Part I of this interview appeared in the November issue of The Metropolitan Corporate Counsel and Part II in December. In Part III, the interviewees continue their analysis of the following hypothetical:
Ultimate Factory (UF) was hired by the Greatest Agency of Global Sourcing (GAGS), the external sourcing agent for Supremo Brands (SB), a small toy and electronic games manufacturer in the United States with global aspirations and an upcoming initial public offering. UF is manufacturing SB's electronic game "Zapped," which features a sophisticated remote control technology, which is a knock-off of a patented system. The game's exterior packaging bears prominent checkmark-like logos that rest on top of the words "Just Win It."
UF's workers work a hundred hours a week, or more in peak season, which lasts nine months each year. UF's workers' hours keep increasing because SB keeps changing its product designs and deadlines. UF has visible cracks in its walls and its foundation. UF's workers are migrants from remote provinces, but they are not paid the current minimum wage, or for the overtime hours they work.
UF also has been using a subcontractor, Uh My (UM), in Mongolia, to fill GAGS' orders on SB's behalf, and it followed all of UF's working practices. UF, however, did not indicate that UM actually made the Zapped units on the shipping documents or bills of lading that accompany them to SB's consolidation center in Toronto, from which they are shipped to a U.S. distribution center in Vidalia, Georgia. Finally, while many of the Zapped controllers malfunction, the problem is promptly resolved by T. Engineer, who is an Iranian national employed by SB, who can fix anything because of his knowledge of sophisticated remote control systems. Mr. Engineer, however, is exhausted by his frequent trips from China, where he gives production line workers training and instructions on how to build the products, to Toronto and Vidalia.
Editor: This requires a lot of damage control. What is the international law group's role in pre-disaster strategizing with a client?
Morgan: One of the things that I routinely counsel clients on is the need for IP clearance early on in the research and development stage of any new product. If the product includes technology, presumably the people working on its development are knowledgeable in their field, but they need to be aware of the other technologies in that field and whether they are patented. In addition, there should be internal oversight on such things as prior art searches: if the company is proposing to come out with something new, it is necessary to determine whether it is protectable, and a prior art search will indicate whether you are infringing someone else's rights and whether you are able to develop and license the product.
With respect to trademarks, clearance work is necessary on a worldwide basis. Much of what I do these days concerns the Internet. Many companies, desiring to operate globally, run into infringement issues by virtue of being on the Internet and selling globally. That entails altering their websites to be in compliance with local laws in other countries.
Levine: Oversight concerning CSR (Corporate Social Responsibility) issues is likely to overlap areas that Marian and Betty will address from their vantage points, and it reinforces the need for consistent advice across the respective practice areas. No one cares about your brand as much as you do, or has as much to lose if something goes wrong. Companies have to assess periodically the following: Do you have the right CSR standards for your suppliers? Does your supplier auditing program have the right elements to meet current challenges? Do you have personnel with the right skill- and mind-sets and the will to effectively analyze audit data and to propose effective solutions to reported issues?
Before a company outsources all or part of its supply chain operations to an agent, it must weigh the benefits and risks and address the risks in related contracts. By ceding the oversight of CSR supply chain issues to these entities, the company may reduce certain expenses, but at what cost? What are the possible risks to its brand? For example, an effective CSR audit program is an invaluable tool in learning about all of the links in a product's supply chain. Skilled third-party auditors retained on behalf of a company may detect the use of unapproved production facilities and deter counterfeiting of the company's goods.
Companies also need to consider other potential risks: some buying agents are producing under their own labels the same goods produced in supply chains they now manage for their corporate customers.
Ladner: On the compliance side, much of what we do is meant to be preventative in nature. Almost always, these issues are much easier to deal with before they emerge as problems. I find it interesting to see how often employees bring certain issues up to management, only to discover that management is reluctant to act. To be sure, the issue may entail some sort of penalty, but if the proper internal controls are in place or, if not, if they are put into place as a result of the employee's actions, the issue should be taken care of for the future. Failing to address the issue makes it all the more likely that a potential problem will arise down the road. This is a sad commentary, I think, on how many companies go about evaluating the risks they face. Waiting until an issue attains crisis proportions before calling in the attorneys is not a good management practice.
One of our principal activities is educating management on the reality of the risks they face and the cost benefits associated with addressing them as soon as they are identified - through internal controls, open communication, reporting up and down the management ladder, developing a culture that is friendly to education and training, and so on. Process is important, and the compliance requirements are not going to be met if the right processes are lacking.
Editor: How do you get a company to take the necessary steps before the issue becomes a disaster situation?
Morgan: One of my mantras is that IP clearance is not merely an expense, but rather insurance for a profit center. In many cases, the brand is where the real value of the company lies. If properly developed, the company's brand may constitute IP that can be licensed and, indeed, increase brand recognition while generating revenue. Many companies with patents are very glad to license their technology to others who are willing to take the risks to develop the next generation. And there are ways to protect brand quality while the licensing activity is generating revenue.
Ladner: I agree entirely. It is important for the people in the boardroom and executive suites to understand that compliance can make money. For example, there are foreign trade zones heavily utilized by the oil and gas, chemical and automobile industries. Certain governmental programs permit a company to claim 99 percent of the duties paid on the importation of goods which are then exported. There are potentially similar opportunities in the apparel industry. Similarly, whether a company structures a transaction as a purchase at the factory door or as a FOB - Freight on Board - purchase may result in taxes. Ultimately, some portion of these supply chain initiatives may legitimately be thought of as representing a cost center, but there are ways - and not too complicated or ingenious - that link compliance enhancements to revenue-generating opportunities. It comes down to making effective use of the programs that are available.
Levine: On the CSR side, there are studies which indicate that corporations that successfully address sustainability issues may operate more profitably as a consequence of having good systems in place. That can attract investment, and it is also a key factor in attracting and retaining the kind of executive and employee talent that powers an organization.
CSR can also be perceived as a profit center in the climate change and other areas. For example, GE has a program in place which is focused on energy-saving products and services, and the effort has resulted in tremendous business growth and profits. Wal-Mart is implementing a program that requires suppliers to address environmental issues posed by the packaging materials they use. Starbucks attracts customers with worker- and environmentally-friendly products, such as its line of "Fair Trade" coffees. Finally, "organic" cotton, and "certified humane" meat products are generating significant sales, often with higher profits than their non-certified counterparts.
Ladner: Let me mention a couple of government programs which represent an opportunity for an importer to save substantial money. By joining the Customs Trade Partnership Against Terrorism, an importer realizes a considerable increase in efficiency because of its scrutiny of the supply chain process. Under the Importer Self-Assessment Program, the importer is encouraged to develop a variety of internal controls to avoid government audits. Not only is such an audit invasive, it can run into hundreds of thousands of dollars in expense, and this is seldom in the budget since no one knows when the government is going to insist on an audit. Another consideration for importers is a "business resumption continuity" plan in the case of a catastrophic incident at our nation's ports of entry.
Levine: A company that is being investigated by the government is also losing valuable executive time and expending resources on crisis-related communications. Time spent by the C.E.O., C.F.O., and General Counsel responding to an investigation or managing a crisis is time lost from managing the business. Having appropriately designed and resourced programs in place, however, means that the company should be able to address even unexpected issues with less of an interruption of its normal activities. A successful business is one that has systems in place that enable its key people to remain focused on its core business challenges, while its compliance and other systems kick in to address crises.
Editor: Is there anything you would like to add?
Levine: Even if a company has good policies in place, it is critical to involve its human resources professionals on an ongoing basis. They are in a position to map out the responsibilities and accountabilities of the workforce, and they are charged with measuring employees' performance. They also play an important role in rewarding good performance and in addressing sub-standard performance. Additionally, they are the company's knowledge and training managers. Ongoing training is needed to give life to the most robust paper policies.
Ladner: Epstein Becker & Green has always had a strong international law practice, and our international trade group is focused on those concerns that add value to our clients' operations, including cross-border compliance, regulatory planning and pre-planning through the company's supply chains, and, of course, a variety of cost minimization strategies. Let me add that the kind of compliance training which Michael refers to is something that has proven to add value to our clients' business operations.
Published January 1, 2007.
