United States: FERC Staff's White Paper On Manipulation Provides Insights On Commission's Developing Manipulation Law

Last Updated: November 30 2016
Article by George D. Billinson, Mark R. Haskell, Thomas Reid Millar, Paul J. Pantano, Jr. and James A. Treanor

Most Read Contributor in United States, August 2018

Introduction

On November 17, 2016, the Office of Enforcement ("FERC Staff") of the Federal Energy Regulatory Commission (the "Commission" or "FERC") issued a White Paper on Anti-Market Manipulation Enforcement Efforts Ten Years After EPAct 2005 ("Manipulation White Paper") to "provide insight" on its ten years of experience investigating potentially manipulative conduct under the Anti-Manipulation Rule.1  During this period, FERC Staff has investigated over 100 matters, settled 24 proceedings resulting from those investigations, and pursued two matters in administrative proceedings.  In addition, FERC currently is litigating six penalty assessment orders in federal district courts.2  According to FERC Staff, through these investigations and proceedings, the Commission and the courts have "developed a body of law that, while still in its early stages and continuing to evolve, identifies and provides notice on specific types of conduct that can constitute market manipulation in the energy markets and factors that are indicative of such conduct."3  

In its Manipulation White Paper, FERC Staff largely restates its litigation positions – many of which currently are being challenged – and seeks to provide notice of: (1) factors that typically indicate manipulative conduct; (2) specific types of conduct that often constitute manipulation; (3) mitigating and aggravating factors affecting penalty amounts for manipulation violations; and (4) the types of investigations that it has closed without further action.

FERC Staff first provides the following non-exhaustive list of key elements emerging from FERC's developing manipulation law:

  • Fraud is a question of fact;
  • Fraud includes open-market transactions (g., transactions executed with manipulative intent on exchanges or public trading platforms);
  • Fraud is not limited to violations of a tariff or other express rule;
  • A manipulation violation does not require a showing that the manipulative conduct resulted in artificial prices;
  • The Anti-Manipulation Rule includes attempted fraud;
  • Manipulative intent, even where it is combined with a legitimate purpose, establishes the scienter element of the Anti-Manipulation Rule;
  • Pursuant to its "in connection with" jurisdiction, the Commission has jurisdiction over conduct that affects jurisdictional transactions, including the "rates, terms, and conditions of service in a market"; and
  • Individuals constitute "entities" and, as such, are subject to the Anti-Manipulation Rule.4

Indicia of Fraud

Identifying what it characterizes as typical indicia of fraud, FERC Staff explains that the distinction between fraudulent and lawful market behavior can hinge on the underlying purpose of the behavior.5  For example, in three orders relating to Up-To Congestion ("UTC") trades, the Commission compared the purpose of UTC trading against the purpose behind respondents' UTC trades and determined that their trades "were neither consistent with how the UTC product historically traded nor aligned with the arbitrage purpose of those trades."6  The Manipulation White Paper does not identify where market participants should look to understand what Staff will view as "the purpose" of particular products like UTCs.  Staff emphasizes, however, that the purpose driving a market participant's behavior in the market is a "critical factor" in a manipulation determination.  FERC Staff recommends, therefore, that companies require employees to document the purpose behind conduct likely to raise red flags.7  In the right circumstances, market participants should also consider documenting their understanding of the purpose of the relevant products and why their trading aligns with those purposes.

Uneconomic market conduct is another of Staff's indicia of manipulation and occurs where "an entity knowingly engages in behavior that loses money . . . or is indifferent to whether it loses money – but engages in the behavior anyway to serve an ulterior purpose."8  Profitability is a relevant factor in a manipulation determination, but, standing alone, it is "neither necessary nor dispositive."9 To avoid fraudulent conduct, FERC Staff recommends that compliance units should monitor whether traders are incurring persistent losses in a price-setting product to benefit a related position.10  Staff, however, does not provide guidance about what it would consider to be "persistent losses."

FERC Staff also reiterates the Commission's repeated emphasis that trading should be guided by supply and demand fundamentals, rather than "ancillary considerations that bear no relation to underlying market fundamentals."11  It further explains that arbitrage, for example "should be aimed at anticipated prices of underlying products based on trading acumen and market fundamentals, not at market rules that can be exploited to profit with little to no risk."12

Types of Market Manipulation

FERC Staff provides guidance on three types of conduct that it says constitute manipulation, but notes that companies can "consult" with FERC Staff before engaging in conduct that could be construed as manipulative.  Staff acknowledges that it cannot provide formal, binding decisions, but it does state that it can informally express its views, including with regard to analysis of potentially relevant factors.13  It is unclear whether non-binding guidance from FERC Staff has much practical value.  First, Staff did not indicate how quickly it would provide guidance.  The timeline within which trading decisions must be made before they are moot typically is very brief.  Second, the informal opinion of one or two Staff members is not binding on the Office of Enforcement or the Commission.  Third, it may be difficult to ensure in tight time constraints that you have provided Staff with all of the material facts, many of which are not available to market participants (e.g., ISO dispatch algorithms) related to a proposed strategy.  Nevertheless, one potential benefit to seeking guidance from Staff is that disclosure makes it difficult for Staff to claim later that a market participant was acting with fraudulent intent.

The first example of a manipulative scheme provided by Staff involves "cross-market" manipulation—trading in one market intentionally to move prices in a direction that will benefit positions in a related market.  Staff explains that in past cross-market manipulation cases, companies' conduct exhibited the following warning signs:  (1) holding large market shares in price-setting instruments; (2) physically trading in a direction that benefited positions in a related market; (3) holding benefiting positions with exposure to related physical trading; (4) entering into large volumes of physical trades without amassing a large net position; and (5) incurring consistent losses, or exhibiting indifference to price, in physical trading.14

Staff's second example, gaming market rules, constitutes "effectively riskless transactions executed for the purpose of receiving a collateral benefit; conduct that is inconsistent or interferes with a market design function; and conduct that takes unfair advantage of market rules to the detriment of other market participants and market efficiency."15  In the UTC enforcement actions previously discussed, the Commission concluded that UTC transactions were deceptive because they created the false appearance of being placed for arbitraging price spreads – the asserted purpose of PJM's market design – but the "sole or primary purpose" of the respondents in those actions was instead to collect credit payments that PJM provided to transmission customers.16

Staff's third and final example discusses misrepresentations or omissions of material fact that fall within the conduct prohibited by the Anti-Manipulation Rule.  In Maxim Power, for example, the Commission found that the company made misrepresentations through its energy offers and statements to the independent market monitor that its generator ran on high-priced fuel – entitling it to larger payments from the independent system operator– when it was actually burning cheaper natural gas.17  These violations also fell within the ambit of 18 C.F.R. 35.41(b), the Commission's candor rule.

Mitigating and Aggravating Factors Relevant to Market Manipulation

FERC Staff explains that the Commission has articulated a variety of mitigating and aggravating factors that affect penalties for manipulation violations, and that "are relevant to the Commission's statutory mandate to consider the seriousness of violations and efforts to remedy them."18  These factors include a company's:  (1) commitment to compliance; (2) self-reporting; (3) history of prior violations; (4) involvement of senior-level employees; (5) obstructionist conduct; and (6) acceptance of responsibility.

FERC Staff claims that "[a]chieving compliance, not assessing penalties, is the central goal of the Commission's enforcement efforts."19  As a result, it states, companies may receive up to a three-point credit for effective compliance programs, which reduces their culpability score for purposes of a penalty calculation.  FERC Staff emphasizes that, standing alone, this compliance credit can reduce a penalty by 60 percent and, combined with other factors, potentially eliminate civil penalties.  For example, the Commission found in Direct Energy that a company engaged in cross-market manipulation, but assessed a civil penalty of only $20,000 to reflect the company's "robust" compliance program.20  Staff touts Direct Energy's compliance program as a model for others to emulate.  FERC Staff explains that Direct Energy independently detected the violation through two means and took reasonable steps to self-report the trading, investigate, and discipline the traders involved. 

FERC Staff cautions that while adequate compliance can lead to a reduced penalty, failure to comply adequately can increase a penalty and even justify a departure above the applicable Penalty Guidelines range.  To ensure effective compliance programs, FERC Staff recommends:  (1) creating standards and procedures to avoid and detect violations; (2) responding appropriately after a violation has occurred; and (3) regularly evaluating a compliance program's effectiveness.21  Staff describes how, in Direct Energy, the company's compliance entailed "more than just a written document" – instead, it "was a program, supported and followed at all levels of the organization, that worked in practice to detect, cease, and respond to violations quickly and effectively."22

FERC Staff stresses the importance of prompt self-reporting, but does not define what constitutes promptness.  It explains that the Commission "place[s] great importance on self-reporting" because of the "significant value [it adds] to overall industry compliance."23  The Commission provides a two-point self-reporting credit for disclosures that are made before the immediate threat of disclosure or government investigation or within a reasonably prompt time frame after discovering the violation.  Again citing the Direct Energy case as a model, FERC Staff describes how the company verbally reported the conduct "very soon after" discovering it, proposed to FERC Staff that the company conduct an internal investigation, submitted a written self-report, regularly updated FERC Staff on its internal investigation, met with FERC Staff to describe the results of the internal investigation, and submitted another written self-report that reflected the results of its completed investigation.24

Cautioning against a delay in self-reporting, FERC Staff advises that prompt self-reports enable FERC Staff to guide reporting entities on potential factors to consider in internal investigations.  Conversely, delaying a self-report for too long risks forfeiting the full self-reporting credit.  In addition, Staff asserts that submitting a self-report does not mean that FERC Staff necessarily will initiate an investigation, nor does it constitute an admission of a violation.25 

On the topic of cooperation, which can result in a one-point credit, FERC Staff advises that cooperation must be "timely and thorough" – commencing once a company is notified about an investigation and disclosing information that enables the Commission to identify the nature and extent of the violation as well as the responsible individuals.  FERC Staff also describes how, in City Power, the Commission denied credit for cooperation and instead increased the company's penalty because the company made "very serious" and "obstructionist" intentional misrepresentations to FERC Staff about whether relevant instant messages existed that "waste[d] valuable time and resources."26

Staff Decisions to Close Investigations

Finally, FERC Staff explains that its Annual Reports on Enforcement, including its recently-released 2016 Report on Enforcement,27 provide "illustrative examples" of manipulation cases that were closed without further action, as well as the reasons for closing them.  Staff cites, for example, to one closed investigation of potential cross-market manipulation where the trader provided a "credible, legitimate explanation" for his decision to enter into virtual trades.  In support of his explanation, the company produced an email that the trader sent to his supervisor explaining that his virtual trades may have unexpectedly affected the company's financial transmission right position and that he would stop trading at the relevant nodes.  FERC Staff explains that it closed the investigation based upon: (1) a lack of sufficient evidence of manipulative intent; (2) the short duration of the trading; (3) the fact that the independent system operator could possibly recover the gains realized through the trades; and (4) the company's decision to implement additional protective measures to avoid further issues with virtual trading.28

Footnotes

1 Office of Enforcement White Paper on Anti-Market Manipulation Enforcement Efforts Ten Years After EPAct 2005, Nov. 17, 2016), available here.  FERC Staff issued its Manipulation White Paper in conjunction with its Office of Enforcement White Paper on Effective Energy Trading Compliance Practices (Nov. 17, 2016) ("Compliance White Paper"), available here.  We summarized this Compliance White Paper in a Clients & Friends Memo published on November 21, 2016 and available here.  In January 2006 and pursuant to EPAct 2005, the Commission promulgated the Anti-Manipulation Rule in Order No. 670, which prohibits an entity from "(1) using a fraudulent device, scheme, or artifice, making a material misrepresentation or omission, or engaging in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any entity; (2) with the requisite scienter; (3) in connection with the purchase or sale of natural gas or electric energy (or the transportation or transmission of such) subject to the jurisdiction of the Commission."  Prohibition of Energy Market Manipulation, Order No. 670, FERC Stats. & Regs. ¶ 31,202, reh'g denied, 114 FERC ¶ 61,300 at P 49 (2006); see also 18 C.F.R. Part 1c (2016).

2 Manipulation White Paper at 3-4.  Appendix A to the Manipulation White Paper provides a complete list of these proceedings.

3 Id. at 4.

4 Id. at 8-10.

5 FERC Staff cites to, among other FERC decisions and federal cases, a federal case involving the Securities and Exchange Commission and holding that conduct may be manipulative "solely because of the actor's purpose."  Markowski v. SEC, 274 F.3d 525, 529 (D.C. Cir. 2001).

6 Coaltrain Energy L.P., 155 FERC ¶ 61,204 at PP 166,191 (2016); City Power Mktg., LLC, 152 FERC ¶ 61,012 at P 103 (2015); Houlian Chen, 151 FERC ¶ 61,179 at P 80 (2015). 

7 This recommendation is discussed in more detail in our Clients & Friends memo analyzing the Compliance White Paper.    

8 Manipulation White Paper at 13.

9 Id. at 13 (quoting Barclays Bank PLC, 144 FERC ¶ 61,041 at P 43 (2013)).

10 Id. at 14.

11 Id. at 15.

12 Id. at 15.

13 Id. at 17-18, n. 60.

14 Id. at 19.

15 Id. at 25-26.

16 Id. at 28.

17 Id. at 31 (citing Maxim Power Corp., 151 FERC ¶ 61,094 at PP 3-4 (2015)).

18 Id. at 33.  See, e.g., Enforcement of Statutes, Orders, Rules, and Regulations, 113 FERC ¶ 61,068 at PP 21-27 (2005) (2005 Policy Statement on Enforcement); Enforcement of Statutes, Regulations, and Orders, 123 FERC ¶ 61,156 at PP 55-71 (2008) (Revised Policy Statement on Enforcement); Compliance with Statutes, Regulations, and Orders, 125 FERC ¶ 61,058 at PP13-21 (2008) (Policy Statement on Compliance); Enforcement of Statutes, Orders, Rules, and Regulations, 132 FERC ¶ 61,216 (2010) (Revised Policy Statement on Penalty Guidelines). 

19 Manipulation White Paper at 33 (quoting FERC Penalty Guidelines at § 1A1.1.2)).

20 Id. at 34 (citing Direct Energy Serv., Inc., 148 FERC ¶ 61,114 (2014)).

21 Id. at 34-35.

22 Id. at 35.  FERC Staff provides several examples of ineffective compliance programs, including in Deutsche Bank, where the company's compliance handbook described the type of trading at issue but management failed to review the trading.  Deutsche Bank Energy Trading, LLC, 142 FERC ¶ 61,056 at P 25 (2013).

23 Id. at 35 (quoting Revised Policy Statement on Penalty Guidelines, 132 FERC ¶ 61,216 at P 141).

24 Id. at 36.

25 Id. at 36-37.

26 Id. at 37-38, n. 174 (citing City Power, 152 FERC ¶ 61,012 at PP 241-47)).

27 See FERC Office of Enforcement, 2016 Report on Enforcement, Docket No. AD07-13-010, at 31-32 (2016), available here.

28 Manipulation White Paper at 39-40.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

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.

By clicking Register you state you have read and agree to our Terms and Conditions