Breach of disclosure obligations: Case studies
Case notes: Sportsworld Media Group
In September 2001, Sportsworld Media announced that its board
was confident that its results for the year ending June 2002 would
be in line with market expectations of £14.9m to £18m.
A week later, the board duly agreed budgeted profits before tax
for the year of £16.1m. And in the following two months,
Sportsworld made further optimistic announcements – results for the
year would, it said, be in line with market expectations of around
£16m.
On Christmas Eve 2001, the November management accounts were
distributed to senior managers, including the chief executive,
Geoffrey Brown. For some reason, they did not go to the company’s
non-executive directors, who received no management accounts from
September 2001 to January 2002. Those November management accounts
showed that Sportsworld had failed to meet its budgeted profits for
every month in the financial year and had in fact made a
significant loss for the four months ended November 2001. This
meant that to achieve profits of £16.1m for the full year, the
company needed to make profits in the second half that were not in
the budget agreed by the board.
But Sportsworld and Brown expected to see additional profits
from acquisitions in the second half and from adjustments regarding
costs in the management accounts. So they concluded that budgeted
profits for the full year could still meet market expectations,
albeit not in the way they had originally intended.
On January 9, 2002, the company’s financial performance was
discussed at a managers’ meeting at which Brown was present. On
January 21, 2002, Brown and the finance director discussed the
December 2001 management accounts. Both agreed that their
expectations of profit before tax for the year ended June 2002 had
now changed but that further work was needed to understand the
position properly.
On Friday, January 25, 2002, a board meeting was held to discuss
the half-year performance, and the board decided to announce that
the company’s expectation of its profit before tax for the year was
in the £9m to £10m range. On the following Monday, a trading
statement was issued to that effect, and the company’s share price
fell by 61 per cent.
Matters then went from bad to worse and, on February 13, a
further corrective announcement was issued: Sportsworld’s results
for the year would be substantially below the £9m to £10m range.
The company’s share price fell a further 87 per cent. In the space
of just six weeks – from the end of 2001 to the middle of February
2002 – Sportsworld’s market capitalisation had gone from £163.5m to
£2.4m. The company’s shares were suspended in April, and an
administrative receiver appointed.
The FSA concluded that Sportsworld’s delay in making an
announcement from December 24, 2001 (the date the November
management accounts were available) to January 28, 2002 was a
breach of the obligation to disclose, as soon as possible,
information on the performance of the company’s business or on
expectations of that performance. It took the view that the market
would have reacted materially and adversely had it known that, to
deliver the expected full-year profit, Sportsworld was relying on a
much more optimistic second-half performance than had previously
been budgeted for. It mattered little, in the eyes of the FSA, that
the company’s subjective expectations of headline profit had
initially stayed the same; expectations about how the profit would
be phased between the first and second halves of the year had
changed, and that would have had a significant effect on the share
price if the market had known.
Sportsworld was publicly censured for the breach, and the FSA
indicated that if the company had had the resources (by now it was
in receivership) it would have been penalised by a substantial
fine. The FSA concluded that Brown was “knowingly concerned” in the
breach and fined him £45,000. He should, in the FSA’s view, have
brought the change in the expectation of the company’s results for
the year to the attention of the full board and otherwise ensured
that the company complied with its disclosure obligations.
Case notes: Universal Salvage
Universal Salvage had a rolling contract with Direct Line
Insurance for vehicle salvage that could be terminated on three
months’ notice. The contract was responsible for approximately 40
per cent of the vehicles handled by the company and for a
significant proportion of its turnover.
Direct Line put the contract up for tender and, at a meeting on
March 18, 2002, informed Martin Hynes, chief executive of Universal
Salvage, that he had lost the business. The Universal Salvage board
was told of this on March 20, 2002, and written confirmation of
termination was received by the company on March 25, 2002. The
termination was to take effect on June 30, 2002. Universal Salvage
thought this was a negotiating ploy and wrote to Direct Line
raising a number of arguments as to why the contract should
continue. Direct Line undertook to investigate the issues raised.
Nevertheless, on April 16, 2002, Universal Salvage again received a
letter that confirmed the loss.
In the meantime, Universal Salvage had been analysing the
financial impact of the termination, all for a presentation to the
board on Thursday, April 18, 2002. At that board meeting, it was
decided that Hynes should seek advice from the company’s financial
adviser, WestLB, about the loss of the contract and the poor
trading performance the company was experiencing in the final
quarter.
The board meeting ended at 1.00pm. Hynes telephoned WestLB at
4.30pm and again at 5.00pm but his usual contact was unavailable.
Hynes got hold of him the next morning, Friday, and it was agreed
that they would meet on Monday, April 22, 2002. At that meeting,
WestLB advised that an announcement should be made to the market
about the lost contract and the poor trading figures. The
announcement duly followed at 3.45pm on Tuesday, April 23, 2002;
the company’s share price fell by 55 per cent.
The delay of only five working days in announcing the
termination of the contract – from April 16 to April 23, 2002 – was
determined by the FSA to be a breach of the obligation to disclose,
as soon as possible, a major new development in the company’s
business. As from April 16, the company needed to win significant
amounts of new business to sustain previous levels of turnover and
profit, and this, held the FSA, was a material fact, likely to lead
to a substantial movement in the company’s share price. The
authority pointed to the 55 per cent drop in the share price to
support its argument.
In addition, the FSA decided that Hynes was “knowingly
concerned” in the breach as he was the director best placed to take
appropriate steps to ensure that the company notified the market
without delay and he had failed to do so.
The company was fined £90,000; Hynes, £10,000.
Case notes: Pace Micro Technology
On January 8, 2002, Pace announced its interim results but
failed to reveal that its trade credit insurance for future
deliveries to one of its largest customers had been withdrawn. The
FSA judged this to be a breach of the obligation to ensure that
information released to the market is not misleading and does not
omit anything “likely to affect the import” of information already
released.
The regulator held that because two annual reports had
previously stated that a credit insurance programme existed for
large customers, the loss of cover was material and did affect “the
import” of the interim results announcement. It criticised Pace for
not seeking sufficient advice on the matter. (The company had
talked to its financial adviser but not its brokers.)
The FSA also found Pace to be in breach of the obligation to
announce a change to the company’s expectations for its revenue
performance without delay.
The interim results showed that revenue for the year to June 1,
2002 would be broadly similar to the 2001 figure of £524m. On
February 4, 2002, Pace revised its forecast to £455m but failed to
inform the market of the change. The company argued that its
earnings expectations had not changed (because the lost sales would
have produced little or no profit) – and it is earnings, rather
than revenue, that would usually be pricesensitive.
It was not until March 5 that a trading statement was made – by
which time things had deteriorated further and expectations had
fallen to £350m. The news led to a share price fall of 67 per cent
and wiped £462m from the company’s market capitalisation.
The case underlines the need to include all material information
when making announcements. The loss of the insurance cover was not
deemed to be price-sensitive – just material to the matter being
announced.
The FSA accepted that Pace had not acted recklessly or
deliberately but had simply come to the wrong conclusion about what
was material. The company was nonetheless fined a hefty £450,000
for breaching the two rules.
