The Office of Enforcement at the Federal Energy Regulatory Commission ("FERC") has changed significantly in the past decade. Its staff has increased from under 20, a decade ago, to 200 lawyers, economists, analysts, and investigators today. Moreover, FERC has historically kept investigations confidential, but the once quiet agency is now making headlines. A recent opinion by the D.C. Circuit Court of Appeals, Hunter v. FERC, was widely read because it highlighted FERC's involvement with the world of futures and derivatives trading. Also, in the past year alone, the agency has made public a number of high profile investigations into energy trading at Wall Street investment firms, such as Barclays and JP Morgan Chase.
The purpose of this three-part series is to give the reader a primer on the new enforcement arm of FERC. The first blog post discusses how the agency's mission has changed in recent years, and how and why the enforcement arm has expanded in size and in authority. The second blog post reviews and analyzes the D.C. Circuit Court of Appeals' opinion in Hunter v. FERC, and discusses what the case reveals about the new enforcement division's priorities and capabilities. The series concludes with an overview of several, current high-profile enforcement cases, and provides some takeaways on how the new enforcement division affects other participants in the energy sector.
Part 1: From Rate-Setting to Energy Trading Enforcement
FERC traces its history back to the 1920's and the creation of its predecessor, the Federal Power Commission ("FPC"), a small executive branch agency that focused mainly on the licensing and oversight of hydropower facilities. A decade later, President Franklin D. Roosevelt worked with Congress during the Great Depression to enact legislation intended to limit the power of utility monopolies. As part of that effort, Congress passed the Federal Power Act in 1935, which transformed the FPC into an independent agency, whose mission was to ensure "just and reasonable" wholesale electricity prices. The FPC was later transformed into FERC in 1977.
Prior to the 1980s, the FPC and FERC remained largely hidden from the public eye. Its responsibilities were limited mainly to overseeing wholesale rates, managing tariffs, and issuing rules on interstate sales of natural gas and electricity. Thus, the agency's original enforcement responsibility was to regulate pricing by requiring that public utilities establish reasonable rates, making sure that utilities adhered to tariffs, and ordering refunds for overcharges to ratepayers. The enforcement staff consisted of a handful of attorneys with a few support personnel within the agency's Office of General Counsel. Moreover, the FPC and FERC rarely made investigations public out of concern for, among other things, how news of the investigation would affect the utilities' stock prices.
That all changed in the late 1980s. As part of the Reagan Administration's efforts to deregulate major industries, FERC began deregulating the gas markets. And, in 1992, Congress passed the Energy Policy Act of 1992 ("EPAct I"), which initiated a partial transition for the nation's electricity industry from full regulation of power sales to partial deregulation and competition for many energy producers and suppliers. Among other things, utility companies were now required to open their transmission lines to electricity wholesalers, and transmission service was effectively unbundled and could be purchased separately. FERC was given oversight powers over this transition. Also, in the 1990s, many states adopted legislation seeking to deregulate the power generation sector, either in whole or in part; electric utilities in these states either sold off their generation assets or moved these assets into separate market-driven affiliates. (Other states chose to preserve their vertically integrated utilities and effectively limited or prohibited direct competition in the generation sector.) In any event, by the early 2000s, prices for energy commodities came to be determined less by FERC staff, and more by the trading of financial instruments – like futures and derivatives – the value of which were tied to the prices of the underlying oil, gas, and energy commodities. As we now know, this transition resulted in some turmoil in gas and energy prices – as well as production and transmission – which culminated in the California Energy Crisis.
Congress responded by passing the Energy Policy Act of 2005 ("EPAct II"), which called for a significant increase in FERC's staff and budget and specifically authorized FERC to pursue market manipulation. The amendments also allowed the agency to impose fines of up to $1 million for each day that a company is found to be in violation of the rules governing electricity, oil, and gas markets. Previously, FERC was only able to level civil penalties of up to $10,000 per day. The amendments also increased the maximum fine and imprisonment time that applied to criminal cases.
Notably, the statutory language authorizing FERC to pursue manipulation was modeled on Section 10(b) of the Securities Exchange Act of 1934. A FERC interpretive release from 2006 explains that FERC will look to cases interpreting the enforcement authority of the Securities and Exchange Commission's ("SEC") under Rule 10b-5, which was promulgated under Section 10(b) of the Exchange Act, for guidance when bringing its own investigations and enforcement actions. Thus, while FERC's original enforcement focus was on making sure that utilities adhered to rate-setting through tariffs and rebates, Congress shifted the agency's efforts to policing market manipulation. In that respect, Congress intended for FERC to become very much an enforcement agency like the SEC.
Fast forward to the present. Since the passage of the EPAct II in 2005, FERC's enforcement division has grown to about 200 staff, up from about 20 a decade ago. The division is currently led by Norman Bay, the former U.S. Attorney for the District of New Mexico. One of his top deputies is a former general counsel of the FBI, and the division's managerial ranks now include other former law enforcement officials and criminal investigators. Moreover, in 2012, the enforcement division created a specialized group, the Division of Analytics and Surveillance ("DAS"), whose primary function is to collect and analyze market data to help detect instances of manipulation and other illegal activity. DAS alone comprises more than 40 staff, including former traders, risk managers, and others with industry experience.
Another consequence of the move toward market-based regulation is FERC's ability to publicize its enforcement efforts. This change is attributable to the fact that energy commodity prices are no longer controlled by FERC and by regulated public utilities, but rather a multitude of direct energy participants as well as trading and investment firms. Specifically, prior to deregulation, there were only a handful of regulated utilities in the gas and electricity space, and so news of an investigation into one of these entities could have significant detrimental effects on the company's well-being. With more competition within the industry, and more entities, that concern has lessened.
Thus, within the past two years, FERC has made public 13 investigations of alleged market manipulation. In March 2012, for example, the agency disclosed that it reached a $245 million settlement with an energy firm, Constellation Energy, to resolve accusations that the company manipulated the New York and New England power markets. And, beginning in the summer of 2012, FERC has disclosed probes of the trading units at Barclays Plc, Deutsche Bank AG and JP Morgan Chase & Co. The Barclays case has drawn particular attention because FERC named individual traders as well as the bank.
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