What Is Enhanced Due Diligence?
The original meaning of due diligence
The Cambridge Dictionary definition of due diligence is: “The detailed examination of a company and its financial records, done before becoming involved in a business arrangement with it.” It is a common practice for companies considering new business partners, mergers and acquisitions, or investments to execute these basic due diligence reports.
Globalization, however, has increased the risks companies face, expanding the need for enhanced due diligence processes that go beyond traditional financial health checks.
Enhanced due diligence: a holistic risk-based monitoring process
Enhanced due diligence helps expose third-party risks across Political, Economic, Socio-cultural, Technological, Legal and Environmental (PESTLE) categories.
Through an enhanced due diligence process, companies can better safeguard their interests—whether those interests are related to potential mergers and acquisitions, supply chain continuity, or ensuring compliance with sanctions and corruption laws.
Why is enhanced due diligence becoming increasingly necessary?
Due diligence laws around the world
Globally, the number of countries that have or are introducing anti-bribery and corruption (ABC) and anti-money laundering (AML) legislation is on the rise. Likewise, enforcement is climbing, with enforcement agencies of different countries collaborating on investigations and prosecutions. More than 40 countries currently have ABC or AML laws governing companies within their borders.
In addition to complying with the laws of their home country, companies conducting business in other countries—whether directly or indirectly through subsidiaries, partners, or other third-party entities—must also consider two relevant laws concerning the prevention of financial crime.
UK Bribery Act
- The UK Bribery Act was enacted in 2010, and it serves as one of the strictest pieces of anti-bribery legislation in the world. Compliance is required for UK companies operating abroad as well as multinational companies if they have a presence in the UK. The act makes it an offense to offer or accept a bribe for the purposes of winning or retaining business or a business advantage. It also further assesses significant corporate liability if a company fails to prevent bribery from taking place—anywhere within their third-party network or supply chain.
- Under FCPA, it is an offense to bribe foreign public officials such as government ministers and customs officers—and both the U.S. Department of Justice and the Securities and Exchange Commission vigorously enforce the law. In 2016, enforcement actions led to 27 companies paying nearly $2.5 billion in penalties in 2016 alone.
These laws have extraterritorial reach and, like other laws, define business partners in broad terms, including customers or clients, suppliers, subcontractors, vendors, sales representatives, and other third parties operating on behalf of a company.
As of January 1, 2017, amendments to the UK Companies Act were enacted, requiring large companies to include disclosures in their annual reports on issues ranging from employment matters and environmental concerns to anti-corruption measures and modern slavery laws. This means that enhanced due diligence is a necessity for all companies, not just those in highly regulated industries.
Starting the due diligence process
To better mitigate risk, companies need to appraise existing and prospective business partners, as well as their subcontractors and authorized representatives. An initial assessment will include self-reported data from the entity being screened, along with independently verified information.
The stages of an enhanced due diligence process: a high-level overview
Key information is obtained from the prospective partner, either directly or through a third party. This is often done using a simple questionnaire.
A corporate entity may be required to submit information about the company, details on key shareholders and beneficiaries, group structure, board members, any political connections, and other details. Official documents and contracts can also be obtained at this stage.
An individual will likely submit details such as sufficient proof of identity, their sources of wealth and funds, any potential political links, etc. depending on the nature of the proposed transaction.
A prospective client or third party will be cross-checked against global sanction lists. Additional checks may be conducted against law enforcement lists and lists published by regulators of debarred or disqualified companies and individuals. Firms will often also have a proprietary “do not do business with” list.
Politically exposed persons (PEPs) are identified and screened against PEP lists. A risk assessment is then carried out if any red flags appear.
The information gathered as part of these investigations is then used as a basis for a risk assessment and the development of a risk-based approach.
Sample due diligence report
A due diligence report provides a detailed summary of the results of the assessment and subsequent investigation, documenting the process from start to finish. The scope of the report differs from case to case, based on the risk assessment and depth of due diligence required. This may include:
- Financial, technical, and organizational due diligence including assessment of managers and employees
- Legal and tax-related due diligence
- Operational due diligence (ODD) to assess risks and the potential for value appreciation that accompany mergers and acquisitions
- Market due diligence to investigate the current and future market situation of the targeted firm
The purpose of a due diligence report is to show that duty of care was exercised in the appraisal. Various regulatory agencies have indicated that maintaining an audit trail of due diligence is a best practice that will receive consideration should a compliance issue arise.
How due diligence software solutions can help
Companies can face serious consequences if their due diligence efforts fall short. As a rule of thumb, the greater the risk potential, the more resources should be invested in due diligence appraisal.
It makes sense to draw on specially trained personnel (employees) or external help (tax consultants, auditors, solicitors, technical appraisers, corporate advisors, etc.) when performing due diligence.
A manual due diligence process, however, can fall short due to limited human resources and inadequate access to relevant, timely information. For those reasons, companies can—and should—take advantage of technology designed to automate screening, assist in due diligence investigations, and support on-going risk monitoring to efficiently and cost-effectively manage the due diligence process and mitigate risk.
Online tools help companies conduct seamless due diligence and document the entire process, eliminating any risk in future audits. A high-performance tool such as Nexis Diligence can help you:
- Screen individuals against PEP and sanction lists
- Access relevant, global news sources with filtering for negative news
- Conduct targeted searches for board members and investors across biographical sources and legal references
- Set up alerts on individuals and firms during and after the search process to stay informed of potential risk events
- Use a built-in report builder to generate comprehensive due diligence reports—including time and date stamps, annotations related to findings, and more—to meet regulator expectations
- Leverage multiple databases for detailed information on businesses, corporate families, and other indicators of beneficial ownership