Mandatory Disclosure (Securities Markets)
1. Introduction; terminology
Mandatory disclosure encompasses the duty to publish a prospectus when raising capital as well as the duty to inform investors of such companies whose securities are already admitted to trading on a regulated market. The duty to publish a prospectus and a corresponding liability date back to the 19th century (prospectus liability). Mandatory disclosure in the narrower sense, ie the duty of stock-listed companies (issuers) to provide information exceeding the requirements of financial accounting to investors on an ongoing basis, however, was only introduced in most European jurisdictions in the course of European harmonization in the 1970s and 1980s. These disclosure duties serve the ongoing trading in securities on the secondary market, which is the circulating market for securities that have been issued previously on the primary market.
The price of a security is significantly determined by the future profits the market participants expect, and which—in case of common stock as dividends—are distributed to the investors. Since the future profitability is naturally uncertain and dependent on a multitude of factors, market participants are reliant on trustworthy and ongoing information from the issuers to be able to price securities continuously and appropriately. Furthermore, it is more efficient to assign disclosure duties to the issuer, who is the ‘producer’ of intra-company circumstances, than to force single investors to wastefully engage in parallel investigations into the business situation of stock-listed companies. Mandatory disclosure thus serves the interests of single investors and, at the same time, the economy as a whole (investor protection and market protection) (securities law).
When raising capital, the gains from false or misleading information accrue with the issuer directly in the form of higher proceeds from the issuance. Thus, the existence of prospectus liability is immediately plausible. The economic advantage for issuers providing misleading information to the secondary market, where they do not trade themselves, is less obvious. This is a major reason why many European jurisdictions traditionally viewed with scepticism the liability for pure economic loss caused by misleading information to the capital market. England, for instance, has acknowledged prospectus liability since the 19th century but only introduced a liability for misstatements on the secondary market in 2006 in the course of implementing the Transparency Directive (Dir 2004/109).
2. Mandatory disclosure in securities law
Mandatory disclosure duties regarding the secondary market can be divided into periodic disclosure, episodic or ad hoc disclosure and disclosure on major holdings. Additionally, there are special disclosure duties in case of a public takeover (takeover law). Periodic disclosure pertains to information provided to investors at regular intervals in the form of annual reports and interim reports. These enable the investors to gain a basic impression about a certain company. In contrast, ad hoc disclosure is meant to bring unexpected circumstances, which occur in the intervals between the periodic reports, to the attention of investors as soon as possible. On the one hand this establishes market transparency as the basis for a correct pricing and, on the other hand, it prevents the exploitation of informational advantages in the form of insider dealing. Disclosures on major holdings complete the informing of investors by requiring a notification when the number of voting rights in a stock-listed company held by a shareholder reaches, exceeds or falls below certain thresholds. The composition of shareholdings and changes in the controlling shareholders in public companies are important criteria for the investment decisions of institutional investors especially.
In the course of implementing the Financial Services Action Plan of 1999, the European framework on mandatory disclosure was completely reformed by enacting a new generation of securities law directives.
a) Periodic disclosure
The duty of making periodic disclosures is laid down in the Transparency Directive and its implementation measures, which have been enacted in the Lamfalussy process, such as the Transparency Implementation Directive (Dir 2007/14). These directives apply to issuers whose securities are already admitted to trading on a regulated market. Pursuant to Art 4 of the Transparency Directive issuers have to make public their annual financial reports, which consist of the audited financial statements (where the issuer falls under the scope of the Consolidated Accounts Directive (Dir 83/349) these are financial statements in accordance with IAS/ IFRS pursuant to the IAS Regulation (Reg 1606/ 2002), otherwise these are financial statements pursuant to the national accounting laws) and the management report. These are accompanied by a responsibility statement in which the persons responsible within the issuer certify ‘to the best of their knowledge’ that the financial statements give a true and fair view and that the management report includes a fair review of the development and performance of the business and the position of the issuer. Furthermore, Art 5 mandates the publication of half-yearly financial reports, which consist of a condensed set of financial statements (interim financial report pursuant to IAS/IFRS for companies that draw up consolidated accounts, otherwise the financial statements are governed by Art 3 of the Transparency Implementation Directive), an interim management report and, again, a responsibility statement. Finally, Art 6 of the Transparency Directive obliges issuers to make public interim management statements during the first six-month period of the financial year and during the second six-month period of the financial year, enabling the public to obtain a more or less detailed report on the situation of the issuer and its financial performance on a quarterly basis. Furthermore, issuers are obliged pursuant to Arts 16, 17 and 18 of the Transparency Directive to provide shareholders or debtholders with additional information concerning their rights and the details of shareholder or debtholder meetings.
Further important duties on periodic disclosure were introduced by Art 10 of the Takeover Bids Directive (Dir 2004/25, takeover law). This provision requires companies whose securities are admitted to trading on a regulated market to include in the management statement a multitude of information concerning defensive structures and mechanisms that could work as strategic obstacles to a public takeover.
In 2006, the Annual Accounts Directive (Dir 78/660) was amended by introducing Art 46a, and the Consolidated Accounts Directive was amended by introducing Art 36a, both provisions also being part of the secondary market periodic disclosure requirements as they apply only to companies whose securities are admitted to trading on a regulated market. Pursuant to these provisions the issuers have to include in the management statement additional information on their corporate governance.
b) Ad hoc disclosure
To prevent price distortions when new material events happen in the intervals between periodic disclosures that imply a different valuation of a financial instrument, issuers are required pursuant to Art 6(1) of the Market Abuse Directive (Dir 2003/6) to inform the public ‘as soon as possible’ about such circumstances which directly concern them. This duty applies as soon as it may reasonably be expected that a circumstance that is relevant for the valuation of a financial instrument will come into existence. The knowledge of such circumstances, at the same time, constitutes inside information, the use of which is prohibited by Art 2 and the disclosure of which is prohibited by Art 3 (insider dealing). Market transparency, however, is not set as an absolute goal. Thus Art 6(2) allows issuers to delay the public disclosure of inside information so as not to prejudice their legitimate interests. This only applies, though, provided that such omission would not be likely to mislead the public and provided that the issuer is able to ensure the confidentiality of that information. The responsibility for meeting this test lies with the issuers.
When it comes to the details of the publication, Art 2(1)(I) of the Market Abuse Implementation Directive (Dir 2003/124) refers to the regime of Arts 20 and 21 of the Transparency Directive. This demonstrates how closely interconnected periodic and ad hoc disclosures are.
c) Disclosure on major holdings
Mandatory disclosure on major holdings has a slightly different goal than periodic and ad hoc disclosures. Pursuant to Art 9 of the Transparency Directive a shareholder has to notify an issuer of the proportion of voting rights of that issuer held by the shareholder as a result of an acquisition or disposal where that proportion reaches, exceeds or falls below the thresholds of 5, 10, 15, 20, 25, 30, 50 and 75 per cent. Article 10 expands this notification requirement to cases in which the investor does not acquire the shares directly but is entitled to acquire, to dispose of, or to exercise voting rights due to contractual or other arrangements. Pursuant to Art 12(2) of the Transparency Directive (as explicated by Arts 8 and 9 of the Transparency Implementation Directive) the notification to the issuer shall be effected as soon as possible, but not later than four trading days. According to Art 12(6) the issuer shall make public all the information contained in that notification upon receipt, but no later than three trading days thereafter.
Besides the notification requirements for shareholders (and the issuer’s duty to make these notifications public) there is also a unique disclosure duty of the issuer pertaining to the acquisition of its own shares. Pursuant to Art 14(1) of the Transparency Directive an issuer who acquires or disposes of its own shares has to make public the proportion of its own shares as soon as possible, but not later than four trading days following such acquisition or disposal, where that proportion reaches, exceeds or falls below the thresholds of 5 or 10 per cent of the voting rights.
Mandatory disclosure on major holdings is closely interconnected with takeover law as it ensures the transparency of major shareholdings already in the forefront of a possible change of control or the takeover’s defeat by the target company. Also, control transactions are major occasions in corporate life and early knowledge about them is similar to inside information. Very often a change of control will actually constitute inside information under the Market Abuse Directive.
3. The capital market liability regime
a) The European framework
The rules on civil liability in case of breach of one of the aforementioned duties are far less detailed. Article 7 of the Transparency Directive only obliges the Member States to ensure that responsibility for the information to be drawn up and made public in the annual financial report, the half-yearly financial report, the interim management statement, and in accordance with Art 16 lies at least with the issuer or its administrative, management or supervisory bodies. Furthermore, the Member States have to ensure that their laws, regulations and administrative provisions on liability apply to these persons. As regards the sanctions for breach of disclosure duties on major holdings, the directive is silent. The Market Abuse Directive contains no explicit liability rules at all when it comes to infringements of the duty to make ad hoc disclosures. In these cases, a duty of the Member States to introduce civil liability can only be derived from general effet utile principles. In this vein, in 2002 Germany introduced a special civil liability provision for the breach of the duty to make ad hoc disclosures, thereby forestalling proceedings to establish infringements of the EC Treaty on account of numerous ad hoc disclosure violations by issuers.
b) The laws of the Member States
Given the scarce European requirements and due to diverse national tort law traditions, the laws of the Member States on capital market liability are still quite heterogeneous (prospectus liability). Nonetheless, there have been some changes in the course of implementing Art 7 of the Transparency Directive. While Germany considered the remedies under its general civil law sufficient, which forces German courts in the future to establish an effective liability scheme derived from an interpretation of general tort law that is in conformance with the European requirements, other countries took the chance to completely revise their capital market liability regime. England, in particular, enacted the Financial Services and Markets Act 2010 (Liability of Issuers) Regulations 2010 (amending the Financial Services and Markets Act 2000). Following the Davies Review of Issuer Liability, these new provisions substantially reform the statutory regime for issuer liability, covering not only periodic disclosures but also ad hoc and voluntary disclosures. Before the implementation of the Transparency Directive, civil liability for disclosure violations on the secondary market was widely rejected under English law.
France and other countries apply the general clause of Art 1382 Code civil. Often liability claims are decided by courts in criminal matters within adhesion procedures which allow victims of a crime to bring their restitution claims before the criminal court.
4. Private international law
The connecting factors for the disclosure duties are in the meantime explicitly governed by the directives. As regards those duties which are implemented by the Transparency Directive, issuers are subject to the laws of their ‘home Member State’. Article 2(1)(i) defines the home Member State; for issuers of shares this is the Member State in which the issuing company has its registered office. The duty to make ad hoc disclosures is governed according to Art 2(1)(I) of the Market Abuse Implementation Directive (in connection with the transitional provision in Art 32 last subpara of the Transparency Directive) by the regime of Arts 20 and 21 of the Transparency Directive, which leads again to the home Member State pursuant to the Transparency Directive.
The connecting factor for capital market liability claims, however, is not explicitly regulated. For the purpose of private international law, capital market liability claims are to be characterized as a matter of tort law. Thus, they fall within the scope of the Rome II Regulation (Reg 864/2007); they are not excluded by Art 1(2)(c) and (d) of the Rome II Regulation. To date, scholars have mostly argued in favour of the law of the country where the securities are traded (market place). However, after the enactment of the home Member State concept by the Transparency Directive, it is more convincing to apply the laws of the Member State that also governs the duty which might have been infringed. This is especially true since the Member States are widely allowed to engage in ‘gold plating’ when implementing the mandatory disclosure duties, especially in the field of periodic disclosures. If one were to apply the laws of the market place instead, these peculiarities would have to be incorporated into the elements of the claim. Against this background it is more convincing to assume a manifestly closer connection pursuant to Art 4(3) of the Rome II Regulation with the home Member State.
5. Development trends
After the implementation of the Financial Services Action Plan, the European harmonization of mandatory capital market disclosure has come to a temporary halt. Current activities are restricted to fine tuning the existing rules at the Committee of European Securities Regulators (CESR). There is, however, substantial need for harmonization in the field of liability for misstatements. This subject is, however, not to be found on the schedule of the Commission. If there were to be a Europe-wide stock market scandal involving misstatements, this could change quickly.
Klaus J Hopt, ‘Disclosure Rules as a Primary Tool for Fostering Party Autonomy—Observations from a Functional and Comparative Legal Perspective’ in Stefan Grundmann, Wolfgang Kerber and Stephen Weatherhill (eds), Party Autonomy and the Role of Information in the Internal Market (2001) 246; Eilís Ferran, Building an EU Securities Market (2004); Hervé Synvet (ed), ‘Dossier: Information Financière et Responsabilité’  Revue de Droit Bancaire et Financier 448; Klaus J Hopt and Hans-Christoph Voigt (eds), Prospekt- und Kapitalmarktinformationshaftung (2005); Paul Davies, Davies Review of Issuer Liability: Final Report (2007) <www.hm-treasury.gov.uk>; Dorothee Fischer-Appelt, ‘Implementation of the Transparency Directive—Room for Variations across the EEA’ (2007) 2 Capital Market Law Journal 133; Didier R Martin, ‘Responsabilité et marchés fianciers—Propos introductifs’  Bulletin Joly Bourse 287; Paul L Davies, Gower and Davies’ Principles of Modern Company Law (8th edn, 2008) ch 26; Niamh Moloney, EC Securities Regulation (2nd edn, 2008) chs II.7 and XII.7; Wolf-Georg Ringe and Alexander Hellgardt, ‘The International Dimension of Issuer Liability—Liability and Choice of Law from a Transatlantic Perspective’ (2011) 31 Oxford J Legal Stud 23.