Biggart Baillie Solicitors

The Regime for Offering Shares to the Public

Friday, January 20, 2006

by Derek Ellery and Ronnie Brown and Damien Bechelli

On 1st July 2005 major changes in the law relating to offering shares to the public came into force with the implementation of the EU  Prospectus Directive.  The Public Offers of Securities Regulations 1995 were repealed and new provisions of the Financial Services and Markets Act 2002 (“FSMA”) came into force along with the Prospectus Rules made under the powers contained in the Act. In addition the new Financial Promotion Order came into force.

The FSMA specifies when a prospectus is required and delegates to the competent authority, which for this purpose is the FSA, the power to make rules relating to the publication of an approved prospectus – these are the Prospectus Rules.

Sections 85 of the FSMA  - the requirement for a prospectus

This section contains the basic prohibition on offering shares without a prospectus.

85(1) It is unlawful for transferable securities to which this subsection applies to be offered to the public in the United Kingdom unless an approved prospectus has been made available to the public before the offer is made.

Offering shares to the public without an approved prospectus is a criminal offence with a maximum penalty of 2years imprisonment and a fine.  It is also gives rise to a right to raise a civil action for any person who suffers loss as a result of the contravention

You need an approved prospectus when transferable securities are offered to the public.

What are transferable securities?

Transferable securities has the meaning given in the investment services directive which is classes of securities which are negotiable on the capital market (with the exception of instruments of payment) such as:

• Shares in companies and other securities equivalent to shares in companies,
• Bonds and other forms of securitised debt which are negotiable on the capital market and
• Any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or other indices or measures.

The requirement for a prospectus applies to all offers of transferable securities other than those listed in schedule 11A to the Act or those specified in the Prospectus Rules. 

Schedule 11A  to the FSMA lists categories of securities which will not be transferable securities this includes units in  open ended collective investment schemes and certain issues of securities by government bodies, housing associations and charities.

The FSA have exercised their power to provide further exemptions in the Prospectus Rules by exempting (Rule 1.2.2)

• Shares issued in substitution for shares of the same class already issued, or if the issue of shares does not involve any increase in the issued capital.
• Shares allotted in connection with a merger or in connection with a takeover by means of an exchange offer.
• Bonus issues or scrip dividends.
• Shares allotted or offered to existing or former directors or employees by their employer which has its shares admitted to trading.

provided in the case of the last 3 a document is made available which has certain minimum information in it.

It is worth noting that the security must be transferable . A security which cannot be transferred is never within the prospectus regime.

What is an offer to the public? 

This is defined in FSMA section 102B as:

“a communication to any person which presents sufficient information on the transferable securities to be offered and the terms on which they are offered to enable an investor to decide to buy or subscribe for the securities in question”

An offer to a single person can be an offer to the public. The communication can be in any form and by any means. It is specifically stated that section 102 includes the placing of transferable securities with a financial intermediary. 

Old arguments that there was a minimum number of people which were needed to constitute an offer to the public are no longer relevant for the purpose of determining if a prospectus is required. The test is whether they are offered on terms which enable the investor to decide whether to buy or subscribe or not. The FSA was asked during the consultation to expand on its understanding of what  would constitute an offer to the public, but declined to do so, saying it was for issuers to take their own legal advice.

The position for private companies

The restriction in section 81 of the Companies Act 1985 on private companies offering their shares to the public remains. The definition of ‘offer to the public’ in the FSMA is limited to the interpretation of that part of the Act and not applicable generally for all statutes which refer to offers to the public, and  the definition of transferable securities is not restricted to public companies shares. Theoretically at least an offer of shares in a private company which did not fall foul of the Companies Act 1985 could fall within the prospectus regime. The FSA has been asked to clarify whether that is the case, but in their view it would depend on whether their was an offer of transferable securities. They acknowledge that the definition of transferable securities can include shares in private companies.

An “approved prospectus”

Assuming then that there is an offer to the public of transferable securities so that an approved prospectus is required, what does this involve? 

An approved prospectus will be a document which contains  all the information required by the prospectus directive and which has been approved before it is issued by the FSA. 

The Prospectus Directive has a number of schedules which list the information which must be included  and these are incorporated into the prospectus rules. Generally the content is similar to that required for listing particulars. These schedules are referred to in the rules as the schedules and  building blocks. The prospectus must contain the following parts in the following order:

1. a clear and detailed table of contents
2. a summary
3. a statement of risk factors
4. the information provided for in the schedules to the prospectus directive.

The FSA cannot require the inclusion of information which is not provided for in the schedules or building blocks.

Once drafted the document has to be submitted in draft to the FSA for approval along with various supporting document and the fee. The procedure is similar to that for listing documents in that all the documents in near final form are submitted annotated to show compliance or with a formal request for omission of information and a list of non-applicable items. The FSA has stated that it will vet all such documents to the same standard as it applies to listed companies.

All this must be at least 20 working days before the offer is made and then revised drafts have to be submitted until the FSA is in a position to issue a certificate of approval. After approval the prospectus is filed with the FSA and made available to the public, and then the offer can be made.

The FSA must not approve a prospectus unless it is satisfied that it contains all the necessary information and complies with the requirements of the Act and the Prospectus Rules.

Exemptions from the requirement to produce a prospectus

In some cases even where there is an offer of transferable securities to the public a prospectus may not be required if it is within one of the exemptions provided by sections 85 and 86.

These exemptions are very important in practice because many  offers are constructed to fall within the exemptions  and this affects the way in which the offer can be marketed.

Section 85(5) provides that the requirement for a prospectus applies to all transferable securities other than those listed in Schedule 11A to the Act.
 
Schedule 11A paragraph 9 exempts form the prospectus requirements transferable securities included in an offer where the total consideration of the offer is less than 2.5million Euros. There must be aggregated all offers by the same issuer of shares of the same class within 12 months of the first offer of shares of that class. The amount in Euros is translated to sterling at the rate applicable when the first offer of the securities is made.  The FSA has expressed the view that this threshold applies to all offers throughout the EU rather than just the UK.

Section 86 of the FSMA provides that an offer to the public of transferable securities may be made without an approved prospectus where:

         (a) the offer is made or directed to qualified investors only;

         (b) the offer is made or directed to less than 100 persons, other than qualified investors per
              EEA state;

         (c) the minimum investment which may be made is  50,000 Euros per investor; 

        (d) the investments are denominated in amounts of at least 50,000 Euros: or

        (e) the total consideration for the securities being offered is less than 100,000 Euros.

It is also worth being aware that there is an exemption for issues of less than 10% of share capital during a 12 month period for companies which are listed on a regulated market.  As  AIM is not a regulated market for this purpose AIM  listed companies would need to produce a prospectus for such an issue unless it fell within one of the other exemptions.

Qualified Investor exemption

A “qualified investor” (defined in section 86(7) FSMA) is:

(a) a person falling within article 2.1(e)(i),(ii) or (iii) of the Prospectus Directive which means:

(i) legal entities authorised or regulated to operate in the financial services market, including credit institutions, investment firms, insurance companies, collective investment schemes and pension funds and their management companies  

(ii) national and regional governments, central banks, international and supranational institutions; or

(iii) other legal entities which are not small or medium size enterprises which mans they do not meet two of the three criteria being less than 250 employees, balance sheet not exceeding EUR 43 000 000 and annual turnover not exceeding EUR  50 000 000

(b) a person registered on the register of qualified investors maintained by the FSA;  or

(c) a person authorised by another EEA state to be recognised as a qualified investor.

In addition where a person who is not a qualified investor (the client) has appointed a parson who is a qualified investor to manage his investments on a discretionary basis, then the offer made or directed to the qualified investors is not regarded as having been made to the client or clients of the discretionary manager.

A list of qualified investors is maintained by the FSA from its records of authorised persons and copies of the list can be purchased from the FSA.

The 100 persons exemption

This is another important exemption in practice. There is no criteria which must be satisfied to be in the 100 people. For the purposed of determining the number of persons to whom an offer is made an offer made to trustees of a trust, members of a partnership in their capacity as such, or to two or more persons investing jointly are to be treated as an offer to a single person.

The 100 persons are in addition to the qualified investors.  If this exemption is to be relied upon good records should be kept of the circulation of the share offering document. The documents should be individually numbered with a list of the recipient of each numbered copy.

Whilst the exemption seems to provide freedom to market the offer to any 100 people, the restrictions on financial promotion in the FSMA, as described below,  mean that this is not in fact the case. 

Financial Exemptions

The financial criteria provide for other situations where the need for a prospectus can be avoided. Offers where the minimum investment exceeds 50,000 Euros or the securities are denominated in those amounts do not need a prospectus. There is also the de minimis of 100,000 Euros for small offers.

This may seem superfluous in the light of the 2.5 million Euro exemption. The 2.5 million Euro exemption was a late addition to the legislation and the FSA has admitted that the interaction of the two provisions may not have been fully explored.  However the 2.5 million exemption takes the offer outside the prospectus directive at all, and national law will apply. The 100,000 exemption is where the prospectus directive applies and therefore national law cannot  require the publication of a prospectus or similar document.  The government will still be free to legislate to provide UK law on the matter of contents of offer document for issues below 2.5 million Euros although they have not indicated that they would intend to do so.

Employee share schemes

There is no general exemption now for issues of shares in connection with employee share schemes, as was the case in the POS regulations.

Listed companies will benefit from the exemption in the prospectus rules for offers to employees and directors provided they produce and document containing the necessary information. AIM listed companies will have to use one of the other exemptions. The 10% exemption is also not available to AIM companies.

If the options are non transferable, as many conventional options would be on grant, then they will be outside the definition of transferable securities and therefore the Prospectus Directive. The view of the FSA is the exercise of an option is ‘unlikely’ to amount to an offer to the public.  This may not be the case for options which are structured in other ways, such as free shares.

If not a prospectus - then what?

Assuming the offer is made in accordance with the exemptions in sections 85 and 86 FSMA, no prospectus is required. Many share offers can be structured to fall within the exemptions. The 2.5 million Euro limit,  qualified investors exemption and the 100 other persons will be enough to permit many share marketing exercises without a prospectus, except those which are truly retail in character.

Assuming that it is desired to raise some money by offering shares to the public but this is kept within the exemptions to avoid the need for a prospectus, what document do you then produce?

Aim Listing -If the client is proposing offer the shares in connection with an application for admission to trading on AIM then an admission document complying with the AIM rules is required. A schedule to the AIM rules lists what is required, often by reference to including information from the schedules of the Prospectus Directive. This document is filed with AIM when the application for admission is made. No filing with Companies House is required as was the case under the POS Regulations.

Other offers – If, however, no AIM admission is sought, as might be the case in a private placing then there is no definitive list of information which you can follow in creating you share offering document.

However, although a prospectus complying with the Prospectus Rules is not required, there are still provisions which impose liability for information provided when shares are offered to the public.
Section 397(2) FSMA makes it an offence for a person to:-

(a) make (knowingly or recklessly) a misleading, false or deceptive statement, promise or forecast; or

(b) dishonestly conceal a material fact;

if he or she does so with a view to inducing another person who is in the United Kingdom to enter into (or refrain from entering into) an investment agreement in the United Kingdom (such as acquiring shares).

Section 397(3) makes it an offence for a person to do something in the United Kingdom which creates a false or misleading impression as to the market in or the price or value of investments and induces another person to acquire, dispose of, subscribe for, or underwrite those investments or refrain from so doing.  It is a defence if the person reasonably believed that his or her act or conduct would not create an impression that was false or misleading.

Each of these offences is punishable with imprisonment or a fine or both. The FSA may also impose remedial sanctions such as injunction, restitution or asset freezing orders. 

In addition to the statutory criminal liability, civil liability may arise under the general law of misrepresentation.  Where a contract is entered into based on a misrepresentation which is fraudulent then the other party to the contract may have the contract set aside.  A representation is fraudulent when it is made knowing it to be false, or where it has been made based on a wholly unreasonable belief it is true. The statement must be one of fact rather than opinion, but fraudulent misrepresentation can arise by positive statement, by active concealment or non-disclosure.

Where the misrepresentation is not fraudulent but innocent it is also possible for the affected part to seek damages, or if the misrepresentation was material to seek to have the contract set aside. The misrepresentation must have been such as would have induced a reasonable person to enter into the contract and have, in fact, induced the person seeking to have the contract set aside to enter into the contract.

The general nature of these provisions can make it difficult to give definitive advice as to what must be included in a share offer but clearly in cases of doubt disclosure is usually best.  It is non disclosure which leads to problems.  It may well be that following broadly the requirements of the prospectus directive will be as good a way as any of checking that  the correct information is included.  If you do not include information that the Prospectus Rules would require for a prospectus then the issuer should consider the reason for this omission.

The Interaction with the Financial Promotion Regime

Avoiding producing a prospectus may save time and money, but a prospectus has the one definite advantage that once approved by the FSA the prospectus may be distributed freely to the public without restriction.

An offer of shares which is made without a prospectus must be conducted within the restrictions in the FSMA and the Financial Promotion Order.

Section 21 FSMA contains the general restriction that a person must not in the course of business communicate an inducement to enter into investment activity unless the person is an authorised person and an authorised person approves the content of the communication for the purposes of the section. This is known as the financial promotion restriction.  This applies to all controlled activities in relation to controlled investments. Making arrangements for the purchase of shares is a controlled activity in relation to controlled investments.

Approval by an Authorised Person

The financial promotion restriction will not apply where the document is approved by an authorised person. If, however, the issue is being made without a prospectus the distribution of the document may well be restricted by the need to stay within a prospectus exemption. The added value of having the prospectus approved by an authorised person is lost if circulation of the document is not be possible beyond qualified investors and 100 other people.  In addition, it is likely that the marketing will be to persons for whom an exemption from the need for approval applies.

It is unlikely that anyone who was a Qualified Investor for the purposes of the prospectus regime would not be within one of the exemption in the FPO.  More care needs to be taken with regard to the 100 other people who in terms of the prospectus regime can be anyone at all, but for the FPO would need you be only persons falling within one of the exemptions if the need for approval is to be avoided.

The Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (‘FPO’)

The FPO specifies circumstances in which the financial promotion restriction does not apply. Exemptions are available where the communications are made only to certain categories of persons or only in relation to certain activities.  The most important exemptions for marketing shares  to the public are usually those allowing communications with investment professionals, high net worth companies and unincorporated associations, high net worth individuals and sophisticated investors.

In each case the FPO sets out the requirements to be within the exemption and usually provides for the marketing restrictions to be specified in the document. Care needs to be taken to put in place a system which ensures the marketing restrictions are complied with. In addition,  the requirements are not identical to the exemption in the  FSMA for qualified investors so care needs to be taken to ensure that the prospectus is only sent to parties who meet both sets of requirements.
 

Offers to existing members

The previous exemptions are ones generally relied on when a company is setting out to introduce new investors to the  company.  Where the proposal is a round of funding from current shareholders, as in a rights issue, then existing members may not all satisfy the criteria to be sophisticated or high net worth individuals.

Article 43 allows communications to members or creditors of a body corporate and the wording of the 2005 order is wider than the previous order to allow the communication to be sent on behalf of the company and by a company to its members or creditors in relation to investments issued by it or a member of the same group as the issuer. Such persons may not be qualified investors for the purposes of determining whether a prospectus is required, so other exemptions such as less than 100 people, or the offer being less than 2.5 million Euros may need to be relied on.

Conclusion

Where any offer of shares is contemplated it will be necessary to determine whether  it falls within the definition of an offer of transferable securities to the public.  If it does and needs a prospectus then it will need to be determined whether there is an exemption from the need to produce a prospectus.  If an exemption is applicable then care needs to be taken to market the offer both in accordance with the exemption relied upon and in accordance with the FPO.

If you would like further advice on any of these matters please contact Derek Ellery, Ronnie Brown or Damien Bechelli on 0141 228 8000.