Small cap and closely held companies represent excellent vehicles for money laundering, drug distribution networks and more dangerous opportunities for dangerous people.
Few companies have an eye on the potentiality for takeover and infiltration by subversive/mob interests, or are represented by counsel, or have access to security facilities, capable of addressing these issues. In the main, the scenarios by which adverse infiltration would/can/will take place are not novel. It is just that now criminal organizations are much more aggressive, and the environment is target rich. Think of it as a tender offer where the attacking company uses a gun instead of a Williams Act filing.
What would constitute sufficient critical mass which, if controlled by nefarious interests, would have the potentiality to grasp control of the company?
If a company is profitable and has a valuable ‘franchise’, it is a target in itself for that value. Depending upon its financial statement, it may be in a position to leverage far beyond anything ever considered by current management. That is an infiltration invitation in itself, just as low debt companies were in the instance of hostile tender offers. The interest of the infiltrator is in the fund borrowed, not in paying it back. Repayment is simply not in the cards. It is hit and run.
Even if a company is not very profitable and not highly leverageable, its distribution network may be a real plum for the distribution of drugs and other contraband and for money laundering.
The bottom line here is that normal diligence is not sufficient to deal with the threat. System misuse infiltration is potentially detectable if you know what to watch for and have in place the appropriate protocols to enable you to stop it.
The red light here is greatly brightened by the impact of technology upon ‘white collar’ and organized crime. The advent of the Russian mafia heralds an enormous escalation in the toughness of the element you are dealing with.
Patterns of conduct may emerge which, if noted, tell you when something like this may be afoot. To be sure, there are one size fits all signals, but in each company and in each system there can and should be customizing of the list of things to watch for. Most of these things have potential to be benign, and further examination is called for to determine whether what is being observed is an invasion.
Similarly, patterns of management conduct frequently are telltale signs of infiltration. Key personnel can become compromised. Management personnel can and will be targeted specifically for the nature of their function in the company and/or specifically for their human weaknesses. This is frequently a two front attack, at the system level as well as management level. The presumed identities and affiliations of those with whom you deal, internally and vendors, can change or become compromised on very short notice and totally without bubbles on the surface, especially if you aren’t looking and don’t know where to look in the first place.
We live in an age where the assumptions that gave us comfort in the past frequently prove to be untrue or unreliable. Sixty years ago we worried about submarines off our coastlines. Thirty years ago we watched the skies and our early warning went down to twenty minutes. Today we worry about threats that are already here and ready to be used to our extreme detriment. There is an infiltration and takeover of business threat that is equally as insidious. It may have been put in place already over several months or years without the company having the slightest clue. The parallels between military threat to our nation and infiltration threat to our companies are compelling for the reason that they are identical in the suddenness of onset and the potentially devastating impact. Just as FEMA could never evacuate New York City in any emergency, companies lay stretched before infiltrators with serious capabilities, unprotected and without easy possibility of resurrection in a real case scenario.
They can be out to get you even if you are paranoid.
When the traditional lawyer thinks of the menu of events that would be found if he knew how to do the due diligence to find it in the first place, he immediately thinks of the RICO statute in the United States, that legislative construct originally aimed at the Mafia. That is what the statute was conceived to deal with. However, as it has been so misused by the litigating bar, seeking to apply it to every business pattern mistake that can happen in any commercial setting, that the courts have severely circumscribed its application. It is now more difficult than ever to use the RICO statute in a private civil litigation setting. Moreover, the entry onto the scene by competent trial counsel would have had to be far in advance of the normal retention mode for trial counsel. Normally, trial counsel is summoned at the moment of battle.
In this scenario, creative approaches to evidence must already have been in place as the normal modus vivendi of the target business, so that the absence or reluctance of witnesses may be remedied by records of regularly performed activity that are kept in the normal course of the target company’s business may be used as exceptions to the hearsay evidentiary rule. Without that advance planning, proofs may be quite difficult to come by. That is another reason why infiltration defenses need to be thought of as something done far in advance, just as poison pill articles and by-laws have been used to thwart tender offer activity.
Other statutory schemes should be screened for usefulness, especially the securities regulation laws if the company is publicly held. Securities regulation rules governing manipulation and proxy information may well be applicable to conduct not customarily thought of in this context. Economic espionage statutes may also provide jurisdictional and substantive opportunities.
State law claims should not be ignored here, but it is important that litigation of these issues occur in Federal court. The issues are complicated and not likely to be familiar to elected state court judges who frequently lack time and resources to deal with multi-issue business cases and lots of legal research. It will usually be harder to get to meaningful relief in a state court than in Federal court in this kind of case. State law claims should be thought of mainly as pendant jurisdiction issues.
Arbitration clauses in franchise and other agreements need to be revisited to prevent them from being obstacles to relief when relief is most needed. Current practice arbitration clause drafting does not usually answer the issues.
In any normal case evaluation, the need to depend upon third party witnesses who have no dog in the fight reduces the prospects for success. In many instances, third party witnesses actually have an interest in the truth of the matter not coming to light. Illustratively, if a manufacturer of hospital diagnostic or surgical equipment had engaged in nefarious conduct, hospital personnel could be excellent witnesses to the conduct and to its detrimental effects. However, to do so could expose the hospital and its doctors to liability for malpractice arising from their knowing application of the dangerous instrumentalities to the treatment of their patients. Thus, obtaining this testimony would be quite difficult to say the least. There are many other illustrations of this evidentiary problem in many different settings.
In the context of this article, one would assume that witnesses were either hostile or that they have been compromised through inducement or threat. Admissible documentary evidence must be already in hand to fill this testamentary void. It will have to be part of an extant business records system when the suspicion of infiltration first arises. It will have to be part of the long-term records management protocols. In these days of electronic data management, file boxes of paper need not clog warehouses. The generation and management of the requisite data is greatly facilitated, but a careful eye must be focused upon the preservation and integrity of the data for reasons of reliability under the new evidentiary rules for electronically generated and preserved evidence.
It must be recognized that this project is multi disciplinary. Lawyers alone cannot complete the job properly. Accountancy types and investigators will be working in tandem with and under the direct supervision of the lawyers, especially if any qualified privileges of attorney work product are to be preserved. To be sure, the data itself will not be privileged, but the management of the effort should be considered a confidential endeavor in every sense of the word.
A good trial lawyer can teach an accountant to become forensic without compromising the integrity of the work. It is not a matter of coaching toward a specific result. If the result is compelled by the data, that would be unnecessary. If the desired result is not compelled by the data, the witness will be destroyed on cross-examination by a competent opposing trial counsel. The job is to teach the accountant to testify truthfully and as an effective communicator. Judges and jurors will quickly tune out the boring accountancy witness, despite the high quality of the data. The lawyer must have a good understanding of the data as well. The lawyer must lead the accountancy projects, not simply turn over a vague and generally described project to accountants and expect them to produce good data. Their discipline teaches them to do many things that are simply evidentiary ‘noise’. They need to be schooled to eliminate the noise without compromising the professionalism of the product, and the lawyer must be able to be the professor.
Similarly, the use of investigators is an effort that must be controlled by counsel. Typical notions of competent investigator resources are frequently off the mark in this kind of case. Lawyers who use investigators in their work are mostly specialists in catching the errant spouse flagrante in delicto at some tryst, and specialists in surveilling disability claimants to catch them climbing ladders, cutting down trees and fixing their roof. Assumptions that former FBI agents or former police department detectives will know what to do once you tell them what you are looking for are not reliable. These too must be schooled to achieve investigative focus and to eliminate ‘noise’. Here again, the lawyer must know what to do in order to instruct the investigative resource what to do, and, with equal importance, what not to do.
When you believe you have uncovered something that could smack of infiltration, the issue of remediation arises.
Notions of touchy-feely, fair dealing and second chance to screw up, which are the typical approach may need to be re-examined. Omelets are not made without cracking eggs. Weak people and relationships are natural targets for predacious elements. In this day and age, you are potentially dealing with compromised dealers who, if not terminated, will get your company name in the paper next time in an article dealing with drugs and prostitution. Provisions in agreements that permit multiple defaults before summary termination is available should be revisited. They may need to be tightened up to provide intensified visitation and supervisory interim remedies, notwithstanding that a default is cured when notice is given. Slow broom opportunities need to be eliminated. Delayed access to information needs to be a summary termination trigger in itself. A ‘right to hack’ provision is appropriate in certain agreements. It allows you to get at information clandestinely, before it is compromised upon receipt of a notice of audit letter.
Large customers are natural targets for infiltration. Their ownership profiles may indicate areas of exploitability. Executives with reputations for aggressive celebratory tendencies and womanizing are easy prey for the syndicate to compromise and control. Indiscretion is the hallmark of the infiltration pigeon, and lavish ostentation is a neon sign invitation. There are often such people in every successful company, and they need to be considered as potential weak links and dealt with accordingly. The tendency of management to accept rides in their private jets, and to participate in their lavish ‘events’ as their guests should be re-examined with an eye to how evidence of such camaraderie will play out later before a jury. Infiltrators will usually attempt to use the compromised guest(s) as a cat’s paw for the furtherance of their agendas. When one thinks, for example, of how much revenue potential is accounted for by control of purchasing discretion, the obvious temptation should not be overlooked.
Where there is suspicion of potentially compromised management conduct, the most obvious mandate is that suspected personnel should not be made aware of any concern or decision to investigate. It may eventuate that the situation is not some organized crime infiltration, but merely a friend or relative of one or more executives being placed in a position to exploit the relationship. It is important to deal with this, to be sure, but it may well be easier to deal with if it is identified as such and it appears that it is not a true organized crime infiltration agenda. On the other hand, people who are exploiting executive relationships are themselves targets of organized crime, for obvious reasons. Usurping those relationship opportunities are major goals of the criminal influence. Immediacy of action is important. The operational integrity of the company and of the system is as degraded by inappropriate executive opportunism as it may be by criminal infiltration, and the one frequently leads to the other.
The selection of the lead counsel for this kind of project is extremely sensitive. A company’s customary counsel, even if experientially qualified, may be so involved in the general governance of the affairs of the company that its being in charge of this kind of project may compromise relationships and duties of long standing confidence that have preserved their usefulness to the company over the years. This is, in most cases, special event work that should be delegated to a firm that has no other potentially impacted relationships within the company. That counsel should also be able to recommend appropriate protocols for how much information about the project and its progress is shared, how often, and with whom.
These are traumatic events in any company, and they should be dealt with decisively and with appropriate sensitivity to the wide range of interests and issues they may impact.