For Great Diligence Throw Out these 5 Excuses

A Story of Loan Documents

Years ago I proudly presented a banker with a freshly revised set of loan documents. I explained that he would be using these for his upcoming deal.

His response was “I can’t use these.”

“What” I thought to myself. He didn’t even read them.

What was wrong. The documents weren’t long, were easy to understand and would protect the bank if the loan went bad. Even though I was new at the job, I knew that it was my responsibility to properly document this loan and this was the right paperwork. I could go over his head and mine to my supervisor but I didn’t want to do that. I was going to have to work with him again and it would be better if we were in agreement. So, I asked him a question,

“Why, why can’t you use these loan documents?”

His answered me, “Because if I ask my clients to sign these papers they will think I don’t trust them and they will just go to another institution that doesn’t require this paperwork.” He then went on to explain that a major lending institution, one of his competitors, didn’t require this paperwork.

I relaxed. I could deal with this. I knew that what he was saying wasn’t correct.

He wasn’t trying to mislead me. He just didn’t know better. He was newly assigned to NY from overseas and this was pre-web so banks were not distributing samples of required documents. Also, in my previous position I had drafted documents used by his competitors. Asking clients to sign these loan documents was industry standard.

So, I talked to him. I explained my background, my expertise what I did in my prior position. I walked him through the documents and without giving away any confidences I got him to understand that requiring these documents was standard practice in the NY lending markets. He stopped objecting and agreed to send them to the client.

Much to his surprise he didn’t get any pushback and to his greater surprise or dismay, within a year the bank had to use their rights under the documents to recover the loan proceeds because the client stopped making payments.

The banker looked as good as he could under the circumstances. He had all the correct paperwork and it was all signed. He never thanked me for insisting that he use the documents. I was okay with that because I also learned a lesson. I learned that to overcome objections you need to identify them, understand them and even if they don’t make sense to you, address them.

That is what we are doing in today’s post. Examining diligence objections and addressing them head on.

Addressing Diligence Objections

These are 5 diligence objections or misconceptions that have come to my attention and these are my responses. Feel free to use them.

There are regulations that require specifically defined diligence. Anti-money laundering regulations and Foreign Assets Control sanctions come to mind. If you don’t do what is required, or your diligence is not sufficient, the organization and even the individuals may face civil or criminal penalties for the failure to comply.

There are also circumstances in which industry standards dictate a traditional level of diligence. This is common in the mergers and acquisition space.

Generally, the term “due diligence” is used to describe diligence that is required by law, regulations, prudent compliance or by industry or market standards. But official definitions of “due diligence” are too narrow a criteria to answer the question, when do you need to perform diligence?

Successful organizations and individuals perform diligence because they want the clarity that diligence provides. They take that clarity and use it to make better business decisions, avoid being involved with criminals and criminal behavior and importantly, to stand firm in their mission, ethics and integrity.

There are some professions and roles such as law, accounting, compliance, journalism, investigation and law enforcement that are focused on or use diligence as a central part of the job. These professions do include formal diligence training, it is part of the education. But the fact that there are professions that focus on diligence is not an excuse to shy away from performing diligence as part of their job.

Every job requires diligence and diligence is everyone’s job. A phone call to verify an address is performing diligence. A quick check of the web to make sure that the CEO is not meeting with someone with an unsavory past is diligence. Looking at customer reviews on social media is diligence. You aren’t doing these things because they are legally required. You are doing them because it is sensible, shrewd and smart business.

So yes, it is wise to leave specialized diligence to professionals but it is unwise to proclaim that diligence is only a diligence professional’s responsibility. Everyone needs to perform diligence on the job.

Research is a key part of the process of doing diligence, but research is not enough.

Research provides the raw material. Analysis and application (what I call synthesis) transforms the raw research material into the knowledge and insight that you apply to your circumstance. If you confine diligence to research alone you will not collect a pile of material that will not be lead you forward.

Think about how many examples we have seen in the news where the raw material was there, the red flags, the data, but there was a failure to take that material and do a proper analysis and application. Two big ones that I can think of are the 2008 mortgage meltdown and all the failed investigations of Bernie Madoff’s business.

Diligence is the process whereby you find the raw material, analyze what you find and then extract knowledge that you use to make better business, financial and compliance/legal related decisions. Diligence is the totality of that process.

No time is probably a proxy excuse for a number of other excuses or concerns including, I don’t want to know, I don’t want to get blamed for bad news, the upside looks too good and diligence may put it in jeopardy. But would you feel that way if you were the:

• victim of a billion-dollar Ponzi scheme.
• investor that put millions of dollars into a healthcare start up on the word of a teenager with no educational or professional background in medicine or science.
• entity that paid millions in fines for bribery schemes conducted in overseas offices.
• leader of an organization that has to restate financials.
• leadership team trying to fix a reputation disaster.
• firm that has to shut down because you failed to understand or perform diligence on financial products that have bankrupted your organization.

These are all real examples of massive failures of diligence. It is easy to say that this is all hindsight talking but it is not.

How do I know this?

Because for every individual, firm or organization that suffered tremendous consequences of these diligence failures there were individuals, firms and leaders that passed. Passed on investing in Ponzi schemes, passed on buying exotic and incomprehensible financial products, passed on getting involved with products that didn’t seem to work or worse with fraudsters and corrupt regimes.

The stories that emerged first focused on the failures but if you take the time to look there were also stories of diligence. Diligence that was used to make decisions that turned out, in some cases, to be the difference between the failure or survival of the organization.

Sometimes. But the cost of not doing diligence will usually far exceed the cost of doing diligence (see #4 above).

There are industries and markets that require costly, technologically sophisticated and legally driven diligence to comply with regulatory and practical concerns. Financial and pharmaceutical industries are an example. If you are in those industries the cost of doing diligence is relevant to your budget but not an excuse to avoid or shortcut diligence. Diligence is a cost of doing that business.

When I first started working with the financial sector the anti-money laundering rules and regulations were fairly new and were basic. At that time there were people in the industry predicting that the industry could not afford to deal with these requirements. But guess what? The rules didn’t go away and now they are a cost of doing business. A cost that includes sophisticated technology and entire departments just to focus on compliance. If you can’t meet the cost, you can’t do the business.

But there are also many examples and situations that don’t fall into this category. Much of day to day diligence does not cost an astronomical sum. And with the rise of the web and AI in the not too distant future, the cost is falling.

But diligence does require principles, the right culture, a good strategy and resources that match the risk profile of the business. In other words, the elements of the Diligence Framework.  

All organizations have to make choices about how to allocate budgets, but when it comes to diligence decisions the question should be:

Can we really afford not to perform diligence?

I’ll give you the answer – no.

We have addressed some “bad” ideas, so now we end with the “good idea” which is that efficient and effective diligence is always a good idea Diligence that is used and applied consistently provides an organization of any type and any size, with the ability to:

• Adhere to ethics and mission
• Make better business decisions
• Properly assess risk
• Gain competitive advantage
• Avoid reputational harm
• Defend your organization from criminals and criminal behavior

Don’t let it pass you by, take the advantage.