- When raising equity capital, potential liabilities may arise where issuers and other parties involved in preparing relevant offer documents are found to have made misleading or deceptive statements.
- In current times, dominated by financial stress and tight timetables, issuers should be particularly vigilant that they implement an appropriate due diligence system to seek to ensure that their offer documents are accurate, or in the event they are not, minimise the risk of liability of parties involved in an equity raising.
The detrimental impact of the ongoing global financial crisis has resulted in financial uncertainty, confusion, a lack of investor confidence and limited access to debt markets. Nevertheless funds and companies have tapped more than $39bn from the Australian listed equity markets since mid-2008 to help strengthen balance sheets, repay debt, get in well ahead of debt refinancing events to calm investor nerves about potential refinancing difficulties, and to retain flexibility in these uncertain times.
Equity financing may involve issuing new securities (eg. units, shares, notes or hybrids) through placements, entitlement offers, rights offers, security purchase plans, or distribution/dividend reinvestment plans. Where there is a proposed issue of securities to retail investors, the following forms of regulated disclosure documents have typically been required to be prepared and given to investors:
- Prospectus - for the issue of securities (shares or notes) required under Part 6D.2 of the Corporations Act 2001 (Cth); or
- Product Disclosure Statement (PDS) - for the issue of financial products (units) required under Part 7.9 of the Act.
Where securities are being issued to wholesale clients or sophisticated investors, or funds are being raised from these clients and retail clients through "low-doc" rights offers, security purchase plans, or distribution/dividend reinvestment plans, there are no statutory requirements to prepare a prospectus or PDS. In this case, it is common practice to prepare and issue an offer booklet, information memorandum or investor presentation (Unregulated Documents).
The issuer and the other members involved in the preparation of the relevant offer document must ensure that it does not contain any misleading or deceptive statements or omissions, or risk civil and / or possible criminal liability under the Act or at common law.
To minimise the possibility that the offer documents are "defective" and to maximise the availability of any applicable statutory defences, issuers need to implement an appropriate due diligence system when undertaking any equity raising. In particular, where a prospectus or PDS (and certain Unregulated Documents like "low-doc" rights issue offer booklets) are being prepared, , the prudent and accepted Australian approach is to establish a due diligence committee (DDC) to manage the process.
Due diligence literally means to take "appropriate attentive care". However, in the realm of funds management and equity capital markets, the question must first be asked of the issuer and all DDC members: How much appropriate attentive care should you take in the preparation of a prospectus, PDS or Unregulated Document to seek to ensure that the offer documents are accurate and you are protected from either criminal or civil liability under statute, tort, or the common law, as applicable?
This paper outlines the various forms of liability that an issuer or a member of a DDC may face when preparing offer documents, the role and purpose of a DDC in managing the due diligence process, and general practical tips for those participating in a DDC to limit their potential liability.
Liability for a defective offer document
Statutory liability - Corporations Act
- Prospectuses and PDS - You may face civil liability (or potentially criminal liability) under the Act if the disclosure document is "defective" - that is, if it includes misleading or deceptive statements, omissions of information required under the Act, or if it fails to include specific information required under the Act. Liability can be avoided if you can show that one of the statutory defences applies to you in the circumstances.
- Unregulated Documents - The Act does not stipulate any content requirements for Unregulated Documents. However, if you are involved in misleading or deceptive conduct in preparing or issuing an Unregulated Document and a person suffers loss or damage as a result, you may incur civil liability under the Act. There are no statutory defences to liability of this nature. Potential criminal liability can also arise under the Australian Securities and Investments Commission Act 2001 (Cth).
- Negligent misstatement - If you are the issuer of either an Unregulated Document, a prospectus or a PDS, and you have carelessly made a misrepresentation in the relevant document which has caused damage to another person, you may be liable for the tort of negligent misstatement, irrespective of there being any dishonesty or recklessness on your part.
- Fraudulent misrepresentation - As an issuer or possibly as a member of the DDC, you may be liable for the tort of fraudulent misrepresentation if you have engaged in fraudulent or deceptive conduct in relation to an offer document. This tort claim would be difficult to establish on the balance of probabilities because it does not extend to the situation where a misrepresentation was made carelessly; that is, where the issuer or the DDC member had an honest but mistaken belief of fact.
Despite the various potential liabilities that exist for issuers and other persons involved in the preparation and issue of offer documents, liability may be avoided if the relevant offer document is prepared in accordance with a controlled due diligence program, and in particular one supervised by a DDC. The following outlines the role and purpose of a DDC.
Role and purpose of a DDC
The preparation of a prospectus, a PDS, or an Unregulated Document can be an onerous task and is generally the collaborative effort of the representatives of the issuer and its advisers.. Where a DDC is used, it typically comprises:
- the issuer, through one or more directors and members of senior management;
- investigative accountants;
- investment banks; and
- taxation adviser.
The DDC is responsible for designing and implementing a due diligence program which seeks to identify all information requiring disclosure to investors and to verify the validity, accuracy, and (where relevant), the reasonableness of the statements to be expressed in the offer document to ensure that they are not misleading or deceptive.
The due diligence process as undertaken by the DDC is a formal arrangement, with the DDC meetings chaired by a pre-determined chairperson, and conducted in accordance with an agenda. The meetings are meticulously minuted by a pre-determined secretary, usually the issuer's junior lawyer, and all supporting or tabled documents are systematically accumulated and indexed.
Practical guide to limit liability of DDC members
There are various pre-emptive and precautionary measures that DDC members should take when participating in a DDC for the preparation and issue of either a prospectus, a PDS or Unregulated Document. The following practices may limit the potential liability of DDC members under statute, common law, or in tort:
- Limitation of scope of duties and liabilities - The due diligence planning memorandum (DDPM) provides for the delineation and delegation of primary reporting duties of the members of the DDC and others. These duties should be clearly defined in the DDPM to ensure DDC members are satisfied that the scope of inquiries as a whole are appropriate. DDC members should ensure that the DDPM states that membership of the DDC does not, in itself, give rise to liability between DDC members. (This does not, of course, limit the terms of the separate engagements between the issuer and each of its advisers.).
- "Consent to having made a statement" exclusion - To circumvent the potential liability imposed on DDC members in relation to consenting to having made a "defective" statement that is included in the prospectus or PDS, it is prudent for DDC members to consent only to statements in the prospectus or PDS that they have actually made or which have actually been based on statements made by them.
- Record-keeping - It is important to ensure that there is an accurate and detailed record of all DDC meetings and documents circulated to DDC members. This may be used as evidence in the event that legal action is brought against the members of the DDC with respect to a defective prospectus, PDS or Unregulated Document.
- Insurance - Prior to commencing the DDC process and agreeing to become a DDC member, we recommend that you review your relevant insurance policy to ensure that it is current and effective, and that its terms cover you for all the likely sources of liability outlined above.
Irrespective of whether you are the issuer of securities, or a member participating in the DDC for the preparation and issue of the prospectus, PDS, or Unregulated Document, you must be aware of the various statutory, tortious and common law grounds of liability that exist if the relevant offer document is defective. If you are involved in an offer, in particular through membership of a DDC, it is advisable that you seek advice on the proposed due diligence process (including as set out in any DDPM for the offer) and keep in mind the guidelines outlined above to seek to limit your liability.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.