What are the consequences of ESG fraud, and how can employers combat it?
Mounting pressures around environmental, social, and governance (ESG) requirement compliance could be increasing the risk of ESG fraud.
ESG fraud occurs when a company's environmental, social and governance efforts or data are exaggerated, embellished or distorted, said a KPMG report.
Overall, 24% of small-and medium-sized enterprises (SMEs) in Canada that had experienced fraud within the past five years have discovered ESG fraud.
Among them:
- 9% are currently dealing with or have previously dealt with internal ESG fraud. For these companies, employees or teams within their company have been found embellishing, distorting, or exaggerating ESG data or efforts
- 8% are currently dealing with or have previously discovered external ESG fraud. For these employers, their suppliers or vendors are embellishing, distorting, or exaggerating their ESG data or efforts
- 7% report that they are experiencing or have experienced internal and external ESG fraud
Public Services and Procurement Canada (PSPC) has recently reported suspected employee fraud within their organization. Meanwhile, in 2023, Toronto’s Fraud and Waste Hotline received 1,054 complaints made up of roughly 1,450 allegations.
ESG pressures could lead to fraud, say employers
Nearly nine in 10 (89%) respondents said they are facing intense scrutiny from their stakeholders to demonstrate tangible progress on ESG targets, finds KPMG’s survey of 300 small-and medium-sized Canadian companies, conducted Feb. 13 to 21, 2024.
The same number of respondents (89%) say their stakeholders are increasingly demanding proof of their ESG records, and 89% say their stakeholders are increasingly demanding proof of compliance with anti-corruption and anti-money laundering regulations.
With these pressures, 86% of Canadian SMEs are concerned about the growing risks of ESG fraud within their organization given how important ESG is becoming, and 81% are concerned their organization could inadvertently commit ESG fraud.
"The consequences of ESG fraud can be significant, including financial and reputational harm, and quite possibly the loss of social license to operate if stakeholder trust is damaged," says Becky Seidler, a partner in KPMG in Canada's forensic and dispute advisory practice.
Also, 89% of Canadian SMEs in the survey say ESG fraud is an emerging litigation risk.
"There's a heightened scrutiny around ESG disclosure and performance right now, and any fraudulent or negligent misrepresentation in financial or other public ESG disclosures – for example, a company's ESG report – could lead to a securities or Competition Bureau investigation, or even class action litigation from shareholders or customers," says Conor Chell, KPMG in Canada's national leader of ESG Legal Risk and Disclosure.
With stakeholders, regulators and consumers requiring effective steps being taken on the ESG front, the failure to meet these expectations with measurable and verifiable actions is increasingly likely to lead to regulatory action and litigation, according to a previous HRD report.
How confident are employers with their ESG compliance programs?
Nine in 10 (90%) respondents say their organization has an ESG compliance program and 92% also have anti-corruption compliance programs in place, reports KPMG.
However, just 59% say their ESG compliance programs "meet or exceed industry peers". About the same number (56%) of small and medium-size employers say the same about their anti-corruption compliance programs.
"Loosely and self-defined ESG metrics provide an opportunity for potential misstatements," says Becky Seidler, a partner in KPMG in Canada's forensic and dispute advisory practice. "Even when the metrics are clear, an organization's internal controls over ESG reporting and regulatory compliance might still be immature.”
She notes, for example, that if there are no qualified individuals to review ESG reporting for accuracy, completeness and understandability against a consistent framework, or “the company lacks external assurance over its ESG reporting,” the risk of fraud increases.
"Given the complexity and changing nature of ESG regulations and metrics, compliance programs need to be updated regularly. Companies really need to be proactive," she adds.
Best practices against ESG fraud
Preventing and addressing ESG fraud requires a multi-faceted approach, notes AdviseCube Consulting via LinkedIn:
To do this, the company shares the following key strategies:
- Companies must provide accurate and comprehensive information about their ESG practices.
- Have independent third-party audits of ESG performance verify claims and identify discrepancies to deter fraudulent behavior.
- Implement strong governance structures to ensure ethical practices from the top down with the use of independent boards, whistleblower protection and ethical guidelines.
- Train employees on ESG principles and the importance of ethical conduct.
