We all remember the emission scandal from 2015 by Volkswagen. The intentionally programmed diesel engines from the car manufacturer demonstrated lower outputs during testing than it would in real-world driving. This was followed by extensive media coverage, societal outrage and reputational damage – no-one wanted to be associated with this kind of outrage. Now, 5 years later, biofuel scandals are still haunting the automotive industry. Just two weeks ago, Dutch authorities raided a well-known biodiesel manufacturer that allegedly markets 'green' diesel with forged certificates. These 'greenwashed' certificates imply Dutch environmental objectives on CO2 reduction are being achieved, while in reality the only one improving from the situation was the fraudster.
Not only the automotive industry is dealing with green fraudsters. A month ago Hindenberg Research disclosed their findings on Loop Industries: a start-up venture based in Montréal promising an effective recycling solution of PET (plastic) bottles. The stakes are high, as big and reputable brands are being pressured through shareholder proposals and even lawsuits if they don't clean up the plastic waste caused by their products. Loop was quick to jump into this opportunity and released ventures with PepsiCo, Coca-Cola, Danone, and other big-name brand owners.
However, the Hindenberg report revealed Loop did not hold any viable technology. Moreover, it turned out that Loop operated two labs: one reserved for the company's two lead scientist brothers and their father, apparently achieving incredible results, and a separate lab where other employees were unable to replicate the supposedly breakthrough results. The two brothers who act as lead scientists for Loop and who co-invented Loop's recycling process, appeared to have no post-graduate education in chemistry and list no work experience other than Loop.
The examples demonstrate that even fraudsters are rapidly learning that it pays to be green. The worldwide attention for the concept of sustainability is greater than ever and for corporate organizations, there is no longer a way around the emerging topics of sustainability and environmental, social and governance (ESG) performance. This is confirmed by a recent study from KPMG and Eversheds Sutherland. The study, that involved more than 500 business leaders from global companies, demonstrates that business leaders are well aware of the importance of sustainability, as well as their role in, and risks associated with, climate change. Regulators, investors, employees and consumers are all putting environmental issues at the top on their listed priorities – and are demanding organizations to do the same.
But, as we also learned from financial fraud cases, with pressure being put on targets and results, this leads to an increase in risks of falsified outcomes. Evidence is increasingly surfacing of organizations that have been involved in the manipulation of their sustainability data. Reasons for this include pressure to comply with regulatory demands, to demonstrate green performance to shareholders, or simply to attract new investors or clients.
An important challenge in addressing and exposing sustainability fraud risks is the lack of a common, established framework to assess an organization's sustainability or ESG performance. Additionally, this imposes challenges for organizations, investors, consumers, employees and even auditors to get full disclosure of, and fully comprehend, sustainability and ESG performance. Over the last years, numerous governmental institutions and corporations have been working on processes and tools to quantify and standardize non-financial measurement. Another example includes the European Central Bank (ECB) that in May 2020 published a guide that addresses their expectations towards corporate responsibility with regard to climate-related and environmental risks. Additionally, KPMG has published an evaluation of several leading sustainability standards on existing infrastructure development projects. It's a start, but frameworks for non-financial reporting are not yet as established as those for financial reporting.
Luckily there are other ways through which organizations can analyze their sustainable and ESG performance, as well as identify related fraud risk factors. Business leaders can start with a focused assessment of the factual claims and statements being made regarding sustainability and ESG effects. Is this supported by the data? Additionally, consideration could for example be given to the following:
- Would there be reasons for specific functions, divisions or individuals to rationalize a fraudulent green performance due to their (personal or professional) circumstances?
- Where are the inherent opportunities within the company, or within the supply chain, to commit fraud with sustainability-related information? And what controls are in place to mitigate these risks?
- What does the governance of sustainability look like? Is there sufficient attention at all organizational levels, including the non-executive board?
- Do we have sufficient hard and soft controls in place to detect fraud cases at an early stage? Where should these be potentially strengthened?
Use common sense: if it looks too good to be true… And if you want to make sure you are making the right green decision, remember, the best check is always the fact-check. Performed independently and objectively, and supported by expertise knowledge.
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In this article you can read more background on the topic of fraud and sustainability.