Best Practices for Conducting Background Checks on Director and Executive Candidates

(This article was contributed to Corporate Compliance Insights by Ms. Theresa Mack, a Senior Manager at Cendrowski Corporate Advisors.

Ms. Mack is a C.P.A., is certified in Financial Forensics, and is also a Certified Anti-Money Laundering Specialist. She has over 22 years of investigative experience working as a Special Agent of the F.B.I.

Theresa Mack can be contacted via telephone at 866.717.1607 or by email at tbm [at] cendsel [dot] com.)

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Best Practices for Conducting Background Checks on
Board of Director and Executive Officer Candidates

Beat the SEC to Skeletons in D&O Candidate Closets

Board of director and executive officer candidates will be subject to heightened public scrutiny if the U.S. Securities and Exchange Commission’s (SEC) proposed amendments for increased disclosure requirements are adopted.

Responding to events in the financial markets over the past 18 months, the SEC seeks to provide shareholders with additional information that will enhance voting and investment decisions. Specifically, the SEC’s Release 33-9052 sets forth proposed amendments to Item 401 of Regulation S-K that will require disclosure of “qualifications, attribute or skills” that qualify a candidate for service in a governance capacity for a particular company, based on that company’s business and structure. Currently, Item 401 only requires “brief biographical information about directors and nominees.” ¹

In light of these proposed changes, thorough background checks will become an even more essential component of not just the initial hiring process but the ongoing due diligence needed for certain board positions. Such checks should be performed not only to prevent embarrassment and unfortunate publicity, but also to reduce the risk of legal liability.

Although the SEC’s proposed changes only apply to SEC filers, private and not-for-profit companies should also use these guidelines as best practices.

Best Practices for D&O Background Checks: The Application

No matter what the level, all potential employees should be asked to sign a waiver to allow the pulling of their consumer credit report both initially and routinely as the need arises. That way the waiver is in place when needed.

Additionally all applicants should prepare a thorough background information form to include all residence addresses used, all names used, and any convictions of either misdemeanors or felonies. As long as the above requisite information is in place, a thorough background investigation can be conducted not only more efficiently but with greater accuracy.

Knowing the counties in which someone has resided in is key to a through criminal history check. And knowing all convictions will give you a complete picture of the applicant. Potential felonies are frequently pled down to a misdemeanor; without knowing the totality of the convictions, important historical information about your applicant may never be known.

Applicants will do most anything to land a job in today’s economy and those already employed may succumb to temptation to fraudulent activities if they are financially stressed. The application must be fine tuned to ask all the questions an employer would want to know, and ask them in a detailed fashion so the applicant is unable to provide vague answers. Education questions should include not only the name of the school but also the city, state, hours earned, name used while in school (important for females) and honors achieved.

The more information that is requested, the more information that can be validated.

Best Practices for D&O Background Checks: Ongoing Risk Management Tool

Background checks are an important risk-management tool not just for the applicants but for current employees as well, performed on a periodic basis. Not only is it embarrassing when a high-ranking officer turns out to have a criminal past, there may be legal consequences as well.

Employers have a duty to protect their employees, customers, clients, and visitors from harm caused by employees. If a reasonably diligent reference check and background investigation would have revealed that the applicant lied, is unfit for the position, or may be a threat to others, then the employer’s failure to investigate with reasonable diligence may result in the employer being held legally liable to an injured party.

Best Practices for D&O Background Checks: Due Diligence

Due diligence in validating information involves a thorough investigation. Several areas are typically examined, as identified below.

Reference Checking

Reference checking, a critical component of the hiring process, is complicated by potential legal ramifications. Prospective employers need to obtain as much information as possible with respect to potential new hires, including detailed checks of their references.

When the position to be filled has significant visibility, involves a high degree of trust, or involves interacting with the public or other important constituents, the use of a professional who specializes in interviewing is highly recommended.

Interviewing

Interviewing is a skill that is only achieved through experience and training. A trained interviewer can often detect deception, ruses and other schemes used by an applicant to corroborate false information. This can include individuals used as references when in fact they had no working relationship with the applicant but are a friend or friend for hire in disguise.

Tough times put applicants under stressful conditions, causing some to do almost anything to land a job, including falsifying references or work history.

Educational Credentials

Educational credentials are commonly misrepresented on job applications and résumés. Accordingly, all claims with respect to education (including such things as degrees earned, honors conferred, and rank in class) must be verified. Where authorship of published works has been claimed, such claims should be verified and the works checked for evidence of plagiarism.

Best Practices for D&O Background Checks: Red Flags

Certain issues should raise red flags. A degree from an unaccredited institution or a “diploma mill” is one red flag. Various agencies, including those authorized by the U.S. Department of Education’s Council for Higher Education Accreditation, can provide assistance.

Schools rarely lose student records. Thus, any claim that the records cannot be found should be checked with the institution. Claims by a candidate that his school is “out of business” should be verified with the Department of Education (DOE) of the state in which the school allegedly operated. DOE should be able to verify that the school existed, when it closed, and also should be able to direct the investigator to the custodian of that school’s student records.

Embezzlement can occur at any level of an organization.  Even mid-level employees with financial problems can succumb to the pressures and commit fraud. Of course, this could be damaging for an employee who handles funds or is in a position of trust or responsibility. Obtaining financial background information on all candidates and on board employees periodically is essential.

Best Practices for D&O Background Checks: Fraud Investigations

During the fact finding process of conducting a background investigation of a current employee the process may quickly turn into suspicion of fraud, thereby changing the dynamics of the next steps.

As always, advice of counsel should be sought if allegations of fraud are discovered during the due diligence process, especially if one has little or no experience in conducting a fraud investigation. Many due diligence investigations do not start out with the expectation of discovering fraud so it is important to be prepared should this occur.

First and foremost is the need to keep employees safe. Second in importance is to obtain the needed evidence to either support the fact a fraud has occurred or to dispel any doubt. As more fraud schemes are being uncovered in declining economies, it is important to be aware of how not only to protect one’s business but to protect one’s employees from harm.

Although violence in white collar crime matters may not occur often, it has happened. The increased frequency and severity of such violence is getting increased media attention. Statistics point to the fact that often the perpetrator directs the violence at whomever he or she feels is responsible for disciplining them.  We need to recognize the signs of discord that should raise our concern.

Best Practices for D&O Background Checks: Conducting Due Diligence Interviews

Interviewing is important in due diligence investigations.

Preparation is key to a successful interview, be it once a fraud is suspected or perhaps during a routine background investigation. Consider the following safeguards to reduce risks in the interviewing process and to better protect not only the interviewer but the employees as a whole. These safeguards should be applied to all interviewees, whether they are witnesses, references or the final interview of the applicant or employee suspected of wrongdoing:

1. Notify someone as to the name of interviewee as well as exact interview location, include time of interview and expected time of return
2. Attempt at all possible to conduct interviews with a partner. This partner can take notes, and more importantly will act as a witness so as to reduce the likelihood of false accusations.
3. Conduct interviews in public places if at all possible, view the situation with caution should the venue be a home or non public place. Consider an interview in a government building (i.e.  courthouse, federal or state building) as this may offer screening devices to detect firearms and other weapons.
4. Avoid disclosing personal information about yourself during an interview as word may travel eventually to a person you would not want to have this information.

Preparing in advance for potential dangers in an interview may be the difference between valuable information obtained and a dangerous incident. If fraud is uncovered, a consultation with legal counsel will direct the next steps, be it a criminal referral and/or a termination.

Summary

Newly proposed SEC regulations as well as the struggling economy are highlighting the need for increasing disclosure as well as thorough background investigations of applicants and on-board employees.

A thorough investigation could reveal indicators of actions that might result in financial loss or legal liability to the employer.  In order to mitigate these risks, organizations should perform detailed background checks of potential new hires; applicants of every level and on-board employees should be scrutinized more than ever before.

It is not enough to simply run an applicant through a screening service that validates the name and key identifiers of the applicant. We must do more.

The economy we find ourselves in forces us to not only demand more information from our applicants and employees but to analyze the information received like never before. These checks should be performed by trained professionals who not only have the tools at their disposal but have the experience to provide the most information about an applicant in the least amount of time and with caution and safety in mind.

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ABOUT THE AUTHOR

Theresa B. Mack is a Senior Manager with Cendrowski Corporate Advisors, LLC, with offices in Chicago, IL and Bloomfield Hills, MI.  Background investigations, fraud investigations and asset searching are her specialty. She is a frequent writer on fraud topics and emerging issues and has over 22 years of investigative experience with the Federal Bureau of Investigation, having directed all aspects of operations and investigations of financial crimes. Ms. Mack can be contacted via e-mail at tbm [at] cendsel [dot] com or by phone at 866.717.1607.

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Footnotes

1. 1. See http://www.sec.gov/rules/proposed/2009/33-9052.pdf

Tags: background checks, best practices, board of directors, CCA Advisors, due diligence, executive officers, fraud investigations, interviewing, sec, Theresa Mack