[T]he Commission has provided a non-exclusive list of six factors it believes generally would be relevant in determining the reasonableness of the underwriter’s basis for assessing truthfulness of key representations in a final official statement. These factors are:
… the role of the underwriter (e.g., manager, syndicate member, selling dealer) …
Thus, an underwriter is subject to 15c2-12 irrespective of their role. Yet, the Orders to date have not distinguished what level of diligence is appropriate (or reasonable) for different roles of underwriters and have simply provided that:
Respondent failed to form a reasonable basis through adequate due diligence for believing the truthfulness of the assertions by these issuers and/or obligors regarding their compliance with previous continuing disclosure undertakings pursuant to Rule 15c2-12.
Market participants are left with the question of “what level of diligence is ‘reasonable’ when it comes to competitive deals and deals where we are the co-manager, syndicate member or selling dealer?” Another relevant question raised by the market: “is it reasonable for me to rely on the lead’s diligence?”
Read More Lumesis Articles and White Papers
For deals where diligence is performed by a co-manager or syndicate member, we hear differing views from market participants with regard to the scope of diligence performed. In an effort to gain clarity, we recently asked the SEC to provide a response but were told they could not comment on the issue.
While the 2010 Exchange Act Release and the Risk Alert do not address the scope of diligence required, they do note the factors that “would be relevant in determining the reasonableness of an underwriter‘s basis for assessing the truthfulness of key representations in the official statement.”
The Risk Alert, citing a 1991 case, provides that a “municipal underwriter’s due diligence obligation has been held to be primary and an obligation that cannot be delegated away (in terms of liability) to underwriter’s counsel” and that “an underwriter’s belief should be based on its independent judgment, not solely on representations of the issuer or obligated person as to materiality of any failure to comply with any undertaking.”
The Risk Alert makes clear that an underwriter’s scope of diligence may be influenced by their role. While the Risk Alert does not directly address the underwriter’s ability to rely on the diligence performed by the lead, it makes clear that the obligation – in terms of liability – cannot be delegated away.
Accordingly, a conservative approach to reliance on third party assessment seems warranted. Until the SEC provides clarity or guidance on the question of the scope of diligence required by those participating in competitive deals, or those acting in the role of co-manager, syndicate member or selling dealer, it seems prudent, at a minimum, to perform some level of diligence to confirm the work done by the lead or other third party is accurate. This diligence may include spot-checking, cursory or substantive review of the work; and/or asking the lead to provide a report documenting their diligence including links to (or copies of) all relevant documents reviewed as part of their diligence.
Whatever approach you take, make sure it’s supported in your policies and procedures, and make sure you can demonstrate with documentary proof your diligence and related supervisory oversight on every deal.
Have a Great Week,
Learn More About Lumesis