Underwriter liability: IIROC‘s guidance on “reasonable“ due diligence

6 minute read
01 January 2015

In the waning days of 2014, the Investment Industry Regulatory Organization of Canada (IIROC) published its final Guidance Note on due diligence by Dealer Members in underwritten public offerings of securities. IIROC stated that its Guidance was designed to promote consistency and enhanced standards by setting out the key elements of the underwriting due diligence process; the types of policies and procedures needed by Dealer Members to support the underwriting due diligence process; and an appropriate supervisory and compliance structure.  Although IIROC was at pains to clarify that the Guidance Note was not intended as a minimum or maximum standard of what constitutes reasonable due diligence nor to create new legal obligations or modify existing ones, underwriters will want to carefully review their existing policies and procedures in light of the Guidance Note. IIROC also specifically noted that the Guidance is intended to inform its compliance reviews of Dealer Members’ policies and procedures.

Substance of the Guidance Note

The Guidance Note has been refined from the draft guidance published in March of 2014 but remains substantially the same. The Guidance sets out nine principles which underwriters should consider in the context of their due diligence of an issuer, including the following:

Business Due Diligence

  • Due diligence should enable the underwriter to understand the business of the issuer and the key internal and external factors affecting the issuer’s business
  • Red flags should be appropriately identified for possible independent verification and further prospectus disclosure

Legal Due Diligence

  • Underwriters’ legal counsel may perform supervised legal due diligence, but business due diligence matters should be reviewed by the underwriters

Reliance on Experts

  • Underwriters should consider the qualifications, expertise, experience, independence and reputation of the expert in order to decide whether or not to rely on the expert’s report or opinion

Syndicate Member Liability

  • Syndicate members are each subject to the same liability under securities legislation and should satisfy themselves that the lead underwriter has adequately carried out the required due diligence investigation

Practical Tips

Revisit Your Policies and Procedures

Dealer Members should revisit their current policies and procedures (of which IIROC has seen considerable variations) and supervisory framework for compliance, and make any necessary updates so as to be ready if and when IIROC’s Business Conduct Compliance personnel arrive to conduct a compliance examination.  Underwriters would be wise to heed IIROC’s warning and reconsider how they conduct due diligence in light of the Guidance, and how such procedures have been documented.

Consider Developing Individual Due Diligence Plans for Each Offering

IIROC suggests that underwriters should have a due diligence plan in place from the outset of an offering that reflects the context of the offering and the issuer’s business so as to tailor the due diligence to the circumstances.  In response to comments, IIROC revised the Guidance to acknowledge that the decision to prepare a formal written due diligence plan is a contextual determination and, if the Dealer Member’s policies and procedures adequately set out the matters to be considered, a separate written plan may not be required for all offerings. IIROC also added the clarification that each syndicate member does not require an individual plan.

Independently Verify Key Material Facts

The goal of the due diligence plan, whether following the Dealer Member’s policies and procedures or drafted specifically for the offering, should be to determine the approach in ensuring prescribed information is included in the prospectus, investigating information provided by the issuer and verifying key material facts. 

Consider Reliance on Third Party Opinions

IIROC has noted that the extent of independent verification for any offering depends on the particular circumstances and in particular that consideration should be given to third party experts’ qualifications, etc. where experts are resident in foreign (and particularly emerging) markets.  By implication, Canadian qualified experts appear to be entitled to a greater degree of deference and reliance under the Guidance Note.

The Guidance Note also now recognizes that practical considerations arise in relation to professional limitations that may impact the ability of auditors or technical consultants to assist in the due diligence review.  Practical considerations also arise with respect to conducting a due diligence review of issuers in industries requiring specialized knowledge, such as mining, oil and gas and technology, where there may be inherent limitations on the Dealer Member’s and its legal counsel’s ability to conduct due diligence in areas requiring technical expertise. In such cases, the Guidance Note suggests that a Dealer Member may seek to retain its own experts or, where it is not reasonable or economically feasible for a Dealer Member to do so, it may be appropriate for a Dealer Member to rely on the issuer’s third party experts, supplemented by appropriate checks and balances.

Closing Thoughts – “Form over Substance”

Much of IIROC’s Guidance Note addresses issues of procedure rather than substance, although IIROC advises that underwriters must not put “form over substance”.  Underwriters are reminded that reasonable due diligence requires the exercise of professional judgment in planning and following through on the due diligence plan, further to their written policies and procedures.  Legal counsel can play an important role in assisting with the due diligence process, but underwriters need to allocate appropriate internal and external resources to conduct “reasonable” due diligence in the circumstances.

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