In July 2016 ASIC (the Australian Securities and Investments Commission) published a report of the key findings of its review into the due diligence practices undertaken by issuers as part of their initial public offerings, and ASIC’s findings make for particularly interesting reading.
‘Due diligence’ is the name given to the process undertaken to identify and confirm the material information in respect of an issuer that is required to be disclosed in the offer documents prepared in connection with an IPO. While the process itself is not statutorily mandated, the requirement to disclose all material information is; and undertaking an efficient and effective due diligence exercise can provide the issuer and those involved in the preparation of the offer documents with a defence from the civil liability provisions under the Financial Markets Conduct Act should the disclosure in those documents be found to be defective.
ASIC’s report, a full copy of which can be found here, is the product of a review of the due diligence processes of 12 IPOs undertaken over the November 2014 to January 2016 period. While the report describes the context in which due diligence is undertaken in the Australian market, we believe the findings and recommendations are equally relevant to the New Zealand marketplace. Among ASIC’s findings and recommendations, the following stood out to us:
- The importance of adopting a ‘substance over form’ approach. ASIC found that a number of issuers adopted a checklist, ‘box ticking’, approach to due diligence, rather than focusing on actual investigation of issues. In our view, this is reflective of a common pitfall of IPO due diligence processes, where responsibility for the investigations is often delegated to advisers without effective and ongoing oversight of the process by directors. In our experience, the most effective and efficient due diligence processes are those undertaken as a collaborative exercise between the company and its advisers, with each party bringing their particular knowledge and experience to bear on the process. This is often best achieved by commencing the process with interviews of the senior management of the issuer, in which all members of the due diligence committee take part (other than perhaps other members of management, who may discourage interviewees from speaking freely). These interviews are particularly useful in identifying and separating out those key areas of the business that drive value or pose risk (and therefore warrant further investigation), from those areas which are likely to be immaterial to investors (and therefore warrant little to no further investigation). The due diligence committee can then determine the appropriate scope and level of due diligence, and direct advisers to undertake investigations accordingly. Those advisers should then report back to the full committee as their investigations progress, to test the materiality and adequacy of their findings and receive further instructions as appropriate. This minimises the likelihood of unnecessary investigations and delays, as well as the related cost.
- Director involvement in the due diligence process. In its review, ASIC observed a number of instances where certain directors had little involvement in the preparation of offer documents before signing off on them. Given that directors are liable at law for any defective disclosure in the offer documents, it is imperative that they engage in the due diligence process and satisfy themselves that a robust and sufficient due diligence process has been undertaken. As ASIC notes, this includes (among other things) making sure that all potential ‘red flag’ issues identified in the due diligence process are followed up and appropriately resolved, as well as directors applying their own skills, knowledge and experience to assess the completeness and accuracy of the statements in the offer documents. In our experience, directors will often provide a unique perspective on the prospects of, and risks facing, an issuer, and accordingly we encourage their early and active participation in the due diligence process.
Undertaking an initial public offering is one of the important and defining steps in a company’s life. Critical to the success of any IPO is getting the disclosure in the offering documentation right, and that in turn relies on running an efficient and effective due diligence process. The length and complexity of the due diligence process will depend on the issuer’s business, but as ASIC notes in its report, engaging appropriate professional and expert advisers can help ensure that the process is as efficient and cost effective as possible. Harmos Horton Lusk is uniquely positioned to assist New Zealand companies that are considering an IPO, having recently advised one of the first initial public offerings to take place under the new Financial Markets Conduct Act regulated offer regime. For more information, contact Tim Mitchelson.