Nation's Top Energy Regulator Keeping a Close Eye on Wall Street

Just as the Commodity Futures Trading Commission evolved from its position as a niche regulator to one of the financial systems' more important agencies in recent years, the Federal Energy Regulatory Commission is also looking to raise its profile, and it's doing so with big fines, big targets, and big controversy.

The complexity of the energy markets has made its expanded world view a necessity, FERC officials say. Nevertheless, its creep into the world of commodities regulation has angered critics who complain of burdensome, duplicative regulatory regimes.

It has also sparked a turf war between the CFTC and FERC, as increasingly complex securities and hedges involving electricity, natural gas, and other energy commodities are cropping up and banks get more involved in the energy industry.

The two agencies have recently hammered out some of these differences and agreed on how to cooperate on regulating the overlap between energy and financial products. Now banks and energy companies are wondering if the greater cooperation will resolve industry concerns, or make matters worse.

FERC's traditional responsibility has been to oversee pricing in the natural gas and electricity markets. More recently, though, it has pursued cases of market manipulation that often involve securitization of energy assets leading it into traditional CFTC territory—the swaps market—in pursuit of large banks, including Barclays, JPMorgan Chase, and Deutsche Bank.  

At issue is the connection between physical natural gas and electricity transactions, the prices they set, and financial products—swaps and hedges—that rise or fall with the value of those commodities. A large bank, mutual fund, or hedge fund with a vested interest of both physical trading and hedges could manipulate one side of the equation to produce profits.

“One of the best ways for a regulator to become more visible is stepping up enforcement,” says Felix Shipkevich, a specialist in CFTC regulation and principal at law firm Shipkevich. “We are going to see FERC stepping up its enforcement powers to be a little more feared, not only in the energy community, but in other financial communities as well.”

The agency has also flexed its muscle more in the energy industry with increased fines and more enforcement actions. “I think the energy industry looks at FERC enforcement very seriously and with concern that they are becoming more aggressive,” says Charles Mills, a partner with K&L Gates who specializes in derivatives. “Enforcement isn't going to winnow away, it is going to be as robust as ever.”

Law firm Morrison & Foerster recently warned clients about the stepped-up enforcement of energy market manipulation by energy companies and banks by the CFTC and FERC. “These regulatory enforcers are investigating and bringing the types of ground-breaking enforcement actions traditionally associated with the Securities and Exchange Commission and the Justice Department,” it said.

In 2013, FERC's Division of Investigations secured more than $304 million in civil penalties and $141 million in disgorgement, including a $285 million penalty against JPMorgan, dwarfing the roughly $37 million in civil penalties the agency averaged in fiscal years 2007 through 2011. 2014 is set to surpass last year's record, especially if its largest civil penalty ever issued, $435 million against Barclays, is approved.

The record-setting year is the culmination of efforts that began in 2005. Reacting to the Enron scandal and power outages that plagued the West Coast a few years earlier, Congress gave FERC a bigger stick. The Energy Policy Act, aimed at preventing market manipulation and fraud in wholesale power and gas markets, increased FERC's civil penalties to $1 million per violation per day; criminal fines could hit $1 million per violation with a prison term of up to five years. The agency also has authority to seek those penalties against any entity that commits fraud or makes a material misrepresentation to a FERC order, rule, or regulation.

“We are going to see FERC stepping up its enforcement powers to be a little more feared, not only in the energy community, but in other financial communities as well.”

—Felix Shipkevich,

Principal,

Shipkevich Attorneys at Law

“They now have authority to go after companies and, in certain cases, individuals, who make false statements to the agencies," says Robert Fleishman, a lawyer at Morrison & Foerster who previously served in FERC's Enforcement Division from 1982 to 1985. “If you are not prepared to give complete and truthful answers, be aware that there is some exposure and risk, even if the statements are not under oath, for an enforcement action.”

The next piece came in February 2012, when FERC created the Division of Analytics and Surveillance to support its investigatory efforts. Its diverse staff of 45 includes economists, energy industry, analysts, and former traders, and former risk managers. It uses a variety of high-tech tools to detect abnormal trading.

Cutting a Deal With the CFTC

FERC officials have long complained that the CFTC was reticent to share its own data and insight into the swaps market. Although former officials at both agencies insist the two Commissions have long had a cordial and productive relationship, the impasse over information sharing rose to the Congressional level, when legislators demanded, through the Dodd-Frank Act, that they hammer out data squabbles and jurisdictional disputes through a memorandum of understanding.

That agreement was signed in January and the initial transmission of market data was announced on March 5. Also announced, as part of that new spirit of cooperation, was the creation of a staff-level Interagency Surveillance and Data Analytics Working Group, which will coordinate information sharing between the Commissions and focus on data security, data sharing infrastructure, and the use of analytical tools for their regulatory purposes.

The announcements “represent a milestone in inter-agency market oversight and will better ensure the integrity of the energy markets,” CFTC Acting Chairman Mark Wetjen said in a statement.

FERC ENFORCEMENT ACTIVITY

The following are notable enforcement cases by the Federal Energy Regulatory Commission, as compiled by the Law Firm Morrison and Foerster.

MN-JPMorgan Ventures Energy Corp.

In response to allegations it engaged in manipulative bidding strategies JPMVEC, in July 2013, paid $285 million in civil penalties, and $125 million in disgorgement. It also agreed to assess its U.S. power compliance policies and submit annual compliance reports for three years.

Barclays Bank

In July 2013, FERC issued an order to show cause and notice of proposed penalty to Barclays and individual traders. It alleged that Barclays and the traders violated the anti-manipulation/fraud rule by engaging in uneconomic trading of next-day, fixed-price physical electricity on the IntercontinentalExchange with the intent to benefit financial swap positions at Western U.S. hubs

The order assessed civil penalties of $435 million and disgorgement of $34.9 million against Barclays and $18 million in civil penalties against the traders. Barclays and the traders elected to challenge the order and penalties in federal court.

Deutsche Bank Energy Trading

The bank's trading unit allegedly manipulated the electricity market by trading in exports with the intent to alter congestion for its financial benefit. FERC imposed civil penalties of $1.5 million, disgorgement of $172,000, adoption of compliance measures, and semi-annual monitoring reports.

Louis Dreyfus Energy Services

FERC alleged Louis Dreyfus manipulated the market by engaging in uneconomic virtual trades to benefit its financial transmission rights positions. In a February 2014 settlement, the company agreed to a $4.1 million civil penalty and $3.3 million in disgorgement. The settlement further requires semi-annual compliance reports until 2016 and compliance safeguards for virtual trading.

BP America

In August 2013, FERC issued an order alleging that multiple BP entities violated the anti-manipulation/fraud rule.

The order questions certain trading by BP of next-day, fixed-price natural gas at the Houston Ship Channel (HSC) that FERC found uneconomic and part of a manipulative scheme to increase the value of BP's financial position based on HSC natural gas prices.

FERC proposes that BP pay a $28 million civil penalty and disgorge $800,000. In October, BP filed an answer denying the allegations and asking FERC to dismiss the proceeding.

Lincoln Paper and Tissue

In August 2013, FERC assessed penalties totaling $5.4 million, $7.7 million, and $1.3 million against Lincoln, Competitive Energy Services, and CES' managing partner, Richard Silkman, respectively, for alleged schemes to collect demand response payments without actually reducing electricity consumption.

In December, FERC petitioned a federal court to affirm the penalties and all parties denied wrongdoing in a February 2014 response. The agency also accused Rumford Paper Company of similar conduct, but Rumford settled with the agency for $3 million.

Source: Morrison Foerster.

The MOU is “a sign that enforcement will be more efficient and possibly more informed,” says Linda Walsh, a partner at the law firm Hunton and Williams, and a former trial attorney for FERC. It “makes the efforts on the agencies' part stronger, more focused, and more worrisome to entities that are in their markets.”

“FERC could see trading activity in the markets it regulates without knowing whether or not the market participant has a financial position in a product it does not regulate,” says Joseph Williams, special counsel for the law firm Cadwalader, Wickersham & Taft who represents clients in both FERC and CFTC investigations. “If FERC thinks you are manipulating prices to benefit a financial position, it can now go to the CFTC and ask for information about that swap.”

“They are hungry for data,” Williams adds. “FERC would like to see more of it, and more of it faster”

Ironing out differences between the CFTC and FERC continues to be complicated by legal challenges, however. Judicial disputes could have a chilling effect on its enforcement ambitions.

A Question of Jurisdiction

FERC's move onto the financial services beat isn't entirely new. In 2007, the agency fined Brian Hunter, a natural gas trader, and his hedge fund, Amaranth Advisors, $30 million for allegedly manipulating natural gas prices. In March 2013, Hunter won an appeal of that fine on the grounds that the futures contracts in question falls within the CFTC's jurisdiction and FERC lacked the authority to issue the fine.

“The Hunter case was a significant decision, essentially limiting the types of actions that FERC has been pursuing,” Walsh says. “It, along with the MOU, will certainly govern how both agencies move forward. I don't think FERC, or any other government agency, wants to get to a point where the court tells them, ‘Sorry, but you don't have jurisdiction,' after spending a lot of time and resources pursuing a matter.”

The Hunter v. FERC decision has also led many, including Norman Bay, director of FERC's office of Enforcement and current nominee to head the agency, to seek Congressional action. Testifying before a Senate banking sub-committee he urged legislative clarity on how the two regulators should either divide their jurisdictions or more definitively work together.

Another setback for FERC enforcement comes from a U.S. District Court decision to halt, at least for now, a $488 million fine against Barclays for allegedly manipulating commodity futures contracts. FERC says traders controlled trades on contracts to deliver physical electricity in an effort to benefit the bank's financial swaps. The bank's defense, echoing the Hunter decision, is that FERC improperly encroached upon the purview of the CFTC.

Despite these controversies, it isn't a given that Congress will tinker with the existing regulatory mix very much, Williams says. “Policymakers like to see two, or multiple, cops on the beat,” he says. “People who defend these actions are frustrated when you have two agencies or more, but policymakers like it. If one doesn't do the trick, maybe the second one will.”