Fraud in a Time of ESG

In April, the Environmental Crimes section of the Justice Department’s Environment and Natural Resources Division unsealed an indictment that charged a major seafood distributor, as well as eight employees and associates, for international wildlife trafficking of endangered eels. Poaching and smuggling eels is one of the world’s biggest wildlife trafficking problems.

As American eels became harder to poach and smuggle with the creation and enforcement of regulations, eel traffickers pivoted to European eels, a rare and endangered species. Since 2010, exporting European eels out of any European Union member country has been illegal, and the European eel has been protected by the Convention on International Trade in Endangered Species (CITES) wildlife protection treaty, which is also enforced in the United States through the Endangered Species Act.

However, the indictment alleges the defendants conspired to smuggle European eels out of Europe to their eel farm in China. Once mature, the Chinese facility would then butcher and process the eels for shipments to the United States, under the label of sushi.

“This case demonstrates the effectiveness and importance of the Endangered Species Act in cracking down on the international trafficking of protected wildlife,” said Assistant Attorney General Todd Kim of the Justice Department’s Environment and Natural Resources Division. “We will not allow United States–based businesses and their executives and associates to cause—and profit off of—the systemic decline of the world’s protected aquatic species.”

Brave Old World

The first federal resource available to officials for managing pollution was created in the Rivers and Harbors Act of 1899, which was enacted to protect navigable waters and tributaries. Specific forms of dumping and construction violations were punishable as misdemeanors.

The Lacey Act of 1900 made it a federal offense to trade in wildlife, fish and plants that have been illegally taken, possessed, transported or sold. While it has been amended significantly over the past century, the Lacey Act remains the cornerstone of federal criminal enforcement of trafficked wildlife. In 2008, an amendment introduced a broader range of protected plants and plant products to include lumber.

The most influential modern environmental law came from the Clean Water Act in 1972, which outlined the basic structure for regulating the discharge of pollutants into the waters of the United States and established quality standards for surface waters.

Environmental laws and concerns are not a new issue. Before Greta Thunberg’s impassioned speech to the United Nations Climate Change Conference in 2018, Canadian environmental activist Severn Cullis-Suzuki addressed the United Nations Earth Summit in Rio de Janeiro in 1992 with a speech that “silenced the world for five minutes.” Generations are continuing to find their voices and let the world know that ethics and integrity still matter. People care about these important issues and are choosing to let their money do the talking, investing with companies that promote good, ethical values and practices.

Environmental, Social, and Governance

Environmental, social and governance (ESG) describes nonfinancial factors that may influence how investors, donors, consumers and workers choose to engage with an organization. ESG management and reporting focuses on measures that reflect standards of sustainability, ethical management, and the quality of employment within an organization.

The environmental aspect of ESG represents the goals and objectives an organization has established to protect and conserve the natural world. It considers issues such as sustainability and carbon-reduction efforts.

The social component is made up of an organization’s efforts to show how it values people and considers matters such as diversity and inclusion, equity, working conditions and social justice.

Governance refers to organizational ethics and includes aspects such as management behavior, transparency and executive compensation.

ESG Fraud

As ESG matters gain influence as a factor in investing in or promoting an organization, the risk of fraud grows. How does one defraud ESG? Consider what a company can do to pretend it is following ESG practices when, actually, it is not.

The ACFE, in partnership with Grant Thornton, created Managing Fraud Risks in an Evolving ESG Environment to help organizations and anti-fraud professionals understand the internal and external fraud risks presented by this evolving landscape. The report presents a straightforward taxonomy of ESG fraud risks and outlines measures organizations can take to protect against these schemes.

Environmental frauds are not new, but now businesses can be held accountable for how they present themselves to the world. The financial, reputational and compliance risks for organizations are now greater than ever. Per the report, “As stakeholders demand increased ESG accountability, they must develop tailored ESG frameworks with fraud risk management components that withstand scrutiny. Incorporating proper checks and balances to mitigate the risk of ESG fraud and misconduct is vital.”

ESG guidance should consider the following with relation to policies, procedures, data governance and reporting controls.

• Accuracy: ESG reporting disclosures should have the same rigor as financial statement reporting. The data must be authentic and free from misrepresentation.
• Completeness: Organizations should present the full picture, with thorough reporting of data, regardless of the weight. This includes reporting all ESG information and disclosures.
• Rights and obligations: Organizations should only disclose information that legally belongs to the organization and is permitted for use. This information includes obligations that organizations will have to settle in the future.
• Existence and occurrence: Organizations should only report ESG matters that have occurred during the designated period(s) or that relate to conditions that exist at the time of reporting.
• Comparability: Organizations should seek a standardized reporting framework that is appropriate for their industry to allow for comparability from one reporting period to the next across organizations.

Organizations that take a proactive approach to mitigating their ESG-related fraud risk will have a unique advantage in the marketplace. They will be better protected and prepared to navigate the ever-changing landscape to address complex environmental, social, and governance issues head-on.

To view Grant Thornton’s ESG Fraud Taxonomy and read more on ESG fraud risk management recommendations, please visit the Managing Fraud Risks in an Evolving ESG Environment report.