Sudan Divestment: U.S. Investors Sold Assets but Could Benefit from Additional Information about Companies' Ties to Sudan
Published: 2010-11-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Recognizing the humanitarian crisis in Darfur, Sudan, Congress enacted the Sudan Accountability and Divestment Act (SADA) in 2007. This law supports U.S. states' and investment companies' decisions to divest from companies with certain business ties to Sudan. It also seeks to prohibit federal contracting with these companies. This testimony (1) identifies actions that U.S. state fund managers and investment companies took regarding Sudan-related assets, (2) describes the factors that these entities considered in determining whether and how to divest, and (3) determines whether the U.S. government has contracted with companies identified as having certain Sudan-related business operations and assesses compliance with SADA's federal contract prohibition provision. This testimony is based on a GAO report (GAO-10-742), for which GAO surveyed states, analyzed investment data, assessed federal contracts, and interviewed government officials.
section_title: What GAO Found
paragraphs: Since 2006, U.S. state treasurers and public pension fund managers have divested or frozen about $3.5 billion in assets primarily related to Sudan in response to their states' laws and policies; U.S. investment companies, which also sold Sudan-related assets, most commonly cited normal business reasons for changes in their holdings. State fund managers GAO surveyed indicated that their primary reason for divesting or freezing Sudan-related assets was to comply with their states' laws or policies. Thirty-five U.S. states have enacted legislation or adopted policies affecting their investments related to Sudan, primarily in response to the Darfur crisis and Sudan's designation by the U.S. government as a state sponsor of terrorism. GAO also found that the value of U.S. shares invested in six key foreign companies with Sudan-related business operations declined by almost 60 percent from March 2007 to December 2009. The decline cannot be accounted for solely by lower stock prices for these companies, indicating that U.S. investors, on net, decided to sell shares in these companies. Investors indicated that they bought and sold Sudan-related assets for normal business reasons, such as maximizing shareholder value. U.S. states and investment companies have often considered three factors when determining whether and how to divest. First, they have considered whether divesting from Sudan is consistent with fiduciary responsibility--generally the duty to act solely and prudently in the interest of a beneficiary or plan participant. Second, they have considered the difficulty in identifying authoritative and consistent information about companies with Sudan-related business operations. GAO analyzed three available lists of these companies and found that they differed significantly from one another. Although information directly provided by companies through public documents, such as Securities and Exchange Commission (SEC) disclosures, is a particularly reliable source of information, federal securities laws do not require companies specifically to disclose business operations in state sponsors of terrorism. The SEC has the discretionary authority to adopt a specific disclosure requirement for this information but has not exercised this authority. Third, investors have considered the effect that divestment might have on operating companies with Sudan-related business activities, such as prompting companies interested in promoting social responsibility to leave Sudan, creating room for companies that do not share that interest to enter the Sudanese market. GAO's analysis, including a review of a nonrandom selection of contracts, indicates that the U.S. government has complied with SADA's contract prohibition provision. Specifically, the U.S. government has contracted with only one company identified on a widely used list of companies with business ties to Sudan, and the contracts awarded to this company did not violate SADA. The U.S. government has contracted with subsidiaries and affiliates of companies with business ties to Sudan, as SADA permits. The related GAO report recommends that the SEC consider issuing a rule requiring companies that trade on U.S. exchanges to disclose their business operations tied to Sudan, as well as possibly other state sponsors of terrorism. The SEC's Division of Corporation Finance agreed to present GAO's recommendation to the commission.

section_title: Letter
paragraphs: I am pleased to be here to discuss our work regarding the Sudan  Accountability and Divestment Act (SADA). Sudan has long been a source  of concern for the U.S. government both because of its support for acts of  international terrorism and its campaign of genocide in the Darfur region.  Congress enacted SADA in 2007 to support U.S. states’ decisions to divest  from foreign companies conducting specific business operations in Sudan  in four economic sectors—power production, mineral extraction, oil- related activities, and production of military equipment—and to give  investment companies that divest from these companies “safe harbor”  from certain lawsuits. The act also contains a contract prohibition clause,  which requires all U.S. government agencies to ensure that each contract  entered into for the procurement of goods or services includes a clause  requiring the contractor to certify that it does not conduct certain business  operations in Sudan in the four key economic sectors.
My testimony summarizes our June 2010 report. As requested, in this  report we (1) identify actions that U.S. state treasurers and public pension  fund managers and U.S.-based investment companies have taken regarding  their Sudan-related assets and attempt to determine the reasons for these  actions, (2) describe the factors that these entities considered in  determining whether and how to divest, and (3) determine whether the  U.S. government has contracted with companies identified as having  certain Sudan-related business operations and assess compliance with  SADA’s federal contract prohibition provision.
For our report, we conducted a survey of treasurers and public pension  fund managers (hereafter referred to as “state fund managers”) in all 50  states and the District of Columbia. Ninety-one percent (or 138 of 151) of  the fund managers we contacted responded to our survey, with at least 1  fund manager from each of the 51 states providing a response. We also  reviewed state laws and policies regarding investment of their Sudan- related assets and interviewed various advocacy organizations. To identify  the actions that investment companies took regarding their Sudan-related  assets, we selected six key foreign companies that have operations in  Sudan’s oil sector and then used shareholder ownership and market data  to analyze U.S. investment companies’ holdings in these companies over  time. We also interviewed investment companies regarding Sudan-related  assets, as well as eight primarily European foreign operating companies  that have or used to have Sudan-related business operations. Because the  Securities and Exchange Commission (SEC) is responsible for overseeing  the federal securities laws and, through its Office of Global Security Risk,  for monitoring operating companies’ disclosure of material business  activities in or ties to state sponsors of terrorism, we reviewed documents  and interviewed officials from this agency. We also interviewed officials  from the Department of State, which oversees U.S. foreign policy toward  Sudan, and the Department of the Treasury, which administers and  enforces U.S. sanctions against Sudan. Finally, we searched the Federal  Procurement Data System—Next Generation to determine whether the  U.S. government awarded federal contracts to foreign companies  identified as having business ties to Sudan, as well as to some of their  subsidiaries and affiliates. We selected the highest dollar amount contract  or contract modification for each of the companies we identified and  reviewed the contract solicitation or other relevant documentation for  presence of the applicable Sudan-related certification clause, if required.  We also reviewed federal rules related to the contract prohibition  provision of SADA and interviewed officials at the Office of Management  and Budget.
In preparing this testimony, we relied on our work supporting the  accompanying report. That report contains a detailed overview of our  scope and methodology. All of our work for this testimony was performed  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: U.S. State Fund Managers and Investment Companies Have Sold Sudan-Related Assets for Varying Reasons
paragraphs: We found that several states have divested or frozen assets primarily  related to Sudan and that the value of U.S. investment companies’ Sudan- related asset holdings has declined considerably since March 2007. Our  survey responses show that state fund managers have divested or frozen  about $3.5 billion in assets primarily related to Sudan (see table 1).  Specifically, fund managers from 23 of the states responding to our survey  reported that, from 2006 to January 2010, they divested or froze about $3.5  billion in assets held in 67 operating companies they identified as related  either to Sudan specifically or to a larger category of divestment targets,  such as state sponsors of terrorism.
All of the states that reported having divested or frozen Sudan-related  assets had laws or policies regarding their Sudan-related assets, and the  state fund managers who responded to our survey cited compliance with  these laws and policies as their primary reason for divestment. Thirty-five  U.S. states have enacted legislation, adopted policies, or both, affecting  their Sudan-related investments. These 35 states did so often out of  concern for the genocide in Darfur, as well as some concerns about  terrorism. Their laws and policies vary in the specificity with which they  address the sale and purchase of Sudan-related assets. For example, most  states with laws and policies requiring divestment also prohibit or restrict  future investments in Sudan-related companies. However, some laws and  policies only mention prohibiting future investments but do not require  divestment of Sudan-related investments held prior to enactment of the  measures. In addition to divestment, many state laws and policies also  mandate or encourage engagement—identifying companies and leveraging  power as a shareholder or potential shareholder in an effort to change the  investment or operating behavior of that company.
Like the states, U.S.-based investment companies have sold Sudan-related  shares. Specifically, our analysis shows that the value of U.S. holdings in  six key foreign companies with Sudan-related business operations fell  from $14.4 billion at the end of March 2007 to $5.9 billion at the end of  December 2009, a decline of nearly 60 percent. This decline cannot be  accounted for solely by changes in share price, indicating that U.S.  investors, on net, chose to sell shares of these companies. Based on a price  index weighted to the U.S. portfolio of Sudan-related equities, prices rose  by roughly 7 percent from March 2007 to December 2009, while equity  holdings fell by nearly 60 percent (see fig. 1). This suggests that net selling  of Sudan-related equities explains the majority of the decline in U.S.  holdings. It is not certain if this selling is related to conditions specific to  Sudan or represents a more general reallocation of assets by U.S.  investors. Nevertheless, some evidence suggests that Sudan-specific  factors may have influenced investors’ decisions to sell. Specifically, from  December 2007 to December 2008, U.S. holdings in Sudan-related equities  declined as a percentage of foreign oil and gas equity holdings and as a  percentage of all foreign equity holdings.
Investors said they weighed various factors in their decisions regarding  Sudan-related assets. Most commonly, investors stated that they bought  and sold Sudan-related assets for normal business reasons, such as  maximizing shareholder value consistent with the guidelines in each fund’s  prospectus, as well as in response to specific client instructions. Each of  the investment companies we interviewed issued a corporate statement  regarding Sudan-related investing, and these corporate statements reflect  a variety of investor perspectives. For example, one firm’s statement  indicated that it would ensure that its funds did not invest in companies  materially involved in Sudan, while another’s explained that it would  remain invested in these companies in order to actively oppose their  practices that it did not condone.
section_title: U.S. Investors Have Often Considered Three Factors When Determining Whether and How to Divest from Companies Tied to Sudan
paragraphs: We found that U.S. investors have often considered three factors when  determining whether and how to divest from companies tied to Sudan:  fiduciary responsibility, the difficulty identifying operating companies with  ties to Sudan, and the possible effects of divestment on operating  companies and the Sudanese people.
subsections: section_title: Fiduciary Responsibility
paragraphs: Both state fund managers and private investment companies we contacted  told us that they consider whether a decision to divest Sudan-related  assets is consistent with fiduciary responsibility—generally the duty to act  solely and prudently in the best interests of the client. Representatives  from organizations that advocate for the interests of state fund managers  told us that fiduciary duty could be a disincentive to divesting, depending  on how each individual state’s law is written. For instance, they expressed  concerns that if the laws place emphasis on maximizing returns first and  on divesting as a second priority, then fiduciary responsibility can be a  disincentive to divesting. While some states make no explicit mention of  fiduciary responsibility in their divestment policies and laws, some state  constitutions emphasize its priority above all other responsibilities. Many  state laws allow fund managers to stop divesting or to reinvest if there is a  drop in the fund’s value. In addition, while most of the 35 states’ Sudan- related measures generally require divestment of Sudan-related assets  consistent with the investing authority’s fiduciary responsibilities, laws  and policies in six states include clauses explicitly stating that the  investing authority should only divest if doing so will not constitute a  breach of fiduciary trust.
Our survey results demonstrate that state fund managers, when expressing  concerns about fiduciary responsibility, focused on the impact that  divestment might have on a fund’s returns and administrative costs.  Specifically, 17 of the 29 fund managers (or 59 percent) who had divested  or frozen their Sudan-related assets, or planned to do so, said they were  concerned to a moderate or large extent that it would be difficult to divest  while ensuring that fiduciary trust requirements were not breached, and  their offices or states were not made vulnerable to lawsuits. This same  concern was also cited as a moderate to large concern for 25 of the 41 (or  61 percent) fund managers who did not divest. Survey results also showed  concern among state fund managers, regardless of whether they divested,  regarding the financial risk of divesting. Specifically, 20 of the 29 managers  (or 69 percent) who divested or planned to divest and 18 of the 41 (or 44  percent) who did not divest were concerned to a large or moderate extent  that divestment could cause their funds to incur high transaction costs,  earn reduced returns on investment, or both.
Private investment companies expressed differing perspectives on  whether divesting from Sudan is consistent with their fiduciary  responsibilities. According to investment companies whose primary goal is  maximizing returns, ceasing to invest in companies with Sudan-related  operations based on criteria other than financial merit is inconsistent with  their fiduciary responsibilities, unless their clients established these  restrictions. Some of these investors stated that limiting the number of  investment opportunities based on nonfinancial criteria can result in lower  investment returns. Other investment companies, particularly those  identifying themselves as socially responsible, maintain that divesting  from Sudan based on nonfinancial criteria is consistent with fiduciary  responsibility, as long as alternative equities selected can compete on the  basis of financial criteria. For these investment companies, creating  financially viable investment options that respond to social concerns, such  as genocide or the environment, is the primary goal. These firms  expressed confidence that taking nonfinancial factors into account results  in an investment product that is competitive with other investments.
As of May 2010, two companies that sold their Sudan-related assets had  relied upon the safe harbor provision in SADA. Most companies told us  that the provision was not necessary to their decision-making regarding  Sudan-related assets.
section_title: Difficulty Identifying Operating Companies with Ties to Sudan, Including Those Monitored by the SEC
paragraphs: Investors considering whether and how to divest from companies with ties  to Sudan have faced difficulties identifying these companies. SADA  requires that, before divesting from Sudan-related companies, responsible  entities must use credible, publicly available information to identify which  companies have prohibited business operations related to Sudan.  Nongovernmental organizations and private companies have sought to  create and, in some cases, sell their lists of operating companies with  business ties to Sudan to the public. Our survey results indicate that state  fund managers have relied heavily on these sources of information.  However, our analysis of available lists indicates that they differ  significantly from one another. We compared three lists of companies with  business ties to Sudan and found that, of the over 250 companies identified  on one or more of these lists, only 15 appeared on all three.
Representatives from the organizations that created these lists told us that  obtaining and evaluating information on operating companies with  business ties to Sudan is difficult, and that information that comes directly  from companies is particularly useful. For example, they would consider  an SEC disclosure filing to be a reliable source of information. However,  the federal securities laws do not require companies specifically to  disclose operations in countries designated as state sponsors of terrorism.  While SEC regulations require disclosure of such operations if they  constitute “material information,” the meaning of “material information” is  not explicitly defined by law and companies are ultimately responsible for  the accuracy and adequacy of the information they disclose to investors.
The SEC’s Office of Global Security Risk, created in 2004, monitors  whether the documents public companies file with the SEC include  disclosure of material information regarding global security risk-related  issues. According to officials from this office, they focus their reviews on  companies with business activities in U.S.-designated state sponsors of  terrorism, including Sudan. This office has suggested to companies that  any operations they have in state sponsors of terrorism might be  considered material because divestment campaigns and legislation  mandating divestment from Sudan indicate that investors would consider  this information important in making investment decisions. However, in  their correspondence with the SEC, companies have raised concerns  about these instructions. For example, one energy company wrote that its  business dealings in state sponsors of terrorism did not need to be further  disclosed in annual reports because, while these dealings may have been  of interest to certain investors, they were not material to the general  investing public.
The Office of Global Security Risk provides limited monitoring of  companies that conduct business in the four sectors covered under SADA.  For example, SEC officials told us that they have corresponded with 59 of  the 74 companies that file periodic reports with the SEC, and that they  have identified as having ties to Sudan. However, many of these  companies operate in industries not covered under SADA, such as food  services, telecommunications, and pharmaceuticals. In addition, our  analysis shows that the office has only corresponded with 5 of the 15  companies that are identified in all three of the lists we analyzed and that  file with the SEC. All 15 of these companies operate in the four economic  sectors identified in SADA. Furthermore, the office has not always  followed up with companies concerning their correspondence. For  example, in December 2005, the Office of Global Security Risk asked an oil  company that was reported to have possible ties to Sudan to describe all  current, historical, and anticipated operations in, and contacts with,  Sudan, including through subsidiaries, controlling shareholders, affiliates,  joint ventures, and other direct and indirect arrangements. The company  did not provide a response to the request. Four years later, the office  reiterated its question to the company.
SEC officials also told us that, in cases where the office determines that its  comment process has not resulted in full disclosure of material operations  by a company, it will refer the company to the SEC’s Division of  Enforcement for possible investigation. According to these officials, the  Office of Global Security Risk has referred one company to this division  since the office was created in 2004. The SEC also has the discretionary  authority to adopt a specific disclosure requirement for companies that  trade on U.S. exchanges (such as requiring disclosure of any operations in  state sponsors of terrorism). Although the SEC has not done so, it could  exercise this authority by issuing an interim rule for comment and a final  rule in the Federal Register. However, the agency has indicated that it is  committed to the practice of relying on companies to ensure that their  disclosures contain all material information about their operations in these  countries.
section_title: The Possible Effects of Divestment on Operating Companies and the Sudanese People
paragraphs: Some companies that have ceased operating in Sudan warned of a  negative effect on the Sudanese people. For example, one company we  spoke with told us that when it decided to leave Sudan and sell its stake in  a project to another company, that company refused to sign the sales  agreement until language conferring responsibility for continuing the  seller’s humanitarian programs was removed from the agreement. Another  company that left the Sudanese market stated that it had been involved in  a nationwide anti-AIDS program in Sudan, which it could no longer  participate in after leaving Sudan.
Because of concerns about these possible negative effects, some investors  have shifted their approach toward engaging with companies in order to  leverage their resources as shareholders to influence companies’ behavior  and promote efforts aimed at improving the lives of the Sudanese people.  Some advocacy groups that were originally at the forefront of the  divestment campaign also have shifted their focus toward engagement.  One advocacy group we spoke with stated that it believed that divestment  was too blunt of an approach because it targeted a wide array of  companies, some of which may not have had material operations in Sudan.  Instead, this group argued for an approach that targets companies  involved in the industries that are most lucrative for the Sudanese  government and that provides alternatives to divestment, such as engaging  companies to try to influence their behavior. Like advocacy groups, some  U.S. investment companies have also embraced the idea of engagement,  and increasingly view divestment as a last resort because engagement  allows companies to continue operating and provides positive incentives  for them to use their resources to help the Sudanese people. U.S. states  have also endorsed engagement as a viable alternative to divestment, with  a few states identifying divestment only as a last resort. Nineteen of the 25  states whose laws or policies require divestment also encourage or require  engagement.
The eight foreign operating companies we spoke with generally agreed  that, for them, engagement is preferable to divestment because it allows  them to continue operating in Sudan and to discuss possible ways to  improve the situation there. These companies consistently told us that  they believe their business operations positively impact the Sudanese  people. For example, a mining company told us that it built seven schools  and a medical clinic, brought water and power supplies to the area around  the mine, and started agricultural training programs for the local  population. This company said it also convinced its business partners from  the Sudanese government to contribute some of their profits from the  mine to support a humanitarian organization operating in Darfur. Almost  all of the companies we spoke with said they donated to or became  directly involved in humanitarian projects as a direct result of their  engagement with various advocacy groups and shareholders. A few of the  companies we spoke with decided to limit their business activities in  Sudan as a result of engagement processes. For example, one company we  spoke with committed to not pursue any new business in Sudan until the  situation in Darfur changes and United Nations peacekeepers are allowed  in the country. The company indicated that this commitment sent a strong  signal to the government of Sudan, which depends on the company to  explore and identify natural resource deposits.
section_title: Our Analysis Indicates That the U.S. Government Has Complied with the Federal Contract Prohibition Provision of SADA
paragraphs: Our analysis indicates that the U.S. government has complied with SADA’s  federal contract prohibition. Specifically, we found no evidence to suggest  that the U.S. government has awarded contracts to companies identified as  having prohibited business operations in Sudan or has violated the Federal  Acquisition Regulation (FAR) rules implementing section 6 of SADA  (Prohibition on United States Government Contracts). SADA seeks to  prohibit the U.S. government from contracting with companies that  conduct certain business operations in Sudan. To that end, section 6 of the  act requires the heads of federal agencies to ensure that each contract for  the procurement of goods or services includes a clause requiring the  contractor to certify that it does not conduct prohibited business  operations in Sudan in the four key economic sectors. Based on our  analysis of one of the most widely used lists of companies with prohibited  business ties to Sudan, we found that only 1 of 88 companies identified in  the list has received federal contracts since the FAR requirements  implementing SADA took effect in June 2008. However, the contract  certification provision was not required for these particular contracts  because they were purchase orders under simplified acquisition  procedures, which generally do not require SADA certification under the  FAR.
In addition to the purchase orders with this company, we found that from  June 12, 2008 to March 1, 2010, the U.S. government awarded 756  contracts to 29 affiliates and subsidiaries of the companies identified in  the list as having prohibited business ties to Sudan. While SADA aims to  prevent companies with prohibited business operations in Sudan from  receiving federal contracts, it does not restrict federal contracting with  these companies’ affiliates and subsidiaries, provided that the affiliates  and subsidiaries certify that they do not have prohibited business  operations in Sudan. Some advocacy groups have disagreed with the FAR  councils’ decision to apply the requirement only to the entity directly  contracting with the government because it allows companies that have  certified to the federal government that they do not conduct prohibited  business operations to continue operating in Sudan through their  subsidiaries or affiliates. The FAR councils, however, stated that  expanding the scope of the rule to include subsidiaries and affiliates would  require the parties seeking federal contracts to attest to the business  operations of parent companies, subsidiaries, and other affiliates about  which they may not have information. In addition, the FAR councils noted  that the company may not have any influence over the affairs of its related  companies. Our review of a nonrandom selection of contracts awarded to  these affiliates and subsidiaries indicates that the contractors provided the  necessary certification, when required. Therefore, for these specific  contracts, the U.S. government has complied with the contract prohibition  section of SADA. We also found that the U.S. government has not granted  any waivers pursuant to SADA, as allowed under the act, or determined  that any companies submitted false certifications under SADA.
section_title: Conclusions
paragraphs: As global awareness of the genocide in Darfur has grown, so too have  efforts to combat this humanitarian crisis. Divestment from Sudan has  been at the forefront of these efforts. However, in deciding whether and  how to divest, stakeholders must consider how divestment affects foreign  companies operating in Sudan, particularly those that strive to make a  positive contribution to the Sudanese people. They must also ensure that  divestment is consistent with their fiduciary responsibility. Additionally,  they must identify and evaluate conflicting sources of information about  which companies have Sudan-related business operations. Requiring  companies to disclose their own operations in Sudan (as well as other  state sponsors of terrorism) would provide more accurate and transparent  information to investors carefully weighing whether and how to divest  from Sudan. Furthermore, the strong demand for this information from  states that require divestment, as well as from other investors, indicates  that this information could be considered material—a judgment that the  SEC has suggested in its correspondence with operating companies.
section_title: GAO Recommends That SEC Consider More Complete Disclosure by Companies with Business Operations Related to Sudan
paragraphs: In our report released today, we recommend that, in order to enhance the  investing public’s access to information needed to make well-informed  decisions when determining whether and how to divest Sudan-related  assets, the SEC consider issuing a rule requiring companies that trade on  U.S. exchanges to disclose their business operations related to Sudan, as  well as possibly other U.S.-designated state sponsors of terrorism.
Mr. Chairman, this concludes my statement. I would be pleased to respond  to any questions that you or other Members of the Subcommittee may  have.
section_title: GAO Contact and Staff Acknowledgments
paragraphs: For questions or further information about this testimony, please contact  Thomas Melito at (202) 512-9601, or melitot@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found on  the last page of this statement. Individuals who made key contributions to  this testimony include Cheryl Goodman, Assistant Director; Elizabeth  Singer; Kay Halpern; Katy Forsyth; Michael Hoffman; R.G. Steinman; Julia  Becker Vieweg; Sada Aksartova; Debbie Chung; JoAnna Berry; Noah  Bleicher; Martin de Alteriis; Patrick Dynes; Justin Fisher; Cathy Hurley;  Ernie Jackson; Debra Johnson; Julia Kennon; Jill Lacey; and Linda Rego.
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