Energy Legal Blog

FERC Looks to Past for Future Anti-fraud Enforcement

In the Domenici-Barton Energy Policy Act of 2005 (EPAct 2005), Congress looked to the antifraud provisions of the Securities Exchange Act of 1934 ('34 Act) in adding new section 4A of the Natural Gas Act (NGA) and new section 222 to the Federal Power Act (FPA), which makes it unlawful for any entity (including municipal and cooperative utilities) to employ any "manipulative or deceptive device or contrivance (as those terms are used in section 10(b) of the [Exchange] Act . . .) in contravention of such rules and regulations as [FERC] may prescribe" to protect ratepayers in connection with the purchase or sale of natural gas, electric energy or the transportation or transmission of either.  Section 10(b) of the Exchange Act similarly prohibits the use of any manipulative or deceptive device or contrivance in connection with the purchase or sale of securities registered on a national exchange; case law spanning 70 years broadly defines what is manipulative or deceptive.  Not surprisingly, in an October 20 notice of proposed rulemaking, FERC proposes to implement new NGA 4A and FPA 222 through new rules modeled on the Securities and Exchange Commission's (SEC) Rule 10b-5 for implementing the section 10(b) of the '34 Act.  To be considered, public comments on the proposed rule must by submitted to FERC by November 23, 2005.

The proposed new rule tracks nearly word-for-word the text of the SEC Rule 10b-5.  In so doing, it proscribes both acts of commission and omission, and, consistent with the directives of EPAct 2005, it is not limited to natural gas companies or public utilities, but rather extends to government utilities, coops, and other market participants who traditionally have fallen outside of federal regulation.  Specifically, the proposed rule, like Rule 10b-5, makes it unlawful for any "entity, directly or indirectly (1) to use or employ any device, scheme, or artifice to defraud, (2) to make any untrue statement of material fact or to omit to state a material fact" needed to make a statement "not misleading, or (3) to engage in any act, practice, or course of business that operates . . . a fraud or deceit . . . in connection with purchase or sale of" natural gas or electricity or the purchase or sale of transmission or transportation subject to FERC's jurisdiction.

FERC emphasizes in the rulemaking that the virtue of parroting SEC Rule 10b-5 is the wealth of case law on the books interpreting the key words and concepts of what is made unlawful.  Rule 10b-5 does so primarily in the context in which an officer, director, or person with a fiduciary relation to a company buys or sells its securities based on material, non-public information ― i.e., insider trading.  It has also been used in cases where a company issues misleading information or keeps quiet when it has a duty to disclose.  Most other applications are unique to the securities business.  In the rulemaking, FERC further notes that the antifraud provision of the Commodity Exchange Act, section 4b, parallels section 10(b) of the '34 Act and new NGA 4A and FPA 22, and that precedents under the Commodity Exchange Act will also be available to help interpret the proposed new natural gas and electric power rules.

Rule 10b-5 under the '34 Act is no stranger to the energy business, however.  The 24-year sentence of Jamie Otis of Dynegy was based in part on 10b-5 violations in connection with hiding a $300 million loan.  The plea bargain of Enron's Andrew Fastow and the upcoming prosecutions of Enron's Ken Lay and Jeff Skilling will play out in part under 10b-5.

Because of the securities and commodities case law that will be available to help interpret FERC's proposed new rules implementing NGA 4A and FPA 222, the industry stands to confront more stationary goal posts than it has under FERC's current Market Behavior Rule (MBR) 2, which, among other things, prohibits transactions "lacking a legitimate business purpose and that are intended to or foreseeably could manipulate market prices . . . conditions . . . or rules . . . ."  In the rulemaking FERC assures the industry that will not seek duplicative sanctions under the proposed new rules and MBR 2 for the same conduct or transaction.  And FERC asks whether MBR 2 should be revised or repealed if the proposed new rules base on SEC Rule 10b-5 are adopted.  [Prohibition of Energy Market Manipulation, 113 FERC ¶ 61,067 (2005)]