Prospectus Liability and Causation

Investors are increasingly seeking to recover damages that they suffer on the stock markets as a result of misleading representations. A company that publishes misleading information or omits material information which results in a misleading representation acts unlawfully. If the misrepresentation concerns a misleading prospectus that is published in the context of an Initial Price Offering (IPO) and/or share issuance, the doctrine of prospectus liability comes into play. Misrepresentations in a prospectus can lead to an artificially high stock price. As a result, investors that buy shares during the relevant period might suffer an economic loss. This loss will be suffered definitively as soon as the misrepresentation is exposed and the stock price subsequently drops. Investors will, however, only be eligible for compensation, if—and to the extent that­—the ­price loss that they suffered is sufficiently causally related to the misleading information in the prospectus. In my article ‘Prospectus Liability and Causation’, published in the Journal of European Tort Law, I analyse this causation requirement both from the perspective of substantive law and from the perspective of the law of evidence.

Establishing causation for claims involving prospectus liability is not uncontroversial. A recurring question is whether establishing causation requires that the investor directly or indirectly relied on the misleading prospectus when purchasing the stock. In my view, irrespective of whether a stricter or a more lenient approach is adopted for establishing causation, any discussion about causation starts with the facts and arguments upon which the investor bases his claim. One cannot speak of ‘causation’ or ‘the causal link’ in abstract terms. The causal link only gains substance when it is linked to particular arguments and to a particular factual basis. In other words, the factual basis of the claim and the corresponding line of argumentation determine the perspective that should be taken as a starting point when establishing causation.

Essentially two factual bases and corresponding lines of argumentation can be distinguished with respect to an investor that allegedly suffered a loss due to a misleading prospectus:

(i) Firstly, the investor may base his claim on the fact that he would also have bought the stock in the absence of the misrepresentation but at a lower price.

(ii) Secondly, the investor may base his claim on the fact that his investment decision was influenced by the misleading prospectus, and that he, had he been given correct and complete information, would not have bought the stock at all.

With respect to the investor that opts for the first-mentioned factual basis, it is, in my opinion, irrelevant whether he directly or indirectly relied on the misleading prospectus and whether his investment decision was influenced by it. After all, he does not base his claim on the argument that he suffered a loss because he relied on the misrepresentation and was thus misled. Instead, he argues that he suffered a loss because he paid too high a price for the stock as a result of the misrepresentation. In other words, he claims to have relied on the integrity of the stock price when purchasing the stock and that his trust has been betrayed. If it can be established that the misrepresentation in fact resulted in a higher stock price, then, for this investor, the causal link between the misrepresentation and the price that he paid is established.

With respect to the investor that opts for the second factual basis, it is relevant whether he relied on the prospectus when purchasing the stock. Yet again, careful consideration should be given to the precise manner in which the investor substantiates his claim that his purchasing decision was causally related to the misleading prospectus. In my view, the investor can substantiate this causal link in three different ways:

(i) Firstly, the investor may take the position that he directly relied on the prospectus and that he directly based his purchasing decision upon it. In this case, whether the investor relied on the prospectus is clearly relevant to establish causation, simply because the investor states so.

(ii) Secondly, the investor may argue that he made his purchasing decision after consulting an expert adviser. In this case, it must be established that the adviser relied on the prospectus, and that the investor subsequently based his purchasing decision on the advice of the expert.

(iii) Thirdly, the investor may argue that he based his purchasing decision on a positive market sentiment that was induced by the misleading prospectus. In that case, it suffices for establishing causation that the prospectus triggered a misleading, positive market sentiment, and that the investor was subsequently misled by that sentiment.

If it is established that an investor would not have bought the stock at all in the absence of the misrepresentation, the liability of the company is not yet automatically established. Liability also requires that it is established that the financial loss that is alleged by the investor is causally linked to the misleading information. A defence that is commonly raised in practice by the defending company is that the investor would have suffered his loss anyway. The investor would have suffered this price loss if, for example, he had invested in an alternative stock that also would have dropped in value over the relevant period.

In its well-known World Online decision, the Dutch Supreme Court adopted the (rebuttable) presumption that the investor relied on the misleading prospectus for both factual bases of causation. This presumption of reliance is based on (the precursor of) Art 11(2) of the Prospectus Regulation. In my article, I discuss the World Online decision extensively and analyse it both from the perspective of substantive law and from the perspective of the law of evidence. In my opinion, Art 11(2) of the Prospectus Regulation does not provide a convincing legal basis for adopting a presumption of reliance. Art 11a(1) of the Unfair Commercial Practices Directive provides a substantially more convincing legal basis.

Arnoud Pijls is Associate Professor of Corporate Law and Capital Markets Law at Erasmus School of Law and an Advisor to the law firm Clifford Chance LLP, Amsterdam.