FERC Enforcement Chief Norman Bay Testifies Regarding FERC’s Energy Market Oversight and Enforcement Authority and Approach

On January 15, 2014, Norman C. Bay, Director of the Office of Enforcement (OE) of the Federal Energy Regulatory Commission (FERC), testified before the U.S. Senate Banking, Housing, and Urban Affairs Subcommittee on Financial Institutions and Consumer Protection regarding FERC’s efforts to detect, investigate, and, as necessary, prosecute fraud and manipulation in FERC-regulated energy markets.  Mr. Bay faced relatively light questioning from the Subcommittee compared to his co-panelists, with most of the questions directed to him focusing on financial information sharing between FERC and the Commodity Futures Trading Commission (CFTC), whose Vincent A. McGonagle, Director of the Division of Market Oversight, also was a witness.  Mr. Bay’s prepared testimony is available here and a webcast of the hearing is available here.

Overview

In his prepared and live testimony, Mr. Bay summarized FERC’s broad statutory authority to protect consumers from fraud in or manipulation of FERC-regulated electricity and natural gas markets.  FERC’s authority arose from Energy Policy Act of 2005 (EPAct 2005) revisions to the Federal Power Act and Natural Gas Act.  EPAct 2005 also enhanced FERC’s civil penalty authority from $10,000 per day per violation to $1 million per day per violation for violations including fraud and manipulation.  These tools, Mr. Bay noted, are “critical to FERC’s efforts to protect consumers from market manipulation.”  Using its enhanced authority, FERC has imposed and collected approximately $873 million in penalties and disgorgement (excluding penalties levied in recent cases still to be reviewed in federal court, such as the Barclays Bank PLC case we addressed here).

Mr. Bay also addressed:  (1) FERC’s current capability to detect and investigate violations of and, if necessary, enforce EPAct 2005’s anti-fraud and manipulation rules; (2) the basic mechanics of common manipulative conduct; (3) obstacles to FERC’s anti-fraud and manipulation oversight, focusing on the longstanding issues of financial information sharing and enforcement jurisdiction between CFTC and FERC; (4) market risks and consequences of financial institutions’ involvement in FERC-regulated markets; (5) emerging trends associated with financial institutions’ energy market operations; and (6) FERC’s coordination with other regulators with regard to enforcement matters.

Assessment of FERC’s Current Capabilities

Mr. Bay noted that EPAct 2005’s anti-fraud and market manipulation provisions and enhanced civil penalty authority, FERC’s implementing regulations, and OE’s enhanced surveillance and investigative capabilities—in particular the 2012 addition of the Division of Analytics and Surveillance—and the expanded and strengthened Division of Investigations, provide FERC with the tools necessary to effectively police its jurisdictional markets.  However, Mr. Bay noted that FERC continually seeks to upgrade its capabilities to best protect the public interest.

Mechanics of Common Manipulative Conduct

Mr. Bay summarized the basic mechanics of common market manipulation schemes, which, especially for financial institutions, frequently involve the fundamental interrelationship of physical and financial energy markets.  Using a “tool” and “target” framework, Mr. Bay explained that manipulation often involves conduct in a physical market (the “tool”) designed to raise or lower prices in that market for the purpose of improving a “benefitting position” in a related physical or financial market (the “target,” which sometimes is not FERC-jurisdictional).

Critical to FERC’s analysis, Mr. Bay emphasized, is intent, because finding a violation generally requires that the “manipulator intended (or in some cases, acted recklessly) to move prices or otherwise distort the proper functioning” of the relevant market(s).  Importantly, trading to “hedge risk or speculate based on market fundamentals,” absent manipulative intent, does not violate the anti-fraud or manipulation rules.  To illustrate the “tool” and “target” framework and a deviation from it, Mr. Bay summarized the conduct at issue in FERC’s recent enforcement cases against Deutsche Bank Energy Trading, LLC, Barclays Bank PLC, et al., and JP Morgan Ventures Energy Corporation.

Obstacles to Effective FERC Market Oversight

Mr. Bay identified two specific limitations to FERC’s market oversight efforts:  (1) limited access to certain financial data, including data regarding CFTC-jurisdictional financial markets, which “creates a gap in [FERC’s] ability to conduct effective and comprehensive surveillance” of natural gas and power markets; and (2) the decision in Hunter v. FERC, 711 F.3d 155 (D.C. Cir. 2013), which we discussed here, in which the United States Court of Appeals for the D.C. Circuit ruled that “the CFTC’s exclusive jurisdiction over futures contracts deprives FERC of authority to bring an action based on manipulation in the futures market, even if the activity affected prices in the physical markets for which FERC has exclusive jurisdiction.”

While Mr. Bay characterized the CFTC’s reluctance to provide access to certain financial information as an obstacle, he described the recent FERC/CFTC Memorandum of Understanding (MOU) on information sharing, which we covered here, as “a first step toward sharing appropriate data in a timely manner.”  Senator Elizabeth Warren (D-Mass.), emphasizing that “market manipulators don’t respect jurisdictional boundaries” and “try to exploit those boundaries and take advantage of gaps in oversight and data-sharing,” pressed Mr. McGonagle on the CFTC’s reluctance to share certain financial information, including its Large Trader Report, which “identifies individuals and institutions that have made large transactions in the futures market,” with FERC.  Mr. McGonagle indicated that the CFTC has made the Large Trader Report data “[f]ully available” to FERC staff on site at the CFTC while the agencies work out the CFTC’s confidentiality concerns related to transferring such data into FERC’s custody.  Mr. Bay acknowledged this access as “a step forward” and noted his hope that the CFTC ultimately will provide an “ongoing live data stream of the relevant financial data for the gas and power markets from the Large Trader Report.”  Senator Warren called that step “absolutely critical” to protecting consumers.  Senator Warren also indicated that she would follow up on the information sharing matter, but hoped inter-agency resolution of the issue would make doing so unnecessary.

With regard to the jurisdictional issue addressed in Hunter, Mr. Bay noted that “a legislative fix to eliminate uncertainty on this matter could ensure that FERC has the full authority needed to police manipulation of wholesale physical natural gas and electric markets.”  In early January, FERC and the CFTC entered into another MOU on jurisdiction, but, as we noted here, that MOU falls short of resolving the issue.

Risks and Consequences of Financial Institutions’ Involvement in Energy Markets

Mr. Bay noted that FERC—as could be expected—does not take a position on the participation in FERC-regulated markets of financial institutions versus other companies, but recognizes that all market participants can provide benefits to markets.  Mr. Bay made clear, however, that FERC does expect financial institutions, like other jurisdictional entities, to have robust compliance programs, follow market rules, cooperate with grid operators and FERC, and self-report potential violations.  Mr. Bay cautioned that, while there is no written FERC guidance specific to financial institutions’ involvement in FERC-jurisdictional markets, such entities should be aware that the rules applicable to traditional energy companies in FERC-regulated markets “apply equally to financial institutions.”

Trends Related to Financial Institutions’ Involvement in Energy Markets

Mr. Bay noted that banks and financial holding companies historically have participated in physical wholesale electric markets and owned interests in physical assets (e.g., generators and pipelines), though their role is comparatively small compared to more traditional energy companies.  Despite their “relatively lower percentage of sales and generation ownership interest,” however, “they may retain the ability to move prices in a manipulative manner.”  With regard to what some perceive as recent rapid growth in enforcement actions against financial institutions, Mr. Bay noted that some recent cases took years to develop and that FERC is now better able to detect, investigate, and, if necessary, seek sanctions for unlawful conduct.  Any “trend,” he reasons, could “be as much a product of [FERC’s] enhanced detection and enforcement abilities . . . rather than any uptick in manipulative conduct.”

Coordination with Other Regulators

Finally, with regard to coordination with other regulators, Mr. Bay noted that FERC has cooperated or shared information related to investigations with the Department of Justice and various U.S. Attorney’s Offices, the CFTC, the Securities and Exchange Commission, the Federal Trade Commission, the Federal Reserve, and the Environmental Protection Agency, as well as international regulators.

Takeaways

As noted, Mr. Bay provided several examples of the types of conduct that FERC watches for in regulated markets, and made clear that FERC’s focus is on conduct that is intentionally (or, in some cases recklessly) fraudulent or manipulative.  Financial institutions that participate in FERC-regulated markets need to understand the mechanics of the conduct that FERC might consider fraudulent or manipulative to avoid such conduct or self-report it when it occurs.

In addition, all participants in FERC-regulated markets must proceed with the understanding that FERC is now better equipped than ever before to detect, investigate, and enforce prohibitions against fraud and manipulation.  All regulated entities must be vigilant in ensuring that their conduct, especially where it involves interactions between physical and financial markets, does not violate those anti-fraud and manipulation prohibitions.

Finally, financial institutions that participate in FERC-jurisdictional markets need to develop and implement, if they have not already done so, robust FERC compliance programs that, among other things, ensure adequate training of employees relative to their responsibility, foster a firm-wide culture of compliance, and include effective internal and external reporting mechanisms.  As illustrated by the recent uptick in major FERC enforcement actions, civil penalties, and disgorgement remedies (whatever the underlying cause(s) might be), the cost of non-compliance can be substantial.

 

Topics:  CFTC, Compliance, Energy, Enforcement Actions, FERC, Fraud

Published In: Business Torts Updates, Consumer Protection Updates, Energy & Utilities Updates, Finance & Banking Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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