A significantly wider statutory liability regime for issuers comes into force on 1 October 2010. The changes are particularly important for issuers with securities traded in the UK, or which have the UK as their home state.
The original regime will be expanded in a variety of ways. The new liability regime will cover not just periodic financial disclosures that are required under the Transparency Directive but all information published, or the availability of which is announced, using an RIS. It will also permit recovery in respect of losses caused by dishonest delay and give a right of action to sellers and those who continue to hold securities as well as to purchasers.
Background
When introduced in 2007, section 90A of the Financial Services and Markets Act 2000 ("FSMA") established a new statutory liability regime under which issuers were liable for fraudulent misstatements in periodic financial disclosures to the market. In response to concerns raised about the limited scope of that statutory liability regime, the government then appointed Professor Paul Davies QC to carry out an independent review of corporate misstatements to the market and to recommend whether or not changes should be made to the existing statutory regime. Professor Davies's recommendations then formed the basis of the government's consultation proposals. The Financial Services and Markets Act 2000 (Liability of Issuers) Regulations, which create the new regime and which will be inserted into the FSMA as a revised section 90A and schedule 10A, reflect the results of that extensive period of review and consultation.
In this e-bulletin we look at the new regime in greater detail and give practical guidance on its impact.
New liability regime
Under new section 90A an issuer of securities traded in the UK, or which has the UK as its home state, will be liable to pay compensation to a person who:
* acquires, continues to hold or disposes of the securities in reliance on published information; and
* suffers loss in respect of the securities as a result of:
o any untrue or misleading statement in that information; or
o the omission from that information of any matter required to be included in it (paragraph 3(1) of schedule 10A).
As is currently the case, liability will then only arise where a person discharging managerial responsibilities within the issuer (a "PDMR") knew the statement to be untrue or misleading or was reckless as to that fact, or, in respect of the omission of information, knew the omission was a dishonest concealment of a material fact.
From 1 October liability will also arise where a person acquires, continues to hold or disposes of the securities and suffers loss as a result of a delay by the issuer in publishing information (paragraph 5 of schedule 10A). The issuer is then however liable only if a PDMR acted dishonestly in delaying the publication of the information. Conduct will, in this respect, only be regarded as dishonest if it is regarded as dishonest by persons who trade on the market in question and the person was aware (or must be taken to have been aware) that it was so regarded. There will be times where the disclosure of information is delayed for good reason, for example, to confirm facts before publication. That of itself will not be dishonest behaviour and will not give rise to a claim.
All information published on or after 1 October 2010 will be subject to the new regime. Any information published before that date will be subject to the current regime.
Which issuers will be within the regime?
New section 90A will apply to issuers of securities admitted to trading on any securities market (whether regulated or unregulated) where either the market is situated or operating in the UK, or the UK is the issuer's home state (paragraph 1 of schedule 10A). In contrast to the current position, this catches multi-lateral trading facilities (for example, AIM or PLUS Markets) and not just regulated markets such as the Main Market of the London Stock Exchange.
The substantial extra-territorial reach of new section 90A (it could, for example catch a UK issuer with shares admitted to trading on the Hong Kong Stock Exchange) may be more apparent than real. HM Treasury confirmed this in its consultation response, where it commented that, in practice, a right of compensation will only arise where English law is found to be the applicable law of the forum in which a claim was brought with the relevant courts determining which law applies. In its view, the number of cases where the courts would apply English law outside the UK and EEA is likely to be small, but it did not see this, or the fact that most overseas listings are in jurisdictions with well-developed securities regimes, as a reason to exclude the relevant investors from the potential scope of the regime.
Which "securities" will be within the regime?
The regime will apply to transferable securities as defined in section 102A(3) of the FSMA. It is therefore very wide and includes derivative securities as well as shares.
In the case of depositary receipts, derivative instruments or other financial instruments representing securities, provided that it has consented to the admission to trading of the secondary securities, the issuer that is liable to pay compensation is the issuer of the underlying securities. Where however the issuer has not consented to their admission, and for all other derivative instruments, the issuer of the depositary receipts or other secondary securities will be the one liable to pay compensation under the regime. For this purpose, an issuer that has accepted responsibility for a document prepared for the purpose of admission of securities to trading on a securities market will be taken to have consented to their admission to that market.
Which disclosures will be caught?
The new regime will apply to all information published by, or the availability of which is announced by, "recognised means" (paragraph 2 of schedule 10A, FSMA). For UK listed companies, "recognised means" includes a regulated information service ("RIS"), or other means required or authorised to be used when an RIS is unavailable. This is very different to the current regime which only applies to periodic financial disclosures. An issuer will then be liable irrespective of whether the claimant obtains the relevant information from an RIS or from another source. The key point is that the information was published on an RIS.
The breadth of the definition of "information" should not be underestimated and issuers should be mindful of the extensive range of disclosures that will fall within it (though note also the comments below about the basis of any claim). For example, it will catch a business plan appended to a joint venture agreement that is identified in an announcement as being on display and where an announcement refers to annual accounts being made available, the entire contents of those accounts will fall within the regime.
Prospectuses and listing particulars will be treated differently to other types of publication as they are already subject to a specific compensation regime in section 90 of the FSMA. Whilst information contained within a prospectus or listing particulars will potentially be within the section 90A regime, an issuer will not be liable to pay compensation in respect of such information if it is liable to pay compensation under section 90 (paragraph 4 of schedule 10A of the FSMA).
What is the basis of liability?
Fraud will remain the basis of liability. The term is used in its civil sense, i.e. for an issuer to be liable under new section 90A there will need to be knowledge, recklessness or dishonesty on the part of the relevant PDMR. The fraud standard, it is hoped, will avoid reporting which is made over-defensive through fear of litigation.
The fraud standard sets a high evidential burden for anybody wishing to bring a section 90A action. It will therefore be difficult for a claimant, on whom the burden of proof lies, to allege fraud in the absence of sufficient evidence and such a claim would be susceptible to strike-out. This will deter unmeritorious claims and help avoid the settlement pressures that tend to surround civil litigation. However, as Professor Davies points out in his report, the bringing of a section 90A claim may in some respects, be easier than bringing a common law deceit claim (see below for more details). Nevertheless, given the high threshold set by the fraud standard, the UK is not expected to see a flood of speculative section 90A claims.
Who can bring a claim?
Under new section 90A, claims for misstatement will be able to be brought not only by buyers of securities but also by sellers and holders of securities. This represents a significant extension to the existing regime which only applies to buyers of securities.
An issuer will however only be liable under the regime if the claimant acquired, continued to hold or disposed of the relevant securities in reliance on the information in question at a time when, and in circumstances in which, it was reasonable for him to do so. On this basis a claimant may not succeed under new section 90A if he has an available means of checking the information but chooses not to do so.
The maker of the statement does not have to have intended the recipient to rely on the information. This arguably makes the bringing of a section 90A claim easier than at common law (where broadly the maker of the statement is liable only if it had intended that the recipient rely on it). However, as outlined above, fraud is a very high threshold for a claimant to satisfy. Furthermore, with regard to claims by holders of securities there is a clear distinction between a passive and an active holder: unless a holder of securities can show that he or she consciously decided to continue to hold the securities in reliance on the misstatement (for example, by cancelling an order with a stock broker to sell the securities) it will be difficult for that claimant to bring a section 90A action.
Who will have liability?
Section 90A liability will continue to attach to issuers only. The general principle is that an issuer is then not subject to any other form of liability for the specific losses covered by the section 90A regime. There are however a number of exceptions to this safe harbour which are listed in paragraph 7 of Schedule 10A . In particular, liability arising from a person having assumed "responsibility to a particular person for a particular purpose" is preserved. This is important as it preserves the common law on misstatement as decided in Caparo v Dickman and subsequent cases.
* Directors - Whilst a director of an issuer to which the section 90A regime applies will not, at least under English law, be subject to any direct liability to shareholders under the regime (paragraph 7 of schedule 10A of the FSMA), a director is nonetheless at risk where any section 90A liability claim succeeds against the company. The director at fault may be liable to the company for breach of duty. In a situation where, following a successful action against a company by an investor, that company decided not to take action against the director, shareholders may seek to pursue a derivative claim against the director; albeit that they would have significant procedural hurdles to overcome to do so.
It is not clear from the legislation whether by giving responsibility statements in reports and accounts directors will inadvertently be regarded as making a representation to a particular person for a particular purpose of the accuracy or completeness of the information concerned. However, the minutes of the Parliamentary committee at which this issue was discussed helpfully confirm that such responsibility statements would not, in and of themselves, be regarded as constituting such a representation.
* Auditors - The government decided against expanding the regime to encompass direct actions by investors against auditors. As mentioned above, the section 90A action itself continues to be against the issuer only.
It will, however, be possible for an issuer that is a defendant to a section 90A action to join its auditors as a third party and claim a contribution or an indemnity in respect of any liability imposed on the issuer in that action, where the auditors did some work on the statement to the market on which the action is based. So, for example, if the action is based on an alleged misstatement in the audited accounts the issuer may join its auditors on the basis that they should have detected the misstatement in the course of their audit work. This highlights the importance for auditors of carefully defining the scope of each task they are asked to perform by an issuer and not being drawn into, for example, approving ad hoc announcements which will now be caught by the regime unless they have documented the basis on which such work is being done.
Finally, the safe harbour provisions described above have been amended to make it clear that where liability may attach to an audit report, for example, by virtue of an assumption of responsibility (i.e. where it is provided to a particular person in the knowledge that that person is going to rely on it for a particular purpose) such liability is not affected by this regime.
Measure of liability
The new regime does not formulate statutory rules for the assessment of damages. Instead, the power of decision making in this regard has been reserved to the courts. Professor Davies's view was that it would be difficult to formulate effective rules which do not tie the hands of the courts in an undesirable way. The measure of liability under section 90A has not yet been the subject of any judicial decision. However, Professor Davies's clear recommendation is that damages should, in most cases, be assessed by reference to the loss caused by the reliance on the statement rather than the loss caused by its falsity.
Practical guidance
Given the impact of the new regime, companies may be wise to consider taking the following action:
* Decide which information you would like to fall within the regime. For example, consider whether information that would normally be treated as "commercial" or non-regulatory information should be released through an RIS so as to take advantage of the safe harbour. Companies should not be concerned where information is disclosed out of hours, the key point is that the information, or its availability, was published using either an RIS or its out of hours equivalent. Where announcements need to be released through an RIS consider whether any cross reference to your website should only be to a specific part of it.
* Review your procedures for making announcements to the market and update any internal guidelines. In contrast to prospectuses and circulars which an issuer will only tend to publish on a limited number of occasions and for which there will be robust verification procedures and often public oversight in the form of an FSA review, RIS announcements are made much more frequently and have tended not to be subject to such rigorous procedures.
* Ensure that relevant members of staff are aware of the changes. In particular make sure that all such staff are aware of the new head of liability for dishonest delay. This would also be a good opportunity to remind such persons of the company's obligations under the Disclosure and Transparency Rules including the FSA's recent statements on the management of leaks.
* Review your D&O insurance for the increased risk of an action being brought against the directors following a successful section 90A action.
Conclusion
New section 90A has provided certainty in this area and has set the threshold at a high level. It is hoped that future case law will assist in settling the precise boundaries of certain concepts used in section 90A. However, given the importance of the factual matrix in determining the extent of any liability imposed, it may be difficult for the common law to evolve a generic set of standards or a test that will apply to all scenarios. Only time will tell.
From an enforcement perspective, the new regime gives a wide range of persons the chance to privately enforce the continuing disclosure obligations to which listed issuers in the UK are subject and which previously have only really been dealt with by way of public enforcement. Whilst the high threshold required to establish liability under section 90A demonstrates a government preference for public rather than private enforcement, it will be interesting to see what impact, if any, private enforcement has on our securities laws and on issuers' behaviour. However, it may be some time before there are enough claims to have any discernible impact.
Finally, when those claims do arise, the subordination of investor claims may be an issue. The current position is that in the event of an issuer's insolvency, investors' claims under the statutory liability regime rank alongside those of other unsecured creditors and ahead of those of shareholders. Professor Davies stated that this was an area which needed further consideration, but the government felt that resolution of this issue should not delay the introduction of these changes. The government has meanwhile acknowledged that this important issue needs further consideration.
Location