Diligent

What Is Diligent?

In finance and business, "diligent" refers to the careful, thorough, and persistent attention required in carrying out duties and responsibilities. It is a fundamental concept within corporate governance and is closely associated with the legal and ethical obligations of individuals in positions of trust, such as members of a board of directors or financial professionals. Being diligent implies acting with the care that an ordinarily prudent person would exercise under similar circumstances, ensuring that decisions are well-informed and in the best interests of the entity and its shareholders and other stakeholders.

History and Origin

The concept of acting diligently has deep roots in legal frameworks, particularly within common law traditions that established principles of fiduciary duty. Historically, the duty of care, which encompasses diligence, emerged from courts' efforts to define the responsibilities and liabilities of corporate directors and officers. These individuals were seen as fiduciaries, obligated to act with fidelity and reasonable diligence. Early English cases from the mid-18th century characterized directors as agents and trustees, thereby subjecting them to a duty of care.¹³, ¹⁴ Over time, this evolved into the modern understanding that directors must exercise the care an "ordinarily prudent person in a like position under similar circumstances" would, a standard adopted by many jurisdictions.¹¹, ¹²

Key Takeaways

• Being diligent in a financial context means acting with careful, thorough, and persistent attention to duties.
• It is a core component of the duty of care for corporate directors, officers, and financial professionals.
• Diligence requires making informed decisions, often involving sufficient inquiry and deliberation.
• A lack of diligence can lead to significant financial, legal, and reputational consequences for individuals and organizations.
• Regulatory bodies emphasize the importance of diligent practices in ensuring market integrity and investor protection.

Interpreting the Diligent Standard

The interpretation of what constitutes diligent conduct is highly contextual, depending on the specific role, industry, and circumstances. For a board of directors, being diligent means actively participating in meetings, questioning management, staying informed about the company's business and financial performance, and overseeing risk management and compliance functions. It doesn't require infallibility or perfect foresight, but rather a good faith effort to gather and assess relevant information before making decisions. The standard focuses on the process of decision-making, not merely the outcome. For financial advisors, it means thoroughly understanding a client's financial situation and goals before recommending investments, which falls under the broader umbrella of due diligence.

Hypothetical Example

Consider the board of directors of "Tech Innovations Inc." (TII), a publicly traded company. A proposal is brought before the board to approve a major acquisition of a smaller, rapidly growing software firm. To act diligently, the board members do not simply vote based on a brief presentation. Instead, they:

1. Request detailed financial projections and analyses from management.
2. Engage independent financial advisors to conduct their own valuations and provide an objective opinion.
3. Review the target company's legal history, intellectual property, and existing contracts.
4. Question management extensively on potential synergies, integration risks, and post-acquisition operational challenges.
5. Hold multiple meetings to discuss the pros and cons, allowing sufficient time for deliberation.

Through this thorough process, the TII board demonstrates its diligence in evaluating the significant transaction, even if the acquisition's ultimate success cannot be guaranteed. This process-oriented approach, focusing on gathering information and deliberating, is key to fulfilling their obligations.

Practical Applications

The requirement for diligent conduct is embedded in various aspects of finance and business:

• Corporate Governance: Directors and officers have a fiduciary duty to act diligently in managing a company's affairs. This includes overseeing strategy, financial reporting, and the effectiveness of internal controls. The G20/OECD Principles of Corporate Governance, an international standard, emphasize the responsibilities of the board, including ensuring effective oversight and promoting transparency.⁹, ¹⁰
• Regulatory Compliance: Financial institutions and professionals are subject to stringent regulations that mandate diligent supervision of their operations and employees. For example, FINRA Rule 3110 requires member firms to establish and maintain a system to diligently supervise the activities of their associated persons, ensuring compliance with applicable securities laws and regulations.⁶, ⁷, ⁸ This rule mandates written supervisory procedures and regular internal inspections to ensure that firms effectively monitor their business and personnel.⁴, ⁵
• Investment Management: Portfolio managers and analysts must conduct diligent research and analysis before making investment decisions for clients or funds. This involves understanding underlying assets, market conditions, and potential risks.
• Mergers & Acquisitions (M&A): Buyers are expected to perform extensive due diligence on target companies to uncover potential liabilities, assess financial health, and verify information presented by the seller.

Limitations and Criticisms

While diligence is a cornerstone of responsible financial conduct, its application can face challenges. One limitation is the "information asymmetry" where directors or external parties may not have access to all critical information, especially if management intentionally conceals facts. Another challenge lies in defining the precise level of diligence required, particularly in fast-moving markets or complex transactions. The "perfect hindsight" bias can also make it easy to criticize past decisions as lacking diligence, even if they were made reasonably at the time.

A notable example of a significant lapse in diligence leading to corporate failure is the case of Theranos. The company's board of directors faced criticism for allegedly failing to implement adequate oversight and monitoring systems, particularly concerning regulatory compliance for a blood testing company that misrepresented its technology.², ³ This highlights that even highly credentialed individuals can fall short if accountability mechanisms are weak or if they are deprived of fundamental information.¹ Critics argue that in such cases, the board's lack of independent inquiry and reliance solely on management's assertions represented a critical failure of their diligent duty.

Diligent vs. Prudent

While often used interchangeably, "diligent" and "prudent" carry slightly different connotations in finance.

• Diligent: Emphasizes the action of being careful, thorough, and persistent in performing a task or duty. It relates to the effort and process involved in gathering information, conducting research, and making inquiries.
• Prudent: Refers more to the quality of being wise, cautious, and exercising good judgment. It implies acting with foresight and conservatism, avoiding undue risks.

A diligent person will gather all necessary information to make an informed decision. A prudent person will then use that information to make a wise and cautious choice. One can be diligent in researching an investment but not prudent if they then invest heavily in a highly speculative venture. Conversely, a prudent person relies on the output of diligent inquiry. Both are essential for sound financial decision-making and are often considered components of ethical conduct in financial roles.

FAQs

What is the primary purpose of being diligent in finance?

The primary purpose is to ensure that individuals in positions of trust, such as corporate executives or financial advisors, make informed and responsible decisions that are in the best interests of the company, its investors, or clients. It underpins sound corporate governance and helps mitigate risk.

Can individuals be held liable for a lack of diligence?

Yes, individuals, particularly corporate directors and officers, can be held liable for a lack of diligence if their conduct falls below the established standard of care and results in harm to the entity. This often involves a breach of their fiduciary duty. The specific standard for liability, such as "gross negligence," varies by jurisdiction, and the business judgment rule often protects directors acting in good faith.

How does diligence apply to everyday investors?

For everyday investors, diligence translates to conducting thorough research before making investment decisions, understanding the risks involved, and not relying solely on tips or hype. It also means actively monitoring their investments and rebalancing their portfolio as needed. This personal due diligence is crucial for managing personal finances effectively.