Congressman Christopher Smith, Chair of the Congressional-Executive Commission on China (CECC) earlier this week held a hearing “Factories and Fraud in the PRC: How Human Rights Violations Make Reliable Audits Impossible.” The panel of Commissioners and expert witnesses offered brutal criticisms of social audits.
Among the points in Smith’s opening statement:
“I also would like to suggest that our securities laws – in particular, our 1934 Securities Exchange Act, and Rule 10b-5 promulgated under it – be put to greater use. That rule, as people are aware, prohibits ‘any untrue statement of material fact,’ as well as any omission of material fact. As we go through annual reports and offering statements of publicly-traded corporations, we should ask whether they are disclosing to their shareholders, and potential shareholders, that their supply chains may indeed be compromised by forced labor, in violation of US law.”
An example of how social audits may directly relate to SEC regulatory jurisdiction was provided by Jim Wormington, Senior Researcher and Advocate on Corporate Accountability, Human Rights Watch. During his testimony, he described a 2023 audit of Volkswagen’s Xinjiang plant. The audit initially stated that the auditors “could not find any indications or evidence of forced labor”; however, the audit firm later admitted the audit wasn’t actually credible due to severe limitations in the audit process:
“Despite these flaws, the release of the Volkswagen audit resulted in MSCI, a financial rating agency, removing a ‘red flag’ rating for the company’s stock.”
Further, he pointed out that social audits are relied on to “assess companies against supply chain due diligence standards such as the Organisation for Economic Co-operation and Development (OECD)’s Due Diligence Guidance for Responsible Business Conduct and the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas” – the basis of determinations disclosed in conflict minerals reports filed with the US SEC.
Smith may have the right idea – and perhaps the timing is right with ESG being at the forefront of investor and materiality conversations. However, while SEC scrutiny and enforcement would go a long way to improving social auditing, it won’t fix everything – especially in settings like China (and other authoritarian regimes) or where corruption is essentially cultural. See tomorrow’s blog for more on that.
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