According to common practice, a strong compliance program focuses on policies, employee training, books and records and internal controls, onboarding questionnaires and risk ranking of third parties, with a little investigative due diligence at the end. Company compliance programs are primarily driven by paperwork and training programs. Overall, the emphasis is on financial controls with due diligence coming in a distant second. It shouldn’t, but it does. This is because most due diligence programs apply legal due diligence on the front end and financial due diligence on the process side of things. Risk management due diligence, or human due diligence, and human intelligence, are often an afterthought if even that. In reality, human due diligence, or due diligence investigations are the main preventative tools in mitigating risk and evaluating the human side of the risk equation.
Due diligence investigations, including business and executive due diligence, is how a business can prevent many future problems, by vetting and screening executives and prospective or existing business partners, up front. The sooner this vetting is performed, the fewer problems a company will have with its internal controls. It’s one of the most important components that is often overlooked. Most companies today think of investigative due diligence or third party due diligence as a check the box exercise, which it shouldn’t be.
Insufficient, subpar, or neglect of due diligence can lead to substantial problems for a company. The simplest way to protect your company is by preventing fraudsters and con artists from gaining entrance to your business to begin with, rather than trying to find bad actors and rogue
players once they come aboard. To accomplish this, first a company needs to know what a proper due diligence investigation looks like and second, what are the significant consequences of insufficient due diligence. It is well known that 90% of FCPA violations occur because of third party issues, often involving bribery and corruption.
What a (Tier III) Due Diligence Investigation Is
Due diligence investigations are designed to detect hidden and undisclosed information that is not readily available in standard background checks. These deep dive due diligence investigations (a Tier III investigation) evaluate, among other markers: relationships of executives to foreign officials and other companies and entities, reputation issues, financial misconduct, legal issues, civil litigation issues, criminal history, political influence, conflicts of interest, shell company involvement, evidence of fraud, signs of money laundering, financial impropriety, behavioral issues, anti-competitive behaviors, and other serious matters.
A Tier III due diligence investigation or executive due diligence background check should be conducted by corporations on new executive hires and board members, or when an executive promotion occurs. Deep dive due diligence investigations are also critical when bringing aboard new entities through Mergers and Acquisitions (M&A); these can be conducted on the business entity itself, as well as the acquired key executive team. Executives will be in the highest positions of trust, a basic background check does not include any of these important searches, and therefore will not reveal these types of issues, however, effective executive due diligence investigations enable this information to be discovered, thus protecting the board and shareholders from unnecessary risk exposure.
This Tier III level due diligence investigation not only incorporates technology, such as incorporating Open Source Intelligence (OSINT), but is conducted by expert investigators who are skilled at triangulating complex and disjointed information, searching for hidden connections, and investigative analysis during which behavioral issues can come to light. The behavioral history of an individual can disclose observable patterns with type and frequency of issues such as, civil lawsuits, sexual harassment, class action lawsuits, fraud, and breach of contract matters.
These due diligence investigations become even more critical when doing business globally. Due diligence investigations when involving foreign entities need to be looked at relative to culture, along with location of executives and organizations. What can be considered socially or even legally acceptable in one nation, may be unacceptable and illegal in another. The Securities and Exchange Commission (SEC) and Department of Justice (DOJ) have joint enforcement authority of the Foreign Corrupt Practice Act (FCPA) to fight corruption. Many US-based multinational companies struggle to have employees understand how common business practices such as gift-giving and small facilitation payments may be considered corruption in the USA.
Significant Consequences of Insufficient Due Diligence
The consequences of not giving as much weight to due diligence investigations in a corporate compliance program can be grave.
Insufficient due diligence can lead to reputational damage, affect the bottom line, cause financial damages, or even lead to criminal convictions, incarceration of executives, and stiff regulatory fines and penalties.
Scandals can ravage brands, destroy careers, tank stock prices, and ruin lives. Insufficient executive due diligence allows individuals with harmful proclivities and histories an easier chance to be hired or work within your company where their external bad actions or their internal bad or illegal ones can do serious harm.
Just recently, the fashion house Balenciaga has come under fire for a holiday ad campaign with toddlers holding teddy bears in bondage gear. Backlash came immediately, the hashtag #boycottBalenciaga and #cancelBalenciaga trending on social media from TikTok to Twitter. Balenciaga and its creative director Denma have been accused of condoning child exploitation and pedophilia. Balenciaga has since pulled the ads, said they would hold internal and external investigations, and while the company did apologize, took no responsibility. Instead, they filed a $25M lawsuit blaming the third-party agency and set designer, whose representative stated her client is “being used as a scapegoat” and that “Everyone from Balenciaga was on the shoot and was present on every shot and worked on the edit of every image in post-production.” Business of Fashion withdrew its 2022 Global Voices Award to Denma. The Balenciaga store in Hollywood was graffitied. People are posting videos cutting up and tossing out their Balenciaga items. Adding fuel to the fire, a Spring 2023 ad by Balenciaga has been noted to have what appears to be a page from a court document of a Supreme Court case that “ruled on federal laws regarding child pornography.” Balenciaga’s current controversy showcases what can go wrong when scandal strikes.
Even when a company has no issues, if their board of directors, employees, executives, or partners are caught in a scandal, their customers, the media, and investors may treat with disfavor a business for having hired them in the first place and question their facility to manage their internal affairs and protect theirs.
Scandals can also affect company stock price. There may also be shareholder lawsuits, particularly if it has a negative impact on company valuation. Enron, the former energy company, whose stock shares reached a high of $90.75, fell to 26 cents around the time the company declared bankruptcy in 2001. Shareholders lost close to $75 billion.
Some recent corporate and individual bad actors that serve as warnings include: Elizabeth Holmes, Martin Shkreli, Harry Weinstein, Volkswagen’s emissions scandal, Stericycle, and Enron, to name a few.
Due diligence investigations (and the decision to act on them) could have made all the difference in every one of these cases.
Culture starts top down in companies. The executives set the tone. When fraudsters and con artists, or unethical people are hired, it can have a highly negative impact on productivity, fairness, teamwork, core business, customers, and the bottom line. Executives and other individuals may have impressive names on their CV or resume, but if they have poor work ethics, showcase litigious behavior, bullying, harassment, gambling or drug and alcohol problems, or other behavioral issues, the morale, trust, and outlook of employees and customers may be negatively impacted. Integrity and good work ethic should be critical for every executive hire. A Tier III due diligence investigation can help assess this and reveal hidden or undisclosed issues.
The Foreign Corrupt Practice Act (FCPA) contains both anti-bribery and accounting provisions. FCPA violations have increased over the last few years, with some COVID-19 related slow down. In 2019, FCPA enforcements rose to $2.65 billion in penalties, an all-time high. 2020 FCPA enforcements rose again to $2.78 billion. That same year also saw the largest singular FCPA fine against a company at $1.6 billion.
Financial damages can be punitive and personal. Additional penalties include: injunctions, forfeiture of associated profits, forfeiture of assets, and suspension (or in some instances banning) from doing business with the government.
As of September 2022, FCPA enforcements for just three companies Stericycle, Inc., South Korea’s KT Corporation, and Tenaris the Luxembourg totaled about $189.3 million and there are over 100 open and on-going FCPA investigations.
For almost twenty years, Bernie Madoff ran a Ponzi scheme defrauding investment clients of billions of dollars. He was convicted of 11 federal crimes and sentenced to 150 years in prison and restitution of $170 billion.
This year, Elizabeth Holmes, whose company Theranos was once valued at over $9 billion was convicted on 4 counts of fraud in a federal court and was sentenced to 11 years and three months in prison. Her one-time romantic partner and Theranos executive Ramesh “Sunny” Balwani was convicted on 12 counts of fraud and awaits sentencing. All of these executives had prior issues that could have been evaluated by investors had they conducted executive due diligence investigations. Smart investors did conduct legal, financial, and investigative due diligence and were able to steer clear of the disasters left in the wake of these fraudulent executives.
Due Diligence Investigations Mitigate Corporate Risk
Due diligence investigations are vital in aiding companies in foreseeing and mitigating risk and minimizing corporate liability exposure. Rather than being tacked on at the end of a compliance program, it should be a serious part of all regulatory compliance efforts.
Companies should not rely on executive recruiting firms to conduct due diligence investigations. Most only conduct only basic background checks and reference interviews which is insufficient due diligence. Today federal regulators at the DoJ and SEC are well aware of the differences.
Tier III due diligence safeguards the interests of the company, board, employees, and stakeholders. Due diligence investigations, also benefit corporate governance programs, FCPA compliance, Sarbanes Oxley (SOX) compliance and minimizes liability exposures from possible future inappropriate activities and crime. These human due diligence investigations add fiduciary protections for corporate board of directors, especially for publicly traded companies
Preventing bad actors and unethical individuals from entering your business to begin with, safeguards your company from the start, so there will be fewer control issues later. Due diligence investigations should stop being an afterthought in corporate compliance programs, but rather, something you lead with.