byMark K. Lewis and Damon R. Daniels
On July 26, 2007, the Federal Energy Regulatory Commission issued two show cause orders to address alleged market manipulation-Amaranth Advisors L.L.C., et al., “Amaranth,” and Energy Transfer Partners, L.P., et al., “ETP.” Irrespective of either proceeding’s outcome, the orders highlight the significance of evaluating day-to-day compliance through periodic monitoring of business practices and operations.
The principal benefit of on-going compliance monitoring is the deterrence of non-compliance in the first place. Where non-compliance is discovered, however, management also can better insulate the company from FERC-imposed liability by demonstrating strong monitoring efforts. Without such measures, Amaranth and ETP reveal that FERC is more likely to seek to hold a company-even individual executives-accountable for alleged compliance failures.
FERC’s findings in Amaranth underline the risk of being unable to demonstrate to FERC staff’s satisfaction at least good-faith efforts at on-going compliance monitoring. In Amaranth, FERC relied principally on perceived inconsistencies between actual business practices and articulated compliance standards to set the stage for its allegations of intentional market manipulation. FERC focused on management’s alleged disregard of certain representations that Amaranth had included in a request for position limit exemptions from the New York Mercantile Exchange. The representations centered on compliance measures that Amaranth claimed to have instituted in its trading business. Essentially, FERC treated management’s alleged failure to monitor compliance with these representations as circumstantial evidence of intent to engage in market manipulation.
Indeed, FERC threatened to go even further with its claims of alleged management inaction in Amaranth, stating that it had given “serious consideration” to penalizing individual executives for “recklessly permit[ing] manipulative conduct to occur” by not monitoring on-going compliance. It was dissuaded from doing so only because it concluded that the executives’ large personal investments in Amaranth’s funds meant they would pay a heavy price nonetheless. The result could be different, FERC said, in future cases involving executive management failures to rein in violations by employees.
FERC’s findings in ETP, like those in Amaranth, reflected the effect of a perceived absence of compliance monitoring on FERC’s evaluation of the company’s alleged culpability. FERC’s decision to seek to hold Energy Transfer liable for alleged market manipulation rested on the perception that the case was not one “where one, or even a handful of employees, embarked on a practice of which senior management may plausibly claim ignorance.” Instead, FERC found that management allegedly failed to prevent, and perhaps even endorsed, manipulative activities that should have been identified and deterred. Of particular importance to the question of “intent” was what FERC viewed as a management-level decision, in furtherance of Energy Transfer’s alleged scheme to manipulate gas prices, to pool profit and loss across affiliated company trading desks in determining trader compensation. Relying largely on the alleged evidence of management’s complicity, and finding insufficient evidence of internal efforts to deter the subject activities, FERC determined to hold the company itself liable for intentional market manipulation.
The other side of the coin is that there may be considerable upside to evidence of a company’s on-going compliance monitoring. Amaranth and ETP both indicate that evidence regarding on-going compliance monitoring, as a practical matter, can impact FERC’s development of the factual case against the company itself. Even where FERC holds the company liable, evidence of an internal “culture of compliance,” including a strong compliance monitoring program, can earn the company “credit” in the form of civil penalty mitigation, consistent with FERC’s policy statement on enforcement. FERC’s recent consent orders with BP Energy Company and MIGC, Inc., for example, approved lower civil penalties because the companies identified and self-reported the potential violations. Public utilities have received similar treatment for self-reporting potential violations under the Federal Power Act. Thus, beyond just demonstrating a commitment to compliance, on-going monitoring allows companies to catch potential violations when there is still time to self-report the activity and seek leniency from FERC.
In fact, FERC’s policy on civil penalty mitigation could conceivably promote a “race to the courthouse,” whereby parties are incentivized to be the first to self-report transactions or activities for which their commercial counterparties or other market participants may also face liability. It is unclear what action, if any, FERC might take with regard to counterparties in such situations, or to what extent FERC would show leniency in a follow-up enforcement proceeding, when the alleged violation already has been self-reported.
Compliance officers have by now spread the word to senior management of FERC’s focus on the “culture of compliance” in its policies on civil penalty mitigation. Amaranth and ETP should further impress upon senior management the importance of conducting periodic “reality checks” on day-to-day compliance. The show cause orders demonstrate that a perceived absence of adequate, on-going monitoring can factor not only into the calculation of civil penalties but into the factual development of FERC’s case against a company and its management.
Amaranth and Energy Transfer, of course, still have the opportunity to defend themselves against FERC’s allegations. Nevertheless, an early lesson for others in the industry is that there is significant value in getting out ahead of FERC on compliance matters through strong internal monitoring programs.
Authors
Mark Lewis is a partner and Damon Daniels is an associate in the global projects group of international law firm Paul, Hastings, Janofsky & Walker LLP. They regularly advise clients on commercial and regulatory matters in the energy industry.