Is greenwashing running rampant?

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So just how reliable are those carbon footprints that many large companies have been publishing in their sustainability reports?  Even putting aside concerns about greenwashing, what about those nebulous Scope 3 GHG emissions?  As we all know, the SEC is now is the midst of revising its proposal for mandatory climate-related disclosure in response to comments.  (See this PubCo post, this PubCo post and this PubCo post).)  The WSJ reports that “[o]ne problem facing regulators and companies: Some of the most important and widely used data is hard to both measure and verify.” According to an academic cited in the article, the “measurement, target-setting, and management of Scope 3 is a mess….There is a wide range of uncertainty in Scope 3 emissions measurement…to the point that numbers can be absurdly off.”

In one example described by the WSJ, a company was able to cut its GHG emissions in half in just a few years—“with a wave of a calculator.” The change came as the company “doubled down on driving accuracy” in its calculations, revising its Scope 3 emissions, which accounted for 97% of its total emissions for the year. The company’s original report published several years before indicated that its estimates might be off “by as much as 50 percent.”  (See this PubCo post.)

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As discussed in this article in the WSJ, the FTC is “considering proposing regulations on environmental marketing of consumer products, which could subject companies to stiff penalties if they run afoul of the rules.” And the risk of SEC-initiated litigation related to ESG fraud and greenwashing appears to be growing. In 2021, Acting Director of Enforcement Melissa Hodgman, warned us to anticipate more ESG disclosure-related enforcement actions. In March 2021, then-Acting SEC Chair Allison Herren Lee announced the creation of a new climate and ESG task force in the Division of Enforcement, which sought to identify ESG-related misconduct. (See this PubCo post and this PubCo post.) Recently, Enforcement has fixed its attention on misleading statements in sustainability reporting—greenwashing—even outside of periodic reports. (See, e.g., this PubCo post and this PubCo post.) And just last year, we saw settled SEC charges in connection with, among other things, alleged disclosure violations that were “the consequence of a deficient disclosure process” regarding environmental contamination and related financial risks. (See this PubCo post.)

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In this article, audit firm Deloitte advises that, with the current attention to ESG and in anticipation of new rulemaking from the SEC on disclosure related to climate, human capital and other ESG-related topics (see this PubCo post), “fraud risk in this area should be top of mind for audit committees and a focal point in fraud risk assessments overseen by the audit committee.” While audit committees focus primarily on financial statement fraud risk, Deloitte suggests that audit committees should consider expanding their attention to fraud risk related to ESG, an area that is “not governed by the same types of controls present in financial reporting processes,” and, therefore, may be more susceptible to manipulation. In their oversight capacity, audit committees have a role to play, Deloitte suggests, by engaging with “management, including internal audit, fraud risk specialists, and independent auditors to understand the extent to which fraud risk is being considered and mitigated.”

With respect to climate, the article observes that companies may be providing climate-related metrics in voluntary reporting that may not be consistent with periodic reports and financial statements. According to the article, “the novelty of ESG-related information and the information gathering process, as well as the reliance stakeholders may be placing on such information, can make it susceptible to fraud risk…. Newer or less mature controls over reporting, ineffective controls, and the absence of controls can increase the opportunity for fraud to occur.” Anticipated regulatory developments and  demands of various investors, lenders, customers and other stakeholders can “create pressure for management and the board to appear well positioned to meet targets or comply with future regulations.” In addition, any climate-related metrics that are included in key contracts or compensation agreements may also impose pressures.  And, to the extent that climate-related disclosures are based on estimates, forecasts and judgments, these are “by their nature subjective and are subject to manipulation or bias.” The article advises that audit committees consider asking management “how reliable data sources are, whether they could be manipulated, and how management could potentially be motivated to intentionally manage these ESG metrics in ways that would serve management or the company’s best interests.”  (See this PubCo post.)

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Under the pressure of institutional investors, environmental groups, employees, consumers and other stakeholders, many companies have sought to demonstrate their bona fides when it comes to ESG through disclosure about their sustainability efforts, goals and achievements, whether in periodic reports or in separate sustainability reports.  But, as reporting increases, so do concerns by some about potential greenwashing.  How can companies assure the quality of their sustainability reporting and create more trust and confidence among stakeholders? One way might be through effective internal controls. So far, however, according to a new report from Committee of Sponsoring Organizations of the Treadway Commission, known as COSO, ”[f]ew best practices have been established. While some larger institutions have progressed in building controls around environmental, social, and governance (ESG) reporting, many organizations have designed ad hoc controls around certain key sustainable business metrics. Many also perform internal verification and assurance procedures to ensure management comfort with this information. Yet few of them seem to have developed effective, integrated systems of internal control over their material or decision-useful sustainable business information.” Now, leveraging insights gleaned from development of the most widely used internal control framework—the COSO Internal Control-Integrated Framework—COSO has developed the concept of  ”internal control over sustainability reporting” (ICSR).  In its new report, which weighs in at 114 pages, COSO provides supplemental guidance that explains and interprets how each of the 17 principles in the 2013 version of the COSO ICIF applies to sustainable business activities and sustainable business information. According to the authors, “[i]nternal controls have value beyond compliance and external financial reporting. Effective internal controls can help an organization articulate its purpose, set its objectives and strategy, and grow on a sustained basis with confidence and integrity in all types of information.”  As companies seek to “generate sustained value—ethically and responsibly—over the longer term,” with an emphasis on sustainability and ESG, both companies and their stakeholders need effective controls and oversight to provide the reliable and high-quality data needed for “decision making in this changing world.” (See this PubCo post.)