An Australian regulator’s report highlighting concerns about the quality of due diligence processes in some initial public offerings (IPOs) should be noted by New Zealand issuers.
The report, issued by the Australian Securities and Investments Commission (ASIC), raised concerns about the quality of due diligence processes, particularly among small to mid-sized issuers. It warned that while benefits were evident from a robust due diligence process, poor quality processes carried significant consequences. It also found a large variation in the quality of advisers engaged to assist on due diligence processes.
Given the similarity in securities laws and practice in New Zealand, the Australian report provides useful learnings for New Zealand issuers and advisers.
The report can be found here: ASIC Report 484
Background to the ASIC report
ASIC reviewed the practices and processes adopted by issuers on 12 IPOs carried out in the past two years.
Key ASIC observations
poor due diligence often leads to defective disclosure,
considerable variation in the quality and depth of due diligence,
a number of issuers took a “form over substance” approach, rather than focusing on disclosure,
Board involvement in due diligence is often superficial,
a large quality differential among advisers, particularly lawyers, and
selection of advisers purely on price ignores the risk of potential delays, liability and reputational damage from a poor quality prospectus.
Key ASIC recommendations
ASIC's key recommendations in the report were:
A due diligence process must contain some key elements to ensure that it is robust:
Due diligence oversight (including by the Board).
Active investigation into the information in the prospectus.
Good record keeping of significant issues.
Verification of all material statements.
Post-lodgement review of new issues during the offer period.
Issuers and advisers must apply a "substance over form" approach.
Directors are responsible for ensuring a robust due diligence process has been undertaken.
Appropriate professional and expert advisers should be engaged: competence, skills, knowledge and experience relevant to the prospectus all play a part; price should not be the determinative factor.
Appropriate review by Australian legal counsel of work by foreign legal advisers in emerging markets is critical.
Bell Gully comment – Relevance to the New Zealand market
The report is relevant to New Zealand practice because the applicable securities legislation in Australia is very similar to the current law in New Zealand and the deeper IPO market in Australia has meant that ASIC has had the opportunity to review numerous examples of due diligence practice over an extended period1.
In contrast, to date there have only been four IPOs carried out under the new Financial Markets Conduct Act 2013 (FMCA) in New Zealand since the new legislation come into force on 1 December 2014. Our experience, having acted on three of those four IPOs, is that the due diligence processes have largely replicated the position under the previous Securities Act 1978 regime. One noticeable change has been the greater number of professional advisers who are "members", rather than "observers" of the due diligence committee constituted to oversee the due diligence process. This has probably been a reaction to advisers having potential accessory liability under the FMCA and a view that committee membership may assist a defence to such liability.
New Zealand’s Financial Markets Authority (FMA) has, correctly in our view, expressed its opinion that the level of due diligence carried out by some listed issuers in the context of "same class" follow-on offers under the FMCA has been overly conservative2. It said that existing on-going due diligence processes should mean the issuer is able to run a much more streamlined due diligence process for a "same class" offer3. In the wake of the Australian report, it will be interesting to see whether the FMA publishes any guidance on its view of due diligence in connection with an IPO under the FMCA.
In the meantime, Boards that are currently considering undertaking an IPO should take note of the ASIC report as a helpful reminder of some important matters relevant to designing and implementing their due diligence process.
Due Diligence – A tailored solution necessary
A due diligence approach should be designed by the directors and their advisers for the particular company and IPO in question. A process that is appropriate for a subsidiary of an existing listed issuer may not be appropriate for a start-up technology company comprising only the founders.
The level and type of due diligence will vary for each IPO. A tailored due diligence, rather than a "tick the box" or "one size fits all" process, will help ensure that potential investors are provided with accurate and complete disclosure about the issuer and its business and ensure those with potential liability for defective disclosure are afforded the best chance of having available defences.
A related point is that there needs to be an appropriate balance between the due diligence inquiries and the need to create a record of those inquiries. It is important that appropriate inquiries are made, and that the record-keeping and wider due diligence process is built around, and is responsive to, those inquiries. This approach is necessary to avoid the "form over substance" approach that ASIC is concerned about.
Too commonly IPO due diligence is viewed by issuers as a commodity box simply to be "ticked" and accordingly is a workstream where corners can be cut and costs saved. This thinking needs to change through Boards having a better understanding of the importance of a well-resourced and well-designed due diligence exercise. Advisers have a real part to play in contributing to this better understanding. In this context, we were pleased to see ASIC commenting that issuers should be careful not to allow costs to dictate the parameters of the due diligence inquiries to be made.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.