Misstatement in prospectus and its consequences10/10/2022 0 By indiafreenotes
A prospectus is a vital part of any business. In general, consumers search for a firm’s prospectus to determine whether or not they should invest in that company. It’s crucial that the things described in the prospectus are genuine. Companies create prospectuses because they want customers to come in and buy the firm’s debentures or credit money through the company. The contents of the prospectus must be accurate. If there are any misstatements in prospectus, and the public acts on that information, the firm may face civil or criminal liability.
Misstatements in prospectus
A prospectus is a document that contains information that the public can use to subscribe to or purchase a company’s securities. If it contains any inaccuracies, it will have major ramifications. Any statement in the prospectus that is erroneous or misleading is referred to as misstatements in the prospectus. A misrepresentation is defined as the inclusion or omission of a fact that is likely to mislead the public. The prospectus shall be regarded a prospectus with an erroneous statement if a relevant matter has been omitted from the prospectus and such omission is likely to mislead the public.
There have been instances when representation for future events has been called into question. A mere remark that something will be done or happen in the future is not a statement of fact that could lead to liability for misrepresentation. A misstatement of an existing fact is required to activate it. If a representation was true only at the time of prospectus issuance and not at the time of allotment, it would trigger liability. A statement in a prospectus about the persons who would be directors is a significant statement, and if it is false, a person who subscribed on the basis of it is prima facie entitled to cancel their subscription.
Liabilities for Misstatements in Prospectus
Liabilities for prospectus misstatements can be classified under the following headings:
- Civil Liability
- Criminal Liability
- Civil Liability in case of misstatements in prospectus
If a person who has subscribed for a company’s securities suffers any loss or harm as a result of any statement made in the prospectus, or any inclusion or omission of an item included in the prospectus that is deceptive, and acts on the content of the prospectus, then the company and everyone involved who:
- Is a director of the company at the time of the prospectus’s issue,
- Or is named in the prospectus as a director of the company or agreed to become one,
- Or is a promoter of the company,
- Or has authorized/allowed the prospectus’s issue, and is an expert who has been engaged or interested in the company’s formation, management, or promotion. Shall be liable to pay compensation to every person, without prejudice to any punishment to which any person may be liable, to every person who has suffered such loss or damage.
Exemption from Liability from misstatements in prospectus
No person shall be liable for misstatement if the person proves that-
- The person had withdrawn his permission prior to the prospectus’s release. If a person who had agreed to become a director of the firm withdraws his consent before to the prospectus’s release and claims that it was released without his permission.
- When the prospectus is distributed without a person’s consent or knowledge. When a prospectus is issued without a person’s knowledge or approval, and the person learns of it, he or she must give a reasonable public notice stating that the prospectus was issued without his consent.
Issuing a prospectus with the intent to defraud or for any other illegal purpose:
If it is proven that a prospectus was issued with the intent to defraud applicants for the company’s securities, or any other person for that matter, or for any other malicious purpose, each person mentioned in the preceding paragraph shall be personally liable for all or any of the damages suffered by any person who subscribed to the securities on the basis of such prospectus.
- Criminal Liability in case of misstatements in prospectus
Criminal liability for misstatements in prospectuses is dealt with in Section 63 of the Companies Act.
Every person who authorises the issue, circulation, or distribution of a prospectus that contains any statement that is incorrect or misleading in any form in which it is contained, or where any inclusion or omission of any matter is likely to mislead, is responsible for fraud.
Sec. 447 defines “fraud” as any act, omission, or concealment of any fact with the aim to deceive, obtain an unfair advantage, or harm the company, its shareholders, creditors, or any other person. It is not required that such a conduct result in any unjust profit or loss. If a person abuses his or her position that is also deemed fraud under this provision.
Prohibition of the Company and directors from dealing with securities following misstatement
In the Matter of Taksheel Solutions Limited, the SEBI (25 Oct. 2013) found that the Red Herring Prospectus/Prospectus had several missing vital pieces of information which resulted in misstatement. SEBI had earlier prohibited the company, its promoters/directors and independent directors from buying, selling, or dealing in securities in any manner. The Board noted that the company had the duty to make true and correct disclosures and statements in the Prospectus to help the applicants take an informed investment decision. The Board further observed that the Prospectus failed to disclose a related party transaction too. Therefore, the Board confirmed the interim order of prohibition on the Company and its Promoters/Directors in dealing with securities. However, the Board vacated the prohibition on the independent directors who had resigned from the Company and had undergone the restraint for more than twenty-one months.
Suspension of the auditor for false certificate attached to the Prospectus
In The Institute of Chartered Accountants of India v. Mukesh Gang, Chartered Accountant Referred Case. No.2 of 2011, the High Court of Andhra Pradesh noted that the prospectus is a special document and a false certificate is issued by the auditor would amount to his failure to discharge his statutory duties. The court added that he must be presumed to be aware of the consequences that flow from such gross negligence of a false certification because the public subscribe to the shares based on the invitation (Prospectus). The court further observed that as per Section 65 of the Companies Act, 1956 untrue statements in the prospectus will result in liability for the loss or damage sustained by a person while subscribing for shares or debentures based on such statements in the Prospectus. Here, the court found that the certification by the statutory auditor has resulted in misleading the general public into subscribing to the shares of the company by placing faith on such a certificate. Therefore, the court suspended the respondent from practising as a Chartered Accountant for a period of three years under Section 21(5) of the Chartered Accountants Act, 1949.
Exceptions from liability for misstatements in Prospectus
A person shall not be criminally liable under sec. 34 if he proves that: the statement or omission was immaterial or
- He had reasonable grounds to believe that the statement was true or the inclusion or omission was necessary and believed in it up to the time of issue of the prospectus.
Likewise, a person shall not be liable under sub-section (1) of sec. 35 (civil liability), if he proves that:
- He withdrew his consent to become a director of the company before the issue of the prospectus, and that it was issued without his authority or consent; or
- The prospectus was issued without his knowledge or consent, and
- On becoming aware of its issue, he gave a reasonable public notice that it was issued without his knowledge or consent.
A person may not be liable for a misleading statement made by an expert if:
- The report is a correct and fair representation of the statement, or
- A correct copy or a correct and fair extract of the report or valuation; and
- He had reasonable ground to believe that such expert was competent to make the statement and had given the consent required by sub-section (5) of section 26 to the issue of the prospectus and had not withdrawn that consent before delivery of a copy of the prospectus for registration. (sec. 35(2)(c)).