United States: Avoiding The ‘Al Capone’ Trap: The Dangers Of Supplying Inaccurate Information To FERC

Last Updated: May 28 2014
Article by Gregory K. Lawrence and Thomas A. Kuczajda

Most Read Contributor in United States, October 2018

One of the primary objectives of the Federal Energy Regulatory Commission's Enforcement division is to prevent, or at least punish, manipulation of the energy markets. But market participants and practitioners should be just as leary of accidentally tripping over the seemingly simple rule against providing inaccurate information to FERC as they are of intentionally committing systemic fraud. A bit like Al Capone's tax infractions relative to his suspected greater misdeeds, allegations that a market participant made an inaccurate statement to FERC is a tempting piece of low-hanging fruit for FERC Enforcement when manipulation claims may be difficult to prove. Below, we outline FERC's increasing willingness to pursue allegedly inaccurate statements made to FERC or FERC Staff, and practical considerations for how best to protect against such claims.1

I. If Proving Manipulation Is Too Difficult, Include an Additional Offense

FERC Enforcement investigations are in high gear as the agency continues to move to establish itself as a credible antifraud enforcer. Without the long history of enforcement of its brethren at the Department of Justice, Securities and Exchange Commission, and Commodities and Futures Trading Commission, FERC seems to be playing an aggressive game; and arguably its most prominent weapon are the anti-manipulation rules covering electricity and natural gas markets.2 Several settlements involving electricity manipulation allegations have given FERC the benefit of some arguably good press, and at least a few pending manipulation matters present the possibility of litigation in the near future – though only regarding conduct that occurred several years ago.3 FERC, however, has yet to litigate to conclusion any alleged electricity manipulation cases. Meanwhile, the DC Circuit recently slapped down FERC's claim that it had jurisdiction over allegations of manipulation of natural gas futures that occurred over six years ago.4

The resulting perception that energy manipulation claims are difficult and time-consuming to litigate and ultimately prove also happens to be the reality.5 Without an established, successful anti-manipulation litigation regime, FERC has shown itself willing to pursue other additional offenses. Section 35.41(b) of the Commission's rules6 – which prohibits making inaccurate statements to FERC – is most prominent among these additional allegations. In numerous cases, some briefly described below, FERC has either included or separately alleged violations of Rule 35.41(b) in the context of fraud and manipulation investigations. It is perhaps easy to see why: such claims appear much simpler for FERC to establish than a substantive fraud or manipulation claim, yet still carry potentially substantial penalties.7 An appreciation for the legal parameters of Rule 35.41(b), including its due diligence defense, and an understanding of how FERC has pursued alleged violations of the Rule, provide the necessary background for considering of how to avoid falling victim to those allegations.

II. Enron's Legacy: The Market Behavior Rule and Accurate Information

Among the impact that Enron's failure had on the energy markets was the regulatory and enforcement response designed to give FERC more authority and more options to prevent and punish wrongdoing. One piece of the regulatory overhaul included the adoption of Market Behavior Rule 3, later codified as Rule 35.41(b).8 That Rule provides: A Seller must provide accurate and factual information and not submit false or misleading information, or omit material information, in any communication with the Commission . . . unless Seller exercises due diligence to prevent such occurrences.9

Violations of the Rule can give rise to sanctions, including civil penalties under Section 316A of the Federal Power Act, and the suspension of market-based rate (MBR) authority under Section 206 of the FPA.10

FERC has applied Rule 35.41(b) in a wide variety of contexts, regardless of intent,11 and whether or not FERC or FERC Staff were actually misled. For example, FERC has:

  • Suspended MBR authority of a seller as a result of a misrepresentation in a discovery dispute, even though Staff was aware of the correct information (J.P. Morgan Ventures Energy Corp., Order Suspending MBR Authority, 141 FERC _ 61,131 (2012) ("JP Morgan"));
  • Ordered monetary penalties where entities misrepresented and omitted facts in the context of their respective MBR applications (see e.g. Vista Energy, 139 FERC _ 61,154 (2012); Moussa I. Kourouma, 135 FERC _ 61,245 (2011) ("Kourouma"));
  • Included violations of Rule 35.41(b) as part of a settlement of market manipulation allegations (Deutsche Bank Energy Trading, LLC, 142 FERC _ 61,056 (2013); Constellation Energy Commodities Group, Inc., 138 FERC _ 61,168 at P 2 (2012); Gila River Power, LLC, 141 FERC _ 61,136 (2012);
  • Approved a settlement including monetary penalty where seller that repeatedly misled Staff in connection with an investigation of the entity's bidding behavior in PJM (Edison Mission, 123 FERC _ 61,170 (2008)).

III. Basic Legal Standards under Rule 35.41(b)

A violation of Rule 35.41(b) occurs only where a seller submitted false or misleading information or omitted material information and failed to exercise due diligence to prevent such a submission or omission. Although "intent" or "scienter" are not required,12 inadvertent misstatements or omissions are not intended to be covered by the Rule.13

Notably, there is no materiality requirement with respect to affirmative misstatements. A seller arguably violates the Rule if a statement to FERC is factually inaccurate or untrue, regardless of the relative importance of the inaccuracy (though still subject to a due diligence defense).14 Unlike affirmative misstatements, however, omissions only violate the Rule if they are "material." Using securities law precedent as a guide, FERC assesses materiality based on whether there was a substantial likelihood that a reasonably prudent person would have viewed the omitted information as altering the total mix of information available.15

IV. Advice of Counsel and the Due Diligence Defense against Rule 35.41(b) Allegations

Rule 35.41(b) provides an explicit due diligence defense. "[T]he due diligence exception was added to the Commission's rules for the purpose of ensuring that inadvertent submissions are not sanctioned."16 The Commission has not outlined what specific efforts constitute due diligence,17 but has explained generally that it expects adequate processes designed to prevent inaccuracies and material omissions.18

[W]here the seller can demonstrate that it has implemented procedures reasonably designed to comply with our rules, we will treat that evidence as a rebuttable presumption that the seller did not engage in conduct prohibited by [Rule 35.41(b)]. . .. As such, we expect the seller submitting the information to have in place processes that assure the accuracy of the submitted information.19

The defense necessarily recognizes that an entity may make a misstatement or a material omission despite exercising adequate due diligence – i.e. if the defense is to have any meaning, a misstatement or material omission cannot be proof, alone, that diligence was lacking.

Importantly, reliance on advice of counsel may constitute a significant component of a due diligence defense. Proof of reliance on counsel is generally permitted to establish that a respondent acted with care.20 In particular, FERC Staff has explicitly recognized that reliance on counsel, as in the securities law context, can demonstrate good faith and due care.21

In practice, however, FERC has found that a blanket and generic assertion of reliance on counsel may not be sufficient to immunize a participant against a Rule 35.41(b) violation. Rather, FERC has suggested that the defense can be deemed adequate only if a participant can explain in detail the specific steps taken and processes in place used to ensure accuracy. In response to a Show Cause Order, JP Morgan argued that it did not violate Rule 35.41(b) because it observed adequate due diligence procedures by hiring experienced lawyers to handle its discovery issues with CAISO and FERC Enforcement.22 The Commission disagreed, stating that, "[c]ontrary to JP Morgan's assertions, its retainer of qualified attorneys does not constitute sufficient due diligence to exonerate JP Morgan's violations."23 The Commission noted further, that JP Morgan's response to the Show Cause Order lacked "any explanation or description of how its counsel performed due diligence to ensure that all statements it made to the Commission in those filings were accurate. Instead, JP Morgan's response suggests that reliance on counsels' memories was 'sufficient, if imperfect, due diligence."'24

It is critical, therefore, that market participants establish and maintain adequate processes to best ensure the accuracy of information submitted to FERC – whether in their day-to-day operations and regulatory setting, or in the context of ongoing FERC investigations or litigation with the agency. The inclusion of in-house and outside counsel as part of that process is prudent and likely necessary in most instances given the specialized nature of energy regulation. By seeking out well-informed advice from credible counsel as part of an established procedure for handling FERC-related communications, market participants can build protections against inadvertent misstatements or omissions under Rule 35.41(b), or unfair allegations of such violations. And, of course, by involving outside counsel, in-house principals are further removed from potential claims against them as individuals. A tree without low-hanging fruit is much harder to pluck.

V. Managing Potential Privilege Waiver Issues

Even when counsel is utilized as part of an effective diligence process, there is a potential serious rub: waiver of the privilege. Assertion of reliance on counsel may act as a waiver of any privilege relating to those specific communications at issue or as to the entire subject matter of those communications. Generally, a respondent cannot use attorney-client communications as a sword on one hand to defend against alleged violations, while using the attorney-client privilege as a shield to prevent disclosure of those communications to an adversary, like FERC.25 Participants, however, can mitigate the potential for waiver, and the potential impact of any waiver.

The inclusion of counsel, or mention of counsel's involvement, in the diligence process does not automatically result in waiver. In response to FERC concerns or allegations relating to a potential Rule 35.41(b) violation, a seller should not hesitate to highlight the fact that trustworthy and well-informed counsel was involved in evaluating or submitting the information at issue. Emphasizing counsel's involvement can impart much of the benefit of a more formal assertion of "reliance on counsel," without putting specific communications at issue and without the need to discuss specific legal advice.26 This result is obviously easier to accomplish when there is a robust and well-documented diligence process, in which legal advice and involvement of counsel play roles but are not the sole steps.

Circumstances may arise, however, where the specific advice of counsel is more pertinent to a due diligence defense. In such cases, handing over specific communications to FERC may be practically unavoidable to the extent a seller chooses to continue to present reliance on counsel as part of the defense. Several options exist that may limit such waiver or its impact.

  • First, FERC Staff may agree to review relevant attorney communications "in camera" without taking possession of the privileged materials, and with an understanding that the respondent does not intend to waive privilege. Doing so may permit FERC Staff to come to a reasonable conclusion about the validity of a due diligence defense while avoiding formal and physical production of privileged materials.
  • Second, the respondent can seek an explicit non-waiver agreement with FERC Staff. Under such an agreement, the parties would agree: to define narrowly the scope of any privileged information to be provided; that the production of any privileged information is not intended and will not act as a broad subject-matter waiver as to FERC; and that the production is not intended and will not act as a waiver for any privilege with respect to third parties. Although courts do not often enforce such non-waiver agreements as to third parties,27 protections against FERC's later attempts to pry open the privilege further, and at least the possibility of limiting third-party waiver, creates considerable incentives for sellers to try to reach agreement on these terms before handing over privileged information.

VI. A Word to the Wise: Avoiding the Al Capone Trap of Rule 35.41(b)

As the pressure for FERC Enforcement to continue to assert itself increases, so too will the pressure for FERC to pursue violations that it believes are easier to prove and that permit the agency to up the ante during negotiations regarding resolving pending investigations. While manipulation cases stand out as the white whale in FERC's hunting grounds, smart market participants will remain very cautious against other fish in FERC's Enforcement sea – Rule 35.41(b) violations. Market participants must be truthful. In addition to watching what they say to FERC, market participants in particular should consciously and explicitly follow well-documented diligence procedures in all communications with FERC and should utilize competent and well-informed in-house and outside counsel to protect their businesses and the individuals within them. When the time comes to defend against both "big" and "small" alleged violations, why tempt FERC with the low-hanging fruit of inaccurate and poorly diligenced statements? Al Capone did not worry much about his taxes, and look what happened to him.

Originally published by The Electricity Journal.


1. We focus here on the application of the rule to communications with FERC or its Staff, which includes Enforcement, the Division of Audits, and the new Division of Analytics and Surveillance, for example. The Rule also applies to communications with an ISO/RTO, its market monitors, and jurisdictional transmission providers.

2. 18 C.F.R. § 1c.1 and 1c.2 (2012); Prohibition of Energy Market Manipulation, Order No. 670, 114 FERC _ 61,047 (2006) (Order No. 670).

3. See e.g. J. Wellinghoff Statement (March 15, 2012) (at http://www.ferc.gov/media/statements-speeches/wellinghoff/2012/03-15-12-wellinghoff.asp) (announcing settlement of allegations of electricity market manipulation against Constellation Energy Commodities Group for conduct occurring in 2007 and 2008); FERC Approves Market Manipulation Settlement with Deutsche Bank (Jan. 22, 2013) (at http://www.ferc.gov/media/news-releases/2013/2013-1/01-22-13.asp); Order to Show Cause against Barclays Bank PLC and others, Docket No. IN08-8-000 (Oct. 31, 2012) (Enforcement Staff seeking nearly $490 million in penalties and disgorgement for alleged manipulation occurring from November 2006 to December 2008); FERC News Release, FERC, JP Morgan Unit Agree to $410 Million in Penalties, Disgorgement to Ratepayers (Jul. 30, 2013) (at http://www.ferc.gov/media/news-releases/2013/2013-3/07-30-13.asp) (announcing settlement of allegations of market manipulation stemming from bidding activities in electricity markets in California and the Midwest from Sept. 2010 through Nov. 2012).

4. Hunter v. FERC, 711 F.3d 155 (D.C. Cir. 2013).

5. See e.g. G. Lawrence and T. Healey, FERC Enforcement: The Pit and the Pendulum, ELEC. J., April 2013.

6. 18 C.F.R. § 35.41(b).

7. The ISOs and RTOs have similar provisions in their tariffs. The CFTC also has a similar rule prohibiting false statements, recently expanded by the Dodd-Frank Act, and has also not been shy to include allegations of its violation as an "add-on" charge to more serious fraud allegations. Prior to Dodd-Frank, CEA Section 6(c) prohibited the dissemination of false information to the Commission in registration applications or reports filed with the CFTC. The Dodd-Frank Act went further to forbid the dissemination of false information made in "any statement of material fact made to the Commission in any context." As a result, the CFTC has increased its prosecution of false statement actions in recent years. See e.g. CFTC v. Arista LLC, et al., No. 12- CV-9043 (S.D.N.Y. Jun. 4, 2013) (Amended Complaint) (adding allegations that the defendants misrepresented certain account balances, asset values, and fee calculations in a letter sent to the CFTC's Division of Enforcement, in violation of CEA Section 6(c)).

8. Rule 35.41(b) codified FERC's Market Behavior Rule 3, with no alteration. See Conditions for Public Utility Market-Based Rate Authorization Holders, Order No. 674, 114 FERC _ 61,163 (2006) (codifying Market Behavior Rule 3 in Part 35); Order Amending Market- Based Rate Tariffs and Authorizations, 105 FERC _ 61,218 (2003) (finalizing Market Behavior Rules).

9. A "Seller" includes "any person that . . . seeks authorization to engage in sales for resale of electric energy, capacity or ancillary services at market-based rates . . ." 18 C.F.R. § 35.36(a)(1).

10. 16 U.S.C. § 825o-1; 16 U.S.C. § 824e. "[T]he Commission has repeatedly emphasized that companies failing to adhere to the Commission's rules and regulations are subject to suspension or revocation of their market-based rate authority, in addition to the disgorgement of unjust profits and the assessment of civil penalties." J.P. Morgan Ventures Energy Corp., Order to Show Cause, 140 FERC _ 61,227 at 2 (2012) (citing, e.g., Enforcement of Statutes, and Regulations and Orders, 123 FERC _ 61,156, at P 49 (2008); Investigation of Terms and Conditions of Pub. Util. Market-Based Rate Authorizations, 114 FERC _ 61,165, at P 32 (2006); Investigation of Terms and Conditions of Pub. Util. Market-Based Rate Authorizations, 105 FERC _ 61,218 at PP 6, 146, 151).

11. Intent is not an element of Rule 35.41(b). See infra, discussing the due diligence defense.

12. "No showing of the respondent's intent or mindset is necessary in order to demonstrate that a violation of section 35.41(b) has occurred." J.P. Morgan Ventures Energy Corp., Order Suspending MBR Authority, 141 FERC _ 61,131 at P 45 (2012) ("JP Morgan"), 141 FERC _ 61,131 at P 45 (citing Kourouma, 135 FERC _ 61,245 at PP 20–22).

13. JP Morgan, Order Suspending MBR Authority, ("[T]he due diligence exception was added to the Commission's rules for the purpose of ensuring that inadvertent submissions are not sanctioned.") (citing Moussa I. Kourouma, 135 FERC _ 61,245 at P 21 (2011) ("Kourouma"); Market Behavior Rules Order, 105 FERC _ 61,218 at P 110). See infra, Section III.A.

14. See, e.g., JP Morgan, Order to Show Cause, 140 FERC _ 61,227 at P 3 (2012) (explaining that the Rule "only applies if a seller submits (i) 'false or misleading information' or (ii) if the seller 'omits material information"') (emphasis added); JP Morgan, Order Suspending MBR Authority, 141 FERC _ 61,131 at P 37 (examining whether or not misstatements were accurate, not whether they were material, and distinguishing material omissions from inaccurate statements in that regard: "filings with the Commission were not only inaccurate, but omitted material information"); see Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order on Rehearing, 107 FERC _ 61,175 at P 93 (2004) ("Market Behavior Rules Rehearing Order") (rejecting comments that suggested FERC revise the rule so that a violation would require a finding that "the information submitted be misleading on an issue that is material to the subject of the communication or submission and creates an artificial price").

15. See, e.g., Cobb Customer Requesters v. Cobb Electric Membership Corp., 136 FERC _ 61,084 at P 42 (2011) ("Guided by securities law precedent, a fact is considered material if there is a substantial likelihood that a reasonable market participant would consider it in making its decision to transact because the material fact significantly altered the total mix of information available.") (internal quotations and citations omitted). In practice, FERC has applied a "reasonably prudent person" standard in defining materiality. See Kourouma, 135 FERC _ 61,245 at P 35 (2011). FERC's application of Rule 35.41(b), however, suggests that the Commission will look at the relative importance of the omitted facts in the context of the particular statements at issue, even if not directly related to an MBR application or MBR eligibility. See, e.g., JP Morgan, Order Suspending Market-Based Rate Authority, 141 FERC _ 61,131 at PP 37–39, 56 (finding, in the context of a discovery dispute related to an underlying market manipulation investigation, that JP Morgan omitted material facts by failing to acknowledge that JP Morgan's counsel had been informed several times that FERC authorized the relevant market monitor to continue its investigation, and ordering a suspension of JP Morgan's MBR authority, without regard to the underlying manipulation investigation, because of "the fundamental role of honesty and candor in the Commission's market-based rate regime"). The Commission has also stated that "sellers [are] accorded a safe harbor under [Rule 35.41(b)] to allow for reasonable, unforeseen differences regarding the meaning of our [materiality] requirement as it may be applied, i.e., our rule will not be applied against a seller shown to have exercised due diligence." Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order on Rehearing, 107 FERC _ 61,175 at P 95 (2004).

16. JP Morgan, Order Suspending MBR Authority, 141 FERC _ 61,131 at P 45 (citing Kourouma, 135 FERC _ 61,245 at P 21; Market Behavior Rules Order, 105 FERC _ 61,218 at P 110).

17. FERC has adopted a case-by-case approach. See Market Behavior Rules Rehearing Order 107 FERC _ 61,175, Comm'n Brownell, Concurring, at P 1 ("The order appropriately rejects requests to provide specific guidance on the application of this due diligence defense. There is a wide range of factors relevant to establishing whether a seller has exercised due diligence in a particular case – the existence of procedures designed to prevent violations, the history of seller's enforcement of such procedures, and the pervasiveness of the violations, to name a few. Therefore, the development of precedent on this issue is best left to case-by-case adjudication.").

18. Although FERC has explicitly rejected claims of due diligence in some instances, to date FERC has not accepted any respondent's due diligence defense in any written order.

19. Market Behavior Rules Rehearing Order, 107 FERC _ 61,175, at P 67 and 110.

20. See e.g. United States v. Van Allen, 525 F.3d 814, 823 (7th Cir. 2008); United States v. Wenger, 427 F.3d 840, 853 (10th Cir. 2005); United States v. Taglione, 546 F.2d 194, 200 (5th Cir. 1977); Linden v. United States, 254. F.2d 560, 568 (4th Cir. 1958).

21. See Seminole Energy Services, LLC, Docket No. IN09-9-000 (Staff Report and Recommendation at 29), quoting United States v. Peterson, 101 F.3d 375, 381 (5th Cir. 1996), and citing favorably Howard v. SEC, 376 F.3d 1136, 1147-49 (D.C. Cir. 2004).

22. JP Morgan, Order Suspending Market-Based Rate Authority, 141 FERC _ 61,131 at P 27.

23. Id. at P 42.

24. Id. at P 43.

25. See e.g. SEC v. Lavin, 111 F.3d 921, 933 (D.C. Cir. 1997) (attorney-client privilege cannot be used "both as a sword and as a shield"); Ideal Electronic Security Co. v. International Fidelity Insurance Co., 129 F.3d 143, 151 (D.C. Cir. 1997) (waiver occurs where client "places otherwise privileged matters in controversy"); Elec. Workers Local No. 26 Pension Trust Fund v. Trust Fund Advisors, Inc., 266 F.R.D. 1, 12 (D.D.C. 2010) (asserting reliance on advice of counsel places attorney-client communications at issue).

26. See Southern Cal. Gas Co. v. Public Utilities Com., 50 Cal.3d 31 (Cal. 1990) (holding that respondent's indication that they had sought and received advice from counsel when evaluating the reasonableness of contract terms did not act as an implied waiver of the attorney-client privilege, because the defendant could establish its defense "without disclosing its actual legal advice").

27. Generally, disclosure to the government provides broad subject matter waiver as to third parties. See e.g. In re Subpoenas Duces Tecum, 738 F.2d 1367 (D.C. Cir. 1984) (disclosure of investigative report and lawyer notes to SEC waived privilege, making the documents available to plaintiff-shareholders in a subsequent civil action); Permian Corp. v. United States, 665 F.2d 1214 (D.C. Cir. 1981) (disclosure of documents to the SEC waived privilege, making the documents discoverable by the Department of Energy in an unrelated investigation). Although the existence of a non-waiver agreement may protect against broad third-party waiver, such agreements have not often operated to do so – especially in recent years. Compare e.g. Teachers Ins. and Annuity Ass'n of America v. Shamrock Broadcasting Co., Inc., 521 F.Supp. 638 (S.D.N.Y. 1981) (recognizing "selective waiver" of privileged materials to the government where "the right to assert the privilege in subsequent proceedings is specifically reserved at the time the disclosure is made"); with e.g. In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289 (6th Cir. 2002) (rejecting "selective waiver" of privilege and work product protections); In re Merck & Co., Inc. Sec., Deriv. & ERISA Litig., 2012 WL 4764589 (D.N.J. Oct. 5, 2012) (rejecting "selective waiver," and holding that voluntary production of privileged materials to government rendered the materials no longer privileged, and collecting cases).

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.

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Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

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