On December 18, 2014, the Investment Industry Regulatory Organization of Canada (IIROC) published Guidance Note 14-0299 about conducting due diligence in respect of public offerings (the Guidance Note). The Guidance Note reviews suggested principles for IIROC dealer members to adhere to in conducting due diligence investigations in connection with public securities offerings, and also provides a number of suggested practices for complying with those principles. The stated objective of the Guidance Note is to promote more consistent and enhanced underwriting due diligence standards, to assist dealers to more effectively perform their role, and to ensure the protection of the investing public. From an industry perspective, the Guidance Note provides an excellent initial roadmap for underwriters seeking to comply with IIROC's expectations.
The Guidance Note states that underwriters—together with auditors, issuers' and underwriters' legal counsel, other professional experts, and applicable exchanges—act as "gatekeepers" to capital markets and that dealers and individuals performing due diligence investigations on behalf of dealers should take an approach to due diligence that goes beyond the avoidance of liability and mitigation of risk to dealers. Dealers acting as underwriters are expected to exercise their professional judgment in determining the appropriate level of due diligence to be conducted on a case-by-case basis based on a number of factors including, but not limited to, the nature of the issuer's business, the location of the issuer's operations, the type and size of the offering, whether a prior offering and associated due diligence investigation has been conducted, and the experience and reputation of the issuer's management team.
The Guidance Note details nine principles for underwriters to follow when conducting due diligence in respect of public offerings of securities.
- Each dealer is expected to have prepared written policies and procedures relating to all aspects of the underwriting process, as well as effective oversight of these activities. These policies and procedures should reflect what constitutes reasonable due diligence and involves, for each underwriting, a contextual determination.
- The dealer 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.
- 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.
- The dealer should perform sufficient business due diligence to ensure that the dealer understands the business of the issuer, and the key internal and external factors affecting the issuer’s business. A dealer should use its professional judgment when determining which material facts will be verified independently, depending on the circumstances of the transaction.
- Dealers should clearly understand the boundary between business and legal due diligence to ensure that matters are be reviewed by the appropriate group. Dealers should also supervise the legal due diligence performed by underwriters’ counsel.
- The extent to which a dealer should rely on an expert opinion is a contextual determination, having regard to the qualifications, expertise, experience, independence and reputation of the expert.
- 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 lead underwriter.
- A Dealer Member should document the due diligence process to demonstrate compliance with its policies and procedures, IIROC requirements and applicable securities laws.
- IIROC Dealer Member Rule 38 requires each IIROC 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’s execution of the prospectus certificate should signify that the dealer has participated in the due diligence process through appropriate personnel and internal processes.
The Guidance Note acknowledges that a dealer’s due diligence investigation of an issuer is highly contextual and, once started, may require modification throughout the process. As a result, IIROC acknowledges that not all of the foregoing principles and practices will be applicable or appropriate in every situation, and promotes a contextual approach to due diligence based on the dealer’s professional judgment where dealers do not place form over substance.
In light of the Guidance Note, dealers should consider:
- Working with their internal compliance teams and external counsel to compare their existing due diligence policies and procedures against IIROC's proposals and work to implement appropriate changes as required;
- Meeting with their counsel and other advisors at the beginning of each public offering to prepare a transaction-specific due diligence plan based on a contextual review of the proposed transaction;
- Ensuring record keeping policies are in place and adhered to in order to confirm that the extent and efforts of the due diligence process are appropriately reflected in the dealer’s historical records; and
- Ensuring that the lead underwriter (in the event it is not the dealer) completed appropriate due diligence, relayed appropriate findings to the syndicate and retained a record of those findings.