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Due diligence in a dangerous world

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Due diligence is a concept that has been around for a long time, but its profile has risen significantly over the past decade.

Due diligence is a concept that has been around for a long time, but its profile has risen significantly over the past decade. While a few years ago its focus was very much on preventing money laundering, and subsequently the disruption of terrorism financing, today due diligence is seen as a key tool to mitigate corruption and fraud-related risks.

IntegraScreen, which has just been acquired by World-Check, has specialised in conducting enhanced due diligence research since 2000. As one of the largest specialist providers of such services in the world, IntegraScreen’s global footprint includes nine international offices and more than 200 full-time researchers. It serves a broad range of clients in the financial services industry, including all the large US and European banks and other financial firms, as well as the manufacturing and technology industries, accountants and indeed any business that requires screening of the background of individuals and companies.

By its nature, the hedge fund industry is an important area of business for World-Check, especially following its expansion into emerging markets over the past three years. Many hedge funds lack transparency in terms of their public footprint – they may not be incorporated as companies, or may lack a publicly disclosed track record – so there is an increased need to focus on the background of the individuals responsible for running these funds.

Many investors base their decisions to do business with a hedge fund on the background of its principals. Enhanced due diligence is in demand to verify that these individuals are who they say they are, that their business record is trustworthy, and that that their education, qualifications and employment history is accurate.

Investors entrusting their assets to portfolio managers need reassurance that they actually have the degree they boast from Harvard Law School or that MBA from Yale, or that they really did spend 10 years as head of US equities with a big investment institution. They also need to know whether their money managers have any red flags such as litigation or bankruptcy against their names.

These concerns have become even more pressing since the discovery of the Madoff scandal, and every new fraud case or Ponzi scheme that is uncovered reinforces the importance of background screening. Before, investors may have relied on the fact that the individual in question had a good word-of-mouth reputation, moved in exalted social circles or was a personal acquaintance – but no longer.

The use of third-party enhanced due diligence is also growing in favour. The expectations placed on in-house staff members are steadily growing, but companies are also becoming aware of the dangers of conflicts of interests if a staff member with a financial interest in a deal is responsible for assessing the integrity of their counterparties.

Independent scrutiny of this kind may also be required by regulators or financial firms’ own investors.

A further factor is the extraterritorial application of the US Foreign Corrupt Practices Act, which can apply to foreign companies with any kind of link to the US; even something as apparently trivial as a bribe paid in US dollars that passes through a New York bank can lead to prosecution.

When executives of foreign companies can be arrested in transit at US airports, they become very conscious of how high the stakes are if due diligence is not carried out properly.

Doug Nairne is head of enhanced due diligence operations at World-Check

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