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Published: Fri, 02 Feb 2018
Prospectus On An International Bond Issue
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A realiable and accurate information is a very important aspect in order to enable the investors to create a good investment decision in respect of transferable securities traded in the financial market. In a situation where securities is offered to the public, the regulatory systems will usually apply strict mandatory prospectus requirements to accomodate the needs for investors protection. A different situation exists to international bond (eurobond) issue. Due to its size, volume and trading frequency, most trades of eurobonds are carried out over the counter (OTC),  insulated from securities regulation and exchange controls of any one country.  For practical reasons, there are exemptions given to facilitate the unique characteristics of the eurobond issue, which is mainly targeted to sophisticated investors, private placements, and offerings by governments and international organisations.  Among the exemptions is that enhanced liabilities of the issuer and others involved with regards to a regulated prospectuses do not apply in eurobond issue. Contracting out of liabilities by the lead managers is commonly found and the directors of the issuer do not have to assume direct liability for the unregulated prospectus.  Hence the advantages of eurobond issue.
Eurobonds are often listed in a stock exchange to reach a larger number of investors  and to ensure investors eligibility,  the content of the prospectus will be regulated by specific requirements of the stock exchange. While listed, the issuer of the eurobond must continuously disclose any relevent information in order to avoid informational assymetries. 
On the first hand, it would seems that the exemptions are in favour of the issuer and others involved with the preparation of the prospectus to exclude certain liabilities, but they are not immune to laws relating to misrepresentation and fraud, at this situation they will be caught under general laws and sometimes in certain jurisdiction tougher liabilities might be enhanced by securities statutes.
The remedies available to bondholders may vary depends on the type of misrepresentation which has to be proven further. The liabilities for the misrepresentation are joint and several between the parties involved in the preparation of the prospectus, often not limited to the issuer. The laws are strict even if the issuer is innocent.  The bondholders may only obtain remedies through the prospectus. 
The difference between prospectuses for public and non-public offering lies within the strictness of its requirements. This paper will examine as to whether these exemptions provided to accomodate the eurobond issue has any impact on weaker protection for the bondholders and therefore, lightens the liabilites of those involves in the preparation of the prospectus for the eurobonds.
Since the scope of misrepresentation is wide, this paper will limit its discussion only to misrepresentation in a prospectus on an international bond, and focus on the approaches taken by certain jurisdictions in leading cases relating to our topic particularly in legal systems at commonwealth countries and from time to time with other jurisdiction whenever appropriate.
The remainder of this paper will be organised as follows. Section 2 will briefly explained the traditional procedure of the eurobond issue, focusing on mechanism of the prospectus preparation by the parties. Section 3 of this paper will examine about remedies available for the investors and misrepresentation in general context and make relevant connection with the issue. Section 4 will investigate further about the roles and liabilities of the parties involved in the preparation of the prospectus, and examine the ruling of the courts in some leading cases in particular jurisdictions. Section 5 concludes with some final remarks.
THE PREPARATION OF THE PROSPECTUS ON AN INTERNATIONAL BOND ISSUE
A prospectus is a detailed document which contain true and plain disclosure of all material facts relating with the issue of a security. The eurobond market is usually underwritten by a multinational syndicate composed of financial institutions and is sold simultaneously in various national markets other than that of the country in whose currency it is denominated, it is also free from regulatory domain of any jurisdiction and strict registration requirements or other governmental regulation.  There are some part of the transaction that still impinged by the national laws. In US, these are under Securities Act of 1933 (SA) and the Securities and Exchange Act of 1934 (SEA); Regulation S and Rule 144A. In UK, these are under the Financial Services and Markets Act of 2000 (FSMA). In European Union harmonisation of law has been reached under EU Prospectus Directive 2003. 
Prospectus in eurobond is issued only to sophisticated investors (e.g insurance companies, banks, pension and investment funds), since they are considered as experts who can sustain losses resulting from investing in a high risk investment. If the eurobond is listed on a stock exchange, the issuer will be oblige to continuously disclose information and be required to submit a number of documents according to listing regulation. 
Traditionally, a mandatory prospectus may be form in a single or tripartite documents, comprising a registration document, securities note and summary note  . Its provisions are complex, and their full detail will not be discussed in this paper. But it is crucial to understand the procedure of international bond issue particularly at the part where the prospectus involved. The procedure start when the issuer give the authorisation to the investment banks (the managers) with a mandate letter to arrange the issue. The lead manager is usually will be the one who works closely with the issuer, to complete any information and drafting legal documents required for the issue. On the other hand, the co-managers rarely involved in the preparation of the prospectus, but their name usually appears on the invitations to potential bank participants or underwriters. Before fixing the interest rate and any discount (premium) on subscription, the managers prospective buyers to inform about the issue and circulate the preliminary prospectus (often called ‘red herring’ or ‘pathfinder’).
After the buyers response to the offering, the managers and the issuer agrees the interest coupon and subscription price (i.e. par, discount or premium). The subscription agreement is signed by the issuer and the managers, and the final prospectus despatched to prospective buyers. Any material changes from preliminary prospectus (offering circular) should have been notified to underwriters before they contract. After assessing the prospectus, the buyers finally decide how many bonds they are going to purchase.
REMEDIES AVAILABLE FOR MISREPRESENTATION IN A PROSPECTUS
There are no universal definition for misrepresentation, but we may describe it as a situation in which there is no genuiness of consent to a contract by one of the parties, there must be a false statement of existing or past fact. Under common law, we may divide misrepresentation into three types. First, an innocent misrepresentation is false statement made by someone who had a reasonable grounds to believe that the statement was true, not only when it was made but also at the time the contract was entered into.
The second type is negligent misrepresentation, which is false statement made by someone who had no reasonable grounds for believing the statement to be true. To bring action for negligent misrepresentation against the issuer or others responsible for prospectuses, one will need to establish that the defendant owed the claimant a duty to use reasonable skill and care in producing the document and that it breached that duty which resulting in loss to the claimant. In UK, as an alternative, broadly similar claims can be framed under s 2(1) of the Misrepresentation Act of 1967. 
The last type is fraudulent misrepresentation, which is false representation of a material fact made knowing it to be false, or believing it to be false, or recklessly not caring whether it be true or false. Mere negligence is not enough, an element of dishonesty is also required.
These are called actionable misrepresentation, which means that a party of a contract can sue the other party for a breach of contract provided that the statement is one of fact, not opinion, or intention, or law; and the statement has induced the contract.
To understand what kind of remedies suitable will depend upon the nature of misrepresentations. The remedies may generally be divided to rescission and damages. Rescission give rights for a party to ask the court to put the contract to be voidable and not void, i.e. to positioned the parties into a condition before the contract was made and followed by the refund of the investment. Although rescission is available for all misrepresentations, but due to its strictness of the rules and high standard of proof, claim of rescission for fraudulent misrepresentation is more difficult to bring in the UK rather than in the US.  Another type of remedy is the right to claim for damages, which is available for fraudulent and negligent misrepresentation but not available for innocent misrepresentation.  Since the remedy obtained from damages are often would not cover the losses incurred by the investors, rescission is considered to be the better option. 
LIABILITIES OF THE PARTIES INVOLVED IN THE MISREPRESENTED PROSPECTUS
The parties involved in the preparation of the prospectus are responsible perform due diligence and ensure that the contents are true and accurate. Theoretically, they are not liable unless they failed to conduct a reasonable enquiries to provide reasonable grounds for a belief that there had been no misrepresentation. In determining what is reasonable investigation or what are reasonable ground for belief, the standard of reasonableness must be that required of a prudent person in the circumstances of the particular case.
When a prospectus contains a misrepresentation, a person who purchases a security is deemed to have relied on the misrepresentation if it was a misrepresentation at the time of purchase. Sometimes in special circumstances, there is no need for reliance or inducement to the prospectuses. Investors may obtain the remedies eventhough they did not read the prospectus.
In a eurobond issue, the parties are liable under general law of misrepresentation and fraud. Since the issuer will most likely turn out to be insolvent, the investors usually will sue the banks who managed the issue, the auditors or even legal advisers involved.
Where a misrepresentation in a prospectus occured, there must be a false statement of existing or past fact. In Edgington v Fitzmaurice,  the case illustrates a misstatements of promise as to future intention. Detail of the case starts when a prospectus was issued by the directors inviting subscriptions for debenture bonds, which the prospectus stated as being needed for altering its buildings (to pay outstanding mortgage), purchasing horses and for the supply of cheap fish. The prospectus did not make clear that the money obtained was used to pay off existing debts of the company. The court finally decided that the intention in the prospectus was a misrepresentation, and the money invested by reverend Edgington should be refunded immediately. The case was settled under civil law and did not bring any criminal charges to the issuer.  If it had been discovered in that case any conspiracies for fraudulent intention, there are possibilities for it may be punishable by imprisonment.
The regulations for prospectuses in UK practically impose liabilites to the issuer and its directors to compensate the losses of the investors.  In any circumstances, the issuer is always liable in the case of negligent or fraudulent misrepresentation, even if they are innocent, their liability is often very strict. The issuer usually put a statement in the prospectus stating that they are responsible for the preparation of the prospectus, taken all reasonable care to ensure that all information contained in the prospectus, to the best of their knowledge is in accordance to the facts and contain no omission likely to affect its import. In a regulated prospectus, the burden of proof for negligence lies with the issuer and others involved in the issue.
Exception to this, is that not all acts of the personnel of the issuer may cause the issuer being criminally liable. It is necessary to establish whether the natural person such as directors have the status and authority which in laws makes their acts in the matter under consideration the acts of the issuer, so that the natural person is to be treated as the issuer itself. It is rather complicated to decide whether or not the person concerned is sufficiently in responsible position to involve the issuer in liability for the acts in question according to the law as laid down by the authorities.
The director may only be held liable if he knew the statement was untrue or misleading or was reckless as to whether it was or he knew that the omission of the information was the dishonest concealment of a material fact. In eurobonds, the directors do not have to assume direct liabilities for the prospectus due to separate legal personality between directors and the company. They are automatically liable if they are proven to be participated in the tort of deceit or undertake any responsibility, e.g. through listing code. In English cases, directors involved or directly authorises the tort will be held accountable, but not for a director who is not directly involved.
For fraudulant misrepresentation, the liabilities is very strict. The test for this laid down in English case Derry v Peek.  The case begin when Derry and other directors of the company issued a prospectus, inviting the public to apply for shares in it, stating that they had power to run trams by steam power. They promise that they would soon be granted permission from the authorities, but in reality was, the permission was rejected except for some parts of the tramway. The directors were sued for fraud by its investor. The court decided that the directors were not fraudulent but honestly believed that the statement in the prospectus was true.
The courts will not allow the corporate form to be used for the purposes of fraud, or as a device to evade a contractual or other legal obligation. To prove whether personal liabilities can be imposed to the directors, it may use a way of discouraging directorships which involves lifting the veil of corporation, i.e. to ignore the principle of separate legal personality. In lifting the corporate veil, the courts will try to find out whether there were mens rea (guilty mind) on the part of directors, i.e. knowing that there is untrue information with regards of the prospectus and ignores it. They need to proof whether the directing mind and will of the directors may lead into misrepresentation or not, and does the actual management had control over the relevant acts. This is different with regulated prospectuses situation where directors may be liable by undertaking statement of responsibility through listing code.
Liabilities is commonly debatable with regards to its fairness. Four conditions where managers and underwriters will be liable for a prospectus regardless of whether it is regulated or unregulated: 
The underwriter will be liable as a seller to direct purchaser if the underwriter subscribes the securities from the issuer and then resell it to direct purchaser. They will be liable under general contract law.
The managers involves in a fraudulent acts during the preparation of the prospectus, knowing it to be false, or believing it to be false, or recklessly not caring whether it be true or false, will attract both criminal and civil liability.
The underwriter or arranger will be liable for its own misstatement to the investors, e.g. during a road show or sales process.
The underwriter is liable if it assumes express responsibility statement (e.g. by listing sponsors).
In theory, banks have the same level of capacity as auditors and lawyers to provide advisory services to their clients. They can limit their liability by accepting only partial responsibility to any contents of prospectus authorised by them. 
As mentioned before, the function of the lead manager in eurobond issue is to work closely with the issuer on preparation of the prospectus. Co-managers usually do not directly involved (commonly associated only because their names appear on invitations to potential bank participants or underwriters). The lead manager is helping the issuer to draft the prospectus. Any information contained within the prospectus came from the issuer, not from the lead manager. A specific representations from the issuer as to the accuracy of the information provided in the prospectus are given to the lead managers as a warranty in the subscription agreement. One thing must be noted that the warranties given will be practically useless if the issuer is insolvent.
In the US case of In re WorldCom Inc Securities Litigation,  the company issues debt securities under two shelf registration statements. Soon it was discovered that the company was wrongfully manipulated their profits by capitalising expenses so as to increase profits. On June 25, 2002, WorldCom announced a massive restatement of its financial statements (which were audited by Arthur Andersen LLP), and on July 21, 2002 WorldCom filed for protection under the federal bankruptcy laws. The next thing is very obvious, the only pocket left available was the lead managers and experts helping the company issued the bonds. The problem was, there were red flags been warned about this since the falling of the DotCom bubble spreading but no action has been taken to prevent this. The rating agency has already downgraded the company due to its deteriorating financial condition. The underwriters asserted that they acted reasonably in relying upon Arthur Andersen’s reports with respect to WorldCom’s audited financial statements and had no duty to investigate further as they had no reasonable ground to believe that these financial statements contained false statements. The underwriters also asserted that they were entitled to rely in the same manner on Andersen’s comfort letters for the unaudited quarterly financial statements incorporated into the registration statements. It was held that the underwriters has failed to exercise due diligince by over relience to financial statements prepared by the auditors. Twelve former directors and 17 investment banks paid more than US$ 6 billion for settlements.
Duty of care
The lead managers of a securities issue may not always be liable for tort of negligence. In England case of Hedley Byrne & Co. Ltd v Heller & Partners Ltd,  the claimants were advertising agents and the defendants were merchant bankers. The claimants had a client called Easipower Ltd who was a customer of the defendants. Easipower Ltd had placed orders to the claimants to advertise Easipower’s products. The claimants asks the defendants as to the creditworthiness of Easipower Ltd. The defendants stated that Easipower was respectably constituted and considered good, although they said in regard to the credit: ‘these are bigger figures than we have seen’ and also that the reverence was given in ‘confidence and without responsibility on our part’. In reliance to this reply, the claimants placed an order on behalf of Easipower Ltd, and assumed personal liability for the payment to the television and newspaper. Soon after Easipower Ltd went into liquidation, the claimants lost the advertising contracts. The claimants sued the defendants on the based of liability of negligent for not informing sufficiently about the actual condition of Easipower Ltd before writing the statement. The court held that the defendants did not owe the claimants a duty of care, but in the absence of the disclaimer, the circumstances would have given rise to a duty of care in spite of the absence of a contract or fiduciary relationship.
Legal defenses for the managers liabilities
Theoretically, when the managers conduct a proper due diligence and believes that a statement was true and not misleading, they will not be liable if it continued in that belief until the time when the securities were acquired, or if the securities were acquired before it was reasonably practicable to bring a correction to the attention of potential investors, or if before the securities were acquired they had taken all reasonable steps to bring a correction to investors attention, or if the securities were acquired after such a lapse of time, the bank ought reasonably to be excused (provided it continued in the belief until after the commencement of dealings on any exchange).
Another defence is, if before the investor acquired the securities, a correction had been effectively published, or the person responsible for the prospectus had taken all reasonable steps to secure its publication, and reasonably believed it had taken place. If the investors knew about the misrepresentation before purchasing the securities, then there is no liability to compensate. 
There is usually statement by the managers in the prospectus stating that they indeed had assisted the issuer in preparing the prospectus, separately verified the content. But they are also put exclusion as to no representation, warranties or undertaking, whether expressed or implied and legal liability as to accuracy or completeness of the information contained in the prospectus or any other suplementary information. Any person received the prospectus cannot rely to the manager or thought that the manager has done investigation to the accuracy of the information of the issue.
In the past time, it was quite onerous for a third-party user of financial statements to sue an accountant for negligent misrepresentations in auditing their clients,  but in Hedley Byrne and Co Ltd v Heller and Partners Ltd,  the decision made the first significant inroad into the general denial of the ability of non clients to sue accountants for negligence. The House of Lords ruled that accountants owe a duty to any third person with whom a “special relationship” exists. The relationship arose because of a voluntary assumption of responsibility by the accountant to the claimant. A “special relationship” includes more than a fiduciary or a contractual relationship,  but the courts failed to specify criteria for deciding when a “special relationship” arises and when a duty of care comes into existence. The clear trend in the law of negligent misstatement after Hedley Byrne was toward expanding the scope of duty to more third parties. The basis of the scope of duty or “special relationship” moved in a progression from first, “voluntary assumption” of responsibility by the accountant, to second, the third party’s “reasonable reliance” and, finally to “foreseeability”.
A landmark decision was given by the House of Lords in Caparo Industries plc v Dickman.  In this case Caparo Industries plc (Caparo) has managed to takeover the Fidelity plc. After relying on the Fidelity’s accounts which is prepared by Touche Ross & Co. Caparo alleged that the accounts were misleading and if the supposed true facts had been known, Caparo would not have made bid at the price it did and might not have made a bid at all. The decision made by the Court of Appeal where there was no sufficiently proximate relationship between an auditor and a potential investor, but on a contrary, there was between an auditor and individual shareholder, was reversed by the House of Lords. the case concluded that a public company auditor, in the absence of special circumstances, owes no duty of care to an outside investor or individual shareholder who purchases shares in reliance on audited financial statements. An explanation to this ruling is through the ‘Caparo test’ by the House of Lords. The court fashioned a test for an auditor’s duty of care to arise. First, foreseeability must exist but it cannot stand alone. There must be proximity relationship be present between the suing party and the accountant. And last, it must be just and reasonable on a policy basis to impose a duty of care on the auditor. 
Since foreseeability is not hard to establish, three conditions must exists in order for proximity relationship to arise. First, there must be auditor awareness that the audited accounts would be used by third party or a known class to which the third party belongs; second, there has to be third party damage as a result of relying on the audited accounts; and the work product was used for the purpose for which it was prepared. 
Since the Caparo case, UK courts have continued to limit the imposition on auditors of a duty to non clients for negligent misstatements. An example is James McNaughton Papers Group Ltd v Hicks Anderson and Co  and Galoo Ltd v Bright Grahame Murray.  This judgment of the case have also been followed by other commonwealth country such as Australia  , New Zealand  and Canada  .
In sum, the Caparo case decision has narrowed the scope of accountant liability to third parties for negligent misstatements. The auditor of a public firm, absent special circumstances, owes no duty of care to an outside investor or an existing shareholder who buys stock in reliance on audited financial statements. Accountant liability for negligent misstatements is confined to cases in which it can be established that the accountant knew his or her work product would be communicated to a nonclient, either individually or as a member of a limited class, and the third party reasonably relied on the work product in connection with a particular transaction.
In the case of Association of Bondholders Coopag Finance
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