OVERVIEW OF ENERGY
TRADING ISSUES
Peggy A. Heeg
Partner, Fulbright & Jaworski L.L.P.
Global Energy Management Institute
UH-GEMI 3rd Annual Energy Trading and
Marketing Conference: Rebuilding the Business
January 20, 2005
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FERC Market Behavior Rules
Peggy A. Heeg
Partner, Fulbright & Jaworski L.L.P.
January 20, 2005
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FERC Investigation of Trading Practices

Investigation of market manipulation strategies and the California
energy crisis.

“Particularly troubling is the common theme that because
everyone knew that everyone else was manipulating the indices
by reporting false prices and volumes, it was somehow acceptable
and even necessary for this to take place.” Final Report on Price
Manipulation in Western Markets.

FERC concluded that rapid-fire trading, Enron-like trading
strategies, wash trades, economic withholding and inflated
bidding distorted prices in the Western United States.
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The Market Behavior Rules

FERC issued two orders establishing market behavior rules for
traders.

The gas and electric rules are similar; the electric rules contain
additional rules that address physical operations of generating
facilities and interactions with grid operators.
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FERC Market Behavior Rules
Market Manipulation

The rules prohibit actions or transactions that are
without a legitimate business purpose and that
are intended to or foreseeably could manipulate
market prices, market conditions, or market
rules for electric energy or electricity products.
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FERC Market Behavior Rules
Market Manipulation

“We clarify that transactions with economic substance, in which a
seller offers or provides service to a willing buyer and where
value is exchanged for value, are not prohibited by our rule . . .
Behaviors and transactions with economic substance will thus be
recognized as reflecting a legitimate business purpose consistent
with just and reasonable rates.”

The Commission declined to clarify the meaning of “legitimate
business purpose” in the Order on Rehearing and suggests that the
rule is deliberately vague.
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FERC Market Behavior Rules
Market Manipulation

Prohibited actions and transactions include, but are not limited to:
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 (sometimes called "wash trades");
b. transactions predicated on submitting false information to transmission
providers or other entities responsible for operation of the transmission
grid (such as inaccurate load or generation data; or scheduling non-firm
service or products sold as firm), unless Seller exercised due diligence to
prevent such occurrences;
c. transactions which create artificial congestion and then purport to relieve
such artificial congestion (unless Seller exercised due diligence to prevent
such an occurrence); and
d. collusion with another party for the purpose of manipulating market
prices, market conditions or market rules.
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FERC Market Behavior Rules
Reporting To Indices

Seller shall provide accurate and factual information to indices
and not knowingly submit false or misleading information or
omit material information to any such publisher.

Data providers that can demonstrate that they have adopted and
followed Commission standards for price reporting will be
presumed to have submitted accurate and timely information.

The Commission will not prosecute and/or penalize parties for
inadvertent errors in reporting, nor will it refer such issues to
other agencies having jurisdiction.
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FERC Market Behavior Rules
Record Retention

Seller shall retain, for a period of three years, all data and information upon
which it billed the prices it charged or the prices it reported for use in price
indices.

Sellers must retain the complete set of contractual and related documentation
upon which they billed their customers for their sales.

The Commission is “indifferent” as to whether this material is retained in
paper form or in an electronic medium as long as the data can be made
accessible in a reasonable fashion if its review is required by the Commission
or its Staff.

The Commission clarified on rehearing that it wants to be able to track the
entire transaction, starting with the inception of the transaction.
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FERC Market Behavior Rules

On rehearing, the Commission declined to further clarify the
record retention rule.

“We also decline to clarify our rule further with the addition of
such distinctions as primary versus secondary records and
documents which may or may not have been expressly relied
upon by the seller … If a given record includes information that
fits this description, it must be retained … regardless of the
medium in which the record is maintained (whether a contractual
document, email, or other record).”
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Procedural Limitations for Alleged Violations

Complaint must be brought within 90 days of: 1) the end of the
Quarter in which violation is alleged to have occurred; or 2) when
the Complainant should have known of the behavior.

Commission must act within 90 days from the date it knew of the
alleged violation.

Commission action on filing not meeting filing deadlines shall be
prospective only.
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Consequences of Violating the Market
Behavior Rules




There are no Commission orders which provide guidance in
interpreting the Market Behavior Rules.
Despite the lack of guidance provided by FERC, the consequence
of non-compliance is severe.
Remedies for violations:
– Disgorgement of unjust profits
– Revocation of its authority to sell at market-based rates
– Other appropriate non-monetary remedies
FERC is a member of Corporate Fraud Task Force.
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Conclusions

FERC has exercised jurisdiction over trading companies.
 FERC has adopted an extremely broad set of rules that are vague
and subject to interpretation.
 In some instances this vagueness appears deliberate.
 Given the intentional vagueness in the rules, market participants
should proceed cautiously:
– Detailed compliance procedures
– Education
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Commodity Futures Trading
Commission
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Commodity Futures Trading Commission

Since 2002, the CFTC has investigated over 40 energy companies
and numerous individuals.

Thus far, the CFTC has filed 20 actions and collected over onequarter billion dollars in penalties; settlements include ongoing
obligations to cooperate.

Cases have dealt primarily with false price reporting to trade
publications.
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Commodity Futures Trading Commission

What is the Commodity Exchange Act?
– Originated in 1922 as the Grain Futures Act
– Commodity Exchange Act gives CFTC exclusive jurisdiction
over energy futures contracts

CFTC becoming more aggressive in exercising its jurisdiction
under the Commodity Exchange Act.
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Commodity Exchange Act

Commodity Exchange Act makes it unlawful for
a person to “manipulate or attempt to manipulate
the price of any commodity in interstate
commerce … or knowingly to deliver or cause to
be delivered … false or misleading or knowingly
inaccurate reports concerning … market
information or conditions that affect or tend to
affect the price of any commodity in interstate
commerce.”
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Commodity Futures Trading Commission

CFTC has teamed up with FERC to monitor markets.

CFTC and FERC conducted a seven month investigation into gas
price movements in late 2003 and recently concluded that price
movement was a result of market forces.
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Commodity Futures Trading Commission
Cooperation Advisory

Outlines factors that CFTC will weigh in evaluating whether a
company has cooperated with the CFTC. Factors include:
 Self reporting
 Privilege waiver
 Provide financial analysis of
harm
 No joint defense agreement
 Hire staff to respond to
subpoena
 Investigate facts
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False Price Reporting

Practice was widespread.

One trading desk maintained a computer spreadsheet named
“IFERC Bogus” for the purpose of providing inaccurate market
information to Inside FERC.
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Criminal Prosecution

To date there have been criminal indictments against traders at
Duke, Dynegy, El Paso, Enron, Reliant and Williams .

Majority of these are for false price reporting in violation of the
Commodity Exchange Act.

Most recent charges have alleged conspiracy to manipulate the
markets.
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Criminal Prosecution

Most recent plea arrangement with ex-Williams trader admitted
that he knew how reporting false price information could benefit
his trading position and that the false reporting affected the Inside
FERC index price.

Most recent indictments allege conspiracy among traders in
different companies to manipulate the price indices.

Cases will lead to litigation.
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CRIMINAL PROCEEDINGS AGAINST
INDIVIDUALS

Traders from numerous companies have been criminally charged with a felony
for violating the Commodities Exchange Act (7 U.S.C. § 13 (a) (2)) and wire
fraud -- El Paso, Dynegy, Reliant and Williams.

In U.S. v. Valencia, Dynegy trader argued that CEA is unconstitutionally
overbroad, is void for vagueness, only applies to futures transactions and
infringes on speech protected by the first amendment.

On December 17, 2004, the Fifth Circuit concluded that the CEA is not
unconstitutionally overbroad; statute requires that person submitting false or
misleading information must know that information is false or misleading.
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For More Information
Please contact:
Peggy A. Heeg
(713) 651-8443
pheeg@fulbright.com
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