November 22, 2016
On November 17, 2016, the Enforcement Staff of the Federal Energy Regulatory Commission ("FERC") released two white papers providing an overview of the Commission’s anti-market manipulation enforcement efforts and offered guidance on effective energy trading compliance practices. Detailing the first decade of FERC’s enhanced enforcement authority granted by the Energy Policy Act of 2005, the papers are an effort by the Commission to provide significant guidance to the regulated community. The papers also reinforce the Commission’s and the Office of Enforcement’s intent to continue aggressively combating market manipulation and encourage market participants to implement effective compliance systems that can help detect and prevent manipulative activity.
This client update provides an overview of the two separate whitepapers and highlights some key takeaways and unanswered questions for industry with respect to FERC’s enforcement policy. Gibson Dunn will provide additional insight and in-depth analysis on these issues in a forthcoming webinar.
FERC’s Staff White Paper on Anti-Market Manipulation Enforcement Efforts Ten Years After EPAct 2005 (the "Enforcement Paper") is reflective of the Commission’s zealous exercise of the enforcement powers granted to it by EPAct 2005. The Enforcement Paper sketches FERC’s evolution over the past decade from a traditional utility regulator charged with establishing "just and reasonable" rates, with limited power to police manipulative activities, to a more muscular and assertive "energy market prosecutor." It details Enforcement Staff’s application of their far-reaching definition of fraud covering any action "impairing, obstructing or defeating a well-functioning market," and Enforcement Staff’s view that the scienter required to prove fraud can be inferred from circumstantial evidence, even when that evidence shows that the activity was largely driven by a legitimate business purpose.
The Enforcement Paper focuses on the "indicia of fraud" FERC looks for in initiating market manipulation enforcement proceedings and common forms of market manipulation. Key indicia include manipulative intent, "uneconomic" behavior, and behavior inconsistent with "market fundamentals of supply and demand." But what distinguishes such prohibited conduct from legitimate trading activities remains a fact specific, case-by-case inquiry.
The Enforcement Paper also discusses three primary forms of market manipulation that FERC has targeted: cross-market manipulation (e.g., trading in physical markets to favorably affect financial positions), gaming of market rules (e.g., taking "unfair advantage" of market rules), and misrepresentations generally.
Finally, the Enforcement Paper suggests steps market participants can take to mitigate penalties for market manipulation, including designing and maintaining internal compliance systems that can detect and prevent potentially fraudulent activity, self-reporting violations, and cooperating with investigators.
To supplement its guidance to energy firms on compliance efforts, FERC Enforcement Staff also released a separate white paper providing more detail on what the Commission expects regulated entities to do to monitor their own trading practices. FERC’s Staff White Paper on Effective Energy Trading Compliance Practices ("Compliance Paper") focuses on Enforcement Staff’s advice on "how-to" (i) design, (ii) establish, implement, and enforce, and (iii) assess the performance of an effective trading compliance program.
The Compliance Paper’s advice on how to design an effective compliance program focuses on organizational structure and composition, human resources, training, and information technology resources. Enforcement Staff’s recommendations include: ensuring that compliance personnel are involved in and apprised of the trading practices of the firm; adequately supporting and effectively incentivizing compliance through budgeting, bonuses, and disciplinary action; vetting business personnel’s "compliance track record" through background checks; and tailoring training to the organization’s specific trading activities.
Regarding establishing, implementing, and enforcing a compliance program, Enforcement Staff’s recommendations include: maintaining a list of prohibited trading strategies; requiring traders to gain approval from compliance personnel before trading new products or at new locations; and implementing restrictions that discourage the use of price-setting instruments to benefit open financial positions.
On assessing the effectiveness of a compliance program, Enforcement Staff underscores the importance of performing regular audits of compliance programs and consistently improving such programs based on the results of those audits and real-life situations. Enforcement Staff also identifies ineffective practices, including overreliance on standardized and long annual trainings, providing insufficient resources for a compliance program, and not providing compliance personnel with sufficient authority within the organization.
These two white papers represent a commendable attempt by Enforcement Staff to offer guidance to the industry, but also highlight a number of issues that remain unresolved:
Gibson Dunn will be providing more insight and in-depth analysis on these and other issues in a forthcoming webinar designed for industry participants seeking to better understand the enforcement regimes of FERC and the Commodity Futures Trading Commission ("CFTC"). The webcast will also address potential policy shifts at FERC and the CFTC under a Trump Administration and the timing of such policy implementation.
The following Gibson Dunn lawyers assisted in the preparation of this client alert: William Scherman, Jeffrey Jakubiak, Jeffrey Steiner, Jason Fleischer, Jennifer Mansh, Kevin Barber, Nick Duvall and Ben Belair.
Gibson Dunn’s Energy Regulation and Litigation lawyers are available to assist in addressing any questions you may have regarding the developments discussed above. Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following:
William S. Scherman – Washington, D.C. (+1 202-887-3510, email@example.com)
Jeffrey M. Jakubiak – New York (+1 212-351-2498, firstname.lastname@example.org)
Jeffrey L. Steiner - Washington, D.C. (+1 202-887-3632, email@example.com)
Jason J. Fleischer – Washington, D.C. (+1 202-887-3737, firstname.lastname@example.org)
Jennifer C. Mansh – Washington, D.C. (+1 202-955-8590, email@example.com)
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