Australia: ASIC report says due diligence ‘box-ticking' not enough

Last Updated: 4 September 2016
Article by Simone Collignon
Services: Corporate & Commercial
Industry Focus: Agribusiness, Life Sciences & Healthcare

What you need to know

  • ASIC has released a report highlighting common failures in the due diligence processes adopted by companies conducting an IPO. It warns that issuers must adopt a comprehensive due diligence process to avoid defective disclosure in their prospectuses and potential personal liability for the issuer, directors and others.
  • Directors must be actively engaged in the process – a 'box-ticking' approach is not enough.
  • If your company is considering an IPO, or if it is already listed and plans to raise funds under a disclosure document, it is vital that the board engages the right team of advisers and implements a robust due diligence process to reduce the risk of liability and costly delays associated with defective disclosure.

A recent report by the Australian Securities and Investments Commission (ASIC) warns that companies seeking to IPO in Australia must adopt a robust due diligence process to avoid defective disclosure in their prospectuses and potential personal liability for directors, underwriters, advisers and others involved in the preparation of the prospectus.

ASIC has warned that it intends to closely scrutinise IPO prospectuses and issuers' due diligence processes over the course of this financial year, as well as public company fundraising practices generally. It therefore pays to ensure that your company engages the right advisers and heeds ASIC's advice about prospectus due diligence and disclosure.

ASIC review of IPO due diligence

ASIC has reviewed the IPO due diligence practices of 12 companies undertaking IPOs over the past two years and identified a number of key failings. In its report issued last month, ASIC establishes a clear link between poor due diligence practices and defective disclosure in prospectuses.1 ASIC emphasises that an effective due diligence process requires much more than a box-ticking exercise by directors, management and their advisers. Rather, it demands active involvement and engagement by directors, management and their advisers.

An inadequate due diligence process exposes issuers, their directors, underwriters and others to the risk of personal liability in relation to loss suffered by investors and others as a result of defective disclosure in the prospectus. The penalties – both civil and criminal – can be severe.

Due diligence: a quick recap

It is market practice in Australia for companies seeking to IPO (and otherwise conduct fundraisings under prospectuses) to adopt a due diligence process designed to ensure that the prospectus contains accurate information and has not omitted information that is material to investors.

A robust due diligence process is vital for two reasons:

  1. to ensure information presented in the prospectus is accurate, complete and not misleading; and
  2. to enable those involved in the preparation of the prospectus to, if necessary, establish and rely upon the due diligence defence to defective prospectus disclosure.

ASIC's key findings and recommendations

ASIC's report identified the following key issues and recommendations:

Issue Recommendation

1. Poor due diligence often leads to defective disclosure, such as misleading and deceptive statements or statements with no reasonable basis.

Adopt a robust due diligence process that involves:

  • establishing a due diligence committee to oversee the due diligence process;
  • verifying of all material statements made in the prospectus;
  • involving of key management personnel and others involved in the operation of the business;
  • maintaining a key issues list throughout the process; and
  • continuing the due diligence process after lodgement of the prospectus (eg confirmation that no other material issues have arisen since lodgement).

2. The extent of due diligence is varied and often inadequate. ASIC found that:

  • small to mid-sized issuers often chose 'less costly' advisers who were less likely to adopt robust and involved due diligence processes (eg convening a committee meeting but generally doing nothing more);
  • investigating accountants generally demonstrated sufficient financial due diligence procedures and provided a high standard of reporting. By contrast, there was a noticeable difference in the quality of advice and due diligence processes implemented by legal advisers; and
  • there was often poor oversight by Australian legal advisers of due diligence inquiries conducted by foreign advisers in relation to overseas matters.

Engage appropriate professional and expert advisers with the requisite skills and experience. This is important because:

  • the scope and nature of due diligence is often driven by the lawyers, so make sure you have selected a legal team that you can trust to implement and drive a rigorous due diligence process;
  • additional procedures may need to be put in place to ensure all material foreign matters have been properly considered;
  • this will ensure accurate and complete disclosure in the prospectus and mitigate the risk of personal liability for defective disclosure; and
  • this will largely eliminate added costs and delays associated with, for instance, ASIC demanding a supplementary prospectus, extending the exposure period or issuing a stop order.

3. A number of companies adopt a 'box ticking' approach that focuses on form over substance, which ultimately impacts on the quality of information presented in the prospectus.

Ensure the due diligence process is:

  • thoroughly documented, planned and mapped out; and
  • implemented, with the committee members and board regularly referring back to the process set out in the due diligence planning memorandum to ensure it is being followed.

In some instances, directors demonstrated only superficial involvement in the due diligence process and preparation of the prospectus itself – this was evident despite directors being directly liable under the Corporations Act for the contents of the prospectus.

Further, foreign directors appeared less likely to be closely involved or engaged in the due diligence process. In some instances, prospectuses and other important documents were not translated for directors unable to read or speak English.

  • Directors must not only ensure that a robust due diligence process is adopted, but also hold each other, their advisers and management accountable by being actively involved and engaged in the process. This is equally true of overseas directors.
  • In the case of non-English speaking directors, the prospectus and supporting documents must be translated to allow those directors to be properly engaged and involved in the due diligence process.
  • As ASIC Commissioner John Price said following release of the report, "Directors are important gatekeepers in our financial system...The effective performance of a director's role involves much more than compliance 'box ticking'. Rather it requires directors to know their company and employ an enquiring mind."2

It is market practice in Australia for companies seeking to IPO (and otherwise conduct fundraisings under prospectuses) to adopt a due diligence process designed to ensure that the prospectus contains accurate information and has not omitted information that is material to investors.

A robust due diligence process is vital for two reasons:

  1. to ensure information presented in the prospectus is accurate, complete and not misleading; and
  2. to enable those involved in the preparation of the prospectus to, if necessary, establish and rely upon the due diligence defence to defective prospectus disclosure.

ASIC's key findings and recommendations

ASIC's report identified the following key issues and recommendations:

What this means for you

ASIC plans to continue its wide ranging reviews of prospectuses and other aspects of public company fundraising, and the due diligence processes underpinning these activities, with the aim of improving market practice. It has reiterated that it will not be shy in exercising its powers to intervene in an issuer's fundraising by, for example:

  • requiring an amendment to be made to the prospectus
  • extending the exposure period, or
  • issuing a stop order.

These actions can result in delays in the fundraising process, as well as additional costs and reputational damage. It is important to get it right the first time round.

If your company is considering an IPO, or if it is already listed and plans to raise funds under a disclosure document, it is vital for the board to engage the right team and implement a robust due diligence process. Otherwise, there is a real risk of civil and criminal penalties for all involved if the prospectus fails to live up to ASIC's standards for disclosure.

Footnotes

1 A copy of ASIC's Report 484 Due diligence practices in initial public offerings can be accessed at http://asic.gov.au/regulatory-resources/find-a-document/reports/rep-484-due-diligence-practices-in-initial-public-offerings/

2 See http://asic.gov.au/regulatory-resources/corporate-governance/corporate-governance-articles/know-your-company-directors-and-due-diligence/

This article is intended to provide commentary and general information. It should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this article. Authors listed may not be admitted in all states and territories

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Simone Collignon
 
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