Prospectus Regulation as a Tool for Investors - Essay Example

?PROSPECTUS REGULATION- 2005 TABLE OF CONTENTS INTRODUCTION A. PROSPECTUS REGULATION- 2005 B. EXEMPTIONS AND CRITERIA FOR APPROVAL C. SUPPLEMENTORY PROSPECTUS 1) D. PASSPORTING 1) E. SUSPENSION OF TRADING AND OFFER TO PUBLIC 1) F. INVESTOR RIGHTS 2. PROSPECTUS REGULATION – IS IT MISLEADING INVESTORS? 3. 2 A) DUTIES OF AN INVESTOR 2 B) IMPORTANCE OF PROSPECTUS SUMMARY 2. C) AMENDMENTS FOR CROSS BORDER DEALS 2. D) INVESTOR PROTECTION REGULATION AND GUIDELINES 2. E) IMPACTS 2. F) TRANSPOSITION ISSUES 2 G) PROSPECTUS NOTICE AND ITS AVAILABILITY 2. H) RECOMMENDATION BY ESME REPORT 2. I) FUTURE CHANGES 4. CONCLUSION 5. REFERENCES 1) INTRODUCTION 1) A. PROSPECTUS REGULATION -2005 Prospectus regulation1 came into effect from 1st July 2005 based on Section 2(2) of European Communities Act 1972 in relation to issuing of prospectus offering transferable securities to public through listing of securities / shares in the respective stock exchanges of the home country (Legislative.gov.uk, 2005). Only an approved prospectus can be offered to the public. The Prospectus Directive (PD) is required to be reviewed every 5 years by the European Commission (Lannoo, 2007). On 25th January 2011, the PD was reviewed and amendments were submitted which was approved. This is the first review that has taken place since the Prospectus Regulation came into effect since 2011. 1) B. EXEMPTIONS AND CRITERIA FOR APPROVAL Securities are exempted from offer to public if – The offer is made to Qualified Investors only The offer is made to less than 100 investors other that the qualified investors Minimum consideration per investor should be at least 50,000 Euros. The transferable securities are denominated in amounts of 50,000 Euros The total consideration should not exceed 100,000 Euros. The prospectus shall be approved only if the following criteria is strictly met by the companies which includes- UK will be the home state where the transferable securities are to be listed The prospectus contains all information related to assets and liabilities, financial statements, the rights of transferable securities. The prospectus needs to be submitted in comprehensible format, non-technical language and also includes a summary, and risk factors. 1) C. SUPPLEMENTORY PROSPECTUS Supplementary prospectus is one which includes significant new factors, corrections due to material mistakes or omissions relating to information included in the prospectus approved by the authority. 1) D. PASSPORTING A prospectus which is approved by another state outside UK where the company is going for issue of transferable securities after getting necessary approval from competent authority. Here the competent authority has to provide with the following documents for approval – certificate of approval, copy of prospectus and translation of summary of specified prospectus. 1. A prospectus can be published only with some types of securities that are either offered to the public or are requested for admission on a regulated market (Legislative.gov.uk, 2005) 1) E. SUSPENSION OF TRADING AND OFFER TO PUBLIC If the competent authority feels that a particular provision has been infringed then it has the power to suspend issue of securities / advertisement of offer for a period not exceeding 10 working days. The aforesaid authority also has the power to require the offeror to with draw the offer of issue to public in case of breach of regulations. Similarly, after listing of shares on respective bourses, if the competent authority finds infringement of provision, then it can inform the market operator to suspend trading in the stock for 10 working days or even in that matter prohibit public from trading in the securities till further notice. 1) F. INVESTOR RIGHTS An investor who has agreed to subscribe for shares in circumstances where the final offer price is not mentioned in the prospectus, then the investor can withdraw his acceptance before the withdrawal period which begins at investors acceptance and ends the second day after the competent authority is informed of the same. Meanwhile, withdrawal is not possible if the prospectus contains details/ criteria whereby the maximum price can be determined for the issue. 2) PROSPECTUS – IS IT MISLEADING INVESTORS? A highly debatable topic which can go on based on case to case aspects of business groups , investors as usual are left in a lurk as to whether these prospectus invariably approved by the Home State Authority still does not lead them in the right way or provide necessary guidance or support services. It would be improper to say that, the entire prospectus misleads an investor as these documents are prepared after thorough due diligence and frequent queries answered by companies from authorities and stock exchanges validating and proving points and facts. A prospectus by and large provides the qualitative and quantitative aspects of the business opportunity to invest. But, the major flaw that occurs here is that, by reading the prospectus none can understand the skills or capabilities of a promoter involved in the business. Being the backbone of the business, the entire show is being handled by him and the end result depends on how well he is able to manage/ run the organization. During rough tides, any company might go bust thereby putting investors in dismay, but it will never be a reason that the prospectus has misled the investors for which they have lost money (Davies Arnold Cooper, 2010). The best example that can be counted over here is the Recession of 2008 led by the all famous Investment Banker – Lehman Brothers. They had invested heavily into property and paved the way to Sub Prime mortgage2 losses. There were huge amount of information hidden from public, almost 5000 employees of Lehman Bros- UK left over without job. The report published by CESR shows the relation between certain flaws in a Prospectus Directive (PD) and its impact which are summarized as follows: 2. A subprime mortgage is a type of loan granted to individuals with poor credit histories (Davies Arnold Cooper, 2010) Cooperation in terms of Passporting – Passporting as we had defined earlier requires close cooperation between Home and State Authorities as the capital market instruments are being approved for passporting under PD, requires presentation of complete information to state authorities in terms of actual sales volumes unless they are asked for it. Comprehensibility – one of the major factors for confusing investors is the complexity at which the financial instruments are dealt with. In case of structured debt instruments, considered to be highly complex, the base criteria of comprehensibility is not met in a PD and hence, investors do not understand the risk factors involved in the product, thereby had ended up losing money in the case of Lehman Bros. Accessibility of prospectus – CESR also points out the difficulty for general public to get access of the prospectus involving various publication practices and regulatory authorities involved. Persons acting in concert (PAC) – if the concerned party is not authorized to issue transferable securities, then a person acting in concert in appointed who is authorized for it (Sidley Austin Brown and Wood, 2005). Hence, in the case of structured instruments it is necessary to understand whether it is the issuer of the bond or an intermediary who repackages the products. Hence, the prospectus should clearly define the acting authority and issuing company’s role. While analyzing the above mentioned hidden drawbacks in a PD, it is always widely used across the EU as it has standardized the entire issuance of transferable securities in European Union. Moreover, the PD provides free choice of home country for approval of prospectus. At the same time, in order to pre-empt the scope of passportability, stock exchanges in EU have started their own listing authorities which does not come under the purview of PD, like the Professional Securities Market started by London Stock Exchange , Euro MTF by Luxembourg Exchange and Alternative Securities Market by Irish Stock Exchange (Schammo, 2011). One of the major disadvantages with a PD is that, it only provides regulatory support during issue of shares in the market, but fails to carry this on a continuous basis post listing. Hence, here timing of issue and its regulatory patters play a major role in the investment criteria for investors. Post issue of securities, the regulatory framework might change and it can either help in further growth or de growth of companies, where the PD cannot have a role to play with. But this one-size –fits-all document in a way does not help in any manner for small and medium sized companies to raise capital from public market (Gallardo, 2010). Recently, few amendments were made in relation to investor size and considerations involved. This involves preparation of prospectus if the offer is to be made for less than 100 persons per member state, where the threshold has been increased to 150 persons and the ticket size of deals has increased from 2.5 Million Euros to 5 Million Euros. Changes have also been made in favor of employees where offer will be extended to them in EU for companies listed and operating in their home country other than EU. In UK, the issuer is also held liable in case of misrepresentation of facts and figures under civil liability (Vignaux and Gouzard, 2006). Similarly, a common format has been drawn in order to compare summaries with similar securities. The withdrawal rights have certain implications on investors where they can exercise the withdrawing power only for public issues and not for prospectus prepared in connection with listing. Also, deals which are being marketed by professional investors will not be b taken into account for withdrawals. Withdrawal rights are only applicable where the circumstances gave rise to supplement directive before the close of Public Offer and delivery of securities (Slaughter and May ,2011). The Directive has also been exemptions for Merger companies where listing happens in EU regulated exchanges for which a prospectus is not required to be provided for merger companies provided a document is provided containing information which is regarded by home member state regulator as being equivalent to a prospectus (Koller et al, 2010). As far as rights issues are concerned the authority has made a minor change in the offering of Article 7 where issuers of rights issue can take advantage of proportionate disclosure regime in order to improve the efficiency of pre emptive issues. This is also applicable to securities trading on multi lateral trading facility subject to appropriate ongoing disclosure requirements and rules on market abuse. Offers for existing investors free of charge- in reference to shares offered, allotted or to be allotted to existing shareholders free of charge (Article 4) is deleted on the basis of which such offers are already covered under exemption in Article 3(2) for offers in total consideration less than Euro 100,000. From the above facts, it is very clear that the PD although has its own merits and demerits always provides a benchmark for companies who are in the mode of raising capital from public thereby helping them to unlock the real value from the market. PD’s cannot be misleading to investors, because it is the major tool used by companies to market their hidden value to investors who sense good investment opportunities (White and Case, 2010). As discussed earlier, PD does not provide an ongoing regulation system to track performance of companies thereby making it difficult for investors to track the growth of the company over a period of time. Invariable there are other tools which at that point of time help investors to evaluate their ongoing investments. As far as PD is concerned it offers a simple and comprehensive outlook for investors to support their decision making activities whether as to invest or not. We consider a PD to mislead investors in certain occasions where, After investment into a company and post public offer there comes material statistics and revelations which hamper the growth of the company thereby affecting investments. It could also be the result of certain corporate actions which again can affect the investment aspects thereby resulting in reduction of investor wealth. This includes resigning of key management personals, mergers which can cause negative impact on business, siphoning of funds from main business etc. Frauds, purposeful misrepresentation of facts by companies, mismanagement can again result in massive wipe out of investor wealth. Violation of regulatory compliances, corporate governance and corporate responsibility issues, violation of environment rules, new criminal and civil cases being charged against company / management. Corporate scams, insider trading best example would be Enron, WorldCom etc. We need to understand that a PD is only a broad framework which provides an idea to investors about the company in where they plan to invest for which the duty is duly fulfilled by the same. But at the same time, it is the investors responsibility to dwell deep and understand more about the company rather than pin pointing issues with PD when their investment decision go wrong. 2 A) DUTIES OF AN INVESTOR Reading between lines – an intelligent investor always analyses and interprets a PD by reading between lines. It gives them hidden meanings / opportunities which when identified turns out into an investment opportunity and later on substantiates into a multibagger. This specific skill set of investor helps him to identify the intention of management, objective, and to some extent visualize future set of actions thereby helping him to make informed decisions. Fundamental analysis and due diligence – an investor needs to conduct a thorough fundamental analysis of companies where he plans to invest and follow a rigorous due diligence procedure to understand the pressure points and nerve centers of business, perception of stakeholders ( customers , suppliers, shareholders) on the company and management and future business and growth possibilities with the company. Management meetings – it is always advisable for the investors to meet the management and understand the business from the “horse’s mouth” rather than depending on rumors for information. Pre-investment meeting is very vital as the investor can put across all his apprehensions and clarify the thought process thereby boosting confidence on the company for investments. History of promoters – understand promoters back ground and his / her history. This helps to know whether the promoter has a successful track record in building businesses and creating wealth to stakeholders, whether they carry a negative impression in the market etc (Ross et al, 2009). After the recent amendments made in PD’s, now a prospectus issued under Prospectus Directive has some major effects listed below for Debt Instruments. Pan EU retail offering – when a security is admitted for trading in a regulated market like EU a prospectus has to be issued. The cut-off denomination of 50,000 Euros clearly provides a pan –EU private placement facility. Once, the PD is approved by the concerned member state then it only needs to intimate the same to other member states and a translation of the summary into the local EU language has to be provided (Schammo , 2006). This entails to a pan EU retail offering thereby providing a single point for retail offerings. Choice of regulator – provided securities are non-equity securities where denominations per unit are in 1000 Euros all issuers have option to choose as to which member state in the EU can provide approval of prospectus. Commercial paper exemption – debt securities issued with less than 1 year maturity are exempt from Prospectus Directive. Disclosure requirements – these requirements are highly stringent and involves disclosures to be made on – Recent and future capital expenditures, investments and funding details Sufficient working capital requirements Disclosure of conflict of interest of management Specialist issuers – at times, more documents have to be furnished in case of newly formed private companies, companies into mining, R&D, real estate and investments. 2 B) IMPORTANCE OF PROSPECTUS SUMMARY A Prospectus Directive requires a Prospects Summary3 which should not be more than 2500 words. It contains an abstract of all information in the PD consisting of risks associated with issuer, guarantor, details of offering, expenses involved and investment risk (DG Internal Market and Services, Online). The summary prepared has to be compared with summaries of similar products ensuring that equivalent information always appears in the same position in the summary. The current provision of civil liability is retained where issuer is held liable in case of misrepresentation of facts when read together with other parts of the prospectus (Moloney, 2010). This acts as key information for investors in terms for making investment decision. 2 C) AMENDMENTS FOR CROSS BORDER DEALS Common language system: introduction of English as common language thereby helping companies prepare single prospectus for all member states of EEA. This in a way helps in speedy admission of transferable securities into regulated markets for public issue and thereby raises capital. Exemption from usage of additional information: inclusion of additional information in a prospectus for those offers which have already been approved by the concerned member states has been exempted (Gerven, 2007). This lately has been a major entry barrier for cross border public offers as there were inclusion of huge amount of tax law summaries which blocked many issuers from coming up with public offers to retail investors. 2D) INVESTOR PROTECTION- REGULATION AND GUIDELINES Let’s analyze the various investor protection guidelines and regulations currently prevailing in EU regarding public issue of securities and those securities already trading in regulated exchanges. Market Abuse Directive (2003/6/EC) – this mainly includes aspects related to insider trading and market manipulation. Many of the corporate scams happen through the above mentioned means where promoters align themselves with market operators who are given exclusive information on the development of companies and thereby manipulate prices by cornering floating shares available in selected few hands and jack up share prices, thereby creating artificial demand (Weatherill, 2011). 3 Prospects Summary – An abstract of the information in the prospectus which provides an overview of all the information (DG Internal Market and Services, Online) Even though regulations are stringent and consequences are well known still there are market forces that resort to these malpractices for easy money. Investor Compensation Scheme Directive (1997/9/EC) – investor protection in case of failure of investment firm thereby making it incompetent to repay investors money or assets held on their behalf. The report published by DG Internal Market and Services points out certain facts based on their evaluation which can be discussed. The report asks for a separate Investor Protection Compensation Scheme for each member states with minimum harmonization of definitions and coverages (Veerle, 2009). This resulted in increased participation of firms in National Compensation Scheme throughout the EU thereby leading way to risk reduction for small retail investors, avoiding undue delays and better coverage on claim settlement and increased cross border investment activity. Article 5 – Prospectus Directive – this states that all information related to issuer and securities should be entrusted clearly in comprehensible format for investors to make informed decisions and assessment of assets and liabilities, financial position, profit and loss , prospects and credibility of issuer and guarantor. A fact to be noted - the absence of timely and accurate information of exposure of banks credit risk is one of the key factors for reduced investor confidence in European Market. The framework created by Prospectus Directive has ensured smooth and easy issue of securities in member states. This has resulted in increased public offers by companies on different variety of products at the same time confining to the framework set by the PD with regards to investor protection. The aspect of withdrawal rights of investors paves way to highly debatable issues in relation to legal certainties pertaining to “offer and admission to trading” as obligation to supplement prospectus ceases with listing of securities, even if public offer is still open (Breslin and Rabinowitz, 2005 ). Similarly, the time frame for withdrawal of investors from offers on cross border deals also differs with member states. Even though most of the member states have set a time frame of 2 days, there are other member states that have set the same for 3 days or more. This lack of common time frame can increase cost of issues. Similar issues are experienced for prospectus summary where all items in Annexure 1 to 4 are important for investors as it pertains to details of R&D activities and patenting. Also, the employee subscription of shares which are considered as offer to public has created debates Article 4(1) grants exemption for offering securities to employees provided that issuer has securities admitted for trading in stock exchanges and a document should be made available containing information on number and nature of securities with reasons of offer along with details of the same (Horing D and Grundl, 2010). This exemption is not available for third country issuers as they do not have listing options in regulated market which is with EU. Meanwhile, the Transparency Directive has certain stringent norms laid to issuers for disclosing periodic information based on Article 21.2 . it is estimated that around 30 million Euros per year can be saved by taking together all listed companies in EU regulated market as the cost of disclosing information accrues to euro 2500 to 5000 per year. Based on these issues the following were suggestions bought forward by the commission – Increase legal clarity and effectiveness in prospectus by way of clarifying roles and duties of issuing shares via placements by financial intermediaries, aligning definitions for qualified investors and professional clients, providing legal certainty in terms of withdrawal rights. Elimination of disproportionate requirements for EU companies while raising funds in European Securities Market and intermediaries which entails to providing equal opportunity for employee share schemes in EU , avoiding overlapping of disclosure norms , choice of home member state for debt offerings and proportionate disclosure for small capitalization companies and right issues (Prentice, 2011). 2 E) IMPACTS. Clarification in terms of share offerings by intermediaries to investors – here the retail investors tend to benefit as financial intermediaries require updating the prospectus while providing offerings to retail investors. Aligning qualified investors and professional clients – investors considered as professional clients under MiFid will benefit as they come under qualified investors because of greater access to more investment avenues which is not available to public. Time frame for withdrawal from offers –here risks in cross border deals are mitigated by the fact that issuers and offerers can extend deadlines in accordance with National Consumer Protection Guidelines. Employee stock option schemes and right issues– employees tend to benefit as they receive updated and tailored information on the offer. Standardized summary – this can boost investor confidence as a standardized summary helps investors to compare similar products and make informed investment decisions. Proportionate prospectus for small quoted companies – investors tend to benefit as they get wider investment avenues and enhance their returns through investing into multi bagger companies. 2 F) TRANSPOSITION ISSUES Timelines set out in the prospective directive is very important as directives incomplete and taking long completion times inspite of timeframes allocated shall not be considered valid. Similar is the case with timelines for approving authorities. This is where approval of home member state comes into picture. According to Article 13, there are no separate conditions set out asking for additional requirements to be bought in by issuer which is imposed by the authorities. Hence, the current practice of delaying the starting period for approval of prospectus till the date the competent authority receives approval decision issued by a different authority. Survey reports of ESME shows that the timeline for approval of IPO also varies among member states as it varies between 40 to 107 days. Hence, a common timeline has to be set for approval from authorities on the prospectus (ESME Report, 2007). 2 G) PROSPECTUS NOTICE AND ITS AVAILABILITY According to Article 31, a breach of guidelines set in Prospectus Directive arises when the member states ask for additional content to be published which is considered as informal source. According to ESME report, 2007 the notices of Prospectus and final terms have to be abolished thereby helping passported issues to announce the same only if required by home member state. Meanwhile, it is imperative that the Prospectus Directive should be easily made available to investors which according to Article 14 provide the issuer the right to choose the best medium for circulation of PD. New developments in media gives cost effective option for issuers to make available PD through internet and company websites thereby making it widely accessible to investors in a cost effective manner. 2 H) RECOMMENDATIONS BY ESME REPORT Some of the major amendments and recommendations suggested by ESME with regard to PD’s can be discussed as follows: Promote more retail participation and provide more investment avenues to this investor class as well as to employees. Promote market efficiency in public offers, trading and listing within single European capital market. Enhance and increase use of prospectus by investors thereby facilitating in informed investment decisions. Reducing burden of issuers from requirements that provide no significant added value to investors. Achieving better balance in risk allocation between investors and issuers. Reflect changes in the structure of international securities markets since the time when Directive was negotiated in 2001-03. Harmonization process by achieving common understanding of rules by National Competent Authorities. 2 I) FUTURE CHANGES Some of the key functional areas where changes can take place in future are: PD regulation changes: the authorities in EU does not have a particular time frame for revising PD regulations which reflects the changes in disclosure requirements set out in annexure due to amendments in PD. Depository receipts – there are possibilities to cover Depository Receipts under the Prospectus Regulation amendments. Low denomination debt threshold: issue of low denomination debts under Euro 1000 for which prospectus issued is approved by the member state in which the issuer is incorporated and non-EEA issuers are locked in to seeking approval from member state where they did their first issue. Right issue disclosure regime: it will be imperative for EU member states to explain the details as to the reduced disclosure requirements for reduced capitalization companies as compared to normal standards of disclosure. CESR is supposed to come up with guidelines related to ongoing disclosure requirements and rules on market abuse. Liability regimes – a comparison of liability regime of each member state has to be issued so as to provide useful insights to banks and financial institutions which conduct pan EU offerings. 4) CONCLUSION On detailed analysis from various reports and recommendations put forward by the regulatory bodies, it is clearly understood that the Prospectus Directive even though having certain drawbacks is the best tool used for companies to convey information to public on the investment avenues to be presented before them. The prospectus regulations has made it easier for companies to access capital from markets and admit for trading in one country or several countries at the same time. PD can be considered as a milestone for single and unified European Securities Market. Through each recommendation the regulation system is getting more stringent, at the same time investor – issuer friendly and enables better dealing through a single window system (Freshfields.com, 2010). One of the primary objectives of Prospectus Directive is to provide Investor Protection by providing complete and accurate information of the Issuer Company and details as stipulated. Of late, based on recommendations , the PD has become more transparent in terms of providing equal amount of information to both qualified investor and retail investors, thereby providing equal investment opportunities for the both the investor class. Similarly, in recent years we have seen the IPO market being vibrant and it is clearly observed that companies have broken the conventional chain of coming up with issues which is time consuming and has cut short the process where the price of issue and quantum of shares are kept flexible thereby making it easier for them to adapt to changing market conditions (Jonesday.com, 2005). This in a way provides better idea to investors and issuers on the demand for the issue based on which they can go ahead with their subscription. Moreover, this provides a balancing act between issuers and investors thereby generating an equal opportunity arena or a win –win situation. While preparing the Prospectus Directive the most important factor that has to be taken into consideration is to keep in mind the investment decisions considered by retail and qualified investors and their comprehensibility which comes up in the Prospectus Summary (Bertan, 2005). Hence, the issuer has to keep the summary precise, clear and focused to simplify the work for investors thereby reducing the timeframe taken in their thought process for investment decision making. The Prospectus Directive despite its drawbacks is the only source of entry for companies into the listed market and hence disclosure of information becomes vital based on which they gain investor confidence (Reinhardt, 2003). Hence, it is always considered that a Prospectus Directive does not intent to mislead investors, but invariably as time passes by and new regulatory norms coming into force, this would be considered as the most reliable document for investors to consider investing into respective companies of interest. References Bertan, C (2005) Raising Capital in Europe: The Legal Framework Following the EU Prospectus Directive. Oxford University Press:UK Breslin, B and Rabinowitz, D (2005), The Prospectus Directive. Journal of Financial Services Marketing 9, 91–103 Davies Arnold Cooper (2010) Prospectus Directive amendments create new civil liability for issuers and directors. Retrieved June 30, 2011 http://www.dac.co.uk/documents/resources/newsletters/Prospectus_Directive_amendments_create_new_civil_liability_for_issuers_and_directors_Digest DG Internal Market and Services (n.d) Executive Report and Recommendations on Evaluation of Investment Compensation Scheme Directive. 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Retrieved June 30, 2011 http://www.whitecase.com/files/Publication/4d608abb-9b13-46fd-91ed-ce630dd29801/Presentation/PublicationAttachment/9fef6075-0145-48cc-936b-d1821515a912/Insight_The_Prospectus_Directive.pdf Weatherill, S (2007) Better Regulation, Hart Publishing: Oxford Ross S, Westerfield R and Jordan B, D (2009) Fundamentals of Corporate Finance Standard Edition, McGraw-Hill:Irwin Read More