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NG Futures Traders: Who’s Your Regulator?

The demise of Amaranth Advisors has been put to a range of illustrative uses. It has been employed, for example, as a test case of quantitative techniques as they apply to due diligence. Politicians have used it mostly to make a case against the usual suspects, those nasty speculators. Practicing lawyers, meanwhile, have also used it as an object lesson to their clients: what not to say in your instant messages to colleagues. A three-judge panel of the U.S. Court of Appeals for the D.C. Circuit has now addressed a question of jurisdiction that arose out of some contested Amaranth trading, and this is something that matters to any asset managers using the energy commodities or their derivatives in the pursuit of alpha: who is your regulator? It appears that to the extent you are trading not in natural gas itself but in NG futures, your regulator (at least according to this case of first impression) is the Commodity Futures Trading Commission, and the CFTC exclusively, not the Federal Energy Regulatory Commission. A spokeswoman at FERC said Monday that the agency has made no decision about an appeal to the full appellate court. At oral arguments in February, Michal Kim argued the case for the petitioner, Amaranth trader Brian Hunter. Robert Solomon argued for FERC, and Mary Connelly, assistant general counsel of the CFTC, argued that agency’s position as intervener. The panel consisted of Judges Stephen F. Williams, Karen L. Henderson, and David S. Tatel. Tatel wrote the decision for the panel issued March 15. There was no dissent. Procedural Stuff In April 2011, FERC fined Hunter $30 million for the manipulation of natural gas futures contracts in the late winter and early spring of 2006. During the settlement periods Hunter’s trading accounted for a very large share of Nymex volume on these contracts. [The matter has become an object lesson because Hunter messaged an NG trader at another firm that a certain trade of his was a “bit of an experiment mainly” and he said he would wait until 2:20 to complete his selling. That suggested he was planning on painting the close.] On July 25, 2007, the CFTC filed a civil enforcement action against Hunter, alleging manipulation in violation of section 13(a)(2) Commodity Exchange Act. The following day, FERC did likewise, filing a lawsuit under section 4A of the Natural Gas Act. Usually, courts defer to administrative agencies when those agencies interpret the statutes it is their specific due to enforce. This is called Chevron deference. But the court in this case said there was no room for such deference, because the two administrative agencies took opposing views on the issue of the relationship of those statutes, and it was logically impossible to defer to them both. It quoted Salleh v. Christopher (D.C. 19976), “we have never deferred where two competing governmental entities assert conflicting jurisdictional claims.” Section 4A of the Natural Gas Act comes from the Energy Policy Act of 2005, which in turn was a response to the California energy crisis at the last turn of the century.  The act authorizes FERC to make rules and regulations governing the use or employment of the purchase, sale, or transportation of NG for the purpose of preventing “any manipulative or deceptive device or contrivance.” Coordination and a Decision The Energy Policy Act made two references to the CFTC. One ordered FERC and the CFTC to conclude a memorandum of understanding with regard to the sharing of information and coordination of the information requests they make to markets.  The other said that the information-sharing provision shall not be construed to limit the exclusive jurisdiction of the CFTC. As the court saw it, there were two questions here. First, did the CEA’s language encompass manipulation of NG futures contracts as part of the exclusive jurisdiction of intervenor CFTC? Second, if so, was that repealed or modified by the 2005 legislation? The court’s answers are “yes” and “no” respectively. The court pointed for example to the language of that memorandum-of-understanding clause, which said that the two agencies were to secure coordination of their requests “within the respective jurisdiction of each agency.” As the court sees it, that language indicates the CFTC and FERC regulate separate markets:  in the matter at hand, derivatives of NG and physical NG respectively. They aren’t co-regulators of one market that includes both sorts of trade. Since the contested trades were in derivatives, the court struck down FERC’s fines.