Corporate governance is rapidly emerging as a critical area of sustainability, but of all the topics under the environmental, social and governance (ESG) umbrella, it is often the area that receives the least attention. ‘Warning.
To put it simply, corporate governance is an essential part of ESG simply because of the growing litigation risk environment on the ESG issue.
Vincent Walden, CEO of Kona AI and FRAUD Magazine columnist, says the rapidly expanding ESG risk environment, including potential fraud risks, is very real. “When company leaders act in a different way that goes against the company’s code of conduct or social standards, it can cause significant financial harm to the company and thus significantly increase the pressure to conceal or misrepresent certain facts,” Walden said, adding that although this is not an actual fraud, the essential role of governance join the game.
“If an organization does not have proper risk assessment, training, reporting, monitoring and investigation protocols in place, the company’s corporate culture could suffer, which could open it up to a variety of fraud schemes, including misappropriation of assets, bribery or financial fraud. misrepresentation,” he explains.
However, set ESG Fraud is not so simple. Indeed, from a legal point of view, it is allegations fraud related to ESG issues concerning errors or inaccuracies, according to Colleen SmithPartner and Global Vice President of the Securities Litigation and Professional Liability practice at Latham & Watkins.
Increase in litigation in ESG areas
The reality is that allegations and complaints about ESG topics are increasing, regardless of how those issues are framed. The heightened scrutiny of regulators around the world – driven by the collective interest of investors, consumers and the public – has brought scrutiny to corporate reports and statements on ESG issues. The fact that the financial performance and share price of public companies can fluctuate based on the information they disclose on ESG matters is a relatively new development.
Sarah Fortt, Partner and Global Co-Chair of the ESG Practice at Latham & Watkins, notes that these aforementioned related events have led to an increase in legal actions over ESG issues, and further, that the scope of who brings legal action against which widens. Specifically, Fortt and Smith agree that plaintiffs, both private consumers and shareholders, both make claims in a number of areas, including allegations of greenwashing, perceived supply chain abuses, and inaccuracies or omissions. assumptions regarding durability claims. In addition, corporate directors are increasingly the target of litigation regarding their alleged breach of fiduciary duty based on allegations of lack of oversight or non-compliance, based on underlying ESG allegations. , they say.
Fortt says she expects to see the growth of ESG-related litigation increase. In fact, she sees pursuing claims about inequality as an additional emerging area for legal action on the horizon. Many companies have added “sustainability-related measures as a driver of executive compensation, and allegations about executive compensation tend to emerge at the forefront of corporate governance during expected periods of economic downturn, stagnation or uncertainty,” says Fortt.
Advice to corporate lawyers
To reduce these ESG-related risks, Fortt and Smith advise their clients to treat ESG in the same way as any corporate reporting and compliance requirements. Specifically, they shared several ways corporate legal functions can stay abreast of ESG concerns, including:
Understand data issues — First, in-house lawyers need to understand how challenging ESG data is. “Even if there are no finalized regulations regarding some of these issues in your jurisdiction, a lot of ESG data comes down to the tedious job of ensuring rigor and consistency when it comes to putting in place internal controls, to audit your processes around KPIs [key performance indicators] that you use and report,” says Fortt. However, internal controls and audits are generally not the responsibility of the corporate legal function, and attorneys should understand the status of any data issues or gaps to determine any potential exposures.
Kona AI’s Walden agrees, adding that attorneys need to be familiar with transactional or structured data, such as third-party payments, operational data, and other forms of financial data. “We are seeing lawyers becoming more tech-savvy when it comes to dashboards, payment analytics, and predictive modeling to statistically identify potentially inappropriate or corrupt payments and/or detect areas of financial misrepresentation. “says Walden, adding that this is also where accountants and lawyers can work hand-in-hand, each bringing their area of expertise.
Invest in learning to understand deeper issues — Training your attorneys to think not just on the surface of what they hear from other business functions, but also on the deeper layers and implications they have for effective and ongoing internal reporting is truly paramount.
To do this effectively, corporate lawyers must constantly invest their efforts in learning about ESG issues that are material to their organization from the perspective of all stakeholders, including shareholders, employees and customers, as well as to identify areas where effective controls are needed to mitigate risk. “Lawyers should advise clients on key areas of firm-specific risk and ensure both that strong supervisory controls are in place and that they are being followed,” Smith advises.
Advocate for proactive and consistent corporate culture assessment, measurement and auditing — Finally, corporate lawyers and managers more broadly need to better measure and audit their corporate culture. Indeed, when situations of management-level misconduct – such as a failed safety issue or an ethics incident – arise, the cultural issues of preventing appropriate internal reporting or compromise in the reporting process are a popular key finding in the investigation process.
Companies talk a lot about corporate culture, but find it hard to do the hard work, Smith suggests. “Very often human behavior is the root of corporate scandal,” she says.
Strong agrees. “When you have people who are afraid to report issues, there’s a lot of our humanity that gets absorbed into our jobs that aren’t necessarily fully recognized or appreciated in a way that would actually help businesses protect themselves. and protect their stakeholders,” she says.