Due Diligence and Why it Matters
In 2018, Big Four accounting firm Ernst & Young (EY) was accused of legal and ethical violations in its audit work for a Dubai gold refiner in a subsequent court claim. The case was brought by Amjad Rihan, a former EY partner based in Dubai, who claimed he was “forced out” of the company after he identified alleged money laundering by Kaloti Jewellery International. Mr Rihan was the audit partner with overall responsibility for Kaloti in 2013.
He sued four EY entities, including its global and European businesses, for roughly £13m. Mr Rihan claimed the accounting firm failed to report suspicious activity at Kaloti and altered a compliance report to hide the apparent wrongdoing from the relevant authorities. EY said the allegations against it were “unfounded”. “Mr. Rihan’s claim is denied and is being vigorously defended,” it said in a statement. “We are confident that all legal and reporting obligations have been complied with by the relevant EY entities.” Kaloti denied any wrongdoing and said that it conducted all appropriate anti-money laundering checks.
However, Mr. Rihan claimed EY suppressed his concerns about large sums of cash being paid out by the company and about gold bars that had been disguised as silver to avoid trade restrictions. In a statement, Mr. Rihan said EY “covered up” his concerns that Kaloti was importing large quantities of silver-coated gold. He said his case “demonstrated the devastating impact on society caused by major international accountancy firms sacrificing their independence and integrity to appease their clients’ interests.” Paul Dowling, a solicitor at Leigh Day who is representing Mr. Rihan, said: “Rather than thanking Mr. Rihan for bringing the violations to their attention, our client’s case is that EY suppressed the findings and left him and his family at risk, forcing him to leave his home in Dubai and resign from his job.”
The BBC quoted Kaloti as saying: “Kaloti would not knowingly enter into a trading relationship with any party in the knowledge that such party had been engaged in financial impropriety or criminal activity of any kind.” When Rihan’s claims first surfaced, they provoked a storm in Dubai, where gold is one of the country’s most important industries, worth more than $70bn annually.
This case illustrates the impact that failures in the due diligence process can have, not only on an individual level and a corporate level, but even on an international level. Thankfully, nightmare scenarios like this can often be avoided thorough the creation and implementation of a proper due diligence policy and its concomitant practices and procedures. Let’s discuss some basics.
What Is Due Diligence?
Due diligence is an investigation, audit, or review performed to confirm facts or details of a matter under consideration. In the financial world, due diligence requires an examination of financial records before entering into a proposed transaction with another party. It is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into any agreement or contract with another party or an act with a certain standard of care. It refers to organizations practicing prudence by carefully assessing associated costs and risks prior to completing transactions. Examples include purchasing new property or equipment, implementing new business information systems, or integrating with another firm. It is a systematic way to analyze and mitigate risk from a business or investment decision.
A properly formulated due diligence strategy will work across multiple commercial scenarios, since the principles of a strong due diligence strategy are somewhat universal, however, formulating such a plan requires serious expertise and experience in the nuances of the law. The process involves examining an entity’s financials in detail, comparing those numbers over time, and even benchmarking them against competitors and across market sectors. Due diligence is even applied in many other contexts, for example, conducting a background check on a potential employee, or reading product reviews, but for our clients’ purposes, we simply want them to avoid scenarios like the one we previously discussed. Simply put, we want to do our best to help clients avoid any potential financial and legal penalties, as well as any risk to reputations in business, which can also have devastating long-term consequences.
How do you ensure due diligence?
For the entity itself, it is important to establish a program to ensure compliance among stakeholders with the acknowledged policies, practices and procedures, and as needed, to perform random checks and complete compliance review reports on a regular basis.
What is doctrine of due diligence?
Due diligence is an obligation of conduct on the part of a subject entering into a transaction or business dealing. Normally, the criterion applied in assessing whether a subject has met that obligation is the conduct of the hypothetical responsible/reasonable person in a similar scenario.
Why is it called due diligence?
The phrase due diligence is a combination of the words due, derived from the Latin word debere which means “to owe,” and diligence, derived from the Latin word diligentia, which means “carefulness or attentiveness.” The term due diligence has been in use in a legal practice for centuries.
Do you need a due diligence report?
A due diligence report is typically prepared as a part of the process and is presented to those who are evaluating the business matters in question. It is also typically a requirement for closing any deal.
What should a proper due diligence policy for new clients look like?
A good due diligence policy should be based on core working principles like the following:
1. Establish contact with the partner: It is important to understand the new business partner in depth, including their attitude and history.
2. Vet the Partner: Research who your partner is, their reputation, line of business, location, social media presence and personality. Red flags should also be identified, such as criminal or other legal cases which involve them.
3. Start small: Focus on one or two small projects first, as a trial run.
4. Establish the final scope of the relationship in writing via an agreement: This is the last process before you can initiate the contract.
The above list is not by any means exhaustive. However, due diligence will play a crucial role in any major business transaction, and therefore taking due diligence seriously is necessary for the protection of your business interests.
For help in due diligence matters, contact us at info@borderlesscounsel.com