The High Court has handed down its long-awaited judgment in the US$5 billion civil fraud action brought by the Hewlett Packard group in connection with its acquisition of the UK software company Autonomy Corporation Limited in 2012: ACL Netherlands BV & Ors v Lynch & Ors  EWHC 1178 (Ch).
The judgment follows a previously published Summary of Conclusions, in which the High Court confirmed that the claimants “substantially succeeded” in their claims against two former Autonomy executives (see this post on our Civil Fraud and Asset Tracing Notes blog, which sets out the background facts to the dispute and summarises the outcome).
The successful claims were brought under s.90A of the Financial Services and Markets Act 2000 (FSMA), common law misrepresentation and deceit, and the Misrepresentation Act 1967, as well as claims for breach of the defendants’ management duties.
The 1657-page judgment is significant, not only because the case is one of the longest and most complex in English legal history, but also because it is the first s.90A FSMA case to come to trial in this jurisdiction.
As a reminder, s.90A (and its successor, Schedule 10A FSMA) is the statutory regime imposing civil liability for inaccurate statements in information disclosed by listed issuers to the market. It imposes liability on the issuers of securities for misleading statements or omissions in certain publications, but only in circumstances where a person discharging managerial responsibilities at the issuer (a PDMR) knew that, or was reckless as to whether, the statement was untrue or misleading, or knew the omission to be a dishonest concealment of a material fact. The issuer is liable to pay compensation to anyone who has acquired securities in reliance on the information contained in the publication, for any losses suffered as a result of the untrue or misleading statement or omission, but only where the reliance was reasonable.
In recent years, there has been a noticeable uptick in securities litigation in the UK, in particular in claims brought under s.90A/Sch 10A FSMA. The purpose of this blog post is to distil the key legal takeaways on s.90A FSMA arising from the judgment, which may be relevant to such claims.
Scope of s.90A / Sch 10A FSMA
The court accepted the defendants’ “general admonition” that the court should not interpret and apply s.90A/Sch 10A FSMA in a way which exposes public companies and their shareholders to unreasonably wide liability.
It emphasised that, in considering the scope of these provisions (and in particular in considering the nature of reliance which must be shown and the measure of damages), the history of the s.90A regime is relevant. The court highlighted the following background to the provisions of FSMA, in particular:
- Prior to s.90A, English law did not provide any remedy (statutory or under the common law) for investors acquiring shares on the basis of inaccuracies in a company’s financial statements (in contrast to the long-established statutory scheme of liability for misstatements contained in prospectuses). The rationale for the different treatment of liability for misstatements in prospectuses and those in other disclosures was because an untrue statement in a prospectus can lead to payments being made to the company on a false basis, but the same cannot be said of an untrue statement contained in an annual report, for example.
- The ultimate catalyst for the introduction of a scheme of liability was the Transparency Directive (Council Directive 2004/1209/EC), which included enhanced disclosure obligations and the requirement for a disclosure statement. This gave rise to concerns that the English law’s restrictive approach to issuer liability would be disturbed and that issuers (and directors and auditors) might be made liable for merely negligent errors contained in narrative reports or financial statements.
- The regime for issuer liability was introduced in this jurisdiction in a piecemeal fashion, recognising the historical tendency against liability. The government was aware that the scheme would involve a balance between: (a) the desire to encourage proper disclosure and affording recourse to a defrauded investor in its absence; and (b) the need to protect existing and longer-term investors who, subject to any claim against relevant directors (who may not be good for the money), may indirectly bear the brunt of any award against the issuer.
- The original s.90A provisions introduced by the government were subsequently extended with effect from 1 October 2010 as follows: (a) to issuers with securities admitted to trading on a greater variety of trading facilities; (b) to relevant information disclosed by an issuer through a UK recognised information service; (c) to permit sellers, as well as buyers, of securities to recover losses incurred through reliance on fraudulent misstatements or omissions; and (d) to permit recovery for losses resulting from dishonest delay in disclosure. However, liability continued to be based on fraud and no change was suggested or made to the limitations that: (i) liability is restricted to issuers; and (ii) liability can only be established through imputation of knowledge or recklessness on the part of PDMRs of the issuer. Further, no specific provisions to determine the basis for the assessment of damages were introduced.
Two-stage test for liability under s.90A /Sch 10A FSMA
The court confirmed that the provisions of s.90A / Sch 10A FSMA make clear that there is an objective and a subjective test, both of which must be satisfied to establish liability:
- Objective test: the relevant information must be demonstrated to be “untrue or misleading” or the omissions a matter “required to be included”.
- Subjective test: a PDMR must know that the statement was untrue or misleading, or know such omission to be a “dishonest concealment of a material fact” (referred to in the judgment as “guilty knowledge”).
Each of these tests is considered separately below.
The objective test (untrue or misleading statement or omission)
The court said that the objective meaning of the impugned statement, is “the meaning which would be ascribed to it by the intended readership, having regard to the circumstances at that time”, endorsing the guidance provided in Raiffeisen Zentralbank Osterreich AG v The Royal Bank of Scotland plc  EWHC 1392 (Comm).
The court gave some further guidance as to how to establish the objective meaning of a statement for the purpose of a s.90A/Sch 10A FSMA claim, including the following:
- The content of the published information covered by s.90A/Sch 10A will often be governed by certain accounting standards, provisions and rules, which involve the exercise of accounting judgement where there may be a range of permissible views. The court confirmed that a statement is not to be regarded as false or misleading where it can be justified by reference to that range of views.
- Where the meaning of a statement is open to two or more legitimate interpretations, it is not the function of the court to determine the more likely meaning. Unless it is shown that the ambiguity was artful or contrived by the defendant, the claim may not satisfy the objective test.
- The claimant must prove that they understood the statement in the sense ascribed to it by the court.
The subjective test (guilty knowledge)
As in the common law of deceit, it must be proven that a PDMR “knew the statement to be untrue or misleading or was reckless as to whether it was untrue or misleading”; or alternatively, that they knew that the omission of matters required to be included was the dishonest concealment of a material fact. The court noted that for both s.90A and Sch 10A, the language used shows that there is a requirement for actual knowledge.
The court clarified several key legal questions as to what will amount to “guilty knowledge” for the purpose of the subjective test, including the following:
- Timing of knowledge. In the context of an allegedly untrue/misleading statement, a party will be liable only if the facts rendering the statement untrue were present in the mind of the PDMR at the moment the statement was made. In the case of an omission, the PDMR must have applied their mind to the omission at the time the information was published and appreciated that a material fact was being concealed (i.e. that it was required to be included, but was being deliberately left out).
- Recklessness. In the context of s.90A/Sch 10A FSMA, recklessness bears the meaning laid down in Derry v Peek (1889) 14 App. Cas. 337, i.e. not caring about the truth of the statement, such as to lack an honest belief in its truth.
- Even on the civil burden of proof, there is a general presumption of innocent incompetence over dishonest design and fraud, and the more serious the allegation, the more cogent the evidence required to prove dishonesty.
- For deliberate concealment by omission, dishonesty has a special definition under Sch 10A (although s.90A contained no such special definition), which represents a statutory codification of the common law test for dishonesty laid down in R v Ghosh  1 QB 1053 (although in a common law context, that test has been revised by Ivey v Genting Casinos (UK) Ltd  AC 391). Under the Sch 10A definition, a person’s conduct is regarded as dishonest only if:
“(a) it is regarded as dishonest by persons who regularly trade on the securities market in question, and (b) the person was aware (or must be taken to have been aware) that it was so regarded.”
- Any advice given to the company and its directors from professionals will be relevant to the question of dishonesty (see below).
- Impact of advice given by professionals on the subjective test
- The court emphasised that, where a PDMR receives guidance from the company’s auditors that a certain fact does not need to be included in the company’s published information, then the omission of that fact on the basis of the advice is unlikely to amount to a dishonest concealment of a material fact (even if the disclosure was in fact required).
- Similarly, where a PDMR has been advised by auditors that a particular statement included in the accounts was a fair description (as required by the relevant accountancy standards), it may be unlikely that the PDMR had knowledge that the statement was untrue/misleading or was reckless as to its truth (unless the auditor was misled).
- However, in the court’s view, directors are likely to be (and should be) in a better position than an auditor to assess the likely impact on their shareholders of what is reported, and (for example) to assess what shareholders will make of possibly ambiguous statements. Accordingly, the court said “on matters within the directors’ proper province, the view of the company’s auditors cannot be regarded as a litmus test nor a ‘safe harbour’: auditors may prompt but they cannot keep the directors’ conscience”.
- Accordingly, narrative “front-end” reports and presentations of business activities cannot be delegated by directors, as their purpose/objective is to reflect the directors’ (not the auditors’) view of the business and require directors to provide an accurate account according to their own conscience and understanding.
- Subjective test to be applied in respect of each false statement. The court confirmed that liability is only engaged in respect of statements known to be untrue. If a company’s annual report contains ten misstatements, each of them relied on by a person acquiring the company, but it can only be shown that a PDMR knew about one of those misstatements, the company will only be liable in respect of that one, not the other nine.
Reasonable reliance is another necessary precondition to liability under s.90A and Sch 10A, although the precise requirements of reliance are not defined in those provisions. In the Autonomy judgment, the court considered the question of reliance in further detail, providing the following guidance:
- Reliance by whom? The court held that reliance must be by the person acquiring the securities, and not by some other person.
- Individual statements vs published information. The court held that reliance must be upon a statement or omission, rather than, in some generalised sense, on a piece of published information (e.g. the annual report for a given year).
- Express statements vs impression. The court suggested that statements and omissions may in combination create an impression which no single one imparts and, if that impression is false, that may found a claim (subject to the “awareness” requirement below).
- Awareness requirement. The court held that, in order to demonstrate reliance upon a statement or omission, a claimant will have to demonstrate that they were consciously aware of the statement or omission in question, and that it induced them to enter into the transaction. The requirement for reliance upon a piece of information will not be satisfied if the claimant cannot demonstrate that they reviewed or considered the information: “it cannot have been intended to give an acquirer of shares a cause of action based on a misstatement that he never even looked at, merely because it is contained, for example, in an annual report, some other part of which he relied on”. Further, the relevant statement “must have been present to the claimant’s mind at the time he took the action on which he bases his claim”, i.e. made his investment decision.
- Standard of reliance. The court held that a claimant must show that the fraudulent representation had an “impact on their mind” or an “influence on their judgement” in relation to the investment decision.
- Presumption of inducement. The court held that the so-called “presumption of inducement” applies in the context of a FSMA claim to the same extent as it does in other cases of deceit. This is a presumption that the claimant was induced by a fraudulent misrepresentation to act in a certain way, which will assist the claimant when proving reliance. The presumption is an inference of fact which is rebuttable on the facts. In addition, for the purposes of s.90A and Sch 10A, any reliance must be “reasonable”, and that reasonableness requirement mitigates the effect of the presumption by introducing an additional test for the claimant to satisfy. The court also made clear that the presumption of inducement is subject to the “awareness” requirement above, i.e. the presumption of inducement will not arise if the claimant was not consciously aware of the representation.
- When is reliance reasonable? The court held that “the test of reasonableness is not further defined, but is plainly to be applied by reference to the conditions at the time when the representee claimant relied on it. Circumstances, caveats or conditions which qualify the apparent reliability of the statement relied on by the claimant are all to be taken into account. The question of when reliance is reasonable is fact-sensitive.”
Loss in the context of FSMA claims
The court expressed its provisional view on some “novel and difficult issues” in the context of loss. In particular, it said that it is for the court to decide, and not for the defrauded party to make an election, as to whether “inflation” damages (i.e. if the truth had been known the claimant would have acquired the shares at a lower price) or “no transaction” damages (i.e. if the truth had been known, the claimant would not have purchased the shares in question) are available. The court will return to this question when addressing issues of quantum (the present judgment considered liability only).
Future use of s.90A / Sch 10A claims in M&A disputes
In the present case, the alleged liability of Autonomy under s.90A/Sch 10A was used as a stepping-stone to a claim against the defendants. This was described by the court as a “dog leg claim” because Autonomy (now under the control of HP) accepted full liability to its shareholder, and Autonomy sought to recover in turn from the defendants as PDMRs of Autonomy at the relevant time. The court said that there was no conceptual impediment to this, but that it was right to bear in mind that in interpreting the provisions and conditions of liability, the relevant question was whether the issuer itself should be liable.
This may open the door for future M&A disputes to be brought by way of a s.90A FSMA claim by disgruntled purchasers against the target company in order – ultimately – to pursue a claim against former directors of the target company (i.e. the vendors), based on breach of their duties owed to the target company.