On February 7, 2014, the Federal Energy Regulatory Commission (FERC) approved a Stipulation and Consent Agreement between the Office of Enforcement (OE) and Louis Dreyfus Energy Services, L.P. (LDES) to resolve an investigation of whether LDES violated FERC’s Anti-Manipulation Rule in connection with certain virtual and Financial Transmission Rights (FTR) trading activity in the Midcontinent Independent System Operator, Inc. (MISO) footprint from November 2009 through February 2010. OE began the investigation in April 2010 after a referral from the MISO Independent Market Monitor. The order comes soon after FERC first publicized its preliminary findings in a notice issued on January 6, 2014.
LDES did not admit or deny the alleged violations, but stipulated to certain facts and agreed to: (1) disgorge $3,340,000 (plus interest of $383,743) to MISO, to be allocated at MISO’s discretion, subject to OE approval, for the benefit of MISO market participants; (2) pay a civil penalty of $4,072,257; and (3) implement compliance safeguards related to virtual transactions in MISO, including filing semi-annual compliance reports through at least 2016. In addition, Xu Cheng, an LDES trader and signatory to the settlement, will pay a civil penalty of $310,000, and not engage in virtual trading in FERC-jurisdictional markets for two years. Cheng also did not admit or deny the alleged violations.
According to the settlement, LDES traded virtual supply (INCs), virtual demand (DECs), and FTRs in MISO, including at a North Dakota node known as “Velva.” Virtual trades are financial transactions that do not involve any actual purchase or delivery of power, while FTRs are a hedging tool used to protect against transmission congestion. OE found that, beginning in April 2009, when Cheng—who in his PhD dissertation described the relationship between virtual trades and FTR positions and the susceptibility of that relationship to manipulation—joined LDES, LDES’s FTR positions and virtual trading increased by approximately 100 percent and 400 percent, respectively. OE further found that, from November 2009 to February 2010, during which period LDES sustained losses on heavy virtual trading at Velva, its virtual trading activity benefitted its FTR positions approximately 80 percent of the time, an increase from approximately 50 percent during the first five months of 2009. FERC notes that LDES’s early FTR trades near Velva earned little or no profit until November 2009, when LDES began making DEC trades at Velva. By February 2010, LDES had realized profit of $3,334,000 on FTR trades directly attributable to its uneconomic virtual trading. In March 2010, LDES’s FTR positions at Velva dropped substantially and LDES ceased virtual trading at Velva.
Based on these facts, OE concluded that LDES and Cheng violated FERC’s Anti-Manipulation Rule through uneconomic virtual trading to inflate the value of LDES’s FTR positions. LDES claimed that it used analysis of market fundamentals to guide its virtual trading activity, but FERC found no support for that claim. FERC notes that, in crafting its sanctions, OE considered the facts that LDES had no prior history of compliance violations and cooperated with the investigation, and emphasizes that using virtual trades to create artificial congestion in day-ahead markets for the purposes of enhancing the value of FTR positions—a clear example of the “tool and target” framework OE director and recent FERC nominee Norman Bay described in Senate subcommittee testimony in January—violates FERC’s Anti-Manipulation Rule.