17. You, the Referee
At Corporate Resolutions, we do not think the information relayed in the background check process is the only thing that drives a deal. You are familiar with the financial aspects of the deal, the legal intricacies, and other liabilities that come into play. Sometimes we may think the information we gather will kill or rescue a deal, but we often only know a small percentage of what is going on in the locker room of the business agreement.
We have been involved in deals where we have uncovered a CEO who was arrested for grand theft, or a COO who had spent years struggling with an addiction to heroin, but the deal still goes through. Conversely, we have seen clients cancel a deal when an executive had two Driving Under the Influence charges, or a fund manager who had several outstanding tax liens. These decisions are based on your own personal judgment, your inner moral compass and, sometimes, just maybe your hunch—and we may not always agree with you.
The Situation: Fraud vs. Brothel: You Choose
At the beginning of 2009, when the markets were shaky and deal flow was pretty dry, an investment adviser was looking to invest in a hedge fund run by Clark Chance, an East Coast native who was pretty well established in the investment world. The investor had friends who had invested in Clark Chance and had seen sizable returns on their investment. Our client wanted in, but before he committed to Clark Chance, he asked us to run a background check.
We did not find any regulatory actions, civil cases, criminal matters, or bankruptcy filings for Chance, or even any companies he had not already disclosed to our client. We found many media articles that lauded Chance for his brilliant investments over the years. In the midst of the media articles, we found an article from the late 1980s with the headline: “Group of Bankers Arrested at Local Brothel.” According to the article, Clark Chance was “entertaining” a client by taking him to a brothel—on the same day that the brothel was raided by the local police. Everyone at the brothel was arrested. The incident was not found in our criminal record searches because we searched criminal records in the areas where Chance had lived and worked within the last ten years. The brothel was located in a completely different state and because we had not found Chance in that state, we had no reason to run criminal record searches there. Nonetheless, we quickly called the local courthouse and the local police and requested copies of any and all information about the matter from their archives. While we waited for the documents to arrive, we met with our client.
As we told our client, our issue was not only that Chance went to the brothel but that he had the poor judgment to bring the client. The investor disagreed. As someone familiar with the “entertaining” practices of some people in the financial community, the investor did not think Chance’s behavior was so outlandish. The investor asked us to continue with our investigation and let him know when the archived documents from the case came in.
A week later, the documents arrived, and we read more about what took place that day. The story in the arrest report was not much different from what was relayed in the media article we found. Again, the brothel incident occurred in a different state than where Chance resided. But because the incident happened almost 15 years prior and our criminal record searches typically go back seven to ten years, we decided we needed to err on the side of caution and expand the scope of our initial criminal record searches. So we reran all of our criminal record searches and searched the archived criminal records to see if Chance had been involved in any matters that were filed more than ten years ago. And, in fact, he had been.
We received a copy of an arrest report from a local police station, and according to the officer involved and the documents we reviewed, this is what went down:
Clark Chance owned two vintage cars: a green 1965 Porsche coupe and a white 1971 Mercedes-Benz convertible. He had insurance policies on both cars that reflected the high value of these automobiles. At midnight in 1987, two years before the brothel incident, Clark Chance called the police in a panic: The vintage cars were stolen! The police came to his house and took Chance’s statement, in which he said the cars were locked in his garage and someone must have broken in and taken the vehicles. Four weeks after the cars were reported stolen, a police officer was doing a routine drive-by in Chance’s neighborhood and noticed Chance’s garage door was left slightly open, and it seemed no one was home. Aware of the report of the stolen cars, the officer pulled over and approached Chance’s garage to make sure someone had not broken in again. The officer went up to the garage and saw the same two vintage cars that were reported stolen. Chance had moved the cars and reported them stolen so he could cash in on his insurance policy. Subsequently, Chance was arrested and charged with insurance fraud and obstruction of justice.
When we told our client the story, he was appalled. The brothel incident he would have overlooked, but insurance fraud was something the client found to be unacceptable. Our client did not invest in Clark Chance.
This is an example of how every client’s personal assessment of a situation dictates how an investment decision is made. Some investors might have blinders on and would have disregarded both incidents and invested with Chance because of the high returns Chance promised. Other people would have walked when they found out about the brothel. Like politics and religion, everyone has a concrete sense of how he sees the world and what is, in his eyes, “right” and “wrong.” These factors always come into play when doing business.
The Situation: Sex, Documents, and a Deal
We had another case where we found the subject was arrested for “disorderly conduct.” When we looked at the court documents, we found the person was originally arrested for soliciting prostitution, but the charges were knocked down to “disorderly conduct.” (Yes, this is the prostitution chapter.)
The documents said that the person had agreed to go to a sex addiction rehabilitation clinic and was ordered by the court to stay 200 feet away from a specific corner in the city where he was arrested. Because of the sentence the person received, it was clear that this was not his first time soliciting prostitution. Did the client do the deal? Yep. The client felt that the incident did not impact the person’s ability to perform and had faith the person had undergone rehab and deserved a second chance.
The Situation: Thieves Then; Executives Now
A private equity (PE) firm was looking to acquire a hardware company in Oregon. The PE firm asked us to check out the two brothers who founded the company: Steve and Dave Abind. The company, Abind Brothers, was small, and there was very little information available about the company. Steve and Dave Abind had spent their entire lives in the same modest town in Oregon where they were born. Their father originally started the company, and when he passed away, Steve and Dave Abind took over and started to expand the roster of items sold at the store. Steve and Dave were both married, and they each had young kids. They had both started working for Abind Brothers when they were young, and they had never worked for any other companies. While all of this seemed like a fine and simple story, the perspective changed when we learned that Steve had been arrested for stealing a pick-up truck when he was 23 years old, and Dave had been arrested for armed robbery when he was 28 years old. Both Steve and Dave had served time in a state penitentiary for their respective crimes. When we told the client about the trouble the Abind brothers had been in, the client said, “But they weren’t involved in drugs, right?”
Right. Steve and Dave Abind were not involved in drugs. The client rationalized that the brothers grew up in the type of neighborhood/family/environment where theft and robbery were not outrageous indicators of bad business acumen or an inability to run a hardware company. The client went ahead with their acquisition, and the Abinds and our client still retain a harmonious business relationship.
The Tactic: Assessing Your Appetite
Yes, we have discussed media articles before. But in the instance of Clark Chance we see how media articles navigated us to a criminal background that would not have been uncovered if we had relied solely on court record searches. It was the synthesis of conducting archived media searches, court record reviews, and contacting local authorities that led us to the actual story about Clark Chance’s past. When criminal records have been expunged, it is often media sources and interviews with industry and law enforcement sources that lead us to the existence of these cases.
We mentioned the case of the person who was originally charged with soliciting prostitution but the charges were knocked down to disorderly conduct. The information available in the court indices only provided the charges to which the person pled guilty. It was only when we requested to review the documents on file in the criminal case that we learned about the prostitution charges.
With the Abinds, we understood the client’s willingness to forgive these criminal histories and move forward with the deal. There are always extraneous circumstances that must be taken into account when making business decisions. There have been times, however, when we have repeatedly cautioned a client to reconsider the deal based on information we found. In one instance we found that a money manager had served time in federal prison for stealing money from investors, and our client did not think the information was pertinent to his deal. But the operative word is his deal. He knew the money manager’s background and said he intended to structure the deal to place certain limits on him. The client was willing to take that risk. Again, it all comes down to your comfort level.
It used to be that companies would hire us to conduct discreet background checks without the subject’s knowledge of our investigative research. Within the last few years however, between the requirements of Sarbanes-Oxley and Know Your Customer and the increases in corporate fiduciary responsibilities, most of our clients now tell the individuals up front that a background check will be conducted on them before the deal. This allows the investor to show that he/she is serious about the investment, and allows the candidate to be up front with any issues that may have happened in the past. It is now viewed as practical and wise for investors to conduct background checks, bringing them to the foreground.
In any transaction in which you are looking to become involved, you are the one to make the final call. Everyone has a different appetite for risk. We have worked with clients who deal primarily in distressed investments, or “vulture funds,” and they are aware that problems exist at the company; for them, the higher the risk, the better. No matter what type of investment you are making, however, the information that unfolds in a background check helps you know everything before moving forward. Sometimes if we do uncover negative information, this can help you restructure the terms of the deal, implement appropriate checks and balances, or simply understand what additional contingencies need to be considered. You should always investigate before you invest. The best advice we can give you is awareness: Be aware of the situation and consider all of the information you have. As they say, “Better the devil you know, than the devil you don’t.”