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Cadwalader Client & Friends Memo: FERC Enforcement Director Calls for Legislative Fix to Address Hunter Decision

On January 15, 2014, Mr. Norman Bay, Director of the Office of Enforcement at the Federal Energy Regulatory Commission (FERC), testified at a Senate Banking Subcommittee on Financial Institutions and Consumer Protection hearing entitled “Regulating Financial Holding Companies and Physical Commodities.”  Mr. Bay’s testimony focused on FERC’s anti-fraud and manipulation oversight with respect to financial institutions trading in FERC-jurisdictional electric and natural gas markets.  Mr. Bay’s prepared remarks and testimony provide an interesting insight into FERC’s enforcement regime.  Notably, Mr. Bay called for a legislative fix to address FERC’s enforcement authority in light of the recent Hunter v. FERC decision. 

Also appearing at the hearing were Mr. Vince McGonagle, Director, Division of Market Oversight, Commodity Futures Trading Commission (CFTC); and Mr. Michael Gibson, Director, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System (Federal Reserve).  Four senators, all Democrats, were present and asked questions at the hearing: Sherrod Brown (D-OH), Jack Reed (D-RI), Jeff Merkley (D-OR) and Elizabeth Warren (D-MA). 

In his testimony, Mr. Bay discussed FERC’s authority for investigating and enforcing the prohibition on fraud and market manipulation in FERC-jurisdictional electric and natural gas markets under the Energy Policy Act of 2005.  Mr. Bay highlighted FERC’s enhanced civil penalty authority, noting that FERC has imposed and collected approximately $873 million in civil penalties and disgorgement since the Energy Policy Act of 2005.  Mr. Bay expressed his view that FERC does have the tools necessary to effectively police FERC-regulated markets to deter fraud and market manipulation.  He highlighted FERC’s expanded enforcement capabilities and surveillance tools in recent years, including the Office of Enforcement’s Division of Analytics and Surveillance. 

Mr. Bay provided an overview of fraudulent and manipulative conduct that has occurred in FERC-regulated markets.  Mr. Bay explained how physical natural gas and electricity transactions can help set the prices on which financial products are based, so an entity can use physical trades to impact prices in a way that benefits its overall financial position.  According to Mr. Bay, there is a common framework across many of the manipulation matters that FERC has or is currently investigating: a physical transaction is used as a “tool” to “target” a physical price in order to raise or lower that price in a way that will increase the value of a “benefitting position,” which is often a financial product.  

Given that FERC’s anti-fraud and manipulation rule is an intent-based rule, FERC’s investigations focus on understanding the nature and scope of an entity’s benefitting financial positions and how they relate to the physical positions.  According to Mr. Bay, “A company can put on a large physical trade that may affect market prices, but if the purpose of that trade is to hedge risk or speculate based on market fundamentals—rather than, for example, the intent to move prices to benefit a related financial position—this conduct, without more, would not violate our anti-fraud and manipulation rule.”  Mr. Bay cited recent FERC enforcement cases involving allegations of market manipulation by financial institutions, including Deutsche Bank and JP Morgan.

Mr. Bay highlighted two regulatory limitations on FERC’s anti-fraud and manipulation efforts, which are related to the recent memoranda of understanding between FERC and the CFTC.  On January 2, 2014, FERC and the CFTC entered into two memoranda of understanding addressing (i) the sharing of information, and (ii) procedures for resolving overlapping jurisdictional issues.  These memoranda are over three years in the making and roughly three years past the deadline set by Congress under the Dodd-Frank Act.  For more information, see FERC and CFTC Reach Agreement on Information Sharing and Jurisdiction

First, Mr. Bay emphasized FERC’s inability to obtain certain financial data—much of which is related to trading in CFTC-regulated markets—that FERC considers important to its surveillance and investigation efforts.  According to Mr. Bay, this missing financial data creates a gap in the FERC’s ability to conduct effective and comprehensive surveillance of the natural gas and electric markets.  In response to questioning from Senator Elizabeth Warren during the hearing, Mr. Bay and Mr. McGonagle testified that the CFTC is making the Large Trader Report, which FERC had previously requested, available for review by FERC at the CFTC’s offices.  According to Mr. McGonagle, FERC and the CFTC are still working out confidentiality and technical issues regarding the data transfer of the Large Trader Report. 

Second, Mr. Bay pointed to the jurisdictional uncertainty created by the decision of the U.S. Court of Appeals for the District of Columbia Circuit last year in Hunter v. FERC.  In that case, the court ruled that manipulation of natural gas futures contracts falls within the CFTC’s exclusive jurisdiction, so FERC does not have authority to pursue actions involving manipulation in the futures markets.  According to Mr. Bay, “Although [FERC] reads the Hunter decision as narrow in scope, some market participants interpret the decision more broadly to cover not only manipulation in the futures market, but also many additional transactions and products, including those squarely within FERC’s jurisdictional markets.”  As a result, Mr. Bay called for a legislative fix to eliminate this uncertainty.

Mr. Bay’s testimony also provides insight into how FERC views financial institutions that participate in FERC-regulated markets.  According to Mr. Bay, FERC “has not taken any view on the participation in its regulated markets by financial holding companies (or any trading firm, bank, or other financial institution) versus more traditional energy companies like generators, utilities, or natural gas pipeline owners.”  Nonetheless, Bay asserted that FERC’s “general view has been that financial institutions of all kinds, as well as energy companies of all kinds, can benefit markets in numerous ways, for example, by providing liquidity to market participants who may want to hedge their risk.”  Mr. Bay highlighted how financial institutions have generally played a role in the physical electricity and natural gas markets regulated by FERC. 

For purposes of analyzing potential market manipulation, Mr. Bay noted that even though banks and financial institutions as a whole may have a relatively lower percentage of sales and generation ownership interest compared to more traditional energy companies, the market share of a given bank or financial institution at a particular natural gas trading hub or electric market trading point could still be high and have a significant effect on the price formed at that hub or point.  Therefore, banks and financial institutions may have the ability to move prices in a manipulative manner.

For more information about the hearing and the testimony, including an archive webcast, see

This memorandum has been prepared by Cadwalader, Wickersham & Taft LLP for informational purposes only and does not constitute advertising or solicitation and should not be used or taken as legal advice. Those seeking legal advice should contact a member of the Firm or legal counsel licensed in their state. Transmission of this information is not intended to create, and receipt does not constitute, an attorney-client relationship. Confidential information should not be sent to Cadwalader, Wickersham & Taft LLP without first communicating directly with a member of the Firm about establishing an attorney-client relationship.

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