FERC Enforcement Update: February Starts With an Unusual “Smoking Gun” Settlement and Closer Scrutiny for Federal Power Act Compliance
FERC's Office of Enforcement continues to take an active role as the “cop on the beat,” policing the activities of energy companies subject to FERC regulation. In 2013, FERC announced it had entered into 19 settlements, assessing more than $304 million in civil penalties and disgorgement of almost $141 million.
We are apprising you of two recently announced FERC enforcement cases which we believe are significant and which you should be aware of.
The Louis Dreyfus Settlement
On February 7, FERC announced a $7.4 million settlement ($4 million civil penalty, $3.4 million disgorgement) with Louis Dreyfus Energy Services for market manipulation and a companion $310,000 civil penalty against one of its individual traders. The alleged violation was a “mixed product” trading scheme which was reported to FERC by the market monitor of the Midcontinent Independent System Operator. According to the FERC, Louis Dreyfus entered into virtual trades that lost money in order to benefit firm transmission rights positions.
What makes this case of special interest is the “smoking gun” that FERC relied on. The "smoking gun" was the doctoral dissertation of the trader involved. The trader, who was subjected to a $310,000 civil penalty, had outlined in his doctoral dissertation the relationship between FTRs and virtual trading, which FERC alleged was the playbook for the manipulative scheme. According to FERC, the trader wrote "[i]t is possible for an FTR holder with a relatively large amount of FTR to make extra profit by creating nonreal congestion or aggravating real congestion by submitting virtual transactions." Then, according to FERC, the trader’s thesis stated, "[f]or the FTR holder, bidding an appropriate amount of virtual transactions on the target congestion is risk-free because of the FTR position." FERC found that "[t]he FTR Group was aware that while virtual trading may not by itself yield any profits, congestion created or exacerbated through virtual trading could inflate the value of FTR positions to a degree that would more than offset low yields or losses that the virtual trading itself might incur -- i.e., the "risk free" trading strategy that [the trader] described in his dissertation."
As is typical in market manipulation cases, there were missed tell-tale signs of possible manipulation that should have resulted in the trades being investigated by those responsible for the company’s FERC compliance. First, the alleged manipulative trading activity differed significantly from prior periods. In addition, the FERC said the virtual trades lost money and likely could not pass the test for whether a trade should be further investigated. The question that should have been asked was: "but for trying to move another position would the company enter into the particular transaction?" If the answer to that question is no -- and FERC certainly thought that was the case here -- then a company should investigate further prior to entering into a trade.
In addition to the civil penalty assessed against Louis Dreyfus and its trader, FERC imposed compliance measures requiring the company to track virtual supply, virtual demand, and FTR trades in MISO, including (a) incorporating into its trading software a log for each virtual trade the FTR traders submit to MISO and the primary congestion that the FTR traders were attempting to capture with the trade and other reason for the trade, and (b) a computer system with software that automatically records key strokes and screen shots.
The International Transmission Company Notice of Alleged Violations
A few days after announcing the Louis Dreyfus settlement, on February 11, 2014, FERC issued a Notice of Alleged Violations against International Transmission Company. According to FERC, certain ITC operating subsidiaries violated Federal Power Act Sections 203 and 205 which govern rates for wholesale sales of electricity and require pre-approval for the disposition of facilities subject to FERC jurisdiction. FPA Section 203 requires prior FERC authorization for the merger or sale, directly or indirectly, of FERC-jurisdictional facilities. As a result of a non-public investigation, FERC staff found that, during the period between 2005 and 2011, the ITC entities engaged in 20 transactions in which they merged or consolidated FERC-jurisdictional facilities without prior FERC authorization. It is unusual for FERC to find violations of FPA Section 203 during the course of an enforcement investigation. The last such case was in 2007 when Gexa Energy, LLC was acquired by FPL Energy LLC without prior FERC authorization.
FPA Section 205 requires all contracts for FERC jurisdictional service to be on file. In the Notice of Alleged Violations, staff also found that, during the period between 2003 and 2011, certain ITC entities provided FERC-jurisdictional service in approximately 174 documents that the utilities either inherited or executed and that should have been, but were not, filed with FERC.
If you have any questions about the implications of these settlements and notices as well as reviewing your internal compliance program, please contact a Stinson Leonard Street LLP attorney.