When a Blackstone-backed company in March sold $260 million in bonds under its Servpro Industries banner, a franchise specializing in fire- and water-damage cleanups, the financing went off without much notice.

But three months later, a whistleblower complaint from two former workers at Fort Bliss, Texas, one of the nation’s largest emergency migrant youth facilities, claimed gross mismanagement. Servpro contractors who usually are paid to clean up damaged buildings, were instead overseeing thousands of youth in an alleged state of distress and filth at the desert encampment on the outskirts of El Paso, according to the complaint.

Blackstone’s own Environmental, Social and Governance (ESG) principles say it directly monitors its portfolio for adherence to “strong governance policies,” as part of its emphasis on “being responsible investors and owners.” The incident raises broader questions for investors with exposure to companies that increasingly say ESG principles are part of the backbone of their operations.

Blackstone told MarketWatch that its company, Servpro Industries, only collects franchise fees, and that it had no part in how an independently owned and run franchise ended up operating at Fort Bliss. 

Blackstone and Servpro Industries have now told MarketWatch that the chain at Fort Bliss they claim offered unauthorized services will be leaving the brand. They declined to provide MarketWatch with the name of the franchisee they claim went rogue.

“​We are deeply proud of our commitment to strong principles of corporate governance,” a Blackstone spokesman said. “This conduct took place at an independent franchise that is not owned by Blackstone or our portfolio company and it would be false to imply otherwise.”

Blackstone Group Inc. BX operates as a public company. Servpro is one of almost 100 companies that its private-equity funds own. Out of roughly $684 billion in assets under management, $224 billion sits in its private equity business.

Servpro is a chain such as Dunkin or Domino’s, for which mostly mom-and-pop operators pay fees to a parent company that requires each to operate under set standards and use shared branding and marketing. The idea is to make a customer’s experience feel — and cost — roughly the same if it’s a family in Florida getting a pizza delivered or an office worker buying a cup of coffee and doughnut in New York.

Blackstone said ​Servpro Industries “took immediate action when it discovered a violation of its policies by an independently owned and operated franchise, and ensured that it will not derive a single dollar of financial benefit from this unauthorized work,” the Blackstone spokesman said.

That action, Blackstone says, shows that governance procedures do work.

“W​e regularly monitor our portfolio companies and work to ensure they have strong corporate governance policies and procedures in place — and that when they identify a violation of those policies they take corrective action (as occurred in this situation),” a Blackstone spokesman said.

Investors said Fort Bliss highlights the challenges of tracking how ESG standards are implemented and measured in complex ownership structures. Brian A. Marks, a lawyer specialized in corporate governance and a professor at the University of New Haven Pompea College of Business, said it also matters how Blackstone or Servpro learned of the unauthorized work. “Was it the result of a news report or an internal investigation?” Marks asked.

Blackstone called it misleading to say the work at Fort Bliss “in any way negatively reflects upon our commitment to ESG principles.”

Investors worry it took whistleblower disclosure and eyewitness accounts for the harsh conditions for children under the care of government contractors to come to light. They also say transparency and reporting can always improve when it comes to ESG, especially in cases such as this, where taxpayers and bond investors played a role in funding a company whose name now has been tied to questionable operations at a child migrant facility.

Morningstar’s Sustainalytics, which assign ESG scores to publicly traded firms, ranks Blackstone Group as a “medium ESG risk” for investors, similar to competitors BlackRock or Brookfield Asset Management. Sustainalytics also includes a whistleblower screen as part of its research offerings. Such a score wouldn’t have applied to the private-equity portion for Blackstone, underscoring how bond investors in companies owned by private equity can lack ESG information more readily available in other parts of finance.

Read: Critics say KKR’s ‘responsible investment’ stance is being clouded by its stake in a controversial tear-gas maker

Transparent contracts?

Democratic Rep. Veronica Escobar, who represents the Fort Bliss district and has visited the migrant intake center about a half-dozen times, told MarketWatch that she wasn’t surprised corporate America ended up in the mix, given the scale of new Department of Health and Human Services contracts for immigration centers. But the lack of checks and balances at Fort Bliss still has taken her aback.

“From the beginning, I have been frustrated by a number of things related to the contracting,” she said. “One thing I am interested in pursuing is an audit,” she said. “We really need an explanation of where the money went and how efficiently it was spent.” 

“Everything within the whistleblower complaint is unfortunately either not surprising or mirrors concerns I also have expressed,” Escobar said. “I have shared all of my concerns with HHS, but also directly with HHS Secretary Xavier Becerra,” she told MarketWatch. “Number one, there is a lack of transparency.” 

“Also, how are we going to hold the contractors accountable for what’s going on?”

Government spending records show that $4 billion was allocated to HHS for unaccompanied children in the fiscal year 2021 budget, with $2.8 billion allocated mostly to four companies with experiences heavily skewed toward federal disaster cleanups. More than 50 other firms split the remainder, through awards ranging from about $15,000 to $100 million each, although many accounted for only about 1% of the funding, according to spending records.

It is not clear how much money the Servpro chain made at Fort Bliss or how it came to work there. Servpro’s name didn’t come up in a public records search of relevant HHS contracts. Servpro Industries declined to provide MarketWatch with those details, but reiterated that the allegedly rogue operator said it was no longer offering those unauthorized services under the franchise.

Escobar said, despite taxpayers footing the bill, the public paper trail around the emergency intake sites has been less than robust, particularly when it comes to subcontracts, staffing services or a breakdown of payments by service.

Sales at Servpro’s network of about 1,860 chains, usually repairing mold, fire and water damage to homes and businesses, last year totaled about $2.8 billion. That’s roughly two times greater than its closest competitor in the U.S., according to KBRA, a bond rating agency. The KBRA report said that about 33% of Servpro’s revenue last year came from products and equipment sales to its franchise operators.

KBRA vetted the bonds sold to investors in March, described as backed by fees, royalties, product supply contracts and other asset-generating collateral from Servpro’s chain. The bonds were sold while the U.S. government was starting to set up its string of emergency intake sites. Thereafter, the independent Servpro franchisee allegedly started engaging in unauthorized migrant children work. 

The roughly 7-year Servpro bonds sold this spring were rated BBB- and pay a coupon of about 2.4%, according to Finsight. They were sold to a variety of investors, including about a dozen insurance companies and retirement funds, such as TIAA-CREF’s Nuveen Investments, and to the SoFi Weekly Income ETF
A spokeswoman for Nuveen declined to comment.

Blackstone wouldn’t say if bondholders were alerted to the unauthorized work done at Fort Bliss under the Servpro brand. But since Servpro Industries won’t derive any financial benefit from the Fort Bliss services, Blackstone told MarketWatch it isn’t part of the collateral for the bond deal.

Fast-expanding market

Hundreds of billions of dollars have been raised to make finance and investing more friendly to ESG issues across the marketplace. For instance, ESG fixed-income funds now manage 600% more in assets than three years ago.

Problems remain when it comes to oversight. This includes a lack of standardization around reporting if goals have been met and what levers of power bondholders and shareholders have to hold companies to account.

Growth in the sector also has prompted the U.S. Securities and Exchange Commission to set up a climate change and broader ESG task force in its enforcement division to police for potential violations in the sector. The SEC is considering new reporting rules when it comes to emissions, climate risk and other ESG factors, which have so far leaned on voluntary reporting. CEOs have largely conceded those rules are coming, they just want a say in how reporting will happen.

Investors say the still-expanding ESG industry offers investors few ways to timely enforce standards when things go awry. Dumping stocks or bonds under less-than-ideal market conditions isn’t the most investor-friendly way to react to ESG misses. Shareholder proxy action on ESG is on the rise but can also be a slog, though firms are also increasingly addressing concerns before they are put to a shareholder vote.

“The mechanisms for enforcement are pretty weak,” said Peter Duffy, chief investment officer for credit at Penn Capital.

“At the end of the day, you make your investment, you buy the bonds, and if you don’t such as what’s going on, your recourse is to sell the bonds,” he said.

Rachel Koning Beals contributed to this article.

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