The Australian Securities & Investments Commission (ASIC) has identified a number of weaknesses in Initial Public Offering (IPO) practices in Australia and has proposed a way forward which, if adopted, is likely to influence thinking here.
ASIC has come out with seven key findings, based on a detailed review of 12 IPOs between November 2014 and January this year. Poor due diligence (DD) often leads to defective disclosure.
- DD processes varied among issuers, with small to mid-sized companies demonstrating less effort and commitment, e.g. convening a DD committee but doing nothing more.
- Often a tick box approach was taken which valued form over substance.
- Engagement by the board was often superficial, particularly by overseas directors.
- Oversight by Australian lawyers of DD conducted by foreign advisers was often poor.
- Legal advisers demonstrated a less consistent standard in terms of DD than did investigating accountants.
- Quality, not price, should be the determinant in appointing external advisers and is probably more cost-effective in the long-run as a “well-advised issuer” will be better placed to avoid the risk of expensive delays, future liability and reputational damage from poor quality IPO documentation. ASIC notes: “We have observed that the extent and scope of the due diligence process would usually be reflected in the costs incurred by the issuer”.
There is nothing to prevent the Financial Markets Authority (FMA) undertaking a similar investigation in New Zealand. It has already looked into the DD behind the Gentrack IPO (Chapman Tripp commentary available here).
ASIC’s concerns regarding the quality of DD related mostly to small and medium-sized issuers.
Issuers should ensure:
- oversight of the DD process – establishing a DD committee, providing guidance on a materiality threshold for investigations, ensuring material matters are escalated to the board, providing a final report on the DD and a conclusion on the completeness and accuracy of the offer documents
- active investigation into the information presented in the offer documents, including but not limited to management interviews, director questionnaires and specific investigations by accounting/legal/tax experts as necessary
- verification of all material statements, and
- post-lodgement review of any material developments within the offer period.
The DD process should be thorough and “substance over form” rather than tick-box, and should ensure not only that the offer documents comply with the law but also that they promote informed decision-making by investors.
Directors are responsible for ensuring that the DD process is robust so need to be actively involved. This means: applying an independent mind and their own skills, knowledge and experience to the information presented, questioning management and expert advisers, participating in the verification processes and ensuring all “red flag” issues are followed up.
Those matters which require expert advice should be identified and the appropriate advisers engaged.
Local advisers should provide effective oversight of the DD carried out by foreign legal and other advisers for emerging market issuers. This will require developing a familiarity with the home political, cultural, business and regulatory environment in which the issuer operates.
ASIC is planning to carry out a further review over this year and next year, focusing on different aspects of public company fund raising practices.
It has also served notice to the Australian legal community that it will consider targeted reviews of offers prepared with the support of particular legal advisers where it has observed practices which cause it concern. This reflects ASIC’s view that a prime driver in the quality of an IPO or other offer is the quality of the legal advice available to the issuer.