News Updates

Due Diligence Always Pays Dividends

New York, February 2009—Today’s world reveals the abnormalities of the past. Boom periods always obscure clear vision and procedures. One of the steps of the investment process often skipped until now was proper due diligence. In “bull” days people did not care about fundamental and intrinsic values. But in “bear” days, things look different. Indeed, including due diligence in the investment process adds to the overall cost, and takes time and effort. Why waste time and money on this when the world is a "shiny and happy” place? It is not wasting, but investing, because proper due diligence always pays back and is worth every single nickel spent on it.

Today we face the consequences of our past practices. The biggest front-page article in the stand-alone “Business Day” section of the New York Times one Wednesday in January 2009 was titled “The Mini-Madoffs.” The other big article on that front page bore this headline: “Bank of America Board Under Gun From Critics.”

Flanking the continuation of the two lead articles was an article about a former executive at A.I.G. Like many large American banks, A.I.G. has been extended a federal bailout payment in the billions to avoid bankruptcy. Christian Milton had been A.I.G.’s vice president in charge of reinsurance from 1982 to 2005. Last year he was convicted of conspiracy, securities fraud, mail fraud and issuing untrue statements to the Securities and Exchange Commission. 

The continuation of the “Mini-Madoffs” article featured a sidebar reporting how Spain’s largest bank, Santander, had agreed to reimburse its private investors $1.7 billion. This was for losses incurred when the bank placed their funds with Bernie Madoff, the mastermind of the $50 billion Ponzi scheme. Santander, which recently took over Sovereign Bank, claims to have done proper due diligence.

Never before has the media more fully highlighted the wisdom of due diligence. Nearly every financial report for the last four months in print, on radio, or on television underscores the dire consequences of inadequate due diligence.

The American Heritage College Dictionary defines diligence as: “1. Ernest, persistent application to an undertaking; assiduity. 2. Attentive care; heedfulness.”

In legal terms due diligence means vetting documents, auditing accounts, and investigating past behaviors of companies and individuals to fully assess them. Proper due diligence will expose harmful, dishonest, or fraudulent actions or tendencies. The old Latin adage “Caveat emptor” (“buyer beware”) sums up why such caution is wise.

Corporations would never dream of skimping on due diligence. They hire top corporate law firms for vetting and evaluation purposes prior to signing any binding agreements or contracts.

These law firms in turn engage elite international investigative firms to conduct proper due diligence on potential business or investment partners. Yet in boom times due diligence tends not to be carried out with the assiduity it requires. The results are usually disastrous because boom times breed scams and empower con artists.

Many investors are now paying a price for lax due diligence. A French-born financial advisor who entrusted his clients’ money to Madoff killed himself a week after the scheme was exposed. Another Madoff investor started a blog to report how his scheme left her a virtual bag lady though she had achieved wealth and fame as a writer before casting her financial fate with such a scoundrel.

Madoff took $2 billion from investors at the Palm Beach Country Club. The week after federal agents took him into custody in New York, no fewer than nine condos went on sale at the Breakers, the exclusive Palm Beach resort and hotel. Though Madoff sat on Yeshiva University’s board of trustees, he bilked it of a nine-figure portion of its endowment. Madoff lost millions for New York University. He also bankrupted several charitable trusts.

One New Jersey woman of modest means reported that Madoff lost her entire life savings and pension. Another elderly retired couple in Florida who invested with him saw their entire net worth of $4 million disappear.

In January 2009 The New York Times ran an article featuring an interview with a profiler of serial killers. The profiler underscored how similar Madoff was to these killers in his narcissistic self-indulgence and lack of contrition or any sense of remorse. Madoff even destroyed his sister’s financial stability. He was clearly a financial sociopath.

All pyramid scheme perpetrators are like that, as the “Mini Madoffs” article made clear. CNBC broke a story about the arrest of Nicolas Cosmo, who operated a Ponzi scheme called Agape World on Long Island. In its “Mini Madoffs” article the Times reported that Cosmo had previously served a prison sentence for securities fraud. He scammed investors of $380 million. Even a cursory due diligence investigation would have exposed his prior criminal behavior.

The article detailed Ponzi schemes recently uncovered in the Haitian community in South Florida, where a self-professed “man of God” operated through his church, victimizing his congregation. Another scheme in North Carolina preyed on the members of a Lutheran church. Ponzi schemes in Idaho, Philadelphia, and Atlanta were also described. All of them were foisted on naïve investors by financial sociopaths.

Since October of last year the S.E.C. has uncovered Ponzi schemes that in total have cheated investors of over $200 million. The Senate Banking Committee is now trying to pass a bill to increase the budgets for enforcement of the F.B.I. and the S.E.C. with regard to Ponzi schemes.

Due diligence is the only known preventative for this kind of fraud. The savvy law firms know how to implement effective due diligence. So do shrewd business executives and entrepreneurs. They hire the upper echelon international investigation firms specializing in such difficult tasks as worldwide asset searches and in-depth background profiling of individual entrepreneurs and executives.

To be carried out thoroughly such tasks require enormous expertise and far reaching contacts. In the global economy the financial network encircles the planet and is as labyrinthine and convoluted as the tracery in a medieval stained glass window. It’s designed to be that way. People and companies bent on perpetrating fraud intend their money trails to be untraceable.

Yet a proper background profile will disclose any prior behavior or tendencies in this direction. True due diligence on an individual goes way beyond the obvious resume and C.V. information. That kind of data can be accessed fairly easily.

What requires real expertise and an extensive network of contacts and seasoned investigators is profiling on site and in depth. Only the top international investigative firms have the trained personnel to carry out such detailed and challenging work. These firms typically retain a network of former diplomatic, espionage and police personnel whose contacts are inexhaustibly wide. Their training is top-notch, their experience vast, and their capacity for discretion is absolute.

This last trait is paramount. When a comprehensive background profile is being put together, the subject must be totally unaware that the process in taking place. Otherwise the investigators may compromise the client and even jeopardize the projected business or investment deal.

What then can truly gifted investigators uncover? They can accumulate a comprehensive history of the subject’s business enterprises and all ownership of assets. If knowledge of local law or if forensic accountants and auditors are needed to analyze holdings or complex money trails, an elite international investigative firm has the personnel to perform these tasks. Their experts have traced the most impenetrable money trails. In foreign jurisdictions they have arrangements with local lawyers, accountants and auditors. They can analyze reports in the native language as well.

Of supreme importance is the ability these firms possess to network former friends, colleagues, classmates, and competing executives and firms to delineate an individual’s business personality. What is he or she like in negotiations? How does he or she treat subordinates, rivals, competitors? Is the subject mercurial, unflappable, inscrutable, cagey, or, most importantly, deceitful and dishonest? How does he or she react to adversity? To success? Is the subject flexible and reasonable, or autocratic and dictatorial? Is the subject forgiving or vindictive? Prompt or tardy ? Reliable or delinquent? A control freak? A micromanager? Is he or she focused on the big picture only? Patient? Quick to kill a deal over a tiny detail?

The top echelon international investigative firms discover the intangibles as well as the hard facts. They cover the subject of the investigation A to Z. The complete profile is rendered, the hidden deals uncovered, the past indiscretions and even frauds exposed.

When even an international corporation as sophisticated as the biggest bank in Spain is hoodwinked by a confidence man like Madoff, it ill suits the average corporation or the normal investor not to expend some time and money on due diligence. All investigation, like all politics, is local. And only a fully equipped elite investigative firm with international reach can pull off the assignment.

And due diligence, unlike many investments, always pays dividends.