Due Diligence Practices. 6. What Is The Scope Of A Due Diligence Review?

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1 Due Diligence Practices Contents 1. Introduction 2. What is Due Diligence? 3. Why Is Due Diligence Required? 4. The Purpose Of Due Diligence 5. Who Must Exercise Due Diligence? 6. What Is The Scope Of A Due Diligence Review? 7. Conducting A Due Diligence Review - The Need For A Sound Due Diligence System 8. The Use Of Due Diligence Checklists 9. Appendix Appendix 2

2 Introduction 1. This publication is produced as an aid for market participants in the securities industry to understand the nature and objectives of due diligence, and to suggest procedures and practices of due diligence which could be established so as to assist market participants in developing a body of due diligence practices. 2. However, this publication is by no means an exhaustive treatise on due diligence nor is it intended to be legal advice or to diminish any statutory duty that is imposed on persons by existing law. It does not deal with all issues or requirements which will arise in any given situation. In addition, future relevant court decisions will affect the scope and application of due diligence as provided in the existing law. 3. All persons should therefore seek professional and/or legal advice on the sufficiency of due diligence having regard to their personal liability under Part IV of the Securities Commission Act 1993 ("the SCA") and the circumstances in any given situation. Guidance on this matter should also be sought from their respective professional associations. What Is Due Diligence 4. There is no legal definition of the words "due diligence". In the present local context, it simply refers to the process by which persons must conduct inquiries for the purposes of timely, sufficient and accurate disclosure of all material statements/information or documents which are required under section 32 of the SCA. Why Is Due Diligence Required? 5. Recent amendments to Part IV of the SCA, have introduced new provisions in section 32B of the SCA which impose criminal liabilities on persons in relation to the submission of proposals under section 32 of the SCA. 6. The SCA also provides for a defence to a prosecution or any proceeding for a contravention of section 32B of the SCA if it is proved that the defendant had made enquiries as were reasonable in the circumstances and had reasonable grounds to believe that there was no contravention of section 32B of the SCA. This provision is reprinted in Appendix 1 for ease of reference. 7. The provision of this statutory defence effectively creates an affirmative obligation by the relevant persons to exercise due diligence and to take steps in ensuring the timeliness, sufficiency and accuracy of the disclosure of all documents, statements and information which are submitted to the Securities Commission. 8. Due diligence practices established by industry exist also in jurisdictions such as the USA, United Kingdom and Australia today. This had similarly stemmed from legal obligations imposed on its market participants in relation to the disclosure and submission of accurate and material information in securities offerings. The Purpose Of Due Diligence 9. The Securities Commission has expressed its commitment towards a gradual shift from a merit based system to a disclosure based regulatory framework in respect of issues of securities. 10. A disclosure based regulatory framework is one in which access to the securities market by issuers is conditional upon such issuers disclosing relevant information to enable the investor and his professional advisers to evaluate the risks or merits of his investment in the issuer.

3 11. Heavier and higher standards of responsibilities and accountability are thus placed on issuers and their directors, promoters, advisers, and other persons involved in a proposal to provide the investor and his professional advisers with timely, sufficient and accurate disclosure of all material information. 12. It is for these reasons that legal provisions have been introduced to impose due diligence obligations on market participants in the submission of proposals to the Securities Commission. Market participants should always bear in mind that the submission of such information and documents to the Securities Commission is for the purposes of providing the investor and his professional advisers with timely, sufficient and accurate disclosure of all material information. Who Must Exercise Due Diligence? 13. The persons who are legally required to comply with this requirement under section 32B of the SCA in any given situation is a matter of judicial interpretation. All such persons would have personal liability under these provisions in the SCA depending on the role and capacity they play in the corporate issue proposal. 14. These persons would include, but are not limited to, public companies which issue or offer securities for purchase or subscription, their directors and promoters, the advising merchant bank, other advisers such as lawyers, accountants and valuers in relation to the submission of information and documents under section 32 of the SCA. 15. Such persons should at all times, adhere to the following broad principles of care and conduct: i. High standards of integrity in all business and financial relationships should always be maintained; ii. Due skill, care and diligence must be given in providing any service or advice; iii. There should be objectivity and independence in all professional and business judgements. What Is The Scope Of A Due Diligence Review? 16. The extent of due diligence required in any given situation is necessarily a question of fact which will depend upon the circumstances surrounding each particular case. This requirement will obviously vary in accordance with the particular corporate proposal issue under consideration. There is no statutory standard in the SCA as to how the sufficiency of due diligence would be assessed. 17. However, at the very least, the extent of the due diligence exercise will require the type of comprehensive and probing review and inquiry which a prudent person would conduct. 18. While this matter must therefore await determination by the courts, some guidance may be obtained from the following factors which are considered important in ascertaining if the extent of due diligence was adequate or reasonable: i. a proper process in which the due diligence exercise is carried out must have been established; ii. there must be adequate supervision to ensure that the process is properly carried out; iii. the inquiries should seek to elicit those facts which an investor and his professional advisers would reasonably consider important in determining whether to invest in

4 the securities in question; iv. data and information furnished should be independently verified as far as is reasonably possible; v. the nature of the securities; vi. the capacity in which the person participates in the submission, offering and issuing process; vii. relationship with regard to the issuer and other parties responsible and involved in the submission of the proposal; viii. if an individual is involved, the particular position held; ix. reasonable reliance on officers, employees and others whose duties should have given them knowledge of the particular facts (in the light of the functions and responsibilities of these particular persons with respect to the issuer, and the submission); x. whether a person has participated in the preparation of a fact or a document which is incorporated by reference in the proposal submitted to the Securities Commission. xi. the nature of the shareholders or persons likely to be the potential investors; and xii. the fact that certain matters may reasonably be expected to be within the knowledge of other professional advisers of any kind which those persons may reasonably expect to consult. 19. These factors are by no means exhaustive. Other considerations or issues may also arise from specific requirements and other guidelines which may be issued by the Securities Commission or such other authorities. 20. The due diligence review is undertaken not only in respect of the submission of the necessary statements, information and documents to the Securities Commission but should be continued until the proposal has been fully implemented or carried out. 21. The Securities Commission would encourage market participants to develop a body of due diligence practices, using the aforementioned factors. Market participants are also encouraged to apply such practices where possible, with regard to the submission of the necessary statements, information and documents to the Kuala Lumpur Stock Exchange, Registrar of Companies and such other relevant authorities. Conducting A Due Diligence Review - The Need For A Sound Due Diligence System 22. A due diligence system ensures that all material information is made available and verified as far as is reasonable. How extensive the system is will depend on the size, complexity and nature of the issuer's operations and the extent to which it already has effective reporting and disclosure processes in place. 23. A suggested manner adopted in some jurisdictions to organise such a process is to establish a due diligence working group comprising senior representatives of the issuer, promoters, advisers and all persons who are responsible for the preparation of information and documents for the submission which would report and advise the board of the issuer. 24. However, it should be emphasised that the existence of such a due diligence working group does not absolve the issuer and its directors and officers or other persons from their personal responsibilities and liabilities to undertake the requisite due diligence review. The issuer, its directors and officers on whose behalf the submission, statement, document or information is made, will at all times, have primary responsibility. 25. Given in Appendix 2 are some matters that a working group, if established, should ensure as far as is reasonable.

5 The Use Of Due Diligence Checklists 26. As each issue of securities will have its own special features, it is impossible to formulate a standard checklist which will cover all possible circumstances and eventualities. However, in order to promptly complete a due diligence review and gather all the relevant information, an organised approach is essential and encouraged. 27. All persons who are required to undertake a due diligence review should therefore ensure that any checklists used by them are sufficiently comprehensive and tailored to meet the specific circumstances arising. Given the diversity of interests by persons responsible for due diligence reviews, further advice should be sought from relevant applicable professional bodies as to procedures and checklists which are necessarily required to be undertaken and complied with. 28. While the Securities Commission encourages professional bodies to develop their own due diligence checklists as a guide for their members, it would caution that these checklists are only an aid to ensuring due diligence. Ticking off a checklist should not be regarded as the end result of a due diligence review.

6 Appendix 1 Securities Commission Act B. False or misleading statements, etc. (1) Where any statement or information is required to be submitted to the Commission under this Division in relation to or in connection with any proposal submitted pursuant to section 32 - (a) an applicant, any of its officers or associates; (b) a financial adviser or an expert; or (c) any other person, shall not - (aa) submit or cause to be submitted any statement or information that is false or misleading; (bb) submit or cause to be submitted any statement or information from which there is a material omission; or (cc) engage in or aid or abet conduct that he knows to be misleading or deceptive or is likely to mislead or deceive the Commission. (2) It shall be a defence to a prosecution or any proceeding for a contravention of subsection (1) if it is proved that the defendant, after making enquiries as were reasonable in the circumstances, had reasonable grounds to believe, and did until the time of the making of the statement or provision of the information or engaging in the conduct, was of the belief that - (a) the statement or information was true and not misleading; (b) the omission was not material; (c) there was no material omission; or (d) the conduct in question was not misleading or deceptive. (3) Where - (a) a statement or information referred to in subsection (1) has been submitted or provided to the Commission, or a conduct referred to in subsection (1) has been engaged in; and (b) a person referred to in that subsection becomes aware before the proposal has been fully implemented or carried out -

7 (i) that the statement or information may be false or misleading or materially incomplete; or (ii)that the conduct may tend to mislead or deceive, the person shall forthwith advise the Commission of the facts referred to in subparagraph (b)(i) or (b)(ii), where applicable, and shall take such action as the Commission may require pursuant to subsection 32(7). (4) A person who contravenes subsection (1) or subsection (3) shall be guilty of an offence and shall on conviction be liable to a fine not exceeding three million ringgit or to imprisonment for a term not exceeding ten years or to both.

8 Appendix 2 Some matters that a working group, if established, should ensure as far as is reasonable: 1. Some matters that a working group, if established, should ensure as far as is reasonable: 2. The work programmes and procedures for the independent due diligence review required to be carried out by each responsible person is co-ordinated to ensure efficient use of time, costs and resources. 3. The scope and depth of the overall due-diligence exercise is agreed upon. 4. Work programmes and procedures for each specific segment of the due diligence exercise are established such that it would, as a whole, cover the scope and depth of the overall due diligence review; 5. The teams of individuals responsible for carrying out the review are sufficiently experienced and qualified; 6. Working group meetings should be held regularly to review the progress of the due diligence exercise. Meetings are intended to be quick updates and requests for prompt decision making. They are intended to enable the due diligence process to flow smoothly with no bottlenecks and to provide assurance that the process is operating according to schedule and that all significant issues that have been identified are raised and resolved; 7. Proper and regular working papers, source records and reports are prepared such that there is a clear trail of the scope of the due diligence, the work done and the results of the work done; 8. A final comprehensive report in respect of each aspect of the due diligence is prepared for the board of the issuer; 9. Verification procedures are established to independently substantiate (as far as reasonably possible) all statements, documents and information submitted to the Securities Commission.