Ten Steps to Effective Due Diligence

by Michael Volkov
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The need for effective due diligence has led to a mushrooming of alternatives – software systems, database checks, and due diligence companies with or without “boots-on-the-ground.”  In this environment, it is hard to keep your eye on the ball.  Everyone has lots of advice, lots of service alternatives, and lots of angles to play.

Lawyers sometimes get in the way and sometimes they can help.  Professionals with an “engineering” approach can offer some guidance.  I like to start with a flow chart on the due diligence process – it keeps things orderly and helps to focus the due diligence system.

From this perspective, here are my ten steps to an effective due diligence program:

1.  Identify the proposed third party – The due diligence process cannot begin without confirmation of who is being hired, why the third party is being hired, and what specific services the third party will provide.  As an initial step, the company must fully identify the proposed third party with as much basic information as can be obtained. 

2.  Require the proponent of hiring third party and the third party to complete questionnaires – The proponent of the third party needs to complete a questionnaire so that basic questions about the proposed third party can be reviewed.  The proponent has to answer the important questions of what specific services will the proposed third party provide and why does the company need to hire the third party.  Equally important is the question of how the third party came to the proponent’s attention.  The third party should complete the questionnaire or answer the questions posed by the company representative in a face-to-face interview.  Both the proponent and the third party need to sign and affirm their answers.

3.  Check basic information about third party, related entities and business references against open source intelligence database – Every relevant individual or organization should be checked against an open source intelligence database.  There are a number of databases out there and it is important to pick the right one which has state-owned enterprises and global enforcement and watch list information.  The results of the searches should be placed in the due diligence file.

4.  Interview business references – The interview of business references can be a very effective way to build support for hiring a third party.  Business reference interviews can be conducted on the telephone.

5.  Directly address red flags with proposed third party – If red flag issues come up, the company should directly address the concerns with the third party and any relevant entity.  More interviews and further investigation may be needed.  In the event that a deeper inquiry is needed, there are plenty of due diligence firms available to assist but it is important to work with one that coordinates the investigation with you, does not write any reports without reviewing issues with you, and has global capabilities to gather relevant information in other countries.

6.  Build financial controls into contract and relationship to minimize risk – This is a critical and often ignored step in the due diligence process.  A company’s ability to minimize risk, monitor performance, and protect against improper behavior will depend on tailoring the financial controls to meet the specific situation.  For example, the contract and controls need to include a requirement that a third party submit detailed bills and regular reports on activities.  The more a company can show that a third party is providing actual services the lower the risk of bribery.

7.  Negotiate contract to include important compliance provisions – The contract negotiations are important to the due diligence process.  While companies may not obtain all the provisions they want, they should maintain a record that they requested each of these important items, including representations and warranties, audit rights, triggers for breach and termination, and requirements that third party participate in training or maintain its own training program.

8.  Obtain advice of counsel supporting the hiring of the third party – As part of the due diligence documentation file, companies should include a brief memorandum from outside counsel reviewing the file and memorializing that there are “no significant risks” to prevent retaining the third party.

9.  Document each step along the way – It sounds like a complete pain, but there is nothing more important than documenting the entire due diligence process.  The most critical part of documentation is to record instances when you exercise discretion, meaning you analyze an issue, consider the facts and circumstances, and reach a determination.  It is not necessary to write a book about the decision-making process but a memo to the file is invaluable to protect the company.

10.  Monitor third party compliance – Companies focus so much on the approval process that they forget the importance of continuous monitoring of their third parties.  There is nothing worse than an effective “initial” review without any follow up.  Compliance requirements have to be audited, transactions have to tested, and risks have to be reassessed on a continuous basis.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Michael Volkov, The Volkov Law Group | Attorney Advertising

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Michael Volkov
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