The FCA has proposed a revolutionary restructuring of the UK listing framework. Its consultation paper (published in May 2023) sets out a blueprint for the UK’s new listing regime.
For an overview of the key proposals in the FCA’s consultation paper, please see our Capital Markets team’s briefing paper: UK Listing Regime Reform.
While the driver of the rule changes is the desire to attract and retain more listed companies in London, they are likely to have an impact on securities litigation. In this blog post, we consider the significance of these changes for claims brought by shareholders, in particular claims under ss.90 and 90A of the Financial Services and Markets Act 2000 (FSMA). Before considering the impact of the rule changes on litigation risk, we set out below a quick recap of these causes of action:
- Section 90 FSMA provides a statutory remedy for shareholders who acquire securities and who suffer loss as a result of untrue or misleading statements in, or omissions of necessary information from, prospectuses or listing particulars relating to those securities (in essence, a “negligence” standard). It is a defence to such a claim if the defendant can show that it reasonably believed a statement was true and not misleading or an omission was properly made (the “reasonable belief defence”).
- Section 90A (and its successor, Schedule 10A FSMA) is the statutory regime imposing civil liability for untrue or misleading statements in, or the omission of required information from, published information disclosed by listed issuers to the market via a recognised information service. An issuer will only be liable to the extent a director of the issuer: (i) knew a statement was untrue or misleading; or (ii) was reckless as to whether it was untrue or misleading; or (iii) knew an omission to be a dishonest concealment of a material fact (the “recklessness” standard). It is a requirement for a successful claim under Section 90A and Schedule 10A that a shareholder must have acquired, continued to hold or disposed of securities in reliance on the published information to which the claim relates.
- Other potential bases for shareholder actions include claims brought under the Misrepresentation Act 1967 and common law claims for deceit and negligent misstatement as well as for breach of fiduciary and other equitable duties.
We consider below the impact of the key changes to the listing regime on future shareholder claims.
1. A single listing category
The FCA is proposing to collapse the current standard and premium listing segments into one single listing category for “equity shares in commercial companies” (the ESCC category), with one set of eligibility requirements and one set of continuing obligations for companies in that category.
The continuing obligations and eligibility requirements combine the existing requirements for premium and standard listed companies. This means that there will be some relaxations for premium listed companies and some increase in regulation for standard listed companies.
2. Class 1 and related party transaction shareholder votes and circulars to be dropped
One of the most revolutionary proposed changes, is the end to the requirements for mandatory shareholder approval and shareholder circulars in most cases on “Class 1” transactions (broadly those worth 25% or more of the listed company) under Listing Rule 10, and the consequent removal of the requirements to disclose historical financial information and a working capital statement. Similarly, the FCA is proposing removing the requirement for shareholder approval and a shareholder circular for large, related party transactions (broadly those worth 5% or more of the listed company).
From a litigation perspective, the most obvious consequence of removing the requirement for shareholders to approve Class 1 and related party transactions, is to eliminate a potential trigger point for claims.
This is most readily understood by reflecting on The Lloyds/HBOS litigation (see our briefing paper). In this case, the claims were centred on the all-share acquisition by Lloyds of its competitor bank, HBOS, at the height of the 2008 financial crisis. As a Class 1 transaction, Lloyds’ shareholders were required to approve the acquisition at an Extraordinary General Meeting. For this purpose, a shareholder circular was produced in November 2008, explaining the benefits and risks of the acquisition and containing a recommendation from the Lloyds directors as to how shareholders should vote. The key elements of the claim were that the directors of Lloyds negligently recommended to the shareholders that they should vote in favour of the acquisition of HBOS, and that they failed to provide shareholders with sufficient information to make an informed decision on how to exercise that vote and/or made negligent misstatements about the merits of the acquisition.
If the facts of this case took place in the future, under the proposed rule changes there would have been no requirement for the Lloyds directors to seek shareholder approval and no shareholder circular prepared, thereby removing the fundamental basis of the claim. However, the new rules provide that a transaction meeting the current Class 1 threshold of 25% would require an announcement containing the information currently required for a “Class 2” transaction (worth 5% or more of the listed company). A Class 2 style announcement requires a description of the effect of the transaction on the listed company, including any benefits which are expected to accrue to the company as a result of the transaction.
In our hypothetical scenario, this would have changed the shape of the litigation. Class 2 style announcements would have provided a platform for the Lloyds shareholders to bring a s.90A FSMA claim on the assertion that Lloyds made statements to the market about the proposed acquisition which were misleading. It would have been a challenging claim to bring in a number of respects, particularly given the higher fault standard under s.90A (dishonesty or recklessness rather than negligence) and the requirement to prove reliance for s.90A FSMA claims (which, although a necessary element of the negligent misstatement case brought against Lloyds and its directors, was not a feature of the negligent recommendation or sufficient information elements of the claim based on the shareholder circular).
More generally and notwithstanding the challenges to bringing a claim under s.90A FSMA (for the reasons set out in the previous paragraph), the importance of the disclosures to be made under the proposed rule changes will be magnified, such that claims may become more likely. In other words, if less information is required to be disclosed, the importance of the information which is disclosed (and the risk of not disclosing material information) increases. In particular, Class 2 style announcements may provide a hook for claims, on the basis that the company is required to give a “true” description of the effect of the transaction on the company and that it did not, for example by not disclosing a piece of information which, with the benefit of hindsight, turned out to be material. It is also worth noting that the requirements for Class 2 style announcements impose quite a high-level test which creates greater scope for argument as to whether it has been met or not.
One further impact of the changes is that there may be less internal scrutiny of a company’s disclosures, and less involvement from professional advisers (for example in preparing a working capital statement), particularly for smaller (less than 25%) transactions. In the Lloyds case, the board was able to take comfort from the large amount of work undertaken internally by management as part of the Class 1 process, and by its sponsors and other professional advisers. If professional advisers are not involved in the assessment of smaller transactions, it will be even more important for companies to ensure that statements made in any announcement can be justified, and that a comprehensive record is kept of judgment calls as to the materiality of information and what should be included/excluded from announcements. It may be that the wisest course to protect against future liability under s.90A will be to continue to undertake a fulsome verification exercise in relation to any transaction-related disclosures.
For other matters that will continue to need shareholder approval, the risks are likely to remain the same (eg cancellation of listing, reverse takeovers, transactions by companies in financial difficulties, issuing shares at a discount and share buybacks).
3. Governance Code and annual reporting
The FCA has proposed that other reporting and “comply or explain” requirements, which currently apply to premium listed companies only, will be applied to all companies in the ESCC category. For example, the FCA is proposing to retain the current key disclosure and “comply or explain” requirements which apply to standard and premium listed companies, in relation to climate and diversity related annual report disclosures.
ESG poses challenges to listed companies, including banks, in many forms – new taxonomies and disclosure standards; scrutiny of banks’ financial exposures to climate change; shareholder resolutions from activists; enhanced due diligence requirements to protect human rights; and warning shots about avoiding greenwashing, to mention a few. The more disclosures made in connection with ESG, the greater the risk of litigation under s.90 FSMA, s.90A FSMA, or at common law or in equity.
4. Simplified eligibility requirements
Some of the eligibility requirements for issuers seeking admission to listing which are seen as acting as a deterrent to companies listing, will be modified and investors will instead need to look to the disclosures made by issuers to make an informed investment decision. The FCA is looking to open the market to more diverse business models and more complex corporate structures.
For example, the FCA is proposing to remove the eligibility requirements relating to historical financial information and revenue earning track record. It is also proposing to delete the requirement that an applicant for listing satisfies the FCA that it has sufficient working capital (ie that it can give a clean working capital statement).
This rule change is underpinned by the principle that many investors are sophisticated enough to analyse financial disclosures to make informed choices. Of course, there will remain a need for specific prospectus regime disclosure requirements in this context, and we look forward to detailed rules from the FCA in this regard. However, the key takeaway from a litigation perspective, is that this shift will inevitably magnify the importance (and potentially increase the number) of financial disclosures made by issuers wishing to carry out an initial public offering (IPO). The simple point is that this may also increase the risks of s.90 FSMA claims in respect of allegedly misleading statements in/omissions from prospectuses.
5. Prospectus regime
The FCA is also taking bold steps to reform the UK’s prospectus regime and has published a series of engagement papers setting out in more detail the key issues it is considering. The engagement papers can be found on the following FCA webpage: New regime for public offers and admissions to trading. Our Capital Markets colleagues have published a full note on the prospectus engagement papers here: UK Prospectus Regime review – bold reform ahead.
The matters on which the FCA is currently seeking views are set out below, together with our initial analysis of the likely impact on litigation risk.
Admission to trading on a regulated market (Engagement Paper 1)
The FCA says that the requirement for a prospectus on an IPO will remain and it will continue to need to contain sufficient detail to meet the “necessary information” test. Accordingly, the overall disclosure standard for prospectuses will be maintained, preserving the status quo for s.90 FSMA claims, in this respect at least.
The FCA is asking for views on when exemptions to this requirement should apply, the required content and format of a prospectus in this context, and the responsibility for, and approval of, such a prospectus.
Further issuances of equity on regulated markets (Engagement Paper 2)
The FCA says there will be no requirement for a listed company to publish a prospectus when it issues further equity securities unless there is a clear need for one. It asks whether there should be a threshold (set by reference to the percentage of existing share capital that the issuance represents) above which a prospectus would be required and what document (if any) should be required if/where a prospectus is not required.
A reduction in the number of prospectuses published would increase investor/market scrutiny of company disclosures/announcements related to equity issues since s.90A claims may be available for any untrue or misleading statements made to the market, or omissions or delays in publishing required information.
Protected forward-looking statements (PFLS) (Engagement Paper 3)
The FCA seeks views on how PFLS, which will be subject to the higher recklessness liability standard under the FCA’s proposals, should be defined. It also asks whether the FCA should set certain minimum criteria for the production of PFLS, how they should be presented and labelled in prospectuses, and whether sustainability-related disclosures should be PFLS.
As a reminder, the rationale for changing the statutory standard of liability for PFLS was underpinned by Lord Hill’s view that the existing prospectus regime deters issuers from including forward-looking information in their prospectuses, due to the current level of liability attached (ie the “negligence” standard under s.90 FSMA described above). In order to improve the quality of information that investors receive directly, Lord Hill recommended adjusting the standard of liability for PFLS to the same recklessness standard as under s.90A FSMA and s.463 of the Companies Act 2006 (in respect of directors’ liability for untrue/misleading statements in, and omissions from, a directors’ report etc.).
Recklessness is a higher fault standard than negligence. While negligence generally involves a failure to exercise reasonable skill and care, recklessness requires a higher degree of awareness and disregard for risk. In ACL Netherlands BV & Ors v Lynch & Ors  EWHC 1178 (Ch) (commonly referred to as the Autonomy judgment), the High Court confirmed that recklessness in this context will have the meaning laid down in Derry v Peek (1889) 14 App. Cas. 337: “not caring about the truth of the statement, such as to lack an honest belief in its truth. Honest belief in the truth of a statement defeats a claim of recklessness, no matter how unreasonable the belief (though of course the more unreasonable the belief asserted the less likely the finder of fact is to accept that it was genuinely held)”. You can find our blog post on the Autonomy decision here: How to navigate the Autonomy judgment: guidance for corporate issuers defending Section 90A / Schedule 10A FSMA shareholder claims.
Accordingly, it will be more difficult for an investor to bring a successful claim for breach of s.90 FSMA in respect of a PFLS as a result of these reforms. In turn, this means that how a PFLS is defined will be very important, to give issuers clarity as to the potential risks attached to any forward-looking statements. The fact that the FCA is looking at whether PFLS includes sustainability-related disclosures will elevate the significance of this engagement paper, given the growing trend of ESG-related litigation, and emerging regulatory requirements to make sustainability disclosures.
Initial thoughts on the engagement papers
If the reforms outlined in the engagement papers go ahead, the likely overall impact will be fewer prospectuses, at least for secondary capital raises, and therefore fewer bases on which to bring s.90 FSMA claims. When combined with the potentially higher liability threshold for forward-looking statements in prospectuses (a shift from negligence to recklessness), it seems likely that we will see more claims being brought instead under s.90A.
From a practical perspective, although prospectuses will no longer be mandated for further equity securities under these reforms, it remains to be seen what disclosures companies will need to make in order to market a particular offer of shares outside the UK, and particularly into the US. It may be that a company has to provide additional information to the market beyond that mandated by UK rules to satisfy overseas securities laws, or that professional advisors recommend additional voluntary disclosures in order to seek to protect the company from potential non-UK liabilities.
6. Next steps
The FCA’s consultation on listing rule reforms closes on 28 June 2023 and written responses to the questions raised by the prospectus engagement papers must be submitted by 29 September 2023. Following the consultation and engagement process, the FCA expects to publish a second consultation paper containing draft listing rules in the autumn and plans to accelerate its final rule making processes. We expect the new listing rules to be implemented in early 2024. A consultation paper on new draft prospectus rules will follow later in 2024.
If you have any specific queries in relation to the impact of the proposals on s.90/90A FSMA claims, please get in touch with one of the contacts below or your usual HSF contact.