America's New Energy Prosecutors
A federal regulator violates due process to extract huge settlements without defining 'market manipulation.'
By
William S. Scherman
Updated May 18, 2014 9:56 p.m. ET
The subjects of investigations by the Federal Energy Regulatory Commission, or FERC, are rarely willing to speak out publicly. Some stay silent, wrongly believing that by cooperating they might convince regulators to leave them alone. Others stay silent because they know they will have to continue to deal with their regulators after the investigation. But Kevin and Richard Gates recently spoke out publicly against FERC, detailing their tribulations during a three-year probe. Having represented dozens of clients under investigation by FERC, we know the Gateses' experience is the tip of the iceberg.
In the Energy Law Journal, we recently revealed numerous due process and substantive infirmities in FERC enforcement, some for the first time publicly. Unless these institutional and systemic defects are cured by FERC or the courts, the energy markets that FERC has long sought to promote and foster may be irreparably harmed.
Like other agencies, FERC investigations start in secret. FERC lawyers collect information from the subject of an investigation and third parties. Once allegations are formulated, they are shared with the commission. The subject then usually has the opportunity to respond in writing. FERC evaluates the response and, if the commission thinks it is warranted, the investigation proceeds and at some point is made public.
But unlike such agencies as the Securities and Exchange Commission, at FERC subjects are forced to fight with one hand tied behind their backs. FERC often doesn't provide the subject with the information it collected during the investigation, even when its allegations are based on that information. FERC enforcement also often does not even provide the subjects with all of the information it has shared with the commission. The SEC provides subjects with virtually everything collected during an investigation.
Nor are subjects permitted to go out and collect information on their own as they would be in an SEC court case. Even worse, FERC recently said its enforcement "is under no obligation to provide any response" to the "legal and factual arguments" raised by subjects. This hardly creates confidence in the fairness and integrity of the process.
Once a FERC enforcement case goes public, the die has been cast. In the past 10 years, FERC has never dismissed even a portion of a public case. In contrast, since 2010 the SEC has dropped about 20% of its investigations that progressed to a similar point. As the SEC has said, this confirms that its enforcers "carefully consider the evidence and arguments."
That FERC follows its enforcement staff's recommendations is unsurprising, since the staff can communicate off-the-record with the commission during an investigation. It can present any information it wants, and claim the subject has engaged in all sorts of wrongdoing, with no record and no one to give the other side of the story. FERC enforcers have no limit on the scope of investigations; they can, and have, literally sought millions of documents, asked thousands of written questions, and questioned dozens of individuals in a single investigation. They have even questioned an individual as many as seven or eight times without permitting him to review his own prior testimony.
FERC investigation subjects are doubly disadvantaged because the commission has failed to adopt a coherent or meaningful definition of market manipulation. Like the SEC, FERC is required to prove that someone intended to and did commit fraud. But FERC has rewritten its own rules to find fraud when someone is "impairing, obstructing, or defeating a well-functioning market." No one outside of FERC enforcement has fair notice of what this means and FERC appears to redefine this "standard" in every case.
Exacerbating this game of "gotcha," FERC has all but eliminated traditional defenses to manipulation allegations, such as when the supposedly manipulative conduct has a legitimate purpose or is permitted by market rules. FERC takes the view that if someone responds to the economic incentives embedded in the FERC market rules, with the intent to profit, and does so openly and without deception, he can still somehow be found to be impairing "a well-functioning market." Not only does this defy mainstream economic thought, but it is curious to allege that someone who follows the rules created by FERC is somehow committing fraud at the same time.
If the commission is willing (and we believe it is), there are pragmatic and straightforward fixes to these due-process problems. FERC can adopt limits on its enforcement power and appoint administrative judges to oversee the investigation process. Other fixes include creating a wall between the commission and enforcement staff far earlier in the process; providing investigation subjects with collected information, including exculpatory information; and granting subjects some limited discovery rights. Defining market manipulation and laying out clear rules, defenses and safe harbors are also essential.
FERC has a difficult job. The markets it has created are large and complex, and FERC must remain vigilant against unscrupulous people who may try to truly manipulate them. At the same time, the majority of FERC regulators and its staff want to protect due-process rights and align the agency's enforcement with its policy and market goals.
The alternative is that those who add great liquidity to energy markets will continue to withdraw rather than face the uncertain and incalculable regulatory risk now inherent in FERC enforcement. Without reform, energy markets could be damaged beyond repair.
Mr. Scherman is a lawyer at Gibson Dunn & Crutcher, as are Brandon Johnson and Jason J. Fleischer, who contributed to this op-ed.
http://online.wsj.com/news/articles/SB10001424052702303409004579562571755052050
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Electric Prosecutor Acid Test
A key Obama energy regulatory nominee has harmed power markets.
Should companies be punished ex post facto for conduct that was perfectly legal when their putative fraud occurred? One of President Obama's regulators thinks so, and now the White House thinks he deserves a promotion. The Senators who scrutinize the nomination on Tuesday may not feel the same.
In February Norman Bay became the nominee to run the Federal Energy Regulatory Commission, or FERC, after energy-state Democrats defeated the anti-fossil fuels Ron Binz last year. FERC used to be independent and noncontroversial until Obama-appointed Chairman Jon Wellinghoff spent five years converting the commission into a regulatory truncheon.
A key figure in this transformation has been Mr. Bay, a former U.S. attorney for New Mexico with no energy expertise until Mr. Wellinghoff appointed him to lead FERC's enforcement arm in 2009. The left has cheered as Mr. Bay has stretched the law to punish what he claims is Wall Street manipulation of electricity markets. His team has levied $1.23 billion in penalties and disgorged profits from actors ranging from J.P. Morgan JPM +0.18% to Maine paper mills.
The problem is that Mr. Bay has declined to share his definition of market manipulation. The deregulated regions of the grid that replaced the old state utility monopolies are basically enormous engineering projects attached to financial exchanges. Buyers and sellers trade megawatts so the machine runs most efficiently at the lowest prices. FERC oversees these markets and makes governing rules known as tariffs, which are supposed to assume that people will make profit-maximizing decisions.
Yet when these incentives change behavior and FERC deems the profits too high, or something, Mr. Bay's team levels selective, subjective, ad hoc allegations of fraud. For Mr. Bay, obeying FERC's own tariffs counts as market manipulation.
As a thought experiment, consider the production tax credit for wind energy. In certain places at certain times, the subsidy is lucrative enough that wind generators make bids at negative prices: Instead of selling their product, they pay the market to drive prices below zero or "buy" electricity that would otherwise go unsold to qualify for the credit.
That strategy harms unsubsidized energy sources, distorts competition and may be an offense against taxpayers. But it isn't a crime in the conventional legal sense because wind outfits are merely exploiting the subsidy in the open. The rational solution would be to end the subsidies that create negative bids, not to indict the wind farms. But for Mr. Bay, the same logic doesn't apply to FERC.
In the nearby op-ed, veteran energy-bar attorney Bill Scherman details the prosecutorial methods that Mr. Bay has self-created using vague powers delegated by Congress in 2005. The lack of due process for his targets, including the failure to turn over exculpatory evidence and ex parte communications between his office and FERC commissioners, is the stuff of a banana republic.
The larger context is the political appetite for medieval justice in U.S. finance, never mind the merits. Mr. Bay has extracted settlements in 18 of his 23 public market-manipulation cases so far and the agreements tend to invoke the ghost of Enron. But in only one case did the target admit wrongdoing.
That caught the notice of Massachusetts Democrats Elizabeth Warren and Ed Markey, and their exchange gives a flavor of the Bay method. In a July 2013 letter the Senators told Mr. Wellinghoff that, "We commend you for . . . the largest civil penalty and settlement in FERC's history"—the $410 million Mr. Bay squeezed out of J.P. Morgan—but mused that the punishment wasn't harsh enough.
Morgan had inherited Eisenhower-era power plants in California and Michigan when the bank took over Bear Stearns in 2008. Less efficient than modern generation, they might have been retired, but commodities traders ran them profitably by capturing legitimate "make whole" rebate payments blessed by FERC. The set-up was no worse than gaming wind subsidies.
Mr. Wellinghoff replied to the Senators that letting J.P. Morgan or its employees have their day in court would involve "considerable delay and uncertainty," so better to force the bank to open its checkbook. He also noted that he had imposed penalties "that could not have been accomplished by taking the matter to trial." Those included "imposing significant consequences on the individual traders involved in the alleged misconduct," even though the 2005 market manipulation law "does not give the commission the authority to ban traders from electricity markets."
In other words, the FERC Chairman is bragging that Mr. Bay abused his legal powers to impose sanctions unlikely to stand up to judicial review, ruining individual reputations and careers in the bargain.
***
The larger liberal goal is to drive "speculators" out of the energy markets and revert to the government-controlled utilities. The low-margin business of finding the cheapest power prices depends on predictable rules, and Mr. Bay's political enforcement is leading to a financial flight from electricity markets. Over the last 12 to 18 months, a wave of banks including FERC targets J.P. Morgan, Deutsche Bank and Barclays have all exited or drastically cut back involvement.
The five major wholesale power markets "have at least one thing in common: liquidity has declined in all of them over the last four years," according to a Platts analysis of FERC data. The market that serves the mid-Atlantic called PJM Interconnection has shrunk by two-thirds. The result has been rising and increasingly volatile prices: FERC reports average on-peak electric spot prices climbed in every market across the country in 2013—54% in New England, 42% in southern California, 66% in the Pacific Northwest.
Some of this reflects Dodd-Frank regulation, the weather and aftershocks of the natural gas boom. But it is also the chilling effect that Mr. Bay's arbitrary and political enforcement has had on the formerly orderly electric markets, harming reliability and raising costs.
Mr. Bay may satisfy the liberal desire for perp walks and business shakedowns, but he's posing as Eliot Ness with no Al Capone. Much is rotten at FERC, and rejecting his nomination would send a message that the Senate wants the legal abuses to stop.
http://online.wsj.com/news/articles/SB10001424052702303663604579501501045319492?mg=reno64-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052702303663604579501501045319492.html
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