Corporate Law Update
A round-up of developments in corporate law for the week ending 5 June 2020.
- Two individuals were co-liable for unapproved financial promotions by a company, whether or not they thought those promotions had been approved
- ICSA publishes revised terms of reference for risk committees of listed companies
- Shareholders with enhanced voting rights were in the same class as other ordinary shareholders on a scheme of arrangement
- The Government sets out its position on the impact of the European Single Electronic Reporting Format on the procedure for signing off accounts
- The QCA publishes the results of a survey of non-executive directors of small and medium-sized companies
- The OECD publishes a summary of national governments’ responses to the Covid-19 pandemic
- IOSCO issues a statement underlining the importance of clear disclosure by issuers in relation to Covid-19
Covid-19 is affecting the way people conduct their business, retain their staff, engage with clients, comply with regulations and the list goes on. Read our thoughts on these issues and many others on our dedicated Covid-19 page.
The High Court has examined whether two directors of a company were “knowingly concerned” in, and therefore liable in relation to, communications by a company that had not been approved by an FCA-authorised person.
FCA v Skinner and others  EWHC 1097 (Ch) concerns Our Price Records Limited (“OPR”), a company established to acquire and exploit the intellectual property in the “Our Price” records brand.
OPR was incorporated in 2003 by a Mr Skinner, but lay dormant between 2004 and 2014. In 2014, however, Mr Skinner decided to revive OPR as an affiliate marketing business. To obtain funding, Mr Skinner and OPR’s other director, a Ms Ferreira, decided to seek equity investments from the public.
Under section 21(1) of the Financial Services and Markets Act 2000 (“FSMA”), it is a criminal offence for a person, in the course of business, to communicate an invitation or inducement to engage in investment activity. In short, subscribing for shares in a company constitutes investment activity, and seeking equity investments from the public will invariably involve a communication within section 21.
This is subject to two qualifications:
- Section 21(2) of FSMA states that section 21(1) “does not apply” if the person making the communication is authorised by the Financial Conduct Authority (FCA), or if the content of the communication has been approved by an FCA-authorised person. As will be seen, the specific phraseology of section 21(2) is highly relevant.
- Under section 21(5) of FSMA, HM Treasury can specify circumstances in which section 21(1) does not apply. The Treasury has done this by enacting the FSMA (Financial Promotion) Order 2005 (the “FPO”), which contains numerous exemptions from section 21(1). These include (among others) where the communication is made solely to “certified high net worth individuals” and/or to “sophisticated investors”.
Initially, OPR (through an intermediary) marketed its securities only to certified high net worth individuals and sophisticated investors. In doing so, it took advantage of exemptions in the FPO, meaning its communications did not need to be approved by an FCA-authorised person. However, these fundraising attempts were entirely unsuccessful.
In due course, therefore, OPR decided to pursue a retail offering. Because this would involve going out to investors who did not fall within the exemptions in the FPO, any communications by OPR would need to be approved by an FCA-authorised person.
OPR engaged a chartered accountant – Leigh Carr – in relation to its marketing communications. Leigh Car was not an FCA-authorised person for the purposes of the activities in question.
Leigh Carr was asked to, and gave, certain confirmations in connection with section 21 of FSMA. Much of the argument before the court revolved around whether Leigh Carr gave those confirmations privately to OPR’s directors or formally in connection with the retail offering.
Either way, OPR (again, through intermediaries) made communications to potential retail investors. The communications stated that they had been approved by Leigh Carr for the purposes of section 21 of FSMA. However, as noted, Leigh Carr was not authorised by the FCA to approve them.
In October 2015, the FCA contacted OPR to express its concern that OPR had (among other things) contravened section 21(1), on the basis that neither Leigh Carr nor certain of OPR’s marketing agents had the appropriate permission to approve OPR’s financial promotions.
However, notwithstanding this, OPR continued to market its securities. The retail offering was successful, ultimately raising around £3.6 million for OPR.
In December 2015, the FCA wrote again to OPR, this time directing it to cease marketing its securities. It then instigated an investigation into whether an offence had been committed under section 21(1).
In April 2017, OPR entered into administration without ever having traded in any material way. At that point, of the £3.6 million raised from investors, only £483,000 remained.
The FCA began legal proceedings. Among other things, it brought a personal claim against Mr Skinner and Ms Ferreira under section 382(1) of FSMA. That section allows the court to make a restitution order against anyone who has been “knowingly concerned” in a breach of (among other things) section 21(1), requiring them to pay compensation in relation to the breach.
The FCA argued that, by causing OPR to make the communications without proper approval, the two individuals had been knowingly concerned in the breach.
In response, the individuals claimed that, although they may have been “concerned” in the breach, they had not “knowingly” been so, because they had believed that Leigh Carr had the appropriate permission to approve the communications and had in fact done so.
What did the court say?
In short, the court found that Mr Skinner and Ms Ferreira had been knowingly concerned in the breach.
It was not in dispute that OPR had breached section 21(1), as Leigh Carr did not have permission to authorise the marketing communications. Nor was it in dispute that the two individuals had been “concerned” in that breach, as they had directed OPR to make (or require) those communications.
The key question was whether, in order to be “knowingly” concerned (and hence liable), the individuals must have known that Leigh Carr was not authorised or that the communication was not approved, or whether it was enough that they knew the communication had been made.
The court said that it was enough that the individuals knew the communication had been made. The judge’s reasoning was as follows:
- The individuals would be liable if they were knowingly concerned in a breach of the prohibition. The prohibition in question was the one in section 21(1).
- Section 21(1) contains an “absolute prohibition” on communicating invitations or inducements. It says nothing about whether a communication has been approved. Rather, section 21(2) states that, if the communication is made or approved by an FCA-authorised person, the prohibition on section 21(1) does not apply. That is, the prohibition is not engaged at all.
- It is therefore irrelevant whether an individual believes that the person purporting to approve the communication is FCA-authorised. This is a question of whether the individual knows that the exemption to the prohibition applies, not whether the contravention has occurred. If the person in question is not FCA-authorised, the contravention still occurs, even if the individual believes that the person is FCA-authorised.
- This has to make sense, not least because the FPO contains over 70 exemptions to the prohibition. If the phrase “knowingly concerned” extends not just to the prohibition but also to exemptions to the prohibition, it would be necessary to examine an individual’s state of mind in relation to “every exemption that might potentially, but on the facts [does] not, apply”. In the court’s view, this would “substantially undermine the effectiveness” of section 382.
The judge reinforced this conclusion by comparing section 21(1) with section 19 of FSMA. That section prohibits a person from carrying on a regulated activity unless they are an authorised person or an exempt person. In section 19, the reference to being an “authorised person” is part of the prohibition itself, unlike in section 21, where the reference forms part of a separate exemption.
This was also the case in section 3 of the Financial Services Act 1986, which was the forerunner to section 21(1). The fact that the wording had changed when old section 3 became new section 21(1), and that it differed from current section 19, clearly encouraged the judge to interpret it differently.
What does this mean for me?
This is a pretty technical judgment, but it does carry a significant message. Ignorance of a person’s lack of authorised status, or a belief that a person is authorised to approve communications, is no defence to a breach of the prohibition in section 21(1).
Therefore, if making a communication to encourage persons to engage in investment activity, unless that communication falls wholly within one or more exemptions in the FPO, it is critical to check that the person approving the communication has permission from the FCA to do so. Steps an organisation can take to do this include:
- Check the firm’s correspondence. Authorised firms are required to state that they are regulated by the FCA and provide their registration number on all correspondence.
- Consult the FCA register to check a firm’s authorised status.
- If you are still in doubt, ask for a copy of the firm’s FCA authorisation.
ICSA: The Chartered Governance Institute has published updated guidance on terms of reference for risk committees of listed companies, including outline terms of reference.
The changes principally reflect the transition to the 2018 versions of the Financial Reporting Council’s UK Corporate Governance Code and Guidance on Board Effectiveness. However, other key changes to ICSA’s recommendations and outline terms include the following:
- All members of the risk committee should be independent non-executive directors (NEDs), rather than a majority (as recommended by the previous guidance).
- Risk committee members should include at least one member of the audit committee and/or the remuneration committee, and/or a NED who is specifically responsible for risk.
- Appointments to the committee should be extended for a maximum of two additional three-year periods.
- The company’s Finance Director and Chief Risk Officer should attend meetings on a regular basis (but not all meetings).
- The committee should meet four times a year, rather than three (as recommended by the previous guidance).
- The committee chair should seek engagement with shareholders on significant matters relating to the committee’s areas of responsibility.
- The committee should seek assurance on specific identified risks to the company’s business. The guidance contains a list of likely risks, many of which are predictable (such as operational risk, transactional risk and insolvency), but including more contemporary risks (such as ESG issues, cyber risk and pandemics).
- The guidance now includes more comprehensive terms of reference for narrative reporting and internal controls and risk management.
- The committee should provide recommendations on executive clawback provisions to the remuneration committee. This is in addition to providing advice to the remuneration committee on risk weightings for executive performance objectives, which was already recommended by the previous guidance.
Also this week…
- Court finds shareholders and founders in same class on scheme. In In the matter of Organic Milk Suppliers Co-operative Limited  EWHC 1270 (Ch), the High Court held that ordinary shareholders who held one vote per share, and founders whose ordinary shares carried enhanced voting rights on certain matters, formed part of the same class. The purpose of the scheme was to insert a new holding company in which all shareholders would hold the same rights before and after the scheme. In this sense, each founder was, like each other ordinary shareholder, giving up all of their existing rights in exchange for the grant of identical rights in the holding company. This did not make their rights so different that they could not consult with the ordinary shareholders with a view to their common interest.
- Government explains impact of European Single Electronic Format (ESEF) on signing off accounts. The UK Government has published a paper setting out its position on how ESEF affects the procedure for UK directors to sign off on their companies’ accounts. Companies which prepared accounts under IFRS and whose securities are admitted to a regulated market must prepare accounts using ESEF for financial years beginning on or after 1 January 2020. In the Government’s view, accounts can be signed off before being formatted electronically to comply with ESEF. This means that the directors’ confirmation that accounts meet the requirements of the Companies Act 2006, including that they give a “true and fair view”, does not extend to iXBRL tagging. This applies even where the accounts are tagged up before being signed off.
- QCA publishes results of NED survey. The Quoted Companies Alliance (QCA) has published the results of a survey of non-executive directors (NEDs) of small and medium-sized quoted companies. The survey covers NEDs’ salaries, working hours, experience, independence and value for money, as well as board evaluations and recruitment.
- OECD publishes summary of national responses to Covid-19. The Organisation for Economic Co-operation and Development (OECD) has published an overview of initiatives taken by national governments in relation to corporate governance and capital markets as a result of the Covid-19 pandemic. The overview covers 37 jurisdictions, including most of Europe and Latin America, parts of Asia and the United States.
- IOSCO emphasises importance of Covid-19 disclosures. The International Organization of Securities Commissions (IOSCO) has published a statement highlighting the importance to investors of high-quality disclosures in relation to the on-going Covid-19 pandemic. In particular, it encourages issuers to release timely and high-quality financial information with transparent and entity-specific disclosures regarding the impact of Covid-19 on the issuer’s operation performance, financial position, liquidity and future prospects.