FERC Imposes US$30,000,000 Fine For Market Manipulation By Natural Gas Futures Trader

On 21 April 2011 the Federal Energy Regulatory Commission (FERC) issued an order imposing a US$30,000,000 civil penalty on Brian Hunter after finding that the former natural gas futures trader at Amaranth Advisors L.L.C. violated FERC's Anti-Manipulation Rule. This order is significant for several reasons. It is FERC's first fully litigated market manipulation case, which analyzes trading conduct, and represents the seminal decision in FERC's market manipulation case law. It is also significant because of the size of the penalty – the largest to be imposed by FERC since the agency's enforcement authority was greatly enhanced by the Energy Policy Act of 2005. Finally, it is important because it has been a source of discord between the FERC and the Commodity Futures Trading Commission (CFTC), which has argued that FERC exceeded its authority in prosecuting the case.

FERC affirmed an Administrative Law Judge's (ALJ) Initial Decision finding that Hunter's trading surrounding NYMEX natural gas futures contracts in the Spring of 2006 violated FERC's Anti-Manipulation Rule. FERC noted, "Hunter's trading practices during the at-issue expiration days [in Spring 2006] were fraudulent or deceptive, undertaken with the requisite scienter, and carried out in connection with FERC-jurisdictional natural gas transactions." Brian Hunter, 135 FERC ¶ 61,054, P 3 (2011). FERC concluded that his trading was "specifically intended to lower the settlement price" of natural gas futures contracts in order to benefit his financially-settled natural gas swap positions on other trading platforms and that Hunter acted "with reckless disregard as to the impact of his conduct upon the physical market for natural gas." Id. at P 32.

Under FERC's policies, FERC Enforcement Staff must satisfy the following three elements to prove a manipulation violation: the entity (1) must use a fraudulent device, scheme, or artifice, or make a material misrepresentation or a material omission as to which there is a duty to speak under a Commission-filed tariff, Commission order, rule or regulation, or engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any entity, (2) with the requisite scienter (i.e. state of mind), (3) in connection with the purchase or sale of natural gas or transportation of natural gas subject to the jurisdiction of the Commission. Prohibition of Energy Market Manipulation, Order No. 670, 114 FERC ¶ 61,047, P 49 order denying reh'g, 114 FERC ¶ 61,300 (2006).

A. FERC's analysis under its three-prong test for market manipulation

1. Fraudulent or deceptive behavior

FERC found that Hunter's sale of a significant number of natural gas futures contracts during the settlement periods for the March, April, and May 2006 prompt months constituted fraudulent behavior. Noting that the creation of an artificial price is not required for a manipulation, FERC found that Hunter acted with the "intent[] of creating a false price" in the natural gas futures market. 135 FERC ¶ 61,054, P 50.

In reaching its conclusion that Hunter's trading constituted manipulation, FERC pointed out the following aspects of Hunter's trading:

• "Prior to February 2006, Hunter rarely sold significant numbers of [natural gas futures contracts] during the settlement periods. That practice changed considerably during the settlement periods in February, March, and April 2006, when Hunter sold an exceptionally large number of such contracts." Id. at P 47.
• "[Hunter's trades] generally took place at prices below those of other traders, and below the volume-weighted average price. . . . Hunter's large sell orders forced his brokers to hit their bids which almost guaranteed a lower price at the close of trading." Id.
• "Amaranth amassed large swap and option positions on other trading platforms that would benefit from falling [natural gas futures contracts] settlement prices." Id.
• "Hunter . . . was compensated based on trading desk profitability and could achieve incentive bonuses based on whether he exceeded prior year's profits." Id.

Notably, FERC also rejected Hunter's claim that open market trading cannot, without some additional deceptive conduct, constitute market manipulation. Id. at P 48. Instead, FERC held that "[t]he difference between legitimate open-market transactions and illegal open-market transactions may be nothing more than a trader's manipulative purpose to executing such transactions." Id. at P 50.

2. Scienter

FERC affirmed the ALJ's finding that Hunter intended to manipulate prices. FERC found that Hunter knew that the natural gas futures market could be manipulated and that he "had a financial motive for the manipulation" because he held short swap positions on other exchanges that would benefit from a lower NYMEX settlement price. Id. at P 76. FERC rejected all of Hunter's explanations for his activities during these months and affirmed the ALJ's decision that Hunter's claimed explanations were not credible and "amount[ed] to after-the-fact defenses of his actions." Id. at P 77.

3. In connection with the purchase of jurisdictional natural gas

Even though Hunter's trading occurred in the NYMEX futures market, FERC found that Hunter's conduct occurred "in connection with FERC-jurisdictional transactions." Id. at P 118. In support of this conclusion, FERC noted that 4,675 natural gas futures contracts went to physical delivery during the time period, that the settlement price for natural gas futures contracts is incorporated into physical basis contracts as the "largest (or even sole) price component," and that the settlement price is incorporated into pricing indices used in physical transactions. Id. at P 119. Finding that the NYMEX settlement prices have a significant impact on price many physical natural gas transactions, FERC concluded that Hunter acted recklessly with regard to the effect of his trades on FERC-jurisdictional transactions.

B. FERC's analysis concerning the US$30,000,000 penalty

This Order provides some clarity regarding how FERC intends to count individual violations of the Anti-Manipulation Rule. Hunter argued that the evidence only supports a finding of three violations of the Anti-Manipulation Rule—limiting his penalty to US$3,000,000 under FERC's statutory authority of US$1 million per day, per violation. Id. at P 134. FERC rejected this approach and found that each sale of the at-issue futures contracts "constitute[ed] a separate violation of the Anti-Manipulation Rule," which was "more than sufficient to support the penalty imposed by the Commission." Id. at P 135.

Further, FERC concluded that Hunter's conduct caused harm to the physical natural gas market because each seller during the relevant period received less money than the market price for gas. FERC also took into consideration the following: (1) the ALJ's observation that Hunter's testimony "lacked candor and was not credible," Id. at P 146, (2) that he was "fully aware of the close interconnection with the settlement price and physical natural gas transactions," Id. at P 142, and (3) he knew "that his conduct was improper," Id. at P 143. In ordering a US$30,000,000 penalty, FERC declared that it was sending a strong signal to deter similar conduct in the future. Notably, the Commission "considered the impact of such a penalty upon Hunter's continued financial viability" and explained that Hunter did not offer any evidence that US$30,000,000 would threaten his financial viability. Id. at P 149.

This order is the latest development in the fallout from the collapse of the Amaranth hedge fund. Both Amaranth and former Amaranth trader Matthew Donohoe settled with FERC and the CFTC for US$7.5 million in August 2009, but Hunter did not participate in the settlement.

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