US Energy Regulator Uses New Powers Against Amaranth

by Leroy Baker, for LawAndTax-News.com, New York

31 July 2007

The Federal Energy Regulatory Commission has for the first time used its new powers to prosecute for market manipulation against the collapsed hedge fund Amaranth and its former head trader Brian Hunter.

FERC announced on July 26 that it had issued show cause orders that made preliminary findings of market manipulation and proposed civil penalties totaling $458 million in two investigations involving traders’ unlawful actions in natural gas markets, including that of Amaranth.

The Commission said that its actions, which come under both the anti-manipulation authority of the Energy Policy Act of 2005 and its former market manipulation rule, "are a signal that FERC will not tolerate manipulation of energy markets."

“Congress granted FERC the authority to prevent manipulation to protect both consumers and the integrity of these markets on which our economy depends,” Commission Chairman Joseph T. Kelliher said. “Bad actors in the industry must recognize that manipulation, even in increasingly complex energy markets, can be detected. And when it is proven, they will be punished severely.”

The first case, brought under the Commission’s new anti-manipulation rule, involves the Greenwich, Conn.-based hedge fund Amaranth LLC and traders Brian Hunter and Matthew Donohoe. The Commission voted unanimously to give Amaranth and the traders 30 days to show why they should not be assessed civil penalties and disgorge profits totaling $291 million for manipulating the price of Commission-jurisdictional transactions by trading in the NYMEX Natural Gas Futures Contract in February, March and April 2006.

In the second case, the Commission voted unanimously to give Energy Transfer Partners, LP (ETP), a Texas-based owner of pipeline assets and a natural gas trading affiliate, 30 days to show that it did not violate the Commission’s former market behavior rule by manipulating the wholesale natural gas market at Houston Ship Channel on certain dates in 2003, 2004 and 2005. The Commission is proposing more than $167 million in total penalties and disgorgement of unjust profits.

“These cases are serious. It is alarming to read and hear the instant message and voice recording evidence of improper actions, some of which were authorized by senior managers. The Commission is right to propose close to the maximum in penalties for actions that harmed millions of consumers and the natural gas markets they depend on for their energy needs,” Kelliher said.

“For these two companies, failure to refute these findings will confirm that their actions harmed many wholesale market participants, creating losses that ultimately hurt natural gas customers across the country,” Kelliher added.

FERC’s actions are related to similar actions by the Commodity Futures Trading Commission for violations of its statutes. The two federal agencies cooperated in the two investigations through their Memorandum of Understanding, though their individual actions fall under separate statutes.

“I also want to praise the Commodity Futures Trading Commission for being a strong partner in coordinating investigations regarding market manipulation,” Kelliher said. “There is a relationship between physical gas sales and gas futures, and coordination between the two agencies is necessary to effectively police market manipulation.”

The Amaranth case involves manipulation of the final, or “settlement,” price of the NYMEX Natural Gas Futures Contract on February 24, March 29 and April 26, 2006, by selling an extraordinary amount of these contracts during the last 30 minutes of trading before these future contracts expired, with the purpose and effect of driving down the settlement price.

Investigators in the Commission’s Office of Enforcement found that Amaranth had previously taken positions in various financial derivatives that were several times larger, and whose values increased, as a direct result of the fall in the settlement price of the natural gas futures contract. Thus, for every dollar lost on its sales of the futures contracts, Amaranth would gain several dollars on its derivative financial positions.

The Commission’s investigation found that Amaranth and its traders Hunter and Donohoe intentionally manipulated the settlement price of the futures contract. That settlement price is explicitly used to determine the price for a substantial volume of FERC-jurisdictional physical natural gas transactions.

Evidence uncovered by the investigation includes instant messages (IM) written by traders. According to one such IM, the scheme began as “a bit of an expiriment (sic)” devised by Hunter on or before Feb. 23, 2006, the day before the first manipulation occurred. The Feb. 24 “experiment” was then repeated and refined on March 29 and April 26, FERC alleged.

FERC noted that these market manipulation violations took place well before Amaranth’s notorious demise in the fall of 2006, when it experienced massive trading losses and ceased trading operations and that its collapse was not related to these manipulations. This investigation was initiated in Summer 2006 by Commission staff, well before those losses and collapse.

The Commission is recommending penalties of $200 million for Amaranth, $30 million for Hunter and $2 million for Donohoe. The Commission also proposes that Amaranth disgorge more than $59 million in unjust profits, plus interest.

Recommended