Prospectus liabilities

Introduction to Prospectus Liabilities

Welcome to one of the most critical areas of public company law! When a company wants to raise money from the public, it issues a prospectus. Think of a prospectus as a "sales brochure" for shares. Because investors rely on this document to make big financial decisions, the law is very strict: it must be truthful.

In this chapter, we will explore what happens when a prospectus contains untrue statements or omissions (leaving out important facts). We will look at who gets in trouble, the types of "trouble" (civil vs. criminal), and how individuals can defend themselves. Don't worry if the legal terms seem heavy—we will break them down step-by-step!

Note: This chapter focuses on liabilities. For the rules on what a prospectus must contain, please refer to the chapter on "Prospectus contents."

1. The Legal Framework

In Hong Kong, the rules governing prospectus liabilities are found in the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32). While most company rules moved to the newer Companies Ordinance (Cap. 622), the rules for prospectuses stayed in Cap. 32.

What is a Misstatement?
A misstatement occurs if:
1. A statement in the prospectus is untrue, misleading, or deceptive.
2. There is an omission of information required by law that misleads the reader.

Quick Review: If the prospectus says the company owns a gold mine when it actually only owns a plot of empty land, that is a classic misstatement!

2. Civil Liability: Compensation for Investors

Civil liability is about money. If an investor loses money because they relied on a bad prospectus, they can sue for compensation (damages). This is covered under Section 40 of Cap. 32.

Who can be held liable?

The law casts a wide net. Investors can sue:

• Directors: Anyone who was a director at the time the prospectus was issued.
• Proposed Directors: People named in the prospectus as future directors.
• Promoters: Those involved in "promoting" or setting up the share offer.
• Persons Authorizing the Issue: Anyone who "authorized" the prospectus to be sent out.

The "Burden of Proof"

Under Section 40, the investor only needs to prove that they relied on the prospectus and suffered a loss. They do not necessarily have to prove the director "intended" to lie. This makes it a powerful tool for investors.

Key Takeaway: Civil liability (s. 40) aims to "make the investor whole" by paying them back for their financial losses.

3. Criminal Liability: Punishment by the State

Criminal liability is about punishment (fines or imprisonment). This is covered under Section 40A of Cap. 32. This is much more serious than civil liability.

The Rule (s. 40A)

If a prospectus is issued with untrue statements, any person who authorized the issue can be found guilty of a criminal offense.

The Difference in Proof

In a criminal case, the prosecution must prove the statement was untrue. However, the defendant (the director) can escape if they can prove they had reasonable grounds to believe the statement was true and that they believed it was true up until the time the prospectus was issued.

Did you know? Criminal liability exists to protect the integrity of the Hong Kong financial market. It ensures that people are extra careful before signing off on public documents.

4. Common Law Liabilities: Tort and Negligence

Beyond the Ordinances (statutes), an investor might also sue under the Law of Tort, which is covered in Syllabus Area 4.

• Negligent Misstatement: If a person (like an expert or director) owes a "duty of care" to the investor and provides false information carelessly, they could be liable for negligence.
• Fraudulent Misrepresentation (Deceit): If someone knowingly lies in the prospectus to trick investors, they can be sued for the tort of deceit.

Example: An auditor provides a report for the prospectus but fails to check the bank balances. If those balances are fake, the auditor might be sued for Negligent Misstatement.

5. Statutory Defences: "How to Protect Yourself"

The law recognizes that even careful people can make mistakes. There are "safe harbors" or defences available to directors and experts to avoid liability:

A. Reasonable Belief

The most common defence. The person must prove they had reasonable grounds to believe the statement was true and they actually believed it was true at the time the prospectus was issued.

B. Reliance on an Expert

If the mistake was in a section written by an expert (like a lawyer, accountant, or engineer), a director is generally not liable if they can show the statement fairly represented the expert's report and they believed the expert was competent.

C. Withdrawal of Consent

If a director realizes there is a mistake before the shares are issued, they must:
1. Withdraw their consent to the prospectus in writing.
2. Give reasonable public notice that the prospectus was issued without their knowledge or consent.

Memory Trick: Think of the "Three W's" for defences: Wasn't me (Withdrawal), Wise expert (Reliance), and Well-founded belief (Reasonable grounds).

6. Summary Table: Civil vs. Criminal Liability

Use this table to quickly distinguish the two in a scenario-based exam question:

Feature	Civil Liability (s. 40)	Criminal Liability (s. 40A)
Primary Goal	Compensate the investor (Money).	Punish the wrongdoer (Fine/Jail).
Who brings the case?	The investor (Plaintiff).	The Government/SFC (Prosecution).
Standard of Proof	Balance of probabilities.	Beyond reasonable doubt.
Key Outcome	Damages (Compensation).	Imprisonment and/or Fines.

7. Exam Advice: Applying the Law

In your HKICPA QP examination, you will likely face a scenario-based question. Here is a step-by-step approach to answering:

1. Identify the Issue: Is there a lie or an omission in the prospectus? Did an investor lose money?
2. State the Law: Mention Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32). Specifically, cite Section 40 for compensation and Section 40A for criminal penalties.
3. Identify the Parties: Who is the victim (investor)? Who are the potential defendants (Directors? Experts? Promoters?)?
4. Apply to Facts: Did the director have "reasonable grounds" to believe the lie? If they just took someone's word for it without checking, they might fail the defence.
5. Conclusion: Advise the party on whether they are likely to be successful in suing or if they have a strong defence.

Common Mistake to Avoid: Don't forget that experts (like auditors) are only liable for the specific parts of the prospectus they prepared (the "expert report"), whereas directors are generally responsible for the whole document.