Objective: Review governance policies after an unanticipated instance of fraud. 

Background:  We held moderate positions in a communications company domiciled in the United Kingdom in several of our Large Cap International Growth and Value portfolios.  We had a favourable view of the company based on its large-scale profitability and strong track record for generating growth. As one of the largest communication companies worldwide, it served customers throughout the UK and in 180 other countries. The company consists of six lines of business, which include technological functions, consumer, mobile services, business/ public sector, wholesale and global services.  

Italian Accounting Scandal: In 2016, an external audit of the company’s global services unit discovered years of accounting fraud in its regional Italian operations. In January 2017, profits fell more than 40%, as the company announced a substantial write-down of $740 million following the scandal. The company also ended up lowering its profit and cash flow guidance for the entire business, citing weakness in the UK public sector and international corporate markets. 

UK Telecom Intervention: In the first quarter of 2017, the company also faced intervention from a UK Telecom regulator who had been scrutinizing the governance practices of its wholesale division. 

In February 2017, our governance analyst and Value CIO met with the company’s CFO, CEO, and Chairman. During these 1-1 phone calls, we sought an explanation for how the company would address two important governance issues: 

Addressing the Scandal: We discussed the company’s Audit and Internal controls in detail, as well as the divisional goal-setting process for the company. We were pleased to learn that the company had cut ties with the Italian divisional leader, and had also hired a new auditor after its previous one had failed to spot the scale of the problems. The company had also taken the initiative to limit a recurrence in its other regional units by completing an internal audit of its global services division. 

Organizational Structure: We also discussed the possibility of a top UK Telecom regulator intervening in the company’s corporate structure. The regulator had recently proposed changes which would require a legal separation of the wholesale division from the rest of the company. This separation would inevitably create a new reporting line which would exclude the unit from reporting to the company’s CEO.

We submitted feedback on this issue directly to the governing Minister, who supervised the agency.  Issue remains pending.

We continued analysing the impact of these issues on the company’s investment case. With regards to  the fraud scandal, we are satisfied with the company’s approach to eliminating a recurrence.  Additionally, we do not view the regulator’s proposal as an immediate threat. The proposals are only in the consultation stage and will ultimately be subject to the agreement of the company, the regulator, and the government. As a result, our investment decision did not change. We continuously engage the company as needed, as progress on the proposal develops.

Objective: Utilize active research to confirm a positive outlook on a potential holding, despite initial concerns. 

Background:  We had been closely monitoring opportunities within the Chinese manufacturing sector since 2016. In April 2017, a large Chinese cement producer looked attractive to us. We had become more positive on construction demand in China, and the cement industry’s competitive structure was also attractive. This cement company stood out against competitors, we thought, for its ability to keep production costs low while still utilizing advanced technologies. Our initial fundamental research indicated a positive outlook for the company. Our investment thesis included: 

 Projected Profitability Increase: The company had benefited from supply-side reform, which broadly created a better supply-demand situation by reducing production cost. The company’s profitability was projected to increase as overall operating expenses fell. 

 Expansion: Through its efficient cost structure, potential mergers and acquisitions could increase growth and expansion. 

Shareholder Maximization:  We expected an increase in shareholder return through a higher dividend payout or the company’s more efficient use of cash. 

We liked the company based on these factors, but we knew that companies in this sector often ran into challenges from an environmental standpoint.  We wanted to understand its ESG profile better.

​Our concern was that the company had received a low ESG rating from one of the major global rating agencies. Given the in-depth fundamental research we had done, and our resulting knowledge of the company, we disagreed with that rating. To further understand the low ESG rating, we contacted the company as well as the rating agencies analyst that had assigned the low rating.  

We learned through discussion with the ratings agency that the agency had initially given the company a low ESG score based primarily on the company’s limited disclosure of information. Because of that, the agency needed to generate the company’s rating based primarily on public records. While the company did not have any actual ESG violations, its lack of transparency was a justifiable cause for concern. In comparison to its higher rated competitors, the company has not yet engaged with the agency on ESG. The company does, however, provide investors with a standard ESG report when requested. 

While competitors may have received higher ESG scores for cooperation, we found that the company generally outperformed in terms of actual ESG process implementation and it had surpassed both competitors and industry standards in key environmental metrics.

Through our first-hand active and in-depth research, as well as through engagement with both the company itself and the ratings agency, we became confident that the company was well in compliance with both national and international ESG standards. As a result, we began investing in the company in May 2017. We maintain moderate exposure to the company in several of our global equity portfolios.  

Objective: Evaluate the business model of this debt collection company given industry-wide incidents of social malpractice in these types of companies. 

Background: In 2016, we had purchased securities of  a Polish debt collection company for our Large Cap Global Equity portfolios. The company currently operates in multiple countries in Eastern Europe. We liked this company for its strong financial performance. It was the company’s fifth quarter in a row in which recoveries from purchased debt portfolios exceeded targets. While we had been comfortable with the company’s social approach during our initial analysis of the company prior to purchase, as part of our ongoing due diligence process on existing holdings, we engaged with the company again in 2017 to ensure that such values were being maintained. 

Historically, we knew that some privately-owned businesses in the debt collection space have had questionable collection practices. Both in developed and developing countries, we knew of reports of customers being threatened with physical harm for non-payment, and in some cases, physical violence was reported. We wanted to make sure this company was different.

In September 2017, we met the company’s COO and President of its Romanian business.  In this region, there had been historical instances of some customers not making a single debt repayment in 10 years. While this was quite extreme, we wanted to further understand how the company would address such issues should they arise in its Romanian and broader Eastern European operations. Our objective was to delve more deeply into the company’s business practices with regards to fairness and social dignity for its customers.  

Debt Collection Strategy: We were pleased to learn that the company’s collection model is based on treating customers fairly and seeking to reach amicable resolutions. The company’s approach emphasizes individual case-by-case evaluations, flexible repayment options, and in-person meetings with their customers to work towards solutions. The company sometimes agrees to accept reduced repayments that better align with the customer’s budget at the time. We also liked the company’s incentive program, in which they assist customers in financing or rebuilding their credit if they repay their loans  on time.  

The company diligently enforces its customer-focused business model by requiring extensive training for all representatives before they can engage with customers.

Having discussed the company’s collection model and heard numerous examples from various countries it operates in, we left the meeting very comfortable with the debt collection practices at this company. In our view, this company demonstrates a progressive approach to fairly treating customers. We believe this company, in fact, contributes positively to the long-term sustainability of the broader debt collection industry. We maintain holdings across several of our global equity portfolios.  While our investment thesis remains unchanged, we continuously engage with the company to remain involved in all related aspects of ESG.

Objective: Gain clarity on company’s sustainability strategy before resuming purchases.  

Background: We had formerly held shares of a Polish copper company with operations globally, in several of our Global Equity accounts. In 2012, the company acquired majority ownership of a large open pit mine in Chile that processes copper, molybdenum and gold.  

Historically, Chilean copper and molybdenum mining have presented high environmental risks from their use of  significant fresh water for processing. The government now requires all mining projects to obtain surface and ground water rights.  Because obtaining such water rights can  take several years, most mining companies have begun using desalinated seawater instead, a challenging process involving significant capital expenditure. 

Since acquiring the mine in 2012, the company had used only seawater for operations. Other mines in Chile had also been using seawater, but those mines did not have as  significant molybdenum processing operations as this mine did. And indeed, this mine’s processing of molybdenum recoveries did not go well initially, with one of the main culprits being the use of seawater. This led to us briefly selling out of our positions. 

During the years that we had held the company, we repeatedly engaged with the company on its use of water in its Chilean mine. Its experimental use of seawater had contributed to low recovery rates and negative cash flows  in 2016 and early 2017. To restore profitability, the company would need to either develop a better methodology or turn to using fresh water, the easier but less environmentally safe option.  

Re-evaluating Opportunities: In July 2017, we engaged with company management again, to see whether their  productivity and approach to improving molybdenum recovery rates while still using seawater had improved. We were pleased to learn of several new approaches the company was implementing, including re-engineered processes. Over the prior two years, the company had re-engineered its molybdenum processing circuit in a way that enabled it to obtain its targeted recovery rates while using seawater. The company had also altered its expansion plans in a more sustainable direction. It had originally planned to expand its existing processing facilities, which would have increased water consumption. Now, however, the company was moving  to target processing of  pre-stockpiled deposits at its current site, which was less water intensive.

In February 2017, we re-entered positions in this company in several Global Equity portfolios. We were able to purchase the securities at attractive prices:  the market had largely priced this project as a failure, and there was limited downside remaining at the time we bought the shares. We made the right move: operating results for the second and third quarters of 2017 showed substantially higher recoveries and profitability.  Given our subsequent discussions with management in July 2017 when we learned more about how this company had re-engineered their processes to make them less water-intensive, we believe these results are sustainable. Importantly, we also  felt comfortable that the company’s water usage would no longer pose a threat to either the environment or the company’s longer-term operations.

Objectives:  Understand the drivers of a company’s low ESG score  on human capital development and corruption and instability; and determine whether warranted. 

Background: As a manufacturer of pharmaceutical packaging and delivery systems for injectable drugs and healthcare products, this US-based healthcare company faced industry-wide sustainability and governance risks. The healthcare sector in general is vulnerable to bribery because of the high degree of government regulation and policies in the sector as well as the government’s potential to be a significant client.   

Despite these potential industry risks, this US healthcare company had received an AA ESG score by one of the global rating agencies. This agency’s ESG score measures a company’s performance in the areas of carbon emissions, product safety and quality, human capital development, corruption and instability, and corporate governance.  Despite scoring highly in all other areas, the company received its lowest rating in human capital development and corruption and instability.  

We held moderate exposure to the company throughout several of our Large-Cap Equity portfolios. The company’s low corruption and human capital scores concerned us.  What was going on? 

In August of 2017, we met with the company’s VP of Health, Safety and Environment to inquire further about its Human Capital practices as well as its policies and procedures for preventing corruption. We wanted to understand what specifically led to the company being assigned low scores in these areas.   

We learned through our engagement that this ratings agency tends to assign low scores to healthcare companies in general, because, in the ratings agency’s words, “healthcare companies are more likely to engage in the bribery of public officials or exercise undue influence on government policies, laws and regulations.”  In the case of this particular company, however, the agency’s general rule shouldn’t have applied, as this company does not engage directly with government entities at all. Its only customers are other large corporations. Bribery risk was not a key risk for this company.  

While bribery risk may not have been an issue, we did note some other areas of concern.  From a social standpoint, we suggested that the company improve certain human capital practices, including  implementing more formal employee engagement channels and opening its employee stock purchase program to all employees globally. Currently, it is limited  to US employees only.

After meeting with the company in August 2017, we felt more confident in the company’s sustainability initiatives, despite the low initial rating. We were also pleasantly surprised to learn that the company was taking steps in the right ESG direction by issuing its very first Corporate Responsibility Report in the second quarter of 2017. This Report outlined the company’s sustainability goals to lessen its environmental impact and improve its use of water. 

Following our engagement with this company, we better understand the company’s ESG score. We are also satisfied with its sustainability efforts. However, we continue to engage this company, as we need to see further material progress on our suggestions above. In the meantime, we are maintaining moderate exposure to this company throughout several of our Large-Cap Equity accounts.

Objective: Review a major Israeli bank’s lending practices, policies and potential reputational risks. 

Background: This financial institution provides a wide range of banking and financial services in Israel and internationally. The bank operates in several market segments: private client, residential mortgage, small business, commercial and corporate.  We have a multi-year history of investing in this bank within our International Equity portfolios. 

Lending Practices:  In the third quarter of 2017, an International human rights organization called on major Israeli banks, including this bank, to halt the financing of settlement activity in the West Bank. The organization argued that the legal justification for doing business in the West Bank was not valid. By providing settlements, the Israeli banks had inadvertently assisted in the colonization of occupied Palestine, a war crime under international law. The bank maintained that ending its services to West Bank clients would violate domestic anti-discrimination laws. While it  cannot refuse customers based on their residence alone, they can avoid financing settlement practices by citing its obligation to human rights. 

US Tax Evasion Investigation: Within its private client segment, the bank was accused of assisting its US-based customers in avoiding taxes. 

​To gain more clarity on the issues above, we met with bank management in July 2017 to address these two important aspects of ESG. We were pleased to learn that the bank had d several initiatives underway to increase transparency and lower social risks. 

Human Rights Risks: In response to the alleged human rights violations, the bank discussed its strong ‘Know your Customer’ policy in which each customer’s creditworthiness and nature of underlying collateral are deeply analyzed. The bank implements a similar stringent due diligence processes for its corporate lending program, in which it insists on maintaining a direct line-of-sight into how its loan proceeds are ultimately deployed.  These practices have increased overall transparency.  

In May 2017, the bank also produced a comprehensive Corporate Responsibility Report that discusses its commitment to the Principles of the UN Global Compact and the UN Guiding Principles on Business and Human Rights. Both are  applicable to the bank’s supply chain management and its own employees.  

Tax Evasion: Following the initial US Department of Justice investigation, the bank’s Chief Risk Officer had conducted an internal investigation, and the bank had developed several new initiatives designed to prevent this issue in the future.

While we were initially skeptical regarding the bank’s lending practices, our reservations were addressed during our engagement, when we saw first-hand the many processes the bank implements to keep its lending activities fully transparent. This bank appears to have implemented strong policies and practices to ensure that it is lending only to legal entities that are making legitimate and lawful use of the loan proceeds. As such, at this time, we do not see any potential reputational risk. We will continue engaging with the bank through regular conversations, and will continue discussing and monitoring the bank’s commitment to human rights. 

Additionally, we believe that the bank has responded appropriately to the US DOJ investigation and the actions it has taken should help them close out this issue within the next 6-12 months. 

We are generally satisfied with the company’s efforts towards eliminating social risks and maintaining sustainable business practices. Following our engagement with the company, our investment thesis remains the same. We continue to hold the bank’s securities throughout several of our International Equity portfolios. 

Objective: Review company’s approach to safe social practices after new industry regulation on selling medically-important antibiotics

Background: We liked this company for its strong financials and exponential growth opportunities worldwide.  

Over the past few years, this producer went through several sustainability phases in line with US regulatory guidelines. 

Medically Important Antibiotics Regulations: In the US, a ‘Vet Feed Directive’ law was passed in 2016 which now requires a veterinary prescription for the use of the medically-important antibiotics. Such antibiotics were often used by farmers and the food industry to promote growth and prevent disease in healthy animals. This is a societal risk, however.  The more antibiotics are used in animal feed or sub-dosed to animals, more humans develop resistance to the antibiotic’s effectiveness, and  the less able humans then are to fight bacterial infections as easily as they have in the past.  

Revenue Impact:  The company did see a slight impact on revenue from the new law, as  a large percentage  of its customers, predominantly small swine producers, did not have the proper veterinary relationships that would enable them to continue to use the company’s products.

During the years that we have held the company, we have continuously engaged on ESG. We support this company’s movement away from selling medically-important antibiotics and its strategic focus instead on the use of injectable antibiotics only when needed, from both a financial and societal standpoint. While we are satisfied with this effort, we believe the company can do even more by engaging their clients and fellow producers in educational efforts. At our most recent meeting in July 2017, we reiterated our suggestions for increased sustainability. 

Specifically, we would like the company to begin publishing a Corporate Responsibility Report that would highlight in more detail the specific environmental and social initiatives the company is pursuing. Examples of items particularly relevant to this company would be its level of carbon emissions over time along with specific objectives for improved energy efficiency. 

After meeting with the company, we felt comfortable with its approach to eliminating environmental and societal risks. We continuously engage with the company and monitor its progress on shifting away from medicinal feed additives to injectable antibiotics. We are also eager to see the company make more explicit efforts to  disclose its ESG initiatives. Following our engagement with the company, our investment thesis remains the same. 

Objective:  Review a company’s approach to environmental sustainability

Background: This company is an American global provider of water, hygiene and energy services to the food, energy, healthcare, industrial and hospitality markets. We have a multi-year investment history within several of our Concentrated Growth Equity portfolios. This company’s products touch virtually every aspect of daily life, are widely used in hospitals, hotels, restaurants, schools, manufacturing plants and refineries worldwide. Many of the world’s most recognizable brands rely on the company to help ensure operational efficiencies, product integrity and brand reputation. As such, we liked this company based on its long-term growth potential and believe it is uniquely positioned for optimal impact since many of its customers rely on its  innovative products to operate efficiently. We also liked its historically strong commitment to ESG.  

One of the company’s main challenges was developing technology for countries with extreme water constraints. By 2030, there will be 3 billion more people in the middle class than there are today, and each will consume 15 more pounds of protein and 18% more electricity on a per capita annual basis.  This implies a 50% increase in energy and 40% increase in water demand globally.

We already knew that the company had a strong commitment to ESG. However, we were specifically interested in learning more about the company’s approach to new sustainable solutions in emerging countries.  In March 2017, we met with company management to discuss progress made. 

In its developed market operations, the company had already established innovative ways to reduce, reuse and recycle water. The company informed us that its current focus was expanding operations in  emerging market countries where the technology will be most needed. The company also presented a business plan which aims to increase its China operations significantly,  doubling revenue from $500 million to $1billion  over the next three to five years. 

Within the company’s overall operations, we were pleased to learn that in the first quarter of 2017, the company’s products and technologies saved 43.5 billion gallons of water, 3.1 trillion BTU’s of energy (equivalent to the annual energy use of 42,000 people), 193,000 metric tons of air emissions (equivalent to the CO2 absorbed by 4.9 million trees over 10 years), and 8 million pounds of waste.  

We left the meeting feeling confident in the company’s approach to water conservation and long-term environmental sustainability within its operations worldwide. 

Following our engagement with the company, our investment thesis remains the same. We continue to hold the company’s securities throughout several of our Concentrated Growth Equity portfolios. We are generally satisfied with the company and will continue to engage as needed with it.  

Background: Across several of our International Growth and Value portfolios, we have a multi-year history of investing in this  French automotive holdings company. The company operates through three segments, which include automotive, finance and “other business” divisions. Activities grouped under its “other business” division include multiple mergers and acquisitions  the company had made.   

In March 2017, the French company made a powerful move in purchasing the entire European business of an American multinational automaker. This $2.3 billion acquisition positioned the company to become the second largest automotive company in Europe, with a 17% market share. While this move positively positioned the company for revenue increase, it also bought on several labor cost challenges.  

The business  the French company acquired historically faced several issues with labor costs. The company had racked up $8 billion in losses since 2010, in part due to inefficient operations and manufacturing processes that were continuously described as ‘inflexible and slow.’ If the new French owner was to benefit from the deal, it would have to cut costs significantly. This became a societal issue, as the company was now faced with the inevitable burden of cutting jobs in one of its large German operating facilities. 

Before the merger, we liked this company and were highly satisfied with its corporate social responsibility practices. We engaged with the company several times over the last year, most recently in November 2017, around its cost savings targets from its acquisition, particularly  labor cost saving forecasts.  We had concerns around the achievability of those cost savings, and way in which those labor cost savings would be implemented, given the importance of those manufacturing jobs to the German facilities local economy.  

Labor Retention Plan: The company informed us of its approach, which included detailed planning and understanding of the cost structure at the local facility to retain jobs and lessen negative impact. Most of the savings would be achieved through a combination of shorter work hours, voluntary departures, and a reduction in the use of contractors and outsourcing.  

We left the meeting feeling satisfied with  the company’s approach. We felt that that company had sufficiently addressed the threat of massive labor cuts by providing innovative compromises that benefited both parties.

In our view, this company demonstrates a strong commitment to fairly retaining its labor force. We are generally satisfied with the company’s efforts and will continue to engage as the labor retention plan is implemented. Following our engagement with the company, our investment thesis remains the same. We continue to hold the company’s securities throughout several of our International Growth and Value Equity portfolios. 

​Background: This UK-based company is a provider of oilfield services. We had a multi-year investment history in several of our international value portfolios. In the first quarter of 2016, we learned that the company was under investigation by the UK Serious Fraud Office (SFO) over alleged bribery and money-laundering. The investigation involved an independent agent who was acting on behalf of the company. This agent had allegedly paid bribes to foreign officials in Kazakhstan, Kuwait and Iraq to help the company win public contracts. The question was, had the company been aware of the bribery and knowingly turned a blind eye? 

We had engaged with the company during early 2016 when the allegations first emerged and had been reassured at that time that the Board was acting promptly and appropriately by hiring external lawyers and accountants to investigate possible impropriety in the past and/or weaknesses in current procedures. The investigation continued despite the company denying any wrong doings. Ultimately, we were uncomfortable with the risks and started exiting positions in May 2016. 

In May 2017, the investigation escalated, and the company’s CEO and COO were arrested. The CEO and COO are founders and material shareholders in the Company. 

Immediately following the arrests, we met with the company’s CFO in May 2017. At this point, we were still marginally exposed to the stock. We wanted specific information on how the company was responding to the investigation and how business could potentially be affected. The company stressed to us that the Board was acting appropriately in responding to the investigation, that the company had robust processes in place, and that it was preparing contingency plans for leadership succession.  

While we were glad to see this evidence, our engagement did prompt us to acknowledge a risk to the CEO and/or COO should new evidence emerge or charges be filed against them. Our concerns were later validated as the company suspended the COO in late May 2017 despite no new evidence emerging. The Chairman explained that this was an attempt to make it clear to the CFO that the Board was taking action to ensure the company provided full cooperation to investigators.

We left the meeting feeling dissatisfied and uncertain that the company’s governance practices would address the risks. History suggested that the SFO investigation would take several months, so we sold our position gradually, to try and minimize price impact. The stock price reaction was, as we had feared, sharp.  We continued with the final portion of the sale, however and had completely exited the position by June 2017.