For the first time, the Antitrust Division of the U.S. Department of Justice (DOJ) is seeking disgorgement of profits earned by a defendant as a remedy in an alleged Section 1 Sherman Act market manipulation case. Equally as groundbreaking is the fact that this case involves the use of derivative swap contracts as an alleged method of violating the antitrust laws. Specifically, in recent court filings, the DOJ is seeking approval of a settlement with KeySpan Corporation, under which KeySpan will disgorge $12 million in allegedly illegal profits obtained by manipulating the New York City wholesale electricity market. The funds would be paid directly to the U.S. Treasury.
According to the DOJ, KeySpan Corporation, one of three wholesale electricity providers in New York City, engaged in a unique form of market manipulation to maintain its profits in light of its competitors’ new generation capacity. KeySpan allegedly was concerned that the additional capacity would cause prices to fall. As per the DOJ, to protect itself, KeySpan entered into a mirror derivative swap contract with a financial services company, which then entered into a mirror swap contract with a KeySpan competitor. Under the arrangement, KeySpan would receive payments on the swap contract tied to the competitor’s revenues from the sale of megawatts in the New York City market. As a result, KeySpan received payments arising from wholesaling of electricity regardless of whether it actually won the applicable contract. The DOJ alleged that KeySpan’s guaranteed revenue stream allowed it to continue to bid for wholesale sales contracts at higher prices than it would have received but for the derivative swap. In addition, the DOJ asserts that KeySpan’s competitors were also encouraged to bid at higher prices because KeySpan essentially removed the need to price compete. The swap contract had the effect of removing meaningful market pricing information from the competitor landscape.
Derivative swap contracts are not new, but their intended use solely to manipulate price is. Under the swap at issue, KeySpan entered into an agreement under which it paid a financial services company a set amount per year. In exchange, if the market price for megawatt capacity was above $7.57 per kW-month, the financial services company would pay KeySpan the difference between the market price and $7.57 times 1800 MW. The bank entered into a mirror contract with KeySpan’s competitor under which the bank received the difference between the market price and $7.07 per kW-month times 1800, while paying the competitor a fixed amount per year.
The DOJ invoked the court’s equity powers to structure an appropriate remedy in pursuing disgorgement. According to the DOJ, it sought disgorgement because of the unique factors involved in the case. To begin with, KeySpan had already sold the power generating assets, and was no longer participating in the derivative swap contract. Further, the filed rate doctrine might bar private suits seeking damages, and FERC, which had concurrent jurisdiction, did not seem to have any regulatory remedies that could address KeySpan’s manipulation. In its filing, the DOJ did state that it believed disgorgement would be an effective remedy to deter similar activities in the future. It did not comment on whether it has developed a set of criteria for assessing disgorgement as opposed to any other remedy.
Out of all of the public comments received by DOJ regarding the use of disgorgement as a remedy, none challenged the DOJ’s authority to seek such a remedy. Rather, the comments focused on contentions that the amount to be disgorged was too little and that the money was to be paid to the U.S. Treasury instead of to the aggrieved ratepayers.
The DOJ’s use of disgorgement is a remarkable development, but so is the nature of the practice under investigation. Derivative swap contracts are pervasive in the financial sector, and their potential negative impact has only come to light since the financial downturn. DOJ’s three-year investigation into the intricacies of these instruments and how they can be used to manipulate a relevant market, coupled with disgorgement of profits in the KeySpan case, could signal a new direction in DOJ’s investigations of antitrust violations and the new realm of potential enforcement mechanisms.