Court Finds Full Trial Needed in FERC Enforcement Action

Ruling on cross-briefs filed by the Federal Energy Regulatory Commission (FERC) and several defendants/respondents, the U.S. District Court for the Eastern District of Virginia has held that, contrary to FERC’s position, the defendants/respondents are entitled to a full civil trial with respect to the underlying enforcement action brought against the defendants by FERC. The court found that absent such a trial, the defendants would be denied due process by virtue of the lack of discovery in the case.

The proceeding arose out of a 2015 decision by the FERC in which it concluded that several financial firms, as well as an individual associated with them, had consorted to defraud wholesale energy markets overseen by the PJM Interconnection. The commission’s investigation into the matter led it to assess a total fine of nearly $30 million.

More specifically, the commission reported that Dr. Houlian Chen, a former market analyst for Merrill Lynch, who also had worked as an independent trader, had spearheaded a series of transactions that violated the Federal Power Act (FPA). In addition to Dr. Chen, the FERC’s inquiry also extended to Powhatan Energy Fund, LLC, and HEEP Fund, LLC, and CU Fund, Inc., the last two of which were owned by Dr. Chen. In conducting its investigation, FERC looked not at the physical movement of electricity within PJM’s footprint, but rather at various financial or virtual transactions that do not involve the exchange of physical energy. The commission said that one such virtual option is referred to as an “Up-To Congestion” (UTC) transaction. As explained by the FERC, a UTC product is a type of spread trade that allows market participants to arbitrage the difference between dayahead and real-time congestion prices at two different locations.

However, the commission said, PJM’s transaction rules require market participants to reserve transmission service in connection with a UTC trade. As a result, the FERC observed, UTC transactions become eligible to receive certain transmission credits, known as Marginal Loss Surplus Allocations (MLSAs). According to the FERC, though, Powhatan, Dr. Chen, and the other members of their trading group had crafted a fraudulent UTC trading scheme that allowed them to receive excessive MLSA payments.

More specifically, the FERC determined that the traders had purposely and willfully placed deceptive round-trip UTC trades that did not provide any benefit to the PJM market. And because of the traders’ expertise and knowledge of the wholesale market, the FERC found that the defendants were well-aware that their round-trip UTC trades not only would produce no market position, but would assure that the MLSA payments they received would exceed actual transaction costs incurred for the trades, so that they would enjoy a tidy profit. Given the advance planning involved in the scheme,  FERC declared the UTC trades fraudulent. It rejected outright the parties’ claims that the subject trades should not be considered fraudulent because a loophole in PJM’s tariffs made them permissible.

After reaching a decision that market abuse had occurred, the FERC ordered Powhatan to pay a penalty of $16.8 million, the CU Fund $10.08 million, the HEEP Fund $1.92 million, and Dr. Chen personally $1.0 million. In addition, the defendants were required to disgorge what FERC termed unjust profits, plus interest. Notably, FERC’s directive was issued without an evidentiary hearing.

When the respondents challenged FERC’s judgment and then failed to pay the fines within 60 days, the commission initiated an enforcement action in federal district court. There FERC and the defendants/respondents disagreed about the extent of the court’s jurisdiction in the matter.

On the one hand, the commission asserted that the court need not preside over a full trial, but instead could exercise its discretion in pursuing a more limited review. The defendants, on the other hand, maintained that a de novo review was required, in accordance with the FPA. The respondents contended that the terms of the FPA applicable to penalty assessments such as that involved in their case was more akin to ordinary civil actions falling under federal district court jurisdiction.

Underscoring the fact that the FERC’s penalty assessment had been imposed without the benefit of an evidentiary hearing, the court found that the defendants had been deprived of a complete administrative record. Thus, the court held, when the respondents refused to pay the fines, a plenary trial became necessary. The court expounded that because there was no evidentiary record from FERC upon which to draw, the court had no firm basis by which to evaluate the reasonableness of FERC’s order.

The court warned that the defendants’ rights to due process could be violated if they were not afforded a chance to develop a formal administrative record. The court pointed out that the procedure followed by FERC in assessing the penalties, while provided for in the FPA, did not include an adequate appeal process should the respondents object to the fines so imposed.

Instead, the court said, the FPA provides for any subsequent action to be filed in a federal district court. Because there is no option thereunder to remand the proceeding back to FERC, and because the court cannot render an opinion without a full factual and legal record, there is no other choice but to initiate a trial de novo, the court concluded. Federal Energy Regulatory Commission v. Powhatan Energy Fund, LLC et al., Civil Action No. 3:15cv452, Dec. 28, 2017 (E.D.Va.).