Impact of CSR Requirements on Supply Chain Management – Challenges and

Risks for Retailers and BrandsErik O. Autor, Esq.

PresidentAutor Global Strategies LLC

(202) 250-9580erik.autor@autor-global.com

Introduction

In today's corporate social responsibility environment, all companies, including retailers and consumer brands, face domestic and foreign government mandates at the national and local level, demands from NGOs and organized labor, public expectations, and their own industry and internal policies requiring unprecedented visibility and control over their supply chains.

Introduction (cont’d)Companies must now monitor products in their supply chains, including components and raw materials, and disclose their due diligence efforts to ensure all tiers are free from:Violations of labor rights, human rights, and

animal welfare laws, regulations, and policiesIllegal, unethical, and unsustainable

environmental practicesUnsafe working conditions

OverviewWe will review specific examples:

Conflict MineralsThe Lacey ActCalifornia Transparency in Supply Chains ActBangladesh Factory Fire and Building SafetyUzbek Cotton

Provide an update on recent developments, and

Examine the impact on companies' supply chain management and risks to brand reputation.

Conflict MineralsBackground

• On-going conflict in the eastern Democratic Republic of Congo involving armed militias and the national army, abetted by neighboring countries, has let to about 3 million deaths, mass rape of thousands of women, and enslavement and forced labor of the local population.

• Concern that militia control of the lucrative mining sector is fueling this humanitarian crisis led Congress in 2010 to pass the conflict minerals law (Dodd-Frank Wall Street Reform and Consumer Protection Act, sec. 1502) and the EU and Canada to consider similar action.

Conflict MineralsStatutory Requirements

The Conflict Minerals statute requires:

Companies that are “issuers” – i.e., file reports with the SEC under sections 13(a) or 15(d) of the Securities Act

Must disclose annually to the SEC Whether conflict minerals – Gold, Columbite-Tantalite, Cassiterite,

and Wolframite and their metal derivatives – Gold (Au), Tantalum (Ta), Tin (Sn), and Tungsten (W) [aka “G+3Ts”]

That are necessary to the functionality or production of products the issuer manufactures or contracts to manufacture

Originated in a “Covered Country” – the Democratic Republic of Congo (DRC) or bordering countries (Angola, Burundi, Central African Republic, Rwanda, South Sudan, Tanzania, Uganda, and Zambia)

Conflict Minerals Regulatory Requirements

Conflict minerals regulations require issuers:

Starting with reporting year 2013File conflict mineral disclosures, reports, and

audits with the SEC on a “Form SD” by May 30, 2014 and annually thereafter

Place Form SD and, if it must file one, conflict minerals report on its website for 1 year

Conflict MineralsChallenges and Risks

Conflict Minerals law has particular challenges: Smelters are information choke points Widespread smuggling and falsified certifications Huge difficulty and cost of collecting required

information due to existence of subject minerals: In minute quantities in products as pure metals or

alloys In thousands of product components or product-line

SKUs Question whether law at great cost is treating

(ineffectively) a symptom rather than the disease

Conflict Minerals Update

On April 14, 2014, the U.S. Court of Appeals for the DC Circuit found that the requirements in the conflict minerals law and rule that companies disclose to the SEC and on their websites that any of their products containing certain metals refined from ores that have “not been found to be conflict free,” amounts to compelled speech in violation of the First Amendment of the Constitution.

National Association of Manufacturers v. SEC, No. 13-5252 (D.C. Cir. April 14, 2014)

Conflict MineralsThe Court’s Reasoning

“The label ‘conflict free’ is a metaphor that conveys moral responsibility for the Congo war. It requires an issuer to tell consumers that its products are ethically tainted, even if they only indirectly finance armed groups. An issuer, including an issuer who condemns the atrocities in the Congo war, may disagree with that assessment of its moral responsibility. And it may covey that ‘message’ through ‘silence.’ . . . By compelling an issuer to confess blood on its hands, the statute interferes with that exercise of freedom of speech under the First Amendment.”

Id. at 20.

Conflict MineralsImplications of the Court Decision

• SEC guidance following the appeals court decision states that no company is required to describe its products as “DRC conflict free,” having “not been found to be DRC conflict free,” or “DRC conflict undeterminable.”

• The court struck down an important part of the statute and denied a motion to stay the SEC’s disclosure requirements:– Therefore, companies will still have to comply with all other

requirements, including filing their first Form SD and conflict minerals reports by the June 2, 2014, deadline, and providing details on the due diligence measures they have undertaken in their supply chains.

Conflict MineralsThe EU and Canadian Approaches

• The EU Commission proposal takes a different approach:

When subject metals or minerals enter the EU via a 'responsible importer' they are treated as conflict-free

Places the compliance burden at the point of importation, not filtered through the entire manufacturing and retail process

• Canadian private member’s bill (Conflict Minerals Act, C-486) is similar to the U.S. conflict minerals law, requiring companies to exercise and report publicly and to the government due diligence measures in extracting, processing, purchasing, trading in or use of subject minerals or contracting therefore from the African Great Lakes Region

California Transparency in Supply Chains Act - Background

Concerned about widespread instances of slavery and human trafficking in many countries, the California legislature in 2010 passed the California Transparency in Supply Chains Act to ensure the state is not inadvertently purchasing products that may have been produced with slave, forced, or child labor somewhere in the supply chain. The law went into effect on January 1, 2012.

California Transparency in Supply Chains Act - Requirements

Requires every retail seller and manufacturer doing business in California with annual worldwide revenues over $100 million to report on efforts to eradicate slavery and human trafficking from its direct supply chain

Lacey ActBackground

In response to environmental NGO and hardwood industry concerns, Congress amended the Lacey Act in 2008 to prohibit the importation or sale of any product containing illegally-harvested wood or plant material under any foreign law or regulation

Lacey ActStatutory Requirements

Importers of products containing wood or plant material must file an import declaration with USDA’s Animal and Plant Health Inspection Service (APHIS) listing genus, species, country of harvest, quantity and value of the material

Lacey ActChallenges and Risks

• Exercise of due diligence to comply with the statute does not protect importers from seizure of merchandise suspected of containing illegally-harvested wood or plant material

• Lacey could apply to products with minute quantities of or cellulosic plant material, which can be virtually impossible to trace

• Lacey could apply to products manufactured years before the law was passed

• Import declaration filing requirements are unduly burdensome and make electronic filing difficult

• Greenwashing• Due diligence standards unclear (ANSI standard?)

Lacey ActUpdate

• Two bills in the House of Representatives (H.R. 3280 & H.R. 3324), would: Preclude retroactive application of amendments prior to their May 22,

2008 effective date Replace filing of a declaration upon “importation” of each shipment

with a “declaration on demand”

• Importers also want Congress to: Limit amendments only to foreign laws directed at protection,

conservation, or management of plants or their ecosystems End application of strict liability for seizure of contraband under the civil

asset forfeiture statute to plants under the Lacey Act; provide a legal means to return seized goods to those who can demonstrate to a federal judge they exercised proper due diligence in compliance with the law

Allow a de minimis exception

BangladeshBackground

• The Nov. 2012 Tazreen factory fire outside Dhaka killed and injured over 300 people

• The April 2013 Rana factory collapse in Dhaka killed and injured over 3,600 people – the worst apparel factory disaster and one of the worst industrial accidents in history.

• Public outcry led to a quick launch by retailers and apparel brand companies of two industry initiatives – The Accord on Fire and Building Safety in Bangladesh and the Alliance for Bangladesh Worker Safety

BangladeshAccord & Alliance Commonalities

• The Center for Business and Human Rights at New York University Stern School of Business concluded that the similarities between the Accord and the Alliance outweigh the differences.

• Both initiatives share common goal of improving workplace safety for Bangladeshi workers in the ready-made garment industry and commit significant financial resources to support:Developing common standardsFactory inspections, improvements, and remediationWorker training, compensation, and representationFFC to share factory audit information

BangladeshAccord & Alliance Differences

Accord and Alliance differ mainly over governance rules and tools they emphasize to achieve common goals.

Membership – Accord 172; Alliance 26 Unions – participate on Accord board; Alliance advisory

board Financing – more focus on grants in Accord; preferential

loans in Alliance Remediation – stricter member funding commitments in

Accord; more voluntary in Alliance Enforcement – Accord rules subject to member-initiated

binding dispute settlement; Alliance financial agreement subject to board-initiated dispute settlement

BangladeshChallenges and Risks

Widespread practice of unauthorized subcontracting (forbidden in Alliance rules)

Scale and cost of the problem – 5k+ factories in BG; many unsafe factories worldwide

Lack of proper governance; infrastructureBG government & industry corruptionAnother catastrophic fire or structural failureUnion & NGO campaigns targeting companiesExiting Bangladesh not a good option

BangladeshUpdate

• Both the Accord and the Alliance making substantial progress on their action plans:

Accord 550+ out of 1500 factories inspected; Alliance 400+ out of 630 factories inspected

Alliance worker helpline pilot launched in 50 factories

• Alliance changed members’ agreement to include key Accord principle on the right of workers to refuse work in an unsafe factory without fear of retaliation

• Accord moving toward the Alliance focus on shared responsibility with Bangladeshi factory owners in remediation and worker compensation

Uzbek CottonBackground

• A legacy of the Soviet era, Uzbekistan, a major cotton producer, has used forced labor, including children, in the annual cotton harvest in violation of ILO conventions.

• In 2008, retail and apparel brand companies joined with NGOs and organized labor to pressure Uzbekistan to end government-supported forced labor in the cotton industry.

Uzbek CottonRequirements/Challenges & Risks

• Most companies have voluntarily imposed policies on suppliers banning use of Uzbek cotton

• Compliance is challenging and risks are high:Forced child labor among worst labor practicesCotton is a commodity product, sold on international

exchanges, and blended by spinners, mainly in ChinaNo reliable tracing/certification system to ensure Uzbek

cotton is not in the supply chainThe Uzbek government does little to address the

problem, and faces few consequences due to its strategic relationship with the U.S.

Uzbek CottonUpdate

• After many years of resistance, Uzbekistan finally allowed ILO monitors to conduct an assessment in Sept. and Oct. 2013 of labor conditions in the cotton industry, which found child labor is infrequent and not systemic.

• The Cotton Campaign disagreed with the ILO and asserted: “the Uzbek government again systematically forced children and adults to pick cotton and farmers to produce state-established quotas of cotton in one of the largest state sponsored systems of forced labor in the world.”

Due DiligenceOverview

• These examples demonstrate continuing trend towards increased due diligence requirements and expectations on companies

• Companies now accept greater responsibility to monitor all tiers of their supply chains for CSR compliance, including knowing:

Where their products are producedWho produces their products, and How their products are produced

Due Diligence Challenges

However, companies have several concerns:

Placing full burden on them to correct problems over which they have little control

Having to assume responsibilities that are properly those of government

Unreasonably high compliance costsUnreasonable, impossible, and overly punitive

requirements that do not advance policy goalsNo good deed goes unpunished

Due DiligenceGeneral Model

CSR due diligence typically requires companies to:Develop and publicly disclose policy on what it is doing to

respond to a CSR problemDevelop and implement a supply chain compliance program to

evaluate and address the problem, preferably using industry or international standards

Communicate expectations to suppliers and provide risk-mitigation training

Require suppliers to certify compliance with company standards and legal requirements (foreign & domestic)

Independent third-party audits of compliance program and due diligence measures

Publicly disclose supply chain due diligence practices

Due DiligenceAudits

Depending on circumstances, there are a variety of supply chain audit protocols:Compliance audits of the entire supply chain

back to the “air, water & dirt”Compliance audits only of tier one or tier two

suppliersAudits that required information is being passed

through the supply chainAudits that examine design and implementation

of a company’s due diligence measures

Due DiligenceConflict Minerals

Conflict minerals due diligence based on OECD Guidelines and EICC-GeSI template. If a company knows, has reason to know, or does not know that its conflict minerals originate in a Covered Country or are not from recycled or scrap sources, it must exercise due diligence – i.e.,:

Make a “sufficiently reasonable inquiry” into the origin of their conflict minerals;

Go beyond the reasonable country-of-origin inquiry by taking further steps to establish the truth or accuracy of relevant information;

Describe the measures taken to ascertain the source and chain of custody of their conflict minerals;

Use a nationally or internationally-recognized due diligence framework (e.g., OECD), if one is available for a particular conflict mineral

File a Conflict Minerals Report outlining its due diligence measures

Conclusion

• The world of CSR compliance is becoming ever more complicated for companies, and it is difficult to anticipate when and where the next issues will emerge (e.g., mandatory sustainability reporting)

• The best strategy is to have a flexible supply chain due diligence structure in place that can be readily adapted to a variety of situations

• As part of this strategy, the Fair Factories Clearinghouse is a good way for companies to share best practices and information