HMT reform of prospectus regime: the potential impact on securities litigation

HM Treasury (HMT) has published an initial consultation on fundamental reforms promising the biggest shake up of the prospectus regime since 2005. The consultation follows the conclusions of the Hill Review of the UK listing regime published in March 2021.

In this blog post, we consider HMT's consultation paper through a securities litigation lens, highlighting the potential impact on claims under s.90 of the Financial Services and Markets Act 2000 (FSMA) for liability for prospectuses and listing particulars.

For an overview of all the key proposals in HMT's consultation paper, please see our Capital Markets team's briefing paper: UK Prospectus Regime review – bold reform ahead?

1) Liability for forward-looking information in a prospectus

The most important reform to highlight in the context of s.90 FSMA claims is the proposed new statutory standard of liability for forward-looking information published in a prospectus.

We examine below the rationale behind this proposal, the current standard of liability for information published in a prospectus, HMT's proposed approach to liability standards and also consider what this will mean for issuers in terms of litigation risk for claims under s.90 FSMA.

The rationale

In Lord Hill's view, the existing prospectus regime deters issuers from including forward-looking information in their prospectuses. This is due to the level of liability attached to a prospectus under the current legislative framework in respect of untrue or misleading statements or omissions relating to both past and future events. Issuers have some certainty over past events, but less so when considering their future plans and trajectory. As a consequence, issuers typically provide very little forward-looking information directly to investors. In order to improve the quality of information that investors receive directly, Lord Hill recommended an adjustment to the current statutory standard of liability for forward-looking information in a prospectus.

The current standard of liability

The current standard of liability under s.90 FSMA for information published in a prospectus is, essentially, a negligence standard with a reverse burden of proof. S.90 FSMA provides that any person responsible for the document is liable to pay compensation to a person who has suffered loss as a result of any untrue or misleading statement in the document, or any omission from the document of "necessary information" (see section (3) below in relation to this disclosure requirement and the proposed reforms to it). Schedule 10 FSMA sets out exemptions to liability under s.90, including that liability does not arise where a person reasonably believed that the statement was true and not misleading or that the omission was properly made. It is generally accepted that it is for Claimants to prove that they have suffered loss as a result of the untrue or misleading statement, or omission, but it is for Defendants to prove the reasonableness of their belief. [1]

By way of contrast, the fault standard under s.90A FSMA, for untrue or misleading statements in information published by an issuer via a recognised information service, is one of recklessness: there is liability where the relevant person (a PDMR or "person discharging managerial responsibilities") within the issuer either knows the statement to be untrue or misleading or is reckless as to whether it is untrue or misleading. In respect of omissions of a matter which is required to be included in information published by an issuer, the fault standard is effectively one of dishonesty: the PDMR must know the omission to be a dishonest concealment of a material fact. It is generally accepted that the burden of proof is on Claimants to prove recklessness or dishonesty. The same liability standard as under s.90A FSMA also applies under s.463 of the Companies Act 2006 (CA 2006) to directors of companies in respect of their potential liability towards the company for untrue or misleading statements in, or omissions from, the directors' report and certain other reports and statements included in a company's annual report.

HMT's proposed standard of liability

HMT is minded to apply the same recklessness standard of liability to forward-looking information in, and to omissions from, prospectuses.

HMT's view is that this standard of liability should only apply in respect of statements in a prospectus which project or predict a future state of affairs. It would not be applicable to statements of fact (e.g. any statement on the state of affairs at the date of the documents or any statement of historic fact), or the working capital statements in a prospectus. An issuer who wishes to be subject to the proposed lower standard of liability for forward-looking information will be required to identify that information explicitly.

Impact on s.90 FSMA litigation risk

Recklessness is a higher fault standard than negligence. Therefore, if the proposals are introduced, it will be more difficult for an investor to bring a successful claim for breach of s.90 FSMA on the basis of alleged untrue or misleading statements in or omissions of necessary information from a prospectus, where those allegations arise in relation to forward-looking statements. The practical impact (and the rationale underpinning the change, as discussed above) is that this should encourage greater disclosure of forward-looking information in prospectuses.

HMT's proposals are yet to have legislative force, but they indicate the likely direction of travel in respect of liability for forward-looking statements in prospectuses for issuers. It will be important for issuers to continue to monitor regulatory developments. It appears, at this stage, that there will be a further Government consultation and a review and consultation by the FCA.

2) Threshold for when a prospectus will be required

The Government consultation suggests a number of other bold reforms, which may lead to a reduction in the number of prospectuses published in the UK. Although prospectuses will remain a key feature of an IPO in the UK, the Government suggests that a prospectus may not be needed in all instances where an admission occurs, such as during a secondary issuance of new securities. The consultation proposes to grant the FCA discretion as to when a prospectus is needed for the admission of securities to a UK regulated market. At present, the FCA cannot amend the UK Prospectus Regulation which governs the requirement to produce a prospectus, and its format and contents – only Parliament can. The consultation proposes to put those powers back into the hands of the FCA (which held them prior to the implementation of the EU Prospectus Directive in the UK in 2005).

A reduction in the number of prospectuses published would result in fewer opportunities for claims under s.90 FSMA. However, this would not remove the securities litigation risk for a prospectus-exempt issuance altogether, since s.90A claims may be available for any untrue or misleading statements made to the market, or omissions or delays in publishing required information.

3) Disclosure requirement

The general disclosure requirement for prospectuses in the UK is the "necessary information" test, which includes an express materiality standard and is found currently at Article 6(1) of the UK Prospectus Regulation: "…a prospectus shall 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) the reasons for the issuance and its impact on the issuer."

The consultation suggests that, for now, the substance of the necessary information test should be retained, thus maintaining the overall disclosure standard for prospectuses. From a litigation perspective, this preserves the status quo for s.90 FSMA claims.

However, the consultation identifies two potential future changes:

• The Government is considering amending the test to better accommodate further issues and non-equity securities. At present, a simplified prospectus content regime exists for secondary offerings contained in Article 14 of the UK Prospectus Regulation. This simplified regime sets out a separate standard with reduced information requirements. The consultation asks for feedback as to whether this revised separate standard has clarified matters. The Government is proposing not to include a separate test for secondary issuances but instead to make clear that a factor considered will be whether an issuer's securities are already admitted to the market.
• The consultation proposes to give the FCA responsibility for making detailed rules on the contents of a prospectus, where one is still required. Theoretically this could mean a change to the general disclosure requirement at some later date, if the rules are altered by the FCA using its new powers.

If either of these changes are implemented, there may be a corresponding impact on s.90 FSMA claims. For example, if the FCA believes that the level of detail required by the current regime is too high, it could downgrade the disclosure threshold, leading to a reduction in the volume of disclosure, which may limit the scope for s.90 FSMA claims.

For more information

Our Capital Markets colleagues have prepared an overview of all the key proposals in HMT's consultation paper.

If you have any specific queries in relation to the impact of the proposals on s.90 FSMA claims, please get in touch with one of the contacts below or your usual HSF contact.

[1] It is also worth noting that the need to show reasonableness applies to the Defendant's specific belief and whether that belief was based on reasonable enquiries rather than a broad assessment of the Defendant's conduct as a whole.