Abstract

Excerpted From: Alvin Velazquez, Making Racial Equity Audits Effective, 99 Chicago-Kent Law Review 123 (2024) (136 Footnotes) (Full Document)

Do corporate racial equity audits (REAs) work as a tool for reducing a company's contribution to systemic racism and address its impacts? For years, scholars have grappled with the problem of racialized harm in America's corporations. Usually, they have framed discourse concerning race within related, and at times intertwined, debates. The first debate that scholars engaged in concerned whether corporate boards should focus on shareholder value maximization or stakeholder value maximization. The second related scholarly debate focused on whether corporations should voluntarily focus on meeting Environmental, Social, and Governance (ESG) goals, or simply leave the pursuit of such goals to government regulation. To the extent that companies targeted racial equity, they did so primarily through internal Diversity, Equity, and Inclusion (DEI) initiatives and corporate philanthropy. The concept of racial equity audits (REAs) entered the corporate governance lexicon as early as 2016 when Airbnb conducted an audit in response to allegations regarding how its platform facilitated racially discriminatory conduct against guests by its hosts. As defined in a recent article on the Harvard Law School Forum on Corporate Governance, “[a] Racial Equity Audit is, at its core, an independent, objective and holistic analysis of a company's policies, practices, products, services and efforts to combat systemic racism in order to end discrimination within or exhibited by the company with respect to its customers, suppliers or other stakeholders.” REAs respond to calls for the establishment of an ESG process that goes deeper than simply an audit that ensures a company does not violate civil rights laws, though REAs do that as well. That very definition of a REA implies both what is at stake and how to succeed. A properly designed REA has to be conducted by a truly independent entity with the expertise to carry out an objective and holistic analysis. If done in this way, the REA has the potential to be a powerful, private ordering tool that provides the company with clear steps to combat the downward drag of structural racism for both shareholders and stakeholders. A poorly designed, scoped, and executed REA conducted without the requisite independence simply wastes company resources. Despite these stakes, boards of directors, corporate governance practitioners, and institutional funds generally focused on using other internal DEI tools to address race related issues.

The true push to have a company conduct a REA came from a galvanizing moment, on May 25, 2020, when police murdered George Floyd. George Floyd's murder took conversations about DEI and ESG out of academic journals and put them into corporate boardrooms and onto the street. While this clamor for justice boiled from below, institutional shareholders voiced concerns about racism and its effect on long-term outcomes. For example, Larry Fink, CEO of BlackRock stated that “[a]s a firm committed to racial equality, we must also consider where racial disparity exists in our own organizations and not tolerate our shortcomings.” Labor affiliated funds and other institutional investors started filing shareholder resolutions at a number of companies. Even in this moment, though, some companies such as Amazon, Johnson & Johnson, Citigroup, and JP Morgan Chase resisted them by seeking their exclusion on the proxy under SEC Rule 14a-8. Eventually, a breakthrough occurred when BlackRock broke the ice by agreeing to implement a proposal sponsored by the SEIU's Master Trust to conduct a REA. The “resolved” language of the BlackRock REA audit resolution contained similar language to other requests. It read:

RESOLVED that shareholders of BlackRock Inc. (“BlackRock”) urge the Board of Directors to oversee a racial equity audit analyzing BlackRock's impacts on nonwhite stakeholders and communities of color. Input from civil rights organizations, employees, and clients should be considered in determining the specific matters to be analyzed. A report on the audit, prepared at reasonable cost and omitting confidential and proprietary information, should be publicly disclosed on BlackRock's website.

This Article's central proposition is that the best way to ensure that REAs will succeed over the long term is for them to be conducted by truly independent auditors who act as “watchdogs” of the public good, as defined by the Supreme Court in United States v. Arthur Young & Co., and who are not financially dependent on the company for other lines of business in the future. Shareholder resolutions calling for a REA tend to utilize fairly standardized language. Despite the common language calling for a REA, there are no set of clear and consistent standards for executing a REA. This Article resolves that tension by borrowing from various auditing standards of independence to construct a definition of independence that corporations should apply when looking for a firm to conduct an audit, whether they be a law firm or accounting firm.

Currently, there is scant work examining or setting out standards for a REA in law review literature, with the exception of Professor Alicia Plerhoples's article, ESG & Anti-Black Racism. In the article, she argues that the SEC should replicate the European Union's efforts in overseeing accounting and auditing standard setting just as it uses the Public Company Accounting Oversight Board (PCAOB). In that way, companies could use a variety of methodologies that best fit them, and the SEC would move to ensure that such firms act with integrity and are truly independent. Others in the popular press and academic press have also raised audit design and oversight questions. The question of who is going to check the corporations conducting a REA is core to ensuring not only that the audits are effective, but that they meet their promise of being a tool for eradicating structural racism's pernicious effects in corporate life.

This Article's contribution to the Symposium will proceed in the following manner. Part I will outline how the development of an appropriate definition for the term “independence” depends on harnessing insights from corporate governance and critical race theories. Part II will make the descriptive claim that REAs allow boards of directors to meet their Caremark obligations. Part III will outline the tension between legal ethics and accounting ethics, and argue for the application of accounting rules of independence while eliminating patronage pathways. Part III will also briefly present some case studies to examine how independence, or lack thereof, affects the effectiveness of the REA at various companies, and then conclude.

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REAs hold great promise for examining the ways that publicly traded companies can harm racial minorities both as employers and stakeholders. In order for them to meet their theoretical potential as a tool that can address systemic racism using current corporate governance models, companies will have to ensure that they obtain independent auditors. This Article proposed the construction of an ethical framework that borrows from both auditing ethics and legal ethics to ensure that independent auditors are conducting the audits. Ensuring independence will not only ensure that the audits will provide strong findings and audit recommendations that boards of directors can implement, but it will also provide boards with protection under the business judgment rule so that they can implement them.

Alvin Velazquez, Associate Professor, Indiana University Maurer School of Law, and outgoing Associate General Counsel for the Service Employees International Union (SEIU).