Top supply chain accountability risk trends for 2016

April 2016  |  SPECIAL REPORT: MANAGING RISK

Financier Worldwide Magazine

April 2016 Issue

April 2016 Issue


The Collins online dictionary defines the phrase “name and shame” as “to reveal the identity of a person or organization guilty of illegal or unacceptable behaviour in order to embarrass them into not repeating the offence”. This concept underlies an expanding set of legal requirements obligating businesses to investigate and publicly disclose aspects of their supply chains related to particular corporate social responsibility concerns. At present, these concerns are focused on human trafficking and slave labour as well as ‘conflict minerals’, four common metals that are being sold to finance warlord-sponsored violence in central Africa.

Public disclosure is the ‘naming’ part of the scheme. The ‘shame’ part comes not from failure to obey the law, but rather from public opprobrium following an acknowledgment that a company’s product is tainted by slave labour or the presence of conflict minerals. This negative impact on brand and competitive position is the real business risk that proponents of these programmes are counting on to motivate corporate behaviour. Executives charged with reducing corporate risk must place a high priority on understanding and managing these proliferating disclosure regimes.

Within the past year, human trafficking and conflict minerals disclosure obligations have expanded both geographically and dimensionally. The following provides a summary of key developments and issues that require high-level attention this year.

In the area of human trafficking and slavery, recent months have seen a significant uptick in activity related to the California Transparency in Supply Chains Act of 2010 and related initiatives. This law, which went into effect in 2012, directs companies that have $100m in annual gross receipts worldwide and manufacture or sell products in California to disclose on their websites what steps they have taken to eliminate human trafficking and slavery in their supply chains. California’s Attorney General has yet to institute enforcement actions, but in April 2015 issued a Resource Guide to assist businesses in complying with the Act’s requirements, perhaps in recognition of underwhelming results. That implication is supported by a November 2015 report published by Development International, an international non-profit group that has also compiled rankings on conflict minerals reporting performance. The report identified only six companies (of 1504) that had top scores and shone a spotlight on many others with a variety of deficiencies. The report’s appendices provide a rich source of benchmarking comparisons that should be carefully reviewed by market participants.

Marketplace optics are not the only concern, however. In August and September 2015, private plaintiffs filed six class action suits in California federal courts against several major companies, claiming misrepresentations or material omissions in California Supply Chains Act disclosures or other corporate statements. The complaints alleged violations of California consumer fraud and unfair competition laws, citing evidence of the companies’ reliance on forced labour in Thailand or West Africa in manufacturing cat food and chocolate products. The cases are currently pending and those based on allegedly false statements in product marketing or labelling could be actionable under other states’ anti-fraud and competition laws as well.

Interest in this issue is not confined to the US. Last year, the United Kingdom enacted the Modern Slavery Act of 2015, which went into effect in October 2015. The Modern Slavery Act applies very broadly to commercial organisations (including foreign corporations) with a global annual turnover of £36m that do any amount of business in the UK. Businesses subject to the Act’s reporting obligations will have to publish a slavery and human trafficking statement for each financial year identifying the actions they have taken to identify and eradicate the use of forced labour in their supply chains.

Comparable legislation has been introduced in the US Congress (H.R. 3226 and S. 1968), but is not expected to pass, notwithstanding a statement in support submitted by more than 100 investors representing US and international public pension funds, unions, faith institutions, and socially responsible asset management funds. As in other areas in which a gridlocked US Congress has not acted, however, the Obama Administration has moved to fill perceived gaps with executive action. In a final rule released in January 2015, the Department of Defense and two other federal agencies amended the Federal Acquisition Regulation (FAR) to impose new requirements on government contractors and subcontractors relating to human trafficking. Under the new rule, companies securing government contracts must certify that, after conducting due diligence, they and their suppliers are not engaged in any human trafficking. Questions remain as to what degree of diligence is sufficient to satisfy this obligation.

In addition to supply chain transparency regarding human trafficking and slavery, businesses must also deal with required disclosures under conflict minerals reporting programmes. Despite ongoing litigation, which is expected to go to the US Supreme Court to clarify exactly what businesses must say in their filings, reports for the third year of the Securities and Exchange Commission’s (SEC) conflict minerals rule are due 31 May 2016. Companies continue to struggle with the rule’s supply chain accountability expectations, although every year a few more are able to declare their products ‘conflict free’, which requires undergoing an independent private sector audit. Costs are considerable; one recent study estimated compliance costs per reporting company at $500,000 in the 2013-14 filing cycle. And, as with human trafficking disclosures, ranking groups have zeroed in on individual corporate performance, offering up poor ratings for businesses that lag behind their competitors. At least one major company has suffered embarrassing demonstrations at its annual shareholder meeting and protest campaigns in the media for perceived insensitivity to conflict minerals concerns.

Meanwhile, the European Union is finalising its plans for a counterpart conflict minerals regime, which is expected to be completed later in 2016, potentially affecting 880,000 downstream firms. The EU legislation is aimed more broadly than the US version, encompassing conflict anywhere in the world as opposed to the US law’s focus on nine central African countries.

As if these concerns were not worry enough, companies must also prepare against risks that supply chain tracing may uncover problems in other sensitive areas, like anti-bribery laws such as the Foreign Corrupt Practice Act and UK Bribery Act and sanctions administered by the US Treasury. In the course of conflict minerals diligence, for example, more than one major international company discovered that its supply chain included forbidden stocks of gold sourced from North Korea, an offence subject to criminal penalties.

There is every reason to expect continued growth in supply chain accountability name and shame schemes. These programmes pose serious business risks for corporations, not only from a compliance standpoint but perhaps even more urgently in terms of reputational and competitive risk. Watchdog consumer and investor groups are actively monitoring corporate supply chain disclosures, and businesses can expect heavy pressure from downstream commercial customers demanding information and credible assurances to meet their own transparency obligations.

For corporate executives facing these challenges, the most critical needs include a coordinated internal compliance system with effective risk management elements that are integrated with external reporting and audit functions. Businesses that are able to outperform their peers in this demanding, evolving environment have a golden opportunity to exploit a competitive advantage in the marketplace.

 

Jane C. Luxton is a partner at Clark Hill PLC. She can be contacted on +1 (202) 572 8674 or by email: jluxton@clarkhill.com.

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