SACRS BREAKOUT SESSION Seven Ways to Avoid the Due Diligence Pitfalls Presented by Joseph J. Tabacco, Jr. Berman DeValerio

I. ESTABLISH A DUE DILIGENCE BUDGET –The size of the investment dictates size of the budget. –Undertake due diligence only on a selected basis. –The goals of due diligence are: (1) comprehend the investment, especially if it is a high reward/high risk; (2) understand the investment environments; (3) carefully review due diligence by any investment advisors recommending the investments.

II. THE 5-MINUTE RULE –Be wary when everything you are told about an investment is provided in less than 5 minutes. –Ask yourself if you have a clear understanding of the investment fundamentals: how it generates its revenues/income, key expenses, principal risks, key competitors and prospects. –If it seems too good to be true, it probably is.

III. LEADERSHIP STARTS AT THE TOP  Research Top Management – Determine Whether They Have Been Subject To: –SEC or grand jury investigations in the past 10 years; –Significant prior civil cases, including securities fraud, antitrust and trade-secret violations; –General reputation, references, specific industry experience.

IV. IDENTIFY KEY ACCOUNTING ISSUES –(1) Get help to thoroughly vet the financials –(2) Check revenue recognition policies –(3) Look for overstated assets/understated liabilities –(4) Question intangibles such as goodwill –(5) Check estimates or reserves –(6) Is the investment the type prone to accounting fraud

V. FAIRNESS OPINIONS: FAIR TO WHOM? –Healthy skepticism. –Begin with the assumption that the Fairness Opinion is fair only to those who have approved it and paid for it. –Pay special attention to the underlying assumptions used in the model to generate the Fairness Opinion in tender offers.

VI. CAUTION: THIRD PARTY RATING –The financial meltdown of 2008 demonstrated that due diligence is not satisfied simply by relying on ratings. –The rating agencies that failed to properly rate the subprime lenders, banks, and other financial companies were rife with conflicts of interest and the practice of “ratings shopping” was pervasive (The New York Times, April 27, 2008).

VII. BE PROACTIVE: WHAT CAN INSTITUTIONAL INVESTORS DO? –Don’t rely on traditional “assurances,” such as ratings, fairness opinions and analyst reports. The days of allowing the fox to guard the henhouse have past. –Dig deep into the investment’s fundamentals to probe the basis for your financial advisors’ recommendations. –Talk to other investors and third parties.

SUMMARY –(1) Establish a due diligence budget –(2) Remember the 5-minute rule –(3) Leadership starts at the top –(4) Identify key accounting issues –(5) Be skeptical of Fairness Opinions –(6) Caution: third party rating –(7) Be proactive