Big Trouble for Big Tech

Tax, HR and governance practices of large tech firms are coming under greater scrutiny from investors, users and governments. 

In 2018, Jack Poulson and a number of his co-workers at tech giant Google uncovered Project Dragonfly; a tailored search engine for mainland China designed to comply with state censorship requirements. When they discovered that ‘sensitive’ speech would be censored – such as searches on ‘human rights’ – they blew the whistle.

What followed was a circus of mismanagement as Poulson’s superiors failed to justify the project’s existence. He and his co-workers spent one month trying to meet with senior management and asked for further clarification of the reasoning behind the project at the next company-wide meeting. When it became clear no clarifications were forthcoming – even after a direct meeting with Google’s Head of Artificial Intelligence Jeff Dean – Poulson handed in his notice, listing his objections to Dragonfly, which were supported by an open letter to Google from human rights groups.

In July 2019, Google was subject to a slap on the wrist at a Senate Judiciary hearing, in which Google’s Vice President of Public Policy Karan Bhatia confirmed the company had abandoned work on Project Dragonfly. However, the Silicon Valley giant failed to pledge to not enter the Chinese search market in the future.

“A lot of this recent history around censorship and ethical issues at Big Tech companies like Google in 2018 have been too easily forgotten,” says Poulson, now a founder of Tech Inquiry, which he launched in order to better hold ‘Big Tech’ firms accountable.

Poulson adds that Bing, a Microsoft search engine, has adopted a similar approach in China. “That can be easily verified by using a VPN and searching something like ‘human rights abuse in China’,” he says.

Big issues for Big Tech

Poulson’s story is just one of many examples of a highly-profitable, innovative and far-reaching sector operating in a morally grey area, practising behaviours that aren’t technically illegal, but are arguably unethical.

With institutional investors increasingly incorporating ESG factors into their investment decisions, it was only a matter of time before their attention focused more closely on the Big Tech firms, broadly considered to include Facebook, Amazon, Apple, Microsoft and Alphabet (Google).

“As big tech companies have rapidly grown, both their influence and their impact has similarly expanded in economies and societies around the world. We believe that Big Tech has a responsibility to be transparent about their impacts across ESG issues,” says Peter Paul van de Wijs, Chief External Affairs Officer at the Global Reporting Initiative (GRI).

Tech firms are engaging on issues surrounding climate risk, Jeremy Richardson, Global Equities Senior Portfolio Manager at RBC Global Asset Management, points out. For example, Microsoft pledged last year to be “carbon negative” by 2030, “recouping the carbon its emitted since its foundation”, Richardson says.

“However, the fact remains that there are big issues around data, governance and accountability,” he adds.

Enforcing change will be far from simple, Poulson warns. Regulators will have to work with the Global Network Initiative, established to prevent censorship and promote privacy, but also a barrier to oversight of members, which include technology and telecoms firms, but also civil society and academic institutions.

Regulatory and policy intervention is necessary, experts argue, in order to tackle issues around tax avoidance, as well as broader social themes, including the treatment of employees, whistleblower policies and the ethical use of consumer data.

Big Four accountancy firm KPMG said that 74% of tech CEOs believe their organisations’ ESG policies should reflect the values of their customers. Its 2020 ‘The ESG Imperative for Technology Companies’ report further noted that 45% of tech companies admitted to struggling to link their growth strategy with a “wider societal purpose”.

This is where the investor comes in, Poulson tells ESG Investor, as tech companies continue to be included in ESG funds and portfolios, often contributing significantly to performance.

“After all, the closest thing to democracy in tech companies is the shareholders’ ability to vote at the annual general meetings (AGMs),” he says.

Poor social performance due to governance structure

Big Tech stocks, although some of the best performing in the tech sector market, don’t stand up well against ESG values, according to Neville White, Head of RI Policy and Research at EdenTree Investment Management.

“At present, only Alphabet has been approved for investment in [EdenTree’s] screened funds, with Facebook, Apple and Amazon excluded owing to multiple ethical concerns,” he says.

White cites issues in company behaviour and policy, such as “data misuse” by Facebook, Apple’s supply chain management record – including serious allegations of “poor working conditions and child labour” – and Amazon’s “aggressive tax avoidance”.

“Governance structures are viewed as particularly weak,” he adds. “Ordinary shareholders are discriminated against via the dual share structure that gives the majority of voting power to executives.”

Facebook Co-Founder and CEO Mark Zuckerberg has implemented a dual-class structure, meaning individual and institutional shareholders with Class A shares have one vote per share, compared to Class B shares where one share equals 10 votes.

According to Forbes, Zuckerberg owned as much as 75% of Facebook’s Class B shares in 2019, meaning he controlled 58% of Facebook’s vote. As of March 2020, Zuckerberg owned 29.3% of Facebook’s Class A shares.

This system makes it almost impossible for shareholders to use the main weapon in their arsenal to persuade powerful tech executives like Zuckerberg into decisions they don’t want to make.

Investors left on read 

Investors rely on annual meetings to ask difficult questions and vote against policies they don’t agree with. But holding high-ups to account in tech firms is no easy feat.

It’s hard for an investor to inspire change if there’s less access to the board, says Ashley Hamilton Claxton, Head of Responsible Investment at Royal London Asset Management (RLAM).

“A lot of tech companies have tricky governance structures with various protection mechanisms that shield management from the influence of shareholders,” she explains. “Less access to the board means the board doesn’t have to be held so accountable by the institutional shareholders. Retail shareholders scarcely get a look-in.”

Investors must push harder, Richardson argues. “In the short- to medium-term, investors need to engage with Big Tech firms on issues surrounding transparency and governance. There also needs to be a constructive conversation between investors, users and democratically-elected governments about where the guardrails should be so that we can move to a more sustainable set of business models that genuinely add value.”

Hamilton Claxton says knowledge gaps make it difficult for investors and regulators to “keep up” with tech firms.

If Big Tech is hiring the very people who best understand the complexities of collating, analysing and using data, for example, there are knock-on consequences for those trying to hold them accountable if their practices breach ethical boundaries. “It’s a resource mismatch issue,” she says.

Investors are constantly playing catch-up. “It takes time to get enough expertise to be able to ask the right questions, and companies are very prone to answering in very general terms,” agrees Michaela Zhirova, Head of Research and Products for Responsible Investments at Nordea Asset Management.

Poulson notes that more widely reporting on tech AGMs may help investors hold Big Tech more accountable.

Tax avoidance is a “game of whack-a-mole”

Tax is a significant investor concern. Corporate taxation accrued from Big Tech could help drive sustainable development, says Vaishnavi Ravishankar, Senior ESG Analyst for the Principles for Responsible Investment (PRI).

“Companies in the tech sector tend to have quite high exposure to tax risks in their business models,” Ravishankar adds. “What we’ve seen is a heavy reliance on low-tax jurisdictions. The level of transparency and accountability on tax issues from the technology sector is really quite dismal.”

This was emphasised by findings from the PRI’s ‘Advancing Tax Transparency’ report, which aimed to identify common issues within tax practices and better improve tax policy, governance and financial reporting by corporates across sectors. Assessed 2017-2019, eight companies refused to provide any information on the topic at all: Align Technology, Alphabet, Amazon, Cisco Systems, Danaher Corporation, Facebook, Sage Group and Intuitive Surgical.

“In the past, companies have resorted to the argument that aggressive tax planning actually drives up profits and is therefore benefiting shareholders, but that’s no longer a defendable argument,” Ravishankar says. “Investors are waking up to the damage this sort of corporate profitability causes.”

Hamilton Claxton likened identifying tax minimising tactics to “a game of whack-a-mole”, admitting it’s ultimately incredibly difficult for regulators to implement an effective framework standard.

Microsoft is often rated “best in class” because of its human rights policy and pledge to be carbon negative by 2030 – and therefore a seemingly attractive option for ESG-conscious investors – but it has achieved tax rate of 16% over the past eight years, Vincent Deluard, Global Macro Strategist at brokerage StoneX, told The Financial Times.

Research by Tech Inquiry into more than 1,000 10-K filings and proxy statements from 57 US tech companies to the Securities and Exchange Commission (SEC) showed that an alarming number had effective tax rates of less than the 21% minimum demanded by the Tax Cuts and Jobs Act (TCJA) – including Big Tech corporates. Yet the median US citizen has a total federal, state and local effective taxation rate of around 26%, Tech Inquiry noted.

To combat poor tax performance, GRI launched its Tax Standard (GRI 207), which came into effect for reporting from 2021. It supports global public disclosures of a company’s business activities and tax payments on a country-by-country basis. Van de Wijs encourages investors in tech companies to ask firms to disclose their tax payments in line with this standard.

“Tax is a highly relevant issue as it’s a key indicator of a company’s support for a sustainable future,” he says. “How much, and where, Big Tech pay their taxes goes a long way towards evidencing their contributions in the countries in which they operate. Investors should require country-by-country tax reporting in order to assess these practices, holding to them account if they fall short.”

So far, none of the Big Tech firms have adopted this standard, van de Wijs points out.

Policymakers are beginning to push policy changes forward. In February, US Treasury Secretary Janet Yellen announced the withdrawal of the US 2019 safe harbour proposal, seemingly adding the US’s voice to calls for a global tax on tech. Furthermore, in December last year, the EU threatened to break up companies that repeatedly engage in anti-competitive behaviour (such as tax evasion) with the issuance of a draft Digital Markets Act. The Act would force tech companies to pay up to 10% of their global revenues if they break the rules.

“The bottom line is that companies are proving unresponsive to opening a dialogue on tax issues, and it’s difficult for investors to elicit any kind of response without a tougher strategy and escalation response,” Ravishankar says.

Whistleblowing and the ethics of NDAs

Strong whistleblowing policies are an indicator of good governance, the PRI noted in a report on the topic last year.

Outlining best practices for investors engaging with corporates on this issue, PRI said that any company that has not engaged with the topic or made progress in establishing a whistleblowing policy within one year of being asked to do so should be subject to “votes against the relevant board director (e.g. the chair of the audit or risk committee)”.

However, employees working for organisations that handle confidential information are often asked to sign a non-disclosure agreement, which may prevent them from coming forward with information investors should know about.

This is something Poulson understands first-hand.

“There’s a lack of public appreciation of the chilling impact NDAs can have on disclosing information that’s in the public’s – and the investor’s – best interests,” he says. “It puts even more pressure on employees who want to come forward about unethical practices they have witnessed or experienced. They’re likely already giving up their job and therefore forfeiting their income. They shouldn’t have to face the added pressure of being sued.”

There are existing protections in place for employees working for EU companies, for example, under the EU Whistleblowing Directive which requires companies with more than 50 employees (or an annual turnover of at least €10 million) to implement effective internal reporting channels that protect employees from these kinds of repercussions. However, investors shouldn’t be complacent.

“At a minimum, investors should be calling on policymakers to better define what kinds of information disclosed by whistleblowers would technically violate the terms of an NDA,” Poulson argues. “More clearly defining what issues are considered to be in the public interest would be a big step towards preventing companies from threatening to sue employees who have signed NDAs without having the legal grounds to do so.”

As called for in the PRI report, investors should ascertain that investee companies provide whistleblowers with “immunity from any form of retaliation – direct or veiled – in the workplace”.

Can leopards change their spots? 

KPMG’s report also revealed that 86% of the 800 surveyed global tech leaders believe that the sector does require more regulation and standards in the area of sustainability.

“Right now, there are no clear-cut guidelines as to what’s good and what’s bad practice in tech,” Hamilton Claxton says. “Investors are having to make a judgement call as to what their ethical boundaries are.”

Until now, Big Tech has been given the regulatory freedom to innovate and grow. Their advances in cloud computing and artificial intelligence could play a huge role as we transition to a sustainable future and build a green economy.

This mix of technological innovation and lax regulation has melded unsustainable and unethical practices into Big Tech business models, says Richardson.

“In the early days of Big Tech, contradictions within their business models were tolerated because we were all learning about the sector together. But now we’ve got to the point where those contradictions are causing real problems.”

Since 2018, with the implementation of the General Data Protection Regulation (GDPR), Zhirova argues that “we are moving in the right direction”.

“Regulators have certainly started to understand the stakes regarding tax and anti-trust issues,” she says.

Big Tech firms are increasingly finding themselves under the investor’s and consumer’s microscope, too. What they have been allowed to do in the past may not have been illegal, but it doesn’t fit with users’ expectations of ethical standards, Richardson explains.

“You have to ask yourself if the leopard can change its spots or if the spots are in the nature of the leopard. It’s an issue that’s engrained in how the average tech business model seems to function,” he adds.

“Policymakers are now having to play catch up,” van de Wijs agrees. “The solution lies somewhere between voluntary reporting on ESG-related impacts and stricter regulatory changes that level the playing field through mandatory disclosure.”

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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