The Commodity Futures Trading Commission (CFTC) announced its first actions for fraud in the voluntary carbon markets (VCMs) on October 2, 2024. These enforcement actions demonstrate the CFTC’s continued focus on the integrity of the VCMs and the voluntary carbon credits (VCCs) transacted in those markets.
The announcement of these enforcement actions come less than two weeks after the CFTC issued final guidance on listing VCC derivative contracts for trading by designated contract markets, as Morgan Lewis reported last month.
BACKGROUND
VCCs are tradeable, intangible instruments issued by a carbon crediting program that represent real reductions or removals of greenhouse gas (GHG) emissions from the atmosphere equivalent to one metric ton of carbon dioxide. The crediting program reviews and certifies mitigation projects or activities that reduce or remove GHG emissions from the atmosphere and issues VCCs to mitigation projects or activities that satisfy the crediting program’s standards based on the calculated amount of reductions or removals.
VCMs provide a forum for individuals, businesses, and nonprofit organizations to purchase and sell VCCs for use to offset their GHG emissions. VCCs can also be traded in derivatives markets; market participants can trade derivatives such as VCC futures. Futures contracts have been offered on various carbon credits by designated contract markets, which are registered with the CFTC, and VCCs are commodities traded on both the spot and derivatives markets.
The CFTC has exclusive jurisdiction over the derivatives markets, including futures contracts, options on futures contracts, and swap transactions under the Commodity Exchange Act (CEA). In addition, it has the authority under the CEA to investigate and charge fraud, manipulation, and deception in connection with any swap or contract of sale of any commodity in interstate commerce.
ENFORCEMENT ACTIONS FOR FRAUD AND DECEPTION AGAINST CARBON CREDIT PROJECT DEVELOPER AND INDIVIDUAL EXECUTIVES
CFTC’s Division of Enforcement investigated a carbon credit project developer that sold VCCs from projects to replace less efficient cooking methods with more efficient cookstoves in sub-Saharan Africa, Central America, and Southeast Asia and to replace less energy efficient incandescent lightbulbs with more efficient light-emitting-diode lightbulbs in poor rural areas. This developer, according to the CFTC, was one of the largest cookstove carbon project developers in the world. The developer was responsible for managing on-the-ground project development and implementation and for arranging project financing.
The investigations resulted in the CFTC entering into consent orders against the developer and its former chief operating officer (COO), as well as a federal court complaint against the developer’s former CEO.
FINDINGS
In the consent orders, the CFTC made several findings, including that the developer and former COO reported false and misleading information about the energy usage and energy savings for its projects to at least one US-based carbon credit registry and verification bodies to inflate the quality of emission-reduction projects. As a result of this conduct, the CFTC found that the developer was issued millions more VCCs for the projects than was warranted.
These acts formed the basis for violations of Section 6(c)(1), 6(c)(1)(A), and 9(a)(2) of the CEA and Section 180.1(a)(1)-(4) of the CFTC’s regulations, which prohibit the use or attempted use of any manipulative or deceptive device, untrue or misleading statements or omissions, or deceptive practice, in connection with any swap or contract of sale of any commodity in interstate commerce, or for future delivery.
The CFTC found that the developer and the former COO intentionally and recklessly engaged in fraud in connection with contracts of sale of VCCs by providing falsified or misleading data on the use of and energy saved by the projects to misrepresent the quality of the projects and increase the number of VCCs issued to the developer. It also found that the developer’s reports included false, misleading, or knowingly inaccurate information.
The developer is required to pay a $1,000,000 civil monetary penalty, cease and desist from violating the applicable provisions of the CEA and CFTC regulations, and comply with certain conditions and undertakings, including canceling the VCCs that were issued as a result of the falsified data.
The order recognizes the developer’s “substantial cooperation” with CFTC’s Division of Enforcement and the developer’s representations of its remediation, including terminating, replacing, or separating from numerous individuals who were responsible for the conduct, appointing new senior executives, implementing improvements to the monitoring, reporting, and verification of VCCs, launching new trainings, and amending policies to ensure future compliance. The developer’s cooperation and remediation resulted in a reduced civil monetary penalty.
The former COO entered into a formal cooperation agreement with the Division of Enforcement that set forth the terms of his agreement to cooperate with the CFTC and the Division of Enforcement.
CFTC COMPLAINT
In addition to the consent order, the CFTC filed a complaint in federal court against the developer’s former CEO and majority shareholder, alleging many of the same facts as the Commission found in the consent order. This includes alleging that he engaged in a fraudulent scheme and reported false, misleading, or inaccurate information on the quality of the developer’s projects to obtain more VCCs than it was entitled to receive, thereby increasing the developer’s revenue by millions of dollars.
The CFTC’s complaint alleges that the former CEO “knowingly, intentionally, or recklessly participated in, directed, and set the tone for the fraud in connection with the VCCs.” The CFTC further alleges that the developer falsified survey results and prepared false reports for a carbon credit registry with the former CEO’s knowledge or at his direction, and that the former CEO certified the accuracy of the impact of the cookstove project. The CFTC also alleges that once employees became aware of the fraud, the former CEO denied or minimized his involvement and provided pretextual explanations.
In addition to seeking an order finding CEA and CFTC regulation violations, the CFTC also seeks a permanent injunction order enjoining the former CEO from engaging in the conduct discussed above or entering in any transactions involving commodity interests, an order directing the former CEO (and any third-party transferee or successor) to disgorge all benefits received from the alleged violative conduct, an order requiring the former CEO to pay a civil monetary penalty, and other relief.
TAKEAWAYS
While these enforcement actions are the first CFTC actions for fraud in the VCMs, other investigations involving VCCs and VCM participation are likely ongoing. More enforcement actions are expected to be announced.
The CFTC has demonstrated its commitment to combat fraud and manipulation in the VCMs through its actions and initiatives that have ramped up over the last few years. These include the voluntary carbon markets convenings, the CFTC Division of Enforcement’s creation of the Environmental Fraud Task Force, the alert issued by the CFTC’s whistleblower program seeking tips of potential CEA violations that are connected to fraud or market manipulation in the VCMs, and most recently, the issuance of the Final Guidance on listing VCC derivative contracts for trading by designated contract markets.
A variety of potential misconduct may be the subject of CFTC investigations. Through its exercise of its anti-fraud and anti-manipulation enforcement authority over the VCMs, the CFTC can pursue investigations into potentially manipulative trading in futures contract, the validity and credibility of VCCs that are issued (as in the enforcement actions discussed above), and fraudulent statements on the material terms of a VCC—including the quality, additionality, permanence, or environmental benefit of the VCC.
Companies that transact VCCs should bear in mind the potential regulatory and enforcement exposure associated with trading and transacting VCC. They will need to ensure that the VCCs held reflect an actual reduction or removal of GHG emissions and that the reduction or removal is accurate, permanent, verifiable, and additional.
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