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Recent Fraud Cases Show Companies Must Be Strategic When Purchasing Carbon Offsets
Introduction
The voluntary carbon credit ("VCC") market has become increasingly important in achieving net-zero goals for companies. However, the market has recently undergone scrutiny after reports of ineffective VCCs. Recent parallel fraud cases from the U.S. Securities and Exchange Commission ("SEC"), Commodity Futures Trading Commission ("CFTC"), and Department of Justice ("DOJ") exacerbate the situation further. While regulators and stakeholders have tried to bring trust back into the markets, purchasers must be diligent in evaluating VCCs, as fraudulent and ineffective credits can still slip through.
Recent Parallel Cases From the SEC, CFTC, and DOJ Continue Scrutiny of the VCC Market
On October 2, 2024, three parallel actions were announced by the SEC, CFTC, and DOJ against CQC Impact Investors LLC ("CQC") in connection with a scheme to commit fraud in the carbon markets. The SEC case settled the charges after CQC admitted material misrepresentations to investors. The CFTC case is a first-of-its-kind enforcement action charging CQC and its former chief executive officer ("CEO") and chief operating officer ("COO") for violating the Commodity Exchange Act, as further explained in an upcoming Jones Day Commentary. The DOJ announced a criminal action, but it declined to charge CQC. The DOJ did charge Kenneth Newcombe, CQC's former CEO, and Tridip Goswami, the former head of CQC's carbon and sustainability accounting team. Jason Steele, the former COO of CQC, was also involved in the scheme; however, he pleaded guilty and entered into a formal cooperation agreement with the CFTC's Division of Enforcement.
The fraud involved emission reduction projects in Africa, Asia, and Central America from 2021 to 2023. Prosecutors for the DOJ accused the three of submitting false, misleading, and inaccurate data, which resulted in the issuances of millions more VCCs than CQC was entitled to receive. Prosecutors also accuse them of deceiving investors that invested $100 million in the firm, relying on this data. Studies suggest that the scheme overstated the benefit of the projects by an average of 1000%.
This Continues a Pattern of Scandal in the VCC Markets, Which Has Destabilized the Market
In recent years, numerous studies have questioned the effectiveness of VCCs, including credits from the majority of Verra-certified (a widely used greenhouse gas crediting program) projects. These studies have contributed to the market shrinking rapidly. By May of this year, reports showed a market decline from $1.9 billion to $723 million, a decline of 61%, from 2022 to 2023.
Regulators and other stakeholders have taken steps to try to correct and instill confidence in the VCC market. The Integrity Council for the Voluntary Carbon Market ("ICVCM"), a nonprofit governance body for VCCs, developed "Core Carbon Principles" to evaluate VCCs. The ICVCM approves projects that abide by the following principles to add confidence in VCCs from those projects:
- Transparency
- Additionality
- Permanence and accounting for the risk of reversal
- Robustness of quantification
- Governance
- Tracking
- Prevention of double counting
- Inspection provisions, including third-party validation and verification
- Monitoring
- Sustainable development benefits and safeguards
- Contribution toward net-zero transition
The CFTC finalized guidance in September for consideration by certain CFTC-regulated markets when addressing certain requirements, including a mandate to list only derivatives that are not susceptible to manipulation. As discussed in a Jones Day White Paper, the guidance includes VCC evaluation factors very similar to the Core Carbon Principles.
The Science Based Targets initiative, or SBTi, still allows the use of VCCs to meet net-zero targets, though that decision faced some opposition.
It is evident that the utility and value of voluntary carbon credits will be questioned for some time to come. Part of the problem lies with the credit certification bodies that in some cases do not appear to have sufficiently stringent checks and balances in place. For some credit generators, the prospect of easy money proves too tempting to adhere to best practices. These challenges highlight the importance of robust legal and factual diligence when transacting voluntary carbon credits. Meanwhile, compliance markets continue to use approved credits without incident.
