Rising Popularity of ESG and the Emergence of Fraud Risk
The widespread adoption of ESG as a business framework has led to a fundamental shift in how firms approach strategy, disclosure, and stakeholder engagement. Over forty percent of Russell 1000 companies have formally committed to reducing emissions, with many pledging to achieve net zero by the year 2050. These commitments signal a meaningful transformation in corporate behavior but also introduce new forms of risk. The rapid growth in ESG integration has created reputational rewards for those seen as leaders, but also temptations for organizations to overstate progress, conceal failures, or cut corners under the pretense of sustainability. This high-pressure environment has accelerated the emergence of ESG fraud.
The problem is not only in bad actors. Even well-meaning firms can find themselves tempted to simplify narratives, ignore inconvenient data, or selectively disclose positive metrics while withholding material challenges. The complexity and cost of building authentic ESG systems further increases the incentive to appear successful without fully achieving results.
Internal and External ESG Fraud
ESG fraud can originate from within an organization or from external entities operating in its ecosystem. Internal ESG fraud typically involves executives, managers, or employees intentionally misrepresenting the company’s ESG practices or outcomes. Examples include concealing the use of child labor in overseas factories, underreporting pollution incidents, or manipulating data to meet diversity quotas. These practices often occur when there is insufficient internal accountability, weak governance structures, or misaligned incentives tied to ESG performance.
External ESG fraud occurs when vendors, contractors, or service providers intentionally deceive the company or its stakeholders. This includes supplying forged ESG certifications, misrepresenting raw material sourcing, or falsifying third-party audit results. These fraudulent practices can infiltrate the supply chain and reflect poorly on the lead firm, regardless of intent. Without rigorous onboarding, oversight, and traceability, even firms with strong internal controls can fall victim to external ESG deception.
ESG Pressure and the Fraud Triangle
The ESG environment is uniquely prone to fraud because it activates the three elements of the fraud triangle:
- Pressure to achieve ESG results is intense. Investors, regulators, customers, and boards are increasingly demanding visible progress. This pressure is compounded by unclear metrics and long timelines, which allow firms to overstate performance in the short term without immediate contradiction.
- Opportunity exists because ESG disclosures often operate outside the rigor of financial audits. Unlike traditional financial reporting, ESG statements may rely on unaudited estimates, nonstandard metrics, or self-reported data. This gap creates room for manipulation.
- Rationalization allows individuals to justify fraudulent actions. In the ESG context, this rationalization is particularly dangerous. Executives may believe they are serving a greater good by exaggerating results. Some convince themselves that short-term deception will eventually be justified by long-term impact. Others rationalize based on competitive pressure, telling themselves that if peers are engaging in the same behavior, they must do so as well to remain relevant.
Cultural norms within industries, along with excessive focus on public image, further fuel this rationalization. In organizations that reward visibility over substance, the temptation to manipulate ESG narratives becomes difficult to resist.
ESG Fraud Schemes Across Domains
Environmental fraud includes inflating the value or quantity of carbon credits, underreporting emissions, or falsifying compliance with environmental standards. A common scheme is harvest mixing, where legal and illegal goods are combined and labeled as fully compliant. This is particularly problematic in resource-intensive industries such as mining, fisheries, and agriculture, where global oversight is fragmented and verification is difficult.
In the social domain, fraud often revolves around labor conditions and diversity metrics. Companies may collaborate with offshore suppliers that conceal unsafe working conditions or labor exploitation. Falsified diversity, equity, and inclusion data has become a growing issue, especially when tied to incentive pay or public rankings. Some suppliers have been found to withhold workers’ wages or funnel wages into inaccessible savings accounts under exploitative arrangements masked as financial inclusion programs.
Governance-related fraud includes misclassifying capital expenditures as ESG investments to trigger bonuses or to mislead stakeholders about alignment with sustainability objectives. It also involves ignoring red flags in foreign subsidiaries, laundering funds through ESG-themed projects, or manipulating audit outcomes. In some cases, audit committees themselves lack independence, allowing ESG violations to go unreported or unchallenged.
Mapping ESG Fraud Risks
Grant Thornton and the Association of Certified Fraud Examiners developed a dedicated taxonomy to help organizations map ESG-related fraud risks. This taxonomy builds upon the traditional fraud tree but expands it to include nonfinancial reporting misconduct. The purpose is to help firms structure their fraud risk assessments in a way that captures the unique nature of ESG deception.
By using this taxonomy, organizations can identify fraud threats across both internal functions and the extended supply chain. For example, virtue signaling refers to making public moral claims or taking symbolic action without substantive backing. Greenwashing involves portraying products, investments, or operations as environmentally sustainable when they are not. Value chain manipulation refers to failing to account for unethical practices among suppliers and distributors. These schemes undermine trust, distort ESG ratings, and mislead investors.
Fraud risk assessments should be integrated into enterprise risk management systems or conducted as stand-alone evaluations. In either format, they must be systematic, data-driven, and repeated periodically to capture changes in external regulations, internal practices, and market expectations.
Mitigating ESG Fraud Risk
Effective mitigation begins with the recognition that ESG fraud is not a theoretical concern but a concrete and growing threat. The absence of universal ESG standards creates ambiguity that allows bad actors to thrive. To counter this, firms should adopt frameworks like the COSO-ACFE model which establish principles for governance, risk assessment, control activities, investigation, and monitoring.
An ESG-specific fraud management program should begin with clearly written policies and procedures. Roles and responsibilities related to ESG analysis, disclosure, and compliance should be defined and regularly reviewed. Firms must ensure ESG claims are backed by evidence and that these claims are updated as facts evolve. Claims that cannot be substantiated through documentation or independent verification should not be made.
Supply chain risk must be addressed through rigorous mapping, onboarding due diligence, and ongoing monitoring. Predictive analytics can identify anomalies in ESG data, while automation can improve control effectiveness and response times. Whistleblower programs must provide channels for reporting ESG-related misconduct, and internal investigations must be supported by subject matter experts who understand both compliance law and ESG metrics
Corrective action involves not just addressing incidents, but ensuring systems are in place to prevent recurrence. Key performance indicators and risk indicators should be developed to track progress and surface emerging issues. ESG must be fully integrated into anti-bribery and anti-corruption frameworks, procurement policies, and executive review protocols.
Materiality and Strategic Governance
Materiality in ESG fraud is not defined by traditional financial thresholds. Instead, it is defined by whether information could influence stakeholder decisions or public trust. This includes how firms treat disclosures about emissions, labor conditions, board practices, and philanthropic partnerships. ESG materiality must be defined in a context-specific way that considers both regulatory expectations and stakeholder priorities.
Organizations should clearly state how they define material ESG information and what criteria they use to determine disclosure. They should prepare procedures for correcting inaccurate or misleading disclosures. ESG-related materiality must be documented in governance statements and embedded in board oversight responsibilities, audit committee charters, and compensation frameworks. When ESG is treated as a compliance function rather than a communications strategy, the organization becomes more resilient to fraud risk.
Leadership should signal that ESG integrity is a non-negotiable principle. Internal audit functions must be equipped to evaluate ESG disclosures with the same rigor applied to financial statements. Stakeholder engagement tools such as surveys, forums, and workshops can help surface areas of concern and reinforce organizational values.
Global Standards and Oversight Bodies
A number of institutions have stepped in to define the global framework for ESG reporting and audit quality. These include the International Auditing and Assurance Standards Board, the International Financial Reporting Standards Foundation, the Sustainability Accounting Standards Board, the International Integrated Reporting Council, and the International Sustainability Standards Board. Each plays a role in shaping how ESG-related data should be collected, reported, and assured.
In the United States, the Securities and Exchange Commission holds jurisdiction over ESG-related disclosures by public companies and registered investment advisers.
Together, these standards bodies are working to close the gap between aspirational ESG language and verifiable ESG outcomes. Their work provides a reference point for organizations seeking to implement credible, defensible ESG programs that withstand regulatory scrutiny and stakeholder examination.
Organizations related to auditing and reporting standards
- National Auditing and Assurance Standards Board (IAASB) - Visit
- International Financial Reporting Standards (IFRS) Foundation - Visit
- International Sustainability Standards Board (ISSB) - Visit
- Value Reporting Foundation (VRF) - Visit
- Sustainability Accounting Standards Board (SASB) - Visit
- International Integrated Reporting Council (IIRC) - Visit
- U.S. Securities and Exchange Commission (SEC) - Visit