FERC Administrative Law Judge Finds Market Manipulation in "Cross-Over"Case
An August 13, 2015 decision of a FERC Administrative Law Judge (ALJ or judge) held that BP America Inc., a large U.S. producer of oil and natural gas, and several affiliated companies (collectively referred to as BP) engaged in market manipulation during a two and a half month period in violation of the Natural Gas Act and FERC regulations. The initial decision, which is subject to Commission review and eventual court appeal, marks another “case of physical for financial benefits” – the sort of “cross-over” case involving both physical and financial energy markets that has been at the heart of questions over FERC’s jurisdiction, which traditionally extends only to physical trading.
A Question of Jurisdiction
FERC has jurisdiction over market manipulation that affects solely physical energy. The Commodities Future Trading Commission (CFTC) has exclusive jurisdiction regarding market manipulation that affects solely financial transactions. FERC continues to take the position that it retains jurisdiction in cross-over cases like the BP case – cases involving both physical and financial energy markets. Thus far, FERC has successfully defended its jurisdictional position in these cross-over cases in court. FERC also has entered into information-sharing and staff level cooperative agreements with the CFTC intended to assist both agencies in their market manipulation investigations, including those in cross-over cases. In order for FERC to have jurisdiction in a cross-over manipulation case, the alleged manipulation must have some connection with a wholesale or interstate transportation of natural gas or electricity within FERC’s traditional jurisdiction.
The BP America Inc., et al. Initial Decision
Relying on a similar earlier case involving Barclays Bank and several of its traders, FERC ALJ Cintron found that BP’s physical trades and related transportation during the September 18, 2008 through November 30, 2008 period under investigation were not supported by market economics, marked a significant change from BP’s earlier trading practices, benefited BP’s financial positions in related financial transactions, and violated FERC’s anti-manipulation rule. The judge found at least 48 BP violations of the manipulation rule and ruled that BP’s conduct warranted increased penalty amounts based upon culpability factors under FERC’s penalty guidelines.
During the period under investigation, BP began buying higher priced gas at the Katy trading hub, shipping the gas through an intrastate pipeline from Katy to the Houston Ship Channel trading point, and selling lower priced gas at the Houston Ship Channel where it held financial “short” positions. This was a change from BP’s earlier conduct, before Hurricane Ike depressed natural gas prices at the Houston Ship Channel relative to prices at the Henry Hub.
Ultimately, and crucially, BP’s short financial positions at the Houston Ship Channel and long financial positions at the Henry Hub trading point each benefited from BP’s “long” physical positions at the Houston Ship Channel – physical positions that evidenced BP’s changed and uneconomic trading behavior. BP’s uneconomic physical trading benefited its financial positions by driving the Houston Ship Channel Gas Daily index gas price down in what the judge called “a classic case of physical for financial benefits.”
BP provided no legitimate explanation for this uneconomic buy-high-sell-low behavior, the judge found. Rather, she found the trading evidenced a coordinated effort to drive down the Houston Ship Channel Gas Daily index price. “Gas Daily prices are the daily benchmark for prices at their respective locations, and are used for settlement of financial contracts and daily and monthly physical contracts.” In reaching the market manipulation conclusion, Judge Cintron found ample evidence of scienter, which consists of intent or reckless behavior. She also found a requisite connection to a FERC-jurisdictional transaction.
Circumstantial Evidence of Scienter
The scienter or intent required to prove market manipulation can be inferred indirectly from circumstantial evidence. Repeated losses on physical trades, suspicious timing or repetition of transactions, a change in trading practices, execution of transactions benefiting derivative positions, and no legitimate explanation for the uneconomic trading each can evidence intent to engage in a cross-market manipulation scheme. The ALJ found all to exist in the BP case.
Specifically, BP shifted its trading at the Houston Ship Channel almost entirely to net selling, and increased the volume and percentage of “fixed-price” sales (gas sold at a fixed price, which Gas Daily uses to calculate its Gas Daily Index) at that point. BP also started selling higher volumes earlier in the gas trading day, and became the largest seller at the Houston Ship Channel during the first five minutes of the trading session at that point.
In addition, BP aggressively increased the sales at seller-offered prices (which tend to be lower than buyer offered bids) even when its natural gas sales prices would have been higher at the Katy hub. Regarding this price differential between Katy and the Houston Ship Channel, BP bought gas at Katy, shipped it through Houston Pipe Line, an intrastate pipeline, to the Houston Ship Channel, and sold the gas in uneconomic trades at the Houston Ship Channel.
Nexus to a FERC-Regulated Transaction
One requirement for FERC jurisdiction is a connection to a transaction involving an interstate transportation or sale for resale of natural gas or electricity. In analyzing the requisite connection to a FERC-jurisdictional transaction, the ALJ found ample evidence of three such connections based on the influence of the Houston Ship Channel Gas Daily Index and the price of natural gas in several types of transactions.
The ALJ found evidence that (1) the price of third party natural gas sales for resale in interstate commerce; (2) the cash-out transactions of Northern Natural Gas Company, an interstate pipeline; and (3) BP’s own natural gas sales for resale in interstate commerce each had some relationship and had been influenced by the Houston Ship Channel Gas Daily Index.
FERC-Regulated Market Manipulation
By way of context, prior to 2005, FERC prohibited certain recognized types of manipulative market behavior – wash trades, transactions predicated on submitting false information, transactions creating and relieving artificial congestions, and collusion – but it lacked authority to impose civil penalties. In 2005, the Energy Policy Act of 2005 (EPAct) amended both the Natural Gas Act and the Federal Power Act and gave FERC new authority to prohibit market manipulation and impose civil penalties for violations.
Pursuant to these amended statutes, FERC prohibits “any manipulative or deceptive device or contrivance (as those terms are used in section 10(b) of the Securities Exchange Act of 1934)” in connection with a physical sale or transmission of natural gas or electricity subject to FERC’s jurisdiction. FERC’s market manipulation rule now provides the Commission with broad anti-fraud authority.
The judge’s initial decision in BP follows similar cases where FERC established market manipulation by looking at a series of affirmative, coordinated actions that lacked a profit in the physical market and which were taken with no legitimate business explanation. The BP case also provides another example of FERC’s willingness to police market manipulation in cross-over cases where a trader’s actions in the physical market benefit its positions in the financial market.
Effective Compliance Program to Achieve Penalty Credits
FERC has issued penalty guidelines with quantitative benchmarks in order to provide the industry with some certainty as to how FERC will calculate penalty amounts. Those guidelines include a definition of “effective compliance program” and provide a credit (reduction) in the penalty calculation for the existence of an effective compliance program.
Notably, Judge Cintron found that BP had not met the criteria that evidence an effective compliance program. Although BP had a compliance program, and it required various reports to monitor trading deviations, BP failed to follow-up on behavior that its reports had identified as suspect. BP’s compliance personnel seemed to predetermine the outcome of the investigation before completing it, and high-level officials within the company did not adequately oversee the internal investigation. BP’s compliance training failed to adequately discuss physical-for-financial manipulation. No evidence existed that BP regularly reviewed its compliance program. BP failed to take reasonable steps after it discovered a violation had occurred.
The initial decision in the BP case marks another occasion of FERC enforcement’s quest to solidify its claim over cross-over market manipulation. The decision illustrates key trading behaviors, such as uneconomic physical trades that benefit related financial positions, that all compliance programs should address, and it highlights company actions that undercut an effective compliance program. This will be an important case to watch as it winds its way through FERC review and the appellate process.
For questions about market manipulation and FERC related investigations and enforcement matters, contact Post & Schell's Energy Compliance Practice Group, or Principal Douglas M. Canter, email@example.com.
Disclaimer: this E-Flash does not offer specific legal advice, nor does it create an attorney-client relationship. You should not reach any legal conclusions based on the information contained in this E-Flash without first seeking the advice of counsel.
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 BP America Inc. et al., 152 FERC ¶ 63,016 at P 1 (2015) (Initial Decision or ID).
 Id. at P 276.
 See Brian Hunter v. FERC, 711 F. 3d 155 (2013) (holding that the CFTC had exclusive jurisdiction over Brian Hunter, a trader at Amaranth, an alleged market manipulation involving trading natural gas futures, a financial instrument bought and sold on the New York Mercantile Exchange, to the benefit of and with the intent to benefit Amaranth’s financial position in natural gas swaps, also CFTC-regulated financial instruments.).
 Charles R. Mills, Megan E. Vetula, CFTC Exclusive and Enforcement Jurisdiction After Dodd-Frank and Hunter v. FERC, 33 No. 9 Futures & Derivatives L. Rep. 1 (2013).
 Id. at P 33 n 11 (discussing Barclays Bank PLC et al., 144 FERC ¶ 61,041 at P 44 (2013) (Barclays), motion to dismiss denied, FERC v. Barclays, et al., No. 2:13-cv-2093-TLN-DAD, 2015 WL 2455538, 2015 U.S. Dist. LEXIS 66184 (E.D. Cal. Filed May 20, 2015)).
 Douglas M. Canter, Ronald H. Levine, Abraham J. Rein, Market Manipulation: Staying A Step Ahead, Public Utilities Fortnightly, April 2015 at <http://www.fortnightly.com/fortnightly/2015/04/market-manipulation-staying-step-ahead>.
 Id. at P 144, citing 15 U.S.C. §717c-1 (2012).
 Barclays, 144 FERC ¶ 61,041 at P 44.
 See Id. at PP 33 n 11, 81-82, 276-277.
 Id. at PP 219 (violation committed less than five years after prior adjudication of violation); 225 (violation of judicial or FERC order or injunction of federal or state enforcement agencies); and 239 (failure to have effective compliance program). See also ID at PP 278-279.
 Id. at P 276; see also ID at 7, 32, 35, 37, 70, 82, 115, 118.
 Id. at PP 32, 35, 52-53, 79, 276.
 IP at P 68 (Footnote omitted).
 Id. at PP 46 n 24, 49-51, 60 n 42,146, 277.
 Id. at P 112; and at P 114, citing Barclays, 144 FERC ¶ 61,041 at 75.
 Id. at P 120, citing Barclays, 144 FERC ¶ 61,041 at P 43; see also ID at PP 72, 75, 81.
 Id. at P 113.
 Id. at P 99; see also Id. at PP 80, 81.
 Id. at P 113.
 Id. at P 126.
 Id. at P 34 n 12.
 Id. at P 176.
 Id. at PP 49-51, 176.
 Id. at PP 46 n 24, 60 n 42 and 176.
 Id. at PP 55-56.
 Id. at P 147.
 Id. at P 153.
 Id. at PP 156-159.
 Id. at P 276.
 Amendments to Codes of Conduct for Unbundled Sales Service and for Persons Holding Blanket Marketing Certificates, Order No. 673, Docket No. RM06-5-000, 114 FERC ¶ 61,166 at P 19 (Feb. 16, 2006); see also Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, 114 FERC ¶ 61,165 at P 24 (2006), reh’g denied, 115 FERC ¶ 61,053 (2006).
 See Id. at P 79, citing Barclays at PP 7, 32; see also ID at P 33 n 11.
 See Enforcement of Statutes, Orders, Rules, and Regulations, 132 FERC ¶ 61,216 at P 2 (2010) (Revised Policy Statement on Penalty Guidelines).
 Revised Policy Statement on Penalty Guidelines, 132 FERC ¶ 61,216 at Appendix, Penalty Guidelines § 1B2.1 and 1C2.3(f).
 Id. at P 239.
 Id. at P 243.
 Id. at PP 245, 248.
 Id. at P 251.
 Id. at P 252.
 Id. at PP 245, 257.