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FERC Adopts Broad Anti-Market Manipulation Rule Modeled After SEC Securities Regs

January 23, 2006
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FERC last Thursday voted out a broad anti-market manipulation rule for natural gas and electric power that is patterned after the Securities and Exchange Commission's (SEC) regulation prohibiting manipulation and fraud in the securities industry.

"It's just very satisfying that five years after the California crisis, I think the Commission has the right tools now to address attempts to manipulate markets in the future," FERC Chairman Joseph Kelliher told reporters after the Commission's open meeting. "We're in a much better position than the Commission was five years ago to act in the event that there are attempts to manipulate markets."

The Commission based its final anti-manipulation rule on the SEC's Rule 10b-5 that implements the requirements of the Securities and Exchange Act of 1934. Interstate pipelines, natural gas producers and power utilities previously expressed concern over the Commission's intent to model nearly word-for-word its anti-market manipulation rule after the SEC's rule. They claimed that wholesale adoption by FERC of the SEC rule would not translate well into energy market situations and was not mandated by the Energy Policy Act of 2005 (EPAct), which was signed into law last August (see NGI, Nov. 28, 2005).

The Commission affirmed in the final rule that it will, on a case-by-case basis, adapt analogous securities precedents as appropriate to specific facts, circumstances and situations involving alleged fraud or manipulation that arise in the energy industry. This will provide "substantial certainty" to the energy industry because of the large body of securities case law, the agency said.

Bowing to the concerns of industry, FERC clarified that the final rule does not create any new affirmative disclosure duty. "Nothing in the final rule requires disclosure of sensitive information that would only function to weaken an entity's bargaining position in arm's-length, bilateral negotiations." But it rejected requests to remove provisions regarding omission of material facts, noting that parties may not misrepresent facts where there is a Commission-imposed requirement to be truthful.

The Commission also clarified that there can be no violation of the new anti-market manipulation rule without a showing of intent to deceive or defraud, legally defined as "scienter." It rejected pleas to change the language addressing scienter or to provide specific language regarding intent. FERC said the concept of scienter was well-established in securities law and clarified that "recklessness" satisfies the scienter requirement.

The new anti-market manipulation rule, which was crafted in response to EPAct, makes it illegal for any entity, directly or indirectly, in connection with the purchase or sale of natural gas or electric energy, 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 [RM06-3].

The rule extends FERC's anti-market manipulation authority to energy entities that are not jurisdictional to the agency, such as government-owned utilities and other market participants, said Kelliher. "To be in violation of the new rules, however, such an entity must act with a requisite intent, and the [fraud] or deceit must be in connection with a transaction subject to the jurisdiction of the Commission." Absent a nexus to a jurisdictional transaction, fraud and manipulation in a non-jurisdictional transaction (such as a first or retail sale) is not subject to the new regulations, the agency noted.

FERC's new anti-market manipulation authority is "exceedingly broad," said Commissioner Suedeen Kelly. Congress has extended FERC's oversight to any entity playing in the energy market that is involved in a jurisdictional transaction, she noted.

"The Commission defines fraud generally, that is, to include any action, transaction or conspiracy for the purpose of impairing, obstructing or defeating the honest functioning of the market. Fraud is a question of fact that is to be determined by all the circumstances of a case," the final rule noted. The rule also increases the agency's maximum civil penalty to $1 million a day per violation.

"While it [the final rule] doesn't give any exhaustive list of possible transgressions" that would be subject to FERC action or penalties, "I think it sets the parameters very clearly," said Commissioner Nora Brownell. It "[will] bring clarity and certainty to the marketplace" finally, she noted. "It's awfully hard to find the sinners without the Ten Commandments."

With this new manipulation rule, "I hope that we will go a long way to restoring our credibility [both] with Congress and the customers who are paying the bills," Brownell said.

Meanwhile, Kelliher told reporters following the open meeting that he expects FERC's enforcement resources in the Office of Market Oversight and Investigations (OMOI) "will have to expand; we'll have to have more staff."

He noted that FERC has "two new major enforcement responsibilities in EPAct." One involves market manipulation, while the other involves reliability. "The job isn't done just when we issue the final rule. There's an ongoing responsibility to enforce, once the final rule is issued, so those are areas where we will have to dedicate additional resources."

The final rule will become effective upon publication in the Federal Register, which Kelliher said should be sometime this week. He noted FERC's existing market behavior rules, which were enacted in 2003, will remain in effect pending the outcome of a proceeding in which the agency is considering the revision or repeal of those rules. Kelliher noted that FERC hopes to act on the revision/repeal of the market behavior rules soon, and added that the outcome will be incorporated in the enforcement of the final anti-manipulation rule.

The rule is "one of the products of EPAct that I'm most proud of," the chairman said.

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