On November 18, 2011, the Federal Energy Regulatory Commission (FERC) denied former Amaranth Advisors LLC trader Brian Hunter’s (Hunter) rehearing request of FERC’s Order Affirming Initial Decision and Ordering Payment of Civil Penalty issued on April 21, 2011.1 In the Affirming Order, FERC found that the record supported the administrative law judge’s (ALJ) determination that “Hunter’s trading practices [in the natural gas futures market during the settlement periods] on expiration days were fraudulent or deceptive, undertaken with the requisite scienter, and carried out in connection with FERC-jurisdictional natural gas transactions” in violation of FERC’s Anti-Manipulation Rule and directed Hunter to pay a $30 million civil penalty.2 Hunter has sixty days to appeal FERC’s decision to the U.S. Court of Appeals. A court decision regarding such an appeal would provide needed guidance to market participants regarding FERC’s interpretation of its authority under the Anti-Manipulation Rule and related precedent.
Rejecting all of Hunter’s arguments and reaffirming its previous decisions, the FERC’s Rehearing Order provides additional insight regarding FERC’s view of its broad authority under the Anti- Manipulation Rule and what constitutes manipulative intent, artificial price and recklessness. For example, FERC reaffirms its:
- rejection of the premise that open market trading cannot constitute manipulation in the absence of some other deceptive conduct.
- view that demonstration of an artificial price would be a sufficient, but not a necessary, basis for finding manipulation and that manipulative trading of natural gas futures contracts can satisfy the “in connection with” FERC-jurisdictional transactions nexus requirement.
- determinations regarding recklessness, the burden of proof, and violation and penalty calculations.
The Rehearing Order arises out of an enforcement action initiated in 2007 that alleged that Amaranth and two of its traders manipulated the natural gas futures market, which directly impacted the price of FERC-jurisdictional natural gas transactions.3 The alleged manipulative scheme involved the sale of large amounts of natural gas futures contracts (NG Futures Contracts) during the New York Mercantile Exchange (NYMEX) settlement periods in February, March, and April 2006. According to the Rehearing Order, Hunter accumulated such NG Futures Contracts and subsequently sold the contracts during the final 30 minutes of trading (the settlement period) on the expiration days, to benefit certain large swap positions that increased in value as the settlement prices declined.4
In August 2009, Amaranth and trader Matthew Donohoe settled with FERC and the U.S. Commodity Futures Trading Commission (CFTC) for $7.5 million, but Hunter did not participate in the settlement. On January 22, 2010, a FERC ALJ issued an initial decision concluding that Hunter violated FERC’s Anti-Manipulation Rule by intentionally manipulating the settlement price of certain natural gas futures contracts in order to lower the NYMEX settlement price and thus benefit Hunter’s swap positions.5
- Rehearing Order
- Subject Matter Jurisdiction
Relying on its previous orders in this proceeding, FERC rejects Hunter’s prior arguments, raised again here by Hunter to preserve them for appeal, that section 4A of the natural gas act (NGA) (1) does not authorize FERC to police manipulation occurring in the futures market, (2) does not permit enforcement actions against natural persons, and (3) vests the federal district courts with exclusive jurisdiction to adjudicate alleged violations.6
- The Elements of FERC’s Anti-Manipulation Rule
FERC responded to Hunter’s contentions that (1) so-called “open market” manipulation requires some showing of deceptive conduct, apart from trading with manipulative intent, (2) artificial price is an element of a manipulation claim under NGA section 4A, and (3) FERC must establish that Hunter intentionally manipulated a jurisdictional transaction.7
- Manipulative Intent
FERC previously rejected Hunter’s assertion that, in the absence of some other deceptive conduct, so-called “open market” trading cannot constitute market manipulation. FERC reaffirmed its finding that “Section 4A of the Natural Gas Act proscribes otherwise legal conduct undertaken with manipulative intent, where a party intends to affect, or recklessly affects Commission-jurisdictional transactions.” 8 FERC rejected Hunter’s argument distinguishing Markowski and cited that court’s decision: “‘manipulation’ can be illegal solely because of the actor’s purpose.”9 FERC then rejected Hunter’s argument of an “other deceptive conduct” requirement under ATSI10 and repeated the Affirming Order, for the proposition that the ATSI court “did not create a safe harbor for manipulative schemes premised upon otherwise legal trading activities.”11 In response to Hunter’s argument that the conduct at issue involved nothing more than open market trading activities that were incapable of deceiving market participants, FERC found that Hunter manipulated “the interplay of trading activities in two separate markets” by “trading against his interest in the futures market in order to reap larger profits in the separate swap market.”12
- Artificial Price
FERC rejected Hunter’s claim that it erred in the Affirming Order by “stating for the very first time” that the existence of an artificial price is not an element of a claim under section 4A of the NGA or the Anti-Manipulation Rule. Rather, FERC maintained that the requirements for a manipulation claim were established in Order No. 670, which did not include artificial price as an element.13
FERC noted that it similarly held in the Affirming Order “that findings regarding artificial price ‘would be a sufficient, but not a necessary, basis for finding manipulation.’”14
In addition, FERC maintained that “even if the existence of an artificial price were an element of the NGA section 4A and the Anti-Manipulation Rule, such element was established” in the Hunter proceeding,15 and finds that “the record supports the ALJ’s determination that the settlement price on the expiration days in question was affected by factors extraneous to the economic pricing system of the NG Futures Contracts – i.e., a desire to benefit opposing positions held by Hunter on other trading platforms.”16 FERC reasoned that
[b]ecause the settlement price is an average of all sales during the settlement period, the challenged trades – as a matter of mathematics – impacted the price. And when such trades are executed with an intent to lower the settlement price in order to benefit positions on other trading platforms, the resulting price is no longer the product of bona fide forces of supply and demand.17
FERC reaffirmed its position that “liability under NGA section 4A may be triggered where a party acts recklessly with regard the manipulation’s effect on participants in the physical natural gas markets subject to the Commission’s jurisdiction.”18 In support of its argument, FERC relied on Order No. 670 stating that “the Commission explained that acting with reckless disregard as to the impact of manipulative conduct upon Commission-jurisdictional transactions is sufficient [and] this reasonable construction of section 4A’s broad ‘in connection with’ requirement ensures that ‘only fraudulent and manipulative activity that has a nexus to a jurisdictional transaction is actionable.’”19
- Burden of Proof
FERC rejected Hunter’s claims that it should not have deferred to the ALJ’s findings that Hunter’s testimony lacked candor and was not credible. FERC found that the ALJ explained that her credibility determination arose from conflicts between Hunter’s testimony and other record evidence and, in other instances, the ALJ’s observations regarding Hunter’s demeanor on the witness stand.20 FERC reaffirmed that the ALJ properly placed the burden of proof upon Enforcement Litigation Staff, and properly measured that proof with a preponderance of the evidence standard.21
- Hunter Acted With the Requisite Scienter
Hunter challenged FERC’s evaluation of the evidence on record supporting FERC and ALJ’s conclusion that the preponderance of the evidence demonstrated that Hunter intentionally manipulated the NG Futures Contract settlement price during the three at-issue expiration days. FERC reiterated that
Such evidence established that Hunter believed that the NYMEX settlement price was susceptible to manipulation; had a financial motive for the manipulation; employed a trading strategy during the at-issue months that differed considerably from all prior periods; and understood that lowering the settlement price of the NG Futures Contracts would benefit his related positions on other trading platforms.22
Moreover, FERC maintained that Hunter in his rehearing request acknowledges “he was compensated based on the profitability of his book and cites evidence submitted by Enforcement Litigation Staff indicating that the at-issue trades resulted in a profit to Amaranth of $18,224,777.”23 FERC disagreed with Hunter’s argument that there was no support for FERC’s conclusion that Hunter had “a financial motive to pursue the manipulative trading strategy” at issue in the case.24 On the contrary, FERC found “it entirely reasonable for the ALJ to conclude that these profits – of which Hunter stood to take home at least seven percent (that is, potentially more than $1,275,000) – could provide a sufficient motive for manipulation.”25 Regarding Hunter’s February, March and April 2006 trading activities, FERC rejected Hunter’s arguments that he was trying to “beat the close”, “leg out” or reduce his position and, instead, reaffirmed the findings that Hunter intentionally manipulated NG Futures Contract settlement prices to benefit his swap positions.
- “In Connection With” the Purchase or Sale of Jurisdictional Natural Gas
FERC rejected Hunter’s claims that no physical market participant testified that it paid or was directly affected by an artificially low price for natural gas during February – April 2006.26 FERC reaffirmed that “a party who enters or exits the market during a period of manipulation will be directly affected by the manipulation” and there is “a direct impact upon parties engaging in Commission-jurisdictional transactions” satisfying the broad “in connection with” requirement found in the NGA section 4A.27 FERC also reaffirmed that there is the required nexus between the NYMEX settlement price and physical basis transactions and pricing indices that are the price basis for large volumes of natural gas sold under long-term contracts.28
Reaffirming the ALJ’s conclusion that Hunter acted with reckless disregard as to the impact of his conduct upon Commission-jurisdictional transactions, FERC rejected Hunter’s argument that there is no evidence that he was familiar with, or understood, NYMEX Rule 2011(d), which provides that “[t]he last settlement price shall be the basis for delivery.”29 FERC stated that “Amaranth’s compliance manual made clear that any trading on NYMEX was subject ‘to heightened regulatory scrutiny’ and must be conducted in compliance with the rules set forth in the NYMEX rulebook” and, even if Hunter “was not familiar with those rules, he plainly should have been.”30
- Due Process
FERC again rejected Hunter’s arguments that he was not on notice that “lawful trading with an intent to affect market prices” – could violate NGA section 4A because such conduct is not prohibited by the Commodity Exchange Act, by citing Markowski for the proposition that “manipulative device” encompasses otherwise lawful trading undertaken with manipulative intent.31 FERC reaffirmed that Hunter received a fair hearing and there is substantial record evidence to support the determinations in the Affirming Order and Rehearing Order.
- Calculation of Violations and Imposition of the Civil Penalty
FERC determined that Hunter directed the sale of 6,875 NG Futures Contracts during the at-issue settlement periods in order to effectuate the alleged manipulative trading strategy and the sale of each NG Futures Contract constituted a separate violation of the NGA.32 Hunter challenged FERC’s assessment on a number of grounds including that the number of violations should be based upon the number of settlement periods affected by his manipulation, rather than the number of NG Futures Contracts used to accomplish that manipulation. FERC reasoned that it “will evaluate each manipulative scheme separately and will exercise its discretion in making the factspecific determination regarding the number of violations occasioned by that scheme and the appropriate penalty.” 33 FERC determined that it was “appropriate to consider the vehicle through which Hunter accomplished his manipulative scheme – i.e., the sale of NG Futures Contracts.”34
In formulating the appropriate penalty, FERC considered the seriousness of Hunter’s violation and the existence of any mitigating factors, such as a commitment to compliance and cooperation with the Commission’s investigation. FERC reiterated that “‘Hunter’s manipulation of the NG Futures Contract settlement price had a direct and substantial impact upon (1) those 4,675 NG Futures Contracts that went to delivery during the months in question, (2) physical basis contracts that incorporated the manipulated settlement prices, and (3) pricing indices utilized in physical basis transactions during the at-issue months.’”35 Based on its review of the entire record, FERC reaffirmed its prior determination that a $30 million penalty was appropriate, in light of the nature and seriousness of Hunter’s violations and the absence of any significant mitigating factors.36
- Next Steps
FERC’s Rehearing Order reaffirmed its expansive view of its authority under the Anti-Manipulation Rule. Hunter has sixty days to appeal FERC’s decision to the U.S. Court of Appeals.