On February 22, 2010, the US Department of Justice (DOJ) Antitrust Division announced a proposed settlement of a suit against KeySpan Corporation, in which the DOJ challenged a derivative agreement allegedly giving KeySpan a financial interest in the sales of its principal competitor in the sale of electric power in New York City.1 Specifically, the suit claimed that KeySpan violated Section 1 of the Sherman Act by entering into a swap agreement with an unnamed financial services company, pursuant to which KeySpan, the market’s largest electricity generator, received payments when market prices for electricity generating capacity were above a specified level, thereby encouraging KeySpan to withhold generating capacity and keep market prices artificially high. DOJ argued that in the highly-concentrated New York City market for electric power, the swap agreement by KeySpan resulted in higher prices for wholesale electricity capacity that were, in turn, passed on to consumers in the form of higher electricity prices. KeySpan agreed to settle the lawsuit and disgorge $12 million in profits resulting from the derivative transactions.
Background Regarding the New York City Electricity Generating Market
In New York City, retail electricity sellers must purchase a product known as “installed capacity”2 from electricity generators. State regulations require electricity retailers to purchase 80% of their capacity from suppliers in the New York City region but also cap the price at which a generator may bid its capacity. Capacity is sold in an auction process wherein the bids from suppliers are “stacked” from lowest to highest. The offering price of the highest bid needed to meet retail demand establishes the market price for the auction and all power demanded from all suppliers is sold at that price. Prior to 2006, due to high demand and very limited supply, KeySpan was able to set its bid at its regulatory cap, which was higher than that of its competitors,3 and still sell nearly all of its capacity. However, in 2006, significant new generating capacity entered the New York City market, leaving KeySpan with the choice of either bidding its capacity at its regulatory cap and having some portion of its capacity go unsold, or competing in the market on the basis of price by lowering its bid to a level where more of its capacity would be sold. According to the DOJ complaint, either strategy would have resulted in substantially lower revenues and profits for KeySpan.
Potential for Future Enforcement: Distinguishing the KeySpan Swap from other Derivatives Transactions
Faced with this choice, KeySpan entered into a swap agreement (the KeySpan Swap) with the unnamed financial services company under which KeySpan received payment when the market price for electricity exceeded a certain threshold. If the market price was below the agreed upon figure, then KeySpan would make payments to the financial services company. The swap agreement with KeySpan was contingent upon the financial services company offsetting the swap agreement by entering into a hedge agreement with KeySpan’s largest competitor, Astoria Generating, so that the financial services firm was not bearing the market risk.
When read together, these agreements allowed KeySpan to continue bidding its capacity at its market cap and make up for its unsold capacity by taking a financial interest in Astoria’s generating capacity. In other words, if KeySpan set the market price, some of its capacity went unsold, but the price would nonetheless remain high enough for Astoria to pay the counterparty pursuant to the hedge and for the counterparty, in turn, to pay KeySpan under the swap. The net effect, the DOJ alleged, was that the market price for installed capacity remained the same despite the entry of significant new generating capacity, and KeySpan effectively received the value of the higher energy prices obtained by Astoria. This, according to DOJ, had a competitive effect “similar to that of actually purchasing Astoria’s capacity” and “eliminated KeySpan’s incentive to compete for sales.”4 DOJ asserted that throughout the period of the swap, KeySpan consistently bid its capacity at the cap “even though a significant portion of its capacity went unsold.”5 As a result, DOJ said, the entry of substantial new capacity did not result in a decline in market price. Likewise, DOJ concluded that the swap “produced no countervailing efficiencies.”6
Finally, and perhaps an under-emphasized factor in DOJ’s decision to challenge the arrangement, was that prior to executing the swap agreement, KeySpan allegedly approached the financial services company that served as its swap counterparty about acquiring Astoria. KeySpan reportedly abandoned that approach after concluding the acquisition of its direct competitor would raise substantial antitrust concerns.
The absence of any direct agreement between KeySpan and an in-market participant makes this case unusual; it also makes it more likely that had the case progressed to litigation, the DOJ would not have pursued a per se theory of illegality. Indeed, there are many types of derivative, swap and covering transactions that are not anticompetitive. Nevertheless, the unique nature of the New York City market, the lack of countervailing efficiencies and the clear price impact of the specific derivative agreements at issue here seem to make this a relatively easy case for DOJ under a rule of reason analysis.
The DOJ action against KeySpan should serve as a warning flag that utility companies engaging in similar derivative transactions need to be alert to potential anticompetitive effects like the ones the DOJ identified in this case. In addition, the DOJ’s pursuit of a case under Section 1 of the Sherman Act, absent a direct agreement between a company and a competitor or other market participant, perhaps indicates the government’s intent to use more novel theories for addressing behavior that it perceives as having clear anticompetitive effects.
The Justice Department’s Willingness to Supplement FERC’s Oversight Authority
Also notable in this case is that DOJ took action against a participant in a heavilyregulated market overseen by the Federal Energy Regulatory Commission (FERC) despite FERC’s prior determination not to take enforcement action with respect to the swap agreement.7 Not only was FERC aware of the KeySpan Swap as early as 2007, but FERC had, in fact, conducted a review of the transactions and determined the rates charged by suppliers in the New York City market were reasonable, the supplier’s bidding behavior in response to the entry of new capacity was predictable and within regulatory limits, and there was no price manipulation by the market participants.8 This willingness to supplement FERC’s oversight authority might signal an increased role for the DOJ in antitrust enforcement in regulated industries.
Unprecedented Pursuit of Disgorgement as a Remedy Under the Sherman Act
This case also marked the first time that the Antitrust Division sought disgorgement as a remedy for a violation of the Sherman Act.9 In the typical case, the DOJ seeks an order to restrain the anticompetitive conduct or invalidate an unlawful agreement. Here, however, those remedies would be largely ineffective because the derivative agreements at issue have, by their own terms, since expired and KeySpan no longer owns electric generating facilities in the New York City market. Likewise, the DOJ argued that private lawsuits would face significant obstacles because of the “filed rate doctrine,” which may preclude monetary relief in private antitrust suits relating to rates filed with a federal regulatory agency.10
Although the Sherman Act only authorizes the government to “prevent and restrain” violations of the Act, the DOJ argued that disgorgement of profits is available as a potential remedy in a civil antitrust action based on the inherent equitable powers of a federal district court. In doing so, the DOJ declared that this settlement is intended to “send a strong message to those considering similar anticompetitive conduct.”11 As such, while the DOJ’s pursuit of disgorgement may have been driven by the unique factual considerations of this case, it is nonetheless noteworthy as a potential new weapon in the Antitrust Division’s enforcement arsenal.