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Sunday, 25 August 2019

Bookrunners face increased liability after World Online IPO ruling

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The horror story that was the IPO of Dutch internet service provider World Online in 2000 may finally have done some good. The slow wheels of justice have finally ground out a verdict that the company and global co-ordinators ABN AMRO Rothschild and Goldman Sachs were guilty of wrongful conduct.

The Dutch Supreme Court gave the final ruling on November 27 and its conclusion also provided some guidance for underwriters on IPOs under current law. The Supreme Court normally just gives its verdict on a particular case, but on World Online it has made a particular effort to make the ruling relevant to the present day and give underwriters an outline of their responsibilities and liabilities.

The €2.9bn World Online IPO was quickly deemed a disaster. The main issue was that Nina Brink, the company's chairman, had sold a large proportion of her stake in the company in December 1999, just three months before the IPO. This fact was noted in the prospectus but the sale price was not. While she had sold her stake at US$6 per share, the March 2000 IPO was priced at €43.

After the flotation, the stock initially rose strongly, thanks to a book that was 22 times covered. It reached €50.20 before easing to €47 in its first week. But it then fell hard as the price at which Brink had sold her shares became public and as other internet stocks such as Lycos Europe and Lastminute.com also fell. The stock was at €30 just two weeks after its debut and by early April 2000 it was even lower, at €13.80.

The lack of disclosure, incomplete information about Brink's career in the prospectus and a flurry of dubious strategic alliance announcements around the IPO were also deemed to have misled investors. The underwriters were deemed to have generated a misleading opening price as the court adopted the "fraud on the market" principle used in the US and Germany.

Duty of care

Underwriters are now clearly subject to a duty of care towards investors on IPOs in the Netherlands, and by implication any other fully-documented securities offering. Lawyers suggest that, as the current interpretation largely relates to European law, underwriters would be wise to adopt the standards across Europe.

Now, underwriters are liable for not only the validity of the contents of a prospectus, but also all statements made by the company during the process. The most challenging aspect of the ruling is that this liability is assumed if publicity unduly "hypes" an issuer. Bankers and lawyers said that an IPO was about selling a company and its business, so it could be hard to avoid what might be construed as "hype".

"For World Online the issue was strategic alliances, but what is a strategic alliance?" asked Tim Stevens, corporate partner at Allen & Overy in the Netherlands. "Lots of companies put out similar releases around their IPOs but they need to be careful. You need to sell the company but not go overboard."

One way underwriters seek to mitigate liability is through listing risk factors in the prospectus. Often, ongoing legal disputes are listed in this section and for some Russian IPOs in recent years the risk factors have constituted a large chunk of the whole prospectus.

The Dutch ruling suggests that even this is not enough. The court rejected the notion that only the prospectus is used to make investment decisions and also said that the average investor could not be expected to read it. Due diligence by the banks ought to ensure that investors were properly informed.

Some bankers welcomed the added clarity, particularly on due diligence.

"Investors can't do due diligence on an IPO. We have to do that and that is why we are paid so much," said one senior originator. "Yet this year I have lost deals purely because of my firm's due diligence standards – which one issuer described as a burden – and other firms pitching on the basis of their lower requirements. You want banks competing on the basis of capabilities, relationship, quality of service, even fees, but not on how lax your underwriting standards are."

Stevens agreed that the ruling should put a stop to that practice. "Those already operating on a higher standard of care for investors should welcome the ruling, while those currently thinking they can cut corners will have to improve quickly," Stevens said.

Guidelines and increased responsibility for underwriters will make class actions much easier to pursue so any slips could quickly lead to investors suing. Bankers should also realise that liability begins from the intention to float and continues into the aftermarket. Exactly how long is unknown, but a ruling on an earlier case determined that it is less than two years.

Owen Wild

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