UK: Directors Fined As FSA Gets Tough

Last Updated: 25 June 2004
Article by Jeremy Phillips

The actions of directors of listed companies are being increasingly scrutinised by the Financial Services Authority (FSA) as the regulator comes down hard on those who fail to ensure their companies comply with the Listing Rules. Two recent instances highlight how even those directors who might think they have acted properly face substantial personal fines for failing to act quickly enough.

Since 1 December 2001, the FSA has had extensive powers to impose penalties on listed companies and their directors in its fight to protect shareholders and maintain an orderly market in listed securities. These powers, under section 91 of the Financial Services and Markets Act 2000 (FSMA), provide that if the FSA considers a director of a listed company has been "knowingly concerned" in a contravention of the Listing Rules by the company, it may impose an unlimited penalty or fine and/or publicly censure him.

The FSA has not until recently exercised these powers. Two recent cases, however, show that the FSA is prepared to take action against listed company directors personally and impose substantial fines. Both cases concerned alleged breaches of the continuing obligations under the Listing Rules, relating to the prompt disclosure of price sensitive information. Both resulted in the company's CEO being fined and publicly censured.

These cases provide an important insight into the way the FSA interprets the continuing obligations under the Listing Rules and uses its powers under the FSMA to impose penalties on directors. They highlight how directors of listed companies may find themselves open to personal liability and criticism in connection with a company's breaches of the Listing Rules.

The facts in these cases are considered here.

We also highlight some of the steps directors may take to minimise their exposure to the risk of personal liability.

Sportsworld Media Group plc

Sportsworld was censured for failure to notify the market of a change in the performance of its business and/or the expectation of its performance, in breach of Listing Rules 9.2(b) and (c), and its CEO was fined £45,000 for being "knowingly concerned" in the breach.

Listing Rule 9.2

A company must notify a Regulatory Information Service without delay of all relevant information which is not public knowledge concerning a change:

(a) in the company's financial condition;

(b) in the performance of its business; or

(c) in the company's expectation as to its performance,

which, if made public, would be likely to lead to substantial movement in the price of its listed securities.

On 10 September 2001, Sportsworld announced that its board was confident that its results for the year ended 30 June 2002 would be in line with market expectations of £14.9 million to £18 million. At a board meeting on 17 September 2001, the board agreed budgeted profits before tax for the year of £16.1 million. Sportsworld made further optimistic announcements, about its expected results for the year being in line with market expectations of around £16 million, with its preliminary results on 3 October 2001 and following its Annual General Meeting on 29 November 2001.

On 24 December 2001, November management accounts were distributed to senior managers, including the CEO, Mr Brown, but not to the company's non-executive directors, who received no management accounts for the period September 2001 to January 2002. The November management accounts showed that Sportsworld had failed to meet its budgeted profits for every month in the financial year and had in fact made a significant loss for the four months ended November 2001. As a result, in order to achieve the budgeted profits of £16.1 million for the full year, the company needed to make profits in the second half which were not included in its agreed budget for that period. Sportsworld and Mr Brown expected that the company would meet market expectations for the full year as a result of additional profits expected from acquisitions in the second half and adjustments regarding costs in the management accounts.

On 9 January 2002, the company's financial performance was discussed at a managers' meeting at which Mr Brown was present. On 21 January 2002, Mr Brown met with the finance director to discuss the December 2001 management accounts. Both agreed there was a change in their expectations as to the profit before tax for the year ended June 2002 but that further work was needed to understand the position properly.

On 25 January 2002, a board meeting was held to discuss the half-year performance, at which the board decided to announce that the company's expectation of its profit before tax for the year was in the range £9 million to £10 million. As a result on 28 January 2002, the company issued a trading statement to the market that profit before tax would be less than previously expected and the company's share price fell by 61%.

On 13 February 2002, a further corrective announcement was issued to the effect that the results for the year would be substantially below the £9 million to £10 million range previously indicated and the company's share price fell a further 87%.

As a result Sportsworld's market capitalisation fell from £163.5 million at 31 December 2001 to £2.4 million at 13 February 2002. Sportsworld's shares were subsequently suspended on 2 April and an administrative receiver appointed on 10 April 2002.

The FSA decided that Sportsworld's delay in making an announcement from 24 December 2001 (the date of distribution of the November management accounts) to 28 January 2002 was a breach of Listing Rules 9.2(b) and/or (c) (see box above). Although the FSA accepted that the company and its CEO's subjective expectations as to the headline profit for the year had not changed, it decided that their expectations as to the phasing of the profit between the first and second halves of the year had changed. It also considered that the market would have reacted materially and adversely had it known that, in order to deliver the expected full year profit, Sportsworld was relying on a much more optimistic second half performance than that previously budgeted. The FSA determined that, in its opinion, this information would have been likely to lead to a substantial movement in the company's share price. Accordingly, the failure to announce this information without delay was determined by the FSA to be a breach of Listing Rules 9.2(b) and (c).

Sportsworld was publicly censured for this breach and the FSA indicated that if the company had had the resources it would have imposed a substantial fine.

In addition the FSA concluded that, Mr Brown, was "knowingly concerned" in the breach and fined him £45,000, as he had a responsibility to bring the change in the expectation of the company's results for the year to the attention of the full board or otherwise ensure that the company complied with its obligations under the Listing Rules and he had failed to do so.

Universal Salvage Plc

Universal Salvage was fined £90,000 for failure to notify the market of the loss of a major contract in breach of Listing Rule 9.1 (a) and its CEO was fined £10,000 for being "knowingly concerned" in the breach.

Listing Rule 9.1(a)

A company must notify a Regulatory Information Service without delay of any major new developments in its sphere of activity which are not public knowledge which may:

Universal Salvage was party to a contract with Direct Line Insurance for vehicle salvage which continued on a rolling basis but was terminable on three months' notice. The contract accounted for approximately 40% of vehicles handled by Universal Salvage and a significant proportion of its turnover.

Direct Line put the contract up for tender in February 2001 and at a meeting attended by the CEO, Mr Hynes, on 18 March 2002, Direct Line informed Universal Salvage that it had lost the tender and the contract would be terminated. The board of Universal Salvage were informed of this on 20 March 2002 and written confirmation of termination was received by the company on 25 March 2002, effective as at 30 June 2002. Universal Salvage considered that the termination was a negotiating ploy and wrote to Direct Line raising a number of arguments as to why the contract should be retained. Direct Line undertook to investigate the issues raised. Nevertheless, on 16 April 2002, Universal Salvage received a letter from Direct Line confirming the termination.

In the meantime, Universal Salvage analysed the financial impact of the termination and possible cost savings for presentation to the board on 18 April 2002.

At the board meeting on 18 April 2002, the board discussed the contract's termination and decided that advice should be sought from the company's financial adviser, WestLB, regarding the termination and the poor trading performance in the final quarter and Mr Hynes was given responsibility for seeking this advice.

The board meeting ended at 1.00 pm. Mr Hynes telephoned WestLB at 4.30 pm and again at 5.00 pm but his usual contact was not available. Mr Hynes spoke to his usual contact the next morning and it was agreed that Mr Hynes would meet WestLB on 22 April 2002. At that meeting, WestLB advised that an announcement should be made to the market about the lost contract and the poor trading figures in the final quarter.

The announcement was made at 3.45pm on 23 April 2002 and the company's share price fell by 55%.

Universal Salvage's delay in making an announcement regarding the termination of the Direct Line contract from 16 April until 23 April 2002 was determined by the FSA to be a breach of Listing Rule 9.1(a) (see earlier box). The contract, accounted for approximately 40% of vehicles handled, and in order to maintain previous levels of turnover and profit, the company would have had to find significant new business. As a result the FSA determined that, in its opinion, it was likely that, if the market had been aware of this, it would have reacted materially and adversely and this would have been likely to lead to a substantial movement in the company's share price.

In addition, the FSA decided that Mr Hynes was "knowingly concerned" in the breach as he was the director best placed to take appropriate steps to ensure that the company notified the market without delay once the obligation to make an announcement was triggered on 16 April 2002 and he had failed to do so.

Comment

The FSA regards the continuing obligations relating to the prompt disclosure of price sensitive information under Listing Rules 9.1 and 9.2 as fundamental to the protection of shareholders, and essential to the maintenance of an orderly market in listed securities and confidence in the financial system.

The FSA's decisions in these cases provide an insight into how the FSA believes the continuing obligations under Listing Rules 9.1(a) and 9.2(b) and (c) should be interpreted. It should be remembered, however, that in neither of these cases was the FSA's interpretation challenged by the companies or individual directors concerned referring the decisions to the Financial Services and Markets Tribunal for independent judicial scrutiny.

Listing Rules tests

In these cases the FSA analysed the tests which, it believes, should be applied in assessing compliance with the continuing obligations under Listing Rules 9.1 and 9.2(b) and (c) and indicated that in relation to:-

  • Listing Rule 9.1(a) regarding new developments in a company's sphere of activity, listed companies must firstly consider objectively the importance of any new development to the company and then objectively, with its advisers, assess whether the development may1 lead to a substantial movement in the company's share price i.e. is price sensitive;
  • Listing Rule 9.2(b) in respect of a change in the performance of a company's business, listed companies must firstly consider whether objectively there has been a change in the performance of the company's business and then objectively, with its advisers, assess the likely price sensitivity of the change;
  • Listing Rule 9.2(c) regarding any change in a company's expectations of its performance, listed companies must firstly assess whether there has been a change in the company's subjective expectations of its performance, which is a question of fact in each case, and then objectively, with its advisers, assess the likely price sensitivity of any change in those expectations.

Personal liability of directors

The test applied by the FSA in these cases, in determining whether a director was "knowingly concerned" in a breach of the Listing Rules, is not a particularly high one and seems merely to require that the director had knowledge of the facts and some involvement in the breach.

It appears that the FSA does not believe that a director needs to intend deliberately to mislead the market, to be "knowingly concerned" in a breach of the Listing Rules. Despite the FSA's public statements that it is not in the business of second guessing directors' decisions, the FSA seems increasingly willing to judge directors' actions with the benefit of hindsight and to substitute its views for the honestly held views of the directors at the time. The absence of bad faith on the part of the directors is not therefore enough to discharge their obligations.

In both these cases, the directors in question were executive directors who had knowledge of the facts relating to the alleged breaches (i.e. that the company's profits were not running to budget or that the company had lost a significant contract).

In addition, as CEOs, they were considered to have primary responsibility for escalating matters, by taking all relevant information, to the full board of directors and/or taking advice from the company's advisers. The delay by the directors in taking these actions and otherwise ensuring the companies discharged their obligations under the Listing Rules seems to have been the deciding factor in the FSA's action against them.

Under Listing Rule 16.2 a listed company is required to ensure that all of its directors accept full responsibility, collectively and individually, for the company's compliance with the Listing Rules.

Although the FSA decided, in both these cases, that the CEOs were particularly responsible, all directors, executive and non-executive, are under a responsibility to ensure the company complies with its continuing obligations and that any price sensitive information relating to the company of which they are aware is brought to the attention of the full board as soon as possible.

Implications for minimising your risk

Listed company directors should take steps to minimise their exposure to, and the risk of, personal liability by taking the following steps:-

  • ensuring the company has a formal documented process to achieve compliance with the continuing obligations under the Listing Rules
  • regularly reviewing compliance with the continuing obligations and, in particular, changes in the company's financial condition, performance and its expectations of its performance
  • ensuring the company and the board of directors are aware of the consensus of market expectations and keeping the company's expectations against market expectations under regular review
  • ensuring all members of the board, executive and non-executive, receive copies of the monthly management accounts and details of any major developments in the company's sphere of activity
  • executive directors, who are primarily responsible for ensuring compliance with the continuing obligations, should ensure issues are elevated to the full board without delay

the board of directors should seek the advice promptly of the company's financial advisers and/or corporate brokers as to whether any information or matter is price sensitive i.e. would be likely to lead to a substantial movement in the company's share price.

The FSA has many more companies and their directors under investigation. Decisions in those cases are imminent. Pinsents has extensive experience of advising listed companies and their directors on FSA investigations and on the implementation of procedures to safeguard against the risks outlined in this briefing.

1 Under Listing Rule 9.1 it would appear that, unlike changes under Listing Rule 9.2, it is not necessary for the new development to be likely to lead to a substantial movement in the company's share price. It is, instead, sufficient for it to have the potential to have such an effect. This distinction was not, however, highlighted by the FSA in the Universal Salvage case.

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.

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