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An Ounce of Prevention

FTI Consulting frequently is engaged to conduct after-the- event investigations to identify assets, unravel major frauds and help resolve other crisis situations. These often are extensive (and expensive).

And, in many instances, such follow on examinations are avoidable.

A common thread in these engagements is that the clients call us because they are mired in a mess that included precious little (or no) due diligence prior to the transaction that got them into trouble in the first place.

With so much money at stake, how can that be?

It’s because what companies commonly view as effective due diligence, in fact, is insufficient. Even though they may spend a fortune conducting legal and financial due diligence leading up to a transaction, that type of inquiry is far too narrow in most cases. Sometimes the decision to limit the extent of due diligence is based on the fact that the parties have had an earlier relationship, and the key principals on each side have personally met. This allows companies to believe that all is as it should be. But this leaves out reputational due diligence — and the failure to discreetly and ethically conduct research into a target business’ activities and reputation may (and often does) cost them dearly.

We all like to think that our instincts are good. Studies have shown that people decide within seconds if someone is trustworthy. Add to that the fact that, dazzled by the prospect of sizable profits, everyone wants to believe that a promising investment package is smart, safe and sound. In many instances, even sophisticated investors, confident that the numbers they’ve seen look good, go with their gut. Plus they may be reluctant to ask incisive or potentially embarrassing questions that could squelch a deal, give offense or cause a loss of face (an especially touchy matter in Asia).

But the world is not a simple place. The roster of companies and individuals having been deceived is impressively long. Rather than considering discrete due diligence into the target company and key principals as an optional or unnecessary extra expense, investors should regard it as an investment — and one that could save them millions of dollars.

For one example among many, our client, representing a consortium of investment banks, loaned tens of millions of dollars to a company in the fish processing business in China. Members of the banking group had visited the operation’s allegedly extensive facilities and granted the loan largely based on instinct and how good the premises looked.

But, again, looks can be deceiving.

FTI Consulting’s Global Risk & Investigations Practice was called in to conduct an asset search six months after the key principals had defaulted on the loan and disappeared. Our investigation quickly confirmed that the company didn’t actually own many of the facilities the bankers had seen. Local industry sources recalled the day the bankers had visited and knew that the key principals had bribed leaders of other companies in the area to pretend to be part of the target group.

This was an expensive lesson that could have been avoided if reputational due diligence had been conducted before the loan was granted.

And where are the fish processing principals today? They’re still missing, along with the bankers’ millions.

The Global Risk & Investigations Practice of FTI Consulting

Published June 2015

© Copyright 2015. The views expressed herein are those of the author and do not necessarily represent the views of FTI Consulting, Inc. or its other professionals.

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The views expressed in this article(s) are those of the author and not necessarily those of FTI Consulting, Inc., or its professionals.
©Copyright, FTI Consulting, Inc., 2012. All rights reserved.

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