We, the consumers, are being misled by many companies when it comes to environmental, social and corporate governance (ESG). There are cases of fraud, and in the near future their number will increase, including in Romania.

Which shower gel do you choose in the store?

Let’s start with an exercise. It was recently introduced by Oana Pitikas, a lawyer at Noerr.

She showed two photos of shower gel bottles, one brand and the same private label.

One of the products had 3 markings that refer to ESG, in this case it is about environmental protection. It costs 4.95 lei for a volume of 300 ml.

Another photo showed a 50ml less shower gel that retails for 6.75 lei and has 7 ESG labels. One of the labels actually says it’s a CO2 offset product.

In translation, this would be: a product made from 100% recyclable material, except for the lid and label.

“Go shopping, see both products on the shelf. Assuming both products satisfy you equally, the ingredient list is similar except for the smell and texture in these products. Which one to choose? The one with an ESG score of 7?” Pitikas asked.

According to her, the preferences of the public and consumers in general are quite clear about the Voke culture that we are becoming a part of.

“We want a product like this, and when we’re standing on the shelf, we get the feeling that if we see 7 marks instead of 3, the product is better: not only for the environment, but for you, and you want to buy it. Those who do not put such a product on the shelf will lose,” she says.

This is how fraud often occurs. That is, to false labels on ESG, which is a somewhat broader concept.

*Definition provided by Ana Sebov (PwC): ESG fraud is the intentional reporting of false or distorted information related to ESG activities or plans. This includes concealing certain material facts or declaring information that is false or misrepresented, failure to declare the use of children in production, use of information from illegal websites, trade in counterfeit products, human trafficking.

We also find fraud in some companies’ job ads

Oana Pitikas says that more and more companies have started to make public statements in the form of sustainability reports, in which they are explicit about gender diversity.

“It’s always trendy to talk about how many women are in the workforce, how many women we have in senior management, on the board, etc.,” she said at the ESG Compliance & Fraud Risk Management Conference 2023.

We can also look at job postings from companies that recently hired, and you’ll find an interesting mention next to the job title: F/M/O, which means it’s open to women, men, and others, Pitikas says.

According to her, the problem with such reports is that they are somewhat confusing and not necessarily reliable.

Why

“If we want to properly report on the social sphere and gender diversity, statistics and specialists show us many factors that we should have taken into account,” she states.

• “I mean, you’re a really gender-diverse company if you go through management and look a little bit at how much they’re making if the pay is the same.”

• “If we were looking at wage compensation, we should look at whether the projects assigned to a woman at work are identical, if not more difficult, to a man’s.”

“When we talk about the complexity of these frauds, we mean this: a situation where we make a statement, but there are many factors behind it that we haven’t considered,” Pitikas said.

How fraud is encouraged

“We unwittingly contributed to ESG fraud. Let’s take a look at the companies in the S&P index. Most incentivize managers based on the progress they make when it comes to ESG metrics. That is, they did better and managed to show that the company is more ecological: it earns more money,” said the lawyer.

• “Let’s also look at the case of Tesla, regarding the lack of standardization (that is, there are currently no standards, that is, there is no such thing as IFRS). The S&P downgraded electric motor company Tesla, even as the S&P retained an impressive number of oil and gas majors.”

• If we consider only the object of activity, it is obvious that theoretically Tesla should pollute much less than oil and gas. However, Tesla was considered a less ecological company.

Where does the pressure for fraud on the part of companies in this area come from?

“Motivation in ESG fraud means pressure. why This is the first time that the pressure is not exclusively internal. That is, it is not only a subjective forum of the author of the fraud. It’s pressure coming from the outside from many sources,” Pitikas said.

First, the pressure comes from investors.

According to her, the number of green funds is growing from year to year, more than 70% of them are in Europe.

In other words, the fact that there is a lot of money available causes some firms to cheat.

There is also pressure from consumers (see the shower gel example from the beginning).

Another pressure on ESG fraud also comes from employees.

“More than 40% of job seekers are interested in the diversity and inclusion policies that employers have. People don’t just want to know how you’re doing with money and benefits, they want to know how you’re doing with these policies,” she said.

What will change in the field of fraud reporting

Ana Sebov, director and head of PwC’s forensic services in Romania, says there are directives being implemented or in the process of being implemented, but they offer freedom and discretion.

When we have freedom and discretion, there is room for interpretation, for manipulation, she says.

“The next two directives, which will be implemented in 2024 and 2025, compensate for the lack of standardization that is not there now. They will introduce measures that must be taken by companies, namely the necessity and obligation to conduct an audit of ESG-related results,” Sebov said.

The obligations will not only be internal to the organization, but also in the supply chain, that is, they will extend to the level of the supplier.

“We remember the case of Volkswagen (dieselgate #), related to the manipulation of information about carbon emissions. Not only Volkswagen was involved here, but also Bosch. We will have to pay more attention to the partners we work with,” she says.

Attempts to introduce new systems, to show a certain image will increase the risk of fraud.

Some famous ESG scandals: Volkswagen, Bosch, Theranos. Xianjing is more recent: a Chinese company used forced labor.

• An example given by Piticas: An investment fund has declared that all investments in the portfolio are green. He was fined $1.5 million.

Profit: The motivation that leads to fraud

The motivation behind fraud is still profit, says Ana Maria Iordake, partner at D&B David&Baias.

“It’s true, this time we are aiming for a stable profit. We seek to involve stakeholders in our efforts to avoid climate change, equal opportunities for women and men,” she says.

Why do we do this? We are trying to maximize our profits.

Well, that always left room for all kinds of scams.

“Both the Consumer Protection Directive and the common law classify these types of fraud as both culpable and intentional,” Jordake said.

Guilt punishable in the same way as intent / Manipulation of ESG data, similar to tax evasion

In this controversial matter, says Yordake, guilt is punished as well as intention.

“So we should not have a purpose to commit such a fraud. This can be done out of carelessness or because we didn’t realize the consequences of this reporting that we do excessively, many times. Negligence can be considered fraud, even if it is committed out of guilt, it is punishable,” she says.

According to her, the manipulation of ESG data is a fraud.

“It’s like tax evasion. This is much more serious, and the intent of their commission should be observed, and at the same time it is accompanied by more onerous sanctions for companies,” said Ana Maria Iordake.

A new directive is due to enter into force, probably from next year: the Corporate Sustainability Due Diligence Directive (CSDDD).

This forces companies to conduct supply chain due diligence.

“Companies that fall under the reporting scope of this directive should go back to their suppliers in the supply chain and ask them what actions they have taken to protect the environment, ensure respect for human rights and respect ethical and governance criteria at the level of these companies,” – she said.

The responsibility for ESG fraud rests with the board, administrators and shareholders of this company.

ANPC will be able to impose fines of up to 4% of turnover for non-compliance with ESG criteria for consumer goods

According to her, a new directive on the protection of consumer rights is being discussed at the level of the European Parliament.

“It will generate a lot of interest because it will fall under the attribution of ANPC in Romania. ANPC is an extremely vocal and active authority,” Yordake states.

Another element we need to keep an eye on for this change and ESG risk management, she says, is the penalty it entails. This is up to 4% of turnover.

A fine will be charged if the company lies or exaggerates environmental issues.

“So it is necessary to implement as many ESG control mechanisms as possible,” Yordake also noted.