Misstatements in Prospectus

This article seeks to elucidate the concept of liability of misstatements in Prospectus.

Introduction

The purpose of this article is to examine the liability for misstatements in the prospectus of a company. Before going to the details of liability, a brief overview of the meaning and significance of the prospectus would be helpful.

What is Prospectus

A prospectus is a document that solicits public offers for the subscription or purchase of a company’s securities, according to section 2(70) of the Companies Act, 2013. The term “prospectus” refers to notices, circulars, and advertising that invite readers to buy or subscribe to securities as well as documents that are designated or issued as prospectuses. In the same way, any document that encourages members of a corporation to sell their shares will be regarded as a prospectus (section 28(2)). The Securities and Exchange Board of India (SEBI) in cooperation with the Central Government shall specify the information and reports on financial information to be included in the prospectus (section 26(1)).

Misstatements in Prospectus

Since the public relies on the prospectus to subscribe for or buy securities from a corporation, any inaccuracies therein invite legal consequences. A statement made in the prospectus that is false or deceptive in form or context is considered a misstatement. Additionally, any information that is included or left out but is likely to mislead may also be regarded as a false statement (sec. 34). Misstatement in the prospectus would include, for instance, an incorrect statement about the reason for the offering of shares or a deceptive statement about where a company has its offices.

Liablity for misstatements in Prospectus

A person is responsible for false statements if they have signed the prospectus and provided their approval. If they signed the prospectus and gave their approval, those who managed the entirety or a significant portion of the company’s business may be held accountable for misstatements made in it. This group will include managers, company secretaries, and directors. However, if the individual signing is neither a manager of the firm nor receives compensation from it, then simply signing the representations in the prospectus will not subject them to liability for falsehood.

In the case of Sahara India Commercial Corporation Ltd.,2018. Here, SEBI took into account the Company Secretary’s claim that he signed the prospectus on the directors’ behalf under their power of attorney and came to the conclusion that he was not liable for misrepresentation in his capacity as a director of the company.

In a similar case, the Gujarat High Court noted in Hafez Rustom Dalal v. Registrar of Companies that the respondent authority is required to draw attention to any statements in the Prospectus that it deems to be false, purposefully misleading, or made to persuade the public to subscribe for the Company’s shares.

Under section 447 of the companies act,2013. Misstatements in Prospectus leads to :

• Civil liability
• Criminal liability

Criminal liability

A person is punishable under Section 34 if they permit the release of a prospectus that contains false or deceptive information. Fraud is punishable in this way according to Section 447. In accordance with Section 447, “fraud” refers to any action taken or omission made with the intent to deceive, obtain an unfair advantage, or harm the interests of the organization, its shareholders, creditors, or any other person. Such an act need not result in any wrongdoing in terms of gain or loss. Fraud under this provision also includes a person abusing their position. Sec. 447 further outlines the penalties for fraud.

• The person found guilty of fraud faces a minimum sentence of six months in jail and a maximum sentence of 10 years in prison if the sum involved in the fraud is ten lakh rupees or more, or 1% of the company’s revenue (whichever is lower). Such a person will also be subject to a fine up to three times the amount involved in the fraud, although it cannot be less than that amount.
• If the fraud involves less than ten lakh rupees or 1% of the company’s annual revenue (whichever is lower) and does not include a matter of public importance, the maximum sentence is five years in jail or a fine of up to one lakh rupeesand can extend upto 50 lakh rupees or both.
• The sentence must be at least three years in jail if the fraud in question involves the public interest.

Civil liability

When a person purchases a company’s stocks based on a deceptive prospectus, they may be held legally liable for any losses or damages they incur (sec. 35). In such cases, the following people are subject to liability under Section 447 and must pay damages to those who have suffered such loss or damage:

• A promoter of the company
• someone who has authorised the issuance of the prospectus
• a person who has agreed to be named as a director in the prospectus and is named as such a director of the company
• a person who has agreed to become such a director
• a specialist who has been involved or interested in the formation, promotion, or management of the company.

The Company and its directors are prohibited from dealing in securities as a result of the false statement

In the matter of Taksheel Solutions Limited,2013 the SEBI discovered that the Red Herring Prospectus/Prospectus had a number of crucial details lacking, leading to misrepresentation. The company, its promoters/directors, and independent directors were previously forbidden by SEBI from purchasing, selling, or otherwise transacting in securities. The Board stated that in order to assist the applicants in making an informed investment decision, the corporation had a responsibility to include honest and accurate disclosures and representations in the Prospectus. The Board also noted that a related party transaction was not disclosed in the Prospectus. The Board affirmed the temporary injunction prohibiting the Company and its Promoters/Directors from dealing in securities as a result. The Board, however, lifted the ban on the independent directors who had left the Company and had been subject to the restraint for more than 21 months.

Suspension of the auditor due to a forged prospectus certificate

The High Court of Andhra Pradesh stated that the prospectus is a special document and that the auditor would be in breach of his statutory obligations if he issued a false certificate, which is what happened in The Institute of Chartered Accountants of India v. Mukesh Gang, Chartered Accountant,2011 . The court further stated that because the public purchased the shares in response to the invitation, he must be assumed to be aware of the repercussions of such gross negligence of a false certification (Prospectus). The court additionally noted that, in accordance with Section 65 of the Companies Act of 1956, false representations in a prospectus will subject the maker to liability for any loss or injury a person suffers as a result of subscribing for shares or debentures based on such assertions. In this case, the court determined that the statutory auditor’s certification led to the general public being misled into buying corporate shares by putting their trust in such a document. In accordance with Section 21(5) of the Chartered Accountants Act of 1949, the court therefore suspended the defendant from practising as a chartered accountant for a term of three years.

Exceptions to the prospectus’s false statement liability

If a person can demonstrate either of the following, they will not be held criminally accountable under Section 34: the statement or omission was irrelevant

• He had good cause to believe that the claim was accurate or that the inclusion or omission was required, and he held onto that belief up until the prospectus’ release.

Similarly, if he can demonstrate the following, he will not be held accountable under Section 35’s Subsection (1) of civil liability:

• either the prospectus was issued without his knowledge or consent,
• and upon becoming aware of its release, he gave a reasonable public notice that it was issued without his knowledge or consent; or
• he withdrew his consent to serve as a director of the company prior to the prospectus’s release and that it was done so without his authority or consent.

A person may not be held accountable for a misrepresentation made by an expert if

• the statement is accurately and fairly represented in the report, or
• a true copy of the report or valuation, or a true and fair excerpt from it; and
• He gave the consent required by section 26’s subsection (5) to the issue of the prospectus and had not withdrawn that consent prior to delivering a copy of the prospectus for registration.
• He had reasonable grounds to believe that such expert was competent to make the statement. (sec. 35(2)(c)).

Conclusion

The prospectus must be created with the utmost care since it serves as an invitation to the public to subscribe to a company’s shares. The claims and reports included in the prospectus are relied upon by the general public when making investment decisions. As a result, those who make false or misleading claims in the prospectus are subject to liability and penalty under the Companies Act.

References

• https://www.legalraasta.com/blog/misstatements-in-prospectus/amp/
• https://vakilsearch.com/blog/misstatement-in-prospectus/amp/
• https://indiankanoon.org/search/?formInput=misstatement%20in%20prospectus%20&pagenum=1
• https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf

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