A seal of approval for companies' social progress

As someone who hunts for ethical firms, Tim Smith pores over hundreds of company social reports about labor conditions and community involvement. But how many does he trust?

Far fewer.

"It's not credible if somebody is monitoring and reporting on themselves," says Mr. Smith, director of socially responsive investing at Walden Asset Management in Boston. "You need to do your own review, but you [also] need an independent monitor who has got integrity and is outside" the company.

Call it the "Good Housekeeping" seal of approval for ethical companies. Just as financial auditors probe whether a company's numbers can be trusted, independent social auditors aim to sniff out whether a scandal of sweatshop proportions lurks behind the many photos of happy workers in an annual report.

At this juncture, independent monitoring of social standards is far from the norm in corporate America, which is still getting used to reporting its own progress on social issues. Almost 1 in 3 of America's top 100 companies reported on their social progress this year, according to a June survey from accounting giant KPMG. That's a huge surge from the handful issuing them five years ago. But only 1 in 100 did so with verification from an independent auditor.

That puts the United States far behind Britain, where 71 percent of top companies issued social-progress reports, and more than half of those came with an independent monitor's assurance, the survey found.

Usually, investors can easily determine whether a company has allowed independent monitors to evaluate either its internal reports or its outsourced operations.

They just need to go to the company website.

Since hiring an outside auditor can cost upwards of $100,000, companies spending the money to win credibility will want the world to know, observers say. Prominently placed on its corporate social responsibility (CSR) report will be the name of the auditing organization. What's not so obvious, however, is that some audits may be more trustworthy than others.

"You've got a whole set of commercial suppliers that are out there [getting into social auditing] but it's very easy for them, frankly, to get hoodwinked by suppliers in developing countries," says Conrad MacKerron, director of corporate social responsibility for the As You Sow Foundation in San Francisco. Because it can be easy for factory managers to steer auditors away from problem areas, he says, the best audits might be those from organizations with a history of digging deep to bring trouble spots to light. "If they're not going the extra mile to talk to workers in a safe spot," Mr. MacKerron asks, "are they going to be able to find problems that were missed" by internal reviews?

Among the most sought-after names in social auditing are nongovernmental organizations (NGOs) with international reputations, according to Jeff Erikson, Washington director of SustainAbility, a consultancy in London that helps firms prepare CSR reports. Reviews done by advocacy groups like Amnesty International, Greenpeace, and others would carry far more weight, Erikson says, than those done by groups with close ties to industry, for instance.

When the auditor's name is not a household word, diligent inquisitors might send off an e-mail to the investor-relations department asking who accredited the independent monitors. If CSR reports are reviewed against the AA1000 standard from AccountAbility, for instance, then the benchmark is the same one used by more than 100 firms, including British Airways, Toyota, and Canon.

"The average consumer could care very little about whether a report has verification," says Maria Sillanpaa, managing director for AccountAbility. "However, an investor looking at a CSR sustainability report without verification would not place much value in the report."

What constitutes an independent auditor remains a matter of debate. NGOs routinely decline a fee, Mr. Erikson says, while accounting firms sometimes regard social auditing as a growth area for their businesses and see no conflict of interest. Meanwhile, social audits are increasingly targeting not just CSR reports, but also far less visible supply-chain facilities overseas.

Since the late 1990s, when sweatshop conditions in Asian factories dragged down such lofty names as Nike and Kathy Lee Gifford's clothing line, monitoring supply chains has become a cottage industry. For investors, that's good news because they now have places to go for answers about ethical standards, especially in some industries. For a tobacco or oil company that's trying to establish credibility, for example, external monitoring can be especially important, Erikson says.

In textiles, the first stop for a concerned investor might be the Fair Labor Association (www.fairlabor.org). Its licensees and member companies identify those that have agreed to let accredited monitors bring International Labor Organization standards to bear on factories in their supply chain. Monitors note issues such as sanitation, child labor, and compensation rates.

In coming years, the association aims to draft standards for use in monitoring other industries, particularly agriculture, according to monitoring program coordinator Roopa Nair. In the meantime, investors concerned with crop-growing and processing conditions can look for a label increasingly familiar to upscale coffee drinkers: Fair Trade.

Investors who see the Fair Trade label on a company's products have assurance from social audits that, for instance, coffee was grown in shady conditions that bode well for the land. What's more, everyone in the supply chain actually got paid as promised, according to an audit that reviews the transactions. Those who are audited ultimately foot the bill, and they need to keep showing progress to retain the label.

"It's not good enough to just meet minimum requirements year after year, especially if you're deriving tremendous fair-trade benefits from the system," says Christopher Himes, of TransFair USA, which audits transactions for the Fair Trade label. "You then have to become more of a model producer, do more for your workers ... do more for the environment, etc."

Another auditing group, Social Accountability International, accredits monitors who then "certify" outsourced factories in toys, apparel, and other industries. Firms that work with SAI-accredited monitors get to use its seal of approval.

Investors aren't likely to see exactly what auditors said since few companies post their reports. Some experts say that's fine as long as investors know the independent audits are being done.

"Ninety-nine percent of the people who see these audits won't understand what it means," says former McDonald's attorney Phillip Rudolph, now a partner in the CSR group at Foley Hoag in Washington, D.C. "It really creates an impediment to effective relationships between the customer - the Nikes of the world or the Reeboks of the world - and their suppliers to have the entire world suddenly become involved."

But others believe the world needs to know what independent auditors are saying. "Even if we ask what's going on, they'll just say, 'Well, we're taking care of it, but no, we're not going to give you the details,' " MacKerron says.