Introduction

The Energy Independence and Security Act (Energy Act) signed into law December 19, 2007, gives the Federal Trade Commission (FTC) new authority to police “market manipulation” and “false reporting” in the petroleum industry. In this role, the FTC joins the Federal Energy Regulatory Commission (FERC) and the U.S. Commodity Futures Trading Commission (CFTC), both of which already had similar statutory authority with respect to certain commodities. This article examines the new power of the FTC in the context of the already existing authority of these agencies in the areas of “price manipulation” and “false reporting,” and evaluates the extent to which the new authority given to the FTC by the Energy Act may change the already muddled regulatory and enforcement landscape in the energy markets.

Until 2005, it was generally assumed that the CFTC had the sole anti-manipulation enforcement authority with respect to “any commodity in interstate commerce.”1 The only limitation on this power was the CFTC’s self-imposed regulatory focus only on commodities that are subject to a traded futures contract.2 After the adoption of the Energy Policy Act of 2005 (EPAct 2005), as the Amaranth show cause order has demonstrated,3 the CFTC’s exclusive jurisdiction has been questioned, and now the CFTC and the FERC are working on reconciling their views and their somewhat different standards in a case for manipulation. With the advent of the FTC in the crude oil and petroleum products space, the regulatory environment became even more complex, and commodities traders now must be mindful of at least three standards for manipulation (given that there are traded futures contracts on crude and gasoline—hence the CFTC’s exclusive jurisdiction is triggered—and given that the FERC has authority over crude oil and gasoline pipelines). Moreover, since the FTC has traditionally never prosecuted anti-manipulation cases, compliance in the crude and petroleum products markets brings particular uncertainty, since a clear FTC standard is not known. This article attempts to ascertain what this standard is likely to be in comparison to the already articulated anti-manipulation and anti-fraud standards of the FERC and the CFTC.

FTC

THE NEW AUTHORITY

Unexpectedly to many in the energy commodities market, the FTC was granted authority to act against “market manipulation” and “false reporting” in the petroleum industry pursuant to the Energy Act,4 which was signed into law in December 2007. The provision on “market manipulation,” section 811, declares unlawful the “direct or indirect” “use or employ[ment]” of “any manipulative or deceptive device or contrivance” by any person “in connection with the purchase or sale of crude oil, gasoline, or petroleum distillates at wholesale” and “in contravention” of rules or regulations created by the FTC under the authority of the Energy Act. In addition, the provision on false reporting makes it unlawful to report false or misleading information to federal agencies with the intent of affecting oil market data. Both provisions give the FTC the power to apply civil penalties.

MANIPULATION PROVISIONS

The language of the “manipulation” provision of the Energy Act is very similar to FERC’s provisions and is also generally based on the U.S. Securities and Exchange Commission’s (SEC) Rule 10b-5 under the Securities Exchange Act of 1934.5 On its face, the FTC’s authority seems slightly narrower than the FERC’s, because the Energy Act provision is explicitly limited to wholesale transactions (i.e., excluding retail sales). However, the FTC’s authority is potentially stronger than the FERC’s in that it does not yet include an intent requirement (as discussed below, the FERC has adopted a “recklessness” standard for its anti-manipulation provision). Correspondingly, the FTC’s authority differs from the CFTC’s authority in that the Energy Act does not specifically require the FTC to prove that the defendant had the intent and ability to raise prices, or that it actually caused those prices to rise. Of course, it remains for the FTC and subsequently the courts to come up with the concrete elements for a case for manipulation, as has been done with respect to the CFTC’s standard, and largely imported from the U.S. securities laws by the FERC with respect to its own standard.

FALSE REPORTING

The Energy Act, in section 812, also includes a provision giving the FTC the authority to act against false reporting in the petroleum industry. The provision, however, gives less authority to the FTC to enforce false reporting than is available to the FERC. First, the FTC’s authority is limited to the false reporting of wholesale transactions. Retail transactions are excluded. Second, the FTC’s authority only applies to false reporting “to a Federal Department or agency.” As it stands, the Energy Act does not seem to encompass the reporting of false or misleading information publicly into the market or to private organizations and industry publications that track pricing.

POTENTIAL PENALTIES

The FTC’s potential penalties for violating the “manipulation” and “false reporting” provisions of the Energy Act are similar to those available to the FERC and the CFTC, except that the FTC does not have the authority to pursue criminal sanctions. The Energy Act specifies that violations of its relevant provisions may result in civil penalties of up to $1 million per violation per day. Under the FTC Act, which applies to these Energy Act provisions, the FTC also has the ability to seek disgorgement of profits from violators.

FTC’S PRIOR EXPERIENCE WITH MANIPULATION CASES

The FTC has a robust experience of pursuing antitrust violations in the oil industry6 and monitoring potential fraudulent and anticompetitive activity in the petroleum markets.7 In addition, when asked by Congress to investigate “price manipulation” in the oil industry in the wake of Hurricane Katrina, the FTC defined price manipulation broadly to include all antitrust violations as well as “all other transactions and practices, irrespective of their legality under the antitrust laws, that tend to increase prices relative to costs and reduce output.”8 Furthermore, in the presentation to Congress of the Katrina report, the FTC chairman emphasized that the “Commission will vigorously implement and enforce any additional legislation that is enacted” to prevent manipulation in petroleum markets.9 Clearly, Congress took this suggestion to heart and gave the FTC an opportunity to act. At the same time, the FTC has shown some discomfort with the concept of “price manipulation;” it is not a term that the agency typically uses in its antitrust and consumer protection enforcement. For example, in its investigation of energy pricing after Hurricane Katrina, the FTC stated that “price manipulation and price gouging are not defined legal or economic terms…Neither antitrust laws nor economics defines ‘price manipulation’ precisely.”10 Although the FTC nonetheless defined “price manipulation” broadly for the report as discussed above, it also included a footnote to the second part of the definition criticizing this very definition.11 And, in the end, the FTC found that no “price manipulation” had occurred in the petroleum industry after Hurricane Katrina: “Conduct of firms in response to supply shocks from the hurricanes was consistent with competition. In particular, firms diverted supply from lower-priced to higher priced areas, firms drew down their inventories, refineries not affected by the hurricanes increased output, and gasoline imports increased.”12 Similarly, in 2003, the FTC objected to proposed FERC regulations that contained “market manipulation” provisions, because the regulations presumed that actions or transactions that manipulate prices, conditions or rules automatically lead to unjust and unreasonable rates. The FTC warned that such a broad definition of market manipulation “may prohibit pro-competitive or competitively neutral agreements.”13

FERC

EPAct 2005 greatly expanded the scope of the FERC’s authority by authorizing it to implement anti-manipulation regulations. The FERC responded in January 2006 by issuing Order No. 670, the final rule implementing the FERC’s new anti-manipulation authority. Shortly thereafter, the FERC also rescinded Market Behavior Rules 2 (which was supplanted by the Anti-Manipulation Rule14) and 6, and codified Market Behavior Rules 1, 3, 4 and 5 into regulations.15 The FERC’s Anti-Manipulation Rule provides that it is “unlawful for any entity, directly or indirectly, in connection with…[a FERC jurisdictional transaction:] (i) to use or employ any device, scheme or artifice to defraud; (ii) to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made; or (iii) to engage in any act, practice or course of business that operates or would operate as a fraud or deceit upon any entity.”16 The language of the new rule is expansive, giving the FERC jurisdiction over “any entity,” not just public utilities or other entities subject to the FERC’s traditional jurisdiction, so long as that entity has engaged in conduct “in connection with” a FERC-jurisdictional transaction. In adopting this rule, the FERC issued Order No. 670 and clarified that the requisite scienter required under the Anti-Manipulation Rule is recklessness.17 The FERC further explained in Order No. 670 that it defines fraud very broadly to include “any action, transaction, or conspiracy for the purpose of impairing,  obstructing or defeating a well-functioning market” and that it is “a question of fact that is to be determined by all the circumstances of a case.”18

The FERC Anti-Manipulation Rule is still in its infancy. In fact, the FERC has initiated only one show cause order under the new rule against Amaranth,19 which has yet to reach a final resolution. As such, the way in which the FERC will apply its new authority continues to remain uncertain, but certain clues can be drawn from the FERC’s analysis in its show cause order. As the Amaranth Show Cause Order demonstrates, the agency is prepared to wield its broad enforcement power outside of its traditional area of jurisdiction by punishing manipulation by any entity “in connection with” jurisdictional transactions, including actions perpetrated on the futures market.20 The “in connection with” language encompasses all instances when there is a “nexus” between the manipulative conduct and the jurisdictional transaction.21 It is important to note however, that the FERC’s jurisdiction over crude oil is limited to the interstate pipeline transmission thereof.22 Additionally, the FERC indicates that it has modeled its Anti-Manipulation Rule after SEC’s Rule 10b-5,23 and is adopting the Supreme Court of the United States’ interpretation and definition of market manipulation under that rule.24 In conjunction with its reliance on the SEC’s precedent, the FERC stated in Order No. 670 that the “SEC does not need to show reliance, loss causation or damages because ‘the Commission’s duty is to enforce the remedial and preventive terms of the statute in the public interest, and not merely police those whose plain violations have already caused demonstrable loss of injury.’”25 This language indicates that the FERC may not consider whether or not the conduct at issue has actually harmed the market to be material to the issue of whether the conduct itself was unlawful under the Anti-Manipulation Rule. Rather, the type of harm and degree thereof appear to be factors that FERC will consider when determining the appropriate penalty once manipulation has been established.26

The EPAct of 2005 also gave the FERC the authority to impose substantial civil and criminal penalties for violations of its Anti- Manipulation Rule. The potential civil penalties for violations are up to $1 million per violation per day, while the potential criminal penalties are a fine of up to $1 million and imprisonment of not more than five years.27

CFTC

The CFTC derives its market manipulation enforcement authority from the Commodity Exchange Act (CEA), under which the CFTC and courts have required a far more exacting standard, obliging the agency to perform a complex factual review to prove the required elements. The CFTC’s market manipulation provision, codified at Section 9(a)(2) of the CEA, makes it unlawful for “any person to manipulate or attempt to manipulate the price of any commodity in interstate commerce, or for future delivery…, or to corner or attempt to corner any such commodity or knowingly to deliver or cause to be delivered…false or misleading or knowingly inaccurate reports concerning…market information or conditions that affect or tend to affect the price of any commodity in interstate commerce....”28 In practice, this means that the government must prove, by a preponderance of the evidence, that the party had: (1) the ability to influence prices, (2) the specific intent to create an artificial price, (3) the existence of an artificial price and (4) causation.29 This is a very high burden to meet, and thus the enforcement staff often includes an alternative claim for attempted manipulation, which requires only proof of the specific intent to create an artificial price30 and an overt act in furtherance of that intent, although the same penalties can be imposed.31 Over the years, this standard has been tested in numerous decisions and is well established. For any manipulation or attempted manipulation violations that occurred after October 23, 2004, the CFTC is authorized to impose civil penalties in an amount not to exceed $130,000 for each violation or triple the monetary gain to defendants, but capped at $625,000 for each violation.32 Additionally, the CFTC may impose criminal penalties of up to $500,000 for individuals and $1 million for entities, and imprisonment for up to five years.33

The CFTC and the FERC have entered into a Memorandum of Understanding, as demanded by EPAct 2005: the agencies have agreed to coordinate discovery and proceedings in cases that fall under both agencies’ jurisdiction to minimize duplicative information requests.34 It remains to be seen, however, what the true extent of such cooperation will be in light of the Amaranth litigation.

Conclusion

In sum, the Energy Act passed in December 2007 gives the FTC important new authority to regulate and pursue instances of price manipulation and false reporting in the wholesale petroleum and related markets. The FTC joins two other agencies, the FERC and the CFTC, in this capacity.

It is possible that the new authority granted to the FTC by the Energy Act will not lead to significantly increased oversight of wholesale petroleum transactions. First, there is a fair amount of overlap between the FTC’s new statutory authority and existing authority of the FERC and the CFTC. Furthermore, in some cases, the Energy Act grants the FTC narrower authority than has been granted to the other agencies, particularly to the FERC. For example, the concept of “false reporting” in the Energy Act is limited to the reporting of information to federal government bodies, whereas the FERC and the CFTC can pursue false or misleading reporting even when it is done to private parties. Second, the Energy Act gives the FTC discretion to create rules and regulations to enforce the manipulation provision of the Energy Act and states that violating these rules or regulations is a condition for violating the Energy Act itself. Potentially, the FTC will not issue any new regulations in response to the Energy Act. The chances that the FTC will not issue new rules or eagerly enforce the Energy Act are improved by the fact that the concept of “price manipulation” seems to be an uncomfortable fit with the economics-based antitrust principles that have come to characterize the FTC. It is therefore conceivable that the new authority granted to the FTC to regulate wholesale petroleum transactions will not in practicality substantially add to the regulation and enforcement faced by companies in those markets.

Nonetheless, the FTC has the statutory authority to enforce these new provisions and has significant discretion in how to do so. For example, it now has broad powers to create new regulations concerning price manipulation in the wholesale petroleum markets and is able to issue severe penalties concerning both price manipulation and false reporting. Moreover, the FTC defined “price manipulation” very broadly in its recent Katrina investigation, and it is unclear what level of intent the agency will apply to the new provisions. In addition, the FTC chairman recently pledged to Congress that the FTC would “vigorously implement and enforce” any additional legislation that is enacted relating to manipulation in the petroleum markets. As a result, FTC statements, actions and regulations regarding the implementation of the “manipulation” and “false reporting” provisions of the Energy Act should be monitored carefully.