Evidence that Western-made microelectronics are being used in Russian weapons systems has prompted a ramp-up in investor engagement with manufacturers.

Last week, shareholders at Microchip Technologies Inc voted on a proposal calling on the semiconductor firm’s board of directors to commission an independent third-party report on its due diligence process to “determine whether its customers’ use of its products contribute or are linked to violations of international law”.  

The resolution, which attracted 16.7 percent support from shareholders, is part of an engagement effort by investors to put the industry on notice regarding alleged links to Russia’s invasion of Ukraine.

More broadly, investors are keen to ensure that firms have sufficient risk mitigation and due diligence processes in relation to conflict-affected and high-risk areas (CAHRA).

In August 2022, the Royal United Services Institute (RUSI) published a report reviewing 27 Russian weapons systems, which found that western semiconductors and other microelectronics have been indispensable to their operation.

Among the firms identified as manufacturers of the “most prevalent” components found in Russian systems were Texas Instruments, Microchip Technology Inc and Analog Devices Inc (ADI).

Investor coalitions

In response to this, investor coalitions – composed of North American and European players – began engaging the trio, with the Heartland Initiative providing technical support. 

Sam Jones, president and co-founder of the Heartland Initiative, tells Responsible Investor that investors wanted to discuss the findings of the report. They also wanted to understand more about the firms’ human rights-related policies, practices and governance measures, and discuss incremental changes the companies could make to limit their products from reaching prohibited end-users.

While RUSI’s report and the Russian invasion of Ukraine catalysed investor action and focus on semiconductors, Jones says, semiconductor companies’ risks “extend well beyond this one conflict”. It was therefore decided that engagements should focus on broader policy.  

“The number and intensity of conflicts are on the rise globally and military drones, which are less expensive and widely accessible by smaller states, are the backbone of geopolitical conflict,” Jones tells RI. “As semiconductors and other microelectronics are indispensable to these weapons systems, companies’ conflict risk exposures are only going to grow.” 

Ideally, firms would focus on improving their know-your-customer (KYC) due diligence practices, including through the integration of human rights criteria, says Jones.

He also advocates the use of red flag indicators to identify third parties being used to evade sanctions, as well as coordination with civil society organisations and supply-chain research firms that specialise in tracing these components to bad actors in Russia, Iran and elsewhere.

“It’s also about companies better integrating their compliance, human rights, operations and sales units instead of keeping them siloed, and selecting board members with relevant human rights and conflict expertise,” he says.

Firms unresponsive

So far, Jones reports limited success with the target firms.

He notes that all three have largely relied on four central arguments: they are compliant with all relevant sanctions and export controls; the majority of the chips in question are off-the-shelf products available in household appliances, as opposed to dual-use items that require additional due diligence; they are largely “legacy” chips that have been on the market for years so they cannot track them; and it is not reasonable to expect 100 percent transparency and traceability.

“Heartland and the investors are not disagreeing with the above,” says Jones. “But a compliance-only approach is clearly inadequate given the sheer number of new, dual-use components that are still making their way to Russian and Iranian weapons systems used in violation of international law.

“Regulatory compliance is the floor, not the ceiling – especially in light of evolving sanctions and KYC regulations, ongoing public reporting resulting in reputational risk and the companies’ responsibilities under the UN Guiding Principles on Business and Human Rights, which they claim to uphold.” 

Jeff Perkins, executive director at Friends Fiduciary, which has been leading engagement with Texas Instruments, confirms that in its engagements with Texas Instruments, the firm kept reiterating its compliance with sanctions – which, he says, “is not sufficient”.

He points to the creation by the Biden administration of a “Disruptive Technology Strikeforce”, charged with investigating and prosecuting violations of export laws and administrative enforcement of export controls.

“There is growing regulatory and legal risk as the Biden administration has said it wants to work with semiconductor industry regarding these concerns so they may not remain compliant,” says Perkins.  

He adds that, as a long-time engager with companies involved in conflict-affected areas, Friends Fiduciary understand the challenges and acknowledges that it is “probably impossible” to mitigate all risks completely.

At the same time, he says: “We want to know that there is sufficient oversight and that the firm is assessing the risks, and they are working on how to mitigate them.”   

Shareholder resolutions

According to Perkins, Friends Fiduciary felt that its dialogue with Texas Instruments was a “one-way conversation” and it did not receive a satisfactory response to its questions. As a result, the faith-based investor decided to act as lead filer of a shareholder resolution at the firm.

As at Microchip, the resolution called on Texas Instruments’ board of directors to commission an independent third-party report on its due diligence process to determine whether customers’ use of its products or services contribute or are linked to violations of international law.

Both the proposals also said the third-party report should include, among other things, an assessment of legal, regulatory and reputational risks to shareholder value posed by the use of products across CAHRA.

At Texas Instruments’ AGM in April, the proposal received 23 percent support. As first-time proposal on a new and technically complex issue, Perkins says he was pleased with the result.  

“We have also had outreach from two major institutional investors to talk about it, which is amazing. We have not yet reached out to Texas Instruments to engage further on these concerns but will be doing so in this coming proxy season. We are interested to see if they will be making any changes.”  

Similarly, Rob Fohr, director of faith-based investing and corporate engagement at Presbyterian Church USA, which was lead filer at Microchip, says he was encouraged by the outcome. “The vote was fairly strong for a first-year human rights-focused resolution. I look forward to continuing the conversation with representatives from Microchip.”

Moving forward, Heartland’s Jones says investors in the coalition are also planning to file a shareholder resolution with ADI seeking a similar third-party report on the company’s KYC and human rights due diligence processes by the 23 September deadline.  

He adds that Heartland and the investors are planning forthcoming engagements with additional firms which have taken a more active stance on the issue.

Microchip and ADI response

A spokesperson for Microchip told RI that the firm does not support or condone the use of  its products for applications for which they are not authorised, including actions by Russia against Ukraine, or any other military actions against civilians in conflict-affected areas.

“In order not to participate in such harmful activities, we comply with trade restrictions and take care to maintain supply chain integrity using various methods.”

The spokesperson added that Microchip voluntarily stopped sales of products to Russia and Belarus, “even those that were not then prohibited by law”. The firm also ended relationships with Russian customers and distributors, and warned non-Russian
customers and distributors not to ship into Russia.

Microchip is also “actively engaged” with the Semiconductor Industry Association (SIA), US government agencies and others in the industry to address the challenges of semiconductor product diversion from legitimate purchasers to unauthorised users, the spokesperson said.

Regarding the engagement by investors, Microchip “listened to their recommendations and determined that adopting their proposal would not provide meaningful information beyond our current programmes and analysis”, the spokesperson said.

“Our board believed that the requested report would micromanage matters which we are already managing appropriately and over which the board is already exercising appropriate oversight.”

A spokesperson for ADI pointed to its statement on combatting unauthorized resale or diversion of products, which said the firm is committed to complying with all applicable laws and regulations in the countries where it operates.

“Following Russia’s invasion of Ukraine, and in compliance with U.S. and EU sanctions, Analog Devices ceased business activities in Russia, and in the Russian-backed regions of Ukraine and Belarus, and promptly instructed all of our distributors to halt shipments of our products into these regions. Any post-sanctions shipment into these regions is a direct violation of our policy and the result of an unauthorized resale or diversion of ADI products.”

The statement added that ADI is trying to combat the problem of unauthorized resale or diversion.

At the time of publication, Texas Instruments had not responded to RI‘s requests for comment.