Compliance InsertBy Johnathan Josephs, MSL, AEM Regulatory Affairs Manager — 

There is a growing need for the equipment manufacturing industry to identify risk drivers and effectively implement mitigating controls within their businesses. Simultaneously we also dabble in the subject of ethics, as we continue to explore environmental, social, and governance (ESG) factors. It becomes more relevant, not only to understand what our immediate regulators are thinking, but to also understand guidance from adjacent regulators who may also impact our business areas. The Securities and Exchange Commission (SEC), the International Sustainability Standards Board (ISSB), and the Global Reporting Initiative (GRI) are now major players in a race to hold the audit/accounting functions, at major publicly traded companies, accountable to ESG metrics. This race toward a 2023 rulemaking frames the comparative politics, between these regulators, in an interesting way. The reason these regulatory bodies are acting now is the same as the reason these regulatory bodies were created.

The Securities Exchange Commission was created in 1933 to regulate markets after a significant market depression in 1929. The stock market crash sparked a reactionary move by the federal government, giving the SEC powers that would only become more prevalent during the Great Recession of 2007- ‘09. Today the SEC, in coordination with the Financial Industry Regulatory Authority (FINRA), has broad authority to create rules governing the exchange and reporting of securities and bring enforcement action across the various industries, including manufacturing.

More recently, international investors with global investment portfolios are increasingly calling for high quality, transparent, reliable, and comparable reporting by companies on climate and other ESG matters. Therefore, on Nov. 3, 2021, the International Financial Reporting Standards Foundation (IFRS) Foundation Trustees created the International Sustainability Standards Board (ISSB) to help meet the demand for reliable sustainable investment disclosure.

Finally, we see the Global Reporting Initiative with their own flavor of communication transparency and compliance. This independent standards organization was designed to help businesses, governments and other organizations understand and communicate their impacts on the economy the environment and people. Most notably, there are known for the concept of double materiality where companies need to not only report on the core financial impact that climate change could wreak on their businesses, but also on their own environmental and social footprint.

In recent years, we have been challenged to think about social impact and how our company's policies affect the “general public.” Therein lies the risk, absent of any direct violation, i.e., rules that have not been made yet. In the absence of strict regulation or direct violation, the responsibility falls on self-regulatory organizations (SROs) --often not-for-profits -- to create market access barriers for companies they deem non-compliance or non-disclosure. FINRA is an example of an SRO that has revolutionized the financial industry and credited with saving companies from paying expensive government fines resulting from regulatory actions. AEM has an opportunity to become an SRO and self-regulate ahead of rulemakings.

Ethics and compliance (E&C) have a symbiotic relationship. Moreover, ESG is the cornerstone argument on why analyzing social impact should now be a regular step in an E&C risk assessment. If the Securities and Exchange Commission Act of 1934 and the U.S. Patriot Act taught us anything, it’s that socioeconomics is a vital consideration when implementing new policy. There are correlations between the off-road industry, finance, and socioeconomics, which is in every other conversation, inseparable. The connective tissue between each part of this theorem is E&C and this article will address our call to action as industry leaders: We are expected to have a newfound conviction in full material disclosure (FMD), restorative social justice, and the rule of “Do No Harm” (a principle of bioethics that is also commonly used in areas such as sustainability).

Next Steps

Firms think that if they have robust and comprehensive enterprise compliance, then enforcement action risks such as fines, consent decrees, and/or litigation will be mitigated. These firms might be right! Fighting a compliance war with a big army of compliance professionals is one way to do it. Alternatively, the more challenging path is to take ESG seriously and make it actionable. Most companies have a paper ESG policy, with a team of compliance professionals to bolster those initiatives. However, turning that gold standard policy into action that impacts the general public in positive ways is more difficult.

We are living in an environment where the C-Suite is now talking to community-based organizations about how to impact change in a positive way. These conversations are about diversity & inclusion, the environment, and international human rights. Dialogue is where to start, but words eventually need to turn into action to avoid “green-washing” accusations. Consequently, the government has chosen to react with increasing regulation of the private sector.

Administrative law is interesting, because the term describes the chokehold regulators have over the industries they choose to regulate. Post-pandemic regulators do not seem to be slowing their efforts in 2022, with a series of regulations set to drop in 2023. The off-road equipment industry has an opportunity to switch from defense to offense. By building self-regulatory regimes, which know more about the environment, social issues, and enterprise compliance than the regulators, early adopters can lead their industries and avoid the regulatory risk concerning us all. Offense means having strong governance that is transparent and not easily swayed by short-term thinking. Moreover, it means investing in ESG today to avoid regulatory risk, fines, and litigation tomorrow. This strategy can save companies billions. Just ask Citicorp, JPMorgan Chase & Co., Barclays PLC, The Royal Bank of Scotland plc and UBS AG, who paid significant fines post-LIBOR scandal. Although the financial industry and the healthcare industry were the first to experience high regulatory risk (i.e., The Dodd-Frank Wall Street Reform and Consumer Protection Act), they will not be the last. Manufacturing could be next.

The Bottom Line

The obvious solution here is usually to let the general public know of ALL potential risks involved with your products. In finance, boilerplate language might go something like: “Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.” This language can usually be found, in fine print, at the bottom of any sales contract or advertisement for a financial product. It would behoove the off-road industry to start gathering similar disclosure language, facilitating FMD. Regulators have been vigilant, especially in recent years, in taking actions against companies who violate sales standards. Moreover, its compliance 101.

As a great professor of mine once said, “DISCLOSURE, DISCLOSURE, DISCLOSURE!” However, even after we mitigate disclosure risks, there is a dramatic amount of residual risk left over. More specifically, this residual risk refers to factors that the general public are not protected against, and a reasonable person would not be expected to foresee. Let us be the first to report these risks and bring even more ethics to manufacturing.

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