Introduction:
A prospectus is defined under Section 2(70) of the Companies Act, 2013 as a document that includes a red-herring prospectus or shelf-prospectus, supplied to invite offers for purchase or subscription of shares or debentures or other instruments of a public listed company or a previously private company which is now a public company.
The main aims of a prospectus include informing the public about the formation of a new company, keeping original data of terms of allotment, and ensuring that the directors, promoters, experts, etc. have assumed the duty for the statements and claims in the prospectus. It is only issued after a company has been incorporated. The prospectus also contains information about the company’s financial history and facts about its previous performance.
Therefore, the prospectus of a company is an important document for an investor, as his decision to subscribe to a company’s securities is based on it. It is essential that the information contained in the prospectus is not misleading and leads to full disclosure of facts about a company. Securities Exchange Board of India (SEBI) in consultation with the Central Government has laid down appropriate guidelines related to this[1].
Section 26 of The Companies Act, 2013
Section 26 of the Companies Act, 2013 states the matters which are to be written in a prospectus.
- It states that the prospectus should be rightly dated and signed by all directors or their authorized agents. The date of signatures is to be considered as the publication date. It must be sent to the registrar on/before such date. Ninety days should not have been passed from this date for the issue of a prospectus.
- It must state essential financial information and give reports as officiated by The Securities Exchange Board of India.
- In the case where an expert’s statement is involved, it must be ensured that such a person is not a beneficiary in the company’s management.
- A declaration that anything written in the prospectus is not in contravention with the following must be made: i) The Companies Act, 2013; ii) Securities Exchange Board of India Act, 1992 and; iii) Securities Contracts (Regulation) Act, 1956.
Violation of Section 26
The golden rule of framing a prospectus is that the entire information contained in it should be true and there should be full disclosure of information. However, there may arise a case wherein the information in the prospectus is misleading, false, or untrue or there is the non-disclosure of any material fact. Let us understand this with the help of a case study of a very recent case:
DLF IPO: Case Study
DLF issued its IPO, and it was alleged later that DLF failed to disclose “material facts” related to its associate companies. The management failed to disclose Felicite, Sudipti, and Shalika as their subsidiaries. They suppressed valuable information related to FIR, related party transactions, and other financial matters. This led to “misstatement in their prospectus.”As a result, the Securities Exchange Board of India imposed a heavy penalty of Rs. 86 Crore on DLF, its chairperson, and other management officials for non-disclosure of essential information in their prospectus[2].
Liability for Misrepresentation
To be liable for misstatement in a prospectus one must be a signatory to the misleading prospectus. However, a person who is a signatory, but not a manager or a salaried employee cannot be held liable for such a misstatement in the prospectus. It was held by the Securities Exchange Board of India, in the case of Sahara India Commercial Corporation Ltd[3]. that a company secretary who used his power of attorney and signed the prospectus on behalf of the Director cannot be made liable for misstatement.
Criminal Liability for Misrepresentation
Section 34
When a prospectus contains an untrue or misleading statement and it is believed that it may fraudulently influence an investor into subscribing to the securities of a body corporate, each person who is a signatory to the issue of such a prospectus is liable under Section 447[4].
Such a person shall be punishable with imprisonment for a term which should not be less than six months and may extend up to ten years; or fine, the minimum amount of which shall be the amount involved in the fraud and maximum may extend up to three times of the amount involved in the fraud; or both.
Who may be Sued in Criminal Liability for Misstatement in the Prospectus under Section 34?
The people who can be sued for misstatement in the prospectus under section 34 of the Indian Companies Act, 2013 are as follows:
- The company which issued the misstatement containing prospectus,
- All directors who authorized such an issue,
- All proposed directors of the company,
- Each promoter,
- Every other person who authorized the issue of the said prospectus,
- Any expert who is involved.
Rex v. Lord Kylsant[5] (Royal Mail Case)
Lord Kylsant was the Director of a company named Royal Mail steam packet Company, he along with another employee made a prospectus which made the company look profitable. It stated that the company declared a past dividend. However, the source of such past dividends was not informed about. The real source of such past dividends was free reserves and not profit. It was not disclosed in the prospectus, even though it was a material fact to induce potential investors. This was against the golden rule of framing a prospectus. Consequently, the director, auditor, and the people involved in such misrepresentation were arrested and punished with imprisonment of twelve months.
Peek V. Gurney[6]
In this case, a company issued a prospectus that had a misstatement. One of the investors knew of the misrepresentation and consequently decided not to invest. Another investor had no knowledge about the misrepresentation and went on to invest in the company. The knowledgeable investor later brought the shares from the other investor in the secondary market. Subsequently, call money was claimed from him. He refused to pay the call money on the ground that there was a misrepresentation in the company’s prospectus. It was held in this case that action against misstatement can only be brought by the party which was misled because of the misrepresentation.
Shiromani Sugar Mills Ltd. V. Debi Prasad[7]
In this case, it was held that if it can be shown that important information is misrepresented in the prospectus, and the shareholder comes forth in time and circumstances, his name can be removed from such a document, and the list of shareholders[8].
Eaglesfield V. Marquis Of Londonderry
In this case, James J. said that misrepresentation should be a matter of fact. A shareholder just cannot get relief if he fails to prove that the specific misstatement was responsible for his action of buying the shares[9].
Civil Liability for Misrepresentation
Section 35(1)
A person who has subscribed to the securities on the faith of the misleading prospectus has a remedy against:
i) The Company- rescission of contract and damages.
ii) The directors, promoters, experts, and every person who authorized the issue of prospectus.
Taksheel Solutions Limited Case, 2013[10]
In this case, the Securities and Exchange Board of India had found certain main facts which were not stated in the prospectus of the company which led to misstatement. It was held that it was the responsibility of the company to make full and true disclosure of material information in the prospectus. SEBI restricted the authorities such as the promoters, directors, and other people of the company who were involved, from taking any action related to securities in any way. It prohibited the promoters and directors from trading in securities due to misstatement.
The Institute of Chartered Accountants of India V. Mukesh Gang[11]
In this case, it was held that if a false certificate about the prospectus is issued by the auditor, he must be prepared to bear its legal consequences. According to Section 65 of the Companies Act, 2013, untrue statements in the prospectus will amount to liability for the loss or damage which is suffered by the person who subscribed to the securities of the company based on the misrepresentation. The court in this case suspended the Chartered Accountant who issued the false certificate to the capacity of an auditor, for three years as per the Chartered Accountants Act, 1949-Section 21(5).
Conclusion
The prospectus is thus the most important document and must declare all material facts. The facts should be true and not misleading in any sense. The Securities Exchange Board of India and the Companies Act, 2013 provides for Criminal Liability in case of misrepresentation of the information under section 34. Considering the above-mentioned cases, this has been reiterated. A prospectus should, therefore, contain true, and full information about a company’s financial history, its reports should be clear and there should not be partial disclosure of any material information. Investor protection is a key responsibility of a company, and it should be its topmost priority. The goodwill of a company, its future reputation, and everything related to its growth is related to its potential investors. The law has made stringent rules to govern frauds related to this, but there is a need for checks at the initial stages itself to prevent losses to investors for many years.
References:
[1] Securities and Exchange Board of India (Disclosure and Investor protection) Guidelines, 2000 https://www.sebi.gov.in/sebi_data/attachdocs/1290148750028.pdf (last visited Jul 15, 2021).
[2] DLF IPO Disclosure case: Sebi imposes Rs. 85 Crore penalties, THE ECONOMIC TIMES, 2015, at 1.
[3] Shara India Real Estate Commercial Corporation & Ors. v. SEBI, Civil Appeal No. 9833 of 2011
[4] Companies Act, 2013
[5] “Rex v. Kylsant. A New Golden Rule for Prospectuses.”, 6 Harvard Law Review 45 (1932).
[6] Peek v Gurney (1873) LR 6 HL 377.
[7] AIR 1950 ALL 508.
[8] Shiromani Sugar Mills Ltd. vs Debi Prasad on 20 February, 1950 [AIR 1950 All 508].
[9] Court of Appeal in Chancery. Eaglesfield v. Marquis of Londonderry. (1877). The American Law Register (1852-1891).
[10] SECURITIES AND EXCHANGE BOARD OF INDIA, ORDER NO. WTM/GM/DRA 1/73/2017-18, https://www.sebi.gov.in/sebi_data/attachdocs/nov-2017/1510762708152.pdf (last visited Jul 21, 2021)
[11] Decided on 26 September, 2016.
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