CFTC, DOJ and SEC Announce First Coordinated Action Aimed at Voluntary Carbon Market Fraud

On Oct. 2, 2024, the Commodity Futures Trading Commission (CFTC), U.S. Department of Justice (DOJ) and U.S. Securities and Exchange Commission (SEC) announced parallel actions against CQC Impact Investors LLC (CQC or the Company) and former senior executives arising out of a scheme to fraudulently generate approximately 6 million carbon offsets. These actions are the first federal cases arising from fraud in the voluntary carbon market.

Background

The CFTC filed a complaint against the former CEO of CQC in the U.S. District Court for the Southern District of New York and announced orders filing and settling charges against CQC and its former COO. CQC paid a $1 million fine and agreed to a number of compliance undertakings and to invalidate all fraudulent carbon offsets. The DOJ announced an indictment against the former COO and the head of the Carbon and Sustainability Accounting Team (CSAT), as well as a Declination Letter declining to prosecute CQC. And the SEC issued an order filing and settling charges against CQC and did not impose any penalties.

As detailed in a previous Holland & Knight alert, voluntary carbon offsets are utilized by companies that voluntarily set goals to offset their greenhouse gas (GHG) emissions and live up to their environmental, social and governance (ESG) goals. One carbon offset typically represents the removal of one metric ton of carbon dioxide equivalent from the atmosphere. By purchasing offsets from project developers such as CQC, companies can finance the reduction of GHG emissions without being directly involved in the relevant projects.

CQC and Executives Misrepresented Emission Reductions Related to Offset Projects

The fraudulent scheme related to more than 27 of CQC's projects involving installation of cleaner cooking systems (as compared to traditional open fires) and more efficient LED lightbulbs in millions of households across sub-Saharan Africa, Asia and Central America. Though this case is novel in that it is the first federal action in voluntary carbon markets, the fraudulent conduct itself was familiar: put simply, CQC and the former CEO, COO, and the head of CSAT, and other CQC employees at their direction, "cooked the books."

Specifically, between approximately 2019 and 2023,¹ CQC submitted false or misleading data to carbon registries and investors to make it appear as if the cooking systems and LED lightbulbs were far more successful in offsetting GHG emissions than in reality² – a form of greenwashing.³ Doing so allowed CQC to fraudulently generate about 6 million more carbon offsets than it should have and raise $250 million in an equity offering.⁴ As evidenced by multiple internal communications provided in the orders and indictments, the CEO, COO and head of CSAT encouraged the manipulation and provided guidance on how to selectively or fraudulently report project outcomes, including instructions to "revise" data via "[b]ack end management if you know what I mean."⁵ This included providing training to employees on how to manage project data to achieve improved, but fraudulent, results.⁶

Who Was Charged and Who Settled?

In mid-2023, several CQC employees raised concerns regarding data discrepancies that were ultimately raised to CQC's board of directors in December 2023.⁷ In early 2024, a special committee of non‑executive directors of CQC's board commissioned an internal investigation, which identified the fraud attributable to the former executives.⁸ CQC subsequently hired a replacement leadership team and voluntarily reported its wrongdoing to federal law enforcement, regulators and the carbon registry.

After CQC's self-disclosure, the former CEO and head of CSAT were indicted in the Southern District of New York for wire fraud, commodities fraud, securities fraud and conspiracy to commit those offenses. If proven, these offenses come with significant potential penalties and the possibility of jail time. The CFTC also filed a complaint against the CEO in the same court, seeking disgorgement of ill-gotten gains, restitution, permanent trading and registration bans, a permanent injunction against further violations of the Commodity Exchange Act (CEA) and significant civil monetary penalties to be assessed by the court (potentially above what CQC paid, as discussed below).

The former COO admitted to fraud and submission of false reports concerning voluntary carbon offsets in violation of the CEA and CFTC Regulation 180.1.⁹ The former COO entered into a formal cooperation agreement with the CFTC's Division of Enforcement but was not penalized in the settlement order.¹⁰

CQC settled fraud and false reporting allegations with the CFTC by agreeing to pay a $1 million civil monetary penalty, cease and desist from violating the applicable provisions of the CEA and CFTC regulations, and cancel or retire the 6 million fraudulent offsets.¹¹ CQC agreed to 1) submit a nonpublic report to the CFTC regarding its remediation activities, including the cancellation or retirement of the offsets, 2) a comprehensive review of its employee training and 3) implement a comprehensive system of testing with respect the generation and submission of project data.

CQC also settled with the SEC by admitting to $250 million of offering fraud.¹² Finally, the DOJ declined to prosecute CQC based on the Company's voluntary self-disclosure, which is discussed in more detail below.¹³

Key Takeaways

This Case Is the First Coordinated Federal Action Against Fraud in the Voluntary Carbon Market

As illustrated in previous Holland & Knight Greenwashing Mitigation Team alerts,¹⁴ various regulators including the CFTC, SEC, Federal Trade Commission and DOJ are expressing increasing amounts of interest in carbon markets. This is the first enforcement action arising from carbon market fraud and represents a degree of coordination between the CFTC, SEC and DOJ. This is also the first case directly tied to the CFTC's new Environmental Fraud Task Force.¹⁵ We expect this to remain an area of focus in a potential Kamala Harris administration.

The Communications Proved Damning

Communications between the former CEO, COO, head of CSAT and other employees revealed endemic fraudulent conduct. For example, when CQC received emission reduction data in 2021, the CEO emailed the former COO and head of CSAT that the numbers were "a disaster for us" and that the "[o]nly option left" was "to 'revise' the [] results." Around May 2022, the executives learned that an employee may have given manipulated data to a third-party bank. The former CEO emailed that "we don't do these surveys properly. That seems to me to be the smoking gun." The former head of CSAT wrote that if the bank found out about the fraud, "we are doomed." In the summer of 2022, the former COO texted the former CEO that the data needed to be changed via "[b]ack end management if you know what I mean."¹⁶

Further, operations staff and the former executives routinely discussed the scheme on weekly operations calls, and CQC's nonpublic training manual explicitly codified that "[a]dditional households should be surveyed in order to compensate/cover up for households where any one or both project stoves were not found operational (equal number)."¹⁷

CQC Paid a Relatively Light Penalty Compared to Other Recent Fraud Settlements

The $1 million civil penalty and cancellation of the fraudulently generated carbon offsets, while not insignificant, are minor penalties compared to other recent CFTC fraud settlements¹⁸ and to the potential penalties at stake in the DOJ and CFTC actions against CQC's former CEO and head of CSAT. If found guilty, the individuals could be imprisoned and required to pay significant criminal penalties, potentially in the millions of dollars.

This discrepancy is likely in large part a result of CQC's internal investigation, remediation and voluntary disclosure to the regulators. After the special committee's internal investigation, CQC installed a new leadership team and is cancelling the fraudulent offsets; adopting new measurement, reporting and verification processes, crediting methodologies and ethics policies; and reorganizing its operations. The new leadership team voluntarily disclosed the results of the internal investigation and remediation to regulators and the carbon registry – including all criminal conduct – promptly after becoming aware of the issues.¹⁹ All three regulators acknowledged CQC's "substantial cooperation" and agreement to continue to cooperate, leading to the decision by DOJ not to prosecute the Company and the significantly reduced civil penalty imposed by the CFTC.

Conclusion

As enforcement efforts increase, it is essential for market participants to recognize the risks associated with fraud and engage in diligent efforts to ensure offsets are high‑quality. CFTC-regulated exchanges, market participants and carbon registries should ensure that carbon offset derivatives listed on CFTC-regulated exchanges comply with the CFTC's newly issued guidance, which is cited in the CFTC's orders in these cases. Market participants should note the value of investigation, remediation and prompt voluntary self‑disclosure if they discover low‑quality offsets or fraudulent conduct.

The authors, along with other members of Holland & Knight's Greenwashing Mitigation Team, are well suited to provide advice regarding these cases, in addition to other CFTC regulatory matters and advice regarding carbon markets generally.

The authors would also like to thank Max Marrero, Holland & Knight law clerk and Juris Doctor candidate at American University Washington College of Law for his assistance drafting this alert.

Notes

¹ Note that the CFTC, DOJ and SEC documents all focus on slightly different time frames ranging from 2019 to 2023.

² CFTC press release (Oct. 2, 2024).

³ Greenwashing occurs when a company makes false or misleading claims about the environmental benefits of its products or services. In the context of carbon offsets and derivatives of carbon offsets, greenwashing could occur, for example, if a company claims to offset 100 percent of its emissions based on its trade in offset derivatives where the underlying offsets risk reversal.

⁴ Order, SEC Administrative Proceeding No. 3-22224, ¶¶ 13, 18 (Oct. 2, 2024) (hereinafter SEC Order).

⁵ Indictment ¶¶ 31.b., 33.b., United States v. Newcombe (S.D. N.Y. Oct. 2, 2024) (hereinafter Indictment).

⁶ Indictment ¶ 40.

⁷ SEC Order ¶ 13.

⁸ "C-Quest Capital Uncovers Wrongdoing by Former CEO Kenneth Newcombe; Takes Decisive Action to Help Company Fulfill its Critical Mission," businesswire (June 26, 2024).

⁹ 7 U.S.C. § 9; 17 C.F.R. § 180.1(a).

¹⁰ Steele Order, CFTC Docket No. 24-36 (Sept. 30, 2024).

¹¹ CQC Order, CFTC Docket No. 24-37 (Sept. 30, 2024).

¹² Section 17(a) of the Securities Act; Section 10(b) of the Exchange Act; SEC Rule 10b-5; see SEC Order.

¹³ CQC Declination Letter, DOJ (Sept. 20, 2024).

¹⁴ See Holland & Knight's previous alerts, "Commodity Futures Trading Commission Finalizes Voluntary Carbon Market Standards," Sept. 24, 2024, "Double Jeopardy for Double Counting? CFTC and FTC Both Scrutinize Fraud in Carbon Markets," Aug. 14, 2023, "FTC Proposes to Clarify Green Guides for Climate Claims Based on Carbon Offsets," June 29, 2023, and "FTC Seeks Input on Potential Updates to Its Green Guides," Dec. 19, 2022.

¹⁵ CFTC release (Oct. 2, 2024), (acknowledging the Environmental Fraud Task Force); CFTC release (June 29, 2023).

¹⁶ Indictment at ¶¶ 31.b., 32.b.–c.33.b.,

¹⁷ Indictment at ¶¶ 40, 46.

¹⁸ For example, the CFTC recently settled with two global energy and commodities trading firms for $55 million and $48 million, respectively. The underlying facts in those cases differ from the facts in this case, but both involved similar fraudulent and manipulative conduct. Order, CFTC Docket No. 24-08 (Jun. 17, 2024), Order, CFTC Docket No. 24-19 (Aug. 27, 2024).

¹⁹ CQC Declination Letter at 2, businesswire (June 26, 2024).

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.