HM Treasury released the outcome of its consultation to reform the UK prospectus regime (the “Prospectus Outcome”) on 1 March 2022. Although setting out future government policy over only nine pages, the legislative changes in due course will likely have a significant impact on the landscape of securities litigation.

Jack Barlow summarises the proposed changes and the implications for liability thresholds.

Background

In November 2020, the UK government tasked Lord Hill of Oareford to lead an independent review of the UK’s listing regime. In light of new freedoms in financial services following the UK’s withdrawal from the EU, the purpose of the review was to consider means of improving the UK as a destination for initial public offerings (“IPOs”).

As Lord Hill noted in his report published in March 2021, between 2015 and 2020, London accounted for only 5% of IPOs globally. Moreover, the number of listed companies in the UK had fallen by approximately 40% from a recent peak in 2008. He recommended a raft of changes to develop the competitiveness of the UK’s capital markets.

The Prospectus Outcome has broadly adopted Lord Hill’s recommendations. This article reflects upon the proposed changes to the Financial Services and Markets Act 2000 (“FSMA”). Specifically, it looks at the increased liability threshold in relation to misleading/incorrect forward-looking information in prospectuses and changes to the “necessary information” test for disclosure. Both these will affect potential claims under Section 90(1) of FSMA.

Existing Section 90(1) of FSMA

Overview

Section 90(1) of FSMA provides a cause of action to an investor where listing particulars or a prospectus relating to securities contains any untrue or misleading statement or omits any information required by statute (so-called “necessary information”). The cause of action permits an investor who has acquired securities and suffered loss to claim compensation against any person responsible for the defective prospectus or listing particulars. Significantly, there is no need for the investor to prove they relied upon the defective document (or even that they had read it) before acquiring the securities in question.

What is “necessary information”?

The “necessary information” test is currently set out in article 5 of the Prospectus Regulation, which came into force in the UK in July 2017. The primary limb of the test is that a prospectus should contain “the necessary information which is material to an investor for making an informed assessment of:

(a) the assets and liabilities, profits and losses, financial position, and prospects of the issuer and of any guarantor;

(b) the rights attaching to the securities; and

(c) reasons for the issuance and its impact of the issuer.”

The second limb of the test acknowledges that the information required under the primary limb may vary depending on the nature of the issuer, its circumstances and, where relevant, whether the non-equity securities have a denomination per unit of at least EUR 100,000 or are traded on a regulated market.

Liability

Schedule 10 of FSMA sets out exemptions to the liability for Section 90(1) claims. Paragraph 1 states liability does not arise where at the time the listing particulars or prospectus were submitted, the issuer reasonably believed that the statement was true and not misleading or the information whose omission caused the loss was validly omitted (the “Negligence threshold”). In effect, this is a test of negligence with a reverse burden of proof in that the defendant needs to show that they were not negligent by establishing a defence of reasonable belief.

Proposed changes to Section 90(1) FSMA

“Necessary information”

While the government will retain the primary limb of the “necessary information” test, it will supplement the secondary limb to accommodate the diversity of issuers and securities offerings available. The Prospectus Outcome confirms the disclosure requirements will vary according to whether an offer of securities relates to a first-time admission to a market or is a secondary issuance.

In addition, a modified “necessary information” test will apply to debt securities that focuses on the issuer or guarantor’s creditworthiness, as opposed to prospects, to ensure that prospectuses contain information that investors need to make an informed assessment. The government will delegate the more detailed content requirements to the Financial Conduct Authority (“FCA”).

Liability

The Prospectus Outcome has endorsed Lord Hill’s recommendation to reduce the liability threshold for claims under Section 90(1) of FSMA in relation to forward-looking information (information that projects or predicts a future state of affairs) in a prospectus.

Forward-looking information is a crucial category of information that investors require when considering possible securities. However, as Lord Hill explained in his report, it is difficult for issuers to have the same level of certainty for such information as they do for past events. Yet the level of liability is consistent for all categories of information under the current FSMA framework.

The effect of this is that issuers tend to provide more limited forward-looking information in prospectuses than they do through other disclosure mechanisms, such as annual reports or regulatory announcements, which do not fall within the ambit of Section 90(1) of FSMA. In short, the rationale behind the move is to facilitate the provision of high-quality forward-looking information in a prospectus.

The liability standard to be adopted in relation to forward-looking information in prospectuses will be met when:

  • The issuer knew a statement to be untrue or misleading or was reckless as to whether it was untrue or misleading,
  • The person discharging managerial responsibilities within the issuer knew the omission of a matter to be a dishonest concealment of a material fact (the “Recklessness threshold”).

The Recklessness threshold is the existing liability standard for causes of action under Section 90A of FSMA, which relates to untrue or misleading statements or dishonest omissions in company announcements and other publications.

Significantly, the FCA will bear the responsibility for specifying the categories of forward-looking information to which the new liability threshold will apply. The Prospectus Outcome also confirms that where an issuer includes forward-looking information and wishes it to be subject to the new lower standard of liability, it will need to include an express warning to investors that the information is forward-looking information and, as such, is subject to a lower standard of liability.

Conclusions

The proposed changes to the “necessary information” test will likely impact the scope of potential Section 90(1) FSMA claims if, as anticipated, the prospectus disclosure requirements are less stringent for different issuers and products. The new regime will need to be closely unpicked once the FCA sets out the detail.

The more significant development is the introduction of the Recklessness threshold for liability. This should make it more difficult for investors to bring claims under Section 90(1) of FSMA on the basis of false or misleading statements or omissions of “necessary information” from a prospectus where the allegations relate to forward-looking information.

Nevertheless, it is important to remember the Negligence threshold will remain in place for statements on the state of affairs at the date of the prospectus or statements on historical facts. Moreover, the government has not gone so far as to include a criterion that an issuer is only liable for losses arising from a defective prospectus where an investor can demonstrate they acquired their securities in reliance of the defective prospectus, which is the position for claims under Section 90A in relation to other misleading information released to the market.

Section 90(1) claims will, therefore, likely remain a particularly attractive basis to bring a large group action given the lack of requirement to prove individual investor reliance.