On 14 July 2016, ASIC released ASIC Report 484: Due diligence practices in initial public offerings(REP 484).
REP 484 sets out the key findings of ASIC's review of recent IPO due diligence processes - which identifies a correlation between poor due diligence and defective disclosure, and highlights ASIC's concerns regarding current due diligence practices (particularly for small to medium sized IPOs). It also sets out ASIC's suggested approach to IPO due diligence, including its view on the elements of a "robust due diligence process".
We recommend that issuers and advisers involved in IPO transactions carefully consider the findings and recommendations set out in REP 484.
ASIC review of IPO due diligence
Between November 2014 and January 2016, ASIC undertook a systematic review of 12 IPOs ‒ comprising 10 small to medium sized issuers and two large issuers (from a variety of industries).
The process involved reviewing due diligence materials (including due diligence process documents, verification materials and opinions / sign-offs) and interviews with the issuers' officers and advisers (including lead managers, brokers, legal and financial advisers).
From the 12 IPOs that were reviewed, 10 resulted in supplementary disclosure, one was withdrawn and one was subject to a final stop order.
Key findings from the ASIC review
ASIC sets out the following key findings in REP 484, arising from its review of the IPO due diligence processes:
- Correlation between poor due diligence and defective disclosure.
- Considerable variation in due diligence processes adopted (with generally fewer due diligence processes for smaller to medium sized issuers), with reasonable inquiries often lacking.
- Concern with a "check the box" approach to due diligence and failure to focus on prospectus disclosure.
- Superficial involvement by the board of directors of the issuer.
- Poor oversight of due diligence conducted by foreign advisers.
- Inconsistency in the quality of contribution of advisers.
- Cost cutting during due diligence may lead to a defective disclosure, delays and costs (to correct defective disclosure), potential liability (for issuers and directors) and reputational damage.
ASIC's recommended approach to IPO due diligence
ASIC acknowledges there is an absence of previously published guidance on implementing / undertaking due diligence.
In REP 484, ASIC has articulated a suggested approach to IPO due diligence, which is summarised below.
- Implement a robust due diligence process
Issuers should adopt a robust due diligence process, which contains the following elements:
- Oversight ‒ by establishing a due diligence committee, escalating material matters to the board of directors, issuing a final report of the due diligence committee and setting materiality guidance for due diligence investigations.
- Investigation ‒ which includes (but is not limited to) conducting management interviews, director questionnaires, and specific investigations being conducted by accounting, legal, tax and industry experts (as necessary).
- Appropriate record keeping ‒ which involves maintaining a key or significant issues list.
- Verification of all material statements in the prospectus.
- Continuation of due diligence process ‒ the due diligence process should not end on lodgement of the prospectus, but should continue throughout the offer period.
- Substance over form approach
ASIC encourages issuers and their advisers to:
- adopt a thorough and investigative approach to due diligence;
- approach due diligence with rigour and an independent mind; and
- exercise professional judgement to determine the appropriate level of due diligence.
- Director involvement
Directors should be actively engaged in the due diligence process and should not be passive participants. In particular, directors should (amongst other things):
- provide effective oversight to ensure that the due diligence process is implemented and followed;
- apply an independent mind to the due diligence process;
- apply their own skills in assessing prospectus disclosure; and
- ensure that all "red flag" issues are followed up and appropriately resolved.
- Engage appropriate professional and expert advisers
Issuers should appoint appropriate experts and advisers who are competent and have the necessary skills, knowledge and experience that is relevant to the preparation of the prospectus.
- Additional recommendations - emerging market issuers
Australian legal advisers should provide oversight and apply an appropriate level of scepticism to the due diligence work of foreign advisers, and ensure an understanding of the local political, cultural and business practices of the jurisdiction in which the issuer operates.
Language and cultural barriers should also be addressed to enable all directors to effectively participate in the due diligence process.
Implications of REP 484
ASIC has indicated that it intends to conduct wider ranging systematic reviews of due diligence (focusing on different aspects of public company fundraising processes) - with the aim of promoting good market practices for fundraising.
With the release of REP 484 and ASIC's continued focus on due diligence processes:
- We recommend that issuers and advisers review their due diligence processes (and due diligence process documents) ‒ for consistency with ASIC's suggested approach to IPO due diligence.
- Directors need to be more involved in due diligence processes, and consideration should be given to increased director representation on due diligence committees for IPOs.
- Issuers should appoint experts and advisers who have the necessary skills, knowledge and expertise on IPOs. Cost cutting during due diligence may lead to defective disclosure, potential liability (for issuers and their directors) and reputational damage.
ASIC's findings and recommendations support our view that robust due diligence is a critical building block for effective disclosure, liability / risk management and ultimately a successful IPO.