Importance of counterparty due diligence

Companies today need to be agile and efficient to remain viable, and this calls for co-operation, collaboration, and delegation to achieve business goals, resulting in a complex network of business relationships that can be fraught with numerous risks. Regulators around the world are increasingly taking a strong stance against questionable practices, holding organizations responsible for any unethical activities that occur within their sphere of influence. This is exemplified in the stringent provisions under the UK Bribery Act and the US Foreign Corrupt Practices Act.

Whether seeking to invest in a promising enterprise, forming a joint venture with a business partner, engaging a vendor, or taking on a large client, organizations need to conduct counterparty due diligence (‘due diligence’) to ensure that these prospective business partners possess the requisite capabilities to fulfil their commitments. Additionally, organizations need to ascertain if these prospective business partners have a history of poor performance, litigiousness, and fraud, or reputational issues such as political exposure or links to organized crime, which could adversely impact their own reputation.

While experts familiar with industry practices and dynamics are able to perform a technical appraisal of prospective partner organizations, a skilled due diligence specialist could uncover issues that can be hidden wilfully. In our own experience, quite a few entities which have been regarded as ‘clean’ have frequently been found to have multiple skeletons hidden in their closet. Political exposure, conflicts of interest, undisclosed related parties, undisclosed litigation, bankruptcy, sanctioned operations, unknown ultimate beneficial ownership, diversion of business, and outright fraud have been some of the issues that can be discovered.

Apart from engaging with enterprises, associating with individuals also requires due diligence. Respondents to our Deloitte India Fraud Survey, Edition I in 2014 indicated that members of senior management were most likely to commit fraud. This underscores the importance of looking into the antecedents of potential candidates for high-level jobs. In our experience, senior management due diligence has frequently revealed issues such as conflicts of interest, adverse reputation, allegations of malfeasance, negative personality traits, and fabricated work history in individuals who would have otherwise been appointed to positions of great responsibility. For closely held or family-controlled enterprises, it is particularly important to determine if the candidate will be a good fit in the company’s culture. Hence, due diligence should form a critical component in hiring members of senior management or independent directors for company boards.

Our 2016 survey report—India Fraud Survey, Edition II—revealed that large companies believe that due diligence is also an important component of fraud prevention measures. 37% of the respondents representing large companies indicated that inadequate due diligence was one of the factors contributing to fraud. As business grows and strategic partnerships/business relationships are formed, it is crucial that organizations engage with a due diligence specialist to better mitigate fraud risks arising from counterparties.

You can read more about the importance of due diligence for fraud prevention here.

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Authored by: Nikhil Bedi, Partner, Deloitte India

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