Is this the new era of ESG fraud?

ESG was a buzzword, but now it's being regulated.
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· 4 min read

Environmental, social, and governance themes, dubbed ESG, have become ubiquitous in the business world over the past decade as employees, investors, and wider stakeholders take an interest in the corporate community’s impact on society.

Talk is cheap, action is expensive: Since 2020, some businesses have begun to answer the ESG calls from stakeholders. More than 400 US businesses have joined the Science Based Targets initiative, which requires them to set net-zero targets to transition to a carbon-neutral business mode. In addition, many businesses have committed to establishing more diverse boards. But, vague commitments only go so far.

DWS, Deutsche Bank’s asset management arm and Goldman Sachs’s asset management division are beinginvestigated by the SEC for allegedly claiming to have greener funds than they actually do. This behavior, known as “greenwashing,” can mislead investors and other stakeholders.

Other bank executives have caused waves in the ESG world in recent weeks: Stuart Kirk, HSBC’s global head of responsible investing, resigned from his post after saying that the climate crisis was a risk “investors need not worry about" at a Financial Times conference in May. Kirk said the bank’s behavior toward him after the speech was “unsustainable.”

ESG misbehavior: While many are familiar with financial fraud, ESG guidelines are still being set. “Typically, when we think about fraud, it’s something that’s been prosecuted in a court of law and someone’s intent has been proven,” Linda Miller, a principal in Grant Thornton’s fraud and financial crimes department, told CFO Brew. “There’s a wide spectrum of behavior that falls under the umbrella of what we’re calling ‘ESG fraud,’ but really it’s misbehavior.”

Miller gave an example of potential fraud: What happens if a company learns that a supplier is using forced labor, but just doesn’t ask questions because of previous sustainability commitments? “Is it fraud that you know that and you’re not telling anybody? It could be here soon,” Miller said.

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“I expect to see arrests. I expect to see criminal charges and jail sentences here in the next year to two years,” she added. “I don’t think it’s just going to be slaps on the wrist…There’s real value at stake here,” Miller warned, as investors increasingly make fund decisions based on company-reported ESG metrics.

Pop goes the green bubble: Desiree Fixler, DWS’s former chief sustainability officer, broke the green bubble by whistleblowing on the company last August. More recently, the SEC has made climate and ESG a focus, proposing a climate-focused rule that would require companies to disclose their greenhouse-gas emissions in annual reports and filings.

Flirting with fraud: According to a new report from Grant Thornton and the Association of Certified Fraud Examiners, “internal ESG fraud often occurs due to a lack of supervisory oversight, poor accountability, and/or a weak internal control environment.” One type of ESG fraud is often referred to as “nonfinancial reporting fraud,” providing misleading information is becoming increasingly costly as regulation in the sector grows. The report encouraged companies to be proactive in recognizing potential ESG fraud risks, noting that companies that do so will likely “fare much better than those who take a more reactive stance.”

In a guide for managing ESG risks released in tandem with the report, Brad Preber, CEO of Grant Thornton said that, “organizations should establish ESG frameworks with built-in fraud risk management strategies.”

ESG factors have “quickly become as important as financial metrics,” according to the report. With that prominence has come “increased pressure and wide opportunity for exploitation,” making it vital for organizations to be transparent about company processes, update reporting standards, take stock of ESG-related programs, and to “establish capabilities to mitigate ESG-related fraud risk.” —KT

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CFO Brew helps finance pros navigate their roles with insights into risk management, compliance, and strategy through our newsletter, virtual events, and digital guides.