Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY 10003 www.law360.com Phone: +1 646 783 7100 Fax: +1 646 783 7161 customerservice@law360.com Political Pressure May Push FERC, CFTC Closer Together Law360, New York (October 24, 2014, 11:44 AM ET) -- At the outset of 2014, we reported on two memoranda of understanding entered into by the Federal Energy Regulatory Commission and U.S. Commodity Futures Trading Commission concerning matters of jurisdiction and information sharing related to the roles of FERC and the CFTC in conducting market surveillance and investigations into potential market manipulation, fraud and abuse.[1] At the time, we questioned the extent of the impact these memoranda would have for ongoing FERC and CFTC investigations involving overlapping jurisdiction and posited that the practical effect might be hard to discern. The outcome of a recent turf battle between the CFTC and FERC ending in the CFTC s settlement of longstanding energy market manipulation allegations against Brian Hunter, a former Amaranth Advisors LLC trader, has put those questions back into the spotlight and suggests further congressional scrutiny of jurisdictional overlap and perceived noncooperation could be in the works. Daniel A. Mullen Senatorial Scrutiny of the Hunter Settlement The stirrings of further congressional inquiry were signaled in a scathing Oct. 8, 2014 letter to CFTC Chairman Timothy Massad by Sens. Maria Cantwell, D-Wash., Dianne Feinstein, D-Calif., and Carl Levin, D-Mich.[2] In the letter, the senators expressed their profound[] disappoint[ment] with the CFTC s Sept. 15, 2014 settlement with Hunter who, in 2006, as the former head natural gas trader at the now defunct Amaranth, allegedly sold massive volumes of futures contracts in order to manipulate the price of natural gas and make illicit profits. [3] In so objecting, the senators expressed dissatisfaction not with the CFTC s decision to settle, but with the commission's willingness to settle for a mere $750,000 an amount the senators deemed an embarrassment that subverted congressional intent, undermine[d] the public interest to the detriment of the American people, and raised concerns about whether the CFTC s authority as currently exercised can effectively regulate energy markets and prohibit market manipulation. [4]
Background on the Hunter Settlement Understanding the senators objection to the scope of the settlement requires some understanding of the background to the Hunter settlement itself, which effectively ended a seven-year enforcement odyssey that dates back to conduct occurring nearly nine years ago. The conduct at issue was publicly outlined in the CFTC s July 25, 2007, complaint, which alleged that Amaranth and Hunter attempted to manipulate the price of natural gas futures contracts on the New York Mercantile Exchange in an effort to benefit a larger short interest in natural gas swaps positions held on the Intercontinental Exchange.[5] The settlement prices for NYMEX natural gas futures contracts are determined by the volume-weighted-average for trades executed during a half-hour window on the contract expiration date. ICE then separately uses the NYMEX settlement price to calculate its own settlement price for natural gas swaps traded on ICE. The CFTC alleged that Amaranth and Hunter attempted to artificially lower the price of NYMEX natural gas futures contracts through a process known as banging the close, essentially selling natural gas futures contracts on the NYMEX during the half-hour closing window, at a time when Amaranth had no commercial purpose for doing so and with the knowledge that it was not capable of delivering physical natural gas.[6] In focusing its complaint on attempted manipulation, the CFTC was trying to sidestep an historical anti-manipulation rule applicable to conduct that predated the Dodd-Frank Wall Street Reform and Consumer Protection Act.[7] Under applicable case law interpreting that rule, demonstrating manipulation required a four-part showing that: (1) the accused had the ability to influence market prices; (2) that the accused specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand; (3) that artificial prices existed; and (4) that the accused caused the artificial prices. [8] The requirement that the CFTC demonstrate the existence of an artificial price historically presented significant obstacles to the CFTC s enforcement program; allegations of attempted manipulation obviated this challenge. In contrast, when on the very next day FERC filed its own Order to Show Cause and Notice of Proposed Penalties (the Show Cause Order ) against Amaranth, Hunter and Hunter s fellow Amaranth trader, Matthew Donohoe, FERC s preliminary determination was that the respondents had engaged in actual manipulation of the natural gas markets through their NYMEX trading.[9] Although the CFTC beat FERC out of the gate by a day in filing charges against Amaranth and Hunter, the conduct at issue was first identified by staff in FERC s Division of Energy Market Oversight within the commission's Office of Enforcement. FERC thereafter notified the CFTC with a request for data on the NYMEX trading at issue and FERC s Director of Investigations then initiated a nonpublic preliminary investigation. The investigation was acknowledged by FERC to have been heavily coordinated with an investigation opened subsequently by the CFTC, with additional coordination with the U.S. Securities and Exchange Commission, among others.[10] Despite this apparent coordination and attempted cooperation, the overlapping regulatory regimes presented an opportunity for Hunter to engage in a long-term strategy of what amounted to regulatory arbitrage, thereby benefiting from the least punitive of the competing regulations that he was alleged to have violated. Hunter s strategy, which is explained in greater detail below, involved a successful judicial challenge to FERC s assertion of jurisdiction over his trading.
As an initial matter, this strategy likely sought to prevent overlapping enforcement efforts, but ultimately had success in exploiting differing penalty provision authority exercised by FERC and the CFTC. As noted in the Show Cause Order, FERC has the authority to impose civil penalties of up to $1 million per violation, per day for any violations of a provision of the [Natural Gas Act] or a commission rule or order implementing one of those provisions that occurred or continued on or after Aug. 8, 2005. [11] Because FERC enforcement staff found that Amaranth s violations consisted of the filing of 219 separate, multicontract executions of fill orders to sell futures contracts, and based on factors determined to weigh in favor of a maximum penalty amount, the FERC Show Cause Order found that the maximum available penalty was $219 million, with an appropriate penalty assessment consisting of a $200 million fine against Amaranth, a $30 million fine against Hunter and a $2 million fine against Donohoe.[12] In contrast, the CFTC complaint referenced its ability to seek civil monetary penalties in an amount not to exceed $130,000, or triple the monetary gain to the respondents for each violation of the Commodity Exchange Act.[13] While the CFTC did not ultimately put forth publicly its assessment of the number of violations at issue or what it believed to be the total monetary gain obtained by the respondents, the FERC Show Cause Order provides at least one possible metric for determining pecuniary gain. In that order, FERC staff made a preliminary finding that Amaranth had profited by a total of at least $59 [million] and perhaps as much as $168 [million] as a direct result of the manipulation. [14] It is worth pointing out that the CFTC complaint alleged attempted manipulation only for conduct in connection with trading done by the respondents in February and April 2006 (in connection with March and May futures contracts), whereas the FERC Show Cause Order contained allegations of manipulation in connection with February, March and April trading for March, April and May futures contracts. However, even without comparable allegations in the CFTC complaint pertaining to the March trading, had the CFTC sought a civil monetary penalty based on findings similar to those of the FERC, these penalties likely would have been substantial.[15] After an initial period in which both regulatory actions worked their way through the administrative and litigation process, Amaranth (and, for the FERC Show Cause Order only, Donohoe) agreed in August 2009 to separate settlements with both agencies, agreeing to pay separate civil penalties to both FERC and the CFTC of $7.5 million.[16] Then, on April 21, 2011, approximately one-and-a-half years after the initial Show Cause Order was issued, FERC upheld a Jan. 22, 2010, initial decision against Hunter and ordered Hunter to pay a civil monetary fine of $30 million.[17] With a final agency action in hand, Hunter moved forward with a prior petition to the D.C. Circuit, seeking review of his challenge to the jurisdictional authority of FERC to assess a fine against him.[18] Hunter s principal jurisdictional argument was that the CFTC had exclusive jurisdiction over conduct in the market for natural gas futures contracts. Despite its prior cooperation in the underlying investigation, the CFTC thereafter intervened in the case on behalf of Hunter and to assert its exclusive jurisdiction over the conduct in question.[19] FERC responded by arguing that, under Section 4A of the Natural Gas Act, manipulation in connection with jurisdictional transactions (essentially, any conduct in a nonjurisdictional transaction that has an impact on a jurisdictional one) is sufficient to bring such conduct within FERC s jurisdiction.[20] The D.C. Circuit disagreed, finding on March 15, 2013, that the CFTC has exclusive jurisdiction over natural gas futures contracts under the CEA and, because the NGA did not repeal the CEA, FERC did not have jurisdiction to assess a fine against Hunter.
The Hunter Settlement and Congressional Scrutiny With the FERC enforcement action against Hunter effectively over, the U.S. District Court for the Southern District of New York lifted a pre-existing stay on the CFTC action that was put in place after the filing of Hunter s case in the D.C. Circuit. The CFTC and Hunter then entered into negotiations over the CFTC s complaint, reaching a final settlement through the entry of a Sept. 15, 2014 consent order.[21] The consent order required Hunter, who settled on a neither admit nor deny basis, to pay a $750,000 civil monetary penalty, and permanently banned Hunter from trading all CFTC-regulated products during the settlement period for the last day of trading of the expiring contract, product or instrument for the next (prompt) delivery month.[22] Hunter was separately banned by the consent order from trading all CFTC-regulated natural gas products during the daily closing period for trading for such contract, product or instrument.[23] The order separately instituted a permanent prohibition against Hunter from registering with the CFTC or claiming exemption from registration.[24] In objecting to the settlement, Sens. Cantwell, Feinstein and Levin expressed the view that the settlement is in conflict with congressional intent and undermines the public interest. The senators expressed two principal concerns. First, they expressed the viewpoint that, by intervening on behalf of Hunter in his challenge to FERC's exercise of jurisdiction, the CFTC subverted congressional intent to expand FERC s regulatory and enforcement authority. The senators expressed specific distaste for the fact that the CFTC, in their view, undermined the FERC case after jointly investigating Hunter, finding clear evidence of manipulation, and coordinating legal action with FERC. Second, the senators expressed the view that the CFTC had undermined FERC's case knowing that the CFTC's existing statutory authority would result in an enforcement action of significantly less impact than what FERC's authorities would have enabled. The senators found it unacceptable that, after undermining FERC s $30 million fine, the CFTC settled for a $750,000 fine and failed to secure an admission of guilt from Hunter. In expressing dissatisfaction with the CFTC settlement, the senators were echoing prior requests for the CFTC and the FERC to engage in greater cooperation. The entrance by FERC and the CFTC into jurisdictional and cooperation-based MOUs earlier this year had been preceded by similar congressional requests.[25] Conclusion Sens. Cantwell, Levin and Feinstein did more than express their displeasure with the Hunter settlement in their letter, demanding the CFTC provide an explanation for its actions and respond to [the concerns expressed in the letter] no later than Oct. 24, 2014, together with a plan of action outlining in detail how the CFTC plans to work proactively with FERC to carry out meaningful market regulation and enforcement in cases of manipulation going forward. In making this request, the senators left the CFTC with a warning, suggesting that they are intent on remedying the institutional failures that led to this outcome. While Congress has yet to express any outright desire to legislatively address Hunter s successful jurisdictional challenge to FERC s attempted oversight of natural gas futures contracts, recent congressional dissatisfaction could signal a willingness to revisit the issue. At a minimum, the CFTC can be expected to address the questions posed to it by Sens. Cantwell, Feinstein and Levin, which may lead to a more clearly defined roadmap for enforcement actions in which there is arguable jurisdictional overlap between FERC and the CFTC.
By Daniel A. Mullen and Nathan M. Erickson, Fried Frank LLP Daniel Mullen is a partner and Nathan Erickson is an associate in Fried Frank's Washington, D.C., office. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. [1] See Fried Frank Client Memorandum, Federal Energy Regulatory Commission and Commodity Futures Trading Commission Sign MOUs on Jurisdiction and Information Sharing (Jan. 6, 2014), available at http://www.friedfrank.com/sitefiles/publications/final%20version2.pdf. [2] See Oct. 8, 2014 Letter from Sens. Cantwell, Feinstein and Levin to CFTC Chairman Massad, available at http://www.feinstein.senate.gov/public/index.cfm/files/serve/?file_id=4174fa56-9c77-4dc2-bcf0-8748d9cdd8a0. While Sens. Feinstein and Cantwell do not currently sit on any common committees, Sens. Levin and Cantwell currently sit on the Senate Committee on Small Business and Entrepreneurship, which is chaired by Sens. Cantwell, and Sens. Levin and Feinstein sit together on the Senate Select Committee on Intelligence, which is chaired by Sen. Feinstein. Sen. Feinstein separately serves on the Energy and Water Development Subcommittee of the Committee on Appropriations, while Sen. Cantwell sits on the Senate Committee on Energy and Natural Resources. [3] See id. [4] See id. [5] See Complaint, Commodity Futures Trading Commission v. Amaranth Advisors LLC, et al., 07-cv-6682 (S.D.N.Y, July 25, 2007), available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfamarant hcomplaint072507.pdf. [6] The CFTC separately alleged that Amaranth and Hunter took steps to cover up its attempted manipulation by making material misrepresentations to NYMEX regarding the manner in which it described its positions and trading strategy. See id. at 80. [7] As a part of its Dodd-Frank rulemaking, the CFTC adopted Rule 180.1. Rule 180.1 implemented amended Commodity Exchange Act Section 6(c)(1), which prohibits, among other conduct, any person from intentionally or recklessly using or employing, or attempting to use or employ, any manipulative device, scheme or artifice to defraud in connection with any swap, or contract of sale of any commodity in interstate commerce. [8] See 76 Fed. Reg. 41398, 41407 (July 14, 2011). [9] See FERC Order to Show Cause and Notice of Proposed Penalties, 120 FERC 61,085, Docket No. IN07-26-000 at 52 56, available at http://www.ferc.gov/eventcalendar/files/20070726084235- IN07-26-000.pdf. [10] See id. at 55.
[11] See id. at 114. [12] See id. at 116 138. [13] See Complaint, Commodity Futures Trading Commission v. Amaranth Advisors LLC, et al., 07-cv- 6682 (S.D.N.Y, July 25, 2007) at VI, F; 17 C.F.R. 143.8 (indicating that the inflation-adjusted maximum civil monetary penalty for each violation of the Commodity Exchange Act or the rules, regulation or orders promulgated thereunder committed between Oct. 23, 2004, and Oct. 22, 2008, that may be assessed shall be not more than the greater of $130,000 or triple the monetary gain to such person for each such violation). The current inflation-adjusted maximum civil monetary penalties for manipulation or attempted manipulation violations under the Commodity Exchange Act range from $1 million to $1.02 million, or triple the monetary gain to such person for each such violation. See 17 C.F.R. 143.8(a)(1)(i)(A), 17 C.F.R. 143.8(a)(3)(i)(B), and 17 C.F.R. 143.8(a)(4)(i)(B). [14] See FERC Show Cause Order at 139 (emphasis in original). See also id. at 80-81, 88, 98-99 and 101-102. [15] The FERC Show Cause Order identifies a lower threshold estimate of pecuniary gain for the February and April trading of $27 million and $20.5 million, respectively, and an upper threshold estimate of $89 million and $37 million, respectively, for the same months. See id. at 80 and 98 and 81 and 102. This puts FERC s estimated pecuniary gain, based on the trading at issue in the CFTC complaint, within the $47.5 million to $126 million range. [16] See CFTC Consent Order of Permanent Injunction, Civil Monetary Penalty and Other Relief as to Defendants Amaranth Advisors LLC and Amaranth Advisors (Calgary) ULC, 07-Civ.6682 (DC), (S.D.N.Y., Aug. 12, 2009); FERC Order Approving Uncontested Settlement, 128 FERC 61,154 (Aug. 12, 2009). The CFTC order provided for a set-off amount of $3.75 million of the $7.5 million fine assessed by FERC. See CFTC Consent Order at 4 ( Payments by the respondents in the FERC [Show Cause Order], other than Brian Hunter, in satisfaction of any civil penalty entered in the FERC [Show Cause Order] shall satisfy the [civil monetary penalty obligation] up to a total of $3.75 million ). [17] See FERC Order Affirming Initial Decision and Ordering Payment of Civil Penalty, Docket No. IN07-26-004, 135 FERC 61,054 (Apr. 21, 2011). [18] See Brief for Petitioner, Brian Hunter, Petitioner v. FERC, Respondent, 2012 WL 1202702 (C.A.D.C, April 10, 2012). Hunter also argued that FERC had inappropriately interpreted the Natural Gas Act s anti-manipulation prohibition to apply to individuals. [19] Brief of Intervenor CFTC, Brian Hunter, Petitioner v. FERC, No. 10-1017, (D.C. Cir. July 16, 2010). [20] Brief of Respondent FERC, Brian Hunter, Petitioner v. FERC, No. 10-1017 (D.C. Cir. Sept. 16, 2010). [21] See Consent Order for Civil Monetary Penalty and Other Equitable Relief Against Brian Hunter, CFTC v. Brian Hunter, 07-Civ-6682 (RA), (S.D.N.Y., Sept. 15, 2014). [22] See id. at 14. [23] See id. at 15.
[24] See id. at 16. [25] See, e.g., April 29, 2013 Letter from Sens. Feinstein, Lisa Murkowski, R-Ala., and Ron Wyden, D-Ore., to CFTC Chairman Gary Gensler and FERC Chairman Wellinghoff, available at http://www.feinstein.senate.gov/public/index.cfm/files/serve/?file_id=52b4267d-cd8b-424a-a2d9- f2229b597f54, (calling on FERC and the CFTC to enter into MOUs necessary to ensure that the agencies will work together to pursue manipulation, will share and integrate all data for natural gas and electricity trading, and will cooperate in order to protect American consumers ). All Content 2003-2014, Portfolio Media, Inc.