Using background investigations to manage risk

March 2011 | 10QUESTIONS | RISK MANAGEMENT

financierworldwide.com

FW speaks with Jerry Oldham at 1stWEST Financial Corporation about the benefits that background investigations bring to the risk management process.

FW: Have you seen an increase in corporate fraud in recent years? If so, what are the underlying causes?

Oldham: Yes, and I believe this is irrefutable at many levels. As is sometimes said ‘desperate people often do desperate things’, and there are no exceptions to this assertion among some corporate executives in difficult times. A great study source for statistics on workplace fraud is the Report to the Nations, published by the Association of Certified Fraud Examiners. I am not a psychologist, so my answer as to cause is purely pragmatic, based upon my professional experience, but I would say greed and the expectation of a business failure are the most pressing causes.

FW: How much corporate fraud activity comes down to the actions of key individuals within a company?

Oldham: A significant amount of fraud is attributable to key individuals. The statistics show that the larger frauds, in terms of money lost, are committed by the senior most managers in a company and the hardest frauds to detect come in situations where there are the fewest accountability and oversight standards in place. Opportunity is the friend of a fraudster and lack of oversight is his or her closest cousin. Establishing, from top down, a company conscience about not tolerating fraud and instituting anti-fraud policies, and procedures to actualise such intentions, is essential to fraud prevention and control.

FW: Can you outline the benefits of using background investigations to reduce potential fraud?

Oldham: The most significant benefit to performing background investigations as part of the lending or investment due diligence is that the lender or investor will significantly reduce the likelihood of being defrauded by an individual that has a fraudster’s background. In our background investigations we frequently discover individuals in responsible management positions of a prospect company that have a serious record of misdeeds, misrepresentations or fraud.

FW: Under what circumstances is it prudent to undertake a background investigation?

Oldham: It is prudent every time an investor or lender is providing equity or debt capital to a business – every time, without exception. It is also prudent as a matter of best practices corporate governance, that the board of directors of a public or private company perform a background investigation on any new executive management person being considered for hire. Additionally, it is prudent that executive management and boards of directors require the performance of a background investigation on the management team of any company that it is considering merging or acquiring. In one case, the head of human resources worldwide for a public company died suddenly at a relatively young age, and a fraud was subsequently discovered whereby he had been paying himself finder’s fees for hired corporate executives that didn’t exist. Posthumously, a background investigation was performed and it was discovered that the individual had a previous felony theft conviction before being hired by a company that the subject company acquired and long before being promoted to the head of HR with the subject company. Had a background investigation been performed prior to the acquisition, this individual would have been extricated from the acquired company many years earlier.

FW: What are some of the best practice approaches to conducting background investigations?

Oldham: The two most significant in my opinion are being sure that the research on a subject is performed in all of the relevant jurisdictions and countries and then using a dual-searching methodology in each of these relevant places – that is, performing on-site and online research investigations methodology, independently. On average, we often find adverse information on a subject on-site that we don’t find online in 25-30 percent of the investigations that we perform. I am not disparaging databases, but they can lack tenure and currency consistently among jurisdictions in the US and when available, in other countries. Also, if a name in a database is misspelled, the subject will likely not be identified. The closer a researcher gets to the jurisdiction when the court case, judgment, tax lien or bankruptcy has been filed or adjudicated, the better chance one has of getting complete, current, dated and accurate information. When in doubt about the data, it is always best practice to corroborate the information in any way necessary.

FW: When companies are weighing up whether to choose an in-house investigation or engage external consultants to carry out the work, what considerations should they make?

Oldham: I suppose the best answer to this is to decide based upon the capabilities and capacity of the in-house investigations group or department vs. a highly qualified and reputable outside firm, and the degree to which the in-house group responds to the answer to the previous question. As has been said about many businesses that rely upon on the best research to execute the job, ‘the devil is in the details’. This is especially true with regard to background investigations, particularly when a lot of money is at risk or a significant investment, acquisition or merger is under consideration.

FW: Are there any particular legal or regulatory issues that can complicate a background investigation?

Oldham: It is a simple matter of knowing the laws and regulations that apply in a country, jurisdiction or province and making sure that all of these are covered in the research. The more difficult issue is with regard to knowing what privacy laws and regulations apply within a country, state, province or other jurisdiction. I would argue that a highly qualified and reputable outside background investigations firm may be better suited to know these laws and regulations, especially those in foreign countries. In the US there are banking regulations that were promulgated in 2003, post-9/11 and the passage of the USA Patriot Act of 2001, which require lenders to adopt and follow a Know Your Customer (KYC) policy – requiring a bank to conduct a certain level of background investigation on a proposed borrower.

FW: To what extent are background investigations more challenging in a cross-border or multi-jurisdictional context?

Oldham: In addition to the considerations noted in the previous question, which can be limiting, the biggest challenge is the degree to which public record information is actually complete, accessible and searchable. Compared to other countries, the US ranks first in these researchable qualities. In some countries, Canada for example, criminal records are protected from public searching and are simply not available in certain provinces, and other laws regulating the access to public records will vary from province to province. Public records in European countries are generally much more limited than in the US as well. As a general rule, in most European countries criminal litigation searches cannot be performed, and one has to rely upon local media records to determine if a criminal case has been filed against a company or an individual, including in the UK – although the UK otherwise has more searchable public records than most other European countries.

FW: Once the results of a background investigation are collated, what are the key points to analyse?

Oldham: Firstly, it is always important to analyse and compare what was known in advance of the investigation to the results of the background investigation, categorically. Variations, even if minor but many, may bring into question someone’s integrity or character. In addition to the possibility of indentifying a previously convicted fraudster, an investigation may reveal a pattern of misrepresentation of certain facts about someone’s background, including an education or certification lie or misrepresentation, or a history of being litigious. In many instances it is a history of lies, misrepresentations or a serial lack of disclosures regarding issues of the past that bear down on an individual’s character.

FW: In your opinion, when a company develops internal policies and processes to combat fraud, should intensive background investigations form part of its standard procedures?

Oldham: Absolutely. As I often say when I speak on this subject those that perform background investigations by exception, will likely be defrauded ‘exceptionally’ when it occurs. It should become a matter of policy to perform background investigations when making significant lending, investing, hiring, merging or acquisition decisions.

Jerry Oldham is co-founder, chairman and CEO of 1stWEST Financial Corporation. Mr Oldham has an extensive investigations and corporate due diligence background and a broad senior management resume in commercial banking and corporate and real estate finance. He frequently serves as a consultant or expert witness in litigation and settlement negotiations involving complex corporate finance, real estate, banking and lending practice issues, having assisted in the settlement of hundreds of lawsuits. He can be contacted on +1 (303) 670 3443 or by email: j.oldham@1stWEST.com.

THE RESPONDENT

Jerry Oldham

1stWEST Financial Corporation