Innovation update

Place 'ESG' on your radar

In the last few years, and especially now as we emerge from the COVID-19 pandemic, the world’s economy has become increasingly values driven. Many consumers care as much or more about a company’s principles (i.e., what the company stands for) as they do about its products or services. The grouping of “environmental,” “social” and “governance” (ESG) to collectively represent an organization’s core values and principles is interesting — as you really can’t have one without the others.

A company might claim to emphasize diversity in its workforce and treat its employees, customers and communities with respect (social responsibility). But, meanwhile, it might dump waste into a river and harm the environment (environmental responsibility) with management’s full knowledge (governance). The company then is deemed unethical despite its claims of social responsibility.

All three ESG elements must come together at satisfactory levels in the public’s eye to render a company ESG-focused.

As fraud examiners, we’re all familiar with the governance role (or the “G” in ESG) because it’s a key pillar in an effective fraud risk management program. (See ACFE/COSO Fraud Risk Management Guide.) But maybe it’s time to also look a little broader and consider CFEs’ roles in environmental and social disclosures along with integrity.

The ESG label is now more important than ever. Nearly one-third of all professionally managed money in the U.S., a staggering $17.1 trillion, is invested in ESG-related funds. (See the 2020 “Report on US Sustainable and Impact Investing Trends,” US SIF Foundation.) And by 2025, assets under management dedicated to ESG investments across the globe are expected to hit $53 trillion. (See “ESG assets may hit $53 trillion by 2025, a third of global AUM,” Bloomberg Intelligence, Feb. 23.) Failure to articulate strong ESG programs could cause companies missed opportunities to lower their funding costs by not meeting ESG investor expectations and losing out on possible customer opportunities or sales.

The global capital markets have seen a surge of bonds linked to social responsibility, environmental goals and other good causes. Yet some investors have grown increasingly skeptical about the trend; they often see it as all show and no substance, and open to abuse. Chamath Palihapitiya, the founder and CEO of venture capital firm Social Capital, has called ESG investing a “complete fraud.” (See “ESG investing is a ‘complete fraud,’ Chamath Palihapitiya says,” by Pippa Stevens, CNBC, Feb. 26, 2020.)

The temptation to demonstrate a strong ESG program through misrepresentations led to an April 9 U.S. Securities and Exchange Commission (SEC) “Risk Alert” specifically addressing management misrepresentation.

The alert calls on market participants promoting ESG investing to assess whether their public statements and claims related to ESG are accurate and consistent and subject to oversight by compliance. “Firms should also consider taking steps to document and maintain records relating to important stages of the ESG investing process,” it says. (See “Risk Alert: The Division of Examinations’ Review of ESG Investing,” SEC, April 9.)

The SEC is expected to make a further push in this direction. The regulator is planning new rules requiring public companies to disclose more information about how they respond to threats linked to climate change. Some investors say the more specific these rules, the better. From a fraud risk perspective, uncertainty and vague guidance often invite fraudulent misstatements. (See “SEC Wants More Climate Disclosures. Businesses Are Preparing for a Fight,” by Dave Michaels, The Wall Street Journal, June 21.)

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