Defective disclosure: FSMA protects holders of shares in dematerialised form

In Omers v Tesco Plc the High Court dismissed an application by Tesco to strike out claims for over £700m brought by two groups of institutional investors alleging that Tesco made untrue and misleading statements, in breach of section 90A Financial Services and Markets Act 2000 (FSMA). The claims relate to Tesco’s profit overstatements, which were revealed in September 2014 and have led to parallel regulatory and criminal proceedings. The proceedings are the first claims to be brought under s.90A and Schedule 10A FSMA, provisions which were introduced to regulate the liability of issuers of UK securities for fraudulent financial reporting.

If successful, Tesco’s arguments would have rendered the provisions for shareholder redress in FSMA ineffective for any shareholder holding their shares in dematerialised form (ie, through CREST or in a custody chain with more than one intermediary), such that they were not the registered legal owners of the Tesco shares. Academic arguments have (since as long ago as an FMLC paper in 2004 ¹) suggested that this might be the correct interpretation of FSMA and recommended that legislative intervention was required. The Law Commission referred to this as an area of uncertainty as recently as August 2019²). This judgment settles that uncertainty; shareholders who hold shares in electronic formats can use statutory protections to claim compensation for defective market disclosure.

A fundamental hole

Mr Justice Hildyard suggested that if Tesco was correct that s.90A did not apply to such shareholdings there was “a fundamental hole in FSMA” as “the provisions enabling investors to vindicate their rights [were] unfit for purpose”. Tesco recognised that its construction would mean there was a fundamental flaw in the FSMA regime for claimants of this sort. However, it claimed that this flaw amounted to a failure of the law to keep abreast with developments in the dematerialised securities market which the court should not seek to bridge with “an impermissible form of judicial legislation”.

The judge readily accepted Tesco’s submissions that the investor at the end of a custody chain did not have any direct proprietary interest in the underlying security; it could not “enforce any rights held in the chain of sub-trusts directly against the issuer”. Authority, such as the Rascals case, suggested that the subject-matter of each sub-trust in the custody chain was only a beneficial interest that the intermediary has and holds on trust. It could not be the underlying securities themselves. Hildyard J noted that in order for “‘custody chains', which by the time of the enactment of FSMA in its latest form had become the market norm and must have been taken to have been in the contemplation of the draftsman”, were to have any legal sustainability the phrase “any interest in securities” must denote something more than a contractual right or economic interest.

He held that the phrase ultimate beneficial owner captured the position of the investor as the ultimate owner of a right to a right held through the custody chain. This right would enable the investor ultimately, even if indirectly, to enjoy the benefit of the bundle of rights represented by the securities. This right to a right amounted to an equitable proprietary right and was sufficient to qualify as an interest in securities conferring standing on such investors to sue under FSMA.

Systemic importance

This judgment brings clarity on a point of systemic importance. The vast majority of shares in the UK are held in a dematerialised form. Had Tesco succeeded, companies’ liability for defective market disclosure would have been greatly narrowed. Instead, the case proceeds towards a trial scheduled for June next year, further delaying Tesco’s ability to put this matter behind them.
The case is another example of the growing trend of overlapping legal proceedings arising from a single event. For more on the unique issues that arise in parallel proceedings, see our website Parallel proceedings: Pathways to solutions.

¹ FMLC, ‘Property Interests in Investment Securities: Analysis of the Need for and nature of Legislation relating to Property Interests in Indirectly held Investment Securities’ (July 2004)
²Law Commission, ‘Intermediated Securities: Call for Evidence’ (August 2019)