February 13, 2024 at 07:41 AM
Section 34 of Companies Act. Criminal liability for misstatements in prospectus
|“— Where a prospectus, issued, circulated or distributed under this Chapter, includes any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead, every person who authorizes the issue of such prospectus shall be liable under section 447: Provided that nothing in this section shall apply to a person if he proves that such statement or omission was immaterial or that he had reasonable grounds to believe, and did up to the time of issue of the prospectus believe, that the statement was true or the inclusion or omission was necessary.”
The Companies Act, 2013 plays a vital role in providing the legal basis for various corporate governance norms in India. Nevertheless, it is not realistic to expect that all the companies comply with it voluntarily. So it is necessary to provide a procedure and for the non-compliance penalties play a deterrent role for companies. Similarly, Section 34 prescribed criminal liability for misstatement in the prospectus which serves the purpose of the critical provision, importance, implications, punishments, and precedents. It acts as a mentor between the issuer of the prospectus and Investors. So we are looking into what the provisions say.
A statement included in a prospectus shall be deemed to be untrue if the statement is misleading in the form or context or if there is any omission from the prospectus in any manner to mislead. A liability arises when any person subscribes for any shares or debentures based on content provided in the prospectus. If any person suffers loss or damages due to untrue information in the prospectus.
There is a collective involvement of the Board in taking any business actions for the company. Sometimes there is collective Board liability or individual directors held liable as per the involvement in the malafide act.
The liabilities can arise for various reasons as given here:
The Securities and Exchange Board of India (SEBI) case against the Biyanis, Future Corporate Resources Pvt Ltd, a Future group company and other related entities, pertains to insider trading in the shares of Future Retail based on unpublished price sensitive information in 2017 when a few companies of the Future group were being restructured.FRL contained false and misleading financial statements and SEBI claimed the inflated financials aimed to get the interest of potential investors for FRL’s initial public offering (IPO). The alleged discrepancies were due to overstating revenue, understating expenses, and misrepresenting inventory levels. Under the Prohibition of Fraudulent and Unfair Trade Practices (PFUTP) Regulations SEBI initiated proceedings against Biyani and Mehrotra and sought repayment of illegal gains and other penalties.
Misrepresented financials: SEBI accused FRL of artificially inflating its sales and profits by including revenue from transactions with related entities that were not yet finalized. Also, Hidden discounts were offered to customers, leading to higher reported revenue. Understating expenses by not fully accounting for promotional costs and employee benefits. Defense by Biyani and Mehrotra: They claimed they relied on information provided by internal teams and auditors and were not aware of any deliberate misrepresentation.
Judgement: The Securities Appellate Tribunal (SAT) partially upheld SEBI’s findings and concluded that while certain discrepancies existed, they were no malafide intention. Hence they didn’t come under fraudulent or unfair trade practices. However, SAT found that there is a fault with FRL’s internal controls and accounting practices, highlighting deficiencies in due diligence and verification procedures. Biyani and Mehrotra were barred from holding director positions for one year in listed companies due to these lapses.
Section 34 has acted as a strong deterrent tool against the violation of provisions made under it. Whereas it protects the Investor in certain cases like misleading information in prospectuses, protecting investor interests, and promoting market integrity. With a brief understanding of its provisions and relevant case laws, companies and individuals involved in prospectus preparation can take all due diligence while preparing it with greater clarity and mitigating potential legal risks.
1. What is the key difference between criminal and civil liability for misstatements in a prospectus under Section 34?
The difference between Criminal and Civil Liability is as below:
Criminal liability as per Section 34, individuals responsible for the company’s malafied act are liable for fines and imprisonment if a misstatement in the prospectus leads to a criminal offense. The burden of proof lies in proving bonafide intention. And Civil liability as per Section 35, protects investors who suffer losses due to misstatements in the prospectus to claim the company and responsible individuals for damages. The burden of proof lies in proving the misstatement, reliance on it, and resulting loss.
2. Who is “responsible” for the company’s conduct under Section 34, and can they escape liability? If so, how?
Section 34 prescribed that individuals in charge of and responsible for the company’s business conduct as potentially liable. This could include directors, managing agents, promoters, and others with significant control over the prospectus issuance. To escape from the it must prove that
3. What specific types of misstatements or omissions in a prospectus could trigger liability under Section 34? Provide examples.
Examples of misstatements triggering liability include
4. Section 34 allows for a defense based on “reasonable grounds to believe.” How strong does this defense need to be for someone to avoid liability?
The strength of this defense depends on the specific circumstances. Individuals must demonstrate they had genuine reasons to believe the statement was true or the omission wasn’t misleading. This requires evidence, such as relying on credible reports, seeking legal advice, or conducting due diligence.