Should the issuer of securities indemnify investors for non-performance or improper performance of the issuer’s obligation to publish truthful and correct information about their financial condition? Does civil liability towards investors arise for audit firms that have audited the issuer’s financial statements? If so, what should the investor prove for the award of damages from the issuer and/or the audit firm?
For the first time in court practice, the Supreme Court of Lithuania (“SCL”) answered all these questions in its ruling passed on 19 November this year, formulating important rules on the professional civil liability of listed companies and their auditors towards third parties. The cassation court agreed with a number of arguments stated by Ellex Valiunas, which represented the company that had performed the financial audit of the issuer, and provided important legal clarifications for any person who is acquiring shares in listed companies to know. In addition, from now on, both issuers and audit firms conducting audits of their financial statements will be able to assess more clearly the circumstances that are significant for their civil liability against investors to arise.
The case of the bankrupt AB Ūkio bankas examined in court
The SCL examined the case pertaining to the claim of the investors of the bankrupt AB Ūkio bankas regarding compensation for the alleged damages from the issuer and the audit company that performed the audit of its annual financial statements.
The plaintiffs in the case who had acquired the bank’s shares sought to show that their investment decisions to acquire and/or hold and not to assign the shares of the issuer that later went bankrupt were due to allegedly incorrect financial statements of the bank and audit report. The SCL rejected such arguments of the investors as unsubstantiated and stated that it is the investor’s responsibility to prove the conditions of an issuer’s civil liability when claiming damages from the issuer, in this particular case to prove that (i) BAB Ūkio bankas’ financial statements were incorrect (illegal actions); that (ii) this misinformation has led or at least contributed to a sufficient degree to investors’ investment decisions (causal link); and that (iii) the relevant investment decisions of the investors have caused losses resulting in the damages claimed (the fact and amount of damages). Only if the investor proves the above conditions, the issuer’s obligation to rebut the presumption of his fault would arise. The SCL did not specify in detail how investors could prove the incorrectness of the financial statements published by the issuer but noted that in this case, the investors did not exercise the right to an expert examination.
A slightly lower standard is set for proving the causal link
A somewhat lower standard has been set for proving the causal link. The SCL stated that the standard of proving a causal link applicable to investors should not be too high. In cases started over investor claims for damages caused by a breach of the duty to disclose information, it is not always possible to prove that every claimant was aware of information that was subsequently found to be untrue and that he made loss-making investment decisions solely on the basis of such information. In such cases, the determination of a causal link could be based on an efficient market theory grounded on the assumption that the price of the company’s shares on the securities market corresponds to all known relevant information about the company. However, such an indirect causation test is appropriate only if the investor is not trying to prove that he personally followed the published allegedly misleading financial statement in making the decision to purchase the shares. On the other hand, a causal link should not be stated in cases where it is found that investors knew or should have known about the inaccuracy of the published information, but ignored this circumstance when making investment decisions.
The limits of the issuer’s civil liability have been clarified
The SCL noted that investing in financial instruments inevitably involves certain specific financial risks, including fluctuations in share prices or the issuer’s insolvency in the case of equity investments. Therefore, the issuer’s civil liability provisions cannot be interpreted and applied in such a way as to pass these risks onto the issuer. The decision not to sell the shares held can be determined by various circumstances, such as investor’s indifference, lack of interest in market changes, lack of demand for the shares held, etc. Thus, in order to recover from an issuer losses incurred in respect of shares of the bankrupt issuer yet at its disposal, the investor must prove not only that the issuer published a false financial statement but also that the investor’s shares could have been successfully sold if other financial statements had been published, thus avoiding the occurrence of relevant losses.
A disciplinary sanction on the auditor does not prove his illegal actions
SCL also commented on the circumstances to be proved regarding the professional civil liability of auditors against third parties. The court found that auditors’ civil liability towards investors could arise only if it is proved that (i) the audit report on the issuer’s financial statements was incorrect; and (ii) that namely this fact influenced the investor’s loss-making investment decisions. In order to prove the inaccuracy of the audit report, it is necessary, among other things, to first prove the inaccuracy of the issuer’s financial statements.
It is very important that the SCL, by the ruling adopted in this case, ended a dispute that had been going on for several years regarding the connection between the disciplinary liability and civil liability of the auditor. Taking into account the arguments of the lawyers, the court emphasized that the imposition of a disciplinary sanction on the audit firm (auditor) does not prove the unlawful actions of the audit firm for its civil liability to arise.
Although the issue of the limitation of auditors’ liability did not arise in the present case, the cassation court also noted that the liability of auditors and audit firms, including group auditors who perform audits of listed companies, should be limited. Lithuanian legislation does not provide for any specific methods of limiting the liability of such auditors; however, the SCL emphasized that in dealing with issues of limitation of auditors’ liability the European Commission’s recommendations of 6 June 2008 concerning the limitation of civil liability of auditors and audit firms could be followed. Limiting the liability of auditors of listed companies towards investors is important for both investors and auditors, therefore we can only hope that this ruling of the SCL will lead to clearly defining the limits of auditors’ liability towards third parties in legal acts.
For more information, please see the SCL ruling of 19 November 2020 in civil case No. e3K-3-290-823/2020.