Inside luxury goods' broken audit system

AZ Operations, a sub-contractor of Manufactures Dior tasked with the production of leather items and based near Italy's fashion capital Milan, was accused by Italian prosecutors in June of being a front for an operation that exploited workers.

However, AZ Operations passed two environmental and social inspections in 2023, in January and July, according to unpublished audit documents reviewed by Reuters.

Widespread Milan investigations have uncovered malpractice inside the Italian luxury goods supply chain of Dior, Giorgio Armani and Alviero Martini this year, Reuters has previously reported.

The audit papers, along with court documents, Reuters interviews with more than two dozen luxury sector workers, auditors, supply chain managers, suppliers, lawyers, industry experts, executives and trade union representatives reveal the pervasiveness of ineffective checks of social and environmental standards inside Italy's sprawling luxury supply chain.

In the case of AZ Operations, a three-page assessment on letterhead from compliance management company Fair Factories Clearinghouse (FFC), carried out by monitor Adamo Adriano on Jan. 18, 2023, stated that AZ Operations did not have sub-contractors. The audit listed no irregularities.

In July 2023, a further audit by Davide Albertario Milano srl, a large direct supplier of Manufactures Dior that worked with AZ Operations, also found "no non-conformities" and certified the work was carried out to a high standard and in accordance with contractual terms.

Despite passing the audits, a police investigation into its 2023 activities found AZ Operations was "de facto non-existent", according to Milan court documents. Furthermore, police inspections in April 2024 alleged the company was a front for a separate business, New Leather Italy, that exploited undocumented workers in sweatshop-like conditions, the same documents showed.

That discovery was one of the factors that prompted Milan's prosecutors to put Manufactures Dior under court administration in June.

Dior and LVMH did not respond to multiple requests for comment about Reuters' findings, including the audits, and on the process to inspect external manufacturers in Italy.

In a July statement following revelations from the Milan prosecutors' inquiries, Dior said it firmly condemned illegal practices discovered at two of its contractors, saying such unworthy acts contradicted "its values and the code of conduct signed by these suppliers."

"Aware of the gravity of the violations committed by these suppliers and the improvements to be made to its checks and procedures, the house of Dior is collaborating with the designated Italian administrator and the Italian authorities," the French brand also said at the time.

Dior added in the statement that its teams were working intensely to reinforce the existing procedures: "Despite regular audits, these two suppliers had evidently succeeded in hiding these practices."

After this article was published, FFC-owner Worldly responded to Reuters queries saying it had never offered facility auditing services to Worldly or FFC users, adding it asks that customers enlist external verifiers to ensure impartial, transparent audits. "Regarding the letterhead in the court documents, this is a template available to customers within the FFC platform," Worldly added in its statement.

Adamo Adriano did not respond to Reuters attempts to reach them. Davide Albertario did not respond to queries by Reuters on inspections at AZ Operations. New Leather Italy did not reply to a Reuters request for comment.

"COST-REDUCTION"

Global luxury groups including LVMH usually outsource most of their production to a myriad of external contractors, industry experts say.

Many are based in Italy, famed for its artisanal skills and accounting for between 50% and 55% of the global production of luxury clothing and leather goods, consultancy Bain calculates.

"No matter how many controls we do, there is always something we miss," Renzo Rosso, founder of Italian fashion group OTB, which makes Diesel clothing, told a business event in September, in reference to the complexity of overseeing Italy's supply chain.

Despite the risks, insiders and experts told Reuters relying on suppliers is a deliberate strategy to keep costs down and manage demand.

"The fashion business model is driven by cost-reduction tactics, leading fashion brands to switch suppliers," said Hakan Karaosman, Associate Professor at Cardiff University, whose research focuses on supply chain sustainability.

Even though Dior did not directly abuse workers, the mechanism of labour exploitation "was culpably fuelled by Manufactures Dior srl which... did not carry out effective inspections or audits over the years to ascertain the actual working conditions and environment," Milan prosecutors said in the June court documents.

Currently, there is no firm legal requirement in Italy for luxury groups to audit their suppliers. But poor oversight can clash with sustainability claims made to investors and consumers over craftsmanship and corporate and social responsibility standards, leading to reputational risks and in some cases civil liability if workers' exploitation is found within the supply chain.

LVMH, for example, said in its 2023 Social and Environmental Responsibility Report it "endeavors to ensure its suppliers and their service providers uphold human rights and to support them with applying the best possible employment, health and safety conditions."

The investigations into Italy's luxury supply chain have prompted some LVMH shareholders to ask the $330-billion behemoth, owned by French billionaire Bernard Arnault, to better monitor how its contractors treat workers.

LVMH told a group of investors in November it was auditing all of its direct suppliers and immediate contractors. In a subsequent statement to Reuters in November, LVMH said it had conducted more than 2,600 on-site audits globally this year.

Italy's antitrust authority said in July it was investigating whether Dior and Armani have misled consumers.

In July, Armani expressed confidence in a "positive result following the (antitrust) investigation", saying in a statement that its companies were fully committed to cooperating with the authorities and that it believed the allegations had no merit.

SKIN-DEEP OVERSIGHT

Brands dictate the depth of the checks and the auditors' scope of action and inspections are often limited to direct suppliers and not to sub-contractors, where the biggest problems usually lie, four auditors and luxury goods supply chain managers Reuters spoke to said.

Audits tend to be planned in advance, allowing suppliers to paint a better picture by, for instance, clearing premises of workers without proper contracts, these people said.

On May 9, 2023, for example, external auditor Adamo Adriano sent Pelletterie Elisabetta Yang, another supplier of Manufactures Dior based near Milan, a written notice flagging that he would hold an inspection on 26 May, 2023, the audit documents reviewed by Reuters show.

In the notice, Adriano asked to analyse employment contracts, organisational charts, pay slips and a dozen more documents.

The check-up did take place, but it was "more formal than substantial," investigators wrote of the audit. The assessment listed no irregularities.

In March 2024, police entered Elisabetta Yang's workshop, which housed also a refectory and several bedrooms. They found 23 workers, five of which were irregular. The workers lived and worked "in hygiene and health conditions that are below the minimum required," the court documents read.

Adriano did not reply to Reuters requests to comment with regards to the audit of Elisabetta Yang. Reuters was not able to contact Elisabetta Yang at the official email addresses cited by the local chamber of commerce.

As private actors, auditors cannot freely access factories or workshops outside agreed hours and may not collect documents that are not spontaneously submitted by suppliers, two Italy-based luxury supply chain auditors told Reuters.

The time allocated for on-site inspections is often too short to examine documents and interview employees, these people said.

Five Tuscany-based luxury chain workers employed at separate workshops serving major brands confirmed to Reuters workshop owners knew in advance of the audits and would clear their premises and prep staff on what answers to give monitoring teams on the day of an inspection.

All declined to be named for fear of losing their job.

"We used to say we only worked four hours a day, as per our (formal) part-time contract," said Pakistani-born Abbas, who works in the leathermaking hub of Prato.

"But how could they think we were making 1,300 bags a day with 50 workers employed only four hours a day?", Abbas, who said he worked 14 hours a day, six days a week, added.

On the day of the audit, employees with part-time contracts were asked to leave as soon as they finished their formal shift, but had to come back and continue work after the auditors left, he added.

Another worker, also from Pakistan and employed at a separate leather workshop in the Florence area, said factory owners warned workers when the inspection would take place and asked them to lie about their working hours.

Fabio Roia, President of the Court of Milan, told Reuters that companies don't invest enough in their control systems and don't normally question the extremely cheap prices contractors offer to provide goods or services.

Small fashion brand Alviero Martini, famed for leather bags decorated with geographical map patterns, was also targeted by the Italian inquiries for allegedly sub-contracting work to Chinese-owned firms in Italy that mistreated workers.

The Alviero Martini group was "careful in selecting direct suppliers ... but the use of sub-suppliers was not actually checked properly," Ilaria Ramoni, who served as court administrator overseeing its operations until October, said in an interview.

The group, which is no longer under court administration, did not respond to a request for comment. It stated in September it was unaware of the illegal behaviour occurring within its supply chain.

Dior and Armani are still under special judicial oversight as part of the Milan's investigation into labour exploitation.