CFTC Enforcement Involving Voluntary Carbon Credits

This week the CFTC announced (click here) a set of three related enforcement actions for fraud in the voluntary carbon credit (VCC) market. These are the first CFTC enforcement actions for fraud in this market and follows the recent finalisation by the CFTC (click here) of their guidance for exchanges that list derivatives on VCCs. The CFTC’s enforcement announcement includes a 14-page Order (click here) against CQC Impact Investors LLC (CQC), a 25-page Complaint (click here) against its former CEO and majority shareholder (Kenneth Newcombe) and an 11-page Order (click here) against its former chief operating officer (COO), Jason Steele.

The facts as presented in the two Orders and one Complaint are summarised briefly below under their respective headings. First however we provide contextual information regarding the VCC market including how it relates to the underlying VCC projects:

• A VCC is a tradeable intangible instrument that is issued by a carbon crediting programme;
• VCCs are designed to represent real reductions or removals of greenhouse gas (GHG) emissions from the atmosphere, which market participants can trade on the voluntary carbon market, and use in efforts to offset GHG emissions to meet emissions reductions goals;
• One VCC typically represents GHG emissions reduced by, or removed from, the atmosphere equivalent to one metric ton of carbon dioxide;
• VCCs are commodities traded in both spot and derivatives markets and VCCs are available for sale and trading in spot voluntary carbon markets, over-the-counter as well as on spot trading platforms;
• In the spot market, market participants such as project developers can trade credits with a wide range of other market participants, such as end-users and intermediaries such as brokers;
• In the derivatives markets, market participants may trade derivatives such as VCC futures, and such derivatives may provide reference prices for spot and other derivatives trades;
• The issuance of VCCs typically involves three categories of participants:

1. The developer (such as CQC) of a mitigation project or activity that is intended to reduce or remove GHG emissions from the atmosphere;
2. A crediting programme (e.g., the Carbon Credit Registry) that, among other things, issues VCCs for mitigation projects or activities that satisfy the crediting programme’s standards; and
3. Third-party validation and verification bodies (VVBs) that validate and verify the mitigation project or activity.

• To develop a mitigation project or activity and ultimately be issued VCCs, a project developer must first select the crediting programme with which it seeks to certify its mitigation project or activity;
• The crediting programme will certify the project if the project appears to satisfy the crediting programme’s standards for issuing VCCs;
• In most cases, once the crediting programme determines that the mitigation project satisfies the crediting programme’s standards for issuing VCCs, the project will be certified, and VCCs will be issued based on the calculated amount of reductions;
• The crediting programme usually operates or makes use of a registry, which serves as a central repository for tracking certified mitigation projects and allows market participants to issue, retire, cancel, and/or trade VCCs;
• Registries also publicly report key information concerning the supply and project specifications of VCCs to assist market participants in making informed evaluations and comparisons of VCC supply and quality;
• The above reporting is based on information provided to the crediting programme by the project developer.

1] CQC Impact Investors (Order – click here): 

• During the period between 2019 to at least December 2023, CQC and its subsidiaries actively developed projects, including projects implementing more-efficient cookstoves (“Cookstove Projects”) and lighting (“LED Lightbulbs Projects”) amongst others;
• The Carbon Credit Registry issued VCCs to CQC in connection with these projects;

Cookstove Projects:

• CQC’s cleaner cookstove projects involved implementing improved cookstoves in countries in sub-Saharan Africa, Central America, and Southeast Asia;
• CQC’s Cookstove Projects together accounted for a significant portion of the world’s supply of carbon credits relating to cookstoves;
• CQC served as a project developer for its Cookstove Projects, maintaining responsibility for managing on-the-ground project development and implementation, and arranging project financing;
• For a Cookstove Project to be eligible to generate VCCs, the project developer must select or create a methodology according to which the project would be implemented and the VCCs quantified;
• During the period in question, CQC helped create a particular methodology referred to as “Methodology-1”, for calculating emissions reductions generated from its Cookstove Projects;
• Methodology-1 included a formula designed to calculate the project’s emissions reductions (and thus carbon credits) based on certain inputs such as the numbers of stoves in use and the project’s efficiency versus the baseline scenario;
• CQC reported the above information to VVBs and the Carbon Credit Registry, and this and other data was considered when determining how many VCCs would be issued by the Carbon Credit Registry for Cookstove Projects and hence listed on the public registry;
• The Carbon Credit Registry made certain elements information public which was provided to it by CQC and/or VVBs about these projects, including:

1. Project descriptions;
2. Number of VCCs that have been issued for a particular project; and
3. Validation, verification, and monitoring reports.

• The Carbon Credit Registry also published information, including CQC’s representations that the information submitted to the Carbon Credit Registry was accurate, truthful, and aligned with the applicable methodology;
• After CQC provided this information, the Carbon Credit Registry issued VCCs to CQC for its Cookstove Projects;
• CQC sold some of these VCCs, including to counterparties in the US such as in Delaware and California, and retained a significant number of others;

LED Lightbulbs Projects:

• CQC’s more-efficient lightbulb projects involved replacing less-energy-efficient incandescent lightbulbs with more-efficient light-emitting-diode (LED) lightbulbs in poor rural areas, thereby reducing carbon emissions;
• The LED Projects purported to follow a separate methodology, referred to as “Methodology-2”, which used a formula to calculate the project’s emissions reductions (and thus number of carbon credits) based on inputs such as numbers of LED bulbs in use and the project’s efficiency versus the baseline scenario of incandescent bulb use;
• The Carbon Credit Registry similarly published certain information on its public registry provided to it by CQC and its partners and/or VVBs about CQC’s LED Projects;
• As for the Cookstove Project, after receiving information provided by CQC or its partners, including certifications that the information submitted was accurate and complied with Methodology-2, the Carbon Credit Registry issued VCCs for the projects;
• Again, CQC sold a portion of these VCCs, including to counterparties in the US.

Fraudulent Activity: 

• According to the Order, CQC intentionally and repeatedly provided false and misleading information to the Carbon Credit Registry and to VVBs, including from the US, for the purpose of presenting a misleading impression of the quality of the Cookstove and LED Projects;
• According to the Order, this was done to wrongfully increase the number of carbon credits a project would produce;
• At the time, certain CQC executives, supervisors, and compliance personnel knew of, oversaw, and participated in these fraudulent efforts (see next section);
• CQC personnel referred internally to the fraudulent falsification of data provided to the Carbon Credit Registry and VVBs euphemistically as “managing” the data;
• CQC falsely and misleadingly reported higher levels of use and efficiency to the Carbon Credit Registry, to VVBs, and others relating to the two projects, and millions more VCCs were issued for those projects and listed on the public registry than were warranted;
• The CFTC found that CQC had violated Sections 6(c)(1), 6(c)(1)(A), and 9(a)(2) of the Act, 7 U.S.C. §§ 9(1), 9(1)(A), 13(a)(2), and Regulation 180.1(a)(1)–(4), 17 C.F.R. § 180.1(a)(1)–(4) (2023);
• CQC was ordered to cease and desist from further such activity and was ordered to pay a civil monetary penalty of USD 1 million;
• CQC will also cancel, through the process set out by the Carbon Credit Registry, the carbon credits that resulted from the fraudulent conduct;
• CQC will also take the following remediation measures:

1. Terminate the employment of the individuals who were responsible for the violative conduct;
2. Appoint new senior executives including a new CEO;
3. Execute numerous improvements relating to the monitoring, reporting, and verification of VCCs;
4. Implement new organizational structures;
5. Launch new training, amended policies, and other compliance-related enhancements; and
6. Redesign IT systems to ensure audit trail capability.

2] Kenneth Newcombe – CEO (Complaint – click here): 

• The CEO founded CQC (the latter is referred to in the Complaint as the “Project Developer” CQC is not named) in 2008 and was the CEO during the period subject to the Complaint (i.e. between 2019 and December 2023);
• Its noteworthy that the Complaint relates to only one of the two sets of projects subject to the CQC Order i.e. the Cookstove Projects;
• As CEO and majority shareholder of CQC, Newcombe oversaw its activities and the work of its officers, employees, and agents, including, among other ways by e-mail, voice calls, text messages, in-person meetings, and site visits;
• The CEO stood to benefit from CQC’s increased revenues and growth, including from the sale of VCCs issued by the Carbon Credit Registry in connection with the Project Developer’s projects;
• During the period in question, Newcombe also was a member of the Board of Directors of the Carbon Credit Registry;
• The order outlines the background to the Cookstove Projects’ Carbon Credits which are substantively similar to what is outlined in the CQC Order hence are not repeated here;
• Newcombe understood, and was involved in, selecting the methodology used to calculated the emissions abatement - CQC prepared project descriptions and validation, verification, and monitoring reports and reported this information to the Carbon Credit Registry from the United States, including from New York;
• In these reports, CQC made representations that in sum and substance the information provided was true, accurate, and materially complete, and not false, fraudulent, or misleading - Newcombe signed certain of these representations in connection with the Cookstove Projects;
• The Carbon Credit Registry issued millions of VCCs to CQC relating to the Cookstove Projects – an exact amount is, rather oddly, not provided;
• The Complaint notes that Newcombe and “others” at CQC repeatedly provided (and caused to be provided) false, misleading, and inaccurate information to the Carbon Credit Registry and to VVBs for the purpose of presenting a misleading impression of the quality and results of the projects, and wrongfully increased the number of VCCs a project would be issued;
• The CEO (as majority shareholder) knowingly, intentionally, or recklessly participated in, directed, and set the tone for the fraud in connection with the VCCs according to the Complaint;
• CQC personnel, including Newcombe, discussed the scheme during in-person meetings, voice calls, and written communications such as emails and chat messages;
• As reported in the CQC Order, CQC personnel, including in communications with Newcombe, referred internally to the fraudulent falsification of data to be reported to the Carbon Credit Registry and VVBs euphemistically as “managing” the data;
• With Newcombe’s knowledge or at his direction, CQC personnel took steps to falsely and misleadingly alter survey results that served as inputs to the calculation of VCCs for the Cookstove Projects;
• As an example of this, one input used to calculate emissions reductions (and thus VCCs) was the number of installed cookstoves that in fact were in place and operational during a given period of time - to obtain this input, CQC personnel typically surveyed a small number of households where stoves had been installed and then extrapolated from those survey results;
• At times CQC personnel performing Cookstove Project surveys found households where previously installed stoves were no longer in place or were not operational - accurately reporting these results would have reduced the amount of VCCs issued for a project;
• Instead of accurately reporting such results, CQC personnel took steps to falsely and misleadingly increase the reported number of cookstoves in place and operational during various survey period;
• As part of this process, CQC personnel performed surveys to gather inputs according to the selected methodology to calculate the amount of estimated GHG reductions - the information they gathered resulted in a low amount of estimated GHG reductions which would have resulted in fewer VCCs being issued for the project;
• When learning the actual result of estimated GHG reductions using the project’s methodology, Newcombe told certain CQC personnel he would have liked to see a “higher, more-favourable output” for the project;
• He then communicated a higher target figure of VCCs per household for the project to one of the CQC personnel - the employee notified Newcombe that the data would have to be altered to meet that goal;
• CQC personnel then falsely and misleadingly altered the project’s survey data in order to get the more favourable calculation who then reported back to Newcombe to confirm that the falsified result was sufficiently favourable;
• Newcombe in response confirmed that the false and misleading result was sufficient for the desired outcome of more VCCs being issued for the project after which CQC personnel then reported this false and misleading information to the Carbon Credit Registry;
• After receiving the false and misleading information, the Carbon Credit Registry issued VCCs to CQC in connection with the project;
• Around November 2023 Newcombe signed a representation attesting to the truth and accuracy of the information in connection with this project that CQC had reported to the registry – this representation was a “lie” according to the Complaint;
• Newcombe signed numerous other written representations in connection with the Cookstove Projects that the information submitted by CQC concerning its projects was accurate;
• For example - in November 2023, Newcombe signed a written representation that the information provided in connection with one of the Cookstove Projects was:

“...to the best of [his] knowledge and after due inquiry, true, accurate, and complete in all material respects”

• The Complaint claims this representation was false and that Newcombe “well knew” the information that CQC had submitted for that project included false and misleading data relating to, for example, cookstove usage or efficiency which was intended to increase the VCCs that would be issued for the project;
• Towards the end of the period in question when others at CQC became aware of the fraud and brought it to Newcombe’s attention, he took steps to deny or minimize his involvement in the scheme and to provide pretextual explanations for the fraud;
• The Complaint concludes by noting that the Carbon Credit Registry received numerous false and misleading reports from CQC in connection with potentially dozens of projects and then publicly reported such information on its website and issued millions more VCCs to CQC than they were entitled to receive;

• As this is still a Complaint, a final settlement is yet to be reached however the two counts are as follows:

1. Manipulative or deceptive device or contrivance in violation of Section 6(c)(1) of the Act and Regulation 180.1(a)(1)–(3);
2. False, misleading, or inaccurate reports in violation of Sections 6(c)(1)(A) and 9(a)(2) of the Act, and Regulation 180.1(a)(4).

• Newcombe has requested a trial by jury.

3] Jason Steele – COO (Order – click here):

• As for the CEO’ Complaint, this Order deals only with the Cookstove Projects in relation to Jason Steele’s involvement, the COO during the period in question;
• The Order claims that Steele intentionally participated in CQC’s scheme by repeatedly and intentionally providing false and misleading information to the Carbon Credit Registry, to VVBs, and to others, including entities from the US;
• As for the CEO, the purpose of presenting a misleading impression of the quality of the Cookstove Projects was to wrongfully increase the number of carbon credits a project would produce;
• Steele knew of, directed or directly participated in such deceptive efforts – as noted in the other cases CQC staff, including Steele, referred internally to the fraudulent falsification of data provided to the Carbon Credit Registry and VVBs euphemistically as “managing” the data;
• Steele, in coordination with others, participated in CQC falsely and misleadingly reporting higher levels of use and efficiency to the Carbon Credit Registry and to VVBs, and others relating to its Cookstove Projects;
• As a result, millions more VCCs were issued for those projects and listed on the public registry than were warranted;
• The CFTC found that Steele had violated Sections 6(c)(1), 6(c)(1)(A), and 9(a)(2) of the Act, 7 U.S.C. §§ 9(1), 9(1)(A), 13(a)(2), and Regulation 180.1(a)(1)-(4), 17 C.F.R. § 180.1(a)(1)-(4) (2023);
• Steele was ordered to cease and desist from repeating such fraudulent activity – no civil monetary penalty is mentioned;
• A section (see page 10 of the Order) details how Steele will be required to cooperate with the CFTC and other enforcement agencies which suggests the former COO will become a state witness in subsequent actions.

 RegTrail Insights

The CFTC’s announcement notes that in separate actions, the US Attorney’s Office for the Southern District of New York and the Securities and Exchange Commission announced filing parallel enforcement actions for related conduct. It seems that this is set to become a marquee case for US Federal agencies in their long-awaited crackdown on the VCC market.