“Burke Files has done a thorough job in presenting and analyzing due diligence issues essential to be considered by professionals committed to excellence.” Richard D. Heideman, Esq. Senior Counsel, Heideman Nudelman & Kalik, P.C. Washington, DC “Files brings a fresh, critical and frequently amusing perspective to the well plowed topic of financial due diligence, and the results are terrific. This book should be required reading for all well intentioned lawyers, accountants, bankers, investment advisors, regulators and other professionals who practice in the international financial sector and can perform a crucial gate keeping function.” F. R. Jenkins, Esq., Meridian 361 International Law Group, PLLC, Inner Temple London “This is it, this is what is missing in the world of due diligence. A well written guide to the thought process and not another book of mindless check lists.” Juan A. Benavides, FBINA, CPP, CPO, DVSA Retired Chief of State Police Nuevo Leon, Monterrey City, Mexico Principal of IPACITEFO International Training for Police and Security. Monterrey City, Mexico “Any CFO who does not read and head these lessons will make errors that could have been foreseen and miss a good read.” Thomas E Ferneau, III Esq. CFO Tarsus Trust Company Charlestown, Nevis “As a security consultant advising global corporations, investment institutions and governments on various aspects of their business, I am required from time to time to carry out due diligence procedures on behalf of my clients. The complexity of the international financial environment today and the increasing vulnerability of companies in our networked age to well-organized fraud make this is challenging task even for the well-prepared professional. In answer to this pressing problem, Burke Files has produced a concise yet comprehensive guide to the techniques, best practices and timesaving tools that help to combat and overcome the wily fraudsters inhabiting our financial environment. With this book as part of your personal armory, you are equipped to steer a confident path through the due diligence processes required in M&A planning, business partnerships, supplier agreements, key employee hires and many other forms of corporate activity. Most important of all, this book is a great read. In an area of endeavor not generally known for its entertaining nature, the author’s light and humorous touch keeps the pages turning nicely, and the colorful characters we encounter throughout the book alternately appall and intrigue us by their single-minded devotion to defrauding their partners, customers and the authorities. Bravo Mr. Files - this book will remain a permanent feature of my library for many years to come!” Jules Trocchi, Senior Consultant, Electronics & Security Practice, Frost & Sullivan London “A refreshingly comprehensive guide explaining the process of financial due diligence. Well written and presented in succinct yet humorous fashion, this book allows readers to go above and beyond the overly simplistic check-box approach that so many have unfortunately been lulled into reliance upon. This should be requisite reading by various business and risk managers, investigators and various gatekeepers associated with or serving those in the financial community, as well as anyone who has interest in this subject matter.” Shaun M. Hassett, CAMS The LUBRINCO Group Algonquin, IL Due Diligence For The Financial Professional L. Burke Files Copyrighted material Copyright © 2010 by Aegis Journal, LLC. All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical means, without the written permission of the publisher, except in case of the brief quotations embodied in critical reviews and certain non-commercial uses permitted by copyright law. For permission requests, please write to the publisher; attention “Permission Coordinator” at the address below. Aegis Journal, LLC POB 27314 Tempe, AZ 85285 Tel (877) 4243 – Fax (877) 438-2603 e-mail: [email protected] Sales are available at: www.AegisJournal.com, Amazon and at Quality Book Stores. Special discounts are available on quantity purchases. Please contact by e-mail for details. For classroom use, please inquire about the availability of additional support materials. Orders for bookstores, please contact by e-mail Editor: John Conway Cover design: Zoe Lowney Aegis Journal, LLC, the title “Aegis Journal”, the Aegis Journal logo, and “Due Diligence for the Financial Professional” are all the property of the Aegis Journal, LLC. To book speaking engagements please contact Mr. Files through Aegis Journal, LLC. Library of Congress Cataloging-in-Publication Data: Files, L. Burke Due Diligence for the Financial Professional Library of Congress Control Number: 2010912845 Printed in the United States of America 1 3 5 7 9 8 6 4 2 ISBN 978-0-9823723-3-3 ii Introduction “Liberation is freedom from ignorance.” Unknown The purpose of this book is to help the financial professional avoid ever being misled again. Financial professionals are challenged by the need for due diligence, not because it is a requirement but because it is not a stocked item. It is a process not a thing. Stale, regimented, check-box information is not due diligence. What’s needed is relevant information gathered in a timely manner. This is key. Properly executed, a due diligence process provides tools for informed choice and eliminates fact noise. So Why Buy This Book... This is not a book of mind-numbing irrelevant checklists, nor is it scribbled by an academic. This book will show you how to filter information and discern the noise from the substance of due diligence. It does not waste time or pages telling you what you already know about AML, SOX, risk management or how to read a balance sheet. No, this book goes into the guts of the idea – due diligence or, as I like to say, Do Diligence. So then, what’s different about this book from the many others like it? It is penned by someone who has run and or overseen thousands of investigative cases from the mundane to the outrageous, involving thousands of dollars to hundreds of millions of dollars in many countries. It is penned by someone who has done due diligence and mopped up when it has not been done. It’s about wiping the lipstick off the pigs! Like any thought experiment, which is the format of this book, the presentation leaves out many complicating details in an attempt to tease out something interesting about core issues. iii How To Use This Book The book is set up with stand-alone chapters. You can read from beginning to end or read the chapters you choose. Don’t lean on the questionnaires and lists without reading the corresponding chapters that precede them. This way you will know questionnaires and lists are not mindless forms to be followed, an end destination – rather they are a road map for journeys. If you are to read a few chapters only, please include Heuristics, Art and Due Diligence, and the Frontiers of Fraud. These take you out of routine thinking and challenge you to think laterally about due diligence and fraud. By the way, I get it – due diligence as practiced by many is so exciting you would rather water the moss garden. On the other hand if you were putting down $1,000,000 of your money on the outcome of the Super Bowl, you would know the entire personal and professional histories of every player and you could follow key players up to the hour of the bet to see who is working out and who is out on the town. Now that’s fun. Or if you are investing other people’s money, are you just going to the mean, median and mode of the Vegas and street bookies, weighing the numbers by a quant formula? It is the difference between doing your own work and relying on a ratings agency. After over 25 years in finance and 19 as an international investigator, I have seen some of the worst and best in finance. My attempt is to offer to you my experiences and encapsulate 14 more years of experience of my own and my firm’s operations conducted on six continents. This book is about change. It is about a change in the social contract that says a little fraud is OK. It is my wish that with the tools in this book you can help change the paradigm and thus the social contract. This book is not a “how to” on due diligence and fraud. Rather, the book’s purpose is to give the reader no refuge but to think about the due diligence process and how fraud attempts to circumvent the process. May we all do well as we do good. L. Burke Files – August 2010 iv Table Of Contents Preamble ................................................................................ 1 Why Are You Doing Due Diligence? ............................. 1 Due Diligence Is Much too Serious of a Matter to Be Entrusted to Your Risk Management .................... 2 Back to Our Roots ........................................................ 7 Chapter 1 Heuristics and Biases ......................................... 9 There Are Five General Categories of Heuristics ............10 Judgment ............................................................10 Representative .....................................................10 Availability ..........................................................10 Adjustment and Anchoring ..................................11 Risk and Loss Aversion ........................................11 Biases, A Sampling ...............................................11 A Thought Experiment ................................................13