Fraud Basics

Preventing fraud through due diligence

Due diligence is a proactive countermeasure against fraud, helping to safeguard the interests of all parties involved in a transaction. Here are some pointers in how to carry out due diligence and prevent fraud in the process.

In March 2019, former New York Lt. Gov. Brian Benjamin, at the time a state senator, asked a real estate developer to help procure a number of small-dollar contributions for his latest political campaign. Benjamin’s unnamed contact, who also led a nonprofit organization, later told investigators from the U.S. Department of Justice (DOJ) that he initially rebuffed Benjamin’s request for several reasons: He didn’t have experience “bundling political contributions” in that manner; he was focused on fundraising for his own nonprofit; and any potential donors he could target were the same ones from whom he intended to solicit contributions for the nonprofit. (See “New York Lieutenant Governor Brian Benjamin Charged With Bribery And Related Offenses,” DOJ press release, April 12, 2022.)

Benjamin was undeterred, telling the developer, “Let me see what I can do,” according to the DOJ. About three months later, New York awarded a $50,000 grant to the developer’s nonprofit, a windfall that the DOJ alleges Benjamin facilitated — with the expectation that the developer acquiesced to his request for campaign donations. The developer did just that in an alleged bribery scheme that disguised his illicit payments to Benjamin’s campaign as “donations” made in the names of unaware family members, as well as from an LLC under his control. The alleged scheme was finally exposed, according to the DOJ, when Benjamin failed to meet disclosure requirements for the LLC, the New York City Campaign Finance Board deemed some of the donations as ineligible, and a media outlet published an article questioning the legitimacy of various contributions to Benjamin’s campaign. In the fallout, Benjamin was indicted by the DOJ for bribery and related offenses and resigned his office, and we can presume that taxpayers are on the hook for the tab in Benjamin’s investigation and prosecution. (See “New York’s lieutenant governor resigns after being charged with bribery and fraud,” NPR, April 13, 2022.)

Benjamin’s case isn’t an outlier. A string of recent fraud investigations illustrates the importance of conducting due diligence, and the repercussions of failing to do so. These range from the well-publicized fraud trial of Trevor Milton, the founder of electric truck company Nikola; to the lesser-known case of the buyer of a laundry service who failed to dig deep into the business’s financials. (See “Nikola founder Trevor Milton found guilty of fraud over statements he made while CEO of the EV company,” by John Rosevear, CNBC, Autos, updated Oct. 14, 2022 and “Buyer’s failure to conduct due diligence defeats claim for misrepresentation against seller of laundry business,” by James R.G. Cook, Gardiner Roberts, Aug. 20, 2021.)

The latter is a good case in point. In 2019, Chirag Patel agreed to buy a coin laundry business in Ontario, Canada, for C$290,000 — C$100,000 upfront and the rest over time through a promissory note — after the seller told him that the business generated a gross income of C$12,000 a month. The agreement allowed Patel to cancel the transaction if he found this to be false after conducting due diligence within a certain period of time. Patel conducted some due diligence, but not enough and eventually found that the business brought in much less money than he was told. He defaulted on the promissory note and accused the seller of fraudulent misrepresentation. The courts, however, ruled in favor of the seller, rejecting Patel’s requests for further financial records as he had not sought them during the time stipulated in the contract. Lesson learned. (See “Canada Inc. v. Ontario Inc. - court file no.: CV-19-00630443,” Ontario Superior Court of Justice, June 25, 2021.)

Due diligence is an essential preemptive measure against fraud, and failing to apply it can be detrimental. Read on to learn how proper due diligence can go a long way toward preventing fraud, irrespective of the nature of a contract and whether it’s related to a mergers and acquisitions (M&A) transaction, vetting of political appointees, preemployment background or vendor screening.

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