As market regulators move towards more disclosure-based regimes, one of the biggest risks to a successful public listing is the lack of full disclosure because of the availability of reliable information – this is especially true in the PRC and other emerging markets. The collection of reliable information about an issuer for the offering document can be particularly difficult for financial and other advisors who have not conducted a full investigative due diligence.

Common Risk Factors

While every industry, geography, enterprise and IPO offering is different, over the many years International Risk has been involved in providing Investigative Due Diligence services, we have identified a number of common risk factors which, historically, can be problematic to the IPO process:

• Principal management of companies to be listed being, in fact, other than the professional management disclosed in the draft prospectus
• Non-disclosure of related party transactions
• Acceptance by accountants, acting for sponsors, as to the valuation of properties involved in inter-company, “paper transactions”, prior to the IPO exercise
• Potential conflicts of interest arising from the involvement of the candidates’ senior management in other competing but not openly disclosed businesses
• Previous or current brushes with the law, both civil and criminal, being omitted or insufficiently described in the prospectus
• Issues over the intended use of the IPO proceeds - especially in relation to companies with a complicated structure
• Inaccurate statements of academic qualifications and technical expertise when describing senior management background and experience
• Undisclosed tax liabilities – a significant problem
• Undisclosed environmental problems or fines
• Undisclosed industrial labor disputes in outlying areas
• Undisclosed previous or current organized crime connections
• Other omissions of important facts, such as previous un-discharged or current pension obligations of state-owned enterprises
• Insufficient separation of the accounting functions in inter-group transactions
• Out and out deception
• Many variations on these themes

Goals of Investigative Due Diligence in the IPO Process

While investigative due diligence is an important part of any significant transaction, the key objectives of a Pre-IPO Investigative Due Diligence are:

• To ensure that offering documents contain all material information about the issuer and its financial condition, and that no important information is omitted; and
• To provide a more comprehensive understanding of the listing candidate and to identify risks at the earliest possible opportunity.

Our Approach

The IPO due diligence process should not just examine financial statements and legal documents, but closely examine people and organizations.

International Risk’s Pre-IPO Investigative Due Diligence services include the review of the client’s draft Prospectus to identify potential areas of risk, based on our previous experience. We then consult with the IPO sponsor and professional advisors, who may wish to raise their own areas of concern in relation to a listing candidate, to establish clear objectives and scope of work.

Our services involve the collection, collation and analysis of information from a wide variety of sources. It starts with comprehensive data mining of publicly available material, online resources, media, public records and corporate filings by our specialist in-house research analysts.

Experienced project managers then oversee in-depth and discreet field inquiries. In a legal and ethical manner, we undertake inquiries into key issues with knowledgeable industry sources, government and regulatory bodies, and with other parties and individuals such as suppliers, customers, distributors and competitors. At the conclusion of our enquiries, we provide a detailed report.

Critical Issues for Examination

Based on our experience, critical issues to be examined in the investigative due diligence process will include:

• The real corporate structure - key officers, shareholders & subsidiaries as compared to the information disclosed in the draft IPO prospectus;
• Background, relevant history & current activities of the issuer and its principals;
• Character, integrity & reputation of key individuals, owners and principal officers;
• Reputation of the business and its principals with vendors, associates and local regulators;
• Litigation history of IPO candidate and its key principals;
• Political connections of key individuals;
• Professional and personal relationships of relevance;
• Other potential material risks associated with the IPO candidate, including regulatory risk; and
• Potential labor-related risks.