IIROC Releases Final Guidance on Underwriting Due Diligence
January 6, 2015
On December 18, 2014, the Investment Industry Regulatory Organization of Canada (IIROC) published Rules Notices 14-0299 and 14-0300 in connection with the release of final guidance respecting underwriting due diligence (Final Guidance). The Final Guidance follows IIROC’s publication of proposed guidance respecting underwriting due diligence (Proposed Guidance) on March 6, 2014 and a public comment process. The Final Guidance is designed to promote consistency and enhanced underwriting due diligence standards among IIROC dealers (Dealer Members) by setting out: (i) the elements of the underwriting due diligence process; (ii) the types of policies and procedures needed by dealer firms to support the underwriting due diligence process; and (iii) an appropriate supervisory and compliance framework.
While the Final Guidance has been amended to address certain comments received in the public comment process and from staff of the Ontario Securities Commission, changes from the Proposed Guidance are limited. The key changes in the Final Guidance as well as some additional considerations and best practices raised by IIROC in the Final Guidance are summarized below. We have also provided an overview of certain implications of the Final Guidance.
For a detailed summary of the Proposed Guidance, please refer to our article published on March 17, 2014.
Key Changes in Final Guidance from Proposed Guidance
Underwriters’ “Gatekeeper” Obligations
- As a result of numerous comments received in the public comment process expressing a concern that the use of the term “gatekeeper” in reference to underwriters in the Proposed Guidance may introduce a new and undefined standard of responsibility, the Final Guidance has been revised to clarify that the term “gatekeeper” refers to Dealer Members’ role as important controls on access to capital markets through the underwriting due diligence process.
Due Diligence Plans
- The Final Guidance has been revised to acknowledge that the decision to prepare a formal due diligence plan is a contextual determination and, if the relevant Dealer Members’ policies and procedures adequately set out the matters to be considered, a separate written due diligence plan may not be required for all offerings. The Final Guidance has also been clarified to indicate that each syndicate member does not require an individual due diligence plan.
Syndicate Members and Due Diligence Materials
- The Final Guidance has been revised to indicate that the lead underwriter should provide copies of due diligence materials to those syndicate members that have requested such materials. The Proposed Guidance indicated an expectation that each syndicate member would automatically receive copies of all due diligence materials from the lead underwriter.
Due Diligence Question and Answer (Q&A) Sessions
- The Final Guidance has been revised to indicate that “investment banking professionals with an appropriate level of seniority” should attend due diligence Q&A sessions, rather than “senior investment banking professionals”, as stated in the Proposed Guidance.
Specific Changes/Additions to Suggested Practices
- The Final Guidance has been revised to include: (i) the potential use of materiality thresholds (from both quantitative and qualitative perspectives) and sampling (in the context of large and complex issuers where it may be relatively impracticable, if not impossible, to review all existing documentation) under “Business Due Diligence”; (ii) a recognition from IIROC that limitations may be imposed on participants in the offering process by their governing rules (e.g., the parameters established by the Chartered Professional Accountants of Canada with respect to auditors’ comfort letters and participation in due diligence Q&A sessions); and (iii) a recognition from IIROC that in specific industries (e.g., mining, oil and gas, and technology), where it is not reasonable or economically feasible for a Dealer Member to retain its own experts, it may be appropriate for a Dealer Member to rely on the issuer’s third party experts, subject to appropriate checks and balances.
Application of the Final Guidance to Private Placements
- To emphasize that the Final Guidance has been prepared specifically in relation to Dealer Members’ involvement in public offerings, and to avoid doubt, the Final Guidance has been revised to remove the statement that some aspects of the guidance may be helpful to Dealer Members in connection with private placements. IIROC will leave the decision to Dealer Members regarding the usefulness of the Final Guidance to private placements.
Additional Considerations and Best Practices Raised by IIROC in Final Guidance
Final Guidance Not to Be Interpreted as Creating New Requirements
- IIROC confirmed that the Final Guidance describes common practices and suggestions which may not be relevant or appropriate in every case. The Final Guidance is not intended as a minimum or maximum standard of what constitutes reasonable due diligence. The Final Guidance does not, and is not intended to, create new legal obligations or modify existing ones.
- IIROC reiterated that the Final Guidance is intended to inform its compliance reviews of Dealer Members’ policies and procedures.
Due Diligence Recordkeeping
- IIROC confirmed that it does not believe that the Final Guidance establishes a new or different standard for Dealer Members’ record-keeping obligations when acting as underwriters. Rather, the Final Guidance identifies different ways in which a Dealer Member may comply with these obligations in the context of underwriting due diligence.
- IIROC confirmed that while records of due diligence Q&A sessions are typically retained, this record need not take the form of a recording or transcript.
- IIROC confirmed that while the Final Guidance indicates that the lead underwriter may keep more detailed documentation than other syndicate members, IIROC does not think it is possible or desirable to be more specific as to the record-keeping required of syndicate members given the contextual nature of the Final Guidance.
Role of Syndicate Members and Lead Underwriter
- IIROC emphasized that it understands that syndicate members’ roles may be dependent on the circumstances of the offering and that a syndicate member’s involvement in specific aspects of the due diligence process is a contextual determination.
- With respect to specific practices of the lead underwriter vis-à-vis other syndicate members, such as circulating a written due diligence plan, draft due diligence Q&A questions and any draft or final due diligence report, IIROC confirmed that it believes that it is more appropriate to state the principle that a syndicate member should satisfy itself that the lead underwriter performed the kind of due diligence investigation that the syndicate member would have performed on its own behalf as lead underwriter, without prescribing the manner in which this may be achieved.
Reliance on Due Diligence Conducted in Prior Offerings
- IIROC confirmed that it believes that the appropriate degree of reliance on a prior due diligence investigation is highly contextual, and as a result it did not specifically address this issue in the Final Guidance.
- IIROC has provided two examples of such circumstances in Rules Notice 14-0300: (i) where the Dealer Member has conducted due diligence on an issuer on a prior offering and has maintained a relationship with the issuer, including for example by way of equity research coverage, it may be reasonable for the Dealer Member to rely on information gathered through these other means; and (ii) where the Dealer Member considers relying on due diligence conducted by another firm in a prior offering, the reasonableness of such reliance will depend on a wide range of factors including the time that has passed since the previous offering, the nature of the previous offering, whether the Dealer Member was part of the syndicate on the previous offering, the degree of familiarity that the Dealer Member has with the other firm and its due diligence practices, and the amount of information available to the Dealer Member regarding the due diligence performed by the other firm.
Implications of Final Guidance
- Dealer Members, compliance teams and counsel should review the principles and commentary in the Final Guidance against existing due diligence policies and procedures as the Final Guidance will be used by IIROC in its due diligence compliance reviews going forward.
- Dealer Members should have written policies and procedures as to what due diligence will be undertaken in particular circumstances.
- Each financing requires a due diligence plan appropriate to the particular transaction; however, if a Dealer Member’s policies and procedures adequately set out the matters to be considered, a separate written due diligence plan may not be required for all offerings.
- Dealer Members should have a comprehensive and effective supervisory and compliance framework to ensure compliance with their due diligence policies and procedures.
- If a Dealer Member determines that it should diverge from its policies and procedures in any respect as a result of the circumstances of a transaction, that divergence should be subject to an appropriate supervisory framework and the reasons for that divergence should be clearly documented in the Dealer Member’s record-keeping.
- Record-keeping on the due diligence process should be consistently applied by the Dealer Member for each deal.
- Syndicate members should satisfy themselves that the lead underwriter performed appropriate due diligence including, when deemed relevant, requesting copies of due diligence materials, and there should be open communication within the syndicate about the diligence findings.
- Where practical, underwriters’ counsel and the lead underwriter may wish to convene a meeting or conference call with the entire syndicate, prior to the management Q&A session, to brief the syndicate on the scope of business and legal due diligence and to report on the status and results of the due diligence completed prior to such meeting or call.
- Dealer Members should ensure that investment banking professionals with an appropriate level of seniority attend due diligence Q&A sessions.
- The Final Guidance is not intended to apply to Dealer Members participating in private placements, and it is up to Dealer Members to determine the usefulness of the Final Guidance to exempt offerings.
- In addition to being used by IIROC in its due diligence compliance reviews going forward, the Final Guidance will also likely become the reference point (superseding the Investment Industry Association of Canada’s 2006 Corporate Finance Due Diligence Guidelines and the Ontario Securities Commission’s March 2012 Emerging Markets Issuer Review) for any court or regulatory action surrounding offerings gone bad and steps taken by underwriters to ensure proper disclosure.