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This important new book discusses disclosure and due diligence in relation to offerings of debt and equity securities in the international capital markets. It is primarily intended as a practical guide to assist lawyers who are asked to draft a description of a new issuer, starting with a blank piece of paper. It will be an equally useful guide to a lawyer or investment banker who is asked to review and comment on a draft description of a new issuer.
In addition, the disclosure discussion in Parts 1 and 2 will be of interest to new issuers. The due diligence and liability discussions in Parts 3 and 4 will be of interest to all issuers, investment banks and other professionals in the context of their potential liability for inadequate disclosure under, and the due diligence defences afforded to them by, English law.
From a regulatory perspective, there has been a clear trend in the international capital markets towards requiring more and better disclosure. In addition to this, lawyers practising in this area need to develop the ability to write good disclosure. If practitioners in this area do not have the necessary skills, there is a high risk this could increase the potential liability to both the practitioner and client.
The book aims to address this requirement by providing practical guidance on how to draft the relevant sections of the offering document with a clear explanation of regulations and potential liabilities.
A copy of the leaflet can be downloaded here
Part 1 – Disclosure
- The Business Description – Structure and Preparation
- The Business Description- Content
- The Financial Review
- Risk Factors
Part 2 – Regulatory Requirements Relating to Disclosure
- Overview of Prospectus Directive Regulated Market Requirements
- Corporate Issuer Disclosure
- Specialist Issuers
- Pro Forma Information
- States and Public International Bodies
- Exchange-regulated Markets
Part 3 – Due Diligence
- Applicable Guidance
- Financial Due Diligence
- Legal Due Diligence
- Business Due Diligence
- US Cases
Part 4 – Potential Liability
- Statutory Liability under Part VI of the FSMA
- Statutory Liability under Section 89 of the Financial Services Act 2012
- Contractual Liability
- Tortious Liability
My first real introduction to drafting disclosure came in the late 1980s and the early 1990s, when I worked on a series of Dutch privatisations which were structured as international offerings of equity securities. In those days, the practice was for the investment bank arrangers involved in the transaction to draft the disclosure until they felt it was in a reasonably advanced state. At that point it was passed to the lawyers and our job was to ensure that it satisfied any applicable regulatory requirements, principally listing requirements, and that it was balanced, factual and complete. This rewriting process was coupled with a verification exercise during which important statements in the draft disclosure were verified by the issuer.
These processes were not designed to make the lawyers the most popular players on the deal team. First, the investment bankers who had invested significant effort in crafting the disclosure were always unhappy when their marketing-focussed document was reduced to a more balanced (and in their view, bland) prospectus. Second, the verification process usually irritated the issuer unduly, particularly when it was asked to verify unnecessary information. For example, on one transaction I worked on the associate at the law firm conducting the verification exercise was nearly defenestrated by an exasperated officer of the issuer. However, these transactions were great training in the areas of disclosure and due diligence.
Through the 1990s and into the early 2000s, I continued to work on equity offerings although the nature of these deals changed significantly following the introduction by the US Securities and Exchange Commission of Rule 144A. This rule allowed companies outside the US to offer securities to professional investors in the US without first having to register the offering with the SEC. As a result, US securities lawyers increasingly became involved on international securities offerings and US disclosure and due diligence practices rapidly became the standard on international equity offerings, pretty much all of which included a Rule 144A placement. This rule was also a key factor in the major English law firms deciding to develop their own US law expertise.
The most significant differences between US and English disclosure and due diligence practices at the time were:
- In the US, the lawyers acting for the issuer wrote the disclosure rather than the investment banks. This is now the norm for all international capital markets transactions where there is a significant disclosure element.
- In the US, in addition to a description of the issuer's business, there was also a significant focus on providing a separate financial analysis section, known as a Management's Discussion and Analysis of Financial Condition and Results of Operations or MD&A for short, and disclosure of the risks associated with the proposed offering. These sections are now standard on all Rule 144A offerings and, since 2006, risk disclosure is required disclosure for any prospectus prepared in accordance with the Prospectus Directive.
- In the US, due diligence on the disclosure document itself principally took the form of a series of drafting meetings and a data room review rather than an independent verification process (which is still the standard practice on UK IPOs).
By the mid 2000s, my involvement in equity offerings had become limited to a few, typically relatively small, transactions principally targeted at European investors. However, I increasingly began to work on debt transactions, and the occasional equity transaction, involving a Rule 144A offering and used this experience to hone my skills in risk factor disclosure and MD&A drafting.
Following the independence of a number of countries in the former USSR, in the mid to late 1990s I also began to work on debt offerings by entities in those countries. These offerings almost always involved debut issuers and therefore required significant disclosure skills as a new description of the issuer was required for almost every issue. In these years, I worked on debut transactions for each of the Czechoslovak, Czech and Slovak central banks, for each of the Lithuanian, Latvian and Estonian sovereigns, for the cities of Prague, Bratislava, Tallinn and Sofia, among others, and for commercial banks and a number of state-owned or other significant companies in a range of former Eastern bloc countries. Although the majority of these transactions were not targeted at US investors, in later years it became increasingly common to include a Rule 144A placement.
Later in the 2000s, I also developed a significant practice in the Middle East as borrowers in that region began to tap the international capital markets for the first time. Here again, I worked on a number of debut transactions including the first sovereign deals by each of Abu Dhabi, Bahrain, Dubai, Iran, Lebanon, Pakistan and Ras Al Khaimah and a large number of debut deals by banks and companies across the region. Many of these transactions involved a Rule 144A placement, particularly those that took place after the onset of the global financial crisis.
In all this time, I never found a book that provided helpful guidance on disclosure writing. So, if I can learn, why can't anyone? No doubt they can, and will. However, this is the book I wish I could have read at the start of my career, or indeed at any time since then. I don't pretend that this book will tell you everything you need to know to write perfect disclosure. Far from it! However, if it helps you develop your thinking and improve your prospectus writing, it will have been worth it.
Why does it matter?
I believe that the ability to write good disclosure in now an indispensable skill for a capital markets lawyer who practices in the international debt or equity markets. Too many practitioners in this area do not have the necessary skills, and this costs their clients time and money and increases their own and their clients' potential liability.
Today, the focus on disclosure and due diligence in the international capital markets relates to Rule 144A placements, issues where there is a requirement to write new disclosure, for example for a debut or infrequent issuer, and issues from emerging markets, which are perceived as being more risky, even for repeat issuers. Clearly these are areas where there is an enhanced risk of litigation and clients will want to choose their lawyers carefully to minimise that risk.
However, of equal concern and almost universally overlooked at the moment, is the disclosure risk faced by well-rated companies who issue debt securities on a regular basis. In the US, issuers of debt securities that are registered under the Securities Act (whatever the rating of the issuer) are required to prepare an offering document that contains detailed business disclosure, an MD&A and a risk factor section. In Europe, only business and risk factor disclosure is required for issuers of debt securities. As a result, most frequent issuers of debt securities targeted at investors outside the US have developed a practice of providing only minimal disclosure in their offering documents. This is the case even where those issuers have a practice of disclosing more detailed information in other contexts, for example management reviews in their annual reports or MD&A and more detailed risk factor disclosure in offering documents issued by them which include a Rule 144A placement.
Although this more limited disclosure complies with the rules, it is hard to see how it could be defended in the situation where an issuer has made more detailed disclosure in another context. Consider this hypothetical scenario:
A company issues stand alone debt securities, including a Rule 144A placement, in May 2013. The risk factors flag that it has made significant investments and acquisitions in the past and there is a risk that these investments may become impaired in future periods and, if extensive, the impairments could materially adversely affect its profitability. At this stage officers of the company have no knowledge of any facts that might indicate that an impairment should be made.
In December 2013, the company issues further debt securities under its medium term note programme which was last updated in February 2013. This programme contains only limited disclosure and has a shorter risk factor section that omits the impairment risk factor. These debt securities are issued in a public offer to a wide range of retail investors. At this time, certain officers at the issuer are beginning to think that an impairment in respect of a past acquisition may be likely but the limited due diligence undertaken does not identify this fact.
When preparing its 2013 accounts in the early months of 2014, the company determines that one of its investments requires a material impairment to be taken and that causes the company to report a significant loss for 2013. When this is announced, the rating agencies downgrade the company and the price of its debt securities falls.
On this fact pattern, an investor in the December issue could make a claim against the company for misleading disclosure. He would argue that the company is required to disclose all material information to him and that when the securities were issued there was more than an insubstantial risk that an impairment would be made. He would also argue that the company must have considered the impairment risk to be material because it had disclosed it in May to different investors. Even if the investor was sophisticated, he would still have a claim in the UK if the action was founded on section 87A of the Financial Services and Markets Act 2000. This is because that section does not permit the company to take into account the nature of the investors when deciding what should be disclosed.
From a regulatory perspective, there has been a clear trend in the international capital markets towards requiring more and better disclosure. For example, following the invention of the medium term note programme in the 1990s, the regulators required that the disclosure included in a prospectus for such a programme should be updated at least annually. In 2006, the Prospectus Directive was implemented with a view to harmonising disclosure requirements across Europe.
In some respects this had a significant impact, including requiring disclosure similar to MD&A for issues of equity securities and making risk factor disclosure mandatory for all issues. Amendments to the Prospectus Directive implemented during 2012 now require an enhanced focus on summaries included in retail offers. These developments are welcome but there is a way to go yet to match the disclosure standards in the US.
Unlike in the US, we do not have a pervasive litigation culture in relation to securities offerings in the UK or even in Europe, notwithstanding a small number of high profile cases over the last decade. Let us hope this will remain the case. I fear, however, that when the circumstances are right litigation will happen, particularly in the context of public offers of securities to retail investors where the courts are more likely to be sympathetic to the plaintiffs.Download the preface
Financial assets differ from the other great classes of assets, notably land and goods, in that they require two people to make the asset, a lender and a borrower, a bondholder and an issuer, a depositor and a bank, a seller as creditor for the price and the buyer, a shareholder and a company. Land – and the planet – will exist whether or not we are here, and land is utterly indifferent to our presence. Although we may manufacture goods, these assets have no heart or feelings. They are a mindless blank.
But in the case of financial assets, two people are necessary. They circle each other with a mixture of suspicion and admiration, bound together by contract and statute. Written into the asset are all the emotions and passions that characterise mutual relationships between people, together with all the rationality that fosters mutual benefit. It is this mix of emotion and reason which gives financial assets their romance and fascination.
Otherwise, unlike land and goods, financial assets have no corporeal existence. You cannot have a picnic on a financial asset or drive it at breath-taking speed down the motorway. They are invisible, intangible, fictions of the legal imagination. You cannot see them, unless they are wrapped in a piece of paper, like an old bond or a share or an antique bill of exchange, assets which have either disappeared from common circulation or else have been de-materialised in clearing systems into an airy nothingness.
Since the asset cannot be shown or exhibited, its personality can only be described by words and figures. The value and worth of the asset can only be exhibited by language.
This essential characteristic is the fundamental reason why this work by Roger Wedderburn-Day on disclosure and due diligence in the international capital markets is of such major importance and why this commentary is central to the operation and conduct of the international capital markets. The capital markets are one of the largest markets in the world, markets of enormous importance to individual economies and to the world as a whole.
The author is unquestionably one of the most experienced practitioners and thinkers in this field, having practised in the area for nearly three decades. This highly intelligent work takes the reader through the intricate rules of the major jurisdictions regulating disclosure in offering circulars and the liability risks which attend defects in disclosure. These are topics of great intellectual refinement and sophistication.
At the same time, the text breathes live practical advice on every page and elegantly distils many years of hands-on experience. For a complex subject like this, it is exceptionally difficult to express exactly how to do it and precisely what happens with such telling detail, but this work does exactly that. You could not get this authentic display of international market practice except from a master practitioner, one of the greatest in the world.
Roger Wedderburn-Day says in his preface ‘this is the book I wish I could have read at the start of my career’. It is indeed fortunate for those who are starting their careers, and also for those who are in the midst or even in the autumn of their careers, that this superb commentary has at last arrived.
Philip R Wood QC (Hon), BA (Cape Town), MA (Oxon), LLD (Lund, Hon)
Head, Allen & Overy Global Law Intelligence Unit
Visiting Professor in International Financial Law, University of Oxford
Yorke Distinguished Visiting Fellow, University of Cambridge
Visiting Professor, Queen Mary College, University of LondonDownload the foreword