2. When FERC Comes Calling: An Update on FERC Enforcement 1 Mosby Perrow, Jones Day Houston Bar Association CLE Seminar April 24, 2015

3. When FERC Comes Calling: An Update on FERC Enforcement SCOPE FERC: Who They Are and What They Do FERC Office of Enforcement Divisions within Office of Enforcement –Audits and Accounting –Energy Market Oversight –Analytics and Surveillance –Investigations Prohibition Against Market Manipulation Culture of Compliance 2

4. FERC: Who They Are and What They Do 3

5. 4 4 Federal Energy Regulatory Commission Independent agency within the Department of Energy. Five commissioners, appointed by the President with Senate approval. No more than three commissioners may be from the President’s party. Serve staggered five year terms. Decisions appealed to Federal Circuit Court. Comm’r, Cheryl A. LaFleur (D) Comm'r, Philip Moeller (R) Comm'r, Tony Clark (R) Chairman, Norman Bay (D) Comm'r, Colette Honorable (D)

6. 5 5 FERC Organization

7. New Chairman – Enforcement Background Chairman Bay was the Director of the Office of Enforcement from July 2009 to July 2014. First time a member of FERC’s Enforcement Staff become a Commissioner. Served in the Department of Justice from 1989 to 2001. –Assistant U.S. Attorney in the District of Columbia and New Mexico from 1989 to 2000. –U.S. Attorney in the District of New Mexico from 2000 to 2001 Chief of Staff Larry Gasteiger. Acting Director of the Office of Enforcement from August 2014 to April 2015 Deputy Director of Enforcement under Bay from 2009 to 2014. Director of the Division of Tariffs and Market Development - East in the Office of Energy Market Regulation (electricity). Before Joining FERC in 1997, attorney in OGC at Commodity Futures Trading Commission. 6

8. FERC Office of Enforcement 7

9. Mission: Assisting consumers to obtain reliable, efficient, and sustainable energy services at a reasonable cost through appropriate regulatory means. Goals to fulfill this mission: Ensure just, reasonable, and non-preferential rates. Promote the development of a safe, reliable, and efficient energy infrastructure. Facilitate Organizational Excellence 8 Office of Enforcement

10. FERC Civil Penalty Authority 9 $1 million per day per violation as long as violation continues. Penalty amount “shall take into consideration the nature and seriousness of the violation and the efforts to remedy the violation.”

11. FERC Penalty Guidelines 10 Modeled after the U.S. Sentencing Guidelines Intended to increase fairness, consistency, and transparency Implements a step-by-step process for determining civil penalties with specific calculations and formulas* Available at Policy Statement on Penalty Guidelines, 130 FERC ¶ 61,220 (2010) and Revised Policy Statement on Penalty Guidelines, 132 FERC ¶ 61,216 (2010) * Jones Day lawyers prepared a flowchart to use for applying the revised penalty guidelines, which is available at www.jonesday.com/fercs_revised_penalty_guidelines/.

12. 11

13. FERC Enforcement Civil Penalties Total Civil Penalties assessed for all years 2007 to present: $611,579,786 Total Civil Penalties does not include the $30,000,000 assessed in Hunter and overturned on jurisdictional grounds by the U.S. Court of Appeals for the District of Columbia Circuit. Also does not include penalties proposed or assessed in the following currently pending matters: $28 million BP America Inc., et al.; $453 million Barclays Bank PLC, et al.; $5 million Lincoln Paper and Tissue, LLC; $7.5 million Competitive Energy Services, LLC; or $1.25 million Richard Silkman; $16.8 million Powhatan Energy Fund LLC; $10.08 million CU Fund Inc.; $1.92 million HEEP Fund Inc.; $1 million Houlian Chen (Powhatan Energy Fund); $5 million Maxim corporate entities ; $50,000 Kyle Mitton (Maxim Power Corporation); $14 million City Power Marketing, LLC; or $1 million K. Stephen Tsingas. 12

14. Total Disgorgement ordered for all years 2007 to present: $300,678,168 Total Disgorgement does not include amounts ordered in the following currently pending matters: $34.9 Barclays Bank PLC, et al.; $379,016 Lincoln Paper and Tissue, LLC; $166,841 Competitive Energy Services, LLC; $3.47 million Powhatan Energy Fund LLC; $1.08 million CU Fund Inc.; $173,100 HEEP Fund, Inc.; or $1.28 million City Power Marketing, LLC 13 FERC Enforcement Disgorgement

15. Divisions within Office of Enforcement 14

16. 15

17. Division of Audits and Accounting Role: Administers audit and accounting programs to foster FERC’s efficient, effective, and appropriate oversight of jurisdictional entities. Focus: –Risk Assessment to Target Audits –Administers Accounting program and field questions. Stats for FY 2014: –Completed 19 financial and operational audits of public utilities and natural gas pipelines in FY 2014. –Audits resulted in 162 recommendations for corrective action and directed over $11.7 million in refunds and recoveries. 16

18. Audits by Topic 17 ETC Tiger Pipeline, LLC. Evaluated ETC Tiger’s compliance with FERC’s accounting and reporting requirements for calculating and accruing allowance for funds used during construction (AFUDC). Commenced November 20, 2012 and concluded March 5, 2014. No Audit Findings Kern River Gas Transmission Golden Pass Pipeline Bison Pipeline

19. Division of Energy Market Oversight Role: Responsible for monitoring and overseeing the nation’s wholesale natural gas and electric power markets. Focus: Performs daily oversight of wholesale natural gas and electric markets and related fuel and financial markets, identifying market events and trends. Identifying market anomalies, flawed market rules, tariff and rule violations, and other unusual market behavior. –Compliance with forms filed with FERC. –Calls to industry –State of the Markets Reports –Gas-Electric Coordination http://www.ferc.gov/market-oversight/reports-analyses/reports-analyses.asp 18

20. Division of Analytics and Surveillance Role: Develops surveillance tools, conducts surveillance, and analyzes transactional and market data to detect potential manipulation, anticompetitive behavior, and other anomalous activities in the energy markets. Focus: Surveillance tools and algorithmic screens to perform continuous surveillance and analysis of market participant behavior, economic incentives, operations, and price formation in both the natural gas and electric markets, to detect “anomalous activities” in the markets, and to identify potential investigative subjects. 19

21. Division of Analytics and Surveillance: Large Trader Report Clearing members, Futures Commission Merchant, and foreign brokers file daily reports with the CFTC that show futures and option positions of traders with positions at or above specific reporting levels. DAS now has a daily feed from the LTR. “The LTR data is particularly useful in identifying manipulative schemes that employ a ‘tool’ to attack a ‘target’ price setting mechanism to improve the value of a ‘benefiting position.’” --2014 Report on Enforcement, Docket No. AD07-13-008 20

22. Division of Analytics and Surveillance: Polar Vortex In January and February 2014, the United States experienced historically cold weather that affected natural gas and electricity markets in the upper Midwest, the Northeast, and the Southeast, and natural gas and electricity prices spiked. DAS conducted a review to determine whether manipulative trading behavior contributed to the high natural gas prices and elevated electricity costs that arose during the Polar Vortex. No evidence of widespread manipulation but... –One non-public investigation ongoing examining potential downward price manipulation in natural gas market. –Two non-public investigations of whether generators improperly benefited from constrained conditions in electric market 21

23. Division of Investigations Role: Conducts public and non-public investigations of possible violations of the statutes, regulations, rules, orders, and tariffs administered by the Commission. Focus: Public and non-public investigations of possible violations of the statutes, regulations, rules, orders, and tariffs administered by FERC. –Market Manipulation –Reliability –OATT, Tariff, Regulations Stats for FY 2014: –17 investigations opened in FY2014 9 Market Manipulation, 8 False Statements to the Commission or an RTI/ISO, 11 Tariff Violations, 1 Commission Accounting Standards and Orders –15 investigations closed in FY2014 8 via settlement 7 upon finding of no violation or insufficient evidence. Settlements totaled almost $25 million in civil penalties and approximately $4 million plus interest in disgorgement. 22

24. Prior to the Investigation Review Information. Consult publicly available data. Contact entity for explanation. Initial stages are typically non-public. Fact Gathering* Customary discovery methods. Main tools for fact-finding are data requests and depositions. Contact with corporate representative. Subjects may contact OE or FERC in writing to explain conduct at any time. Preliminary Conclusions* Staff informs subject that a violation occurred warranting sanctions. Subject may respond with additional info. *Settlement Discussions occur throughout the entire investigation and are the Office of Enforcement’s preferred method of resolution. Civil Prosecution Hearing before an ALJ or Commission order with de novo review (FPA and NGPA v/s NGA split). If FERC issues a final order assessing penalties or other remedies, may appeal to Federal Court of Appeals for review. No Further Action Determines no violation occurred. Evidence is insufficient to warrant further investigation. No further action otherwise called for based on totality of the circumstances. Division of Investigations: Process Show Cause* OE prepares a 1b.19 Notice, notifying subject of the investigation and a possible show cause order. Subject has 30 days to respond. FERC reviews OE’s report and the subject’s response If a majority of the Commissioners vote in favor of proceeding, FERC issues Order to Show Cause and Notice of Proposed Civil Penalty.

25. Division of Investigation: Trends 24

26. Self-reports Closed with No Action Certificate Violation –A utility company discovered and reported its failure to obtain appropriate certificate exemptions for a small portion of intrastate pipeline facilities crossing state lines during its preparation to sell the facilities. –The company filed a request for a Limited Jurisdiction Blanket Certificate while the sale was pending. –The Purchaser filed for a NGA Section 7(f) exemption to exempt the facility after the sale. –The Staff closed the matter without action because the violation was unintentional. Price Reporting Violation –A public utility failed to timely report certain daily and Bid-week trades to price index publishers but later cured the deficiency. –The company enhanced its process for capturing all trades and their reporting to index publishers. –The Staff closed the matter without action because the violations were inadvertent and caused no harm to market participants. 25

27. Self-reports Closed with No Action Regulatory Filing Violation –A pipeline failed to make a prior notice filing with the Commission before operating a new gas delivery point. –Upon discovering the violation, the pipeline immediately shut down the delivery point and offered to credit a portion of the customer’s gas purchases from the customer’s prior source of gas. FERC approved the company’s application, once filed. –DOI closed the self-report without action because the violation was isolated and inadvertent, unlikely to recur, and the company quickly remedied the violation upon its discovery. Shipper-Must-Have-Title Violation –An oil and gas E&P company self-reported that one of its subsidiaries transported 151,800 MMBtus of natural gas titled to another subsidiary over an 11 day period. –DOI closed the matter with no action because the violation was inadvertent, of limited duration, and the company quickly corrected the violation and provided notice to the DOI. 26

28. Investigations Closed with No Action Market Manipulation (Gas) –DOI Staff opened an investigation of trades at two California hubs to investigate potential market manipulation. –After reviewing ICE data, data from the entity, and interviewing the relevant traders DOI Staff concluded the facts did not indicate intent to benefit the entity’s financial positions or otherwise manipulate the market. Market Manipulation (Gas) –DOI Staff opened a preliminary non-public investigation based on a Hotline caller for manipulation of natural gas trading at Henry Hub. –After analyzing company trades and documents and taking testimony of relevant witnesses, the DOI Staff determined there was insufficient evidence of a manipulative trading scheme. 27

29. PROHIBITION AGAINST MARKET MANIPULATION 28

30. Statutory Basis for Anti-Manipulation Authority The Energy Policy Act of 2005 (a) added to the two main federal statutes that delineate the jurisdiction of the Federal Energy Regulatory Commission (FERC) an express prohibition on manipulation in energy markets, and (b) authorized the FERC to establish specific rules and regulations defining and addressing such manipulation. New Statutory Provisions –Section 4A of the Natural Gas Act –Section 222 of the Federal Power Act Statutory language provides broad authority for the FERC to foster well-functioning electricity and natural gas markets, free of market manipulation and fraud. 29

31. Natural Gas Act: Anti-Manipulation Prohibition on Market Manipulation “It shall be unlawful for any entity, directly or indirectly, to use or employ, in connection with the purchase or sale of natural gas or the purchase or sale of transportation services subject to the jurisdiction of the Commission, any manipulative or deceptive device or contrivance... in contravention of such rules and regulations as the Commission may prescribe as necessary in the public interest or for the protection of natural gas ratepayers. Nothing in this section shall be construed to create a private right of action.” 15 U.S.C. § 717c-1. 30

32. FERC's Anti-Manipulation Rule 31 18 C.F.R. § 1c.1 “(a) It shall be unlawful for any entity, directly or indirectly, in connection with the purchase or sale of natural gas or the purchase or sale of transportation services subject to the jurisdiction of the Commission, (1) To use or employ any device, scheme, or artifice to defraud, (2) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or (3) To engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any entity.” Elements (1) Use of a fraudulent scheme (2) With the requisite scienter (mental state) (3) In connection with a FERC-jurisdictional transaction

33. “Conduct involving fraud and market manipulation poses a significant threat to the markets the Commission oversees. Such intentional misconduct undermines the Commission’s goal of ensuring provision of efficient energy services at a reasonable cost because the losses imposed by fraud and manipulation are ultimately passed on to consumers.” FERC Office of Enforcement on Manipulation “Similarly, anticompetitive conduct and conduct that threatens market transparency undermine confidence in the energy markets and harm consumers and competitors.” 2014 FERC Report on Enforcement 32

34. The Well-Functioning Market A well-functioning market operates in conformance with the law of supply and demand. Attempts to move supply or demand artificially or to artificial levels could be deemed fraudulent – and thus could be market manipulation. In a well-functioning market, supply and demand levels (and their relationship) are the natural result of parties engaging in transactions with legitimate business purposes. 33

35. Prohibition Against Market Manipulation FERC Enforcement charged that DB Energy Trading LLC manipulated CAISO markets by trading in one product, physical exports of electric energy (at a point called Silver Peak), with the intent to benefit a second product, DB’s position in Congestion Revenue Rights (also at Silver Peak). FERC issued “show cause” order to BP America, accusing company traders of manipulating next-day, fixed-price gas market at Houston Ship Channel (HSC) to benefit the company’s HSC-Henry Hub spread position. 34 Civil Penalty: $1.5 million Disgorgement: $172,645 Civil Penalty (pending): $28 million Disgorgement (pending): $800,000

36. FERC Enforcement charged that JPMorgan Ventures Energy Corp. manipulated CAISO and MISO markets by submitting bids that appeared economic to market software but were intended to, and in almost all cases did, lead CAISO and MISO to pay JPMorgan at rates far above market prices. FERC Enforcement charged that traders at Louis Dreyfus Energy Services, a subsidiary of Louis Dreyfus Highbridge Energy, manipulated the MISO market by engaging in uneconomic trading of virtual supply and demand (INCs & DECs) to benefit their positions in Financial Transmission Rights. 35 Civil Penalty: $285 million Disgorgement: $125 million Civil Penalty: $4.1 million Disgorgement: $3.7 million Prohibition Against Market Manipulation

37. In 2009, FERC approved settlements that FERC Enforcement had reached with Tenaska Marketing Ventures and OneOK (and others) in connection with a pipeline capacity open season conducted in 2007 by Cheyenne Plains Natural Gas Company, LLC. Each of Tenaska and OneOK had arranged with its affiliates to combine their bidding efforts, each entity bidding the full quantity offered, the maximum allowable rate, and the full term. The affiliates’ pro-rata allocations then were combined. Enforcement concluded that the bidders’ activity was fraudulent and manipulative. 36 Civil Penalty: $3 million Disgorgement: $1,972,842 Civil Penalty: $4,500,000 Disgorgement: $1,914,495 Prohibition Against Market Manipulation

38. Direct Energy self-reported that two traders made sales intended to decrease Gas Daily index while holding financial positions that would benefit. FERC Enforcement charged manipulation. Settlement stated that penalty calculation was lenient, because of Direct Energy’s “[having] an effective compliance program [and] promptly detecting and investigating the trading at issue and disciplining the traders responsible...” FERC Enforcement received two hotline calls saying that Constellation Energy Commodities Group was engaging in improper trading in NYISO power markets. Enforcement investigated and concluded that Constellation had manipulated by engaging in certain trading in NYISO and ISO-NE markets that was uneconomic on a stand-alone basis, to benefit Constellation’s position in financial instruments known as “Contracts For Differences.” 37 Civil Penalty: $20,000 Disgorgement: $31,935 Civil Penalty: $135 million Disgorgement: $110 million Prohibition Against Market Manipulation

39. Maxim acquired the Pittsfield Plant (MA) in 2008. The plant typically burns natural gas to generate electricity, but can burn fuel oil. The Pittsfield Plant is expensive to run, but often gets called on by ISO New England for reliability when loads are high. ISO-NE often provided “make-whole” payments to Maxim (the difference between plant’s offer price and lower market rates). For a period of time, Maxim offered into the market using high oil prices even though it generated electricity using natural gas, thus recouping Show Cause Order issued February 2, 2015. 38 Civil Penalty: $5 million Individual Civil Penalty: $50,000 Mitigation: $2.99 million Prohibition Against Market Manipulation

40. FERC’s August 2013 show cause order accuses BP America traders of manipulating the next-day, fixed-price gas market at Houston Ship Channel (HSC) following Hurricane Ike in 2008. Before Hurricane Ike, BP had pre-existing HSC-Henry Hub spread position that included short index swaps at HSC and long index swaps at Henry Hub. This financial position benefited when the spread between daily physical gas prices at HSC and Henry Hub grew wider. When Hurricane Ike made landfall on September 13, 2008, HSC gas prices plummeted, due to lower-than-normal flows of gas out of the region and resulting oversupply in HSC area. 39 Case Study: BP America Prohibition Against Market Manipulation

41. Given Ike-related price drop at HSC, the company’s September 2008 spread position suddenly had potential to be worth millions, but only if daily spread between HSC and Henry Hub prices remained wide through month-end. Three BP traders began selling gas at HSC, making use of BP’s capacity on Houston Pipeline (HPL) to do so, to suppress prices at HSC and slow shrinkage of HSC-Henry Hub spread. The traders believed that their scheme would be hard to detect because they were only trying to slow down the shrinkage of an already profitable spread, and they were only expanding their pre-existing positions. 40 Case Study: BP America Prohibition Against Market Manipulation

42. The alledged scheme was discovered when one of the junior traders, Clayton Luskie, attending a corporate training and development program, boasted of the trading strategy in a casual discussion with an a BP executive, Jim Parker, Head of Trading for BP North. Parker questioned the scheme and asked Luskie to call his team leader, Gradyn Comfort, to ensure that nothing improper was going on. Clayton Luskie phoned Gradyn Comfort at his desk, attempting to obtain or understand a defensible rationale for the trading strategy and associated use of HPL transportation. The call took place on a recorded line. (“Gradyn here …”) 41 Case Study: BP America Prohibition Against Market Manipulation

43. Case Study: BP America 42 Clayton Luskie Gradyn Comfort Prohibition Against Market Manipulation

44. 43 Case Study: BP America Prohibition Against Market Manipulation

45. Don’t s : Flawed Economics Don’t intentionally engage in transactions that have no economic substance, or are uneconomic on a stand-alone basis. – Especially risky where the transactions would benefit positions in other products or markets. FERC Commissioner Norman Bay calls this “tool and target” manipulation – i.e., using trades to raise or lower prices in one market (usu. physical and usu. FERC-jurisdictional) to benefit positions in another market (not necessarily either physical or FERC-jurisdictional) – Trading at illiquid points, and with large positions, are especially risky from a market power perspective 44

46. Don’t s : False Signals Don’t do anything to send false or misleading or anomalous signals to the marketplace. – Misreporting prices is illegal per se. – But also note: Intentionally varying levels of consumption, production, sales or purchases (away from levels that would result naturally from a well-functioning market) would likely be deemed market manipulation. 45

47. Don’t s : Rumor-Mongering, Hoarding Don’t spread false rumors that could affect the market price. Don’t attempt to corner a market, or hoard transportation or transmission capacity. “Marking the close” (high volume of trades near end of trading period) could be viewed as a strategy to manipulate the market. 46

48. Don’t s : Misusing Affiliates Don’t use affiliates to circumvent rules. FERC Enforcement has interpreted affiliate coordination as market manipulation in both electricity and natural gas markets: – Natural gas: affiliates’ coordination or aggregation of bids for pipeline capacity in an open season, intended to secure a larger share than a single bidder would receive from the open season pro-rata allocation. – Electricity: affiliates’ coordination of trading activity in physical and financial markets. 47

49. More Don’t s: Collusion with another party for the purpose of affecting market prices or conditions violates the antitrust laws as well as the FERC anti-market manipulation rule – Forbidden: agreements (even informal or oral!) with competitors regarding prices, terms, and/or volumes. – For example, in responding to RFPs for natural gas, don’t communicate with competing potential bidders Of course, energy traders can agree on prices at which they will do business with each other, in connection with bona fide purchase and sale transactions. 48

50. Key Take-Aways First, there is nothing wrong with seeking creative ways to make profits or otherwise to maximize economic benefits; to the contrary, those are positive attributes. But... Traders, schedulers and all market participants must bear in mind how strategies and communications could later be interpreted by someone looking for improprieties. Rules were not “made to be broken.” – Creativity and profitability need not come at the expense of compliance. – Be wary of “workarounds.” 49

51. ENSURING A CULTURE OF COMPLIANCE 50

52. Ensuring a Culture of Compliance 51 All personnel, including management, are responsible for perpetuating a culture of compliance. All personnel, including management, are responsible for achieving compliance. Responsibility for Compliance

53. Effective Compliance and Ethics Program FERC's Policy Statement on Penalty Guidelines provides that, when determining penalties for violations, FERC will consider whether a company has an “effective compliance and ethics program.” An “effective” program includes training on rules and obligations arising under FERC rules, regulations, and policies. Even where a company has discovered a violation, penalties can be mitigated (reduced) if the company has an effective compliance program that includes regular training. 52

54. Effective Compliance and Ethics Program 53 “The Commission cannot spell out what constitutes [an] effective compliance program in all circumstances, but we can identify the compliance-related credit factors we will consider when companies, despite strong compliance efforts, have lapses that result in violations of Commission statutes, regulations, or orders. A proactive approach to correcting such violations and reporting them to the Commission is demonstrably beneficial.” -- FERC Policy Statement on Compliance, 125 FERC ¶ 61,058, at P 12 (2008)

55. Culture of Compliance: Individual Responsibility Carefully review and analyze transactions and business practices in light of all applicable requirements Actively participate in and attend training sessions Raise any and all concerns or questions with other personnel, including management and/or legal professionals. 54 Individuals must:

56. 55

57. Culture of Compliance – Penalty Guidelines 56

58. Culture of Compliance – Penalty Guidelines 57

59. Key Compliance Takeaways Avoid using careless language that could look like it signals manipulation – “control the market”; “move the price”; “bang the close”; “manipulate.” Assume that every activity will be reviewed by FERC enforcement months later. Recorded phone lines, emails, and IMs live on forever – particularly since you never know about someone else's retention policies. Temper desire to act promptly with well-thought-out and deliberate responses to FERC Staff. When in doubt, ask a question! 58

60. 59 Mosby Perrow Jones Day 717 Texas Houston, TX mgperrow@jonesday.com 832.239.3895 Thank You!