More actions on the way as CFTC sets sights on Voluntary Carbon Credit transactions
In brief
Acting with other US regulators, the Commodities Futures Trading Commission (“CFTC“or “Commission”) recently issued two consent orders (“CFTC Orders”) and filed a complaint (“CFTC Complaint”) alleging fraud and false, misleading, or inaccurate reports relating to voluntary carbon credits (“VCCs“)1. As noted by CFTC Director of Enforcement Ian McGinley, “[these actions] demonstrate [the CFTC’s] commitment to vigorously fight frauds in its markets, whether long-established or new and evolving, such as the carbon credit markets.”2 These are the first CFTC actions for fraud in the VCC market, and closely follow the CFTC’s recently published final Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts (“Final Guidance”)3. The Final Guidance and these enforcement actions highlight carbon credit compliance as a growing interest within the CFTC, and we expect further enforcement activity by the CFTC on carbon credit producers and markets in the near future.
Background
CQC Impact Investors LLC (“CQC“), a leading global developer of voluntary carbon credit projects, launched initiatives aimed at cutting carbon emissions, including installing efficient cookstoves and LED bulbs in sub-Saharan Africa, Asia, and Central America. Based on the reported reductions, CQC sought and received issuances of carbon credits from various crediting programs4. However, per the CFTC Consent Orders and allegations in the CFTC Complaint, CQC reported materially inaccurate reduction numbers leading to the issuance of millions of additional carbon credits for CQC. For instance, the CFTC’s investigation found that CQC personnel repaired missing or broken stoves and falsely claimed that they had been consistently operational, or completely omitted negative survey results. Certain former executives, supervisors, and compliance staff were also involved in CQC’s fraudulent activities. CQC sold the legitimate carbon credits and the additional carbon credits to which they were not entitled in voluntary carbon credit markets, including to buyers in the United States5.
CFTC complaint and orders
The CFTC Complaint alleges that the CEO, founder, and majority shareholder of CQC, along with other CQC executives, knowingly participated in and facilitated the fraud in connection with the VCCs. According to the CFTC Complaint, the former CEO did so in order to present a misleading impression of the quality of emission reduction projects and to obtain carbon credits far beyond what CQC was entitled to receive. Without the enforcement actions, the CFTC believes that the former CEO “is likely to continue to engage in the acts and practices alleged” in the CFTC Complaint, significantly undermining the integrity of the VCC markets6. Accordingly, the CFTC seeks to bar the former CEO from participating in commodities or derivatives trading, disgorgement of ill-gotten gains, and civil monetary penalties.
The CFTC Orders against CQC and its former COO list violations of regulations that prohibit the use of manipulative or deceptive devices, untrue or misleading statements or omissions, deceptive practices, or fraud in connection with the sale of a commodity or derivative in interstate commerce7. Additionally, the CFTC included a charge for knowingly providing false or inaccurate reports concerning market information or conditions that affect the price of a commodity8.
CQC was ordered to pay a USD 1 million fine, cease and desist from further violations of the Commodities Exchange Act, and cooperate with the CFTC in any current or future investigation or action related thereto. In what is becoming common practice for the CFTC, the Commission noted CQC’s “substantial cooperation” with the CFTC’s enforcement action and CQC’s swift remediation led to a reduced civil monetary penalty9.
The former COO entered into a consent order with the CFTC, agreeing to all of the claims against him and to cooperate with the current investigation and any future investigations. Additionally, the former COO pled guilty to charges of wire fraud conspiracy, commodities fraud conspiracy, and securities fraud conspiracy for his participation in the fraud scheme. The former COO is cooperating in the investigation, and the plea deal should result in a lighter sentence.
Other actions
The Securities and Exchange Commission (“SEC“) announced settled charges against CQC and its subsidiaries for securities fraud. CQC admitted to a USD 250 million offering fraud and agreed to cease and desist “from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.”10 The SEC noted CQC’s remedial acts and cooperation, though the settlement does not provide the agreed upon terms or actions taken to make investors whole.
The United States Attorney for the Southern District of New York and the Federal Bureau of Investigation (“FBI“) also announced criminal charges against CQC’s former CEO and the Head of CQC’s Carbon & Sustainability Accounting Team (“CSAT“) for conspiracy, wire fraud, and securities fraud. The indictment states that the Head of CSAT and the former CEO’s actions directly led to CQC fraudulently obtaining carbon credits worth tens of millions of dollars and fraudulently securing an investment of over USD 100 million. CQC was not named as a defendant in these actions “in light of CQC’s voluntary and timely self-disclosure of misconduct, full and proactive cooperation, timely and appropriate remediation, and agreement to cancel or void certain VCUs.”11
Key takeaways
These joint actions by the CFTC, the SEC, the US Attorney’s Office for the Southern District of New York, and the FBI demonstrates collaboration among government entities and their authority to regulate and take actions against alleged sustainability fraud, whether it involves commodities, securities, or simply interstate commerce.
Commodity producers should remember that they are in the scope of the CFTC’s enforcement authority. While this is the CFTC’s first enforcement action charging fraud in connection with the issuance and sale of VCCs, more enforcement actions are expected to follow. According to CFTC Chairman Rostin Behnam, the “[enforcement] actions [combined with the Final Guidance] show that strong enforcement is another critical step in ensuring the integrity of these markets”12. Consequently, VCC producers and voluntary carbon market participants should be on the lookout for fraud or misleading statements, and ensure that their compliance and reporting structures meet the CFTC’s requirements and any exchange rules.
Baker McKenzie has extensive experience on matters relating to the CFTC, commodities (including carbon credits), and derivatives, and can answer any questions relating to this client alert or CFTC regulatory matters in general. If you have any questions or require additional information, please contact Matthew Smith.
1 A carbon credit is a tradeable intangible instrument that is designed to represent one metric ton of carbon emissions avoided or reduced. In the United States, carbon credits are also “commodities” as described in Section 1a(9) of the Commodities Exchange Act, and fall under the CFTC’s jurisdiction. Futures contracts referencing carbon credits are traded on various CFTC regulated exchanges. VCCs are carbon credits in voluntary markets that are issued by a carbon crediting program that are designed to represent real reductions or removals of greenhouse gas emissions. A participant in the voluntary carbon markets may purchase VCCs to offset greenhouse emissions and otherwise meet climate pledges and emission goals.
2 Press Release, Commodity Futures Trading Comm’n, CFTC Charges Former CEO of Carbon Credit Project Developer with Fraud Involving Voluntary Carbon Credits, Commodity Futures Trading Comm’n, Release No. 8994-24 (Oct. 2, 2024).
3 The Final Guidance addresses the listing of VCC derivative contracts by designated contract markets. It discusses how registered DCMs can comply with DCM Core Principles 3 and 4, and addresses the CFTC’s product submission requirements related to VCC derivatives. The Final Guidance, however, does not set binding rules or establish new regulations for DCMs. The CFTC expects the Final Guidance will drive standardization and efficient capital allocation to scale the underlying cash market for high integrity VCCs.
4 The creation of VCCs typically involves three participants: (1) the developer of the greenhouse gas reducing project, (2) the crediting program certifying the projects and issuing the VCCs, and (3) a third party validation and verification body (“VVB”). The crediting program and VVB rely on inputs and data provided by the developer to calculate and certify the total amount of greenhouse gas reductions, and thereby the number of VCCs issued.
5 Carbon credit markets include both voluntary markets and compliance markets. Voluntary markets are not generally established or maintained by a government body, and tend to have more flexible arrangements for participants to meet corporate social responsibility goals or otherwise maintain a lower level of environmental impact. Compliance markets cover legally mandated environmental compliance requirements (e.g. the Kyoto Protocol, Paris Agreement) regulated by governmental bodies at national, regional, or international levels. Entities in a mandatory compliance regime must meet emissions standards by either directly reducing their emissions or purchasing eligible compliance credits representing reductions or removals achieved by others. See Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts, RIN 3038-AF40, at 8-9.
6 CFTC v. Kenneth Newcombe, Civil Action No. 24-cv-7477 (S.D.N.Y. Oct. 2, 2024).
7 17 C.F.R. § 180.1(1)-(3).
8 17 C.F.R. § 180.1(a)(4).
9 In re Impact Investors LLC, CFTC No. 24-37(Sept. 30, 2024).
10 In re Impact Investors LLC, Securities Act Release No. 11315 (Oct. 2, 2024).
11 Press Release, US Attorney Announces Criminal Charges in Multi-Year Fraud Scheme in the Market for Carbon Credits, U.S. Dep’t of Justice (Oct. 17, 2024).
12 Press Release, Commodity Futures Trading Comm’n, CFTC Charges Former CEO of Carbon Credit Project Developer with Fraud Involving Voluntary Carbon Credits, Commodity Futures Trading Comm’n, Release No. 8994-24 (Oct. 2, 2024).
