FERC COMPLIANCE AND ENFORCEMENT. October 29, 2014 Washington, DC

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1 FERC COMPLIANCE AND ENFORCEMENT October 29, 2014 Washington, DC

2 INTRODUCTION

3 INTRODUCTION AND OUTLINE FERC Compliance and Enforcement Overview General Regulatory Compliance Requirements Reliability Oversight Cybersecurity Oversight CFTC Regulation Oversight FERC Enforcement Practice & Procedure FERC Guidance on Penalties & Mitigation Compliance Best Practices 2

4 FERC COMPLIANCE AND ENFORCEMENT OVERVIEW

5 Federal Energy Regulatory Commission (FERC) FERC, an independent regulatory commission within the Department of Energy (DOE), is composed of four commissioners and one chairman. Created by the Department of Energy Organization Act on October 1, 1977, FERC assumed the responsibilities of its predecessor, the Federal Power Commission (FPC). Has jurisdiction over electric utilities, the interstate natural gas industry, electric utilities, hydroelectric projects, and oil pipelines. 4

6 FERC administers a variety of statutes that provide the framework under which it regulates the natural gas and electric industries, as well as the transportation of oil, including: Federal Power Act Natural Gas Act (NGA) Natural Gas Policy Act of 1978 (NGPA) Public Utility Holding Company Act of 2005 Public Utility Regulatory Policies Act of 1978 Interstate Commerce Act Federal regulations set forth in 18 C.F.R. Parts

7 FERC s Duties FERC regulates the interstate electric, natural gas and oil pipeline industries and, as such, it: 1. Regulates the transmission and wholesale sales of natural gas in interstate commerce; 2. Regulates the transmission and wholesale sales of electricity in interstate commerce; 3. Licenses and inspects private, municipal, and state hydroelectric projects; 4. Approves the siting and abandonment of interstate natural gas pipelines and storage facilities, and ensures the safe operation and reliability of proposed and operating liquefied natural gas (LNG) terminals; 6

8 FERC s Duties (cont d) 5. Ensures the reliability of high-voltage interstate transmission systems; 6. Monitors and investigates energy markets; 7. Uses civil penalties and other means against energy organizations and individuals who violate FERC rules in the energy markets; 8. Oversees environmental matters related to natural gas, hydroelectric projects, and major electricity policy initiatives; 9. Administers accounting and financial reporting regulations and the conduct of regulated companies; and 10. Regulates the transmission of oil by pipelines in interstate commerce. 7

9 Federal Power Act (FPA) In 1920, Congress enacted the Federal Water Power Act for the purpose of coordinating the development of hydroelectric projects within the United States. The Act also created the Federal Power Commission (FPC) as the licensing authority for these projects. In 1935, Congress amended and renamed the Act the Federal Power Act and expanded the FPC s jurisdiction to include: 1. the transmission of electricity in interstate commerce; 2. its sale in interstate commerce for resale; and 3. all facilities used for the sale or transmission of electricity in interstate commerce. 8

10 MAJOR FPA Amendments Public Utility Regulatory Policies Act of 1978 Required electric utilities to buy the energy generated by Qualifying Facilities (e.g., cogenerators) at i.e., the utilities avoided cost. Energy Policy Act of 1992 (EPAct 92) Reduced regulatory burden for Exempt Wholesale Generators (EWGs) and required FERC to open the nation s electric transmission grid to wholesale suppliers on a case-by-case basis. Energy Policy Act of 2005 (EPAct 2005) FERC to oversee the reliability of the transmission grid. FERC can assess civil penalties of up to $1 M per day. National interest electric transmission corridors siting. FERC authorization required before a public utility acquires electric generating facilities over $10 Million. 9

11 FERC Regulations FERC s regulations are located in volume 18 of the Code of Federal Regulations, 18 C.F.R. 1, et seq. Sections of note include the following: 1b 1c Rules relating to Enforcement Investigations; Rules relating to Prohibition of Market Manipulation; 33 Applications under FPA Section 203 (e.g., to sell FERC jurisdictional electric facilities or acquire generation facilities valued at $10 million or more); 35 Filing of rate schedules and tariffs by electric utilities; 358 Standards of conduct for transmission providers, that is, both electric utilities and interstate natural gas pipelines; and 385 FERC s Rules of Practice and Procedure. 10

12 FERC COMMISSIONERS FERC is currently comprised of: Acting Chairman Cheryl A. LaFleur (D, Massachusetts) Commissioner Phillip D. Moeller (R, Washington) Commissioner John R. Norris (D, Iowa) Commissioner Tony Clark (R, North Dakota) FERC commissioners serve staggered five-year terms. By law, no more than three commissioners can be from the same political party. 11

13 F E D E R A L E N E R G Y R E G U L A T O R Y C O M M I S S I O N Organizational Chart 12

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15 O f f i c e o f E n e r g y M a r k e t R e g u l a t i o n ( O E M R ) OEMR integrates FERC s economic regulation of the electric, natural gas, and oil industries. One of FERC s primary goals is to prevent the exercise of market power by wholesale power sellers, electric transmission companies, and natural gas and oil companies. This is accomplished by striking the right balance between competition and regulation. OEMR also deals with ensuring just and reasonable rates, tariffs and conditions in natural gas pipeline, oil pipeline and electric power markets and the reliability of the electric grid. 14

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17 Office of Enforcement Assures compliance with FERC rules and regulations. The office is made up of a multi-disciplinary team of economists, engineers, attorneys, auditors, data management specialists, financial analysts, and policy analysts. Initiates and executes investigations of possible violations of FERC s rules, and regulations; pursues remedies through negotiation or litigation. Maintains the Enforcement Hotline to informally resolve disputes concerning any matter subject to FERC s jurisdiction. 16

18 F E R C s C i vil a n d C r i m i n a l P e n a l t y A u t h o r i t y Violations of the FPA, NGA, and FERC s Rules and Regulations promulgated thereunder (e.g., market manipulation under 18 CFR 1c and market based rate requirements; quarterly reports, change in status) are now subject to: $1,000,000 civil penalty per violation per day: Up to 5 years in prison. Individual civil liability for traders: Former Amaranth trader Brian Hunter is facing FERC civil penalties of $30 million for alleged market manipulation. Disgorgement of unjust profits: No statute of limitations. Revocation of market-based rate authority 17

19 Complying with FERC s Market Manipulation Rules Jon Schneider Stinson Leonard Street EUCI, Washington, D.C. October 29,

20 The Statutory Framework Market Manipulation in wholesale markets for Electricity and Natural Gas and filing false Information with federal officials is prohibited under: Federal Power Act ( FPA ) Sections 221 and 222 Natural Gas Act ( NGA ) Sections 4A The law is expressly applicable to Municipalities (FPA 201(f) entities). The potential criminal and civil penalties include up to $1 million per day in fines and 5 years in prison applicable to corporations/municipalities AND individuals. These statutory provisions have been operational since January 26, 2006, when FERC issued implementing regulations in Order No

21 False Data Reporting is Prohibited Federal Power Act Section 221 Prohibition on Filing False Information No entity (including an entity described in section 201(f)) [i.e., a municipal utility] shall willfully and knowingly report any information relating to the price of electricity sold at wholesale or the availability of transmission capacity, which information the person or any other entity knew to be false at the time of the reporting, to a Federal agency with intent to fraudulently affect the data being compiled by the Federal agency. Natural Gas Act: False Reports violate Commission orders and are subject to enforcement too. FERC rules applicable to entities authorized to sell power at marketbased rate tariff also require honesty with respect to interaction with ISOs. Good policy calls for this rule to be honored. 20

22 Manipulation of Electric Markets Is Unlawful Federal Power Act Section 222 Prohibition of Energy Market Manipulation (a) In General - It shall be unlawful for any entity (including an entity described in section 201(f)), directly or indirectly: to use or employ, in connection with the purchase or sale of electric energy or the purchase or sale of transmission services subject to the jurisdiction of the Commission, any manipulative or deceptive device or contrivance (as those terms are used in section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j(b)), in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of electric ratepayers. 21

23 Manipulation of Natural Gas Markets Is Unlawful Natural Gas Act Section 4A Prohibition of Market Manipulation It shall be unlawful for any entity, directly or indirectly, to use or employ, in connection with the purchase or sale of natural gas or the purchase or sale of transportation services subject to the jurisdiction of the Commission, any manipulative or deceptive device or contrivance (as those terms are used in section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j(b)) in contravention of such rules and regulations as the Commission may prescribe as necessary in the public interest or for the protection of natural gas ratepayers. 22

24 Implementing the Law Through FERC Order No. 670 FERC s regulations, 18 C.F.R. 1c.1 and 1c.2, call for action where an entity: Uses a fraudulent device, scheme or artifice, or makes a material misrepresentation or a material omission, or engages in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any entity; With the requisite scienter [ill-intention]; In connection with the purchase or sale of natural gas or electric energy or transportation of natural gas or transmission of electric energy subject to the jurisdiction of the Commission. 23

25 Fraud and Deceit Fraud: Defined by FERC to include any action, transaction, or conspiracy for the purpose of impairing, obstructing or defeating a wellfunctioning market. Order No. 670 at P 50. Common Element: Actions taken with no legitimate business purpose other than to alter market results. Deceit: Used by FERC to snag entities engaged in misleading practices under FERC tariffs. 24

26 Three Common Areas of Focus Collusive behavior Price Fixing, e.g. Activity in one market without legitimate business purpose that has an effect on another. Misrepresentation in dealings under FERC-jurisdictional tariffs 25

27 What s Fraud And What s Not? Even freely operating markets don t always work so well. Taking advantage of legitimate market opportunities, in response to changing market conditions, does not constitute fraud. Permissible Activity: Market arbitrage Scarcity pricing 26

28 Scienter You Have to Intend to Mess Up Scienter refers a party s affirmative intention to manipulate the market FERC s rules follow SEC market manipulation Rule 10b-5 and require knowing or intentional conduct designed to deceive or defraud by controlling or artificially affecting prices Only intentional conduct is prohibited. Scienter cannot be found where a party acted negligently or inadvertently, even if those actions affect prices Reckless conduct, including willful blindness, can satisfy the scienter requirement if the violator followed a course of action that involved a known or patently obvious danger of misleading 27

29 Only Acts In Connection With A Jurisdictional Purchase or Sale Are Subject To the Rule FPA 222, NGA 4A, and Rule 1c encompass only activity that is in connection with the purchase or sale of FERC jurisdictional service l.e., wholesale sales of natural gas/electricity or transportation/transmission subject to FERC jurisdiction. Interpreted under SEC law to implicate activities where any point in a planned chain of events includes a jurisdictional transaction. Sale by a municipal into an organized (RTO) market is considered in connection with a jurisdictional sale. Any sale impacting FERC markets is probably the same category. Sale across jurisdictional wires or to a jurisdictional entity may also qualify. Bottom Line: Don t try to manipulate any aspect of a deal that could become part of an interstate transaction because FERC will find a nexus. 28

30 Commodities Exchange Act and Regulations CEA section 6(c)(1): It shall be unlawful for any person, directly or indirectly, to use or employ, or attempt to use or employ, in connection with any swap, or contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity, any manipulative or deceptive device or contrivance, in contravention of.[cec rules]. Elements of Manipulation: Is there evidence of an attempt to defraud, or to make misleading statements or false reports in order to alter the natural outcome of a competitive market. 29

31 What s Prohibited - Examples Wash Trades Pre-arranged offsetting trades of the same product among the same parties which involve no economic risk and no net change in beneficial ownership Motivation: gives the appearance of setting a market price or of increased sales activity or liquidity in a market Any resulting advantages are considered improper because the trades are fictitious, and do not represent the normal operation of a freely competitive market Key to understanding behavior: No legitimate business reason for transaction outside manipulative intent. 30

32 What s Prohibited: Examples drawn from FERC Market Rules While Wash Trades are prohibited, some simultaneous exchanges of similar products are allowed. Examples of permitted transactions include: Power exchange to avoid need to use physical transmission Why? Different prices and change of beneficial ownership. Sales or purchases to offset an error Why? Not intentionally prearranged Sleeves: Designed to assure third party of buyer s creditworthiness Why? Not designed to cancel out a trade, but to facilitate one. Bookouts: companies with offsetting delivery obligations agree not to deliver. Why? Occurs after parties took the risks of original transactions based on changed conditions 31

33 What s Prohibited - Examples Transactions predicated on submitting false information Inaccurate or intentionally misleading schedules, load or generation data that is intended to distort the market Excessively high bids in the day ahead market that effectively remove generation from that market so it can be offered in the real time market Scheduling non-firm service or products as firm But not inadvertent or honest errors, or forecasted good faith estimates, so long as organization has procedures in place to evaluate information and reduce risk of error 32

34 What s Prohibited - Examples Artificial Congestion: Transactions in which an entity creates artificial congestion and purports to relieve it scheduling conterflow transactions to cause and relieve congestion, entitling scheduler to congestion relief payments (Enron Death Star ) scheduling non-firm power over congested path with no intention of delivering power, but done to obtain congestion payment upon agreement to cut schedule. Theory: Deceit to take advantage of revenue stream under tariff 33

35 What s Prohibited, and What s Not Not Prohibited: Virtual bidding I.e., bids for the purchase or sale of energy with no expectation of physical delivery. Considered a legitimate form of arbitrage in which a buyer or seller bids in the day ahead market and hopes to profit from a purchase or sale of the energy at real time prices. Unlike a physical bid, the buyer or seller does not have to have load or power to back up its virtual bid. 34

36 Prohibited: What s Prohibited Collusion with another party for purposes of manipulating market prices, market conditions, or market rules related to the jurisdictional sale or transportation of electricity or natural gas Among other things, this prohibition overlaps antitrust law (agreements in restraint of trade) Intentional false reporting (to Gov t or trade press) to advantage a market position 35

37 What s Prohibited Amaranth Advisors, LLC Case Study FERC s findings of fact: Amaranth employees drove down the month-ahead futures contract settlement price by high volume sales at the very end of the settlement period shortly prior to month close. Purpose of activity: To take advantage of the impact of price decline on opposing financial or physical positions in the ensuing month. No legitimate business reason for trades outside intention to manipulate market and affect derivative prices. (Note: Amaranth lost money on trading in prompt month.) 36

38 What s Prohibited Amaranth Advisors, LLC Case Study FERC s conclusions: Amaranth employees intended to deceive/defraud investors in swaps/options and physical markets by interfering with the natural function of the futures market (scienter). Intention established through Amaranth employees knowledge of impact of futures pricing on derivatives and physical markets. Impact on physical markets establishes activity in connection with FERC jurisdictional activity. $30 million penalty assessed Case reversed on jurisdictional grounds 37

39 Rumford Paper Co. 142 FERC 61,218 (2012) ISO-NE Demand Response program provides payment for reduction to base-line load. Rumford is a co-generator. Reduced cogeneration by MW /day for the period during which the baseline was established. Held: Market manipulation. Artificial base-line designed to defraud ISO-NE. Misrepresentation under ISO tariff to take advantage of revenue stream. Compare payments for artificial congestion 38

40 Constellation Energy Commodities Group 138 FERC 61,168 (2012) Traders took long and short Contract for Difference Positions (CFD), and supported them by virtual or actual imports/exports altering market price. When net CFD position was short (betting on price decline), traders arranged to import day ahead power. Note: traders short CFD position offers hedge to buyer seeking insurance against price rise. When net CFD position was long (betting on price rise), traders arranged to export day ahead power (generally at a loss). Holding: Manipulative behavior. $110 million disgorgement; $135 million civil penalty. 39

41 Edison Mission PJM rules require entities designated as capacity resources following winning capacity market bids must bid energy into day-ahead market. Edison Mission, knowing that real-time market is more profitable entered unrealistically high bids into day-ahead market, in order to keep power eligible for real-time market. Held: Edison found to misrepresent strategy to FERC Staff (violation of market-based tariff rules). 40

42 FERC s Penalty Authority Applicable to Organizations and Individuals Criminal Penalties ( FERC refers to Department of Justice) Up to $1 million/day Up to 5 years in prison Civil Penalties Up to $1 million/day FERC has substantial discretion, based on factors including cooperation and quality of compliance program, and level of harm. Disgorgement: FERC will always require disgorgement of ill-gotten profits Refunds: FPA 206 also provides for refunds by 201(f) entities (except for those with less than 8 million mwh/year and cooperatives) for short-term sales into organized markets in violation of Commission-approved tariffs or rules 41

43 What to Do When Something Has Gone Wrong Report the incident immediately to the chief compliance officer Retain all documents related to incident Minimize any ongoing damage Conduct an internal investigation, and report findings to chief compliance officer, senior management, and/or Board Determine whether to conduct outside investigation Take disciplinary action, if necessary Determine if books or reported prices need to be restated Determine whether to self-report 42

44 What to Do When the Government Calls Notify Chief Compliance Officer. No obligation to speak in the meantime. Cooperate with government investigation, at the direction of the Chief Compliance Officer. Chief Compliance Officer will supervise an internal investigation with counsel. Longer term responses include assessment of current control mechanisms and need for new or improved procedures, consideration of whether to shift compliance resources to new areas, whether new hiring and promotion policies are needed, whether the affected department needs new procedures or control mechanisms. 43

45 Fun with Case Studies 44

46 Case Study No. 1 - Electric Utility trader takes a short position (or sale at fixed price) in the month ahead, then asks the utility s affiliated generator to sell at below marginal cost in order to drive the forward market price down. 45

47 Case Study No. 1 - Analysis Generation sales have no legitimate business purpose other than to affect forward market position. Use of physical assets to affect the natural operation of the forward market is manipulative. 46

48 Case Study No. 2 Electric Utility trader takes a long position (could be sale at an indexed price) in the month ahead, then asks the utility s affiliated generator to take plants off line, even though the market is above the generators marginal cost. 47

49 Case Study No. 2 Analysis Taking plant off-line when remunerative sales may be made has no legitimate business purpose. Economic withholding in order to affect market price is a form of market manipulation. 48

50 Case Study - 3 Utility trader takes a long position (or sale an indexed price) in month ahead at Henry Hub and works with other traders to churn market at end of the previous month s close, driving settlement prices up. 49

51 Analysis - 3 End of month churning has no legitimate business purpose and is designed to affect forward market. Manipulation, per Amaranth approach. 50

52 Case Study No. 4 Electric and Gas Trader with combination electric and gas utility offers neighboring utility gas sales from an affiliated storage field at below market prices, for use in generation that was previously priced out of wholesale market. Trader maintains short position in related electric markets. 51

53 Case Study No. 4 - Analysis Below market gas sales have no legitimate business purpose other than to affect forward market position. Use of physical assets to affect the natural operation of the forward market is manipulative. 52

54 Case Study 5 Electric Trader takes long position (or purchase at fixed price). Works with affiliated transmission provider to take key line out of service for unscheduled maintenance (or understates ATC). 53

55 Case Study 5 Analysis Manipulative Conduct - affects natural outcome of market. Violation of Standard of Conduct Possible permutation: Work with neighboring utility (collusion) 54

56 Case Study No. 6 Utility Transmission Function Employee learns that neighboring ATC has been erroneously understated and will soon be corrected. Transmission employee turns information over to trading group, which takes a short position (or sale at fixed price) in the affected market. 55

57 Case Study No. 6 - Analysis Market manipulation follows from a trade based on intentionally misleading data. Collusion to manipulate the market is also present if a marketer is involved. Violation of Standards of Conduct 56

58 Case Study No. 7 Natural Gas Utility Traders report prices to trade press 15% above closing trades and take short position at reflected prices prior to reports. 57

59 Case Study No. 7 Analysis False reporting in order to influence market results constitutes market manipulation. See Coral Energy 58

60 Case Study No. 8 ISO Operations Utility submits a schedule for delivery of power across the CAISO which is erroneously overstated The error is discovered, but goes uncorrected, with knowledge that it will affect forward prices. 59

61 Case Study No. 8 - Analysis If the decision not to correct the schedule was made knowing that the schedule would influence forward market prices to Utility s advantage, this may be market manipulation. Analysis: Intentional omission to alter market outcome 60

62 Case Study No. 9 ISO Operations FERC caps ISO market rate for instate generation in order to control exercise of market power In-state Utility ships power out of state and arranges purchase of an equal amount of power to be shipped in-state 61

63 Case Study No. 9 - Analysis Wash trade designed to circumvent market rules constitutes market manipulation. ENRON Code Name: Richocet Red Flag: Violation of Market Rules 62

64 Case Study No. 10 Under ISO rules, a utility which bids successfully into capacity market is obligated to bid energy into the day-ahead market. Knowing that real-time market is more profitable, utility bids energy into dayahead market at prices it knows are wellabove the market-clearing price. Utility sells energy into the real-time market 63

65 Case Study No. 10 Analysis Intentional effort to circumvent ISO rules through effective misrepresentation is likely to be held to be manipulative. (Note: Edison Mission was penalized for misleading representations, not manipulation) 64

66 Case Study No. 11 Trader takes CRR position at intertie between the CAISO and an external control area Position allows trader to profit from export congestion at the intertie point; suffer losses from import congestion. To decrease losses from the CRR position, trader schedules physical exports from CAISO at the congested intertie, and imports at a separate intertie (at loss or nominal gain). Arrangement designated a wheel-through, but without an external resource/load to which to wheel Exports at the intertie eliminates import congestion, raising the intertie price, increasing CRR value 65

67 Case Study No Analysis Violation #1: Cross-Product Manipulation (18 C.F.R. 1c.2) Traded in one product (physical exports) with the intent to benefit a second product (financial CRR position) Engaged in a scheme involving fraud and deceit under FERC s Anti-Manipulation Rule: Trader s actions injected false and deceptive information into the marketplace and affected the price at the intertie, which hindered the proper functioning of the physical market and the CRR market 66

68 Case Study No. 11 Analysis (contin.) Violation #2: Prohibition of submission of false or misleading information or the omission of material information (18 C.F.R (b)) Submitted false & fraudulent wheel-through transactions to the CAISO, which did not meet CAISO requirements, because they did not have an external resource and load. FERC: This undermines the proper functioning of the CAISO markets Deutsche Bank Energy Trading, LLC, 142 FERC 61,056 (2013) 67

69 GENERAL REGULATORY COMPLIANCE REQUIREMENTS

70 FERC Electric Forms Form No. 1: Annual Report of Major Electric Utility Form No. 1-F: Annual Report of Non-major Electric Utility Form No. 3-Q: Quarterly Financial Report of Electric Utilities, Licensees, and Natural Gas Companies Form No. 423: Cost and Quality of Fuels for Electric Plants Form No. 520: Application for Authority to Hold Interlocking Directorate Positions Form No. 523: Application for Authorization of the Issuance of Securities or the Assumption of Liabilities Form No. 556: Certification of QF Status for Small Power Production and Cogeneration Facilities Form No. 561: Interlocking Directorates FERC-566: Twenty Largest Purchasers FERC-580: Interrogatory on Fuel and Energy Purchase Practices Form No. 714: Annual Electric Control and Planning Area Report Form No. 715: Annual Transmission Planning and Evaluation Report FERC-730: Report of Transmission Investment Activity FERC-920: Electric Quarterly Report 69

71 Forms (cont d) FERC Gas Forms Form No. 2: Major Natural Gas Pipeline Annual Report Form No. 2A: Non-major Natural Gas Pipeline Annual Report Form No. 3-Q: Quarterly Financial Report of Electric Utilities, Licensees, and Natural Gas Companies Form No. 11: Quarterly Statement of Monthly Data Form No. 537: Annual Certificate Report Form No. 537: Annual Report of 311 Facility Activities Form No. 537: Notice of Bypass Form No. 537: Semi-annual Storage Report Form No. 549B: Index of Customers Form No. 549B: Capacity Report Under Section Form No. 549D: Quarterly Transportation & Storage Report for Intrastate Natural Gas and Hinshaw Pipelines Form No. 552: Annual Report of Natural Gas Transactions Form No. 567: System Flow Diagrams Form No. 576: Report of Service Interruptions Form No. 577: Annual Report of Replacement of Certificated Facilities Form No. 592: Marketing Affiliates of Interstate Pipelines 70

72 Forms (cont d) FERC Hydro Power Forms Form No. 3-Q: Quarterly Financial Report of Electric Utilities, Licensees, and Natural Gas Companies Form No. 80: Licensed Hydropower Development Recreation Report Form No. 587: Federal Land Description Other Federal Agency Cost Submission Form 71

73 Cost-Based Rate and Tariff Review An electric utility must obtain FPA section 205 rate approval to change 1. Cost-of-Service rates (e.g., transmission) and 2. Tariff 72

74 Market-Based Rate Review by FERC Granted if neither seller or its affiliates have market power in generation or transmission (or such market power has been mitigated) Conditioned on (1) restrictions governing transactions and conduct between power sales affiliates with captive customers; (2) filing post-transaction election quarterly transaction reports (EQRs), and (3) notice of change in status Under Order 697, marketers with market-based rate authority no longer need to file triennial updates if they are determined to be a Category 1 Seller (own/control <500 MW generation per region). Category 2 sellers (everyone else) are required to file regularly scheduled updated market power analyses. 73

75 E Q R s - M u s t s u m m a r i z e e a c h q u a r t e r The contractual terms and conditions of its agreements for all jurisdictional services (including market-based power sales). Transaction information for short-term and long-term market-based power sales. Agreements entered into pursuant to a marketbased rate tariff do not need to be filed with FERC; the terms of the agreements only need to be summarized in the EQRs. Financial transactions that do not go to physical delivery, e.g., virtual bidding, do not need to be filed in the EQRs. Filing deadlines last day of the month following the quarter. For example, for the period January 1 through March 31, the EQR due by April

76 C h a n g e i n S t a t u s M a r k e t - B a s e d R a t e s A change in status is triggered by: A change in ownership or control of generation or transmission facilities or inputs to electric power production and Affiliation with any entity not disclosed in the application for market-based rate authority that owns or controls generation or transmission facilities or inputs to electric power production (other than fuel supply), or affiliation with any entity that has a franchised service area. 18 C.F.R (c)(1)(i) and (ii). Control arrangements, contractual or otherwise, granting control of generation or transmission facilities, just as effectively as they could through ownership. FERC considers the totality of circumstances on a fact-specific basis, with no single factor or factors necessarily resulting in control. 75

77 MBR holder must file a change in status report when it (or an affiliate): Gains control over the operation of a generation facility, either by ownership or contractual arrangement (e.g., energy management, asset management, tolling, scheduling, or dispatching agreements). Obtains cumulative increases in generation owned or of 100 MW or greater (net of decreases) since the initial application or last triennial review/change in status report. Gains ownership or control of natural gas transportation, storage or distribution facilities. 76

78 Presumption of Control: [A]n entity controls the facilities when it controls the decision-making over sales of electric energy, including discretion as to how and when power generated by these facilities will be sold. Operation of the real-time desk 76% of the time (16 hours during the work week (off peak) and 24 hours per day during weekends and holidays); decision-making authority over sales of electric energy, including discretion as to how, when and to whom to sell power, subject only to reliability concerns; dispatch instructions while manning trading desk; power scheduling services. Setting price, as long as operational and reliability criteria met. 77

79 Occasional sales of wholesale energy to itself while operating the real-time desk, i.e., taking title to power. Access to sensitive, competitive information (e.g., load information, unit heat rate, etc.). Authority to enter into day-ahead wholesale electricity contracts with provided volume and acceptable prices (minimum, not ceiling); with occasional scheduling of the physical power. Authority to determine timing and volume of RTO bids. Authority to dispose of the output of certain generation assets. Ability to withhold the supply from the market. 78

80 Interlocking Positions FPA Section 305(b) deals with the holding of interlocking positions, that is, an officer or director of: more than one public utility (which includes entities with market-based rate authority a public utility and (a) a bank, trust company or firm authorized to underwrite public utility securities; or (b) a company supplying electrical equipment to such public utility. An Officer or Director is defined as: a president, vice president, secretary, treasurer, general manager, comptroller, chief purchasing agent, director or partner, or anyone who performs similar executive duties or functions. 18 C.F.R

81 Individuals holding the position of officer or director of a public utility and of any bank, trust company, banking association, or firm authorized to underwrite utility securities or an entity providing electrical equipment to a public utility must file an application seeking FERC authorization to hold the interlocking positions. If FERC does not act on the application within 60 days, it is deemed granted. The key to the interlock rules is that the initial filing must be made (and approval received if necessary) before the person takes the position. Subsequently, each individual holding interlocking positions must file a FERC Form 561 by April 30 listing the interlocking positions held for the prior calendar year. 80

82 Rules On Standards Of Conduct

83 Elements Of This Segment Explain Standards of Conduct governing organization of utilities with both Marketing and Transmission Functions under one roof. Explain the core principle embodied in the Standards of Conduct the Independent Functioning Rule. Describe the No-Conduit Rule as it pertains to transmission information. Describe the procedure to be utilized when transmission information is improperly disclosed. Tariff administration requirements 82

84 History: Order 888 And 889 In 1996, FERC issued Order 888, which compelled Investor Owned Utilities to provide transmission service to eligible customers under a standard (pro forma) Open Access Transmission Tariff (OATT). At the same time, FERC issued Order 889 which established standards of conduct governing the relationship between transmission operations and wholesale merchant operations within a utility. 83

85 Application Of Rules Governing Standard Of Conduct Standards of Conduct Rules apply directly to FERC jurisdictional utilities Electric and Natural Gas (interstate pipeline) Public Utilities For FPA 201(f) Entities (generally nonjurisdictional utilities),the Reciprocity Rule appplies Reciprocity permits an investor owned utility to deny service to a non-jurisdictional utility unless the NJU first offers to provide reciprocal service to the IOU. 84

86 History: Post-order 889 Standards Order 2004 Expanded Standards of Conduct rules adopted in FERC Order 2004 in 2003 Order 2004 rules were perceived as overly expansive and overly complex Portions of Order 2004 invalidated on appeal FERC ultimately acknowledged the problems with Order 2004 and went back to the drawing board 85

87 Order No. 717 FERC announced revised standards of conduct rules in Order No. 717, issued on October 16, 2008 Standards of Conduct rules adopted in Order No. 717, with some later clarifications, remain in place Part 358 of FERC s regulations 18 C.F.R. Pt

88 Order No. 717 Key Aspects Core purpose is to prevent sharing of non-public transmission function information with affiliated marketing function that might provide marketing function with advantage over unaffiliated transmission customers 87

89 Keep In Mind... Two Fundamental Rules: Independent Functioning of Transmission and Wholesale Merchant Function Employees Golden Rule: Utility Merchant employees cannot have any non-public transmission information. 88

90 Employees Governed By Standards Of Conduct Rules Everybody within a utility, with particular application to: Marketing Function Employees Transmission Function Employees Individuals within the utility to whom Wholesale Marketing and Transmission function employees report and with whom they conduct business 89

91 The Core Principle: Independent Functioning Focus is on functions performed by individual employees Transmission function employees must function independently of wholesale marketing function employees ( Functional Unbundling ) Transmission operations personnel and management cannot treat wholesale marketing employees any differently than any other independent marketers. This relates to the nature of service and information exchanged within the utility and with third parties. 90

92 Employees Governed By Standards Of Conduct Rules - Definitions Marketing Function - the sale for resale in interstate commerce or the submission of offers to sell for resale in interstate commerce, of electric energy or capacity, demand response, virtual transactions, or financial or physical transmission rights. It excludes bundled retail service Purchases of power are not covered Marketing Function Employee an employee, contractor, consultant or agent of a transmission provider or of an affiliate of a transmission provider who actively and personally engages on a day-to-day basis in marketing functions. 91

93 Employees Governed By Standards Of Conduct Rules - Definitions Transmission Function - the planning, directing, organizing or carrying out of dayto-day transmission operations, including the granting and denying of transmission service requests. Does not include long-range planning activities Transmission Function Employee an employee, contractor, consultant or agent of a transmission provider who actively and personally engages on a day-to-day basis in transmission functions. 92

94 Day-to-day Transmission Operations Granting or denying transmissions service requests, regardless of duration Coordinating actual physical flows of power Isolating portions of system to prevent cascades Imposing transmission loading relief Performing system impact studies if the SIS is performed to determine whether the system can support a transmission service request SIS for generator interconnection request is not a transmission function 93

95 Who Are Not Transmission Function Or Marketing Function Employees? Field Maintenance Construction Clerical Engineering Unless actively and personally involved on a day-to-day basis in transmission or marketing operations 94

96 Who May Be Transmission Function Or Marketing Function Employees? Attorneys Accountants Risk Management Personnel Regulatory Personnel Rate Design Personnel Strategic planning personnel Procurement employees Officers Consultants and Contractors These employees may be Transmission or Marketing Function Personnel if they are actively and personally involved on a day-to-day basis in transmission or marketing operations. 95

97 Independent Functioning Rule (18 C.F.R ) Transmission Function employees must function independently of its Wholesale Marketing Employees. Marketing Function Employees may not conduct transmission functions Transmission Function Employees may not conduct marketing functions 96

98 Physical And Organizational Separation: Organizations may meld transmission and marketing employees, but must honor No conduct and independent Function Rule. Structural Separation often implemented. Note: Employees engaged in the Wholesale Merchant Function have no access to the System Control Room. Officers and Directors may maintain dual responsibility, but may not engage in dayto-day transmission and merchant functions 97

99 Information Access - No-conduit Rule (18 C.F.R ) No conduit rule applies to all utility employees, contractors and agents. Non-public transmission function information is transmission information not available to OATT customers on OASIS. 98

100 Examples Of Information That May Not Be Disclosed To Marketing Employees Transmission Capability (if not on OASIS), Transmission Reliability Margins and Capacity Benefit Margins for other companies Information about planned transmission outages, now matter how far in the future Non-public transmission costs and budgets Non-public transmission customer information Transmission studies (System Impact, Facilities), other than to applicants 99

101 Examples Of Information That May Not Be Disclosed To Marketing Employees Transmission planning information (e.g., additions, upgrades) Maintenance schedules Information on pending transmission requests Transmission information about other systems, if not public 100

102 Integrated Resource Planning Revised Standards of Conduct Rules permit long-term integrated resource planning (integration of transmission, generation and load planning) How did the rules change? Transmission planning (other than day-to-day) is no longer defined as a Transmission Function Resource Procurement (buying power) is no longer defined as a Marketing Function Generation operations personnel are not defined as marketing function employees BUT, Marketing Function Employees may not work with Transmission Function Employees on Integrated Resource plans. 101

103 Exemptions To Non-disclosure Rule Information pertaining to compliance with NERC Reliability Standards may be disclosed to Marketing Employees Information necessary to maintain or restore operation of the transmission system, or generating units, or that may impact dispatch of generating units may be disclosed to Marketing Employees. Where information is disclosed under these exemptions, report must be made to the Chief Compliance Officer, who will retain record of the disclosure for five years. 102

104 Transparency Rule Improper Disclosure Improper disclosure of transmission function information must be promptly reported to Chief Compliance Officer. Disclosed information must be promptly posted on OASIS. For two categories of information, only notice of improper disclosure should be posted, not the information itself: (a) Critical Infrastructure Information (CEII); and (b) transmission customer information Posting does not cure original violation; failure to post is a separate violation 103

105 Transparency Rule General Posting Requirements Standards of Conduct implementation procedures Affiliates with marketing function employees Facilities shared by transmission function employees and marketing function employees Job titles and job descriptions of transmission function employees Notice of transfer of a transmission function employee to a marketing function position and vice-versa Potential merger partners 104

106 Tariff Administration FERC Standards of Conduct regulations in Part 358 also include general rules to ensure non-discrimination in the provision of transmission service and administration of the OATT Overarching requirement to treat all transmission customers on a not unduly discriminatory basis and not to grant any undue preference or advantage (a) 105

107 Tariff Administration Tariff provisions not providing for discretion Employees engaged in transmission system operations or reliability functions shall strictly enforce all Tariff provisions relating to the sale or purchase of open access transmission service, if these provisions do not provide for the use of discretion. Tariff Provisions providing for discretion. Employees engaged in transmission system operations shall apply all tariff provisions relating to the sale or purchase of open access transmission service in a fair and impartial manner that treats all customers in a nondiscriminatory manner if these provisions involve discretion. 106

108 RELIABILITY OVERSIGHT

109 FPA Section 215 & Background 108

110 NERC s Story: The Tale Of Two Blackouts November 9, 1965 August 14,

111 110

112 Problem Who Has Regulatory Authority? FERC s authority over reliability of the transmission system was unclear until Energy Policy Act of NERC was a voluntary organization, relying on reciprocity and the mutual self-interest of all those involved State authority varied and limited. In some cases, may be non-existent 111

113 FPA Section Statutory Basics A Few Observations Congress enacted mandatory reliability regime with full industry support - Energy Policy Act of 2005 Congress rejected FERC-centric regime in favor of an ERO required to consider stakeholder input in Choosing board of trustees Populating committees Relationship with Industry is complicated: The ERO must be independent of industry, but it depends on industry for the content of the standards. Relationship with FERC is complicated: NERC is overseen by FERC which approves standards and can reverse enforcement actions. NERC occupies the same space as FERC, which: is also authorized to direct NERC to develop specific standards; and may undertake its own enforcement actions. 112

114 Energy Policy Act Of 2005: Federal Power Act Section 215, 16 U.S.C. 824o (a)(4): The term reliable operation means operating the elements of the bulk-power system within equipment and electric system thermal, voltage, and stability limits so that instability, uncontrolled separation, or cascading failures of such system will not occur as a result of a sudden disturbance, including a cybersecurity incident, or unanticipated failure of system elements. (b) Jurisdiction and applicability (1)The Commission [FERC] shall have jurisdiction, within the United States, over the ERO [Electric Reliability Organization] certified by the Commission under subsection (c) of this section, any regional entities, and all users, owners and operators of the bulk-power system, including but not limited to the entities described in section 201(f) for purposes of approving reliability standards established under this section and enforcing compliance with this section. All users, owners and operators of the bulk-power system shall comply with reliability standards that take effect under this section. 113

115 Federal Power Act Section 215, Statutory Basics Certification Of ERO The Commission may certify an ERO that: (1)has the ability to develop and enforce reliability standards that provide for an adequate level of reliability of the bulk-power system; and (2)has established rules that (A) assure its independence of the users and owners and operators of the bulk-power system, while assuring fair stakeholder representation in the selection of its directors and balanced decisionmaking in any ERO committee or subordinate organizational structure; 114

116 Federal Power Act Section 215, Statutory Basics - Certification The Commission may certify an ERO that: (2) has established rules that (B) Allocate equitably reasonable dues; (C)provide fair and impartial procedures for enforcement of reliability standards through the imposition of penalties in accordance with subsection (e) of this section; (D)provide for reasonable notice and opportunity for public comment, due process, openness, and balance of interests in developing reliability standards and otherwise exercising its duties; and (E)provide for taking, after certification, appropriate steps to gain recognition in Canada and Mexico. 115

117 Federal Power Act Section 215, Statutory Basics Reliability Standards 215(d) ERO must file each standard with FERC; FERC may approve standard if determined to be just and reasonable, not unduly discriminatory or preferential and in the public interest. FERC will give due weight to technical expertise of the ERO [untested in court] FERC shall remand proposed standards that are disapproved [FERC does not have authority directly to modify standards also untested] 215(d)(5): FERC may order ERO to submit proposed reliability standards or modifications that address specific matters that FERC determines are needed to carry out section 215 [but FERC can t draft standards again untested] See: FERC s March 7, 2014 order directing NERC to develops standards addressing physical security Reliability Standards for Physical Security Measures, 146 FERC 61,166 (2014) 116

118 Federal Power Act Section 215, Enforcement FPA Section 215(e) (e) Enforcement (1) The ERO may impose, subject to paragraph (2), a penalty on a user or owner or operator of the bulk-power system for a violation of a reliability standard approved by the Commission under subsection (d) of this section if the ERO, after notice and an opportunity for a hearing (A)finds that the user or owner or operator has violated a reliability standard approved by the Commission under subsection (d) of this section; and (B)files notice and the record of the proceeding with the Commission. 117

119 Federal Power Act Section 215, Enforcement FPA Section 215(e) (e) Enforcement By FERC: (3)On its own motion or upon complaint, the Commission may order compliance with a reliability standard and may impose a penalty against a user or owner or operator of the bulk-power system if the Commission finds, after notice and opportunity for a hearing, that the user or owner or operator of the bulk-power system has engaged or is about to engage in any acts or practices that constitute or will constitute a violation of a reliability standard. By Regional Entities: (4) FERC may authorize the ERO to delegate enforcement authority to a regional entity that is governed by an independent or balanced stakeholder board (or a combination) 118

120 NERC as ERO; Mandatory Standards: FERC Order No. 672 NERC was certified as the ERO on July 20, 2006 Standards were rushed from their state as voluntary guidelines to mandatory status by June FERC Order No 693: FERC approved 83 of 107 proposed standards, making them mandatory & enforceable NERC pressed to morph from an industrysponsored voluntary organization into an entity capable of producing enforceable standards and enforcing them in the same time-frame. There were bound to be growing pains. 119

121 The Current FERC/NERC Model NERC: Develops & enforces reliability standards Monitors the BPS Educates & trains industry personnel NERC s Vulnerabilities: Standards development Enforcement backlog FERC s overlapping authority FERC: Approves standards; penalties Makes recommendations & directives to NERC to improve/develop standards Investigates & enforces serious violations Analyzes wide-scale events 120

122 NERC Reliability Standards 121

123 Reliability Standards Applicability Reliability standards apply to all elements and facilities that fall with Bulk Electric System (BES) Definition 2010: FERC Order 743 directs new BES definition New core BES definition employs 100kv bright-line threshold, with specified inclusions & exclusions approved by FERC in Order No. 773; effective 7/1/14 Additional refinements to inclusions & exclusions approved in March

124 Reliability Standards Applicability NERC s new BES definition employ a 3-step process: Step 1: Core BES Definition: All Transmission Elements operated at 100 kv or higher, and Real Power and Reactive Power resources connected at 100 kv or higher. 123

125 Reliability Standards Applicability Step 2: Application of Inclusions (five) I1 Transformers with the primary terminal and at least one secondary terminal operated at 100 kv or higher unless excluded by application of Exclusion E1 or E3. I2 Generating resource(s) including the generator terminals through the high side of the step up transformer(s) connected at a voltage of 100 kv or above with: Gross individual nameplate rating greater than 20 MVA. Or, Gross plant/facility aggregate nameplate rating greater than 75 MVA. I3 Blackstart Resources identified in the Transmission Operator s restoration plan. I4 Dispersed power producing resources that aggregate to a total capacity greater than 75 MVA (gross nameplate rating), and that are connected through a system designed primarily for delivering such capacity to a common point of connection at a voltage of 100 kv or above. Thus, the facilities designated as BES are: The individual resources, and The system designed primarily for delivering capacity from the point where those resources aggregate to greater than 75 MVA to a common point of connection at a voltage of 100 kv or above. I5 Static or dynamic devices (excluding generators) dedicated to supplying or absorbing Reactive Power that are connected at 100 kv or higher, or through a dedicated transformer with a high side voltage of 100 kv or higher, or through a transformer that is designated in Inclusion I1 unless excluded by application of Exclusion E4. 124

126 Reliability Standards Applicability Step 3: Application of Exclusions (four) 125

127 NERC Standards (BAL) Resource and Demand Balancing BAL BAL-001-TRE-1 BAL BAL b BAL BAL-004-WECC-02 BAL b BAL BAL-502-RFC-02 BAL-STD Real Power Balancing Control Performance Primary Frequency Response in the ERCOT Region Disturbance Control Performance Frequency Response and Bias Time Error Correction Automatic Time Error Correction Automatic Generation Control Inadvertent Interchange Planning Resource Adequacy Analysis, Assessment and Documentation Operating Reserves (WECC) 126

128 NERC Standards (CIP) Critical Infrastructure Protection CIP CIP CIP-004-3a CIP-005-3a CIP-006-3c CIP-007-3a CIP CIP Cyber Security - Critical Cyber Asset Identification Cyber Security - Security Management Controls Cyber Security - Personnel & Training Cyber Security - Electronic Security Perimeter(s) Cyber Security - Physical Security of Critical Cyber Assets Cyber Security Systems Security Management Cyber Security - Incident Reporting and Response Planning Cyber Security - Recovery Plans for Critical Cyber Assets 127

129 NERC Standards (COM) Communications COM COM Telecommunications Communications and Coordination 128

130 NERC Standards (EOP) Emergency Preparedness & Operations EOP b Emergency Operations Planning EOP Capacity and Energy Emergencies EOP Load Shedding Plans EOP Event Reporting EOP System Restoration from Blackstart Resources EOP System Restoration Coordination EOP Loss of Control Center Functionality 129

131 NERC Standards (FAC) Facilities Design, Connections and Maintenance FAC FAC FAC FAC FAC FAC FAC FAC FAC-501-WECC-1 Facility Connection Requirements Coordination of Plans For New Generation, Transmission, and End-User Facilities Transmission Vegetation Management Program Facility Ratings System Operating Limits Methodology for the Planning Horizon System Operating Limits Methodology for the Operations Horizon Assessment of Transfer Capability for the Near-term Transmission Planning Horizon Establish and Communicate System Operating Limits Transmission Maintenance (WECC) 130

132 NERC Standards (INT) Interchange Scheduling & Coordination INT INT INT INT INT INT INT INT INT Interchange Information Interchange Transaction Implementation Dynamic Interchange Transaction Modifications Interchange Authority Distributes Arranged Interchange Response to Interchange Authority Interchange Confirmation Interchange Authority Distributes Status Implementation of Interchange Interchange Coordination Exemptions 131

133 NERC Standards (IRO) Interconnection Reliability Operations & Coordination IRO IRO IRO IRO IRO a IRO IRO-006-EAST-1 IRO-006-TRE-1 IRO-006-WECC-1 IRO IRO IRO-010-1a IRO IRO IRO Reliability Coordination - Responsibilities and Authorities Reliability Coordination - Facilities Reliability Coordination - Wide-Area View Reliability Coordination - Operations Planning Reliability Coordination - Current Day Operations Reliability Coordination - Transmission Loading Relief (TLR) Transmission Loading Relief Procedure for the Eastern Interconnection IROL and SOL Mitigation in the ERCOT Region Qualified Transfer Path Unscheduled Flow Relief (WECC) Reliability Coordinator Operational Analyses and Real-time Assessments Reliability Coordinator Actions to Operate Within IROLs Reliability Coordinator Data Specification and Collection Procedures, Processes, or Plans to Support Coordination Between Reliability Coordinators Notifications and Information Exchange Between Reliability Coordinators Coordination of Real-time Activities Between Reliability Coordinators 132

134 NERC Standards (MOD) Modeling, Data & Analysis MOD-001-1a MOD MOD MOD MOD MOD MOD Available Transmission System Capability Capacity Benefit Margin Transmission Reliability Margin Calculation Methodology Steady-State Data for Modeling and Simulation of the Interconnected Transmission System Dynamics Data for Modeling and Simulation of the Interconnected Transmission System Documentation of Data Reporting Requirements for Actual and Forecast Demands, Net energy for Load, and Controllable Demand-Side Management Aggregated Actual and Forecast Demands and Net Energy for Load MOD MOD Treatment of Nonmember Demand Data and How Uncertainties are Addressed in the Forecasts of Demand and Net Energy for Load Reporting of Interruptible Demands and Direct Control Load Management MOD MOD MOD MOD-029-1a MOD Providing Interruptible Demands and Direct Control Load Management Data to System Operators and Reliability Coordinators Documentation of the Accounting Methodology for the Effects of Demand-Side Management in Demand and Energy Forecasts Area Interchange Methodology Rated System Path Methodology Flowgate Methodology 133

135 NERC Standards (NUC) Nuclear NUC Nuclear Plant Interface Coordination 134

136 NERC Standards (PER) Personnel Performance, Training & Qualifications PER PER PER PER Operating Personnel Responsibility and Authority Operating Personnel Credentials Reliability Coordination - Staffing System Personnel Training 135

137 NERC Standards (PRC) Protection and Control PRC PRC-002-NPCC-01 PRC a System Protection Coordination Disturbance Monitoring Analysis and Mitigation of Transmission and Generation Protection System Misoperations PRC-004-WECC-1 Protection System and Remedial Action Scheme Misoperation (WECC) PRC b Transmission and Generation Protection System Maintenance and Testing PRC PRC-006-SERC-01 PRC PRC Automatic Underfrequency Load Shedding Automatic Underfrequency Load Shedding Requirements Implementation and Documentation of Underfrequency Load Shedding Equipment Maintenance Program Technical Assessment of the Design and Effectiveness of Undervoltage Load Shedding Program PRC PRC PRC PRC PRC Undervoltage Load Shedding System Maintenance and Testing Special Protection System Data and Documentation Special Protection System Misoperations Special Protection System Maintenance and Testing Disturbance Monitoring Equipment Installation and Data Reporting PRC PRC PRC Under-Voltage Load Shedding Program Data Under-Voltage Load Shedding Program Performance Transmission Relay Loadability 136

138 NERC Standards (TOP) Transmission Operations TOP-001-1a TOP b TOP TOP TOP-005-2a TOP TOP TOP-007-WECC-1 TOP Reliability Responsibilities and Authorities Normal Operations Planning Planned Outage Coordination Transmission Operations Operational Reliability Information Monitoring System Conditions Reporting System Operating Limit (SOL) and Interconnection Reliability Operating Limit (IROL) Violations System Operating Limits (WECC) Response to Transmission Limit Violations 137

139 NERC Standards (TPL) Transmission Planning TPL TPL-002-0b TPL-003-0b TPL-004-0a System Performance Under Normal (No Contingency) Conditions (Category A) System Performance Following Loss of a Single Bulk Electric System Element (Category B) System Performance Following Loss of Two or More Bulk Electric System Elements (Category C) System Performance Following Extreme Events Resulting in the Loss of Two or More Bulk Electric System Elements (Category D) 138

140 NERC Standards (VAR) Voltage & Reactive VAR VAR-002-2b VAR-002-WECC-1 VAR-501-WECC-1 Voltage and Reactive Control Generator Operation for Maintaining Network Voltage Schedules Automatic Voltage Regulators (AVR) (WECC) Power System Stabilizer (PSS) (WECC) 139

141 NERC Standards Development Process 140

142 NERC Standards Development Process 141

143 Standards Development - 9 Steps 1. Identify need for standard & Draft Standard Authorization Request (SAR) 2. Post SAR for 30-day Informal Comment Period 3. Develop draft of standard Form Standards Drafting Team Field testing & quality review Informal feedback loop; revisions made as needed 142

144 Standards Development - 9 Steps 4. Obtain Standard Committee approval to post for comment/ballot 5. Comment Period and Ballot Draft changes/conduct additional Ballot if significant changes needed 6. Post response to Comments 143

145 Standards Development - 9 Steps 7. Conduct Final Ballot 8. Submit standard to Board of Trustees for adoption and approval 9. Submit BOT-approved standard to FERC for approval 144

146 NERC Compliance & Enforcement 145

147 NERC Compliance & Enforcement Organization 146

148 Regional Entities 147

149 Compliance Monitoring Processes Compliance Audits 5 stages: Pre-Audit; Planning; Fieldwork; Reporting; Performance Assessment Annual Self-certifications Spot Checks Compliance Investigations Self-reports Periodic Data Submittals Complaints Exception Reports 148

150 Self-Reports: Why Disclose Potential credit for self-reporting Request Expedited treatment: Find, Fix, Track & Report (FFT) Process (for minimal and moderate risk issues) Enhance reputation with the agency Negotiate settlement Reduce fines 149

151 Self-report Now What? Assessment of possible violation Preliminary Screen Meetings Data Requests Dismissed Find, Fix and Track Acceptance Still a violation No penalties Notice of Alleged Violation (NERC Enforcement Process) 150

152 NERC Internal Compliance Program FERC s Policy Statements on Compliance October 16, 2008 Supplemented May 15, 2008 Revised Policy Statement on Enforcement. Four Hallmarks of Compliance Program Active engagement by senior management Preventive measures Prompt detection, cessation and reporting Remediation of misconduct NERC s Sanction Guidelines emphasize similar factors, and gear penalties to Violation Severity Levels and Violation Risk Factors (unique to each requirement) and Violation Severity Levels (measure of responsible entity performance) 151

153 NERC Enforcement Process 1. Preliminary Screen 2. Possible Alleged Violation 3. Notice of Alleged Violation (NAV) 4. Registered Entity Response 152

154 NERC Enforcement Process 5. Settlement Process 6. Notice of Confirmed Violation (NOCV) 7. Notice of Penalty (NOP) 8. FERC Review 9. Closure of Enforcement Action 153

155 What s Filed with FERC? NERC s monthly enforcement filings: Notice of Penalties Spreadsheet Notice of Penalties What s not filed, but posted & retained for informational purposes: Find, Fix, Track & Report Spreadsheet 154

156 NERC Appeals Process Appeal to NERC Use NERC Rules of Procedure No settlement? Appeal to FERC Use FERC Rules of Procedure No settlement with FERC? US Court of Appeals 155

157 Mitigation Plans An entity found in violation of a standard SHALL file with the Region: A proposed mitigation plan to correct the violation; or A description of how the violation has been mitigated. An entity MAY also submit a proposed mitigation plan at any other time (i.e., with a self-report, in response to a NOPV or NAV) without admitting it has committed a violation 156

158 NERC Compliance & Enforcement: What the Future Holds 157

159 In a Nutshell: NERC s Reliability Assurance Initiative (RAI) A shift in thinking about reliability compliance & enforcement, towards a sustainable end state A move towards a risk-based approach to ensure proper allocation of resources Why? Not practical, effective or sustainable to monitor all compliance issues to the same degree, or to treat all non-compliance similarly Must right size compliance monitoring and enforcement based on: Key Elements: Entity Risk factors Entity internal controls (practices related to self-detection, assessment, mitigation & reporting of non-compliance) Focuses on each entity Removes compliance concerns regarding data retention Provides incentives for taking control of compliance Compliance a necessary component of reliability Emphasizes self-monitoring and self-reporting 158

160 NERC RAI Compliance Monitoring Process Flow 159

161 Risk-Based Enforcement Risk and Control Assessment Input Audit, Spot Check, Etc. Log, Self- Report, Self- Certification Triage Record Compliance Exception Enforce Feedback to Risk and Controls Assessment 160

162 Penalties Under the FPA, civil penalties for violations of reliability standards: up to $1M per day, per violation, for its duration. 161

163 Additional Resources 162

164 Resources Federal Power Act, Title 16 USC, Chap. 12 (Sec. 215) Energy Policy Act of 2005, 42 USC CFR Part 40, Mandatory Reliability Standards for the Bulk-Power System FERC: FERC Order No. 693, Mandatory Reliability Standards for the Bulk-Power System, March 16, 2007 FERC Order No. 706, Mandatory Reliability Standards for Critical Infrastructure Protection, January 18, 2008 FERC Order No. 773, Revisions to Electric Reliability Organization Definition of the Bulk Power System and Rules of Procedure FERC s Policy Statement on Compliance, 125 FERC 61,058 (2008) FERC s Revised Policy Statement on Enforcement, 123 FERC 61,156 (2008) NERC: Rules of Procedure of the North American Electric Reliability Corporation (NERC) NERC CMEP; CMEP Implementation Plan; AML NERC Reliability Standard Audit Worksheets (RSAWs) NERC Compliance Application Notices (CANs) RAI: 163

165 Helpful Websites FERC - NERC - Standards Mandatory, approved, proposed Webinars Resource Documents Procedures Regional Entity websites US Sentencing Guidelines

166 CONCLUSION & QUESTIONS

167 CYBERSECURITY OVERSIGHT

168 Getting Serious About Cybersecurity EUCI Compliance and Enforcement Washington, D.C. Jonathan Schneider October 29,

169 Background Evidence of the nation s cyber vulnerability has increased geometrically over the past five years Mandiant report of the concerted effort apparently mounted by China s military was eye-opening. Recent CrowdStrike report details Chinese military strikes at government, military contractor, and research facilities in satellite and space industries. High profile incidents pointing to potential destructive potential include: Shamoon attack on Saudi Aramco disabled 30,000 computers 23 attacks on US Pipeline systems in 2012 Dozens of attacks on financial institutions in 2012 (DHS report) Major Denial of Service attack successfully brought down internet service to Jacksonville Electric Authority in late-2013 May, 2014 ICS-CERT reported successful intrusion into internet-facing utility control system through password compromised by brute-force attack. Soviet Invasion of Georgia - Potential for full-out cyber warfare demonstrated Former Secretary of Defense Leon Panetta warned of potential for a Cyber Pearl Harbor. DOE Idaho Labs Aurora Test 168

170 DHS Industrial Control Systems Emergency Response Team (ICS-CERT) 10/2012 Report Energy sector has been a focal point: - 40% of all cyber attacks in % in

171 Department of Homeland Security - Industrial Control Systems Cyber Emergency Response Team (ICS-CERT) 2013 Report 170

172 Understanding Cyber Vulnerabilities Attack Vectors Internet access (hacking) Phishing ( ) Watering Hole Attacks (logging on to mined websites) Inserted malware (Stuxnet and reversed engineered versions) Mobile device attacks Internal exposure Electric Sector Vulnerabilities Operations/Control Systems Idaho Labs Aurora Test Industry wake-up call Televant (project files for OASyS SCADA system stolen) Communications and Information Systems Communications: JEA Denial of Internet Service Theft (proprietary data Nortel, banking) 171

173 Legislative Gridlock At least half-dozen bills introduced in Congress over the past five years, and dozens of amendments Most legislative activity targeted energy industry Ironically, energy industry may be better protected through NERC standards than any other sector Focus now encompasses other major economic, physical infrastructure and manufacturing sectors. Electric Industry Supported: Information Sharing Govt. to Industry Emergency Directives Liability Protection Electric Industry Opposed: Redundant mandatory standards Disruption of Industry-based (NERC) Standards Development Process 172

174 White House Response to Legislative Gridlock White House stepped into the legislative void on February 12, 2013 with its Executive Order ( Improving Critical Infrastructure Cybersecurity ) Executive Order sets up a broad program: Provides for information sharing by federal agencies w/owners of critical assets Cybersecurity Framework to be promulgated by the National Institute of Standards and Technology (NIST) A voluntary framework for managing cyber vulnerabilities Preliminary draft was due 10/10/13 173

175 Evaluating the NIST Framework Against Existing Standards and Guidelines NERC s Suite of Critical Infrastructure Protection Standards Versions 3, 4 (moot) and 5 DOE s Maturity Model Electricity Subsector Cybersecurity Maturity Model ( C2M2 ) 174

176 Critical Infrastructure Protection ( CIP ) under North American Electric Reliability Corporation (NERC) Standards The State of Play NERC s Suite of CIP Standards V. 3 - now in effect V. 5 Approved with modifications by FERC Rule issued Nov. 22, 2013 Enforceable on April 1, 2016, though technically effective April 1, 2014 (Transition Period) V. 4 (never effective) held moot in order approving V. 5 NERC Transition from V 3 to V. 5 See June 9 Transition Guidance Compliance with V. 5 will satisfy V. 3 during the transition period NERC Transition Guidance maps V. 3 to V., showing where standards are Mostly Compatible. 175

177 Critical Infrastructure Protection ( CIP ) Under NERC Standards CIP BES Cyber System Categorization - identification and risk-based ranking of BES Cyber Systems Definitions: BES Cyber System defined as one or more BES Cyber Assets logically grouped by a responsible entity to perform one or more reliability tasks. Cyber Assets Programmable electronic devices, including hardware, software and data» [Note: communication deleted w/v.5] BES Cyber Assets - are those that if rendered unavailable, degraded or misused would, within 15 minutes of required operation.adversely impact one or more facilities.which if unavailable, would affect the reliable operation of the Bulk Electric System. [subject to one year study] Impact Ranking of Cyber Systems - High, Medium and Low 176

178 CIP Standards - CIP BES Cyber System Categorization V. 5: Categorizes ALL BES Cyber Systems (Impact Rating Criteria): High Impact: BES Systems located at Large Control Centers (Reliability Coordinators; BAs with generation aggregating to 3000 MW); specified Transmission and Generation Medium Impact: Generation and Transmission + smaller control centers Generation aggregated to 1500 MW or higher Transmission at 500 kv or higher or between 200 and 499, where it aggregates at a weighted average value of Low Impact: All other BES Cyber Systems NOTE: FERC directed NERC to: (1) develop objective criteria for evaluating protection systems for low impact assets; and (2) require entities to identify assets NOTE: Applicability to limited Distribution Facilitites: Underfrequency Load shedding or Undervoltage Load shdding; Special Protection Systems V. 3 calls for risk-based identification of critical cyber assets (control centers, transmission, generation) and identification of associated critical cyber assets key to operation of Critical Assets. 177

179 Existing Protection: Critical Infrastructure Protection under North American Electric Reliability Corporation (NERC) Standards CIP Security Management Controls Utilities must maintain/implement/document cybersecurity policies addressing requirements of CIP More prescriptive and routinized than V. 3 CIP Personnel & Training training, awarement and personnel risk assessment CIP Electronic Security Perimeters High and medium impact Cyber Systems connected to network via routable protocol (network address allowing inter-network communication) must reside behind an electronic security perimeter (secure access) External routable connectivity must be via protected Electronic Access Point accompanied by method for detecting malicious communication. 178

180 Existing Protection: Critical Infrastructure Protection under North American Electric Reliability Corporation (NERC) Standards CIP Physical Security of Cyber System Assets Secure physical access to high and medium impact Cyber System Assets CIP Systems Security Management Port management Security Patch Management Malicious Software Prevention Authenticate users (authorized access) Security status monitoring CIP Incident Reporting and Response Planning Process for identifying, reporting and responding to cyber incidents ES-ISAC must be notified w/in one hour (change from V.3) CIP Recovery Plans for Critical Cyber Assets Responsible entities must devise, document, implement and test (full operational exercise) recovery plans. 179

181 Existing Protection: Critical Infrastructure Protection under North American Electric Reliability Corporation (NERC) Standards CIP (New) Configuration Change Management and Vulnerability. Purpose: to detect and prevent unauthorized changes to BES Cyber systems by specifying configuration change management and vulnerability assessment. Baseline configuration tracked; process for making changes documented and verified. Active vulnerability assessment. CIP (New) Information Protection Purpose: To prevent unauthorized access to BES Cyber system information by specifying information protection requirements. 180

182 Upcoming Changes to CIP V. 5 Removal of Identify, Assess, Correct language Reliability Assurance Initiative to Cover (June, 2014 filing) Low Impact Assets (June, 2014 filing) NERC to administer objective criteria for evaluating protections Registered Entities to develop ability to identify nature and location of assets for audit and compliance purposes Communications Networks NERC to develop definition and propose standards (December, 2014) Transient Devices (thumb drives, etc.) - New or revised standards are directed to address vulnerabilities. 181

183 Existing Protection DOE s Cybersecurity Capability Maturity Model 1.1 (ES C2M2) (Feb. 2014) Ten Core Domains (Competencies) (1) Risk Management; (2) Asset, Change, and Configuration Management; (3) Identity and Access Management; (4) Threat and Vulnerability Management; (5) Situational Awareness; (6) Information Sharing and Communications; (7) Event and Incident Response, Continuity of Operations; (8) Supply Chain and External Dependencies Management; (9) Workforce Management; and (10) Cybersecurity Program Management Maturity Levels (Process Oriented Approach, geared to each domain): (1) Initiation; (2) certain degree of performance including program documentation, stakeholder involvement, resource commitment and reliance on standards or guidelines; and (3) a fully managed program, reflecting evolving risks. 182

184 2/12/13 Executive Order Improving Critical Infrastructure Cybersecurity Headline News: Without legislation, the White House has directed the Secretary of Homeland Security, the Attorney General, DOD, and the NIST (National Institute of Standards and Technology) to implement a broad program ensuring: Information Sharing by Governmental Agencies with private sector regarding cyber threats The identification of Critical Infrastructure at risk The creation of a voluntary Critical Infrastructure Cybersecurity baseline program ( the Framework ) by NIST 183

185 Application to Industries and Responsible Sector-Specific Agencies Chemical: Department of Homeland Security Commercial Facilities: Department of Homeland Security Communications: Department of Homeland Security Critical Manufacturing: Department of Homeland Security Dams: Department of Homeland Security Defense Industrial Base: Department of Defense Emergency Services: Department of Homeland Security Energy: Department of Energy Financial Services: Department of the Treasury Food and Agriculture: U.S. Department of Agriculture and Department of Health and Human Services Government Facilities: Department of Homeland Security and General Services Administration Healthcare and Public Health: Department of Health and Human Services Information Technology: Department of Homeland Security Nuclear Reactors, Materials, and Waste: Department of Homeland Security Transportation Systems: Department of Homeland Security and Department of Transportation Water and Wastewater Systems: Environmental Protection Agency 184

186 What Is Critical Infrastructure? Executive Order defined Critical Infrastructure to mean: systems and assets, whether physical or virtual, so vital to the United States that the incapacity or destruction of such systems and assets would have a debilitating impact on security, national economic security, national public health or safety, or any combination of those matters. Identification of assets deemed most critical: Within 150 days of the date of the Executive Order (mid-july, 2013), the Secretary shall use a risk-based approach to identify critical infrastructure where a cybersecurity incident could reasonably result in catastrophic regional or national effects on public health or safety, economic security, or national security.» Assets were tentatively identified through a consultative process, but final cut is a work in progress. 185

187 NIST Cybersecurity Baseline Program ( The Framework ) Goal of The Framework: To establish a common language to address and manage cybersecurity without added regulatory requirements. Components: Framework Core - Substantive activities and outcomes Framework Tiers - Levels of cybersecurity risk management, rigor and sophistication Framework Profile Internal description of current and desired state of cybersecurity risk protection, reflecting risk tolerance, legal/regulatory requirements 186

188 Framework Core 187

189 Framework Core Functions Meaning Categories Subcategories (selected) Identify Develop the organizational understanding to manage cybersecurity risk to systems, assets, data, and capabilities. Asset Management Business Environment Supply chain Place in industry sector and critical infrastructure Priorities Dependencies Resilience requirements Governance Information security policy, roles and responsibilities Legal and regulatory requirements Governance and risk management Risk Assessment Identify asset vulnerabilities Information sharing forums Risk and responses identified and prioritized Risk Management Processes established, managed Organization risk tolerance assessed/expressed Understanding the business context, the resources that support critical functions, and the related cybersecurity risks. Enables an organization to focus and prioritize its efforts, consistent with its risk management strategy and business Physical and systems inventory Communications Resource priority Intra-org responsibilities 188

190 Framework Core Functions Meaning Categories Subcategories (selected) Protect Develop and implement appropriate safeguards for delivery of services Access Control Physical and electronic access controlled on site and remote Awareness and Training All users, including third parties and senior executives Data Security Data at rest protected Data in transit protected Assets managed through removal, transfer, disposition Data leaks protected Integrity checking for software Information Protection Processes and procedures Baseline configuration maintained System development life cycle Configuration change control processes Backup information Physical protection Maintenance Protective Technology Removable devices Communication and control networks System access limited 189

191 Framework Core Functions Meaning Categories Subcategories (selected) Detect Develop and implement activities to timely identify the occurrence of cybersecurity events Anomalies and Events Detected events analyzed Impact of events determined Incident alert threshold established Continuous Security Monitoring Detection Processes Roles and responsibilities Testing detection systems Communication Network monitored Personnel Activity monitored Physical plant monitored Malicious code detected Unauthorized mobile code detected External service provider monitored Monitoring for unauthorized personnel, connections, devices 190

192 Framework Core Functions Meaning Categories Subcategories (selected) Respond Develop and implement activities to take action in response to cybersecurity event Response Planning Physical and electronic access controlled on site and remote Communications Analysis Notifications from Detection systems analyzed Impact understood Forensics undertaken Mitigation Incidents contained and mitigated Improvements Implement lessons learned 191

193 Framework Core Functions Meaning Categories Recover Develop and implement appropriate activities to maintain plans or resilience and to restore capability and service. Recovery planning Subcategories (selected) Improvements Communications PR managed (!) Reputation repair Recovery activity communicated to internal stakesholders 192

194 Implementation Tiers Tier 1 Partial Risk Management Process Organizational cybersecurity risk management practices are not formalized, and risk is managed in an ad hoc and sometimes reactive manner. Prioritization of cybersecurity activities may not be directly informed by organizational risk objectives, the threat environment, or business/mission requirements. Integrated Risk Management Program There is limited awareness of cybersecurity risk at the organizational level and an organization-wide approach to managing cybersecurity risk has not been established. Tier 2 Risk Informed Risk Management Process Risk management practices are approved by management but may not be established as organizational-wide policy. Prioritization of cybersecurity activities is directly informed by organizational risk objectives, the threat environment, or business/mission requirements. Integrated Risk Management Program There is an awareness of cybersecurity risk at the organizational level but an organization-wide approach to managing cybersecurity risk has not been established. Risk-informed, management-approved processes and procedures are defined and implemented, and staff has adequate resources to perform their cybersecurity duties. Cybersecurity information is shared within the organization on an informal basis. External Participation The organization knows its role in the larger ecosystem, but has not formalized its capabilities to interact and share information externally. 193

195 Cyber Framework Implementation Tiers Tier 3 Repeatable Risk Management Process The organization s risk management practices are formally approved and expressed as policy. Organizational cybersecurity practices are regularly updated based on the application of risk management processes to changes in business/mission requirements and a changing threat and technology landscape. Integrated Risk Management Program There is an organization-wide approach to managing cybersecurity risk. Risk-informed policies, processes, and procedures are defined, implemented as intended, and reviewed. Consistent methods are in place to respond effectively to changes in risk. Personnel possess the knowledge and skills to perform their appointed roles and responsibilities. External Participation The organization understands its dependencies and partners and receives information from these partners that enables collaboration and risk-based management decisions within the organization in response to events. Tier 4 Adaptive All of the above, plus: Organization updates its practices based on lessons learned and predictive indicators. Continuous improvement and active adaptation to changing risks. Organizational culture reflects risk management philosophy Active information sharing 194

196 Organization Profile under the Framework The Profile is the alignment of Functions, Categories and Subcategories with business requirements, risk tolerance and resources of the organization. Creation of Profile follows from senior management direction re: priorities, resources and risk tolerance to business processes and operations. Feedback loop follows development of Profile at operating level. In so many words, the Profile is designed to describe where an organization is and where it wants to be. 195

197 Coordination of Framework Implementation 196

198 Implementing the Framework: Department of Energy DOE Glossy points to Framework/C2M2 Overlap Framework Core compares with C2M2 Domains Framework Tiers overlap C2M2 Maturity levels DOE provides implementation guidance Recommends that C2M2 be used as a tool to implement the Framework DOE will NOT map the Framework to CIP Standards 197

199 The Framework is Voluntary, but cannot reasonably be ignored The Framework is Voluntary It will inevitably be relevant for these purposes: Liability in the event of harm standard of care Regulatory obligations and investigations Insurance Markets Financial Risk Disclosure 198

200 Additional Resources DHS Critical Infrastructure Cyber Community Voluntary Program Stakeholder Assistance and Outreach COBIT 5 (Control Objectives for Information and Related Technology) - Information Systems Audit and Control Association ISO International Organization for Standardization ISA Security for Industrial Control Systems NIST Standards 199

201 What Must Asset Owners Do and What Should They Do? Critical Infrastructure owners/operators must: Comply with CIP Requirements Determine whether to participate in the Framework Weigh risks of non-participation Potential liability in not meeting benchmark Possible Disclosure Issue Liability Implications are important Standard of Care Established Insurance Markets Likely to Be Affected Asset owners should consider application of CIP Standards and Framework to nonbes and non-critical Assets 200

202 201

203 COMMODITY FUTURE TRADING COMMISSION REGULATION OVERSIGHT

204 CFTC OVERVIEW 203

205 Commodity Futures Trading Commission (CFTC) Created in 1974 since then, derivatives market has evolved from predominantly agricultural futures to an astounding array of complex financial instruments. Mission: Protect market users and public from fraud, manipulation, and abusive practices in commodity and financial derivatives and foster open, competitive, and financially sound derivatives markets. 5 Commissioners (no more than 3 from one party). Currently only Mark P. Wetjen (Acting Chair) and Scott D. O Malia. Three seats are vacant. Divisions include: Market Oversight, Enforcement, Clearing and Risk, and Swap Dealer and Intermediary Oversight. 204

206 CFTC S Penalty Authority Civil penalties for each violation: Up to $100,000/$140,000 (judicial/administrative hearing) or 3x monetary gain Manipulation or attempted manipulation up to $1,000,000 or 3x monetary gain Restitution of victims losses Disgorgement of gains Criminal violations Fines up to $1,000,000, plus costs of prosecution Up to 10 years imprisonment 205

207 Recent CFTC Enforcement CFTC Enforcement for FY 2013: Filed 82 enforcement actions. Charges attempted manipulation, false reporting, customer fund violations, position limit violations, wash trading, supervision failures, Ponzi schemes & other fraud. Over $1.5 billion in civil monetary penalties, and over $200 million in restitution & disgorgement. 206

208 TRADING PROHIBITIONS (FUTURES & SWAPS) 207

209 Prohibition of Manipulative and Deceptive Devices New, expanded SEC-like authority prohibits intentionally or recklessly: Employing or attempting manipulative device, scheme, or artifice to defraud; Making or attempting misleading statements or omissions; Engaging or attempting any act, practice, or course of business that would operate as fraud or deceit; Delivering false, misleading, or inaccurate market report tending to affect prices; (But, no requirement to disclose nonpublic information to any person unless necessary to make another statement not misleading) 208

210 Prohibition of Price Manipulation Elements of Price Manipulation: Accused had ability to influence market prices; Accused intended to affect price beyond legitimate supply and demand; Artificial price existed; and Accused caused the artificial price Example: Taking and accepting loss on one position to profit off other, much larger position 209

211 Prohibited Transactions The Commodity Exchange Act prohibits engaging in any transaction that: Is, is of the character of, or is commonly known to the trade as, a wash sale or accommodation trade (non-competitive trade entered into to, e.g., assist another trader with illegal trades or tax evasion); Is a fictitious sale; or Is used to cause any price to be reported, registered, or recorded that is not a true and bona fide price. 210

212 Prohibition of Disruptive Trading Practices Violating bids or offers Buying/selling a contract at a price that is higher/lower than the lowest/highest available offer/bid Disregard for orderly execution during close E.g., banging/slamming the close Orderliness rational relationship between price changes and volume of trades, levels of volatility that do not materially affect liquidity, accurate relationships between price of derivative and underlying, reasonable spreads between contracts for near and remote months 211

213 Prohibition of Disruptive Trading Practices (cont d) Spoofing Bidding or offering with intent to cancel before execution Submitting or cancelling bids or offers to: Overload quotation system of a registered entity; Delay another person s execution of trades; or Create an appearance of false market depth. Enforcement CFTC has filed at least two spoofing complaints against traders/companies in the recent years for submitting and cancelling bids with no intent to execute: Bunge (CFTC 2011) traders merely sought to probe market Moncado (S.D.N.Y. 2012) traders merely sought to offer a false appearance of liquidity 212

214 Examples of Illegal or Suspect Trading Activities Taking position in one market to benefit position in another market Marking the close Executing a number of transactions near the close of a day s or contract s trading to affect the closing or settlement price Example: FERC v. Amaranth (vacated by D.C. Circuit for lack of FERC jurisdiction; potential CFTC case to follow) rapid selling at close of NYMEX NG Futures, allegedly to drive down settlement price to benefit swap and option positions Banging the open Buying or selling a large quantity at the opening of trading to induce others to trade at that price level and to signal information on fundamentals Wash Trades (1) Prearranged to cancel each other out; and (2) Involve no economic risk. Classic wash trade: Same price, volumes, counterparties Do not include trades made to correct scheduling or nomination errors, etc. 213

215 FUTURES REGULATION 214

216 Definition of Futures Contract A futures contract a standardized contract between two parties to buy or sell a particular asset (e.g., electricity) of standardized quantity and quality for an agreed upon price with delivery and payment occurring at a specified, future date The party agreeing to buy the contract asset is said to be "long," and the party agreeing to sell the asset is said to be "short." The terminology reflects the expectations of the parties the buyer anticipates that the asset price will increase, while the seller expects the price to decrease. 215

217 CFTC Futures Regulation As a general rule, all futures contracts traded within the United States must be traded on a designated contract market (DCM) such as ICE Futures U.S., NYMEX, or CME or a foreign board of trade, such as NGX. See 7 U.S.C. 6(a)-(b). CFTC futures regulation focuses on DCMs and intermediaries such as futures commission merchants (FCMs), clearing members, and foreign brokers By comparison, CFTC futures regulation of traders is relatively light 216

218 SWAPS REGULATION 217

219 The Dodd-Frank Act The Dodd-Frank Wall Street Reform and Consumer Protection Act Passed as direct response to financial crisis of 2008 Signed into law by President Obama July 21, 2010 Title VII provides for regulation of swap markets by amending and expanding the Commodity Exchange Act ( CEA ), which is administered by the CFTC Repeals prior regulatory exemptions for OTC derivatives, including energy derivatives Imposes a regulatory frame-work upon the OTC derivatives market Purposes reduce risk, increase transparency, and promote market integrity Monitor developments in Dodd-Frank Act regulation at: 218

220 Swap An energy swap is a financial instrument whereby one participant agrees to a fixed-price contract for say crude oil, natural gas, gasoline, electricity, coal and other energies on a settlement date, while the other counterparty takes on the spot price, or the floating price of the commodity. The contracts are often used to hedge the fluctuating price of an energy commodity. For example, say a large energy user agrees to pay a set price for crude oil. The other participant, usually a large financial institution, then agrees to pay the current market, or spot price. Energy swaps are used by energy producers, commercial users of energy, banks and other financial institutions to hedge energy price risk. 219

221 What is a Swap? CFTC definition of swap includes: Any contract that provides on an executory basis for the exchange of payments based on the value of rates, currencies, commodities, and certain other items and that transfers the financial risk associated with a future change in such values without also conveying an ownership interest in an underlying asset; Options Includes many forward contracts with embedded optionality Trade options are subject to reduced regulatory requirements Commodity swaps (e.g., financial contracts in metals, energy, agricultural, or other physical commodities) Energy swaps (same, in electricity, natural gas, crude, etc.) Basis swaps (financial contracts based on commodity price differences between two locations) 220

222 Contracts Excluded From Definition of Swap Futures contracts Intercontinental Exchange (ICE) has transitioned its cleared energy swaps to futures contracts FERC-Regulated RTO/ISO Contracts 1. Financial Transmission Rights (FTRs) 2. Energy Transactions (including virtual & convergence bids/offers) 3. Forward Capacity Transactions 4. Reserve or Regulation Transactions Exclusion applies only to CAISO, ERCOT, ISO NE, MISO, NYISO, and PJM products Each party must be an appropriate person or eligible contract participant (generally, must meet certain net worth or gross asset thresholds) or a person who actively participates in the generation, transmission or distribution of electric energy 221

223 Forward Contract Exclusion The term swap does not include... Any sale of a nonfinancial commodity... For deferred shipment or delivery, so long as the transaction is intended to be physically settled. Key Requirement Intent of the parties to make or take physical delivery (at time of execution) 222

224 Forward Contract Exclusion Limitations or Exceptions to the Exclusion Financial Settlement Rights Forward contract that allows for financial settlement in place of physical delivery will likely be viewed as a swap Embedded Optionality Forward contract that allows a party to specify performance requirements between two or more options may be viewed as an option Embedded volumetric optionality Where one party has right to elect what volume(s) are delivered under the contract Common in many energy contracts (e.g., swing gas, electric capacity, tolling agreements) CFTC has multi-part tests for determining whether forward contracts with embedded optionality qualify for exclusion 223

225 7-Part Test for Exclusion of Forward Contracts with Embedded Volumetric Optionality A transaction falls within the forward exclusion from the swap and future delivery definitions, notwithstanding that it contains embedded volumetric optionality, when: 1. The embedded optionality does not undermine the overall nature of the agreement, contract, or transaction as a forward contract; 2. The predominant feature of the agreement, contract, or transaction is actual delivery; 3. The embedded optionality cannot be severed and marketed separately from the overall agreement, contract, or transaction in which it is embedded; 4. The seller of a nonfinancial commodity underlying the agreement, contract, or transaction with embedded volumetric optionality intends, at the time it enters into the agreement, contract, or transaction to deliver the underlying nonfinancial commodity if the optionality is exercised; 5. The buyer of a nonfinancial commodity underlying the agreement, contract or transaction with embedded volumetric optionality intends, at the time it enters into the agreement, contract, or transaction, to take delivery of the underlying nonfinancial commodity if it exercises the embedded volumetric optionality; 6. Both parties are commercial parties; and 7. The exercise or non-exercise of the embedded volumetric optionality is based primarily on physical factors, or regulatory requirements, that are outside the control of the parties and are influencing demand for, or supply of, the nonfinancial commodity. 224

226 Book-Outs of Forward Contracts Book-Outs are transactions whereby offsetting physical delivery obligations under two or more forward contracts are cancelled CFTC s Brent Interpretation provides safe harbor from booked out forward contracts being viewed as swaps Parties must be commercial market participants that regularly make or take delivery of the commodity Parties must intend to make or take delivery of the commodity The book-out must be effected through a separately negotiated agreement, not as of right under the forward contract Documenting Oral/IM Book-Outs must be documented in writing or electronically within a commercially reasonable time frame 225

227 Trade Options Trade options are subject to reduced regulatory requirements compared to other options/swaps Trade option a commodity option for which: 1. The offeror* and offeree are both: a. Producers, processors, or commercial users of, or merchants handling, the subject commodity; and b. Entering into the transaction solely for purposes related to their business as such; and 2. The parties intend to physically settle the transaction if the option is exercised * Alternatively, offeror satisfies the first prong if it is an eligible contract participant 226

228 Swap Dealers and Major Swap Participants Section 721 of the Dodd-Frank Act amends the CEA by adding definitions of the terms swap dealer and major swap participant. There are only two MSPs (Cournot Financial Products and MBIA Insurance), and they are subject to a regulatory regime almost identical to that imposed on swap dealers. There are about 100 SDs, many of which are financial institutions. Others include, BP, Cargill, and Shell. 227

229 Definition of Swap Dealer Any person who: 1. Holds self out as a dealer in swaps; 2. Makes a market in swaps; 3. Regularly enters into swaps with counterparties as an ordinary course of business for its own account; or 4. Engages in activity causing one to be commonly known as a dealer or market maker in swaps. Fact-specific self-determination Swaps excluded from swap dealer determination: Inter-affiliate swaps (majority-owned) Certain swaps to hedge physical positions Certain swaps by cooperatives or floor traders Trade options 228

230 De Minimis Exception to Swap Dealer Definition A person is not a swap dealer if, over the prior 12 months, the aggregate gross notional amount of swaps it enters into in connection with dealing activities does not exceed: $8 billion ($3 billion after 3- to 5-year phase-in period); $25 million with non-utility special entities (government bodies, pension plans, endowments); or $800 million with utility special entities using the swaps to hedge Must provide quarterly notice to CFTC beginning December 31, 2012 if utilizing this threshold No-Action Letter No (effective until final Commission rulemaking on petition) Aggregation across affiliates (entities controlling, controlled by, or under common control) 229

231 CFTC Regulatory Requirements Applicable to Swaps (Including Options) Reporting requirements Recordkeeping requirements Mandatory clearing for swaps determined as required to be cleared End user exception Comprehensive regulation of swap dealers and major swap participants Prohibitions of manipulation and disruptive trading practices (discussed above) 230

232 Swap Reporting Four Rules Swap Data Reporting Reporting of Pre-Enactment and Transition Swaps Real-Time Swap Reporting Trade Option Reporting 231

233 Swap Reporting (Rules 1-3) All swaps (except trade options between nonsd/msps) must be individually reported to a swap data repository (SDR) Three SDRs accept natural gas and electricity swaps: DTCC Data Repository ICE Trade Vault Chicago Mercantile Exchange Data reported: Swap creation data (primary economic terms or PET) Continuation data (quarterly mark-to-market; changes to PET) 232

234 Swap Reporting (Rules 1-3) Reporting Counterparty A non-sd/msp is not required to report any swap with a Swap Dealer (SD) or Major Swap Participant (MSP) counterparty Non-SD/MSP is not required to report, or has reduced reporting requirements, for any swap that is: Traded on an exchange; or Submitted for clearing (Consult detailed rules in 17 C.F.R. Parts 43, 45-46) Swaps with non-sd/msps: Non-SD/MSP or its counterparty s commodity pool or U.S. Person status may dictate which is the reporting counterparty Otherwise, the counterparties must agree who will be the reporting counterparty as a term of each swap or master agreement 233

235 Reporting Pre-Enactment and Transition Swaps Pre-Enactment Swaps Open as of July 21, 2010 Transition Swaps Executed on or after July 21, 2010 and prior to reporting counterparty s compliance data (i.e., April 10, 2013) Must have reported such swaps by October 31, 2013, unless transacted with a swap dealer or major swap participant counterparty or executed and cleared on the InterContinental Exchange (ICE) 234

236 Real Time Reporting What Swaps Are Subject? Only swaps that represent arm s length transactions (i.e., not swaps between wholly-owned subsidiaries) With respect to energy contracts, only contracts that reference one of the following: NYMEX Henry Hub Natural Gas NYMEX Light Sweet Crude Oil NYMEX NY Harbor Gasoline Blendstock NYMEX NY Harbor Heating Oil Brent Crude Oil (ICE) 235

237 Trade Option Reporting Trade options between end users: CFTC Form TO ( Applies only to trade options entered into on or after April 10, 2013 that are not reported to a SDR Report aggregate volume exercised ($0; 0 to $10M; $10M to $100M; $100M+ ) during the previous calendar year in each identified swap category (energy, metals, agriculture, other) Due March 1, 2014 and each year thereafter Both parties include the trade option in their aggregate reports Must notify CFTC if enter into trade options in excess of $1 billion aggregate notional value during any calendar year Trade options with SD/MSP counterparties Generally, the SD/MSP must report each trade option to a SDR like any other option/swap 236

238 Swap Recordkeeping Requirements All counterparties and swaps are subject Full, complete, and systematic records, together with all pertinent data and memoranda, with respect to each swap Any master agreement, credit support arrangement, and confirmation for the swap Reduced requirements for pre-enactment and transition swaps Retention: 5 years after termination Accessibility: 5 business days (for end users) Compliance date for end users April 10,

239 Mandatory Swap Clearing Swaps that are Required to be Cleared Class of Swap Final Determination 4 classes of interest rate swaps 2 classes of credit default swaps Natural Gas Swaps Electricity Swaps 77 FED. REG (Dec. 13, 2012) 77 FED. REG (Dec. 13, 2012) [none] [none] End User Compliance Date September 9, 2013 September 9, 2013 [Oct 2014 or later] [Oct 2014 or later] 238

240 ENFORCEMENT PRACTICE AND PROCEDURE

241 FERC Investigatory & Enforcement Procedure 240

242 Investigations 241

243 INVESTIGATIONS Overview FERC investigations are conducted by the Office of Enforcement, Division of Investigations (DOI) Two types: Formal: investigation initiated by the Commission via order Preliminary: investigation initiated by the Commission or FERC Enforcement Staff. Scope: May relate to any matter subject to FERC s jurisdiction See 18 C.F.R. Part 1b 242

244 INVESTIGATIONS Initiation of an Investigation DOI staff initiates investigations when it (1) has reason to suspect violations; or (2) has received information from a variety of sources, including: Referrals from within FERC s Office of Enforcement Division of Audits Division of Energy Market Oversight Referrals from other FERC offices Office of Energy Market Regulation Office of Electric Reliability Referrals from the Commission Other Sources Tips from the industry Market monitors Self-reports Hotline Note: all information received is treated as non-public; disclosure only permitted at Commission s discretion, or as otherwise required to disclose 243

245 INVESTIGATIONS Staff Initial Assessment Staff will: review information received; conduct preliminary exam; consult publically-available data; seek input from FERC Staff SMEs; contact the entity for explanation Based on this initial assessment, and consideration of the factors below (as needed), DOI determines whether there is substantial basis for opening an investigation Seriousness of the harm Extent of the harm Efforts made to remedy the alleged violation Violations are willful or inadvertent Violations are widespread or isolated Likelihood of the conduct recurring Compliance history of the alleged wrongdoer Amount of detail in the allegation or suspicion of wrongdoing Importance of documenting and remedying the potential violations to advance Commission policy objectives Likelihood that staff could assemble a legally and factually sufficient case Staff resources 244

246 INVESTIGATIONS Investigation Formally Opened: If a substantial basis for investigation is found, DOI will notify the subject entity that an investigation is being opened Discovery: Once opened, Staff collects information through customary discovery methods data/document requests, interrogatories, interviews, and depositions All information received during an investigation, as well as the existence of an investigation, is non-public information Length: Length of investigation depends on complexity; nature of alleged violations Communications: Staff in frequent contact with entity throughout process; entity may contact Enforcement Staff to provide additional information/explanations 245

247 INVESTIGATIONS At any time during the course of its investigation, DOI Staff may close the investigation without taking further action (and notify the entity of its decision) Reasons include: Determination of no violation Insufficient evidence to warrant further investigation If Staff concludes that a violation may have occurred, warranting sanctions, staff informs the entity, providing relevant facts and legal theories May be done orally; typically via a preliminary findings letter. Subject has an opportunity to respond and provide further information. DOI staff may reevaluate & modify allegations based on this response If Staff continues to believe sanctions are warranted, the investigation can take one of two courses: 1) Commence settlement talks 2) Subject contests Enforcement s conclusions, in which case FERC may issue a public order to show cause 246

248 Prosecutorial Discretion 247

249 PROSECUTORIAL DISCRETION US Supreme Court The United States Attorney is the representative not of an ordinary party to a controversy, but of a sovereignty whose obligation to govern impartially is as compelling as its obligation to govern at all; and whose interest, therefore, in a criminal prosecution is not that it shall win a case, but that justice shall be done. Berger v. United States, 295 U.S. 78 (1935) FERC Endorsed DOJ s McNulty Memorandum as a statement of its emphasis on fairness in its own investigative approach Revised Policy Statement on Enforcement 61,156, n17 (May 15, 2008) 123 FERC A prosecutor s duty to enforce the law requires the investigation and prosecution of criminal wrongdoing if it is discovered. Deputy Attorney General Paul J. McNulty, December 12,

250 Ex Parte Rules 249

251 EX PARTE CONTACT FERC Policy Regarding Communications with the Commission: Neither the Commissioners nor their assistants will receive oral communications, in person or by telephone, from any person concerning an ongoing staff investigation as to which such person is the subject The subject of an investigation is permitted to submit written information to the Commission at any time during an investigation, up to the point that Order to Show procedures come into play Revised Policy Statement on Enforcement 123 FERC 61,156, P 27 (May 15, 2008) 250

252 Public Disclosure of Investigations 251

253 PUBLIC DISCLOSURE OF INVESTIGATIONS Public disclosure of an investigation typically does not occur until: 1. A settlement is reached; or 2. FERC issues an Order to Show Cause Premature disclosure could impact entity reputation in the public eye To increase transparency of non-public Staff investigations and potential violations, FERC in 2009 authorized release of Staff Preliminary Notices of Violation Timing: public disclosure after the subject has had opportunity to respond to Staff s preliminary findings letter Notice identifies: entity subject to the investigation; time/place of alleged conduct; rules/regulations alleged to have been violated; description of the alleged wrongful conduct 252

254 Settlements 253

255 SETTLEMENTS Staff s preferred method of resolution for investigations that result in a recommendation for remedial action Why? Faster resolution Allows FERC to allocate resources to other matters Compliance problems are fixed sooner Disgorged profits are returned to customers more quickly 254

256 SETTLEMENTS The Settlement Process Staff request for settlement authority: Enforcement staff seeks settlement authority from Commission, within a range of potential civil penalties and/or disgorgement Staff provides the Commission: (1) Staff s views on the investigation; and (2) the subject s comments (if any) Settlement Negotiations: If settlement authority is granted, staff & subject meet to negotiate Stipulation & Consent Agreement: If staff and the subject agree in principle on the terms of a settlement, staff drafts a proposed stipulation and consent agreement, and sends it to subject for review After further negotiations, an executed stipulation and consent agreement is submitted to the Commission for consideration Upon approval, the stipulation and consent agreement and the order approving the settlement are generally released publicly 255

257 Orders to Show Cause 256

258 ORDERS TO SHOW CAUSE If Enforcement staff and the subject of an investigation are unable to reach a settlement, staff may recommend that the Commission initiate public enforcement proceedings Enforcement staff will notify the subject of its intention to recommend enforcement proceedings The subject may then respond (within 30 days) explaining why an Order to Show should not issue Staff submits to the Commission its report and any submissions timely received from the subject In extreme cases (e.g., a case in which injunction is being sought), notice of recommendation may not be given to entity 257

259 ORDERS TO SHOW CAUSE After considering the recommendations and submissions, the Commission determines whether an Order to Show Cause is appropriate If so, the Commission issues Order to Show Cause with Enforcement staff s report attached (18 C.F.R (a)(2)) The Order to Show Cause outlines: 1. The alleged violation; and 2. Proposed penalties (civil fines; disgorgement of profits; etc.) The Commission will also issue a separate Notice designating certain FERC staff as non-decisional employees (i.e., FERC staff who are prohibited from conducting off-therecord communications about the investigation with any Commissioner or decisional staff) An Order to Show Cause commences a Part 385 proceeding (18 CFR Part 385) it does NOT make any finding as to a violation of law. 258

260 ORDERS TO SHOW CAUSE The Order will outline next steps & options for the subject. Typically, the subject has 30 days from issuance of Order to: 1. File an answer (per 18 C.F.R ) showing cause: (A) why it should not be found to have committed the violation listed in the order; and (B) why the alleged violation should not warrant the remedies listed in the order. AND 2. Choose one of the following options: (A) An administrative hearing before a FERC Administrative Law Judge (ALJ) prior to assessment of a penalty (per 16 U.S.C. 823b(d)(2)); or (B) An immediate penalty assessment by the Commission (if it finds a violation) which a U.S. District Court is authorized to review de novo (per 16 U.S.C. 823b(d)(3)) 259

261 ORDERS TO SHOW CAUSE The answer should address all disputed legal, factual & procedural issues; admit/deny each allegation; set forth defenses Failure to answer will be treated as a general denial, and may be a basis for summary disposition per 18 C.F.R (e)(2). FERC Staff may file a reply within 30 days after the subject files its answer NOTE: the Commission will not issue findings until after it has received the subject s responses to the Order to Show Cause 260

262 ORDERS TO SHOW CAUSE If the subject contests the allegations or proposed penalties, the Commission has several options: 1. Administrative Hearing: If the subject elects an administrative hearing before a FERC ALJ, the Commission will set the case for a trial-type hearing, with full discovery (per Part 385 regulations) 2. Immediate Penalty Assessment: If the subject elects an immediate penalty assessment, and the Commission finds a violation, it will issue an order on the merits, and assessing penalties. 3. Where the record is insufficient, the Commission may also set the case for paper hearing (i.e., request briefs), after which it will issue an order on the paper hearing record. See BP America, Inc., et al., 144 FERC 61,100, P3 (2013); Amaranth Advisors LLC, 120 FERC 61,085, n.7 (2007) 261

263 ORDERS TO SHOW CAUSE Enforcement staff who participate become non-decisional Office of General Counsel takes the lead in advising the Commission regarding disposition of arguments Settlements may proceed according to Rule 602 (18 CFR ) Any participant in the proceedings may submit a settlement offer at any time, which is transmitted to the Commission If the offer is uncontested, the Commission may approve it upon a finding that it is fair, reasonable, and the in the public interest An approved settlement closes the investigation and concludes the enforcement proceedings with respect to all matters covered in the settlement If no settlement: the proceeding continues to conclusion 262

264 Administrative Hearing 263

265 ADMINISTRATIVE HEARING If the subject contests the Order to Show Cause & proposed penalties, and opts for an administrative hearing: 1. Hearing Order: The Commission will issue a hearing order setting the case for trial-type hearing 2. Hearing: The ALJ will conduct a hearing pursuant to FERC s hearing procedures (18 C.F.R ); with FERC Enforcement Staff serving as Trial Staff at the hearing 3. Initial Decision: After hearing, the ALJ will issue an Initial Decision (ID) and determine whether a violation occurred. If so, the ID will include recommended penalties. 4. Exceptions: Parties may file exceptions to the ID within 30 days 5. Commission Order: The Commission, after consideration, will issue an order. If it finds a violation, it may assess penalties. 264

266 ADMINISTRATIVE HEARING PROCEDURE FERC Process for Administrative Hearings: Hearing Process Begins Commission Establishes Hearing - Discovery Testimony/Briefs Filed Hearing is Held Initial/Reply Briefs Filed Judge Issues Initial Decision; Parties File Briefs on Exception and Opposing Exceptions Commission Issues Final Decision 265

267 Appeals 266

268 APPEALS Appeal of FERC a order assessing penalties: A Commission order following an administrative hearing process: Rehearing: Within 30 days after issuance of order, the subject may seek rehearing by the Commission. Appeal: Within 60 days from issuance of the final Commission order, the subject may appeal to the U.S. Court of Appeals, The court may enter a judgment affirming, modifying, or setting aside (in whole or in part) the Commission s order, or remand to the Commission. 267

269 APPEALS Appeal of FERC a order assessing penalties: An immediate penalty assessment order issued by the Commission: If the subject does not pay the civil penalty within 60 days, the Commission shall institute an action in the appropriate U.S. district court for an order affirming the assessment of the penalty. The district court shall have authority to review the case de novo The court shall have authority to enter a judgment enforcing, modifying, and enforcing as modified, or setting aside (in whole or in part) the penalty assessment. Appeal of district court order to the U.S. Court of Appeals FERC can appeal to the U.S. Court of Appeals a district court order that modifies or sets aside the Commission s penalty assessment The subject can appeal a district court order 268

270 APPEALS Settlement Judge FERC Orders Rehearing Request Appeal US Court of Appeals Appeal Supreme Court Litigation Judge 269

271 Remedies 270

272 REMEDIES If the Commission finds a violation it may assess the following remedies at its broad discretion: 1. Civil penalties 2. Disgorgement of profits 3. Compliance plans 4. Other non-monetary measures 271

273 FERC Staff Guidance: No-Action Letters & Guidance Letters 272

274 NO-ACTION LETTERS A way to obtain written advice as to whether FERC staff would recommend that the Commission take no enforcement action with respect to specific proposed transactions, practices or situations No-Action Letter responses provide increased certainty regarding staff s view on whether a particular transaction, practice or situation would be subject to agency enforcement action Key Orders 2005: process formalized (113 FERC 61,174) 2008: process clarified and expanded (123 FERC 61,157) 273

275 NO-ACTION LETTERS Scope Docket No. PL FERC expanded the scope of issues for which No-Action Letter requests may be submitted Any issue that falls within the Commission s jurisdiction, except for issues arising under: Part I of the FPA (licensing of hydroelectric projects) Sections 215 and 216 of the FPA (reliability standards) Sections 3, 7, and 15 of the NGA (certification of natural gas pipelines) Section 311 of the NGPA (operation of LNG terminals) 274

276 NO-ACTION LETTERS Additional requirements: The request may not be anonymous The request must relate to a situation in which the requesting party is or may be involved and not involve hypothetical circumstances or completed transactions NALs are: Signed by representatives of the Office of the General Counsel and the Office of Enforcement and reflect the consensus views of those offices Office of Energy Market Regulation may also be consulted However, NALs are not binding 275

277 NO-ACTION LETTERS Confidentiality Once submitted, a NAL request generally may not be withdrawn Until a response is issued, NAL requests are treated as non-public Applicants can request that staff continue to treat both NAL requests and responses as non-public for an additional 120 days after a response is issued Once NAL response is public, it is posted in the Commission s elibrary system in searchable format 276

278 GUIDANCE LETTERS 1. General Counsel Opinion Letters Used to provide guidance regarding interpretation of any statute or implementing regulation under FERC s jurisdiction Addressed such issues as FERC jurisdiction over natural gas pipelines; electric energy sales, and whether certain sales would be subject to price mitigation and must-offer obligations Typically prepared with input from FERC s other offices The views expressed in an opinion letter are only those of the General Counsel not binding on FERC There is a filing fee associated with a General Counsel opinion letter except for requests solely to matters under Part I of the FPA (18 C.F.R (c); ) Opinion letters are publicly posted on elibrary, absent confidentiality issues 277

279 GUIDANCE LETTERS 2. Accounting Interpretations Per FERC s USofA: to maintain uniformity of accounting, regulated entities must submit questions of doubtful interpretations to the Commission for consideration. FERC & Chief Accountant provide guidance to, and respond to inquiries from, regulated entities on the implementation of standards issued by the Financial Accounting Standards Board and existing/emerging industry-wide or entity-specific accounting issues within the context of FERC s Uniform System of Accounts See Order No. PL at pp Past guidance letters have addressed: (A) accounting for uncertainty in income taxes, (B) accounting for the funded status of defined benefit postretirement plans, (C) appropriate accounting treatment for earnings on use-restricted debt funds used for construction Effect of guidance letters issued by Chief Accountant: Controlling accounting guidance for regulated entities, unless or until superseded by rehearing or other FERC action non-binding on Commission not controlling precedent for ratemaking purposes 278

280 Audits Substance & Procedures 279

281 AUDITS Overview Audits are conducted by FERC s Division of Audits Most audits are initiated without any information of or allegation regarding any specific wrongdoing (in contrast to investigations) Initial Step Commencement Letter Sent to Company Sets out purpose and scope of audit Describes audit staff s authority to perform the audit Identifies audit team members Provides contact information for Enforcement staff leadership Audit team contacts company to discusses commencement letter NOTE: Commencement Letter is public (posted to FERC s elibrary) All information/documentation gathered during audit fieldwork is treated as nonpublic information exception: company s written response to the draft audit report 280

282 AUDITS Fieldwork & Discovery Staff collects data using several techniques: Data Requests primary means of obtaining audit data information requested may include financial information, procedures manuals, and s Company should institute document hold during audit generally treated as non-public, but may be subject to FOIA requests (assertions of exemption from FOIA should be made at the time of production) Documents must be reviewed for privilege and work product Site Visits auditors collect materials, review documents, observe processes/controls, and conduct interviews Includes an opening & wrap-up conference with company mgmt. Interviews face-to-face or over the phone Analysis of publicly-available documents FERC filings, state filings, etc. 281

283 AUDITS Exit Conference conducted at the completion of all audit fieldwork discuss staff s preliminary audit findings & recommendations with the company NOTE: By this stage, staff s preliminary findings/ recommendations have been approved by OE leadership, in consultation with other FERC offices may be conducted in person or through conference call discuss next steps Confidentiality of Fieldwork all information and documentation gathered during audit fieldwork is non-public 282

284 AUDITS The Audit Report Draft Audit Report & Opportunity for Company Comments Once FERC Staff has completed its audit fieldwork, it provides the company with a non-public draft audit report and discusses preliminary findings with the company to ensure the audit report is fair, accurate, complete, and objective the company has the opportunity to comment on the draft audit findings and recommendations, as well as the facts in the report Final Audit Report after the company has the opportunity to comment, FERC will issues a final audit report with FERC s findings and the company s response Includes: detailed description of audit findings and recommendations, the audit methodology, and company s written response to draft audit report either issued under delegated authority by the Director of Enforcement or approved by the Commission publicly reported 283

285 AUDITS Disposition of Contested Audit Matters If the company disputes any of FERC s findings, it may dispute those findings pursuant to procedures in FERC Order No. 675 Company may elect: shortened procedure (decision upon submission of briefs); or trial-type procedure to challenged disputed matters ** FERC will honor the company s choice unless it determines that there are no material facts in dispute a trial-type proceeding ** which require Referral to Division of Investigations (DOI) Evidence collected by Staff at any point during the audit which indicates that a violation may have occurred may be referred to FERC DOI Staff The matter may be resolved during the audit or become the subject of a separate investigation 284

286 AUDITS Recap: FERC s Audit Process in a Nutshell Public Commencement letter sent to the company describing purpose and scope of the audit Company comments to FERC staff Staff collects data to reach findings & conclusions NO Commission issues a final report through Delegated Authority or Commission Order YES Company provided with draft audit report Company can dispute the findings following procedures set forth in the Commission s regulations FERC incorporates company comments into Report 285

287 Case Study: FERC v. Barclays Bank PLC, et al. 286

288 Barclays Bank PLC: FERC s Alleged facts Barclays & 4 traders violated FERC anti-market manipulation rules from Nov Dec Loss-generating trading of day-ahead fixed price physical electricity at CA trading points to benefit Barclay s ICE fixed-forfloating financial swaps Barclays assembled large physical index positions in the opposite direction of its fixed-for-floating financial swap positions at the same points Barclays flattened its physical positions in the next-day fixed-price markets to move the ICE daily index settlement up or down to benefit its swap positions. Barclays trading was highly coordinated and discussed amongst the traders daily Estimated losses to market participants (in the next-day fixed-price physical markets): $139.3M Barclays flattening of physical positions through cash trading produced significant losses; however the cash trading resulted in gains to Barclays financial swap positions. 287

289 This is the first time that a FERC electric market manipulation claim is being adjudicated in a federal district court 288

290 Barclays Bank PLC: Timeline July 2007: FERC staff initiates non-public formal investigation, following anonymous call via FERC Enforcement Hotline 6/10/11: FERC Staff issues preliminary conclusions letters to Barclays & traders 4/5/12: FERC Staff issues Notice of Alleged Violations involving Barclays and four individual traders Settlement discussions comments, proving unproductive 5/3/12: Staff issues notice of intent to recommend that FERC initiate a public proceeding (per 18 CFR 1b.19) 6/11/12: Barclays, et al. file responses 10/31/12: FERC issues Order to Show Cause; Enforcement Staff Report & Recommendation 11/29/12: Barclays, et al. elects immediate penalty assessment and de novo review by Dist. Ct. 289

291 Barclays Bank PLC: Timeline 12/14/12: Barclays, et al. files answer Barclays opposes Enforcement staff s findings; claims that OE lacks sufficient evidence to prove that Barclays engaged in manipulative conduct, or that Barclays trades impacted market prices 7/16/13: FERC order finding violation and assessing civil penalties Barclays: $435M & disgorge $34.9M profits Separate individual fines to other traders between $1M and $15M 10/9/13: FERC files complaint with U.S. Dist. Court of Eastern CA, asking court to affirm agency s penalty assessment without modification 12/16/13: Barclays files to dismiss for improper venue; failure to state a claim 2/14/14: FERC files opposition to motion Hearing scheduled for 4/24/14 4/14/14: Court cancels hearing 290

292 Barclays Bank PLC: Key Issues In addition to satisfying the applicable legal standard for finding a violation of FERC s anti-manipulation rule (18 CFR 1c.2), other issues are at play: Statute of Limitations Barclays: Allegations are time barred by statute of limitations FERC cannot impose penalties more than 5 years after the conduct giving rise to those penalties occurred. Barclays & Staff entered agreements on 6/21/11 to toll SOL; Barclays argued that FERC s issuance of NAV on 4/5/12 terminated the tolling agreement, and the remaining time left under the SOL has run FERC: a NAV does not necessarily mark the end of staff s investigation; the tolling agreements remain in effect and the 5-year SOL has not lapsed Estoppel Barclays: FERC is estopped from enforcing the alleged manipulation/pursuing claims that post-date Barclays request to OE staff to advise them if they should discontinue trading activity FERC: neither Commission nor FERC is estopped, and neither waived authority because they did not respond to B s request for guidance during the investigation 291

293 Barclays Bank PLC: Key Issues Barclays raises the following in its Motion to Dismiss: (E.D. Cal.) Adjudication of case in Federal Court: FERC s 10/9/13 complaint asks court to affirm agency s penalty assessment without modification, while the FPA provides for de novo review by court. Barclays: FERC employed no adjudicative process prior to filing complaint, and Barclays elected immediate penalty assessment (without ALJ hearing). Thus, FERC proffers only factual & legal allegations. Improper Venue: Barclays: All alleged acts occurred at Barclay s trading desk in NYC; no defendant is an inhabitant of the Eastern District of CA. Barclays asks for transfer to SDNY 292

294 Barclays Bank PLC: Key Issues Barclays raises the following in its Motion to Dismiss: (E.D. Cal.) (continued) FERC lacks jurisdiction CFTC has exclusive jurisdiction over transactions involving the swap contracts Barclays traded on ICE are futures contracts FERC lacks jurisdiction, since Barclays is not alleged to have receive/delivered physical electricity in fact FERC alleges that Barclays structured the transactions to avoid physical delivery FERC has not adequately alleged that it has jurisdiction over Barclays conduct because it occurred in connection with FERC-jurisdictional transactions. FERC lacks jurisdiction under FPA to bring manipulation claims against individual traders FPA prohibition against manipulation applies to any entity, which Barclays argues does not include natural persons 293

295 Barclays Bank PLC: Key Issues Barclays raises the following in its Motion to Dismiss: (E.D. Cal.) (continued) Complaint does not adequately state a claim for manipulation under FPA FERC s complaint acknowledges that the transactions were trades with willing counterparties who accepted the risk of entering into contracts opposite Barclays and pursuant to which Barclays performed its obligations. Such open-market transactions cannot constitute the predicate for a manipulation claim Statute of limitations: FERC s allegations based on conduct prior to 12/26/07 are precluded by SOL FERC s claim is governed by 5-yr SOL starting on date when alleged conduct occurred Barclays entered tolling agreements with FERC, which terminated on 4/5/12 when FERC issued its NAV Barclays: FERC policy is that NAV is issued only after investigation concludes 294

296 Why is this important? Barclays litigation calls into question the breadth and scope of FERC s enforcement regime for power markets. 295

297 If Barclays Prevails On CFTC Exclusive Jurisdiction FERC s enforcement authority would be significantly constrained limited only to activities within physical markets cross-market (physical/financial) transactions would be solely within the CFTC s jurisdiction 296

298 If Barclays Prevails On Physical Delivery Requirement FERC s authority would be seriously limited The power market contains multiple types of physical contracts that may not result delivery. The following types of transactions could be outside FERC s jurisdiction: forward power transactions that booked out or subject to other market arrangements; dispatchable power purchase agreements involving power plants that do not result in physical delivery of power unless the plant is dispatched; options on the physical sale/delivery of power that do not result in physical delivery unless option is exercised capacity products and markets that represent the ability to generate power but do not involve physical deliveries virtual markets in FERC-regulated RTOs In short, FERC s enforcement authority would not be triggered unless and until power flowed over a transmission line or was delivered pursuant to a contract 297

299 If Barclays Prevails On Open Market Transactions FERC could only bring a manipulation claim for transactions involving direct fraud. A marketer s scheme to lose money in open market transactions with will counterparties to benefit positions in other markets would be beyond FERC s enforcement jurisdiction 298

300 Bottom Line If FERC prevails: expanded enforcement authority, involving physical transactions and other transactions in connection with If Barclays prevails: limited view of enforcement authority, just fraudulent transactions involving physical transmitted or delivered power 299

301 Case Study: Deutsche Bank 300

302 Deutsche Bank AG unit In December 2011, FERC accused a Deutsche Bank AG unit of engaging in market manipulation by trading energy in the California ISO to boost its congestion revenue rights positions, and creating schedules in which no power was transmitted. FERC issued an Order to Show Cause to Deutsche Bank Energy Trading LLC to show: Why it should not be found to have violated the Anti-Manipulation Rule of the Federal Power Act; and Why it should not be found to have violated the accuracy requirements of the Commission s regulations. On January 22, 2013 the Commission approved a Stipulation and Consent Agreement between the Office of Enforcement and Deutsche Bank resolving the proceeding. Determined that DB did engage in market manipulation Civil penalty of $1,500,000 Disgorgement of $172,645 in profits Compliance and reporting requirement 301

303 FERC GUIDANCE ON PENALTIES AND MITIGATION Craig Silverstein

304 PENALTIES UNDER THE FPA FERC has had investigative and penalty authority for a long time, but it was limited and always treated as subordinate to its responsibilities as a rate regulator Western Energy Crisis and Enron meltdown, and to a lesser extent the emergence of markets and RTOs, changed everything. 2002: Office of Market Oversight and Investigation (OMOI) created, and first major action was a factfinding investigation to figure out what went wrong. 303

305 PENALTIES UNDER THE FPA By 2003, major cases with dozens of parties were underway to figure out what went wrong in the wholesale electric markets. By this point, the Enron Memo was out, and FERC OMOI was looking into both simple and advanced strategies to manipulate energy prices: Trading schemes like Fat Boy, Get Shorty, Death Star, were investigated. Accuracy of reporting transactions also became a concern. FERC started to change its rules, particularly those relating to regulated entities, but told Congress that its enforcement authority had no teeth beyond disgorgement of profit. 304

306 PENALTIES UNDER THE FPA In 2005, Congress gave FERC what it wanted in the Energy Policy Act of 2005: Expanded the Commission's FPA civil penalty authority to cover violations of any provision of Part II of the FPA, as well as of any rule or order issued there under. Extended the Commission's civil penalty authority to cover violations of the NGA or any rule, regulation, restriction, condition, or order made or imposed by the Commission under NGA authority. Established the maximum civil penalty the Commission may assess under the NGA, NGPA, or Part II of the FPA as $1,000,000 per violation per day. 305

307 PENALTIES UNDER THE FPA 306

308 PENALTIES UNDER THE FPA We ve got the power, what now? Civil penalties in the earlier years were not that large, but started growing: 2007: 12 cases, ranging from $300k to $10 M 2008: 10 cases, ranging from $250k to $5 M 2009: 15 cases, ranging from $300k to $25 M More parties under investigation, more people clamoring for transparency in how FERC Enforcement was determining penalties. Dec. 2006: Process for Assessing Civil Penalties 307

309 CREATION OF PENALTY GUIDELINES In 2010 FERC issued guidance: March 2010: Enforcement of Statutes, Orders, Rules, and Regulations, 130 FERC 61,220 (2010) (Policy Statement on Penalty Guidelines). April 2010: the Commission suspended the Policy Statement on Penalty Guidelines and application of the Penalty Guidelines to allow 60 days within which comments could be submitted. Workshops held in several cities. September 2010: Enforcement of Statutes, Orders, Rules, and Regulations, 132 FERC 61,216 (2010) (Revised Policy Statement on Penalty Guidelines) 308

310 CREATION OF PENALTY GUIDELINES The modified Penalty Guidelines will play a significant role in our determinations of civil penalties and will add greater fairness, consistency, and transparency to our enforcement program. These Penalty Guidelines continue to base penalties on the same factors as those present in our policy statements on enforcement, but do so in a more focused manner by assigning specific and transparent weight to each factor. For example, we will continue to base penalties on the seriousness of the violation, measured in large part by the harm or risk of harm caused, an organization s efforts to remedy the violation, as well as other culpability factors, such as senior-level involvement, prior history, compliance, selfreporting, and cooperation. While these factors remain the same, organizations will now know with more certainty how each is applied. At the same time, the modified Penalty Guidelines do not restrict our discretion to make an individualized assessment based on the facts presented in a given case. 309

311 FERC S PENALTY GUIDELINES Five-step process: Step One: Determine the Base Violation Level Step Two: Adjust the Base Level Violation to reflect ƚśğ ƐĞƌŝŽƵƐŶĞƐƐ ŽĨ ƚśğ Žī ĞŶƐĞ ї &ŝŷăů s ŝžůăɵžŷ Level. Step Three: Calculate a Base Penalty Step Four: Calculate a Culpability Score. Step Five: Multiply the Base Penalty Amount (from Step Three) by the Multipliers (from Step Four). 310

312 FERC S PENALTY GUIDELINES Fraud, Anticompetitive Conduct and other Rule, Tariff and Order Violations Start with a Base Violation Level 6 and Increase level from 0 to 30 depending on the size of the loss resulting from violation Increase level from 2 to 6 depending on the amount of the electricity or natural gas involved Increase level from 2 to 6 depending on the duration of the violation 311

313 FERC S PENALTY GUIDELINES Intentional or Reckless Misrepresentations and False Statements to FERC Start with a Base Violation Level 18 and Increase by 3 levels if violation resulted in substantial interference Increase by 2 levels if evidence was fabricated, destroyed 312

314 FERC S PENALTY GUIDELINES Reliability Standards Start with a Base Violation Level 6 and Increase up to 26 levels depending on the risk of harm resulting from violation Increase up to 32 levels depending on the loss of firm load 313

315 FERC S PENALTY GUIDELINES Culpability Score (Add/Subtract) Add 1 point (ten or more employees) to 5 points (5,000 or more employees) 2 points (violation of FERC order) 3 points for obstructing justice during investigation Subtract 2 points for self-report 1 point for full cooperation 1 point for settling (i.e. no hearing) 1 point for accepting responsibility for violation 314

316 FERC S PENALTY GUIDELINES FERC still has discretion in the application of the Guidelines: The Guidelines do not affect Staff s exercise of discretion to close investigations and self-reports without sanctions. The Commission may depart from application of the Guidelines if appropriate. 315

317 DISGORGEMENT AS A REMEDY When disgorgement is ordered, the amount disgorged may be refunded to the party harmed by the violation, or, if FERC determines that it would be inappropriate to refund to that party or that it is not possible to determine who that party would be, FERC may direct that the amount disgorged be paid to an energy assistance program. 316

318 USING THE PENALTY GUIDELINES: EXAMPLE For a 90-day period, a small natural gas marketer (52 employees), without an effective Asset Management Agreement, and as part of tied arrangement released 25,000 MMBtu/day of capacity on an interstate pipeline. The additional compensation from the tying arrangement exceeded the pipeline s applicable maximum rate by $0.40 MMBtu. Marketer, which does not have effective compliance program, had an inkling that the transaction might violate a FERC rule, but never bothered to explore. Eventually, marketer was referred to the Enforcement Hotline by an anonymous caller (likely a competitor). Marketer was dismayed, destroyed a couple incriminating s, and misled the FERC Staff during the initial part of the investigation. Ultimately, however, the marketer assumed responsibility for the violation and informally resolved the investigation through settlement 317

319 USING THE PENALTY GUIDELINES: EXAMPLE Two discernable violations to calculate: Violation of a FERC Order and Misrepresentation. 90 day period $900k profit No compliance program Destroyed documents Reported to FERC Only smart thing the entity did was settle! 318

320 Application of Penalty Guidelines Violation of FERC Order Step 1: 6 Base Violation Level for violation of FERC orders (tying prohibition) Step 2: + + Step 3: 14 6 More than $400,000 loss ($900,000 see above) More than 700,000 MMBtu 26 Final Violation Level $3,700,000 Base Penalty (from a Table in the Revised Policy Statement) Step 4: 5 Starting Culpability Score + 2 More than 50 employees and willful ignorance of violation + 3 Obstruction of justice 1 Informal Resolution 1 Accepting Responsibility 8 Final Culpability Score Minimum Multiplier 1.6 Maximum Multiplier 3.2 Step 5: Penalty Range $3,700,000 (Base Penalty) x 1.6 (Minimum Multiplier) = $5,920,000* $3,700,000 (Base Penalty) x 3.2 (Maximum Multiplier) = $11,840,000* 319

321 Application of Penalty Guidelines Misrepresentation Step 1: 18 Step 2: + Step 3: Base Violation Level involving reckless misrepresentation to FERC Staff 2 Document destruction 20 Final Violation Level $650,000 Base Penalty Step 4: 5 Starting Culpability Score 2 More than 50 employees and willful ignorance of violation 3 Obstruction of justice 1 Informal Resolution 1 Accepting Responsibility 8 Final Culpability Score Minimum Multiplier 1.6 Maximum Multiplier Step 5: Penalty Range $650,000 (Base Penalty) x 1.6 (Minimum Multiplier) = $1,040,000* $650,000 (Base Penalty) x 3.2 (Maximum Multiplier) = $2,080,000* 320

322 Using the penalty guidelines: EXAMPLE Total: Disgorgement of $900,000 (25,000 x 90 x.40) Penalty for the order violation: between $5,920,000 and $11,840,000* Penalty for the misrepresentation: between $1,040,000 and $2,080,000* Penalty amount could be in either range or cumulative for both ranges, that is, from $1,940,000 to $14,820,000 (including disgorgement) 321

323 PENALTIES UNDER THE FPA Total Civil Penalties assessed for all years 2007 to present: $602,329,786 Total Civil Penalties does not include the $30,000,000 assessed in Hunter and overturned on jurisdictional grounds by the U.S. Court of Appeals for the District of Columbia Circuit. Also does not include penalties proposed or assessed in the following currently pending matters: $28,000,000 in BP America Inc., et al.; $453,000,000 in Barclays Bank PLC, et al.; $5,000,000 assessed in Lincoln Paper and Tissue, LLC; $7,500,000 assessed in Competitive Energy Services, LLC; or $1,250,000 assessed in Richard Silkman. Total Disgorgement ordered for all years 2007 to present: $299,699,982 Total Disgorgement does not include amounts ordered in the following currently pending matters: $34,900,000 ordered in Barclays Bank PLC, et al.; $ ordered in Lincoln Paper and Tissue, LLC; or $166,841 ordered in Competitive Energy Services, LLC. 322

324 OTHER PENALTIES Revocation of Market-Based Rate Authority Ban specific traders Require detailed reporting to FERC for a period of years Spend $$$ on a compliance program and training

325 COMPLIANCE BEST PRACTICES

326 FERC s Suggestions For a Compliance Program FERC has stated that an effective compliance program will have the following two goals: (1) (2) exercising due diligence to prevent and detect violations; and promoting an organizational culture that encourages a commitment to compliance with the law. When deciding the amount of civil penalties, FERC will give serious consideration to whether a regulated entity has a compliance program. 325

327 The seven components to achieve these two goals are as follows: (1) Adopting standards and procedures to prevent and detect violations; (2) Involving the highest governing body of the organization, e.g., the Board of Directors, in the compliance program and assigning overall responsibility for the program to high level personnel; (3) Preventing individuals, whose previous conduct would have been inconsistent with an effective compliance program, from having substantial authority within the organization; (4) Communicating, through effective training or otherwise disseminating information, the current standards, procedures and other aspects of the compliance program; (5) Taking reasonable steps to (i) detect violations, including adopting an employee hotline, and (ii) evaluate the effectiveness of the compliance program; (6) Using both carrots (incentives) and sticks (disciplinary actions) with employees to achieve compliance; and (7) Reporting any violations without "unreasonable delay", while taking appropriate steps to prevent future violations. See Enforcement of Statutes, Orders, Rules and Regulations,132 FERC 61,216 (2010). 326

328 Attributes of a Culture of Compliance if a company acts aggressively to adopt, foster, and maintain an effective corporate culture of compliance, and has in place rigorous procedures and processes that provide effective accountability for compliance, but a violation nonetheless occurs, the Commission may provide a significant reduction in, or even in some cases the elimination of, the civil penalty that otherwise would be imposed. Compliance with Statutes, Regulations and Orders, 125 FERC 61,058 at P 4 (October 16, 2008). 327