Green Energy Fraud

The growing green energy sector is attracting an increasing number of fraudsters. One recent high-profile case involved Pennsylvania-based Mantria Corporation. The company claimed to be developing “carbon negative” residential communities and producing “biochar” – a form of charcoal made from organic wastes. But a complaint filed by the Securities and Exchange Commission (SEC) in November 2009 tells a different story. The SEC alleged that Mantria was in fact a Ponzi scheme, and its promoters had bilked approximately 300 investors out of $30 million through fraudulent and unregistered securities offerings.

Thanks to this example of green energy fraud and others like it, regulators and investors are taking a more critical look at the claims of promoters of green energy investments today. The Mantria matter (see sidebar below) and other recently uncovered fraud schemes in the green energy sector prompted the Financial Institutions Regulatory Authority (FINRA) to issue an investor alert in the United States advising the public on the signals of green fraud schemes.¹

Governments and private investors around the world are spending billions to subsidize green energy projects, but many of the emerging technologies in this industry are unproven and controls often are lax. All too frequently, investors in green energy aren’t motivated by solid business judgment but by hope, hype, and good intentions. The result is an environment ripe for fraud.

This article applies Cressey’s Fraud Triangle to examine characteristics of green investments that make them vulnerable to fraud. It also discusses some high-profile cases and opportunities for CFEs to make a difference in this sector.

GOVERNMENT SUBSIDIES AND PUBLIC CORRUPTION 

As CFEs know, opportunities for fraud arise when large amounts of money are spent in a lax control environment. In the green energy sector, there’s an added wrinkle. Green energy development takes place in a politically charged arena in which government often provides capital, which determines the projects that will be pursued.

Generally speaking, the green energy sector is flush with money. Green energy projects are the beneficiaries of large amounts of economic recovery spending by government. Deutsche Bank estimates that governments worldwide have allocated more than $200 billion in direct spending, subsidies, and tax credits for green investments.²

In the United States, the American Recovery and Reinvestment Act gave an enormous boost to the green energy sector. Deutsche Bank estimates that the $787 billion stimulus contained $84.6 billion in new spending and $21.6 billion in tax credits for energy, transport, and climate science spending. (By comparison, the entire 2008 budget of the U.S. Department of Energy was $24.8 billion.)

Such large subsidies, of course, heighten the risk of fraud. A high-profile case involving the alleged misappropriation of European Union (EU) subsidies for wind energy development is unfolding in Italy. In November, Italian authorities arrested four people and charged 11 others in an operation named “Gone with the Wind.”³ Among those arrested was Oreste Vigorito, the president of Italy’s National Association of Wind Energy and IVPC, a wind-energy developer.

The alleged fraud involved the misuse of up to €30 million in EU wind farm development subsidies.⁴ In the scheme, a company would apply and receive subsidies from the EU. However, only part of the funding would go toward development; the remaining balance would be transferred to another company within a web of companies, and be used to illegally obtain additional EU subsidies.

Public corruption also is becoming a problem in the green energy sector. Green energy development often requires the developer to secure land-use rights from property owners and obtain a large number of environmental and construction permits. Cases involving bribery and ethical lapses among public officials to obtain permits are on the rise in many countries, including the United States.

In 2008, The Office of the New York State Attorney General investigated two wind farm developers.⁵ Wind farm development depends critically on securing land-use rights for hilltops and other areas where wind turbines are most efficient.

The investigation was in response to complaints from residents and law enforcement in upstate New York communities that developers had bribed or intimidated local officials to secure land-use rights.

No one was prosecuted. However, the attorney general’s office introduced a voluntary code of conduct for state wind farm developers and formed a task force for monitoring compliance.

The code prohibits gifts, compensation, or any benefit to a municipal official, relative, or third party on behalf of a municipal official and requires disclosure of agreements and easements obtained by the developer. It also requires the disclosure of any financial interests of a municipal official or a relative of a municipal official in any property identified for wind farm development.

Code violators can be punished with civil penalties. To date, all major wind farm developers in the state of New York have signed the code.

EMOTIONAL APPEAL 

In addition to its political nature, green energy has an obvious emotional appeal. Potential investors are enticed by the chance to better the environment while achieving financial gain. This combination of hope and hype provides fraudsters with opportunity to deceive investors.

Instrumental to Mantria’s appeal to investors was the company’s purported commitment to ecology. In a press release titled “Every Day is Earth Day at Mantria,” the company suggested ways that other companies could also celebrate the unofficial holiday. Mantria boasted of its own programs that it said encouraged its employees to engage in green living including “treat[ing] employees to organic lunches the last Friday of each month” and giving employees paid time off to volunteer for green charities.

Company releases also mentioned its philanthropic arm, The Mantria Foundation, whose mission was “improving the health of children and communities through targeted donations.” The company’s promoters not only stressed social consciousness but promised investors safe returns from 17 percent to “hundreds of percent” according to the SEC complaint.

Green energy’s appeal to popular culture can serve as a hard-to-resist opportunity and rationalization to commit fraud – two elements of the fraud triangle.

Green fraudsters also can reap non-pecuniary benefits. In the Mantria case, the company’s founder and CEO, Troy Wragg, appeared to enjoy the public spotlight. He spoke frequently at conferences. A video on the company’s website shows Wragg hobnobbing with world leaders. In fact, two months before the SEC issued its complaint, former President Bill Clinton and Secretary of State Hillary Clinton honored Wragg and Amanda Knorr, Mantria’s president and COO, at the Fifth Annual Meeting of the Clinton Global Initiative. Wragg also made a cameo appearance in a music video by ICEBLOC, a hip-hop artist promoted by the Mantria Records label.

Green energy’s emotional appeal also might make it easier for a perpetrator to rationalize his or her actions. Promoters of green energy projects might exaggerate the prospects or success of their technologies because of their desires to save the world or contribute to science. They might justify their activities by rationalizing that traditional energy producers are unjust or unethical. Polling data indicates that the American public generally doesn’t hold energy companies and public utilities in high esteem.

UNPROVEN TECHNOLOGIES 

Unproven green energy technologies have opened the door to fraud in this sector, particularly in the advanced biofuel market. The U.S. government has set aggressive targets for cellustic biofuel production. Cellustic biofuel is motor fuel made from tree pulp or grasses, as opposed to grains, which are used to make ethanol.

Alabama-based Cello Energy claimed to be a leader in cellustic biofuel development. Jack Boykin, a biochemist and entrepreneur, founded the firm. He claimed to have produced four million gallons of diesel fuel in just one year at his pilot plant from hay, grass, wood chips, paper, plastic, and garbage.⁶ Among the company’s investors was Khosla Ventures, a prestigious venture capital firm operated by Vinod Khosla, a founder of Sun Microsystems.

In a dispute among investors, it was revealed that Boykin’s production process didn’t work, and samples of his biofuel didn’t contain any organic carbon. The Wall Street Journal reported that Boykin in his deposition contradicted his earlier claims that he’d successfully used wood chips or grass to produce fuel.⁷ An Alabama jury awarded an investor $10.4 million in damages.

Fraud also occurs among manufacturers of green energy products and services. Governments have issued a flood of energy usage regulations on consumer products and in commercial and residential construction. Because consumers often don’t have the means to actually measure energy consumption of a product, they must rely on manufacturer claims or those of third-party verifiers when making product selections. Stiff market competition can encourage fraudulent behavior.

The U.S. Government Accountability Office (GAO) recently investigated problems with the Energy Star program’s certification process.⁸ Energy Star is a voluntary federal program. Products that bear the Energy Star label are supposed to be energy efficient, and certain tax credits are available if consumers use Energy Star products. In its investigation, the GAO submitted 20 bogus products for Energy Star’s approval. Of the 20, 15 were approved, two were rejected and three were still in process at the time the GAO submitted its report.

Products approved included a gas-powered alarm clock. The manufacturer described the alarm clock as “sleek, durable, easy on your electric bill, and surprisingly quiet.” The clock was the size of a small generator. The GAO faulted the Energy Star program for its lack of independent, third-party verification on manufacturer claims. The GAO also criticized Energy Star’s lax security concerning access to the program’s labels.

REGULATORY COMPLEXITY 

New and complex institutional arrangements for handling environmental issues are also increasing fraud opportunities. And these arrangements are further complicated because of differing regulations among countries.

Carbon trading (or the trading of emissions permits) is an arrangement that allows for the purchase and sale of the right to discharge CO² into the atmosphere. The market for carbon emissions is very active; the research firm Point Carbon estimates that $170 billion in CO² emissions will change hands this year – up from $136 billion in 2009.

Recently European authorities discovered an enormous fraud in this new and hard-to-regulate market. (See the sidebar, “Case Study: Missing Trader Intra-Community Fraud for Carbon Credits” below.) The fraud potentially could cost European governments €5 billion in lost value-added tax revenues.

Fraudsters committed this scam by relying on differences in the ways EU member states treat the taxation of CO² emissions permits. The scheme involved shell corporations and the unjustified trading of CO² emissions rights. After selling the rights to a third party, the shell corporation went “missing” and failed to remit VAT payments to the taxing authorities. After the fraud was discovered, European governments took steps to alter the tax treatment of carbon permits.

A NEW FRONTIER FOR CFES 

The surge of expenditures in the green energy sector has made it difficult for governments and investors to monitor developers and projects. This is where CFEs can step in and make a difference.

The green energy sector presents opportunities for fraud and fraud prevention specialists. Policy makers and program administrators often aren’t familiar with the ways poorly designed subsidy programs and control weaknesses can create opportunities for fraudsters to gain at public expense. CFEs, with their specialized abilities, can help design control systems and investigate the misuse of public funds.

The rising number of frauds victimizing private investors also will increase demand for CFEs with the right mix of training and expertise in this sector. The nature of the potential frauds – misrepresentation, securities fraud, public corruption, and thefts of intellectual property — aren’t new. However, the institutional context is.

CFEs with backgrounds in engineering or environmental science are particularly qualified for this work because assessing the validity of green energy technologies requires an understanding of the underlying technology, industry regulation, and market economics.

CFEs can play a vital role in identifying fraud risks and control weaknesses in this market, so that it runs as efficiently as green energy itself.

James G. Bohn, Ph.D., CFE, CFA, has been involved in the examination of accounting and securities fraud as well as frauds in the energy sector. He formerly was a principal with UHY Advisors.

[Some links are no longer available. —Ed.]

¹ FINRA Investor Alert. “FINRA Warns Investing Public of Green Energy Investment Scams.” Dec. 29, 2009. Available at: www.finra.org/Newsroom/NewsReleases/2009/P120645.
² “DB Climate Change Advisors, Global Climate Change Regulation Policy Developments: July 2008-February 2009.” Available at: www.db.com/usa/download/Global_Climate_Change_Regulation._Feb_2009.pdf
³ Guy Dinmore. “Top Executives Arrested in Italy Wind Farm Probe.” Financial Times. Nov. 12, 2009.
⁴ Doreen Carvajal. “With Wind Energy, Opportunity for Corruption.” The New York Times. Dec. 14, 2009.
⁵ Ken Belson. “Amid Talk of Hidden Deals, Wind Farms Agree to Code of Conduct.” The New York Times. Oct. 31, 2008.
⁶ WKRG.com. “Turning Thrash into Gas.” Sept. 17, 2008. www.wkrg.com/alabama/article/turning_trash_into_gas/18119/Sep-17-2008_7-01-pm/; Fox 10TV.com. “Local Company Makes Synthetic Fuel.” Feb. 16, 2009. www.fox10tv.com/dpp/news/LocalCompanyMakesSyntheticFuel.
⁷ Ann Davis and Russell Gold. “U.S. Biofuel Boom Running on Empty.” The Wall Street Journal. Aug. 27, 2009.
⁸ United States Government Accountability Office. “Energy Star Program: Covert Testing Shows the Energy Star Program Certification Process is Vulnerable to Fraud and Abuse.” March 5, 2010. GAO-10-470. 

Case study: Missing Trader Intra-Community Fraud for Carbon Credits

In 2009, European authorities uncovered an enormous fraud in the market for CO² emissions permits. The fraud, involving more than €5 billion in uncollected Value-Added Tax (VAT) payments, was a form of Missing Trader Intra-Community (MTIC) fraud.¹

An emissions permit allows the holder to discharge one ton of CO² into the atmosphere. Permits can be traded across national borders. In some countries, emissions permits are subject to a VAT, which is similar to a sales tax. The permit seller has the obligation to collect the VAT from the buyer. The seller then remits the payment to the taxing authority. The VAT can be a large proportion of the total value of the permit. Prior to the discovery of the MTIC fraud in CO² permits, France levied a VAT of 19.6 percent on CO² emissions permits. 

Figure 2 illustrates the structure of an MTIC, or carousel, fraud. For simplicity, assume that trader A is located in a country that doesn’t assess a VAT on emissions permits, and traders B and C are located in a country that assesses a VAT on emissions permits. Trader B purchases a permit from trader A. No VAT is assessed at the time of the transaction because the country in which trader A is located doesn’t have a VAT. Trader B then quickly sells the permit to trader C. Trader B collects a VAT from trader C. The fraud arises when trader B fails to remit the VAT to the authorities and instead goes “missing.” [Figure 2 reference here is no longer available — Ed.]

The fraud deprives the taxing authority of the VAT payment. Traders might be harmed if the taxing authority disallows a deduction from taxable income for the VAT that was paid to the missing trader. The rumor of a possible MTIC fraud increases transaction costs and disrupts financial markets by causing legitimate traders to expend effort to investigate counterparties and make sure they’re legitimate.

Rumors of the MTIC fraud emerging on June 8, 2009, caused a two-day suspension in trading of CO² permits on BlueNext, the main European exchange for emissions permits. The incident caused France to revise the treatment of CO² emissions permits so they’re no longer subject to a VAT. A number of other EU nations have also exempted emissions permits from VAT over concerns of MTIC fraud.

¹ Press release, EUROPOL, “Carbon Credit Fraud Causes More Than 5 Billion Euros’ Damage for European Taxpayer,” Dec. 9, 2009, www.europol.europa.eu/index.asp?page=news&news=pr091209.htm. 

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