Proposed Guidance Respecting Underwriting Due Diligence

Transcription

1 Rules Ntice Request fr Cmments Dealer Member Rules Please distribute internally t: Crprate Finance Internal Audit Legal and Cmpliance Senir Management Cntact: Dug Harris General Cunsel March 6, 2014 Prpsed Guidance Respecting Underwriting Due Diligence Executive Summary When acting as an underwriter fr a securities ffering, IIROC Dealer Members play an imprtant rle as ne f the gatekeepers t the Canadian capital markets. IIROC has prepared the attached prpsed guidance (the Prpsed Guidance ) in an effrt t prmte cnsistency and enhanced standards amngst its Dealer Members in the underwriting due diligence prcess. IIROC is requesting cmments n the Prpsed Guidance that describes cmmn practices and suggestins fr underwriting due diligence in the fllwing areas: Dealer Members plicies and prcedures fr underwriting due diligence; due diligence plans; due diligence Q&A sessins;

2 business due diligence; legal due diligence; Dealer Members reliance n experts and ther third parties; syndicate members reliance n the lead underwriter; due diligence recrd-keeping by Dealer Members; and the rle f supervisin and cmpliance in the due diligence prcess. Plicy Develpment Prcess IIROC s Business Cnduct Cmpliance examinatins f Dealer Members engaged in underwriting activities have identified variatins in due diligence practices and recrd-keeping. IIROC established an industry advisry cmmittee n underwriting due diligence standards (the Industry Cmmittee ) t slicit input int the current and best practices fr underwriting due diligence (including thse fferings which invlve emerging market issuers), and t identify any gaps r deficiencies in current practices and ways t address them. The Industry Cmmittee was cmpsed f senir industry representatives frm 21 Dealer Members that undertake underwriting activities. The Industry Cmmittee reflected a crss-sectin f large, medium and small firms with reginal representatin acrss Canada. IIROC staff met with the Industry Cmmittee t cnsult n specific elements relating t the underwriting prcess. T help infrm the dialgue, IIROC staff and the Industry Cmmittee reviewed the Crprate Finance Due Diligence Guidelines prepared by the Investment Industry Assciatin f Canada in 2006 (the IIAC Guidelines ) 1, as well as IIROC s benchmarking f regulatry requirements/guidance frm internatinal jurisdictins. Fllwing its wrk with the Industry Cmmittee, IIROC staff als cnsulted with the Natinal Advisry Cmmittee, the Executive f the Cmpliance and Legal Sectin advisry cmmittee, a grup f western Dealer Members with specific experience in the venture market, the IIAC Small Dealers / Intrducing Firms Cmmittee and a grup f senir securities lawyers wh represent Dealer Members in public fferings. While IIROC gained invaluable insights frm the expertise and experience f the Industry Cmmittee and ther industry grups in the underwriting due diligence prcess, the Prpsed Guidance has been prepared by and reflects the views f IIROC staff. Dealer Members and ther interested parties are requested t prvide cmments n any aspect f the Prpsed Guidance. Cmments shuld be made in writing and delivered by June 4, The IIAC Guidelines were distributed t IIAC s members, but were nt therwise widely publicized. Much f the cntent f the IIAC Guidelines remains relevant and has been incrprated int the Prpsed Guidance. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 2

3 Cmments n the Prpsed Guidance may be delivered by mail, fax r t: Victr Peter Senir Crprate Cunsel Investment Industry Regulatry Organizatin f Canada Suite 2000, 121 King Street West Trnt, ON M5H 3T9 Fax: vpeter@iirc.ca Thse submitting cmment letters shuld be aware that a cpy f their cmment letter will be made publicly available n the IIROC website ( under the heading IIROC Rulebk - Dealer Member Rules Prpsed Plicy ). After cnsidering the cmments n the Prpsed Guidance received in respnse t this Request fr Cmments, IIROC may make revisins t the Prpsed Guidance prir t the issuance f the final Guidance Ntice. The text f the Prpsed Guidance is set ut in Appendix A. Underwriting Due Diligence Underwriters, tgether with auditrs, issuers and underwriters legal cunsel, ther prfessinal experts and exchanges, act as gatekeepers t capital markets. When acting as an underwriter fr an ffering f securities, IIROC Dealer Members and their fficers, emplyees, with assistance frm underwriters cunsel and ther expert advisrs, discharge their gatekeeper rle by cmpleting a due diligence investigatin, participating in the preparatin f a prspectus and certifying the cntents f the prspectus activities that are critical t fstering fair and efficient capital markets. In legal terms, each Dealer Member participating as an underwriter f a public ffering must sign a prspectus in which the firm certifies that, t the best f its knwledge, infrmatin and belief, the prspectus cnstitutes full, true and plain disclsure f all material facts relating t the ffered securities. 2 An investigatin f the material facts underlying the disclsure in the prspectus due diligence allws the underwriter t respnsibly sign the certificate in the prspectus, and further allws the underwriter t demnstrate that it cnducted an investigatin sufficient t establish a statutry "due diligence defence" in the event that the prspectus, in fact, cntained a misrepresentatin. In the case f private placements, althugh the Dealer Member as placement agent has n statutry liability, effective due diligence mitigates ptential cmmn law liability and reputatinal risk. The 2 Emphasis added. This is in cntrast t the prspectus certificate signed n behalf f the issuer, in which the issuer certifies withut qualificatin that the prspectus cnstitutes full, true and plain disclsure f all material facts relating t the ffered securities. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 3

4 Prpsed Guidance is nt intended t apply t Dealer Members participating in private placements, althugh sme aspects f it may be helpful t Dealer Members. As gatekeepers t the capital markets, Dealer Members and individuals perfrming due diligence investigatins n their behalf shuld take an apprach t due diligence that ges beynd the avidance f liability and mitigatin f risk t Dealer Members. Dealer Members, tgether with ther gatekeepers, play a rle in prtecting investrs, fstering fair and efficient capital markets and creating and maintaining cnfidence in capital markets. Due diligence is, by its nature, a fluid and evlving prcess. It shuld be custmized t be relevant t the particular issuer, the industry in which it perates and the type f security being ffered. Underwriters must nt put frm ver substance and are expected t exercise prfessinal judgment t determine the apprpriate level f due diligence in each set f circumstances. The Prpsed Guidance expands n the fllwing key principles: Each Dealer Member is expected t have written plicies and prcedures in place relating t all aspects f the underwriting prcess and t have effective versight f these activities. These plicies and prcedures shuld acknwledge that what cnstitutes reasnable due diligence invlves, fr each underwriting, a cntextual determinatin. The Dealer Member shuld have a due diligence plan that reflects the cntext f the ffering and the level f due diligence that will be reasnable in the circumstances. Due diligence Q&A sessins shuld be held at apprpriate pints during the ffering prcess and are an pprtunity fr all syndicate members t ask detailed questins f the issuer s management, auditrs and cunsel. The Dealer Member shuld perfrm business due diligence sufficient t ensure that the Dealer Member understands the business f the issuer and the key internal and external factrs affecting the issuer s business. A Dealer Member shuld use its prfessinal judgment when determining which material facts will be verified independently depending n the circumstances f the transactin. Dealer Members shuld clearly understand the bundary between business due diligence and legal due diligence, t ensure that matters that shuld be reviewed by the underwriters are nt delegated t underwriters cunsel. The extent t which a Dealer Member shuld rely n an expert pinin is a cntextual determinatin, having regard t the qualificatins, expertise, experience, independence and reputatin f the expert. Each syndicate member is subject t the same liability fr any misrepresentatin under securities legislatin. A syndicate member shuld satisfy itself that the lead underwriter perfrmed the kind f due diligence investigatin that the syndicate member wuld have perfrmed n its wn behalf as lead underwriter. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 4

5 A Dealer Member shuld dcument the due diligence prcess t demnstrate cmpliance with its plicies and prcedures, IIROC requirements and applicable securities laws. IIROC Dealer Member Rule 38 requires each Dealer Member t have a cmprehensive and effective supervisry and cmpliance framewrk in place t ensure cmpliance with plicies and prcedures, IIROC requirements and applicable securities laws. A Dealer Member s executin f the prspectus certificate shuld signify that the Dealer Member has participated in the due diligence prcess thrugh apprpriate persnnel and internal prcesses. The Prpsed Guidance describes cmmn practices and suggestins which may nt be relevant r apprpriate in every case. It is nt intended as a minimum r maximum standard f what cnstitutes reasnable due diligence. The Prpsed Guidance des nt, and is nt intended t, create new legal bligatins r mdify existing nes. Next Steps Registratin Regime Prir t the implementatin f Natinal Instrument Registratin Requirements, Exemptins and Onging Registrant Obligatins and related registratin refrm amendments made t IIROC's Dealer Member Rules (cllectively Registratin Refrm ), any individual wh was designated as an fficer under a by-law r similar authrity f an investment dealer was required t seek registratin in the individual IIROC apprval categry f Officer and cmplete the Partners, Directrs and Senir Officers Curse. As a result, the IIROC Officer apprval categry histrically encmpassed many individuals invlved in investment banking and crprate finance activity at their firms, including supervisry persnnel, as these individuals tended t be crprate fficers at their firms. With the implementatin f Registratin Refrm, IIROC simplified and streamlined its Officer apprval categry and replaced it with the new Executive apprval categry. The new Executive apprval categry is intended t encmpass thse individuals wh have a significant influence n a Dealer Member and, in particular, thse wh frm part f the s-called mind and management f the firm, tgether with sme ther specific rles at the Dealer Member which are deemed t be included in the Executive categry. As a result f these refrms, many individuals invlved in investment banking and crprate finance were de-registered. Since Registratin Refrm sme firms have sught, hwever, IIROC apprval fr thse individuals verseeing investment banking and crprate finance activities at their firm in the Supervisr apprval categry, but this apprach has nt been cnsistently pursued by all firms. IIROC is reviewing the registratin regime as it relates t individuals invlved in investment banking and crprate finance activities, including Supervisrs, and will publish any prpsed changes fr public cmment. Business Cnduct Cmpliance Examinatins IIROC s Business Cnduct Cmpliance examinatins f Dealer Members plicies and prcedures relating t underwriting due diligence have revealed cnsiderable variatins. In sme cases, Dealer Members plicies and prcedures described nly ne standard prcess and nly basic categries f IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 5

6 infrmatin t be included, regardless f the nature f the underwriting. In ther cases, the plicies and prcedures cntemplated varying degrees f due diligence investigatin and supervisin, based n the risk factrs f particular fferings. Ging frward, cnsistent with the tp-dwn, risk-based apprach adpted by IIROC cmpliance units, cmpliance examinatins will fcus n the adequacy f a Dealer Member s plicies and prcedures and whether the prcess has been fllwed in sampled files. The results f the examinatins will infrm further ptential plicy develpment by IIROC in this area. Private Placements The Prpsed Guidance is nt intended t apply t Dealer Members participating in fferings cnducted in reliance n ne r mre exemptins frm the prspectus and/r registratin requirements ( private placements ), as the Prpsed Guidance is fcussed n due diligence in public fferings. Hwever, the exempt market is a significant cmpnent f Canada s capital market. Fr example, in 2012 initial public fferings raised apprximately $1.8 billin n Canadian equity markets 3 and $56.5 billin in equity capital was raised n the TSX and TSXV 4, while in the same year apprximately $143 billin was raised in Ontari alne in reliance n exemptins frm the prspectus requirement. In 2011, apprximately $73 billin was raised in Ontari in reliance n the accredited investr exemptin alne. 5 During its cnsultatins, IIROC received cmments cncerning the desirability f enhanced standards in ther cntexts, including private placements, and that sme aspects f the Prpsed Guidance may be helpful t Dealer Members in this cntext. It must be recgnized, hwever, that IIROC Dealer Members are nt the nly market intermediaries participating in such fferings (e.g., Exempt Market Dealers als have significant invlvement in private placements). IIROC believes that investrs shuld be affrded the same level f prtectin frm due diligence regardless f which type f registrant is invlved. Questins While cmment is sught n all aspects f the Prpsed Guidance, IIROC specifically requests respnses n the fllwing questins: 1. Are there any further practices fr Dealer Members cnducting underwriting due diligence that shuld be included in the Prpsed Guidance? 2. Are there ther cnsideratins unique t specific types f public fferings, such as bught deals r debt fferings, r public fferings by issuers in specific types f industries (e.g., mining, il and gas, technlgy)? 3 PwC, Survey f Canadian IPO Markets January 2012 December TSX, MIG Reprt (December 2012). 5 Davies Ward Phillips & Vineberg, Canadian Capital Markets Reprt Lking Back, Lking Frward 2013 (April 2013). IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 6

7 3. Are there ther circumstances that cnstitute red flags indicating that heightened due diligence and/r enhanced disclsure may be apprpriate (fr example, fferings by emerging market issuers)? 4. The Prpsed Guidance is nt meant t re-allcate r result in duplicatin f the respnsibilities fr due diligence as between the lead underwriter and a syndicate member. When acting as a syndicate member, d Dealer Members feel there are sufficient pprtunities and adequate prcesses t allw them t discharge their respnsibilities? 5. Is the Prpsed Guidance useful fr general applicatin t private placements, r shuld there be cnsistent standards fr all market intermediaries, including Dealer Members and Exempt Market Dealers, participating in private placements in rder t affrd investrs the same level f prtectin frm due diligence regardless f which type f registrant is invlved? IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 7

8 Appendix A Text f Prpsed Guidance Rules Ntice Guidance Nte Dealer Member Rules Please distribute internally t: Crprate Finance Internal Audit Legal and Cmpliance Senir Management Cntact: Dug Harris General Cunsel dharris@iirc.ca 14-0*** ### *, 2014 Guidance respecting underwriting due diligence 1. Intrductin 1.1. The Rle f Underwriters in Public Offerings Underwriters, tgether with auditrs, issuers and underwriters legal cunsel, ther prfessinal experts and exchanges, act as gatekeepers t capital markets. When acting as an underwriter fr an ffering f securities, IIROC Dealer Members and their fficers, emplyees, with assistance frm underwriters cunsel and ther expert advisrs, discharge their gatekeeper rle by cmpleting a due diligence investigatin, participating in the preparatin f a prspectus and certifying the cntents f the prspectus activities that are critical t fstering fair and efficient capital markets. In legal terms, each Dealer Member participating as an underwriter f a public ffering must sign a prspectus in which the firm certifies that, t the best f its knwledge, infrmatin and belief, the prspectus cnstitutes full, true and plain disclsure f all material facts relating t the ffered

9 securities. 1 An investigatin f the material facts underlying the disclsure in the prspectus due diligence allws the underwriter t respnsibly sign the certificate in the prspectus, and further allws the underwriter t demnstrate that it cnducted an investigatin sufficient t establish a statutry "due diligence defence" in the event that the prspectus, in fact, cntained a misrepresentatin. In the case f private placements, althugh the Dealer Member as placement agent has n statutry liability, effective due diligence mitigates ptential cmmn law liability and reputatinal risk. This Guidance Nte is nt intended t apply t Dealer Members participating in private placements, althugh sme aspects f it may be helpful t Dealer Members. As gatekeepers t the capital markets, Dealer Members and individuals perfrming due diligence investigatins n their behalf shuld take an apprach t due diligence that ges beynd the avidance f liability and mitigatin f risk t Dealer Members. Dealer Members, tgether with ther gatekeepers, play a rle in prtecting investrs, fstering fair and efficient capital markets and creating and maintaining cnfidence in capital markets IIROC Dealer Member Rules and Statutry Prvisins Applicable t the Underwriting Functin IIROC Dealer Member Rule 29 sets ut the general requirement that each Dealer Member and each partner, directr, fficer, supervisr, registered representative, investment representative and emplyee f a Dealer Member must bserve high standards f ethics and cnduct in the transactin f their business and must nt engage in any business cnduct r practice which is unbecming r detrimental t the public interest. Other sectins f Dealer Member Rule 29 set ut mre specific business cnduct requirements fr Dealer Members invlved in a distributin f securities (fr example Dealer Member Rule n pre-marketing) and Dealer Member Rule sets ut certain margin requirements when engaging in underwriting activities. IIROC Dealer Member Rule 2500 requires each Dealer Member t supervise its business activities, including all dealings in securities such as public fferings and private placements. Dealer Members are intermediaries with bligatins t bth issuers and investrs. As underwriters, Dealer Members have cntractual bligatins t issuers and, under prvincial and territrial securities legislatin, Dealer Members are als required t deal fairly, hnestly and in gd faith with their investr clients. Other prvisins, fr example s. 59(1) f the Securities Act (Ontari), require underwriters t sign a certificate fr each prspectus in the prescribed frm. Natinal Instrument General Prspectus Requirements ( NI ) (and Frm F1) set ut the prescribed prspectus certificate as fllws: T the best f ur knwledge, infrmatin and belief, this prspectus cnstitutes full, true and plain disclsure f all material facts relating t the securities ffered by this 1 Emphasis added. This is in cntrast t the prspectus certificate signed n behalf f the issuer, in which the issuer certifies withut qualificatin that the prspectus cnstitutes full, true and plain disclsure f all material facts relating t the ffered securities. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 2

10 prspectus as required by the securities legislatin f [insert jurisdictins]. 2 An issuer filing a prspectus is required t make full, true and plain disclsure f all material facts relating t the securities being distributed, and must ensure that the prspectus des nt cntain a misrepresentatin. A misrepresentatin means (a) an untrue statement f a material fact r (b) an missin t state a material fact that is required t be stated r (c) an missin t state a material fact that is necessary t make a statement nt misleading in the light f the circumstances in which it was made. Prvincial and territrial securities legislatin als sets ut a defence with respect t liability fr misrepresentatins in a prspectus where sufficient due diligence has been cnducted. Fr example, sectin 122(1) (b) f the Securities Act (Ontari) prvides that every persn r cmpany that makes a statement in any prspectus that, in a material respect and at the time and in the light f the circumstances under which it is made, is misleading r untrue r des nt state a fact that is required t be stated r that is necessary t make the statement nt misleading is guilty f an ffence and n cnvictin is liable t a fine and/r imprisnment. Sectin 122(2) prvides a due diligence defence where the persn r cmpany did nt knw and in the exercise f reasnable diligence culd nt have knwn that the dcument cntained a misrepresentatin. Similarly with respect t civil liability under the Securities Act (Ontari), sectin 130(5) prvides that: N persn r cmpany, ther than the issuer r selling security hlder, is liable under subsectin (1) with respect t any part f the prspectus... unless he, she r it, (a) failed t cnduct such reasnable investigatin as t prvide reasnable grunds fr a belief that there was n misrepresentatin; r (b) believed that there had been a misrepresentatin. Sectin 132 f the Securities Act (Ontari) indicates that the standard f reasnableness in determining what cnstitutes a reasnable investigatin r reasnable grunds fr belief is that f a prudent persn in the circumstances f the particular case. Sectin 2.2 f the Cmpanin Plicy t NI addresses the benefits f underwriter participatin in prspectus fferings, stating that the due diligence investigatin undertaken by an underwriter in relatin t the business f the issuer ften results in enhanced quality f disclsure in the prspectus Underwriting Due Diligence Standards Due diligence in cnnectin with a public ffering is the prcess by which the underwriter takes reasnable steps t ensure that all prescribed infrmatin is included in the prspectus, t investigate the infrmatin prvided by the issuer fr inclusin in the prspectus and t verify key material facts. Due diligence is, by its nature, a fluid and evlving prcess. It shuld be custmized t be relevant t the particular issuer, the industry in which it perates and the type f security being ffered. 2 Alternate frms f underwriters certificates, incrprating the same knwledge, infrmatin and belief standard, are set ut in Natinal Instrument Shrt Frm Prspectus Distributins, Natinal Instrument Shelf Distributins and Natinal Instrument Pst Receipt Pricing. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 3

11 Underwriters must nt put frm ver substance and are expected t exercise prfessinal judgment t determine the apprpriate level f due diligence in each set f circumstances. As nted abve, the due diligence defence is statutry, under sectin 130(5) f the Securities Act (Ontari) and the crrespnding prvisins f ther securities legislatin. Althugh securities legislatin des nt prescribe the frm r substance f a reasnable due diligence investigatin, curt decisins and securities regulatry settlement agreements prvide sme guidance cncerning the standards expected f underwriters. The Ontari Securities Cmmissin ( OSC ) prvided a number f recmmendatins regarding due diligence in its Emerging Market Issuer Review (the EMIR ). 3 The EMIR lists several cnsideratins fr underwriters when dealing with an issuer whse business peratins are based in what is referred t as an emerging market jurisdictin and identified, as a central cncern, an apparent frm ver substance' apprach t cmpliance with applicable standards fr due diligence practices, and a lack f rigr and independent-mindedness. The EMIR nted that underwriters shuld participate in the ffering prcess fr an emerging market issuer with a healthy amunt f scepticism regarding management claims. Dealer Members shuld, therefre, perfrm due diligence with an pen and questining mind. 2. Guidance Respecting Underwriting Due Diligence This Guidance Nte describes cmmn practices and suggestins which may nt be relevant r apprpriate in every case. It is nt intended as a minimum r maximum standard f what cnstitutes reasnable due diligence. This Guidance Nte des nt, and is nt intended t, create new legal bligatins r mdify existing nes. Appendix A t this Guidance Nte prvides a summary f these cmmn practices and suggestins Plicies and Prcedures fr Underwriting Due Diligence Principle: Each Dealer Member is expected t have written plicies and prcedures in place relating t all aspects f the underwriting prcess and t have effective versight f these activities. These plicies and prcedures shuld reflect that what cnstitutes reasnable due diligence invlves, fr each underwriting, a cntextual determinatin. Dealer Members have an bligatin t establish, maintain and apply plicies and prcedures that establish an effective cmpliance system that prvides assurance that the firm and individuals acting n its behalf cmply with IIROC rules and applicable securities laws, and manage business risk in accrdance with prudent business practices. As a general matter, a Dealer Member s plicies and prcedures applicable t underwriting due diligence shuld reflect the fllwing apprach: 1. Due diligence in cnnectin with a public ffering is the prcess by which the underwriter takes reasnable steps t ensure that all prescribed infrmatin is 3 OSC Staff Ntice , Emerging Markets Issuer Review (March 20, 2012). IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 4

12 included in the prspectus, t investigate the infrmatin prvided by the issuer fr inclusin in the prspectus and t verify key material facts; that is, that a prspectus cntains full, true and plain disclsure f all material facts relating t the securities being ffered. 2. What cnstitutes reasnable due diligence invlves a cntextual determinatin in the circumstances f each underwriting, requiring a careful cnsideratin f the circumstances f the particular ffering and the exercise f prfessinal judgment by senir investment banking and ther prfessinals within the Dealer Member. 3. Because f this cntextual nature f the due diligence prcess, beynd certain basic elements, effective due diligence shuld g beynd prescriptive checklists alne, as such an apprach wuld necessarily be superficial and ften incmplete Matters t be Addressed in Plicies and Prcedures fr Underwriting Due Diligence Dealer Members shuld cnsider the fllwing matters in develping their plicies and prcedures fr underwriting due diligence Due Diligence Plan Principle: The Dealer Member shuld have a due diligence plan that reflects the cntext f the ffering and the level f due diligence that will be reasnable in the circumstances. The Dealer Member shuld have an verall understanding f the business f the issuer and the industry in which it perates in rder t determine the scpe and bjectives f the due diligence investigatin. There shuld be a due diligence plan that reflects the cntext f the ffering and the level f due diligence that will be reasnable in the circumstances. The frm f the plan will depend n the Dealer Member s practice, and will generally include a list and descriptin f the matters t be investigated. The plan shuld be prepared in cnjunctin with underwriters cunsel (including lcal cunsel in freign jurisdictins, as applicable) and set ut the lead underwriter s preliminary expectatins f the scpe f its due diligence investigatin. Such expectatins shuld be shared with the issuer s management, legal cunsel and auditrs s that they can be in a psitin t satisfy the underwriters infrmatin and verificatin expectatins. A due diligence plan will, by necessity, be iterative and subject t change as circumstances change, and may be tailred t reflect the Dealer Member s structure and peratins. In the prcess f creating a due diligence plan, the Dealer Member shuld cnsider cntextual matters, examples f which are set ut in the Appendix t this Ntice. The due diligence plan may reflect the fact that less extensive due diligence prcedures may be reasnable fr seasned, significant and widely-fllwed issuers, in particular thse with whm the Dealer Member is familiar as a result f an nging relatinship (as lender, investr, financial advisr r financier). Due diligence may, therefre, be an nging prcess, in which case Dealer Members wh have knwledge f the issuer thrugh an nging relatinship may fcus their transactinspecific due diligence investigatin n recent events and results. Dealer Members shuld cnsider, IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 5

13 hwever, what due diligence is apprpriate even fr seasned, significant and widely-fllwed issuers, and issuers with whm the Dealer Member is familiar, such as where the issuer is undertaking an unusual, cmplex r significant transactin, r is a freign and/r emerging market issuer. The due diligence plan may als reflect the type f ffering. Fr example, initial public fferings (r where an issuer became a reprting issuer by way f a reverse take-ver ( RTO )) typically require mre due diligence than fferings by existing reprting issuers. Public fferings by smaller and/r infrequent issuers typically require mre due diligence than fferings by frequent issuers that that have larger market capitalizatins and are fllwed by multiple research analysts and the financial media. Equity fferings, including fferings f cnvertible debentures, may require mre due diligence than investment grade debt fferings and highly rated preferred share fferings, depending n the level f reliance n the rating that is apprpriate in the circumstances. Finally, public fferings by emerging market issuers typically require enhanced due diligence, taking int accunt the cnsideratins described in the EMIR and in this Guidance Nte. The due diligence plan may als reflect the Dealer Member s specific plicies and prcedures fr bught deals 4. While the timing f such transactins may nt, as a practical matter, allw fr extensive, transactin-specific due diligence t be perfrmed prir t the launch f the bught deal, it is expected that reasnable due diligence will be cmpleted befre the underwriters certify the final prspectus Due Diligence Q&A Sessins Principle: Due diligence Q&A sessins shuld be held at apprpriate pints during the ffering prcess and are an pprtunity fr all syndicate members t ask detailed questins f the issuer s management, auditrs and cunsel. The due diligence plan shuld cntemplate due diligence Q&A sessins at apprpriate pints during the ffering prcess (typically, fr equity fferings, ne prir t filing the preliminary prspectus and anther update r bring-dwn sessin prir t filing the final prspectus). This inpersn Q&A sessin is the underwriters pprtunity t ask detailed questins f the issuer s management, auditrs, cunsel and any ther relevant subject matter experts in rder t cnfirm the cmpleteness and accuracy f the infrmatin cntained in the prspectus. Given the imprtance f these sessins, the underwriters shuld participate with underwriters cunsel in the preparatin f the list f questins t be psed t the issuer s management and auditrs. The underwriters r their cunsel shuld prvide the list f questins t the issuer's management, cunsel and auditrs sufficiently prir t the hlding f the sessin in rder t allw the persns being asked the questins t undertake such enquiries as are necessary fr them t be able t answer the questins as thrughly and accurately as pssible. The underwriters shuld ensure that the individuals in the best psitin t have the necessary infrmatin participate in the sessin. All 4 A transactin in which underwriters are permitted t slicit expressins f interest befre a shrt frm prspectus-eligible issuer files a preliminary prspectus, prvided that the issuer and underwriters have entered int an agreement fr the purchase and sale f the ffered securities, annunce the ffering publicly and file the preliminary prspectus within certain time perids. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 6

14 syndicate members shuld be given an pprtunity t participate in, and ask questins at, each Q&A sessin, and shuld be represented by senir investment banking prfessinals. This sessin is als an pprtunity fr red flags that arse during the due diligence prcess t be nted by the issuer s management, cunsel and/r auditrs and t cnfirm, fr the benefit f all syndicate members, that the issues have been addressed. Any respnses that appear incmplete r evasive shuld be cnsidered a red flag that triggers fllw-up questins r ther further review. It is als imprtant that any fllw up due diligence r enhanced disclsure arising ut f these sessins be cmpleted befre the underwriters certify the final prspectus Business Due Diligence Principle: The Dealer Member shuld perfrm business due diligence sufficient t ensure that the Dealer Member understands the business f the issuer and the key internal and external factrs affecting the issuer s business. A Dealer Member shuld use its prfessinal judgment when determining which material facts will be verified independently depending n the circumstances f the transactin. The due diligence plan shuld distinguish clearly between the matters that will be addressed in business due diligence t be cnducted by the underwriters and the matters that will be addressed in legal due diligence t be cnducted by underwriters cunsel n the underwriters behalf. The extent f apprpriate business due diligence is a cntextual determinatin. The fllwing sets ut the principal elements f business due diligence: visiting the issuer s head ffice and principal peratins sites; reviewing the issuer s business plans, budgets and prjectins t understand the issuer s strategy and cmpetitive envirnment; cnducting in-depth discussins with the issuer s management, financial and accunting persnnel, independent auditrs and external legal cunsel; reviewing the issuer s publicly available disclsure dcuments (such as financial statements, MD&A, annual reprts and annual infrmatin frms), and cmparing the issuer s disclsure t that f cmparable issuers t identify any anmalies that may warrant further investigatin; reviewing the issuer s key peratinal data; reviewing the issuer s material cntracts (r a summary f their terms prepared by underwriter's cunsel), litigatin, regulatry crrespndence and ther key dcuments relating t the issuer; reviewing relevant surces f external infrmatin relating t the issuer and its business envirnment, including any freign jurisdictins in which the issuer has assets r des business, including industry surveys, trade jurnals, law firm publicatins, rating agency reprts, research analyst reprts, industry assciatin/rganizatin publicatins and internet searches. Fr equity fferings, Dealer Members may als cnsult research analysts and ther industry experts IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 7

15 relating t the issuer and/r its industry within the underwriters affiliates, subject t applicable regulatry requirements and cnfidentiality walls. A central element in the business due diligence prcess is independent verificatin f key material facts in the prspectus. The extent f independent verificatin fr any ffering depends n the particular circumstances. Dealer Members are expected t exercise prfessinal judgment taking int accunt all relevant factrs in determining which factual statements will be verified independently, including, the firm s familiarity with the issuer, the nature f the issuer s business, the issuer s histry, size, cmplexity, financial psitin, management and reprting histry and the type f security being ffered. It is imprtant fr the Dealer Member t ensure that the files, dcuments r ther infrmatin that are selected t be reviewed r verified by the Dealer Member are nt chsen slely by the issuer s management. Underwriters cmmnly cnduct their wn review, including backgrund checks, f the issuer s bard f directrs, senir executives and ther key members f the issuer s management, particularly in the cntext f initial public fferings. T the extent that an issuer has senir members f management r directrs that are lcated utside Canada, Dealer Members shuld cnsider retaining lcal agents t cnduct these checks. Dealer Members shuld nte the ptential limitatins f backgrund checks in sme jurisdictins, where certain persnal infrmatin may nt be readily available. T the extent that Dealer Members als rely n the reputatin and persnal references f individuals, again this may nt be pssible r the infrmatin may nt be reliable with respect t individuals in freign jurisdictins. Dealer Members shuld cnsider whether such limitatins shuld be disclsed as a risk f the ffering and Dealer Members shuld factr these limitatins int their determinatin f whether t cmplete the ffering. Underwriters shuld, where apprpriate, interview the issuer s custmers, suppliers and/r cunterparties t material cntracts t better understand the issuer s market, t cnfirm management s representatins and t receive independent verificatin f certain aspects f the business referred t in the prspectus (e.g. verifying terms f rders, hw terms are adhered t in practice, etc.). The extent t which interviews are cnducted and the identificatin f the third parties t be interviewed is a cntextual determinatin; such interviews shuld particularly be cnsidered as an element f business due diligence in the cntext f an initial public ffering, an ffering by a junir issuer, an ffering where the issuer is materially reliant n a custmer and/r supplier, r an ffering where red flags exist with respect t custmer and/r supplier relatinships. Dealer Members shuld cnsider ways in which t engage in such inquiries taking apprpriate measures t ensure that the infrmatin prvided t such parties in the curse f such enquiries des nt vilate the prhibitin under securities laws against "tipping. A Dealer Member s plicies and prcedures shuld establish the prcess t be fllwed where circumstances that may cnstitute red flags indicate that heightened due diligence and/r enhanced disclsure is required. Dealer Members shuld fllw up n any red flags with enquiries fr additinal issuer infrmatin r invlvement by independent experts r ther third parties, as apprpriate, and shuld maintain a recrd f the prcess by which the Dealer Member reslved the issue. A red flag exists where, fr example, an issuer s management prvides ral infrmatin that is materially incnsistent with the issuer s written dcumentatin r where an expert r ther third party having apparent credibility expresses t the underwriters significant dubts, cncerns r reservatins IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 8

16 abut an issuer s public disclsure, financial statements, financial cnditin, accunting practices, management integrity, internal cntrls r cmpliance with laws. Other examples include: the issuer has experienced, during the preceding mnths, ne r mre significant changes in its business, financial psitin, senir management, auditrs and/r legal cunsel; the presentatin r accunting treatment f the issuer s financial infrmatin r ther disclsure is incnsistent with that f its peers r cmpetitrs, including unusual year-ver-year grwth; the issuer displays a high degree f reliance n its funder, CEO, r gvernment relatinships; there has been recent cntrversy surrunding the issuer r any f its directrs r senir fficers, including issues raised by institutinal sharehlders r crprate gvernance advisry rganizatins; the issuer r any f its directrs r senir fficers has been the subject f criminal, regulatry r disciplinary prceedings; significant sharehldings by the funder r senir management f the issuer, and related party transactins (transactins with ther issuers in the same grup f issuers, r with parties linked t an issuer s sharehlders, directrs r management) invlving the issuer; the issuer has apprved material grants f stck ptins that are nt cnsistent with past practice, r there have been material sales f securities by insiders; r the issuer has experienced a recent ratings dwngrade r significant changes t equity research analysts target prices. The respnses that Dealer Members receive frm the issuer r third parties during business due diligence may als cnstitute a red flag, fr example, when: identical answers are given by custmers and ther third parties in due diligence interviews; respndents in due diligence interviews deflect r avid direct questins; requested infrmatin is nt prvided; r there is undue delay r the issuer des nt facilitate a site visit t a business lcatin. In respect f freign issuers, and particularly emerging market issuers, the due diligence shuld als fcus n ensuring that Dealer Members understand the plitical and cultural envirnment in which the issuer perates, lcal business practices affecting the issuer, lcal laws affecting the issuer, lcal experts (including legal advisrs and auditrs) and the extent t which the issuer relies n lcal management, particularly in the cntext f an initial public ffering r a subsequent ffering by a smaller r infrequent issuer. The Dealer Member shuld be prepared t deal with differences in time znes, language and/r cultural barriers which may affect the quality f the due diligence, crdinatin and timelines. It is imprtant that any red flags be fllwed up n and escalated t senir investment banking prfessinals. Please refer t the EMIR which identified ptential additinal due diligence infrmatin requirements and examples f red flags in the case f emerging markets issuers. OSC staff als issued, in Nvember 2012, Staff Ntice Issuer Guide fr Cmpanies Operating in IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 9

17 Emerging Markets which prvides assistance t emerging market issuers and their directrs and management n gvernance and disclsure practices Legal Due Diligence Principle: Dealer Members shuld clearly understand the bundary between business due diligence and legal due diligence, t ensure that matters that shuld be reviewed by the underwriters are nt delegated t underwriters cunsel. Dealer Members shuld prvide adequate supervisin f the legal due diligence perfrmed by underwriters cunsel. Legal cunsel als play a key rle in the due diligence prcess issuer s cunsel n behalf f the issuer and its bard f directrs, and underwriters cunsel n behalf f the underwriting syndicate. Underwriters cunsel, including lcal cunsel in freign jurisdictins, as applicable, can prvide valuable assistance t underwriters in preparing a due diligence plan and in executing a legal due diligence investigatin n the underwriters behalf. The lead underwriter shuld discuss with underwriters cunsel the scpe f the legal due diligence that cunsel will perfrm, and the due diligence plan shuld clearly delineate the respective rles f the underwriters and their cunsel. The analysis f the scpe f legal due diligence shuld include any enhanced due diligence that is apprpriate in cnnectin with freign and emerging market issuers (including hw cunsel prpses t address issues relating t lcal business practices affecting the issuer, lcal laws affecting the issuer, the issuer s gvernment relatinships and issues relating t asset wnership within the issuer s jurisdictin, and retaining lcal experts). Thrughut the legal due diligence prcess, the Dealer Member shuld instruct and supervise underwriters cunsel adequately and discuss any significant issues with cunsel. The results f legal due diligence shuld infrm business due diligence and the Dealer Member shuld fllw up n missing recrds and/r infrmatin discvered during the legal due diligence prcess that appears t cntradict management s ral statements r the disclsure in the draft prspectus. Absent any special limitatins in cunsel s retainer, underwriters cunsel will have prfessinal bligatins t all f the underwriters, and nt just t the lead underwriter. Underwriters cunsel shuld therefre be prepared t cmmunicate the results f legal due diligence t the entire syndicate. Where it is practical t d s, underwriters cunsel and the lead underwriter may wish t cnvene a meeting r cnference call with underwriters cunsel and the entire underwriting syndicate, prir t the management Q&A sessin, t brief the syndicate n the scpe f business and legal due diligence and t reprt n the status and results f any due diligence cmpleted prir t such meeting r call. This permits syndicate members t have an pprtunity, relatively early in the ffering prcess, t assess the adequacy f the due diligence plan and t ffer input Reliance n Experts and Other Third Parties Principle: The extent t which a Dealer Member shuld rely n an expert pinin is a cntextual determinatin, having regard t the qualificatins, expertise, experience, independence and reputatin f the expert. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 10

18 Securities legislatin prvides that underwriters are nt liable fr a misrepresentatin with respect t any part f the prspectus purprting t be made n the authrity f an expert r purprting t be a cpy f r an extract frm a reprt, pinin r statement f an expert, if the underwriter had n reasnable grunds t believe and did nt believe that there had been a misrepresentatin, r that such part f the prspectus did nt fairly represent the reprt, pinin r statement f the expert r was nt a fair cpy f r extract frm the reprt, pinin r statement f the expert. This is smetimes referred t as the reliance upn experts defence. The term expert is nt defined in the Securities Act (Ontari). NI suggests that the term is intended t refer t slicitrs, auditrs, accuntants, engineers, appraisers and thers whse prfessin gives authrity t their statements (fr example, a gescientist wh is qualified t prepare a technical reprt). While the underwriters liability in respect f expertised prtins f a prspectus is therefre limited, underwriters shuld cnsider whether any such expert is qualified t give its reprt r pinin and shuld btain reasnable evidence that such expert has cnsented in writing t its reprt r pinin (r any extract r summary) being used in the prspectus. Factrs that may assist an underwriter in making this determinatin may include the reputatin and qualificatins f the firm r individual acting as an expert, whether the firm r individual has the relevant subject matter expertise and, if applicable, reginal knwledge and expertise, the independence f the expert and whether any red flags have been identified in the due diligence prcess. With respect t experts resident in freign (and especially emerging) markets, the Dealer Member shuld cnsider the experts credentials, knwledge and experience (with the assistance, where apprpriate, f Canadian experts frm the same field) and assess whether they are similar t what wuld be expected f a Canadian expert in the same field. The Dealer Member shuld als assess the requirements f any prfessinal gverning bdies and the standard f care f experts in thse jurisdictins, t determine the extent f reliance n such experts in these circumstances and, in sme cases, cnsider whether crrbratin by ther experts is warranted. The EMIR nted that the issuer s external auditr has a unique rle in the reprting prcess fr annual financial statements which are relied upn by the bard, audit cmmittee and, mst imprtantly, investrs t prvide an independent assessment f whether the infrmatin presented in the issuer's annual financial statements has been fairly presented. 5 The issuer s auditr is an expert fr purpses f securities legislatin, which makes an auditr s reprt an expert pinin that is subject t the reliance upn experts defence. Hwever, underwriters shuld review an issuer s financial statements, particularly in the cntext f initial public fferings, fferings by smaller r infrequent issuers and fferings f unrated r belw-investment-grade debt securities, and the issuer s auditr shuld be asked t prvide a custmary lng-frm cmfrt letter cncerning the financial infrmatin cntained in the prspectus. The auditrs shuld participate in the Q&A sessins s there is an pprtunity fr underwriters t ask and fr the auditrs t respnd t questins. Like auditrs, sme f the experts that may be invlved in an ffering are subject t specific prvisins f securities legislatin 6 and prfessinal regulatin. It may nt be clear in ther areas such as life 5 EMIR, p See, fr example, NI Standards f Disclsure fr Oil and Gas Prperties and the cncepts f a qualified reserves auditr and qualified reserves evaluatr set ut therein. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 11

19 sciences r real estate wh cnstitutes an expert. The underwriter shuld take int accunt the expertise, experience and reputatin f each such expert in determining the apprpriate level f reliance Reliance n Lead Underwriter Principle: Each syndicate member is subject t the same liability fr misrepresentatin under securities legislatin. A syndicate member shuld satisfy itself that the lead underwriter perfrmed the kind f due diligence investigatin that the syndicate member wuld have perfrmed n its wn behalf as lead underwriter. Each member f the underwriting syndicate is liable fr any misrepresentatin in a prspectus (subject t prvisins capping the statutry civil liability t the amunt underwritten); each member f the underwriting syndicate must therefre be in a psitin t establish its wn due diligence defence. The lead underwriter may bear additinal reputatinal and regulatry risk. The lead underwriter will typically assume primary respnsibility fr cnducting and supervising the due diligence investigatin, including preparing the due diligence plan in cnsultatin with syndicate members, and fr ensuring that syndicate members are updated n the status and results f the due diligence prcess. Each syndicate member shuld therefre be in a psitin t satisfy itself that the lead underwriter perfrmed the kind f due diligence investigatin that the syndicate member wuld have perfrmed n its wn behalf as lead underwriter. The recmmendatins in this Guidance Nte are nt meant t re-allcate r result in duplicatin f the respnsibilities fr due diligence as between the lead underwriter and a syndicate member. Each syndicate member shuld, hwever, receive cpies f all letters, pinins r memranda relating t the underwriters' due diligence investigatin, and shuld be invited t and given the pprtunity t ask questins f the issuer and its cunsel and auditrs during the Q&A sessin Due Diligence Recrd-Keeping Principle: A Dealer Member shuld dcument the due diligence prcess t demnstrate cmpliance with its plicies and prcedures, IIROC requirements and applicable securities laws. Each Dealer Member shuld maintain recrds f its due diligence prcess in rder t be in a psitin t demnstrate that it cnducted a reasnable due diligence investigatin, fllwed its wn plicies and prcedures and cmplied with IIROC requirements and recrd-keeping bligatins under applicable securities laws. This dcumentatin may be kept by the Dealer Member r by its legal cunsel. Dealer Members shuld ensure that such dcumentatin is available fr IIROC cmpliance examinatins cvering the relevant perid. We recgnize that the Dealer Member acting as lead underwriter may keep mre detailed dcumentatin than thse Dealer Members acting as syndicate members. There des nt appear t be any file retentin plicy that is universally adpted by Dealer Members. IIROC s cmpliance examinatins have fund varying practices amng Dealer Members with respect t dcumenting the due diligence prcess and retaining such dcumentatin. Similarly, the EMIR als nted that the amunt and degree f due diligence dcumentatin varied widely and that [i]n IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 12

20 sme circumstances, the dcumentatin did nt reflect the prcess by which due diligence was undertaken and cmpleted nr the risks identified in cnnectin with the ffering. 7 We recgnize that a file retentin plicy will balance the legitimate cnsideratins in favur f pruning the due diligence file with the Dealer Members need t dcument cmpliance with their wn plicies and prcedures fr underwriting due diligence. A Dealer Member s plicies and prcedures shuld describe which dcuments must be kept in the transactin file, typically called a file list. Fr example, there shuld be a recrd f any cmmittee meetings (and attendance), as applicable and the Q&A sessin with issuer s management, auditrs and legal cunsel. If a specified dcument is nt cntained in the file, there shuld be an explanatin fr its absence. Alternatively, sme Dealer Members plicies and prcedures require cnfirmatin frm senir investment banking prfessinals that all aspects f the due diligence prcess have been cmpleted and were in cmpliance with such plicies and prcedures, IIROC rules and applicable securities legislatin. If taking this apprach, it is expected that the Dealer Member s plicies and prcedures are cmprehensive and set ut a rbust supervisin and cmpliance prcess The Rle f Supervisin and Cmpliance Principle: IIROC Dealer Member Rule 38 requires each Dealer Member t have a cmprehensive and effective supervisry and cmpliance framewrk in place t ensure cmpliance with plicies and prcedures, IIROC requirements and applicable securities laws. A Dealer Member s executin f the prspectus certificate shuld signify that the Dealer Member has participated in the due diligence prcess thrugh apprpriate persnnel and internal prcesses. Effective due diligence requires bth effective supervisin and effective cmpliance. IIROC Ntice The Rle f Cmpliance and Supervisin (December 17, 2012) sets ut IIROC s general expectatins regarding Dealer Members supervisin and cmpliance functins. IIROC recgnizes that apprpriate appraches t supervisin and cmpliance fr underwriting due diligence may differ amng Dealer Members depending n the nature f the activities and/r the characteristics f the Dealer Member. The discussin belw utlines sme f the effective appraches that Dealer Members have taken. The rle f supervisin in underwriting due diligence is t ensure that the business unit itself takes respnsibility fr the versight f due diligence activity n an nging basis. While the specific activities that cmprise due diligence may be perfrmed by a range f persnnel, including junir persnnel as part f the team, external legal cunsel and ther experts retained by the underwriters, there shuld be a senir investment banking prfessinal wh is invlved thrughut the due diligence prcess (nt just at the cnclusin f the prcess) and is ultimately respnsible fr the quality and extent f the due diligence fr each ffering f securities underwritten by the Dealer Member. Any difficult r unusual disclsure issues shuld be escalated t this senir supervisr. In sme Dealer Members, the senir supervisr will ften be the same individual wh signs the 7 EMIR, p. 16. IIROC Ntice Rules Ntice Request fr Cmments Guidance Respecting Underwriting Due Diligence 13