16. Investigating the Inc.
So far we have focused primarily on individuals who have engaged in misconduct on some level. But what if you are investing in or acquiring a company? Do you need to do a background check on the company too? Yes.
If you are investing in a company, you have probably looked at the company’s balance sheet, analyzed the revenue stream, and examined other financial aspects of the company. But conducting investigative research on the company is also a critical step. Like the results from our research on management teams, the information we find about a company can also impact a deal.
Some of the issues you need to uncover include a company’s involvement in active lawsuits. If a lawsuit is active at the time of your acquisition or investment, you need to know the ramifications of the case. How much time (and money) will the company need to devote to participating in the active case? Does the case involve an issue that may impact the success of the company or its reputation, such as a patent infringement (will your target company lose its rights to market a product) and securities class action cases (will this result in sizable fines or monies owed to plaintiffs)?
When we look at a company’s involvement in lawsuits, we also focus on cases that have been closed. Does the company have a pattern of being sued and then settling out of court? This could affect your deal as the company would be spending lots of money on unnecessary legal fees. Or we look at the dates civil cases or judgments were closed or paid off to see if the company has deliberately tried to resolve all of its legal issues within a few months of seeking funding.
Regulatory issues are also common findings in our research. It is important for you to be aware if the company has been fined by any regulatory agencies and to confirm the certifications the company claims it has been awarded. All of these matters play a vital role in the company’s future and are not always brought to your attention when you are in negotiations with the company.
The Situation: Submitting to a Scam
We have all engaged in some form of online shopping. No matter the product, you know the drill: Click on the item you want to buy, go to your “shopping cart,” input your name, billing, and shipping addresses, your credit card information, review your purchase again, click “submit” (or some variation of that) and, within minutes, you receive an email confirming the details of your transaction.
What if you were unknowingly charged the second you clicked on the item? If, for example, you were looking for a book and found that Digging for Disclosure sounded interesting but wanted to read more about it before you made your purchase, you would click the icon for the book and get more details. If you were buying the book on ETricks, you would have just been charged for the book.
ETricks was a company we investigated, along with the members of the company’s management team. ETricks’ scam described here was unknown to our client, who was looking to acquire the company. We found out that the Federal Trade Commission (FTC) sued ETricks a few months prior to our client beginning negotiations with the company. The docket sheet for the federal case said it had been settled. When we ran our review of disciplinary actions filed by regulatory agencies both nationally and internationally, we found out more details.
The FTC had received complaints about ETricks, conducted its own investigation about the complaints, filed a suit against ETricks, and the matter was settled when ETricks agreed to pay a $4 million fine for engaging in the deceitful game of secretly charging its customers before they pressed the Submit button. Our client was unaware of the fines, the charges by the FTC, or the fact that the company engaged in such practices. The client decided to look for a different online opportunity.
The Tactic: Regulators Rule
We always contact regulatory agencies and other appropriate compliance departments to confirm a company has not been involved in any illicit practices. In the case of ETricks, the FTC is what helped guide our investigation. The Better Business Bureau is a quick way to check if a company has had any consumer complaints filed against it. When checking on companies that do business directly with consumers, this is a good resource.
The Occupational Safety and Health Administration (OSHA) website is also a tool we often use. OSHA ensures companies do not have hazardous workplaces or job sites and is tasked with overseeing the safety of employees. OSHA conducts routine inspections at companies and has a record of any violations a company has received, complaints filed, inspections conducted, and the results of these actions. When you look at these OSHA records, you can see if a company has been in violation of OSHA standards and whether the company has had to pay fines and/or has properly fixed the problem. Again, this affects your deal. If a company has had repeat problems and has been fined by OSHA, this could mean the company is recklessly spending money on OSHA fines and not fixing the problem, or it could end up that an employee is harmed on the job because of its shoddy conditions, and the employee sues, thus causing your company unnecessary negative publicity, embarrassment, and expensive legal fees.
When conducting inquiries on companies or individuals involved in the financial community, there are several fundamental regulatory resources that have easily searchable websites for you to access information. The Securities Exchange Commission (SEC) is responsible for overseeing the securities industry and related stock and options exchanges. The website, www.sec.gov, allows you to search to identify any companies that are registered as investment advisors with the SEC (which applies to many hedge funds). When a firm is registered as an investment adviser with the SEC, the Form ADVs (as they are called) are available for free to the public, online on the SEC website. When properly executed by the firm, these Form ADVs provide detailed information on the owners and indirect owners, the approximate amount of monies invested in the fund, affiliate funds, and any previous disciplinary actions taken against the owners or the fund, and often these documents list service providers to the firm/fund; that is, fund administrators, prime brokers, accountants, attorneys, and so on.
To determine if an individual or company is licensed as a broker, you can search the website of the Financial Industry Regulatory Authority (FINRA), formerly known as the National Association of Securities Dealers (NASD). FINRA is an independent regulatory body that oversees financial brokers and securities firms and has its own searchable website. The FINRA website allows you to search for an individual or firm to identify registrations, violations, arbitrations, and a host of additional free information available on the company or person.
Just as the SEC and FINRA are involved in overseeing the financial services industry, there are numerous state and federal regulatory agencies that are responsible for ensuring companies are in compliance with state and federal laws in almost every industry. For companies involved in banking, we check with appropriate state and federal banking departments, and similarly when checking out companies involved in the insurance industry, we contact appropriate state insurance departments to find out what is on record for the company. When we are conducting inquiries on companies that are in the food services or pharmaceutical industries, we reach out to the Food and Drug Administration (FDA) to see what is available with the FDA about the company. If we are looking into a company that has a product that affects the environment (dry cleaning companies, waste or recycling companies), we reach out to the Environmental Protection Agency (EPA) and determine if the EPA has any information about the subject company. And if we are checking out a company in communications (broadcast, radio, Internet, and so on), we contact the Federal Communications Commission (FCC) to identify any complaints filed against the company and to confirm licenses issued by the FCC.
A list of regulatory agencies we frequently use is provided in the Resource Guide, but some of these other agencies include the following:
• General Services Administration (GSA). When companies are involved in working for the government, the GSA maintains a database of companies that have been excluded from working for the government. The website, https://www.epls.gov/, allows you to search to see if any companies have been barred from working for the federal government.
• Office of Foreign Assets Control (OFAC). This is a department of the U.S. Treasury and is responsible for ensuring companies and individuals who work in foreign countries are in compliance with U.S. regulations. OFAC often works with foreign governments and is responsible for administering sanctions against the companies or individuals who are in violation of U.S. policies. Through its website, http://www.ustreas.gov/offices/enforcement/ofac/, OFAC maintains records of all sanctions it has handed down.
• United States Patent and Trademark Office. This agency keeps track of every patent and trademark filed in the United States. Companies (and individuals) frequently rely on their respective patents and trademarks as the cornerstone of business. In asset searches, we always search for patents and trademarks, as this is a form of intellectual property and has value. The department has a website, http://www.uspto.gov/, that is easily searchable and allows you to identify or confirm any patents or trademarks assigned to companies or individuals (as discussed in Chapter 15, “Show Me the Money: Asset Investigations).
These are just some of the regulatory bodies that we regularly contact to learn more about a company and to make sure the subject company is in compliance and not subject to anything that would negatively affect its ability to perform.
In previous chapters, we have discussed our search strategies and how we find former employees of a company who have given great insight into the operations of a company. These former employees are identified when we conduct research on the company. And as we have pointed out, former employees often have internal information about a company that would not otherwise be known.
We were looking into a company that was about to be acquired and found out it was ensnared in an ugly political mess because of the actions of the former CEO. The CEO had left two years before our client was looking to invest, but the issue only recently came up because of an investigation into one of these political figures. None of the current officers were involved, so had we just focused our investigation on the current management team, we would not have uncovered the problem.
There are many resources we use to make sure the company with which you are about to do business will perform accordingly. Overlooking a background check on the company can mean overlooking critical information that might impact your deal.