Barclays Fights Price-Fixing Fine in Power-Market Testby
FERC flexes enforcement muscle with $488 million penalty
Once a `toothless tiger,' agency now is hunting big game
In the southwest corner of Arizona, just east of the California line, sits the Palo Verde nuclear plant, the provider of power to 4 million residents in four separate states.
It’s in this market that a Barclays Plc trader manipulated electricity prices so brazenly in 2006 that he bragged in one message that he’d “totally fukked with the Palo mrkt,” according to federal regulators.
Almost a decade later, that message and other documents are coming back to haunt Barclays in a closely watched civil case that marks the first public test of the Federal Energy Regulatory Commission’s enforcement powers. At stake for Barclays and four associated traders is $488 million in fines and profit disgorgement, the largest penalty ever sought by the agency.
The bank was supposed to get its day in a federal court in California on April 22. Now, though, the judge on his own initiative canceled oral arguments and the two sides are awaiting to learn what the next step will be. A new schedule for arguments could be set, or District Judge Troy L. Nunley could come to a decision based on the papers already filed with the court. If there is a decision, it would be the first time this type of case has come all the way to a ruling. Earlier suits were all settled.
The message FERC is sending to the market with its aggressive stand in cases like this should be clear, according to Larry Parkinson, a former FBI lawyer who became the commission’s head of enforcement last year. “If you’ve engaged in manipulative behavior, you will be held accountable," he said.
In denying the charges, Barclays said its trades were motivated by legitimate business purposes, and that no fraud can exist with open market transactions "based solely on transparent bids and offers.” All four traders facing penalties are challenging the accusations.
Michael Spafford, a Washington-based lawyer, represents Ryan Smith, whose 2006 comments about the Palo Verde market are key in the case. Spafford declined to comment, deferring to documents filed with the court. In those papers, Smith’s attorneys said there is no evidence the trader built physical positions to benefit the swaps, or that he collaborated with others to do so. They describe Smith’s comments to fellow traders “not as nefarious, but as typical, innocuous trader talk.”
At the heart of the cases is whether a trade made in an open market transaction can be manipulative. Energy regulators have declined to define such behavior. This stance is drawing criticism that FERC is borrowing the Supreme Court justice’s classic definition of obscenity -- “You know it when you see it” -- as their guide. It’s an approach that critics say feeds uncertainty over what is acceptable and risks chilling legitimate trading.
“Markets encourage people to innovate,” said Frank Wolak, a Stanford University economics professor who focuses on energy markets. “If you are afraid of anything for fear that you are going to be taken to court, then you are less likely to take those risks.”
The case goes back to November 2006 when the manipulation alleged began, FERC said in its filings. Smith and other traders bought hundreds of megawatt-hours of power at above-market rates at Palo Verde, the papers say. The goal, according to FERC, was to artificially boost the physical price even though it lost the bank thousands of dollars.
$35 Million Gain
The traders then bought swaps contracts that entitled them to the higher price in exchange for a lower fixed payment. In total, the four Barclays traders made almost $35 million by losing in the U.S. West physical markets to gain in financial swaps, the agency says.
Spokesmen for U.K.-based Barclays declined to comment.
Suspicions of illegal gaming have plagued trading for decades in everything from oil to ethanol and metals. But FERC was “a toothless tiger” that would go after manipulators only to “gum them to death,” said Susan Court, who was the first head of enforcement for the commission, serving in that role from 2005 to 2009.
It came to a head with the western U.S. energy crisis in 2000 and 2001. Traders including Enron Corp. manipulated power and gas markets, helping trigger rolling blackouts that left millions of Californians in the dark, according to a FERC investigation and U.S. Senate report.
“At the end of the day you don’t want a reputation that energy companies can rip you off,” said Tyson Slocum, who directs the energy program of Washington-based consumer advocacy group Public Citizen. “We finally see a FERC willing to crack down.”
California was forced to spend $9 billion to buy replacement electricity and consumers are still paying for it, said Shaun Ledgerwood, a principal at the Brattle Group consulting firm.
Spurred by that scandal, Congress ordered FERC in 2005 to crack down on manipulation and raised the penalties it could levy to $1 million a day from $11,000. Since then, the agency collected almost $1 billion in fines, and filed six pending manipulation cases. The agency’s enforcement staff of 200 now includes programmers building algorithms to catch trades that don’t seem to make sense.
Concern has risen again as trading has boomed with new participants including hedge funds and renewable-generation owners piling in. PJM Interconnection LLC, the largest U.S. grid, has seen the number of power traders increase 44 percent since 2010 amid a record supply of low-cost natural gas and surging use of wind and solar generation.
FERC has become so “overly aggressive” that its actions threaten to “unnecessarily kill legitimate trading,” said Brattle Group’s Ledgerwood, who worked in the agency’s enforcement division.
One company that’s been highly vocal in its criticism of FERC’s enforcement actions is Powhatan Energy Fund LLC. The company waged an online campaign portraying itself as a victim of a heavy-handed enforcer.
The commission accused Powhatan of exploiting a market loophole, which has since been closed. In 2010, the company sold electricity in the PJM market for little-to-no-profit for the purpose of capturing a rebate that made them almost $8 million.
That’s what Parkinson describes as the “one free bite rule.”
“One of the reasons we focus primarily on manipulation is because those are the ones that have the biggest potential impact on consumers and on the markets,” Parkinson said. “Look what happened in Enron.”
In denying the allegations, Powhatan said that “taking advantage of loopholes in laws is a time-honored American tradition” and regulators should have first warned that such behavior would be considered manipulation, according to documents. In court filings, Powhatan said its trades were legitimate and the company accused the commission of rushing to judgment without first handing out a warning.
“We won’t settle with the FERC as we did absolutely nothing wrong,” Kevin Gates, co-manager of Powhatan with his twin brother Rich, said in an April 25 e-mail. “We have a civic and moral obligation not to succumb to their bullying tactics.”
(An earlier version of this story was corrected to remove a FERC official's attribution from a reference to a Supreme Court standard.)