Federal investigators on Monday ordered Reliant Resources Inc. and CenterPoint Energy (formerly Reliant Energy Inc.) to cease violations of the anti-fraud and reporting/recordkeeping requirements of federal securities laws as part of a settlement entered into between the Securities and Exchange Commission and the companies. No penalties were involved.

The settlement, which was proposed by the companies, follows nearly a year-long formal investigation by the SEC into “round-trip,” structured and “swing-swap” energy trading transactions of the Reliant companies during 1999-2001. SEC spokesman Josh Felker said the agency factored the Reliant companies’ “prompt response” to the sham trading problem, as well as restatement of earnings, in choosing not to impose a fine.

The cease-and-desist order covers the trading activities of the companies prior to 2002, when CenterPoint Energy (then operating as Reliant Energy), a major power and natural gas utility holding company, spun off Reliant Resources as a separate company. “We are pleased the SEC investigation is now closed,” said Reliant Resources Chairman Joel Staff, adding this was “another milestone in putting the past behind us.”

The now-separate Reliant firms “engaged in round-trip trades that dramatically overstated [their] trading volumes in their annual and periodic reports. [They] also overstated their revenue and expenses. Because these amounts were offsetting, [the trades] did not affect net income,” according to the SEC order. The companies “also violated the anti-fraud provisions by booking one of the structured transactions as a cash-flow hedge based on documents that certain employees had postdated, and by using the swing-swap transactions to move earnings from December 2000 [when gas prices were high] to January 2001,” when prices were expected to drop.

The SEC order did not say whether round-trip trading per se was illegal or not. “Our jurisdiction is just over the securities laws,” said Felker. The agency found that the publicly-traded Reliant supplied “inaccurate” volumes, gross revenues and costs of goods in quarterly and annual reports as a result of the sham trading activities, which violated federal securities laws, he noted. If the round-trip activity had taken place between private companies which are not required to report earnings, “I have no idea if they would be illegal or not.”

Between 1999-2001, the SEC said the Reliant companies carried out 17 round-trip power trades that accounted for 26%, 14.5% and 19.5%, respectively, of their total reported megawatt hours of power volume in each year. “Each round-trip trade was for a large volume in order to achieve with one transaction the increased volume that would only result from hundreds of small trades,” the order said.

In 1999 and 2001, the Reliant firms engaged in two round-trip gas trades that accounted for 20% and 6%, respectively, of their reported 1 Bcf of gas volume, according to the SEC. During that period, they also entered into a “swing-swap” consisting of four financially-settled gas swap transactions that had the effect of deferring fourth-quarter 2000 pre-tax earnings of $20 million until the first quarter of 2001.

Federal investigators said the prime motivation behind the round-trip trading activity was the Reliant companies’ wish to increase their standing in energy publications’ rankings of power and gas marketers.

“The idea of engaging in round-trip trades grew out of a desire by certain employees in the Wholesale Group to increase [Reliant’s] status in the industry as energy marketers and traders. Various industry publications kept track of power trading volumes that energy companies reported quarterly to the Federal Energy Regulatory Commission. Other publications tracked energy companies’ natural gas trading volumes…The charts in these publications, which came to be called the industry rankings, or “league tables,” were regularly published by several energy industry trade publications in the late 1990s,” the SEC noted.

Starting in 1999, the Reliant companies “decided that it was advantageous to be in the top ten, and then the top five, and ultimately the top three in these industry league tables in terms of volumes traded because it would help [them] market ‘power origination products’ to large energy users,” the agency said, adding this led to the large pre-arranged trades between Reliant and others.

In carrying out the round-trip trades, the Reliant companies “made an effort to find counterparties that were lower in the rankings than [they were] so that any resulting increase in the counterparty’s standing in the league tables would not adversely affect [Reliant’s] move upward in the rankings,” according to the SEC.

Because the round-trip trades were recorded on a gross basis, the Reliant companies — which had not been split at this point — reported inflated gross revenue and expenses, the agency noted. As a result, Reliant last May was forced to restate its revenues for the 1999-2001 period, removing 17.7%, 5.3% and 10.6%, respectively, of reported revenues for those three years.

For the most part, the SEC said the round-trip trading activity did not affect the profits of the parties engaged in the transactions.

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