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NEWS & INSIGHTS
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21 MAY 2009
Framework Established For Us Auditor Participation In Oral Due Diligence For Securities Offerings
CAPITAL MARKETS ALERT
Marjorie Sybul Adams Jack I. Kantrowitz Christopher C. Paci
The Big Four US accounting firms (KPMG LLP, Ernst & Young LLP, Deloitte LLP and PriceWaterhouseCoopers LLP) and a number of major investment banks have agreed on a set of principles covering US auditor participation in oral due diligence with underwriters and other financial intermediaries in connection with all SEC-registered and certain unregistered securities offerings. Some of these banks and accounting firms have entered into formal agreements based on these principles. For others, the principles may nonetheless constitute a basis upon which auditors will participate in oral due diligence discussions. Background As part of their procedures to establish a defense to potential liability under Section 11 and Section 12 (a)(2) of the Securities Act of 1933 in the case of registered public offerings, and antifraud liability under Rule 10b-5 under the Securities Exchange Act of 1934 in the case of unregistered placements of securities, underwriters and other financial intermediaries typically conduct a due diligence investigation of the issuer, including financial and accounting matters and related issues. As part of their financial and accounting due diligence review, underwriters and other financial intermediaries seek to obtain the assistance of the issuer’s auditor, which is both independent and knowledgeable with respect to the issuer’s financial statements, accounting and financial reporting. Traditionally, in this context, auditors have provided written support (generally referred to as comfort letters) with respect to the financial statements and other financial information contained or incorporated
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by reference into offering documentation. The preparation and issuance of these letters are governed by Statements of Auditing Standards No. 72 (SAS 72), with respect to audited financial statements and certain other fiscal year financial information, and No. 100 (SAS 100), with respect to interim financial statements and other interim financial information, issued by the American Institute of Certified Public Accountants. However, SAS 72 and SAS 100 do not govern oral communications between auditors and underwriters and other financial intermediaries regarding the issuer’s financial reporting, aspects of its accounting systems and internal controls and related issues that have traditionally formed a part of the due diligence process. Because of the lack of governing structure for these oral communications, in recent years audit firms have become increasingly unwilling to participate in due diligence discussions with investment banks in the context of securities offerings. This led to the AICPA’s issuance in August 2005 of a draft white paper proposing new guidelines for auditor participation in underwriter due diligence discussions. This white paper was withdrawn in October 2005. Thereafter, the Big Four audit firms, the Securities Industry and Financial Markets Association (SIFMA) and some of the major investment banks held discussions on a set of principles that would govern auditor participation in oral diligence discussions with underwriters based on the protection of investors and capital markets. The culmination of these discussions was an agreement on the new framework. Principles The objective of the Big Four accounting firms and the participating investment banks was to create, with SIFMA’s assistance, a framework agreement governing auditor participation in oral due diligence to facilitate the due diligence process and protect investors (by fostering an environment where more information regarding the issuing company is provided). This new framework is intended to create as open an atmosphere as possible for those discussions. It is based on an understanding that auditors should be able to respond freely to due diligence inquiries from investment banks in connection with securities offerings as to matters within the auditors’ professional competence and knowledge. The four principles summarized below form the centerpiece of the agreement: 1. Auditors recognize the importance to the capital markets of the due diligence performed by underwriters and understand that the information auditors provide in response to due diligence inquiries will be used by underwriters in their due diligence review. An auditor who is asked by an audit client to participate in the due diligence process should approach those discussions with a willingness to respond freely to questions framed by underwriters and other financial intermediaries about matters within the auditor’s professional competence as to which the auditor has knowledge and a basis for a view as a professional. Underwriters and other financial intermediaries understand that auditors are not responsible for the sufficiency of the underwriters’ and other financial intermediaries’ inquiries and that auditors have not performed procedures for the specific purpose of responding to questions raised by underwriters during due diligence. Underwriters also understand that auditors assume no duty to supplement their responses to questions from underwriters in the course of due diligence once they are given, but underwriters may request one or more supplemental discussions. In consideration for an auditor’s orally responding to questions from underwriters, the underwriters and other financial intermediaries agree that, with respect to any oral statement by the auditor, except to the extent that such oral statement was known to be false or misleading when made and was made with intent to deceive, the underwriters do not acquire, and will not
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assert that they have acquired, any rights against the auditor as a result of such oral statement. These principles, which limit liability and apply to an auditor’s oral responses to specific questions posed by the underwriter or other financial intermediary in due diligence discussions, are intended to encourage auditor participation in the due diligence process to give underwriters more access to company information and enhance investor protection. The principles apply to all SEC-registered and unregistered securities offerings by companies, including non-US companies, that employ US accounting firms. The principles can be attached to a framework agreement between the accounting firm and lead underwriter or other financial intermediary. That agreement will state that the parties agree to be bound by the principles concerning oral due diligence. The framework agreement would also be binding on any syndicate member participating in a securities offering governed by that agreement. The Big Four accounting firms and a number of major large investment banks have already entered into written agreements adopting these principles for auditor participation in oral due diligence discussions in offerings of securities led by those banks. These principles may also may serve as guidelines for offerings led by investment banks and auditors that have not yet adopted them. If you have any questions regarding the matters summarized in this alert, please contact your DLA Piper relationship partner or: Marjorie Sybul Adams Jack Kantrowitz Christopher Paci
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