7.2 Corporate practice - History 'due diligence'

Due diligence is not a new concept. The term ' due diligence' in corporate practice stems from American securities law. When a company wishes to attract capital from the public at large - i.e. by issuing shares or notes, in general: securities - it has to involve a bank. The bank can offer the new securities to the public and arrange for the listing thereof at a stock exchange (the so-called 'lead manager'). After the initial public sale of the securities, the Initial Public Offering (IPO), the securities can be resold through the stock exchange trading systems. For the listing, the lead manager - usually jointly with the company that issues the securities (the issuer) - has to prepare a 'prospectus', i.e. a brochure which introduces the issuing company and the securities to be offered to the public. The lead manager acts as an intermediary between the issuer and the investors who are buying the shares. The prospectus itself is 'an offer to sell'; hence it is a legal document stating the purpose of the security issue. It contains a description of the business of the company, the product groups, the geographical regions in which it operates, the principal officers, the securities offered and how they can be purchased, the financial results and prospects, such as the return on the investment: the expected annual dividend. The prospectus also contains a chapter on business risks. Investors will base their decision to buy the new securities on the prospectus; hence the lead manager has to carefully draft the content of the prospectus.

Countries employ different systems to supervise the quality of a prospectus. In the US, federal and state securities laws as well as stock exchange rules give detailed instructions on how to prepare a prospectus.1 In the EU, the Prospectus Directive, implemented in national legislation in EU Member States, prescribes which subjects need be covered in a prospectus.2 Typically, a draft of the prospectus has to be approved by a national supervisory authority before it can be made public.3 The rationale of this system is to protect investors against misleading or fraudulent information on securities sales.

However, even when the procedures have been followed, it sometimes occurs that new shareholders are disappointed about the results of the company or the value of the securities, and want to cancel their purchase or receive compensation. They institute legal proceedings against the issuer and/or the lead manager. This was for example the case after the IPO of World Online (WOL) in the Netherlands in March 2000. WOL was a European Internet Service Provider (ISP), which came to prominence in the late 1990s dotcom boom. After the IPO, the value of the newly listed shares dropped dramatically. Moreover, the financial results of WOL lagged behind the projections communicated in the prospectus, and the internet bubble collapsed. Legal claims were instituted against WOL, the issuer of the shares, and against the Dutch bank ABN-AMRO and the US investment bank Goldman Sachs, the joint lead managers of the IPO. Basically, the claims alleged that WOL and the lead managers had failed to adequately disclose certain information necessary to correctly inform the investors. In 2009, the Dutch Supreme Court (DSC) judged that WOL and the lead managers had misled the investors.4

Often, when an issuing company performs poorly, and does not offer sufficient recourse, the investors turn to the bank that organised the public sale of the shares. They will state that they were misled, i.e. that the bank had drawn a too positive picture of the company, and claim compensation for their losses. As a defence, the bank will explain that it has carried out an extensive investigation into the affairs and business of a company on which to base its prospectus. The bank will state that the company's subsequent negative results could not have been foreseen. In short, the bank will explain that it has adequately assessed the company's affairs, and that any business or other risks found were clearly described in the prospectus, implying that the investor consciously took the risk to buy the shares. In other words, the bank claims that it performed the IPO ' diligently', ' with due care', ' with sufficient diligence' (met de nodige waakzaamheid).

The standard to be measured against is what other banks would have done, how they would have investigated this company if they had done so with due diligence, and whether any information disseminated about the new shares and the company, in the prospectus or in any other manner in view of an IPO, would have misled a normal, prudent investor in his decision to buy the shares.5