Fundamentals of Due Diligence: A Critical Business Tool (Part Two)

Part one of this article discussed the scope of due diligence and why it is such an important area for financial institutions. This article will take a look at the documentation required to ensure an effective due diligence policy is in place.

Documentation Required for Due Diligence

The following is a checklist on what documentation should be obtained in order to fulfill due diligence requirements.

• Full identification of the proposed customer should be accompanied by established documents of identification, certified copies of which should be obtained. This documentation will include passport, proof of residence, and proof of nationality of birth and/or proof of nationality by adoption, details of occupation including position held, name and address of company and photographic identification.
• In company applications, originals of the memorandum and articles of incorporation should be inspected and certified copies obtained.
• Full and complete details of directors and the company secretary should be obtained, including personal contact details.
• Full identification of nominees and statement of requirement is also needed.
• Proper indication of funds source, proposed frequency of transactions, transfer amounts in approximation is all required. This is an expected customer requirement of bank services.
• In partnerships, all details of partners should be obtained together with notarized authorities from those partners.
• Applications should not be accompanied by a personal cheque. It is not uncommon for immediate credit to be given by some banks or companies for a personal cheque. The problems start when the relationship has commenced and the first knowledge of anything amiss is when the item is returned.
• Introduction by a known customer who has conducted satisfactory business for a period of at least 12 months must be accompanied by a separate signed form by that referee. Identification of the new customer is still required and should be certified by the referee.
• Bank references should be requested (this is not acceptable by fax or from the customer). All bank references should be verified directly with the issuing bank.
• References from law and accountancy firms should be accepted but not in the form of a financial or bank reference.
• Occasional checks should be made on the status of the professional referee to ensure that they are not subject to investigation or other proceedings. It is important to ensure that the member or partner in the referee organization is not acting independently or with the applicant or applicant company.
• Address information should include the physical address as well as the mailing address together with a telephone contact for that country and an offshore telephone contact point if the account holder is based outside that country. This applies to individuals, companies or other corporate entities.

There are some exceptions from the checklist of documentation required above for due diligence. For example, companies trading on a recognised and properly regulated stock exchange may be exempted from some of these requirements. Although these guidelines are not exhaustive, they do assist in the prevention of future problems where answers to direct questions about customers do not contain the statements ‘we believe’, ‘we assume’ or ‘we think’, but ‘we know’.

Banking Offshore Customers

In banking, and certainly where the subject of due diligence is involved, there are those people who unfortunately suffer from that human flaw – ego.

When dealing with matters offshore or in another jurisdiction it must be remembered that different rules apply. Practices used as standard business behavior in one country may not be legal in another. There is great danger when ill-informed or inexperienced people start to meddle with situations outside their experience and field of expertise when dealing with international matters.

I am sure we have all met those who, for whatever reason, have an inflated opinion of themselves, their ability and judgment. To them I recommend the advice from the late Lord Denning, (former Master of the Rolls), of the High Court of England: “There is a risk in dealing with a corporation registered in a country where the company law is so loose that nothing is known about it, where it does no work and has no officers and no assets. Nothing can be found out about the membership, its controls, its assets or the charges against them. Judgments cannot be enforced against it. There is no reciprocal enforcement of judgments. The corporation is nothing more than a name grasped from the air and as elusive. In such cases the very fact of incorporation there gives some ground for believing that there is a risk if it is only that should judgment need to be obtained or some award granted, it would go unsatisfied.”

What Organizational Methods and Control should be Used?

The very nature of a due diligence operation requires a confidentiality that may only be found ‘in house’. The formation of a due diligence research/investigative operation requires specialist expertise at the core of it. Many banks do not have this facility although they do have investigators. The additional skills required by a due diligence analyst or researcher include a sensitivity to the circumstances of the inquiry.

It is of primary importance that companies recognize that all information obtained by this research process is liable to discovery in judicial proceedings. Data legislation and regulations differ from one jurisdiction to another. Do not assume that because a company has multi-jurisdictional operations, that information obtained in one country can be absorbed as company property and distributed throughout the organization. Great care must be taken to safeguard the information and to ensure that the confidentiality is properly respected and that improper disclosure of that research is regarded as a breach of the company’s code of ethics or conduct. Responsibility for the storage and retrieval of the information should be decided as part of the company policy.

Conclusion

The process of due diligence is an art form and not an exact science. To be effective it must be well planned and executed to provide sound corporate governance and form the foundation of a strong ethical culture. No organization should lose sight of the fact that valuable information from effective due diligence will save a company money, it can make a company money but, if misused, it will cost a company an irreplaceable commodity – their reputation.