On April 21, 2011, the Federal Energy Regulatory Commission (FERC) ruled that former Amaranth Advisors LLC trader Brian Hunter violated FERC’s Anti-Manipulation Rule and ordered Hunter to pay a $30 million civil penalty.1 This is the first litigated case involving FERC’s enhanced antimanipulation authority under section 4A of the Natural Gas Act, which prohibits manipulation in connection with FERC-jurisdictional transactions.2 FERC’s order, which affirmed a previous decision by a FERC Administrative Law Judge (ALJ), found that “Hunter’s trading practices [in the natural gas futures market during the settlement periods on] expiration days were fraudulent or deceptive, undertaken with the requisite scienter, and carried out in connection with FERCjurisdictional natural gas transactions.”3
FERC’s order arises out of an enforcement action initiated in 2007 that alleged that Amaranth and two of its traders manipulated the natural gas futures market, which directly impacted the price of FERC-jurisdictional natural gas transactions. The alleged manipulative scheme involved the sale of large amounts of natural gas futures contracts during the New York Mercantile Exchange (NYMEX) settlement periods in February, March, and April 2006. According to FERC Enforcement Staff, Hunter intended to drive down the settlement price for the natural gas (NG) Futures Contract, which is based on the volume-weighted average of trades during the last thirty minutes of trading on the expiration day, to benefit certain large swap positions that increased in value as the settlement prices declined.
In August 2009, Amaranth and trader Matthew Donohoe settled with FERC and the U.S. Commodity Futures Trading Commission (CFTC) for $7.5 million, but Hunter did not participate in the settlement. Unlike the FERC, which alleged that Amaranth and its traders had manipulated atural gas futures contract prices and natural gas cash market prices, the CFTC alleged that Amaranth had attempted to manipulate natural gas futures contract prices. On January 22, 2010, following hearing, a FERC ALJ issued an initial decision concluding that Hunter violated the Commission’s Anti-Manipulation Rule. The ALJ found that Hunter intentionally manipulated the settlement price of certain natural gas futures contracts in order to lower the NYMEX settlement price and thus benefit Hunter’s swap positions.
II. FERC Decision
A. Procedural Issues
As an initial matter, FERC ruled that it had personal jurisdiction over Hunter, a Canadian citizen, because the conduct at issue involved trades executed and/or directed by Hunter on the NYMEX in New York. FERC also found that the ALJ correctly applied a “preponderance of the evidence” standard, which required FERC Enforcement Staff to establish that it was “more likely than not” that Hunter committed the alleged violation. According to FERC, the ALJ did not improperly shift this burden to Hunter.
B. Summary of FERC’s Decision
FERC ultimately found that Hunter’s conduct violated FERC’s Anti-Manipulation Rule, which prohibits (1) fraudulent or deceptive behavior, (2) with the requisite scienter, (3) in connection with the purchase or sale of jurisdictional natural gas or electric energy.4 According to FERC, Hunter specifically intended to lower the settlement price for NG Futures Contracts in order to benefit Amaranth’s positions on other trading platforms, which was done with reckless disregard for the impact of the conduct on the physical natural gas market.
C. Fraudulent or Deceptive Behavior
FERC found that Hunter accumulated large amounts of NG Futures Contracts, which were then sold during the settlement periods on the expiration days in February, March, and April 2006. According to FERC, Hunter engaged in these trades to drive down the NYMEX settlement price, which would benefit the much larger short natural gas swap positions held by Amaranth because the short swap positions increased in value as the NG Futures Contract settlement price declined. Therefore, FERC affirmed the ALJ’s determination that “the evidence established that Hunter conducted trades in the NYMEX futures market with the intent to depress prices, actually caused artificial prices in that market, and held significant positions on other platforms that would benefit from those artificially depressed prices.”5
1. Manipulative Intent
FERC rejected Hunter’s claim that open-market transactions cannot constitute market manipulation in the absence of some other deceptive conduct. In a ruling that differs with several US Court of Appeals’ decisions, FERC held that openmarket trading can send false signals to the marketplace if done to create an artificial price. FERC reasoned that the “difference between legitimate openmarket transactions and illegal open-market transactions may be nothing more than a trader’s manipulative purpose for executing such transactions.”6 To support this holding, FERC cited to a number of cases recognizing that transactions entered into with manipulative intent, as opposed to a legitimate economic purpose, can send false price signals to the market. Thus, FERC concluded that “transactions entered into with manipulative intent can serve as the basis for a manipulation claim, even in the absence of some other deceptive conduct.”7
FERC specifically rejected Hunter’s contention that his conduct merely involved open market trading, which could not deceive market participants. FERC agreed with the ALJ’s findings that Hunter’s trades were intentionally done to drive down the settlement price in order to benefit Hunter’s short swap positions on other platforms. Thus, Hunter’s trading scheme involved the interplay between two separate markets, as Hunter traded against his interest in the futures market in order obtain greater profits in the swap market.
2. Artificial and Prevailing Prices
FERC emphasized that an artificial price—a price not produced by the normal forces of supply and demand—is not element of its Anti-Manipulation Rule. According to FERC, the finding of an intentionally created artificial price is a sufficient, but not necessary, basis for finding market manipulation. Nevertheless, despite the fact that Hunter’s trades comprised 19.4, 15 and 14.4 percent of the market volume during the NYMEX closing period for the months at issue, FERC affirmed the ALJ’s finding that Hunter’s trading created price artificiality.
FERC also rejected Hunter’s argument that FERC Enforcement Staff had to prove that his trades were not made at prevailing prices because, as FERC noted, trading at prevailing prices is not an element of the Anti-Manipulation Rule. Regardless, FERC found that Hunter’s trades actually moved the prevailing price through the sale of a large number of futures contracts at low prices during the settlement periods at issued, which affected other traders in the market.
3. Expert Testimony
FERC rejected Hunter’s arguments regarding the relative weight that the ALJ placed on both Enforcement Staff’s and Hunter’s expert witnesses. In doing so, FERC also affirmed the ALJ’s finding that “market fundamentals had no bearing on the at-issue settlement prices.”
FERC affirmed the ALJ’s finding, by a preponderance of the evidence, that Hunter traded with an intent to manipulate the NG Futures Contract settlement price during the relevant settlement periods in order to benefit his positions on other trading platforms. According to FERC, “Hunter employed a trading pattern during the at-issue months that deviated significantly from all prior periods; had a financial motive for the manipulation; understood that lowering the NG Futures Contracts settlement price would benefit his related positions on other trading platforms; and believed that the NYMEX settlement period could be manipulated.”8
FERC found that Hunter knew that the NYMEX natural gas futures market could be manipulated, as evidenced by a letter that Amaranth sent to NYMEX and Hunter’s statements in instant messages. Hunter previously argued that he could not manipulate the settlement price because there is roughly equivalent amounts of sell side and buy side pressure in the market during the settlement period. However, FERC rejected this argument, noting that “not everyone has to get flat.”9 Physical natural gas traders—who did not need to be flat (without long or short positions) prior to settlement—transacted during the settlement period, which could create imbalances and price movements in the market.
FERC also found that Hunter had a financial motive to manipulate the NG Futures Contract settlement prices during the months at issue. Amaranth compensated Hunter based on the profitability of the portfolio that he managed, so any profits gained through Hunter’s manipulative trading scheme would result in additional compensation for Hunter. FERC dismissed Hunter’s argument that he lacked motive based on his claim that the value of his book was based on physical spreads; rather, FERC agreed with the ALJ’s finding that this fact alone does not preclude manipulation of the prompt-month contract.
Lastly, FERC reasoned that Hunter’s trading activities during the three months at issue significantly departed from his prior strategy of selling relatively small amounts during the expiration day. While such evidence alone would not necessarily establish scienter, FERC found that this evidence further supports the conclusion that Hunter acted with the requisite intent to manipulate.
E. In Connection with the Purchase or Sale of Jurisdictional Natural Gas
FERC found that Hunter’s conduct met the third prong of the Anti-Manipulation Rule due to the close “nexus” between physical natural gas transactions and the NG Futures Contract settlement price. As FERC noted,
(1) 4,675 NG Futures Contracts went to delivery during the months in question and utilized the NG Futures Contract settlement price as a basis for pricing the physical delivery obligations; (2) the settlement price for NG Futures Contracts is incorporated into physical basis contracts as the largest (or even sole) price component; and (3) the NG Futures Contracts settlement price is incorporated into pricing indices utilized in physical basis transactions.10
As a result, FERC found that any manipulation of the settlement price of NG Futures Contracts would affect FERC-jurisdictional physical natural gas transactions. Moreover, FERC affirmed the ALJ’s determination that Hunter acted recklessly with regard to the effect his conduct would have on such jurisdictional transactions.
III. Civil Penalty Determination
Based on the above findings, FERC ordered Hunter to pay $30 million in civil penalties for his manipulative conduct. Rejecting Hunter’s claim that the evidence supported a finding of only three violations (one for each month at issue), FERC found that the sale of each NG Futures Contract during the settlement periods at issue constituted a separate violation under the Anti-Manipulation Rule. Therefore, FERC held:
Although it is within the Commission’s statutory authority to impose a penalty that significantly exceeds $30,000,000, in light of the thousands of NG Futures Contracts sold at Hunter’s direction during the course of his manipulative scheme, the Commission concludes that a civil penalty of $30,000,000 is appropriate and sufficient to discourage Hunter and others from engaging in market manipulation.11
In determining the appropriate penalty, FERC considered a number of factors, including the seriousness of the offense. FERC emphasized the fact that Hunter’s conduct resulted in financial losses to other market participants, both in the physical and financial markets, during the relevant time period. Further, Hunter engaged in the conduct with an understanding of the relationship between the physical natural gas transactions and the NYMEX settlement price. FERC cited to Hunter’s knowledge that his conduct was improper and Hunter’s senior management role within Amaranth as further aggravating factors.
FERC also considered, but ultimately dismissed, potential mitigating factors. According to FERC, Hunter lacked a commitment to compliance and willfully ignored compliance manuals prohibiting “marking the close.” FERC also highlighted the ALJ’s findings that Hunter lacked credibility and candor, which was demonstrated by Hunter’s lack of cooperation. Finally, FERC took into account the fact that neither Hunter nor Amaranth self-reported the violations.
FERC’s decision is notable for several reasons. First, it represents the first time FERC has found a violation of its Anti-Manipulation rule in a litigated proceeding. To date, FERC has only applied penalties for potential manipulation through settlement proceedings. Second, FERC disagreed with the holdings of several US Courts of Appeals that have held that open market transactions do not violate anti-manipulation regulations absent evidence that the trader injected false information into the marketplace. Finally it affirms FERC’s expansive view of the Anti-Manipulation rule’s nexus requirement by finding manipulation in connection with contracts (natural gas futures contracts) not subject to FERC’s jurisdiction.
Moving forward, Hunter has thirty days to seek rehearing of FERC’s order. If FERC upholds its decision, Hunter can seek review in a federal appeals court. If Hunter appeals, it will be interesting to see if a reviewing court will affirm FERC’s decision based on the record developed before the ALJ.