Management due diligence
The underwriters and their counsel also meet with the issuer’s management to learn about the issuer and its business. These meetings are typically preceded by lists of questions covering areas such as operations, industry, competition, strategy, acquisitions and dispositions, properties, management and employee matters and legal, financial and accounting matters. Most U.S.-registered offerings also feature what are known as bring-down calls with management to confirm diligence matters at the times of pre-marketing, launch, pricing and closing. Furthermore, directors’ and officers’ due diligence questionnaires drafted by underwriters’ counsel must be completed and signed by the members of the issuer’s management and supervisory boards. These questionnaires are similar to those used in German offerings to confirm certain requirements under the European Prospectus Directive. They request certain information on each board member, including current and former positions and a description of any business dealings with the issuer.
Financial due diligence and statistical information
Financial statements and other financial information are a central part of the offering documents. Although they are expertized sections of the registration statement, underwriters’ reliance on audited financial statements “may not be blind,” and any red flag concerning the reliability of such information imposes investigative obligations. Conducting interviews with and receiving comfort letters from the issuer’s auditors form a critical part of the underwriters’ reasonable investigation. These comfort letters are evidence that the financial information in the offering documents is accurate and complete and has been independently verified and that there have been no changes in an issuer’s financial affairs since the last financial statements included in the offering documents.
To ensure the accuracy of the statistical information in the offering documents, back-up due diligence is undertaken, which requires an issuer to provide support for the statistics used and to explain how it reached certain conclusions. Verifying the accuracy of statements on the issuer’s market position with third-party sources is of particular importance.
Internal processes and controls
The review (often through management interviews) of an issuer’s internal processes, internal and group reporting and of the adequacy and effectiveness of its risk control mechanisms also plays a significant role. After an issuer is public, its management will be required to attest to the effectiveness of its internal controls over financial reporting. During the due diligence process, letters from the issuer’s auditors are reviewed regarding the presence of any material weaknesses in internal controls at the time of the offering. If so, these must be disclosed in the offering documents, and the underwriters must investigate management’s ability to cure the weaknesses going forward.
FINRA review of underwriter compensation
Although not part of the due diligence process, the review of the underwriters’ compensation (as agreed upon in an underwriting agreement) by the U.S. Financial Industry Regulatory Authority (FINRA) is of equal importance to issuers. FINRA reviews agreements with the underwriters for items of value, applying an “unfair or unreasonable” standard. This is important because a registration statement will not be declared effective without FINRA’s approval. In German offerings, there is no such review of the underwriters’ compensation.
While there are many different focuses of due diligence, an underwriter’s investigation of a German issuer in connection with a U.S.-registered offering does not differ significantly from that which would be done in connection with a German offering. While due diligence is undoubtedly a burden on an issuer, a well-prepared, structured and streamlined process in line with required standards and U.S. market practices can eliminate much of this burden.
International legal counsel on both the underwriters’ and the issuer’s side need to be able to adjust their approach to the specific situation of the issuer and its business and must understand the differences between the two legal systems at play in order to seamlessly coordinate work between the U.S. and German teams. Having experienced counsel like this is crucial for keeping an issuer’s time commitment to a minimum. This way, the issuer can remain focused on running its business and facing the challenges that a transformational transaction such as a U.S.-registered offering may present for a German issuer.
About the Authors
Dr. Roland Maass, LL.M. (NYU) is partner in the corporate department of Latham & Watkins in Frankfurt. His practice focuses on capital markets law, advising domestic and international companies on European and U.S. initial public offerings and rights issues and all aspects of corporate law. Christopher D. Lueking is partner in the corporate department of Latham & Watkins in Chicago. His practice focuses on corporate finance, securities and public company representation, including initial public, secondary, high yield bond and private securities offerings.
The Article was first published in GoingPublic Magazines Special „Going Abroad“. Read the full Article here.