© b. fasterling 2003 m.sc. in european business law björn fasterling financial market law course...

© B. Fasterling 2003© B. Fasterling 2003

M.Sc. M.Sc. in in European Business LawEuropean Business Law

Björn FASTERLINGBjörn FASTERLING

Financial market lawFinancial market lawCourse 2: Regulatory control of Course 2: Regulatory control of

prospectuses and Prospectus liability in the prospectuses and Prospectus liability in the EU EU


CaseCase Medica AG, a German stock company based in Leipzig and

manufacturer of pharmaceutical products created new shares for public offer on the Frankfurt stock exchange. Before, the company’s shares had not been traded publicly. Medica and the six underwriting banks, the investment bank Nocredito being the Lead Manager, assumed responsibility for the Offering Prospectus in accordance with German law. Already years before the IPO Mr Gierig, the Company’s CEO (Vorstandsvorsitzender) and Mrs Obskur, CFO and member of Medica’s Management Board (Vorstand), had jointly forged numerous documents boosting sales figures in order to increase their respective sales related incentive remuneration. Mr Gierig and Mrs Obskur had been forging documents since three years but no directors or other board members of the company had ever become aware of this practice.


CaseCase

In the course of the IPO due diligence procedure, a junior associate of Nocredito’s outside legal counsel « Parx & Graye », a leading global lawfirm, detected irregularities in certain inter-company loan agreements between the company and some of its subsidiaries. In a confidential meeting, the lawyers of « Parx & Graye » explained to Mr Blind of Nocredito, who was in charge of conducting the IPO, that these irregularities could be explained by « unorthodox », yet legal accounting procedures. The lawyers added, however, that the irregularities could also be a result of criminal practices of one or more of the company’s directors. In any case a deeper investigation into these matters would be necessary. Mr Blind concluded that the accounting procedures were not illegal. He was however aware that there was considerable uncertainty attached to this issue. Nevertheless, since he did not want to endanger his good relationship with Medica executives, he decided not to follow the issue of inter-company loans any further. (A thorough investigation could have revealed the criminal practices of Gierig and Obskur).


CaseCase

The prospectus was published including results that were based upon Gierig’s and Obskur’s forgeries. After the offering Gierig and Obskur stopped forging documents.

Mrs Emescee bought 500 shares in Medica from the underwriters to a price of 100€ per share. She had based her investment decision on Medica’s Offering prospectus. The value of the shares increased steadily and apparently the business of Medica was doing well. However, two years after the offering, an accounting employee of Medica discovered the forgeries that Gierig and Obskur had committed in the past. They were criminally prosecuted. The criminal investigation against two Medica top managers and its press coverage harmed Medica’s good reputation severely and led to a dramatic decrease of Medica’s share value. Mrs Edhec filed a claim against Nocredito with the State Court of Frankfurt demanding compensation of the original purchase price of the shares (50.000€) plus acquisition related costs of 500€.

Will Mrs Emescee be successful with her claim?


Introduction:Introduction:How to disciplin issuers/banks to publish correct and How to disciplin issuers/banks to publish correct and

complete prospectusescomplete prospectuses Regulatory control

Pre-publication measure of prevention: A governmental authority or a private authority with supervisory powers (delegated to it by a public authority) examines the prospectus before it is published.

Legal technique: The publication of the prospectus is subject to the approval of such authority.

Applicable Laws: National administrative laws (example: Security admission laws) of the State, in which the public offering of the securities is applied for.

See also: Art. 13 EU Prospectus Directive

Civil liability The liability risk could pressurize the issuer, its directors, and the underwriters to carefully

draft the Offering Prospectus. Legal technique: either special prospectus liability laws (example § 44 Börsengesetz) or

general tort law (example Art. 1382 CC) of the State, in which the securities are offered. Applicable laws: national laws on civil liability (general tort law or special prospectus

liability laws)


Ex-course: « European Passport »Ex-course: « European Passport »

Momentary status in the EU: Competent Member State authorities must recognize prospectuses that were

approved by a competent authority of another Member State (principle of mutual recognition.

However, the host Member State may require a translation of the prospectus. No uniform rules on exemptions

Practical Problems with « European Passport » The home Member State of the Issuer could grant certain exemptions from

publication requirements that are not accepted by another Member State. This has led to the practice that authorities of Member States scrutinize prospectuses approved by other Member State authorities. This is often time consuming and costly.

Translation requirement can become burdensome. Key provisions within the new « EU prospectus Directive »

No recognition procedure, no additional approval, only notification (see Article 17) Translation in English sufficient (Art. 19 (2)) Harmonization of Exemption rules (see Articles 3 and 4)


Prospectus liability in Prospectus liability in EU prospectus directiveEU prospectus directive

Read first:

Article 6 (2), 1st sentence« Member States shall ensure that their laws, regulation and administrative provisions on civil liability apply to those persons responsible for the information given in a prospectus. »

and then:

Article 6 (1), 1st sentence« Member States shall ensure that responsibility for the information given in a prospectus attaches at least to the issuer or its administrative, management or supervisory bodies, the offeror, the person asking for the admission to trading on a regulated market or the guarantor, as the case may be. »


General questions regarding prospectus General questions regarding prospectus liabilityliability

The following issues could become relevant in any national legislation or case law on prospectus liability: Basis of claim:

General tort law or special prospectus liability laws?

Basic Requirements of claim: Incomplete, misleading or false statements in prospectus

Problem: evaluations, forecasts (state of the art) Problem: horizon of addressees (well-informed but non-professional

investor with limited knowledge)


General questions regarding prospectus General questions regarding prospectus liability liability

(General requirements, continued) Scope of responsible persons

Issuers, company directors, boards, underwriters, lead managers of underwriters, accountants, lawyers, parent company of issuer

Causality: There are two different questions to ask with regard to causality, namely

Was the decision to buy the securities (also) based upon the information contained in the prospectus?

Did the ommission of information or false statement result in the damage claimed by the investor?


General questions regarding prospectus liabilityGeneral questions regarding prospectus liability

(General requirements, continued)

Causality (continued) Burden of proof: Who must prove the causality (regarding both questions)? [German law operates

with a presumed causality. This means the defendant must prove that the investment decision was not based upon the prospectus or the damage in question was not caused by the prospectus’ misstatement.]

Fault? Techniques: strict liability; liability only for gross negligence and wilful conduct, liability for

negligence Burden of proof: presumed liability, burden on defendant to « excuse itself » Possible solution: presumed liability, but defense possible that the defendant did not know about

about misstatement or its lacking knowledge does not result from a gross negligent action/ommission

If negligence/gross negligence plays a role for the assessment of prospectus liability, the next questions will concern the different standards of care. The issuer may be subject to a very strict standard, while an external board member may have less restrictive duties (see Barchris case). In many legislations the standard of care of the underwriters could become a crucial question.


General questions regarding prospectus General questions regarding prospectus liabilityliability

(General requirements, continued)

Scope of compensation: Purchase price, acquisition costs, difference between (high)

purchase price and (low) sales price Expectations? (most likely not)

Statute of limitations: When is a claim based on prospectus liability time barred?


Case StudyCase Study

Jurisdiction (assume that State court in Frankfurt is the competent

court)

Legal Basis Applicable Law German law: § 44 Börsengesetz

Requirements to fulfil Evidence problems

© b. fasterling 2003 m.sc. in european business law björn fasterling financial market law course...

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