Pointing the finger
22 March 2010
While investors know securitisation prospectuses are not infallible, the question of which party shoulders the blame should information be remiss remains something of
an enigma. By Andrew Twigger
Many different specialists are involved in structuring a securitisation, including valuers and financial modellers who estimate the value of the income stream, the rating agencies and the ’arranger’, normally an investment bank, which takes overall organisational control in return for a fee.
Do these financial experts risk having to compensate investors if the securitisation fails? In particular, might they incur liability by virtue of statements made in the prospectus, or offering circular, issued to inform investors about the transaction?
The current regulatory regime in relation to prospectuses is derived from EU legislation and is principally to be found in Part VI of the Financial Services and Markets Act 2000, the Prospectus Regulations 2005 and the relevant section of the FSA Handbook.
If the regulations apply, certain people are declared expressly ’responsible’ for the prospectus. These include any person who “is stated in the prospectus as accepting responsibility for the prospectus”. But even where (as often) the securitisation is exempt from regulation (because the offer of securities is being made principally to ’qualified investors’), prospectuses tend to include a statement that “the issuer accepts responsibility for the information contained in this document”. Does this affect the potential liability of parties other than the issuer for any inaccuracies?
Pinning the blame
Fraud aside, there are three principal ways by which the liability of such a party might arise: first under Section 2(1) of the Misrepresentation Act 1967; second for negligent misstatement; and third for breach of a duty of care owed to investors by virtue of the role played by the potential defendant in the transaction.
The principal advantage of a claim based on Section 2(1) of the 1967 act is that a duty of care need not be established. The principal disadvantage is that the misrepresentation must have been made by the other party. Consequently, if the vendor was itself an investor selling the bonds in the aftermarket, the act is unlikely to assist a purchaser who was misled by the offering circular.
Even if the vendor was, for example, the arranger of the securitisation, the statement commonly found in offering circulars, to the effect that the issuer is responsible for its contents, might make it difficult to establish that the arranger made any statements in the offering circular.
Related problems arise in relation to a claim based on negligent misstatement or a duty of care. If the appropriate legal test is that of an assumption of responsibility, does the statement in the offering circular, that the issuer accepts responsibility, preclude the possibility that someone else might have assumed responsibility to investors?
The answer to this question may depend on whether the claimant could reasonably have relied on an assumption of responsibility by the defendant. Such reliance might be reasonable for a number of reasons.
First, the purpose of identifying the issuer as responsible for the information is to comply with the regulatory provisions. They expressly contemplate that liability may arise in other ways.
Second, the issuer is, by design, a vehicle with a single purpose. It relies on third parties to provide the information in the offering circular and normally has no assets other than the cashflows being securitised. If those cashflows are insufficient, it is unlikely that the issuer’s acceptance of responsibility will be of any comfort to an investor.
Third, there is an important distinction to be made between the risk that the investment might not perform as anticipated (for example because property values fall), which investors accept, and the risk that statements of fact in the offering circular turn out to have been inaccurate, which investors do not accept.
Fourth, although investors are likely to be sophisticated institutions, they cannot undertake the kind of due diligence that would be required to confirm that every statement in the offering circular is accurate.
Finally, those operating in the securitisation market normally expect arrangers to have checked information in the offering circular with the intention that it will be relied upon by investors.
Thus, while much must depend on the terms of the particular offering circular, an investor might argue fairly that parties other than the issuer should be liable if the information in the offering circular turns out to be inaccurate.
Andrew Twigger is a barrister at 3 Stone Buildings