Due diligence is fundamental to the survival of any corporate risk-based business operation, whether it operates in one or many jurisdictions. In fact, due diligence is essential for financial institutions that want to prevent or minimize losses from fraud and protect themselves from misuse by those with criminal intent.

"It is a wise father that knows his own child."--William Shakespeare, The Merchant of Venice, Act 2, Scene 2. Shakespeare's sentiment on parenthood is applicable to due diligence because it is also true to say: "It is a wise banker who knows his own customer."

Due diligence is an essential weapon in the arsenal of the banker to prevent or minimize losses from fraud and to help the bank protect itself from misuse by those with criminal intent. It is also a valuable tool to help prevent mistakes occurring through naivete or bad judgment.

Experience has shown that some bankers believe that having a due diligence program in place is enough to remove the risk of commercial decision making from them; this is not the case. Due diligence is an advisory process and supplies information to assist in decision-making hut it is not fail-safe. In essence, due diligence is a form of insurance fundamental to the survival of any corporate risk-based business operation whether it operates in one or many jurisdictions. A due diligence program is only effective if used properly.

What Is Due Diligence And Why is It Needed?

Due diligence is the "insurance" program that, when properly administered, will introduce policy on automatic procedures that every bank employee or company credit professional should follow, whether a cash handler or not, when new business relationships are entered into. This should prevent, among other problems, the establishment of accounts in fictitious names. The due diligence system will identify from the outset the requirements of the account thus establishing an account profile.

Due diligence should not apply to new customers only. Existing relationships in some jurisdictions are automatically "grandfathered" in. Although this may be an acceptable norm, it is not satisfactory. Regular compliance examinations of existing accounts should take place where possible to ensure that there is not a problem waiting to manifest itself.

Due diligence is required to set out common standards that establish an ethical culture and establish roots of sound corporate governance. The maxim of "know your customer" is imperative and when staff ignores this principle, they do so at their peril.

What Legal Frameworks Are Required?

Each jurisdiction has individual laws, rules and regulations concerning the requirements of bank/company secrecy and the reporting of suspected criminal transactions within that sovereign area. Although similarities may occur between some countries, historically many countries have strong bank and financial secrecy legislation with severe penalties for any person or organization breaching those rules.

As a guide to the legal frameworks in various jurisdictions, attention should be paid to the activities of The Financial Action Task Force (FATF). In 1989, the G-7 group of countries held an Economic Summit in Paris to examine the measures to combat money laundering. At this meeting, the FATF was formed and membership now comprises 28 jurisdictions and regional organizations representing the world's major financial centers.

In April 1990, the FATF issued a program of 40 recommendations, which were adopted in total or in part by the members. From this, legislation has been implemented in all the members' countries relating to money laundering and bank/information reporting requirements. The due diligence program instituted by banks and financial institutions will obviously be formulated in compliance with the legislation in that jurisdiction.

The Scope Of Due Diligence

Appropriate development of a due diligence system or process fulfilling identified criteria will soon pay dividends. First of all, guidelines are created which may not be all-encompassing parameters but suggestions to assist the bank or corporate officer. Each set of circumstances will be different; common sense and experience will assist this process, together with supervisory support in areas of doubt. As new and different areas of concern are identified, so the program can be updated and improved. Although due diligence is not an exact science, it is essential.

Should due diligence start with the customer? To be a proper and effective tool, due diligence should start at the door of the personnel or human resources department of the bank or company. How many people are hired without references being requested? How many references are just accepted without verification? Many security, compliance and regulatory personnel would be horrified at the true figure. The excuses of "We are understaffed," "The position is not one of responsibility," or "The position does not include cash handling, risk areas or access to sensitive material," are not acceptable.

Rather like the small customer who is paid little attention over the years and is then suddenly found to be involved in fraudulent activities, the trusted and irreplaceable employee could turn out to he the enemy within. Checking references after problems occur is a pointless and possibly embarrassing pastime. As the small customer may grow, so the employee in the non-cash handling, non-sensitive area may apply for a transfer, promotion or both.

Due diligence is required to create awareness among ALL staff. It identifies the warning signs or red flags that there may be a problem or potential problem with a new business application or an existing relationship.

Problem Prevention

Attacks on, and misuse of, financial institutions are increasing and becoming more complex every day. Of these attacks, some are readily identified by those who have experienced them before; others are identified when it is too late and the damage done.

Experience is a great teacher; this is especially true if one can learn from the experiences and mistakes of others. The established financial institutions have suffered fraud and financial crime from within the organization and outside it. Many valuable lessons have been learned--or have they? Due diligence is predominately preventative, highlighting the distinction between proactive and reactive investigations and research.

The buzzwords here are training and awareness. Constant training updates and review programs held by experienced and qualified trainers with practical experience in the areas of fraud, money laundering prevention and compliance are required for all staff. Substantial, real-time, objective training with practical demonstrations, although time consuming, are invaluable. The involvement of management in the training creates an understanding of potential problem areas.

Remember the benefits of effective due diligence: the reduction of risk and liability. The process benefits and strengthens a commercial relationship therefore encouraging further business. Most importantly, effective due diligence enhances a bank's or company's reputation.

Every part of finance and credit--from recruitment to areas where there is the presence of a bank customer, contractor or temporary employee to acquisitions of other commercial organizations and companies--requires due diligence. In fact, this process is most essential when dealing with business involving foreign countries. How often do people, when presented with in formation, have that sneaking suspicion that things are not how they should be?

What Is The Basis For Suspicion?

The perennial question: what is the definition of suspicion? Fortunately, over the centuries, no legislature or government has satisfactorily defined the word. For that we must be grateful because it leaves a broad scope, similar to that of a due diligence program.

Suspicion arises when something appears out of the ordinary, wrong or out of place in the circumstances in which it is found. A common fault among people is not trusting their own judgment. There is a general misconception that because a person is suspicious of an action, person or circumstance, they have to be able to prove that fact before they voice that suspicion. Each individual does have a personal level of understanding and knowledge within their field of enterprise or responsibility and that should be trusted and, if needed, acted upon.

If activity occurs that does not pass an individual's own "makes sense" test, then that alone is a good enough basis to consider the matter suspicious and report the circumstances to those responsible for the due diligence program within the organization.

What else can be grounds for suspicion? Due diligence will, with proper use, identify the negative. That means identifying the deliberate lie or the lie by omission: the discovery of areas not disclosed or covered over, facts relevant to the business or application that have not been satisfactorily answered. These scenarios are happily dismissed or justified by some bank and corporate officers hungry for new business or happy with continuing business even though they may have nagging doubts about the veracity of a client or customer's business. Indeed, under no circumstances should a due diligence report be edited for content, for instance, conveniently excluding certain negative material.

Due diligence is not just a search for the negative or what is "suspicious". It should also reveal positive factors that an astute banker or credit/risk manager can use to nurture business relationships.

Conclusion

Due diligence is an essential component in good business practice. To have a due diligence policy in place and not use it properly and consistently is a serious error that could be detrimental to the entire organization.

In the words of George Washington: "Timely disbursements to prepare for danger frequently prevent much greater disbursements to repel them," which translates to, "Prevention is better than the cure (and much cheaper!)"

RELATED ARTICLE: Women-owned businesses on the rise.

The latest available statistics from the U.S. SBA Office of Advocacy shows that women-owned businesses increased nearly 20 percent from 1997 to 2002. That figure compares to an increase of 7 percent for all U.S. firms.

* In 2002, women owned 6.5 million or 28.2 percent of non-farm U.S. firms. More than 14 percent of these women-owned firms were employers, with 7.1 million workers and $173.7 billion in annual payroll.

* Women-owned firms accounted for 6.5 percent of total employment in U.S. firms in 2002 and 4.2 percent of total receipts.

* Of all women business owners in 2002, 85.95 percent were White, 8.43 percent African American, 8.33 percent of Hispanic heritage, 5.25 percent Asian, 1.23 percent American Indian and Alaska Native and 0.18 percent Native Hawaiian and other Pacific Islander (total does not add to 100 due to some double counting across ethnic groups).

* According to 2002 data, significant proportions of women-owned businesses were in professional, scientific and technical services, and in health care and social assistance.

The complete report is available at http://www.sba.gov/advo/research/rs280tot.pdf

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