Due diligence is all about following up on red flags, but if you don’t find them, there’s nothing on which to follow up.
Thus, our tireless refrain: turn over every piece of public record information you can about a person, and don’t leave it to others.
We were reminded of this by the story this weekend in the Wall Street Journal, which found that the brokerage industry regulator, FINRA, leaves a lot of red flags concerning members off its BrokerCheck website. While it’s laudable that FINRA recommends that investors check to see if brokers have ever been subjected to disciplinary action, that check is of limited use if bankruptcies, state-level actions and litigation are left off of BrokerCheck.
We have been writing for years about the need to do thorough searches when conducting due diligence on anyone – pre-employment, pre-deal, or during litigation. In Avoiding Due Diligence Failure: Following Up on Red Flags, we dealt with the problem of the Semmelweis reflex in due diligence.
This is when you want to confirm that someone who is supposed to be squeaky clean really is, and so you write off what looks like a problem in his past to database error. You can also see confirmation bias, in which people rely too heavily on bad or incomplete evidence that leads them to their desired conclusion.
But, before you even get to battling Semmelweis and bias in mishandling red flags, you have to see the flags in the first place. For that, we provide a non-exhaustive checklist to our clients of the kinds of sources we will check. We wrote about it here.
It’s critically important to note that these sources are not checked on line much of the time, but on site. That’s because a lot of information at the county or state level is not available on the internet. You need a good network of on-site retrievers to go pull it at the courthouse and send it back to you. You then need to double check to make sure your retriever didn’t miss anything. While not everything is on line, abstracts of some matters may be. When you get your pile of documents back, it’s always good to make sure that everything you found on line is represented in the results.