Prospectuses and the New Commercial Code

Dec 21 , 2019
By Ahadu Y. Assefa

A prospectus is a document through which an issuer of a security (mainly shares) discloses material information to potential investors. It is a document prepared when a company wants to offer its shares to the public or in other cases when it wants to be listed in a securities market. As a general rule, a prospectus must contain all the financial and non-financial information that potential investors and the public require in order to make an informed investment decision. And it must be properly regulated by the authorities to protect the public from misleading information by issuers of shares. This is not the case in Ethiopia.

In Ethiopia, public offerings of shares are used to raise financial capital from the public. But there is still a lack of a sufficient legal regime and organisational structure to properly regulate information these companies provide in the form of a prospectus. The Ethiopian Commercial Code of 1960 is still the only law regulating prospectuses. The Code has not been amended apart from a few provisions. There are recent efforts to amend this code, but the provisions on prospectuses are entirely unaltered. Hence, questions must be raised whether the rules on prospectuses in Ethiopia lack the advancements made in other jurisdictions. And this needs to be addressed as the country seeks to reform its economic structure.

In order to achieve middle-income status by 2025, the Ethiopian government has recently unveiled what it calls Ethiopia’s Homegrown Economic Reform Agenda as a well-coordinated response and blueprint to propel the country’s economic progress. In this Agenda, one of the overall developmental goals for the next 10 years is building an emerging market economy with a modern policy and institutional framework by building an efficient, resilient and well-functioning financial market system that provides affordable access to finance for investors and consumers.

The Agenda also mentions that this will be achieved by amending existing laws and legislating new laws that can cope with the ever-changing commercial and financial sectors. This hopefully includes amending the Commercial Code.

The Code states that an offer to subscribers shall be made through a prospectus during the formation of share companies. As mentioned above, a prospectus must generally contain all the financial (assets, liabilities, initial capital and so forth) and non-financial (founders, directors, purpose and so forth) information that potential investors and the public require in order to make an informed investment decision.

In other countries, a prospectus is also required when a company wants to be listed in a securities market. Although working toward a securities market for the near future, Ethiopia does not currently have one. But the lessons and laws drawn by the new Commercial Code can be used similarly when the time comes to enact regulations for the securities market.

Leaving this aside, the focus in Ethiopia should be on the public offering of shares. In general, one of the key legal consequences of a company’s decision to go public is the requirement to prepare and publish a prospectus.

The inadequate law surrounding prospectuses in Ethiopia can have significant shortcomings in protecting potential investors. Enticed by the advertised profit prediction of a business, lots of investors are subscribing to these companies without being given a prospectus detailing the risks of the potential investment.

Securities like shares are complex investment instruments that are intangible. They are neither produced nor consumed. Therefore, in large part because of this nature, securities and the securities market can be susceptible to fraud and manipulation. Investors and the public at large subscribing to the shares will question the legal system as to whether a proper mechanism is in place to protect their interest in case the issuers deceive and manipulate them. In order to avoid these pitfalls and mistrust by investors and the public toward companies, the law needs to carefully and effectively regulate prospectuses.

The issue of prospectuses and the legal regulations surrounding them are a complex process subject to extensive legal requirements in most jurisdictions around the world. For instance, in the United Kingdom, prospectuses are regulated by combining frequently amended European Union directives and regulations with the handbooks and guidelines from the concerned government authority and other supplementary laws. However, this is not the case in Ethiopia. To date, five provisions in the Commercial Code are used to govern prospectuses.

Safeguarding the rules on prospectuses might lead to proper information being disseminated to investors and the public. Given the importance of information in a prospectus, it is surprising that it has not been a subject for academic researchers in Ethiopia. Plus, the newly prepared Draft Commercial Code of Ethiopia has not amended the previous provisions of prospectuses. Therefore, it is important to mention a few aspects of how it can be amended.

For instance, there is no requirement for approval and registration of the draft prospectus by regulatory authorities before issued and offered to the public contrary to other country’s mandatory approval. The Commercial Code states that an offer to the public shall be made by a prospectus. The word "shall" indicates a mandatory requirement. However, the Ministry of Trade (MoT) does not currently require issuers to provide a prospectus before they issue shares to the public.

Another issue is that the Code does not clearly establish if communications other than printed documents form part of the prospectus. In Ethiopia, soliciting the public to subscribe for shares has been made mostly through brochures, phone calls, internet and oral communication. Advertisements by radio and television are also used in order to offer shares to the public. And the Code does not address the question of whether or not these means are considered part of the prospectus. This will mean that citizens who may have been misled by such advertisements will find it difficult to bring legal action on the basis of the Commercial Code. The defendant might argue that these were just advertisements and are not legally binding statements.

The concept of an informed decision must also be raised. As already mentioned, a prospectus must contain certain information. Mainly the assets and liabilities, financial position, profits and losses (if it applies) and prospects of the issuer. Thus, the question now is, whether the information required to be disclosed is sufficient enough to enable subscribers to make an informed decision. An informed assessment is, therefore, a result of relevant and sufficient information contained in a prospectus.

The informed assessment test is not a test based on the information that a professional would require. Rather, it will be on the information a layperson would expect. Hence, a prospectus must contain all of the information required for lay investors to make an informed assessment, including warnings and risks. This seems to be the reason that most countries require a prospectus to be presented in a form that is comprehensible and easy to analyse.

There is also a reasonable person standard for the information to be included in a prospectus. In fact, the duty of considering what fulfills the information necessary for an informed assessment should lie with those who prepare it. These people must consider the level of information that is required for an investor to make an informed decision on the security offered. The people responsible for the contents of a prospectus may include mainly the issuer (the entity issuing the securities), founders or directors and anyone else who authorise themselves to be named responsible for the prospectus.

In this regard, the Code also neglected to clearly identify who is responsible for preparing a prospectus and failed to articulate the liabilities of founders/issuers in cases where an offered prospectus to the public contains untrue or misleading statements or omits the relevant information for investors’ decisions. This will again leave subscribers with no clear guidelines on who to bring legal action against.

What is required of a prospectus is that the responsible people prepare it to contain all of the information necessary to enable the investor to decide in an appropriately informed manner. This does not mean discussing absolutely all information, as a prospectus is not expected to be a textbook on management or finance. Instead, it must let an investor decide whether to invest in the security by taking the risk.

At the moment, the MoT is working on a directive to deal with prospectuses. However, its contents, approval procedures and date of enactment have not been determined and a copy of the draft is inaccessible. This makes it difficult to further comment on the anticipated changes to the definition or list of documentation for a prospectus in Ethiopia.

But for now, the new draft Commercial Code should analyse the provisions on prospectuses and include additional provisions to protect the public from misleading information from companies. These new provisions might also help when the time comes to open a securities market in the country. A prospectus is a crucial document in any securities market and practising how to regulate it from now on will enable lawmakers to lay grounds for better codes and laws when the securities market becomes operational.

PUBLISHED ON Dec 21,2019 [ VOL 20 , NO 1025]

Ahadu Y. Assefa , an LLM student at Greenwich University in London.

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