MILAN, Dec 31 (Reuters) - LVMH-owned Dior's production

arm in Italy, Manufactures Dior, relied on formal inspections to

assess working and safety standards inside its supply chain last

year. In some cases, such certifications missed glaring

problems, a Reuters review of unpublished court documents has

found.

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unpublished audit documents reviewed by Reuters.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."

FFC and 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.

(Reporting by Elisa Anzolin and Emilio Parodi in Milan, Silvia

Ognibene in Florence, additional reporting by Mimosa Spencer in

Paris and Isabel Demetz in Gdansk; Editing by Lisa Jucca)