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Background checks: Proceed with caution

High profile events of the last few years, including the corporate accounting scandals and September 11, have forever changed the US business landscape. One important change is that employers are seeking to learn more about the backgrounds of applicants and employees. This is equally true of private equity investors, which are increasingly insisting on background checks for management teams as part of their due diligence, according to Adam Forman and Robert Kilroy of Testa, Hurwitz & Thibeault.

In attempting to meet these concerns, employers increasingly have been requesting background checks on both applicants and current employees. Moreover, private equity investors as well as strategic vendors, such as auditors, have also begun insisting on background checks for management teams as part of their due diligence before providing financing or services. When properly conducted, background checks provide a valuable source of information for use in employment-related and investment decision-making. Employers and private equity investors using such investigative techniques, however, must ensure that they comply with the Fair Credit Reporting Act ("FCRA") and any state law counterparts.

The Fair Credit Reporting Act. The FCRA imposes notice, consent and reporting obligations upon an employer who requests reports on applicants or current employees from a consumer reporting agency. There are two types of reports that an employer may seek - "Consumer Reports" and "Investigative Consumer Reports." Consumer Reports include information bearing on the individual's creditworthiness, character, general reputation, personal characteristics or mode of living. Investigative Consumer Reports include the same type of information found in Consumer Reports, but the information is gained through personal interviews with neighbours, friends, associates or others with whom the individual is acquainted, as well as publicly-available sources. In other words, Consumer Reports are background checks based on a search of records, and Investigative Consumer Reports include both a records search and interviews of people who may possess relevant information about the applicant/employee.

Notably, the FCRA only applies to instances in which the Consumer Reports and Investigative Consumer Reports are produced by a "consumer reporting agency." Thus, an employer that conducts its own reference checks is not subject to the FCRA. Likewise, an employer conducting an Internet search for publicly available information on an applicant/employee is not subject to the FCRA. If, however, an employer relies on a reference checking or investigatory agency for this type of information, the employer will be subject to the FCRA's requirements.

Obtaining a Consumer Report. Before requesting a Consumer Report on an applicant/employee from a consumer reporting agency, the employer must provide the applicant/employee with a stand-alone document which clearly discloses that a Consumer Report may be obtained for employment purposes and obtains the applicant's/employee's written authorization. This authorization should be maintained in the employee's personnel file.

Obtaining an Investigative Consumer Report. Before requesting an Investigative Consumer Report, the employer must (1) comply with the requirements for obtaining a Consumer Report and (2) disclose to the applicant/employee in writing that an Investigative Consumer Report may be made; that the applicant/employee has a right to a complete disclosure of the nature and scope of the investigation requested; and that the applicant/employee has a right to a written summary of his rights under the FCRA.

If the applicant/employee exercises these rights, the employer must provide this information within five days from receipt of the request or the date the Investigative Consumer Report was requested, whichever is later. The disclosure of the nature and scope of the investigation will differ depending on each applicant/employee, and therefore must be done on a case-by-case basis. The summary of rights under the FCRA, however, is a standard document, entitled "A Summary of Your Rights Under the Fair Credit Reporting Act."

Taking Adverse Action Based on a Report. If an employer relies, even in part, upon a Consumer Report or Investigative Consumer Report when taking adverse action against an applicant/employee (e.g., decision not to hire, denial of promotion, discharge of employee), the employer, prior to taking the action, must provide the applicant/employee with a "pre-adverse action disclosure" that includes a copy of the individual's report and the summary of rights document described above.

After taking the adverse action, the employer must make certain additional disclosures to the applicant/employee, including notice of the adverse action taken; the name, address, and telephone number of the consumer reporting agency that made the report; and notice of the individual's right to dispute with the consumer reporting agency the accuracy or completeness of any information the agency furnished. The two-step procedure contemplated by the FCRA - a pre-adverse action disclosure and then the additional disclosures - is often unwieldy. As a practical matter, an employer can meet these requirements by consolidating the process and all of the required information into a single disclosure prior to taking the adverse action.

Pre-Investment Due Diligence. Obligations under the FCRA may be triggered outside of the employment context. For example, a private equity firm that wants to obtain Consumer Reports or Investigative Consumer Reports for founders or management of a company prior to making an investment also may have obligations under the FCRA. The FCRA does not specifically address the obligations of potential investors in this circumstance. In the absence of definitive guidelines, private equity investors are well advised to comply with the consent and disclosure obligations applicable to employers under the FCRA in connection with investment-related background checks. Of course, private equity firms also must comply with the FCRA when doing background checks on the firm's own employees.

Penalties. Failure to comply with the requirements of the FCRA can result in civil liability in the form of actual damages sustained by the applicant/employee, punitive damages (in the case of wilful non-compliance), and imposition of costs and attorneys' fees. Additionally, it is a felony to procure a Consumer Report under false pretences. If convicted, the person who knowingly and wilfully obtained the information is subject to a fine, imprisonment for up to two years, or both.

Conclusion. Background checks are an increasingly important part of employers' hiring processes and investors' due diligence investigations. However, it is important for employers and investors to comply with FCRA obligations in the course of obtaining this useful background information.

This article is reproduced with permission of Testa, Hurwitz & Thibeault, LLP. For more information about Testa, Hurwitz & Thibeault, LLP, please contact www.tht.com

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