UK: Claims Against Traded Companies for Misleading and Delayed Announcements

Last Updated: 14 September 2010
Article by James Parkes and Peter Bateman

From 1 October 2010 investors in publicly-traded companies will have a new statutory right to claim compensation from their company (but not its directors) if they suffer loss as a result of relying on an announcement made by the company to the market, or a document published for the benefit of the market, that is misleading or delayed. But an investor will have to show that the announcement or document was misleading due to deliberate or reckless behaviour by one or more of the company's directors, or that one or more directors acted dishonestly in delaying publication, and in either case that it was reasonable in all the circumstances for him to rely on it in deciding to buy, sell, or hold on to, the company's securities. Annual, preliminary, half-yearly and quarterly financial results could potentially form the basis of such a claim; as well as documents published in connection with takeover offers, and ad hoc announcements about, for example, price-sensitive developments, transactions, dealings by directors and changes in major shareholdings. Circulars sent to a company's shareholders might sometimes contain information on which a claim could be brought.

The new regime will be set out in an amended section 90A and a new Schedule 10A of the Financial Services and Markets Act 2000 (FSMA). Companies affected are:

  • All companies (wherever incorporated) with equity or debt securities, or depositary receipts (DRs), traded with their consent on either the UK Official List (Main Market), AIM or PLUS markets.
  • UK-incorporated companies, and companies incorporated outside the EEA whose home member state is the UK, with equity, debt or DRs traded with their consent on a non-UK market that is similar to those UK markets – e.g. NASDAQ or the New York Stock Exchange. In practice, the new right of compensation in relation to these companies will be available only where the court hearing the claim decides that the question of liability should be governed by English law.

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From 1 October 2010 investors in publicly-traded companies will have a new statutory right to claim compensation from their company (but not its directors) if they suffer loss as a result of relying on an announcement made by the company to the market, or a document published for the benefit of the market, that is misleading or delayed. But an investor will have to show that the announcement or document was misleading due to deliberate or reckless behaviour by one or more of the company's directors, or that one or more directors acted dishonestly in delaying publication, and in either case that it was reasonable in all the circumstances for him to rely on it in deciding to buy, sell, or hold on to, the company's securities. Annual, preliminary, half-yearly and quarterly financial results could potentially form the basis of such a claim; as well as documents published in connection with takeover offers, and ad hoc announcements about, for example, price-sensitive developments, transactions, dealings by directors and changes in major shareholdings. Circulars sent to a company's shareholders might sometimes contain information on which a claim could be brought.

The new regime will be set out in an amended section 90A and a new Schedule 10A of the Financial Services and Markets Act 2000 (FSMA). Companies affected are:

  • All companies (wherever incorporated) with equity or debt securities, or depositary receipts (DRs), traded with their consent on either the UK Official List (Main Market), AIM or PLUS markets.
  • UK-incorporated companies, and companies incorporated outside the EEA whose home member state is the UK, with equity, debt or DRs traded with their consent on a non-UK market that is similar to those UK markets – e.g. NASDAQ or the New York Stock Exchange. In practice, the new right of compensation in relation to these companies will be available only where the court hearing the claim decides that the question of liability should be governed by English law.

Investors will continue to have a similar right to compensation where they suffer loss as a result of buying securities after a company incorporated in the UK, or a non-EEA company whose home member state is the UK, publishes a prospectus or listing particulars that contain a misleading statement or omission (under section 90 FSMA).

The new rules significantly extend the scope of the current statutory right of investors to claim compensation for misleading statements under the current section 90A FSMA. In particular, the new regime:

  • Applies to all information published by a company via a Regulatory Information Service (RIS) or whose publication – e.g. on the company's website - is announced via any RIS. The current regime applies only to annual, preliminary, half-yearly and quarterly financial results.
  • Covers announcements and publications that are made voluntarily (such as trading updates and announcements of contract wins).
  • Covers announcements and publications that are delayed, as well as those that are misleading.
  • Allows claims to be brought by investors who hold on to, or sell, securities, as well as those who acquire them. In practice, however, it will often be difficult for an investor who holds on to his securities to prove that he suffered loss in reliance on a statement made by the company.
  • Gives investors in AIM and PLUS Markets companies the same right to compensation as investors in Official List companies.

The new regime does not change the basis of liability, namely fraud (in the civil, not criminal, law sense). Where an investor claims that a statement was misleading, he must show that a director knew it to be false, or that he did not care whether it was true or false, or that a director knew the omission to be a dishonest concealment of a material fact. Someone with a genuine belief in the truth of what was said would not be acting fraudulently, even if that belief were based on inadequate checking. Similarly, where an investor claims that a statement was delayed, he must show that a director acted dishonestly in delaying publication – i.e. that his conduct would be regarded as dishonest by market participants, and that the director was aware that his conduct would be regarded as dishonest.

Arguments that the basis for liability should be negligence, or gross negligence, were rejected by the Government, principally on the grounds that a negligence standard would be likely to lead to defensive and bland reporting, and that the FSA already has sufficient power to fine companies and their directors personally for announcements that are published negligently (see below).

Other private remedies for investors

Paragraph 7(2) of the new Schedule 10A expressly states that no person other than the company concerned is subject to any liability to an investor who suffers loss in reliance on an announcement or publication that is misleading or delayed. This means that investors cannot recover damages from directors, auditors or advisers of a company in respect of an announcement or publication that is made by the company. But paragraph 7(2) does not prevent an investor claiming damages from a director, auditor, adviser or other person in respect of a statement or publication that is separately made by that person. For example, where an investment bank makes a misleading statement to a potential placee in an equity fundraising, or an audit firm unequivocally states to a potential investor whom it knows is using the company's most recent set of annual accounts to decide whether and at what price to invest that it stands behind its audit report on those accounts, paragraph 7(2) does not prevent the investor bringing a claim against the bank or audit firm for negligence, misrepresentation etc if the constituent elements for liability can be made out. Such instances will continue to be relatively rare, however.

Directors will of course remain liable to their company if they are negligent or guilty of some other breach of duty owed to the company – e.g. if they fail to take sufficient care to ensure that an announcement is accurate. However, directors' liability in negligence to their companies in respect of the directors' report and the directors' remuneration report (and any summary financial statement derived from them) is excluded by section 463 of the Companies Act 2006, in order to encourage more open, meaningful and forward-looking narrative reporting.

The new regime also preserves the right of investors to seek damages from the company under the common law for breach of contract and misrepresentation under the Misrepresentation Act 1967. But these private remedies are effective only in limited circumstances. Damages for breach of contract or misrepresentation are likely to be available only where the company has made the statement in connection with a fundraising or takeover offer, as the investor must show that it has a contract with the company - e.g. to buy, subscribe for, or sell shares - and, in the case of misrepresentation, that the statement induced him to enter into the contract. It also remains possible for an investor to claim against a company for the tort of negligent misstatement if (unusually) the company, rather than one of its directors or its auditor, makes a statement to that investor accepting responsibility for the accuracy of an announcement or document, but only if the investor can show that the company knew that that particular investor was likely to use the statement in the context of a particular class of transaction of which the company was or should have been aware.

Criminal and regulatory sanctions

Companies and their directors will continue to face criminal and civil penalties if a misleading statement is made to the market, or publication is improperly delayed. In particular:

  • Criminal liability for misleading, false or deceptive statements under section 397 FSMA. In particular, under section 397(1) it is a criminal offence for a person (broadly) knowingly or recklessly to make a statement, promise or forecast that is materially misleading, false or deceptive, or dishonestly to conceal any material fact, either with the intention of inducing someone else to buy, sell, or exercise a right attached to, any securities or not caring whether it may induce them to do so. A person guilty of an offence under section 397 is liable on conviction on indictment to a maximum of seven years in prison or a fine or both. In 2005 two former directors of listed software company, AIT, were sent to prison, and ordered to pay more than £1m, in part to compensate investors, for breach of this section.
  • Civil liability to pay fines for committing market abuse contrary to section 118 FSMA. Market abuse is committed if, among other things, a person disseminates information by any means which gives, or is likely to give, a false or misleading impression about securities and that person knew, or could reasonably be expected to have known, that the information was false or misleading. In recent years, the FSA has stepped up its enforcement actions against companies and directors personally for making announcements that were misleading. Fines can run into millions of pounds.
  • Civil liability to pay fines for breach of the FSA's Listing or Disclosure and Transparency Rules. Under section 91 FSMA, the FSA has power to impose unlimited fines on companies and on directors who are "knowingly concerned" in a breach. Again, a number of cases have shown that the FSA is prepared to use this power, especially where announcements are improperly delayed.

Companies that have securities admitted to a market overseas, or that invite overseas persons to invest in their shares, could also be liable to criminal and civil penalties under overseas securities laws and regulations.

Practical implications

Announcements and documents that present the greatest risk to companies, their directors and advisers – such as prospectuses, offer documents, and announcements relating to equity fundraisings – tend already to be subjected to careful scrutiny by directors and the company's legal and financial advisers. No additional scrutiny or verification of these documents is likely to be needed because of the new regime.

For other types of announcements and documents, the existence of the new regime creates a further incentive for publicly-traded companies to ensure that they put in place appropriate and robust systems to ensure that all matters that could require an announcement to be made are escalated to the board or an appropriate committee as soon as possible; that arrangements are in place for members of the board or relevant committee to meet at very short notice to discuss such matters and, if necessary, to approve an announcement; and that, even where an announcement has to be made very quickly, the contents of all announcements are carefully checked by all directors who may have relevant knowledge, with source documents, other employees and advisers being consulted where necessary. But the existence of the new regime probably does not, of itself, necessitate companies implementing procedures or verification processes that are additional to those that should already be in place.

Background

The current statutory right in section 90A FSMA for investors to claim compensation for misleading statements in annual, preliminary, half-yearly and quarterly financial results was introduced in November 2006 to implement the EU Transparency Directive. It was intended to be an interim measure, pending the outcome of a Government-sponsored consultation on the extent to which publicly-traded companies should be liable for announcements and market-directed publications generally. That consultation started in March 2007 with the publication of a Discussion Paper by Professor Paul Davies QC. Professor Davies published his Final Report in June 2007. And in March this year the Government published a Response Paper setting out how it proposed to change the law.

How the changes will be effected

On 1 October 2010 section 90A FSMA will be replaced, and a new Schedule 10A introduced, by the Financial Services and Markets Act 2000 (Liability of Issuers) Regulations 2010 (SI 2010/1192). Schedule 10A sets out the circumstances in which the new statutory right to compensation is available, and the conditions that must be met. The right will apply to any information that a company publishes to the market on or after 1 October 2010.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 13/09/2010.

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