Definitions

due care

Due diligence

Due Diligence is a term used for a number of concepts involving either the performance of an investigation of a business or person, or the performance of an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for acquisition.

Origin of the term "Due Diligence"

The term "Due Diligence" first came into common use as a result of the US Securities Act of 1933.

The US Securities Act included a defense referred to in the Act as the "Due Diligence" defense which could be used by broker-dealers when accused of inadequate disclosure to investors of material information with respect to the purchase of securities.

So long as broker-dealers conducted a "Due Diligence" investigation into the company whose equity they were selling, and disclosed to the investor what they found, they would not be held liable for nondisclosure of information that was not discovered in the process of that investigation.

The entire broker-dealer community quickly institutionalized, as a standard practice, the conducting of due diligence investigations of any stock offerings in which they involved themselves.

Originally the term was limited to public offerings of equity investments, but over time it has come to be associated with investigations of private mergers and acquisitions as well. The term has slowly been adapted for use in other situations.

Due diligence in business transactions

In business transactions, the due diligence process varies for different types of companies. The relevant areas of concern may include the financial, legal, labor, tax, IT, environment and market/commercial situation of the company. Other areas include intellectual property, real and personal property, insurance and liability coverage, debt instrument review, employee benefits and labor matters, immigration, and international transactions.

Consider the somewhat related business terms of malfeasance and nonfeasance. The American Heritage Dictionary defines these terms as follows: malfeasance is misconduct or wrongdoing esp. by a public official. Nonfeasance is a failure to perform an official duty or legal requirement. Furthermore the term misfeasance means to perform a duty or responsibility inadequately or poorly.

Due diligence for hedge funds

An insight in-detail review of a hedge fund's activity in order to ensure ultimately that the fund is in compliance with its prospectus. It is a roadmap for a potential investor in understanding whether a specific fund will meet his/her investment horizon, Risk tolerance and investment strategy. and for an existing investor; a roadmap as to whether a fund has performed the way it claimed it would. In a non exhaustive list the due diligence will look into:

  • A Fund snapshot
  • Disclosed Investment Strategy
  • Historical returns
  • Assets under Management (A copy of the funds portfolio from the custodian is usually requested)
  • Audited Financial statements if the Fund is SEC regulated
  • Fund's terms and Details
  • Regulatory registration if any.
  • Risk Factors
  • Valuation

Every investor is going to have different investment horizons and risk tolerance, as well as a strategy preference. It thus follows that there is no "best" hedge fund, but a fund that closer matches investors preferences. An investor should almost always:

  • Request consultation from a professional,
  • Read the fund's prospectus or offering memorandum
  • Understand how a fund's assets are valued
  • Understand how fees are charged
  • Understand any limitations towards the redemption of shares
  • Research the backgrounds of hedge fund managers

As a concept in civil litigation

Due diligence in civil litigation (also known as due care) is the effort made by an ordinarily prudent or reasonable party to avoid harm to another party. Failure to make this effort may be considered negligence. This is conceptually distinct from investigative due diligence, involving a general obligation to meet a standard of behavior. Quite often a contract will specify that a party is required to provide due diligence.'''

It is not correct to confuse due care and due diligence. Due care should be spelled out in full as duty of care. It is a legal concept by itself. Duty of care may be very wide, far reaching, and also a grey area subject to argument. Basically, parents owe their infant a duty of care in everything. As the infant grows to be a child, to be an adolescent, an adult, the duty of care and its scope become less and less. Fundamentally, a duty of care is a moral duty to care. When legal acknowledgment is extended to this moral obligation, then this duty becomes a legal requirement. Inversely, the legislature sets the duty in the statute. Then we consider this duty as legal and amoral ["a-", without, not having to consider the moral aspect].

When read carefully, care is the passive mode; diligence is the active mode.

First the duty of care (due care) arises, making it a requirement. In order to fulfill this duty, due diligence is exercised. The flow may be continuous, but these two concepts are different. When due diligence is called for, then there will be a set of demands to be complied with, depending on the context. For example, before a surgery, what should be done and who should be present in the theater? After the surgery, what must be done to the patient, equipment, facilities?

As a matter of independent inquiry, whether by a court of law or professional body, the line of investigation is: (1) Is there a duty of care? How is this duty of care imputed? (Previous case law, statute, new case) (2) If the duty of care exists, what are the applicable standards? In other words, what due diligence (and the components that go to make it a comprehensive due diligence) is required?

The last issue is always considered in light of specific circumstances of the case. If brain surgery is involved, the standards are those required of competent brain surgeons. If deep sea welding is involved, the standards are those required of competent deep sea welders. In an auction of a Picasso, due diligence standard must be comparable with an international auctioneer to authenticate an art object. In the sale of a diamond, due diligence may be necessary from human rights and political aspects. As such, expert opinions are often considered.

For supplier quality engineering

Due diligence is a term used for a number of concepts involving either the performance of source inspection or source surveillance, or the performance of quality duties such as PVA (Process Validation Assessment) or System Audits with a certain standard of care.

Due diligence in Supplier Quality (also known as due care) is the effort made by an SQE professional to validate conformance of product provided by the seller to the purchaser. Failure to make this effort may be considered negligence. This is conceptually distinct from investigative due diligence, involving a general obligation to identify true, root cause for non-compliance to meet a standard or contract requirement.

As a criminal defense

In criminal law, due diligence is the only available defense to a crime that is one of strict liability (i.e. a crime that only requires an actus reus and no mens rea). Once the criminal offense is proven, the defendant must prove on the balance of probabilities that they did everything possible to prevent the act from happening. It is not enough that they took the normal standard of care in their industry - they must show that they took every reasonable precaution.

Environmental due diligence

Environmental due diligence during commercial real estate transactions can include Phase I and Phase II Environmental site assessments. Such assessments are often undertaken in the United States to avoid liability under the Comprehensive Environmental Response, Compensation, and Liability Act, commonly referred to as the "Superfund law".

Information security due diligence

Information security due diligence is often undertaken during the information technology procurement process to ensure risks are known and managed, and during mergers and acquisitions due diligence reviews to identify and assess the business risks.

See also

References

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