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Policing Market Manipulation: A Review of Evolving Federal Energy Regulatory Commission Policy
Policing Market Manipulation: A Review of Evolving Federal Energy Regulatory Commission Policy
Mark R. Haskell is a Partner with the law firm of Morgan, Lewis & Bockius in Washington, DC. He is a 1982 graduate of the University of Maine and a 1985 graduate of Harvard Law School. His practice has focused primarily on regulatory compliance, enforcement, litigation, and dispute resolution affecting market participants in the natural gas, oil, petrochemical, and electric industries. Levi McAllister is an Associate with Morgan, Lewis & Bockius. He is a 2003 graduate of the University of Texas at Austin and a 2008 graduate of American University’s Washington College of Law. The views expressed in this article are those of the authors alone and do not necessarily reflect those of the authors’ law firm or its clients.
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To date the Federal Energy Regulatory Commission has not meaningfully articulated for market participants a clear definition of what market manipulation is and how it may be avoided. Nor has FERC acted through rulemakings, policy statements, or no-action letters to provide additional clarity. As a result, the law of market manipulation at FERC still remains largely unwritten. Mark R. Haskell and Levi McAllister
I. Introduction The Energy Policy Act of 2005 gave the Federal Energy Regulatory Commission (FERC) a new mandate: deter and detect market manipulation in wholesale gas and power markets. With this new mandate came substantially enhanced penalty authority. As we stand at the beginning of
2011, what has become of this mandate? Has FERC meaningfully articulated for market participants a clear definition of what market manipulation is and how it may be avoided? The short answer is ‘‘no.’’ art II of this article describes the history of FERC’s market manipulation enforcement authority, including how and
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when FERC received explicit authority to investigate and penalize market manipulation as well as what FERC is required to demonstrate to prove that market manipulation has occurred. Part III of this article describes the reported instances in which FERC has investigated market manipulation. Part III.A briefly describes a variety of investigations, in both the electricity and natural gas markets, that FERC has conducted in response to allegations that a market participant has engaged in market manipulation. Part III.B focuses on FERC’s most recent proceeding, involving North America Power Partners (NAPP), which resulted in a $2.7 million settlement. Finally, Part IV comments on FERC’s path forward in providing market participants with an understanding of what constitutes market manipulation.
II. FERC’s Market Manipulation Enforcement Authority In November 2003, FERC took a step toward establishing a regulatory paradigm specifically tailored to prohibit market manipulation. At that time, FERC issued Market Behavior Rules to fill a perceived void in the regulation of market-based trading activity.1 The Market Behavior Rules were an outgrowth of
FERC’s investigation of trading activity in Western energy markets during 2000– 2001, which uncovered a number of trading practices allegedly designed to take advantage of the then-existing electricity market in California as well as claimed abuses in reporting of natural gas prices to price index publishers for purposes of manipulating price indices.
Following FERC’s issuance of the Market Behavior Rules, certain entities challenged the legality of the rules in federal court.
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core provision of the Market Behavior Rules, as issued by FERC in 2003, was Rule 2, which stated that ‘‘[a]ctions or transactions that are without a legitimate business purpose and that are intended to or foreseeably could manipulate market prices, market conditions, or market rules for electric energy or electricity products are prohibited.’’2 In addition, Market Behavior Rule 2 expressly prohibited wash trades, transactions predicated on submitting false information, creating and relieving artificial congestion, and collusion with another party for the purpose of
manipulating market prices, market conditions, or market rules.3 A. Statutory and regulatory framework of FERC’s market manipulation authority Following FERC’s issuance of the Market Behavior Rules, certain entities challenged the legality of the rules in federal court. FERC Commissioners requested explicit authority to investigate and penalize market manipulation. Shortly thereafter, Congress passed the Energy Policy Act of 2005 (‘‘EPAct 2005’’), which President George W. Bush signed into law on Aug. 8, 2005.4 EPAct 2005 expressly prohibited ‘‘market manipulation’’ in conjunction with both electric power and natural gas sales and transmission, and gave FERC authority to promulgate rules to enforce that prohibition. In doing so, EPAct 2005, inter alia, amended both the Natural Gas Act5 (NGA) and portions of the Federal Power Act6 (FPA).7 Substantively, the market manipulation provisions are identical. FPA Section 222 provides: It shall be unlawful for any entity (including an entity described in section 201(f)), directly or indirectly, to use or employ, in connection with the purchase or sale of electric energy or the purchase or sale of transmission services subject to the jurisdiction of the Commission, any manipulative or deceptive device or contrivance (as those terms are used in section
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10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j(b))), in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of electric ratepayers.8
NGA Section 4A provides: It shall be unlawful for any entity, directly or indirectly, to use or employ, in connection with the purchase or sale of natural gas or the purchase or sale of transportation services subject to the jurisdiction of the Commission, any manipulative or deceptive device or contrivance (as those terms are used in § 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b))), in contravention of such rules and regulations as the Commission may prescribe as necessary in the public interest or for the protection of natural gas ratepayers . . ..9
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ursuant to its statutory authority, FERC promulgated regulations prohibiting market manipulation,10 which are codified at 18 C.F.R. Part 1c. Section 1c.1 prohibits market manipulation in connection with ‘‘the purchase or sale of natural gas or the purchase or sale of transportation services subject to the jurisdiction of the Commission.’’11 Section 1c.2 prohibits market manipulation in connection with ‘‘the purchase or sale of electric energy or the purchase or sale of transmission services subject to the jurisdiction of the Commission.’’12 The provisions are substantively identical, making it ‘‘unlawful for any entity, directly or indirectly,’’ in 36
connection with the aforementioned activities: (1) To use or employ any device, scheme, or artifice to defraud, (2) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
Demonstrating market manipulation requires FERC to undertake a significant degree of interpretation of its authority. (3) To engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any entity.
B. Proving violations of market manipulation As the amended provisions of the FPA and NGA as well as FERC’s manipulation-related regulations suggest, demonstrating market manipulation requires FERC to undertake a significant degree of interpretation of its authority. To that end, FERC
views its anti-manipulation authority broadly, taking the position that the regulations ‘‘permit the Commission to police all forms of fraud and manipulation that affect natural gas and electric energy transactions and activities the Commission is charged with protecting.’’13 FERC also defines ‘‘fraud’’ broadly, ‘‘to include any action, transaction, or conspiracy for the purpose of impairing, obstructing or defeating a well-functioning market.’’14 FERC’s market manipulation regulations are modeled after the Securities and Exchange Commission’s (SEC) Rule 10b-5,15 stating that this approach ‘‘should provide benefits to entities subject to the new rule because there is a substantial body of precedent applying the comparable language of Rule 10b-5.’’16 However, FERC acknowledged that its function is not identical to the SEC’s mandate because ‘‘the SEC does not have a duty to ensure that the price of a security is just and reasonable, and that our duty is not to protect purchasers through a regime of disclosure.’’17 Accordingly, FERC has indicated that it will recognize such differing roles, on a case-by-case basis, ‘‘in determining whether it is appropriate to adopt securities precedents to specific energy industry facts, circumstances, or situations.’’18 n light of such a paradigm, FERC must demonstrate the
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existence of several elements to prove that an entity has engaged in market manipulation. First, FERC must demonstrate that an entity used a fraudulent device, scheme or artifice, or makes a material misrepresentation or a material omission as to which there is a duty to speak under a Commission-filed tariff, Commission order, rule or regulation, or engaged in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any entity. Second, FERC must demonstrate that the entity acted with the requisite scienter. Third, FERC must demonstrate that the entity’s conduct occurred in connection with the purchase or sale of natural gas or electric energy or transportation of natural gas or transmission of electric energy subject to the jurisdiction of the Commission.19 ith regard to the scienter requirement, scienter is ‘‘a mental state embracing intent to deceive, manipulate, or defraud.’’20 However, in its Final Rule promulgating regulations prohibiting market manipulation, FERC was asked to clarify whether recklessness would satisfy the scienter requirement. In response, FERC observed that the Supreme Court had not addressed the issue but that Courts of Appeals addressing the question in the context of Rule 10b-5 concluded that recklessness satisfied the Rule 10b-5 scienter
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requirement. As a result, FERC stated ‘‘that recklessness satisfies the element of the Final Rule’’ relating to anti-manipulation provisions.21 FERC did not elaborate on the degree of recklessness required to establish scienter, and Courts of Appeals differ on the degree of recklessness that could sufficiently satisfy the scienter requirement in the context of Rule 10b-5. Therefore, it is
It is unclear whether FERC believes that any recklessness would suffice or whether severe recklessness would be required to satisfy the scienter requirement. unclear whether FERC believes that any recklessness would suffice or whether severe recklessness would be required to satisfy the scienter requirement. Notably, EPAct 2005 does not explicitly authorize recklessness as a standard for establishing scienter and those courts that have endorsed it have not equated recklessness and negligence. Beyond these general principles, FERC has provided little systematic guidance to the industry on what specific conduct is to be avoided in connection with market manipulation.
III. Implementing FERC’s Manipulation Authority A. FERC’s prior manipulation-related orders After receiving its market manipulation investigation authority from Congress in EPAct 2005 and prior to the FERC Office of Enforcement’s investigation of NAPP, FERC actively investigated allegations of market manipulation.22 In March 2007, FERC initiated an investigation involving an investigation of the New York installed capacity (ICAP) market administered by the New York Independent System Operator (NYISO).23 Through the course of the investigation, FERC turned its focus to allegations that KeySpanRavenswood, LLC (‘‘KeySpan’’) had engaged in economic withholding in the ICAP market by entering into a financial derivative agreement in 2006 whereby KeySpan gained a financial interest in sales of electricity capacity by its largest competitor, Astoria Generating Company. In 2008, FERC declined to take further action on parties’ allegations of market manipulation after the Office of Enforcement determined that insufficient evidence of market manipulation existed.24 Also in March 2007, FERC initiated four investigations arising from calls to the FERC Enforcement Hotline that alleged several separate entities engaged in fraudulent conduct in the open-
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season bidding for capacity on the Cheyenne Plains Natural Gas Company pipeline in March 2007. Following an investigation, the Office of Enforcement alleged that the entities and their affiliates submitted multiple bids through their affiliates in order to manipulate the pro rata distribution of Cheyenne’s capacity and obtain more capacity for their corporate family than would have been possible through bids submitted by only one affiliate.25 The Office of Enforcement alleged that the entities’ behavior did not constitute violations of Cheyenne’s tariff, but instead constituted market manipulation because the entities submission of ‘‘multiple-affiliate bids to impair the pro rata allocation mechanism employed by Cheyenne’’26 amounted to an intentional fraud or deceit upon Cheyenne’s open season, which was in connection with the purchase or sale of natural gas subject to FERC’s jurisdiction.27 In January 2009, FERC approved a settlement with the entities, which obligated the entities to collectively pay a $8.3 million civil penalty and disgorge almost $3.9 million in unjust profits.28 On the same day that FERC approved the settlement, FERC also issued an Order to Show Cause to two entities, Seminole Energy Services, LLC, and National Fuel Marketing Company, LLC.29 Both of the Orders to Show Cause allege that each entity engaged in the same behavior at issue in the settlement. Specifically, FERC alleged that 38
Seminole and National Fuel each engaged in market manipulation by submitting multiple bids through their affiliates in order to manipulate the pro rata distribution of Cheyenne’s capacity. As of this writing, neither proceeding has reached resolution. n June 2007, FERC initiated an investigation involving a
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complaint filed by DC Energy, LLC, against H.Q. Energy Services (U.S.) Inc., alleging that H.Q. Energy violated FERC’s market manipulation regulations by exercising market power to unlawfully affect congestion and energy pricing in the NYISO energy and transmission congestion contract markets. DC Energy alleged that H.Q. Energy would offer energy at price estimates to be below the anticipated NYISO reference price, which created minimal congestion between the H.Q. Energy proxy node and the NYSIO control area. Following such activity, DC Energy alleged that H.Q. Energy would then cause congestion and capitalize
financially from congestion rents that resulted from the increased congestion. In September 2008, FERC denied the complaint following an Office of Enforcement investigation concluding that there was insufficient evidence that H.Q. Energy engaged in market manipulation.30 n July 2007, FERC initiated two separate investigations. First, FERC initiated a proceeding involving allegations that Amaranth Advisors and individual Amaranth traders manipulated the price of natural gas transactions through its trading activities on the New York Mercantile Exchange Natural Gas Futures Contract.31 FERC preliminary concluded that Amaranth traders manipulated the settlement price of the Natural Gas Futures Contract in order to benefit their positions in opposing financial swaps and options. FERC designated the matter for hearing before an Administrative Law Judge (ALJ), and issued an order directing the Office of Enforcement’s Litigation Staff to file a brief addressing the issues that it recommended be set for evidentiary hearing for an ALJ.32 In 2009, following settlement negotiations, FERC approved an uncontested settlement obligating Amaranth to pay a $7.5 million civil penalty as a result of FERC’s allegations.33 The settlement approved by FERC, however, did not encompass the alleged manipulative activities of one Amaranth trader, Brian Hunter. Instead, a hearing was conducted
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with regard to the allegations that Mr. Hunter engaged in manipulative activity. In January 2010, the ALJ issued an Initial Decision, which concluded that Mr. Hunter engaged in fraudulent or deceptive behavior through his sales of futures contracts that were traded on the New York Mercantile Exchange As determined by the ALJ, Mr. Hunter sold a significant volume of futures contracts during the settlement period (for example, the last 30 minutes of the trading day) of each day. Because Mr. Hunter held a short position on futures contracts on other exchanges, the ALJ reasoned that Mr. Hunter’s sales were undertaken to depress the prices of the futures contract being settled on each day at issue, and therefore were ‘‘specifically designed to lower the NYMEX price in order to benefit his swap positions on other exchanges.’’34 Presently, FERC has not issued an Order on Initial Decision or determined a sanction. However, the ALJ’s decision is notable because, among other things, the decision is the first time that FERC has found a violation of its market manipulation rules in a contested proceeding. As this article demonstrates, FERC investigations relating to allegations of market manipulation have always previously resulted in settlement agreements resolving the allegations. econd, FERC initiated an investigation in July 2007 involving allegations that Energy
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Transfer Partners, L.P. manipulated the price of fixedprice natural gas at Houston Ship Channel by suppressing the price for natural gas.35 FERC also preliminarily concluded that Energy Transfer Partners manipulated natural gas prices at other hubs, Waha and Permian, in an effort to benefit a short position in basis swaps.
FERC approved an uncontested settlement obligating Energy Transfer Partners to pay a $5 million civil penalty and disgorge $25 million in unjust profits as a result of FERC’s allegations.36 In April 2008, FERC initiated an investigation in response to a complaint filed by PJM Interconnection, LLC, against a number of entities alleging that the entities manipulated PJM’s Day-ahead energy and financial transmission rights (FTR) markets. Among other things, PJM alleged that certain affiliates of the entities entered into coordinated, offsetting positions in the market for FTRs, concentrating high-risk or losing
positions in one affiliate, and deliberately causing that affiliate to default on its obligations by saddling it with these positions while hedging its risk in its more profitable affiliates. Following an investigation, the Office of Enforcement concluded that insufficient evidence existed to support a finding that market manipulation occurred. In response to the Office of Enforcement’s conclusions, FERC denied the portion of the complaint alleging that the conduct constituted manipulation.37 In July 2008, FERC initiated an investigation into allegations that certain market participants in the NYISO control area had violated FERC’s market manipulation regulations by engaging in intercontrol area transactions that allegedly exploited a seam in the pricing methods used by NYISO, PJM, the Midwest Independent Transmission System Operator, Inc. (MISO) and Ontario’s Independent Electricity System Operator (IESO). The NYISO further alleged that the market participants were disguising the true source or sink of the schedules at issue, and that the schedules resulted in physical flows substantially at variance from scheduled flows. Following an investigation into the allegations, the Office of Enforcement determined that insufficient evidence existed to demonstrate that market manipulation had occurred. As a result of the Office of Enforcement’s conclusions, in
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July 2009, FERC declined to take further action.38 n August 2010, FERC also initiated a new proceeding – a non-public investigation that is a matter of public record – relating to trades associated with large volumes of up-to-congestion transactions in the PJM markets.39 In initiating the investigation, FERC noted that both PJM and its market monitor observed that ‘‘trades were undertaken with the intent of manipulating PJM market rules so as to gain an allocation of marginal loss surplus revenue without any corresponding usage of the transmission system.’’40 As a result, FERC initiated the investigation to determine whether a violation of Part 1c.2 of its regulations occurred. The proceeding is ongoing.
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B. FERC’s recent manipulation action FERC recently has addressed alleged manipulation occurring in connection with the PJM Interconnection, LLC’s Demand Response programs. On Oct. 28, 2010, FERC issued an order approving a $2.7 million settlement relating to allegations that NAPP, among other things, engaged in fraudulent conduct in violation of FERC’s prohibition against market manipulation.41 FERC’s order resolved an Office of Enforcement investigation into NAPP’s alleged conduct that occurred over two years ago. In resolving the investigation, NAPP did not admit or deny any of the 40
allegations contained in the settlement with the Office of Enforcement. 1. Office of Enforcement’s allegations regarding NAPP’s activities The Office of Enforcement’s investigation stemmed from NAPP’s activities in PJM’s Demand Response programs in
2007 and 2008. NAPP, a Curtailment Service Provider, acts as an agent for individual resources that seek to participate in PJM’s Demand Response programs. As a Curtailment Service Provider, NAPP is responsible for registering resources into various Demand Response programs and offering those resources as available during needed periods. Additionally, NAPP notifies the resources when PJM has ordered a demand reduction. n March 2008, PJM referred to the Office of Enforcement issues relating to NAPP’s participation in PJM’s Synchronized Reserve Market (SRM), Interruptible Load for
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Reliability Program (ILR), and the Interchange Energy Market (IEM). As a result of the referral, the Office of Enforcement opened an investigation pursuant to Part 1b of FERC’s regulations, which sets forth the rules relating to FERC investigations of alleged misconduct. Through the course of its investigation, the Office of Enforcement alleged that NAPP violated FERC’s market manipulation regulations in two respects.42 First, the Office of Enforcement alleged that NAPP offered resources into PJM’s SRM at times when NAPP was aware that the resources were unavailable to respond to a Synchronized Reserve Event requiring the resources to reduce demand.43 PJM’s SRM is an hourly ancillary services market that allows PJM to respond to sudden changes and serve load immediately in the event that a contingency event occurs on the PJM system. The Office of Enforcement alleged that because NAPP knew that the resources were unavailable to respond to a Synchronized Reserve Event but offered the resources notwithstanding that fact, NAPP’s actions constituted a fraudulent scheme or artifice in violation of Part 1c.2 of FERC’s regulations. Further, the Office of Enforcement alleged that NAPP’s manipulative activity allowed NAPP to collect unjust profits amount to $334,116.44 Second, the Office of Enforcement alleged that NAPP
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registered 101 resources as participants in PJM’s ILR Program before obtaining the authorization of those resources to participate in the program.45 PJM’s ILR Program is a capacity product that is offered on an annual basis and used by PJM in emergency circumstances to maintain reliability. After a Curtailment Service Provider, such as NAPP, registers resources into the program, the Curtailment Service Provider provides submits peak load data to PJM, which uses that data to represent that peak demand of participating resources and to allocate payments to ILR Program participants. The Office of Enforcement alleged further that NAPP registered the resources with knowledge that the resources had not authorized the registration, and therefore NAPP’s actions in connection with the ILR Program constituted a fraudulent scheme or artifice in violation of Part 1c.2 of FERC’s regulations. The Office of Enforcement alleged that NAPP collected unjust profits amount to $1,924,011.46 2. Determining an appropriate civil penalty As a product of NAPP’s settlement with the Office of Enforcement, NAPP is obligated to pay a civil penalty of $500,000, disgorge $2,258,127, plus interest, in unjust profits, and undertake a compliance program that provides periodic reports to the Office of Enforcement for two years.
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n determining the civil penalty, the Office of Enforcement considered several factors described in FERC’s Revised Policy Statement on Enforcement.47 Notably, the Office of Enforcement concluded that NAPP violated the Commission’s prohibition against market manipulation even though NAPP’s activities did not affect
market prices or cause actual harm to system reliability.48 Instead, the Office of Enforcement maintained that the Commission’s market manipulation prohibition was violated because NAPP’s actions operated as a fraud upon PJM. In this regard, the Office of Enforcement asserted that NAPP’s most serious violations were committed willfully and intentionally through the participation or oversight of NAPP’s Senior Vice President of Operations at that time. Further, NAPP’s alleged lack of cooperation at the initial stages of the investigation was cited as an exacerbating factor in determining the penalty.
However, the Office of Enforcement determined that the exacerbating factor was partially offset by NAPP’s improved cooperation in later stages of the investigation, and NAPP’s strengthened commitment to compliance. Finally, the Office of Enforcement considered that a substantially high penalty or immediate large payment could jeopardize NAPP’s continued financial viability. Under such a circumstance, FERC’s ability to disgorge NAPP’s unjust profits and obtain any civil penalty would be threatened. In that regard, FERC’s order approving the settlement explained that: Absent consideration of NAPP’s financial viability, Enforcement would have sought a significantly higher penalty and would likely seek a higher penalty for similar conduct by a more financially viable entity in the future.49
IV. FERC’s Path Forward While the settlements approved by FERC to date provide some indication of how FERC views the scope of its own authority, little can be determined from them. The limited number of contested manipulation-related investigations make it difficult to determine precisely what constitutes manipulation and what authority Congress intended FERC to possess when EPAct 2005 was enacted. To date, FERC has not meaningfully articulated for market
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participants a clear definition of what market manipulation is and how it may be avoided. The NAPP decision emphasizes that conduct alleged to constitute fraud can form the basis of a manipulation claim. So much was clear on the face of EPAct 2005. Nor has FERC acted through rulemakings, policy statements, or no-action letters to provide additional clarity. As a result, the law of market manipulation at FERC still remains largely unwritten.&
Utility Market-Based Rate Authorizations, 105 FERC ô 61,218 at Appendix A (2003). 4. Energy Policy Act of 2005, Pub. L. 109-58, 119 Stat. 594 (2005) (‘‘EPAct 2005’’). 5. 15 U.S.C. §§ 717-717z. See EPAct 2005, § 315, 119 Stat. 594 (2005). 6. 16 U.S.C. §§ 824-824w. EPAct 2005, § 1283. 7. EPAct 2005 also created an apparent difference in how an
2. See Investigations of Terms and Conditions of Public Utility Market-Based Rate Authorizations, 105 FERC ô 61,218 at Appendix A (2003). Sections 284.288(a) and 284.403(a) of the Commission’s regulations, promulgated in Order No. 644, contained substantially similar language: a pipeline that provides unbundled natural gas service under section 284.284 or any person making natural gas sales for resale in interstate commerce pursuant to section 284.402 ‘‘is prohibited from engaging in actions or transactions that are without a legitimate business purpose and are intended to or foreseeably could manipulate market prices, market conditions, or market rules for natural gas.’’ 3. See 18 C.F.R. § 284.288 (2004); 18 C.F.R. § 284.403 (2004); Investigations of Terms and Conditions of Public 42
10. Prohibition of Energy Market Manipulation, Order No. 670, 114 FERC ô 61,047, 71 Fed. Reg. 4,244 (Jan. 26, 2006), reh’g denied 114 FERC ô 61,300 (2006) (‘‘Final Rule’’). 11. 18 C.F.R. § 1c.1 (2008). 12. Id. § 1c.2. 13. Final Rule at P 25 (emphasis added). 14. Id. at P 50. 15. 15 U.S.C. § 78j. Rule 10b-5 is essentially identical to Section 10(b) of the Securities Exchange Act, which provides in pertinent part:
Endnotes: 1. See Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, ‘‘Order Amending Market-Based Rate Tariffs and Authorizations,’’ 105 FERC ô 61,218 (2003), reh’g denied, 107 FERC ô 61,175 (2004), appeal denied, Colorado Office of Consumer Counsel v. FERC, 490 F.3d 954 (D.C. Cir. 2007); Order No. 644, Amendment to Blanket Sales Certificates, FERC Stats. & Regs. ô 31,153 (2003), reh’g denied, 107 FERC ô 61,174 (2004).
9. EPAct 2005 § 315.
individual trader may be penalized for certain conduct depending on whether the trader is a gas or power trader. Following EPAct 2005’s enactment, natural gas traders who violate the prohibition of market manipulation set forth in the NGA, or FERC’s rules implementing that prohibition, may be prohibited by a court from purchasing or selling natural gas or transmission services subject to FERC’s jurisdiction. A similar provision applicable to power traders does not appear in the FPA. See 15 U.S.C. 717s (d) (2006). In contrast, power traders that violate the prohibition of knowingly submitting false information relating to power prices or available transmission capacity, or FERC’s rules implementing that prohibition, may be prohibited by a court from purchasing or selling electric energy or transmission services subject to FERC’s jurisdiction. See 16 U.S.C. 825m (d) (2006). 8. EPAct 2005 § 1283.
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . to use or employ, in connection with the purchase or sale of any security, . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. See also, J. Michel Marcoux, Canaries in the Coal Mine: Facts From Securities Fraud Private Civil Actions Can Identify Intent to Manipulate Energy Markets, 29 ENERGY L.J. 141 (2008). 16. Notice of Proposed Rulemaking, Prohibition of Energy Market Manipulation, 113 FERC ô 61,067 (2005) at P 2 (‘‘Market Manipulation NOPR’’). 17. Final Rule at P 32. 18. Id. at P 31. 19. Id. at P 49 (emphasis added). 20. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). 21. Final Rule at P 53. FERC noted that various circuit courts of appeal have adopted differing definitions of recklessness. Id. at P 109. FERC has based one market manipulation show
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cause order on alleged trade recklessness. See Amaranth Advisors, L.L.C., 124 FERC ô 61,050 at P 72 (2008). As discussed infra, FERC alleged that both Amaranth and individual traders engaged in market manipulation. Subsequently, Amaranth reached a settlement with FERC and FERC pursued its claims against one of the traders, Brian Hunter. Mr. Hunter argued, on several occasions before FERC, that recklessness was not an appropriate standard to apply to allegations of market manipulation. On Dec. 22, 2010, following Mr. Hunter’s appeal of a FERC order denying rehearing of a jurisdictionalrelated order, the D.C. Circuit dismissed Mr. Hunter’s appeal for lack of ripeness. See Hunter v. FERC, No. 10-1017, slip op. at 2 (D.C. Cir. Dec. 22, 2010). 22. FERC annually issues a report on enforcement, which provides information concerning the Office of Enforcement’s activities during the preceding fiscal year. The reports FERC issues include an overview and statistics on the activities of the three divisions within the Office of Enforcement: the Division of Investigations, Division of Audits, and Division of Energy Market Oversight. The annual report provides information regarding the nature of non-public Office of Enforcement activities, including self-reported violations and investigations that are closed without any enforcement action or civil penalty assessment. See, e.g., 2010 Report on Enforcement, Docket No. AD07-13-003 (Nov. 18, 2010), at http://www.ferc.gov/legal/staffreports/11-18-10-enforcement.pdf. 23. New York Independent System Operator, Inc., 118 FERC ô 61,182, reh’g denied, 118 FERC ô 61,251 (2007). 24. See New York Independent System Operator, Inc., 122 FERC ô 61,211 at P 149 (2008). Although FERC determined that insufficient evidence of market manipulation existed, the Department of Justice (DOJ) initiated its own investigation. DOJ concluded that the same facts on which FERC relied when choosing to not take
further action constituted a restraint in competition in violation of the Sherman Act. See U.S. v. KeySpan Corp., Civil Action No. 10-cv-1415 (WHP), Competitive Impact Statement, filed Feb. 23, 2010, at http:// www.justice.gov/atr/cases/f255500/ 255578.htm. As a result of DOJ’s allegations, KeySpan entered into a settlement with DOJ in which KeySpan agreed to disgorge $12 million in profits. In doing so, KeySpan did not admit or deny any of DOJ’s allegations. Presently, the proposed settlement is pending judicial approval in the Southern District of New York.
35. FERC’s investigation of Energy Transfer Partners was conducted in the context of FERC’s Market Behavior Rules rather than Part 1c of its regulations because the market manipulation regulations were not in effect at the time that the alleged manipulation occurred. 36. See Energy Transfer Partners, L.P., 128 FERC ô 61,269 (2009). 37. See PJM Interconnection, LLC v. Accord Energy, LLC, 127 FERC ô 61,007 (2009). 38. See New York Independent System Operator, Inc., 128 FERC ô 61,049 (2009). 39. PJM Up-To Congestion Transactions, 132 FERC ô 61,169 (2010). 40. Id. at P 1; PJM Interconnection, LLC, Tariff Filing, Docket No. ER10-2280-000 at 6 (filed Aug. 18, 2010). 41. See North America Power Partners, 133 FERC ô 61,089 (2010) (‘‘Order Approving Settlement’’).
25. See In re Tenaska Marketing Ventures, 126 FERC ô 61,040 at P 9 (2009). 26. Id. at P 22. 27. Id. 28. Id. at P 3. 29. See Seminole Energy Servs., LLC, 126 FERC ô 61,041 (2009); National Fuel Marketing Co., LLC, 126 FERC ô 61,042 (2009). 30. See DC Energy, LLC v. H.Q. Energy Services (U.S.), Inc., 124 FERC ô 61,295 (2008). 31. Amaranth Advisors, LLC, 120 FERC ô 61,085 (2007). 32. Amaranth Advisors, LLC, 122 FERC ô 61,087 (2008). 33. Amaranth Advisors, LLC, 128 FERC ô 61,154 (2009). 34. See Brian Hunter, 130 FERC ô 63,004 (2010).
42. The Office of Enforcement also claimed that NAPP violated the PJM Open Access Transmission Tariff (OATT) in three respects: (1) through the submission of 52 inaccurate peak load contribution values, which collectively overstated the peak load contribution of NAPP’s resources by 39.5 MW; (2) by offering a resource with a real-time locational marginal pricing rate into PJM’s day-ahead energy market; and (3) by transacting in the day-ahead IEM without having such transactions controlled by a sufficiently staffed and communications enabled market operations center. 43. Id. at P 6. 44. Id. at P 8. 45. Id. at P 11. 46. Id. at P 13. 47. See 123 FERC ô 61,156 (2008). 48. Order Approving Settlement at P 18. 49. Id. at P 19.
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Mark R. Haskell is a Partner with the law firm of Morgan, Lewis & Bockius in Washington, DC. He is a 1982 graduate of the University of Maine and a 1985 graduate of Harvard Law School. His practice has focused primarily on regulatory compliance, enforcement, litigation, and dispute resolution affecting market participants in the natural gas, oil, petrochemical, and electric industries. Levi McAllister is an Associate with Morgan, Lewis & Bockius. He is a 2003 graduate of the University of Texas at Austin and a 2008 graduate of American University’s Washington College of Law. The views expressed in this article are those of the authors alone and do not necessarily reflect those of the authors’ law firm or its clients.
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To date the Federal Energy Regulatory Commission has not meaningfully articulated for market participants a clear definition of what market manipulation is and how it may be avoided. Nor has FERC acted through rulemakings, policy statements, or no-action letters to provide additional clarity. As a result, the law of market manipulation at FERC still remains largely unwritten. Mark R. Haskell and Levi McAllister
I. Introduction The Energy Policy Act of 2005 gave the Federal Energy Regulatory Commission (FERC) a new mandate: deter and detect market manipulation in wholesale gas and power markets. With this new mandate came substantially enhanced penalty authority. As we stand at the beginning of
2011, what has become of this mandate? Has FERC meaningfully articulated for market participants a clear definition of what market manipulation is and how it may be avoided? The short answer is ‘‘no.’’ art II of this article describes the history of FERC’s market manipulation enforcement authority, including how and
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when FERC received explicit authority to investigate and penalize market manipulation as well as what FERC is required to demonstrate to prove that market manipulation has occurred. Part III of this article describes the reported instances in which FERC has investigated market manipulation. Part III.A briefly describes a variety of investigations, in both the electricity and natural gas markets, that FERC has conducted in response to allegations that a market participant has engaged in market manipulation. Part III.B focuses on FERC’s most recent proceeding, involving North America Power Partners (NAPP), which resulted in a $2.7 million settlement. Finally, Part IV comments on FERC’s path forward in providing market participants with an understanding of what constitutes market manipulation.
II. FERC’s Market Manipulation Enforcement Authority In November 2003, FERC took a step toward establishing a regulatory paradigm specifically tailored to prohibit market manipulation. At that time, FERC issued Market Behavior Rules to fill a perceived void in the regulation of market-based trading activity.1 The Market Behavior Rules were an outgrowth of
FERC’s investigation of trading activity in Western energy markets during 2000– 2001, which uncovered a number of trading practices allegedly designed to take advantage of the then-existing electricity market in California as well as claimed abuses in reporting of natural gas prices to price index publishers for purposes of manipulating price indices.
Following FERC’s issuance of the Market Behavior Rules, certain entities challenged the legality of the rules in federal court.
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core provision of the Market Behavior Rules, as issued by FERC in 2003, was Rule 2, which stated that ‘‘[a]ctions or transactions that are without a legitimate business purpose and that are intended to or foreseeably could manipulate market prices, market conditions, or market rules for electric energy or electricity products are prohibited.’’2 In addition, Market Behavior Rule 2 expressly prohibited wash trades, transactions predicated on submitting false information, creating and relieving artificial congestion, and collusion with another party for the purpose of
manipulating market prices, market conditions, or market rules.3 A. Statutory and regulatory framework of FERC’s market manipulation authority Following FERC’s issuance of the Market Behavior Rules, certain entities challenged the legality of the rules in federal court. FERC Commissioners requested explicit authority to investigate and penalize market manipulation. Shortly thereafter, Congress passed the Energy Policy Act of 2005 (‘‘EPAct 2005’’), which President George W. Bush signed into law on Aug. 8, 2005.4 EPAct 2005 expressly prohibited ‘‘market manipulation’’ in conjunction with both electric power and natural gas sales and transmission, and gave FERC authority to promulgate rules to enforce that prohibition. In doing so, EPAct 2005, inter alia, amended both the Natural Gas Act5 (NGA) and portions of the Federal Power Act6 (FPA).7 Substantively, the market manipulation provisions are identical. FPA Section 222 provides: It shall be unlawful for any entity (including an entity described in section 201(f)), directly or indirectly, to use or employ, in connection with the purchase or sale of electric energy or the purchase or sale of transmission services subject to the jurisdiction of the Commission, any manipulative or deceptive device or contrivance (as those terms are used in section
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10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j(b))), in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of electric ratepayers.8
NGA Section 4A provides: It shall be unlawful for any entity, directly or indirectly, to use or employ, in connection with the purchase or sale of natural gas or the purchase or sale of transportation services subject to the jurisdiction of the Commission, any manipulative or deceptive device or contrivance (as those terms are used in § 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b))), in contravention of such rules and regulations as the Commission may prescribe as necessary in the public interest or for the protection of natural gas ratepayers . . ..9
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ursuant to its statutory authority, FERC promulgated regulations prohibiting market manipulation,10 which are codified at 18 C.F.R. Part 1c. Section 1c.1 prohibits market manipulation in connection with ‘‘the purchase or sale of natural gas or the purchase or sale of transportation services subject to the jurisdiction of the Commission.’’11 Section 1c.2 prohibits market manipulation in connection with ‘‘the purchase or sale of electric energy or the purchase or sale of transmission services subject to the jurisdiction of the Commission.’’12 The provisions are substantively identical, making it ‘‘unlawful for any entity, directly or indirectly,’’ in 36
connection with the aforementioned activities: (1) To use or employ any device, scheme, or artifice to defraud, (2) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
Demonstrating market manipulation requires FERC to undertake a significant degree of interpretation of its authority. (3) To engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any entity.
B. Proving violations of market manipulation As the amended provisions of the FPA and NGA as well as FERC’s manipulation-related regulations suggest, demonstrating market manipulation requires FERC to undertake a significant degree of interpretation of its authority. To that end, FERC
views its anti-manipulation authority broadly, taking the position that the regulations ‘‘permit the Commission to police all forms of fraud and manipulation that affect natural gas and electric energy transactions and activities the Commission is charged with protecting.’’13 FERC also defines ‘‘fraud’’ broadly, ‘‘to include any action, transaction, or conspiracy for the purpose of impairing, obstructing or defeating a well-functioning market.’’14 FERC’s market manipulation regulations are modeled after the Securities and Exchange Commission’s (SEC) Rule 10b-5,15 stating that this approach ‘‘should provide benefits to entities subject to the new rule because there is a substantial body of precedent applying the comparable language of Rule 10b-5.’’16 However, FERC acknowledged that its function is not identical to the SEC’s mandate because ‘‘the SEC does not have a duty to ensure that the price of a security is just and reasonable, and that our duty is not to protect purchasers through a regime of disclosure.’’17 Accordingly, FERC has indicated that it will recognize such differing roles, on a case-by-case basis, ‘‘in determining whether it is appropriate to adopt securities precedents to specific energy industry facts, circumstances, or situations.’’18 n light of such a paradigm, FERC must demonstrate the
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existence of several elements to prove that an entity has engaged in market manipulation. First, FERC must demonstrate that an entity used a fraudulent device, scheme or artifice, or makes a material misrepresentation or a material omission as to which there is a duty to speak under a Commission-filed tariff, Commission order, rule or regulation, or engaged in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any entity. Second, FERC must demonstrate that the entity acted with the requisite scienter. Third, FERC must demonstrate that the entity’s conduct occurred in connection with the purchase or sale of natural gas or electric energy or transportation of natural gas or transmission of electric energy subject to the jurisdiction of the Commission.19 ith regard to the scienter requirement, scienter is ‘‘a mental state embracing intent to deceive, manipulate, or defraud.’’20 However, in its Final Rule promulgating regulations prohibiting market manipulation, FERC was asked to clarify whether recklessness would satisfy the scienter requirement. In response, FERC observed that the Supreme Court had not addressed the issue but that Courts of Appeals addressing the question in the context of Rule 10b-5 concluded that recklessness satisfied the Rule 10b-5 scienter
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requirement. As a result, FERC stated ‘‘that recklessness satisfies the element of the Final Rule’’ relating to anti-manipulation provisions.21 FERC did not elaborate on the degree of recklessness required to establish scienter, and Courts of Appeals differ on the degree of recklessness that could sufficiently satisfy the scienter requirement in the context of Rule 10b-5. Therefore, it is
It is unclear whether FERC believes that any recklessness would suffice or whether severe recklessness would be required to satisfy the scienter requirement. unclear whether FERC believes that any recklessness would suffice or whether severe recklessness would be required to satisfy the scienter requirement. Notably, EPAct 2005 does not explicitly authorize recklessness as a standard for establishing scienter and those courts that have endorsed it have not equated recklessness and negligence. Beyond these general principles, FERC has provided little systematic guidance to the industry on what specific conduct is to be avoided in connection with market manipulation.
III. Implementing FERC’s Manipulation Authority A. FERC’s prior manipulation-related orders After receiving its market manipulation investigation authority from Congress in EPAct 2005 and prior to the FERC Office of Enforcement’s investigation of NAPP, FERC actively investigated allegations of market manipulation.22 In March 2007, FERC initiated an investigation involving an investigation of the New York installed capacity (ICAP) market administered by the New York Independent System Operator (NYISO).23 Through the course of the investigation, FERC turned its focus to allegations that KeySpanRavenswood, LLC (‘‘KeySpan’’) had engaged in economic withholding in the ICAP market by entering into a financial derivative agreement in 2006 whereby KeySpan gained a financial interest in sales of electricity capacity by its largest competitor, Astoria Generating Company. In 2008, FERC declined to take further action on parties’ allegations of market manipulation after the Office of Enforcement determined that insufficient evidence of market manipulation existed.24 Also in March 2007, FERC initiated four investigations arising from calls to the FERC Enforcement Hotline that alleged several separate entities engaged in fraudulent conduct in the open-
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season bidding for capacity on the Cheyenne Plains Natural Gas Company pipeline in March 2007. Following an investigation, the Office of Enforcement alleged that the entities and their affiliates submitted multiple bids through their affiliates in order to manipulate the pro rata distribution of Cheyenne’s capacity and obtain more capacity for their corporate family than would have been possible through bids submitted by only one affiliate.25 The Office of Enforcement alleged that the entities’ behavior did not constitute violations of Cheyenne’s tariff, but instead constituted market manipulation because the entities submission of ‘‘multiple-affiliate bids to impair the pro rata allocation mechanism employed by Cheyenne’’26 amounted to an intentional fraud or deceit upon Cheyenne’s open season, which was in connection with the purchase or sale of natural gas subject to FERC’s jurisdiction.27 In January 2009, FERC approved a settlement with the entities, which obligated the entities to collectively pay a $8.3 million civil penalty and disgorge almost $3.9 million in unjust profits.28 On the same day that FERC approved the settlement, FERC also issued an Order to Show Cause to two entities, Seminole Energy Services, LLC, and National Fuel Marketing Company, LLC.29 Both of the Orders to Show Cause allege that each entity engaged in the same behavior at issue in the settlement. Specifically, FERC alleged that 38
Seminole and National Fuel each engaged in market manipulation by submitting multiple bids through their affiliates in order to manipulate the pro rata distribution of Cheyenne’s capacity. As of this writing, neither proceeding has reached resolution. n June 2007, FERC initiated an investigation involving a
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complaint filed by DC Energy, LLC, against H.Q. Energy Services (U.S.) Inc., alleging that H.Q. Energy violated FERC’s market manipulation regulations by exercising market power to unlawfully affect congestion and energy pricing in the NYISO energy and transmission congestion contract markets. DC Energy alleged that H.Q. Energy would offer energy at price estimates to be below the anticipated NYISO reference price, which created minimal congestion between the H.Q. Energy proxy node and the NYSIO control area. Following such activity, DC Energy alleged that H.Q. Energy would then cause congestion and capitalize
financially from congestion rents that resulted from the increased congestion. In September 2008, FERC denied the complaint following an Office of Enforcement investigation concluding that there was insufficient evidence that H.Q. Energy engaged in market manipulation.30 n July 2007, FERC initiated two separate investigations. First, FERC initiated a proceeding involving allegations that Amaranth Advisors and individual Amaranth traders manipulated the price of natural gas transactions through its trading activities on the New York Mercantile Exchange Natural Gas Futures Contract.31 FERC preliminary concluded that Amaranth traders manipulated the settlement price of the Natural Gas Futures Contract in order to benefit their positions in opposing financial swaps and options. FERC designated the matter for hearing before an Administrative Law Judge (ALJ), and issued an order directing the Office of Enforcement’s Litigation Staff to file a brief addressing the issues that it recommended be set for evidentiary hearing for an ALJ.32 In 2009, following settlement negotiations, FERC approved an uncontested settlement obligating Amaranth to pay a $7.5 million civil penalty as a result of FERC’s allegations.33 The settlement approved by FERC, however, did not encompass the alleged manipulative activities of one Amaranth trader, Brian Hunter. Instead, a hearing was conducted
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with regard to the allegations that Mr. Hunter engaged in manipulative activity. In January 2010, the ALJ issued an Initial Decision, which concluded that Mr. Hunter engaged in fraudulent or deceptive behavior through his sales of futures contracts that were traded on the New York Mercantile Exchange As determined by the ALJ, Mr. Hunter sold a significant volume of futures contracts during the settlement period (for example, the last 30 minutes of the trading day) of each day. Because Mr. Hunter held a short position on futures contracts on other exchanges, the ALJ reasoned that Mr. Hunter’s sales were undertaken to depress the prices of the futures contract being settled on each day at issue, and therefore were ‘‘specifically designed to lower the NYMEX price in order to benefit his swap positions on other exchanges.’’34 Presently, FERC has not issued an Order on Initial Decision or determined a sanction. However, the ALJ’s decision is notable because, among other things, the decision is the first time that FERC has found a violation of its market manipulation rules in a contested proceeding. As this article demonstrates, FERC investigations relating to allegations of market manipulation have always previously resulted in settlement agreements resolving the allegations. econd, FERC initiated an investigation in July 2007 involving allegations that Energy
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Transfer Partners, L.P. manipulated the price of fixedprice natural gas at Houston Ship Channel by suppressing the price for natural gas.35 FERC also preliminarily concluded that Energy Transfer Partners manipulated natural gas prices at other hubs, Waha and Permian, in an effort to benefit a short position in basis swaps.
FERC approved an uncontested settlement obligating Energy Transfer Partners to pay a $5 million civil penalty and disgorge $25 million in unjust profits as a result of FERC’s allegations.36 In April 2008, FERC initiated an investigation in response to a complaint filed by PJM Interconnection, LLC, against a number of entities alleging that the entities manipulated PJM’s Day-ahead energy and financial transmission rights (FTR) markets. Among other things, PJM alleged that certain affiliates of the entities entered into coordinated, offsetting positions in the market for FTRs, concentrating high-risk or losing
positions in one affiliate, and deliberately causing that affiliate to default on its obligations by saddling it with these positions while hedging its risk in its more profitable affiliates. Following an investigation, the Office of Enforcement concluded that insufficient evidence existed to support a finding that market manipulation occurred. In response to the Office of Enforcement’s conclusions, FERC denied the portion of the complaint alleging that the conduct constituted manipulation.37 In July 2008, FERC initiated an investigation into allegations that certain market participants in the NYISO control area had violated FERC’s market manipulation regulations by engaging in intercontrol area transactions that allegedly exploited a seam in the pricing methods used by NYISO, PJM, the Midwest Independent Transmission System Operator, Inc. (MISO) and Ontario’s Independent Electricity System Operator (IESO). The NYISO further alleged that the market participants were disguising the true source or sink of the schedules at issue, and that the schedules resulted in physical flows substantially at variance from scheduled flows. Following an investigation into the allegations, the Office of Enforcement determined that insufficient evidence existed to demonstrate that market manipulation had occurred. As a result of the Office of Enforcement’s conclusions, in
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July 2009, FERC declined to take further action.38 n August 2010, FERC also initiated a new proceeding – a non-public investigation that is a matter of public record – relating to trades associated with large volumes of up-to-congestion transactions in the PJM markets.39 In initiating the investigation, FERC noted that both PJM and its market monitor observed that ‘‘trades were undertaken with the intent of manipulating PJM market rules so as to gain an allocation of marginal loss surplus revenue without any corresponding usage of the transmission system.’’40 As a result, FERC initiated the investigation to determine whether a violation of Part 1c.2 of its regulations occurred. The proceeding is ongoing.
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B. FERC’s recent manipulation action FERC recently has addressed alleged manipulation occurring in connection with the PJM Interconnection, LLC’s Demand Response programs. On Oct. 28, 2010, FERC issued an order approving a $2.7 million settlement relating to allegations that NAPP, among other things, engaged in fraudulent conduct in violation of FERC’s prohibition against market manipulation.41 FERC’s order resolved an Office of Enforcement investigation into NAPP’s alleged conduct that occurred over two years ago. In resolving the investigation, NAPP did not admit or deny any of the 40
allegations contained in the settlement with the Office of Enforcement. 1. Office of Enforcement’s allegations regarding NAPP’s activities The Office of Enforcement’s investigation stemmed from NAPP’s activities in PJM’s Demand Response programs in
2007 and 2008. NAPP, a Curtailment Service Provider, acts as an agent for individual resources that seek to participate in PJM’s Demand Response programs. As a Curtailment Service Provider, NAPP is responsible for registering resources into various Demand Response programs and offering those resources as available during needed periods. Additionally, NAPP notifies the resources when PJM has ordered a demand reduction. n March 2008, PJM referred to the Office of Enforcement issues relating to NAPP’s participation in PJM’s Synchronized Reserve Market (SRM), Interruptible Load for
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Reliability Program (ILR), and the Interchange Energy Market (IEM). As a result of the referral, the Office of Enforcement opened an investigation pursuant to Part 1b of FERC’s regulations, which sets forth the rules relating to FERC investigations of alleged misconduct. Through the course of its investigation, the Office of Enforcement alleged that NAPP violated FERC’s market manipulation regulations in two respects.42 First, the Office of Enforcement alleged that NAPP offered resources into PJM’s SRM at times when NAPP was aware that the resources were unavailable to respond to a Synchronized Reserve Event requiring the resources to reduce demand.43 PJM’s SRM is an hourly ancillary services market that allows PJM to respond to sudden changes and serve load immediately in the event that a contingency event occurs on the PJM system. The Office of Enforcement alleged that because NAPP knew that the resources were unavailable to respond to a Synchronized Reserve Event but offered the resources notwithstanding that fact, NAPP’s actions constituted a fraudulent scheme or artifice in violation of Part 1c.2 of FERC’s regulations. Further, the Office of Enforcement alleged that NAPP’s manipulative activity allowed NAPP to collect unjust profits amount to $334,116.44 Second, the Office of Enforcement alleged that NAPP
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registered 101 resources as participants in PJM’s ILR Program before obtaining the authorization of those resources to participate in the program.45 PJM’s ILR Program is a capacity product that is offered on an annual basis and used by PJM in emergency circumstances to maintain reliability. After a Curtailment Service Provider, such as NAPP, registers resources into the program, the Curtailment Service Provider provides submits peak load data to PJM, which uses that data to represent that peak demand of participating resources and to allocate payments to ILR Program participants. The Office of Enforcement alleged further that NAPP registered the resources with knowledge that the resources had not authorized the registration, and therefore NAPP’s actions in connection with the ILR Program constituted a fraudulent scheme or artifice in violation of Part 1c.2 of FERC’s regulations. The Office of Enforcement alleged that NAPP collected unjust profits amount to $1,924,011.46 2. Determining an appropriate civil penalty As a product of NAPP’s settlement with the Office of Enforcement, NAPP is obligated to pay a civil penalty of $500,000, disgorge $2,258,127, plus interest, in unjust profits, and undertake a compliance program that provides periodic reports to the Office of Enforcement for two years.
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n determining the civil penalty, the Office of Enforcement considered several factors described in FERC’s Revised Policy Statement on Enforcement.47 Notably, the Office of Enforcement concluded that NAPP violated the Commission’s prohibition against market manipulation even though NAPP’s activities did not affect
market prices or cause actual harm to system reliability.48 Instead, the Office of Enforcement maintained that the Commission’s market manipulation prohibition was violated because NAPP’s actions operated as a fraud upon PJM. In this regard, the Office of Enforcement asserted that NAPP’s most serious violations were committed willfully and intentionally through the participation or oversight of NAPP’s Senior Vice President of Operations at that time. Further, NAPP’s alleged lack of cooperation at the initial stages of the investigation was cited as an exacerbating factor in determining the penalty.
However, the Office of Enforcement determined that the exacerbating factor was partially offset by NAPP’s improved cooperation in later stages of the investigation, and NAPP’s strengthened commitment to compliance. Finally, the Office of Enforcement considered that a substantially high penalty or immediate large payment could jeopardize NAPP’s continued financial viability. Under such a circumstance, FERC’s ability to disgorge NAPP’s unjust profits and obtain any civil penalty would be threatened. In that regard, FERC’s order approving the settlement explained that: Absent consideration of NAPP’s financial viability, Enforcement would have sought a significantly higher penalty and would likely seek a higher penalty for similar conduct by a more financially viable entity in the future.49
IV. FERC’s Path Forward While the settlements approved by FERC to date provide some indication of how FERC views the scope of its own authority, little can be determined from them. The limited number of contested manipulation-related investigations make it difficult to determine precisely what constitutes manipulation and what authority Congress intended FERC to possess when EPAct 2005 was enacted. To date, FERC has not meaningfully articulated for market
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participants a clear definition of what market manipulation is and how it may be avoided. The NAPP decision emphasizes that conduct alleged to constitute fraud can form the basis of a manipulation claim. So much was clear on the face of EPAct 2005. Nor has FERC acted through rulemakings, policy statements, or no-action letters to provide additional clarity. As a result, the law of market manipulation at FERC still remains largely unwritten.&
Utility Market-Based Rate Authorizations, 105 FERC ô 61,218 at Appendix A (2003). 4. Energy Policy Act of 2005, Pub. L. 109-58, 119 Stat. 594 (2005) (‘‘EPAct 2005’’). 5. 15 U.S.C. §§ 717-717z. See EPAct 2005, § 315, 119 Stat. 594 (2005). 6. 16 U.S.C. §§ 824-824w. EPAct 2005, § 1283. 7. EPAct 2005 also created an apparent difference in how an
2. See Investigations of Terms and Conditions of Public Utility Market-Based Rate Authorizations, 105 FERC ô 61,218 at Appendix A (2003). Sections 284.288(a) and 284.403(a) of the Commission’s regulations, promulgated in Order No. 644, contained substantially similar language: a pipeline that provides unbundled natural gas service under section 284.284 or any person making natural gas sales for resale in interstate commerce pursuant to section 284.402 ‘‘is prohibited from engaging in actions or transactions that are without a legitimate business purpose and are intended to or foreseeably could manipulate market prices, market conditions, or market rules for natural gas.’’ 3. See 18 C.F.R. § 284.288 (2004); 18 C.F.R. § 284.403 (2004); Investigations of Terms and Conditions of Public 42
10. Prohibition of Energy Market Manipulation, Order No. 670, 114 FERC ô 61,047, 71 Fed. Reg. 4,244 (Jan. 26, 2006), reh’g denied 114 FERC ô 61,300 (2006) (‘‘Final Rule’’). 11. 18 C.F.R. § 1c.1 (2008). 12. Id. § 1c.2. 13. Final Rule at P 25 (emphasis added). 14. Id. at P 50. 15. 15 U.S.C. § 78j. Rule 10b-5 is essentially identical to Section 10(b) of the Securities Exchange Act, which provides in pertinent part:
Endnotes: 1. See Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, ‘‘Order Amending Market-Based Rate Tariffs and Authorizations,’’ 105 FERC ô 61,218 (2003), reh’g denied, 107 FERC ô 61,175 (2004), appeal denied, Colorado Office of Consumer Counsel v. FERC, 490 F.3d 954 (D.C. Cir. 2007); Order No. 644, Amendment to Blanket Sales Certificates, FERC Stats. & Regs. ô 31,153 (2003), reh’g denied, 107 FERC ô 61,174 (2004).
9. EPAct 2005 § 315.
individual trader may be penalized for certain conduct depending on whether the trader is a gas or power trader. Following EPAct 2005’s enactment, natural gas traders who violate the prohibition of market manipulation set forth in the NGA, or FERC’s rules implementing that prohibition, may be prohibited by a court from purchasing or selling natural gas or transmission services subject to FERC’s jurisdiction. A similar provision applicable to power traders does not appear in the FPA. See 15 U.S.C. 717s (d) (2006). In contrast, power traders that violate the prohibition of knowingly submitting false information relating to power prices or available transmission capacity, or FERC’s rules implementing that prohibition, may be prohibited by a court from purchasing or selling electric energy or transmission services subject to FERC’s jurisdiction. See 16 U.S.C. 825m (d) (2006). 8. EPAct 2005 § 1283.
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . to use or employ, in connection with the purchase or sale of any security, . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. See also, J. Michel Marcoux, Canaries in the Coal Mine: Facts From Securities Fraud Private Civil Actions Can Identify Intent to Manipulate Energy Markets, 29 ENERGY L.J. 141 (2008). 16. Notice of Proposed Rulemaking, Prohibition of Energy Market Manipulation, 113 FERC ô 61,067 (2005) at P 2 (‘‘Market Manipulation NOPR’’). 17. Final Rule at P 32. 18. Id. at P 31. 19. Id. at P 49 (emphasis added). 20. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). 21. Final Rule at P 53. FERC noted that various circuit courts of appeal have adopted differing definitions of recklessness. Id. at P 109. FERC has based one market manipulation show
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cause order on alleged trade recklessness. See Amaranth Advisors, L.L.C., 124 FERC ô 61,050 at P 72 (2008). As discussed infra, FERC alleged that both Amaranth and individual traders engaged in market manipulation. Subsequently, Amaranth reached a settlement with FERC and FERC pursued its claims against one of the traders, Brian Hunter. Mr. Hunter argued, on several occasions before FERC, that recklessness was not an appropriate standard to apply to allegations of market manipulation. On Dec. 22, 2010, following Mr. Hunter’s appeal of a FERC order denying rehearing of a jurisdictionalrelated order, the D.C. Circuit dismissed Mr. Hunter’s appeal for lack of ripeness. See Hunter v. FERC, No. 10-1017, slip op. at 2 (D.C. Cir. Dec. 22, 2010). 22. FERC annually issues a report on enforcement, which provides information concerning the Office of Enforcement’s activities during the preceding fiscal year. The reports FERC issues include an overview and statistics on the activities of the three divisions within the Office of Enforcement: the Division of Investigations, Division of Audits, and Division of Energy Market Oversight. The annual report provides information regarding the nature of non-public Office of Enforcement activities, including self-reported violations and investigations that are closed without any enforcement action or civil penalty assessment. See, e.g., 2010 Report on Enforcement, Docket No. AD07-13-003 (Nov. 18, 2010), at http://www.ferc.gov/legal/staffreports/11-18-10-enforcement.pdf. 23. New York Independent System Operator, Inc., 118 FERC ô 61,182, reh’g denied, 118 FERC ô 61,251 (2007). 24. See New York Independent System Operator, Inc., 122 FERC ô 61,211 at P 149 (2008). Although FERC determined that insufficient evidence of market manipulation existed, the Department of Justice (DOJ) initiated its own investigation. DOJ concluded that the same facts on which FERC relied when choosing to not take
further action constituted a restraint in competition in violation of the Sherman Act. See U.S. v. KeySpan Corp., Civil Action No. 10-cv-1415 (WHP), Competitive Impact Statement, filed Feb. 23, 2010, at http:// www.justice.gov/atr/cases/f255500/ 255578.htm. As a result of DOJ’s allegations, KeySpan entered into a settlement with DOJ in which KeySpan agreed to disgorge $12 million in profits. In doing so, KeySpan did not admit or deny any of DOJ’s allegations. Presently, the proposed settlement is pending judicial approval in the Southern District of New York.
35. FERC’s investigation of Energy Transfer Partners was conducted in the context of FERC’s Market Behavior Rules rather than Part 1c of its regulations because the market manipulation regulations were not in effect at the time that the alleged manipulation occurred. 36. See Energy Transfer Partners, L.P., 128 FERC ô 61,269 (2009). 37. See PJM Interconnection, LLC v. Accord Energy, LLC, 127 FERC ô 61,007 (2009). 38. See New York Independent System Operator, Inc., 128 FERC ô 61,049 (2009). 39. PJM Up-To Congestion Transactions, 132 FERC ô 61,169 (2010). 40. Id. at P 1; PJM Interconnection, LLC, Tariff Filing, Docket No. ER10-2280-000 at 6 (filed Aug. 18, 2010). 41. See North America Power Partners, 133 FERC ô 61,089 (2010) (‘‘Order Approving Settlement’’).
25. See In re Tenaska Marketing Ventures, 126 FERC ô 61,040 at P 9 (2009). 26. Id. at P 22. 27. Id. 28. Id. at P 3. 29. See Seminole Energy Servs., LLC, 126 FERC ô 61,041 (2009); National Fuel Marketing Co., LLC, 126 FERC ô 61,042 (2009). 30. See DC Energy, LLC v. H.Q. Energy Services (U.S.), Inc., 124 FERC ô 61,295 (2008). 31. Amaranth Advisors, LLC, 120 FERC ô 61,085 (2007). 32. Amaranth Advisors, LLC, 122 FERC ô 61,087 (2008). 33. Amaranth Advisors, LLC, 128 FERC ô 61,154 (2009). 34. See Brian Hunter, 130 FERC ô 63,004 (2010).
42. The Office of Enforcement also claimed that NAPP violated the PJM Open Access Transmission Tariff (OATT) in three respects: (1) through the submission of 52 inaccurate peak load contribution values, which collectively overstated the peak load contribution of NAPP’s resources by 39.5 MW; (2) by offering a resource with a real-time locational marginal pricing rate into PJM’s day-ahead energy market; and (3) by transacting in the day-ahead IEM without having such transactions controlled by a sufficiently staffed and communications enabled market operations center. 43. Id. at P 6. 44. Id. at P 8. 45. Id. at P 11. 46. Id. at P 13. 47. See 123 FERC ô 61,156 (2008). 48. Order Approving Settlement at P 18. 49. Id. at P 19.
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