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FERC's Plan to Pattern Anti-Manipulation Rule After SEC Regulation Raises Red Flags

The Federal Energy Regulatory Commission's proposed rule aimed at broadening its anti-manipulation reach in energy markets last week raised red flags in both the natural gas and electricity industries.

Interstate pipelines, gas producers and power utilities expressed concern over FERC's plan to model nearly word-for-word its proposed anti-manipulation rule, which was issued in October, after the Securities and Exchange Commission's (SEC) Rule 10b-5 that prohibits manipulation and fraud in the securities industry. "Wholesale adoption [by FERC] of securities jurisprudence under Rule 10b-5 is not mandated by the terms" of the Energy Policy Act of 2005, which was signed into law in August, said LG&E Energy LLC in comments filed at the agency [RM06-3]. The SEC's Rule 10b-5 is based on the requirements of the Securities and Exchange Act of 1934.

The new energy law "clearly grants the FERC authority and direction to adopt its own rules, appropriately tailored to its regulated industries. Because of the great differences in the securities and energy markets, it is very important to do so," said the Louisville, KY-based holding company. "Otherwise, a wholesale adoption of [the SEC's] Rule 10b-5 precedent would require a large volume of future interpretations by the Commission and the courts to help define what that Rule 10b-5 precedent actually means when the item sold is an energy commodity and not a security."

The implementation of the SEC rule in the energy industry also "would impose a significant level of risk on well-intentioned industry participants and potentially chill their market activities out of fear that bona fide business transactions may be subsequently misconstrued," LG&E Energy said.

"Due to [the] fundamental differences in securities and energy markets, LG&E Energy believes the Commission should not overly rely upon unfiltered industry jurisprudence. In particular, Rule 10b-5 has been broadly used to regulate numerous securities industry concerns which do not translate well, or at all, into energy market situations. These include accounting improprieties, controlling person liability, insider trading, selective disclosure practices, tipper-tippee situations, underwriter and broker-dealer misconduct and many others. Absent appropriate and considered rules tailored to the energy markets, extensive uncertainty may develop as to if or how these and other securities law 10b-5 concepts are applicable to energy markets."

The proposed anti-manipulation rule, which is pending at FERC, would make it illegal for any entity, directly or indirectly, in connection with the purchase or sale of electric energy or natural gas, or in providing transmission or transportation services subject to FERC regulation, to do the following: 1) defraud using any device, scheme or artifice; 2) make a false statement of material fact or omit a material fact; or 3) engage in any act, practice or course of business that operates or would operate as a fraud or deceit (see NGI, Oct. 24). The proposed rule is patterned after language in the Securities and Exchange Act and the SEC Rule 10b-5.

Under the proposed rule, FERC would have the authority to police any potential market manipulation by energy companies, even by those firms over which the agency does not have jurisdiction.

The Interstate Natural Gas Association of America (INGAA), which represents interstate gas pipes, cited concerns about the pending rule as well. "The Commission must take the differences between the securities markets and the natural gas markets into consideration, and apply its expertise in picking and choosing which provisions of Section 10(b) [of the Securities Exchange Act], and which securities or commodities law precedent should be applied to the natural gas industry," INGAA told FERC.

For example, INGAA questioned whether the SEC's regulation that makes it illegal "to omit to state a material fact" in securities markets would translate well in natural gas markets. "While seeing that the information investors receive does not omit material information is important to enforcement of the [Securities] Exchange Act's disclosure regime, it is far from clear that Congress intended to impose the same sort of standard on the contractual arrangements between the large sophisticated companies operating under the [Natural Gas Act]," the group said.

"While it would be one thing for a company to deliberately misrepresent the capacity of its pipeline, it should not be incumbent on the company to disclose the results of its own market projection studies." INGAA said it agreed with the Electric Edison Institute that FERC should revise its proposed regulation to "delete or limit any affirmative obligation to disclose information to a counterparty, or to educate another party in sophisticated energy market negotiations."

The pipeline group said it supported the Commission's reliance on the Securities Exchange Act and the implementing SEC Rule 10b-5 to provide guidance to the agency in administering its new anti-manipulation authority under the Energy Policy Act. However, it recommended that FERC provide greater guidance to the energy industry on their application in the context of the natural gas markets.

The Electric Power Supply Association (EPSA) called on FERC to define the "relevant nature and scope of disclosure obligations" that would apply to energy companies under the proposed anti-manipulation rule. "The body of SEC precedent that FERC intends to rely upon contains cases concerning disclosure issues that are simply not relevant or applicable to the trading activities that occur in energy markets," the EPSA said.

"Unless narrowed, the broader range of potential disclosure obligations that could provide the basis for enforcement actions under FERC's proposed regulations actually creates substantial uncertainty," the power group noted. Like INGAA, the EPSA called on the Commission to eliminate opportunities for disgruntled parties to invoke the "omit to state a material fact" provision in the agency's proposed rule "as a means of redressing what amounts to poor business judgment."

The EPSA, as did other critics, said the Energy Policy Act of 2005 did not require FERC to adopt the SEC's Rule 10b-5 "word for word."

The Commission has extended the deadline for comments on its proposed anti-manipulation rule, which was initially Nov. 25, to Dec. 5.

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