHB incurred higher costs for the delivery of cardiac surgery on a sub-contracted basis than it would have incurred to provide the service in its public hospitals. The minutes of the CCDHB Hospital Advisory Committee (HAC) meeting on 27 March 2001 recorded the Committee's consideration of issues about the Cardiothoracic Service:

"A workshop with staff in Cardiothoracic, ICU and Theatres was held to find better ways of processing the work. ...Lack of available beds in ICU seems to be the prime issue causing theatre cancellations and CCH loses about $11 000 per patient that goes to Wakefield Hospital, so a possible course of action is to add another four beds to ICU to cope with the demand."

45. In a letter dated 16 March 2001 Mr Chris Northover, the Contracts Manager at CCDHB, advised WHL that:

"From our perspective it would obviously be more financially acceptable to spend public monies in-house, where we can do the job for less cost..."

"We are also cognisant of the advantages of having a strong relationship with a provider such as yourselves, close at hand, and prepared to explore and progress synergies benefiting both of us. We are keen to explore the collegial and training opportunities that present themselves and to develop our relationship further.

From the timing perspective, we are not able to sub-contract work to you that we ourselves are not certain of being contracted to perform. This means that our contracts with you cannot extend further than our contract with our own funder. At present this means year by year, but we are aware of the advantages of a longer-term arrangement, and will be discussing this with the funding arm of the DHB when appropriate."

46. A further letter to WHL dated 29 March 2001 from Ms Margot Mains, CEO of CCDHB, stated:

"For the reasons given in Chris's letter to you of 16 March 2001 we will not be able to contract further out than 30 June 2001 at this stage, until our next year's funding is determined."

This letter did also discuss possible pricing for future contracts, but qualified this:

"We would like to explore this further during the next few weeks as a matter of priority, with a view to contracting for next year on a costweight basis (should we need to contract)..."

47. WHL recognised CCDHB's position in relation to the cost of subcontracting. WHL's 2000/2001 Business Plan noted that CCDHB lost a significant contribution to its own overheads when it subcontracted cardiac surgery to WHL.
48. There were other warnings available that CCDHB intended to cease sub-contracting cardiac surgery. The CCDHB 2000/2001 Business Plan (released publicly in July 2000) stated the objective to "provide all cardiac surgery services from Wellington Hospital facilities". The Business Plan stated that this objective was to be achieved by 30 June 2001. The risk analysis approach adopted for the Business Plan considered the contingency that subcontracting might be required if CCDHB was not able to meet this objective. Management of this contingency required CCDHB to maintain good relations with external service providers, including WHL.
49. Mr Richard Barnes, the General Manager of WHL, told the Commission that at a meeting on 14 June 2001 he was told by the CEO of CCDHB, Ms Margot Mains, that CCDHB was going to try to do all cardiac surgery in-house. Mr Barnes told the Commission he would have passed this on to the board at its next monthly meeting. According to Mr Barnes, Ms Mains did not say that CCHDB would do all of their contracting in-house, simply that CCDHB would try to achieve this.
50. Mr Barnes told the Commission that correspondence from CCDHB management supported his view that there would be an ongoing relationship with CCDHB and that CCDHB would need to use WHL's services under a subcontracting arrangement. He referred to the letter from Mr Northover dated 16 March (quoted in paragraph 45 above), which recognised the fact that WHL wanted more stable contracts.
51. The CCDHB CEO's Hospital Operating Report for February 2001 for the HAC meeting held on 27 March 2001 recorded that :

"Planning continues with this service [Cardiothoracic Service] and the supporting service (ICU, Theatre, Anaesthesia) to bring cardiothoracic surgery back in house progressively over the next 12 months."

52. The Operating Report for March 2001 for the HAC meeting held on 1 May 2001 recorded that:

"Good progress has been made with planning by the Cardiothoracic service and the supporting services ... to bring cardiothoracic surgery back in house progressively over the next 12 months. The proposal for approval in the Service Plan for 2001/02 is to bring 95% of Cardiac surgery in house starting with 7 theatre days per week (14 sessions) from July ..."

53. The minutes of the HAC Meeting on 1 May 2001 recorded the Committee's consideration of the financial result reported in the March 2001 HAC Operating Report, as follows:

"The Committee noted the deterioration of the deficit. ... Margot Mains advised that management is focussing on ... key priorities for now and for the coming year. Clinical services contracted out had increased, contrary to expectations last year, and ways of reducing the need for this is a priority."

54. The minutes of the HAC meeting held on 31 July 2001 recorded that "since 1 July all cardiothoracic cases are to be done within CCH".
55. The meetings of CCDHB and its committees are public meetings. The minutes of the meetings are publicly available. WHL's directors told the Commission that they had not seen these minutes at the time of their preparation for the IPO.
56. Evidence given by the directors and management of WHL indicated that the board believed that WHL would continue to receive revenue from publicly funded cardiac surgery. Mr Barnes told the Commission:

"[CCDHB] were unable to do as much cardiac surgery as they were required to do under the terms of the contract with the Funding Authority, and certainly even less in relation to the six month maximum waiting list because the demand for surgery exceeds the contract."

57. In his General Manager's report to the WHL board for July 2001 Mr Barnes noted:

"While DHB policy is to avoid subcontracting, it has been informally reported that the waiting list for cardiac surgery is building month by month, so resumption of contracting is considered likely in the second half, ie possibly commencing in October."

58. The directors' beliefs about the future of cardiac subcontracting were grounded in their view that the government's benchmark waiting list period for elective cardiac surgery would have to be adhered to by CCDHB. This belief was strongly influenced by clinical and ethical considerations. Three directors on WHL's board at the time of the IPO were experienced medical specialists (four up until mid-July 2001). Their combined experience of the political environment of the public health sector shaped the WHL board's views on the influence of government policy on delivery of health services in the public sector, and particularly by CCDHB.
59. The Chairman of WHL, Mr John Calder, told the Commission that the board considered the possibility that waiting lists might be allowed to continue growing, but discounted this in view of the Government's key service delivery objective that waiting lists be no longer than 6 months. On this basis the board believed that CCDHB would have to resume subcontracting cardiac surgery.
60. Mr Riordan was an important source of information to WHL regarding the likelihood of resumption of cardiac contracting with CCDHB. Mr Riordan was an alternate director of WHL until mid-July 2002. He was also at that time Clinical Leader of the Cardiothoracic Unit at CCDHB, and performed cardiothoracic surgery at both Wellington Hospital and WHL. After he resigned as an alternate director, just prior to the IPO, Mr Riordan continued to attend WHL Board meetings as a "User Representative".
61. In his evidence Mr Riordan told the Commission:

"[CCDHB] were trying to get all the contracting done in-house for financial reasons but my view was at the time that this was clinically not going to be viable and that the waiting lists had to continue and would continue to grow".

62. Mr Riordan was an attendee at workshops of the CCDHB Cardiothoracic Unit held in the early stages of 2001 to devise operational strategies for implementation of the strategy to bring all cardiac surgery in-house by the target date of 30 June 2001. He told the Commission that his view of the strategy at the time was that there were "insurmountable problems that were outside the scope of this particular group".
63. Mr Riordan informed the directors at the June 2001 board meeting that "CCH was now firmly against contracting, but "waiting lists" were already growing". At the July board meeting Mr Riordan reported that waiting lists had already stretched to 4 to 6 months, and conveyed his view to the other directors it was inevitable that "medical priorities were compromised by this combination of circumstances." In August Mr Riordan updated the board on the capacity constraints at CCDHB, which were causing service delivery difficulties.
64. The directors shared the view that at some point additional funding would have to be obtained to bring the waiting list back within the targeted limits. Mr Aburn gave evidence to the Commission on the extent to which the directors examined the prospect of future contracting with CCDHB.

"That included a consideration, obviously, of the ability or the inability of Capital Coast Health to undertake that work. We were of the view this was a matter that was discussed frequently by the directors, and of course, we had the advantage of Mr Riordan sitting at our Board table some of that time, one of Wellington's cardiac surgeons, and throughout all these discussions it was patently apparent that Capital and Coast Health for a variety of reasons had, in our own view and probably in their own view, no possibility of meeting the standards that had been imposed on them by the government and by the Minister of Health to keep the waiting list under six months. There was a gradual build up of cardiac patients. They simply could not undertake that with themselves. They simply could not get through it and Wakefield, of course, was the only hospital in the central area of the country that was able to undertake that work."

65. Taking this view of future events, the directors assessed that any uncertainty about the resumption of subcontracting with WHL after 1 July 2001 was slight because of the government objective to keep waiting lists below six months. This clinical/medical professional judgement dictated the risk analysis, without regard to the commercial prospect that CCDHB might relegate its aim to achieve the target waiting list periods to a lesser priority than that of budgetary or other considerations.
66. The Commission was told that management of WHL did not expect the number of contracted cardiac cases for 2001/02 to be as high as those for the 2000/01 year, which had been described in WHL's 2001/2002 Business Plan as a "bonanza" in terms of the number of publicly funded cardiac cases. The WHL 2001/2002 budget prepared by management in March 2001 estimated that 175 publicly funded cardiac surgery cases would be undertaken by WHL in the 2001/02 financial year.
67. WHL advised the Commission that it used the budgeted volume of cardiac cases as the basis for the forecast cardiac surgery revenues in the prospective financial information contained in the offer document.

The Effects of CCDHB Policy Changes on WHL

68. WHL's financial year runs from 1 April to 31 March. While the 2000/01 financial year had seen an exceptional number of publicly funded cardiac surgery cases, this was evidently not the case from the beginning of the 2001/02 financial year. The General Manager's report to the board for June 2001 (presented at the July board meeting) noted that cardiac admissions for the first quarter were down 30% on the previous year. Revenues from cardiac surgery were down 33%. This situation was described as follows:

"While gains have been made where anticipated the extent of the downturn in cardiac procedures and GI surgery was not anticipated. It is due to the complete cessation of subcontracted cardiac surgery by CCH despite prior "good faith" discussions to the contrary, and the absence (sick leave) of one of two GI surgeons."

69. In the same report the General Manager commented on the likely effects of the situation:

"The actual [net profit after tax] shortfall vs budget of $345,000 is unlikely to be recovered even given improving levels of activity - though not yet cardiac surgery. It has implications for the IPO in that even if budget is attained from July on NPAT would be just over the $1.900 million forecast in the Prospectus. (Budget NPAT is $2.278 million.) It is going to take tight management and a sustained upturn in business to achieve the $1.9 million forecast, and this probably requires a significant volume of subcontracted cardiac surgery. There is little possibility of this occurring in the first half of our financial year."

70. One month later the General Manager's report for July 2001 (presented at the August board meeting) showed that the downturn in revenues continued. This report stated that earnings before interest and tax (EBIT) was around one third of that achieved in the same period of the previous year and 70% down on the budget for the 2001/02 year. The report described the drop in earnings as "disastrous". The General Manager described the cause:

"The major problem is obviously cardiac surgery where contract work has ceased completely (although the case for it is reported to be building steadily, i.e. waiting-list expanding) and private volumes were also down."

71. No cardiac surgery cases have been referred to WHL by CCDHB since 1 July 2001.
72. Evidence from CCDHB's Board and Committee Meeting minutes available prior to the IPO indicate that CCDHB's intention, at that time, was to pursue internal strategies to provide all cardiac surgery in-house. CCDHB's 2001/2002 Annual Plan (prepared, but not released publicly, before the IPO) included the same strategy.
73. This strategic direction is in line with the suggested NZHS strategies for improving access to elective services. The NZHS envisaged that increased emphasis would be "placed on action on these [government health] priorities over time".
74. Information provided by CCDHB indicates that waiting lists have been allowed to grow since their low point in September 2000. At that time there were 87 patients on the waiting list, of whom 16 had been waiting for cardiothoracic surgery for more than 6 months. At the end of the June quarter of 2001 the number of patients on the waiting list was 148 (with 10 waiting longer than six months). By the end of December 2001 the number of patients on the waiting list was 225 (with 52 waiting longer than six months).
75. In this context it appears to the Commission that the following matters constituted important risk factors in relation to future financial performance of Wakefield hospital:
    1. the uncertainty surrounding the future of publicly funded cardiac surgery at Wakefield Hospital; and
    2. the fact that from 1 July 2001 there was no active Schedule between WHL and CCDHB for the provision of any cardiac services; and
    100. the fact that since 1 July 2001 no cardiac contracting with CCDHB had in fact occurred.

The Commission considers these were risk factors that were material to the share offer, and which should have been clearly and specifically explained to investors in the offer document.

THE IPO PROCESS

76. Prior to the IPO WHL had 68 shareholders. In 1998 and 1999 the WHL board began investigating ways to increase the market liquidity of the WHL shares and to raise further capital.
77. In 2000 the board considered an offer from a private institution to purchase WHL, but turned this down because they considered the offer was too low. In the same year WHL considered listing on the New Capital Market of the NZSE. This was also rejected.
78. In March 2001, following talks with Mr Andrew McDouall of Forsyth Barr (FB) the board decided to make a public offer of WHL shares and to list on the NZSE. FB was appointed to act as lead manager and organising broker.
79. In April 2001 FB prepared a timetable for the IPO. This contemplated an offer document being ready in July 2001 for the offer to be made in August 2001.
80. WHL appointed Buddle Findlay (BF) as solicitors for the offer, and to carry out legal due diligence. PwC was WHL's auditor.
81. The Finance Committee of WHL, comprising the General Manager, Mr Richard Barnes and two independent directors, Mr John Aburn and Mr Michael Morris, took primary responsibility for the share offer, including preparation of the offer document.
82. The final form of the registered prospectus was approved by the board at its meeting on 27 July 2001. The prospectus was registered on 6 August 2001. The offer was fully subscribed, and the new shares were allotted on 5 September 2001.

THE OFFER DOCUMENT

Disclosure Requirements

83. Offers of securities to the public must be made in compliance with the Securities Act 1978. In general this requires issuers to register a prospectus and to produce an investment statement. Each of these documents must contain certain information that is relevant to decisions whether or not to invest in the securities being offered.
84. The purpose of these documents is to allow prospective investors to make an informed decision about their investment.
85. A registered prospectus contains detailed historical and prospective financial information, and information about the issuer, its directors, promoters, and substantial security holders, and the terms of the offer of securities.
86. An investment statement is designed to provide key information to assist the "prudent but non-expert" person to make an investment decision, and to draw to that person's attention the fact that more information is available in other documents. The investment statement must contain prescribed information answering eleven important questions about the offer of securities.
87. The prospectus and investment statement disclosure requirements are set out in the Securities Act 1978 and the Securities Regulations 1983. Both the registered prospectus and investment statement must disclose risks associated with the offer of securities.
88. The purpose of risk disclosure in a prospectus or an investment statement is to inform prospective investors about matters that may impact adversely on their investment. In the course of operating a business it is ordinarily the responsibility of the management and directors of a company to consider risk factors and to take decisions based on assessment of those risks. However, where a company decides to raise money from the public the securities laws require these material risk factors to be publicly disclosed so that prospective investors and their advisers can carry out their own assessment of the desirability of investment in the company.
89. Whether or not a risk or a fact must be disclosed in a prospectus or an investment statement depends on whether it is "material". When this term is used in securities law it means that a matter is one that would be likely to influence a reasonable person in making a decision whether or not to subscribe for the securities, without necessarily being determinative of the decision.
90. Information is material if it is needed to allow a reader of the prospectus or investment statement to properly assess the risk of an investment. Because of this the disclosure of risk factors in a prospectus and an investment statement is particularly important.
91. Assessing whether a risk factor is material to an offer of securities requires a balancing of its potential impact on the investment with the degree of likelihood that it will eventuate. If a risk factor would, if it came about, have a serious impact on the investment then it may be material even though there is a low likelihood of the risk eventuating. Equally, a risk factor that would have a less serious impact on the investment may need to be disclosed as material if it is highly likely to eventuate.

The investment statement

92. One of the questions to be answered in the investment statement is: "What are my risks?". Under this heading the investment statement must set out:

93. All the information that is required to answer this question must be set out together in the investment statement under the heading.

The registered prospectus

94. A registered prospectus for shares must contain certain information that is prescribed in regulations. These regulations include a "catch-all" obligation requiring the registered prospectus to contain "particulars of any material matters relating to the offer of securities".
95. One of the specific disclosure requirements relates to "prospects and forecasts". The relevant provision says the registered prospectus must contain:
    1. A statement as to the trading prospects of the issuing group, together with any material information that may be relevant thereto.
    2. The statement required by subclause (1) of this clause shall include a description of all special trade factors and risks that-
       1. Are not mentioned elsewhere in the registered prospectus; and
       2. Are not likely to be known or anticipated by the general public; and
       100. Could materially affect the prospects of the issuing group.
96. The disclosure requirements of the Securities Regulations 1983 do not limit the information that an issuer can put in a registered prospectus. These Regulations provide that if any statement that is required to be in a registered prospectus would be misleading if additional information were not also included, then the prospectus must also contain that additional information.

Risk Disclosure in WHL's Offer Document

97. WHL combined the registered prospectus and investment statement into one document. This is allowed under the Securities Act 1978, although the Commission has warned in the past that care must be taken in doing this to ensure that neither document is concealed by the other. Each must remain clearly distinguishable and prospective investors must be able to find the important information they require.
98. The offer document discussed risks in several places. The principal discussion about risks material to the offer of securities was set out in a section entitled "Risk Factors".
99. The Risk Factors section began on page 30 of the offer document. Both the investment statement part of the document, under the question "What are my Risks?", and the registered prospectus part of the document, detailing risks and special trade factors, referred readers to the Risk Factors section.
100. The introduction to the Risk Factors section contained the following statement:

"In analysing an investment in the Shares, prospective investors should carefully consider, along with other matters referred to in this Offer Document, the risk factors described below. Wakefield cautions prospective investors, however, that this list of risk factors may not be exhaustive."

101. The description of risks began with a general statement about the nature of investment risk. Other risk factors were described under the heading "Specific Risks". The subheadings to this were:
     • Loss of key surgeons
     • Lower patient admissions
     • Competitive risks
     • Government policy changes
     • Regional government contracts
     • Loss of key personnel
     • Infectious diseases
     • Professional negligence
     • Costs of medical supplies and labour
     • Development project
     • Technological or medical advancements
     • Regulation
     • Risks to operations
     • Taxation
102. The directors of WHL invited the Commission to conclude that the offer document comprehensively covered the uncertainties and risks facing the company in relation to its business, and particularly with regard to contracting for publicly funded cardiac surgery.
103. Cardiac surgery is referred to under the heading "Loss of key surgeons". Here the offer document noted that WHL relies on surgeons electing to perform surgery at Wakefield Hospital. It stated that WHL's performance could be adversely affected if it lost certain key surgeons. The example given stated:

"For example, a significant portion of Wakefield's revenue in the 2000/01 financial year was generated by cardiac procedures, carried out by two surgeons."

104. Under the heading "Lower patient admissions" the offer document noted WHL's revenue is predominantly generated by the number of patients admitted for medical/surgical procedures by surgeons, and the use of WHL's facilities. It stated that a material decrease in the number of patients admitted to Wakefield Hospital or in the usage of WHL's facilities would adversely affect WHL's financial performance.
105. This section described a general risk that was fundamental to WHL's business. The statement was undoubtedly true. It was not, however, a description of the risk associated with subcontracted cardiac surgery. In the Commission's opinion a generic statement such as this may be a material matter in its own right, but it does not substitute for a clear description of a specific risk, even if the general statement can be said to cover the specific case.
106. Risk factors relating to the provision of publicly funded services were set out under the headings "Government policy changes" and "Regional Government contracts". The first of these read:

"Government Policy Changes

The Government, through the Ministry of Health and the District Health Boards, remains the single largest provider of health care funding in New Zealand. A change in policy in relation to the level and targeting of health expenditure could adversely impact on Wakefield's business. In particular any increase in the public funding of elective surgery in public hospitals could impact adversely on Wakefield's financial performance.

The Directors believe that, for any policy change to have an adverse effect on Wakefield's business, it would have to result in increased expenditure on elective surgery in public hospitals over and above the real rate of inflation in the healthcare industry. In the Directors' opinion, it would be contrary to national and international trends if the government increased expenditure to that extent."

107. This section referred to a change in the government's policy regarding public funding for elective surgery. Higher government funding for elective surgery could result in a decrease in private surgery demand. However, under the current model for funding of public health services by government, the decision as to how public funding is applied to the provision of health services is influenced by the district health boards' assessment of regional health priority needs, together with government health objectives and strategies. District health boards have a discretion to apply public funding either for the provision of services by public hospitals or for the purchase of services from private hospitals, subject to the application of appropriate financial management principles to that consideration.
108. This section addressed the risk of a change in government policy leading to a decrease in private surgery revenues. It did not differentiate between government policy and District Health Board strategies. It also did not address the specific risk presented by the CCDHB policy that could prevent future revenues for WHL from publicly funded cardiac surgery.
109. Risks associated with WHL's contracting with CCDHB were set out under the heading "Regional Government Contracts". This read:

"Regional Government Contracts

Wakefield performs elective surgical and consultative services on behalf of DHB and ACC. Any material variation in the volume of this work carried out at Wakefield may effect [sic] the financial performance of Wakefield.

The current contracts with ACC expire on 31 October 2002, each with a two year right of renewal if each party is satisfied with the arrangements. To date, DHB has contracted with Wakefield on an as needed basis and has not contractually committed to any particular level of expenditure."

110. The continuation of a significant volume of contracted cardiac surgery was important if WHL was to achieve the forecast financial performance, position, and cashflows indicated in the offer document (see below). In view of this the Commission does not consider the statement headed "Regional Government Contracts" accurately or adequately described the risks WHL faced at the time of its public offer in relation to its cardiac surgery contracting with CCDHB, which are summarised in paragraph 75 above.

Other disclosures

111. As noted above, all the information required to answer the risk questions in an investment statement is required to be set out under the relevant heading. Nevertheless, the Commission was invited to read the risk disclosures on page 30 of the offer document in conjunction with other statements in the offer document. Attention was drawn to a statement on page 11 of the offer document, in the section entitled "Company Background and Profile" that referred to relationships with Government agencies:

"Wakefield contracts with DHB to provide surgical services to DHB patients. Whilst these contracts do not require DHB to commit to any level of expenditure and may be terminated by DHB at any time, they have provided significant revenue streams in recent years. The Directors believe that surgery for DHB is likely to continue to be a source of revenue for Wakefield."

112. WHL noted that this disclosed that there was no commitment by CCDHB to any level of expenditure. The statement did not disclose, however, that at the time of the offer document, no cardiac contracting revenues were in fact being received by WHL.
113. The Commission was also asked to consider a statement on page 53 of the offer document, under the heading "Other Material Matters":

"From time to time Wakefield contracts with DHB to provide surgical services on a fixed price basis as required. To date, there has been no contractual commitment by DHB to any level of expenditure and DHB has retained the discretion to terminate any such contract at any time without cause."

114. The offer document was finalised in early August 2001. In an e-mail message to Buddle Findlay sent on 2 August Mr Barnes ordered a change to the wording of the section headed "Other Material Matters" in the draft offer document. The draft had previously included the following sentence at the end of the paragraph dealing with district health board contracting:

"The only current contract is for surgical cardiac services."

Mr Barnes' e-mail instructed Buddle Findlay to delete this, saying:

"40 '... contracts with the DHB ....'
Delete the last sentence of the first paragraph - there is no current contract or understanding even."

115. The statement under "Other Material Matters" appears to be the most cautious statement in the offer document regarding the contracting situation with CCDHB. It says that Wakefield contracts with the DHB "from time to time" and "as required". In contrast to other descriptions it refers to "any such contract", rather than "these contracts". In the Commission's opinion the disclosure would have been clarified further had Mr Barnes' comment that there was "no current contract or understanding even" been included in the offer document.
116. The Commission's attention was drawn also to the assumptions on which WHL's forecasts were based. We consider these separately below.
117. In its submissions to the Commission WHL argued that the offer document adequately disclosed the risk to investors associated with publicly funded cardiac surgery. WHL submitted that the directors of WHL, who between them had considerable commercial and clinical experience, assessed the risk of cardiac contracting not resuming after 1 July 2001, and considered it to be slight.
118. The directors' assessment of that risk was formed with reference to:
     • their belief that CCDHB would continue to refer cardiac surgery to WHL after 30 June 2001;
     • the growing waiting list for cardiac surgery; and
     • the past inability of CCDHB to perform all its cardiac surgery in-house.
119. On this basis the directors of WHL considered that the risk statements in the offer document to be sufficient.
120. Despite the caveats in the "Other Material Matters" statement, the Commission is of the opinion that the offer document failed to adequately describe the risks associated with the provision of publicly funded cardiac surgery. Further, it fails to set out the required information under the relevant heading in so far as the document is an investment statement. The Commission accepts that the directors of WHL turned their minds to the risks associated with cardiac contracting. The directors made a judgement as to the likely future of cardiac contracting based on their experience. Without making any finding on the reasonableness of the directors' judgement, the Commission is of the opinion that the material risk factors relating to that judgement should have been fully disclosed in the offer document. In the Commission's opinion the offer document:
     • failed to fully describe the nature of the existing contractual relationship, and was misleading by reason of this omission;
     • was misleading in the manner in which it described the ACC contracts in conjunction with the CCDHB contract; and
     • failed to describe the risks arising from the stated CCDHB policy to undertake all future cardiac surgery in public hospitals, and was misleading by reason of this omission.

Existing Contractual Relationship

121. It is the Commission's opinion that the statements in the offer document relating to contracting with CCDHB were likely to mislead readers by giving the impression that there was, at the time of the public offer, an active (in the sense of revenue-producing) cardiac surgery contract between WHL and CCDHB. Readers are likely to have gained the impression that at the time of the public offer WHL was providing services to CCDHB under contract.
122. In reaching these conclusions the Commission refers in particular to the following:
     • the statement under "Company Background and Profile" that WHL "contracts with DHB to provide surgical services on a fixed price basis as required";
     • the reference in the same section to CCDHB's ability to terminate the contracts between itself and WHL at any time;
     • the statement under "Regional Government contracts" that WHL "performs elective surgical and consultative services on behalf of DHB";
     • the reference under "Other Material Matters" to CCDHB's ability to terminate the contracts.
123. It was argued by WHL that the existence of the January 2000 agreement meant that WHL did have "a contract" with CCDHB at the time of the public offer. What it did not have was an active Schedule relating to cardiac surgery. Even accepting that the agreement was a "contract", the Commission considers the limited nature of this agreement should have been disclosed. The Prospectus was required to refer to the contracting arrangements with CCDHB as a matter material to the investment (and as a principal risk factor). If disclosure of a matter in a prospectus would be misleading without the inclusion of additional information, then this additional information must also be disclosed. The Commission considers that without clarification of the limited effect of the "evergreen contract", references to this agreement as "contracting with CCDHB" were likely to mislead investors by omitting material information.

ACC Contracts

124. In the Commission's opinion the misleading effect of the disclosures about contracting with CCDHB was aggravated by the juxtapositioning in the offer document of statements about the ACC and CCDHB contracts.
125. The ACC and CCDHB contracts in place at the time of the IPO were very different. This was put to Mr Barnes in questioning:
     17. As I understand it, the nature of those two contracts [ACC and CCDHB] at [the time the offer document was prepared] was quite different?
     18. Yes.
     17. A distinction between those two contracts is not very clearly spelt out for investors, it seems to me, because the ACC contract was going to continue. You had been told the DHB contract was not going to be renewed, or was unlikely to be renewed, because they were going to do all of their cardiac surgery in-house. Now, you had some other optimistic hopes, perhaps, about that but the nature of those two contracts is quite different, and I would suggest to you that it's not clear in the prospectus, the position?
     18. Well, in hindsight, I would agree with you, but that hindsight; actually now and probably back to about November.
     17. Mr Barnes, in June the distinction between those two contracts was clear to you? There was a difference between the nature or quality of those contracts in the potential revenues that they were going to bring?
     18. Yes, they were important, and certainly the revenues from the ACC contract are - they are set out very exactly and precisely.

The nature of our contracting with Capital Coast Health has always been more casual, good faith is in fact a kind word for it, and there was an underlying contract that said 'Whenever we deal with you, Wakefield, this is how we'll deal with you and we will activate a contract from time to time by uplifting the schedule', and frequently a schedule to cover a specific tranche of surgery for whatever, at a price and a volume, and a speciality. A number of those were raised over the preceding time and, I think, that their letters to me in March indicated quite clearly, though they were unable to commit beyond the end of June they were certainly contemplating making a contractual arrangement with us soon after, actually, in their new financial year."

126. In the Commission's opinion the offer document did not clearly set out the differences between these contracts and the differences in the contracting relationships with ACC and CCDHB. By referring to both relationships together the impression was given that active contracts existed with both agencies. This was not the case. CCDHB Policy
127. The offer document disclosed a risk associated with a change in government health policy relating to the level and targeting of health expenditure. It particularly identified a risk associated with an increase in public funding for elective surgery. It did not identify a risk associated with the CCDHB policy to cease subcontracting of cardiac surgery.
128. The CCDHB policy is described above. This policy had been expressed publicly and CCDHB's intention had been conveyed to WHL prior to the public offer. The change in policy is not described in the offer document.
129. WHL's directors put it to the Commission that several factors were relevant in assessing the change in CCDHB policy.
     • According to Mr Barnes, CCDHB had not unequivocally said that there would be no further subcontracting. As he said to the Commission:

"I had spoken to Margot Mains. She had never said to me 'We are not going to do any more contracting with you.' She said 'We will be trying to avoid contracting with you'."

• Mr Barnes told the Commission that correspondence from CCDHB management (see paragraph 45) supported his view that there would be an ongoing subcontracting relationship with CCDHB.

Ms Mains told the Commission that she did not believe she gave WHL any signal that CCDHB was going to recommence contracting after 30 June 2001.

• WHL told the Commission that a major factor in assessing this risk was its belief, based on past experience, that CCDHB would resume subcontracting despite its stated policy. The principal reason for this belief was that CCDHB did not have resources in public hospitals sufficient to carry out enough cardiac surgery to meet the targets for which it had been funded, and to meet the government objective that waiting lists for elective cardiac surgery should be kept within six months. This was stated in questioning by Mr Morris, an independent director of WHL:

• For CCDHB, Ms Mains acknowledged that in previous years CCDHB had not achieved its intention (first expressed publicly in July 2000) to take all cardiac surgery in-house:
• "We certainly had signalled it to Wakefield. Wakefield may have felt that, 'Well, you haven't achieved it for two years, are you going to achieve it next year?'. Now, that's a decision that Wakefield makes.."
• Mr Barnes told the Commission:
• "...we reassessed the position again in July, knowing there had been no contracting and knowing that the policy was that they would try not to contract, and we said. 'Okay, but how real is this?'."
• WHL pointed out that a legal due diligence exercise was carried out by Buddle Findlay. A legal opinion dated 6 August 2001 stated:

We are of the opinion, on the basis of the assumptions and subject to the qualifications set out in sections 3 to 6 of this letter, that the Offer Document complies with the relevant provisions of the Securities Act 1978, the Securities Regulations 1983, and any other applicable New Zealand laws.

The qualifications included the following:

The management of Wakefield has carried out verification of the material contained in the Offer Document, and we assume no responsibility for the accuracy or completeness of the information contained in the Offer Document. However, we confirm that nothing has come to our attention in the course of acting in this matter that causes us to believe the Offer Document contains any material misstatement or that there is any material omission from the Offer Document;

This legal opinion was accompanied by a due diligence report. On the subject of CCDHB this report stated:

We have not sighted any executed contract in relation to the services provided for CCDHB. We understand from Wakefield's management that Wakefield is very much an "on-call" supplier and has a contract to provide services as and when required. We understand that the services that are required from time to time are agreed in a Schedule to the main agreement (which we have not sighted). Since the cardiac surgical services schedule expired on 30 June 2001, management have advised that there are no current schedules in place and therefore Wakefield is not currently providing any services to CCDHB...

The informal nature of the arrangements with surgeons and with CCDHB may constitute a risk to Wakefield's business as there is no contractual certainty of tenure/revenue, even if the commercial reality is that Wakefield is guaranteed a certain level of work from CCDHB.

125. On the basis of the evidence it has received the Commission accepts the directors of WHL believed that subcontracting would need to resume.
126. The directors of WHL weighed up their past contracting experiences with CCDHB, the statements from CCDHB management that were perceived as supporting recommencement of contracting, and their awareness of government objectives for waiting lists against CCDHB's stated policy, and formed the view that the risk that contracting would not resume was slight.
127. The Commission is primarily concerned with the disclosure in the offer document of the bases of the directors' judgement.
128. The CCDHB policy had been expressed publicly in the 2000/2001 Business Plan, published in July 2000. CCDHB was aware that it would take some time to achieve this strategic intention. The Business Plan set a target date of 30 June 2001 to "Provide all cardiac surgery services from Wellington Hospital facilities". Internal planning workshops of the Cardiothoracic Service were held early in 2001 to establish ways to implement the policy. The workshops were attended by Mr Riordan, in his capacity as a cardiothoracic surgeon working for CCDHB.
129. The target date for CCDHB's policy was 30 June 2001. No Schedule for cardiac surgery was in place between CCDHB and WHL beyond that date. No cardiac surgery cases had been referred to WHL after 30 June 2001. In the Commission's view these facts increased the need for the offer document to disclose the risk presented by the policy.
130. In the opinion of the Commission, the offer document should have disclosed as a risk factor CCDHB's policy to perform all cardiac surgery in-house after 1 July 2001. It should also have disclosed that there was no active Schedule for cardiac surgery in place after 30 June 2001 and that no contracting had occurred since 30 June 2001. This could have been accompanied by an expression of the directors' belief that contracting would resume, and the basis for that judgement. Disclosure of the risk would have allowed investors to take this into account in making their decisions.

FORECAST FINANCIAL STATEMENTS

Legal Requirements

136. Under the Securities Act and Securities Regulations a registered prospectus for an offer of shares to the public must contain certain financial information. The registered prospectus for a company making its first offer of shares to the public must also contain certain prospective financial information.
137. The share offer made in August 2001 was WHL's first public offer of shares. The registered prospectus for the offer was required by law to contain a prospective statement of cash flows of WHL and any subsidiaries which the directors expected to occur in the year commencing on the date the prospectus was delivered for registration (i.e., a prospective statement of cash flows for the year ending 5 August 2002).
138. The offer document contained this prospective statement of cash flows. In addition, WHL included prospective statements of financial performance, financial position, and cash flows for the year ending 31 March 2002 (as noted earlier, WHL's financial year runs from 1 April to 31 March).
139. Prospective financial information presented in a registered prospectus falls within the meaning of "general purpose prospective financial information" contained in Financial Reporting Standard 29 Prospective Financial Information (FRS-29), issued by the Institute of Chartered Accountants of New Zealand (ICANZ). Financial reporting standards are the primary indicators of generally accepted accounting practice (GAAP) in New Zealand.
140. The Securities Regulations do not expressly require that prospective financial information in a registered prospectus be prepared in accordance with GAAP. However, the professional standards of ICANZ require accountants and auditors to ensure that general purpose prospective financial information is prepared in accordance with GAAP (i.e. FRS-29). The Commission is of the opinion that information prepared other than in accordance with FRS-29 is likely to be misleading.
141. Prospective financial information is forward looking financial information which is necessarily based on assumptions about the future. Knowledge of the assumptions is vital to those using the prospective financial information. The soundness of the prospective financial information depends on the assumptions on which it is based.
142. FRS-29 establishes principles for the preparation and presentation of general purpose prospective financial information, and specifies minimum disclosures. The Standard explains that, "the preparation of prospective financial information requires the exercise of significant judgement", given the inherent uncertainty associated with assumptions about events or actions that may or may not occur in the future.
143. The Securities Regulations require that where an issuer includes prospective financial information in a registered prospectus then the prospectus must also disclose the principal assumptions on which the prospective financial information is based.
144. In addition, where a registered prospectus contains prospective financial information the auditor's report in the prospectus must contain the following statement:

"In our opinion, the prospective financial information, so far as the accounting policies and calculations are concerned, has been properly compiled on the footing of the assumptions made or adopted by the issuer set out at pp... of this prospectus and is presented on a basis consistent with the accounting policies normally adopted by the company."

145. Both the prospective statement of cash flows for the year to 5 August 2002 and the prospective financial statements for the year to 31 March 2002 in WHL's offer document were required to include the principal assumptions that WHL had used when preparing this information. PwC, as WHL's auditor, was required to examine the prospective financial information with a view to expressing an opinion that the information was compiled on the basis of the assumptions made by the company .
146. It should be noted that an auditor's task in respect of prospective financial information in a prospectus is limited. He or she is not required to verify the information the company used to prepare the prospective information in a prospectus, or to go behind the assumptions used to seek information about their validity. This increases the importance of clear and complete disclosure of all the principal assumptions that underlie the prospective information, for prospective investors to properly understand the basis of its preparation and to be able to consider the reasonableness of the assumptions.
147. Prospective financial information can be presented in the form of a forecast or a projection. Put simply, the difference is that a forecast is considered by those preparing the information to be "the most probable outcome", whereas a projection reflects one of a range of possible outcomes. FRS-29 defines the two terms in the following way:

"'A forecast' means prospective financial information prepared on the basis of assumptions as to future events that the governing body reasonably expects to occur associated with the actions the governing body reasonably expects to take as at the date that the information is prepared (best-estimate assumptions).

'A projection' means prospective financial information prepared on the basis of one of more hypothetical but realistic assumptions, (or 'what-if' scenarios), that reflect possible courses of action for the reporting periods concerned as at the date that the information is prepared."

148. The WHL offer document stated that the prospective financial information it contained was forecast financial information.
149. The offer document stated that the forecasts were based on "events and conditions existing at the date of this Offer Document".
150. As with other information in a registered prospectus or investment statement, prospective financial information must not be false or misleading. Prospective financial information is not false or misleading simply because the results projected or forecast do not eventuate. It may be false or misleading if it is based on demonstrably incorrect, unreasonable, or incompletely stated assumptions.
151. FRS-29 requires that any error in prospective financial information must be amended as soon as this comes to the attention of the governing body of the issuer (the board of directors in the case of WHL). The Standard describes the meaning of the expression "errors in prospective financial information" as follows:

"For the purposes of this Standard, an error in prospective financial information occurs where:

1. in the case of a forecast:
   1. an arithmetic error is made in the preparation of the forecast; or
   2. an error is made in the process of deriving the assumptions underlying the forecast; or
   3. one or more of the assumptions as to future events on which the forecast is based are subsequently deemed not to be reasonably expected.
2. in the case of a projection:
   1. an arithmetic error is made in the preparation of the projection; or
   2. an error is made in the process of deriving the assumptions underlying the projection; or
   3. one or more of the assumptions as to future courses of action on which the projection is based are subsequently deemed not to be realistic or deemed not to reflect possible courses of action.

152. The question of when a forecast might be considered "untrue" or "false or misleading" under securities legislation has not been considered by the courts in New Zealand. The High Court has held that forecast financial information prepared for a stock exchange profile can be found to be "likely to mislead or deceive" for the purpose of section 9 of the Fair Trading Act 1986 if a representation in the forecast either is not honestly believed by its maker or if there was no reasonable ground for it.
153. The Commission considers that an offer document is likely to be false or misleading if it contains prospective financial information that contains an "error in prospective financial information" for the purposes of FRS-29. For the purposes of securities law the Commission considers that an offer document containing prospective financial information is likely to be misleading (in addition to being in breach of the law) if it does not fully and accurately disclose the principal assumptions on which the information is based.

WHL's Forecast Financial Information

Forecasts

154. WHL's forecast statement of financial performance in the offer document predicted a net profit after tax (NPAT) for the year ending 31 March 2002 of $1.96 million, from revenues of $26.57 million. This represented an expected increase of 7.4% in revenues and 14.7% in net profit compared with the results for the year ended 31 March 2001.
155. The forecast statement of financial position stated that total net tangible assets as at 31 March 2002 were expected to be $19.36 million, up from $12.17 million at the same time the previous year.
156. The forecast statement of cash flows forecast a decline in cash flow from operating activities for the year ending 31 March 2002 (to $3.14 million as against $3.42 million for the year ended 31 March 2001), and an increase for the year ending 5 August 2002 (to $3.66 million).
157. The figures included in the forecast financial statements were based on WHL's 2001/2002 Business Plan, which was approved by the board in April 2001. The Business Plan incorporated the 2002 budget for WHL, which was finalised in March 2001 and presented at that month's board meeting. Mr Andrew Carpenter, WHL's Finance and Administration Manager at the time of the IPO, described the process for deriving prospective figures for the Business Plan:

"The major assumptions throughout the Plan are the number of admissions from each speciality by month and the average revenue received by Wakefield for each admission under each speciality. These are initially prepared by Mr Barnes and validated by myself using the admissions recorded in the Hospital's patient administration system databases and the billing system...

On 14 February 2001 Mr Barnes completed the revenue assumptions and gave them to me for inclusion in the Plan. These assumptions included 175 hearts for CCH with a value of $2.6 million and 'private' hearts at 290 with a value of $4.3m (In the year to 31 March 2001 254 CCH and 243 private hearts were performed, therefore the assumption was valid and the capacity available).

158. The 2000/01 year was described in the WHL Business Plan as a "bonanza" in terms of the number of publicly funded cardiac cases subcontracted to WHL by CCDHB. The 2001/2002 Business Plan (finalised for approval by the board in April 2001) and the 2002 Budget (completed in March 2001) allowed for a 30% reduction in the number of contracted cardiac cases. Mr Barnes informed the Commission that he budgeted for a drop of 30% "because in March 2001 it became evident CCH had funding issues". Mr Barnes said it was apparent to him from information he received in early March that CCDHB had funding difficulties in respect of services to be provided to the end of the CCDHB year, being 30 June 2001. However, he believed contracting would continue after this date.
159. Internal working papers prepared by Mr Barnes and provided to the Commission show that the budgeted number of 175 contracted cases was taken as an approximate mid-point between the previous year high of 254 cases and a possible "minimum" of 100 cases. It does not appear that any sensitivity analysis was undertaken that estimated the financial effect of the possibility of contracted cardiac surgery ceasing altogether.
160. The Commission was informed by Mr Barnes that the WHL board and management reviewed the forecast figures in late July, just before the prospectus was registered. This review took account of the actual first quarter results (which were lower than budgeted). It also included adjustments to the revenues and expenses for the remainder of the year to allow for higher than previously budgeted volumes of contract cardiac surgery for the remainder of the year. In this way the revised forecast accommodated the lower (than budgeted) number of contract cardiac cases actually performed in the first quarter within the total forecast volume of 175 cases for the year. The directors' assumption that 175 contract cases would be completed over the full year remained unchanged at this time. In the opinion of the board this forecast was achievable.
161. The directors also gave evidence that the board again reviewed the reasonableness of the prospective information in August, prior to the allotment date. At this time the total expected volume of contracted cardiac surgery for the year was recast to a lower volume (135 cases). This was on the assumption that CCDBH contracting would recommence from October 2001. Expected revenues for contracted cardiac surgery were also revised downwards by around 25%. The anticipated volume of private cardiac surgery remained at the same level as before, but expected revenues from private cardiac surgery were revised upwards reflecting an overall increase in those revenues of around 4.5% in the August revised forecast for the full year.
162. Mr Aburn told the Commission that the October recommencement date was assumed on the basis that CCDHB had to complete its budget discussions for the 2001/02 year, so it was unlikely that contracting would recommence before October.
163. The effect of these changes was a 7% overall reduction in total expected revenue from cardiac surgery (contracted and private). The effect of the changes to prospective revenue from contracted cardiac surgery was that almost 80% of the total was expected to be earned in the second half of WHL's financial year ending 31 March 2002. WHL's directors advised the Commission that they considered this to be achievable.

Assumptions

164. The offer document said that investors must read the assumptions described in the offer document in order to fully understand the prospective financial information. The offer document also advised readers to refer to the risks and uncertainties discussed in the offer document under the heading "Risk Factors" when considering the forecasts. It advised readers not to place "undue reliance" on the forecasts.
165. Under the heading "Assumptions for Forecasts" the offer document stated:

"Those forward-looking statements are based on the current beliefs of Wakefield's Board and management as well as on assumptions made by, and information available to, Wakefield's Board and management at the time those statements were made."

166. The list of assumptions was introduced by a statement about a drop in actual revenues and profits for the first quarter of the year ending 31 March 2002:

"For the first quarter of the 2002 year, actual revenues and profits have been adversely affected by a combination of the temporary absences of some surgeons and a reduction in the volume of contracted cardiac surgery. These events are not unusual and allowance for them has been made in the forecast of financial performance for the year."

167. The assumptions listed included, under the heading "General Assumptions":
     • "There will be no change in legislation or its administration which will have a material impact on the operations of the Group.
     • There will be no major structural changes in the way health care is delivered by the public health system.
     • Wakefield's present senior executives and other key staff will continue in their current roles..."
168. Under the heading "Revenues and Receivables" was added:
     • "Existing activities of Wakefield will be continued. Revenues will continue to grow both in terms of volume (6.4% increase in theatre hours) and price (1% increase).
     • The current specialists using the clinical facilities will continue to base their practices at the Hospital..."
169. The assumptions to the forecasts did not otherwise mention publicly funded cardiac surgery.

Issues

170. The Commission has concluded above that the uncertainties surrounding the contracting situation with CCDHB constituted a risk factor that was material to the offer of securities. For the same reasons the Commission considers that the board's assumptions regarding the recommencement of publicly funded cardiac surgery should have been disclosed as significant assumptions underlying the prospective financial information.
171. FRS-29 requires, in paragraph 5.15, that:

"All significant assumptions underlying prospective financial information shall be disclosed separately and clearly identified."

The question of whether an assumption is significant is assessed with reference to its potential impact on the prospective financial information and the degree of uncertainty associated with the assumption. There is a higher degree of uncertainty associated with assumptions about matters over which management has little control or influence.

"FRS-29 also states that:

" Where significant assumptions are subject to a high degree of uncertainty, this uncertainty, together with its potential financial effect on the prospective financial information, shall be disclosed."

This indicates that in addition to disclosing significant assumptions, where there is a high degree of uncertainty associated with an assumption then the uncertainty must be disclosed. Furthermore, a sensitivity analysis should be undertaken to determine the potential financial effect of the uncertainty on the prospective financial information. The financial effects should be disclosed together with the assumptions.

172. The Commission is of the opinion that the prospective financial information in the offer document raises three specific issues:
     • the adequacy of disclosure of the assumptions; and
     • the disclosure of general assumptions to cover specific risks, rather than disclosure of specific significant assumptions and the risks and uncertainties associated with them; and
     • whether the forecast financial statements in the prospectus qualified to be presented to investors as forecasts on the basis of the underlying assumptions.

Adequacy of Disclosure of Assumptions

173. The forecast figures for the offer document were prepared on the basis of an assumption that WHL would receive 175 subcontracted cardiac cases from CCDHB in the 2001/02 financial year. These forecasts were based on the 2002 Budget approved in March 2001 and the 2001/2002 Business Plan finalised in April 2001. The assumption that WHL would receive 175 subcontracted cardiac cases from CCDHB did not change during the period from March 2001 to August 2001.
174. This report has discussed already the indications given to WHL by CCDHB that it did not intend to subcontract further cardiac surgery after 30 June 2001. Clear indications seem to have been given in March 2001, if not earlier, of this intention. As is also noted above, the directors of WHL were aware of the CCDHB intention, but did not believe that CCDHB would be able to meet its goal.
175. The Commission considers the assumptions in the offer document were misleading by reason of omission of a principal assumption underlying the prospective financial information, namely that the directors assumed that CCDHB would subcontract a certain number of cardiac cases to WHL in the 2001/02 year.
176. Further, the Commission is of the view that the assumptions stated were likely to mislead investors regarding the status of subcontracted cardiac surgery. The statement in the offer document disclosing the drop in revenue in the first quarter as a result of a reduction in the number of subcontracted cardiac cases gives the impression that this was a temporary and not unusual matter. The statement went on to say that this reduction had been taken into account in determining the forecast figures.
177. The reduction in the volume of contracted cardiac surgery cases in the first quarter amounted to a 37% drop in actual contracted cardiac admissions against the budgeted admissions for the quarter (28 actual cases against 45 budgeted cases). The associated revenue effect was a 43% drop in actual revenues measured against forecast revenue for the first quarter.
178. The minutes of WHL's June 2001 board meeting show that Mr Riordan confirmed that "CCH was now firmly against contracting". The General Manager's Report to the board for June 2001 reported the "complete cessation of subcontracted surgery by CCH despite prior "good faith" discussions to the contrary". On the Commission's assessment of the information available to the board, it appears that the reduction in the volume of cardiac surgery contracting was in fact unusual, and was not of a temporary nature at the time of the offer document.
179. The statement in the assumptions that "Existing activities at Wakefield will be continued" also lends support to an impression that subcontracted cardiac surgery was being undertaken by WHL as at the date of the registered prospectus. This was not so.
180. The directors of WHL formed the business judgement that CCDHB would recommence subcontracting at a level that would provide a significant percentage of WHL's total revenue for the 2001/02 year. They assumed this despite indications that this was uncertain.
181. When the potential impact of this assumption on WHL's financial performance is assessed alongside the level of uncertainty surrounding the future contracting situation, it is the Commission's opinion that the directors had adopted an assumption for the prospective financial information which was significant. This assumption should have been disclosed to investors in the offer document.
182. The Commission is of the opinion that the statement of assumptions in the offer document was misleading by reason of failing to specifically state a significant assumption underlying the prospective financial information in the offer document, namely the assumption that WHL would receive significant revenues from publicly funded cardiac surgery in the 2001/02 year.

Use of General Assumptions

183. FRS-29 requires that any significant assumptions be disclosed separately and clearly identified. The Standard explains why this is required:

"Prospective financial information will be based on many assumptions about future conditions and events which may or may not occur. The quality of the information will be dependent largely on the appropriateness of these assumptions. Therefore, users are to be provided with these assumptions so as to make their own informed judgement on the quality and reliability of the assumptions. For users to make their own judgement it is necessary to provide information which assists them in assessing the sensitivity of prospective financial information to changes in assumptions which are subject to high degrees of uncertainty."

184. In his statement to the Commission Mr Barnes drew attention to the disclosure in the offer document, under "General Assumptions", of the assumption that "There will be no major structural changes in the way health care is delivered in the public health system", and the assumption that "Existing activities...will be continued".
185. A stated assumption regarding "no major structural changes in the way health care is delivered by the public health system" may be viewed as a general assumption covering the possibility that future changes in CCDHB policy could have an effect on WHL's prospective financial information.
186. In evidence given to the Commission Mr John Aburn, an independent director of WHL, spoke of the importance of publicly funded cardiac surgery to WHL:

187. For the purpose of the prospective financial information in the offer document the directors had made a business judgement that future revenues and profits would flow from entering into a new Schedule for cardiac surgery during the forthcoming year. The revenues, profits and cash flows included in the prospective information on the basis of that business judgement were significant. At the date of the prospectus no Schedule was in place for publicly funded cardiac surgery, and there was uncertainty as to whether a contract would be concluded in future at all. No such Schedule was concluded in the year following the issue of the prospectus.
188. Assumptions accompanying prospective financial information in prospectuses should be capable of assisting prospective investors to make their investment decisions. Significant assumptions need to be set out with sufficient clarity to allow investors to identify the particular risks to the achievement of a forecast or projection that may eventuate if those assumptions prove to be incorrect.
189. In this context the Commission does not consider that the general assumptions in the offer document provide an adequate substitute for disclosure of the specific assumption regarding future district health board contracting on which the directors of WHL based the forecast financial statements.
190. The Commission does not consider that the disclosure of the general assumptions was sufficient for the purposes of the obligation under the Securities Regulations 1983 to disclose "principal assumptions" underlying its prospective financial information.

Assumptions Relating to the Forecast Financial Statements

191. FRS-29 requires all disclosures of prospective financial information to be labelled clearly as a forecast or a projection. WHL's prospective financial information in the prospectus was presented as forecast financial information.
192. FRS-29 requires that prospective financial information include a statement explaining the differences between forecasts and projections. This statement must emphasise that a forecast is based on "assumptions which the governing body reasonably expects to occur", while a projection is based on "one or more hypothetical but realistic assumptions".
193. Potential investors can expect to be able to place more confidence in forecasts than in projections. The commentary to FRS-29 notes that a clear distinction between the two reduces the possibility of unwarranted credibility being attached to the information. Where prospective financial information is labelled as a forecast it is important that it qualifies as a forecast under the definition of that term in FRS-29.
194. The component of the prospective financial information in WHL's offer document relating to revenues, profits, and cash flows from subcontracted cardiac surgery with CCDHB rested on the directors' business judgement that cardiac contracting would recommence, and would provide significant revenue in the 2001/02 year.
195. The contracted cardiac surgery component of the prospective financial information may have been based originally (when the budgets were finalised in March /April 2001) on an assumption that was a "best-estimate". In the Commission's opinion this assumption became objectively less supportable as the year progressed.
196. This raises questions for the Commission as to whether or not, at the date of the prospectus, and at the latest by the date of allotment of the shares, the prospective financial information qualified to be described as forecast financial statements because one of the significant assumptions on which they were based was a hypothetical rather than a "best-estimate" assumption.
197. Mr John Aburn, an independent director of WHL, told the Commission that WHL's management were asked to "retest" the forecast figures at both the July and August board meetings (prior to signing off on the prospectus and prior to allotment of the shares). The management reports for June and July (presented at board meetings at the end of July and August respectively) show an awareness that the actual revenues and net profits were less than the budget and forecast amounts on a year-to-date basis, and the acknowledgement that this was due largely to the cessation in publicly funded cardiac surgery.
198. The assumptions for the forecasts stated that an allowance had been made for the reduction in contracted cardiac surgery in the first quarter of 2001/02. Evidence was given by Mr Aburn, Mr Morris, and Mr Barnes that the directors continued, until after the date of the registered prospectus, to assume that 175 cases would be referred to WHL in the 2001/02 financial year. Mr Barnes told the Commission:

"Our forecast had always been on the basis that the 175 cases that we anticipated at the time we made that forecast would not commence at earliest until about mid-September."

199. The July General Manager's report, given to the board at the end of August, spoke of a "disastrous drop in profitability" compared to the previous year. That report still expected contracting to resume, possibly re-commencing in October, on the basis of information available to management and the directors concerning the growing public waiting lists for elective cardiac surgery.
200. The July General Manager's report attached a revised forecast for the 2001/02 year, which estimated a total 135 publicly funded cardiac cases instead of the previously estimated 175 cases. This revised forecast showed only a relatively small variation in the total forecast revenue and total forecast net profit for the year. The decline in total forecast net profit amounted to $45,000, which the directors considered was not a material decline. The reason for this was mainly that the revised forecast incorporated the effects of proposed increased prices for various services, including cardiac surgery.
201. It appears that no sensitivity analysis was undertaken at the time of the revised forecast in August 2001, to examine the financial effects on the prospective information of a total cessation of publicly funded cardiac surgery. Mr Aburn and Mr Morris told the Commission that WHL anticipated subcontracting would resume around mid-October. The Commission asked whether this would make it difficult for WHL to deal with the forecast number of publicly funded cardiac cases, even if CCDHB resumed contracting:

202. The directors did, however, consider it achievable:

"...the forecast in the prospectus was based on the fact that with contracting resuming in October we built a figure of slightly in excess of 100 cases into our forecast and we believe we could manage that with the resources we have..."

203. At the August board meeting the board resolved, after considering the revised forecast, that:

"nothing has occurred since the 6 August signing of the offer document which makes the offer misleading."

The board authorised Mr Barnes to sign the required notice.

204. The chairman of WHL, Mr Calder, told the Commission that he warned the board to take care with this decision:

"I recall myself saying to members of the Board that they should be very clear that if they had any doubts as to our ability to perform that they should speak up, but at that meeting we affirmed our opinion of the July meeting, which was we were confident that predictions were as accurate as they could be."

205. It appears to the Commission that the directors of WHL continued to believe that contracting would recommence and, from an operational perspective, that WHL had the capacity and resources to cope with the additional operational demands of undertaking almost 80% of the total forecast cardiac admissions in the second half of the year. The directors informed the Commission that WHL had, in the past year, coped with as many as 28 contracted cardiac cases per month, in addition to its normal level of demand for private cardiac and other surgery.
206. FRS-29 states, in relation to the assumptions supporting a forecast, that:

"Assumptions used in preparing forecasts shall be reasonable, supportable, consistent among themselves and with the strategic plans of the entity, and be applied consistently."

The Standard further explains the term "supportable":

"To be supportable, best-estimate assumptions need to be based on the past performance of the entity itself, the performance of similar entities, feasibility or other studies that provide objective corroboration, and the prevailing economic environment...The extent of detailed information supporting each assumption and an assessment of the reasonableness of each assumption will vary according to circumstances, and will be influenced by factors such as the significance of the assumption and the availability and quality of the supporting information"

207. On the basis of the criteria set out in FRS-29, an assumption for a forecast must be supportable on the basis of objective information. The directors' belief that the forecast was likely to be achieved continued to rely on the assumption that cardiac contracting was likely to recommence. The Commission doubts whether this assumption was supportable at latest by the date of allotment of the shares.
208. It appears to the Commission that evidence available at the time gives rise to clear questions about whether the assumption was supportable. In particular:
     • CCDHB had publicly communicated its strategic intention to work towards performing all cardiac surgery on an "in-house" basis from 1 July 2001. Information about its intention to implement this plan was publicly available prior to the date of the prospectus and prior to the date of the allotment.
     • CCDHB had communicated its intention to WHL that it would not enter into a new contract for cardiac surgery after 30 June 2001 (and after that date had not done so). The communication of this information took place between CCDHB and WHL at the executive management level, and was available to the directors at the date of the prospectus and the date of the allotment.
     • No Schedule to perform publicly funded cardiac surgery existed at the date of the prospectus and at the date of allotment.
     • CCDHB had not referred any cardiac cases to WHL after 30 June 2001.
209. WHL argued that evidence provided by the directors to the Commission demonstrated that the board's beliefs were sufficiently supported. This support was derived from the individual directors' past experience of WHL's business and, in the case of certain directors, from their experiences as medical specialists with extensive experience of the delivery of health services in the public sector. Fundamental to this opinion was their view that the pressure on waiting lists that would result from the attempt by CCDHB to perform all its cardiac surgery in-house would require CCDHB to resume contracting.
210. WHL also submitted that Ms Mains had been non-committal in her response regarding the assumption on cardiac subcontracting:

211. The Commission's impression of Ms Main's response was that she declined to express any view herself, but considered this a role for others.
212. Mr Bruce Wattie, a partner at PwC, was involved in the review of the prospective financial information. He provided an affidavit for the Commission in which he said:

"From the work undertaken by PwC to enable it to give the auditor's report in respect of prospective financial information contained in the Prospectus and Investment Statement I believed that WHL had such confidence, that the future events on which the prospective financial information contained in the Prospectus and Investment Statement was based were likely to occur, that the information could be characterised as a forecast rather than a projection."

213. Taking into account the arguments and submissions of WHL and the evidence of Mr Wattie regarding the directors' confidence in the assumptions, the Commission notes that by the date of allotment two months had passed with no referrals from CCDHB and no positive indications from CCDHB that any would be forthcoming, despite the growing waiting lists. At that stage the directors' expectation that the forecast revenues would flow from the anticipated recommencement of contracting later in the year would seem to have been possible, but not probable.
214. In the circumstances the Commission considers that, by the date of allotment, the use of the term "forecast" to describe the prospective financial information was likely to mislead prospective investors in terms of the level of confidence they could have in the prospective financial information.

THE DUE DILIGENCE PROCESS

215. The Commission has concluded that the offer document for the IPO failed to adequately disclose key risks associated with the offer of shares, and failed to adequately identify and disclose the assumptions underlying the prospective financial information set out in the offer document. The Commission has concluded that a significant assumption underlying the prospective financial information had become, by the date of the allotment, a hypothetical possibility rather than a "best-estimate".
216. Having heard evidence the Commission is satisfied that at the time of allotment of the shares the directors of WHL believed that the subcontracting for publicly funded cardiac surgery would resume, and that WHL would be able to achieve its forecast results for the financial year ending 31 March 2002. However, the Commission considers that this honest belief on the part of the directors was mistaken.
217. The Commission is aware that hindsight provides for much easier identification of risks. One of the documents obtained by the Commission in the course of its inquiry was a copy of minutes of a meeting held by Forsyth Barr, the lead manager for the share offer, on 28 November 2001. Mr Barnes attended this meeting. The minutes of the meeting record him saying:

"with the benefit of hindsight would have said assumption that cardiac contract will not be reduced."

When questioned about this by the Commission Mr Barnes explained this statement:

"With the benefit of hindsight we should probably have flagged that the non-resumption of a contract at all was a risk. If not a likely risk, a risk and it should have been said. But that, I might say, is with the benefit of hindsight and, of course, I have even more acute hindsight now."

218. Other than by hindsight, identification of risk factors is often best achieved by involving an independent person in the identification and assessment process. We note this is supported by FRS-29, which makes the following point in relation to developing assumptions for prospective financial information:

"It is usual to examine closely for inherent flaws the process used to develop the assumptions. The use of an independent third party to review these assumptions is often a valuable aid to reduce internal bias, and to provide an additional perspective on the validity of the assumptions. This is particularly so when the development of assumptions requires specialist skills."

219. In the case of WHL the identification and assessment of financial risks for the preparation of the offer document, and the development of assumptions for the prospective financial information responsive to the risks, was undertaken largely in reliance on members of WHL's management and directors who were themselves very close to the offer process. In particular, reliance was placed on Mr Barnes to provide accurate figures to the board. Mr Barnes, as well as the other directors, appear to have placed significant weight on the opinion repeatedly expressed by Mr Riordan that CCDHB would have to resume contracting, as it would be untenable, in terms of government's health policy, to allow the waiting list for elective cardiac surgery to grow beyond the six month waiting period.
220. The Commission has concluded that it seems unlikely that the directors' implicit assumptions relating to contracted cardiac surgery could, on an objective assessment, have been considered probable, at latest by the date of allotment. It appears to the Commission that WHL should have obtained external assessment of financial aspects of its offer document, and in particular its prospective financial information.

WHL's Due Diligence

Legal due diligence

221. WHL's solicitors and auditors both advised of the importance of a thorough due diligence process for the IPO, particularly in relation to financial aspects. Buddle Findlay (BF) wrote to the board of WHL on 1 June 2001 to clarify the due diligence process to be implemented for the IPO. This letter summarised the objectives of the due diligence process prior to finalisation of offer documents for the share offer:

222. In relation to the second objective, Buddle Findlay clarified that the aim was to assist the company and its directors to take advantage of any available "due diligence" defences to liability under the Securities Act and Regulations. On this point Buddle Findlay noted:

"while the SA provisions relating to those defences refer to directors having reasonable grounds for believing statements to be true and not misleading, where offer documents contain material errors or omissions the Courts are likely to impose a high threshold on directors seeking to avail themselves of such defences. In other words, a high standard of investigation and enquiry by directors would need to be shown to take advantage of the due diligence defences."

223. Buddle Findlay provided a legal opinion and due diligence report on 6 August 2001. The legal opinion is referred to earlier in this Report. It concluded that the Offer Document complied with relevant law, but was expressly qualified and did not extend to "statements of a financial, accounting or commercial nature".

Commercial due diligence

224. Forsyth Barr, the lead manager and organising broker for the IPO, also undertook a due diligence process. This was carried out by Forsyth Barr's solicitors, Horsley Christie, and was termed "Commercial Due Diligence". Forsyth Barr advised WHL that this due diligence was part of Forsyth Barr's usual internal procedures to cover reputational risks for Forsyth Barr.
225. The commercial due diligence process included provision of a questionnaire for WHL management addressing commercial, business, strategic, and financial aspects of WHL's operations. This questionnaire was completed and discussed at a meeting on 25 June 2001 between Forsyth Barr and WHL's directors. Horsley Christie provided a due diligence report for Forsyth Barr on 10 July 2001.
226. This exercise was intended for the benefit of Forsyth Barr, not WHL. The opinion provided by Horsley Christie confirmed this.
227. It is clear from evidence received by the Commission that WHL understood the purpose of the Forsyth Barr due diligence. The matter was raised in evidence from Mr Barnes.

228. However, it also appears from evidence heard by the Commission that WHL's directors did take some comfort from the Forsyth Barr exercise, despite this being carried out expressly for the benefit of the broker. Mr Calder was asked about the purpose of the due diligence:

229. A copy of the transcript of the commercial due diligence questionnaire and the answers given was provided to WHL. It was reported at the Finance Committee meeting on 6 July 2001 and at the WHL board meeting on 13 July 2001 that no material matters were reported arising from the commercial due diligence.
230. A file note prepared by a Buddle Findlay solicitor of a meeting of the WHL Finance Committee held on 29 May 2001 records that the position of the Forsyth Barr due diligence was explained to the Finance Committee. It appears from this that Forsyth Barr did not intend this process to be something that WHL should rely on:

"AZS [solicitor from Buddle Findlay] asked [Forsyth Barr] where the commercial due diligence being carried out by Forsyth Barr fit in in the process - i.e. would it result in a report to the Board or was it merely an internal report by Forsyth Barr to protect its reputational interests. [Forsyth Barr] noted it was to protect Forsyth Barr's interests. AZS asked ... whether Forsyth Barr's report could be presented to Wakefield's board - he noted that, in terms of the legal due diligence, we would be presenting a report to Wakefield's directors, for them to rely on. Michael Morris remarked that he assumed that if Forsyth Barr came across any difficulties, those would be communicated to Wakefield. There was no response from Forsyth Barr and the matter was not decided."

231. It appears that the Horsley Christie due diligence report was not given to the WHL board.

Financial due diligence

232. In late April PwC offered to provide, in addition to its audit services, a financial due diligence service for the IPO. This would be undertaken by a specialist due diligence partner, separate from the audit partners, reporting directly to WHL's due diligence committee. The purpose was to act in a quality control role ensuring that all financial and tax matters required by the due diligence committee were completed.
233. Mr Morris told the Commission that WHL's Finance Committee decided on 29 May 2001 that an external financial due diligence was unnecessary, and that WHL would get no benefit from such an exercise. This decision was commented on by Buddle Findlay in their letter of 1 June 2001:

"In our experience it is common for the directors of a company preparing for an IPO to engage either its auditors or other independent accountants to conduct financial (and sometimes commercial) due diligence on the company as part of the due diligence process.

As noted above, the Committee has concluded that in this case, external financial due diligence is not necessary, given the proximity to the end of the previous financial year (for which there will be audited accounts), the steady nature of the business's financial performance, and the close and detailed understanding that directors have of Wakefield's financial affairs. We understand the Committee is confident that in practical terms, the internal due diligence proposed will be sufficient in the present circumstances to identify all material financial information for inclusion in the prospectus and to ensure the accuracy of the offer documents as far as Wakefield's financial position is concerned.

External due diligence would obviously provide the highest level of assurance to a company's directors that all material financial matters had been included in the offer documents. In Court proceedings in relation to offer documents that are found to be false or misleading or to omit material information, it is possible that the Court may perceive internal management financial due diligence on its own to be less rigorous than external due diligence, which in turn might undermine the availability of due diligence defences under the Securities Act."

234. In order to be able to demonstrate that the internal due diligence process was thorough, Buddle Findlay recommended a documented process for the Committee's requirements for investigations by management. The Commission was told that precedent forms were provided for completion by management, detailing aspects of the financial affairs of the company. Mr Aburn and Mr Morris told the Commission that these forms were not used. Mr Morris told the Commission:

"I did ask about that. They weren't used in the form that I had seen them used for other issues but, again, Wakefield is a relatively small straightforward business operating from one location.

The other one I have seen has been a much larger complex organisation operating from a number of locations. It would have been good practice for it to have been signed off but I didn't think it was necessary."

235. Mr Aburn said:

"We decided that the process we were using was robust enough and it followed the process that we had been using in previous years, and the executives Carpenter and Barnes having taken that information past Michael Morris and myself and then taken along to the Board, and it being discussed and questioned by the Board in some detail, we decided that was sufficient."

236. According to the Finance Committee members the financial due diligence process followed the same processes adopted in previous years for the annual planning process and completion of the business plan.
237. PwC's engagement letter confirmed the limited nature of its review of the prospective financial information. This consisted solely of a review of the information for the purposes of the required statement under the Securities Regulations. Importantly PwC did not undertake any external verification of the information in the offer document.
238. It does not appear that WHL's internal financial due diligence involved steps to obtain an objective, independent evaluation of the assumptions underlying the prospective financial information. In particular WHL did not directly enquire into CCDHB's future plans to bring all cardiac surgery in-house, or the likelihood of subcontracting of cardiac surgery resuming in future.
239. In the Commission's opinion this weakened WHL's due diligence process. Publicly funded cardiac surgery represented a significant part of the prospective revenues of WHL. Whether this was a source of revenue that was likely to continue may have been clarified by a direct approach to CCDHB at the executive or Board level. The question was put to Ms Mains:

240. In the event no enquiry was made. On the evidence before the Commission, an objective enquiry such as one undertaken by an external due diligence adviser could have achieved a more thorough assessment of the risks and assumptions that needed to be disclosed in the offer document.
241. Mr Wattie's affidavit referred also to the subject of financial due diligence. Mr Wattie told the Commission that he has participated in about 10 due diligence assignments. Mr Wattie did not consider that an external due diligence exercise would have been likely to include an approach to CCDHB:

"A financial due diligence would have been undertaken for the Board of Directors of WHL under terms of reference agreed with the board. The initial investigations would have been internal to the company and would have included a detailed consideration of the financial reports of WHL, and its business records. From these a report would have been prepared for submission to the Board of Directors. The scope of the work undertaken at this time is most unlikely to have included direct contact with either major customers or suppliers of WHL. If the financial due diligence report identified that there was a high risk in relation to any particular issue, then this would have been brought to the attention of the Board. Following this initial report to the Board, any additional procedures to be performed would have been agreed by the Board.

I cannot exclude the possibility that the Board of Directors of WHL, having received an initial report, may have wished to have inquiries made of Capital Coast District Health Board. However, this would only have been undertaken at the request of the Board of Directors of WHL and only if it believed it required more information to enable it to assess the risks identified as a result of the initial inquiries. If the Board of Directors of WHL believed they had an adequate understanding of the risks identified in an initial report, then it is unlikely that they would have thought it necessary to ask an external adviser to make contact with purchasers or suppliers."

242. Mr Morris also told the Commission that from his experience it would be unusual for an investigating accountant carrying out financial due diligence to approach customers.
243. Despite these statements the Commission is of the view that an objective financial due diligence exercise would have carefully reviewed risks and uncertainties around the key sources of revenue, including major customers. Use of an external financial due diligence adviser could have allowed for more objective testing of the assumptions. It may have included seeking out CCDHB's public statements about its future plans and its position in relation to contracting (including the minutes of CCDHB meetings referred to in this report). It could have assisted to obtain sufficient information about CCDHB's policy in relation to future contracting to convince directors to seek some formal confirmation from the board of CCDHB about the contracting for the coming year, and to make a more objectively informed assessment of the risks and assumptions underlying the information in the offer document.
244. The Commission is of the opinion that the failure by WHL either to engage an external firm to carry out financial due diligence or to conduct a structured internal process that included appropriate objective assessment of its forecasts and assumptions may have contributed to the offer document being likely to mislead prospective investors in its description of the risks of investment in the business and in its presentation of the assumptions underlying the prospective financial information.

CONSEQUENCES

245. In view of the Commission's findings about the offer document we describe the possible consequences below.

Voidable Allotments

246. Under section 37A(1)(b) of the Securities Act a security offered to the public must not be allotted if at the time of allotment the investment statement or registered prospectus relating to the security is known by the issuer of the security, or any director of the issuer, to be false or misleading in a material particular by reason of failing to refer, or give proper emphasis, to adverse circumstances. This applies whether or not the investment statement or registered prospectus became false or misleading as a result of a change of circumstances occurring after the date of the investment statement or registered prospectus.
247. If an allotment of securities is made in contravention of this section then that allotment is voidable if the subscriber gives notice in writing to the issuer. This notice can only be given within a certain time period, which is the lesser of:
     1. a period of one year after the security or a certificate of the security has been sent to the subscriber; or
     2. a period of 6 months after the subscriber knows, or ought reasonably to know, that the allotment was made in contravention of the section.
248. The shares were allotted on 5 September 2001. Because WHL is listed on the NZSE (and its shares traded on the FASTER electronic trading system) there is no requirement for it to issue share certificates. In the circumstances we think the one year period, if applicable, is likely to apply from the date on which shareholders were given confirmation of their allotments.
249. The Commission is of the view that the offer document was at the time of allotment of shares, false or misleading in a material particular by reason of failing to refer, or give proper emphasis to, adverse circumstances. The adverse circumstances in this case were the uncertainties surrounding contracting with CCDHB and, by the date of allotment in particular, the fact that there had been no referrals of publicly funded cardiac surgery cases to WHL after 30 June 2001.
250. On the evidence it has heard the Commission is satisfied that the directors of WHL held an honest belief that the subcontracting with CCDHB would resume, both when they prepared the offer document and when the securities were allotted.

Liability

251. The Securities Act imposes criminal and civil liability for breaches of the Act and for use of offer documents containing untrue statements. It is possible that some of these liability provisions might apply. It is also possible that some defences might apply. It is not for the Commission to determine liability under any of these provisions - that is the role of the Courts.
252. The Securities Act provides for both criminal and civil liability where a registered prospectus or advertisement (including an investment statement) contains an "untrue statement". These liability provisions apply to the issuer of the securities and/or its directors.
253. For these purposes an "untrue statement" includes one that is misleading:
     1. in the form and context in which it is included; or
     2. by reason of the omission of a particular that is material to the statement in the form and context in which it is included.
254. Under section 56 of the Securities Act, every person who has signed the registered prospectus as a director of the issuer (or who has authorised someone else to sign for him or her) may be liable to compensate anyone who subscribes for securities on the faith of a registered prospectus which contains any untrue statement for any loss or damage sustained by reason of the untrue statement.
255. Section 58 of the Securities Act states that if a registered prospectus containing an untrue statement is distributed then any person who has signed the registered prospectus as a director of the issuer (or who has authorised someone else to sign for him or her) may be liable to be fined or imprisoned.
256. Under section 59 of the Securities Act, where an offer of securities is made to the public, or a registered prospectus is distributed, or a security allotted, in contravention of the Securities Act, the issuer and every person who has authorised himself or herself to be named in the registered prospectus as a director of the issuer (and who is named) may be liable to be fined.
257. There are certain defences available to liability under each of these provisions. Principally, a person will not be liable under sections 56 or 58 in respect of any untrue statement if that person proves that he or she had reasonable grounds to believe, and did believe, that the statement was true.
258. On the evidence it has heard the Commission is satisfied that the directors of WHL held an honest belief that the subcontracting with CCDHB would resume. The Commission is satisfied that the directors of WHL believed that the risk statements and assumptions were not misleading by reason of omitting references to the risks associated with the contracting situation with CCDHB.
259. Whether the belief held by the directors of WHL was, objectively, held on reasonable grounds will depend on the circumstances of the offer and of WHL, and the steps taken by WHL and its directors in preparing the offer document.
260. The Commission considers that relevant factors to any assessment of the reasonableness of the beliefs held by directors may include:
     • the extent of the financial due diligence conducted, and the failure to perform an objective, independent evaluation of the basis for the directors' beliefs about the future of publicly funded cardiac surgery at WHL;
     • the fact that WHL did obtain an external legal due diligence report, and a legal opinion in respect of the legal compliance of the offer document (excluding statements of a financial, accounting, or commercial nature);
     • the history of the contracting arrangements between WHL and CCDHB, and of CCDHB's past inability to carry out all its own cardiac surgery in public hospitals.
261. It is not for the Commission to determine liability of any person under these provisions. That is the role of the Court.

ACTIONS

262. The Commission refers this report to the shareholders of WHL who subscribed for shares in the IPO, for them to consider the questions of civil liability and the question of voidable allotments. Whether any action should be taken is a matter for those shareholders to determine.
263. The Commission's findings have highlighted possible breaches of securities law. The Commission will refer this report to the Companies Office.

________________________________
Jane Diplock
Chairman of the Securities Commission

7 August 2002

TERMS OF REFERENCE: WAKEFIELD HOSPITAL LIMITED

PURSUANT to section 10 of the Securities Act 1978 the Securities Commission has decided to undertake an inquiry to review the facts and circumstances of the offer and allotment of the shares of Wakefield Hospital Limited ("WHL") for the company's initial public offering as a company listed on the New Zealand Stock Exchange ("NZSE") in September 2001, and the company's communications to the share market subsequent to the allotment.

	THE Commission wishes to consider any evidence which may be material to:
	(a)	(i)	whether the registered prospectus issued by WHL dated 6 August 2001 was false or misleading as to any material information, or omitted any material information or did not comply with the Securities Act 1978 or the Securities Regulations 1983;
		(ii)	whether at the time of allotment of the securities offered under the WHL prospectus it was known by WHL or any of its directors to be false or misleading in a material particular by reason of failing to refer, or give emphasis, to adverse circumstances affecting the entity and any information included in or omitted from the prospectus pertaining to those circumstances;
		(ii)	whether, in respect of any materially untrue, inaccurate or misleading information included in the WHL prospectus or any material information omitted from the prospectus, the directors of WHL had reasonable grounds to believe, and did believe up to the time of allotment of the securities, that the prospectus was true in respect of the manner of presentation of that information in the prospectus;
	(b)	the nature of the information communicated to shareholders and the NZSE about the performance and prospective performance of WHL after the date of allotment of the securities;
	(c)	the procedures observed by the directors of WHL in relation to:
		(i)	preparation of the prospectus dated 6 August 2001;
		(ii)	approval of the allotment of securities under the offer supported by that prospectus;
	AND to consider:
	(d)	any other matters material to the inquiry;
	(e)	whether the Commission should comment on any matters arising in the inquiry to WHL, its directors, its shareholders, the NZSE or to any other appropriate body under section 10(c) of the Securities Act;
	(f)	whether the Commission should publish a report or take any other action.
	SUBJECT to the discretion of the Commission to amend these Terms of Reference as it may consider fit. 12 March 2002