The Due Diligence Defense

Over the last year and a half, federal, state and local governments have opened a myriad of investigations focusing on hedge funds, fund of funds and other financial institutions, trying to ascertain the causes of the economic downturn. These investigations have resulted in numerous criminal charges for negligence and fraud.

Additionally, courts have held that the members of the board of directors of a corporation who recommend a merger to shareholders or members can beheld personally and individually responsible if adverse results occur from the merger, if the board members had failed to closely examine the merger partners in advance.

Interfor Inc. has been involved in several of these investigations and based upon its 30 years of experience is of the opinion that this is only the beginning of an avalanche of investigations to be launched.

However, organizations can proactively prepare for increased government scrutiny and investigations, avoid criminal fraud charges, create deniability and reduce culpability by undertaking the proper due diligence process of investigations. See, Federal Sentencing Guidelines, Section 8 (b) (2), Due diligence in this case is an insurance policy for each governing board involved in the merger.

Proper due diligence activity can also provide underwriters with a complete defense under Sections 11 and 12 of the Securities Act. See, For example, the underwriters for bankrupt WorldCom’s 2000 and 2001 debt offerings paid more than $6 billion dollars to settle Security Act claims after being denied summary judgment on the due diligence defense in court. The court rejected the underwriters argument that they should have been able to rely on WorldCom’s audited financial statements without further investigation unless there was “clear and direct” notice of accounting problems. The court held that there were several red flags in the financial statements and that it was the responsibility of the underwriters to do their own investigation. Even independently audited financial statements did not protect the underwriter from liability.

Nonprofits can also establish deniability if faced with criminal allegations involving bad investments, if they can prove that they had done proper due diligence.

For more information about due diligence or the due diligence services offered by my company, Interfor, please visit

The Due Diligence Defense

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