Risk Management

Stopping Supply Chain Slavery

Governments are cracking down on the use of slave labor in supply chains. Companies risk their reputations if they don’t find the practice on their own and end it.
By: | October 1, 2016 • 7 min read

Modern day slavery is alive and well.

And with large food companies such as Nestle, Archer Daniels Midland Co. and Cargill under legal fire for selling products that were allegedly made in part by slave labor (often unpaid child labor), it’s critical that all companies know the score throughout their ever-expanding global supply chains.

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In the latest example of the U.S. government attempting to stop — or at least greatly reduce — modern slavery, U.S. Customs and Border Protection seized low-calorie sweetener stevia imported from China by PureCircle Ltd. The plant extract is used to sweeten Coca-Cola Life, Pepsi True and other soft drinks. The U.S. alleged that PureCircle sourced the Stevia rebaudiana plant (from which the sweetener is extracted) from a company accused of using forced labor, Reuters reported in early June.

It’s the third time the U.S. has cracked down using a new law that bans imports of products made by forced labor. The importer had three months to prove its innocence, according to Reuters.

There is growing pressure on risk managers to have a much more focused approach to supply chain management, said Andrew Boutros, a former U.S. attorney and partner in the Chicago office of Seyfarth Shaw.

“It really comes down to compliance professionals making judgment calls,” he said. “Compliance often is viewed as a cost center, so companies spend their dollars on the highest litigation risks. But as these new statutes become more enforced, there will be more attention paid to them.”

“It’s very hard to verify with confidence that [a product component] … made its way to the U.S. without slavery, corruption, bribery, falsification, etc.,”  – Andrew Boutros, partner, Seyfarth Shaw

Boutros said determining if there is a slave labor component in the supply chain is more often than not an incredibly complex endeavor.

Andrew Boutros, partner, Seyfarth Shaw

Andrew Boutros, partner, Seyfarth Shaw

“Imagine being able to know with a high degree of confidence if the beans in your coffee were collected using forced labor,” he said. “And that’s just coffee. What about parts in computers or tech gadgets? Or minerals and certain metals? Or the fishing industry?

“It’s very hard to verify with confidence that it made its way to the U.S. without slavery, corruption, bribery, falsification, etc.,” he said.

The scope of modern day slavery is devastating.

According to the Walk Free Foundation’s Global Slavery Index 2016, there are about 45.8 million people working as slaves globally, with 58 percent in India, China, Pakistan, Bangladesh and Uzbekistan. That number includes sex trafficking, which would not be part of supply chain data.

For example, as of 2014, the United Nations estimated 21 million slave labor victims worldwide. Also, a 2014 report from the UN’s International Labor Organization (ILO) estimates that $150 billion in illegal profits are made in the private economy each year through modern slavery.

Modern slavery and forced labor is not as openly or frequently mitigated as other regulatory supply chain risks — such as foreign corrupt practices or conflict minerals, according to Kris Hutton, head of product management at ACL, a Vancouver, B.C.-based global compliance and audit software firm and consultancy.

“Slavery is a much more diverse, complex issue to govern, monitor, detect and regulate.”  — Kris Hutton, head of product management, ACL

And that’s a primary reason why major Western nations like the U.S. and the United Kingdom only recently enacted anti-slavery legislation (2015 in the U.S.), unlike the Foreign Corrupt Practices Act (FCPA) enacted in 1977.

“Based on maturity of legislation alone, jurisdictional regulators, such as the Department of Justice in the U.S., are far more likely to issue punitive fines against abuses of FCPA and Dodd Frank than those of anti-slavery regulations,” Hutton said.

Kris Hutton, head of product management, ACL

Kris Hutton, head of product management, ACL

This focus will change in the future, due to pressure from external social forces — such as consumer protests.

Modern slavery is also much more difficult to detect compared to other crimes, he said.

Corruption involving an electronic trail of payment or expense, for example, can be monitored by the organization and the regulator. Modern slavery, however, has to do with the conditions surrounding the workforce, which often rely more on qualitative evidence such as interviews and observation than documentation.

“Slavery is a much more diverse, complex issue to govern, monitor, detect and regulate,” Hutton said.

Finally, modern slavery carries a more serious social stigma compared to either corruption or conflict minerals.  Many companies look the other way to avoid having to act on the knowledge.

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Hutton expects this will start to change with more social awareness and increased regulatory enforcement; one thing that will drive organizational behavior is a combination of monetary and reputational damage that influences consumers and investors.

“Companies are responsible not only for their own integrity and ethics, but also for acts of their third-party suppliers,” said Scott Lane, CEO at The Red Flag Group, an independent corporate governance and compliance firm in Tempe, Ariz.

“A company that uses suppliers engaged in actions such as forced migrant or child labor, or human trafficking, could sustain significant fines and reputational damage,” he said.

Lane cited the example of Nestlé, which revealed late last year that poor workers from developing countries such as Thailand, Myanmar and Cambodia often ended up trapped in illegal and brutal working conditions as part of the company’s supply chain.

“A company that uses suppliers engaged in actions such as forced migrant or child labor, or human trafficking, could sustain significant fines and reputational damage.”  — Scott Lane, CEO, The Red Flag Group

He added that modern laws place an obligation on companies to assess whether or not it is happening, or could happen, in their supply chain. And if the answer is yes, is it being taken care of?

Finally, they need to report how they are doing in that process.

Scott Lane, CEO, The Red Flag Group

Scott Lane, CEO, The Red Flag Group

“These laws are creating an obligation on companies to do these things,” Lane said. “It’s less about the risk of fines and litigation and more about the reputational damage to the extent you don’t do anything once you find it.”

“It’s safe to say there is not a single company in the world within the Fortune 1000 that knowingly wants to violate these laws,” says Jeff Hunter, a partner in PricewaterhouseCoopers’ U.S. risk assurance services practice.

“With the expansiveness of today’s supply chain, there are much deeper ways to monitor and surveil third-party suppliers,” he said. “In the past, there was word of mouth, trust and the transparency of how they did business before. But that is changing, and the lead companies will have to look deeper into their supply chains.”

Some proactive steps

There are three critical areas that need to be addressed within organizations looking to reduce supply chain risks connected with slave labor, ACL’s Hutton said.

First, organizational leadership and the board need to make it part of their corporate mandate and be committed to educating, training and building awareness.

“One concrete way this is done is by including anti-slavery culture into the Code of Conduct — create policy and training for procurement professionals and enforce it,” he said.

Next is including prevention and detection controls in the supply chain vetting process, not just internally using vendor pre-approval, but by extending the obligations and awareness of the anti-slavery mandate to all vendors.

“Insist on supply chain traceability,” he said. “Make the key indicators of slavery highly visible — age and mobility of the workforce, fair wages (absent of fees or indentures) and working hours, and humane treatment to name a few.”

Point-scoring systems can be created where certain criteria would raise a red flag — such as vendors located in known conflict regions.

Finally, invest in auditing, monitoring and/or investigative measures — hold procurement and risk professionals accountable internally and hold vendors equally accountable.

Provide a whistleblower hotline so grievances can be reported.

As for data, Hutton said, the best angle is to create preventive controls that use a scoring model to indicate a higher risk for slavery. For instance, when a procurement professional wants to buy from a new vendor, the vendor has to be approved.

“If it is in a region that is in an emerging market or is a conflict region, the score should reflect that higher risk,” he said.

It’s still too early to tell if the new laws will have a positive impact on reducing the world’s slave labor market, Hutton said.

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On the one hand, there is much more social awareness and pressure for ethically and socially responsible corporate behavior.

On the other, the global supply chain is complex and it’s not an easy problem to solve by just running a data analytic monitoring program.
“It’s going to take time and it’s going to take pressure from regulators with punitive enforcement around the globe,” he said. “From that perspective, it’s early in the transformation to socially responsible outsourcing and procurement.”

According to Seyfarth Shaw’s Boutros, risk managers should always look for one key indicator when it comes to supply chain purchasing.

“If the price is too good to be true, there probably is a reason for it,” he said. “It’s not necessarily always a red flag, but it certainly needs to be investigated.” &

Tom Starner is a freelance business writer and editor. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Cyber Liability

Fresh Worries for Boards of Directors

New cyber security regulations increase exposure for directors and officers at financial institutions.
By: | June 1, 2017 • 6 min read

Boards of directors could face a fresh wave of directors and officers (D&O) claims following the introduction of tough new cybersecurity rules for financial institutions by The New York State Department of Financial Services (DFS).

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Prompted by recent high profile cyber attacks on JPMorgan Chase, Sony, Target, and others, the state regulations are the first of their kind and went into effect on March 1.

The new rules require banks, insurers and other financial institutions to establish an enterprise-wide cybersecurity program and adopt a written policy that must be reviewed by the board and approved by a senior officer annually.

The regulation also requires the more than 3,000 financial services firms operating in the state to appoint a chief information security officer to oversee the program, to report possible breaches within 72 hours, and to ensure that third-party vendors meet the new standards.

Companies will have until September 1 to comply with most of the new requirements, and beginning February 15, 2018, they will have to submit an annual certification of compliance.

The responsibility for cybersecurity will now fall squarely on the board and senior management actively overseeing the entity’s overall program. Some experts fear that the D&O insurance market is far from prepared to absorb this risk.

“The new rules could raise compliance risks for financial institutions and, in turn, premiums and loss potential for D&O insurance underwriters,” warned Fitch Ratings in a statement. “If management and directors of financial institutions that experience future cyber incidents are subsequently found to be noncompliant with the New York regulations, then they will be more exposed to litigation that would be covered under professional liability policies.”

D&O Challenge

Judy Selby, managing director in BDO Consulting’s technology advisory services practice, said that while many directors and officers rely on a CISO to deal with cybersecurity, under the new rules the buck stops with the board.

“The common refrain I hear from directors and officers is ‘we have a great IT guy or CIO,’ and while it’s important to have them in place, as the board, they are ultimately responsible for cybersecurity oversight,” she said.

William Kelly, senior vice president, underwriting, Argo Pro

William Kelly, senior vice president, underwriting at Argo Pro, said that unknown cyber threats, untested policy language and developing case laws would all make it more difficult for the D&O market to respond accurately to any such new claims.

“Insurers will need to account for the increased exposures presented by these new regulations and charge appropriately for such added exposure,” he said.

Going forward, said Larry Hamilton, partner at Mayer Brown, D&O underwriters also need to scrutinize a company’s compliance with the regulations.

“To the extent that this risk was not adequately taken into account in the first place in the underwriting of in-force D&O policies, there could be unanticipated additional exposure for the D&O insurers,” he said.

Michelle Lopilato, Hub International’s director of cyber and technology solutions, added that some carriers may offer more coverage, while others may pull back.

“How the markets react will evolve as we see how involved the department becomes in investigating and fining financial institutions for noncompliance and its result on the balance sheet and dividends,” she said.

Christopher Keegan, senior managing director at Beecher Carlson, said that by setting a benchmark, the new rules would make it easier for claimants to make a case that the company had been negligent.

“If stock prices drop, then this makes it easier for class action lawyers to make their cases in D&O situations,” he said. “As a result, D&O carriers may see an uptick in cases against their insureds and an easier path for plaintiffs to show that the company did not meet its duty of care.”

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One area that regulators and plaintiffs might seize upon is the certification compliance requirement, according to Rob Yellen, executive vice president, D&O and fiduciary liability product leader, FINEX at Willis Towers Watson.

“A mere inaccuracy in a certification could result in criminal enforcement, in which case it would then become a boardroom issue,” he said.

A big grey area, however, said Shiraz Saeed, national practice leader for cyber risk at Starr Companies, is determining if a violation is a cyber or management liability issue in the first place.

“The complication arises when a company only has D&O coverage, but it doesn’t have a cyber policy and then they have to try and push all the claims down the D&O route, irrespective of their nature,” he said.

“Insurers, on their part, will need to account for the increased exposures presented by these new regulations and charge appropriately for such added exposure.” — William Kelly, senior vice president, underwriting, Argo Pro

Jim McCue, managing director at Aon’s financial services group, said many small and mid-size businesses may struggle to comply with the new rules in time.

“It’s going to be a steep learning curve and a lot of work in terms of preparedness and the implementation of a highly detailed cyber security program, risk assessment and response plan, all by September 2017,” he said.

The new regulation also has the potential to impact third parties including accounting, law, IT and even maintenance and repair firms who have access to a company’s information systems and personal data, said Keegan.

“That can include everyone from IT vendors to the people who maintain the building’s air conditioning,” he said.

New Models

Others have followed New York’s lead, with similar regulations being considered across federal, state and non-governmental regulators.

The National Association of Insurance Commissioners’ Cyber-security Taskforce has proposed an insurance data security model law that establishes exclusive standards for data security and investigation, and notification of a breach of data security for insurance providers.

Once enacted, each state would be free to adopt the new law, however, “our main concern is if regulators in different states start to adopt different standards from each other,” said Alex Hageli, director, personal lines policy at the Property Casualty Insurers Association of America.

“It would only serve to make compliance harder, increase the cost of burden on companies, and at the end of the day it doesn’t really help anybody.”

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Richard Morris, partner at law firm Herrick, Feinstein LLP, said companies need to review their current cybersecurity program with their chief technology officer or IT provider.

“Companies should assess whether their current technology budget is adequate and consider what investments will be required in 2017 to keep up with regulatory and market expectations,” he said. “They should also review and assess the adequacy of insurance policies with respect to coverages, deductibles and other limitations.”

Adam Hamm, former NAIC chair and MD of Protiviti’s risk and compliance practice, added: “With New York’s new cyber regulation, this is a sea change from where we were a couple of years ago and it’s soon going to become the new norm for regulating cyber security.” &

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at [email protected]