The Golden Rule, or Golden Legacy

2. Nothing may be stated that is untrue. The obvious limb, and the one that is easiest to prove.

3. Nothing may be so stated as to mislead, even if literally true. This is the limb the phrase exists for. "The company has an order from a public sector undertaking" may be true and still misleading if the order was cancelled last month. Section 34 is drafted to catch exactly this: it applies where a statement is untrue or misleading in form or context in which it is included, or where any inclusion or omission of any matter is likely to mislead.

4. The arrangement must not mislead. Burying a material qualification in a footnote while the claim it qualifies is in bold on the cover offends the rule even though both appear.

Where the rule lives in the Act

Section 26(1) carries the modern disclosure standard. Since 7 May 2018 the contents themselves are specified by SEBI in consultation with the Central Government, with SEBI's existing regulations applying meanwhile, and the surviving clause (c) requires a declaration of compliance with this Act, the Securities Contracts (Regulation) Act 1956 and the SEBI Act 1992. See [What a Prospectus Is, and What It Must Say] and FINDINGS.md section 3.6.

Section 26(5) protects the reader against a dressed up expert: an expert's statement may not be included unless the expert is not and has never been engaged or interested in the formation, promotion or management of the company, has consented in writing, and has not withdrawn that consent before delivery to the Registrar, and the prospectus must say so.

Section 34 enforces the rule criminally, section 35 civilly, and section 36 catches fraudulent inducement even outside a prospectus. Those three have their own chapters.

Section 27: the rule after the money is raised

The golden rule would be worth little if a company could tell the truth in the prospectus and then spend the money on something else. Section 27 closes that gap, and MU's syllabus reaches it through the same topic.

Section 27(1). A company shall not at any time vary the terms of a contract referred to in the prospectus, or the objects for which the prospectus was issued, except subject to the approval of, or authority given by, the company in general meeting by way of special resolution.

The first proviso adds publicity with a reason. The prescribed details of the notice of that resolution to shareholders shall also be published in the newspapers, one in English and one in the vernacular language, in the city where the registered office is situated, indicating clearly the justification for such variation.

The second proviso is a flat prohibition and is easy to miss: such a company shall not use any amount raised through the prospectus for buying, trading or otherwise dealing in equity shares of any other listed company. So prospectus money cannot be turned into a share portfolio.

Section 27(2): the exit. Dissenting shareholders, being those who have not agreed to the proposal to vary the terms of contracts or objects referred to in the prospectus, shall be given an exit offer by promoters or controlling shareholders, at such exit price and in such manner and conditions as SEBI may specify by regulations.

Compare section 13(8), which does the same work for a change of objects while prospectus money is unutilised: special resolution, newspaper and website publication with a justification, and an exit for dissenters. The two sections are deliberately parallel, and an answer that notices the parallel reads well.

A worked example

Palghar Textiles Limited issues a prospectus to raise sixty crore rupees. It states three objects: building a dyeing unit, buying looms, and general corporate purposes. It also refers to a supply contract with a large garment exporter.

A half truth. The prospectus says "the company has a long term supply arrangement with a leading garment exporter". True when written. But the exporter served a termination notice a fortnight before the prospectus was dated, and that is not mentioned. The statement is literally true and misleading in the context in which it is included, which is precisely what section 34 covers, and the omission is one likely to mislead. Every person who authorised the issue is liable under section 447 unless he proves the omission was immaterial or that he had reasonable grounds to believe, and did believe up to the time of issue, that the inclusion or omission was necessary.

Concealment. The prospectus does not mention that the land for the dyeing unit is subject to a pending title suit. That is a material fact a reasonable investor would weigh, so the golden rule is broken by silence.

Varying the contract. A year later the company wants to replace the supply contract referred to in the prospectus with a different one on worse terms. Section 27(1) requires a special resolution. The prescribed details of the notice must be published in one English and one vernacular newspaper in the city of the registered office, with the justification. And section 27(2) requires the promoters or controlling shareholders to offer an exit to shareholders who did not agree, at the price and on the conditions SEBI specifies.

And a flat prohibition. The company has eleven crore rupees of prospectus money left and its treasurer proposes to park it in the shares of a listed cement company. The second proviso to section 27(1) forbids it outright: prospectus money may not be used for buying, trading or otherwise dealing in equity shares of any other listed company. No resolution can authorise it.

Distinctions that carry marks

What this does NOT mean

It does not mean everything must be disclosed. The test is materiality. A prospectus that recited every fact about a company would be unreadable and would conceal by volume.

It does not mean an honest belief is always a defence. Under the proviso to section 34 the belief must be held on reasonable grounds and up to the time of issue.

It does not mean the rule stops at the date of issue. Section 27 keeps the company to the contracts and objects the prospectus described, and section 13(8) keeps it to the objects while the money is unspent.

It does not mean only subscribers can sue. Section 37 allows a suit or any other action under sections 34, 35 or 36 by any person, group of persons or association of persons affected.

Quick revision

• The rule: full, frank and honest disclosure of every material fact; nothing untrue; nothing misleading in form or context; nothing misleading by arrangement or omission.
• The case named for it: New Brunswick and Canada Railway and Land Co. v. Muggeridge. Named without a citation.
• In the Act: section 26(1), contents as SEBI specifies plus the clause (c) declaration; section 26(5), the independent, consenting expert; enforced by sections 34, 35 and 36; complainants defined by section 37.
• Section 27(1): no variation of a contract referred to in the prospectus, or of the objects for which it was issued, except by special resolution; notice details published in one English and one vernacular newspaper in the city of the registered office with the justification; and prospectus money may not be used to buy, trade or deal in equity shares of any other listed company.
• Section 27(2): dissenting shareholders get an exit offer from promoters or controlling shareholders at the price and on the conditions SEBI specifies.
• Parallel: section 13(8) for a change of objects while prospectus money is unutilised.

Test yourself

1. State the golden rule for framing a prospectus. Those who issue a prospectus must make a full, frank and honest disclosure of every material fact. Nothing untrue may be stated, nothing may be stated so as to mislead even if literally true, and nothing material may be concealed or buried.

2. Which provision catches a statement that is literally true but misleading? Section 34, which applies where a statement is untrue or misleading in form or context in which it is included, or where any inclusion or omission of any matter is likely to mislead.

3. What is needed to vary the terms of a contract referred to in a prospectus? A special resolution of the company in general meeting, with the prescribed details of the notice published in one English and one vernacular newspaper in the city where the registered office is situated, clearly indicating the justification: section 27(1) and its first proviso.

4. What must be offered to shareholders who do not agree to such a variation? An exit offer by the promoters or controlling shareholders, at such exit price and in such manner and conditions as SEBI may specify by regulations: section 27(2).

5. May a company invest its unspent prospectus money in the shares of a listed company? No. The second proviso to section 27(1) prohibits a company from using any amount raised through a prospectus for buying, trading or otherwise dealing in the equity shares of any other listed company.

6. Who may take action for a misleading prospectus? Any person, group of persons or association of persons affected by the misleading statement or by the inclusion or omission of any matter, by suit or any other action under sections 34, 35 or 36: section 37.