On December 18, 2014, the Investment Industry Regulatory Organization of Canada (“IIROC”) issued a guidance note (the “Guidance Note”) to its dealer members (“Dealer Members”) respecting underwriting due diligence in public offerings. A draft of the Guidance Note had previously been published for comment in March 2014.
Purpose of the Guidance Note
Due diligence in connection with a public offering is the process by which underwriters take reasonable steps to ensure that all material information is included in the prospectus. During the due diligence process, underwriters investigate the information provided by the issuer for inclusion in the prospectus and verify key material facts. As a result, due diligence is, by its nature, a fluid and evolving process.
The Guidance Note is intended to promote more consistent and enhanced underwriting due diligence standards, and to assist Dealer Members to more effectively perform their role and to ensure the protection of the investing public. Underwriters’ due diligence procedures have long existed to help underwriters guard against liability for misrepresentations contained in a prospectus. However, the Guidance Note acknowledges that the role of due diligence now goes beyond addressing underwriter liability to investors under securities legislation, as underwriters (together with auditors and other professional advisors) act as “gatekeepers” whose activities are critical to fostering fair and efficient capital markets.
Does the Guidance Note Create a New Standard for Due Diligence?
In developing the Guidance Note, IIROC was sensitive to concerns that the Guidance Note could be interpreted as creating new requirements regarding what constitutes a “reasonable” due diligence investigation. As a result, the Guidance Note now explicitly states:
This Guidance Note describes common practices and suggestions which may not be relevant or appropriate in every case. It is not intended as a minimum or maximum standard of what constitutes reasonable due diligence. This Guidance Note does not, and is not intended to, create new legal obligations or modify existing ones.
In response to comments during the comment period, IIROC also softened other language in the Guidance Note, to emphasize that one size does not fit all and that underwriters are expected to make efforts that are appropriate in the context of their specific transaction.
While the Guidance Note is not intended to be construed as a “checklist”, there can be little doubt that it will be utilized by regulators and courts as a starting point in any assessment of an underwriters’ due diligence efforts in connection with a particular transaction. As a result, Dealer Members are strongly urged to reassess their own due diligence procedures to ensure that the animating principles set out in the Guidance Note are addressed.
Key Principles in a Nutshell
The Guidance Note describes a number of common practices and suggestions that may or may not be relevant or appropriate in every case. Nevertheless, the Guidance Note also identifies a number of key principles that should always be addressed by a Dealer Member in the course of conducting due diligence.
1. Policies and Procedures for Underwriting Due Diligence.
A Dealer Member is expected to have written policies and procedures in place relating to all aspects of the underwriting process and to have effective oversight of these activities. These policies and procedures should reflect that what constitutes reasonable due diligence involves, for each underwriting, a contextual determination. One size does not fit all.
2. Contents of Due Diligence Policies and Procedures.
The following matters should be addressed by a Dealer Member’s policies and procedures:
- Due Diligence Plan. A Dealer Member should have a due diligence plan that reflects the context of the offering and the level of due diligence that will be reasonable in the circumstances.
- Question and Answer Sessions. Due diligence “Q&A” sessions should be held at appropriate points during the offering process and are an opportunity for all syndicate members to ask detailed questions of the issuer’s management, auditors and counsel.
- Business Due Diligence. A Dealer Member should perform business due diligence sufficient to ensure that the Dealer Member understands the business of the issuer and the key internal and external factors affecting the issuer’s business. A Dealer Member should use its professional judgement when determining which material facts to verify independently in the circumstances of the transaction.
- Legal Due Diligence. The Dealer Member should also clearly understand the boundary between business due diligence and legal due diligence, to ensure that matters that should be reviewed by the underwriters are not delegated to underwriters’ counsel. A Dealer Member should provide adequate supervision of the legal due diligence performed by underwriters’ counsel.
- Reliance on Experts and Other Third Parties. The extent to which a Dealer Member should rely on an expert opinion is a contextual determination, having regard to the qualifications, expertise, experience, independence and reputation of the expert.
- Reliance on Lead Underwriter. Each syndicate member is subject to the same liability for misrepresentation under securities legislation. A syndicate member should satisfy itself that the lead underwriter performed the kind of due diligence investigation that the syndicate member would have performed on its own behalf as a lead underwriter.
- Due Diligence Record Keeping. A Dealer Member should document the due diligence process to demonstrate compliance with its policies and procedures, IIROC requirements and applicable securities laws.
- Role of Supervision and Compliance. IIROC Dealer Member Rule 38 requires a Dealer Member to have a comprehensive and effective supervisory and compliance framework in place to ensure compliance with policies and procedures, IIROC requirements and applicable securities laws. A Dealer Member’s execution of the prospectus certificate should signify that the Dealer Member has participated in the due diligence process through appropriate personnel and internal processes.
A full copy of the Guidance Note is available here.