ClientEarth’s application to challenge the approval of a prospectus is dismissed

11 January 2024

The High Court has dismissed a judicial review application by ClientEarth to challenge a decision of the Financial Conduct Authority (FCA) to approve a prospectus published by an oil and gas exploration company.

What happened?

Ithaca Energy plc is an oil and gas exploration company with operations in the North Sea.

In 2022, Ithaca began work to carry out an initial public offering (IPO) to admit its shares to the Main Market of the London Stock Exchange.

As part of this (and as is required to admit shares to the Main Market), Ithaca published a prospectus. For more information on the requirement to publish a prospectus, see box “What is a prospectus?” below.

What is a prospectus?

A prospectus is a document designed to provide information to potential investors in publicly-traded securities.

Under UK law, a company — usually referred to as an “issuer” — is required to publish a prospectus in either of two scenarios:

  • If the issuer wishes to offer its securities to the public. This could include the company’s first ever offer to the public at large (i.e. on an IPO) or a follow-on offer after the company has been listed (a “secondary issue”).
  • If the issuer wishes to admit its securities to a “regulated market”. This includes the Main Market of the London Stock Exchange. It does not include AIM or the AQSE Growth Market.

These two triggers are separate, although in many cases both will apply. For example, a company wishing to IPO on the Main Market will usually need to publish a prospectus both because it is admitting its shares to a regulated market and because it is making an offer to the public.

There are exemptions available from the obligation to publish a prospectus.

Some exemptions apply only to the “public offer” trigger. For example, an offer made to fewer than 150 persons or which is made only to “qualified investors” is exempt from the “public offer” trigger. But a prospectus will still be required if the securities are to be admitted to a regulated market and there is no available exemption under the “regulated market” trigger.

Some exemptions apply only to the “regulated market” trigger. For example, an issue of securities that represents less than 20% of a class of securities already admitted to trading is exempt from the “regulated market” trigger. But a prospectus will still be required if the issue involves a public offer and it is not exempt from the “public offer” trigger.

Finally, some exemptions apply to both triggers (meaning that, if the exemption applies, no prospectus will be required). For example, an offer of securities only to former and existing employees and directors may be exempt from both triggers and so no prospectus may be required at all.

This can have the result that, for some IPOs, no prospectus is required. For example, if (as is common) a company is seeking admission to AIM or the AQSE Growth Market and intends to IPO by conducting a placing with a restricted number of pre-identified investors, the IPO will fall outside the prospectus regime. However, the issuer will still need to publish an admission document, which, although shorter than a full prospectus, will still need to contain a significant amount of information.

The prospectus regime applies to a wide range of securities, including shares, bonds and notes. However, in each case, to fall within the prospectus regime, the securities must be “transferable” (i.e. broadly speaking, they must be designed to be traded).

If a prospectus is required, it must be approved by the FCA before it can be published.

Under section 85(1) of the Financial Services and Markets Act 2000 (FSMA), it is a criminal offence to offer securities to the public without first publishing a prospectus.

Under section 85(2) of FSMA 2000, it is a criminal offence to request admission to trading on a regulated market without first publishing a prospectus. However, in practice, this is highly unlikely, as the relevant securities exchange and (if the issuer is also seeking a listing) the FCA will not admit the issuer to trading without a prospectus unless the admission is exempt.

This is how the regime operates at the time of writing. The Government is intending to reform the way the UK’s prospectus regime operates. For more information on the proposed changes, read our separate in-depth piece on the future of the UK’s prospectus regime.

The FCA approved Ithaca’s registration document (the first part of a prospectus), which was published in October 2022. Following publication, ClientEarth raised questions about statements in the document. Ithaca subsequently published a final prospectus in November 2022, which contained an amended registration document (dealing with the questions raised by ClientEarth), a securities note and a summary. These were approved by the FCA, and the IPO took place.

ClientEarth subsequently challenged the FCA’s decision to approve Ithaca’s prospectus. It claimed that the documents failed to comply with legal requirements for the contents of a prospectus. For more information on the requirement to publish a prospectus, see box “What information must a prospectus contain?” below.

Specifically, ClientEarth alleged three specific grounds for challenging the FCA’s decision.

  • Although the prospectus disclosed climate-related risks that might affect Ithaca, it did not disclose (either adequately or at all) Ithaca’s assessment of those risks or the magnitude of their impact. It merely referred generically to climate change, the Paris Agreement and a net zero commitment. However, article 16 contained a separate obligation to disclose how the issuer has assessed the materiality of those risks.
  • The prospectus did not adequately describe the specificity of those risks. Instead, it merely made less specific references to risks arising from climate activism and any material adverse effect on the hydrocarbon industry.
  • The prospectus did not contain the necessary information that was material to a person investing in Ithaca’s securities. In particular, the prospectus did not adequately deal with the potential impacts of the Paris Agreement (if it were to be fully implemented) on Ithaca’s business.

ClientEarth claimed that grounds 1 and 2 both contravened article 16 of the Prospectus Regulation.

It said that the FCA had misinterpreted article 16, because it had assumed (wrongly) that simply disclosing risks in itself satisfied the alleged separate obligation to disclose the issuer’s assessment of those risks, and that it was for the FCA to evaluate and decide whether the prospectus complied with article 16 (rather than a simple question of law).

It claimed that ground 3 contravened article 6 of the Prospectus Regulation.

What information must a prospectus contain?

The contents of a prospectus are dictated by the UK Prospectus Regulation and the UK Prospectus Delegated Regulation. Both regulations originate in EU law but now, in slightly modified form, are part of UK domestic law (in the form of so-called assimilated law).

The Prospectus Regulation sets out two key overriding content requirements for a prospectus:

  • Article 6(1) requires a prospectus to contain the necessary information which is material to an investor for making an informed assessment in relation to the issuer, the securities and the issue of the securities. Article 6(2) requires this information to be concise and comprehensible.
  • Article 16(1) requires a prospectus to contain a separate risk factors section, setting out risks that are specific to the issuer and/or the securities it is proposing to issue and which are material for taking an informed investment decision. The precise wording of article 16(1) is relevant to this case and so we have set it out in a separate box below.

Articles 6 and 16(1) are open-ended. The burden is on the issuer, working together with its financial and legal advisers, to decide what information it needs to include in order to satisfy its duties under the Prospectus Regulation.

Separately, the Prospectus Delegated Regulation sets out specific information which an issuer must include in its prospectus. This information is set out in so-called “building blocks” in annexes to the regulation and varies depending on:

  • the type of issuer (e.g. commercial company, closed-ended fund, open-ended fund);
  • the type of security (e.g. equity shares, non-equity securities (e.g. bonds, derivatives and asset-backed securities), depositary receipts); and
  • the type of issue (e.g. IPO, secondary issuance, growth issuance).

These contents are detailed and fixed. If the relevant building blocks apply, the issuer must include the information specifically required by the Delegated Regulation.

Article 16(1) of the Prospectus Regulation

The risk factors featured in a prospectus shall be limited to risks which are specific to the issuer and/or to the securities and which are material for taking an informed investment decision, as corroborated by the content of the registration document and the securities note.

When drawing up the prospectus, the issuer, the offeror or the person asking for admission to trading on a regulated market shall assess the materiality of the risk factors based on the probability of their occurrence and the expected magnitude of their negative impact.

Each risk factor shall be adequately described, explaining how it affects the issuer or the securities being offered or to be admitted to trading. The assessment of the materiality of the risk factors provided for in the second subparagraph may also be disclosed by using a qualitative scale of low, medium or high.

The risk factors shall be presented in a limited number of categories depending on their nature. In each category the most material risk factors shall be mentioned first according to the assessment provided for in the second subparagraph.

ClientEarth argued that, as a result of these contraventions of the Prospectus Regulation, the FCA should not have approved Ithaca’s prospectus.

ClientEarth therefore asked the court for permission to pursue a judicial review of the FCA’s decision, seeking a declaration that the FCA’s decision was wrong. For more information on judicial review, see box “What is judicial review?”.

What is judicial review?

Judicial review is a means of challenging a decision taken by a public body or authority.

Many public bodies have the power or responsibility to take decisions that affect third parties. This may include a decision to grant a permission or licence, approve a document, or block a transaction.

Where a public body makes a decision of this kind, it must do so in accordance with the rules of public law. In particular, a decision of a public body can be challenged by judicial review if:

  • the body has misunderstood the law or regulatory framework in question, has stepped outside the bounds of its decision-making authority or has exercised its power wrongly;
  • it has reached a decision that no reasonable person in its position could have reached (often referred to as acting “irrationally”);
  • the body took into account irrelevant factors when reaching its decision, or it failed to take relevant factors into account;
  • it failed to follow any proper procedures when reaching its decision;
  • the body failed to follow principles of “natural justice” (such as acting in a biased fashion or failing to allow parties to make representations); or
  • it created a legitimate expectation as to how it would carry out the procedure of reaching its decision and then failed to meet that expectation.

There are various similar remedies open to a person looking to challenge a decision via judicial review. Usually, an applicant looks for an order quashing the original decision and requiring the body to make the decision all over again, but this time properly.

If this is not possible, an applicant can seek a simple declaration stating, in effect, that the decision was made incorrectly. This may be more appropriate if it is impractical to undo the decision (e.g. because some time has passed and third parties have taken action in reliance on the decision).

In general, it is not possible to claim damages through a judicial review claim.

In its application, ClientEarth sought a declaration that the FCA’s decision to approve Ithaca’s prospectus was incorrect. This would not revoke or rescind the FCA’s decision, but merely declare that it was improper.

In the circumstances, that was likely to be the most appropriate order. Ithaca’s shares were admitted to the Main Market off the back of its prospectus, and investors will have been trading in those shares for some time now. It would have been simply impossible to reverse this course of events.

What did the court say?

The court dismissed ClientEarth’s application, stating that it had no realistic prospect of succeeding.

On grounds 1 and 2, the court concluded that the FCA was entitled to reach an “evaluative judgment” on whether the risk factors in Ithaca’s prospectus satisfied the requirements of article 16 of the Prospectus Regulation. Provided the FCA reached a rational decision, the court would not substitute its own view for the FCA’s.

In that respect, the court found that the FCA had correctly interpreted article 16. Ithaca’s prospectus had identified the risks to its business. There was no separate requirement to disclose how Ithaca had assessed those risks and their materiality or specificity. The words “may also be disclosed by using a qualitative scale of low, medium or high” did not create a freestanding requirement to disclose a risk assessment, as distinct from a risk.

The FCA, as an expert regulator, had been required to exercise its judgment as to whether the prospectus complied with article 16. The prospectus plainly addressed risks to Ithaca’s business arising out of climate change factors (among other things) and the FCA had considered that it adequately disclosed those risks.

On ground 3, the court felt that Ithaca’s prospectus had clearly identified the Paris Agreement as a material risk for its business. It even referred to Ithaca’s and ClientEarth’s competing arguments over the compatibility of Ithaca’s business with the Paris Agreement.

The FCA had concluded that this level of information was sufficient to comply with article 6 of the Prospectus Regulation. In the court’s words, ClientEarth had “not come close to demonstrating that the FCA acted irrationally”.

What does this mean for me?

The decision emphasises the primacy of the FCA’s judgment in approving a prospectus. This is all the more important in light of the Government’s proposals to devolve even more authority to the FCA under its proposed reformed prospectus regime.

For issuers (including companies applying to list for the first time), it gives a strong degree of comfort that, once the FCA has approved the issuer’s prospectus, that decision cannot be challenged and the issuer can proceed happily.

It is not possible to definitively rule out any future applications for judicial review of the approval of a prospectus. There is always a possibility, however theoretical, that the FCA may overstep its authority or reach a decision that is wholly unreasonable.

But the FCA is a highly sophisticated body with teams that scrutinise prospectuses in detail, making this possibility highly speculative. In practice, the court’s decision is likely to put a dampener on any other judicial review applications that might otherwise have been in the pipeline.

It is important to note that ClientEarth was only seeking confirmation that the FCA’s decision to approve the prospectus was wrong, not that the prospectus itself was misleading. Other avenues of claim remain open to investors who feel that a prospectus fails to meet the required standard.

For example, an investor who relies on an issuer’s prospectus to acquire or dispose of shares in the issuer may have a claim under section 90A of the Financial Services and Markets Act 2000 if they suffer loss as a result. This is a direct claim against the issuer, and the investor can seek damages as compensation.

But section 90A claims are infrequent and can be difficult to mount. In particular, to succeed, an investor must show that they suffered loss. This is usually measured by reference to a drop (or putative drop) in the value of the shares. In a case such as Ithaca’s, even if its prospectus had been misleading, it is difficult to see how an investor would have suffered any loss (at least, not immediately).

However, the mere threat of judicial review proceedings (or, indeed, any proceedings) may, for some issuers, be significant enough to warrant action. Issuers in a position analogous to Ithaca’s might prefer to err on the side of caution and include more detail in an attempt to avoid any potential litigation.

In this context, issuers should lean on their sponsor and legal advisers for comfort that their draft prospectus meets legal requirements and is likely to be acceptable to the FCA and investors.

Ultimately, the phrasing of risk factors and the level of detail to be included in a prospectus remains a judgment call to be made on a case-by-case basis with professional advice.

Access the court’s decision on ClientEarth’s application for judicial review of the approval of Ithaca’s prospectus (R (on the application of ClientEarth) v Financial Conduct Authority [2023] EWHC 3301 (Admin))

Our litigation colleagues have considered this decision in the context of climate litigation in general. Read their analysis of how the courts may continue to be used in attempts to tackle climate change.

Read our separate in-depth piece on the future of the UK’s prospectus regime