Background

From January 2007, as part of the UK’s implementation of the Transparency Directive, the Financial Services and Markets Act 2000 (FSMA) introduced a statutory civil liability regime for fraudulent misstatements in periodic disclosures made to the market by issuers of securities. The regime entitles a person who has acquired securities and suffered loss as a result of a fraudulent misstatement in a periodic disclosure to be compensated by the issuer.

Last year the Government commissioned Professor Paul Davies QC to carry out a review of the scope of the regime of issuer liability. The resulting report, issued in June 2007, has been considered by the Government and this month saw the publication of a consultation paper seeking views on proposals to extend the statutory regime.

The implementation of the key proposals will represent a significant extension of the potential liability of issuers. In particular, the extension to AIM companies and companies listed on other EEA exchanges and the extension to a wider category of disclosures, means that companies will need to take more care in verifying or recording the basis on which they have made information disclosures to the market in the future to avoid liability.

Key proposals in the Treasury’s consultation paper

The following extensions to the statutory liability regime are proposed:

  • Issuers traded on UK MTFs: at present the regime applies only to issuers of securities admitted to trading on regulated markets, which include the Main Market and PLUS-listed. It is proposed that the statutory regime should extend to disclosures made by issuers with securities admitted to trading on all UK MTFs (multilateral trading facilities) such as those on the AIM and PLUS-quoted markets.
  • Issuers traded on an EEA regulated market or MTF: the Government proposes to extend the regime to issuers of securities admitted to trading on an EEA regulated market or MTF where the UK is the issuer's home state under the Transparency Directive or the issuer has its registered office in the UK.
  • Information disclosed by issuers by means of a recognised information service: currently, the statutory liability regime applies to the annual financial report, the half-yearly report, interim management statements and any prelims published in advance of the annual financial report. It is proposed that the regime be extended to apply to ad hoc disclosures and that all information which is published or announced as available by an issuer by means of a recognised information service will come within the statutory regime.

A “recognised information service” for these purposes would include any service used to publish regulated information under the Transparency Directive including all Regulated Information Services (RISs) and information services used to disseminate information required to be published under the rules of a regulated market or MTF. Liability can also attach where the information relied on is acquired from a secondary source. If an investor can prove that the information in question was published on a recognised information service, then he will not have to prove that he obtained the information himself from the recognised information service in order to bring a successful claim for compensation.

  • Dishonest delay of a disclosure: the Government proposes that the statutory regime be extended to permit recovery for losses resulting from dishonest delay of a disclosure. An issuer would be liable where the delay is a dishonest act and is for the purpose of enabling a gain to be made or to cause loss to another or expose another to a risk of loss.
  • Sellers, as well as buyers, of securities to be permitted to recover losses: the Government believes that the regime should be extended to include sellers of securities as their loss is the same as that suffered by buyers (i.e. the difference between the price paid and the price which would have prevailed had the truth been known). However, the regime is not to be extended to holders of securities.

The consultation paper also recommends the following:

  • Issuers who have consented to the admission of secondary securities to remain liable: the Government also considered the question of whom should be considered the issuer of the security on the admission of secondary securities and so liable to pay compensation for misstatements. In the case of depositary receipts and other secondary securities giving the right to acquire or sell other transferable securities, the Government proposes that the issuer liable to pay compensation will be the issuer of the underlying securities, provided the secondary securities concerned have been admitted to trading by or with its consent. The reason for this is that a decision to acquire or sell depositary receipts is influenced by information published by the issuer of the underlying securities, not the issuer of the depositary receipts.

For depositary receipts and other secondary securities admitted to trading without the consent of the issuer of the underlying securities, and for all other derivative instruments, the issuer of the secondary securities or derivative instruments will be liable to pay compensation under the statutory regime. The reason for this is that if the issuer of the underlying securities has not consented to the admission to trading of the secondary securities, then it should not be liable to compensate investors in such securities for their loss.

  • Liability should attach irrespective of whether the transaction takes place on or off market: the appropriate test is that the investor relied on the disclosure in circumstances where it was reasonable to do so.
  • Subordination of investors’ claims to those of other unsecured creditors: investors’ claims currently rank alongside those of other unsecured creditors and ahead of shareholders’ claims. The consultation paper states that the issue of subordination will be deferred for further consideration.

It is proposed that no changes are made to the following aspects of the statutory liability regime:

  • Regime to continue to apply to “transferable securities” as defined in section 102A(3) FSMA: the Government considered the question of the categories of securities in respect of which there would be a right to compensation. It looked at both restricting the categories to debt and equity securities (including depositary receipts representing such securities), or extending it to a much wider list of financial instruments. However, the Government has decided against this and proposes that the regime apply to “transferable securities” as defined in s102A(3) FSMA.
  • The current basis of liability based on fraud: the recommendation is that liability should remain limited to fraudulent misstatements and not be extended to negligent misstatements, after concerns that liability for negligent misstatements would lead to defensive and bland reporting and full disclosure not being made and greater opportunities for speculative litigation. “Fraud” in this context is the civil standard, so includes a statement whose maker knew it to be false or did not care whether it was true or false.
  • Liability should continue to apply only to issuers: the Government agrees with Professor Davies’ recommendation not to extend the statutory liability regime to directors and advisers.
  • The assessment of damages: the Government considers that the assessment of damages should be left as an issue for the courts to determine, as is currently the case.

The Treasury is inviting comments on this consultation paper by 9 October 2008. The consultation paper can be found on the Treasury’s website.