The Federal Energy Regulatory Commission's Office of Enforcement has been on the march, targeting market participants for a range of activities in the wholesale electricity and natural gas markets. The pendulum has swung hard toward enforcement. The agency has moved to expand its manipulation theories and enforcement capabilities, while anticipating more settlements and possible litigation with the targets of its enforcement efforts.

I. Introduction

The Federal Energy Regulatory Commission's Office of Enforcement (OE) has been on the march, its anti-manipulation and civil penalty authority under the Energy Policy Act of 2005 (''EPAct 2005'')1 in hand, targeting market participants for a range of activities in the wholesale electricity and natural gas markets. The pendulum has swung hard toward enforcement. FERC shows no signs of retreat or a contemplative pause. Instead, FERC continues to pursue investigative targets with vigor. FERC has moved to expand its manipulation theories and enforcement capabilities, while anticipating more settlements and possible litigation with the targets of its enforcement efforts.

FERC's claims of manipulative conduct continue to grab headlines and stir debate about fundamental market and legal issues. During the last several years there have been multiple Order to Show Cause proceedings, notices of potential violations, and a steady drumbeat of settlement agreements resolving manipulation investigations.2 Several have included eye-popping disgorgement and civil monetary penalty figures never seen before at FERC. OE staff also recently extracted an admission of wrongdoing as part of a settlement agreement with Gila River Power, LLC—an unprecedented ''get'' for FERC, and a critical consideration with which targets will need to grapple.3 FERC remains steadfast in its pursuit and expansion of its ''loss leader'' and ''relational'' economic manipulation theories while also announcing that it will continue targeting specific individuals in addition to companies. FERC continues to build its capabilities by increasing OE staff levels, acquiring more data, and expanding its market surveillance infrastructure.

Pendulums tend to swing back, however. A number of manipulation investigations are progressing through the investigatory, administrative, and judicial process. Targets in electricity investigations (but not natural gas investigations) have the option of remaining before a FERC administrative law judge (ALJ) or electing to litigate a manipulation claim in a federal district court—the latter being unprecedented for a FERC enforcement matter.4 FERC's recent push to achieve material concessions (financial and otherwise) from its targets could well be a bellwether for increased litigation. Admissions of wrongdoing, or even factual stipulations of manipulative conduct that stop short of an outright admission, are not given easily—especially considering the potential for significant collateral consequences to the target.

If faced with the prospect of admitting violations and/or paying high settlement dollars, targets may elect to postpone settlement and litigate FERC's legal and economic theories outside of the confines of the agency. Although evidentiary rules in an administrative hearing are more lenient than in federal court and an ALJ will follow FERC precedent, FERC in either forum must prove before a judge its legal and factual claims.5 FERC would need to refute open market defenses and demonstrate its jurisdiction especially over financial transactions including those that do not result in delivery, the viability of its circumstantial evidence and economic formulations, and its claims of impact and harm to the market.

Indeed, the U.S. Court of Appeals for the DC Circuit on Feb. 7, 2013, heard oral arguments regarding FERC's case against Brian Hunter, the former Amaranth Advisors trader.6 Indeed, after FERC faced tough questions from the judges, the court on March 15, 2013, granted Hunter's petition for review ''because manipulation of natural gas futures contracts falls within the CFTC's [U.S. Commodity Futures Trading Commission's] exclusive jurisdiction'' signaling an important court-determined jurisdictional boundary for FERC's anti-manipulation jurisdiction.

The bounds of FERC's enforcement reach have not yet been tested. Like the prisoner in Poe's tale, The Pit and the Pendulum, a market participant may one unfortunate day find itself at the brink of a pit, the extent of which it may have scant means of ascertaining.

II. FERC and its Office of Enforcement have the Mandate

Through EPAct 2005, Congress dramatically changed FERC's enforcement and civil penalty authority to address manipulative conduct and deceptive practices in the wholesale electricity and natural gas markets. Prior to EPAct 2005, FERC's enforcement authority was more limited. Enron changed the landscape. EPAct 2005amended the Natural Gas Act and the Federal Power Act to explicitly prohibit manipulation in connection with the purchase or sale of natural gas, electric energy, or transportation transmission services subject to FERC's jurisdiction.7 As codified in FERC's regulations, it is unlawful for any entity, directly or indirectly, in connection with the purchase or sale of electric energy or natural gas or the purchase or sale of transmission or transportation services subject to FERC's jurisdiction:

  1. To defraud using any device, scheme or artifice (i.e., intentional or reckless conduct);
  2. To make any untrue statement of material fact or omit a material fact; or
  3. To engage in any act, practice or course of business that operates or would operate as a fraud or deceit.8

FERC has broadly defined ''fraud'' to include ''any action, transaction or conspiracy for the purpose of impairing, obstructing or defeating a well-functioning market.''9 FERC also stated that the ''in connection with'' language should be construed liberally.10 Although not without bounds, FERC considers a transaction to be covered if ''in committing fraud, the entity . . . intended to affect, or have acted recklessly to affect, a [FERC-]jurisdictional transaction''—as long as there is a ''nexus'' between the conduct and a FERC-jurisdictional transaction.11 In its short history with its expanded authority, FERC has pursued conduct that is not within its primary jurisdiction.

A. Admissions of wrongdoing, weighed against collateral consequences

On Nov. 19, 2012, FERC approved a settlement agreement with Gila River Power LLC (''Gila River'') addressing market behavior and manipulation claims related to Gila River's activity in the California energy markets.12 As part of the settlement, Gila River admitted to violating both FERC's anti-manipulation rule and regulations prohibiting inaccurate information. Never before has a market participant admitted to violating FERC's anti-manipulation rule in an energy trading case. OE alleged that Gila River designed certain physical transactions solely to benefit imports from its plant in Arizona. Gila River agreed to pay a $2.5 million civil penalty and disgorge $911,553 in profits.

This settlement potentially marks a new course by which FERC will seek ''admissions'' in order to settle enforcement actions. If this becomes standard procedure, it may mean more litigation and fewer settlements— partly due to the collateral consequences that can result from admissions. Market participants need to carefully consider the potential ramifications of agreeing to admissions as part of an unlitigated settlement agreement. For example, an admission could preclude a target from later denying the factual basis for other types of claims, including fraud or antitrust violations. An admission also could be the predicate for state law violations, disqualification from registering with other agencies or contracting with government agencies, or trigger required disclosures under applicable securities laws.

Beyond disgorgement of profits, application of civil penalties and other punitive measures, an admission could carry other significant consequences for the target before FERC. Despite no private right of action under its anti-manipulation rule, FERC has allowed a private party to present accusations of manipulative conduct for adjudication through a public evidentiary hearing with full discovery rights.13 Additionally, under FERC's Penalty Guidelines, an admission could count as an ''adjudication'' for any future manipulation claim, allowing FERC to treat the target as a ''repeat offender'' for penalty purposes.14 Moreover, FERC could push to require a ''no denial'' provision as part of settlement (typical in CFTC settlements but not FERC settlements), thereby preventing the target from asserting, other than in a legal proceeding, that it had not engaged in manipulative conduct.

Issues could also arise under the Commodity Exchange Act (CEA).15 For example, a private right of action might exist under Section 22(a)(1) of the CEA, which provides exclusive remedies to a plaintiff asserting a private cause of action for damages under the CEA. A company also may become disqualified from registering with the CFTC as a swap dealer if it enters into a settlement based upon a fraud claim.16

The Securities Act of 1933 and the Securities Exchange Act of 1934 could come into play given various registration statement requirements and, in turn, the potential for statutory disqualification for certain registrations.17 Certain disclosures also may be required. In addition, a private right of action exists under Securities and Exchange Commission (SEC) anti-fraud regulations in certain circumstances.18 Furthermore, under securities law it is unlawful for an issuer to make any materially false or misleading statement or omission, in connection with the purchase or sale of securities.19 Accordingly, as a result of a settlement in which FERC alleges that a company manipulated energy markets or achieves an adverse litigated finding, shareholders and/or the SEC could pursue the company for the same conduct.

A target needs to examine carefully all potential impacts that could result from providing an admission or even an expansive stipulation of facts related to alleged wrongful conduct as part of a settlement agreement with FERC. Granting concessions in order to end the pain with one regulator may well give rise to equal or greater pain with other regulators or private claimants.

B. The pursuit of individuals

In addition to seeking greater concessions from its targets, FERC has recently made clear that it will continue to target individuals for manipulative conduct. At FERC's Nov. 15, 2012, Open Meeting, Commissioner Moeller stated:

''We've had a number of high-profile Enforcement cases. . .seem to be a few individuals who have created an enormous amount of issues. . .. If we can find a way to get rid of some specific individuals in this trading, we could possibly take away a lot of what we have to deal with on a constant basis related to allegations of market manipulation [by] going after individual traders, perhaps in a model closer to some of our other enforcement agencies.''20

FERC's decision to target individuals can further complicate a target's ability to respond efficiently to an OE request for information and overall inquiry. For example, fact gathering can become complicated by the potential need for multiple counsel and the possibility of divergent interests. Privilege issues may arise between the company and individual employees. Although not novel, and in some cases perhaps appropriate, the pursuit of individuals is yet another tool that FERC will bring to bear as part of its investigative process. Employees of market participants should consider that their conduct can result in problems for their employer as well as significant personal liability.

C. Growing in numbers and reach

FERC has also made a concerted effort to expand its investigatory apparatus. Notably, FERC created the Division of Analytics and Surveillance (DAS) in early 2012 to analyze data related to the physical natural gas and electric power markets, and to develop surveillance tools capable of detecting potential manipulative and anomalous market activities.21 DAS likely communicates with other federal agencies, market operators, and monitors, as it performs its functions. Indeed, DAS may take a different view than a market operator or monitor as to the nature of observed conduct. Conversations between market participants and DAS must be taken very seriously— participants are obligated to provide accurate and truthful information. FERC's OE staff levels also have steadily increased, from about 12 in 2005, to approximately 200 today.

FERC has also undertaken efforts to increase the already large pool of data made available to FERC (and DAS) for analysis. For example, Order No. 760 requires RTOs/ISOs to deliver market data directly to FERC, including physical and virtual bids and offer, market awards, resource outputs, marginal cost estimates, shift factors, financial transmission rights, internal bilateral contracts, uplift, and interchange pricing.22 Order No. 768 (Electricity Market Transparency Provisions of Section 220 of the FPA) requires market participants that are excluded from FERC jurisdiction under Section 205 and have more than a de minimis market presence to file EQRs with the Commission, and further revises some of the existing EQR reporting obligations (including by requiring participants to include e-tag data in theirEQRs).23 FERC also recently issued aNotice of Inquiry (NOI) in Docket No. RM13-1-000 seeking comments on the extent to which quarterly reporting of jurisdictional natural gas transactions might provide useful information for improving transparency. Currently, this information is only available to FERC on an aggregated basis (e.g., Form 552 reporting).24

D. 'Relational' and 'loss leader' manipulation trading theories

FERC's recent headlines focus on ''relational'' and loss leader'' trading, where trading in one product, often at a loss or without a regard to profitability (referred to by FERC as ''uneconomic trading''), is used to benefit trading in another product—often a financial position such as a swap or a financial hedging product, like congestion revenue rights (CRRs). Moreover, FERC recently indicated that even if trading was profit-seeking or profitable, profitability is not determinative of and does not inoculate the conduct from a relational trading review and any potential manipulation claim.

FERC appears to follow a framework for analyzing market manipulation.25 This framework posits that so-called uneconomic trading has characteristics of both fraud and market power, thus providing a foundation for analyzing potential manipulative behavior. The framework describes price-based manipulation as an intentional act (the ''trigger'') made to cause a directional price movement (the ''nexus'') to benefit financially leveraged positions that tie to that price (the ''target'').26 FERC has applied this or similar trigger– nexus-target approach as part of its manipulation analysis. Amaranth Advisors, LLC27, Energy Transfer Partners,28 and the recent headline cases in 2012 to date confirm FERC's continued aggressive pursuit of relational and loss leader trading.29 FERC's allegations underlying the Gila River settlement, for example, were based on theories of ''relational'' trading, claiming that Gila River's conduct was undertaken to move price and benefit revenues for imports from Gila River's plant—and was not based on market fundamentals.

III. What's Next

Given FERC's expanding enforcement intentions and capabilities, the contours of and concessions made in recent settlements, and the slate of enforcement actions pending before the FERC OE, targets will weigh the collateral consequences of settlement with the risks of litigation. Decisions in a litigated setting could result in much needed clarity for the U.S. energy industry regarding the viability of FERC's economic and legal theories and the bounds of its authority. Until then, all signs indicate that FERC will continue to flex its enforcement muscle with a shrouded pit waiting for those who misstep.

Footnotes

1. Energy Policy Act of 2005, §§ 315, 1283 (codified at 15 U.S.C. § 717c (2005) and 16 U.S.C. § 824 et seq. (2005)).

2. For FY2012, FERC's Division of Investigation Staff opened sixteen investigations and closed twenty-one. Nine investigations resulted in settlements, five in Orders to Show Cause, and seven in Notices of Alleged Violations. FERC obtained over $148 million in civil penalties, and over $119 million disgorgement of unjust profits. See 2012 Report on Enforcement, Docket No. AD07-13-005, at 3 (Nov. 15, 2012).

3. Gila River Power, LLC, 141 FERC _ 61,136, at PP 12–13 (2012).

4. 16 U.S.C. § 823b(d) (2010). There is no analogous election procedure under the Natural Gas Act, so targets in natural gas investigations must litigate before a FERC ALJ. Upon such an election, FERC assesses a penalty shortly after the target's answer to the Show Cause Order if FERC finds that a violation occurred.

5. See 5 U.S.C. § 556(d) (2010); Brian Hunter, 135 FERC _ 61,054, at P 29 (2011).

6. In April 2011, as later appealed to the Court of Appeals, FERC found that Hunter had internally manipulated the settlement price of NYMEX natural gas futures contracts in order to lower the settlement price and therefore benefit his swap positions.

7. Energy Policy Act of 2005, §§ 315, 1283 (codified at 15 U.S.C. § 717c (2005) and 16 U.S.C. § 824 et seq. (2005)).

8. See 18 C.F.R. § 1c.

9. See Prohibition of Energy Market Manipulation, Order No. 670, 71 Fed. Reg. 4244 (Jan. 26, 2006), FERC Stats. & Regs. _ 31,202 at P 49 (2006) (Order No. 670).

10. See footnote 9 at P 22.

11. See footnote 10.

12. See Gila River Power, LLC, 141 FERC _ 61,136 (Nov. 19, 2012).

13. See 18 C.F.R. § 1c.2(b) (''Nothing in this section shall be construed to create a private right of action.''); Blumenthal v. ISO New England, 129 FERC _ 61,057, at P 18 (2009) (''Section 222(b) of the FPA, while barring 'private rights of action,' does not operate as a bar to a complainant alleging market manipulation in a complaint filed with the Commission and thereby bringing alleged market manipulation to the Commission's attention.'').

14. Enforcement of Statutes, Orders, Rules, and Regulations, Revised Policy Statement on Penalty Guidelines, 132 FERC _ 61,216, at PP 162–164 (2010).

15. 7 U.S.C § 1, et seq.

16. 7 U.S.C § 12a(2) (2010).

17. 15 U.S.C § 78c(a)(39) (2010).

18. See Herman & MacLean v. Huddleston, 459 U.S. 375, 380 (1983) (''[A] private right of action under § 10(b) of the 1934 Act and Rule 10b-5 has been consistently recognized for more than 35 years. The existence of this implied remedy is simply beyond peradventure.'').

19. 15 U.S.C. § 78j(b) (2010).

20. FERC Open Meeting, Nov. 15, 2012.

21. FERC Division of Analytics and Surveillance, http://www.ferc.gov/ about/offices/oe/oe-das.asp (last visited Feb. 2, 2013).

22. Enhancement of Electricity Market Surveillance and Analysis through Ongoing Electronic Delivery of Data from RTOs and ISOs, Order No. 760, 139 FERC _ 61,053 (2012) (''Order No. 760'').

23. Electricity Market Transparency Provisions of Section 220 of the FPA, Order No. 768, 140 FERC _ 61,232 (2012) (''Order No. 768'').

24. Enhanced Natural Gas Market Transparency, 141 FERC _ 61,124 (2012).

25. See, e.g., A Framework for the Analysis of Market Manipulation, by Shaun D. Ledgerwood and Paul R. Carpenter, Review of Law & Economics, September 2012.

26. See footnote 25.

27. See Order to Show Cause and Notice of Proposed Penalties, 120 FERC _ 61,085 (July 26, 2007). FERC alleged that Amaranth natural gas trader Brian Hunter ''dumped'' large amounts of natural gas futures contracts on NYMEX during the last 30 minutes of trading in order to depress settlement prices, thereby benefiting considerably larger short positions Amaranth held that settled against the NYMEX price.

28. See Order to Show Cause and Notice of Proposed Penalties, 120 FERC _ 61,086 (July 26, 2007). FERC alleged that Energy Transfer Partners, L.P., caused the price of natural gas at the Houston Ship Channel location to be artificially low by ''dumping'' natural gas on to the market—selling natural gas at depressed prices, and then reporting these artificially low prices to Platts (a company that compiles price indices).

29. See FERC Enforcement Notices of Alleged Violations, http://ferc.gov/enforcement/alleged-violation/notices.asp (last visited Feb. 2, 2013) and FERC Enforcement Civil Penalty Actions, http://ferc.gov/enforcement/civil-penalties/civil-penalty-action.asp (last visited Feb. 2, 2013).

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