Know Your Customer, Know Yourself: Due Diligence’s Role in Preventing Fraud Complicity

Welcome to the October 2020 edition of our newsletter!  In this issue, we’ll examine how vetting of employees and key account customers can help banks and other businesses avoid regulatory headaches.

Service Provider or Fraud Abettor?  Precautions to Prevent Becoming an Accessory to Fraud

For more than 40 years, banks and other financial institutions have relied upon “know your customer” protocols to vet prospective and existing customers and better ensure that their motives are toward legitimate, legal ends.  As we have seen with recent high-profile settlements, these efforts are not always as exhaustive or effective as perhaps they should be.

Human nature, as is often the case, is one impediment.  If an executive has been with the company for 20 years and his performance has been satisfactory or better, do you really need to re-examine his personal financial situation?  In short, yes.  Although not feasible for every transaction and every executive, it is prudent to establish – and maintain – a threshold for reviewing the financial and personal situation of key persons involved in a proposed transaction as part of that process.  Has the executive experienced any recent financial or personal strains that could make him susceptible to bribery or motivate him toward other unwelcome behavior?  A review of public records, likely coupled with discreet interviews of co-workers and other sources, may provide an indication if any vulnerabilities exist which could be exploited to compromise an employee’s role to act on behalf of the company.

The other side of this equation is, of course, the customer.  A thorough analysis of a potential – or existing – customer’s known business dealings, litigation and regulatory history, and media footprint can provide indicators as to whether he may have an incentive to use your firm to engage in fraudulent activity.  Has he recently sought bankruptcy protection, or dissolved a company?  Have liens or other judgments been filed against him, and has he satisfied them or are they outstanding?  Is he looking to open an account for a newly formed company with no track record?  If the latter, its aims may be legitimate, but as it hasn’t existed for very long the focus should be on its principals, suppliers and its industry in general.  Are there difficulties in the supply chain, or other industry-specific risks, that could create problems later?

Although this level of due diligence is more typical in cross-border accounts – requiring an understanding of another country’s regulatory and legal landscape as well as your own – many of the principles apply to domestic customers as well.  Vigilance prior to or during a transaction is not a panacea, but it is a much more effective preventative measure than having to answer to authorities after a fraud has been exposed.