United States: U.S. Federal Energy Regulatory Commission Adopts Market-Based Rate Behavioral Rules

On November 17, 2003, the U.S. Federal Energy Regulatory Commission (FERC or Commission) issued two orders implementing behavioral rules for market-based electricity and natural gas sales. Order Amending Market-Based Rate Tariffs and Authorizations, 105 FERC ¶ 61,218 (November 17, 2003) ("Order"); Amendments to Blanket Sales Certificates, Order No. 644 (November 17, 2003). The electricity order requires power marketers (parties authorized to transact at market-based rates) to file tariff amendments incorporating certain behavioral rules into their market-based rate tariffs, in some instances as early as December 2, 2003. The natural gas order integrates the new rules into the FERC’s official regulations. The orders also adopt specific timetables and procedures for filing complaints or initiating investigations arising out of alleged behavioral rule violations. The new electricity behavioral rules will become effective on December 17, 2003. The natural gas rules become effective 30 days after publication in the Federal Register.

FERC explained that it adopted the rules to provide market participants with the "rules of the road" governing their future behavior. However, the rules are only partially successful in achieving the Commission’s stated goal. They are not sufficiently clear to provide market participants with the guidance they need to comply with all of the new requirements. In addition, the rules only address seller behavior. They do not apply to entities such as control area operators, independent system operators, regional transmission owners, governmental entities (e.g., municipals), load-serving entities and others, which also have the ability to engage in activities that adversely impact natural gas, energy, ancillary services or transmission prices.

Market Behavior Rule 1, Unit Operations, states that:

Rule 1 applies to all Sellers, including those that do not own generation but participate in markets, bid supply and control generation resources through contract rights. Rule 1 does not create a must-offer requirement to bid or supply energy into the market. Instead, the Rule governs a Seller’s conduct in the market. The Commission clarified that FERC-approved market rules (such as Independent System Operator (ISO) or Regional Transmission Organization (RTO) tariffs) establish the scope of Rule 1, not explanatory or technical guidelines that ISOs and RTOs may post on their website or otherwise distribute to Sellers, but which are not filed with and approved by FERC. The Commission also clarified that Rule 1 is not applicable to bilateral power sales or other transactions.

Market Behavior Rule 2, Market Manipulation, states that:

The Market Manipulation Rule is intended to prohibit anticompetitive market behavior, not transactions with "economic substance" and transactions that reflect a "legitimate business purpose." The rule is vague due to FERC’s failure to define with specificity what constitutes a legitimate versus illegitimate business purpose. The Commission only indicated that it would consider the facts and circumstances associated with the conduct to determine its purpose and intended/foreseeable result. For example, actions undertaken at the direction of an ISO or RTO will not violate the rule, nor should behavior adjustments that are made in conformance with legitimate market forces. FERC also noted that its primary focus would be on actions that have distorted market prices.

FERC’s decision to impose a foreseeability element also raises compliance concerns. Foreseeability is an objective tort standard that asks whether a reasonable person in the defendant’s shoes would have foreseen the harm, as compared to a subjective standard that considers only what the market participant intended when the market behavior occurred. The reasonable person approach injects 20/20 hindsight into the evaluation process. Furthermore, other agencies that are charged with prohibiting market manipulation do not apply a foreseeability standard. Thus, market participants subject to the jurisdiction of more than one agency must comply with different standards applicable to comparable behavior.

The U.S. Federal Trade Commission (FTC) urged FERC to avoid potential conflicts between the antitrust laws and Rule 2 by prohibiting Sellers from engaging in conduct that would violate the antitrust laws. The Commission rejected the FTC’s proposal, stating that while Rule 2 may prohibit behaviors that are similar in some respects to those prohibited under antitrust law, FERC’s authority to implement and enforce the Rule does not derive from federal antitrust law. The Commission stated that it would review market manipulation, including collusion, in the context of the Federal Power Act.

The Commission rejected comments recommending that it define wash trades as transactions involving the same delivery location. FERC asserted without explanation that wash trades could involve more than one location. This contrasts with the Commodity Exchange Act prohibition against wash trades in futures contracts, which, by definition, involve the same delivery point. Because of their pre-arranged nature, the Commission reasoned that wash trades implicitly include the intent to manipulate and will be considered per se Rule 2 violations. FERC properly clarified that sleeves and book-out transactions do not meet the Rule’s definition of prohibited wash trades. The Commission also noted that close-out transactions used to cancel or correct a prior erroneous transaction are not prohibited. This seems to ignore the fact that wash transactions can be done at current market prices and, therefore, do not necessarily produce unjust and unreasonable prices.

The Commission clarified that to violate the false information rule, the Seller must know that the information is false. FERC does not indicate what constitutes false information. FERC also failed to clarify how Rule 2.b differs from Rule 3. Finally, the Commission did not incorporate an adverse impact element into the Rule (e.g., false information inappropriately increased prices, etc.). It explained that inadvertent or honest errors, or submitting information based on good faith estimates that turn out to be incorrect (e.g., variations between forecasted and actual demand or generation availability), will not violate the rule, as such submissions are not knowingly false. The Seller must put processes in place to assure the sufficiency and accuracy of the submitted information. The Commission does not intend to allow a Seller to escape responsibility merely because the individual submitting the data did not know the submission was false. Virtual bidding and other Commission-approved activities will not violate the prohibition against submitting false information.

The Commission explained that "artificial congestion" includes all forms of congestion that may result from a Seller scheduling power flows in an uneconomic manner for the purpose of creating real or perceived congestion. The Rule is not intended to apply when market participants respond legitimately to changed circumstances between the day-ahead and real-time markets. Sellers can be deemed to violate the Rule if the prohibited conduct occurred in the absence of adequate internal procedures designed to prevent the conduct.

Market Behavior Rule 3, Communications, states that:

As noted above, FERC has not clarified the interplay between Rules 2 and 3. Each rule addresses the need for factual and accurate communications but establishes different compliance requirements. Rule 3 uses vague terms, including references to "misleading information," that will make it difficult for market participants to assess whether their communications are sufficient. While the Rule prohibits the knowing submission of false or misleading data, the Commission will not sanction parties for inadvertently inaccurate or incomplete submissions. Sellers must have procedures in place to assure the accuracy of submitted data. FERC clarified that jurisdictional entities may not use this Rule as a basis for compelling sellers to provide information or to avoid treating information provided to them confidentially.

Market Behavior Rule 4, Reporting, states that:

The Commission is not mandating reporting at this time. However, if Sellers report energy or natural gas transactions to index publishers, they are required to provide accurate and factual information, consistent with the procedures set forth in FERC’s recent Policy Statement on Natural Gas and Electric Price Indices (104 FERC ¶ 61,121 (2003)). As with Rule 3, FERC does not define terms such as "misleading." FERC also has not required index publishers to establish clear and consistent standards for the data they collect from market participants, thereby adding to the complexities that a market participant must consider when attempting to comply with Rule 4.

For purposes of enforcing Rule 4, the Commission adopts the transaction reporting standards set forth in the Policy Statement, as well as the Policy Statement’s "safe harbor" provision related to certain reporting errors. Sellers must inform FERC within 15 days of the effective date of this Order whether they report transactions to indices and must notify FERC within 15 days of any change to their transaction reporting status.

Market Behavior Rule 5, Record Retention states that:

The Commission explained that Sellers need not retain all analytical or cost-of-service data, but they must maintain a complete set of the contractual and related documentation that formed the basis for bills sent to customers. FERC indicated that it is immaterial whether the records are paper or electronic as long as they are reasonably accessible.

Market Behavior Rule 6, Related Tariff Matters, states that:

This Rule only applies to Sellers’ codes of conduct contained in their market-based rate tariffs and any "Order No. 889" standards of conduct the Seller may be required to have in place.

The Market Behavior Rules will not supercede parties’ rights to file complaints under the Federal Power Act. However, a party seeking contract modification based on an alleged violation of the Rules must demonstrate that there is a direct nexus between the alleged Rule violation and contract formation. This latter requirement should eliminate specious, but frequently filed, complaints based on broad allegations of wrongdoing (e.g., market participant X manipulated the market, so the Commission should abrogate market participant A’s contract).

Parties may bring complaints at FERC regarding alleged Rule violations within 90 days from the end of the calendar quarter in which the challenged transaction or market action occurred. If a complainant can show that it did not know and should not have known about the behavior that forms the basis of the complaint within that time period, the 90-day period will begin to run from the time when the complainant knew or should have known about the behavior at issue.

FERC also limited its ability to enforce the Rules. The Commission must act, by initiating an investigation or issuing an order, within 90 days from the date that it knew of an alleged Rule violation or of the potentially manipulative character of an action or transaction. (See Appendix A for the complete Complaint Procedures.) Because the Administrative Procedure Act requires FERC to comply with its own regulations, the new complaint procedures will provide finality for power transactions, which should bring much needed certainty to the markets. This should prevent FERC from changing its position, as it has sometimes done in the past (e.g., when FERC elected to apply refunds to all CAISO and CalPX spot market transactions even though it had previously ordered that it would apply refunds only to transactions that occurred during a Stage 3 emergency at prices that exceeded a monthly proxy price).

The Order directs Sellers to include the Rules in their tariffs on the earlier of when they: (1) file any amendment to their market-based rates tariff; or (2) seek continued authorization to sell at market-based rates (e.g., the triennial filing). Notwithstanding this time allowance, the tariff revisions approved in the Order are effective on December 17, 2003. Additionally, orders approving market-based rate tariffs that were issued after FERC initiated this proceeding included language requiring Sellers to make a compliance filing to amend their tariff to reflect the Rules within 15 days of the issuance of this Order. Thus, Sellers whose market-based rate tariff approvals contain that language are obligated to file their amended tariff by December 2, 2003. Sellers should review their market-based rate tariffs to determine whether this requirement is applicable to them.

Any violation of the Market Behavior Rules will constitute a tariff violation. Sellers will be subject to disgorgement of unjust profits associated with the tariff violation from the date on which the tariff violation occurred. Sellers also may be subject to suspension or revocation of their authority to sell at market-based rates or other appropriate non-monetary remedies. Finally, FERC clarified that it will impose additional remedies included in any new laws that Congress passes.

The Natural Gas Behavioral Rules only apply to interstate pipelines that provide unbundled natural gas sales service under FERC’s open access requirements and to entities selling wholesale natural gas at negotiated rates in interstate commerce under FERC’s blanket authorization provisions. The Natural Gas Behavioral Rules are substantially similar to the Market Behavior Rules for power, although not as extensive. The Commission omitted from the Natural Gas Behavioral Rules the Unit Operation and Related Tariff prohibitions, which are not applicable to gas sales, as well as the Communications prohibition. FERC did not include in the natural gas version of the Market Manipulation Rule (i.e., Rule 2) the prohibitions against transactions that are predicated on false information or creating false congestion, which also are not applicable to gas sales. In all other respects, the Natural Gas Behavioral Rules and Market Behavior Rules are virtually identical. FERC’s decision not to impose rules on natural gas sellers that require accurate and truthful statements to the Commission (e.g., Rule 3 in the electricity Market Behavior Rules) makes the Natural Gas Behavioral Rules less rigorous.

Complaints alleging any violation of the Commission’s Market Behavior Rules will be subject to the following remedies and procedures, in addition to all other remedies and procedures, as may be applicable, pursuant to the Commission’s Rules of Practice and Procedure.

1. Any complaint seeking relief for a violation of the Commission’s Market Behavior Rules shall be made no later than 90 days after the end of the calendar quarter in which the violation is alleged to have occurred.
2. If a complainant can show that it did not know and should not have known of the behavior which forms the basis for its complaint, within the period prescribed by these procedures, then the 90-day period will be deemed to run from the time when the complainant knew or should have known of the behavior.
3. Commission action on a complaint not meeting the filing deadlines, as prescribed in these procedures, will be prospective only.
4. The applicability of the Commission’s disgorgement remedy in any complaint proceeding alleging a violation of the Commission’s Market Behavior Rules will be limited by a requirement that the complainants show that the violation occurred on a transaction-specific basis.
5. The Commission will act within 90 days from the date it knew of an alleged violation of its Market Behavior Rules or knew of the potentially manipulative character of an action or transaction. Commission action, in this context, means a Commission order or the initiation of a preliminary investigation by Commission Staff pursuant to 18 C.F.R. Section 1b. If the Commission does not act within this time period, the seller will not be exposed to potential liability regarding the subject action or transaction. Knowledge on the part of the Commission must take the form of a call to FERC’s Hotline alleging inappropriate behavior or communication with its enforcement Staff.