A record £27.9bn was raised through IPOs on the London Stock Exchange’s markets during 2006, with IPO fundraising up by 71% on 2005. This trend has continued in the first two quarters of 2007, with over £16bn being raised. Next time the market falls we are likely to see a rise in IPO claims - so what are the risks for directors?
The significant levels of IPO activity and the possibility of a slowdown in the global economy (which could contribute to an increase in business failures) are both factors that could increase the possibility of claims against directors arising out of IPOs.
When a company either requests admission to a share trading market or makes an offer of shares to the public in the UK, the company will issue a prospectus. The purpose of a prospectus is to disclose to potential investors information about the offering and the company in order to assist them to decide whether to invest.
Directors may be held responsible for statements made within a prospectus and therefore be liable if those statements are found to be incorrect. However, the risk exposure for directors whose companies list on regulated and non-regulated markets is different.
Regulated v non-regulated markets
Markets regulated by the FSA, for instance the London Stock Exchange (LSE), require an ‘Approved Prospectus’ as part of their admission criteria. Companies wishing to avoid the need for an Approved Prospectus may wish to enter onto a market which is not regulated by the FSA, for example AIM. It is debatable whether companies entering onto a non-regulated market may still be required to submit an Approved Prospectus by virtue of their marketing of securities to the public. In practice, however, a company is usually entitled to take advantage of an ‘AIM exemption’ to avoid this requirement.
Instead of an Approved Prospectus, non-regulated markets usually require some form of admission document to be prepared and signed by the directors, which, whilst not as onerous as an Approved Prospectus, still includes a number of fairly stringent disclosure requirements.
A negligent misstatement contained in an Approved Prospectus will incur both statutory and regulatory liability. Directors’ responsibilities for statements made in an Approved Prospectus are regulated by the Prospectus Rules, a breach of which will give rise to a penalty. Civil liability for the directors and the company issuer can arise under the common law relating to negligent misstatement and deceit or under s90 Financial Services and Markets Act 2000 (FSMA).
S90 FSMA provides for the payment of statutory compensation where loss is suffered by persons as a result of untrue or misleading statements in a prospectus on a regulated market. The fact that s90 FSMA does not apply to non-regulated markets is an important distinction and one that may be remedied in the future given that the Davies Review into statutory liability for periodic disclosures under s90AFSMArecommended that it be amended to apply to non-regulated markets (see above).
In practice, claims are more likely to be pursued under s90 FSMA as it provides more protection to investors than the common law. This right is available to any person who has acquired any of the securities in question and suffered loss as a result of any untrue or misleading statement in the prospectus.
A shareholder does not need to show reliance on the misstatement in acquiring the securities in question. All that is necessary is for the loss to have resulted from the misstatement, but in practice this is likely to be contentious. The right to compensation is available to those who subscribe or purchase the securities pursuant to the offer contained in the prospectus. The right may also be available to subsequent purchasers of the securities if they can demonstrate that their loss resulted from the statement or omission in the prospectus. A director will avoid liability if he can show that he reasonably believed that the statement was not misleading.
There is no statutory remedy under s90 FSMA for misstatements made in an admission document. Consequently, liability for investor’s losses in relation to non-regulated markets such as AIM is founded in the common law relating to negligent misstatement and so liability is only likely to arise where a ‘special relationship’ exists between the investor and issuer.
Whether the issuer and/or the directors will owe a duty of care to shareholders is fact sensitive and in the case of directors depends partly on whether there has been an assumption of personal responsibility. The admission document itself is likely to contain a verification statement by the directors that could, depending on its wording, give rise to an assumption of personal responsibility by the directors. Even if it can be established that a duty of care is owed, it is still necessary for investors to establish that they relied on the misstatement or misrepresentation, which can be problematic.
There is speculation that investor claims are more likely to arise out of IPOs on non-regulated markets, rather than those on the LSE. The rationale for this is principally the LSE’s more stringent listing requirements, which are likely to ensure that companies listed on the LSE are less likely to fail than those listed on non-regulated markets. This is a reasonable presumption, particularly if trading conditions worsen on account of a slow down in the global economy. However, this increased risk is likely to be balanced by the fact that there are more legal hurdles and uncertainty for investors pursuing such claims.