Risk Mitigation and Due Diligence Tips for Global Growth

For this edition of the SPAC Notebook, I had the opportunity to speak with I-OnAsia COO James Tunkey. As an experienced risk management executive, he helps clients, including those in the SPAC market, take advantage of global growth opportunities by offering due diligence and litigation support, and other related consulting work.

Since many of our SPAC Notebook readers and listeners are affiliated with foreign companies who are looking to list their companies in the United States, our conversation focused on answering some of their frequent questions. Here are the highlights.

Due Diligence Steps Before Listing on the US Exchange

Yelena Dunaevsky: First, let’s turn to service providers in the US, like investment banks and law firms, that are taking on projects with a foreign company which is looking to list in the US. What kind of issues do they need to protect against and what steps should they take when minimizing their own risk?

James Tunkey: When we first think about doing background checks on behalf of these service providers (aka gatekeepers), we want to make sure the information provided by the directors and officers is verifiable. It’s important because some people have inflated their biographies. These are simple but important facts that need to be checked because they end up being on the S-1s and the F-1s.

Next, we examine whether a director or an officer has any civil or criminal litigation history and whether they’ve been sanctioned. Investors want to know if there are risks in somebody’s background that must be disclosed. So, a third-party independent background check is essential.

The final step is to search for any negative media. The investors, the public and the litigation attorneys are smart. If there has been negative media in the past, they will discover it. Likewise, the regulators are going to discover it.

Yelena Dunaevsky: From the insurance perspective, directors & officers insurance coverage (D&O insurance) is a necessary part of the process for going public in the United States.

Availability, terms and pricing of this insurance coverage will be, in large part, based on the backgrounds of the directors and officers of the company. Insurance underwriters, as part of their underwriting, will closely examine the director’s background, the company’s background, negative media, articles, and litigation to evaluate the risk before they offer coverage options. You don’t want to be surprised with this information close to your listing or IPO.

Considerations for Companies Coming to the US

James Tunkey: Most foreign companies are surprised by how active litigation is in the United States, including the role that activists and short sellers play here and how they scrutinize new listings.

Also, the US regulatory environment follows different rules than many foreign countries. A part of our process is to begin to prepare companies for this challenge.

Yelena Dunaevsky: As someone who practiced capital markets law before becoming an insurance broker, I can say that the litigation and regulatory enforcement environment is something we watch very closely here at Woodruff Sawyer because it is central to the kinds of risk mitigation and insurance coverage recommendations that we give to our clients as they move towards an IPO.

For example, many foreign companies do not realize that the minute you hit that button on the IPO, you are exposed to an enormous amount of risk from the public market. You can have a securities class action filed against you for various reasons. Most commonly, the price of the stock drops, and boom, you have public shareholders coming out of the woodwork filing expensive lawsuits.

Thirteen percent of all newly public companies will be subject to securities class action suits. These suits can cost millions of dollars in attorney fees and settlement costs. For SPACs, there’s an 18% chance of having to foot the bill for millions of dollars of litigation costs just out of the IPO gate.

Working with a knowledgeable insurance broker specializing in this area in the US to correctly structure your insurance coverage is incredibly important.

Risk in the US vs. Other Countries

James Tunkey: There are differences in what the words risk and insurance mean in different countries. One gap in understanding is knowing what coverage is necessary and how to get that coverage internationally as a firm grows.

For example, let’s say you are a contract manufacturer in Asia with US customers. You might have the required $2 million in general liability coverage in your home country and think that will be sufficient in the US. The risk and litigation environment in the US, however, is often very different and a lot more difficult and costly than in other countries.

Yelena Dunaevsky: Yes. Also, understanding differences in insurance coverages and complexity is crucial. General liability coverage, for example, is a world away from directors and officers (D&O) insurance coverage. If there’s a lawsuit against the company, that lawsuit will likely pull in the directors and officers of that public company, at which point they will be individually and personally responsible for the costs of defending against that lawsuit if their company has not purchased D&O insurance coverage. Lawsuit defense and settlements costs often run into millions of dollars. A $2 million D&O policy is not even going to make a dent in those costs.

What’s worse, in addition to financial liability, the directors and officers of a public company could be subject to criminal liability, with legal defense costs for any criminal action also falling on their shoulders. On the enforcement side as well, investigation costs and other expenses can snowball into millions of dollars of attorney fees. These risks are nothing to trifle with but are often not well understood by non-US company management teams.

Tips for Understanding the US Market

James Tunkey: The US has been booming as a market for foreign companies, and I expect it will continue to do so in the years ahead. We recommend getting your disclosures ready for scrutiny and collecting your documents as a form of defensive due diligence.

When you take control of this process, this proactive approach has the added benefit of reducing costs. If you do all background checks through a reliable third party, you don’t have to keep paying people to repeat the process. The background check is in order. It’s portable from one place to the next, and people can rely upon it and fill it in over time.

Yelena Dunaevsky: For a newly minted public company in the US, the disclosure regime is fairly heavy and requires time, effort, and expertise. When you invest in the right advisors, they’ll be able to save you a ton of trouble and money down the road.

The bottom line is experienced advisors see many companies go through similar problems over and over. They have the expertise to steer less-experienced teams, who may not be familiar with a new market, in the right direction and help them avoid many unnecessary risks and costs.

James Tunkey will join SPAC Notebook again in a few months for another conversation, we will dig into what foreign companies need to know about litigation in the US and will discuss the D&O insurance claims process.

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