2011 Exercising a broader due diligence for investment in a charity

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Exercising a broader due diligence for charity investment


RUBY SANDHU of law firm AMSTERDAM & PEROFF argues that charities must adopt a new due diligence to avoid investments which could lead to unwelcome controversy.

Consciously ethical investment may not be a policy which all charities wish to specifically pursue – and here we are talking about equity or social investment – but one would argue that increasingly charities will have to take on board that investment by them does require some sort of screening of companies in a portfolio to avoid, at the very lea st, controversy arising in the future. Charities which invest in companies cannot escape the burden of ensuring that a company is compliant with important business codes and is not linked to breaches of such codes.

This is particularly the case when companies are based overseas or have overseas operations, the risk being necessarily greater in certain areas. There is also a general atmosphere of heightened public and political sensitivity about non-investment matters which can have added relevance for charities when making or holding investments.

The current proliferation of principles and guidelines addressing issues of business compliance in the global marketplace is making life harder for charity investors, including those which accept they have to keep a watchful eye on the way guidelines are being developed all the time for corporate behaviour – and how the companies they invest in adhere to them. These guidelines include the United Nations Protect, Respect and Remedy Framework for Business and Human Rights, and the Private Equity Council Guidelines for Responsible Investment. Then there is the Charity Commission’s CC14 – Charities and Investment Matters: a Guide for Trustees – which is a set of guidelines within a legal framework.

Incorporating core principles

As we are all well aware, guidelines are not hard law and are therefore not enforceable in a court of law. However, any responsible charity investment policy requires incorporation of the core principles provided in such guidelines and importantly an awareness of the guidelines’ development and implementation.

The awareness, incorporation and implementation of these guidelines become relevant for charities not only because of the Charity Commission’s CC14 guidelines, but also where an inadvertent investment in a portfolio with an element of high risk – involving, for instance, a business supply chain in an emerging and/or frontier market – could trigger the impact of other guidelines.

A case in point is the UN Human Rights Council’s adoption in June 2011 of the Protect, Respect and Remedy guidelines. The PRR guidelines were created to redress the failure of state and non-state entities to provide the appropriate institutional and investment framework for ensuring that business violations of human rights and the environment did not take place on such a flagrant scale. These violations were brought to the court of public opinion by impassioned stakeholders and NGOs. This was compounded by the intensified social media and the speed and medium with which information could be disseminated.

Suffering reputational damage

An investment under the guise of “business as usual” in an emerging/frontier market could suddenly find itself subject to reputational damage and/or political risk. Trustees have a duty to further the purpose of a charity’s objective, while ensuring a best return on investments within a defined level of risk. Due diligence is therefore required in the screening of investments, including mixed motive and programme related investments, to ensure these developments are incorporated into a charity’s investment policy to avoid reputational damage or political risk.

However, there are no specific parameters to define the incorporation of guidelines (unless specifically directed to a legal obligation within the guidelines) in relation to a charity’s investment objectives. It then begs the question as to exactly how intensive the due diligence needs to be and how it should be conducted? There is unfortunately no size that fits all. However, account must be taken of the current wave of unrest and change, and in social patterns, with a clear undercurrent for building values based on ESG (environmental, social and governance principles), transparency, responsibility and accountability.

Triple bottom line investing

“Triple bottom line investing” (TBLI) is one example of an attempt to provide a solution to the unrest without impacting profitability. That is, creating structures with an ethical investment, appropriate social impact and successful generation of profits for the stakeholder. However, funds investing in companies with a compliance based due diligence, linked to perceived responsibilities, and built on “green washing” (misleadingly proclaiming rather than actually doing) will not be enough to ameliorate the unrest and avoid inadvertent risk.

The dynamic and emerging reality based on an emotive mix of ethics, morals, values and fairness – concepts which in themselves are hard to define or specifically legalise – are at least providing a basis for the emerging principles and guidelines.

A due diligence framework which incorporates these values therefore requires a genuine attempt at an assessment of activities of the fund, an understanding of the investment relationship in their social, political, and economic context, along with the charity’s investment mission, ethical criteria and standards.

The scope of due diligence

However, the parameters are wide and there is the emergence at the very best of norms. As such due diligence extends beyond an investment’s own activities to include relationships with business partners, suppliers and other non-state and state entities which are associated in the investment activities’ supply chain. A failure to take into account these considerations could result in a charity facing a claim for negligence.

In addition, such a due diligence process would need to be a continuing and evolving one. Appropriate systems would need to be devised and implemented which take action on the empirical information received from such due diligence and with the appropriate reporting requirements.

As the due diligence system matures, the lack of enforceability of these principles can be balanced by providing for the appropriate grievance mechanism in the investment. Such a grievance mechanism ensures that where there is a real/perceived violation, the initial failure to redress the wrong does not escalate into a situation which proves to be costly, unnecessary and a reputational threat to the investment.

Vital role of stakeholder activism

Stakeholders, including charities, play a vital role in addressing the compliance of investments with these emerging and evolving guidelines by this form of stakeholder activism. This stakeholder activism ensures that they are not complicit in human rights or environmental violations. The criteria that charities should take into account are the importance placed by an investment on its transparency, internal systems and procedures, openness and awareness of the vulnerability of attacks from other active stakeholders.

An investment which takes a proactive stance in incorporating and operationalising values and ethics is critically necessary and not just advantageous. A management which is willing to educate, is aware of developments and is subsequently reviewing is internal systems in line with a multi- stakeholder approach to address concerns at an early stage is clearly beneficial.

These emerging guidelines and principles may appear to be onerous obligations, but with today’s viral and sophisticated social media and speed of communication, they are the essential infrastructure required for enhanced due diligence and a charity’s adherence to an evolving set of model principles.