Cemile Sultan Bambal

Attorney

30.01.2024

Legal Reports in Initial Public Offering Processes

INTRODUCTION


      The Initial Public Offering (IPO) stands out as a crucial method employed by firms to fulfill their requirements. Through IPOs, firms cater to their needs, while investors channel their savings into capital market avenues. IPOs represent one of the foremost financial mechanisms within capital markets. They enable consumers to partake in economic progress by contributing both capital and economic insight. Additionally, stocks offer a financing avenue for companies during financial hardships. Furthermore, IPOs facilitate the institutionalization and standardization of companies, rendering them easily auditable by the state. As such, IPOs pique curiosity and interest across various segments of society.

        All necessary information regarding the shares offered to the public is disclosed to the public in a clear and comprehensible manner in the prospectus, thus ensuring access to all information for the investors to make decisions. Regarding the issue of whether legal reports should be a part of the prospectus or not, Annex No. 4 of the Listing Directive Application Documents states that in the declaration letter required to be submitted by the independent legal counsel, it is accepted and undertaken that it is known that the legal report will be published as a part of the prospectus of the capital market.

       Companies are required to prepare a compliance report on whether they comply with the corporate governance principles annexed to the Communiqué in their annual reports, and the reasons for this and explanations on the conflicts of interest that this may cause if the corporate governance principles are not complied with. Disclosure of the legal processes within the scope of the production and activities of the companies organized by the legal firm, a legal report stating that the legal status of the company's activities is in compliance with the legislation is required. 

        Within the scope of this study, we have tried to determine the legal framework of the liability arising from legal reports by evaluating whether a legal report is a part of the prospectus or based on the prospectus in initial public offering processes. 

I.
              IPO OF SHARES AND PROSPECTUS 
 
A.   The Concept of Initial Public Offering
 
            The Law and the Communiqué on the Prospectus define an initial public offering as "a general call for the purchase of capital market instruments through any means and the sale realized following such call" (Art. 3/1/(f) of the Law, Art. 4/1/(e) of the Communiqué on the Prospectus).
 
           Firms may need funds for different reasons, such as working capital needs, financing of new investments, and economic conjuncture. The first of these is the money market and the second is the capital markets. Money markets can be defined as the market where those who supply funds with a maturity of less than one year and those who demand funds meet. Capital markets, on the other hand, serve to meet the fund supply and demand of companies with maturities longer than one year. (Ümit ATAMAN, 1999).  In terms of the Capital Markets Law, an initial public offering refers to making a call to the public by any means for the purchase of capital market instruments, inviting the public to join or become a founder of a joint stock company, the continuous trading of shares on stock exchanges or other organized markets, and the sale of shares of publicly traded joint stock companies due to capital increases. (Ünal, 1997).
 
        An initial public offering is one of the methods used by companies to meet their financing needs. The concept of initial public offering is defined in Article 3 of the Capital Markets Law (CMB). Accordingly, the types of initial public offerings can be listed as follows (UŞAKLI, 2010).
 - Making a public call for the purchase of capital market instruments by any means, 
 - Inviting the public to join or become founders of a joint stock company, 
 - Continuous trading of shares on stock exchanges and other organized markets,
 - According to the CMB, it refers to the sale of shares of public joint stock companies due to capital increases.
 
B.    Prospectus to be Prepared for the Initial Public Offering of Shares
 
          Preparation of the prospectus and initial public offering documents and their approval by the board are among the most important steps of the initial public offering process. In the definition of prospectus, it is stated in the Capital Markets Law No. 6362 as "a public disclosure text that includes the financial status and performance of the issuer, its expectations for the future, its activities, the characteristics of the capital market instruments to be issued or traded on the stock exchange, and all information that investors can use to evaluate the rights and risks that these securities will provide". In short, the prospectus is the document containing the information that affects the decisions of the investors on their decision to acquire a capital market instrument (Gürbüz, 2023).
 
       Within the scope of public disclosure, the prospectus can be defined as an important document that contains the most comprehensive information about the companies, enables the public to obtain and receive all necessary positive, negative, financial and legal information about the issuer or public offer, and provides information about the future of the investment. (Kara, 2015).
 
        A prospectus is a public disclosure document that is required to be published in initial public offerings of capital market instruments and applications to be traded on the stock exchange. The prospectus, which is referred to as a public disclosure document under the Law (Articles 3/1-j and 32/1 of the CML), also serves as a means of proof for the allegations of breach of public disclosure principles (GÖZÜYEŞİL, 2019).  The content of the prospectus should include all kinds of information regarding the issuer or public offer and the shares to be offered to the public, which may be effective on the investment decisions of the investors, in a clear and detailed manner. (Çetin, 2014). 
 
II.           THE LINK BETWEEN THE EXPLANATORY STATEMENT AND THE LEGAL EXPERT'S REPORT 
 
A.    Preparation of Legal Experts' Reports within the Scope of the Prospectus 
 
       The main purpose of the principle of public disclosure is to provide investors with information about capital market instruments that may affect their investment decisions. In this way, a secure capital market is created, the management structure is institutionalized, and small investors are protected against company management and controlling shareholders. It aims to create an effective capital market by eliminating injustice and imbalance (İhtiyar, 2006). 
 
      The liability arising from prospectuses and public disclosure documents is regulated in detail by Law No. 6362. Article 32 of Law No. 6362 regulates the liability arising from the damages that may arise before investors due to the fact that the information does not reflect the truth in public disclosure documents in general and in the prospectus in particular, in Article 10. There is no direct reference to legal experts' reports in the Law No. 6362. On the other hand, the concepts of "legal expert report" and "preparers of legal expert report" are not explicitly mentioned in Law No. 6362.
 
      The legal expert report is regulated under the Borsa İstanbul Inc. Listing Directive ("Listing Directive"), which is a secondary regulation of Law No. 6362.  As per Article 8/1 of the Listing Directive, the scope of the legal expert's report is defined as "the absence of significant legal disputes that may affect the production and operation of the company, and in addition to this, the legal status of the company in terms of establishment and operation and the legal status of the shares are in compliance with the legislation to which they are subject, documented with a legal expert's report issued by a legal expert who is not directly or indirectly related to the company.". 
 
      The issues to be examined in the legal expert report are as follows:
- List of the legislation to which the Company is subject, 
- Whether there are any authorizations, licenses, etc. that the company needs to obtain in order to carry out its activities, 
- Whether the resolutions of the Company's Board of Directors and General Assembly are taken in accordance with the meeting and resolution quorums under the Turkish Commercial Code,
 - The list of legal disputes that may affect  the Company's operations and the current and potential impact on the Company's operations if these legal disputes are resolved against the Company, 
- Assets registered in the Company's assets and restrictions on these assets,
- The important clauses of the contracts signed for the execution of the Company's activities and the Company's contracts signed with financial institutions are reviewed.
 
      Pursuant to the Listing Regulation, submission of the legal expert's report to the Exchange as an annex to the prospectus, and the independent legal expert's acceptance and undertaking that the legal expert's report will be published as a part of the prospectus of the capital market instrument, considering the fact that the prospectus published to the public is accompanied by a report that is the basis of the prospectus, that a significant portion of the findings in the legal expert report are also included in the prospectus, that the title of the independent legal expert is referred to in the prospectus and that the prospectus is a whole with its annexes, it is considered that the legal expert report is also an essential and complementary part of the prospectus.
 
       In the declaration letter required to be submitted by the independent legal expert as per Annex No. 4 of the Listing Directive Application Documents, it is accepted and undertaken that it is known that the legal expert's report will be published as a part of the prospectus of the capital market instrument. 
 
B.     Legal Nature of the Public Disclosure Responsibility Arising from the Prospectus
 
             With respect to the liability arising from the prospectus, Article 10 of the Law No. 6362 titled "Persons Responsible for the Prospectus" and Article 32 titled "Liability Arising from Public Disclosure Documents" shall be applied for the matters not regulated in this article. Article 32 of the Law No. 6362 stipulates that the persons stated to be responsible in Article 10 and the signatories of the public disclosure document are responsible for public disclosure. Article 10 of the Law reads as follows: "Issuers are liable for damages arising from incorrect, misleading and incomplete information in the prospectus. In the event that the damage cannot be indemnified from such persons or it is clearly evident that it cannot be indemnified from such persons, the public offerors, the leading intermediary institution intermediating the issuance, the guarantor, if any, and the members of the board of directors of the issuer are liable to the extent that the damages can be attributed to them according to their faults and the requirements of the situation." In the second paragraph of the same article, liability is regulated as follows: "Persons and institutions preparing the reports prepared to be included in the prospectus, such as independent audit, rating and valuation institutions, are also liable for false, misleading and incomplete information contained in the reports they prepare, within the framework of the provisions of this Law." 
 
        Article 32/2 of the Law No. 6362 stipulates that "Persons and institutions such as independent audit, rating and valuation institutions that prepare the reports included in public disclosure documents or prepared on the basis of these documents are also liable under the provisions of this Law." The reports mentioned in this provision should be considered to have been prepared on the basis of other public disclosure documents other than the prospectus. This is because the liability regulation for the reports prepared on the basis of the prospectus is regulated in Article 10 of the Law No. 6362. 
 
          A legal expert report, which is a type of report prepared within the scope of the prospectus, should be evaluated within the scope of the liability stated in Article 10 of the Law No. 6362: "Persons and institutions that prepare reports prepared to be included in the prospectus, such as independent audit, rating and valuation institutions, are also liable for false, misleading and incomplete information contained in the reports they prepare within the framework of the provisions of this Law." In the application of the liability specified in paragraph 32/2 of the same law, the persons who prepare legal reports should not be evaluated within this scope. As a result, Articles 10 and 32 of the Law No. 6362 will be applicable for the public disclosure liability arising from the prospectus for publicly traded companies or companies applying to go public.
 
     Another legislation regulating the responsibility for public disclosure is the TCC. Article 549 of the TCC states that "Those who issue the documents or make the statements, and those who participate in them in the event of their fault, are liable for the damages arising from false, fraudulent, forged, false, untrue, concealing the truth and other unlawfulness of the documents, prospectuses, commitments, declarations and guarantees related to the establishment of the company, increase and decrease of its capital, merger, spin-off, change of type and issuance of securities." Among the documents listed in the article is the prospectus.
 
       Within the scope of the initial public offering process, in addition to the application to be made to the Capital Markets Board to issue capital market instruments, a listing application is made to Borsa Istanbul Inc. for the shares to be listed on the stock exchange. In the initial listing applications to be made to Borsa İstanbul, the information and documents determined by the General Directorate of Borsa İstanbul according to the nature of the capital market instrument and the issuer and published on the Borsa İstanbul website must be submitted to Borsa İstanbul as an attachment to a petition. Additional information and documents may be requested, depending on the nature of the issuance. A legal report prepared by an independent legal expert must also be submitted to Borsa Istanbul during the listing application phase. Pursuant to Article 6 of the Listing Directive, the preparers of the legal report are liable for any inaccuracies in the information contained in the legal report that must be submitted to the Exchange for the listing of the shares to be offered to the public within the scope of the Listing Directive, according to their fault and the requirements of the situation.
 
        The scope and nature of the responsibility of those who are responsible for the reports they prepare are different from those who are primarily and secondarily responsible. Their liability will be limited only to the reports they prepare for inclusion in the prospectus (UÇAR, 2019). 
 
CONCLUSION
 
       There is a life cycle for every business. The beginning of this life cycle starts with the establishment of the business and ends with its liquidation. Businesses need finance to carry their operating structure forward in this life cycle. An important method of meeting these financial needs is through an initial public offering. Thanks to initial public offerings, companies can reach a size that allows them to compete in national and international markets and have a solid financial and corporate structure with the funds provided by investors.
 
      The prospectus is a mandatory document that must be prepared for       all issuances to be realized through an initial public offering or for capital market instruments to be traded on the stock exchange. The prospectus is a document that shapes the investor's investment decision by providing information about the capital market instruments to be offered to the public and the issuer. The prospectus is defined in the Capital Markets Law No. 6362 as follows: "It is a public disclosure text that includes the financial status and performance of the issuer, its expectations for the future, its activities, the characteristics of the capital market instruments to be issued or traded on the stock exchange, and all information that investors can use to evaluate the rights and risks that these securities will provide." A prospectus is a document containing important information that affects investors' decisions to acquire a capital market instrument. 
 
         Pursuant to paragraph 10/2 of Law No. 6362, persons and institutions that prepare reports such as independent audit, rating, valuation, etc. prepared for inclusion in the prospectus are also held liable under the provisions of Law No. 6362 for false, misleading and incomplete information contained in the reports they prepare. Although the legal expert report is not explicitly mentioned in the said paragraph, it is considered that the legal expert report is one of the underlying reports.
 
         In conclusion, when the issues such as the reference to the legal expert's report in the main text of the prospectus, the fact that the findings in the legal expert's report constitute a part of the essential information in the prospectus, and Article 22/2 of the Communiqué are evaluated together, it is possible to consider the legal expert's report as a part of the prospectus.


SOURCES
 
Çetin, N. (2014). Systematic Analysis of the Capital Markets Law No. 6362. 
Gözüyeşil, F. F. (2019). Liability Arising from Prospectus in Capital Markets Law. 
Gürbüz, U. C. (2023). Valuation Methods Used in Determining the IPO Price: Borsa Istanbul Application. Istanbul.
İhtiyar, M. (2006). The Principle of Public Disclosure in Capital Markets. Istanbul.
Kara, M. S. (2015). Liability Arising from Public Disclosure Documents. 
Listing Directive
Poroy/Tekinalp/Çamoğlu, Partnership Law I. 
Uçar, D. (2019). Public Disclosure Responsibility Arising from the Prospectus in initial public offering of Shares. Gazi University Institute of Social Sciences.
Uşaklı, S. M. (2010). The Concept of Initial Public Offerings and Sales Methods Used in Initial Public Offerings. Turkmen Bookstore.
Ümit Ataman, H. K. (1999). Calculation of the Actual Value of Stocks. Türkmen Kitabevi.
Ünal, K. O. (1997). Initial Public Offering Agreements and Contracts in Capital Markets. Gazi University Law Faculty Journal, 1.