Trading Spaces?
Will the CFTC move Into FERC's house?
January 2004
By Robert C. McDiarmid
Most of us in the energy industry have long thought that the "transmission of electric energy in interstate commerce" falls within the exclusive jurisdiction of the Federal Energy Regulatory Commission (FERC). The same goes for electric sales at wholesale, if also conducted in interstate commerce. We know that because the law1 and the courts tell us so. And natural gas is much the same.2
We learned all of this at least a half-century ago, as the courts began to develop what we now know as the "filed rate doctrine"-that FERC has exclusive power to set wholesale rates, and that such power extends also to allocations of power that affect wholesale rates.
The U.S. Supreme Court confirmed in 1988-in Missssippi Power & Light Co. v. Mississippi ex rel. Moore (487 U.S. 354)-that courts cannot invade the commission's province to determine, in its opinion, that a given rate is the only or the more reasonable one. This principle binds both state and federal courts and is mandated, in the former respect, by the Supremacy Clause. Indeed, the whole framework is built upon the inherent assumption that FERC is the only entity that can resolve questions as to rates, terms, and conditions. And where it cannot, there will be no change in rates at all!
The court ruled as much in 1951 in Montana-Dakota Utils. Co. v. Northwestern Public Service Co., 341 U.S. 246, in which a legitimate claim of a violation of the Sherman Act played itself out in an overcharge in jurisdictional rates, and the court held that there was no remedy. This line of cases is certainly not defunct; the court has followed it as recently as last term. See, Entergy Louisiana, Inc. v. Louisiana Pub. Serv. Comm'n, 123 S. Ct. 2050.
Nevertheless, there is a slight problem. No one has defined for sure what electricity "is." If it qualifies as a "commodity"-and in particular a commodity regularly bought and sold on an organized commercial exchange or board of trade that deals in futures trading-then everything we have said up to this point may just go up in smoke.
In that case, much of what FERC heretofore has claimed as its own could well pass on to a usurper who would enter the neighbor's house and commence to redecorate, just as in the popular television show Trading Spaces, which airs on The Learning Channel. That redecorator is the federal agency we know today as the Commodity Futures Trading Commission (CFTC).
This prospect has lingered on the horizon for some time now. But it will gain in credence in the days to come, especially if we see Congress attempt this year to resuscitate a new version of H.R. 6, the proposed "Energy Policy Act of 2003" that died at the end of last year. In short, that bill contained sections that passed largely under the radar of most energy aficionados, but that could significantly exacerbate this situation. If these provisions should pass, the FERC that we know (and may or may not love) may soon find the basic authority it uses to set rates in the hands of another federal agency.
The CFTC and the act under which it operates, the Commodity Exchange Act (CEA),3 deal with commodities and may well be part of our future, whether we like it or not. This probably should have been apparent to all of us much earlier, when some of the organized Boards of Trade (NYMEX, et al.) began to trade contracts for the future delivery of power, but no one can avoid noticing that in the proposed Energy Policy Act of 2003, Section 1281 would amend Part II of the Federal Power Act by adding, inter alia, a new Section 220, "Market Transparency Rules," which would have included subsection c:4
(c) This section shall not affect the exclusive jurisdiction of the Commodity Futures Trading Commission with respect to accounts, agreements, contracts, or transactions in commodities under the Commodity Exchange Act. … Any request for information to a designated contract market, registered derivatives transaction execution facility, board of trade, exchange, or market involving accounts, agreements, contracts, or transactions in commodities (including natural gas, electricity and other energy commodities) within the exclusive jurisdiction of the Commodity Futures Trading Commission shall be directed to the Commodity Futures Trading Commission..
Moreoever, Section 332 (c) of H.R. 6 would have added similar language in a new Section 26 of the Natural Gas Act. So what is going on here?
As it turns out, Congress is not trying to pull a fast one but is reacting to developments that have been in progress for some time, and doing so in a manner that is arguably sympathetic to CFTC jurisdiction rather than to that of FERC. We have been watching for some months a train wreck in progress. While some attempts have been made to try to avert the upcoming clash of commissions, those efforts have thus far been unsuccessful.
With hindsight, the conceptual commoditization of electricity, however correct as a matter of economic theory, appears to have arguably handed jurisdictional control of a number of transactions over to the CFTC. Certainly, some at the CFTC think so, and it is pretty clear that this issue is headed to the Supreme Court the first time it swings a decisional result. As explained below, CFTC rules are different from those of FERC, with different statutes of limitations, so it will eventually be in the interest of someone ordered by FERC to pay money to assert CFTC exclusive jurisdiction. As a result, this issue may arise faster than some think will occur.
In fact, however, we should not be too much surprised.
The idea that we can distinguish electric generation product from the transmission needed to deliver it and can treat this new item ("energy") as a commodity-with any kilowatt-hour essentially indistinguishable from another at the same location-underlies much of the rationale upon which the antitrust laws have been applied to the electric industry. This assumption also drives many of the ideas we have seen in PURPA (the Public Utility Regulatory Policies Act of 1978), EPACT (Energy Policy Act of 1992), FERC Order 888 (equal access), and FERC Order 2000 (regional transmission organizations, or RTOs).
Yet the consequences of this idea are today much more significant for the public interest than a simple territorial dispute among agencies.
The CFTC: The Agency That Might Be King
The CFTC, which began life as the Grain Futures Administration within the Department of Agriculture in 1922, morphed into the Commodity Exchange Authority when Congress passed the first Commodity Exchange Act in 1936. At that time its authority was expanded to cover trading not only in grain, but also in cotton and several other specified agricultural commodities, but the authority remained within the Department of Agriculture. In 1968 its coverage was expanded to include livestock, livestock products and frozen concentrated orange juice.
In 1974, however, the CEA was substantially overhauled, and the CFTC was created as an independent agency. The Senate Committee on Agriculture and Forestry noted that:
"[A] person trading in one of the currently unregulated futures markets should receive the same protection afforded to those trading in the regulated markets. Whether a commodity is grown or mined, or whether it is produced in the United States or outside, makes little difference to those in this country who buy, sell, and process the commodity, or to the U.S. consumers whose prices are affected by the futures market in that commodity." S. Rep. No. 93-1131, 1974 U.S.C.C.A.N. at 5859.
The 1974 Amendments granted the CFTC exclusive jurisdiction over a fair number of possible transactions involving commodities.5 CEA section 2(a)(1)(A) now provides [emphasis supplied]:
"(A) In General.-The Commission shall have exclusive jurisdiction … with respect to accounts, agreements, … and transactions involving contracts of sale of a commodity for future delivery, traded or executed on a contract market designated … or any other board of trade, exchange, or market.… Except as hereinabove provided, nothing contained in this section shall (I) supersede or limit the jurisdiction at any time conferred on the Securities and Exchange Commission or other regulatory authorities under the laws of the United States or of any State, or (II) restrict the Securities and Exchange Commission and such other authorities from carrying out their duties and responsibilities in accordance with such laws. Nothing in this section shall supersede or limit the jurisdiction conferred on courts of the United States or any State."
In short, the first sentence appears to provide the CFTC exclusive jurisdiction over agreements and transactions involving contracts of sale of a commodity for future delivery, traded, or executed on a contract market or any other board of trade, exchange or market. The second sentence (much of the CEA is not well written) saves the jurisdiction of other agencies "except as hereinabove provided" in the first sentence. Since the first sentence gives the CFTC exclusive jurisdiction, it is not clear what is preserved in the second sentence. Some attention has been given to the fact that the SEC regulates securities under the Securities Exchange Act of 1934.6 There is a more real savings clause for the SEC and the securities products it regulates elsewhere in the CEA, but none for other agencies, aside from financial products regulated by the various federal banking authorities. So unless electricity or natural gas are excepted elsewhere, there is a real question as to where FERC jurisdiction may stand.
The CEA defines "commodity" at section 1(a)(4):7 [emphasis supplied]:
(4) Commodity
"The term 'commodity' means [a long series of agricultural products] and all other goods and articles, except onions... and all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in."
This is quite a broad spectrum. So if contracts for future delivery of electricity are being traded, and if electricity is not onions,8 electricity is considered by the CFTC to be a commodity for CEA purposes. The jurisdictional key is the fact that "contracts for future delivery are presently or in the future dealt in." Note, however, that there is a qualification as to "future delivery" in CEA section 1(a)(19):9
(19) Future delivery
"The term ''future delivery' does not include any sale of any cash commodity for deferred shipment or delivery."
The test for exclusion here seems to be a transaction where an immediate sale occurs but where, for the convenience of the parties or otherwise, the actual transfer of the commodity is deferred. These were known as "forward contracts" in the agricultural context, where, for example, grain merchants would commit to buy a portion of the farmers' plantings at a fixed price, but recognized that delivery would have to await the harvest. One might argue that bilateral traditional full or partial requirements service contracts for future delivery of electricity would fall within this section 1(a)(19) exclusion.
RTO: Just Another Futures Exchange?
As FERC has developed the concept, the institution known as an RTO-a regional transmission organization-is now seen in a key respect as an institution that develops a 24-hour-day-ahead, hour-ahead, and real-time balancing markets for buying and selling electricity. As to the day-ahead and hour-ahead markets, at least, the product sold may well constitute "futures." Importantly, this essential element of the current design of RTOs plays right into the jurisdiction of the CFTC, which might very well claim jurisdiction over RTO markets under the law as it is currently written, and even more strongly under the proposed terms of the proposed new Energy Policy Act.
For example, CEA section 1(a)(2)10 defines a "Board of Trade" as "any organized exchange or other trading facility."
Further, CEA section 1a(27)11 defines an "organized exchange" as a trading facility that:
- (A) permits trading-
- (i) by or on behalf of a person that is not an eligible contract participant; or
- (ii) by persons other than on a principal-to-principal basis; or
- (B) has adopted (directly or through another nongovernmental entity) rules that
- (i) govern the conduct of participants, other than rules that govern the submission of orders or execution of transactions on the trading facility; and
- (ii) include disciplinary sanctions other than the exclusion of participants from trading.
And finally, CEA section 1a(33)(A) defines "trading facility" as:
"[A] person or group of persons that constitutes, maintains, or provides a physical or electronic facility or system in which multiple participants have the ability to execute or trade agreements, contracts, or transactions by accepting bids and offers made by other participants that are open to multiple participants in the facility or system."
There is much more to the CEA, but these are the relevant jurisdictional elements.12 One can see the argument of some at the CFTC that RTO/ISO markets fall within its jurisdiction.13
Clearly the New York Mercantile Exchange (NYMEX) and the Chicago Board of Trade are "boards of trade," and FERC has not yet sought to exert jurisdiction (except as to discovery matters, a dispute that seems to have led to the language in H.R. 6) over them. But what about an RTO or ISO operating a day-ahead or hour-ahead market? Although the CEA has undergone numerous revisions since its initial implementation, the Act has always maintained a structure that requires all futures trading to be conducted on CFTC regulated exchanges.14 As now envisioned (at least by FERC) and operating, RTO and ISO markets are regulated by FERC.
While it is not entirely clear whether an RTO or ISO operating a day ahead or forward market would be an organized exchange, discussions with CFTC officers suggest that at least some at the CFTC believe they fall within that definition. A key point is that not all transactions clear physically, so it does not appear clear that these transactions are forward contracts excluded under CEA section 1a(19).
Thus, at best, there is no bright line test that would take such a market out of CFTC jurisdiction. So one very big question is who makes the rules for such a market, which most of us have thought of as arguably operating as a self-regulating organization (SRO) under the jurisdiction of FERC. If those trading in electric and natural gas futures are within the exclusive jurisdiction of the CFTC, for example, how does FERC get the authority to require behavioral rules for those who trade in such markets? And what behavioral rules would CFTC apply?
A Different Philosophy: If the CFTC Held Sway
In this context, it may be useful to look at what the CFTC does and at its statutory mission.
There are a number of parallels between the regulation of the CFTC in the commodities markets and that of the Securities and Exchange Commission (SEC) in the securities markets under the SEA. The most basic point is that both view their mission as regulation of markets, not as regulation of prices. Thus the tools they have at their disposal are quite different than those tools expressly provided to FERC under the Power Act. The different tools result in quite disparate regulatory approaches originally taken by the three agencies.
Nevertheless, FERC is clearly attempting to move itself into a CFTC/SEC market regulator mode, where it regulates markets through RTO/ISO market monitors that report to it as well as to their own boards. With some simplification, the legal argument is that if FERC can control the operation of the market so as to assure a competitive result, it may then classify the resulting price as "just and reasonable." This approach also entails having market rules which become tariff requirements, so that all of those that work through the markets are contractually bound to the rules.15 Following this line of reasoning, FERC has imposed, as a condition of being able to sell power at market prices, an obligation for all generators to agree to a set of tariff restrictions which FERC can then enforce directly as well as through RTOs. This "bootstrap" approach may be the best FERC can do in the absence of direct legislative authorization, and may even work on a prospective basis once all elements are in place.16
In the markets for other commodities and services, regulated both by the SEC and the CFTC, the regulatory agency can make findings that the market has been manipulated, and can seek individual and firm penalties against the perpetrators that have the effect of barring those involved from ever participating in the markets again as well as penalizing the actions. There are cases approving actions by those agencies to provide reparations as well. That approach-the regulatory equivalent of the death penalty-has been upheld by the courts.
Legal Remedies: When Markets (Traders?) Go Bad
In most markets and in most cases, the question of reimbursement of those who lost money due to the manipulation of the market is generally left to the courts to resolve. This means that the injured parties can bring suit for all of their damages against the malefactors who manipulated the market, but that those who were innocent sellers into a high market are not at risk. The black-letter rule in most markets, absent statutory limitation, is that (here quoting the Securities Exchange Act):17
"Section 10(b) of the Securities Exchange Act of 1934 § 15 U.S.C.A. 78j(b)) imposes private civil liability on those who commit a manipulative or deceptive act in connection with the purchase or sale of securities, but it does not impose liability on those who do not engage in a manipulative or deceptive practice but who aid and abet such a violation of § 10(b)-and specifically does not apply to a bank which, as indenture trustee for some bond issues by a public building authority, is alleged to be secondarily liable for aiding and abetting a claimed fraud as to those bonds, but is not alleged to have committed a manipulative or deceptive act within the meaning of § 10(b). Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, . . . (1994)."
Accord, Strobl v. New York Mercantile Exchange, 768 F.2d 22 (2d Cir. 1985) (also permitting suit under the antitrust laws); Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353 (1982). Following Merrill Lynch, however, Congress added CEA section 22, 7 U.S.C. 25, which regularizes private actions for violation of the CEA, and expands the implied right of action found by the Court to suits against those who willfully abet the violation, but imposes a nexus obligation and a relatively short two year statute of limitations.
That widespread approach to the regulation of markets, rather than prices, fits far better with normal American concepts of fairness than the approach taken by FERC in the ongoing California proceedings. Consider a simple but useful example.
If widow Jones, seeing the silver market rise when it was cornered by the Hunt Brothers and others, decided to melt down the family silver to put her children through college, and sold it at a price later determined to have been excessive, she has no obligation to refund to the people who bought her silver. But the Hunts did. (See., e.g., Minpeco v. Conticommodity Services, 552 F.Supp 332 (S.D. NY 1982).
The same rule, as noted above, applies in the financial markets, Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994); Vandenberg v. Adler, et al., 2000 U.S.Dist. LEXIS 4050 (S.D. NY 2000).
The SEC and the CFTC are supposed in general to nip market manipulation in the bud and then let the courts take care of where the damages fall out, with only the civil and criminal penalties being assessed by the agencies, not normally restitution, although the SEC may also bring civil suits asking for restitution. SEC v. Zandford, 535 U.S. 7813, 122 (2002). The CFTC has some reparations authority pursuant to CEA section 14.18 Note that the Racketeer Influenced and Corrupt Organizations Act (RICO)19 has also been used from time to time against commodities fraud.
The SEC has extensive authority under section 10(b) of the Securities and Exchange Act of 1934, and Rule 10(b)(5) promulgated under the authority of that section, to define manipulation.20 The CFTC authority under section 6(d) of the CEA is more complicated but analogous.21
FERC does not have that sort of statutory authority, although it may well be that it should. A model like that in use in the financial and commodity markets means that the person who is responsible for the problem is also responsible for paying for more of the damages, not just limited to the amount of extra money he/she accrued. This means that there is a real disincentive to manipulation, not just the risk of losing one's ill-gotten gains, since the damages to market participants will normally be substantially more than the gain to the malefactor.
There are wide ranging civil and criminal penalties under the CEA and SEA that apply for manipulation of prices in commodities and securities, whether that manipulation occurs directly on the organized exchanges or not. Most of the CFTC actions so far which deal with energy matters22 charge entities with the reporting of false price or quantity information to the press. The amounts recovered are not trivial although they are certainly not at the multibillion dollar level of the losses occasioned by the West Coast market excursions in 2000-2001. Note, moreover, that the CFTC settlements and complaints do not purport to preclude direct suits by those injured by the practices that were the subject of the settlements.
Some Thoughts to Ponder
The CFTC and FERC seem to be at loggerheads on the fact that each claims exclusive jurisdiction over certain overlapping kinds of transactions. That raises several serious questions, including, but certainly not limited to:
- How can FERC and the CFTC each have exclusive jurisdiction over the sale of electricity at wholesale in interstate commerce under two wildly disparate acts? If FERC does not have the jurisdiction to establish the form and rules by which these markets work, how can it possibly make the claim that its regulation of the markets assures that the prices resulting are just and reasonable?
- Authority arguably exists under the CEA for the CFTC to regulate commercial cash or spot market transactions as well as futures trading, if the transactions in question affect futures trading. But this is the precise sort of transaction over which FERC claims exclusive jurisdiction.
- Who sets the rules for these markets operated by RTOs/ISOs? It does not appear that any of the current RTO/ISO markets keep records or operate by rules that are consistent with CFTC rules for markets it regulates. Is PJM, for example, in violation of the CEA requirements?
- What happens when there has been a violation of the "rules" of a market? What is the remedy? Where?
- Both FERC and the CFTC seem to be going after those who are deemed to have manipulatemd the markets in the West Coast and California. At what point do these efforts, to the extent duplicative, invoke double jeopardy or due process protections?
- How will the CFTC approach affect participants in electricity and natural gas sales? How far will the CFTC go?
There are no answers here; it seems pretty clear that there will be significant litigation required before these issues can be resolved unless and until Congress focuses on these problems much more seriously than it has thus far been willing to do.
Endnotes
- Federal Power Act ("FPA") section 201(a), 16 U.S.C. 824.
- We focus on electricity here, but the same issue applies to trading in natural gas.
- 7 U.S.C. 1, et seq.
- Here and elsewhere, emphasis within quotations is supplied.
- The CEA has been amended on a pretty regular basis. The last big amendment was in 1992.
- 15 U.S.C. 78(a), et seq. Sometimes referred to herein as the "SEA."
- 7 U.S.C. 1(a)(4).
- We are not aware of anyone who has argued that the CEA is entirely consistent internally.
- 7 U.S.C. 1(a)(19).
- 7 U.S.C. 1(a)(2).
- 7 U.S.C. 1(a)(27).
- A careful reader will note (we think) some of the reasons why Enron originally structured Enron OnLine as it did, to attempt to avoid CFTC jurisdiction, but note the CFTC action against Enron alleging the operation of an unregistered exchange.
- CFTC Commissioner Brown-Hruska delivered a speech before the Energy Bar Association on Dec. 4, 2003, in which she asserted that the "cash markets" for energy remained within FERC jurisdiction. Responding to a question thereafter, she stated that she (as a non-lawyer) had no intention of asserting jurisdiction over the RTO day-ahead and hour-ahead markets.
- In re Global Link Miami Corp., 1999 CFTC Lexis 130 (1999).
- See, e.g., Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, 105 F.E.R.C. 61,218 (Nov. 17, 2003).
- Retroactively, that approach cannot work with the Power Act in its current form. FERC has elected to address the California energy market malfunctions in a manner that basically is disconnected from and significantly different from the way in which all other markets in this country are regulated. Thus FERC is currently going through an exercise of figuring out what parties should have bid (given the assumption that all sellers should bid their opportunity costs, usually their short-run marginal costs), given what they should have paid for natural gas, and concluding that the level at which such reconstructed bids should have cleared was the just and reasonable rate, and that all sales in excess of that reconstructed price were at unjust and unreasonable rates.
- bE. H. Schopler, Annotation, Civil Action By Private Person Under § 10(B) Of Securities Exchange Act Of 1934 (15 U.S.C. § 78J(B)), 37 A.L.R.2d 649 (2002).
- U.S.C. 18.
- U.S.C. 1961-1968.
- U.S.C. 78(j) provides that it shall be unlawful for any person to employ, in the purchase or sale of any security, any manipulative device as defined by the SEC or in contravention of such rules and regulations as the SEC may prescribe.
- U.S.C. 13b (to be used together with the "death sentence" provisions of section 6, 7 U.S.C. 9, 15) provides that if any person is manipulating or attempting to manipulate the market price of any commodity in interstate commerce or for future delivery on or subject to the rules of an exchange (or has done so in the past), or has otherwise violated the CEA or any of the rules, regulations, or orders of the CFTC under the CEA, the CFTC may issue a cease and desist order, the violation of the terms of which will be penalized.
- These are reported at the CFTC Web site, http://www.cftc.gov/cftchome.htm.
Bob McDiarmid is a partner in the Washington, D.C., law firm of Spiegel & McDiarmid. Contact him at 202-879-4040. The opinions expressed are those solely of the author, and not of his firm, clients, or friends. The author reserves the right to change his mind.
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