Antitrust Alert: Fifth Circuit Adopts "Specific Intent" Standard to Dismiss Natural Gas Market Manipulation Class Action
Affirming the dismissal of a private lawsuit claiming harm from natural gas market manipulation, the Fifth Circuit Court of Appeals has clarified the requirements for private claims under the Commodity Exchange Act. Although the private complaint was modeled on actions brought by both the Federal Energy Regulatory Commission and Commodities Futures Trading Commission, the class plaintiffs were unable to connect the defendants' alleged market manipulation with the plaintiffs' trading losses or to show the required intent. These actions nevertheless are a reminder of the legal risks of commodity trading and the numerous enforcement regimes that may be used to police market manipulation.
Complaints by the FERC and CFTC
The private action followed investigations and complaints by the FERC and CFTC link to against Energy Transfer Partners and related defendants (ETP). ETP was by far the largest seller of natural gas at the Houston Ship Channel trading hub (HSC). According to the FERC and CFTC, on various occasions in 2003-2005, ETP offered large quantities of gas for sale at HSC for less than the competitive price. (These were bid week sales of fixed-price gas for prompt month delivery.) ETP then took advantage of the lower price in two ways. First, ETP reported its low-price sales to Platts' Inside FERC's Gas Market Report, which publishes a gas price index based on HSC transactions. ETP then purchased gas at HSC, under contracts it had with other suppliers that were tied to that index. Buying in greater quantities than it had sold, ETP benefited because its purchase price was lower as the index price dropped.
Second, ETP had entered into basis swap transactions, based on the difference between the HSC index and the NYMEX natural gas futures contract price, which is tied to the price of gas at the Henry Hub in Louisiana. ETP would benefit if the HSC price fell relative to the NYMEX price. As ETP's low-price physical sales had caused the HSC price to fall, ETP made more in basis swaps. ETP's short position in HSC basis swaps was a bet that the HSC index would diverge from the NYMEX Contract, a bet ETP could be confident to win because it could influence the HSC index.
FERC and CFTC actions
Trading in natural gas and natural gas futures is governed by both the Natural Gas Act, which is enforced by the FERC, and the Commodities Exchange Act, enforced by the CFTC. Under the Natural Gas Act, the FERC has adopted a “market behavior rule” that prohibits “transactions that are without legitimate business purpose and…foreseeably could manipulate market prices.” Under the Commodities Exchange Act, it is unlawful to manipulate the price of a commodity or a commodity futures contract.
According to the FERC, ETP's market manipulation at HSC and other Texas hubs brought it almost $70 million in unjust profits.
Following an investigation initiated by a 2005 call to its enforcement hotline, in 2007 the FERC sought disgorgement of $70 million plus $82 million in civil penalties. This was the largest penalty the FERC could seek, and which it did not reduce given its conclusion that ETP had willfully engaged in market manipulation, caused serious harm, and not fully cooperated in the FERC investigation. The CFTC brought an action for civil penalties. In 2008, the FERC settled for a $30 million payment and the CFTC for a $10 million payment.
Private class action
Following the FERC and CFTC actions, in 2007 private plaintiffs brought a class action for damages under the Commodities Exchange Act, filed in the Southern District of Texas. The named plaintiffs had purchased and sold at a loss long positions in NYMEX natural gas futures (which by definition are contracts to buy gas at Henry Hub). They did not buy at HSC. The plaintiffs alleged that ETP's manipulating the HSC price had lessened the value of their NYMEX contracts. In particular, the plaintiffs alleged that ETP's actions to suppress the price of gas at HSC foreseeably would suppress natural gas prices elsewhere, including at Henry Hub, thereby devaluing their NYMEX contracts.
The district court dismissed the complaint. The Commodities Exchange Act allows a private action only for manipulation of the commodity underlying the contract in question. For these plaintiffs, that was a NYMEX contract, which prescribes delivery of gas at Henry Hub, not anywhere else. But the alleged manipulation took place at HSC. The district court also held that the plaintiffs had failed to plead that ETP intended to create an artificial NYMEX price, as opposed to affecting the HSC price.
The Fifth Circuit affirmed, holding that a private action for manipulation under the Commodities Exchange Act requires that the defendant had the ability to influence market prices and specifically have intended to cause an artificial price in the underlying commodity of the contract in question. It was not enough that ETP knew it was inevitable that dumping gas at HSC would depress Henry Hub prices: “inevitability” is not “intentionality.” Furthermore, an allegation that ETP intended to suppress Henry Hub prices would not have been plausible, as ETP sought to benefit by the HSC index dropping relative to the NYMEX contract based on Henry Hub prices.
These challenges to ETP's trading activities raise a number of issues of which energy businesses and their counsel should be aware. Most importantly, counsel should be familiar with the various market manipulation regimes and caution against conduct that may violate the regulations that apply to a client's industry. This was especially risky for ETP, at a time when the FERC was exercising new authority under the Energy Policy Act. The Fifth Circuit decision cements the elements and specific intent standard as settled law there.
Today participants in energy commodity sectors face oversight from multiple federal and state government agencies, not to mention private plaintiffs. ETP's natural gas trading was challenged by both FERC and CFTC. Petroleum products market manipulation may be reviewed by CFTC and the Federal Trade Commission (under new authority). Electricity suppliers may have to answer to both FERC and the Justice Department (as reflected in its recent antitrust action against KeySpan).
For more information, please contact your principal Jones Day representative or either of the lawyers listed below.
Jason F. Leif
J. Bruce McDonald
Washington / Houston
+1.202.879.5570 / +1.832.239.3822
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