Layne E. Kruse, Peggy A. Heeg and David J. Van Susteren
April 21, 2009
After months of considering comments, the Federal Trade Commission issued revised proposed rules on April 16, 2009 to implement authority granted in the Energy Independence and Security Act of 2007 to prevent market manipulation in the petroleum industry. The FTC’s revised rules follow on the heels of a Commodity Futures Trading Commission’s rule extending its regulatory reach over Exempt Commercial Markets and recent action by the Federal Energy Regulatory Commission expanding its view of market manipulation.
The public has thirty days to comment on the FTC’s latest version of its market manipulation rules.
Will the FTC’s Third Attempt be the Charm?
Following an Advanced Notice of Proposed Rulemaking to solicit comments on the FTC’s authority to prevent market manipulation in the petroleum industry, the FTC issued a proposed rule on August 19, 2008 setting forth proposed petroleum market manipulation rules. Commentators, including Fulbright & Jaworski, raised many concerns about the proposed rule. The most significant concerns expressed by commenters related to the (1) level of scienter required to prove market manipulation; (2) whether a showing of price effect should be required to prove market manipulation; and (3) whether omitting statements that contain material facts should be viewed as market manipulation.
Market Manipulation Definition
The FTC’s revised proposed rule modifies its earlier proposed standard for market manipulation, but continues to follow a securities fraud standard in accordance with the Energy Independence and Security Act of 2007. The revised proposed rules modify the FTC’s original proposal to clearly define a scienter standard for market manipulation. Specifically, to establish market manipulation, the FTC must establish intentional or knowing conduct that acts as a fraud or deceit. Alternatively, to prove market manipulation, there must be an intentional failure to state a material fact that distorts or tends to distort market conditions for petroleum products. 16 C.F.R. § 317.3 (proposed). In response to comments, the FTC concluded that a showing of price effects is not required to establish market manipulation and that the FTC would not be required to show that the market has actually been distorted.
The new revised rule is as follows:
“It shall be unlawful for any person, directly or indirectly, in connection with the purchase or sale of crude oil, gasoline, or petroleum distillates at wholesale, to:
(a) knowingly engage in any act, practice, or course of business – including the making of any untrue statement of material fact – that operates or would operate as a fraud or deceit upon any person; or
(b) intentionally fail to state a material fact that under the circumstances renders a statement made by such person misleading, provided that such omission distorts or tends to distort market conditions for any such product.”
16 C.F.R. §317.3 (proposed).
The FTC, drawing on federal circuit court rulings in securities fraud cases, proposes to define “knowingly” as requiring “actual or constructive knowledge such that the person knew or must have known that his or her conduct was fraudulent or deceptive.” 16 C.F.R. §317.2(c) (proposed). The FTC clarified, however, that “extreme recklessness” could meet the scienter requirement.
FTC - CFTC Coordination
Critics complained that the proposed rules would interfere with the CFTC’s regulation of the futures market. In response, the FTC clarified that it “does not intend to adopt a blanket safe harbor for futures market activities,” but it intends to work “cooperatively” with the CFTC.
Private Right of Action
Commenters asked the FTC to clarify that the final rule or the Energy Independence and Security Act of 2007 does not create a private right of action. The FTC declined to address directly the question of whether a private right of action is granted in the Energy Independence and Security Act of 2007. Instead, the FTC responded that whether a private right of action may be implied is a question of legislative intent for Congress or the courts to resolve, not the FTC.
Guidance on Specific Conduct
The FTC provided guidance on specific activities that the FTC would consider manipulative and conduct that the FTC would not view as manipulative. The FTC stated that “inadvertent mistakes, unintended conduct, or legitimate conduct undertaken in the ordinary course of business” would not be considered manipulative. The FTC clarified that the revised proposed rule does not impose recordkeeping requirements and that the FTC “currently does not expect to impose specific conduct or duty requirements such as a duty to supply product, a duty to provide access to pipelines or terminals, a duty to disclose, or a duty to update or correct information.” The FTC further clarified that the revised proposed rule would not require covered entities to disclose price, volume, or other data to individual market participants or the market at large.
The FTC also provided a few examples of manipulative behavior: The revised proposed rules provide that fraudulent or deceptive conduct includes conduct that does not serve a legitimate purpose or impairs the efficient functioning of wholesale petroleum markets. Specific examples provided by the FTC include “(1) false public announcements of plan pricing or output decisions; (2) false statistical other person – who may serve as a conduit for the dissemination of the information, or who might act on the information – such as traders, suppliers, brokers or agents; federal, state or local government; and government or private publishers.”
The revised proposed rules declined to rule out supplier operator decisions and stated that the FTC would determine on a case-by case basis whether to reach supply and operation decisions, or any other type of conduct that is in connection with the covered
CFTC Action Over Exempt Commercial Markets
On March 23, 2009, the CFTC promulgated final rules implementing provisions of the CFTC Reauthorization Act of 2008 which amended the Commodity Exchange Act to expand significantly the CFTC’s jurisdiction over Exempt Commercial Markets. 74 Fed. Reg. 12178. The CFTC’s rule places requirements and restrictions on Exempt Commercial Markets, such as ICE, regardless of whether they list significant price discovery contracts.
Exempt Commercial Markets that list contracts that serve a significant price discovery function will be “registered entities” under the Commodity Exchange Act. The CFTC’s regulation of Exempt Commercial Markets will be similar to its regulation of Designated Contract Markets, such as NYMEX. Exempt Commercial Markets that list contracts that serve a significant price discovery function will be subject to broad reporting and surveillance requirements. The rule will have broad implications to Exempt Commercial Markets, as well as traders that utilize Exempt Commercial Markets.
FERC Expanded View of Market Manipulation
Earlier this year, in a 3-2 vote (and with the recent departure of FERC Commissioner Kelliher would now be a split 2-2 decision), the FERC took action clarifying its view that its market manipulation authority extends broadly to a “fraud on the market,” even if there is no price impact or misrepresentation. In a series of orders relating to customer participation in an open season for the allocation of pipeline capacity, the FERC found that submitting multiple affiliated bids to obtain a higher proportion of allocated capacity constituted market manipulation. Seminole Energy Services, L.L.C., 126 FERC ¶ 61,041 (2009); In re Tenaska Marketing Ventures, 126 FERC ¶ 61,040 (2009); National Fuel Marketing Company, L.L.C., 126 FERC ¶ 61,042 (2009).
In a sign that the FERC will aggressively pursue allegations of market manipulation, in February, the FERC rejected in two sentences an uncontested joint settlement between Amaranth and FERC’s Enforcement Staff. Amaranth Advisors L.L.C., 126 FERC ¶ 61,112 (2009). Despite FERC’s long-standing policy favoring resolution of enforcement matters through settlement, FERC rejected the settlement after considering “the gravity of the alleged violations, the potential remedies for those violations if proven to have occurred, and the remedies offered in the Settlement….”
Next Steps For the FTC and the Impact of Revised Proposed Rules on Corporate Compliance Programs
Public comment on the FTC’s revised proposed rules are due in thirty days. Given the extensive procedural history, it is unlikely that any significant changes will be made and the rules likely will go into effect as currently written.
Companies engaged in energy marketing should carefully review their compliance programs in light of the proposed rule. Following the lead of other government agencies, the FERC and CFTC have adopted policies to reduce or eliminate penalties for companies that can demonstrate that they have implemented an effective compliance program. Neither agency, however, has promulgated a model compliance program or adopted specific rules that mandate the elements of an effective program. FERC and CFTC pronouncements, along with the Federal Organizational Sentencing Guidelines provide a clear path for designing and implementing a successful market manipulation compliance program. These pronouncements, however, demonstrate that the agencies, especially the FERC, have very high expectations as to the process, costs and procedures that companies should undertake in implementing compliance programs. As recently stressed by the CFTC and FERC, companies engaged in the marketing and trading of energy products should focus on establishing effective compliance programs that are designed, implemented and audited to ensure compliance with this complex area of the law.
This article was prepared by Layne E. Kruse (email@example.com or 713 651 5194), Peggy A. Heeg (firstname.lastname@example.org or 713 651 8443) and David J. Van Susteren from Fulbright's Energy Regulation Practice Group.
Layne E. Kruse
Peggy A. Heeg
David J. Van Susteren