Transcript Enter Title Here - American Public Power Association

FERC’S NEW RULE
PROHIBITING FRAUD, DECEPTION
AND MISLEADING STATEMENTS
Presented by: Debbie Swanstrom
Melanie Devoe
Patton Boggs LLP
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For further information, please contact:
Debbie Swanstrom at (202) 457-6565 or
[email protected]
Overview
This presentation includes:
• an explanation of the scope and underlying purpose of
FERC’s new rule;
• a description of the penalties that could be imposed
for violations of FERC’s rule;
• an overview of trading practices that would and would
not violate FERC’s rule; and
• a summary of FERC’s Enforcement Policy Statement
which illustrates the importance of conducting internal
audits and self-reporting.
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FERC’s New Rule
It shall be unlawful for any entity directly or indirectly, in
connection with the purchase or sale of electric energy or
natural gas or the purchase or sale of transmission or
transportation services subject to the jurisdiction of the
Commission:
(1) to use or employ any device, scheme, or artifice to
defraud;
(2) to make any untrue statement of a material fact or to omit
to state a material fact necessary in order to make the
statements made, in the light of the circumstances under
which they were made, not misleading, or
(3) to engage in any act, practice, or course of business that
operates or would operate as a fraud or deceit upon any
entity.
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Goal of FERC’s Rule
• The goal of the rule is to “deter or punish
fraud in wholesale energy markets”
regulated by FERC.
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FERC’s Definition of Fraud
• FERC generally defines “fraud” to
include “any action, transaction, or
conspiracy for the purpose of
impairing, obstructing or defeating a
well-functioning market.”
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Scope of FERC’s Rule
• FERC’s new rule applies broadly to “any
entity,” including governmental utilities and
other market participants that are not
traditionally jurisdictional.
• However, the rule is limited to FERC
jurisdictional transactions and excludes
activities such as retail sales which are
outside of FERC’s jurisdiction.
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Nexus Requirement
• There must be a nexus between the
fraudulent conduct and a jurisdictional
transaction.
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ISO/RTO Example
• According to FERC’s interpretation of the new
rule, “any entity engaging in a non-jurisdictional
transaction through a Commission-regulated
RTO/ISO market that acts with intent or with
recklessness to affect the single auction clearing
price (which sets the price for both jurisdictional
and non-jurisdictional entities) would be engaging
in fraudulent conduct in connection with
a jurisdictional transaction . . . .”
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Penalties for Violations
of FERC’S Rule
• A civil penalty of up to $1 million a day
potentially could be imposed for each violation of
FERC’s rule.
• Criminal penalties also potentially could be
imposed. A person who violates FERC’s rule is
subject to imprisonment for a term of not more
than 5 years and a fine of not more than $1
million.
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FERC has indicated that it plans to apply
penalties to governmental utilities. Arguably,
however, the penalty provisions of EPAct do not
apply to governmental utilities because they do
not fall within the definition of a “person.”
The penalty provisions could still potentially be
applied to individual officers or employees of
governmental utilities.
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Other FERC Remedies
•
FERC has additional remedies at its
disposal, such as:
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disgorgement of unjust profits;
conditioning, suspending, or revoking marketbased rate authority; or
revoking safe harbor status of governmental
utilities’ reciprocity transmission tariffs.
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Scienter
• Before a person can be found guilty of
violating FERC’s rule, there must be a
showing of “scienter.”
• Scienter has been interpreted to include
knowing, intentional or reckless
misconduct.
• Inadvertent errors would not violate
FERC’s rule.
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• FERC likely will look for evidence of
scienter in voice recordings of trader calls,
instant messages, emails, meeting minutes
or trader logs.
• Scienter also may be inferred through
unusual patterns of trading or withholding
and outage behavior.
• This is particularly true in an organized
ISO/RTO market where trading patterns
may be noticed by market monitors.
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Disclosures
• The new rule does not create an affirmative duty
to disclose any information that is not otherwise
required to be disclosed pursuant to a separate law,
order, rule or tariff.
• But if an entity, either voluntarily or through a
separate legal requirement, does provide
information and it misrepresents or omits a
material fact such that information provided is
“materially misleading” this can be a violation of
the rule.
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Materiality
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A fact is material if there is a substantial
likelihood that a reasonable market participant
would consider it in making its decision to
transact because the fact significantly altered the
total mix of information available.
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Examples of Material Information
• Transmission information FERC requires to
be posted on an OASIS, such as TTC or
ATC calculations, likely will be deemed
material.
• Information used to settle an organized
ISO/RTO market clearing price also likely
will be deemed material.
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Price Reporting
• Although there is no duty to report trade
prices to publications that create indices, if
a company does report its trade prices, and
intentionally reports them falsely, this
would violate FERC’s rule.
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Puffery
• FERC stated that “mere puffery” is not a
violation of its rule.
• “Puffery” is described as “general
expressions of optimism for the future” or
“vague statements” that are not sufficiently
“concrete” or “specific” to be material.
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FERC’s Prior
Market Behavior Rules
• FERC’s new rule replaces, in part, and
supplants, in part, several “market
behavior” rules adopted previously by
FERC.
• Some of the trading practices prohibited by
FERC’s old market behavior rules are now
prohibited by FERC’s new rule, including,
for example:
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Examples of Prohibited Transactions
a.
pre-arranged offsetting trades of
the same product among the same parties,
which involve no economic risk and no net
change in beneficial ownership (i.e., "wash
trades");
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b. transactions predicated on submitting
false information to transmission
providers or other entities responsible for
operation of transmission grid (such as
inaccurate load or generation data or
scheduling non-firm service or products
sold as firm);
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c. transactions in which the entity first
creates artificial congestion and then
purports to relieve such artificial
congestion; and
d. collusion with another party for the
purpose of manipulating market prices,
market conditions, or market rules for
electricity.
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• FERC views all of these activities as
“manipulative or deceptive devices or
contrivances” that are prohibited by
FERC’s new rule.
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Defenses
• If a market participant undertakes an action or
transaction that is explicitly contemplated in
Commission-approved rules or regulations,
FERC will presume the participant is not in
violation of FERC’s rule.
• If a market participant undertakes an action or
transaction at the direction of an ISO or RTO,
the participant generally can assert this as a
defense.
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• However, if a market participant acting with the
requisite scienter has provided inaccurate or
incomplete information to the ISO or RTO, and
the ISO or RTO issues a directive in reliance on
the false or incomplete information, following
such ISO or RTO directive is not a legitimate
defense.
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LESSONS LEARNED FROM
PRIOR FERC INVESTIGATIONS
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Enron Trading Practices
• Following the Western energy crisis of 2000-2001,
FERC investigated trading practices used by
Enron and others with colorful names like
Ricochet, Deathstar and Fat Boy.
• Deception or the submission of false and
misleading information is an element common to
each trading practice deemed unlawful by FERC.
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• FERC found that Enron’s trading practices violated
provisions in the California ISO and PX tariffs
restricting gaming and anomalous market behavior.
• FERC also found that Enron’s trading practices
violated an implicit condition of all market-based
rate authority granted by FERC, namely that “a
company’s behavior will not involve fraud,
deception or misrepresentation” (106 FERC ¶ 61,024
at P 20).
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False Import Practice
• False Import (aka “Ricochet" or "Megawatt Laundering“)
was a trading practice designed to mislead the ISO into
believing that power had been imported from out-of-state
in order to receive a price above the cap imposed on sales
of generation inside the California market.
• A market participant would purportedly export power
purchased in the California day-ahead or day-of market,
sell it to an out of state entity who would temporarily
“park” the power for a small fee, and then repurchase it
and sell it back in the California real-time market at a price
above the market cap.
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• No power actually left the State of California,
however, in this type of parking transaction. The
market participant simply created a fictional
export/import transaction to receive a price above
the cap.
• Similar strategies to avoid market price caps
through the submission of false or deceptive
schedules also would likely violate FERC’s new
rule.
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Congestion-Related
Gaming Practices
• In the California ISO, market participants received
“congestion relief payments” for relieving flows in
the direction of congestion or increasing counterflows in the opposite direction.
• Using a variety of deceptive practices, market
participants submitted false schedules to create the
impression of relieving congestion in order to
receive these payments.
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Cutting Non-Firm
• Cutting Non-firm (a.k.a. Non-firm Export) involved the
scheduling of non-firm power by a market participant who
either did not intend to deliver or could not deliver the
power because it had not even acquired the power.
• The market participant would schedule non-firm power
over a congested path even though it had no intention of
delivering the power. Upon receipt of a congestion
payment for cutting the schedule, the market participant
would cancel the non-firm power after the hour-ahead
market closed but keep the congestion payment.
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Ancillary Services-Related Practices
• Paper Trading (a.k.a. Get Shorty) is a trading
practice whereby a market participant would
sell ancillary services in the day-ahead market
even though the market participant did not
actually have the required resources available to
provide the ancillary services. The market
participant then bought back the ancillary
services in the hour-ahead market at a lower
price.
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– Double Selling (also a.k.a Get Shorty ) is
a trading practice whereby a market
participant would sell ancillary services
in the day-ahead market from resources
available at that time and then sell those
same resources again as energy in the
hour-ahead or real-time markets.
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Selling Non-Firm Energy as Firm
• Selling Non-Firm Energy as Firm is a
trading practice whereby a market
participant bought non-firm energy from
outside California and then sold it to the
ISO as firm energy.
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Authorized Trading Practices
• FERC recognized that practices which do “not involve any
false representations or take unfair advantage of ISO rules”
are “appropriate and legitimate practices,” including for
example:
– Export of California Power - This practice involved a purchase of
power in the California day-ahead market at or below the price cap
and then a resale of that power outside the state at a higher,
uncapped price. Unlike the False Import practice, energy was
actually exported out of California. FERC found this was a
legitimate price arbitrage strategy. It would not violate the new
rule because it does not involve the use of a device or scheme to
defraud.
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– Ancillary Services Arbitrage – This practice involved
selling ancillary services in the Day-Ahead market and
buying them in the Real-Time market. So long as the
market participant actually had the resources to provide
the ancillary services, FERC found this was a legitimate
arbitrage strategy.
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Investigations of Physical and
Economic Withholding
• FERC has investigated many electric
companies to see if they engaged in either
“physical” or “economic” withholding
during the Western energy crisis.
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• Physical Withholding: A company
unnecessarily takes a generation plant out of
service to intentionally increase prices or
create shortages.
• Economic Withholding: A company bids its
generation into an organized market at a
price that is inconsistent with, and higher
than, prevailing supply and demand
conditions warrant, such as bidding
$500/MW in a market that is clearing at
$50/MW.
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FERC’s Enforcement Policy
• Historically, FERC has imposed the most severe
remedies on companies that:
– granted preferential treatment to affiliates;
– did not fully disclose requested information to
the Commission; or
– repeatedly violated FERC’s regulations.
• FERC formalized its enforcement policy recently
in a policy statement (113 FERC ¶ 61,068 (2005)).
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• Chairman Kelliher summarized FERC’s
policy as “firm but fair enforcement.”
• FERC expects a company to engage in
compliance training, auditing, and selfreporting and, generally, promote a “culture
of compliance.”
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SEC, CFTC and DOJ
Enforcement Policies
• FERC modeled its Enforcement Policy
Statement on similar policy statements
issued by the SEC, CFTC and DOJ.
• All of these policy statements take into
account self-reporting and strong
compliance programs when determining
appropriate remedies to impose for
violations.
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Unjust Profits
• Although the Enforcement Policy Statement
lays out mitigating factors FERC will
consider when determining penalties, FERC
has announced that it will always require
unjust profits be disgorged.
• Disgorgement is designed to prevent unjust
enrichment whereas penalties are designed
to punish and deter bad conduct.
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Penalty Determination Factors
• FPA Section 316A mandates that the
“seriousness of the violation” be
considered.
• Under the Enforcement Policy, FERC will
consider, among other things, the following
factors:
– Extent and type of harm
– The intent underlying the wrongdoing;
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– Whether the company had a history of
violations;
– Senior management’s involvement in the
violation;
– How the wrongdoing came to light; and,
– The financial viability of the company.
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Credit for Cooperation
• FPA Section 316A requires FERC to
consider efforts the company made to
“remedy the violation in a timely manner.”
• “Credit” will be given to companies that:
– Self-monitor to prevent and stop misconduct;
– Self-report violations to FERC; and,
– Cooperate with FERC’s enforcement action.
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• FERC will evaluate internal
compliance based on whether the
company had:
– A formal, independent compliance program
with sufficient resources and support by
senior management;
– An ongoing process for auditing and
training to comply with FERC’s regulations;
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– An employee compensation, promotion, and
discipline policy based on compliance with
FERC’s rules and regulations;
– Responded to prior wrongdoing by setting
up internal controls to prevent future
wrongdoing; and,
– Repeated prior violations.
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Self-Reporting
• FERC recognizes that companies are in the
best position to detect and correct
violations.
• FERC will give credit for self-reporting
based on how the misconduct was
uncovered. It will look at several factors
including whether:
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• The misconduct was uncovered by an internal
audit;
• The company notified FERC promptly;
• Senior management participated in and
encouraged information gathering;
• The company took immediate steps to respond
to and stop the misconduct;
• The company met with FERC Enforcement
and brought the relevant employees; and
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• The company presented the results of
its investigation to Enforcement
Staff, including:
- Full disclosure of the scope of the
wrongdoing;
- Who was involved;
- What was done upon discovering the
violation; and
- All relevant communications and
documents.
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Exemplary Cooperation
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Although entities subject to FERC’s jurisdiction
are required to give information to Commission
staff, staff will give credit for exemplary
cooperation.
Factors FERC will consider in determining
whether to give credit include whether the
company:
– Volunteered to provide investigation or audit
reports;
– Hired an independent third-party to assist in the
investigation;
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– Supported employee cooperation with the
investigation;
– Made records available to staff and provided
assistance in understanding the documents; and,
– Fairly and accurately determined the effects of
the misconduct, including profits and who was
affected adversely by the misconduct.
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Failure to Cooperate
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FERC also defined what it considered to
be uncooperative conduct. This includes:
– Failure to respond to data requests,
produce documents or witnesses in a
timely manner;
– Misrepresenting the nature or extent of
the misconduct;
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– Falsely claiming that records are
unavailable;
– Limiting staff access to employees;
– Directing/influencing employees (or
their counsel) not to cooperate with the
investigation;
– Engaging in obstructive conduct during
depositions or interviews;
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– Providing inaccurate explanations for
instances of misconduct that are
uncovered;
– Failing properly to search computer hard
drives for documents and images; and,
– Failing to provide documents in the way
they are maintained in the course of
business.
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Compliance Plans
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In addition to monetary remedies, FERC
has a tradition of requiring companies to
adopt compliance plans to prevent the
violation from recurring.
These generally are written plans that are
attached to a stipulation and consent
agreement and agreed to by the company.
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Potential Compliance Plan
Components
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Reporting quarterly to FERC
Monitoring of communications
Internal self-auditing
FERC-approved staff training
Document retention
Hotline to report violations
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Indefinite Compliance Plan
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Although FERC compliance plans usually have
a set time limit, in one investigation involving
the improper sharing of transmission
information and abuse of native load priority,
Idaho Power agreed to an indefinite compliance
plan until FERC deemed the compliance plan
could be ended for good cause shown.
Additionally, FERC required Idaho Power to
retain an independent auditor to ensure
compliance with the Standards of Conduct.
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Enogex/Ozark Self-Reports
$95,000 Enogex Settlement
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Ozark self-reported a pipeline construction
violation, but was a repeat offender. It and
its affiliate paid a total of $95,000.
$20,000 was a voluntary payment by Ozark.
$15,000 of the Enogex payment was waived
for performing an outreach program to other
industry members regarding clearances
needed for pipeline construction.
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Coral Fails to Disclose
$3.5 Million Voluntary Payment
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During FERC’s Westwide investigation,
Coral responded that it did not engage in
false price reporting to indices.
CFTC informed FERC of Coral’s potential
false-reporting and, therefore potential
inaccurate responses to FERC’s Westwide
inquiry.
Coral made a voluntary payment to FERC of
$3.5 million to settle FERC’s investigation
and agreed to develop a compliance plan.
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No Action Letters
• Market participants can request “no-action” letters
from FERC Staff before undertaking a
questionable transaction.
• FERC’s no-action letter process is based on those
of the SEC and CFTC. All three agencies state that
no-action letters are not binding on the
Commissions. Instead, they are binding only on
the staff of the division issuing the no-action letter.
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Limitations on No-Action Requests
• Currently, requests for no-action letters are limited to
questions concerning FERC’s Standards of Conduct,
Market Behavior Rules and new Market Manipulation
Rule because FERC realizes these rules may “present
interpretive challenges and substantial exposure to
potential enforcement actions.”
• No hypothetical questions will be answered as the noaction letter process is intended to assist regulated
entities in seeking guidance on the real world
application of FERC’s regulations and orders.
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No-Action Letter Responses
• If the information submitted is not sufficient, staff
may request additional information or inform the
requester that it will not respond to the request and
give a reason.
• The response to a no-action letter will either allow
as described, allow with some alterations, or
recommend enforcement action is done as
described.
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– Staff will not recommend enforcement action if the
matter is implemented as described. (Bottom line – it is
ok as described.)
– Staff will not recommend enforcement action if the
matter is implemented as so described only under
conditions stated in the response. (Bottom Line – it is
not ok as described, but would be ok if adopted with
staff’s suggestions described in the response.)
– Staff may recommend enforcement action if the matter
is implemented as so described. (Bottom Line – don’t
do this.)
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Other Options for Advice
• FERC considers avenues for informal advice
valuable, and intends its staff to continue its
present efforts to render informal, non-binding
advice
• Pre-Filing Meetings: Meeting between company
and FERC senior staff to receive advice on a
particular filing that the company wants to make.
• Hotline Calls: FERC’s Enforcement Hotline staff
will address questions or complaints related to
activities under FERC’s jurisdiction.
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Binding Advice
• Any person who seeks a binding
Commission determination concerning a
proposed transaction, practice, situation or
other matter has the option to instead file a
petition for a declaratory order. (18 C.F.R.
section 385.207).
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Examples of Things To Do To
Ensure Continued Compliance
• Have a written compliance plan and
establish auditing and compliance training
procedures.
• Perform regular training and have all
trading employees attend and sign training
acknowledgements.
• Monitor FERC investigative orders,
settlements and compliance plans, and keep
track of changes in FERC rules.
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• Track No-Audit letters coming out of FERC
to determine practices that are allowed or
prohibited.
• Monitor the group’s overall Value at Risk
and trading practices.
• Establish data retention and monitoring
practices for e-mail, instant messages,
electronic documents, trade capture
systems, tape recording systems.
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• Establish a policy on instant messaging; if
you permit traders to use it, consider having
all of the messages preserved.
• Perform periodic compliance inspections of
trader communications.
• Listen to voice recordings and read instant
messages and emails particularly on peak
trading days: high LMP days for organized
markets, and days with price spikes or
extreme hot or cold days for non-organized
markets.
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• Perform an analysis of a trader's and a
desk's trades for indication of any aberrant
trading patterns. There are software
systems that can perform these analyses.
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• Meet regularly with traders to discuss
compliance issues, solicit and answer their
regulatory questions, and give reminders on
best practices.
• Consider hiring an independent law firm to
audit your trading practices annually.
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Self-Reporting
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If you learn of wrongdoing, contact an outside
law firm immediately. We recommend that you
have a law firm conduct an independent internal
investigation. If the investigation determines
wrongdoing or there is a great likelihood of
wrongdoing in connection with a jurisdictional
transaction, report the matter immediately to
FERC.
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Benefits of Self-Reporting
•
Giving the results of your investigation to
the government may:
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help focus the investigation more narrowly to
the areas of violations you have uncovered;
and,
save your company money through lower
legal fees and civil penalty assessments.
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Bottom Line
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FERC places a high value on internal
compliance, self-reporting and cooperation
and will take these factors into account when
determining the appropriate penalties for
violations.
On the other hand, if Enforcement Staff feels
that the company is uncooperative, FERC
may impose the full extent of its penalties.
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