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New Rules Barring Energy Market Manipulation to Take Effect Soon

Wednesday, January 25, 2006 9:11 pm by

FERC has adopted final rules implementing the new sections 4A and 222 of the Natural Gas and Federal Power Acts, respectively, which were added by the Energy Policy Act of 2005 (EPAct 2005) and adopts a scheme pioneered in securities laws for combating fraud.  [Prohibition of Energy Market Manipulation, Order No. 670, (2006)]  The texts of the natural gas and power rules are the same.  See FERC Looks to Past for Future Anti-fraud Enforcement.  These final rules adopt word-for-word the rules as FERC originally proposed them last October 20, with one exception.  The prohibition against engaging in any act, practice or course of business “that operates as a fraud or deceit upon any person” was changed to bar any such act, practice or course of business “that operates a fraud or deceit upon any entity.”   This change reflects the scope of the of the new law, which prohibits any entity from engaging in frauds or misrepresentations that affect wholesale energy market transactions subject to FERC’s jurisdiction.  Since the relevant statutes exclude municipal power and gas companies from the definition of “person,” the originally proposed rules asymmetrically would have penalized munis for their frauds but not the frauds perpetrated on them.  The final rules go into effect as soon as they are published in the Federal Register – probably some day early in February.

In its announcement of the final rules, FERC emphasized that the intent is not to punish negligent practices or corporate mismanagement.  Instead, the rules seek to punish misconduct that is intentional, knowing or reckless.  This distinguishes these anti-fraud rules from FERC’s market behavioral rules, which, for the most part, prohibit certain conduct irrespective of the actor’s state of mind. Under the new rules, FERC will seek sanctions whenever an entity “(1) uses a fraudulent device, scheme or artifice, or makes a material misrepresentation or a material omission as to which there is a duty [to disclose] under a tariff or FERC ruling, or engages in any act . . . that operates or would operate as a fraud or deceit upon any entity,”  (2) with an intentional, knowing or reckless state of mind, (3) in connection with a natural gas or power purchase or sale or transportation/transmission over which FERC has jurisdiction.  Notably, there is no requirement that the victim rely on the misrepresentation, fraud or deceit or that the victim damage due to the misrepresentation, fraud or deceit.   Sanctions for violations include disgorgement of profits and possible civil penalties.  See Policy Statement on Enforcement of Statutes, Orders, Rules and Regulations.
 
In public comments, critics of the proposed rules objected forcefully to FERC’s adoption of the vilification of material omissions from securities laws.  According to these critiques, omitting material information (e.g., potential litigation exposure) in connection with securities sold to the general, non-expert public finds no parallel in wholesale power transactions in which all parties are typically large and sophisticated.  Why make these sophisticated players report all material information, much of which may be proprietary and commercially valuable, they asked.  But FERC rejected these arguments and retained the material omission proscription.  The agency clarified, however, that the final rule creates no new affirmative disclosure rule, and sanctions will be doled out only when there is an affirmative duty under a tariff or other directive to disclose the omitted information.

FERC also clarified that entities alleged to have violated the new antifraud rules will be given an opportunity to counter the allegation before charges are formally brought.   The agency deferred ruling on whether to eliminate its market behavioral rules as redundant or unnecessary in light of its implementation of the antifraud rules.


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