Companies with trading operations are experiencing increased difficulty navigating the rapidly evolving and complex regulatory environment. One critical trend involves market manipulation investigations brought by newly empowered federal regulators, including the Commodities Futures Trading Commission (CFTC) and the Federal Energy Regulatory Commission (FERC), among others. This eUpdate analyzes the current and future path of those federal enforcement investigations. Successfully coping with these trends requires strategic and careful preparation as you enter 2014.
Federal market regulators are aggressively investigating market manipulation claims in the oil, electric power, futures, swaps and other markets. Enforcement actions are being brought based on open-ended antifraud-type statutes. Any company with a trading operation may face the scrutiny of a regulator.
The stakes are high. Investigations are being resolved with fines as high as one billion dollars. Settlements have included restrictions on the relevant company’s trading operation and access to the markets. Parallel criminal investigations targeting the company and individuals are on-going in some instances.
Successful defenses are few. Traditional compliance systems are not a defense. The lawfulness of specific, individual trades is not necessarily a defense. Suffering a loss is not a defense and may aid the prosecution. Making a profit may also aid enforcement officials. Even following the “letter” of market rules may not be enough to avoid liability. There are, however, steps that can be taken to protect your company.
Examples of recent cases
Federal regulators, such as the CFTC and FERC, are using open-ended antifraud statutes that trace to the SEC’s longtime favorite weapon, Exchange Act Section 10(b), a far reaching fraud statute, to bring manipulation cases. The actions typically claim that the trading was uneconomic, “gamed” the system or inserted false or fictitious information into the market place. Recent examples of these cases include:
- Settlement: $1 billion in fines paid by the Dutch financial giant to the CFTC, Department of Justice (DOJ), Financial Conduct Authority in Britain and Dutch prosecutor
- Charge: Manipulation of benchmark interest rates through insertion of false bids
- Settlement: $100 million paid to the CFTC
- Admissions were required
- Charge: Reckless trading in the derivatives market
- Criminal investigation continues
- Settlement: About $245 million paid to FERC
- Restrictions: Adoption of a series of compliance procedures
- Charge: Manipulation by taking “uneconomic positions” in one energy market to profit in another
- Settlement: $410 million paid to FERC
- Restrictions: Adoption of monitor imposed
- Charge: Manipulation of select electric markets by “gaming the system,” using bids and tactics within the relevant tariff rules but which were uneconomic to create outsized profits that harmed the market
- Criminal investigation continues
Barclays Bank PLC
- Settlement: About $200 million paid to CFTC
- Charge: Manipulated monthly physical index positions to benefit swap positions
Panther Energy Trading LLC
- Settlement: $2.8 million paid to CFTC
- Restrictions: One year trading ban imposed
- Charge: Injection of false information into the market by placing orders and canceling them to draw in traders and achieve a better price on other trades
Rumford Paper Company
- Settlement: $13 million paid to FERC
- Restrictions: Adoption of new compliance measures
- Charge: Manipulation by gaming the system, using the rules to create an inflated baseline – a false statement -- which is then used to maximize profits under the system
In August 2013 FERC charged BP America, Inc. and its affiliates with manipulating the price of natural gas. The regulator alleged that BP engaged in uneconomic trading in one market which negatively impacted the price there to fraudulently boost the price and thus its profits in another. The firm faces payments of just under $29 million in this on-going proceeding.
The approach of enforcement agencies
Enforcement officials are building these cases on a rigorous scrutiny of market place conduct and trading activity. Investigators make a detailed analysis of the individual trades and/or conduct; a critical evaluation of specific portfolios; a careful assessment of overall trading patterns; and an evaluation of market and consumer impact.
Intent and deception in the market place, both critical elements of the manipulation claims, are often inferred from evidence such as:
- Cancelled trades: Repeatedly placing and canceling trades suggests luring participants to market – a false statement -- to get better execution on other trades;
- Fictitious bidding patterns: Bidding patterns seemingly out of sync with the market, suggesting the bids are a sham;
- Trading at a loss: Repeatedly trading at a loss, suggesting an ulterior motive for the transactions such as obtaining a bigger profit on other trades;
- Gaming the system: Placing seemingly lawful but uneconomic trades that are rarely implemented because of the rules or practices in the market as part of a plan to achieve large profits that hurt the market or manipulating the rules to maximize profit; and
- Market impact: Negative effects in the market from bids and trades that were not intended to be executed, or outsized positions that alter or distort the market and price.
Regulators frequently bolster their trading analysis with proof of persistent, repetitive conduct or a showing that the transactions constitute a significant change of tactics. E-mails, instant messages and tapes of telephone calls placed by traders frequently aid enforcement officials with admissions. Whistleblowers are providing a road map inside the company and its trading operation to speed enforcement investigators. And, company or trader statements to officials about market conduct, the reasons for trades, or the purpose of a transaction which are less than full and complete become weapons for enforcers who view them as false statements and a cover-up, suggesting guilty knowledge.
What you can do to protect your company in 2014
A proactive approach to compliance built not just on traditional systems but the approach of enforcement officials yesterday and tomorrow is critical. This begins with a culture that centers on fair and ethical conduct rather than simply following specific rules. In this culture, the statutes and rules are viewed through the eyes of enforcement officials who see them not as a list of “do’s and don’ts” but as a code of ethics.
Compliance efforts should focus on periodically analyzing the trading operation using the same approach employed by enforcement officials. The objective is to identify any potential issue or question at the earliest time, fully investigate it and take any necessary action. An essential supplement to these efforts is the creation of an atmosphere that encourages employees to report any question to the company rather than become a whistleblower for the regulators. Finally, if a law enforcement inquiry begins, prompt investigation and remediation is frequently the key to a quick and effective resolution.
In the end, vigilance, informed by closely monitoring changing and evolving regulatory trends in the market place which are then used to analyze your trading book, is the best approach to avoiding difficulties. Stated differently, the company’s trading activity should be carefully and constantly monitored through the lens of the code of ethics being enforced by the regulators and their investigative techniques.