Published: June 16, 2008
Guest Column By Mark H. Allenbaugh
Taming the Dragon:
Ethics, Compliance and the Sino-U.S. Supply Chain
Napoleon Bonaparte famously observed that “When China awakes, the world will tremble.” Now the world’s second largest economy behind only the U.S.,1 China has finally awakened and is flexing her economic muscle.
Nowhere have the effects of her strength been made more clear than through the continuing import safety crisis. From poisoned pet food and lead-painted toys, to defective tires and most recently tainted anti-coagulant medicine, the scope of recalled products from China is breath-taking.
Indeed, according to the Consumer Product Safety Commission, “During fiscal year 2007 (October 1, 2006 – September 30, 2007), the agency announced 473 recalls. Of those, 389 (82.4%) involved imported products. 74% of those (288) were of products made in China. While the increase in imports largely explains the recent growth in the number and percentage of CPSC recalls that are of imported products, recalls overall are disproportionately represented by imports, particularly those from China.”2
This article discusses recent government efforts to address the import safety crisis and it concludes that these efforts will be insufficient unless they focus on the primary actors in the import supply-chain, specifically, China-based manufacturers and their U.S. importers. Moreover, this focus requires a paradigm shift away from exclusive reliance on third-party regulation and oversight, toward cultivating cultures of ethics and compliance within the individual actors themselves. Only through self-regulation and process improvements within individual manufacturing and importing organizations—the vast majority of which are small to mid-size entities—can the import safety crisis be effectively addressed.
U.S. Responses to the Import Safety Crisis
In reaction to this import safety crisis, last summer the President created a Cabinet-level Interagency Working Group on Import Safety tasked with developing strategies for addressing import safety concerns.3 The Working Group held a series of hearings on the crisis and released an Action Plan in November 2007 to address safety issues. The Plan contains "14 broad recommendations and 50 specific action steps" to improve import safety.
Legislation also is moving forward to improve import safety. On October 30, the Senate Commerce Committee approved the "CPSC Reform Act of 2007," S. 2045 (the house version is H.R. 4040), to "reform the Consumer Product Safety Commission to provide greater protection for children's products, to improve the screening of noncompliant consumer products, [and] to improve the effectiveness of consumer product recall programs." The bill now is in conference committee and looks likely to be enacted into law in the very near future.
While both the Action Plan and the CPSC Reform Act share the same goals and propose some of the same strategies for improving import safety, the Reform Act has met stiff resistance from the White House and, ironically, from the Consumer Product Safety Commission itself.
Unfortunately, both fall short of achieving their shared goals. The key to minimizing the number of defective and dangerous imported products that reach store shelves must focus on prevention at the source, and not just detection at some point along the extended supply chain. While detection certainly is a necessary component of any import safety program, it is by no means sufficient.
The Action Plan
Although the Action Plan purports to speak to "Prevention with Verification," the main focus is on the "[c]reation of mandatory and voluntary third-party certification programs for foreign producers that are based on product risk, to verify compliance with U.S. safety standards."
The first problem with this proposal is that there are few third-party entities competent to perform such certifications, which also would include auditing and monitoring services. In fact, during a public conference call on the day the Action Plan was released, the Working Group could not identify one such entity.
The second problem is that, presumably, these third-parties would also have to be accredited and themselves trained on the appropriate testing procedures for the plethora of products and manufacturing processes they may encounter. While testing, monitoring, and auditing firms do exist in China, many of them are relatively new or are mere trading companies -- thus placing their objectivity in question.
In all events, who would do accreditation and training of such third-party certifiers for foreign-based manufacturers? The Action Plan is silent on this important point.
Prevention at the source can best be achieved through direct training of China-based suppliers by their U.S.-based importers on internal compliance, ethics, auditing, testing and reporting programs and procedures, as well as relevant U.S. laws and regulations. In short, the importers themselves must take direct responsibility to develop strategies focused on prevention. In fact, a poll conducted last summer indicates most Americans believe that the U.S. Government, importers and consumers themselves are at least partially to blame for the import safety crisis.4
The Action Plan also discusses the development "of good importer practices" and the "[u]se of strong penalties against bad actors." While the former may in fact work toward a prevention model, certainly the latter does not, inasmuch as it is focused on deterrence and punishment.
In any event, as the Action Plan itself recognizes, "[a]lthough some members of the importing community have established and met their own best practices, the importing community does not have available Good Importer Practices focused on ensuring product safety throughout the supply chain." So, unfortunately, the suggestion that good importer practices be developed is, thus far, an empty one.
The CPSC Reform Act: A Realistic Solution?
Introduced by Senator Pryor (D-AR) and Senator Inouye (D-HI), the chairman of the Senate Commerce Committee, the CPSC Reform Act of 2007 seeks to substantially increase funding for the CPSC and to provide for more personnel to assist in monitoring the compliance of consumer products with relevant safety laws and regulations. It also seeks to significantly increase civil and criminal penalties for violations of product safety regulations. And like the Action Plan, it too calls for third-party certification of imported products.
So why would Nancy Nord, the acting chairman of the CPSC, object to this legislation?
In a letter dated October 24, 2007 to Senator Inouye, Nord noted that, despite the increased funding and allocation for additional personnel, the Act "would impose a number of substantial new missions" that would hamper the effectiveness of the agency and would otherwise be impossible to implement in the timeframe given."
For instance, the Act would provide for whistleblower protection, which Nord believes "represents a colossal and wholly unfamiliar new mission for the CPSC. . . [which] has neither the resources nor the expertise to administer such a complain and appeal system."
Furthermore, the Act would "grant state attorneys general a cause of action in federal court to effectively enforce the statutes that [the CPSC] administer[s] [and] would invite nothing short of product safety chaos."
And while Nord agrees with an increase in penalty caps, as does the Working Group, she does not agree with an increase from the present $1.825 million to the $100 million the Act proposes. Instead, she suggests an increase to only $10 million.
Finally, Nord believes the criminal penalties proposed against company officials "for mere knowledge of an act at issue. . . without the requirement that the act was done in willful violation of the law" are excessive and "a very significant departure from current law."
Likewise, Allan B. Hubbard, the former assistant to the President for economic policy and former director of the National Economic Council, has opposed the Act on the grounds that it dictates "mandatory compensation for whistleblowers between 15 and 25 percent of any civil penalty imposed."
According to Hubbard in a letter dated October 29, 2007 to Senator Inouye, this would provide "significant financial incentive[s]" to employees and others to bring "meritless claims" in hopes of being awarded up to $25 million. Such potential for "bounty hunt[ing]" could produce "an adverse impact on our economy."
Unfortunately, the criticism leveled against the Reform Act by Nord, a Bush appointee, and Hubbard has led to calls for Nord's resignation by Democratic members of Congress, including Nancy Pelosi, the Speaker of the House. Such apparent partisanship in favor of a flawed Act certainly will not help to address import safety concerns.
Since the Act has progressed to conference, it is likely that such disagreements will be resolved, but, as noted below, there still is a significant gap in providing effective resolutions to the import safety crisis.
Ethics: The Crucial Remedy
Still missing in the Action Plan and the Reform Act is any discussion of fostering internal ethics and compliance programs within foreign-based factories themselves. As China-based manufacturers continually are pressed to produce higher quality products at ever lower prices (and in an economic environment with an ever-weakening dollar and higher transportation costs), incentives for cutting corners will remain. Only internal ethics and compliance programs can effectively address and counteract those incentives.
The Working Group is right to move away from a detection-based model to one focused on prevention, intervention and response. However, the current strategies the Group has endorsed, as outlined above, either are too general to serve these aims, or do not necessarily advance a prevention-focused import safety model.
The number of U.S. importers has grown from 732,000 in 2003 to 862,000 in 2007 (an increase of nearly 18%), meaning that prevention can only be achieved through heavy reliance on the import industry. Specifically, prevention must occur through the relationship between the importers and their foreign factories.
Unfortunately, the key component that appears missing in the Working Group's strategy is any program regarding training and encouraging importers to implement compliance and ethics programs. The government has the chance to help importers get their factories to implement these programs on their own, but it may be missing that chance if the Group's recommendations are not expanded to encompass this area.
Compliance and ethics programs were born out of the U.S. Government's recognition, many years ago, that intra-organizational systems designed to detect, resolve, and - especially -- prevent violations of laws and regulations could go a long way to doing just that. Championed by the United States Sentencing Commission, and endorsed by the Department of Justice and other executive branch agencies, compliance and ethics programs have been adopted by virtually every Fortune 500 company in the U.S. as well as thousands of other organizations, and have been credited with reducing both criminal and civil liability for all types of organizations.
In essence, an effective compliance and ethics program as defined by the U.S. Sentencing Commission contains the following general criteria:
- The organization shall establish standards and procedures to prevent and detect criminal conduct.
- (A) The organization’s governing authority shall be knowledgeable about the content and operation of the compliance and ethics program and shall exercise reasonable oversight with respect to the implementation and effectiveness of the compliance and ethics program.
(B) High-level personnel of the organization shall ensure that the organization has an effective compliance and ethics program, as described in this guideline. Specific individual(s) within high-level personnel shall be assigned overall responsibility for the compliance and ethics program.
(C) Specific individual(s) within the organization shall be delegated day-to-day operational responsibility for the compliance and ethics program. Individual(s) with operational responsibility shall report periodically to high-level personnel and, as appropriate, to the governing authority, or an appropriate subgroup of the governing authority, on the effectiveness of the compliance and ethics program. To carry out such operational responsibility, such individual(s) shall be given adequate resources, appropriate authority, and direct access to the governing authority or an appropriate subgroup of the governing authority. - The organization shall use reasonable efforts not to include within the substantial authority personnel of the organization any individual who the organization knew, or should have known through the exercise of due diligence, has engaged in illegal activities or other conduct inconsistent with an effective compliance and ethics program.
- A) The organization shall take reasonable steps to communicate periodically and in a practical manner its standards and procedures, and other aspects of the compliance and ethics program, to the individuals referred to in subdivision
(B) by conducting effective training programs and otherwise disseminating information appropriate to such individuals’ respective roles and responsibilities.
(B) The individuals referred to in subdivision (A) are the members of the governing authority, high-level personnel, substantial authority personnel, the organization’s employees, and, as appropriate, the organization’s agents. - The organization shall take reasonable steps—
(A) to ensure that the organization’s compliance and ethics program is followed, including monitoring and auditing to detect criminal conduct;
(B) to evaluate periodically the effectiveness of the organization’s compliance and ethics program; and
(C) to have and publicize a system, which may include mechanisms that allow for anonymity or confidentiality, whereby the organization’s employees and agents may report or seek guidance regarding potential or actual criminal conduct without fear of retaliation. - The organization’s compliance and ethics program shall be promoted and enforced consistently throughout the organization through (A) appropriate incentives to perform in accordance with the compliance and ethics program; and (B) appropriate disciplinary measures for engaging in criminal conduct and for failing to take reasonable steps to prevent or detect criminal conduct.
- After criminal conduct has been detected, the organization shall take reasonable steps to respond appropriately to the criminal conduct and to prevent further similar criminal conduct, including making any necessary modifications to the organization’s compliance and ethics program.5
In light of the fact that there are proven systems to prevent violations of laws and regulations whether in regard to shoddy product or fraudulent financial statements, the key is to make them optimally effective in foreign factories, with prevention as a critical focus. In short, we must export our best compliance and ethics practices to Chinese manufacturers through on-site training and regular follow-up evaluations. And the best entities for doing it are not government organizations, but U.S. importers themselves.
Certainly, as urged by both the Working Group and the CPSC legislation, third-party audits and certifications can help in effective prevention. However, in many respects, such audits still only provide a "snapshot" of a factory's status on the day of the audit or certification. Constant monitoring also can be costly and easily circumvented. As opposed to a snapshot model of oversight, a true "video" model as proposed by the Working Group’s Action Plan, would provide an ongoing culture of ethics and compliance within a factory, would foster relationships between importers and their suppliers, such that the purposes underlying the audits, certifications and monitoring activity would become part and parcel of the daily management activities of the factories.
In sum, until our government officials recognize the necessity of developing programs that will assist U.S. importers in getting their foreign-based manufacturers to adopt internal ethics and compliance programs, the wave of recalls likely will continue for the foreseeable future. The Action Plan and the Reform Act, in other words, will be far from enough to proactively prevent imported products from putting consumers in danger. Much more, therefore, must be done.
#####
Mr. Allenbaugh is a partner in the law firm Allenbaugh | Samini LLP with offices in Newport Beach, Calif., Washington, D.C., and Guangzhou, China. He manages the firms China Trade & Risk Assessment Practice Group (www.alsalaw.com). Mr. Allenbaugh also serves as CEO for MAG Manufacturing, a company that imports consumer products from China for distribution to major national retailers in North America (www.magmfg.com). Prior to entering private practice he served as a staff attorney to the U.S. Sentencing Commission (www.ussc.gov), and was an adjunct professor in business and professional ethics at George Washington University.
This article is an updated version of a series of articles previously published online by FindLaw’s Writ legal commentary website. The views expressed herein are Mr. Allenbaugh’s and do not necessarily reflect the views of any of the named organizations.
1. See Economy of the People’s Republic of China at http://en.wikipedia.org/wiki/Economy_of_the_People%27s_Republic_of_China
2. See Consumer Product Safety Commission Staff, “Executive Summary: Import Safety Strategy” at http://www.cpsc.gov/businfo/intl/importsafetystrategy.pdf.
3. See www.importsafety.gov.
4. See Associated Press, Poll: Americans Share Blame for China Recalls—Americans think Companies, Governments Failed to Protect Consumersavailable at http://www.msnbc.msn.com/id/20513123/.
5. See United States Sentencing Guidelines §8B2.1; see also Hon. Diana E. Murphy, The Federal Sentencing Guidelines for Organizations: A Decade of Promoting Compliance and Ethics, 87 Iowa L. Rev. 697 (2002), available at http://www.ussc.gov/corp/Murphy1.pdf.