Organizational Risk and Third-Party Compliance: What You Need To Know - Essay Sample

Introduction

Under many legal frameworks, business organizations may be held accountable for unwarranted acts by their third parties. Many governments around the world are enacting stricter laws to ensure that organizations, as well as their third parties, remain compliant in business transactions. Whether it is a distributor, supplier, layer, accountant or an agent, contracting a third party in business can lead to significant risks, and often come with regulatory requirements. Therefore, before outsourcing, or getting into a relationship with any third party, organizations must take the relevant procedures to ensure that potential risks that may arise from such alliances are responsibly evaluated and managed. Specifically, businesses must ensure that their third parties work in accordance with their policies, protect confidential IT information, maintain ethical standards, as well as a safe and healthy working environment. In addition, companies must ensure that their third parties are compliant with government regulations, including Anti-Money laundering requirements, the Federal Trade Commission Act, the Dodd-Frank Act et cetera (Ruggie, 2008). Ideally, facilitating business growth while adhering to regulatory mandate, and fulfilling customers' needs require a robust third-party due-diligence program which includes the scope analysis, risk assessment, due diligence, and preventive actions.

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Overview of Third Party Due-Diligence

Many organizations engage in outsourcing practices as a way of saving on costs and labor, freeing up unnecessary infrastructure, to improve their competitiveness both locally and internationally, and also to focus on core business activities. However, employing third parties such as consultants or suppliers to improve business activities often come with a share of multiple risks ranging from corruption, operations to regulatory compliance (Hofmann, Schleper, & Blome, 2018).

In light of these risks, organizations are devoting tremendous resources to establishing policies and processes aimed at assessing the threats when finalizing a third party. This is because, in today's markets, conducting risk-based due diligence on third parties when outsourcing has become part of the legal requirement in many governments from all regions. Although this process is critical for businesses, it can only be done before an associate is brought on board, after which, third party management and due diligence take a back seat. However, this can be impactful as it leaves organizations exposed to third party risks, which if left unmitigated, can develop into serious issues that can affect both the reputation and the profitability of the organization. Ultimately, the business will be held accountable by customers and regulators, even if the fault is on the side of the third party.

According to Schumm, Leymann, Ma, Scheibler, and Strauch (2010), organizations must also ensure that their third parties are in compliance with multiple regulations including Conflict Minerals Reporting requirements, Anti-Money Laundering requirements, the Foreign Corrupt Practices Act, and Health Insurance Portability and Accountability Act. Even so, with limited resources, it is sometimes challenging for these organizations to effectively manage the vast network of third parties spread across geographies. Fulfilling these obligations requires organizations to implement a robust risk-based due diligence process, which can help them conduct a third party due diligence with a view of mitigating threats that might arise from their association with outside businesses. If this process is not effective, the risks associated with third parties can transform into serious threats that will eventually affect the credibility of the organizations which hired the third party. Nevertheless, many businesses continue to struggle when implementing the appropriate measures due to the high cost of compliance management, lack of visibility into due diligence as well as the vastness and the complexity of the third party network.

Conducting Third-Party Due Diligence

Understanding organizations' partners is critical in business and an essential requirement for third party due diligence. This means undertaking appropriate steps to examine and determine whether an organization, as well as its third-parties, are operating within the confines of the law. This is to make organizations feel confident with the third-parties they are dealing with. In most cases, right from the beginning, many organizations may have confidence in their relationship with a third party in a legitimate business transaction, for example, a supplier with a good reputation. In other situations, however, organizations may feel less confident with the third-parties they are conducting legitimate business with. Either way, organizations are required to be vigilant and should implement a robust third-party risk management process right from the onset of their relationships with third parties. This will enable them to examine the scope of their third parties and assess various risks that might be associated with it.

Scope of Third Parties

The initial step in conducting third-party due diligence is to examine all the third-parties associated with an organization and to determine the ones that pose threats to the company or subject to risk-based due diligence. In this step, it is critical that all the third parties associated with an organization be subjected to third-party due diligence since it is extremely difficult to know which ones pose an immediate threat. For instance, while history indicates that sales intermediaries such as distributors or agents may be more susceptible to threats than a third-parties involved in the supply, the latter can likewise pose significant threats to an organization. Even so, according to Morrison, Kinley, and Ficery (2008), not all of an organization's third parties must be subjected to risk-based due diligence. This is because many medium and large organizations tend to have numerous third-party business relationships, and many of these alliances may or may not pose any significant threats. Subjecting all these third-parties to risk-based due diligence would yield relatively little results, and might be burdensome as well as costly in terms of resources and time. For this reason, organizations must understand which third-parties pose the most consequential risks and targeting them for immediate review.

Similarly, not all the third-parties identified for a thoughtful review will require the same level of due diligence. The key to an effective third-party due diligence in business compliance is employing the right approach based on the levels of risk. This will make the process manageable for organizations and enable them to mitigate the risks associated with third-parties effectively. Organizations may also conduct the initial screening of third-parties by determining if the third party has a history of non-compliance, if the agent will perform transactions on behalf of the company, or if the third party will frequently come into contact with government officials.

Third-Party Risk Assessment

After the initial step which involves a collection of preliminary information and watchlist screening is complete, and an organization has identified third-parties to be subjected to risk-based due-diligence, the second step is to analyze the risks and identify their levels of due diligence (Taylor, Zandvliet, & Forouhar, 2009). The amount of due diligence should be based on the results of the analysis of various risks. Essentially, using key indicators such as geographic location, industry or background and identity, the assessment will be done based on whether a third-party is high-, medium- or low-risk. Organizations should use various tools to evaluate whether individual third-parties and the business relationship being reviewed pose a low, medium or high risk. Some of the valuable tools organizations can use in assessing and substantiating risk evaluations in the risk assessment process are the employees and management interviews. These discussions are valuable since they provide an in-depth view of business operations and assists organizations understand what is conventional in terms of third-party business relationships. Additionally, these conversations can also shade lights on certain risks that might have been witnessed in the past or could materialize at present.

The step of risk assessment requires good faith judgment. In many business institutions, the responsibility of conducting a risk assessment of a third-party is often given to experienced individuals managing third-party relationships. Essentially, for an effective risk assessment in an organization, it is critical that the process includes consultation with significant inputs from various experts in government regulations. This is important since the process requires not only inputs from an organization's management but also the contribution of independent experts to ensure objectivity. Although third parties are usually viewed as high-, medium- or low-risk, some may present both high-risk and low-risk factors. This means that both the high and low risks factors the third-parties portray are so great that they override other indicators.

Due Diligence

Due diligence process begins after identifying the third parties to be included in due diligence and level of risk their relationship with an organization poses in the risk assessment stage. It is conducted differently depending on the level of risk factor third-party poses. For instance, if the risk is relatively low, due diligence will likely take place within the business and consists only of database checks and internet searches. However, when dealing with both high-and medium-risk factors, a more comprehensive data collection and analysis will be conducted and may require relevant inputs from independent experts. In particular, a thorough third-party due diligence in business compliance involves data collection, verification and validation of data, and evaluation of results.

Data collection: In this process, an organization is required to assemble and document valuable information about the operations, ownership and the structure of the third-parties it is involved with. It also includes relevant data on third-parties' compliance with rules, integrity as well as their sustainability for the type of business. The process involves an internal questionnaire, external questionnaire, and internal searches.

Verification and Validation of Data: This process requires that the collected data is verified and validated. Although the collection of data happens within an organization that intends to hire a third party, the validation and verification process requires inputs from independent individuals.

Evaluation of results: After verification and validation of data by independent experts, the results need to be evaluated to determine whether or not to hire a third party. This stage will also require both the inputs of the management, which proposed the third party business relationship and a certain degree of judgment from independent experts. The judgment should also be based on red flags, which are the circumstances suggesting various risks associated with third-party relationships. Finally, organizations are required to document their due diligence efforts and also explain how they came to the decision of approving third-parties.

Preventive Actions

Once an organization has become confident with the third-party, it intends to get into a business relationship with, it needs to take mitigating measures to address various risks identified in the due diligence process. The choice of these preventive measures usually depends on the level of risks emergin...