latest developments in market manipulation
TRANSCRIPT
#EnergyTrading
ACI’s 10th National Forum on Energy Trading Compliance & Regulatory Enforcement
Jerry Jeske
Group Chief Compliance Officer
Mercuria Energy Trading
Latest Developments in Market Manipulation Responding to Regulatory Inquiries, What Does (and Does Not) Currently Constitute Market Manipulation, and Best Practices in Shaping a Robust
Compliance Program to Avoid Government Scrutiny
Alexandra Guest
Chief Compliance Officer for FCM
Barclays Capital
Vincenzo Franco
Assistant General Counsel – Wholesale Trading Compliance
Exelon Business Services Co., LLC
November 20th – 21st, 2014
Demetrios G. Pulas
Senior Counsel
Husch Blackwell LLP
Daniel A. Mullen
Partner
Fried, Frank, Harris, Shriver & Jacobson LLP
David M. Perlman
Partner
Bracewell & Giuliani LLP
Tweeting about this conference?
Robert S. Fleishman (Moderator)
Senior Of Counsel
Morrison & Foerster LLP
Jeff Lam
Chief Compliance Officer
Powerex Corp.
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Outline
•Market manipulation – definitions and matters being pursued
•Best practices
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Defining Market Manipulation
• FERC rules
•CFTC rules (and disruptive trade practices)
•What are regulatory enforcers pursuing?
•Real cases/real sanctions
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Relevant FERC Rules
The Anti-Manipulation Rule: shall be unlawful for any entity, directly or indirectly, in connection with the purchase or sale of natural gas/electric energy or the purchase or sale of natural gas transportation/electric transmission 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 the 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.
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Relevant FERC Rules (cont’d)
The “Market Behavior” Rules – Sections 35.41 and 284.403 – key elements: • Comply with the rules of organized electric markets • Provide accurate/factual information to FERC/RTO/ISO,
or other Transmission Operators; do not submit false/misleading information or omit material information
• Strict liability vs. exercise due diligence defense • Report accurately (if at all) to price reporting indices
(applies to electric and gas sellers) Attempted manipulation?
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CFTC – Dodd-Frank 10b5-Manipulation: Rule 180.1 for Fraud
Like FERC (and FTC): • A person acting intentionally or recklessly
• In connection with (per CFTC, read broadly)
• Any swap (including options), cash commodity contract
or futures contract
• Artificial price not required
• Traditional price manipulation (and attempt) authority still exists
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CFTC Rule 180.1 (cont’d)
Including: • Using or attempting to use any device or scheme to
defraud
• Making or attempting to make any untrue or misleading statement of a material fact
• Engaging or attempting to engage in any act that would operate as a fraud or deceit
• Delivering or attempting to deliver by any means of communication a false, misleading, or inaccurate report that bears on the price of any commodity
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CFTC Rule 180.1 (cont’d)
Fraud under Rule 180.1 includes:
• False reporting to Price Reporting Agencies for benchmarks
• False statements to Government, Exchanges, SROs and SDRs
• Lying to influence prices in particular direction to benefit position
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CFTC –Disruptive Trade Practices Generally
• Pre-Dodd-Frank Sec. 4c(a)(1)-(2) still exist: • Wash sales
• Accommodation trades
• Fictitious sales
• Causing price that is “not . . . true and bona fide”
• CFTC Rule 1.38: Exchange trades must be executed “openly and competitively”
• Dodd-Frank Authorities Do Not Apply to: • Block futures transactions
• Forward transactions between commercial market participants
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CFTC – Dodd Frank - Disruptive Trade Practices Sec. 4c(a)(5)(A)
Violating bids and offers applicable to execution venues, including SEF order book (i.e., no best execution requirement between venues) • If party buys higher than prevailing offer or sells
lower than prevailing bid, party will be per se liable and CFTC will not have to prove intent.
• Does not apply to: • Buying or selling the board • Order-matching algorithms
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CFTC – DF Disruptive Trade Practices Sec. 4c(a)(5)(B)
Disregard for orderly execution of transactions during closing period (banging the close) • Any intentional or reckless activity (bids,
offers and executions) that may “disrupt the orderliness of the market”
• Includes pre-closing activity: Accumulating sizable position leading up to close then large liquidation
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CFTC – DF Disruptive Trade Practices Sec. 4c(a)(5)(C)
Spoofing
• Bidding or offering with the intent (beyond recklessness) to cancel the bid or offer prior to execution on an Exchange, including to:
• Overload quotation system
• Delay another person’s execution of trades
• Create false appearance of market depth
• Create artificial price movements up or down
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CFTC – DF Disruptive Trade Practices Sec. 4c(a)(5)(C) (cont’d)
• A party’s pattern of activity will come under question if he/she has an audit trail history of repetitive order cancellations over time.
• Pre-market activity is also subject to ban on spoofing.
• Does not apply to partial fills, RFQs and authorized pre-trade communications.
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Role of Exchanges in Manipulation Cases • CEA requires exchanges (DCMs) to establish and enforce
compliance with rules, including rules prohibiting abusive trading practices, such as manipulation
• Exchanges have own Surveillance Staff to detect rule violations and Enforcement Staff that prosecute violations
• Violators may include not just members of the exchange, but also market participants who trade on the exchange by or through members
• Exchanges may impose fines as well as trading prohibitions; alternatively, they may refer cases to CFTC Enforcement
• Cases are heard by business conduct committees, who issue decisions that may be appealed to the CFTC
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CME Disruptive Trading Practices Rule and FAQs
• On August 29, 2014, CME issued a new rule (CME Rule 575) prohibiting certain disruptive trading practices, as well as 22 FAQs regarding prohibited and non-prohibited conduct
• CME rule builds on the new disruptive trading practices in Dodd-Frank and became effective September 15, 2014
• The new rule does not prohibit disruptive conduct for the first time because disruptive practices in the rule have previously been considered by CME as violations of “just and equitable principles of trade”
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CME Disruptive Trading Practices Rule and FAQs (cont’d)
• Specifically, CME Rule 575 makes it unlawful to enter or cause to be entered:
• An order with the intent, at the time of order entry, to cancel the order before execution or to modify the order to avoid execution;
• An actionable or non-actionable message or messages with intent to mislead other market participants, or to overload, delay, or disrupt the systems of the Exchange or other market participants; and
• An actionable or non-actionable message with intent to disrupt, or with reckless disregard for the adverse impact on, the orderly conduct of trading or the fair execution of transactions.
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What Regulatory Enforcers Are Pursuing
Areas of Recent FERC Attention:
• Transactions that, standing alone, appear to lack an economic purpose or a legitimate business purpose such as: • Suffering sustained (seemingly irrational) losses • Attempting to buy high and sell low; • Ignoring competitive market feedback for discrete periods of time;
• False or misleading statements to federal and state officials concerning transactions, strategies, or market conditions;
• Trading in price setting mechanisms while holding benefiting positions (such as trading in physical and financial markets and/or products in a manner designed to affect prices or otherwise benefit positions held in another market/product);
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What Regulatory Enforcers Are Pursuing (cont’d)
• Exploiting or “gaming” market flaws
• Trading during acute market conditions arising from summer peak demand times or extreme weather (such as hurricanes and storms);
• Transactions involving unusually high volumes, high market concentrations, or non-market prices;
• “Banging the close” or “banging/framing the market open” of a settling index product
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What Regulatory Enforcers Are Pursuing (cont’d)
• Trading to affect the formation of an index price
• Unusual trading patterns or sudden reversal of positions;
• Trading that violates internal risk limits;
• Engaging in transactions that are wash trades or have a wash trading character.
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Real Cases, Real Sanctions - FERC
• ETP – Selling NG on ICE to depress HSC prices in Platts Index; $40 million (FERC and CFTC).
• Amaranth/Hunter – Selling NG futures on NYMEX to enhance value of opposing swap (FERC and CFTC) • Amaranth settled with FERC in 2009 for $7.5 million
• In 2011, FERC ordered Hunter to pay $30 million civil penalty. Hunter challenged penalty and D.C. Circuit held in 2013 that FERC lacked authority to impose penalty for futures trading because CFTC had exclusive jurisdiction.
• CFTC settled with Hunter for $750,000 on September 15, 2014.
• Constellation – Arranging virtual and DA deals in ISOs to benefit CFDs; $235 million and trading bans (FERC).
#EnergyTrading
Real Cases, Real Sanctions - FERC (cont’d) • Deutsche Bank – Trading in physical exports in CAISO
market with the intent to benefit its CRR position; submitting inaccurate information to FERC by designating physical trades as Wheeling-Through transactions; $1.6 million (FERC).
• BP America – Trading physical natural gas at HSC to increase the value of BP’s financial position; Order to Show Cause issued Aug. 5, 2013; Order setting case for hearing before ALJ and denying motion to dismiss issued on May 15, 2014; Extensive OE testimony filed; ALJ decision expected in August 2015 (FERC).
• Louis Dreyfus Energy Services – Uneconomic virtual trading to benefit FTR position in MISO; $7.8 million (FERC).
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Real Cases, Real Sanctions - FERC (cont’d) • JP Morgan Ventures Energy Corp. – Creating artificial
market conditions in CAISO through manipulative bidding strategies; $410 million (FERC).
• Powhatan Energy Fund, LLC / City Power Marketing, LLC – Alleged offsetting Up To Congestion trades designed to appear as spread trades to capture marginal loss surplus payments in PJM; Powhatan publicly fighting allegations; NAV stage (FERC). • Oceanside Power, LLC and a trader settled similar manipulation
allegations on Feb. 1, 2013; $51,000 civil penalty and $29,563 disgorgement for company; 1-year trading ban for trader.
• Exelon (formerly Constellation Energy Commodities Group) – Failing to provide California’s grid operator with accurate information; $650,000 (FERC).
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Real Cases, Real Sanctions - FERC (cont’d)
• Barclays Bank – Manipulating index price in California electricity markets; $470 million, plus $1-15 million for individual traders (FERC).
• For the first time since EPAct 2005 was enacted, FERC filed a civil action asking for a federal court to affirm its decision
• Key issues: FERC’s jurisdiction over products that do not result in physical delivery of electricity; FERC’s ability to prosecute individuals; “open-market” manipulation; and nature of de novo review of FERC orders
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Real Cases, Real Sanctions - FERC (cont’d)
• Lincoln Paper and Competitive Energy Servs./ Rumford Paper – Defrauding ISO-NE by inflating customer baseline in order to be paid for demand response that it did not provide; $5.4 million (Lincoln); $7.6 Million (CES).
• Pending in federal district court in Massachusetts
• Unclear what effect, if any, D.C. Circuit’s vacating Order No. 745 will have on case
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Real Cases, Real Sanctions - FERC (cont’d)
Pursuit of Individuals:
• Brian Hunter
• Barclays’ traders
• Richard Silkman
• Moussa Khourama
• Chen, Tsingas, Scavo (Up To Congestion)
• Others
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What Regulatory Enforcers Are Pursuing
Areas of Recent CFTC Attention: • Manipulation and false reporting relating to
benchmarks – LIBOR • Manipulation by recklessness – JP Morgan (London
Whale) • Manipulation in one market to benefit other positions
– Amaranth/Hunter, Optiver, Parnon Energy • Disruptive trade practices – Panther Energy, Gelber
and Lorenzen, Moore Capital Mgmt., Moncada • False statements – Stroop, Altamont, Oblensky, Nunn,
Butterfield, Optiver • Liability of senior management – MF Global
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Real Cases, Real Sanctions – CFTC
• LIBOR – Manipulation and false reporting relating to global benchmark interest rates by Barclays, UBS, RBS, ICAP, Rabobank; $1.8 billion and detailed compliance requirements; RP Martin Holdings (Yen LIBOR).
• JP Morgan – Manipulation under Dodd-Frank by recklessly selling “staggering” volume of credit default swaps in a concentrated period to “defend the position”; $100 million and compliance requirements.
• Amaranth/Hunter – Attempted manipulation of natural gas futures prices; $7.5 million (Amaranth); $750,000 and permanent trading ban (Hunter).
#EnergyTrading
Real Cases, Real Sanctions – CFTC
• Optiver – Pre-Dodd-Frank banging the close in opposite direction of large positions in TAS contracts in crude oil, heating oil and gasoline; false statements to NYMEX; $14 million, compliance requirements and trading bans.
• Parnon Energy – Manipulation of WTI at Cushing to profit on parallel derivatives trades; $13 million, trading limitations, and compliance measures.
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Real Cases, Real Sanctions – CFTC
• Panther Energy Trading – Spoofing under Dodd-Frank by using computer algorithm to place and quickly cancel large bids and offers in futures on Globex to give impression of significant trading interest; $2.8 million and trading ban. • Chicago USAO charged principal trader, Michael Coscia,
with 12 combined counts of criminal commodities fraud and spoofing.
• Each fraud count carries a maximum sentence of 25 years in prison and a $250,000 fine, and each spoofing count carries a maximum penalty of 10 years in prison and a $1 million fine.
• Indictment marks first federal prosecution nationwide under the anti-spoofing provision added to the CEA by Dodd-Frank.
#EnergyTrading
Real Cases, Real Sanctions – CFTC
• Gelber and Lorenzen – Pre-Dodd-Frank spoofing by proprietary trading firm that caused non-bona fide prices by reporting orders during pre-open session with no intention of execution; firm and trader engaged in wash sales; $1 million.
• Moncada – Pre-Dodd-Frank spoofing in wheat futures, fictitious sales, and non-competitive transactions; $1.56 million and trading restrictions.
• Moore Capital Mgmt. – Pre-Dodd-Frank banging the close
in NYMEX platinum and palladium futures to exert upward pressure on settlement price; $25 million, compliance requirements, registration and trading restrictions.
#EnergyTrading
Real Cases, Real Sanctions – CFTC
• False statements to CFTC and SROs • Stroop: $250,000 penalty against principal for alleged false
and misleading financial statement supplied to the CFTC during investigation (March 2014).
• Altamont: $3.6 million penalty for pool fraud, misappropriation, and false statements to the National Futures Association (D. Fla. February 2014).
• Oblensky: $250,000 penalty against bank president for alleged false statements to CFTC (January 2014).
• Nunn: Order imposing trading ban and $600,000 fine for alleged false statements and material omission in statements to ICE (S.D.N.Y. December 2013).
• Butterfield: $50,000 penalty against administrative employee of floor broker for alleged false and misleading statements in investigatory testimony (September 2013).
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Some Recent Charges - CFTC
• MF Global • CFTC v. MF Global Inc., No. 13 Civ. 4463 (S.D.N.Y. filed
June 27, 2013) – Controlling person liability charged against former CEO Jon S. Corzine.
• CEA section 13(b): Controlling person liable for underlying violation if: i) did not act in good faith; or ii) knowingly induced the violative acts; if registrant, also liable for failure to diligently supervise.
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Best Practices
• Building on lessons learned from recent enforcement actions and agency priorities, what are some market manipulation-related best practices?
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Working with Senior Management and Related Issues
• How do you best work with Senior Management to understand the implications of a market manipulation enforcement action?
• How do you effectively maintain productivity and morale during an enforcement investigation and minimize disruption to the business enterprise?
• How do you effectively manage the reputational consequences?
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Working with Senior Management and Related Issues (cont’d)
• If the company firmly believes its current business practices are acceptable but understands there is risk that the regulator investigating the firm disagrees, how should the company approach the continued use of that business practice?
• How can trader compensation structures best incent compliant behavior?
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Self-Reporting and Whistleblowers
• Generally, under what circumstances is self-reporting appropriate?
• When may self-reporting not be appropriate with respect to market manipulation?
• How do the CFTC’s whistleblower provisions change things?
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Surveillance and Documentation
• Can proper surveillance and documentation mitigate civil penalties in the event of wrongdoing?
• How do you develop data filters regarding “related
positions” to avoid false flags that are just identifying clearly benign behavior?
• What are some best practices for monitoring and reviewing trader communications?
• To what extent does the most effective trading surveillance system impede business, and what is the proper balance between effectiveness and cost/disruption?
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Surveillance and Documentation (cont’d)
• How can you properly document trading activity, and what is the wisdom of a sampling or audit approach?
• What other steps can an organization take to monitor and detect transactional activity that may raise red flags with regulators and enforcers?
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Working with Staff, Market Monitors, and Market Operators Prior to FERC Investigations/CFTC Special Calls • How can you best respond to initial inquiries or
requests?
• How can you best navigate the market monitor referral process (FERC)?
• How can you best respond to special calls?
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Compliance and Penalties
• How can you get traders/supervisors to also “own” compliance?
• How can an effective compliance program help avoid civil and criminal penalties?
• What is the real value of routine training, self-checks, and internal audits if trouble arises?
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Compliance Programs
• What is a “culture of compliance” and what is the value proposition of efforts to enhance your organization’s compliance culture?
• How do you convince management to devote appropriate resources to a compliance program?
• How does an organization balance avoiding regulatory scrutiny with legitimate profit-seeking activities?
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Questions?
Jerry Jeske
Group Chief Compliance Officer
Mercuria Energy Trading
Alexandra Guest
Chief Compliance Officer for FCM
Barclays Capital
Vincenzo Franco
Assistant General Counsel – Wholesale Trading Compliance
Exelon Business Services Co., LLC
Demetrios G. Pulas
Senior Counsel
Husch Blackwell LLP
Daniel A. Mullen
Partner
Fried, Frank, Harris, Shriver & Jacobson LLP
David M. Perlman
Partner
Bracewell & Giuliani LLP
Robert S. Fleishman (Moderator)
Senior Of Counsel
Morrison & Foerster LLP
Jeff Lam
Chief Compliance Officer
Powerex Corp.