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Companies seeking to conduct transactions obviously need to start the process with due diligence — the investigation of facts that can have an effect on an investment, an acquisition, or any other kind of corporate transaction. Due diligence is also a critical component of compliance with aspects of federal law, including the Foreign Corrupt Practices Act, the federal law that puts the onus on American corporations to ensure their employees or agents are not bribing foreign officials in order to obtain or retain business. But what companies often don’t realize is that due-diligence investigations can miss important issues and create costly risks that could otherwise be easily avoided. Company leaders should not assume their staff have conducted such corporate investigations simply because they’ve been assured these have been done. Often, the actual definition of the term is what causes this costly miscommunication. SURE, IT’S DONE In fact, the misuse of the term “due diligence” is so prevalent that even sophisticated corporations have been fooled by those who promote a deal to them by certifying that due diligence has been completed. In one instance, my firm, which conducts corporate investigations, learned that the internal acquisitions professional in a large investment firm had repeatedly assured management that he had finished the required due diligence on a deal. What many in the company didn’t understand, however, was that his compensation was partially tied to the deal’s completion. The acquisitions manager had not conducted the due diligence; instead he had been assured by the outside investment bank that was syndicating the investment that due diligence had been completed and no problems had been identified. In this case the deal was far along when it reached the general counsel’s office for a signature. Sensing something wrong, the general counsel correctly identified that there were too many people involved with too many potential conflicts of interest. We were brought in during the last stages of the deal, long after the letter of intent had been signed, when the general counsel asked for an independent investigation by an outside firm. In relatively short order it was possible to identify a host of red-flag issues about the investment target: • The CEO of the company had been implicated in a federal investigation of influence peddling and bribery, and his brother, who was serving as CFO, had been implicated as an unindicted co-conspirator in a federal investigation of illegal campaign contributions.

• The company’s main project — which had received a grant from the Department of Energy, a fact that was being used to illustrate the firm’s bona fides — was actually owned by a sister company and would in no way benefit the new investors. • A site survey of the company’s purported operating location provided digital images of boards on windows and a parking lot overgrown with weeds. These findings allowed the client to get out of its letter-of-intent obligations by asserting that the promoting company had misrepresented the material facts about its due diligence. This allowed the client to avoid a costly and potentially embarrassing acquisition that never should have been allowed to proceed past the presentation stage. Ultimately, due diligence is only as effective as a company wants it to be; sometimes the company is serious, and sometimes it is figuratively checking a box. When executed correctly, each of the various forms of due diligence is an invaluable tool to help a corporate decision maker fill in the blanks — shedding light on risk factors, the truthfulness of representations, and opportunities for negotiation, as well as increasing the efficiency of the deal. External, independent investigators can provide objectivity in an environment where various parties have parochial interests and where the decision maker has questions or concerns. In the case of a potential acquisition it is not uncommon to see all of the following occurring simultaneously and without coordination:

• The CEO crafted the acquisition arrangement and has a personal pride in the deal, pushing him to see it consummated — sometimes to the point of unintentionally glossing over problems that surface during the process.

• In some large companies an acquisition manager’s compensation may be tied to the consummation of deals, regardless of whether each acquisition proves to be a good decision for the company over time. • The law and accounting firms advising the company on the deal are looking at due diligence by their respective professional definitions, so a lawyer reviews the acquisition target’s corporate documents and board minutes, whereas an accountant checks annual statements and tax filings. • External investors and financiers have their own due-diligence process to calculate the financial fundamentals and creditworthiness of a deal and its participants. This kind of balance-sheet analysis is focused on whether the numbers make sense, not whether there are larger problems inherent in the entities. • Depending on the size of the institutions involved, the human resources department may be doing its own due diligence on the personnel and organizational structure. Often, such exercises identify both key personnel and redundant positions that can be eliminated after the acquisition is finalized. VARIETY OF DEFINITIONS Unscientific searches on the Internet using the search term “due diligence” validate the point about the variety of definitions for the term. Internet searches highlight financial due diligence for venture capital investments, environmental due diligence for corporate construction projects, banking due diligence in the context of Know Your Customer requirements, technology due diligence for chief information officers making enterprise purchases, human resources due diligence as a euphemism for pre-employment background checks, and so on. Experience conducting due-diligence investigations for a wide variety of companies has shown us that all of the above are, in fact, “due diligence,” but that any can be misconstrued by various professionals within a company as being all that is required to address all relevant issues and risks. This positions a CEO to ask senior staff if due diligence has been conducted and to get an affirmative response that does not necessarily answer the question. In fact, due diligence does not stop when a report is produced. Evaluation of the findings by the CEO or a senior management committee charged with risk management is an integral element of the risk-acceptance process. My firm often submits a report to a corporate client, and then the client follows up with questions that focus on an area of further interest to it. Corporate investigations conducted by an outside investigator fill the gap between the legal and financial functions by looking at corporate reputation, historical malfeasance, political relationships, potential conflicts, and nonfinancial risk factors. Most of the time, this is done in a way that does not alert the acquisition target that due diligence is being conducted. Thus a client can avoid telegraphing its intentions while identifying a plan for approaching the acquisition target before the company is able to respond, obfuscate, or change its posture. One of our investigations presents a perfect example. In one telecom investment project in the Philippines, a client started with a list of five companies that had already won government licenses for a new technology. Via due diligence, our client eliminated three of the candidates for reasons that included bribery allegations that would create a Foreign Corrupt Practices Act risk, political relationships with the opposition party, and questionable local reputation. Our client then used information gleaned while the target companies did not know they were being investigated to craft a strategy to approach one of the two remaining candidates. The client offered to solve the company’s build-out problem, a risk factor that could have cost the target company its license and for which it was glad to have outside technical and financial assistance. In markets where there is less transparency, due diligence becomes all that much more critical to corporate risk management. This example illustrates the importance of using the appropriate form of due diligence in a given transaction. Often the due-diligence process starts and stops with an assessment of a company’s reputation. Knowing in the early stages that a targeted company is beset by improper behavior or false statements can save a company valuable time and resources. Assessing the risk of a corporate transaction is critical today, especially in the context of the various laws and regulations that put responsibility squarely on corporate officers. The FCPA, the USA Patriot Act, Sarbanes-Oxley, and many other laws and regulations all give good reasons for a company to establish a universal definition of due diligence and to put a process in place that ensures each of the substantive boxes will be checked before a deal is allowed to go through.


Eric Lebson has conducted corporate investigations and managed due-diligence programs for 17 years. He runs the investigative services practice group at TD International, a Washington, D.C., business intelligence firm.

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