Beware the Ides of March, Regulators unsheath their daggers

by Tanya Bodell

Despite more than 30 years of deregulation efforts, energy continues to be one of the most regulated industries in the country. Even energy trading, which grew outside the shadow of energy regulation as a competitive activity, is increasingly falling under this regulatory rubric. For companies such as hedge funds that have operated largely outside the confines of most regulatory risk, beware. The tides of regulation are turning against you.

FERC doth bestride the narrow world like a colossus

Energy sales have traditionally been regulated by state public utility commissions and the Federal Energy Regulatory Commission. Although FERC has had long-standing power to audit company books and records at its discretion, in practice, investigations were initiated only upon receipt of a formal complaint.

In the last few years, however, FERC has issued new orders, increasing its investigative scope and the reporting requirements of market participants. Physical energy traders are required to file electronic quarterly reports that describe their transactions, including counterparties and terms of trade. Standards of conduct dictate how regulated functions must be separated from competitive trading activities. Market behavior rules issued in 2003 to ensure a “reliable and fair” market were replaced in 2006 by prohibition of market manipulation based on established financial concepts of “fraud” and “scienter.” The Energy Policy Act of 2005 (EPAct) granted the Commission the authority to require information from any market participant and the ability to levy stiff penalties-up to $1 million per day per incident-upon a finding of wrong-doing. FERC Chairman Joseph Kelliher noted, “The combination of legal authority, spelled-out regulations, and civil penalty power create a new regime for the power markets.”

In 2006, there was little public evidence that FERC was wielding its newly granted powers, although several confidential investigations were underway and FERC’s Office of Enforcement and, in particular, its Division of Energy Market Oversight (ironically donning the acronym DEMO), was rapidly ramping up its staffing and capabilities. Market participants self-reported more than 40 potential violations. Yet not until January 2007, nearly a year after FERC passed its anti-manipulation Order No. 670, did the Commission impose its first penalties under EPAct, settling with five companies for civil penalties totaling $22.5 million, in addition to disgorgement of unjust profits.

Settlement characteristics allow us to surmise where FERC may focus its coming efforts. SCANA, PacifiCorp and NorthWestern allegedly violated their open-access transmission tariffs (OATT), while the Commission claimed that Entergy failed to maintain and post information in violation of regulatory requirements; NRG was assessed a civil penalty for perceived violations of market behavior rules. In most of these cases, FERC assessed fines well below the maximum penalties in consideration of the voluntary self-reporting that unveiled these violations.

These settlements also illustrate the importance of in-house compliance efforts. Not only were penalties reduced as a result of self-reporting, each of the settlement agreements included a compliance component. PacifiCorp is retaining an independent auditor to monitor and report on its compliance. NRG and NorthWestern are undertaking compliance programs that include periodic reporting and filings to FERC. Entergy is implementing a substantial compliance plan that includes a number of reporting, auditing and training elements. Finally, SCANA is implementing a program to allow the Commission to ascertain the company’s compliance with the network service provisions of its OATT.

FERC’s reach has not stopped growing. Although no additional legal regulations have been put in place since Order 670, FERC recently initiated discussions on rules to increase price transparency in electric and gas markets, establishing yet another means of targeting energy traders.

Among which number, CFTC, be you one

Traditionally more active than FERC in regulating price transparency, the Commodities Future Trading Commission is also receiving expanded authority. Established in 1974, CFTC’s oversight responsibilities of futures and options have grown rapidly. As the most recent reauthorization legislation plods through the approval process, proposals promise to increase potential penalties and expand the CFTC’s authority over natural gas markets to require more thorough reporting and monitoring.

CFTC activities have traditionally been confined to established futures exchanges, leaving electronic trading platforms such as the Intercontinental Exchange (ICE) and other bilateral transaction marketplaces to limited oversight. An increasing number of legislators, however, are moving for expanded powers that would encompass normally unregulated trading markets. Sen. Diane Feinstein (D-CA) is rallying support to provide the CFTC with regulator oversight over otherwise unregulated exchanges and traders. Rep. Bart Stupak (D-MI) has authored a bill that could gain momentum in the new Congress. In February, the ranking member of the Senate Energy and Natural Resources Committee, Sen. Jeff Bingaman (D-NM), wrote separate letters to FERC and the CFTC asking about their market oversight activity and claiming the need for more transparency in trading markets and access to ICE records.

CFTC has been very active during the past five years in penalizing companies for market manipulation. Between 2002 and 2005, nearly all of the $300 million in civil monetary penalties levied on energy companies was for reporting false information to trade publications in attempted manipulation of over-the-counter markets. The CFTC collected a $4.25 million fine from Dominion Resources in September 2006 for similar allegations and continues to investigate criminal activities involving energy trading and reporting practices. Recently, high profile investigations targeted BP for alleged manipulation of propane markets and Amaranth’s potential manipulation of natural gas markets.

Et tu, NERC?

The North American Electric Reliability Corporation is subject to audit by FERC and governmental authorities in Canada. Yet even NERC has developed a Compliance Enforcement Program (CEP) to ensure compliance with its reliability standards-yet another form of regulatory oversight.

Under CEP, NERC oversees each region’s compliance review and enforcement process under two activities: compliance reviews and compliance enforcement that includes penalties and sanctions based on performance. Until EPAct, industry compliance with NERC was mandatory but not enforceable, limiting NERC’s activities to reviews. However, the EPAct contains provisions that will make compliance with NERC standards both mandatory and enforceable. NERC is currently working to implement the reliability provisions of that law.

The fault lies not in the stars

Despite the rising tide of regulation, energy market participants can protect themselves. FERC, the CFTC and NERC all encourage comprehensive compliance programs, self-reporting, and ongoing communication with regulatory agencies, and have provided clear indications that such activities will generate good will and offset penalties assessed for violations.

What does this mean for energy commodity traders, including hedge funds that normally operate outside the scope of financial regulations? First, being immune to certain regulatory requirements of the Securities and Exchange Commission does not provide protection from other regulators who are tasked with protecting U.S. energy markets. Second, recent legislation and regulations expand regulatory scope and control over otherwise unregulated players in energy markets. Third, some of the largest energy market participants already have regulatory compliance programs in place, including investment banks that are adapting their existing compliance platforms for securities and banking services to energy. Whereas in-house compliance programs may have been optional for traders in the past, failing to have one now is becoming a competitive disadvantage. To quote the bard one last time, “The ides of March are come. Ay, Caesar; but not gone.”


Tanya Bodell is vice president, leader trading and institutional structures, in the energy and environment practice at CRA International Inc., an economic and management consulting firm. In trading and risk management, Bodell’s work spans all energy-related commodities, including regulatory compliance, tradebook valuation and portfolio optimization. Contact her at

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