Overview
Carbon market participants are now learning about the effect of the Commodity Futures Trading Commission's (CFTC) Environmental Fraud Task Force, just a year after its creation. Launched to "combat environmental fraud and misconduct in derivatives and relevant spot markets," the unit's creation further conveyed the agency’s interest in policing fraud in voluntary carbon markets on an ongoing basis.1 The Task Force has now earned the CFTC a sizeable monetary ruling that will likely incentivize similar enforcement pursuit.
On July 3, 2024, a federal court in Chicago (US District Court for the Northern District of Illinois) granted the CFTC summary judgment in its first enforcement action relating to environmental fraud. With the decision, any lingering question of whether additional action from the Environmental Fraud Task Force will be completed, becomes a matter of when the next action will be publicized.
Case Background
In entering the order for summary judgment, the court held that respondents violated the Commodity Exchange Act (CEA) by misappropriating funds through a carbon offset program, among other civil violations. The court ordered more than $83 million in restitution and nearly $37 million in disgorgement against respondents.2
Defendant Sam Ikkurty, who established his companies Jafia LLC in 2006 and Ikkurty Capital LLC in 2017, created the Rose City Income Fund I (RCIF I) starting in 2017 and Rose City Income Fund II (RCIF II) (collectively, RCIF Funds) in 2021. Ikkurty referred to the RCIF Funds as "crypto hedge funds."3 Ikkurty solicited investments by telling investors that the goal was to "earn income with exposure to crypto assets," promising a "steady distribution of 15% annual income per year," and touting the success of RCIF I.4 Client funds were invested in Bitcoin, Ethereum, OHM, and Klima crypto assets. However, Ikkurty overstated the profits of RCIF I from inception through October 2021, and later failed to disclose that RCIF I had lost 98.99% of its aggregate returns from November 2021 through March 2022.5
Jafia LLC created two investment instruments for RCIF participants: a crypto savings note (CSN) and a carbon offset bond (COB), promissory notes of which 80% of contributions were to be invested in "'stable proof of stake' tokens" and would purportedly generate monthly interest payments totaling 18% per year.6 Ikkurty placed almost 90% of RCIF funds into a cryptocurrency called OHM, which "was not stable in 2021 through early 2022” and returned no net profits to participants.7 Instead, later investor contributions were distributed to earlier investors.8 After RCIF I rapidly began to lose value in November 2021, Ikkurty offered RCIF I participants either buyouts or COBs, totaling over $29 million in cash and COBs—an amount which reflected RCIF I's October and November 2021 positions, not the much reduced December 2021 position.9
When Jafia's accounts were frozen, over $6 million in CSNs and over $20 million in COBs remained outstanding. When the funds were ended, remaining RCIF participants had lost a total of $58 million combined in aggregate contributions which were never returned to them.10
Summary Judgment
The court found that Ikkurty violated the CEA's anti-fraud provisions, which make it unlawful for any person to intentionally or recklessly employ, or attempt to use or employ any manipulative device, scheme, or artifice to defraud in connection with a "contract of sale . . . of any commodity in interstate commerce."11 First, the court held that crypto in which the RCIF Funds invested, including Bitcoin, Ethereum, OHM and Klima, were commodities under the CEA.12 Second, the court held that Ikkurty made multiple misrepresentations, particularly with regard to RCIF I’s historical performance, RCIF II's "net profit" return to participants, the use of RCIF III funds and the risks involved, and Ikkurty's investment background and experience.13
Aside from the standard fraud count relating to the Ponzi scheme, the court also found that the defendants misappropriated investor funds through the carbon offset program.14 Specifically, the buyouts offered to RCIF I participants (after the fund's value collapsed) included offers of both cash and COBs.15 Furthermore, much of the COB and CSN contributions from RCIF II participants were paid out to RCIF I participants, over $29 million for a position nominally worth only $7.7 million.16 The court found that the misappropriation of COB contributions rose to the level of fraud under the CEA's anti-fraud provisions.17
Finally, defendants were found in violation of the CEA by operating as commodity pool operators without registration, and for committing commodity pool operator fraud.18 The court subsequently ordered the defendants to pay over $83 million in restitution for customer losses and almost $37 million in disgorgement of profits, the latter of which is offset by sums paid to restitution.19
Takeaways
The CFTC's enforcement action is its first to address fraud in carbon offsets, and more are likely to follow. While the summary judgment involved a traditional Ponzi scheme, future enforcement actions will likely focus on varying types of fraudulent conduct, such as double counting, "ghost" credits, and other fraud previously outlined by the Commission in its whistleblower alert on carbon market misconduct.20 These efforts will be spearheaded by the Environmental Fraud Task Force, and the Commission will continue to devote resources to policing carbon markets, applying its anti-fraud and manipulation authorities to combat environmental misconduct, misrepresentations and to “examine…fraud with respect to the purported environmental benefits of purchased carbon credits..."21
The court swiftly rejected arguments raised by the defendants that they did not transact in commodities covered by the CEA. While the court could have relied solely on relevant transactions in Bitcoin and Ethereum, for which futures contracts currently trade, it also found that OHM and Klima tokens are properly characterized as commodities. The court cited judicial precedent that treats any crypto asset within the CEA definition of "commodity" under the premise that "the CEA only requires the existence of futures trading within a certain class…in order for all items within that class to be considered commodities."22
As a result, the CFTC will likely continue to pursue its anti-fraud and manipulation oversight of spot transactions in connection with any crypto asset. There may be fact patterns in the future, however, where the characteristics of a crypto asset are so dissimilar to Bitcoin or Ethereum that stronger arguments could be proffered to distinguish the crypto asset and challenge whether it is appropriately characterized as a commodity.
The action precedes the anticipated CFTC-issuance of guidelines for exchanges listing derivatives contracts on voluntary carbon credits.23 For more information on the CFTC's proposed guidelines impacting both spot and derivative contracts listed on derivatives exchanges, please read our client alert here.
1 CFTC Division of Enforcement Creates Two New Task Forces, Commodity Futures Trading Commission (June 29, 2023), https://www.cftc.gov/PressRoom/PressReleases/8736-23.
2 Federal Court Enters Summary Judgment Against Oregon Man and Orders $83 Million in Restitution for Fraud Victims, Commodity Futures Trading Commission (July 3, 2024), https://www.cftc.gov/PressRoom/PressReleases/8931-24.
3 Memorandum Opinion and Order at 3, CFTC v. Ikkurty, No. 1:22-cv-02465 (N.D. Ill. July 1, 2024), ECF No. 369.
4 Id. at 4.
5 Id. at 4–5.
6 Id. at 6–7.
7 Id. at 6.
8 Id.
9 Id. at 7.
10 Id. at 7–8.
11 Id. at 9–10.
12 Id. at 11.
13 Id. at 13–17.
14 Id. at 17.
15 Id. at 17–18.
16 Id. at 18–19.
17 Id. at 19.
18 Id. at 19–23.
19 Id. at 24–25.
20 See, for example, "CFTC Whistleblower Alert: Blow the Whistle on Fraud or Market Manipulation in the Carbon Markets" (June 20, 2023), https://www.whistleblower.gov/sites/whistleblower/files/2023-06/06.20.23%20Carbon%20Markets%20WBO%20Alert.pdf.
21 CFTC Division of Enforcement Creates Two New Task Forces, COMMODITY FUTURES TRADING COMMISSION (June 29, 2023), https://www.cftc.gov/PressRoom/PressReleases/8736-23.
22 See the Order at 11, citing to CFTC v. My Big Coin Pay, Incl., 334 F. Supp. 3d 492, 498 (D. Mass. 2018).
23 CFTC Issues Proposed Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts, Commodity Futures Trading Commission (Dec. 4, 2023), https://www.cftc.gov/PressRoom/PressReleases/8829-23.
