Poor Due Diligence Can Cost Money...and More

By Tom Harnish on 2 February 2011 (Updated 8 March 2011) 0 comments
Photo: arenacreative

When you’re looking for freelance help, contractors for a software project, or overseas strategic partners, due diligence is required to ensure you don’t look foolish, waste money, or worse.

The Securities Act of 1933 introduced the concept of "due diligence" as a defense that could be used by a securities broker or dealer if they were accused by investors of inadequate investigation of a company. In other words, if the broker exercised a proper degree of care — made a duly diligent effort to assure buyers that the company was as represented — they could not be accused of misrepresenting what they were selling if it turned out the company didn't perform as planned.

Over the years, the concept of due diligence has taken on new meaning extending from financial transactions to mergers and acquisitions, civil and criminal law, philanthropy, commercial real estate, and even information security. Indeed, the general idea of looking carefully at any situation is often referred to as "doing your due diligence."

The Foreign Corrupt Practices Act of 1977 (FCPA) was signed into law by President Jimmy Carter to "bring a halt to the bribery of foreign officials and restore public confidence in the integrity of the American business system." The law has forced companies to look closely at overseas relationships. If your trade overseas, failure to assure due diligence could result in your company doing business with foreign officials or state owned business in violation of the law. Such a violation is subject to severe financial penalties.

Depending on the type of company involved, and the nature of the transaction, the due diligence process may include not only financial and tax reviews, but also investigations into recent, on-going, and anticipated legal proceedings. Labor relations issues, environmental risks, and market factors might be the focus of a due diligence review, or they might be peripheral to other areas such as intellectual property, insurance and liability coverage, or immigration.

Due diligence in the age of the internet is a simple matter, at least at the initial stages. It isn't difficult, for example, to run a search for the name of someone you're thinking of working with or hiring. You can find out from sites such as LinkedIn and Facebook what jobs they claim to have had and where they went to school.

In my own personal case of having done poor due diligence, during the final stages of closing a multi-million dollar venture capital deal my wife discovered that the company’s management team included a convicted felon. In extreme cases, failure to adequately conduct due diligence reviews can have even more serious consequences.

My brother's life was threatened recently by a jealous colleague who, it turns out, didn’t have the professional healthcare credentials he claimed — something that should have been discovered by his hospital’s pre-employment due diligence.

In one of the worst recent cases of failed due diligence, children have died, and more will be lost. The tragedy began when intentionally falsified data was used to suggest that common childhood vaccinations produce autism. Some parents now refuse to vaccinate their kids, putting their and other children’s lives at risk from preventable diseases. Due diligence, properly carried out, could have revealed the fraud, and might have prevented this ongoing tragedy.

So, please, do do the due diligence that you should do, and do so well. The financial success or survival of your business may depend on it.

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