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Risky Business: The High Price of Lax Due Diligence. Is it a Cost Your Company Can Afford?

Hero or villain?

Onboarding a new executive incurs a substantial cost. Companies spend a lot of time and resources on finding the right hires and often pay 20% to 30% of first year’s salary just to the recruiting firms, and that does not include benefits and other compensation. Multiple interview rounds are the current norm whether placing higher level executives or hiring managerial level positions. Questions for prospective hires range from those targeting particular skillsets to culture fit. Candidates are often vetted, not only by managers but co-workers, cross-functional team members, and direct reports. But how thorough is your vetting of new hires for impending hidden risks?

Does your screening stop with a routine background check designed for lower level hires? Once aboard, are you on top of ongoing background executive due diligence or does your screening end right after hire? And what is the potential cost to your company? While intensive interview questions might let you know who the new executive’s favorite superhero is, it will not reveal if he is secretly a super villain and can damage your company and your company’s reputation now or in the future. Are you willing to take that risk?

“Today, risk management is becoming even more important,” according to Edward Hilda II, Deloitte Global Risk & Capital Management Leader in Deloitte’s 10th global risk management survey. He goes on to say, “Financial institutions confront a variety of trends that have introduced greater uncertainty than before into the future direction of the business and regulatory environment.”

COSTS
A myriad of scandals have rocked the business world at a severe cost to companies; many instances could have been potentially mitigated by effective executive due diligence investigations. Among these are:

The Enron scandal: The founder, CEO, and Chairman were found guilty of corporate abuse and accounting fraud. Other charges against executives included money laundering, securities fraud, wire fraud, mail fraud, money laundering, conspiracy, and insider trading. Enron’s shareholders lost $74 billion during the four years leading up to the company’s bankruptcy. The employees lost billions in pensions.
Stanford Financial Group of Companies – Cost: $8 billion; owner and CEO; involved in major fraud and Ponzi scheme; violated US securities laws.
Clients of Bernie Madoff – Cost: billions of dollars; Investment advisor; involved in widespread frauds that squandered the investments of thousands of investors.
Peregrine Financial – Cost: $200 million; CEO; embezzled and reported false income statements.
Fry’s Electronics –  Cost: $65.6 million; vice president of merchandising and operations; used vendor fraud and kickbacks in purchasing electronics inventory for store, including a dummy store he set up.
Tenens Corp., d.b.a. Essex Street Associates – Cost: $61 million; Chief Operating Officer; transferred funds from the trusts of heirs of industrialist Frederick Ayers, whose accounts he was managing, to his own personal accounts, and submitted false financial statements to not raise suspicions.
NYC Laborers Sandhogs Union Local 147 – Cost: $42.6 million; Employee Benefits Manager; embezzled through employee benefits plan, mostly money laundering.
Koss Inc. – Cost:  $30 million; vice president of finance; devised plan to commit wire fraud in order to keep up with compulsive shopping disorder.
First Security Bank of Malta – Cost: $3.7 million; vice president of operations, created fraudulent credit cards at bank to cover personal debts.
Dane Cook – Cost: Millions of dollars; business manager and brother, used position as brother and manager to steal through larceny, forgery, and embezzlement.
Woodruff Arts Center – Cost: $1.48 million; accounts receivable employee, created fictitious company with an assigned vendor number, and turned in invoices for it regularly.
Pacific Seafood Group – Cost: $900 million estimated; vice president of employee leadership and development; embezzlement, wire fraud, filing a false tax return. He used a company credit card and his authority to issue corporate checks to secretly divert company funds to make personal purchases, including: electronics, jewelry, firearms, vacations, and prostitution services

All of these criminals, from a wide variety of industries, were charged for embezzlement – just one of many possible findings in an executive due diligence check—and received, or are in the process of receiving, substantial sentences. In the case of some of the most severe offenders at the top of the list, they each received prison sentences for well over 100 year periods. The duration and depth of their criminal activities resulting in serious verdicts by the courts that tried them.

In addition to the prison sentences, in Massachusetts or in other states, most of these people are also forced to disgorge profits, pay retribution, or pay back the money that they stole to the people they stole it from. This enables the court to freeze all monies that the criminal now has, or will have in the future, in order to see that as much of the required repayment to the victims is completed.

This listing shows that the crime of embezzlement is able to be committed in organizations of all sizes and styles. It can be done by high level executives, or in many other cases, such as Woodruff Arts Center, by an accounts receivable employee.

CURRENT AFFAIRS
Investigations characteristically conducted by a company’s Board of Directors are typical routine employment level checks done by executive recruiters or HR departments at larger corporations. They usually consist of a basic check into criminal history, education, employment verification, and sometimes, credit history. These routine background components are a small snapshot of publicly available information. Most routine background checks are missing critical data. They are by their nature, very basic. A substantial amount of hidden and undisclosed information is not even looked at, because these are very preliminary checks. This type of check should be the jumping off point, but are completely insufficient when evaluating a new executive hire’s history, reputation, and current state of affairs.

For example, there have been substantial issues where executive hires have cleared a routine background check, but have been operating under various aliases, which could hide a number of disreputable activities. Investigations show this is far from an uncommon occurrence. It can occur in companies of any size, from large to small and has shown to be especially prevalent in middle market companies and start-ups who are often cash strapped, and as a result have not done an executive due diligence background investigation, or they simply have not realized the need and implications for their own future growth.

The types of issues that would be missed in a routine background check could be very serious. They could include: money laundering, embezzlement, bribery, racketeering, intellectual property theft, SEC violations, and interstate bankruptcy; even manslaughter and murder convictions. Part of the reason these issues do not come up in these basic background checks is that most background screening companies do not know how to conduct effective due diligence investigations which involve investigative analysis compiled from numerous public records sources and require an investigative license and knowledge. Criminal records are often pulled from statewide and nationwide databases which often have massive data gaps and report mostly felony convictions. They pull media records from Google and other search engines which only index portions of the web. Investigators research the World Wide Web which is about 500 times greater in size and the data found must then undergo investigative analysis which is a highly specialized methodology. There is a lot of hidden and undisclosed information that most background screening companies are not finding. Around 20% of executives have these serious types of issues in their backgrounds, whereas in a routine background check you may find less than 1% of these issues actually being disclosed.

Companies tend to view executives in a different light than other employees. If an executive had a severe drug abuse problem, they could never have climbed the ranks, right? Wrong. Executives, just like every other hire, are subject to the same human issues as everyone else. But not finding out about them, can cause greater company problems and are often far more costly than those of other employees, including long term reputational damage that may last years beyond the issue itself and may even cause the demise of the primary business. In Mergers & Aquisitions situations the problems an executive brings about may cause the deal to be more costly and may have serious implications for the acquirer if not known in advance.
Risks can only be mitigated if they are known.

POTENTIAL RISKS
The company’s losses impact both direct costs and indirect costs—such loss of business, reputation degradation, and negative news headlines.
Most commonly the adverse problems for executives comprise hidden business dealings that may compromise a company’s new venture, criminal history, SEC violations, education and degree fallacy, loss of professional licensure, misleading representation of personal success and wealth, multiple bankruptcies, litigiousness, and duplicitous activities. Consider this: bribery and corruption are considered a normal part of business dealings in many parts of the world, so it is prudent to always check executives being hired from other countries to better understand their past performance and reputation in their country of origin.

An important area not looked at in a standard background check includes behavioral issues, which can range from business or personal conflicts of interest to litigious behavior, sexual harassment, and anger-related issues such as road rage or domestic violence, to even being a sexual predator. Serious financial pressures, high tax liens, or numerous collection accounts, may indicate a history of gambling or a drug habit, tax avoidance, or mismanagement of monies. While some situations may be rationalized, others are potential red flags. Serious financial pressures when compounded with other issues can elicit unusual behaviors, even at the executive level.

Some surprising finds in deep level background due diligence have uncovered things such as: hidden aliases, IP theft, money laundering and bribery, SEC violations, interstate bankruptcies, concealed criminal activity, murder and manslaughter, historical issues, undisclosed business ownership, undisclosed board involvement, signs of malfeasance and/or misconduct, financial pressures, and litigious behaviors.

HOW TO PROACTIVELY PROTECT YOUR COMPANY
When it comes to addressing how to attend your company’s best interests, investing in a Tier III level background check from a highly-reputable and experienced investigation firm is the only solution for executive hires, executive promotions, and board level involvement.

Board advisory and board screening are certainly a very important step for most corporations today. However, many companies are reluctant to screen their boards, but it an essential component for minimizing risk of very high level PR nightmares, and very high level risk exposures for corporations – most of which are avoidable.

Not knowing about issues is not an acceptable defense in court. When a scandal erupts it affects the company stock price. There may be a wide variety of issues in addition to shareholder lawsuits, particularly if any value was lost for the company; these are simple things that could have been done to prevent that. An executive background due diligence check is not that expensive to conduct. They are actually very inexpensive when you look at the cost of even hiring an executive, so it should be standard in the tools of a board to screen the board, if not annually, at least once every couple of years. It does not have to be a very invasive process. Most of the board advisory work is public record analysis, making it not that complicated to do, and yet it affords the board an extra layer of very important fiduciary protection. Not the least of which should be part of their D&O insurance consideration for reducing risk to other board members as well as company shareholders. There are very serious implications for company directors when other directors have issues.

By the board setting a positive example through effective due diligence, it creates a culture of transparency within the organization, which is further beneficial to gathering the support of other employees within the organization. It also helps to set tone at the top and sends a clear message of how the company prefers to conduct business.

Deep-level due diligence investigations are designed to supply a company with comprehensive analysis of all available public records data, supplemented with detailed field intelligence, to identify known and more importantly unknown situations. There is a huge difference in what is obtained for a company’s investment in doing a routine background check versus a due diligence report on prospective hires and ongoing checks on current executive staff or those being promoted to executive levels from within.

So now that you know the risks are you willing to gamble on your company’s reputation, security, and potential financial loss? Twenty percent of executives do not check out well. An executive due diligence investigation is a small investment in mitigating risky business. Make sure your superstars are exactly who and what they claim to be.

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