The Vicodin Thieves. Chip Jacobs
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deliberations. Attention mainly focused on provisions allowing companies to soften emission damage offsite, even overseas, if it is cheaper, and the initial giveaway of eighty-five percent of credits to carbon-dependent businesses and regions facing sharply higher energy prices. As the bill stands, market oversight will be spread out among the Federal Energy Regulatory Commission, the EPA, and several unspecified agencies. “Most of the people I talk to think [the market] will be set up for fraud,” said policy analyst Joel Kotkin. “There’s scamming and then there’s scamming.”
Simultaneously, seven Western states and parts of western Canada are considering launching their own regional cap-and-trade under a Schwarzenegger administration plan. It is aimed at rolling back carbon dioxide emissions to 1990 levels by 2020. The Western Climate Initiative may be dissolved or modified if a national market is approved. Until then, West Coast officials are studying how to ward off cheaters in areas such as insider trading, excessive speculation, and market manipulation. Sometimes, however, the threat hides in the open.
ANOTHER DIRECTION
L.A.’s implacable smog problem stood to make Sholtz rich, and maybe more influential. A dark haired woman with wide-set eyes and a slight Midwestern twang, she grew up the brainy daughter of an aeronautical engineer. Schooled in Minnesota and elsewhere, Sholtz said her aptitude in math and science won her countless honors and early interest from NASA. It was a job offer teaching economics at Caltech that pulled her from Washington University in St. Louis, where she was in a doctoral program, to Southern California. Her timing was superb.
The Cold War had just ended and California’s recession was buzz-sawing thousands of blue collar jobs. Bigwigs then were not debating carbon footprints. They were grouching about regulatory overkill in the fight against chronic smog. Legislators, lobbyists and boosters, convinced that costly rules were suffocating manufacturers, saw their chance to emasculate the AQMD’s power. To neutralize the threat, the air district offered something chancy.
The AQMD has not invented the concept of injecting market principles to detoxify the environment and allow industry leeway in deciding how and when to run its smokestacks, towers, generators, and other machinery cleaner and greener. It originated with academics decades earlier, and then was embraced by the first Bush Administration to address acid rain, a harmful, sulfur dioxide-laced mist emitted from Midwestern power plants that drifted over Northeastern states and into parts of Canada. Most consider the congressionally adopted program a success. Whether the same system will translate for a prodigiously larger, national greenhouse gas market is anyone’s guess.
It is for this reason that L.A.’s experience is instructive. Instead of continuing to rely on fine print dictates to regulate individual machinery at power stations, oil refineries, cement companies, defense plants, and other manufacturers, as smog officials had done for decades, the AQMD in 1994 gambled on economics. Some tactic was needed to chop emissions by seventy percent to meet national clean air standards. Environmental groups fretted that cap-and-trade here was a recipe for stalling progress, but regulatory chic was in trader’s garb. The spectacle of L.A.’s notorious air pollution being traded like a blue chip stock sounded exotic and the world press flocked to the district’s eco-conscious Diamond Bar headquarters to hear the details.
GREEN FAIRYTALE
Under the now fifteen year old market, 332 of the area’s heaviest polluters are allotted credits based on their aggregate emissions of two harmful chemicals: oxides of nitrogen and sulfur. These credits, calculated from baseline production levels, essentially are permits to pollute by the pound. If an entity reduces more of its discharges than required under its cap set by regulators—usually by installing high tech, gunk-trapping equipment—it can sell the differential between what it is allowed to emit and what it actually released into the skies, or expects to, to others in the form of credits. (A company can choose not to trade, just as long as its emissions fall below its limits.) Every year, firms’ emission allotments shrink by a certain percentage so pollution dips regionally. Each credit is assigned a period for its one year use, the date it was issued and one of two geographic zones it can be used in.
To date, there have been 5,170 trades worth $980 million in the “Regional Clean Air Incentives Market” (RECLAIM). District officials argue that it is has achieved its goals, shrinking nitrogen oxides seventy-three percent and sulfur oxides fifty-nine percent. Trades are made company to company, or through broker-type middlemen. Here is where symmetry enters. During the RECLAIM design phase, the district solicited technical expertise from lawyers, academics, and others, bidding out consulting contracts to some of them. The Pacific Stock Exchange and Caltech received work performing market analyses, with Sholtz one piece of their brainpower. It was there she hobnobbed with AQMD staff and there she promoted two concepts of her own: a plan to stabilize prices and planning by establishing two staggered cycles for RECLAIM credits expiring in a given year; and to deter fraud by assigning credits identifying numbers, somewhat akin to a bar code, so officials could track their movements. Only the staggering portion of Sholtz’s plan was approved.
Jack Broadbent administered RECLAIM for the district back then and remembered Sholtz. “She came across in a very professional manner, pretty slick, part advertising, part substance,” said Broadbent, now executive officer of the Bay Area AQMD. “Anne [also] did a good job of ticking a number of us off. She asked what air pollution regulators know about these…ideas.” Arrogant or merely self-assured, few seemed as poised to capitalize on RECLAIM as the ever-hustling Midwesterner. While still working out of her apartment and teaching at Caltech, as well as at USC as an environmental law scholar, she founded a smog credit exchange allowing buyers and sellers to arrange favorable deals. Every RECLAIM transaction in this eBay-like auction made her a three percent to six percent commission.
Her company, Automated Credit Exchange, touted itself as the first-ever electronic trading system for pollution credits. Unlike traditional brokerages such as Cantor Fitzgerald, Sholtz’s system relied on analytical, NASA space-exploration software licensed through Caltech to create mathematically optimal trades from a mishmash of data. Industrial heavyweights like Disney, Northrop-Grumman, Chevron, and the L.A. Department of Water and Power signed up as clients; the Pacific Stock Exchange, Bank of America, and U.S. Trust served as trade clearinghouses.
In February 1996, Sholtz celebrated her company auctioning a record 2.4 million RECLAIM credits in a single week. A Los Angeles Times story the next year exalted Sholtz’s ingenuity, quoting one client who called it “absolutely wonderful.” She later set up shop with an office on South Raymond Avenue in trendy Old Pasadena. With money and publicity flowing, and nibbles about selling her analytical software to advertisers and officials auctioning federal airwaves, Sholtz appeared destined for the cover of Forbes. There were trips to the United Nations, meetings with Al Gore, her 7,000 square foot estate festooned with Koi ponds in gated Bradbury a few miles east of Pasadena, not to mention exhilaration for what lay ahead.
It was an Horatio-Alger-meets-green-entrepreneur fairytale. Unfortunately, some fairytales end miserably. In 2002, nine of Sholtz’s clients complained to the AQMD that the fast-riser known for her wonky lingo and oft-clingy outfits had bamboozled them in what would become a convoluted bankruptcy of her firms, with claims in the $80 million range. The EPA was summoned. Before long, investigators had zeroed in on a particular transaction.
Beginning in fall 1999, Sholtz informed one of her clients, a New York-based energy trading firm called A.G. Clean Air, that then-Mobil Corporation (now ExxonMobil) needed to purchase about $17.5 million in RECLAIM credits to operate in the L.A. Basin. Mobil indeed had an option contract with her to acquire those credits, and if A.G. sold them to the oil titan through her, it could make a bundle, perhaps $5 million, depending on credit prices. But when A.G. couldn’t buy enough credits to complete the Mobil transaction itself, Sholtz discovered that credits from her own company that she needed to use had been committed elsewhere by an employee while she was out ill. She had a dilemma: come clean or try to fix the muddle herself.
To trick A.G. into believing she could still consummate the deal for credits, Sholtz staged an elaborate act, court records show. From November 2000 to April 2002, she emailed and faxed fraudulent sales documents to A.G., including phony invoices showing, Mobil owed her about $16 million when in fact it did not under the option contract. In more artifice,