New Transparency Directive: issuers, directors and auditors may face increased liability

United Kingdom

The Financial Markets Law Committee ("FMLC") has published a paper considering the potential for the extension of the liability of issuers of listed securities, their directors and auditors for misleading or inaccurate published financial reports and accounts under the new EU Transparency Directive (the "Directive").

Under the Directive, which is expected to come into force later this autumn, and is required to be implemented into the national laws of the Member States no later than 2 years after the date on which it comes into force, issuers will be required to produce annual and half-yearly financial reports, and issuers of shares are will also be required to publish interim management statements on a quarterly basis. These reports and management statements will be required to be made available to the public throughout the European Union. The Directive makes extensive references to the concept of investor protection and the provision of information to investors, and further requires that Member States lay down appropriate liability rules applicable to issuers and their management.

The FMLC has raised concerns that, once implemented into English law, the Directive may alter the current English law position, which limits the extent to which issuers, their directors and auditors are liable for negligent misstatements in audit reports and financial statements. With its emphasis on investor protection, it appears that the Directive may extend this duty of care so that it is owed not only to existing shareholders, but also to past and future shareholders throughout the EU and, arguably, even to "the European public at large" in relation to investment decisions (thus including, for example, non-shareholders who decide not to buy the relevant securities). Furthermore, since the Directive requires reports and management statements to be made available to investors throughout the EU, issuers could potentially face multiple liabilities in different jurisdictions, depending on where the information was received and acted upon.

The FMLC paper suggests that auditors' duty of care could also be extended as a consequence of the broader class of person to whom reports are required to be made available under the Directive. At present auditors cannot, as a matter of English law, limit their liability, but are subject only to the narrow duty of care confirmed in Caparo Industries plc v Dickman [1990] 1 All ER 568. If the duty of care of auditors is widened following implementation of the Directive, however, then it would seem fair that an ability for them to limit their liability by agreement should follow. Whilst the government has rejected the Conservative Party's attempt to introduce such a cap on auditors' liability in companies legislation currently going through Parliament, Jacqui Smith, the industry minister, has indicated that measures allowing auditors to limit their liability by contract could be included in a companies bill due after the next general election.

The FMLC also warns that, if their concerns are justified, information provided in financial reports published pursuant to the Directive may have to be verified and scoured with a rigour and diligence until now only required for the issue of prospectuses. Any increased exposure on the part of issuers and auditors would also be likely to impose a significant burden on issuers in terms of both time and money and may increase the need for extensive insurance coverage. It may also have the negative effect of limiting the amount of information issuers feel able to release, and as such may undermine the very aims of the Directive.

The FMLC paper discusses an array of further potential problems which could arise under the Directive, and proposes that the EU Commission deals with these problems now by way of implementing measures rather than letting the law evolve on a case by case basis. The paper also points out that extending liability for negligent misstatements in financial reports to a wider class of investors need not be the only option, and that it may be more appropriate to impose appropriate regulatory controls and sanctions such as statutory fines. As the FMLC points out, the consequences of leaving unresolved the uncertainties caused by the wording of the Directive may be severe.

To view the FMLC's paper in full please click here.

If you require further information on this topic please contact Jason Harding at [email protected] or on +44 (0)20 7367 3138 or Stephen Hewett at [email protected] or on +44 (0)20 7367 2970 or Edina Cavalli at [email protected] or on +44 (0)20 7367 3126.