FERC Fines Power Traders Nearly $30 Million

FERC issued an order concluding that, "Dr. Houlian Chen (Dr. Chen), Powhatan Energy Fund, LLC (Powhatan), HEEP Fund, LLC (HEEP), and CU Fund, Inc. (CU Fund) (collectively, Respondents) violated section 222 of the Federal Power Act (FPA) and section 1c.2 of the Commission’s regulations, which prohibit energy market manipulation, through a scheme to engage in fraudulent Up-To Congestion (UTC) transactions in PJM Interconnection L.L.C.’s (PJM) energy markets to garner excessive amounts of certain credit payments to transmission customers."

FERC assessed civil penalties in the following amounts:

• $16,800,000 against Powhatan

• $10,080,000 against CU Fund

• $1,920,000 against HEEP

• $1,000,000 against Dr. Chen

FERC also ordered the disgorge of about $4 million, plus interest

The respondents have indicated that they will appeal FERC's decision in court.

FERC's order states that, "Respondents designed and implemented a fraudulent UTC trading scheme to receive excessive amounts of MLSA [Marginal Loss Surplus Allocation] payments. To do this, Respondents intentionally placed a high-volume of 'round-trip' UTC trades that canceled each other out by placing the first leg of the trade from locations A to B, and simultaneously placing a second leg of equal volume from locations B to A. The contemporaneous evidence shows that Respondents artificially created these round-trip UTC trades solely to reserve transmission service to enable them to collect excessive MLSA payments during the Manipulation Period."

FERC said that, "When used appropriately, UTC trades in PJM permit financial traders to profit by arbitraging market prices between two locations in the day-ahead and real-time market; these transactions can benefit PJM’s market by encouraging convergence between day-ahead and real-time market prices. Respondents’ testimony makes clear that they understood this, yet they intentionally placed fraudulent round-trip UTC trades that did not provide any benefit to the PJM market. Respondents knew that their round-trip UTC trades would net no market position, and that on their own these round-trip trades would not generate a profit or a loss based on price spreads. But, by making these trades, Respondents collected MLSA payments exceeding the transaction costs they incurred for the trades, and yielding a significant profit, as they expected."

The respondents have argued that their trades were permissible under the PJM tariff.

FERC reiterated that, "As the Commission has previously articulated, '[a]n entity need not violate a tariff, rule or regulation to commit fraud.'"

"Moreover, we find that Respondents’ round-trip UTC transactions constitute wash trades, and that all market participants had notice that wash trades violate section 222 of the FPA and the Commission’s Anti-Manipulation Rule. Respondents’ round-trip UTC trades were designed to ensure that both legs of a transaction would cancel each other out, thereby eliminating any associated price spread risk. As the Commission has previously articulated, trades that are pre-arranged to cancel each other out and involve no economic risk are wash trades, which are inherently fraudulent," FERC said.

The respondents have argued that, contrary to FERC's characterization of the trades as wash trades, the trades had had risk and exposure to congestion profit and loss, and that the trades were entered into to potentially profit from congestion revenues, especially should one of the legs of the transaction break (i.e., fail to clear) and hit a "home run."

"Testimony, email communications, and other evidence demonstrate that Respondents chose to engage in UTC trades solely to garner excessive MLSA payments in a manner inconsistent with the market function of UTC transactions," FERC said.