9.5 Proposal for the law applicable to prospectus liability

Legal scholars have proposed a number of different connecting factors with respect to prospectus liability claims:1

Many legal scholars proposed that the law applicable to liability claims based on the provision of false information by the issuer to investors should be the laws of the Member States in which the securities are admitted to listing on a regulated market.3 The location of the regulated market on which the securities are admitted to listing and are, in fact, traded would be a better connecting factor.4 The place of the regulated market may be easily deterrnined.5 This conflict of law tule protects the issuers and their directors from liability claims with unforeseeably and unpredictably many applicable laws.6 However, if the securities are listed on multiple regulated markets, this tule could be to the detriment of investors who do not know where their orders for investment will be executed by their investment firm. The investment firm owes a duty to the investor to take all reasonable steps to execute the order with the best possible result for its client.7 When the securities are listed on multiple regulated markets, the investment firm has to execute the order at the market where it can obtain the best result based on a set of criteria: price, cost, speed, likelihood of execution and settlement and the size or nature of the order. Unless the investor gives a specific instruction to the investment firm, the regulated market on which the order will be executed is unknown to the investor. For this reason, the regulated market as connecting factor for the law applicable to prospectus liability claims is not a better solution.8

Furthermore, the determination of the market place with respect to securities that are not listed remains difficult.9 Various definitions of `market place' may be used: the place where the investors makes their investment; the place where the securities are offered for sale; the place where the prospectus was published;10 the place where the prospectus was drawn up;11 or the place where investor received the prospectus.12 The uncertainty created by this variation in definitions renders the `market place' as connecting factor not useful.

A better solution would be to align the applicable liability regime to the applicable financial disclosure duties on the basis of article 4(3) of the Rome II regulation.13 Even though this escape clause is to be used only in exceptional circumstances, legal scholars have argued to have prospectus liability claims brought generically under this exception clause and to bring about this alignment. In that case, the connecting factor in regard to prospectus liability claims against the issuer, its directors and the sponsoring banks including the lead manager will shift from the place where the investor holds his investment account to the place of incorporation of the issuing company. Since all the aforementioned parties are jointly and severally liable for the information contained in the prospectus, it is für and practicable that the same law applies to liability claims against each and every one of the defendants who are held jointly and severally liable.

Given the fact that application of article 4(3) requires that all circumstances of the case need to indicate a manifestly closer connection, it is difficult to argue for a generical exception. Another option to achieve this modification of the connecting factor is to adopt a specific provision for corporate misinformation cases14at this moment when the Rome II regulation is under review by the Commission.15 This latter option is preferable because enactment of this rule in a regulation should create more certainty that courts will apply this conflict of law rule. Furthermore, the broader scope of application, i.e. in regard to all corporate misinformation cases, ensures that all claims with a similar nature are treated in the same way. I define corporate misinformation as all noncontractual duties to disclose information about the corporation to the financial market participants in a prospectus or the periodical annual accounts, halfyearly and quarterly financial reports. It has been argued that the prospectus is different from annual accounts, because the former is more a marketing instrument and prospective in nature while the latter is an instrument to account for the company's performance in the last year and therefore backwardlooking.16In my opinion, the distinction is not so strict, e.g. a significant part of the prospectus consists of historical financial information and information about the company's interaal organisation that is directly copied from the annual accounts and the annual report of the directors usually contains information on the future direction of the company.17 Liability for violation of the duty to disclose inside information18 should be included in the definition of corporate misinformation, because the purpose of this obligation is to provide equal opportunities to investors19 and equal treatment of their damage claims irrespective of the place where the investor concluded his transaction as well.

The alignment of financial disclosure duties and liability for a violation thereof enhances the foreseeability for issuers, their directors and investors alike. A second advantage of alignment is that the law of the Member State where the issuer has its registered office (place of incorporation) will determine all the company's financial reporting duties, whether it is under company law for its annual accounts20 or it is under financial market law for its prospectus, half-yearly reports or interim management statements, will be governed by one single jurisdiction.21 This alignment ensures that investors and current shareholders will receive equal treatment in the sense that the same legal regime determines the liability for misleading financial information irrespective whether it is in a prospectus, annual accounts or interim statements. However, with regard to third country issuers, i.e. legal persons not incorporated or officially registered in one of the Member States, it is noteworthy to mention that the EU disclosure duties apply nonetheless.22 In regard to contracts governed by the legislation of a non-EU state, the European Court of Justice in Ingmar held that provisions of mandatory nature in EU legislation cannot be derogated from by parties, if the situation is closely connected to the EU.23 Even though some third country24 issuer's prospectus, annual accounts and other financial reports may be drawn up in accordance with third country's Generally Accepted Accounting Principles recognised by the Commission,25 the law applicable to private liability claims arising from these financial statements, in my opinion, should be the law of the "home" Member State, as designated by the Prospectus Directive 2003 for purposes of financial supervision, so as to ensure that the investors domiciled in the EU are protected against infringements of mandatory EU disclosure duties.26 The home Member State of a third country issuer is the Member State where the securities are intended to be offered to the public for the first time or where the first application for admission to trading on a regulated market is made, at the choice of the issuer, the offeror or the person asking for admission, as the case may be, subject to a subsequent election by issuers incorporated in a third country if the home Member State was not determined by their choice.27

A third advantage of this alignment is that the competent authority of the home Member State is the Member State where the registered office is situated.28 As a result, the public enforcement of the prospectus rules by the national competent authority and the private enforcement of the prospectus liability rules are subject to the same jurisdiction. It is noteworthy that the European securities law directives have already determined that the element whether the defendant's behaviour qualifies as tortious, i.e. the information in the prospectus is misleading, is to be determined by the law of the home Member State. Under the currently applicable private international law regime, the other conditions to establish private law liability, e.g. causation and the quantification of damages are not necessarily subject to the home Member State's private law.29 As a result, issuers are unable to predict or foresee to what extent and by what rules they can be held liable.

A fourth advantage is that in case one single law, i.e. the law where the issuer's registered office is situated, applies to all prospectus liability claims, collective proceedings are facilitated.30 In collective proceedings, the court can only tule upon a question of law or fact common to all damage claims; commonality is a prerequisite to collective proceedings.31 In case the issuer has a cross-border listing, one single law applies to the same issue of securities, such that investors are able to proceed collectively irrespective of the regulated market on which they acquired their securities. Given the fact that their orders have to be executed by the investment firm on the regulated market where the prices those orders receive reflect the optimal mix of price improvement, speed and likelihood of execution. Even though it is true that the court could apply different laws to different subclasses, the costs of multiple legal experts32 explaining the implications of each applicable legal regime could potentially jeopardise the advantages, in terras of costs as well as time, of proceeding collectively. Even though the Rome II regulation allows parties to agree that a specific law is applicable to the claim in tort, the fact that this agreement has to be concluded between all investors, who are supposed to be bound by the judgment in the collective proceedings, and the defendant again impedes efficient collective proceedings. The issue of binding effect and competent courts in collective proceedings are dealt with in chapter 9.

Some scholars argue that alignment also avoids the frictions that arise in simultaneously applying disclosure duties of one jurisdiction and liability rules of another. They state that due to different private international law characterisations in different jurisdictions, situations may arise where out of two different rules, neither would apply (rule shortage) or, alternatively, both rules claim to be applicable (rule accumulation).33 However, it must be noted that the substantive financial disclosure duties are fully harmonised in the EU. Furthermore, there is one exclusive jurisdiction that enforces these duties: the Member State where the issuer's registered office is situated.34 Therefore, in my opinion, there will be neither rule shortage nor rule accumulation if EU jurisdictions are involved.

An objection against the registered office as connecting factor for prospectus liability damage claims is the fact that it might be confusing for investors who invest in securities issued by several issuers on one particular market that their rights in relation to prospectus liability damage claims differ amongst the issuers listed on the same market.35 However, note that the law applicable to their claim is clearly presented in the prospectus because the registered office of the issuer is an item that must be disclosed. The investors can predict on the basis of the conflict of law rule and the information in the prospectus about the registered office of the issuer, the law applicable to the prospectus liability claims.

Another argument against adherence to the principle of home Member State is the fear for a 'race to the bottom', i.e. transferring the statutory seat to the Member State with the most lenient private law liability regime.36 The progressing acceptance among legal scholars that the effect of mandatory EU disclosure duties is not restricted to public law sanctions but (equally) impacts the private law relationship between the issuer and its investors or financial institutions and their clients.37

For the abovementioned reasons, I suggest that the courts in the Member States, and preferably with endorsement by the European Court of Justice, apply the law of the place where the issuer has its registered office, i.e. the law of the company's statutes, to prospectus liability claims on the basis of article 4(3) of the Rome II regulation. Moreover, the European Commission could use its power38 to submit a proposal to adapt the regulation in the abovementioned sense.