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The Prospectus Approval System

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Abstract

Under the provisions of the Prospectus Directive, the publication of a prospectus for an offer of securities to the public, or an admission of securities to trading on a regulated market, is subject to the prior approval of the prospectus by the competent authority of the issuer’s home Member State. This article examines the approval system as envisaged under the Directive. The aim is two-fold. First, the article conceptualises the approval system as a regulatory instrument. By studying the provisions relating to the prior approval in the Prospectus Directive, and by drawing on the literature on regulation, the approval system will be conceptualised as an ex ante enforcement system. Second, the article examines the approval system critically as an investor protection measure and as a risk reduction strategy for issuers. Proceeding on the premise that in order to justify the prior approval, the approval system must not only improve upon the quality of disclosure but that this improvement must matter if considered from the perspective of the recipient of the approved prospectus, the benefits and costs of the prior approval will be assessed for investors and issuers. These two points will be developed hereunder by examining in turn the regulatory nature and the purpose of the approval system.

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References

  1. Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003 on the prospectus to be published when securities are offered to the public or admitted to trading and amending Directive 2001/34/EC, OJ 2003 L 345/64.

  2. Directive 2001/34/EC of the European Parliament and of the Council of 28 May 2001 on the admission of securities to official stock exchange listing and on information to be published on those securities, OJ 2001 L 184/1; Council Directive 89/298/EEC of 17 April 1989 coordinating the requirements for the drawing-up, scrutiny and distribution of the prospectus to be published when transferable securities are offered to the public, OJ 1989 L 124/8.

  3. Commission Regulation (EC) No. 809/2004 of 29 April 2004 implementing Directive 2003/71/EC of the European Parliament and of the Council as regards information contained in prospectuses as well as the format, incorporation by reference and publication of such prospectuses and dissemination of advertisements, OJ 2004 L 149/1 (hereinafter, Commission Regulation).

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  6. See A. Bhagwat, ‘Modes of Regulatory Enforcement and the Problem of Administrative Discretion’, 50 Hastings Law Journal (1999) p. 1275 (discussing ex ante and ex post enforcement systems).

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  7. Ibid., at p. 1283.

  8. A. Ogus, Regulation — Legal Form and Economic Theory (Oxford, Clarendon Press 1994) p. 214 (highlighting administrative and opportunity costs in the context of a licensing system).

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  10. PD, Arts. 3(2), 4(1) and 4(2) set out a number of exceptions to the obligation to publish a prospectus.

  11. Two points are worth noting. First, Art. 5(3) states that a prospectus may either consist of a single document or be composed of separate documents (a registration document which includes the information regarding the issuer, a securities note which includes the information on the securities to be offered to the public or admitted to trading on a regulated market and a summary note). Pursuant to Art. 12(2), if the registration document has been approved earlier, the securities and the summary notes are subject to a separate approval. Second, in the case of programmes (e. g., MTN programmes), Art. 5(4) allows issuers to make use of a ‘base prospectus’ ‘containing all relevant information concerning the issuer and the securities offered to the public or to be admitted to trading on a regulated market’. Art. 5(4) further provides that in cases where the final terms of the offer are not included in the base prospectus they ‘shall be provided to investors and filed with the competent authority when each public offer is made as soon as practicable and if possible in advance of the beginning of the offer’. Interesting to highlight for the present purposes is that, while the base prospectus and any prospectus supplements are subject to the competent authority’s approval, Rec. (21) of the Commission Regulation makes explicit that ‘where the final terms are not included in the base prospectus they do not have to be approved by the competent authority’.

  12. PD,Art. 13(2).

  13. Admittedly, Art. 13(2) and (3) now provides for time limits within which an authority has to inform the applicant of its decision. Yet, a priori, these limits are of limited import. Art. 13(4) provides that if a competent authority considers that the information is incomplete or that additional information is required the limits ‘apply only from the date on which such information is provided…’. Arguably, an authority can thus always disable the time limits by requesting additional information, although, admittedly, there is a safeguard. Under the PD, the whole process is subject to a ‘reasonable grounds’ condition. In other words, an authority has to find on ‘reasonable grounds’ that the documents are incomplete or that supplementary information is required.

  14. According to the Commission the review practices ranged ‘from a simple verification that a document has been sent to the competent authority, without reading the document, to an extensive verification of the clearness, the objectivity, accuracy and consistency of the prospectus on all items of information, including the financial statements’. Written Question E-1874-03 by Christopher Huhne to the Commission, OJ 2004 C 65E/97.

  15. It is worth noting that as part of the recent review of the UK Listing Rules, the sponsor regime and the role of the sponsor have also been reassessed.

  16. Whether, for instance, the information given on p. 5 of the prospectus is consistent with the figures disclosed on p. 50.

  17. Commission Regulation, op. cit. n. 3; Committee of European Securities Regulators, ‘CESR’s recommendations for the consistent implementation of the European Commission’s Regulation on Prospectuses no 809/2004’ (Ref. CESR/05-054b, February 2005), available at: http://www.cesr-eu.org (hereinafter, CESR’s Recommendations).

  18. CESR’s Recommendations, op. cit. n. 17, at p. 5.

  19. Committee of European Securities Regulators, ‘Standard No. 1 on Financial Information — Enforcement of Standards on Financial Information in Europe’ (CESR/03-073, March 2003), available at: http://www.cesr-eu.org (hereinafter, Standard No. 1); Committee of European Securities Regulators, ‘Standard No. 2 on Financial Information — Coordination of Enforcement Activities’ (CESR/03-317c, April 2004), available at: http://www.cesr-eu.org (hereinafter, Standard No. 2).

  20. Art. 21(3) provides for a minimum list of powers which national authorities have to be equipped with. These powers are of course critical in order to make sure that authorities can fulfil their review tasks.

  21. It is worth noting that there may be some overlap here. For instance, if the information in the prospectus is not true and sincere it may also be inconsistent with other sources of information to which an authority may have access. Hence, it is important to determine the precise extent of an authority’s obligation to verify the consistency of the information and the completeness of the prospectus, which are quality characteristics an authority has to review and the failure of which may result in an authority being held liable depending on the applicable national law.

  22. In the literature, this form of assessment is also referred to as ‘merit regulation’. See, for instance, G. Hertig, R. Kraakman and E. Rock, ‘Issuers and Investor Protection’, in R. Kraakman, P. Davies, H. Hansmann, G. Hertig, K. Hopt, H. Kanda and E. Rock, eds., The Anatomy of Corporate Law’ A Comparative and Functional Approach (Oxford, Oxford University 2004) p. 193 at pp. 207–208.

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  23. The question of paternalism as a motivation for regulation is examined in Ogus, op. cit. n. 8, at pp. 51–53.

  24. Hertig, Kraakman and Rock, loc. cit. n. 22, at pp. 199–201 (dividing information requirements into (i) ‘hard “benchmark” data’, (ii) ‘“soft”, “projective,” or “forward-looking” information’ and (iii) information relating to ‘governance issues and agency problems’).

  25. Commission Regulation, op. cit. n. 3.

  26. e. g., G. Stigler, ‘Public Regulation of the Securities Markets’, 37 J. Bus. Law (1964) p. 117; G. Benston, ‘The Value of the SEC’s Accounting Disclosure Requirements’, 44 Acct. Rev. (1969) p. 515; G. Benston, ‘Required Disclosure and the Stock Market: An Evaluation of the Securities Exchange Act of 1934’, 63 American Economic Review (1973) p. 132; J. Seligman, ‘The Historical Need for a Mandatory Corporate Disclosure System’, 9 The Journal of Corporation Law (1983) p. 1; J. Coffee, ‘Market Failure and the Economic Case for a Mandatory Disclosure System’, 70 Virginia Law Review (1984) p. 717; F. Easterbrook and D. Fischel, ‘Mandatory Disclosure and the Protection of Investors’, 70 Virginia Law Review (1984) p. 669; R. Daines and C. Jones ‘Mandatory Disclosure, Asymmetric Information and Liquidity: The Impact of the 1934 Act’ (March 2003), available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=686888.

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  27. e. g., R. Romano, ‘Empowering Investors: A Market Approach to Securities Regulation’ 107 Yale Law Journal (1998) p. 2359; M. Fox, ‘Retaining Mandatory Securities Disclosure: Why Issuer Choice Is Not Investor Empowerment’, 85 Virginia Law Review 1 (1999)p. 1335.

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  29. Hertig, Kraakman and Rock, loc. cit. n. 22, at p. 204.

  30. Admittedly, the more detailed the information items, the less discretion is left to issuers.

  31. L. Loss and J. Seligman, Fundamentals of Securities Regulation (New York, Aspen 2004) p. 129.

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  32. Hertig, Kraakman and Rock, loc. cit. n. 22, at p. 204.

  33. See B. Black, ‘The Legal and Institutional Preconditions for Strong Securities Markets’, 48 UCLA Law Review (2001) p. 781 at pp. 796–797. On the importance of investor protection for the development of securities markets, see also the empirical work by R. La Porta, F. Lopez-de-Silanes, A. Shleifer and R. Vishny, ‘Legal Determinants of External Finance’, 52 Journal of Finance (1997) p. 1131. See also R. La Porta, F. Lopez-de-Silanes and A. Shleifer, ‘What Works in Securities Laws?’, 61 Journal of Finance (2006) p. 1. The work of La Porta, et al., has notably been criticised for assuming too easily that strong investor protection laws cause strong securities markets to develop. See J. Coffee, ‘The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control’, 111 Yale Law Journal (2001) p. 1; E. Ferran, Building an EU Securities Markets (Cambridge, Cambridge University Press 2004) pp. 27–28.

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  34. J. Cox and R. Thomas, ‘SEC Enforcement Heuristics: An Empirical Inquiry’, 53 Duke Law Journal (2003) p. 737 at p. 749.

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  35. e. g., J. Coffee, ‘Gatekeeper Failure and Reform: The Challenge of Fashioning Relevant Reforms’, 84 Boston University Law Review (2004) p. 301 atp. 343.

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  36. The importance of private enforcement was recently discussed by G. Ferrarini and P. Guidici when examining the Parmalat scandal. In particular, the authors pointed to deficiencies in civil procedure law and stressed the need for reforms in civil procedure systems. G. Ferrarini and P. Guidici, Financial Scandals and the Role of Private Enforcement: The Parmalat Case, ECGI Law Working Paper No. 40/2005 (May 2005), available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=730403.

  37. In relation to the prospectus summary the same article provides that ‘… Member States shall ensure that no civil liability shall attach to any persons solely on the basis of the summary, including any translation thereof, unless it is misleading, inaccurate or inconsistent when read together with the other parts of the prospectus’.

  38. See Ogus, op. cit. n. 8, at p. 214; J. Beales III, ‘Licensing and Certification Systems’, in P. Newman, ed., The New Palgrave Dictionary of Economics and the Law, Volume 2 (New York, Palgrave Macmillan 2002) p. 578.

  39. G. Akerlof, ‘The market for “lemons”: quality uncertainty and the market mechanism’, 84 Quarterly Journal of Economics (1970) p. 488.

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  40. See Black, loc. cit. n. 33, at p. 786.

  41. Easterbrook and Fischel, loc. cit. n. 26, at p. 674; H. Scott, ‘Internationalization of Primary Public Securities Markets’, 63 Law and Contemporary Problems (2000) p. 71 at p. 75 (‘… there is generally no way for an investor, sophisticated or otherwise, to know that he is missing information and to attach an appropriate discount to that risk’). See also Black, loc. cit. n. 33, at p. 786.

  42. e. g., R. Kraakman, ‘Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy’, 2 Journal of Law, Economics & Organization (1986) p. 53; S. Choi, ‘Market Lessons for Gatekeepers’, 92 Northwestern University Law Review (1998) p. 916; F. Partnoy, ‘Barbarians at the Gatekeepers?: A Proposal for a Modified Strict Liability Regime’, 79 Washington University Law Quarterly (2001) p. 491; Coffee, loc. cit. n. 35.

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  43. Coffee, loc. cit. n. 35, at p. 309.

  44. The ‘product’ in this context is the prospectus and the subject of enquiry is the disclosure provided therein.

  45. Black, loc. cit. n. 33, at pp. 789–790. On the relative importance of the regulator and courts in enforcing the law, see E. Glaeser, S. Johnson and A. Shleifer, ‘Coase vs. Coasians’, 116 Quarterly Journal of Economics (2001) p. 853; C. Xu and K. Pistor, Law Enforcement under Incomplete Law: Theory and Evidence from Financial Market Regulation, Columbia Law and Economics Working Paper No. 222 (April 2003), available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=396141 (distinguishing between ‘proactive’ law enforcement by a regulator and ‘reactive’ enforcement by courts). On the empirical side, La Porta, Lopez-de-Silanes and Shleifer, loc. cit. n. 33, at p. 27 provide a more ambiguous picture as to the importance of public enforcement: ‘… securities laws matter because they facilitate private contracting rather than provide for public regulatory enforcement’).

  46. Admittedly, the investigations by gatekeepers may contribute to establishing quality characteristics such as the accuracy of the information, and national authorities may rely on these enquiries before they decide upon the approval. Yet, establishing the importance of gatekeepers for ensuring the quality of disclosure does not provide support for the establishment of a prior approval system. Moreover, it should be borne in mind that the gatekeeper system may suffer from serious defects.

  47. The relation between verification and processing costs (as types of information costs) and market efficiency is discussed in R. Gilson and R. Kraakman, ‘The Mechanisms of Market Efficiency’, 70 Virginia Law Review (1984) p. 549 at pp. 592–614. The same authors provide a sobering assessment of the Efficient Market Hypothesis in R. Gilson and R. Kraakman, ‘The Mechanisms of Market Efficiency Twenty Years Later: The Hindsight Bias’, 28 Journal of Corporation Law (2003) p. 715.

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  48. PD, Rec. 18; Standard No. 1, op. cit. n. 19, at p. 3.

  49. Loss and Seligman, op. cit. n. 31, at p.128.

  50. Cf., Romano, loc. cit. n. 27, at p. 2378 (noting that ‘[t]he institutional investors who dominate today’s markets have far greater ability, as well as financial incentives, to process information and price securities than does the SEC staff’).

  51. Easterbrook and Fischel, loc. cit. n. 26, at p. 675 (noting that ‘[i]nvestors do not even want to inspect; they seek to be passive recipients of an income stream, not to be private investigators’); Scott, loc. cit. n. 41, at p. 75 (noting that ‘… there is generally no way for an investor, sophisticated or otherwise, to know that he is missing information and to attach an appropriate discount to that risk’).

  52. Admittedly, corporate scandals such as Enron have revealed the limits of the gatekeeper system. Yet, highlighting the failures of such a system in the present context misses the crucial point which is that the approval system does not contribute to making the gatekeeper more effective.

  53. Hertig, Kraakman and Rock, loc. cit. n. 22, at p. 206 (noting that ‘[standardization improves comprehensibility and comparability, thus increasing the value of information to investors’).

  54. PD,Art. 21(3)(a).

  55. See also N. Moloney, ‘New Frontiers in EC Capital Markets Law: From Market Construction to Market Regulation’, 40 Common Market Law Review (2003) p. 809 at pp. 822–833 (referring to a ‘paradigm shift’ in relation to investor protection at EC level).

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  56. e. g., A. Serafin, ‘Kicking the Legalese Habit: The SEC’s “Plain English Disclosure” Proposal’, 29 Loyola University Chicago Law Journal (1998) p. 681.

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  57. Scott, loc. cit. n. 41, at p. 73 (noting that most individual investors are not reading prospectuses).

  58. PD, Art. 5(2).

  59. It is worth noting that in the literature it is argued that ordinary investors may be protected by professional trading in the market. Yet, this point should not be overrated. Hertig, Kraakman and Rock, loc. cit. n. 22, at p. 206, for instance, note that ‘… the empirical literature suggests that liquid share markets mitigate this problem of unsophisticated investors, since professional trading efficiently reflects public information into share prices, and so (inadvertently) protects poorly informed traders. Yet there is no such protection when markets are thin and illiquid because, for example, they lack a clientele of professional traders dealing in the shares of small and mid-sized issuers’ [footnotes omitted]).

  60. Easterbrook and Fischel, loc. cit. n. 26, at p. 699.

  61. Cf., ibid., at pp. 704–705.

  62. The PD now provides for time limits. See n. 13 supra.

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  1. University of Oxford, UK

    Pierre Schammo D.Phil, LL.M. (candidate, maîtrise en droit)

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Schammo, P. The Prospectus Approval System. Eur Bus Org Law Rev 7, 501–523 (2006). https://doi.org/10.1017/S1566752906005015

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