Due diligence certificate

The offer document is written by the issuer's lawyers and signed by the issuer's directors. So why should an investor believe it? Because a SEBI-registered merchant banker has read the underlying documents, questioned the promoters, and put its own registration behind a certificate saying so.

That certificate is the due diligence certificate. There is no legal definition of "due diligence" itself — the workbook says so plainly. What exists instead is an obligation, a set of prescribed formats in Schedule V of the ICDR Regulations, and a list of moments at which the certificate must be on SEBI's desk.

The merchant banker's code of conduct frames the duty: exercise due diligence, ensure proper care and exercise independent professional judgment, and ensure that adequate disclosures are made to investors in a timely manner so they can make an informed investment decision.

When it is filed — a public issue.

A rights issue runs the same pattern with different forms — Part H of Schedule V with the draft letter of offer, Part C at registering, Form D on a material development. A REIT's draft offer document must likewise be accompanied by a due diligence certificate signed by the lead merchant banker, and in a public issue of debt securities or non-convertible redeemable preference shares the lead merchant banker furnishes one prior to filing the offer document with the Registrar of Companies.

What the diligence actually covers. Following the AIBI Due Diligence Manual, it includes discussions with the issuer's promoters, directors, key managerial personnel and other key employees; independent review of every document and piece of information provided; and briefing the issuer's representatives on their statutory responsibilities under the Companies Act 2013, ICDR, LODR, the listing agreement, the insider trading regulations and SAST. The named areas are promoter and promoter group, capital structure, capital built-up, risk factors, management, business, financial statements and litigations.

Who helps, and who signs. Legal counsel carry out legal documentary diligence and may issue legal and disclosure opinions; statutory auditors report on the financial information and issue comfort letters for periods after the last audited financials. None of that transfers the certificate — SEBI has barred the merchant banker from outsourcing due diligence activities and preparation of offer-related documents.

The file. Contracts including the issue agreement, the MOU with the registrar, the escrow agreement, the syndicate agreement, the underwriting agreement, the tripartite agreement with NSDL/CDSL, and the monitoring agency agreement; plus the memorandum and articles, board and shareholder resolutions, auditors' reports, annual reports, the tax benefit report, appraisal or valuation reports, initial listing approvals, correspondence with SEBI including the due diligence certificates themselves, legal opinions, and KYC documentation of promoters and key management personnel. Exchanges now run an online Document Repository platform on which merchant bankers upload and maintain these electronically.

A mainboard IPO of Rs 1,500 crore, one lead manager, one co-manager.

The 9 August event is the one that separates a real diligence process from a filing exercise. A Rs 180 crore award against a company raising Rs 1,500 crore is 12% of the issue size; it did not exist when the RHP was registered five days earlier; and the lead manager cannot simply let the issue run. It must cause the issuer to disclose the development by public notice and must certify again.

Had the issue failed for want of minimum subscription instead, the same final report and certificate would be due within seven days of the refund of money, not seven days of allotment — the obligation does not lapse because the issue did.

Chapter 5, sections 5.2.2 (Due Diligence and Preparation of Offer Document), 5.2.4 (Filing of Offer Document) and 5.2.5 (Documents to be submitted before Opening of the Issue) carry the public-issue chain, and Chapter 6 carries the rights-issue and QIP versions. The lead manager's post-issue duties at the end of Chapter 5 carry the seven-day final report.

Expect stage-matching questions — which certificate goes with which filing, and which Schedule V form — and expect the seven days and the 30 day SEBI observation period as numbers. The conceptual question worth knowing is that due diligence has no legal definition; what binds is the obligation and the prescribed format.

• It is filed more than once. A single certificate with the DRHP is not the job: Form C at registration, a further certificate on any material development, and one with the final post-issue report.
• Seven days runs from finalisation of the basis of allotment — or from refund of money if the issue fails. It is not seven days from listing.
• Two different retention periods appear in the workbook. Chapter 5 says records and documents pertaining to due diligence in pre-issue and post-issue matters are kept for a minimum of five years; Chapter 3 says the books of account, records and documents under Regulation 14 — which include the due diligence records for issue management, takeover, buy-back and delisting — are kept for a minimum of eight years. Read which record the question is about.
• Legal counsel and auditors assist; they do not certify. Due diligence activities and the preparation of offer-related documents cannot be outsourced.
• A convertible debt issue needs a second certificate from the debenture trustee, in addition to the lead manager's.
• The 30-day SEBI observation period runs from the later of the specified dates, not simply from the filing date.
• Due diligence is not the same as the merchant banker's underwriting obligation. One is about the truth of the document; the other is about the money.