Facebook data privacy issue already identified by ESG investment screens

Socially responsible investors typically look at data privacy, an increasingly pertinent issue for companies and businesses.

Shortly after it was revealed that Cambridge Analytica collected data on Facebook users during the 2016 election campaign, Domini Impact Investments, a registered investment advisory firm that specializes in responsible investing, decided to drop Facebook shares from its holdings. It had already flagged the company for data privacy issues the year before.

“We decided Facebook was really the most clear-cut example of soliciting intimate details about you and selling it to advertisers,” said Amy Lee Domini, founder of Domini.

Nora Chan, Facebook corporate communications associate manager, said in an email that Facebook had no comment.

This was not the first time that Domini, which evaluates investments based on environmental, social and governance standards, had chosen to divest from a company to make a statement. In the past, the investment firm eliminated Walmart from its holdings because of labor violations in its supply chains, and Computer Associates International, now known as CA Technologies, due to high executive pay.

Though most well-known for negatively screening “sin” stocks like weapons, tobacco and pornography, ESG standards also typically look at data privacy, an issue increasingly pertinent to companies and businesses.

“Data privacy is becoming a bigger issue for investors to monitor,” said Iyassu Essayas, director of ESG research at Parnassus Investments, in an email. “Data privacy is not just an issue for social media companies. It’s an issue for any company that stores, maintains or monetizes sensitive or personal data.”

(More: DOL guidance on ESG funds shouldn’t have chilling effect on social impact investments)

Over the years, significant controversies have brought the issue of data privacy to the foreground. In 2005, Yahoo disclosed the contents of a Chinese reporter’s emails regarding Tiananmen Square to the Chinese government.

In 2013, Target Corp. was the focus of one of the largest data breaches ever, which exposed more than 40 million customer debit and credit card accounts. In 2017, Equifax, a credit reporting agency, was hacked, exposing 143 million American consumers to information theft.

Socially responsible trends

ESG-focused investments do not hold to universal standards, though companies look to initiatives like the United Nations Global Compact, a strategic initiative for supporting socially responsible companies, as a framework.

However, with data aggregation, ESG analysis has evolved from screening out sin stocks to evaluating material risk for companies. It then drills down on the issues that are most likely to affect a company’s profitability. In other words, it makes more sense to rate a tech company or a bank based on data privacy than, say, carbon emissions.

That focus can help evaluate a company for negative impact that the markets and traditional financial analysis might miss. Jon Hale, global head of sustainability research at Morningstar, said that anyone analyzing for ESG prior to last year would have been aware that data breaches could occur.

For example, Arabesque, a global asset management firm headquartered in London, had screened out Facebook several months before its recent issues came to light because its quantitative investment processes had identified the tech giant’s data privacy practices. The firm’s screen takes out companies that fall below 25% in its ESG ratings.

Because of weaknesses in gathering data, the company had built a framework for analysis, called S-Ray, that fills in gaps in information by aggregating data from the companies, from news, from non-government organizations and Google trends.

“There’s always the thing the company is saying,” said Andreas Feiner, head of ESG research at Arabesque. “But then there’s news that comes out that says that isn’t the case. So we always try to balance the internal information with the external information.”

Is it profitable?

Critics of ESG investing argue that socially minded funds do not make for profitable investment portfolios. In fact, despite Facebook’s stock dropping steeply due to the Cambridge Analytica scandal, nearly 18% in March, it still recovered and reached new all-time highs. It crossed the $200 per share threshold in June, signaling the strength of the social media company.

(More: Advisers still think ESG strategies underperform)

Nevertheless, Mr. Feiner said that there generally is a good correlation with ESG analysis and stock market performance.

“It’s about a percent of additional revenue,” he said.

And companies involved in significant data privacy controversies risk increased regulatory risks, reputational harm and potential fines.

Facebook is under investigation by the Department of Justice and Federal Trade Commission, an investigation which the Securities and Exchange Commission and the Federal Bureau of Investigation have joined, as reported by the Wall Street Journal.

Companies aren’t necessarily going to go out of business, but a data breach can be a costly misstep that requires them to spend significant time and resources to improve data privacy practices and to win back public trust.

“It’s a serious issue,” Mr. Hale said.