ASIC puts IPO processes under the microscope, in a new report on due diligence practices (Report 484 – 14 July 2016).

Report 484 is a must-read for those involved in equity capital markets.

ASIC highlights concerns with current due diligence practices in the IPO industry, particularly for small to medium IPOs (which were the focus of its review). Continued scrutiny of diligence practices is likely in light of these findings.

The Report identifies a correlation between poor due diligence and deficient disclosure outcomes. This could leave directors hung out to dry, with no defence to liability.

Helpfully, ASIC provides strong, practical guidance in Report 484 on areas of reform by the industry for the implementation of “good” due diligence.

ASIC Review Process

ASIC has performed systematic reviews of 12 recent IPO’s, leading to a requirement to replace the prospectus in 10 cases, and 2 were withdrawn or stopped.

ASIC delved into due diligence committee materials (DDC minutes, materials supporting the preparation of the prospectus, verification materials and expert’s reports) and interviewed company officers and their legal, corporate and financial advisors. The reviews spanned a wide range of industries, and incorporated 8 reviews of companies in NSW, 2 in Victoria and 2 in Western Australia. The review process is part of normal ASIC practice.

ASIC Key Findings

The key findings of ASIC raise concerns with the conduct of due diligence, particularly by small to mid-sized issuers.

Key Findings of Review Process by ASIC

  • Poor due diligence generally corresponds with poor disclosure.
  • Significant differences in the quality and depth of due diligence.
  • “Box-ticking” is no substitute for a focus on the key due diligence issues.
  • Board involvement in due diligence is often superficial, particularly by foreign directors.
  • Inadequate supervision and testing of work of foreign advisors by local advisors, particularly lawyers.
  • Large quality differential amongst advisors.
  • Selection of advisors purely on price ignores risk of potential delays, liability and reputational damage from a poor quality prospectus.

ASIC Recommendations for Good Due Diligence

ASIC stresses that good due diligence is a win-win for everyone: directors, advisors, management, regulators and investors.

ASIC Recommendations for Good Due Diligence

  1. Due Diligence process must contain some key mechanisms that cannot be overlooked:
    • Due diligence oversight (including by the board).
    • Active investigation.
    • Good record keeping.
    • Appropriate verification.
    • Post-lodgement review of new issues during offer period.
  2. Issuer and risk advisors must apply an active and thorough investigation process: not a “form over substance” or “box-ticking” approach.
  3. Directors cannot stand to one side: they are responsible for ensuring a robust due diligence process.
  4. Issuers should appoint appropriate professional and expert advisors: competence, skills, knowledge and experience relevant to the prospectus all play a part; price should not be the determinative factor.
  5. Appropriate review by Australian legal counsel of work by foreign legal advisors in emerging markets is critical.

What's Next

We think most advisors will review their due diligence planning memorandums and associated documents and processes – ultimately a greater degree of rigour may be required, particularly by small to medium sized issuers and their advisors.

Boards who are currently considering undertaking an IPO should carefully consider the implications of Report 484 in the selection of their legal and financial advisors, and should examine whether the scope of work is sufficient.

The risk analysis process adopted in due diligence by the DDC should specifically address the issues faced by the issuer and not adopt a checklist approach.

Due Diligence Committees for IPOs may be broadened to include more directors.

Companies who employ advisors who undertake more thorough review processes may be rewarded with less ASIC scrutiny.

Cross-border due diligence must contemplate how issues are to be resolved for foreign Board members and other participants, including solving translation issues.

Reliance on an opinion from local counsel in an emerging jurisdiction for due diligence purposes may not be sufficient – further interrogation of the opinion may be required for it to be relied upon.

Report 484 is well drafted and worth a read: