Law and You > Corporate Laws > Companies Act, 2013 > Legal Requirements for Issuance of a Prospectus
The Companies Act, 2013 prescribes several legal requirements for the issuance of a prospectus when a company offers securities to the public. These provisions aim to ensure transparency, investor protection, and regulatory compliance. The prospectus serves as a key document that discloses relevant information about the company and the securities being offered, enabling investors to make informed decisions. Let us discuss legal requirements for issuance of a prospectus under the Companies Act, 2013.
According to Section 2(70) of the Companies Act, 2013 prospectus means any document described or issued as a prospectus and includes a red herring prospectus referred to in section 32 or shelf prospectus referred to in section 31 or any notice, circular, advertisement or other document inviting offers from the public for the subscription or purchase of any securities of body corporate. A prospectus is not merely an advertisement.
Legal Requirements for Issuance of a Prospectus:
Issue of Prospectus – General Requirements (Section 26):
Section 26 of the Companies Act, 2013 outlines the contents and legal formalities required for the issuance of a prospectus. Contents of the Prospectus: The prospectus must provide detailed information, including:
- Name and registered office of the company.
- Details of the company’s directors, managers, and key management.
- Financial statements and auditor’s report.
- Risk factors associated with the investment.
- Purpose of the issue and how the funds raised will be utilized.
- Details of the securities being offered (e.g., shares, debentures).
- Terms and conditions of the offer, including pricing, allotment, and refunds.
The prospectus must be filed and registered with the Registrar of Companies (ROC) before it is issued to the public. A declaration that the provisions of the Companies Act, SEBI guidelines, and other applicable laws have been complied with must be included. A prospectus issued by, or on behalf of a company, or in relation to an intended company, shall be dated, and that date shall be taken as the date of publication of the prospectus.
Non-compliance with these requirements can lead to severe penalties, including fines and imprisonment of those responsible for issuing the prospectus.
Filing with the Registrar of Companies (Section 26(4)):
- It is mandatory to get the prospectus filed and registered with the Registrar of Companies before it is issued to the public. The procedure of getting the prospectus registered is as under:
- A copy of the prospectus, duly signed by every person who is named therein as a director or a proposed director of the company must be filed with Registrar of Companies before the prospectus is issued to the public.
- The following document must be attached thereto:
- Consent to the issue of the prospectus required under any person as an expert confirming his written consent to the issue thereof, and that he has not withdrawn his consent as aforesaid appears in the prospectus.
- Copies of all contracts entered into with respect to the appointment of the managing director, directors and other officers of the company must also be filed with Registrar.
- If the auditor or accountant of the company has made any adjustments in the company’s account, the said adjustments and the reasons thereof must be filed with the documents.
- There must be a copy of the application which is to be filled for the issue of the company’s shares and debentures attached with the prospectus.
- The prospectus must have the written consent of all the persons who have been named as auditors, solicitors, bankers, brokers, etc.
- Every prospectus must have, on the face of it, a statement that:
- A copy of the prospectus has been delivered to the Registrar for registration.
- Specifies that any documents required to be endorsed by this section have been delivered to the Registrar.
- A copy of the prospectus must be filed with the Registrar of Companies.
- According to the Section 26, no prospectus shall be issued more than ninety days after the date on which a copy thereof is delivered for registration. If a prospectus issued in contravention of the above –stated provisions, then the company and every person who knows a party to the issue of the prospectus shall be punishable with a fine
Variation in Terms of Contract or Objects in Prospectus (Section 27):
Any change in the terms of a contract or the objects for which the funds raised from the prospectus were intended must be approved by a special resolution passed by the company. The company must also provide the shareholders an opportunity to exit the investment if they disagree with the variation.
Issue of Abridged Prospectus (Section 33):
Every application form for securities must be accompanied by an Abridged Prospectus, which is a summary of the full prospectus. This ensures that investors receive key information in a simplified form before applying for the purchase of securities.
Red Herring Prospectus (Section 32):
A company making a public offer through a book-building process can issue a Red Herring Prospectus (RHP). The RHP must be filed with the ROC at least three days before the opening of the subscription list and the offer. After the price is determined (through bidding), the final prospectus is issued, and the RHP is no longer valid.
Shelf Prospectus (Section 31):
Companies eligible (e.g., financial institutions, banks) can issue a Shelf Prospectus for multiple offerings of securities over a year. This allows the company to issue securities in tranches without filing a fresh prospectus each time, but it must file an Information Memorandum with the ROC before each subsequent issue.
Deemed Prospectus (Section 25):
If a company’s securities are offered for sale to the public by third parties (e.g., existing shareholders), the document associated with such a sale is treated as a Deemed Prospectus. This ensures that even indirect public offers comply with the legal requirements applicable to a formal prospectus.
Private Placement (Section 42):
When securities are issued via private placement, the company is exempt from issuing a public prospectus, but a Private Placement Offer Letter must be provided to selected investors. A return of allotment must be filed with the ROC within 15 days of allotment.
Prohibition on Public Issue without Prospectus (Section 40):
A company cannot make an offer to the public without issuing a prospectus. Before making an offer of securities, the company must apply to at least one recognized stock exchange to have the securities listed.
Misstatement in Prospectus and Liability:
A misleading prospectus or misstatement in a prospectus under the Companies Act, 2013 refers to any untrue, incorrect, or incomplete statements made in the prospectus, which can mislead investors. The prospectus is a key document for potential investors, and the law strictly regulates its accuracy and completeness to protect investors from fraud or misrepresentation. If a prospectus contains false information, omits material facts, or presents facts in a way that is misleading, the company and those responsible can face serious legal consequences.
Examples of Misleading Statements:
- False Financial Statements: A prospectus showing inflated profits or manipulated balance sheets to mislead investors about the company’s financial health.
- Omission of Material Facts: Not disclosing significant litigation or contingent liabilities that could materially impact the company’s future.
- Risk Misrepresentation: Failing to disclose critical risks associated with the company’s business or operations.
In Rex v. Kylsant [1932] case, all the statements included in the prospectus issued by the company were literally true. One of the statements disclosed the rates of dividends paid for a number of years. But, dividends had been paid not out of trading profits but out of realised capital profits. This material fact was not disclosed. The Court held, that the prospectus was false in material particular and Lord Kylsant, the managing director and chairman, who knew that it was false, was held guilty of fraud.
In Peek v. Gurney [1873] case, the prospectus issued did not mention about certain liabilities. This created a false impression about the company being very prosperous. The prospectus was held to be untrue
Untrue Statements (Section 34 – Criminal Liability):
Section 34 of the Companies Act, 2013, provides for criminal liability in cases where a prospectus contains untrue or misleading statements. A statement is considered “untrue” if It is misleading in the form and context in which it is included or/and the omission of any material fact makes the statement misleading. Every person who authorises the issue of such prospectus shall be liable under section 447 i.e. fraud.
Defences available in this section are:
- Person prove that statement or omission was immaterial;
- Person has reasonable ground to believe and did believe that statement was true; or
- Person has reasonable ground to believe and did believe that the inclusion or omission was necessary.
Civil Liability for Misstatement (Section 35):
Section 35 imposes civil liability on any person who authorizes the issue of a prospectus that includes false, misleading, or incomplete information. These persons may include: directors of the company at the time of the issue of the prospectus, promoters of the company, and experts (such as auditors or valuers) who have provided consent for including their statements in the prospectus.
Liability arises if the investor relies on the prospectus and suffers a loss because of the misleading information. The company and its officers responsible for issuing the prospectus can be held liable to compensate investors for any loss or damage caused due to reliance on the misleading information.
Certain defenses are available to those accused of authorizing a misleading prospectus under Section 35(2) of the Companies Act, 2013:
- They withdrew their consent before the issue of the prospectus and notified the public accordingly.
- The prospectus was issued without their knowledge or consent, and upon becoming aware, they immediately acted to withdraw their name from the prospectus.
- They believed that the statement was true, based on reasonable grounds at the time of the issue of the prospectus.
- The misleading statement was made by an expert, and the person relied on that expert’s opinion in good faith.
Punishment for Fraudulently Inducing Persons to Invest (Section 36):
Section 36 addresses situations where fraud is involved in inducing people to invest in a company through a misleading prospectus. Any person who knowingly or recklessly makes false, deceptive, or misleading statements to induce others to invest can face severe penalties, under Section 447 of the Companies Act.
Liability for Misstatements in Deemed Prospectus (Section 25):
If a deemed prospectus (a document that is treated as a prospectus, though issued by third parties) contains misleading information, the company is also liable under the provisions of the Companies Act, 2013. The same rules of civil and criminal liability for misstatements apply to deemed prospectuses as they do to a formal prospectus issued by the company itself.
Officers in Default (Section 2(60)):
The term “officer in default” is defined under Section 2(60) of the Companies Act, 2013. These are individuals who can be held liable for the issuance of a misleading prospectus, including: Directors, Promoters, Key managerial personnel, any person who is directly or indirectly involved in the issuance of the prospectus.
Consequences for Investors:
Investors who have suffered losses due to a misleading prospectus can seek compensation under civil liability provisions. In addition to civil claims, criminal penalties may be imposed on the responsible individuals, which could result in imprisonment or fines.
The Companies Act, 2013 establishes strict legal requirements to prevent misleading statements in prospectuses and ensure that investors have access to accurate and complete information. The provisions for both civil and criminal liability serve as a deterrent against fraudulent practices, ensuring that companies and their officers remain accountable for the accuracy of the information presented to potential investors. These regulations aim to protect investor interests and maintain the integrity of financial markets, promoting transparency and fairness in public offerings.
The Companies Act, 2013 places a strong emphasis on ensuring transparency, accuracy, and investor protection through the legal requirements governing the issue of a prospectus. By mandating specific disclosures, registrations, and filing requirements, it ensures that companies provide sufficient and reliable information to potential investors. These provisions help to maintain market integrity and investor confidence, while holding companies and their officers accountable for any misstatements or omissions.
Golden Rule for the Framing of a Prospectus:
The Golden Rule for the framing of a prospectus is a fundamental principle established by case law that mandates companies to provide full, true, and fair disclosure of all material facts in the prospectus. This rule is designed to ensure transparency and prevent companies from misleading potential investors with false or incomplete information.
The Golden Rule was established in the New Brunswick and Canada Railway and Land Company v. Muggeridge (1870) case, where it was held that companies are under a duty to disclose all material facts related to the securities they offer, and any suppression of facts could lead to liabilities.
Key Aspects of the Golden Rule:
- Complete Disclosure: The prospectus must disclose all material information that an investor would reasonably need to make an informed decision. No significant fact or risk factor should be hidden or downplayed.
- No Misrepresentation: The Company should avoid making false or misleading statements. Every fact presented in the prospectus must be accurate and presented in its true form and context.
- Fair Presentation: The information provided must not only be correct but also fairly represented. The prospectus should not mislead investors through selective presentation of facts or by omitting important details.
- Investor Protection: The rule ensures that investors are protected from fraudulent practices and can assess the risks and benefits of investing in a company based on complete and truthful information.
Application Under the Companies Act, 2013:
- The Companies Act, 2013 aligns with the Golden Rule through its provisions, such as Section 26, which outlines the requirements for full disclosure in a prospectus, and Sections 34 and 35, which impose criminal and civil liabilities for untrue statements or omissions.
- The Act emphasizes that the prospectus should present a true and fair view of the company’s financial position, risks, and future prospects, without misleading investors.
In Rex v. Kylsant (1932) case, the prospectus stated that dividends of 5 to 8 per cent had been regularly paid over a long period. The truth was that the company had been incurring substantial losses during the seven years preceding the date of the prospectus and dividends had been paid out of the realised capital profits. The Court held, the prospectus was false and misleading. The statement though true in itself was rendered false in the context in which it was stated.
In Aarons Reefs v. Twisa case, Lord Halsbury said that a half truth, for instance, represented as a whole truth may tantamount to a false statement.
The Golden Rule for framing a prospectus is a cornerstone of securities regulation, ensuring that companies provide honest, clear, and complete information to potential investors. It protects the integrity of the market by promoting transparency and fostering investor confidence. Any failure to adhere to this rule can lead to legal liabilities and loss of investor trust.
Conclusion:
The Companies Act, 2013 outlines comprehensive legal requirements for issuance of a prospectus to ensure transparency, investor protection, and compliance with regulatory norms. These regulations mandate that companies provide detailed, accurate, and complete disclosures in their prospectus, helping investors make informed decisions before investing in securities. Key provisions cover the content of the prospectus, registration with the Registrar of Companies (ROC), and liabilities for false or misleading statements. Any misstatements or omissions in the prospectus expose the company and its officers to severe civil and criminal liabilities, including fines and imprisonment. The Act also provides safeguards against fraud, ensures that investors are protected, and promotes the integrity of financial markets.
By regulating how companies issue prospectuses, the Companies Act, 2013 ensures that public offerings are conducted in a transparent and fair manner, reinforcing investor confidence and contributing to the stability of capital markets.