It is no secret that climate policy and human rights are now at the top of the US government’s policy agenda[1]. While social and environmental responsibility and sustainability efforts have long been a routine business practice in the consumer goods supply chain, those efforts have been largely perfunctory rather than substantive and rarely, if ever, have these areas driven corporate decision making. Underscoring the change in tone on ESG matters, the Securities and Exchange Commission have recently announced their formation of an enforcement task force for ESG compliance[2], which demonstrates the seriousness of this compliance area in a company’s overall regulatory compliance efforts. Beyond the SEC’s own task force, it is also expected that the government under the Biden Administration will rely much more heavily on whistleblowers for identifying violations and initiating enforcement actions[3]. It is clear that now is the time for consumer goods companies, brand owners, and private equity funds[4] to examine your company’s or portfolio companies’ ESG compliance efforts. In this regard, there are some common and basic mistakes many companies make, which warrant further attention. Here are three of the most common:
1. Organizational Misalignment
Whether called “sustainability”, “supply chain compliance” or the like, the staff responsible for administering a company’s environmental and human rights efforts very often fall within the supply chain group or even the brand protection groups (think anti-counterfeit team) of the company. It is indeed rather unusual for these social and environmental compliance teams to sit within a compliance or legal team. This generally results in the company’s ESG efforts being marginalized at the outset. In the case of those sustainability or supply chain compliance teams that sit within the company’s supply chain organization, ESG compliance efforts clearly run contrary to the basic objectives of their superiors (i.e., the quick and efficient movement of raw materials and finished goods through manufacturing to consumption).
When ESG compliance teams sit within a company’s brand protection organization, ESG compliance efforts may not fare much better. Brand protection teams predominantly focus on anti-counterfeit and anti-piracy efforts, protecting a company’s intellectual property. For many consumer goods companies, this is the heart and soul of the company—it’s brand. ESG compliance efforts may have operational efficiencies with brand protection in the conduct of multipurpose factory and vendor audits for example, but the core objectives of ESG compliance and brand protection do not necessarily overlap at the day-to-day operational level. This results in ESG getting lip service but not often getting the management attention or dedicated efforts it deserves.
2. Underpowered Leadership
While there are some exceptions, corporate ESG compliance teams are often operationally led by relatively junior executives within the corporate hierarchy. Managers, Directors, or even Senior Directors are commonly tasked with leading a company’s ESG compliance efforts. This creates a serious deficit of influence and authority when it comes to addressing and remediating violations and red flags that may be uncovered as part of the factory and vendor audits that form the backbone of the oversight efforts in the ESG area. It also sends a message to the outside world as to the level of import with which the company treats ESG matters. Elevating this position will send the appropriate message internally and externally that ESG is indeed beyond mere lip service.
3. Lack of Real Remediation
Among the various tasks undertaken by the ESG compliance team perhaps the most significant is the coordination of factory visits and audits and the review and summarization of the reports that come out of those audits and visits. In Fact, under the California Transparency Act[5], the reporting of these efforts has become the end in and of itself. Preparing flashy summaries of audit and factory visit efforts, corporate policies, and pie charts of data derived from these efforts are dutifully posted to company’s website in compliance with California’s law. While it cannot be disputed that these factory reviews are fundamental to ensuring a socially and environmentally compliant supply chain, the reports that are the product of these efforts are perhaps the company’s biggest weakness in its ESG compliance.
In fact, most often the company’s efforts and planning in regard to ESG compliance stops at the production of the reports that come out of the factory visits and audits. Where a red flag or more significant finding is made at a key vendor’s factory, the company may not have an undisputed method with which to handle such a finding. The procurement or sourcing teams may overpower the ESG team in determining the next steps. The supply chain team, which may oversee the ESG compliance team, are likely to be operationally aligned with the procurement or sourcing teams as it relates to this key vendor. In the end, there may be escalation of reporting and negative spotlights put on the vendor but it’s unlikely anything much more substantively is done. The end result is likely to be a well-documented road map to company actions which are inconsistent with its public disclosures or statements regarding its ESG compliance efforts.
Conclusion
Some simple, if not easy, steps can be taken to address these three major weaknesses. First, consider realigning the ESG compliance team within the company’s legal department or dedicated compliance team. This will properly align the ESG efforts with those ultimately overseeing those efforts rather than internal conflicts of interest. Secondly, elevate the standing of the ESG compliance leadership. This elevation can be done directly through the executive leadership level of those appointed to carry out the ESG compliance tasks or at least indirectly through the executive leadership level of those who oversee the ESG team—i.e., the General Counsel or Chief Compliance Officer. Lastly, take more care in how findings and red flags are documented, ensure consistency in dealing with such incidences with the public statements and declarations on the company’s ESG efforts. Rather than simply provide a colorful, pie-charted road map to penalties and fines, follow-up on findings and red flags and take concrete actions on those vendors. Document the remediation efforts as carefully as the audits and findings have been documented. Increasing spend with key vendors who are consistently ESG risks is very common. There is no substitute for ensuring the company’s actions match its public statements and declarations. Lastly, the teams that perform the ESG compliance function internally often take such compliance very seriously. If their findings, red flags, and recommendations are not taken as seriously by others or if their voice within the company is drowned out, it is a recipe for creating homegrown whistleblowers. With the SEC doubling down on its enforcement in the ESG space, in line with the Biden Administration’s policy objectives, the time is now to take these efforts seriously.
[1] See, Executive Order on Tackling the Climate Crisis at Home and Abroad available at https://www.whitehouse.gov/briefing-room/statements-releases/2021/01/27/fact-sheet-president-biden-takes-executive-actions-to-tackle-the-climate-crisis-at-home-and-abroad-create-jobs-and-restore-scientific-integrity-across-federal-government/
[2] SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (https://www.sec.gov/news/press-release/2021-42)
[3] See, Michael A. Filoromo, III & Greg C. Keating, The Future of SOX Whistleblower Claims and the SEC Whistleblower Program Under the Biden Administration , presented to the 2021 Federal Labor Standards Legislation Committee American Bar Association, February 18 and 19, 202; see also, Biden’s DOJ Predicted to Up the Ante on False Claims Act Enforcement, Bloomberg Law at https://news.bloomberglaw.com/health-law-and-business/bidens-doj-predicted-to-up-the-ante-on-false-claims-act-enforcement
[4] Private equity companies have been found responsible for FCA violations of their portfolio companies. Accordingly, any SEC enforcement pursuant to ESG-related violations of a portfolio company could be expected to affect the private equity investor. See U.S. ex rel. Martino-Fleming v. S. Bay Mental Health Centers settled with Dept. of Justice. See also, Dept. o\f Justice press release: Compounding Pharmacy, Two of Its Executives, and Private Equity Firm Agree to Pay $21.36 Million to Resolve False Claims Act Allegations available at https://www.justice.gov/opa/pr/compounding-pharmacy-two-its-executives-and-private-equity-firm-agree-pay-2136-million.
[5] California Transparency in Supply Chains Act of 2010, Civil Code Section 1714.43, also known as Senate Bill 657 (Steinberg) (2009-10)