Matthew B. Greene International Law Blog on Lawyers.com

Copyright 2002, 2009 STILAS International Law Services, P.A.  All International Rights Reserved.

Matthew Greene is the founder of STILAS, originally a government contractor for international economic security.  Matthew Greene is a former Chief of Special Operations in anti-organized crime and anti-corruption, and is an international legal expert and career strategic advisor to governments, agencies and ministries in various countries. 

This article is a brief extract from one of a series of expert reports developed by Matthew Greene and STILAS, in cooperation with certain federal law enforcement and national security agencies of multiple countries, for protection of national critical infrastructure in the private sector.

What is “Due Diligence”?

The term “due diligence” comes from the legal concept that corporate executives have a legal obligation to duly exercise reasonable diligence in researching any potentially adverse facts in a business or transaction.

The phrase “due diligence” was first made popular by multinational law firms.  It later became even more commonly used when prominent financial consulting firms began to incorporate the related practices of law firms into their services.  As a result of this widespread popularity, “due diligence” is like a diluted trademark, often used as an interchangeable synonym for a “background check”, although real “background checks” can only effectively be provided by detective agencies, investigative or security firms.  The essence of professional due diligence work is to provide complete, accurate and reliable fact finding, to establish a true and correct representation of a business situation for effective decision making.

Types and Methods of Due Diligence

The Due Diligence methods used by the law and financial firms that made the term popular are generally limited, and are not “investigative” in character.  Such professional practice firms generally advise the client on requesting available corporate documents or accounting statements from potential business partners prior to contract closings, and assist the client in obtaining copies of similar publicly filed records declared by the subject of the inquiry.

This method commonly uses “check lists” of documents, licenses, etc. that should be identified and collected as the basis for specific types of transactions, such as mergers and acquisitions, real estate development deals, franchising and product licensing, joint venture contracts, or direct investment.  The firm will have different checklists that are used for each type or category of transaction.  In addition to identifying and collecting legal and commercial documents, the firm will review them to ensure that documents are properly signed, complete, accurate and otherwise legitimate.

Legal and management consulting firms do not attempt or purport to meet the standards of the economic security industry for background checks or investigations.  This type of Due Diligence is not intended to provide a conclusion as to whether a potential partner is reliable.  Accordingly, law and financial firms often hire security firms to conduct economic security investigations as a supplement to the “management consulting” type corporate Due Diligence.

Open Source Research

The most widely used due diligence methods in the security industry are referred to by professionals as “Open Source” research.  This type of background checks are conducted on the level of official registered information, such as corporate registrations and business filings, proprietary ownership registrations, mass media articles, publications and broadcast transcripts (called “media search”), licensing records, and similar data that is commonly referred to as “public records”.

Taken by itself without any additional methods, however, this type of background check is highly limited in usefulness.  There are many “security” companies on the market that offer “public records” and “open source” research, providing only unverified raw data obtained from the most readily available computerized databases.  While this approach is popular for its minimal cost, it most often cannot address the most valuable information upon which clients must make important business decisions.  At worst, limited “public records” checks can overlook critical facts and mislead decision makers.  At best, they usually raise many more questions than they answer.

Background Check Investigations

A professional “Background Check” investigation consists of a full and advanced “open source” investigation, enhanced by extensive verification and analysis of data.  Conducting effective “open source” background checks for use in due diligence investigations is both an art and a science.

For reliable results, it is necessary to use experienced professional investigators who know exactly what factors and indications to look for, can quickly assess or verify the validity of information discovered.  For results to have practical value and benefit for the client to use in real-world business situations, the investigators must also be able to fully explain and interpret the significance of information, and make practical recommendations.

Guidelines for Conducting Due Diligence

The most effective approach, although perhaps counter-intuitive, is to directly engage the subject company in the process, asking for “voluntary disclosure”.  Tell them that you need to do “due diligence” and want to verify or have a record of certain things that are important to you as a potential customer or partner.

This approach has three primary benefits:  First, it will automatically filter out most fraudulent companies, who will quickly stop talking to you, while legitimate ones will gladly mutually engage to facilitate the process.  Second, you let the subject do most of the work for you, minimizing both time and cost.  Third, the subject is aware that you will undertake verification of information provided, so they will be more careful to avoid misrepresentations and give accurate information.

The following is a list of recommended information, materials and documents that you should ask the company to provide.  The absence of any of these items does not constitute any “fraud flag” by itself, and some may not apply, but these are the most effective things to ask for and verify.

1.      Articles of Incorporation – If you are considering working with an individual partner or hiring an individual professional, and the individual can reasonably be expected to effectively perform the work alone, then the existence of a registered corporate entity is not necessary.  For all other businesses and transactions, a corporate registration is the cornerstone and basis for legitimacy, as it requires the business to rely upon its corporate name, image and reputation.

2.      Certificate of Good Standing – This is useful to show that the company continues to exist and operate as a legal entity, and has not been dissolved and/or reincorporated under another name.  It is not necessary to obtain the most recent Certificate of Good Standing.  Most companies that actively engage in business with serious clients will have one that is relatively recent, and obtain a new one from the State Corporation Commission every 1-2 years.

3.      Bank Account for Transferring Payments – The purpose of this information is to verify that your payments will create a “paper trail” as evidence to ensure that the corporate entity that owns the receiving account will have legal liability for proper use of the funds.  This should not be confused with an intrusive request to show their primary assets bank account.  You only want to know the bank account that you can make wire transfer payments into, that they will have to disclose to you anyway when it comes time to pay them.  Ask for the beneficiary name, bank name, account numbers and SWIFT code.

4.      Licenses or Certifications – Ask for a copy of licenses, permits, registrations or certifications if they are directly related to and required for the specific work the company must perform for you.  If copies are not available (often professional licenses are too large to copy or scan), request the number and issuing authority of each document, and the year and place of issuance.

5.      Web Site Addresses – Beware of companies that tell you they do not have a web site or “don’t need one”.  Legitimate companies always make efforts to allow clients or partners to keep in touch with them, receive notice of changes of office address, e-mail addresses or phone numbers, reminders of services offered or updates on new services.

6.      Resumes of Managers or Key Employees – Ask for resumes (also called “professional bio” or “curriculum vitae” (CV), as used for job applications) of managers or key employees of the company who will be working on your project.  This will give you some additional leads and information to verify the company’s ability to perform the work promised and general capabilities.

7.      Corporate Brochure or Company Overview – Every company should have a professional and well-developed presentation of their business concept or services.  This evidences the level of preparation of the company, and demonstrates whether they have sufficiently developed the capabilities or services they claim to offer.

8.      Detailed Written Presentation of Services Offered – Ask for a detailed written presentation of the proposed business, product or services offered.  The key indicator of legitimacy and reliability is the transparency and disclosure of detailed mechanisms of the proposed transaction and methods of work to be performed.  The best evidence of a company’s experience and capabilities is its willingness to disclose detailed verifiable information in writing, and the level of preparation and quality of its presentation materials.

9.      Reports or Articles Written by Principals or Managers – Ask for any other reports, articles, publications or non-proprietary research memorandums written by principals or managers of the company who are related to proposed work on your project.  While not required, such materials can be excellent evidence that the company is actively engaged in the sphere of business that they claim to be, or is an authority on the capabilities that you are considering it for.

10.   Sample or Standard Contracts – Ask them to provide copies of sample contracts or standard agreements related to the proposed transaction.  If they do not have a standard contract, then that is an indication that they have not engaged in that type of business before, and may lack experience.  Beware of contracts that misuse financial or legal terms, contain ambiguous colloquial wording, or have apparently not been developed with the participation of any lawyers.  Unprofessional contractual documents are a risk factor in and of themselves.  At worst, they may be intentionally misleading to perpetrate a fraud.  At best, they suggest that the company is not properly prepared to engage in the transaction.

Matthew Greene and STILAS avoid accepting any business from the general public.  Consultation is generally provided only to government agencies and banking institutions.  Provision of services to the private sector may be considered only upon introduction through trusted partners or colleagues of Matthew Greene and STILAS.