SECURITIES REGULATION AND IR

The Investment Industry Regulatory Organization of Canada (IIROC) in March 2014 issued proposed guidance (‘Proposed Guidance’) for the underwriting due diligence process aimed at promoting consistency and enhanced standards among its dealer members in connection with prospectus offerings of securities. Interested parties are invited to provide comments in writing on the Proposed Guidance by June 4, 2014.

Previously, IIROC had identified variations in due diligence practices and recordkeeping among its members and had established an industry advisory committee on underwriting due diligence standards to solicit input regarding current and best practices for underwriting due diligence and to identify any gaps or deficiencies in current practices and ways to address them.

The Proposed Guidance starts from the proposition that underwriters, together with auditors, issuers’ and underwriters’ counsel, other professional experts and exchanges, act as gatekeepers to the capital markets. As gatekeepers, dealer members play a role in protecting investors, fostering fair and efficient capital markets and creating and maintaining confidence in capital markets. In connection with offerings of securities by prospectus, each IIROC dealer member discharges its gatekeeper role by completing a due diligence investigation, participating in the preparation of the required prospectus and certifying the contents of the prospectus.

A dealer member participating as an underwriter in a public offering must sign a prospectus in which the firm certifies 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. Investigation of the material facts underlying the disclosure in the prospectus, otherwise known as due diligence, allows the underwriter to responsibly sign the certificate in the prospectus and further allows the underwriter to demonstrate that it conducted an investigation sufficient to establish a statutory “due diligence defence” in the event that the prospectus, in fact, contains a misrepresentation.

Dealer members also conduct due diligence in connection with private placement offerings as effective due diligence mitigates potential common law liability and reputational risk even if the underwriter has no statutory liability in such offerings.

The Proposed Guidance recognizes that by its nature due diligence is a fluid and evolving process and must be customized to be relevant to a particular issuer, the industry in which the issuer operates and the type of security being offered by the issuer. The Proposed Guidance is not intended as a minimum or maximum standard of what constitutes reasonable due diligence. The Proposed Guidance does not, and is not intended to, create new legal obligations or modify existing legal obligations.

The Proposed Guidance expands on the following key principles:

1. Each dealer member is expected to have written policies and procedures in place relating to all aspects of the underwriting process and to have effective oversight of these activities. These policies and procedures should acknowledge that what constitutes “reasonable” due diligence, for each underwriting, involves a contextual determination.
2. Each dealer member should have a due diligence plan that reflects the context of the offering and the level of due diligence that would be reasonable in the circumstances.
3. Due diligence ‘Q&A’ sessions should be held at appropriate points during the offering process and are an opportunity for all syndicate members involved in the offering process to ask detailed questions of the issuer’s management, auditors and counsel.
4. Each dealer member should perform business due diligence sufficient to ensure that the dealer member understands the business of the issuer and the key internal and external factors affecting an issuer’s business. Each dealer member should use its professional judgment when determining which material facts will be verified independently depending on the circumstances of the financing.
5. Each dealer member should clearly understand the boundary between business due diligence and legal due diligence to ensure that matters that should be reviewed by the underwriter are not delegated to underwriter’s counsel.
6. The extent to which a dealer member should rely on an expert’s opinion is a contextual determination related to the qualifications, expertise, experience and independence, and reputation of the expert.
7. Each syndicate member involved in the offering process is subject to the same liability for any misrepresentation under applicable securities legislation. 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, if it had been the lead underwriter.
8. Each dealer member should document the due diligence process to demonstrate compliance with its policies and procedures, IIROC requirements and applicable securities legislation.
9. Each dealer member is required to have a comprehensive and effective supervisory and compliance framework in place to ensure compliance with policies and procedures, IIROC requirements and applicable securities legislation. A dealer member’s execution of the prospectus certificate should signify that the dealer member has participated in the due diligence process through the appropriate personnel and internal processes.

Underwriting due diligence, like any due diligence, requires the exercise of good judgment. The fact that underwriting due diligence should be appropriately tailored to the situation at hand is not new. The fact that dealer members should document the due diligence process is also not new. By explicitly stating its expectations in the Proposed Guidance, IIROC is, however, identifying that underwriting due diligence is an area of focus and therefore dealer managers would be wise to pay specific attention to the Proposed Guidance to ensure compliance with “best practices”.

Hellen Siwanowicz is a Partner at McMillan LLP.