RED HERRING PROSPECTUS AND ITS IMPORTANCE

RED HERRING PROSPECTUS AND ITS IMPORTANCE

Author: Ritesh Kumar,
5th year,
 Damodaram Sanjivayya National Law University, Visakhapatnam.


1.      INTRODUCTION


“Prospectus” has been defined in S. 2(70) in the following words “Prospectus” means any Document described or issued as a prospectus and include red herring prospectus referred to in section 32 and  shelf prospectus referred in section 31 or any notice, circular, advertisement  or other document inviting offers from public for subscription or purchase of any securities of a body corporate. It can be said that red-herring prospectus is a different type of prospectus.


According to Webster’s Encyclopedia Unabridged Dictionary of English Language[1], a “red herring prospectus” is a tentative prospectus circulated by the underwriters of a new issue of stocks or bonds which is pending approval; so called because front page of  such prospectus must carry a special notice printed in red. 

Also a “red-herring prospectus”, also termed as “preliminary prospectus” means a prospectus for a stock issue that has been filed but not yet approved by the securities and Exchange Commission.[2] The Securities and Exchange Commission requires such a prospectus to contain a notice- printed in distinctive red lettering- that the document is not complete or  final.

If a firm or body corporate  proposes to  make an offer of securities may issue a red herring prospectus which will not include complete particulars of the quantum or price of the securities included therein. The basic purpose of the red herring prospectus is to bring in securities by offering a tentative quantum or price by the Company.[3]

The Companies Act provides that red-herring prospectus shall carry same obligations as are applicable to the prospectus. This would imply that any misstatement or omission of any material fact in red-herring prospectus shall attract the same criminal and civil liabilities as are applicable in the case of prospectus. Also, non-intimation of variations which are material between the contents of non disclosure in red-herring prospectus shall also amount to misstatement in the prospectus.  Thus there is benefit of red-herring prospectus as it can be brought before prospectus and there is no requirement of exact price for the securities to be mentioned, tentative pricing can be mentioned which gives liberty to promoters/ underwriters to give a lump sum value of the securities for invitation of investors. At th
e same time  mis-statement should not be given in red herring prospectus which will lead on to criminal liability which will be dealt on in the research paper.

2.      IMPORTANCE OF RED HERRING PROSPECTUS


Section 32 defines red herring prospectus and corresponding provision to Companies Act 1956 is S.60B. The difference between the 2013 Act and 1956 Act is:-
1.      Compared to 1956 Act, the 2013 Act provides a much more simplified procedure for the issue of a red herring prospectus.
2.      Section. 60 B of the 1956 Act envisaged filling of information memorandum, red-herring prospectus and final prospectus whereas section 32 of the 2103 Act only envisages filing of red-herring prospectus and final prospectus.
3.      The requirement of Section 60B (5) to (8) of the 1956 Act have been omitted by the 2013.

2.1.REQUIREMENT REGARDING RED-HERRING PROSPECTUS


1.      A company proposing to make an offer of securities may issue a red herring prospectus prior to the issue of a prospectus.[4]
2.      A company proposing to issue a red herring prospectus shall file it with registrar at least three days prior to the opening of the subscription list and the offer.[5]
3.      A red-herring prospectus shall carry the same obligations as are applicable to a prospectus and any variation between the red herring prospectus and a prospectus shall be highlighted as variations in the prospectus.[6]
4.      Upon the closing of the offer of securities, the prospectus stating there in the total capital raised, whether by way of debt or share capital, and the closing price of the securities and any other details as are not included in the red herring prospectus shall be filed with the Registrar and the securities and Exchange Board.[7]

Requirement of SEBI ICDR Regulations in case of listed Companies .
Regulation 11 (3) provides that the issuer shall , before registering the red-herring prospectus (in case of book built case) or prospectus (in case of a fixed price issue) with the Registrar of th
e Companies or filling the letter of offer with the designated stock exchange, as the case may be , file with the SEBI through the lead merchant bankers, an updated offer document high lightening all changes made in offer document.

Regulation 57 provides that the red-herring prospectus, shelf prospectus and prospectus shall contain the disclosures specified in the Companies Act and the discourse specified in the Companies Act and disclosure specified in Para A of Schedule VIII of ICDR Regulations, subject to the provisions of parts B and C thereof.[8]

Regulation 51 A provides that the disclosure made in the red herring prospectus while making and initial public offer, shall be updated on an annual basis by the issuer and shall be made publicly accessible in the manner specified by the Board.

The importance of the red herring prospectus is that there can be quantum of quantum or price of the securities included therein. Initially the company can come up with red-herring prospectus before coming up with the final prospectus. Red herring prospectus is issued during book building process. Red herring prospectus contains either the floor price of securities offered or a price band along with the range within which the Bids can move. The applicants bid for the shares quoting the price and the quantity that they would like to bid at. SEBI (ICDR) Regulations prescribe certain disclosures to be made in the red-herring prospectus.
Once the offer for securities is closed, a final prospectus stating therein the total capital raised whether by way of debt or share capital, the closing price of the securities and any other details which are not complete in the red-herring prospectus shall be filed with SEBI in the case of listed public company and in any other case with the Registrar of companies only.

The other benefit is that the Company can bring in changes in the final prospectus with reference to red-herring prospectus as red-herring prospectus is not final prospectus. Red herring prospectus is brought before the final prospectus so, if the company thinks that a change might benefit the company then the company can bring in change in the  prospectus.

3.      LIABILITY DUE TO MISSTATEMENT IN  RED-HERRING PROSPECTUS


The company although coming up with red-herring prospectus in which they are required to mention quantum of price can be held liable for criminal and civil wrong if the company has given mis-statement in the red-herring prospectus.


3.1.Criminal Liability


It is established that the liabilities of misstatement in the prospectus and red-herring prospectus is same. Thus Section 34[9] provides that when a prospectus, issued, circulated or distributed under the provisions of company law,  if it includes any statement which is not true 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 of Indian Companies Act, 2013.


Even if every word is true, suppression of material facts may render it fraudulent. In order to make a prospectus fraudulent it is not necessary that there should be false representation in it . To judge its effect, it should be read as a whole: It is in not necessarily enough if the prospectus refers to the contracts and puts the intending shareholder upon enquiry to their contents.[10]

It is impression as a whole not each statement that may give false impression. If by a number of statements one gives a false impression and induce a person to act upon it, it is not less false although if one takes each statement by itself, there may be difficulty in showing that any specific statement is untrue . No particular word is enough to convey false impression. One may use a language in such a way as, though in the form of  hope and expectation,, it becomes a representation to existing facts, and if so, and if it is brought to one’s knowledge that these facts are false, it is fraud.[11]

The misstatement in the prospectus not only leads to criminal liability but also has civil liability the person affected may approach the Court for compensation if any breach or misstatement is found in the red-herring prospectus.


Liability of Directors under section 34[12]:-

If going by the facts and circumstances it is found that Director was known to the fact that any misstatement is there in the prospectus the director will be held criminally liable. In the case of Hefez  Rustom Dalal v. Registrar of Companies[13] it has been held that where objection was raised after ten years and Registrar had not pointed out specific instances stating which false or deliberate mis-statements were made in prospectus to include public for subscribing share of company, no prosecution proceedings could be concluded that applicants had acted bona fide and there was no deliberate intention on their part to defraud public and there was no false statement in prospectus. Therefore, the prosecution proceedings launched against them were liable to be set aside.


In the case of DLF Limited and Ors v. SEBI[14]

In this case the  DLF had filed a draft of Red Herring Prospectus before SEBI and in the prospectus it stated that  Sudipt Estates Pvt. Ltd. was joint venture of DLF. Subsequently this stance was changed after they issued a new prospectus and they withdraw the old one. Consequently SEBI passed an order against DLF and prohibited its 6 Directors from trading in securities market for next three years on the basis of complaint  claiming that contrary to the disclosure in the prospectus disclosed by DLF its only two wholly owned subsidiaries were the only in SELP. DLF approached Securities Exchange Board Appellate Tribunal  against the order of SEBI. DLF’s one of the arguments  in front of Appellate Tribunal was that non-disclosure of the relation between DLF and its subsidiaries would have no significance in the investors’ decision and that there was nothing which points out that DLF was illegally benefitting with its subsidiaries, the prohibition order by SEBI must be set aside. The Tribunal agreed that there was violation of DIP guidelines by DLF because they did not disclose information about their subsidiaries but at the same time Tribunal discredited the prohibitory order by SEBI stating that DLF had not relied on any document which would have misled the investors and also that prohibiting DLF from trading in securities for long period of three years would affect the interest of investors as well. There are averments supporting the contention that the three subsidiary companies  were not “acting in concert” as just holding-subsidiary relation is not everything to determine that. However, the very point of issuing a draft prospectus is to make sure that any information in relation to any business practice or financials to which the resultant proceeds of the securities may either directly or indirectly apply must be mentioned in the prospectus. Therefore it can be concluded that non-disclosure of a holding-subsidiary relation between the companies would certainly constitute important information that would need to be disclosed in the prospectus.

Some instances have not been held as misstatement for the purpose of criminal liability as in the case Progressive Aluminum Ltd. v. Registrar of Companies[15]in this case where there was no intention to defraud public for any pecuniary gain, failure to commence commercial production on date stipulated in prospectus would not amount to mis-statement when there was reasonable cause for such delay. Where statement given in prospectus suffered only from want of clarification about experience of promoter company, same could not be said to be untrue.

In the case of Yugantar v. Union of India[16] it was observed that where respondent bank issued advertisement for public issue of shares under caption ‘India’s highest profit making nationalized bank and though bank’s balance sheet showed debit balance, its losses were due to revised RBI norms, otherwise it was showing operating profits, advertisement made by bank could not be said deceptive or misleading.

3.2.CIVIL LIABILITY


Section 35 of the Company Act 2013 provides for civil liability where a person can be compensated for the loss incurred due to the mis-statement of the company in the prospectus. The director or a person who has authorized himself to be named as a director of the company at the time of issue of prospectus or the promoter of company.

The person liable to pay compensation they have to pay compensation to the person who has subscribed for securities of the company, anyone who has subscribed acting on any statement included, or the inclusion or omission of any statement included, or the inclusion or omission of any matter, the prospectus which is misleading; and he has sustained any loss or damage as a consequence thereof.

In  the case of Shiromani Sugar Mills Ltd. v. Debi Prasad[17] it was observed that :-

‘Omission of any particular from prospectus does not automatically entitle shareholder to rescind contract for purchase of shares unless the particulars omitted are material facts the very concealment of which gives to the truth which is told the character of falsehood’.

 It will not do for the promoters of a company to plead that everything which is stated in the prospectus is literally true; they must be able to meet the objection, ‘not that it does not state the truth as as it goes, but it conceals most material facts with which public ought to have been made acquainted, the very concealment of which gives the truth which is told the character is falsehood.

Also in the case of T.S. Rajagopal Iyer v. South Indian Rubber Works Ltd[18] the plaintiff had applied foe shares in the respondent- company on the basis of the prospectus issued on 20-01-1937, containing, inter alia, the names of several persons as directors and specifying the sum of Rs. 40,000 as the minimum sum upon which the compay will proceed to allotment of the shares. Before the allotment took place, there were changes in the directorate.  Further the minimum subscription required before  allotment was reduced from Rs. 40,000 to Rs. 10,000. It was held that there was a material change in the prospectus and that the plaintiff was entitled to a fraud.

In the case of Sahara India Real Estate Corporations Ltd. And Others v. SEBI[19] Sahara India incorporated  2 new companies- Sahara India Real Estate Corporation Limited (SIRECL) and Sahara Housing Investment Corporation (SHIC) in 2005 by registering them under the Companies Act, 1956 with the relevant Registrar of Companies in Kanpur and Maharashtra respectively. In the annual meetings held by both the companies, a resolution was passed to raise funds through private placement of optionally fully convertible debentures (OFCD‘s) from the friends, associates, and family members of the Board of Directors. Funds were also to be raised through the circulation of an information memorandum to a few trusted investors. SIRECL collected Rs. 17,656.53 crores (net value) between 25th April, 2008 and 13th April, 2011. SHICL collected Rs. 6373.20 crores (net value) between 20th November, 2009 and 13th April, 2011. Thus both the companies collected Rs. 24,029.73 crores from 30 million investors over a period of 3 years. In 2009, when a red herring prospectus for Sahara Prime City (a real estate venture of Sahara India) was submitted to SEBI for approval, SEBI noticed unusual fund raising activity in the 2 firms- SHICL and SIRECL. SEBIT held liable for the misstatement in RHL. Sahara approached Appellate Tribunal SAT, SAT asked Sahara to return all the monies collected from the investors as they have not complied with rules and they have misstated in RHL. They approached Supreme Court . Supreme Court after going into the depth of the case , uphold the decision of SAT and held Sahara liable for misappropriation for money of investors. 

CONCLUSION

It can be summarized that the Section 32 of companies Act, 2013 deals with red-herring prospectus. The company before bringing in prospectus can issue red-herring certificate in which the company is not required to fix the price of the secu
rity the company can give the quantum of price. The SEBI ICDR regulations regulate the issuance of red-herring prospectus. At the same time the company has benefit of issuing red herring prospectus as the company is not required to give the exact price of the  securities and they can issue a prospectus before the final prospectus which will bring in buyer for the securities. As always there are two sides of coin, the Company Act gives relief to the Company to issue red-herring prospectus but they are not exempted if they have given misstatement in the red-herring prospectus. There has been many judicial precedents in which the company has been held liable criminally and  for civil wrong for misstatement in the red-herring prospectus.
The red-herring has importance as it benefits the company and shareholder also because in final prospectus it may take time but before that they can bring in red-herring prospectus and ask for buyers for the securities. But the first and foremost  motive behind having such a document is ensuring welfare of investors and misappropriation of funds raised by companies through sale of securities.

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[1]Webster’s Encyclopedia Unabridged Dictionary of English Language, 1996 Edn., p. 1203.


[2] Black’s Law Dictionary, 7th Edn., 1999, p.1238.

[3] S. 32 of Companies Act, 2013.

[4] S. 32(1) of Companies Act, 2013.

[5] Section 32 (2) of Companies Act, 2013.

[6] Section 32(3) of Companies Act, 2013.

[7] Section 32 (4) of the Companies Act, 2013.

[8] Section 26 of ICDR Regulations.

[9] Indian Companies Act, 2013.

[10] In re Sreenivasan, [1944] 14 Comp. Cas. 193 (Mad).

[11] Aaron;s Reefs  v. Twiss,  [1896] AC 273 (HL).

[12]Indian  Companies Act, 2013.

[13]  Hafez Rustom Dalal v. Registrar of Companies, [2005] 59 SCL 265 (Guj).

[14] DLF Limited and Ors v. SEBI, Appeal No. 331 of 2014.


[15] Progressive Aluminium Ltd. v. Registrar of Companies, [1997]89 Comp.Cas. 147/ 14 SCL 177 (AP).

[16]Yugantar v. Union of India,  [1997] 13 SCL 145 (Delhi).

[17] Shiromani Sugar Mills Ltd. v. Debi Prasad, [1950] 20 Comp. Cas. 296 (All.).

[18] T.S. Rajagopal Iyer v. South Indian Rubber Works Ltd, [1942] 12 Comp. Cas. 203 (Mad).

[19]Sahara India Real Estate Corporations Ltd. and Others  v. SEBI, CIVIL APPEAL NO. 9813 OF 2011.
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