In a recent opinion denying the defendants’ motion to dismiss in FERC v. City Power Marketing, LLC, No. 1:15-cv-01428-JDB (D. D.C.), the district court accepted FERC’s application of its Anti-Manipulation Rule to riskless transactions in PJM, but also upheld defendants’ right to take discovery under the Federal Rules of Civil Procedure as part of the court’s de novo review of a FERC penalty order. The court also affirmed FERC’s authority to sanction individuals.

The case is before the US District Court for the District of Columbia pursuant to FPA § 31 for de novo review of FERC’s July 2, 2015 Order assessing penalties of $15 million and ordering disgorgement of profits against City Power Marketing LLC (City Power) and its founder for alleged violations of FERC’s Anti-Manipulation Rule and its Market Behavior Rule 3. The case centers on City Power’s 2010 trading activity in Up-to-Congestion (UTC) transactions in PJM. FERC’s penalty order found that City Power engaged in riskless “sham” UTC transactions that provided no value to the market, for the sole purpose of receiving Marginal Loss Surplus Allocation (MLSA) payments (which compensate parties for line loss in transmission).

UTCs allow traders to arbitrage the day-ahead price spreads between a generation source and a sink on the PJM grid and the real-time price spreads between the same points. UTCs also require the trader to reserve transmission, which qualifies the trader to receive MLSA payments. FERC’s order alleges that City Power’s UTC transactions largely eliminated the risk of loss by choosing a source and a sink that historically had very low or nonexistent price differences and by entering pairs of UTCs that would effectively cancel each other’s profit or loss but nonetheless qualify for MLSAs.

The decision’s notable holdings include:

  • Procedural protections: De novo review under the FPA accords defendants the same rights to discovery available under the Federal Rules of Civil Procedure in all civil actions.
  • Proof of deception required: The court held that FERC’s Anti-Manipulation Rule requires proof of deception and did not adopt FERC’s interpretation that “fraud” includes “any action, transaction, or conspiracy for the purpose of impairing, obstructing or defeating a well-functioning market.” It found, however, that trades designed to incur only negligible market price risks and that did not “spur convergence of day-ahead and real-time prices” could be deemed “sham transactions” that satisfy the element of deception. The court further declared that “traders are presumed to be trading on their best estimates of a [product’s] . . . underlying economic value . . ., and to trade for other purposes can be deceptive.”
  • PJM’s ability to discern riskless trades does not preclude a finding of deception: The court rejected City Power’s defense that there was no deception because the details and character of its trades were self-evident to PJM when they were entered into PJM’s trade system. The court found that, given the computerized mechanics of the trades and the volume of trading activity, it cannot be assumed that PJM would necessarily notice their riskless characteristics when transacted.
  • Absence of harm not a defense: The absence of harm from the trades is not a defense to a FERC manipulation enforcement action.
  • FERC’s Anti-Manipulation Rule provided fair notice that the UTC trades violated its proscriptions: The court stated, “A reasonable person would have recognized that . . . trades of this sort were sham transactions, and that to use them as a mechanism for collecting MLSA – to get money ‘for doing nothing,’ . . . would constitute a scheme to defraud.”
  • Reservation of transmission, even if not used, is sufficient to give FERC jurisdiction.
  • Natural persons are within FPA Section 222’s term “any entity.” This holding authorizes FERC to sanction natural persons for Anti-Manipulation Rule violations.
  • Withholding documents and making misleading statements in a FERC investigation provides a basis for a violation of FERC’s Market Behavior Rule 3 (18 C.F.R. §35.41(b)).

Tactical Considerations: Where discovery might reveal exculpatory evidence, defendants should consider whether to seek discovery of that evidence before asking the court to address the legal sufficiency of a penalty order. Overturning penalty orders at the outset of a case on legal grounds may have a lower potential for success than common motions to dismiss that attack the legal sufficiency of mere allegations in a complaint. Courts may accord penalty orders more deference than the allegations of a complaint because they typically will have more detailed factual content than a complaint and read as though they are the product of adjudicated findings, even though they are not. Also, asking a court to declare legal standards based only on the one-sided factual presentation of a penalty order that omits exculpatory evidence risks receiving a declaration that is overly deferential to the government’s position because the court will not have before it the countervailing evidence that can affect the proper scope and application of legal standards.