Regulators are alarmed that a company could tap the capital markets while on the brink of bankruptcy, and are asking whether by raising funds through unregistered offerings issuers can avoid proper examination before raising capital. Of particular concern to banks' legal and accounting advisers is whether professional advisers on securities issues could be held liable for failing to expose Parmalat's troubles.
Since Parmalat declared bankruptcy on December 24, US regulators have been working with Italian counterparts. Within five days of the declaration, the SEC filed charges of securities fraud against Parmalat Finanziaria in a New York federal court. It is also reported to have widened its investigations to look at the role of the investment banks that helped Parmalat raise up to $1.5 billion over recent years through bond sales to US investors.
The US attorney's office in New York is said to be involved, and the Manhattan district attorney's office is working with Italian regulators on related Parmalat issues.
Rule 144A immunities
At the centre of the controversy are Rule 144A offerings, which enable non-US issuers to raise money in the world's largest domestic capital market by selling unregistered securities to qualified institutional buyers (QIBs) with at least $100 million in assets.
Part of the attraction is that issuers can tap the market quickly if they do not need to wait for registration with the SEC. According to the SEC's complaint against Parmalat, the company sold up to $1.5 billion in notes and bonds in the US between 1998 and 2002.
Following Gustafson v Alloyd in 1995, underwriters of unregistered offerings cannot be sued under section 12(a2) of the 1933 Securities Act, which says that the seller of a security is liable if there are omissions or untrue statements in its sales information. In these circumstances, sellers must prove that they did not know, and could not with reasonable care have known, of the misinformation. Banks are still liable under rule 10b5 of the 1934 Securities Exchange Act, but this imposes a tougher standard under which plaintiffs must prove that the underwriter acted with intentional or reckless negligence.
On registered offerings, by contrast, underwriters can be sued under both Sections 12(a2) and 11 of the Securities Act, as well as Rule 10b5 – and in practice are usually sued under all three. The burden also falls on underwriters to prove that they conducted due diligence on the offering correctly.
Despite this, say lawyers, both underwriters and their legal counsel are cautious about their liabilities on private placements and apply essentially the same levels of care as on registered deals. Nicolas Grabar of Cleary Gottlieb Steen & Hamilton says: "On paper, liabilities are less on 144A offerings than on registered deals, but as a practical matter underwriters conduct themselves similarly in both cases. Most underwriters and lawyers have decided that the differences are not such that they can take a different view on due diligence."
Documentation for a private placement is comprehensive, say lawyers, although it may not include all the details commonly seen in a registered offering. One difference is that non-US issuers may leave out an assessment of their finances under US generally accepted accounting principles (Gaap). The sophisticated investors involved in 144A offerings are assumed to be able to understand and cope with different local accounting standards.
In recent years, approaches to due diligence have changed. Audited information such as regular SEC filings (for foreign-listed issuers this includes annual 20F forms) provides a wealth of details on a company. It also enables parties in some cases to avoid duplicating general due diligence already conducted and to focus their checks on specific deals.
Thus private litigation involving 144A offerings is rare. If problems do arise, QIBs may be inclined to settle their grievances privately with banks. In a case such as Parmalat where the issuer is bankrupt, however, creditors may be more inclined to take an aggressive approach because they fear they are unlikely to receive full compensation through a workout. There is also little room for a private settlement in such a high-profile case. Any complaints brought by the SEC against parties involved in Parmalat's 144A deals could therefore lead to a slew of private litigation.
Comfort letters offer assurance
Underwriters' legal counsel are also highly conscious of their liabilities on 144A offerings. Lawyers typically give banks a 10b5 comfort letter on such deals, which includes an assurance that nothing has come to their attention that would indicate problems. Counsel work on the basis that by doing so they are not liable, assuming they have followed procedures correctly and examined information such as accounting reports thoroughly.
"Based on what has come out so far, it would be difficult to make a case against the banks showing that they knew or should have known that anything was wrong with Parmalat," says Grabar. Ultimately, lawyers and underwriters can only work with the information available to them. If the issuer's management and accountants are determined to hide problems, there may be little that legal or other advisers can do to uncover them.
A spokesperson for the SEC would not comment on investigations. A spokesperson for the US attorney for the southern district of New York also declined to comment on the case. A spokesperson for the Manhattan district attorney said the office is not investigating banks related to the Parmalat case. No banks have been named in the investigation, and there are no implications of wrongdoing by any bank, law firm or accountancy firm.