How integrity due diligence can protect your company from a world of risks
INSIGHT ARTICLE |
Since 2001, integrity due diligence (IDD) has been driven by the need to comply with a global explosion of legislation targeting corruption, money laundering, terrorist financing and related crimes. The steady increase in international commerce is also pushing this trend. With a growing number of companies exposed to these concerns, key regulatory and judicial authorities, especially in the U.S., have ramped up enforcement of existing statutes, such as the Foreign Corrupt Practices Act.
Lost in this compliance-driven environment, however, is an appreciation of the strategic utility of in-depth IDD work, both to improve risk management in the broadest sense and to support better decisions on new investments and partnerships in all forms, including acquisitions, joint ventures, minority investments, strategic cooperation agreements or supplier-, distributor- or local agent relationships.
What is IDD?
As with any due diligence, the goal of IDD is a deeper understanding of the potential partner business, primarily from a risk perspective. IDD focuses on two areas: the target company itself and the key individuals who own and manage it.
One key focus of IDD is to identify the key strategic and operational decision-makers within the company and then to examine:
- Their track records
- Their competence and areas of expertise
- Their management modus operandi
- The division of roles within the business among these key players
IDD considers these issues within the context of the company’s development, looking at the historical and current roles of the principal founders, how both the strategy and market perception of the company has evolved over time and any track record of partnerships with Western companies.
A final important feature of IDD work focuses on gaining an understanding of any hidden beneficial ownership that might exist within the company, which on the surface is not apparent.
IDD also examines the target company’s operations to identify issues that might pose major, but unquantifiable financial or reputational risks to an acquirer. Major focal points in this phase of the investigation include:
- The existence of any connections between the business and any political figures, as well as how the company interacts with regulators, government entities, etc.
- The nature and strength of any such connections and whether any of those connections have been leveraged for the benefit of the company
- The extent, nature and credibility of any allegations made against the company or its key principals relating to bribery, corruption, money laundering, large-scale tax evasion, fraud or asset stripping
- Any alleged connections between the company and organized crime or terrorist groups or broader risk of exposure to such groups
While the above are issues frequently analyzed during an IDD project, the work can also be tailored to address specific concerns, such as labor and employment abuses, environmental matters or other issues of importance to the parties. Moreover, IDD is not limited to the target company alone. IDD can also provide a macro examination of the risks inherent to doing business in a specific country, which is especially useful when a transaction will bring your business into a new location for the first time.
IDD work is undertaken confidentially and usually without access to any books or internal records of the target. IDD is essentially an investigative process that combines examination of a vast array of public records with in-depth human intelligence gathering through trusted sources on the ground in the relevant jurisdictions. In markets where press freedom is limited, where competitors will frequently engage in “black propaganda” to damage their rivals, having a strong intelligence network on the ground is vital. IDD professionals then put that information in context by ensuring that it is clearly and credibly sourced, weighing its importance and placing it in the context of the transaction in question.
What are the results of an IDD analysis?
Following are some of the key risks that IDD can uncover:
- Issues of hidden beneficial ownership
- The potential de facto control, ownership or leverage exerted over a business by key officials through strong political patronage
- Asset stripping of the target company or of parts of a target business group
- Leakage of intellectual property or products, leading to the emergence of grey markets or smuggling networks
- Board members acting as representatives of specific outside interest groups
- Indications or allegations of mismanagement by key principals of the business (frequently the original founders of a company that has since grown substantially)
- Credible allegations of significant, corrupt payments to officials
- Allegations of ongoing fraudulent activity within the company or of previous fraudulent incidents that have been covered up and not properly addressed
- Overreliance on key political relationships, leaving the company vulnerable to future changes in government
- Allegations of the use of the business as a conduit for money laundering
- The existence of well-connected minority investors with a track record of not fulfilling investment promises
This listing of risks is daunting, but ignoring them is not an option. Your company could face substantial legal penalties, reputational damage, litigation exposure and financial losses through fraud. Understanding the risks of doing business internationally in advance — and learning how to prevent or mitigate these risks — is vital to informed, effective transaction decisions.