Greenwashing, or allegations of fraud related to environmental, social & governance (ESG) matters around misconduct or misstatements, can be a high-stakes risk for companies
However, are these incidents considered fraudulent? It depends on whom you ask.
Vincent Walden, CEO of Kona AI and FRAUD Magazine columnist, says maybe. In his view, fraud is fraud regardless of context, and he references the Association of Certified Fraud Examiners’ definition of fraud as being any activity that relies on deception in order to achieve a gain.
Fraud becomes a crime when it is a “knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment,” according to Black’s Law Dictionary. In other words, if a person lies in order to deprive another individual or organization of their money or property, it is fraud.
From a legal point of view, greenwashing involves allegations of fraud related to environmental, social & governance (ESG) matters around misconduct or misstatements. Yet, while claims of greenwashing get the most attention, allegations involving environmental fraud are potentially very expansive. For example, if a company — while claiming publicly and in its required reporting to be socially responsible — is found to have been covertly taking steps to cover up harms to the environment it may have had a hand in causing, then this is an example of how vast the definition of environmental fraud could be. Similarly, bribing officials to allow illegal dumping or unauthorized permits, or misrepresenting or flat out lying about certain environmental controls or initiatives on a company’s public disclosures when indeed those statements are false or exaggerated is another example of this type of fraud, according to Walden.
In the social category, examples of fraud cut across multiple areas. For example, paying off or bribing certain influencers or political officials to take gain an unfair advantage or certain advantageous position is an example of this type of social fraud. And while strictly not fraud, when company executives act in a way that is counter to the company’s code of conduct or social norms, it can cause significant financial harm to the company and its stock price, and thus significantly increase pressure to cover up or misstate certain facts.
Yet, despite all the attention now being paid to ESG and greenwashing allegations, there are issues on the horizon that could hinder further adoption for good practices. For example, with inflation, Russia sanctions, and the looming threat of a recession on the minds of corporate executives, companies around the world are proactively looking for ways to drive operational efficiency, reduce risk, increase transparency into their supply chains, and align with their regulators’ expectations related to anti-fraud, sanctions, and anti-corruption compliance.
Mitigations to ESG fraud
Most of the required work by corporations to mitigate ESG fraud is in the areas of governance and acquiring the right tools. Indeed, cash disbursements areas and purchasing departments are the risk areas in which organizations are most commonly seeking to upgrade their data analytics and fraud-monitoring tools, says Walden.
Other ways companies can sharpen their protection against allegations of greenwashing or other types of ESG fraud include:
Create strong corporate governance — Having a strong corporate compliance program in place with proper governance and controls is paramount to demonstrating an effective ESG program, especially in the eyes of the regulators. In the governance context, if an organization does not have proper risk assessment, training, reporting, monitoring, and investigation protocols in place, the company’s corporate culture could suffer which could open it up to a variety of fraud schemes, including asset misappropriation, corruption, or financial misstatements.
To create strong governance, corporate executives needing to understand and seek transparency into their data as a strong first step. Indeed, the US Department of Justice (DOJ) has emphasized the use of data analytics in their prosecutions and in compliance; and in May 2020, the DOJ issued a statement that corporate compliance officers have a responsibility to understand their data landscapes. Falling victim to previously undiscovered or siloed data is no longer an excuse. Establishing and securing access to relevant data sources can effectively prevent and detect fraud risks, particularly in ESG-related matters — and that is becoming the expectation in compliance, not just a nice-to-have feature.
Employ data analytics tools and technology — To help understand and gain transparency into their data, companies need to employ tools and technologies. And, using analytics to increase transparency of commercial activity across organizations at scale enables better corporate governance than does traditional process-oriented compliance activities.
For example, a partnership among Kona AI, the Massachusetts Institute of Technology (MIT), and several law firms established Integrity Distributed, a not-for-profit shared technology platform that allows organizations all over the world to contribute their anti-fraud, ESG, and corruption intelligence to power stronger, data-driven ESG compliance.
The law firms are functioning as advisors to the initiative, troubleshooting issues around workflow and privilege as the system gets off the ground. The platform will allow organizations to train algorithms that detect patterns of fraud and corruption in their respective industries with a goal of predicting improper or corrupt payments with up to 90% statistical accuracy.
Through this unique model of collaboration in data analytics, all of the participating organizations benefit, and the learning is continual throughout the Integrity Distributed network, according to Matt Galvin, Research Fellow at Harvard Business School. “Using leading blockchain technology, all of this can be done securely, without sharing any proprietary company data between the participants,” he explains.
Clearly, no matter how ESG fraud is defined, the end state is the same for corporations; and there is much work to be done to respond to the onslaught of upcoming regulations in this space.