Due Diligence

Covers an underwriter's affirmative defense to liability claims brought under Securities Act §§ 11 and 12

Term also refers to an underwriter's investigatory responsibilities under the securities laws
Term is not expressly defined by the securities laws
Derived from the language of Securities Act §§ 11 and 12

Which subject underwriters to potential liability for any material misrepresentations or omissions contained in a registration statement or prospectus, unless they've exercised due diligence
Section 11 precludes liability where the underwriter reasonably believed, after reasonable investigation that no violation existed
Section 12(a)(2) precludes liability where the underwriter, having exercised reasonable care, did not or could not have known of the violation

Provides factors for courts to consider when determining the "reasonableness" of an investigation for purposes of Section 11
Text of Rule 176
Adopting release 1982

Presents particular difficulties for underwriters

In re WorldCom SDNY 2004

Opinion Table of contents
Denied summary judgment to underwriter defendants
Who then settled for a record amount
See WorldCom Aftermath
Raises significant questions about underwriters' liability
Particularly in the context of shelf registrations
Underwriters argued that they were entitled to rely on audited financials without further investigation unless plaintiffs could establish that the underwriters had actual notice of "red flags"
Underwriters argued they were similarly entitled to rely on auditor's comfort letters with respect to unaudited interim financials
Court disagreed, holding that deeper investigation was required

A jury could conclude that underwriters had not conducted a reasonable investigation:

Court relied on Rule 436 to make distinction that unaudited interim financials are not an expertised part of a registration statement, requiring inquiry beyond a comfort letter

Securities Offering Reform Release 2005

SEC makes significant changes to its rules
Allows automatic shelf registration
for well-known seasoned issuers
Further complicating efforts by underwriters to conduct
due diligence
ABA comment letter suggests expanding Rule 176 to better cover shelf registration

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