The Kerik Files: Three Cases That Show Why Due Diligence Is a Risk Manager's Best Friend

March 2005

Whether the reason is misplaced trust or cost-saving, the policy of neglecting to conduct proper background examinations of prospective employees, business partners, and even senior level executives and board members, is always risky business.

by David Nicastro
Secure Source, Inc.

It started with reports of an illegal immigrant nanny and quickly blossomed into an all-out scandal: Bernard Kerik, New York City's former top cop who had been selected to become the new Homeland Security director, was bowing out of the job. By the time Mr. Kerik's background was fully vetted, the details of his questionable past acts were the subject of extensive press coverage, Kerik was out and his would-be boss, President George W. Bush, was left scrambling—the proverbial egg stuck on his face—for a replacement.

"I can't believe they let this nomination through and didn't know about [the nanny]," one White House official complained to the press. "They should have known about this."

That's what I thought when I was following the story. More specifically, I wonder how could the White House, of all places, get something so simple as a routine due diligence screening of a presidential nominee so wrong? Part of me suspects we may never get all the real answers, but one answer seems to involve misguided trust: You can never trust that a person is the right candidate simply because they have good references, even when those references are Rudy Giuliani and Hillary Clinton.

Unfortunately, what happened with Kerik is not an uncommon experience. I see cases like the Kerik debacle happen routinely. In the private sector, it is not surprising that some executives attempt to cut corners by skipping the due diligence process because it does not generate income.

In this article, I want to share three examples of recent cases my company responded to that illustrate the importance of due diligence—not only as a pre-hiring or pre-contract regimen, but also as an ongoing weapon that should be used when inevitable troubles arise.

Pre-Employment/Pre-Contract Screening

No matter how many cases we work, the audacious ways of con artists, charlatans, and other common criminals never cease to amaze me. Take, for example, the case of "Tom," the name I'll give to the man my team recently investigated on behalf of a client. Our client is the general counsel for a midsized firm that was looking for a partner to execute a reverse merger agreement. As our client was well aware, the world of reverse mergers is a tad murky and, therefore, the need to find an ethical partner was paramount. The prospective partner turned out to be Tom and two of his assistants, who I'll call Dick and Harry.

Tom's case is a classic example of why due diligence is an essential component of any pre-employment or, in this case, pre-deal vetting process.

As part of his pitch, Tom presented our client with a thick brochure about the privately held company he is supposed to have created and a copy of his resume, along with the resumes of Dick and Harry. Naturally, the material looked impressive—the three partners had brokered one multi-million dollar transaction after the next, some of which were even documented by short business reports that appeared in various Internet web sites.

When it comes to putting together complex transactions, our client is no novice—the firm's executives have a solid track record for choosing trustworthy partners and completing successful deals. As they are accustomed to doing in-house, our client interviewed Tom's listed references, all of whom offered glowing reports. Everything seemed ready to proceed, except for one problem: Our client's instincts told him something was wrong. When he called us, our client couldn't say what, exactly, bothered him. He only knew that something about Tom "didn't fit."

The first thing my investigators set out to do was verify the information Tom provided on his resume. It wasn't long before they found information that didn't fit. First, no person by Tom's name was living at the home address Tom provided, and no one by his name ever lived there. Second, the private company Tom claimed to have created was not, in fact, incorporated. As my investigators began to think Tom was hiding something, they noticed his resume contained no information that could establish or be used to confirm his full identity—besides the false address, Tom didn't provide his full name, date of birth, or even the years he supposedly attended college.

With the help of various databases and a little creativity, a noteworthy fact about Tom emerged: Tom was a registered sex offender who had recently been arrested for failing to register with police in accordance with the terms of his probation. Having established Tom's identity, the investigators turned their eyes to Dick. They quickly discovered that he had a history of being named as a defendant in civil lawsuits alleging breach of contract and, more importantly, he had recently stood trial on federal charges of money laundering and securities violations. The information about Tom and Dick was so compelling; there was no need to even bother looking at Harry. Our clients killed the deal.

Senior Level Management Screening

In the second example, we received a call from the president of a company that had gone from employing a half dozen people to more than a hundred since taking it public several years ago. When the company was founded, it was a mom-and-pop shop, and the founders didn't see any reason to investigate each other's backgrounds.

As the years passed, and the company grew, one of the original partners was becoming increasingly disgruntled. Ever since he was passed over for a salary increase, the partner was often upset while he was at work. Later, the board of directors began hearing reports that he was telling employees that he had started a competing company and would pay them more money if they came to work for him.

Thinking they had to move to protect their current client list, the board asked my company to conduct an investigation to locate this competing company. What we found was much worse: The disgruntled partner was a convicted felon who was currently serving a 10-year probation sentence for having orchestrated a check fraud scheme at the company where he was employed immediately prior to joining our client's company. Worse, this company was in the same industry as our client's.

Once this information came to light, our clients realized they had may have a bigger problem than a disgruntled employee turned competitor. Unauthorized loans they had previously uncovered and thought to be unrelated to the disgruntled employee now looked like evidence of the same type of fraudulent scheme that led to the employee's conviction.

Today this client understands the need for routine due diligence. Had the company completed these inquiries on a regular basis—as the company grew and its employees were promoted—this particular employee's criminal record would have been discovered. The company would not be in the difficult position it is now in—having to conduct a full-scale internal fraud audit, the results of which will have to be reported to Wall Street and, no doubt, will negatively impact the company's stock.

Opportunities for Disaster

As the president of my own small, growing company, I spend most of my days looking for clients like the one in my first example—executives who call us before they ink a deal or hire that new executive. Unfortunately, most of our clients are like the client in our third example, and they illustrate the tragic outcomes that occur in cases when decisions are made before due diligence is preformed.

In this example, I was contacted by a client for whom my company had provided executive protection services for in the past. Like a lot of investors who have grown tired of our nation's stubbornly low interest rates, this client and a few of his well-heeled friends were looking for a place to invest several million of their own money. In recent weeks, a member of the group had been approached by a stranger who had an elaborate investment plan that sounded brilliant, or so it seemed at the time.

Once again, everything about this stranger looked great. He had a professional demeanor, good references, and a beautiful office suite in a modern office tower. The stranger was so confident that his investment plan would succeed, that he had already set up a Christian-oriented nonprofit organization he was going to fund with the extra proceeds.

All good Christian family men themselves, the investors were impressed with this man. After a visit to the stranger's office confirmed its existence, the investors offered up a combined $5 million—the first of what they thought could be several larger investments. As was the case in the first example, one of the investors listened to his instincts, and they were telling him something was wrong. When the client contacted me, he explained that he went along with the investment because his partners agreed the idea was sound, but he wasn't so sure. Something about the stranger, he said, "didn't fit."

Our investigators uncovered information that confirmed our client's instincts: The stranger, who happened to be awaiting trial on his second drunk driving arrest, had a string of bankruptcies and a long history of leaving his creditors in the cold. Of the many people who had sued the stranger in an effort to recover their money, one was his very own Christian minister.

Not one who enjoys being the bearer of bad news, I was relieved to hear the client tell me that our investigators had only confirmed what instincts already told him was the case: His potential business partner was a con artist. The only good news was our investigation had detected the fraud soon enough to offer hope that the $5 million investment could be recouped.

Conclusion

Before I sat down to write this article, I checked his company's web site—it's still there, and his telephone number is still turned on. In the aftermath of the Bernard Kerik affair, I am sure the White House has a new appreciation for the importance of due diligence. Knowing that this stranger is still out there, operating, I can only hope the private sector does, too.

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