Firms Face Antitrust Scrutiny for Dealing in Derivatives with Anticompetitive Effects

On September 30, 2011, the Antitrust Division of the Department of Justice (“the DOJ”) announced a settlement with Morgan Stanley (“MS”) that requires MS to disgorge $4.8 million in profits resulting from a 2006 derivative agreement with KeySpan Corporation (“KeySpan”).1 The DOJ alleged that the agreement restrained competition in the New York City electricity generating capacity market and likely led to increased electricity prices for consumers. KeySpan paid $12 million earlier this year to settle allegations over its role in the agreement after the U.S. District Court for the Southern District of New York approved the DOJ’s application to seek disgorgement for a Sherman Act violation. The settlement with MS is pending approval by the court.

Anticompetitive Behavior

KeySpan is an energy distributor based in Brooklyn, New York2 and is the largest supplier of electricity generating capacity in New York City. KeySpan and two other large firms controlled a substantial portion of the market. From 2003-2006, KeySpan enjoyed significant revenues due to tight supply conditions in the generating capacity market. However, these favorable supply conditions were set to change in 2006, when two large generation plants were scheduled to increase capacity.

The DOJ alleged that KeySpan realized the negative impact that additional capacity would have on its business and considered various strategies to maintain the profitability it enjoyed under the previously tighter supply conditions. According to the DOJ, KeySpan solved its concerns over increasing supply through a plan to avoid competition with its largest competitor, Astoria Generating Company (“Astoria”). In 2006, through a complex financial derivative instrument, KeySpan effectively acquired an interest in all of Astoria’s generating capacity. The agreement set a range for the market price of generating capacity. If the market price went above the top end of the range, MS would pay KeySpan based on the spread. Conversely, if the price went below the range, KeySpan would pay MS. MS simultaneously executed an off-setting derivative contract with Astoria to hedge its derivative agreement with KeySpan.

The DOJ alleged that the derivative agreement incentivized KeySpan to withhold generating capacity to keep prices artificially high. Higher prices meant that KeySpan not only received higher revenues from its own sales, but also generated additional income from its derivative agreement. The DOJ alleged that, because the derivative agreement gave KeySpan a financial interest in the capacity of its largest competitor, KeySpan could artificially maintain high market prices without regard to losing business to Astoria. Indeed, despite the increase in capacity from the new generation plants, prices did not decline.

The Financial Services Firm’s Role

The DOJ alleged that MS was aware of its role in effectively combining KeySpan and Astoria’s generating capacities since it negotiated the terms of both derivative agreements with KeySpan and Astoria. KeySpan also initially consulted with MS regarding a possible acquisition of Astoria before deciding to proceed with the derivative agreement. The DOJ’s complaint alleged that MS violated Section 1 of the Sherman Act by entering “into an agreement the likely effect of which has been to increase prices in the NYC Capacity Market.” The DOJ based its complaint on the allegation that the agreement ensured that KeySpan would withhold output from the market and thus keep prices artificially high for consumers. As a result of the derivative agreements, MS earned $21.6 million in net revenues.


Announcing the settlement, Acting Assistant Attorney General Sharis A. Pozen stated that this is a “signal to the financial services community” that the use of derivatives for anticompetitive ends will not be tolerated and that the DOJ is likely to pursue significant penalties against such activities.

More broadly, the case puts firms on notice that any type of agreement facilitating anticompetitive conduct is subject to scrutiny and that the DOJ may seek penalties against indirect third party participants, as well as direct competitors.  

This case further underscores the DOJ’s ability and intention to seek disgorgement where appropriate for antitrust violations. In the past, the government has sought disgorgement of profits in contempt actions for consent decree violations, but even those occasions have been rare. The DOJ stated that it sought disgorgement against MS in order to deter “other parties from entering into similar financial agreements that result in anticompetitive effects in the underlying markets, or from otherwise engaging in similar anticompetitive conduct.” The DOJ’s desire for disgorgement in this case could signal the increased use of disgorgement of profits as a penalty where other remedies are unavailable or inadequate.