Today the Federal Trade Commission issued its long-awaited rule targeting "market manipulation" in wholesale petroleum markets. With high, daily penalties, the rule is likely to cause petroleum suppliers to develop cautious compliance programs that restrict information disclosed to the market. The final rule becomes effective November 4, 2009.
Under the Energy Independence and Security Act of 2007 (EISA) Congress granted the FTC authority to write and enforce regulations to prohibit "any manipulative or deceptive device or contrivance" in connection with wholesale petroleum transactions. Passed in part in response to concerns that manipulation had contributed to energy price volatility and increases in petroleum prices, this legislation sought to restrict various market activities through increased regulation.
The Commission generally modeled its rule on the anti-fraud approach of SEC Rule 10-b(5), but the FTC rule will reach further into the daily operations of petroleum suppliers. The Rule prohibits companies from making (a) knowingly fraudulent statements or actions or (b) omissions that, although true, mislead market participants and distort or are likely to distort market conditions:
It shall be unlawful for any person, directly or indirectly, in connection with the purchase or sale of crude oil, gasoline, or petroleum distillates at wholesale, to:
- Knowingly engage in any act, practice, or course of business – including the making of any untrue statement of material fact – that operates or would operate as a fraud or deceit upon any person; or
- Intentionally mislead by failing to state a material fact that under the circumstances renders a statement made by such person misleading, provided that such omission distorts or is likely to distort market conditions for any such product.
Paragraph (a) applies to knowing misstatements. As examples of conduct that could violate this paragraph, in today's announcement the FTC highlighted false public announcements of planned pricing or output decisions, false data reporting, and wash sales intended to disguise market liquidity or prices. However, this paragraph also could reach false statements made in the context of bilateral negotiations that result in false information reaching the broader market. Although "knowingly" is defined to mean that the person "knew or must have known that his conduct was fraudulent or deceptive," under the rule it may be sufficient for the person to be "extremely reckless," knowing that his conduct created a danger of misleading buyers or sellers. Paragraph (b) applies to misleading omissions. The FTC provided as an example a person's reporting price information to a private data reporting company that is in the business of providing price reports to the marketplace, but intentionally omitting material facts that the reporting company required to be reported. The more risky scenarios involve public statements that fall short of "full" disclosure or situations in which one person speaking on behalf of a company does not have the information available to another at the same company. Further, a paragraph (b) violation does not require proof of a specific price effect, but only that it "distorts or is likely to distort market conditions," although this is an improvement over the "tends to distort" standard earlier proposed. Significantly, this standard does not require a showing that the person intended to manipulate a wholesale petroleum market or intended to have an impact on the larger market; it requires only that the person intended to make a statement misleading by means of an intentional omission of material fact, which makes even a possibly-incorrect statement risky.
The rule covers all purchases or sales of gasoline or petroleum distillates at the terminal rack level or upstream of the terminal rack level and all purchases of jet fuel. The rule creates some possibilities for duplicative enforcement between the FTC and the CFTC, as the FTC explicitly covered futures transactions, over which the CFTC already had jurisdiction.
The Commission adopted the rule by a 3-1 vote. In the announcement, Chairman Jon Leibowitz said that "this new Rule will allow the FTC to crack down on fraud and manipulation that can drive up prices at the pump. We will police the oil markets – and if we find companies that are manipulating the markets, we will go after them." Commissioner Bill Kovacic dissented, highlighting the burden the rule imposes on petroleum markets and predicting "that the contributions of a rule against market manipulation for petroleum products to the solution of the nation's larger energy problems are likely to be small." Concurring, Commissioner Tom Rosch stated that he agrees with many of Commissioner Kovacic's criticisms of the rule but that he would take those into account in decisions on enforcement actions.
This new rule undoubtedly will lead to petroleum companies exercising special caution in their public statements and will reduce the communication of valuable information into the market. As a policy matter, the new rule may be criticized for burdening petroleum markets and market participants – even though the FTC has in numerous studies uncovered no evidence of significant or systemic fraud in participants' public statements. As a practical matter, the new rule will cover thousands of daily, routine transactions and significantly affect the way petroleum suppliers, traders, and purchasers conduct business to comply with the regulatory regime. Although the FTC announced that no new recordingkeeping procedures are required, many companies will independently seek to develop new procedures and other internal policies in response to the risk of challenges by the FTC or others. Violations of the Commission's Final Rule are punishable with civil penalties of $1 million per violation, and each day on which the misconduct continues is treated as a separate offense.
Read more on the FTC's new rule at http://www.ftc.gov/opa/2009/08/mmr.shtm.