PJM Interconnection, L.L.C. v. Accord Energy, LLC, 127 FERC 61,007 (2009)
On April 2, 2009, the Federal Energy Regulatory Commission ("FERC") issued an order1 partially denying PJM Interconnection, L.L.C.'s ("PJM") complaint ("Complaint") against Tower Research Capital Investments LLC and several affiliates, including Power Edge LLC ("Power Edge") (collectively, the "Tower Companies"). FERC rejected certain claims that one Tower Company had intentionally engaged in transactions which would cause it substantial losses by far exceeding the collateral it posted with PJM in order to change prices so that another Tower Company could profit.
Background and PJM's Complaint
In December 2007, PJM declared a major default by Power Edge, estimating the magnitude of Power Edge's default to be around $80 million. PJM subsequently filed the Complaint on March 7, 2008 in Docket No. EL08-44-000, alleging that the Tower Companies' engaged in manipulative and fraudulent conduct, which included, among other things: (i) collusion among affiliates so as to purchase coordinated and offsetting Financial Transmission Rights ("FTR") positions, concentrating high-risk or losing positions in one affiliate, Power Edge, and deliberately causing Power Edge to default on its obligations by saddling it with these positions, and hedging its risk in its more profitable affiliates; (ii) deliberately under- or de-capitalizing Power Edge in order to trigger its collapse; and (iii) engaging in virtual bidding in the day-ahead energy market and intentionally increasing congestion in order to enhance the financial value of one affiliate's FTRs, while at the same time enlarging the known default of another affiliate's counterflow FTR position. FERC found that, based on the pleadings alone, it did not have sufficient information to grant or deny the Complaint.2 FERC's Office of Enforcement ("OE") instituted a non-public investigation in January 2008 into the Tower Companies' activities in PJM's markets. FERC explained that once OE's investigation is complete, it would issue a further order on the Complaint.
In the April 2 Order, FERC reported that, although the OE investigation is still ongoing, OE completed its investigation with respect to two of the allegations set forth in the Complaint (i.e., (i) that certain Tower Company affiliates perpetrated a fraud upon PJM by entering into coordinated, offsetting positions in the FTR market, and (ii) that Power Edge was deliberately under- or de-capitalized in order to trigger its collapse). As explained in OE's report attached to the order, regarding these two specific complaint allegations, OE found insufficient evidence of manipulation to support a finding of a violation of FERC's anti-market manipulation regulations, 18 C.F.R. § 1c.2 (2008). OE explained that there are no per se violations of Part 1c, and in order to determine whether an entity's actions violate Part 1c, FERC will examine all the facts and circumstances concerning the entities conduct. In its investigation, OE considered: (i) the purpose for which Power Edge was created; (ii) the reasons that led to Power Edge's default; (iii) whether the Tower Companies' FTR market transactions were fraudulent or deceitful; and (iv) whether the Tower Companies intended to, or with reckless disregard did, manipulate PJM's FTR market by engaging in coordinated offsetting transactions. As part of OE's investigation, OE staff examined, (i) the formation and organization of Tower Research and its affiliates, including, but not limited, to strategies of the Tower Companies, the functional organization of the Tower Companies, and the capitalization and flow of funds among such companies; (ii) the Tower Companies' FTR transactions, including, but not limited to, the rationale for and the manner in which the FTR transactions were structured; and (iii) the intentions and motivations of key Tower Company employees, including, but not limited to, the relevant economic and other incentives.
OE concluded that, based on all of the facts and circumstances surrounding the various Tower Companies' transactions in the PJM FTR market, the Tower Companies did not violate Part 1c.2 by arranging coordinated offsetting positions and under-capitalizing or de-capitalizing Power Edge for the purpose of causing it to default. Among other things, OE concluded that (i) Power Edge was expected to be profitable; (ii) the primary driver of Power Edge's default was an unusual pattern of transmission outages, the timing and duration of which were unforeseen when Power Edge acquired its FTR portfolio; (iii) Power Edge acquired a counterflow heavy portfolio from another market participant which was a key factor in the large magnitude of Power Edge's default, and which Power Edge did not intend to acquire in full until PJM persuaded it to do so; (iv) Power Edge's affiliates did not actually take offsetting FTR positions; (v) Power Edge's affiliates' FTR positions were largely acquired at auctions in which Power Edge was not able to acquire additional FTR positions; (vi) Power Edge was not deliberately under- or de-capitalized, but rather that millions of dollars were invested in Power Edge up until the month preceding its default; (vii) the key players at the Tower Companies all had financial and professional incentives to avoid a collapse by Power Edge; and (viii) Power Edge traders undertook a variety of efforts intended to mitigate Power Edge's exposure and return it to profitability. Accordingly, OE determined that there was insufficient evidence to conclude that the actions undertaken by Power Edge and the other Tower Companies constitute a scheme or artifice to defraud made with scienter, and that the Tower Companies actions therefore did not violate 18 C.F.R. § 1c.2
The April 2 Order makes clear that FERC and its OE staff will examine all the facts and circumstances concerning an entity's conduct in order to determine whether the entity's actions violate FERC's anti-market manipulation regulations. While OE determined that the Tower Companies' conduct did not violate FERC's regulations with respect to two allegations set forth in PJM's Complaint, OE continues to investigate whether any of PJM's other allegations have merit, and whether there were any other violations of Part 1c.2 in connection with the Tower Companies transactions in the PJM market. The April 2 Order was predicated on OE's determination that the Tower Companies did not engage in some of the schemes PJM alleged. The Order does NOT stand for the proposition that it is acceptable to engage in such schemes. Consequently, companies considering structuring their trading businesses must still be sensitive to the need for legitimate business purposes. For example, OE found that one Tower Company was not deliberately engaging in transactions in which it fully expected to suffer losses for the benefit of another affiliate; it did not find that such a scheme would have been acceptable. Additional FERC orders in this case may provide additional guidance on the scope of FERC's anti-market-manipulation rule.