Red Herring Prospectus

From Justice Definitions Project

What is 'Red Herring Prospectus'

A prospectus is issued by a public company to invite applications for its shares or debentures. Section 2(1)[1] of the Company Act 2013 (hereinafter as the Act) defines an abridged prospectus[2], a memorandum consisting of salient features of a prospectus having regulations specified by the Securities and Exchange Board of India (SEBI). A prospectus defined as per section 2(70)[3], is any document describing or issued as a prospectus given as per section 32 as a red herring[4], or shelf prospectus[5] in section 31, or notices, documents, or circulars offered from the public for subscription or purchase of securities of body corporate.

Before the prospectus, securities are offered as a proposal by a company as a red herring prospectus. These prospectuses are issued three days before the Registrar before the opening of the subscription list and the offer. The obligations for the red herring are the same as those applicable to the prospectus. The variations that occur between the red herring prospectus and the prospectus will be highlighted as variations in the final prospectus. When the offer of securities is closed, then the prospectus will have to mention the total capital raised, whether by debt or share capital. If the closing prospectus fails to address the price of closing securities or any other details in red herring then information shall be filed before the Registrar and SEBI.

Official Definition of 'Red Herring Prospectus'

The Red Herring Prospectus provides details of the company that is planning to public. It is a preliminary document that provides information to potential investors and SEBI about the company’s finances, business operations, and its future plans. The term “Red Herring” is displayed on the cover of this document, indicating it is not an offer to sell securities but an invitation to potential investors to express their interests.[6]

Evolution of Red-Herring Prospectus

Till the pre-liberalisation era, the red-herring prospectus was absent due to the Government of India controlling the nation's economy. Later, SEBI introduced a guideline[7] in 1996, where private companies were directed to submit their temporary prospectus before going into the Initial Public Offering (IPO).

With the improvement of technology, the prospectus is easily accessible to people, building transparency and becoming a crucial document due to their periodic amendments bringing requirements disclosed for accurate representation. The changes in the document supported building interest in foreign enterprises to invest in private companies in India.

Legal provision(s) relating to 'Red Herring Prospectus'

Delineating a fair picture of their company in the Red Herring prospectus is imperative. Otherwise, they will undergo consequences for releasing false or non-disclosing information required in the prospectus.

The word Misstatement[8] is defined in the Company Act 2013. There is an explanation of the word in section 447[9], where any act of omission, concealment of facts, abuse of position by a person, or in connivance with a person to gain undue advantage by deceiving any party related to the company, including their shareholders and creditors.

Fraud and Misrepresentation will apply to the criminal liability.  

Criminal Liability

If the information written in the prospectus is false by omission or inclusion, the person authorise will be held liable for the commission of crime. In continuation, section 447 of the Act 2013[10] addresses about the punishment imposed on the offender, minimum is six months and maximum will be of ten years, and fine will range from the amount involving in the fraud to three times.

If the situation arises, where the offence is suppression of facts causing to violate public interest in the preliminary public offer, then the minimum punishment will be three years. Section 441 of the Act 2013[11] states, the offence shall not be compoundable, where the offence is any misstatement in the prospectus.

Civil Liability

The directors, promoters and professionals involved in the prospectus preparation may also be called upon to indemnify third parties who suffered losses because of the false information in the prospectus. If it is intended to evade the public or is meant for an unlawful purpose, all persons conducting the business of issuing such a prospectus may be personally executed for any loss or damage caused by such actions[12].

However, a director or any other individual authorized to be a signatory would be exonerated if within a short period of time after the signing of the red herring prospectus he/she withdraws the consent on the signing of the red herring prospectus. It is of great importance for such persons to publish a notice to the entire public that the prospectus was issued without their approval.

Essentials in the Red Herring Prospectus

Before the submission of the document for the IPO, companies will have to provide essential information[13], which are as follows:

  • Name, Address, and their companies’ structure.
  • The company will need to explain its purpose in raising funds from the initial offering and how the funds are utilised by breaking down the funds allocated to it.
  • They will need to provide financial statements from previous years, including balance sheets, income statements, and cash flow statements.
  • The risk factors include their business, industry, market conditions, potential challenges and uncertainties.
  • The landscape in which the company operates and trends of the market.
  • They will disclose the legal disputes and developments coming up in the material.
  • The credit rating assigned to the company and overview of its debt instruments.
  • The research and development initiatives and their plans.

Procedure to Submit Red Herring Prospectus

Before the Board of Directors approves the red herring prospectus to be submitted before the SEBI for submission. The company appoint intermediaries, such as promoters, lead managers, underwriters, solicitors, and other professionals to issue securities. Apart from that, due diligence conducted on the operations, and financials ensuring an accurate and comprehensive prospectus. In the prospectus, issue price and quantities of securities are excluded, but other information will be available.

The prospectus is filed to the Registrar of Companies (RoC)[14] including the exchange in which the company wants to list their securities. The company will need to clarify the observation queried by the SEBI, after which; the prospectus will be made available to the public for awareness. A notice is published for the public about securities listed in the exchange through different channels, and the company is also permitted to publish information about its securities.

Other Requirements

Private companies will need to adhere to the requirements provided in the Companies Act 1956. If the company discloses additional information, Part A of Schedule VII and Part B and C, respectively, will follow. In another situation, if the company is interested in issuing capital to the public through the book-building process, it will fulfil the requirements in Regulation 57(2)[15] of the SEBI (Issue of Capital and Disclosure Requirement) Regulations 2009.

International Experience

Similarly, in the United Kingdom, under the Financial Conduct Authority (FCA)[16], a pathfinder or draft prospectus serves a similar function, circulated to institutional investors before approval. In jurisdictions like Canada[17] and Australia[18], securities regulators also allow for red herring-style documents, enabling companies to test the waters and revise offering details based on investor feedback. Despite regional regulatory variations, the red herring prospectus globally serves as a key tool for transparency and market engagement during initial public offerings (IPOs).

As Defined in Case Laws

Indowind Energy Limited v. Wescare (India) Ltd. & Ors. Subuthi Pvt. Ltd

Indowind Energy Limited v. Wescare (India) Ltd. & Ors. Subuthi Pvt. Ltd (2010)[19]

In Indowind Energy Limited v. Wescare (India) Ltd. & Ors. Subuthi Pvt. Ltd[19]. (2010), the facts of the case related to a contractual arrangement between Subhuti and Wescare, wherein the arbitration clause hinged on concurrence by all three parties, including Indowind. It was reported that work was done by Subhuti and Wescare, notwithstanding the absence of consent from Indowind. In turn, Subhuti initiated an arbitration proceeding against Indowind, aimed at restraining Indowind's IPO.

The case is important in addressing the liability of underwriters in the IPO process. The function of underwriters relates to structuring, pricing, and distributing securities. The underwriters become liable if they have material undisclosed information or if they do not perform proper diligence. The court mentioned the necessity for specifying ambiguities in the so-called "red herring" prospectuses, especially in the case of referenced agreements where the mention of authorities arose in ascertainable provisions.

References

  1. ↑ https://indiankanoon.org/doc/70888016/
  2. ↑ https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&sectionId=185&sectionno=2&orderno=2
  3. ↑ https://ca2013.com/section-270-prospectus/
  4. ↑ https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&orderno=34#:~:text=(1)%20A%20company%20proposing%20to,subscription%20list%20and%20the%20offer.
  5. ↑ https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&sectionId=1221&sectionno=31&orderno=33#:~:text=(1)%20Any%20class%20or%20classes,period%20of%20validity%20of%20such
  6. ↑ HDFC Bank, What is a red herring prospectus? HDFC Bank Learning Centre. Retrieved from https://www.hdfcbank.com/personal/resources/learning-centre/invest/what-is-a-red-herring-prospectus#:~:text=Synopsis,operations%2C%20and%20its%20future%20plans.
  7. ↑ https://www.sebi.gov.in/sebi_data/commondocs/mutualfundupdated06may2014.pdf
  8. ↑ https://blog.ipleaders.in/red-herring-prospectus-under-company-law/
  9. ↑ https://ca2013.com/447-punishment-for-fraud/
  10. ↑ https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&sectionId=49342&sectionno=447&orderno=503
  11. ↑ https://ca2013.com/441-compounding-of-certain-offences/
  12. ↑ https://ca2013.com/civil-liability-for-mis-statements-in-prospectus/
  13. ↑ https://corporatefinanceinstitute.com/resources/valuation/ipo-initial-public-offering/
  14. ↑ https://www.mca.gov.in/content/mca/global/en/contact-us/roc.html#:~:text=Registrars%20of%20Companies%20(ROC)%20appointed,and%20LLPs%20comply%20with%20statutory
  15. ↑ https://ca2013.com/regulation-57-manner-disclosures-offer-document/
  16. ↑ Financial Conduct Authority. (2021). Prospectus regulation rules. FCA Handbook. https://www.handbook.fca.org.uk/handbook/PRR/
  17. ↑ Canadian Securities Administrators. (n.d.). National Instrument 41-101 – General Prospectus Requirements. https://www.securities-administrators.ca/
  18. ↑ Australian Securities and Investments Commission. (2023). Offering securities: Prospectuses. ASIC. https://asic.gov.au/regulatory-resources/find-a-document/regulatory-guides/rg-254-offering-securities-under-a-prospectus/
  19. ↑ 19.0 19.1 https://indiankanoon.org/doc/997909/
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