Prospectus Liability Insurance Explained

The reality of the ASX is that most listed companies on the exchange are small cap (maybe even micro-cap), while these stand-alone products are priced to an amount that is (usually) not feasible for most of these smaller companies. This is why we recommend each client explore multiple options before deciding to purchase this robust (but expensive) stand-alone insurance product.

Option 1

Purchase a stand-alone multi-year prospectus liability insurance product

Option 2

Add the prospectus liability to the annual Directors & Officers insurance policy

Self-insure

We have broken down these in detail below, but since we don’t recommend self-insuring, we will only focus on the first two options.

These policies are highly customisable and can be purchased for one year all the way up to lifetime coverage. They are comprehensive policies that can be put into the vault until they are needed. So, what is covered and included in a stand-alone prospectus liability insurance policy?

• What does it include?

Prospectus liability insurance protects your company and relevant directors/officers should a claim arise from the prospectus, or the statements made during the roadshows for the IPO. Some possible examples include a mistake in the prospectus, mismanagement, a warranty promised that you could be forced to honour, or incorrect information presented in the marketing packages or roadshows promoting the prospectus. These policies can cover investigations and critical regulatory events.

Cover can also extend to include those who may be exposed to the risks of an IPO, such as: the underwriters, controlling shareholder and even the vendor.

Resulting claims could then require legal defence or public relations consultants to help mitigate the damage, which this specialised insurance can protect you against.

• What are the limitations?

The main limitations of this product are the price and the underwriting appetite of the insurers.

Although the product is extremely comprehensive, there are many cases where the stand-alone prospectus liability insurance product isn’t feasible for the smaller junior public companies, or the insurers are not even willing to provide the option as the company is too small or not yet profitable.

• What are the benefits?

It is a way to ring-fence the exposure related to the prospectus and other documents that can be noted on the policy and does not affect the Directors & Officers insurance.

These policies can be structured to include Lifetime coverage (where the premium is paid outright, and the policy cannot then be cancelled), as compared to attaching it to the annual D&O insurance policy which is subject to renewal each year. The Corporations Act imposes personal liability on directors and other parties for misstatements or omissions in a prospectus, so this provides protection for the full statute of limitations.

Given prospectus liability insurance is specific to the risks associated with the prospectus, it is also beneficial to the many stakeholders for various reasons:

• It can be a multi-year policy to protect the stakeholders up to the statute of limitations
• It will not erode the existing D&O policy in place to cover the standard Directors & Officers exposure
• It can add other interested parties such as the issuing underwriter, advisers to the transaction and the selling and/or controlling shareholder

Many people don’t realise that the prospectus liability exposure can be added on to an existing/new Directors & Officers insurance policy. This option does have some limitations but can be both more suitable and feasible for certain clients.

• How is this done?

We typically add the coverage by way of adding a specific “writeback” to the policy.
This involves noting the actual prospectus document (after it is reviewed by the insurer) which then extends cover for that specific prospectus. Once this is done, the usual exclusions – capital raising exclusion / threshold endorsement – will not apply to the specific prospectus.

• What does it include?

The coverage is essentially the same as the stand-alone Prospectus Liability insurance option, covering the prospectus liability exposure to protect your company and relevant directors/officers should a claim arise from the prospectus, or the statements made during the road shows for the IPO. The examples are the same and include: a mistake in the prospectus, mismanagement, a warranty promised that you could be forced to honour, or incorrect information presented in the marketing packages or roadshows promoting the prospectus. These policies also can cover investigations and critical regulatory events, depending on the policy structure.

• What are the benefits?

The main benefit is that this is a feasible way to obtain insurance for prospectus liability cover.

The reality is that Prospectus Liability insurance is very expensive and many small cap companies cannot afford the large upfront cost for a 6, 7 or lifetime prospectus liability policy and, in many cases, this is the only option available for junior public companies.

In addition to this, many insurers will not offer a stand-alone long-term prospectus liability policy to smaller companies that are not showing profitability (or revenue for that matter) and are only raising smaller amounts of capital (i.e. $5,000,000). With these restraints, there is often not an alternative option when insuring a prospectus liability insurance.

• What are the limitations?

This option is an effective way to obtain insurance for the prospectus liability exposure, but it has its limitations.

This option means that the directors & officers are sharing their D&O insurance policy with the prospectus liability exposure, therefore increasing their chances of exhausting the limit in the event of a major claim. Directors & Officers policy limits are normally structured in a way that the limit does not “reset” during the policy period if it has been exhausted (the occurrence limit being the same as the aggregate limit / no reinstatement).

The other limitation derives from D&O policies being renewable on an annual basis. If there are unforeseen circumstances that cause insurers to non-renew and decline to write the policy, the board will have to self-insure both the Directors & Officers and Prospectus Liability exposure.

This option is also restrictive when it comes to flexibility and the ability to customise the policy to add additional insureds, such as underwriters, vendors and controlling shareholders.

• Taking this into account, these two policies do include similar coverages, such as:

• Damages awarded to claimants
• Legal costs incurred by you and (possibly) the claimants
• Fines and penalties assessed by regulators
• Other expenses associated with the claim

• There are also similarities in the claimants involved:

• Shareholders can issue a suit for misleading or errors & omissions in the disclosure documents or financials.
• Regulatory authorities, who can conduct investigations and initiate claims against directors and officers.
• Creditors, who, if not properly informed about the organisation’s financial position, can target directors for any unpaid debts/funds. This is usually in the event of insolvency/bankruptcy.
• Other sources such as clients, competitors, the entity or organisation, and other directors

An example of a D&O claim would be a shareholder suing the board for a misleading press release during the policy period. For a claim to hit the prospectus liability, it would have to come directly from a misleading statement in the specific prospectus.

• Copy of the Prospectus
• Completed Proposal Form

• Any additional information that explains the details of the transaction and future plans. This can include the corporate presentation, underwriting agreement, etc.

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