When a company decides to go public through an Initial Public Offering (IPO), or raise capital through other securities offerings like Follow-on Public Offerings (FPOs), Rights Issues, or Debt Offerings, it faces significant legal and financial risks. One critical way to mitigate these risks is by opting for a Public Offering of Securities Insurance (POSI) policy. This specialized insurance policy provides crucial protection for companies, their directors, officers, shareholders, and underwriters against liabilities that may arise from misstatements or omissions in the offering documents.

In this article, we will explore the key features of a POSI policy, its need in the context of securities offerings, coverage aspects, real-world examples, and how it differs from Directors & Officers (D&O) insurance policies.

What is a POSI Policy?

A Public Offering of Securities Insurance (POSI) policy is designed to cover the legal liabilities that arise from any errors, omissions, or misstatements made in the prospectus or other securities offering documents. It protects the insured parties, including the company, its directors and officers, underwriters, and selling shareholders, from claims made by investors if they feel misled by the information provided during the securities offering process.

Whether a company is raising funds through an IPO, FPO, Rights Issue, or even international listings like American Depository Receipts (ADRs) or Global Depository Receipts (GDRs), a POSI policy acts as a shield against lawsuits arising from inaccurate or incomplete disclosures in offering documents.

Key Coverage Provided by a POSI Policy

Defense Costs: POSI covers the legal defense expenses incurred by the insured parties if they are sued due to misstatements in the offering documents.

Compensatory Damages: If the court awards compensatory damages to plaintiffs (investors or regulators), the policy provides coverage for these damages.

Prospectus Claims: The policy covers claims arising from misleading information in the prospectus. A "prospectus claim" refers to any actual or alleged act of misrepresentation, omission, or negligence made before or immediately after the prospectus is issued. This claim could result from errors in financial disclosures, misstatements about company operations, or any other inaccuracies that investors relied on during the securities offering.

Who Needs a POSI Policy?

The following entities are typically insured under a POSI policy:

1. Directors and Officers: The senior management of the company, who are often at risk of being held accountable for the contents of the prospectus.

2. The Company: The corporate entity offering the securities.

3. Underwriters: The financial institutions responsible for the issuance and marketing of the securities.

4. Selling Shareholders: Individuals or entities selling their shares during the securities offering.

5. Controlling Shareholders: Major shareholders who are often involved in the process of preparing the offering documents.

Why is POSI Important?

Companies in India, especially those experiencing rapid growth, are increasingly turning to capital markets to raise funds. Whether through equity offerings like IPOs or debt offerings, these companies are required by the Securities and Exchange Board of India (SEBI) to provide a detailed prospectus that outlines all material information regarding the offering. However, preparing these documents with absolute accuracy can be challenging, and any misstatements or omissions could result in severe financial and reputational damages.

Without POSI, directors and officers could face lawsuits from shareholders or regulatory bodies, potentially leading to personal financial liability. Furthermore, penalties for misleading prospectus information are covered under sections of the Companies Act 2013, including:

- Section 34: Criminal liability for misstatements in a prospectus.

- Section 35: Civil liability for misstatements.

- Section 36: Punishment for fraudulently inducing people to invest.

- Section 245: Class action lawsuits initiated by affected investors.

By opting for a POSI policy, companies protect themselves from these risks, ensuring that the costs of legal defense and compensatory damages do not severely impact their finances.

Differences Between POSI and D&O Insurance

While both POSI and D&O (Directors & Officers) insurance policies offer liability protection, there are critical distinctions:

POSI is specific to securities offerings, particularly IPOs or other equity/debt issues, and covers liabilities arising from the prospectus. A POSI policy typically lasts 3-6 years, covering the entire period when claims related to the securities offering are most likely to occur.

D&O insurance provides broader coverage for general wrongful acts committed by directors and officers, which may or may not be related to a specific securities offering. However, a D&O policy does not usually cover underwriters, selling shareholders, or prospectus-related claims in the same comprehensive way as POSI.

Additionally, if a company’s D&O insurance policy is extended to cover IPO-related claims, it may erode the overall liability limit available for other claims, leaving the company exposed to risks outside the IPO process. POSI, on the other hand, is a one-off, non-renewable policy, designed exclusively to cover the period of heightened risk surrounding the public offering.

Exclusions Under a POSI Policy

While POSI provides robust protection, there are certain exclusions to be aware of, including:

• Fraudulent Acts: Claims arising from intentional or fraudulent acts by the insured are not covered.

• Pre-existing Issues: Any claims based on actions that occurred before the policy’s inception are excluded.

• Claims by Insured Parties: Claims made by the insured parties themselves (e.g., directors suing each other) are not covered.

Real-Life Examples of IPO-Related Claims in India

The risks associated with IPOs are not just theoretical. There have been several high-profile cases in India where companies faced significant legal challenges after going public. Some notable examples include:

1. Infosys (2018): Retail investors filed a class action lawsuit against Infosys, alleging that the company's 1999 IPO prospectus contained misleading statements regarding revenues. The case highlighted how liability from IPO-related misstatements can persist for decades after the offering.

2. SREI Infrastructure Finance (2018): Multiple lawsuits were filed against SREI for overstating financials in its IPO documents. The company and its directors were accused of misleading investors, leading to SEBI banning the company from the securities market.

These cases underline the importance of having a POSI policy in place to safeguard against long-tail liabilities that could arise years after the public offering is completed.

Conclusion

A Public Offering of Securities Insurance (POSI) policy is a vital safeguard for companies planning to raise capital through securities offerings. By offering protection against claims of misrepresentation or negligence in offering documents, POSI ensures that companies and their key stakeholders are shielded from financial and reputational damage. Given the complexities and risks involved in public offerings, especially IPOs, opting for a POSI policy should be a priority for companies entering the capital markets.

By understanding the differences between POSI and D&O insurance, and recognizing the exclusions and real-world applications of these policies, companies can make informed decisions to protect themselves in an increasingly litigious financial environment.