In the wake of corporate scandals such as Sino-Forest, securities regulators are reminding brokers of their due diligence obligations when it comes to underwriting securities offerings.
The Investment Industry Regulatory Organization of Canada (IIROC) Thursday published revised guidance for dealers that, it says, “is designed to promote consistency and enhanced standards” for underwriting due diligence. The guidance sets out the elements of the due diligence process; the types of policies and procedures dealers need; and, the required supervisory and compliance framework.
“Due diligence is, by its nature, a fluid and evolving process. It should be customized to be relevant to the particular issuer, the industry in which it operates and the type of security being offered,” the guidance notes. And, it stresses that due diligence should not simply become an exercise in checking boxes.
Regulators have, in the past, found instances of inadequate underwriting due diligence that has resulted in investor harm. Notably, the Ontario Securities Commission’s (OSC) review of emerging market (EM) issuers, in the wake of the collapse of Sino-Forest and other EM firms, found an, “apparent ‘form over substance’ approach to compliance with applicable standards for due diligence practices, and a lack of rigor and independent-mindedness,” the IIROC guidance points out.
It notes that the OSC stressed that underwriters should participate in the offering process for emerging market issuers with a “healthy amount of scepticism regarding management claims.”
“[Dealers] should, therefore, perform due diligence with an open and questioning mind,” it says.
The guidance also notes that the level of due diligence varies depending on the type of deal. For example, it says that initial public offerings and reverse take-overs typically require more due diligence than secondary offerings; that offerings by smaller and/or infrequent issuers also often require more due diligence than offerings from larger, more active firms; and, that equity offerings may require more attention than investment grade debt or highly-rated preferred share deals.
Moreover, when it comes to foreign issuers, the guidance notes that dealers also have to “understand the political and cultural environment in which the issuer operates, local business practices … [and] local laws.” Firms also have to deal with differences in time zones, and language and/or cultural barriers that may affect the quality of the due diligence. “It is important that any red flags be followed up on and escalated to senior investment banking professionals,” it says.
The guidance was developed in consultation with the industry, including dealers with specific expertise in the venture market, and a public comment process earlier this year.
“Capital-raising is essential to a vibrant economy and the professionals who facilitate this important activity play an important role in maintaining fairness and efficiency, and fostering confidence in capital markets,” said Andrew Kriegler, IIROC president and CEO.