due diligence

How To Ruin Due Diligence

due diligence.jpgThe inquiry into what the banks knew about the structured credit products they built from mortgages has begun to show signs of moral panic and paranoia. Already we’re seeing the typical result: really bad, radical ideas being put forth as sensible, or even obvious reforms.
Take the proposal coming from some securities industry specialists to make public the due-diligence reports provided to banks by independent diligence specialist. “We need to…improve the due-diligence process by standardizing it and by disclosing” the results to ratings agencies and investors, said Rod Dubitsky, head of asset-backed securities research at Credit Suisse Group, told the Wall Street Journal.
We now know that more information does not equal transparency—it often simply muddies things further. Even worse, knowledge that diligence reports will be seen by investors will create incentives for banks and diligence companies to conspire to produce clean reports. A public diligence report would very likely be less diligent than one that can be kept private.
This is not an abstract fear. The pressure to clean up reports already exists for fear of litigation. Everyone who has done this kind of work knows that there are certain things you save for the conference call, the contents of which are far harder to subpoena, request through discovery or conclude. One bank we worked with—in our lives before DealBreaker—regularly requested that no records be kept from diligence and all reports be delivered verbally.
Destroying due diligence won’t save it.