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“Due diligence investigation” is a phrase that varies in meaning among different business organizations and industries.

From the perspective of a venture capitalist or a private equity investment manager, it’s about assessing the business model, conducting market research and talking to the market.

For an accountant, it may be analyzing the books and records.

From an investigator’s perspective, a due diligence investigation is utilized to assess the character, integrity and reputation of potential business partner(s) or key player(s) in a venture before the client enters into a substantial financial relationship.

What is a due diligence investigation?

A due diligence investigation is conducted to assess the qualifications and track records of the people involved in the deal, to identify potential inconsistencies, misrepresentations, omissions or controversies in their backgrounds.

When is a due diligence investigation performed?

These investigations are commonly performed prior to transactions such as a merger or acquisition, formation of a business partnership or strategic partnership, or a significant investment or financing arrangement.

Who requests a due diligence investigation?

Due diligence investigations are typically conducted on behalf of small and medium-size businesses, large corporations, investment banks, private equity firms or other investors. In many cases, the investigation is initiated by a legal team involved with the deal in order to protect the integrity of the information.

What is included in a due diligence investigation?

Information that is typically covered in a due diligence investigation includes the following:

  • Personal and professional history, which includes work history, board memberships and nonprofit affiliations
  • Historical news media research on the individuals and businesses with which they have been affiliated
  • Details of civil litigation and criminal case history, including on-site court research and retrieval, where applicable
  • Regulatory records, professional licenses and government compliance checks
  • Financial history, which includes personal assets, judgments, liens, bankruptcies and U.S. Tax Court cases
  • Corporate affiliations, sex offender registries, driving history records and political contribution records
  • Credit history (with consent)

In addition to the above, a due diligence investigation can include interviews with references, sources or relevant parties.

What kind of information is found in a due diligence investigation?

Some of the more common issues that are revealed in a due diligence investigation include the following:

  • Misrepresentations of employment history or falsified degree information
  • Financial troubles, including bankruptcies, tax liens and foreclosures
  • Accusations in lawsuits, such as harassment or fraud
  • Regulatory issues
  • Past criminal trouble, including drunk driving
  • History of litigiousness
  • Undisclosed corporate affiliations, government scrutiny or a trail of failed companies

Why conduct a due diligence investigation?

In today’s business world, information is power. In the end, the purpose of conducting a due diligence investigation is to gather as much intelligence and information as possible to help you make a more informed decision.

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This weekend, many moviegoers and avid baseball fans around the country will be taking some time away from the grind of daily life to see Brad Pitt and Jonah Hill star in the film “Moneyball,” based on the 2003 Michael Lewis best seller that catapulted the Oakland Athletics general manager Billy Beane into the most outsized, polarizing and wealthy general manager in professional baseball.

Shortly after taking his current position as general manager of the Oakland Athletics, Beane became the lead evangelist for a new baseball orthodoxy he adapted from sabermetrics, a form of analysis pioneered by Bill James that emphasizes greater statistical analysis in the scouting and development of players. Instead of hiring old-time scouts, Beane hired an Ivy League nerd, drafted players nobody wanted and turned around a flailing franchise.

His success prompted copycats who admired Beane and his approach for its reliance on credible information, the process of analysis and the ability to question previously held assumptions.

Moneyball Approach Applied Elsewhere

What others quickly learned is that general sabermetric (or “Moneyball”) techniques are applicable not only to sports but to many aspects of life and business. Since the acclaim of his philosophy, many other baseball teams, other professional sports franchises and Fortune 500 companies have partially credited their respective successes to adapting the quantitative analysis approach to their businesses, while utilizing all of the resources and information available.

In an October 2008 New York Times op-ed, Beane, along with Newt Gingrich and Senator John Kerry, wrote about using sabermetric-style techniques for improving health care by focusing on data mining, statistical analysis, reducing medical errors and cutting costs. In an interview with ESPN in 2010, Beane said:

“It’s all about evaluating skills and putting a price on them. Thirty years ago, stockbrokers used to buy stock strictly by feel. Let’s put it this way: Anyone in the game with a 401(k) has a choice. They can choose a fund manager who manages their retirement by gut instinct or one who chooses by research and analysis. I know which way I’d choose.”

Final Thought

In today’s business world, information is power. Successful professional investigators can provide their clients with both the resources and the information available to help them make better-informed decisions. Unfortunately even today, any business deals that are consummated with “collective wisdom” or “gut instinct” can end up in litigation simply because the parties failed to do their homework and turn to a professional for due diligence research.

In today’s competitive marketplace, it is no longer manageable or healthy to “fly blind” into any business deal. Yes, the familiar “Trust, but Verify” motto is still applicable here—but verify only through credible resources that can provide you with the intelligence and analysis that you might not find on the Internet.

Beane chose data over intuition, but the key point here is that your analysis of the data is only as good as the information you put into it.

Other Reading:

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A due diligence background check on potential investments can help your family office preserve wealth and protect assets for generations to come.

Frauds, Ponzi Schemes and Financial Fraudsters

The news is filled with stories of some of the most sophisticated investors in the world being duped by investment frauds, Ponzi schemes and financial fraudsters.

While institutional investors have been splashed across the news for their lack of due diligence and background checks, in truth, it is the smaller family offices and wealthy individual investors who have been most affected. For institutional investors, losses can be more easily absorbed, but any losses sustained by a family office from an investment fraud can affect generations of family wealth.

A recent poll by Rothstein Kass Family Office Group found that 85% of single-family office operations are currently invested in hedge funds.

The fact of the matter is that fraudsters prey on wealthy individuals, family offices, endowments and even nonprofit organizations because they know that they do not have the same due diligence resources as institutional investors and are less likely to perform a due diligence investigation. As financial frauds have become prominent, so too have the services of professional investigative firms to uncover potential issues and minimize investment risk.

What your family office could have avoided with a due diligence background check:

  • Sam Israel (Bayou Fund) – In 2005, Sam Israel was charged with losing more than $400 million from investors in the Bayou Fund and was sentenced to 25 years in prison in 2008. A due diligence background check on Israel and the Bayou Fund would have identified multiple red flags, including embellished employment credentials, an accounting firm that had ties to Bayou’s own chief financial officer, and DUI and criminal possession of a controlled substance charges against Israel.
  • Samuel “Mouli” Cohen – In August 2010, federal prosecutors in California unsealed a criminal indictment accusing local businessman Samuel “Mouli” Cohen of defrauding more than 55 investors, including actor Danny Glover, out of more than $30 million. An investigation into Mouli Cohen would have identified previous failed business ventures, prior allegations of fraud and nearly $500,000 in back taxes owed to the government.
  • Danny Pang (PEM Group) – In 2009, Danny Pang, the principal of a $4 billion international investment firm, was accused of defrauding investors of hundreds of millions of dollars. A background check would have revealed that Pang was misrepresenting his education credentials, his property was in foreclosure five years prior to charges being brought against him, and multiple civil lawsuits including harassment charges were filed against him.

Final Thought

Don’t become another statistic. Due diligence background checks can help you minimize your risks, protect your assets, make more informed decisions about your investments and protect assets for generations to come.

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“Due Diligence” is a phrase that varies in meaning between different business organizations and industries, but from a private investigator’s perspective, investigative due diligence most commonly refers to the assessment of the background and reputation of a potential business partner(s) or key player(s) in a venture before parties enter into a substantial financial relationship.

Investigative due diligence can also encompass the assessment  of company-wide issues including quality of assets, liability issues (such as lawsuits) or regulatory or environmental issues, but for the purposes of this post, we are only discussing the reputation of a potential business partner(s) or key player(s).

Minimizing Your Risk

When your business or reputation is on the line, investigative due diligence can help you minimize the risk of potentially bad investments, costly mistakes or angry investors. If you are not conducting a comprehensive background check and instead are relying on inexperienced fly-by-night  companies that provide unorganized “data dumps” of information from random database records, you are asking for trouble. Thorough analysis of data identified by a trained professional private investigator can assist you in understanding what is out there and help you make informed decisions instead of disastrous ones.

What key issues can be uncovered on potential business partner(s) or key player(s)?

  • Business Interests – Corporate executives engaging in self-dealing, hidden business interests or historical affiliations that have been the subject of controversy, bankruptcy or sanctions
  • Personal History – Multiple divorce filings with allegations of personal misconduct
  • Professional History – Falsified education credentials or misrepresentations of previous work history
  • Regulatory Issues – Undisclosed regulatory complaints or disciplinary actions taken by state or federal regulatory agency
  • Criminal/Civil Cases – Multiple convictions for driving under the influence of alcohol, allegations of soliciting a prostitute or litigious past
  • Financial Status – Hundreds of thousands of dollars in federal tax liens, credit issues to grievances filed with U.S. Tax Court
  • Assets – Multiple houses and boats which could show someone living beyond their means

Final Thought

Investigative due diligence can help you identify self-dealing, hidden interests, personal issues or past red flags on potential business partner(s) or key player(s), that can help you minimize the risk of potentially bad investments.

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One of the most overlooked areas in a private equity transaction is a due diligence background investigation on the key players or principals part of the transaction.  The purpose of the due diligence background investigation is to evaluate the integrity of individuals – both personally and professionally – that you are going to be doing business with. Understanding the personal and professional history of those key players can be the difference between a successful transaction and a complete failure.

People are Assets

In some cases, the key assets that are being acquired as part of an acquisition are hard assets such as a product, factory, patent  or even an idea.  But in other cases, the most important assets are the people that are going to be on board, especially in service related businesses.  If the transaction involves the acquisition of key principals that are going to be the foundation to the future success of the company, among the key issues that need to be answered as part of the due diligence investigation process is the background and reputations of the parties whom you will be doing business with.

Key issues that could be uncovered:

  • Business Interests – Corporate executives engaging in self-dealing or previous business interests that have been the subject of controversy, bankruptcy or sanctions
  • Personal History – Multiple divorce filings with allegations of personal misconduct
  • Professional History – Falsified education credentials or misrepresentations of previous work history
  • Regulatory Issues – Undisclosed regulatory complaints or disciplinary actions taken by state or federal regulatory agency
  • Criminal/Civil Cases – Multiple convictions for driving under the influence of alcohol, allegations of soliciting a prostitute or litigious past
  • Financial Status – Hundreds of thousands of dollars in federal tax liens, credit issues to grievances filed with U.S. Tax Court
  • Assets – Multiple houses and boats which could show someone living beyond their means

In Depth: Anatomy of a Comprehensive Background Investigations [Infographic]

Who should a private equity firm conduct a due diligence background investigation on?

To best answer this question, some of the key questions that you need to ask yourself is: how much capital is at risk, how much reliance is being placed on the key principals of this transaction and the nature of the business (a paper mill and an oil exploration business have two totally different risk profiles). Ultimately, it’s a choice that the private equity firm must make, but at the very least, a due diligence background investigation should be conducted on the key principals as part of the transaction, specifically those individuals whom you have identified during the transaction as keys to the future success to the company.

Final Thought

Having the wrong management in charge can be the  difference between an immediately successful acquisition or a complete failure. The goal of the due diligence background investigation is to identify relevant issues in management’s background and track record to make a well informed business decision that could impact your investment decision.

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The Securities and Exchange Commission (“SEC”) has recently initiated a program to educate both first-time investors and seasoned professionals on the identification of various red flags of investment fraud to conduct a “do-it-yourself” due diligence investigation. While the SEC outlines several important ways to avoid falling victim to an investment advisor fraud, (e.g. “pump and dump,” pyramid, ponzi scheme or affinity scheme), an experienced due investigator specializing in due diligence investigations is trained to tap into numerous resources to obtain critical facts which often help investors make more “informed” decisions and help you avoid an investment fraud.

In addition to conducting quantitative due diligence on a potential investment advisor/broker/hedge fund manager (i.e. reviewing financial statements, understanding the investment scheme, etc.), here are some additional tips on how to avoid falling victim to an investment-related fraud from a due diligence investigation perspective:

“Googling” is not due diligence

Did you know that by recent estimates, the surface web (a typical “Google” or search engine) accounts for less than 1% of what is actually on the Internet? Consider that the next time you spend an hour “Googling” a particular person or company and come up empty. It is also important to understand that the more successful and more complicated the particular scheme has become, the more likely the fraudster will “bury” any derogatory or damaging information about themselves into the Internet. (See related post, What You Find on the Internet May Not Be True?)

Value your references, but check it out anyway!

Someone who has been referred to you by a respected member of your community should be treated with the same skepticism as anyone else. There has been an explosion of affinity frauds (investment frauds that prey on an identifiable group) over the last few years, including the now infamous Madoff scandal. Former investors, employees and business associates can provide critical details that you may not be able to find anywhere else.

Verify Credentials

It is common for fraudsters to claim numerous memberships to exclusive organizations or relationships with wealthy families. In addition to finding information to support such claims, attempts should also be made to confirm that the broker or advisor really did receive that “ivy league education” or that they are licensed with appropriate regulatory agencies (e.g. FINRA).

Review Litigation

Historical civil complaints filed by current or former investors are oftentimes the first warning sign that trouble has been brewing. Federal and state litigation searches can also identify potential red flags such as divorce petitions, which often provide evidence of stress/tension or information concerning conflicts with former employees, employers, suppliers or business partners.

“Conspicuous Consumption”

A major warning flag for investors is a “showcase” of wealth. Investment fraudsters driven by greed and power, often camouflage the legitimacy of their investments by purchasing luxury homes, automobiles, yachts and one-of-a-kind items (e.g. artwork). In addition, certain fraudsters will make significant contributions to exclusive charities or organizations, often with a big splash or press release attached.

Review Criminal/DMV Records

Would it surprise you that several high profile fraudsters have had criminal records or a history of alcohol abuse, which could have been easily identified during a routine background check? For example, Sam Israel (Bayou Hedge Fund Group), who defrauded over $400 million from loyal investors, had a history of alcohol abuse. While Nicholas Cosmo (Agape World, Inc.), who is awaiting trial on a separate $400 million Ponzi scheme, previously served more than a year in federal prison for stealing client funds.

Confirm Service Providers

Outside accounting firms and fund administrators, who are “independent” third-party providers, provide an important buffer between the investment managers and their victims. But what if these “independent” providers were not so independent after all and were actually aiding in the scheme? Bernie Madoff used a unusually small two-person accounting firm to manage his billion dollar hedge fund while Sam Israel used an accounting firm run by his CFO. Are these arms-length relationships worth knowing bout beforehand?

Conclusion

As the daily headlines reveal more and more fraudulent investment schemes, individuals and businesses should use all of the investigative due diligence resources available today to avoid becoming another statistic tomorrow.

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