Due Diligence guide for AIM Nominated Advisers, Brokers, Directors and Stakeholders
This due diligence guide is our overview of what, why and how director and stakeholder due diligence can be applied by corporate finance brokers, private equity teams or qualified executive (“Advisers”) and how furnishing them with reliable background intelligence enables them to make sound investment decisions.
The appropriateness of a company listed on a stock exchange, alternative market or private equity investment, has a crucial role to play in maintaining the quality, reputation and the integrity of the company, the market and, or investment itself. Accordingly, the quality of due diligence performed on directors, stakeholders, beneficiaries, and the companies themselves, is vital.
Under financial regulation rules and corporate governance best practice guidelines, this due diligence guide outlines procedures on directors, companies and stakeholders should be applied consistently for:
- listed market admissions
- the take-on of an existing listed company from another Adviser
- the appointment of a new director, board or significant shareholder to an existing listed company
- private equity investments
- enhanced due diligence requirements
Meaningful Due Diligence Guide
As a starting point, due diligence on new directors and stakeholders should be meaningful and undertaken to help Advisers assess their fitness and appropriateness, or as the Financial Conduct Authority states, “Fit and Proper”, rather than simply as a “tick box” exercise to satisfy a regulatory process.
Rightly, background checks on directors and other stakeholders should be based on an Adviser’s reasonable judgement as to what information it requires to make an informed decision on an individual’s suitability to be a director.
Our due diligence guide and official guidance from the London Stock Exchange (and other financial regulators) expects Advisers on the Alternative Investment Market (AIM) for example, to use a “range of sources” when undertaking due diligence. This will include a “suitable Director’s Questionnaire (DQ), web-based general searches, Companies House or similar overseas checks, interviews, reviewing references etc”.
Yes, some checks in the UK are relatively easy to perform and can be conducted in-house, but what does “web based” and “general searches” or “similar overseas checks” actually entail?
Look for undisclosed histories
A vital part of any director due diligence should be to interrogate the individual’s CV, DQ, application forms and corporate history. This will help both verify the information provided, but will also uncover adverse information and risk such as undisclosed information, regulatory red flags, conflicting findings, false or exaggerated statements and any breach of AIM rules such as undisclosed company liquidations etc.
Advisers are also reminded that any individual making a false statement in order to gain employment or a voluntary position, is a criminal offence under Sections 2 & 3 (False Representation and Failure to Disclose) of the UK’s Fraud Act 2006, and can carry a maximum sentence of ten years’ imprisonment.
In our experience, background checks into senior executives and new hires entails rigorous interrogation and analysis of information gathered from a range of open sources. These open sources include, but are not limited to:
- directorship & company registries
- CCJ, civil & criminal litigation cases
- company liquidation searches
- an examination of public records and documents
- personal insolvency histories
- independent regulatory reference checks
- previous employment/education verifications
- social media platforms
- deep web sources
- professional qualifications
- financial regulator enforcement history
- PEP, sanctions & leaked document checks
- historical press articles
- other subscribed databases
- where possible and appropriate, criminal record checks
- key word searches
International Director Background Checks
When it comes to overseas’ directors in particular, financial regulators would expect it to be “the norm rather than the exception” for an Adviser to undertake third-party due diligence. The objective of third-party due diligence is to provide reliable and independent information which will be beyond what Advisers are able to ascertain from normal desktop searches.
Most importantly, our due diligence guide recommends that research must be performed in the relevant language or languages, rather than relying exclusively on data gathered from just English language sources and searches. Therefore, the open source information gathering described should be performed in appropriate jurisdictions and in key languages, depending on where the director or stakeholder has had a corporate or residential presence.
Having gathered the key findings from the background checks and due diligence exercise, an Adviser should take a step back, review and consider all the issues arising from the information it has assembled.
Any issues and recommendations should be shared with an appropriate person and challenged by experienced members of the firm who, where possible, are independent from the transaction team.
It is critical to identify and challenge all the potential risks uncovered from the background checks, as the additional cost for supplementary research phases is minimal compared to the possible losses incurred from a bad business decision.
Where issues of concern are raised, the Adviser must reconcile these by way of further reasonable enquiry from the director or stakeholder, and then verify and evaluate the responses given.
If any concerns arise that cannot be reconciled, the Adviser should consider how it will impact upon their appropriateness, and with the integrity of the market and reputation of the client in mind, its governance responsibilities.
In some situations, an Adviser will have to conclude that the individual is not suitable to be a director or stakeholder of the company.
Derived from over 1500 completed background checks performed by the TenIntelligence team between 2018 and 2020, results from each check were categorised using a simple traffic light system. Each background check received a status of Red, Amber or Green, depending on the severity of the findings:
- Red showed a significant red flag had been found
- Amber confirmed that discrepancies were identified
- Green meant there were no issues identified on their CV or application form.
The results of our research showed a total of 69% of cases were identified as having an Amber flag, meaning we identified an undisclosed or inaccurate finding during the open-source phase.
- Undisclosed company directorships
- Incomplete university degrees
- Expired professional qualifications
- Inaccurate employment dates
- Gaps in employment
During the due diligence process, most directors and stakeholders are given the opportunity to disclose such adverse findings on their DQ or application form; yet, often self-preservation instincts kick in and people may choose to fabricate, conceal or ignore the truth.
Remember it is a criminal offence under the Fraud Act 2006 in making a false statement to gain employment.
This defence mechanism was highlighted during our research as we identified a further 6% of cases that raised red flags, including allegations of insider trading, sexual harassment, fraud, drug taking, court litigation cases, compulsory liquidations, undeclared insolvencies, criminal convictions, ties to sanctioned individuals and companies and Politically Exposed Persons.
Clients have been poised to appoint a professional who at first glance seemed like the ideal candidate, but after checking their background, turned out to be less than desirable.
Source Intelligence & Regulatory References
As part of our due diligence guide, an independent analysis of a director or stakeholder’s character should also be considered to assess the appropriateness of their professional background.
One of the best ways to obtain this information is by speaking directly with former colleagues, clients and senior management, a process we call Industry Insight or “Regulatory References”.
We have seen a substantial increase in requests for Industry Insight research and interviews, complementing our background checks and due diligence. The driving force behind this is in response to an increase in regulatory requirements and scrutiny as well as good “corporate governance”.
Advisers tend to utilise this source intelligence offering for:
- board directors who are new to the listed market sector
- international directors
- directors not known to the Adviser
- enhanced due diligence best practice
- a later phase if an amber or red flag is identified during the first phase of background checks
But what does Industry Insight entail and why is it such a vital part of Enhanced Due Diligence?
Industry Insight is an investigative research tool that complements and adds value to information gathered in respect of the individual director or stakeholder. It provides clients with a deepened understanding and valuable context when trying to identify sensitive or adverse information.
Conducting Industry Insight interviews requires skill and preparation to obtain quality responses. A standard framework of questions is a useful start, but the interviewer also needs to know when and how to adapt lines of questioning or to probe for further explanations; including questions such as, explaining their management style under stress, boardroom leadership qualities and explore possible weaknesses.
It is also important that the credibility and relevance of the interviewee is thoroughly researched beforehand.
The interviews can be face-to-face, although telephone interviews are more common as they are more cost effective and not restricted geographically; and especially now, with new “Covid Secure” measures in play. In most cases the individual director or stakeholder will provide authorisation for our team to perform such interviews. However, the provisions of protecting personal data will need to be carefully considered.
Not just a Google search
When 75% of our background checks identify Red or Amber flags, a simple Google search is not enough. Whether it is through an in-depth interview with a former colleague which reveals criminal activity or undeclared financial issues identified through official records, relying on a Google search to identify these kinds of risks is unwise. Our study proved that using standard search engines will not necessarily recover subscribed data from the deep web or hidden behind pay walls.
In summary, collect meaningful information, spot the flags and report appropriately. Detailed examination of databases, online resources, and interviews with carefully chosen individuals and sources, is the only way Advisors can be certain to minimise risks when engaging with a new stakeholder, senior hire, partner, investment, or business. Continue to apply a risk based approach and evaluate your research sources, review whether your background checks processes are fit for purpose, consider outsourcing to an independent party and always challenge any discrepancies found in the due diligence to help maintain integrity.