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. In our first blog post, we discussed how the agency's mission has changed in recent years, and how and why the enforcement arm has expanded in size and in authority. This 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.
Part 2: Hunter v. FERC
On March 15, 2013, in a closely watched case, FERC lost a battle in the D.C. Circuit Court of Appeals involving the agency's efforts to fine Brian Hunter, a former trader at the now defunct hedge fund, Amaranth Advisors. Hunter v. FERC, 711 F.3d 155 (D.C. Cir. 2013). FERC's investigation into Hunter's trading activity and the subsequent administrative process lasted roughly five years. Ultimately, FERC determined that Hunter manipulated trades in futures contracts that unlawfully depressed the price of natural gas, and so FERC imposed a $30 million penalty against Hunter. The D.C. Circuit, however, vacated the agency's findings and penalty, on grounds that the Commodity Futures Trading Commission ("CFTC") had exclusive jurisdiction over this case.
By way of background, Hunter traded natural gas futures contracts on the New York Mercantile Exchange ("NYMEX"). According to FERC, Hunter's scheme was executed over the course of three settlement days in 2006 – February 24, March 29, and April 26. On those dates, Hunter essentially used his futures trades to drive downward the prices of physical natural gas products. Hunter's related portfolio of swap-based derivatives, which he purchased on the Intercontinental Exchange ("ICE"), had been constructed to benefit from a decline in gas prices. According to FERC, Hunter's scheme resulted in a net profit to Hunter and his firm, Amaranth Advisors, of $18.2 million.
As set forth in FERC's Show Cause Order, an analyst in FERC's enforcement division observed in real time the "sharp rise in price" of gas prices "followed by the sharp decline during the last half-hour of trading." In May 2006, FERC requested and received information from the CFTC, which led to the conclusion that Amaranth was, by far, the largest seller in futures trades affecting the fluctuation of energy prices on those three days. Importantly, during this time, the CFTC was not monitoring derivatives trades. Thus, over the next few months, FERC worked extensively with the CFTC, NYMEX, ICE, and experts, piecing together a trail linking the futures trades, the impact those trades had on energy prices, and the resulting profit that Hunter and Amaranth made in their portfolio of swap-based derivatives.
In July 2007, the CFTC filed an enforcement action against Hunter, alleging manipulation in violation of the Commodity Exchange Act ("CEA"). FERC followed, filing an administrative proceeding against Hunter alleging manipulation in violation of Section 4A of the Natural Gas Act ("NGA"). A federal district court in New York, however, issued a stay in the CFTC action, essentially because FERC's investigation was already more advanced. Eventually, FERC found against Hunter, imposing a $30 million fine. The appeal to the D.C. Circuit followed. The CFTC intervened in support of Hunter on his claim that FERC lacked jurisdiction to bring the case in the first place.
The D.C. Circuit began its analysis by noting that the CEA gives the CFTC "exclusive jurisdiction" over trades made in the futures and derivatives markets. In contrast, the NGA makes it unlawful to manipulate the price of natural gas. The Court further noted that a provision in the Energy Policy Act of 2005 directed FERC and the CFTC to enter into a memorandum of understanding ("MOU") about information sharing. In this case, Hunter's alleged scheme was performed solely through trading of natural gas futures contracts and derivatives. The Court concluded that regardless of whether Hunter had the intent to manipulate energy prices, the CEA "by its plain terms" vested the CFTC with exclusive jurisdiction over this case. FERC countered that because the manipulation of the futures market indirectly affected the market for physical gas – i.e., the futures trades drove down the prices of physical gas commodities – both agencies should have an enforcement role. Such an argument, the Court held, ignores the plain language of the CEA.
The Hunter case is notable because of the unusually significant amount of financial and legal press coverage that the case generated throughout its life cycle. On the one hand, the Hunter case may have been widely followed because it highlighted FERC's involvement with the world of futures and derivatives trading, topics that have gained notoriety in recent years because similar financial instruments played large a role in the financial crisis of 2007-2008. On the other hand, the case is indicative of how oil, gas, and electricity prices have become inextricably intertwined with the trading of financial products. As many observers note, the Hunter case makes clear that FERC has set its cross-hairs on uneconomic trading of products related to oil, gas, and electricity – i.e., executing trades that lose money in one market in order to benefit positions in another market.
Since the Hunter appeal was decided, FERC has announced that it will not appeal the decision to the Supreme Court. According to FERC, it will instead look to Congress to address the situation through legislation. We note that such a "fix" would require amendments to the CEA, and possibly the NGA and the Federal Power Act ("FPA"), which would require a complex legislative effort. In the meantime, the Dodd-Frank Act, which was signed into law in July 2010, required that the CFTC and FERC enter into a revised memorandum of understanding ("Revised MOU") about information sharing by July 2011. Because of the Hunter appeal, the two agencies have yet to finalize the Revised MOU. In light of the D.C. Circuit's opinion, the Revised MOU may contain provisions about how FERC and the CFTC could work together in bringing similar, future cases.
That said, the facts in Hunter are unusually narrow in that Hunter and Amaranth only purchased financial instruments on futures and derivatives exchanges – i.e., they did not actually purchase contracts for physical oil, gas, or electricity. Current cases being pursued by FERC, which we will discuss in our next blog post, make clear that if a firm or entity makes actual purchases of oil, gas, or electricity products, in order to effectuate a scheme involving products in futures and/or derivatives, FERC will pursue the case. Further, we note that actual purchases and sales between trading and investment firms and direct energy producers or suppliers would likely enhance FERC's authority.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
