A banker drafts a prospectus, opens a data room, and tells the seller which documents the buyer must see. One omitted lawsuit, one stale financial, and the offering document becomes legally defective. Due diligence is how you earn the defense.
Every offering document lives or dies by one rule. It must not contain an untrue statement of material fact, and it must not omit a material fact necessary to make the statements made, in light of the circumstances, not misleading. That is the disclosure standard, and it governs both registered (public) and exempt (private) offerings.
Two failure modes exist. The first is an affirmative lie, a stated fact that is false. The second is the silent gap, a true statement rendered misleading because a needed fact was left out. A prospectus that touts record revenue while omitting that a top customer just terminated its contract is misleading by omission, even though the revenue figure is accurate.
KEY: Materiality turns on whether a reasonable investor would consider the fact important in deciding to invest. If yes, it must be disclosed.
Common mistakes
- Thinking the disclosure standard only bans lies. It equally bans omissions of material facts needed to keep statements from misleading. The silent gap is a violation, not just the false statement.
- Assigning the data room to the buy-side. The sell-side builds, indexes, and monitors access to the data room. The buy-side only coordinates getting its team in.
- Swapping the SOX section numbers. 402 is executive loans (conflicts), 403 is insider transaction reporting, 404 is internal-control assessment. Confusing 402 and 404 is the most common trap.
Bottom line
- The disclosure standard: an offering document must not state an untrue material fact or omit a material fact needed to make its statements not misleading
- Sell-side diligence reviews the issuer's business and financials, interviews management, contacts vendors, suppliers, and customers, runs site visits, and ends with bring-down diligence just before closing
- Bring-down diligence reconfirms that nothing material changed between drafting and the closing date
- The data room is built, indexed, and access-controlled by the sell-side; the buy-side coordinates management presentations, data-room access, and site visits with the target
Exam shortcut
Sides split by data room. If a question describes building, indexing, or policing the data room, it is sell-side; if it describes coordinating access, presentations, and site visits for the buyer, it is buy-side. SOX number ladder, "loan, list, controls." 402 = no executive loans, 403 = list insider transactions, 404 = internal controls. Climbing the numbers goes loan, then list, then controls. Section 11 means public, defense means investigate.
The full lesson (about 2,884 words, 19 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- A11
- A12
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