7.3.2.1 Capital markets transactions - legal reasons and scope

As section 7.2 explained, a due diligence investigation in the context of issuing new securities is usually, directly or indirectly, obligatory under the law, or recognised by case law. Where a jurisdiction requires the issuer and lead manager to issue a prospectus, it indirectly implies that they should execute a due diligence process to collect the information needed to prepare the prospectus. Moreover, as argued, conducting a due diligence process in view of an IPO can constitute a defence against claims from investors who allege that they were misled by false or incomplete information contained in the prospectus.

Regarding the scope of a capital market due diligence, it was recorded in section 7.2 that the EU Prospectus Directive details the information which has to be included in a prospectus.1 This indirectly determines the main subjects that are to be addressed in the diligence process. Since capital market transactions usually concern the sale of securities in the capital of a holding company, the due diligence has to cover all operations of the company and its subsidiaries. Any miscalculation or business problem in any part of the world could affect the value of the securities. Still, in practice, the lead manager, the issuing company and their lawyers have to decide on the scope and level of the due diligence investigation. For instance: may the lead manager rely on a company secretary's communication stating that no substantial litigation is pending anywhere in the world? Or do the lead manager's lawyers have to assess this for themselves? In that case, do they have to examine all court documents, or can they rely on communicating with the counsels who actually litigate such cases? These types of issues need to be agreed on to make the due diligence process transparent and workable. Best practices in the market will lead the way in this respect. No lead manager or lawyer wants to take the risk of performing an insufficient due diligence assessment. Commonly, the standard applied to determine professional liability is whether the professional has acted in the same professional manner as another skilled professional would have done in his place. Consequently, it is important to keep up-to-date with best practices.2