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

Article excerpt

Due diligence is fundamental to the survival of any corporate risk-based business operation, whether it operates in one or many jurisdictions. In fact, due diligence is essential for financial institutions that want to prevent or minimize losses from fraud and protect themselves from misuse by those with criminal intent.

"It is a wise father that knows his own child."--William Shakespeare, The Merchant of Venice, Act 2, Scene 2. Shakespeare's sentiment on parenthood is applicable to due diligence because it is also true to say: "It is a wise banker who knows his own customer."

Due diligence is an essential weapon in the arsenal of the banker to prevent or minimize losses from fraud and to help the bank protect itself from misuse by those with criminal intent. It is also a valuable tool to help prevent mistakes occurring through naivete or bad judgment.

Experience has shown that some bankers believe that having a due diligence program in place is enough to remove the risk of commercial decision making from them; this is not the case. Due diligence is an advisory process and supplies information to assist in decision-making hut it is not fail-safe. In essence, due diligence is a form of insurance fundamental to the survival of any corporate risk-based business operation whether it operates in one or many jurisdictions. A due diligence program is only effective if used properly.

What Is Due Diligence And Why is It Needed?

Due diligence is the "insurance" program that, when properly administered, will introduce policy on automatic procedures that every bank employee or company credit professional should follow, whether a cash handler or not, when new business relationships are entered into. This should prevent, among other problems, the establishment of accounts in fictitious names. The due diligence system will identify from the outset the requirements of the account thus establishing an account profile.

Due diligence should not apply to new customers only. Existing relationships in some jurisdictions are automatically "grandfathered" in. Although this may be an acceptable norm, it is not satisfactory. Regular compliance examinations of existing accounts should take place where possible to ensure that there is not a problem waiting to manifest itself.

Due diligence is required to set out common standards that establish an ethical culture and establish roots of sound corporate governance. The maxim of "know your customer" is imperative and when staff ignores this principle, they do so at their peril.

What Legal Frameworks Are Required?

Each jurisdiction has individual laws, rules and regulations concerning the requirements of bank/company secrecy and the reporting of suspected criminal transactions within that sovereign area. Although similarities may occur between some countries, historically many countries have strong bank and financial secrecy legislation with severe penalties for any person or organization breaching those rules.

As a guide to the legal frameworks in various jurisdictions, attention should be paid to the activities of The Financial Action Task Force (FATF). In 1989, the G-7 group of countries held an Economic Summit in Paris to examine the measures to combat money laundering. At this meeting, the FATF was formed and membership now comprises 28 jurisdictions and regional organizations representing the world's major financial centers.

In April 1990, the FATF issued a program of 40 recommendations, which were adopted in total or in part by the members. From this, legislation has been implemented in all the members' countries relating to money laundering and bank/information reporting requirements. The due diligence program instituted by banks and financial institutions will obviously be formulated in compliance with the legislation in that jurisdiction.

The Scope Of Due Diligence

Appropriate development of a due diligence system or process fulfilling identified criteria will soon pay dividends. …

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