Misleading Prospectus and its consequences are explained in a more descriptive manner as follows :
A prospectus constitutes the basis of the contract between the company and the shareholders and therefore it must disclose all material facts (i.e. facts likely to influence the judgement of a prospective investor in deciding whether to take shares or debentures or not) very accurately. It must not misrepresent or conceal material facts and thereby improperly influence and mislead the prospective investor into becoming an allottee of shares or debentures and in consequence suffer loss.
A prospectus containing false, misleading ambiguous or fraudulent statements of material facts, or suppressing material facts, is termed as “misleading prospectus” and in that case a misled investor (original allottee of shares who had relied on the prospectus and not a buyer in the open market) is entitled to proceed against those who misled him.
What is a false or untrue statement? A general commendation, even if too highly coloured, is not a false statement, but to say that something has been done, when it is not so, is a mis-statement of fact. If there is omission of material facts from a prospectus or/and where the statement is ambiguous in the form and context in which it is included, the prospectus shall be deemed to be untrue (Sec. 65).
Hence a prospectus should be honestly framed and should not by any half statement of the truth or ambiguous phraseology give a false impression or mislead the investor, for the whole prospectus is to be read, and if, as a whole, it be misleading, those who issue it cannot escape on the ground that there is not a single statement which, standing alone, can be challenged as false.
A prospectus was issued in 1928 stating that dividends varying from five to eight per cent had been regularly paid over long term of years upto the date of the prospectus, whereas the truth was that the company had been incurring substantial trading losses during the seven years preceding the date of the prospectus and dividends could be paid only out of accumulated earnings in the abnormal war period. It was the that the prospectus was false not because of what it stated, but because of what it did not state and what, as a whole, it implied (Rex vs Kylsant).
The facts of Smith vs. Chadwick also provide a good illustration on the point. The prospectus, in this case, stated that the ‘present value of the turnover’ is £ 10 lakhs per annum. The statement ‘present value of the turnover’ might bear two meanings—’actual produce’ or ‘capable of producing.’ It was held that as the statement is ambiguous —might bear two meanings, one of which i.e. ‘actual produce’ is false, liability for mis-statement cannot be escaped. Lord Blackburn observed, “if they put forth a statement which they knew may bear two meanings one of which is false to their knowledge and thereby the plaintiff putting that meaning on it is misled, they cannot escape by saying ‘he ought to have put the other’.”
It must, however, be observed that in order to call a prospectus a ‘misleading prospectus’ there must be misrepresentation of facts and not of law. For example, if a prospectus represents that the company’s shares will be issued at half of their nominal value, whereas Section 79 prohibits the issue of shares at a discount exceeding ten percent, it is a mis-representation of law and a person deceived by it will have no remedy.