IIROC Proposes Guidance on Underwriting Due Diligence


The Investment Industry Regulatory Organization of Canada (IIROC) recently published for comment a proposed guidance note (Proposed Guidance) setting out general principles and specific suggested practices for underwriting due diligence in respect of public offerings. The goal of the Proposed Guidance is to promote consistency and enhanced underwriting due diligence standards. The Proposed Guidance is principally based on current market practices and does not create new legal obligations or prescribe what constitutes “reasonable” due diligence. The deadline for providing comments on the Proposed Guidance is June 4, 2014.
Each firm underwriting a public offering is required to certify that to the best of its knowledge, information and belief the prospectus constitutes full, true and plain disclosure of all material facts relating to the offered securities. A reasonable investigation of the material facts underlying the disclosure in the prospectus allows underwriters to do this responsibly and establish a statutory due diligence defence in the event that the prospectus contains a misrepresentation.
IIROC stresses the underwriter’s role as a gatekeeper to the capital markets and that underwriters should take an approach to due diligence that goes beyond the mere avoidance of liability and mitigation of risk to underwriters. The Proposed Guidance recognizes that due diligence is a fluid and evolving process that should be customized to the issuer, the issuer’s industry and the type of securities being offered, and as such, underwriters must not put “form over substance” in conducting due diligence. Underwriters are expected to use their professional judgment in determining the level of due diligence appropriate to a given offering.
In the Proposed Guidance IIROC repeatedly touches on certain themes, including the need for:
  • proper planning, record keeping and documentation of the diligence process, including the expectation that underwriters have written due diligence policies and procedures in place with which they should be able to demonstrate compliance;
  • due diligence that is responsive to the circumstances of the issuer, including the size, experience, industry and jurisdiction of the issuer’s business and the nature of the transaction and securities;
  • recognition of the distinction between business and legal due diligence and proper delegation to and supervision of counsel performing legal due diligence;
  • conducting business diligence sufficient to understand key internal and external factors affecting the issuer’s business; and
  • responsible supervision of personnel conducting diligence and reasonable reliance on outside experts and (for a syndicate member) the lead underwriter.
The Proposed Guidance is not intended to apply to underwriters participating in a private placement, although IIROC notes that some aspects may be helpful for such offerings nonetheless.
The following summarizes some key features and principles set out in the Proposed Guidance.
Written Due Diligence Policies and Procedures
Underwriters are expected to establish, maintain and apply written policies and procedures relating to all aspects of the underwriting process to help ensure compliance with legal and regulatory standards and prudent management of business risk. Such policies and procedures should promote a contextual approach to due diligence that varies with the facts of each offering.
Individualized Due Diligence Plan for Each Offering
Underwriters should have an overall understanding of the business of the issuer and its industry. They should use this understanding to create a due diligence plan tailored to the circumstances of the offering. Offerings by seasoned, significant and widely followed issuers with whom the underwriter has an ongoing relationship (e.g., as lender or adviser) may require less extensive due diligence, but not in every case. Conversely, more extensive due diligence may be appropriate for smaller or infrequent issuers; emerging markets and other foreign issuers; unusual, complex or significant transactions such as initial public offerings or reverse takeovers; or offerings of unrated or low-rated securities, depending on the level of reliance on the rating that is appropriate in the circumstances.
The due diligence plan should generally include a list and description of the matters to be investigated. The Proposed Guidance attaches a list of matters to consider in preparing a due diligence plan.
Q&A Sessions
A diligence plan should contemplate a Q&A session at appropriate points in the process, for example, prior to public announcement and a “bring down” session prior to pricing of the offering. Underwriters – in conjunction with their legal counsel – should provide the list of questions to the issuer and its advisers with enough lead time to allow them to thoroughly prepare answers prior to a Q&A session. All members of an underwriting syndicate and legal counsel should be given a chance to participate in the session and should be represented by senior personnel. Answers that appear incomplete or evasive should be investigated.
Business Due Diligence
The Proposed Guidance lists a number of common practices that should be considered in an underwriter’s business due diligence review in order to allow an underwriter to understand the business of the issuer and key external and internal factors affecting its business, and to independently verify material facts in the prospectus. An appendix to the Proposed Guidance provides practice points relating to items such as document review, visits to head office and operations sites, interviews with issuer personnel and customers/suppliers, background checks of key personnel and particular “red flags” that should trigger further inquiry.
Legal Due Diligence
Underwriters should understand the boundaries between business due diligence and legal due diligence and ensure that such matters are adequately distinguished so that business matters are not delegated to underwriters’ counsel. Underwriters should adequately supervise legal due diligence and adapt their own review to the findings of the legal review.
Supervision and Reliance
IIROC rules require underwriters to have a comprehensive and effective supervisory framework in place to ensure compliance with internal policies and procedures and legal and regulatory standards. Generally, a senior investment banking professional should be involved throughout the due diligence process and ultimately responsible for its extent and quality. Difficult or unusual issues should be escalated to this professional. Some underwriters may use committees in the oversight role. IIROC is flexible as to how compliance is overseen but stresses that supervisors should have a clear mandate to identify and report non-compliance with due diligence policies.
Underwriters should make a contextual determination as to the extent to which they should rely on expert opinion having due regard to, among other things, the expert’s qualifications, experience, regional expertise, independence and reputation.
In addition, members of an underwriting syndicate are subject to the same liability for misrepresentation under securities law as the lead underwriter. Syndicate members should therefore be satisfied that the lead underwriter has undertaken the kind of due diligence they themselves would have done if acting as lead underwriter. While IIROC states that it does not wish to duplicate responsibilities, it notes that syndicate members should be provided with relevant documents and results in connection with the review and should participate in Q&A sessions.
Record Keeping and Documentation
IIROC emphasizes the importance of maintaining a record of the due diligence process such that underwriters can demonstrate compliance with internal policies, procedures and regulatory and legal standards. IIROC recognizes that industry standards vary. Alternatives to extensive record keeping may be appropriate where underwriters have due diligence policies that are comprehensive and set out a robust supervision and compliance process.
IIROC is soliciting comments on the Proposed Guidance generally and on specific questions set out in the Proposed Guidance. These questions include: whether there are considerations that ought to be described that are specific to certain kinds of offerings or certain issuer industries, whether any further practices should be included in the Proposed Guidance, and whether the Proposed Guidance would be useful for application to private placements.
The comment period ends June 4, 2014.
For further information, please contact:
Christopher Jones         416-863-2704
Michael Hickey              416-863-4318
Chris Barker                  416-863-2710
or any other member of our Capital Markets & Securities Regulation group.


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