In a pair of show cause orders issued on July 26, 2007,1 the Federal Energy Regulatory Commission (FERC) proposed to exercise for the first time in contested proceedings its recently granted authority under the Natural Gas Act (NGA) and the Natural Gas Policy Act (NGPA) to impose civil penalties of up to $1 million per day per violation for violations of those statutes, or of the Commission’s rules, regulations, and orders promulgated thereunder.2 After reviewing evidentiary submissions by the entities whose conduct is under investigation – Amaranth Advisors L.L.C. (Amaranth) and certain of its affiliated entities and two individual traders, and Energy Transfer Partners, L.P. (ETP) and certain of its affiliated entities – as well as briefs filed by these entities and by FERC’s Enforcement Litigation Staff, FERC has now ordered evidentiary hearings before an administrative law judge (ALJ) in each of these proceedings.3
The Alleged Violations and Proposed Penalties
In the show cause orders, FERC made preliminary determinations concerning violations of the NGA, NGPA, and FERC’s regulations.4 In Amaranth, FERC made a preliminary finding that Amaranth Advisors L.L.C., several other Amaranth entities, and two former Amaranth natural gas traders manipulated the price of FERC-jurisdictional transactions through trading on the New York Mercantile Exchange (NYMEX) Natural Gas Futures Contract (Futures Contract) on certain dates in 2006. According to FERC, Amaranth traders manipulated settlement prices of the Futures Contract by selling “extraordinary” amounts of these contracts within the last 30 minutes of trading before the contracts expired. The resulting artificial decrease in the settlement prices allegedly increased the value of various financial derivatives in which Amaranth had taken long positions, resulting in gains to Amaranth’s derivative financial positions.
Although trading in the Futures Contract is not subject to FERC’s jurisdiction, FERC asserted that Amaranth’s manipulation of the settlement prices directly affected FERC-jurisdictional natural gas transactions where the price of the transactions is directly tied to the settlement price of the Futures Contract. According to FERC, the manipulation occurred “in connection with the purchase or sale of natural gas . . . subject to [its] jurisdiction,” and therefore falls within the purview of the antimanipulation rule recently adopted by FERC in compliance with EPAct.5 FERC proposed to assess a civil penalty of $200 million against the Amaranth entities, concluding that the balance of considerations warranted a penalty of close to the maximum amount.6 In addition, FERC preliminarily determined that Amaranth should disgorge $59 million in alleged unjust profits, plus interest.7
FERC’s preliminary findings in ETP involved allegations that ETP violated the pre-EPAct antimanipulation rule, Market Behavior Rule 2, by manipulating wholesale natural gas markets at Houston Ship Channel and Waha, Texas on certain dates from December 2003 through December 2005. The alleged scheme, as in Amaranth, was to drive the price of fixed-price gas down in order to increase the value of the company’s financial derivative positions. FERC also determined preliminarily that ETP’s intrastate pipeline subsidiary, Oasis Pipeline, L.P. (Oasis), which provides interstate transportation service pursuant to section 311 of the NGPA:8 (1) engaged in preferential and unduly discriminatory conduct by favoring affiliated shippers and disfavoring non-affiliates; (2) charged non-affiliates more than the maximum rate approved by FERC for interstate transportation service from Waha to Katy, Texas; and (3) failed to file an amended operating statement to reflect an agreement that changed how it operated the pipeline.
FERC concluded that ETP should be assessed a civil penalty of $79 million for its price manipulation at Houston Ship Channel, and concluded that ETP should disgorge $67,638,416 in unjust profits, plus interest, for this manipulation.9 FERC also concluded that ETP should be assessed a civil penalty of $3 million for its price manipulation at Waha, and should disgorge $2,228,550 in unjust profits, plus interest for that manipulation.10 FERC also proposed to assess $15 million in civil penalties against Oasis for its allegedly unduly preferential and unduly discriminatory actions, and to require disgorgement of $267,122 in unjust profits, plus interest.11 Finally, FERC proposed to assess a civil penalty of $500,000 against Oasis for its failure to amend its operating statement to accurately reflect the manner in which it operated the pipeline, and further required Oasis to amend its current operating statement within sixty days of the order.
The Hearing Orders
In the ETP Hearing Order, FERC determined that genuine issues of material fact exist which require an evidentiary hearing before an ALJ. FERC directed the ALJ to determine whether ETP violated the then-existing section 284.203(a) of FERC’s regulations, which prohibited persons making sales for resale of natural gas in interstate commerce from “engaging in actions or transactions that are without a legitimate business purpose and that are intended to or foreseeably could manipulate market prices, market conditions, or market rules for natural gas.”12 FERC also directed the ALJ to determine whether ETP unjustly profited from its activities and, if so, the level of unjust profits.13 With respect to Oasis, FERC ordered the ALJ to determine whether the pipeline (1) unduly discriminated against nonaffiliated shippers and unduly preferred affiliated shippers, (2) charged rates in excess of the FERC-approved fair and equitable rates (and, if so, the amount of unjust profits due to the excessive rates), and (3) failed to file an amended operating statement as required by FERC’s regulations.14 FERC reserved for its own decision, based on the record developed at the hearing, the following issues: (1) whether civil penalties should be imposed for the alleged violations by ETP and Oasis; (2) whether ETP’s blanket marketing certificate should be revoked; (3) the method by which any unjust profits should be disgorged; and (4) whether any conditions should be placed on continued provision of interruptible transportation service by Oasis pursuant to NGPA section 311.15
In the Amaranth Hearing Order, FERC likewise determined that an evidentiary hearing was required to resolve genuine issues of material fact.16 FERC directed the ALJ to determine whether any of the respondent Amaranth entities, including the individual traders, violated the anti-manipulation rule, whether any of the respondents unjustly profited from their activities, and the level of any such unjust profits. FERC also directed the ALJ to determine whether two of the respondents, Amaranth International Limited (a Bermuda corporation) and Brian Hunter (a resident of Canada), had sufficient contacts with the United States to justify FERC’s exercise of personal jurisdiction over them.17 As in the ETP Hearing Order, FERC reserved for itself the issues of whether civil penalties should be imposed and how any unjust profits should be disgorged.18
The Amaranth Hearing Order also addressed a set of pending rehearing issues that FERC had not previously addressed in its initial order on rehearing of the Amaranth show cause order. FERC rejected the position of Amaranth trader Matthew Donohoe that FERC may not enforce the antimanipulation provisions of the NGA against natural persons, affirming its conclusion in promulgating the anti-manipulation rule that Congress intended for natural persons to be covered.19 FERC also agreed with Enforcement Litigation Staff that a showing that respondents made false statements is not a necessary predicate for liability under the anti-manipulation rule, noting that “[o]pen market transactions send false signals to market participants if such transactions are undertaken with the intention of creating a false price.”20 Likewise, FERC reasserted its position that “intentional behavior that recklessly affects jurisdictional markets” is subject to the anti-manipulation rule, whether or not that conduct directly involved jurisdictional transactions.21 Finally, FERC reaffirmed its conclusion that any assessment of penalties by the Commission under NGA section 22 should be reviewed by a court of appeals, rather than a federal district court, noting that two federal district courts had agreed with its position.22
To date, FERC’s Office of Enforcement has been highly successful in negotiating settlements with entities against which it has pursued investigations. The cases FERC has now set for hearing represent the first instances in which Enforcement Litigation Staff will be put to the test of proving market manipulation at evidentiary hearings. The hearings will provide an opportunity to observe how these types of proceedings will be processed by FERC and by its Enforcement Litigation Staff.
Both cases involve complex sets of issues and analyses of large sets of transactions, and both ETP and Amaranth have vigorously denied that their conduct was manipulative. ETP, in particular, has characterized the economic analysis underlying the show cause order against it as “junk science.” Should Enforcement Litigation Staff prevail in the hearings, both ETP and Amaranth have raised numerous issues regarding FERC’s jurisdiction and authority, as well as the proper forum for judicial review, that likely will be raised in any subsequent appellate proceedings. Thus, the hearing orders in the ETP and Amaranth cases represent merely the latest steps down what may be a long road of litigation.