Human Trafficking and the Link to Fraud in Supply Chains

The problem is exacerbated in developing markets, where the risk of fraud and corruption may be higher and the rule of law weaker. While regular audits of vendors is increasingly accepted as a best practice in many industries, the risk of improper payments, corruption and fraud by vendors remains high. Furthermore, with a growing demand for companies to implement sustainability practices, and a parallel emergence of related regulations, it is imperative for companies to get ahead of potential ethical risks such as forced labor, land disputes and poor working conditions within their supply chain.

In the last year, numerous headlines exposed instances of forced and child labor, land disputes and poor working conditions in the supply chains of prominent global brands, particularly those in the electronics, garment and seafood industries. Conventional approaches to due diligence and compliance are often inadequate to detect these violations, especially in increasingly complex and multijurisdictional supply chains.

Navigating the myriad regulations and compliance risks within supply chains can be a daunting task for any company, one that may be perceived as too expensive, cumbersome and difficult. However, undetected noncompliance can lead to not only potentially significant financial and legal repercussions; it can also damage a company’s reputation among clients, consumers and other key stakeholders. A well-designed approach to address risks throughout the life cycle of a vendor relationship, and increasing visibility into supply chains, can help companies mitigate against these risks and get ahead of potential problems.

Challenges in detecting fraud
Even companies with robust supply chain compliance practices face unexpected challenges in detecting and investigating fraud in emerging markets. The opaque nature of many of these markets and the increasingly sophisticated forms of unethical activity are difficult to trace. Common challenges companies face in addressing these risks within supply chains include:

• Limited visibility – Knowing your business partner or supplier is fundamental, but in many emerging markets determining the true ownership of a company, property or factory is difficult. Obtaining reliable corporate information can be challenging in jurisdictions where records may not exist or may be unreliable. This may lead to proximity to entities that are politically exposed or sanctioned or engage in disreputable activities. Kroll investigations have uncovered instances of child labor, forced labor and undisclosed subcontracting in the supply chains of companies, including those with compliance programs in place.
• Audit limitations – Many companies rely on internal or third-party compliance audits to root out fraud and noncompliance. While regular audits are essential to identifying potential issues, the overt approach and broad scope of audits can permit information gaps that may leave a company unaware of fraudulent activity and noncompliance. While audits can help identify compliance issues with a particular supplier, it is imperative to understand the network of third parties, such as brokers, recruitment agencies and other vendors, where violations are more likely to occur. This requires an audit strategy that goes beyond the proverbial factory walls and the first tier of suppliers.
• Subcontracting – The common practice of subcontracting, often undisclosed, can hamper conventional audit and compliance efforts. Hence, standards enshrined in contracts or codes of conduct may be disregarded by subcontractors and other third-party agencies that provide services or labor to a primary vendor. This is the tier of the supply chain where fraud and labor issues, such as human trafficking, are most likely to occur. Auditing all vendors and subcontractors engaged by a company is often not a realistic or practical option; however, companies can implement a strategic approach to identify and monitor high-risk vendors to ensure compliance to contracts and codes of conduct.

Emerging regulations
The emergence of regulations aimed at addressing labor violations in supply chains is a reflection of increased pressure for companies to take a proactive stance in addressing fraud and unethical activities in their supply chains. In the United States, new regulations, such as the California Transparency in Supply Chains Act, require certain companies to disclose their efforts to identify and address human trafficking within their supply chain. Similarly, the Executive Order on Strengthening Protections Against Trafficking in Persons in Federal Contracts issued by Barack Obama in 2012 directs the amendment of federal contracting regulations to contain various prohibitions and requirements for federal contracts, subcontractors and their employees that are aimed at eliminating the potential for trafficked labor in their supply chains. Similar laws are being mooted in Europe and Asia.

Companies also need to consider the secondary risks associated with unethical and noncompliant operations within supply chains. In many cases where trafficking or forced labor has surfaced, there is an associated risk of suppliers and contractors making inappropriate payments to officials, labor agencies and other agents. These payments risk violating existing anti-bribery and anti-money laundering laws, and could even lead to complicity in inadvertently supporting criminal activity such as human trafficking.

Strategic response
Detecting fraud in supply chains requires a strategic approach that leverages available tools—such as procurement data, analytics and due diligence—and comprehensive regular audits to identify and target high-risk vendors. Conducting thorough due diligence on new vendors and a periodic review of existing ones will help develop an understanding of risks that goes beyond performance to include a sophisticated understanding of a vendor’s ownership structure, connection to government officials and their relationship with subcontractors.
Kroll’s ability to undertake investigations, overt and discreet, into supply chains can reveal hidden compliance and reputational issues and help you develop a comprehensive understanding of risks throughout supply chains to avoid information gaps and illuminate areas where fraud is most likely to occur.

Learn more about fraud statistics and trends in Kroll’s annual Global Fraud Report.

This article first appeared in The Business Times (Singapore) on December 30, 2015.