Due Diligence Must Be Accurate, In-Depth

By Michael Adams, Commercial Business Intelligence

Fraud and misrepresentation in the ISO industry is not new. But the ability to increase the number of relationships via the Internet, and the hungry appetite for "Right Now" approval and accelerated acceptance processes, means it will get much worse before it gets better.

The tools to combat many types of identity fraud and misrepresentation are available today. They are affordable, timely and comprehensive. To be useful, however, companies must change their risk-management policies. Knowing what information resources to look for, and how to get the best bang for your buck, takes a little due diligence itself. Ultimately, it might take a fundamental industry-wide paradigm shift to properly implement a "know your customer" policy.

Private investigators, information brokers and due diligence companies are becoming more ubiquitous as the amount of public record data expands. Unfortunately, the quality of the information, and the lack of licensing requirements for many research "professionals," has led to a general lack of background-check standards.

Added frustration comes into play as the turnaround time and cost for seemingly quick and dirty information becomes wildly exaggerated or discounted, depending on what part of the country you're asking questions about. As an added concern, many inexperienced businesspersons are selling so-called "$49 background checks" that are incomplete, misleading and prone to error.

The value of public-record research can be illustrated by its use in verifying the reputation of people and companies. However, the real value is in knowing which public records are most likely to point to problems down the road.

Our company, Commercial Business Intelligence in Ventura, Calif., started its due diligence business for commercial lenders and attorneys. For the past two years, we have worked with sponsor banks on their ISO portfolios. We gather multiple-source public record data to build an in-depth profile on the subject entity or person.

We've learned that problems exist when a customer asks for investigative shortcuts to learn about financial risk or courtroom opposition. After all, clean criminal record searches don't mean a person is honest. An active corporation doesn't mean it is a legitimate business. A lack of civil records will not point to an upfront businessperson.

But if you take an overall look at an address history, name and social security number history, assets owned, business ownership past and present, criminal and civil record searches, bankruptcies, news articles, UCC lien searches, news sources, and liens or judgments, one starts to get an in-depth view of the subject.

Some public record sources - Choicepoint, for example - tout their expertise in an inexpensive, automated report-retrieval program. Although this particular solution provides some information, it tends to provide too much or too little consolidated knowledge.

To counter this shortcoming, I recommend re-purchasing the same report from more than one data reseller (there are approximately six such sources), drawing the strengths and weaknesses from seemingly redundant data. Some are stronger in the eastern U.S., some in the west. Others are better at corporate data but weak in assets. Some include social security numbers whereas others don't. One in particular has uniquely historical address histories not found in credit header files.

Many researchers sell inexpensive "index search" criminal and civil records. These are dangerously incomplete and do not meet FCRA guidelines. Our researchers always order "walk-in" physical criminal and civil research at county-level courthouses and supplement each due diligence-level report with federal court searches and other little-known, cost-based "bad player" databases. It is a time-consuming, expensive and tedious process, but it is the only method available if one wants to learn accurate, useful facts.

Some information sources seem minor and unimportant but are quite valuable. News coverage from sources such as Dow Jones Online is, in my opinion, one such source. I have found news stories that pointed to problems no one knew existed, such as the ISO owner accused of casino bribery in a distant state. Or the allegations of gross financial improprieties involving a missing $1.2 million, dated many years earlier, at a local college.

These cases may not have been filed in court. They might have never made it to the public record, yet they say something about a person's character and reputation. Such stories may name a person who is innocent of the accusation, but at least the risk holder knows where to look further and might ask more questions.

Approximately two years ago, we received a call from a sponsor bank in the Southwest, requesting they customize a due diligence process for their ISO portfolio. The bank's officials believed they knew too little about the companies for which they were financially responsible. Cost and turnaround time was also an issue, so we were able bring our rate down to an affordable package price.

The customer eventually requested reports on more than 60 companies and twice as many business owners and corporate officers. Our researchers followed this exercise with several other sponsor bank portfolios based on referrals. What we found pointed to a general trend among bad players in the financial industry: to tell part of the truth but not always the whole truth.

Our research found some pretty interesting characters in the ISO industry, such as corporations run out of run-down residences with duct-taped house numbers, criminal and civil records for breach of contract, assault and theft, huge unpaid tax liens, defunct corporations represented as active, laundromat owners turned financial wizards, and a healthy dose of assorted liars, cheats and thieves.

Even the cleanest players eventually might have a run of bad luck or are just starting out and have not had the opportunity to show their true colors. The trend is amplified in results from the annual review, a process strongly recommended by CBI.

The following matrix illustrates fundamental changes in a 12-month period during a review of 27 ISOs and 34 principals. One of the federal court cases noted below involved a serious illegal drug sale charge filed two months after the initial due diligence report:

Corporations:

Addresses Used: 0 Liens, Judgments & Bankruptcies: 3 Corporate Affiliations: 1 UCC's 8 Property Owned: 1 Federal Courts: 0 Total Corporation Changes: 13

Principals:

Addresses Used: 2 Liens, Judgments, & Bankruptcies: 3 Corporate Affiliations: 5 UCC's 5 Property Owned: 3 Federal Courts: 2 Total Principal Changes: 20

In nearly all business relationships, the subject is required to tell a creditor when it declares bankruptcies, but not all do. Secured property should not be transferred, but sometimes it is. Address changes should be forwarded, but sometimes they are not. Corporations are wound down or revoked but still are represented as active. As Gomer Pyle would say, "Surprise, surprise, surprise."

It would be nice to be able to fully trust those you're in business with, working with, hiring to represent your company, or extending credit to. But in this global 24-hour economy, growth-minded companies must take risks with unknown relationships. It is our job to assure those risks are, to some degree, measured and minimized.

The worst part of the due diligence and background check business is that not all con men and thieves will be identified. They either walk away from a bad situation instead of being sued, or keep a drug habit from family and employers until it's an unmanageable problem, or are just starting out in a life of deceit. But when someone has been caught victimizing creditors and honest businesses and it has been publicly documented, it's a crime to not look in the first place.

Know your customers, know your employees and know your debtors. You'll know your risks.