IIROC Issues Proposed Guidelines Respecting Underwriting Due Diligence

May 26, 2014 | Dwight D. Dee, Sarah Fitzpatrick

Registered dealers should be aware of proposed guidelines for due diligence in connection with prospectus offerings. On March 6, 2014, the Investment Industry Regulatory Organization of Canada (“IIROC”) issued proposed guidance with respect to underwriting due diligence for its Dealer Members (the “Proposed Guidance”).  IIROC previously established an advisory committee to solicit input into current practices on underwriting due diligence and to identify gaps in the current industry practices.   As a result of the committee’s work and additional industry consultation, the Proposed Guidance has been published and is out for comment until June 4, 2014.   We expect that, when finalized, the guidelines will become the standards by which the securities regulatory authorities will evaluate the adequacy of an underwriter’s due diligence procedures.

In the Proposed Guidance, IIROC emphasizes that underwriters, together with their advisors, act as gatekeepers to the capital markets.  Therefore, IIROC believes that the due diligence performed by underwriters should go beyond simply avoiding liability and mitigating risk.  The due diligence that members undertake in connection with a prospectus offering should be viewed as part of the underwriters’ role in protecting investors and fostering confidence in the capital markets.

Of significance, IIROC expects that every underwriter will have written due diligence policies and procedures. The policies and procedures should recognize that what is reasonable due diligence will depend on the context for a particular undertaking. As such, underwriters cannot simply rely on a checklist and must determine what is necessary for a particular undertaking. 

There are eight principles that underwriters should address in their policies and procedures:

1.  Due Diligence Plan

Underwriters should have a due diligence plan for every offering that reflects the context of the offering. The scope of the plan will depend on factors such as the type of offering, whether the issuer is seasoned, and the complexity of the offering.

2.  Due Diligence Q&A Sessions

The due diligence plan should provide for due diligence Q&A sessions at appropriate times. Underwriters should work with their counsel to prepare a list of questions for the issuer’s management and auditors. All syndicate members should also be given the opportunity to participate in and ask questions in the Q&A sessions.

3.  Business Due Diligence

Underwriters should conduct their own business due diligence in order to understand the business of the issuer and the key internal and external factors affecting the business of the issuer. The purpose of the business due diligence is to independently verify key material facts in the prospectus.    Underwriters should where appropriate interview customers, supplies and counterparties and dealers should consider whether any potential limitations on due diligence should be disclosed as risks.

4.  Legal Due Diligence

Dealers should understand the scope of their counsel’s legal due diligence and not delegate business matters which should be verified by the underwriter.   The underwriter must supervise its lawyers in conducting the legal due diligence. The underwriter’s counsel and lead underwriter may wish to brief the underwriting syndicate on the business and legal due diligence prior to the management Q&A session.

5.  Reliance on Experts and Other Third Parties

The extent to which an underwriter should rely on the opinion of an expert or a third party will depend on factors like their qualifications, expertise, experience, independence, and reputation.

6.  Reliance on Lead Underwriter

As a syndicate member is also subject to liability, each syndicate member should satisfy itself that the due diligence performed by the lead underwriter is similar to the kind that the syndicate member would have performed as the lead underwriter. Further, syndicate members should receive copies of all letters, opinions, or memoranda relating to the due diligence investigation.

7.  Due Diligence Record-Keeping

An underwriter should document the due diligence process to demonstrate compliance with its policies and procedures, IIROC requirements and applicable securities laws. The underwriter’s policies should indicate which documents must be kept on file.

8.  The Role of Supervision and Compliance

Pursuant to IIROC Dealer Member Rule 38, Dealer Members must have a comprehensive and effective supervisory and compliance framework in place to ensure compliance with policies and procedures, IIROC requirements and applicable securities laws. Underwriters should use appropriate personnel and internal processes to supervise due diligence.  For instance, the due diligence may be supervised by a senior investment banking professional who is involved throughout the process and is responsible for the quality and extent of the due diligence.

With the Proposed Guidance now out for comment, it is an opportune time for underwriters to commence a comprehensive review of their due diligence practices and policies.  Many dealers will likely require their formal written policies to be updated and revised in light of the Proposed Guidance.  We expect that when the due diligence guidelines are published in final form, IIROC will focus on this area in its future compliance audits for dealer members.


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