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A Comparison of Anti-Manipulation Rules in U.S. and EU Electricity and Natural Gas Markets a Proposal for a Common Standard | Commodity Futures Trading Commission | Federal Energy Regulatory Commission
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A COMPARISON OF ANTI-MANIPULATION RULES
IN U.S. AND EU ELECTRICITY AND NATURAL GAS
MARKETS: A PROPOSAL FOR A COMMON
Shaun Ledgerwood* & Dan Harris**
Synopsis: In this paper, we describe the development and current status of antimanipulation rules as they apply to wholesale electricity and natural gas markets
in the United States and the European Union, including the institutions that are
responsible for overseeing these rules. We then compare and contrast these
jurisdictions to discuss similarities, differences, and potential gaps in coverage
within and across their internal markets. We note that while the behavior
prohibited by the U.S. and EU statutes is remarkably similar, there is in fact no
common standard for defining market manipulation. The absence of a common
EU/U.S. framework for examining manipulative behavior introduces uncertainty
into compliance efforts by failing to provide safe harbors and by potentially
wasting scarce resources through efforts to continually detect and deter behavior
that is in fact legitimate. We propose an economic framework to describe
manipulation in a manner that could generally harmonize such compliance and
enforcement efforts, providing a uniform approach to the detection, analysis and
punishment of manipulative behavior within and across both the U.S. and EU
Background of Relevant U.S. and EU Anti-Manipulation
Enforcement Systems .................................................................................. 3
* J.D., The University of Texas (at Austin); Ph.D., The University of Oklahoma. Dr. Ledgerwood is a
Senior Consultant with The Brattle Group in Washington, D.C. and is an Adjunct Professor with the Public
Policy Institute of Georgetown University. He formerly served as an economist and attorney with the Office of
Enforcement of the Federal Energy Regulatory Commission.
** MSc. Economics (Merit), London School of Economics; M.Eng Chemical Engineering (First Class
Honours), Imperial College, London. Mr. Harris is a Principal with The Brattle Group in Rome, Italy.
The opinions expressed herein are those of the authors and are not necessarily shared by others at The
Brattle Group. The authors wish to thank John Ratliff of WilmerHale for his valuable comments regarding this
manuscript and Matthew L. Hunter for his many insights relevant to this topic.
Electronic copy available at: http://ssrn.com/abstract=2045773
[Vol. 33:1
A. The Evolution of U.S. Anti-Manipulation Rules for Electricity
and Natural Gas Markets ..................................................................... 4
1. The FERCs Market Behavior Rule 2, EPAct 2005, and
Rule 1c ........................................................................................... 5
2. CFTC Anti-Manipulation Authority over Energy Markets
Pre- and Post-Dodd-Frank.............................................................. 7
B. Discussion of European Regulation and the REMIT Process ............ 10
1. The Features and Foibles of MAD ............................................... 11
2. Toward a Dedicated Market Manipulation Statute for
Wholesale Energy Markets .......................................................... 13
3. The Regulation on Energy Market Integrity and
Transparency ................................................................................ 15
III. The Challenges to and Need for a Unified Enforcement Framework ....... 18
A. Institutional Commonalities and Clashes for Deterring
Manipulative Behavior....................................................................... 19
B. Current Legal Precedent Fails to Provide a Single Rulebook
Concerning Manipulation .................................................................. 21
C. A Proposed Framework to Unify the Analysis of Market
Manipulation ...................................................................................... 24
1. The Analytical Framework of a Market Manipulation ................ 25
2. Market Characteristics That Accentuate the Likelihood of
Successful Manipulation .............................................................. 26
3. Types of Behavior That Can Trigger a Manipulation .................. 27
a. Uneconomic Trading .............................................................. 27
b. Outright Fraud ........................................................................ 30
c. The Exercise of Market Power ............................................... 30
4. Positions That Could Be Targeted by a Manipulation ................. 31
5. The Importance of the Nexus ....................................................... 32
IV. The Framework Offers a Single Rulebook for the Detection,
Analysis, and Proof (or Disproof) of Manipulative Behavior ................... 33
A. Using the Framework to Assist Market Monitoring and
Surveillance ....................................................................................... 33
B. Interaction of Market Monitoring with Compliance Programs.......... 35
C. Consistency in Enforcement .............................................................. 36
D. Consistency of the Framework Across Different Market
Manipulation Standards ..................................................................... 36
V. Conclusion: An Improvement in the Clarity Provided to the
Definition of Manipulative Behavior ........................................................ 38
The last decade has witnessed an unprecedented volume of legislation in the
United States and the European Union prohibiting the manipulation of wholesale
natural gas and electricity markets. In the United States, the Federal Energy
Regulatory Commission (FERC) and Commodity Futures Trading Commission
(CFTC) were given new fraud-based anti-manipulation statutes and enhanced
power to monitor for, detect, and deter manipulative behavior, evidenced most
recently by the FERCs $245 million settlement with Constellation Energy
2012] PROPOSED FRAMEWORK FOR U.S. & EU ANTI-MANIPULATION RULES
Commodities Group, Inc.1 The European Union has also made bold steps by
revising its key piece of market abuse legislation and for the first time extending
market abuse legislation to wholesale energy markets, which were previously
covered only by general antitrust law. The new anti-manipulation, information
disclosure, and inside information laws that will apply to energy markets
represent the largest change to how EU energy markets will function since the
beginning of the European Unions liberalization project in 1998 and will be
overseen by two new EU level institutions.
Despite significant differences in the institutional processes used to derive
their respective anti-manipulation laws and in the maturity and complexity of the
physical and financial markets that are to be regulated, the behavior prohibited
by the U.S. and EU statutes is strikingly similar. Fraud-based behavior is
prohibited by all of these anti-manipulations statutes, with actions that create (or
attempt to create) an artificial price prohibited in the European Union and by
the CFTC in the United States. Although this statutory congruity suggests that a
uniform approach to analyzing manipulative behavior is in place, the limited
case precedent tried on such issues lacks a cohesive logic. The absence of a
cogent framework for examining manipulative behavior introduces uncertainty
into compliance efforts by failing to provide safe harbors from enforcement
scrutiny and could waste scarce regulatory resources through inefficient efforts
to continually detect and deter behavior that is poorly understood and
In this article, we seek to address these issues by proposing an economic
framework that could provide uniformity to the analysis of manipulative
behavior across cases, agencies, statutes, and continents. The framework could
also reduce the reliance upon subjective judgment in identifying actions that do
(and do not) cause manipulation. In Section II, we summarize the evolution of
the anti-manipulation laws that are now relevant to wholesale electricity and
natural gas markets in the United States and European Union. In Section III, we
compare and contrast these enforcement regimes to show the need for the
unifying framework we propose herein. Section IV discusses how this
framework could harmonize the detection and analysis of manipulative behavior
and bring uniformity to enforcement and compliance efforts. Section V
concludes our discussion.
II. BACKGROUND OF RELEVANT U.S. AND EU ANTI-MANIPULATION
In this section, we describe the legislative and regulatory development of
anti-manipulation laws relevant to the U.S. and EU wholesale electricity and
natural gas markets. Although physical and financial markets in the United
States are generally further developed than their European equivalents, the
European Unions steps toward the assemblage of regulatory components
necessary to comprehensively monitor for, detect, analyze, and bring
enforcement actions against manipulative behavior have closed substantially
with those in the United States given the relatively quick adoption of REMIT in
the European Union and delays in the implementation of Dodd-Frank in the
1. Order Approving Stipulation and Consent Agreement, Constellation Energy Commodities Group,
Inc., 138 F.E.R.C. 61,168 (2012) [hereinafter Constellation Settlement].
United States. We begin by discussing the status of U.S. anti-manipulation law,
a topic we address relatively briefly given the audiences familiarity with the
subject.2 We then discuss the evolution of anti-manipulation law in European
energy markets, beginning with the growing awareness of the ineffectiveness of
antitrust law as applied thereto and moving to the passage of a tailor-made
market abuse regime for energy wholesale markets REMIT. This sets up the
ability to compare and contrast the development of these two systems and to
discuss their potential future harmonization, a topic we address in Section III.
A. The Evolution of U.S. Anti-Manipulation Rules for Electricity and Natural
Prior to this millennium, the responsibility for preventing market
manipulation resided in the Securities Exchange Commission (SEC), with the
authority conferred by Rule 10b-5,3 and the CFTC, with the authority granted
under the Commodity Exchange Act (CEA).4 Whereas the SEC succeeded in
prosecuting cases under a variety of fraud-based theories,5 the CFTC failed to
successfully prosecute a manipulation case under the artificial price standard
of the CEA until many years later.6 This patchwork of laws governing antimanipulation enforcement left a significant gap in coverage for energy markets,
for Rule 10b-5 applied only to securities, not commodities or financial
derivatives, while the CFTCs artificial price standard had many holes
concerning physical trading, trading in self-regulated markets, and cross-market
trading.7 The authority of the FERC to prohibit such behavior was limited under
the then existing provisions of the Federal Power Act8 and Natural Gas Act.9
2. Specifically, Volume 31 of the Energy Law Journal included several articles that discussed different
aspects of this topic from the perspective of U.S. law. See generally Craig Pirrong, Energy Market
Manipulation: Definition, Diagnosis, and Deterrence, 31 ENERGY L.J. 1 (2010); William Scherman, John
Shepherd & Jason Fleischer, The New FERC Enforcement: Due Process Issues in the Post-EPAct 2005
Enforcement Cases, 31 ENERGY L.J. 55 (2010); and William F. Demarest, Jr., Traditional NGA
Jurisdictional Limits Constrain FERCs Market Manipulation Authority, 31 ENERGY L.J. 471 (2010).
3. The SECs anti-manipulation rule is codified at 17 C.F.R. 240.10b-5 (2011) (promulgated under
the authority granted in 15 U.S.C. 78j(b) (Supp. 2010)).
4. The CFTC Anti-Manipulation Rule is codified at 7 U.S.C. 13b (Supp. 2010).
5. See generally, In re Richard D. Chema, Exchange Act Release No. ID-71, 60 SEC Docket 121-62
(Aug. 24, 1995) (involving wash trades and marking the close); SEC v. Zayed, No. 1:98-CV-327 (E.D.
Tenn., Sept. 24, 1998) (alleged pump-and-dump scheme).
6. As lamented by CFTC Commissioner Bart Chilton in remarks made on March 23, 2010 to the
Metals Market Investors group in Washington, D.C., in 35 years, there has been only one successful
prosecution for manipulation under the CEA prior to Dodd-Frank. Bart Chilton, Commr, CFTC, Remarks of
Commissioner Bart Chilton to Metals Market Investors (Mar. 23, 2010), available at
http://www.cftc.gov/PressRoom/SpeechesTestimony/opachilton-30. The one successful prosecution referred
to is DiPlacido v. CFTC, 364 F. Appx 657 (2d Cir. 2009), cert. denied, 130 S. Ct. 1883 (2010). See also
SHAUN LEDGERWOOD, GARY TAYLOR, ROMKAEW BROEHM & DAN ARTHUR, THE BRATTLE GRP., LOSING
MONEY TO INCREASE PROFITS: A PROPOSED FRAMEWORK FOR DEFINING MARKET MANIPULATION 2, n.5
(Mar. 2011), available at http://www.brattle.com/_documents/UploadLibrary /Upload919.pdf.
7. 17 C.F.R 240.10b-5; 7 U.S.C. 13b.
8. The FERC maintains oversight of the wholesale market for electricity pursuant to the Federal Power
Act. 16 U.S.C. 791-828c (2006). In 1996, the FERC issued Order 888, opening the wholesale electric
market to competition. Order 888, Promoting Wholesale Competition Through Open Access NonDiscriminatory Transmission Services by Public Utilities, F.E.R.C. STATS. & REGS. 31,036, 61 Fed. Reg.
21,540 (1996) (codified at 18 C.F.R. pts 35, 385).
Antitrust law likewise was an awkward fit for addressing such behavior because
the exercise of market power is not necessary for executing a market
manipulation, as we will discuss in Section III.10
The explosion of financial derivatives markets in the early 2000s
permanently altered the landscape for trading many commodities, including
energy.11 Rapid growth in the availability and evolution of financial swaps
substantially increased the liquidity of trading wholesale gas and (to a lesser
extent) electricity,12 giving physical players added ability to hedge their positions
but also giving would-be manipulators greater ability to assemble price-taking
positions that could benefit from directional price movements.13 As we discuss
in this section, the wake of the Enron crisis at the end of 2001 made it clear that
the FERCs then-existing ability to detect and prevent market manipulation was
insufficient, leading the Commission to adopt new rulemakings and ultimately to
request more comprehensive anti-manipulation authority from Congress.
Additional anti-manipulation authority was also sought by and granted to the
CFTC following the wake of the 2008 financial crisis, as we will discuss later in
1. The FERCs Market Behavior Rule 2, EPAct 2005, and Rule 1c
On June 26, 2003, the FERC offered for public comment six Market
Behavior Rules that were designed to address various behaviors deemed
inappropriate for electricity providers with market-based rate authority.14 The
FERC issued modified versions of these rules on November 17, 2003, which
included Market Rule 2 concerning manipulation of wholesale electricity
9. The FERC maintains regulatory authority over the wholesale natural gas market pursuant to the
Natural Gas Act. 15 U.S.C. 717-717z (2006). In 1992, the FERC issued Order No. 636, opening the
wholesale natural gas market to competition. Order No. 636, Regulation of Natural Gas Pipelines After
Wellhead Decontrol, F.E.R.C. STATS. & REGS. 30,939, 57 Fed. Reg. 13,267 (1992) (codified at 18 C.F.R. pt.
10. See generally Shaun Ledgerwood & Paul Carpenter, A Framework for Analyzing Market
Manipulation (latest revised draft Feb. 3, 2012) (unpublished manuscript in the revision process for publication
in the REVIEW OF LAW & ECONOMICS), available at http://ssrn.com/abstract=1811764; Pirrong, supra note 2,
11. This growth was fueled in part by the Commodity Futures Modernization Act of 2000. Pub .L. No.
106-554 app. E, 114 Stat. 2763A-365 (2000). Most notably, this act specifically removed exempt commercial
markets (ECMs) and bilaterally traded swaps from the oversight and reporting requirements afforded to
products trading on other types of exchanges, such as Derivative Clearing Organizations (DCOs). The closing
of this Enron loophole is part of what Dodd-Frank is designed to accomplish.
12. Several trading platforms registered as ECMs during this period, including the Intercontinental
Exchange (ICE) on December 21, 2001. Trading Organizations, CFTC, http://www.cftc.gov/IndustryOversigh
t/TradingOrganizations/index.htm (last visited Mar. 5, 2012) [hereinafter Trading Organizations].
13. The potential for such positions to be manipulated was considered and viewed with skepticism by
early authors in the early 1990s. See, e.g., Daniel R. Fischel & David J. Ross, Should the Law Prohibit
Manipulation in Financial Markets?, 105 HARV. L. REV. 503 (1991); Paveen Kumar & Duane J. Seppi,
Futures Manipulation with Cash Settlement, 47 J. FIN. 1485 (1992). But see Craig Pirrong, Manipulation of
Cash-Settled Futures Contracts, 74 J. BUS. 221 (2001) (considers the possibility of manipulating futures, albeit
through the lens of a market corner).
14. Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, 103
F.E.R.C. 61,349 at PP 3, 6 (2003).
markets.15 This rule explicitly prohibited a wide variety of behavior, including
actions that were intended to or foreseeably could manipulate market prices,
market conditions, or market rules,16 wash trades,17 transactions predicated on
submitting false information,18 transactions creating then relieving artificial
congestion,19 and collusion to manipulate.20 This language reflects a morass of
provisions borrowed conceptually from the SECs Rule 10b-5 (fraud, wash
trades), the CEA (the concept of artificiality), and antitrust (collusion and
allusions to market power). The rule also included several key holes, most
notably a broad general exemption for behavior that served a legitimate business
purpose, a lack of prohibitions against manipulations performed on the buyers
side of the market, and no similar provisions for overseeing natural gas
markets.21
Recognizing the limitations in its authority, the Commission sought greater
comprehensive ability to detect and deter market manipulation in the wholesale
natural gas and electricity markets. This was granted through the Energy Policy
Act of 2005 (EPAct),22 which gave the FERC a statutory anti-manipulation
mandate tied to the same fraud-based statute (and associated lineage of relatively
successful case precedent) that underlies the SECs Rule 10b-5.23 The new
market manipulation Rule 1c was adopted by the Commission on January 19,
2006 in Order 670,24 giving the FERC the ability to prohibit the use of any
device, scheme, or artifice to defraud, the making of any untrue statement of a
material fact or to omit to state a material fact necessary in order to make the
statements made . . . not misleading, or to engage in any act, practice, or
course of business that operates or would operate as a fraud or deceit upon any
[entity].25 Recognizing in Order 670 that Rule 1c would preempt Market
Behavior Rule 2, the FERC rescinded Market Rule 2 on February 16, 2006.26
The EPAct gave significant anti-manipulation authority to the Commission
through its Office of Enforcement, which consists of the Divisions of Analytics
and Surveillance, Energy Market Oversight, Audits, and Investigations.27 The
Commission has access to injunctive relief28 and the ability to order the
15. Investigations of Terms and Conditions of Public Utility Market-Based Rate Authorizations, 105
F.E.R.C. 61,218 (2003).
16. Id. at P 35.
17. Id. at P 46.
18. Id. at P 59.
19. Id. at P 70.
20. Id. at P 81.
21. Id. at P 24.
22. Energy Policy Act of 2005 (EPAct 05), Pub. L. No. 109-58, 315, 1283, 119 Stat. 594, 691, 97980; see also, EPAct 05, sec. 1283, 16 U.S.C. 824v (2006) and EPAct 05, sec. 314, 15 U.S.C. 717c-1 (2006).
23. The authority is based on 15 U.S.C. 78j (2006).
24. Order No. 670, Prohibition of Energy Market Manipulation, F.E.R.C. STATS. & REGS. 31,202, 71
Fed. Reg. 4,244 (2006) (codified at 18 C.F.R. pt. 1c).
25. Id. at P 1.
26. Investigation of Terms and Conditions of Public Utility Market Rates-Based Rate Authorizations,
114 F.E.R.C. 61,165, rehg denied, 115 F.E.R.C. 61,053 (2006). The remaining Market Behavior Rules
now reside in 18 C.F.R. 35.37 (2011).
27. Office of Enforcement, FERC, http://www.ferc.gov/about/offices/oe/org-oe.asp (last visited Mar. 5,
28. Natural Gas Act 20, 15 U.S.C. 717s(d) (2006).
disgorgement of profits.29 Because private causes of action are not permitted
under Rule 1c,30 the compensation of private parties injured by a manipulation is
paid for from disgorged profits, raising the possibility that private injuries caused
by a manipulation may be undercompensated.31 The Commission also has the
ability to assess civil penalties of up to $1 million per incident, per day.32 In an
effort to establish a sense of proportionality similar to the Federal Sentencing
Guidelines,33 the Commission issued Penalty Guidelines in 2010 designed to link
the civil penalty calculation to the harm caused by the manipulation.34
The FERC has been active in exercising its authority since Rule 1c came
into effect, levying approximately $300 million in civil penalties, $151 million in
disgorgement, and $5 million in compulsory compliance plans.35 However, in a
prominent case involving the manipulation of natural gas futures on the New
York Mercantile Exchange (NYMEX), the FERCs jurisdiction was openly
challenged by the CFTC, a sign of the frictions that exist between the these two
agencies as future anti-manipulation enforcement actions are coordinated post
Dodd-Frank.36 In the next section, we discuss the CFTCs past, present, and
future role in detecting and deterring manipulation in wholesale electricity and
2. CFTC Anti-Manipulation Authority over Energy Markets Pre- and
In the years between passage of the Commodity Futures Modernization Act
of 2000 and EPAct 2005, the CFTC pursued enforcement cases against traders
accused of the manipulation of electricity and natural gas derivatives markets or
indices, generally settling the matters pre-trial.37 The CFTCs jurisdiction over
these cases derived from its continuing ability to regulate Derivatives Clearing
Organizations (DCOs, such as the NYMEX), Designated Contract Markets
29. Enforcement of Statutes, Order, Rules, and Regulations, 132 F.E.R.C. 61,216 at P 216 (2010).
30. 18 C.F.R. 1c.1(b), 1c.2(b) (2011).
31. The manipulators profits will offset the losses of counterparties that are the target of the
manipulation but will not cover the losses incurred by others induced by fraudulent behavior to trigger the
manipulation. For further discussion, see generally Ledgerwood & Carpenter, supra note 10, at 55.
32. 16 U.S.C. 825o-1(b) (2006).
33. U.S. SENTENCING COMMN, 2011 FEDERAL SENTENCING GUIDELINES MANUAL (Nov. 1, 2011),
available at http://www.ussc.gov/guidelines/2011_guidelines/index.cfm.
34. Enforcement of Statutes, Order, Rules, and Regulations, 130 F.E.R.C. 61,220 at P 8, subsequently
suspended, 131 F.E.R.C. 61,040, revised and reissued, 132 F.E.R.C. 61,216 (2010) [hereinafter Penalty
35. Civil Penalty Actions, FERC, http://www.ferc.gov/enforcement/civil-penalties/civil-penaltyaction.asp (last visited Mar. 5, 2012, adjusted for the penalties discussed supra note 1).
36. Amicus Brief of Futures Industry Assn et al., Amaranth Advisors, L.L.C. v. FERC, No. 07-1491
(D.C. Cir. 2008), 2008 WL 4960210.
37. See, e.g., In re Avista Energy, Inc., CFTC Docket No. 01-21 (Aug. 21, 2001) (electricity futures
manipulation); In re Dynegy Mktg. & Trade, CFTC Docket No. 03-03 (Dec. 18, 2002) (false reporting re
natural gas); In re WD Energy Servs., Inc., CFTC Docket No. 03-20 (July 28, 2003) (false reporting re natural
gas); In re Williams Energy Mktg. & Trading, CFTC Docket No. 03-21 (July 29, 2003) (false reporting re
natural gas); In re Enserco Energy, Inc., CFTC Docket No. 03-22 (July 31, 2003) (false reporting re natural
gas); In re Taylor, CFTC Docket No. 01-23 (Sept 30, 2003) (electricity futures manipulation); In re Knauth,
CFTC Docket No. 04-15 (May 10, 2004) (electricity wash trades); In re Mirant Americas Energy Mktg. LP,
CFTC Docket No. 05-05 (Dec. 3, 2004) (false reporting re natural gas).
(DCMs, such as LCH Clearnet),38 and to a lesser extent markets overseen by the
National Futures Association.39 However, derivatives trading over-the-counter
(OTC) and on exempt exchanges continued to grow rapidly,40 allowing market
participants to amass large directional derivatives positions outside of the bounds
of the CFTCs reporting requirements.
The result of the inevitable convergence of unlikely circumstances and
unabated speculation was demonstrated most dramatically by the implosion of
Amaranth Advisors, LLC (Amaranth) in September of 2006.41 The FERC and
the CFTC both filed enforcement actions for manipulation based on the firms
behavior prior to its destruction, the CFTC claiming jurisdiction based on the
manipulation of futures contracts and the FERC claiming jurisdiction because
the trades used to execute the manipulation were used in connection with the
establishment of the price of physical gas ultimately delivered under those
contracts.42 Jurisdictional frictions between the agencies grew during the course
of the case as both Commissions separately proceeded with enforcement actions,
with the CFTC filing an amicus brief in support of Amaranth Trader Brian
Hunters suit to enjoin the FERC proceeding and asserting its claim to exclusive
jurisdiction as to the matter.43 Mr. Hunter was later found guilty of market
manipulation by a FERC administrative law judge on January 22, 2010,44 with
the Commission approving that decision on April 21, 2011.45
38. Trading Organizations, supra note 12.
39. Following the Commodity Futures Modernization Act of 2000, the CFTC also retained limited
authority over financial intermediaries including Futures Commission Merchants (FCMs), Introducing Brokers
(IBs), Commodity Pool Operators (CPOs), and Commodity Trading Advisors (CTAs). Compliance, NATL
FUTURES ASSN, http://www.nfa.futures.org/NFA-compliance/index.HTML (last visited Mar. 5, 2012).
40. Exempt markets included ECMs and Exempt Boards of Trade (EBOTs, which include markets for
the traders of weather swaps, interest rate index swaps, and REITs). See generally, Exempt Markets, CFTC,
http://www.cftc.gov/IndustryOversight/TradingOrganizations/EBOTs/ebot (last visited Mar. 5, 2012).
41. Amaranth was an energy hedge fund which established increasingly large speculative positions
based on the settlement price of the NYMEX NG contract. Trader Brian Hunter was alleged by the FERC and
the CFTC to have manipulated the NYMEX price on three occasions in early 2006. While these acts proved
profitable, Mr. Hunter leveraged the profits into a directional play tied to the occurrence of hurricanes in the
Gulf of Mexico. When no hurricanes occurred, the fund rapidly lost value, triggering margin calls and
eventually liquidation. See generally Amaranth Advisors L.L.C., 120 F.E.R.C. 61,085 (2007). See also
Ledgerwood & Carpenter, supra note 10, at 12-14.
42. 120 F.E.R.C. 61,085 at P 3; CFTC v. Amaranth Advisors, L.L.C., 554 F. Supp. 2d 523 (S.D.N.Y.
43. Amicus Brief of Futures Industry Assn, supra note 36. The CFTC settled its case against all
defendants on August 12, 2009, while the FERC settled its case with respect to all defendants except Mr.
Hunter on August 31, 2009. Consent Order of Permanent Injunction, Civil Monetary Penalty and Other Relief
as to Defendants Amaranth Advisors, L.L.C. and Amaranth Advisors (Calgary) ULC, CFTC v. Amaranth
Advisors, L.L.C., No. 07-6682 (S.D.N.Y. Aug. 12, 2009); Energy Transfer Partners L.P., 128 F.E.R.C.
61,269 at P 9 (2009).
44. Initial Decision, Brian Hunter, 130 F.E.R.C. 63,004 (2010).
45. Order Affirming Initial Decision and Ordering Payment of Civil Penalty, Brian Hunter, 135
F.E.R.C. 61,054 (2011). Note that the FERC did not rule on its ALJs decision until after Mr. Hunters
lawsuit disputing the Commissions jurisdiction was deemed to be unripe. Brian Hunter v. FERC, 403 F.
Appx 525, 527 (D.C. Cir. Dec. 22, 2010). Mr. Hunter refiled his petition in the D.C. Circuit on June 20, 2011,
raising the issue that the CFTC might again intervene. Brian Hunter v. FERC, No. 11-1236 (D.C. Cir. filed
Jun. 20, 2011). The court granted the FERCs motion to dismiss on Oct. 14, 2011. Brian Hunter v. FERC, No.
11-1236, 2011 U.S. App. LEXIS 20974 (D.C. Cir. Oct. 14, 2011).
Just before the financial crisis of 2008, the CFTC was given limited
regulatory authority over specific financial derivatives traded on ECMs and
determined to be Significant Price Discovery Contracts (SPDCs).46 Immediately
following the crisis, political pressure to increase regulatory controls over the
trading of swaps increased substantially. The CFTC responded by declaring
several energy derivatives as SPDCs, including natural gas and electricity
contracts.47 Rumors persisted that the CFTC was considering declaring certain
FERC jurisdictional instruments to be SPDCs, most notably Financial
Transmission Rights (FTRs),48 a concern ultimately proven valid following the
passage of Dodd-Frank in 2010.49 Tensions between the agencies continued in
the wake of Dodd-Frank, which greatly expanded the CFTCs regulatory
authority by eliminating many exemptions to Commission oversight, including
the expansion of entities regulated (swap dealers, major swap participants),50
expanded reporting requirements,51 the requirement that swaps subject to
mandatory clearing must be cleared through a DCO after trading on Swap
46. This power was granted by the Food, Conservation, and Energy Act of 2008, Pub. L. No. 110-234,
122 Stat. 923.
47. See, e.g., Final Rule, Order Finding That the Socal Border Financial Basis Contract Traded on the
IntercontinentalExchange, Inc., Performs a Significant Price Discovery Function, 75 Fed. Reg. 24,648 (2010);
Final Orders, Orders Finding That the Mid-C Financial Peak Contract and Mid-C Financial Off-Peak Contract,
Offered for Trading on the IntercontinentalExchange, Inc., Perform a Significant Price Discovery Function, 75
Fed. Reg. 38,469 (2010).
48. See generally Letter from R. Trabue Bland, Dir. of Regulatory Affairs, IntercontinentalExchange,
Inc., to David Stawick, Secy, CFTC (Nov. 6, 2009), available at http://www.cftc.gov/ucm/groups/public/@lr
federalregister/documents/frcomment/09-032c006.pdf (discussing comments by PJM filed on November 6,
2009 with the CFTC and why FTRs do not constitute SPDCs).
49. After the passage of Dodd-Frank, the CFTC questioned in a Notice of Proposed Rulemaking
whether FTRs and other FERC jurisdictional instruments may inherently belong under CFTC jurisdiction, but
noted that the treatment of these products should be considered under the standards and procedures specified
in section 722 of the Dodd-Frank Act for a public interest waiver, rather than through this joint rulemaking to
define the terms swap and security based swap. Proposed Rules & Interpretations, Further Definition of
Swap, Security-Based Swap, and Security-Based Swap Agreement; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, 76 Fed. Reg. 29,818, 29,839 (2011) (to be codified 17 C.F.R. pt. 240). A footnote
suggests that this statement is not meant to connote jurisdiction, but it is noteworthy that no comments were
solicited on this point. Id. at n.155 (This approach, however, should not be taken to suggest any findings by
the Commissions as to whether or not FTRs or any other FERC-regulated products are swaps (or futures
contracts).). A filing by the RTOs made February 7, 2012, requested a general public interest exemption from
CFTC jurisdiction for all non-real-time RTO transactions, including day-ahead energy, virtual bids and offers,
FTRs, ancillary services, and capacity transactions. ISO/RTO Consolidated Request for CFTC Exemption
from Regulation at 5-9, CFTC (Feb. 7, 2012), http://www.cftc.gov/stellent/groups/public/@requestsandactions/
documents/ifdocs/iso-rto4capplication.pdf. However, this filing explicitly does not seek an exemption from the
CFTCs anti-manipulation authority, leaving the agencies to hash out the issue of enforcement jurisdiction. Id.
50. Proposed Rule & Interpretations, Further Definition of Swap Dealer, Security-Based Swap
Dealer, Major Swap Participant, Major Security-Based Swap Participant and Eligible Contract
Participant, 75 Fed. Reg. 80,174 (2010) (to be codified at 17 C.F.R. pt. 240).
51. See generally Proposed Rule, Swap Data Recordkeeping and Reporting Requirements: PreEnactment and Transition Swaps, 76 Fed. Reg. 22,833 (2011) (to be codified at 17 C.F.R. pt. 46); Interim Final
Rule, Reporting Certain Post-Enactment Swap Transactions, 75 Fed. Reg. 78,892 (2010) (to be codified at 17
C.F.R. pt. 44); Notice of Proposed Rulemaking, Reporting, Recordkeeping, and Daily Trading Records
Requirements for Swap Dealers and Major Swap Participants, 75 Fed. Reg. 76,666 (2010) (to be codified at 17
C.F.R. pt. 23); Proposed Rule, Swap Data Recordkeeping and Reporting Requirements, 75 Fed. Reg. 76,574
(2010) (to be codified at 17 C.F.R. pt. 45).
Execution Facilities (SEFs) or DCMs,52 the expansion of mandatory position
limits53 with end-user exemptions,54 and the phase out of ECMs and EBOTs.55
This regulatory friction remains evident, as the Memorandum of Understanding
(MOU) between the agencies required by Dodd-Frank as of January 11, 2011
has yet to be agreed to at the time of this writing.56
Dodd-Frank also addressed the CFTCs difficulty in meeting the burden of
proof required by the artificial price standard of the CEAs anti-manipulation
provision. Although the CFTC succeeded in obtaining its first successful
outcome from litigation in 2009,57 the Commission nevertheless sought statutory
language similar to that of the SECs Rule 10b-5 because of the relative success
that agency experienced in prosecuting manipulation cases. This was provided
by Dodd-Frank through the provision of dual statutory provisions, the first based
on the language of 10b-5 and the second based on the existing CEA standard tied
to the establishment of artificial price.58 This optionality not only eases the
CFTCs future burden of proof by eliminating the need to demonstrate an
artificial price as a material element of the offense,59 but potentially aligns the
CFTCs anti-manipulation authority with that of the FERC and other agencies in
the United States and European Union which share equivalent enforcement
goals.60 As we will discuss later in Section III, if a common analytical
framework for analyzing manipulation were adopted, a more cooperative
position might be forged to bolster future analyses of manipulative behavior.
B. Discussion of European Regulation and the REMIT Process
Until late 2011, the key piece of anti-market manipulation legislation in the
European Union was the Market Abuse Directive (2003/6/EC) (MAD).61 MAD,
52. Notice of Proposed Rulemaking, Core Principles and Other Requirements for Swap Execution
Facilities, 76 Fed. Reg. 1,214 (2011) (to be codified at 17 C.F.R. pt. 37); Notice of Proposed Rulemaking, Core
Principles and Other Requirements for Designated Contract Markets, 75 Fed. Reg. 80,572 (2010) (to be
codified at 17 C.F.R. pts. 1, 16, 38); 17 C.F.R. pts. 1, 21, 39, 140 (2011).
53. 17 C.F.R. pts. 1, 150, 151 (2011).
54. Proposed Rule, End-User Exceptions to Mandatory Clearing of Swaps, 75 Fed. Reg. 80,747 (2010)
(to be codified at 17 C.F.R. pt. 39).
55. Although Dodd-Frank requires the dissolution of these entities, the Commission has chosen to
extend the time period for this phase out. See generally Final Orders, Orders Regarding the Treatment of
Petitions Seeking Grandfather Relief for Exempt Commercial Markets and Exempt Boards of Trade, 75 Fed.
Reg. 56,513 (2010).
56. Kate Winston & Esther Whieldon, CFTC, FERC Squabble Stalls MOUs: Wellinghoff, PLATTS:
ELECTRIC POWER DAILY (Dec. 20, 2011), available at http://www.a123systems.com/Collateral/Documents/En
glish-US/Platts%20Electric%20Power%20Daily_12-20-2011.pdf. The MOU is required under Dodd-Frank,
Pub. L. No. 111-203, title VII, 720(a)(1)(A), (B), (C), 124 Stat. 1376, 1657 (codified at 15 U.S.C. 8308
(Supp. 2010)).
57. DiPlacido v. CFTC, 364 F. Appx 657 (2d Cir. 2009).
58. Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices,
17 C.F.R. 180.1 (2011); Prohibition on Price Manipulation, 17 C.F.R. 180.2 (2011).
59. See generally LEDGERWOOD ET AL., supra note 6, at 6-7.
60. The need for a dual standard for prosecuting market power manipulations versus manipulations
based on fraud was argued by Pirrong, supra note 2, at 5. However, as we will discuss below, the framework
we propose works equally well under either standard and can be used to describe manipulations generally.
61. Directive No. 2003/6, of the European Parliament and of the Council of 28 January 2003 on Insider
Dealing and Market Manipulation (Market Abuse), 2003 O.J. (L 96) 16 (EC) [hereinafter MAD 2003/6];
Commission Directive No. 2004/72, of 29 April 2004 Implementing Directive 2003/6 of the European
which is currently being updated as the Market Abuse Regulation (MAR),62
applies to financial instruments63 which are essentially securities, derivatives
on commodities, options, swaps, and any other instrument admitted to trading on
a regulated market,64 a Multi-lateral Trading Facility (MTF),65 or an Organised
Trading Facility (OTF),66 as well as to any related financial instruments traded
OTC.67 In essence, MAD was a European predecessor to Dodd-Frank,68
designed to prohibit abuse in the European Unions financial markets. However,
in contrast to the United States where financial reform followed the creation of
seasoned regulatory structures for wholesale physical gas and electric markets,
MAD predated the creation of structures for regulating the European Unions
nascent wholesale energy markets.
1. The Features and Foibles of MAD
MAD has essentially two key elements. First, it prohibits market
manipulation, examples of which include: making transactions or orders to trade
which give . . . false or misleading signals as to the supply of, demand for or
price of financial instruments;69 making transactions or orders to trade which
employ fictitious devices or any other form of deception or contrivance;70
dissemination of information through the media . . . which gives false or
misleading signals regarding the value of financial instruments;71 and conduct
. . . to secure a dominant position over the supply of or demand for a financial
instrument which has the effect of fixing . . . purchase or sale prices or creating
Parliament and of the Council as Regards Accepted Market Practices, the Definition of Inside Information in
Relation to Directives on Commodities, the Drawing up of Lists of Insiders, the Notification of Managers
Transactions and the Notification of Suspicious Transactions, 2004 O.J. (L 162) 70 (EC).
62. Commission Proposal for a Regulation of the European Parliament and of the Council on Insider
Dealing and Market Manipulation (Market Abuse), at 56, COM (2011) 651 final (Oct. 20, 2011).
63. Commission Proposal for a Directive of the European Parliament and of the Council on Markets in
Financial Instruments Repealing Directive 2004/39/EC of the European Parliament and of the Council, at 16869, COM (2011) 656 final (Oct. 20, 2011) (defining financial instruments).
64. Proposal for a Regulation of the European Parliament and of the Council on Markets in Financial
Instruments and Amending Regulation [EMIR] on OTC derivatives, Central Counterparties and Trade
Repositories, at art. 2(5), COM (2011) 652 final (Oct. 20, 2011) [hereinafter Oct. 20, 2011 Proposal](defining
a regulated market as, a multilateral system operated and/or managed by a market operator, which brings
together or facilitates the bringing together of multiple third-party buying and selling interests in financial
instruments in the system and in accordance with its non-discretionary rules in a way that results in a
contract, in respect of the financial instruments admitted to trading under its rules and/or systems, and which is
authorised and functions regularly). A regulated market is also defined by Article 1(13) of Directive
93/22/EEC. Council Directive 93/22, 1993 O.J. (L 141) 27, 32 (EEC).
65. Oct. 20, 2011 Proposal, supra note 64, at art. 2(6) (defining a MTF as a multilateral system,
operated by an investment firm or a market operator, which brings together multiple third-party buying and
selling interests in financial instruments in the system and in accordance with non-discretionary rules).
66. Id. at art. 2(7) (defining an OTF as any system or facility, which is not a regulated market or MTF,
operated by an investment firm or a market operator, in which multiple third-party buying and selling interests
in financial instruments are able to interact in the system).
67. Id. at art. 2(1).
68. See generally Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203,
124 Stat. 1376 (2010).
69. MAD 2003/6, supra note 61, at art. 1(2)(a).
70. Id. at art. 1(2)(b).
71. Id. at art. 1(2)(c).
other unfair trading conditions.72 Second, MAD prohibits trading on inside
information and lays out rules on the disclosure of inside information.73 MAD
defines inside information as information of a precise nature which has not been
made public, relating, directly or indirectly, to one or more such derivatives and
which users of markets on which such derivatives are traded would expect to
receive in accordance with accepted market practices on those markets.74
Crucially, commodity trading, including electricity and gas trading, is
generally not covered by MAD unless it is considered to be trading in derivatives
on commodities. Gas and electricity products traded OTC, including forward
gas and electricity products not traded on an exchange, are therefore not defined
as financial instruments and MAD does not apply to these products an issue we
discuss in more detail below. Because the majority of gas and electricity
volumes in the European Union are traded OTC, MAD therefore does not apply
to most gas and electricity transactions. While exact numbers for OTC products
are difficult to obtain, the European Commission estimated that in 2009, only
16% of electricity traded by volume was covered by MAD.75
A related piece of legislation is the Markets in Financial Instruments
Directive (MiFID).76 MiFID essentially aims to ensure financial stability and
investor protections, though its provisions mainly protect small investors.77 As
the European Commission noted, the objective of investor protection seems less
relevant for energy since energy derivatives are typically not investment
products but are primarily used as hedging instruments for mitigating price risks
of energy market participants (e.g., some utilities).78 Moreover, as with MAD,
MiFID applies only to financial instruments and, so again, excludes the majority
of energy volumes actually traded.
Because the anti-manipulation provisions of MAD run only to derivatives
markets, regulators and competition authorities could only prosecute suspected
market manipulations of physical energy markets using general antitrust law.79
In Europe, this consists of Article 102 of the Treaty on the Functioning of the
European Union, which prohibits abuse of a dominant position, and/or Article
101 of the Treaty which prohibits cartels and other agreements that could disrupt
free competition in the European Economic Areas common market.80 However,
as we explain in more detail later in this article, many cases of market
73. Id. at art. 2.
74. Id. at art. 1(1).
75. Commission Staff Working Document: Impact Assessment: Accompanying Document to the
Proposal for a Regulation of the European Parliament and of the Council on Energy Market Integrity and
Transparency, at 13, SEC (2010) 1510 final (Dec. 8, 2010) [hereinafter Final Impact Assessment].
76. See generally Council Directive 2004/39, On Markets in Financial Instruments, 2004 O.J (L 145) 1
78. Final Impact Assessment, supra note 75.
79. Some jurisdictions or markets in Europe have specific national market abuse legislation for
example, the Nordic pool electricity market in Scandinavia and the EX market in Germany. But this is the
exception rather than the rule. NORDIC ENERGY REGULATORS, THE NORDIC FINANCIAL ELECTRICITY MARKET
50 (2010), https://www.nordicenergyregulators.org/upload/Reports/Nordic_financial_market_NordREG_Repor
t_8_2010.pdf (last visited Mar. 5, 2012).
80. Consolidated Version of the Treaty on the Functioning of the European Union, arts. 101, 102, Mar.
30, 2010, 2010 O.J. (C 83) 47, 88-89.
manipulation do not involve dominance in the sense envisaged by Article 102.
The position established by the manipulator can be short-lived and transitory,
and the relevant markets difficult to define. Accordingly, the absence of specific
legislation to deal with market manipulation and other forms of market abuse has
made it extremely difficult to prosecute suspected cases of market abuse in EU
gas and electricity markets. As Europes energy markets have liberalized and
grown, the number of markets vulnerable to abuse has increased, and the need
for effective legislation has become more urgent.
This issue was recognized as early as 1999 by the energy regulator of Great
Britain (GB), Ofgem.81 The GB electricity and gas markets were the first in
Europe to liberalize and were, therefore, also the first to experience abuse of
electricity and gas markets.82 To address perceived issues with the abuse of
market power in the GB electricity pool and the absence of any effective
legislation with which to prosecute such behavior, Ofgem inserted a so-called
Market Abuse License Condition (MALC) in the license of every generator
active in the GB market.83 The condition prohibited the license holder from
abusing market power and prohibited each generator from abusing its position
and adversely affecting consumers or distorting competition between
companies.84 Two generators refused to consent to this modification of their
license conditions, and as a result, the Director General of Electricity Supply
(DGES) referred the matter to the UK Competition Commission.85 In 2000, the
Competition Commission agreed with the appeal and annulled the MALC,
noting that, among other things, Ofgems definition of market abuse was so
broad as to cause uncertainty, because of the difficulty of distinguishing
between abusive and acceptable conduct, and would risk deterring normal
competitive behaviour.86 Ofgems inability to introduce a market abuse license
condition illustrates the problems historically faced by many regulators and
competition authorities in dealing with abuse in EU energy markets.
2. Toward a Dedicated Market Manipulation Statute for Wholesale
The next significant step towards a market abuse law for energy markets
occurred in 2006 and 2007, when the European Commission conducted a wide
ranging sector inquiry into EU energy and gas markets based on Article 17 of
81. About Us, OFGEM, http://www.ofgem.gov.uk/About%20us/Pages/AboutUsPage.aspx (last visited
Mar. 5, 2012).
82. A Leading Voice in Europe, OFGEM, http://www.ofgem.gov.uk/Europe/Pages/Europe.aspx (last
83. Electricity generation is a licensed activity in Great Britain. Generators must hold a license issued
by the GB energy regulator. Consultation, Ofgem, Addressing Market Power Concerns in the Electricity
Wholesale Sector - Initial Policy Proposals 5 (Mar. 30, 2009) (Ref: 30/09), http://www.ofgem.gov.uk/Markets/
WhlMkts/CompandEff/Documents1/Market%20Power%20Concerns-%20Initial%20Policy%20Proposals.pdf.
85. UK COMPETITION COMMN, AES & BRITISH ENERGY: A REPORT ON REFERENCES MADE UNDER
SECTION 12 OF THE ELECTRICITY ACT 1989, app. 2.1 (2001).
86. Id. at 1.12.
Regulation 1/2003 on the implementation of the Treaty rules on competition.87
Among other things, the sector inquiry concluded that:
A monitoring system for trading on wholesale markets (e.g. power exchanges)
would increase market participants confidence in the market and limit the risk of
market manipulation. Regulators should be empowered to collect and exchange
relevant information in this respect. They should have the power to make
recommendations for enforcement action or have the power to carry out such
enforcement action themselves.
As a result of this and other related findings, in December 2007, the
European Commission requested the Committee of European Securities
Regulators (CESR) and European Regulators Group for Electricity and Gas
(ERGEG) for advice on issues concerning record keeping and transparency of
transactions in electricity and gas supply contracts and derivatives.89 The
European Commission also asked for advice on a possible extension of MAD to
trading in energy and energy derivatives.90
In October 2008, CESR/ERGEG reported their findings.91 They agreed that
MAD did not extend to spot and forward energy products that are not admitted
to trading on a regulated market and that the commodity derivative specific
definition of insider information in MAD is difficult for securities regulators to
apply, in the absence of a clear definition of the information that users of
commodity markets can expect to receive in accordance with accepted market
practices on those markets.92 In essence, actors in commodity markets can
claim that since it is not accepted market practice to, for example, announce the
unexpected failure of a production plant, they did not have to disclose such
information and it was legal to trade on the basis of such privately held
CESR/ERGEG recommended [s]ector specific disclosure
obligations that obliged market actors to disclose information likely to
influence physical and/or derivatives markets prices in a timely manner.93
More importantly, CESR/ERGEG recommended a tailor-made market abuse
framework in the energy sector legislation for all electricity and gas products not
covered by MAD,94 noting that:
A mere extension of the scope of market abuse regulations (insider trading, market
manipulation) in MAD to physical products is not recommended, particularly
because it would not reflect the needs of the electricity and gas markets and would
bear the risk of leading to an inappropriate application of MAD in other areas.
87. Council Regulation (EC) No 1/2003, On the Implementation of the Rules on Competition Laid
Down in Articles 81 and 82 of the Treaty, art. 17, 2002 O.J. (L 1) 1, 13.
88. DG Competition Report on Energy Sector Inquiry, at 17, SEC (2006) 1724 (Jan. 10, 2007)
89. Comm. of Eur. Sec. Regulators [CESR] & Eur. Regulators Grp. for Elec. & Gas [ERGEG], Advice
to the European Commission in the Context of the Third Energy Package, Response to Question F.20 Market
Abuse, at 6 and annex I, CESR/08-739, E08-FIS-07-04 (Oct. 2008), available at http://www.esma.europa.eu/
system/files/08_739.pdf.
92. Id. at 3-4.
3. The Regulation on Energy Market Integrity and Transparency
As a result of CESR/ERGEGs advice, in 2009 and 2010, the European
Commission developed proposals for a tailor-made regime for dealing with
market abuse in energy markets. On December 8, 2010, the European
Commission presented its legislative proposal for a Regulation on Energy
Market Integrity and Transparency (REMIT).96 REMIT and MAD are intended
to complement one another to eliminate the regulatory gaps highlighted above.
As such, REMIT encompasses the same two concepts of MAD, a prohibition on
the use of inside information and the prohibition of market manipulation.
REMIT applies to wholesale energy products, which are defined as contracts
for the supply of natural gas or electricity with delivery in the European
Union;97 derivatives relating to natural gas or electricity produced, traded or
delivered in the European Union;98 contracts relating to the transportation of
natural gas or electricity in the European Union;99 and derivatives relating to
the transportation of natural gas or electricity in the European Union.100 The
definitions apply irrespective of where and how the products are traded, but
specifically do not apply to financial instruments covered by MAD.101
Following CESR/ERGEGs advice, the language of REMIT is more
specific to the nature of the electricity and gas markets than MAD. For example,
REMIT overcomes the defects in MADs broad definition of inside information
as nonpublic information of a precise nature that is made available to market
users according to accepted market practices.102 REMIT explicitly defines that
inside information includes information relat[ed] to the capacity and use of
facilities for production, storage, consumption or transmission of electricity or
natural gas or related to the capacity and use of LNG facilities, including planned
or unplanned unavailability of these facilities,103 reducing doubt as to the types
of information covered. The obligation to disclose inside information falls on all
market participants, defined as persons who enter[] into transactions, including
the placing of orders to trade, in one or more wholesale energy markets.104
The definition of market manipulation within REMIT is essentially the
same as MAD, thus including prohibitions against fraud-based manipulations
and behavior which gives rise to an artificial price.105 The recital gives a number
of energy-specific examples of market manipulation including
deliberately providing false information to undertakings which provide price
assessments or market reports with the effect of misleading market participants
96. Commission Proposal for a Regulation of the European Parliament and of the Council on Energy
Market Integrity and Transparency, COM (2010) 726 final (Dec. 8, 2010) [hereinafter REMIT Proposal].
97. Council Regulation (EU) No 1227/2011, On Wholesale Energy Market Integrity and Transparency,
at art. 2(4)(a), 2011 O.J. (L326) 1, 6 [hereinafter REMIT].
98. Id. at art. 2(4)(b).
99. Id. at art. 2(4)(c).
100. Id. at art. 2(4)(d); see also Draft Report of the Comm. on Indus., Research and Energy on the
Proposal for REMIT, at art. 2(4) (July 15, 2011) [hereinafter Draft Report], available at http://www.europarl.e
uropa.eu/meetdocs/2009_2014/documents/itre/pr/860/860344/860344en.pdf.
101. REMIT, supra note 97, at art. 1(2).
102. MAD 2003/6, supra note 61, at art. 1(1).
103. REMIT, supra note 97, at art. 2(1)(b).
104. Id. at art. 2(7).
105. Id. at art. 2(2).
acting on the basis of those price assessments or market reports; and deliberately
making it appear that the availability of electricity generation capacity or . . . gas
availability, or the availability of transmission capacity is other than the capacity
which is actually technically available where such information affects or is likely to
be affecting the price of wholesale energy products.
Although illustrative, these examples do not provide a cohesive definition of the
behavior that the regulation prohibits as manipulative.
In terms of jurisdictions and responsibilities, the European Union has the
advantage of starting with a relatively clean slate as compared to the United
States. Accordingly, two new agencies with demarcated responsibilities will
oversee REMIT and the to-be-revised MAD legislation. The Agency for
Cooperation of Energy Regulators (ACER), which was established under
Regulation (EC) No. 713/2009 and formally launched in March 2011, is
responsible for overseeing the enforcement of REMIT.107 The European
Securities and Markets Authority (ESMA), which was formed by November
2010 legislation, will take the lead in enforcing MAD.108 Much like the
interactions between the FERC and the CFTC in the United States, how well the
inter-agency cooperation works in practice remains to be seen, and there remains
scope for jurisdictional conflict and confusion in cases which involve both
wholesale energy products and financial instruments.
REMIT improves market transparency by requiring that market participants
report all transactions in wholesale energy products, including orders to trade, to
the ACER.109 The precise format and timing of this reporting will be defined in
subsequent implementing acts by the European Commission.110 Similarly,
market participants are also required to report information to the ACER and
National Regulatory Authorities (NRAs) on the capacity and use of production,
storage, and transmission facilities the details will again be determined by
implementing acts.111 REMIT provides for the ACER to monitor trading in
wholesale energy markets using the data it collects.112 This data will also be
available to NRAs, who will also be able to monitor activity at the national
level.113 Article 16 of REMIT describes the forms of inter-agency co-operation
and accountability, requiring that NRAs cooperate with the ACER for the
purpose of enforcing REMIT.114 [NRAs], competent financial authorities and
the national competition authorit[ies] . . . may establish appropriate forms of
cooperation . . . to ensure effective and efficient investigation and
enforcement.115
106. Id. at recital 13.
107. Council Regulation (EC) No 713/2009, Establishing an Agency for the Cooperation of Energy
Regulators, art. 1(1)-(2), 2009 O.J. (L 211) 1, 4.
108. Council Regulation (EU) No 1095/2010, Establishing a European Supervisory Authority (European
Securities and Markets Authority), art. 1(1)-(5), 2010 O.J. (L 331) 84, 93-94.
109. REMIT, supra note 97, at art. 8.
110. Id. at art. 8(2).
111. Id. at art. 8(5).
112. Id. at art. 7(1).
113. Id. at art. 7(2).
114. Id. at art. 16.
115. Id. at art. 16(1).
NRAs are required to inform the ACER without delay if they suspect that
acts which affect wholesale energy markets or the price of wholesale energy
products in that Member State are being carried out in their Member State or
another Member State.116 The ACER is obliged to inform ESMA and the
[appropriate] competent financial authority if it suspects market abuse is or has
been carried out on wholesale energy markets and [affects] financial
instruments.117 Where the ACER suspects a breach of REMIT, it has the power
to request the NRA to investigate and/or for the NRA to supply relevant
information to the ACER.118 The ACER can also form ad hoc groups of NRAs
to investigate suspected cross-border market abuse cases.119 The regulation also
requires Member States to adopt penalty regimes for infringements of REMIT120
and to give NRAs the investigatory and enforcement powers necessary to
enforce compliance.121 According to REMIT, the penalties must be effective,
dissuasive and proportionate, reflecting the nature, duration and seriousness of
the infringement, the damage caused to consumers and the potential gains from
trading on the basis of inside information and market manipulation.122 While
Member States are charged with defining their own penalties, the European
Commission will take action to ensure that these penalty regimes are
consistent.123
The negotiated text of REMIT was adopted by the European Parliament at
the first reading on September 14, 2011, and by the Council on October 10,
2011.124 REMIT was published in the Official Journal of the European Union on
December 8, 2011, and came into force on December 28, 2011.125 Industry
concerns that the regulations broad language could result in the potential
misidentification of legitimate trading as manipulative prompted the ACER to
issue guidance as to the definitions of manipulation under the act, albeit in the
form of reiterating and adding to the examples provided in REMITs recitals and
the provision of several examples of specific types of behaviour that might be
considered suspicious.126 It is also worth noting that both MiFID and MAD are
currently in the process of being revised, largely with the intention of providing
clarity on some definitions and removing previous loopholes or exemptions.127
The European Commission has also tabled the Energy Market Infrastructure
116. Id. at art. 16(2).
117. Id. at art. 16(3)(b).
118. Id. at art. 16(4)(a)-(b).
119. Id. at art. 16(4)(c).
120. Id. at art. 18.
121. Id. at art. 13.
122. Id. at art. 18.
123. Id. at 2011 O.J. (L 326) 1, 16.
124. Press Release, Council of the European Union, New Framework for Monitoring of Energy Markets
Adopted (Oct. 10, 2011), available at http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/tran
s/124995.pdf.
125. REMIT, supra note 97.
126. Agency for the Cooperation of Energy Regulators [ACER], Guidance on the Application of the
Definitions Set out in Article 2 of Regulation (EU) No 1227/2011 on Wholesale Energy Market Integrity and
Transparency, at 3 (Dec. 20, 2011) [hereinafter ACER Guidance].
127. Press Release, European Commn, New Rule for More Efficient, Resilient and Transparent Financial
Markets in Europe (Oct. 20, 2011), available at http://europa.eu/rapid/pressReleasesAction.do?reference=IP/11
/1219&format=HTML&aged=0&language=en&guiLanguage=en (last visited Mar. 5, 2012).
Regulation (EMIR), which imposes reporting requirements on market
participants as well as requiring greater collateral or else clearing of standardized
REMIT specifically anticipates that the ACER may develop contacts and
enter into administrative arrangements with supervisory authorities, international
organisations and the administrations of third countries in particular with those
impacting the [EU] energy wholesale market in order to promote the
harmonisation of the regulatory framework.128 The provisions of Dodd-Frank
also include specific considerations for trade by foreign entities, thus recognizing
that the positions held abroad can be used in stealth as targets for manipulations
just as easily as positions that were previously traded OTC or on ECMs.129
Because energy will continue to be traded on an increasingly multinational basis,
the financial derivatives markets that support those transactions will also evolve.
The need for interagency and international cooperation is therefore a prerequisite
for the creation of an effective and comprehensive anti-manipulation
enforcement system both within and between the United States and European
Union. We discuss the factors that may tend to help or hinder such efforts in the
III. THE CHALLENGES TO AND NEED FOR A UNIFIED ENFORCEMENT
In this section, we discuss the need for a unified framework for the
detection, analysis, proof (or disproof), and deterrence of manipulation in
wholesale electric and natural gas markets. We begin by discussing the
institutional characteristics of the entities tasked with implementing and
coordinating the new anti-manipulation laws and regulations. While we identify
many common institutional attributes of the enforcement systems that are to be
created in the United States and European Union, we also discuss several
differences amongst the relevant entities that may frustrate their abilities to work
together effectively. We then discuss the patchy case precedent in the United
States and examples provided in REMIT that provide no clear guidance as to the
behavior that is considered manipulative, leading to an I know it when I see
it130 market manipulation standard that provides little guidance for regulators
seeking to coordinate enforcement efforts and for traders seeking to comply with
the law. In this vein, the most recent EU consultations for MAD and MiFID
have called for a single rulebook131 to assist the implementation of its new
anti-manipulation statutes, a sentiment oft-echoed by CFTC Chairman Gensler
in discussing the coordination of efforts between agencies in the United States
128. REMIT, supra note 97, at art. 19.
129. See generally Notice of Proposed Rule Making, Registration of Foreign Boards of Trade, 75 Fed.
Reg. 70,974 (2010) (to be codified at 17 C.F.R. pt. 48); see also Dodd-Frank 738, 7 U.S.C. 6(b) (Supp.
130. Jacobellis v. Ohio, 378 U.S. 184, 197 (1964) (Stewart, J. concurring).
131. EUROPEAN COMMN, PUBLIC CONSULTATION ON A REVISION OF THE MARKET ABUSE DIRECTIVE
(MAD) 13-16 (June 25, 2010), available at http://ec.europa.eu/internal_market/consultations/docs/2010/mad/c
onsultation_paper.pdf [hereinafter MAD CONSULTATION]; EUROPEAN COMMN, PUBLIC CONSULTATION:
REVIEW OF THE MARKETS IN FINANCIAL INSTRUMENTS DIRECTIVE (MIFID) 7 (Dec. 8, 2010), available at
MIFID CONSULTATION].
and between the United States and European Union.132 To further this purpose,
we conclude the section by proposing a framework designed to unify the
analysis of manipulative behavior across cases, statutes, agencies, nations, and
A. Institutional Commonalities and Clashes for Deterring Manipulative
Although the paths of the European Union and United States in creating a
comprehensive system for overseeing the trade of physical and financial
commodities were very different, the regulatory structures that are emerging
from various legislative processes are strikingly similar. For example, a
comparison of Dodd-Frank, MiFID, MAD, and REMIT shows relative
equivalence in the trading platforms to be regulated,133 the types of instruments
regulated,134 the types of behavior regulated,135 and the tools used to bring
compliance (injunctions and fines). The basic allocation of supervisory authority
and duties across national and state regulators is also very similar, as Table 1
Comparison of Entities with Anti-Manipulation Mandates
Markets Regulated
FERC, State Regulators
CFTC, FIA, SROs
FERC, State Regulators,
RTOs, Independent Market
CFTC and/or FERC in
RTOs; CFTC otherwise
ACER, National
EMSA, Competent
132. Gary Gensler, CFTC Chairman, Remarks at the London School of Economics (Oct. 13, 2011),
available at http://www.commodities-now.com/commodities-now-reports/general/8313-gary-gensler-remarksat-the-london-school-of-economics.html.
133. For example, Dodd-Frank contemplates the regulation of DCOs, DCMs, SEFs, and FCMs in the
United States, which roughly compare to Regulated Markets, MTFs, Systematic Internalisers, and OTFs in the
European Union. Compare, Trading Organizations, supra note 12, with MIFID CONSULTATION, supra note
131, 2.2.
134. These include futures, options, and swaps. The CFTC regulates futures and associated options
through its original jurisdiction under the CEA, whereas comprehensive regulation of swaps is provided by
Dodd-Frank. See generally, Commodity Exchange Act, CFTC, http://www.cftc.gov/LawRegulation/Commodi
tyExchangeAct/index.htm (last visited Mar. 5, 2012) (regarding futures and options contracts); Dodd-Frank
Act, CFTC, http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm regarding swaps (last visited Mar. 5,
2012); MIFID CONSULTATION, supra note 131, 2.2.3; and MAD CONSULTATION, supra note 131.
135. This includes trading on inside information (or material nonpublic information as per Dodd-Frank)
and market manipulation caused by fraud or through the creation of an artificial price. Final Rule, Prohibition
on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on
Price Manipulation, 76 Fed. Reg. 41,398, 41,410 (2011) (to be codified at 17 C.F.R. pt. 180); MAD
CONSULTATION, supra note 131, 1-2; and REMIT, supra note 97, at arts. 4, 5.
Notwithstanding these structural similarities, the fact remains that very
different evolutionary processes spawned the development of the many agencies
and entities that will need to cooperate to effectively execute this antimanipulation mandate. In the United States, resolving jurisdictional friction
between the FERC and CFTC may be easy compared to aligning the
philosophical differences of the agencies as to what behavior constitutes
manipulative activity.136 Coordination of federal and state regulators with each
other and with private entities such as SROs or Independent Market Monitors
will likewise be challenging, especially because the anti-manipulation mandate is
less (or not) binding on said entities. Indeed, it is possible that unperceived
overlaps and gaps in enforcement could emerge, as might arise if antitrust
liability were attached to behavior that is also considered manipulative.137 Even
greater discord is possible within the European Union given that energy markets
differ significantly in size and complexity across the various member nations
systems. Differences across the associated National Regulators and Competent
Financial Authorities will likewise emerge in their abilities and willingness to
contribute to REMITs pan-European goals. Finally, because the physical and
financial trading of energy is an increasingly global activity, the coordination of
international efforts to monitor for manipulative activity will be a challenge,
especially if nations with significant trading venues do not join the effort.
Central to the resolution and ultimate success of any coordinated
enforcement efforts will be the effective collection, compilation, and analysis of
tremendous amounts of data.138 Differences across systems will need to be
addressed, with compromises made while non-compliant systems are upgraded
to adhere to minimal requirements.139 The data must be stored in a medium that
136. Specifically, the FERCs mission is to provide Reliable, Efficient and Sustainable Energy for
Customers [and to a]ssist consumers in obtaining reliable, efficient and sustainable energy services at a
reasonable cost through appropriate regulatory and market means. About FERC, FERC, http://www.ferc.gov/
about/about.asp (emphasis omitted) (last visited Mar. 5, 2012). By comparison, [t]he CFTCs mission is to
protect market users and the public from fraud, manipulation, abusive practices and systemic risk related to
derivatives that are subject to the Commodity Exchange Act, and to foster open, competitive, and financially
sound markets. Mission & Responsibilities, CFTC, http://www.cftc.gov/About/MissionResponsibilities/index.
htm (emphasis omitted) (last visited Mar.5, 2012). Thus, behavior perceived by one agency as potentially
manipulative could be deemed by the other to be of no consequence.
137. For example, an act of economic withholding by an electric generator to benefit the price paid to the
remainder of its generation fleet could simultaneously be perceived as an antitrust violation and a market
manipulation. See generally United States v. KeySpan Corp., 763 F. Supp. 2d 633 (2011). This is clarified
138. For example, three of the CFTCs thirty-two Dodd-Frank rulemaking areas concern the
accumulation of data. See generally, Rulemaking Areas, CFTC, http://www.cftc.gov/LawRegulation/DoddFran
kAct/Rulemakings/index.htm (last visited Mar. 5, 2012) (these rulemaking areas may be accessed by selecting
Titles XXVI-XXVIII).
139. As an intuitive example, differences as simple as units of measurement in metric versus English
standards can wreak havoc on analyses on otherwise comparable data. More technically, great care must be
used to assure that comparable instruments traded on different venues are in fact similar. For example, the
NYMEX Henry Hub look-alike swap traded on the CME Group web site is for 2,500 MMBtu delivered over
the course of a contract month, whereas the Henry Hub look-alike swap traded on ICE is for 2,500 MMBtu
delivered each day over the course of a contract month, meaning that it varies between being 28 and 31 times
larger than the CME Group equivalent. Compare, Henry Financial LD1 Fixed Price, ICE, https://www.theice.
is cost effective and accessible to competent authorities, yet secure enough to
ensure the protection of proprietary data and other sensitive information such as
that concerning critical infrastructure. Analysis of the accumulated data will
likewise tend to be uneven, depending upon the resources available to each
entity with surveillance responsibilities. Analyses must first be developed and
coordinated internally by each agency, then coordinated across agencies as
resources allow. In short, the creation of a comprehensive system for the
detection and analysis of manipulation will require a monumental initial effort,
with substantial continuing investments required to maintain the system as
markets evolve over time.
In conjunction with the development of a market monitoring function,
resources must also be devoted to the enforcement of the anti-manipulation rules.
It is at this point where the need for a consistent analytical framework for
analyzing manipulation becomes essential, for variances across jurisdictions will
allow for regulatory arbitrage and the ability to hide illegal activity by exploiting
the gaps and inconsistencies across markets.140 As we discuss next, the
paradigm of enforcement currently relied upon in U.S. manipulation law is a
patchwork of legal cases tried by the SEC, CFTC, and FERC that tended to label
behavior rather than create a comprehensive economic theory as to the cause and
effect of manipulative behavior generally. Indeed, the recital of REMIT also
relies upon a hodgepodge of examples to define manipulative behavior, as does
the ACERs guidance concerning the issue.141 While these efforts are certainly
useful, they do not provide a standardized approach to manipulation consistent
with the single rulebook concept, which we believe is warranted and would
benefit market participants and enforcement authorities alike through greater
certainty as to the behavior that is prohibited across all jurisdictions.142
B. Current Legal Precedent Fails to Provide a Single Rulebook Concerning
Outside of cases brought by the SEC, there has been only one successful
and fully litigated case brought the under U.S. anti-manipulation laws.143 The
relative success of the SEC in bringing such cases is often attributed to its fraudbased manipulation Rule 10b-5, which does not require proof of the creation of
com/productguide/ProductDetails.shtml?specId=693 (last visited Mar. 5, 2012), with, Henry Hub Natural Gas
Last Day Financial Futures, CME GROUP, http://www.cmegroup.com/trading/energy/natural-gas/henry-hub-n
atural-gas-swap-futures-financial_contract_specifications.html (last visited Mar. 5, 2012).
140. See generally LEDGERWOOD ET AL., supra note 6, at 8.
141. See generally ACER Guidance, supra note 126.
142. The authors introduced the framework in the context of REMIT earlier this year. SHAUN
LEDGERWOOD, DAN HARRIS, BIN ZHOU & PINAR BAGCI, THE BRATTLE GRP., DEFINING MARKET
MANIPULATION IN A POST-REMIT WORLD (2011), available at http://www.brattle.com/_documents/UploadLi
brary/Upload960.pdf. This paper became the impetus for a seminar hosted by The Brattle Group and delivered
in London on October 20, 2011. Conference Schedule, The Brattle Group: Perspectives on the Implementation
and Enforcement of REMIT: A Seminar on Manipulation Concerns in European Energy Markets (Oct. 20,
2011), available at http://www.wilmerhale.com/files/upload/REMIT SeminarProgram.pdf.
143. DiPlacido v. CFTC, 364 Fed. Appx 657 (2nd Cir. 2009). The FERCs case against Amaranth trader
Brian Hunter is under appeal following the Commissions denial of rehearing on November 11, 2011. Order
Denying Rehearing, Brian Hunter, 137 F.E.R.C. 61,146 (2011) [hereinafter Hunter Rehearing]. See also
Brian Hunter v. FERC, No. 11-1477 (D.C. Cir. filed Dec. 12, 2011).
an artificial price.144 However, the economic logic that underlies SEC case
precedent under Rule 10b-5 is somewhat discordant and reflects a mixture of
example-driven findings based on specific types of behavior that do not readily
provide a cogent manipulation theory. Examples of such cases include the
prosecution of wash trades,145 trading on insider information,146 marking the
close,147 painting the tape,148 pump-and-dump schemes,149 and other acts
where inaccurate information is being injected into the marketplace.150 Taken
to an extreme, this I know it when I see it approach to manipulation suggests
that any erroneous or errant statements by a trader could later be taken out of
context and bring unwarranted liability. This is especially concerning in energy
markets, where highly complex and interrelated markets could erroneously find
manipulative intent from legitimate trading behavior.151
The examples provided in the recitals in the REMIT Parliamentary
Report152 demonstrate a similar reliance upon examples to define manipulation
rather than a cohesive economic theory:
[P]lacing and withdrawal of false orders; spreading of false or misleading
information or rumours through the media, including the internet, or by any other
means; deliberately providing false information to undertakings which provide
price assessments or market reports with the effect of misleading market
participants acting on the basis of those price assessments or market reports;
144. 17 C.F.R. 240.10b5-1 (2011); Hunter Rehearing, supra note 143, at PP 5-11.
145. Wash trades are executed to create churn without necessarily creating any perceptible market price
effect and are specifically prohibited under Section 9a-1 of the Securities Exchange Act of 1934. 15 U.S.C.
78i(a)(1).
146. Such cases are treated as a misappropriation of information in breach of a fiduciary duty, falling
under the broad definition of a market manipulation. This misappropriation theory derived from United
States v. OHagan, 521 U.S. 642, 652 (1997). Like wash trades, there is no perceptible market price effect that
needs to be shown for such cases to be brought successfully. Insider trading is prohibited under Section 10b5-1
of the Securities Exchange Act of 1934. 17 C.F.R. 240.10b5-1.
147. This occurs when a trader concentrates its activity at the end of the trading day to move the closing
price to its benefit. SEC v. Masri, 523 F. Supp. 2d 361, 372-372 (S.D.N.Y. 2007); Markowski v. SEC, 274
F.3d 525, 529 (D.C. Cir. 2001) (stating that manipulation can be illegal solely because of the actors
148. Painting the tape signifies creating an appearance of trading activity without an actual change in
beneficial ownership. Marsi, 523 F. Supp. 2d at 367 n.10 (quoting Nanopierce Techs., Inc. v. Southridge
Capital Mgmt. LLC, No. 02 Civ. 767, 2002 U.S. Dist. LEXIS 24049, at *5 n.8 (S.D.N.Y. 2002)).
149. These schemes involve buying a stock at a low price, then putting false information into the market
to cause a rally such that the stock can be sold at a higher price. See, e.g., SEC v. Whittemore, 659 F.3d 1, 10
150. GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 205 (2001) (stating that intentional
dissemination of false information is specifically prohibited by Sections 9a-2 through 9a-4 of the Exchange
Act). See also the complaint filed in SEC v. Dynkowski, Case No. 09-361 (D. Del. May 20, 2009), available at
http://www.sec.gov/litigation/complaints/2009/comp21053.pdf.
151. All U.S. agencies with anti-manipulation authority now have a fraud-based statute based upon the
SECs Rule 10b-5. 17 C.F.R. 240.10b-5 (2011) (arising under the authority granted in 15 U.S.C. 78j(b)
(Supp. 2010))(SEC); 18 C.F.R. pt. 1c (2011) (FERC); 16 C.F.R. pt. 317 (2011) (arising under the authority
granted in 42 U.S.C. 17301-17305 as amended by Section 811 of Subtitle B of Title VIII of the Energy
Independence and Security Act of 2007, Pub. L. No. 110-140, 121 Stat. 1723) (FTC); 7 U.S.C. 6(a)(1) (Supp.
2010) (CFTC). The CFTC has also retained its original anti-manipulation statute based upon a finding of
artificial price, now codified by Dodd-Frank as 7 U.S.C. 6(a)(3) (Supp. 2010). The European Unions
REMIT Proposal also includes language for both a fraud-based and an artificial price standard. REMIT, supra
note 97, at art. 1(2).
152. Draft Report, supra note 100.
deliberately making it appear that the availability of electricity generation capacity
or gas availability, or the availability of transmission capacity is other than the
capacity which is actually technically available where such information affects or is
likely to be affecting the price of wholesale energy products. . . . conduct by a
person or persons acting in collaboration, to secure a decisive position over the
supply of or demand for a wholesale energy product which has, or could have, the
effect of fixing, directly or indirectly, prices or creating other unfair trading
conditions; the offering, buying or selling of wholesale energy products with the
purpose, intention or effect of misleading market participants acting on the basis of
The use of examples as the basis for laying the foundation of future enforcement
and compliance efforts is less than ideal and is made worse by the fact that the
examples draw from historical behavior that was evaluated under two different
legal standards.154
REMIT includes both fraud-based anti-manipulation language and language
prohibiting the creation of an artificial price,155 the latter often assumed to be the
result of a successful exercise of market power. The perceived need for dual
anti-manipulation language was articulated in this Journal by Dr. Craig Pirrong,
who reasoned that:
Market power manipulations and fraud-based manipulations are quite distinct.
A large trader can corner a market without making any false or misleading
statements. Moreover, a trader can spread a false rumor that moves prices even if
his position is not large enough to permit him to exercise market power. Further,
market power manipulations and fraud-based manipulations can have different
effects on prices and quantities in a market.
While it is certainly true that the exercise of market power can be
conceptually distinguished from outright fraud, actual manipulative behavior is
rarely so clear-cut. Specifically, as we will discuss in detail in the next section,
many types of market power manipulation (including corners) arise from
uneconomic trading,157 which could simultaneously be viewed as intentionally
misrepresenting the value of the asset traded (a fraud) and assisting the creation
of an artificial price. The promotion of a single rulebook calls for an approach
to the analysis of manipulative behavior that can conceptually accommodate all
such behavior under either legal standard.
While the legal concept of fraud is easy to understand in theory, applying
the concept to trading activity forensically and without an economic foundation
for why the behavior causes harm introduces uncertainty to the markets, causing
compliance officers to avoid legitimate trades due to excessive caution and
forcing regulators with anti-manipulation authority to expend resources
searching for behavior that is neither well defined nor completely understood.
This is only made worse as efforts are made to coordinate monitoring and
enforcement activities across entities and jurisdictions, as the potential for
incongruities then increase exponentially. The lack of a single rulebook
therefore harms market efficiency through the unwarranted addition of costs to
the regulators and regulated alike. More importantly, the removal of liquidity
Id. at 8-9 (emphasis omitted).
ACER Guidance, supra note 126.
REMIT, supra note 97, at art. 2(2)(a)(ii).
Pirrong, supra note 2, at 5.
See generally, Constellation Settlement, supra note 1, at PP 9, 15.
from the market out of fear of unwarranted prosecution introduces inefficiencies
that make the probability of successful manipulation that much more likely. A
potential solution to this conundrum would be to provide a straightforward and
unifying analytical structure for the analysis of all forms of market manipulation
that would apply across cases, agencies, statutes, and nations. This single
rulebook could simultaneously promote efficiency and coordination of
monitoring and enforcement across entities with anti-manipulation mandates and
give certainty as to behavior that is prohibited such that market participants can
effectively comply. In the next section, we propose such a structure, which we
refer to as the framework.
C. A Proposed Framework to Unify the Analysis of Market Manipulation
Consider the following example: a natural gas producer wishes to sell gas at
a major trading hub for next months delivery. Fearing a possible drop in natural
gas prices, the producer buys a series of put options that tie to the next months
natural gas futures contract, thus hedging the financial risk of lower future prices
associated with its physical position. Next, assume that the price of the next
months natural gas contract begins to fall precipitously. The producer reacts by
first liquidating its physical position, then selling its put option contracts that are
now more valuable at the lower market price. On its face, there is nothing in this
example that necessarily indicates manipulation; the producer hedged its
financial exposure to a drop in natural gas prices, sold out of its physical position
to minimize losses once those prices actually started to fall, and captured the
value of its hedge to offset its losses. If viewed individually or in combination,
these steps could be shown to serve a legitimate business purpose and,
furthermore, exemplify why physical markets can greatly benefit from the
liquidity provided from robust financial markets. However, these same actions
could provide the mechanism for a market manipulation. This is because the
value of the producers put options hedge ties to the futures price of the next
months natural gas contract, which the producer may have intentionally
influenced through the liquidation of its physical position.
The notion that the producers actions might be construed as manipulative
in the example above may offend conventional thought. Some of our clients and
associates in the United States and Europe voiced legitimate concerns that
defining manipulation so broadly could chill legitimate trading behavior (such as
hedging) to the detriment of market efficiency. While this logic is reasonable,
some advocates of limited regulation would combine it with a slippery slope
fallacy to propagate fears that all future trading will be subject to ex post reviews
for legitimacy, ultimately causing market participants to stop trading entirely to
avoid the massive and uncertain liability associated with private and agency
enforcement actions brought under the various anti-manipulation laws.158 Such
arguments, though disingenuous, must be addressed.
It is clear that an overzealous and unwarranted application of antimanipulation regulations could chill legitimate trading, thus reducing market
liquidity and introducing inefficiency and uncertainty to the market. However, a
lack of sufficient anti-manipulation enforcement will also cause inefficiency as
legitimate traders will avoid markets wherein prices consistently appear to
See generally Ledgerwood & Carpenter, supra note 10, at 51.
deviate from fair value. In either event, market participants are forced to pay
higher costs for compliance and will face higher transaction costs for legitimate
trading (including hedging). Regulators likewise lose through the waste of
scarce regulatory resources expended in pursuit of false positives or in the
inefficient prosecution of legitimate cases brought under uncertain or poorly
defined anti-manipulation rules. Such issues must be proactively addressed, as
there is no longer a question as to whether anti-manipulation laws will be
implemented, but only as to how these rules will be applied and enforced on a
go-forward basis. It is for these reasons that we propose the use of the analytical
framework described below.
1. An Analytical Framework of a Market Manipulation
A market manipulation has three components:
The Trigger: An intentional act performed to produce a directional
price movement;
The Target: One or more positions that stand to benefit from the price
The Nexus: The causal linkage between the trigger and target.159
As an example of how these apply, consider the merits of an enforcement action
brought against the natural gas producer discussed above. The accuser would
That the producer intentionally liquidated its physical position in a
manner designed to exacerbate (and thus trigger) the lower price of the
next months natural gas contract;
That the producer used its put options position as the manipulations
target, benefitting from the lower price of the next months natural gas
contract caused by the trigger; and
That a sufficiently causal nexus exists between the trigger and target,
such that the price movement produced by the trigger will predictably
increase the value of the target.160
Breaking the manipulation into these components allows for the targeted
analysis of questions that lay at the heart of all manipulation cases. How is
legitimate trading behavior (e.g., loss minimization by liquidating a losing
position) distinguished from that designed to intentionally trigger a manipulation
(e.g., purposeful selling designed to exacerbate low prices)? What aspects of the
producers put options position demonstrate that it is the target of the
manipulation and not simply a legitimate hedge? Is the pricing mechanism that
is manipulated by the alleged trigger sufficiently causal to the value of the target
such that a nexus is known and exploited? It is these questions that the
framework is designed to address and which we explore further below.
159. Id. at 4; Hunter Rehearing, supra note 143, at PP 27-31.
160. Shaun D. Ledgerwood, Screens for the Detection of Manipulative Intent 41 (Dec. 19, 2010)
(unpublished manuscript), available at http://ssrn.com/abstract=1728473.
The benefits of using this framework can inure to market participants and
regulators alike.161 Because it allows for identification of the market qualities
that enhance the likelihood of a successful manipulation, the framework allows
agencies to focus their scarce regulatory resources into markets at greatest risk
for manipulative behavior.162 Separate analysis of the behavior comprising the
manipulations trigger also allows for the specific identification of the acts that
regulators see as potentiating a manipulation versus those which are legitimate,
providing much needed clarity to market participants as to prohibited behavior
and safe harbors such that compliance and liquidity can be maximized.163
Additionally, the separation of the trigger from the target informs surveillance
and oversight efforts such that market screens can focus upon trading designed
to potentiate directional price movements, again allowing for scarce regulatory
resources to be optimized within and across agencies that have an antimanipulation enforcement mandate. Each of these benefits is described in more
detail in this section and the section that follows.
2. Market Characteristics That Accentuate the Likelihood of Successful
As discussed and mathematically proven in other academic pieces we have
written on this topic, the likelihood of a manipulations success increases (1) as
the cost of the manipulation trigger decreases, (2) as market supply and demand
become more inelastic, and (3) as the amount of leverage held in the target
increases relative to the size of the trigger.164 These three elements coincide with
the three components of the framework, as couched in a cost/benefit analysis.
Specifically, the manipulator will evaluate the cost of the manipulation trigger (if
any) relative to the leveraged benefit it receives from the targeted positions, with
the nexus between the trigger and target strengthened as demand or supply
becomes less elastic.165 The logic of the framework is therefore based on a
simple foundation that underlies all basic economic decision making.
This simplicity does not impinge the value of the framework for informing
regulators, market participants, lawmakers, and academicians as to the direction
of market design, surveillance, and enforcement. Because cheap triggers better
enable manipulations, improvements in the certainty of detection and increases
in the penalties for proven non-compliance will decrease the number of
manipulations attempted.166 In addition, since the inelasticity of supply and
demand increase the ability of a manipulator to exploit a nexus between triggers
and targets, the articulation of certainty with respect to the types of behavior that
are deemed to be manipulative will increase the liquidity of trading where
possible and inform regulators as to the markets that are most in need of
continual oversight and surveillance.167 Because the accumulation of large pricetaking positions provides an incentive for manipulation, continued oversight of
See generally LEDGERWOOD ET AL., supra note 142, at 7.
Ledgerwood, supra note 160, at 13-18; see also Ledgerwood & Carpenter, supra note 10, at 36-42.
See generally Ledgerwood & Carpenter, supra note 10, at 36-42.
firms with large physical holdings, as well as greater transparency and regulation
concerning financial positions, will reduce the ability of those with manipulative
intent to accumulate such positions.168
3. Types of Behavior That Can Trigger a Manipulation
Any actions that intentionally cause an anomalous directional movement in
one or more market prices could theoretically potentiate a market manipulation.
However, there are three types of behavior that are of clear interest: uneconomic
trading, outright fraud, and the exercise of market power. We discuss these
a. Uneconomic Trading
Uneconomic trades include bids made significantly above or offers made
significantly below prevailing market prices, such that the trader losses money
relative to its opportunity costs that is, the trade may make an accounting
profit, but the trader could have made more money by following another course
of action.169 Such trades are economically counterintuitive, as they injure their
proponent on a stand-alone basis.170 However, it is the manipulators willingness
to intentionally accrue such losses that enables its ability to trigger a
manipulation.171 For example, consider the hypothetical natural gas producer
discussed above. The producers willingness to sell gas into a competitive,
declining market suggests that it has no market power in the traditional sense
(i.e., no ability to withhold its gas to raise its price above market). In contrast,
the producer can avoid competition entirely if it is willing to offer its gas at a
price significantly below market, thus guaranteeing the execution of its trades if
demand is sufficient to absorb its offered quantity. The producer then willingly
incurs opportunity-based losses in exchange for successfully executing trades
that lower the market price. Importantly, this demonstrates that a manipulation
can be triggered by uneconomic trades executed by market participants who
possess no market power in any traditional sense.172
The use of opportunity costs as the barometer against which uneconomic
trading is evaluated will raise legitimate concerns. Indeed, a rational and
unbiased forensic deconstruction of almost any historical trading decision will
show that the trader could have made more money elsewhere if only he or she
had looked hard enough. Such dispassionate analysis might fail to consider the
difficult decisions made in the heat of a trading day, wrongfully interpreting
erroneous decisions as the malevolent vehicle of manipulative intent. To be
mindful of such concerns, the threshold for applying opportunity costs as a
yardstick must focus less upon the fact that losses are accrued indeed, about
half of all trades should lose money in a fair market than upon the pattern and
size of losses, measured on an opportunity cost basis, accrued over time.173
Traders who regularly (or massively) lose money relative to their opportunity
Id. at 4, n.4.
costs are leaving money on the table, an oversight unlikely to be sustainable
under the eyes of prudent management in the highly competitive world of
trading. The tolerance of such losses could therefore suggest that the trading
behavior is designed not to make money on a stand-alone basis but to
directionally move a price to the benefit of some other position.174 We
acknowledge that the identification of losses based on opportunity costs requires
careful analysis and that subjective judgments are required. Nevertheless,
evaluating uneconomic losses with an opportunity cost standard will reduce the
scope for subjective judgment relative to the current manipulation standards.
The market characteristics that accentuate the likelihood of successful
manipulation are of particular relevance to loss-based manipulations. For
example, as the size of the loss required to trigger the manipulation declines, the
likelihood of success increases. Thus, manipulations are most likely to occur in
markets where there is little liquidity in the price-making mechanism or where
the manipulator can create momentum to incent others to move the price in the
direction it seeks, as the costs of the trades used to trigger the manipulation then
decrease. Likewise, the ability of a manipulator to build leverage in positions
that derive their value from the price set by the trigger (such as financial
derivatives) increases the benefits derived from the manipulation, thereby
making it more likely to occur.175 Finally, fixities in supply and/or demand tend
to increase the reactivity of prices to smaller orders, strengthening the nexus
between the triggering trades and the targeted positions.176 The decision to
manipulate a market through uneconomic trading is thus a rational, profit
seeking strategy derived from comparing the expected costs of the trigger to the
expected benefits derived from the target.177
Interestingly, the framework is equally applicable irrespective of the timing
of when the loss of the manipulation occurs relative to the gain. Consider three
A pool hustle, where the hustler intentionally loses money on small bets
up front (the trigger) to induce a large wager for a greater subsequent
gain (the target).178
A derivatives manipulation, where intentional losses on the trades that
set prices (the trigger) simultaneously increase the value of price-taking
positions (the target).179
A market corner, where the manipulator causes a price increase by
buying a commodity in excess of deliverable volumes, attracting short
sellers who are ultimately squeezed by the manipulators continued
price-making purchases (the trigger); once the price is high enough, the
manipulator will sell as a price-taker to the covering shorts (the target)
LEDGERWOOD ET AL., supra note 142, at 1.
LEDGERWOOD ET AL., supra note 6, at 5.
until the price collapses, causing it to lose money on whatever quantity
of the commodity it still holds at the end of the manipulation.180
While the risk profiles of these three examples are quite different, all are
explainable as examples of a loss-based manipulation as defined within the
framework. This also explains why corners can be executed by market
participants with relatively low market shares.181
Because the execution of trades at a loss requires no market power in any
traditional sense, loss-based manipulations can be executed by any entity that
holds sufficient financial leverage such that the losses it intentionally takes on its
price setting trades are more than offset by the resulting gains made in its
targeted positions.182 This is especially concerning in energy markets, wherein
the likelihood of a successful manipulation is enhanced by frequent episodes of
inelastic demand and supply,183 heavy reliance on price indices as the pricemaking mechanism,184 and the use of price-making transactions by market
participants that simultaneously hold large physical and financial price-taking
positions.185 This is evidenced by recent enforcement actions by the FERC
against Amaranth Advisors,186 Energy Transfer Partners,187 and Constellation
Energy Commodities Group,188 and by the CFTC in proceedings against trader
Anthony DiPlacido189 and more recently Parnon Energy et al.190
These observations demonstrate the immediate need for a clear antimanipulation standard as proposed by our framework. Certainty with respect to
the behavior prohibited maximizes market liquidity,191 muting the effect of
uneconomic trades designed to trigger a manipulation.192 Additional liquidity
will also tend to reduce the inelasticity of supply and demand, decreasing the
180. Id. See generally Craig Pirrong, Commodity Market Manipulation Law: A (Very) Critical Analysis
of the Existing Doctrine and a Proposed Alternative, 51 WASH. & LEE L. REV. 945, 954 (1994). Dr. Pirrong
has contributed much insight in the academic literature with respect to this particular type of market
manipulation, beginning with the aforementioned seminal work; see Pirrong, supra note 2. However, we again
note that corners and many other forms of market power manipulation are not the result of the exercise of
market power as typically described under antitrust law, since the party undertaking the action does not have a
dominant position in a defined market. Rather, the action involves the execution of uneconomic trades into
181. See, e.g., Sheryl WuDunn, Ex-Trader in Sumitomo Scandal Admits Guilt on Fraud Charges, N.Y.
TIMES, Feb. 17, 1997, http://www.nytimes.com/1997/02/17/business/ex-trader-in-sumitomo-scandal-admitsguilt-on-fraud-charges.html (Sumitomo trader Yasuo Hamanaka plead guilty to cornering the world copper
market with a market share of only 5%.).
182. Id.; LEDGERWOOD ET AL., supra note 6, at 3. Special thanks to Matthew L. Hunter for his significant
insight on this point.
183. LEDGERWOOD ET AL., supra note 142, at 3.
185. Ledgerwood, supra note 160, at 18; see generally Ledgerwood & Carpenter, supra note 10, at 39-42.
186. Amaranth Advisors L.L.C., 120 F.E.R.C. 61,085 (2007); Initial Decision, Brian Hunter, 130
F.E.R.C. 63,004 (2010); Order Affirming Initial Decision and Ordering Payment of Civil Penalty, Brian
Hunter, 135 F.E.R.C. 61,054 (2011).
187. Energy Transfer Partners, 120 F.E.R.C. 61,086 (2007).
188. Constellation Settlement, supra note 1.
189. DiPlacido v. CFTC, 364 F. Appx 657, 657 (2d Cir. 2009).
190. CTFC v. Parnon Energy, Inc., No. 11-CV-3543, 2011 WL 1998680 (S.D.N.Y. filed May 24, 2011).
191. LEDGERWOOD ET AL., supra note 6, at 1.
ability to significantly move prices to exploit a nexus between triggers and
targets. Finally, certainty as to the types of behavior considered manipulative
under the laws will promote effective deterrence through increasing the
likelihood of detection and punishment. Well-defined anti-manipulation rules
therefore reduce the likelihood of a manipulation by simultaneously reducing its
potential benefits while increasing its associated costs, thus altering the decision
making calculus to favor compliance in place of rationally manipulative
b. Outright Fraud
Like uneconomic trading, outright fraud can be used to trigger a directional
change in market prices to misrepresent the price (or some other key aspect
central to the trade) of the underlying asset, such that other market participants
unwittingly execute trades that increase the value of the manipulators targeted
positions.193 From the perspective of the framework, the only difference in
using outright fraud as a trigger as compared to the execution of uneconomic
trades is who bears the associated loss on the price-making trades.194 In the
former case, the manipulator dupes other traders into executing all of the losing
transactions that directionally move the price, whereas in the latter the
manipulator bears some loss due to its own uneconomic trades. Unsurprisingly,
the characteristics that increase the likelihood of a successful manipulation using
loss-based trading will also assist the ability to use outright fraud for such
purposes. Indeed, few triggers are as cheap to a manipulator as those that push
all losses of uneconomic trading to someone else.
c. The Exercise of Market Power
While unnecessary to the execution of a market manipulation using
uneconomic transactions or outright fraud, traditional market power can be used
intentionally to cause directional changes in price at the will of its holder.195
Should that holder also own positions that tie to the price over which it has
influence, it can use the market power to trigger a manipulation.196 Market
power can also strengthen the nexus between trigger and target by reducing the
elasticity of market supply and demand, a market characteristic that can be
exploited by the manipulator irrespective of the type of trigger used. This may
seem to cloud the distinction between the anti-manipulation rules and antitrust
law, for the same price change that drives the profitability of the anticompetitive
act under antitrust also triggers the manipulation. The distinction is that while
market power is not necessary for the execution of a manipulation, holding
market power can assist a manipulation by maximizing the price effect that
provides the nexus between the manipulations trigger and target.197
The components of the framework can also provide guidance to explain the
potential overlap in antitrust and anti-manipulation law. Consider the case of a
multi-plant electric generator that withholds output from one power plant to
See generally id. at 3.
Ledgerwood & Carpenter, supra note 10, at 50.
See generally LEDGERWOOD ET AL., supra note 142, at 3.
Id.; Ledgerwood & Carpenter, supra note 10, at 15-17.
LEDGERWOOD ET AL., supra note 142, at 3.
increase the profitability of its remaining units, such that the withholding is
profitable overall. This scheme could reasonably be thought of as either an
antitrust violation (economic withholding) or a stand-alone market manipulation,
the latter view characterizing the withholding as an uneconomic act (the trigger)
intended to cause a price increase (the nexus) in benefit to the generators fleet of
units that remain online (the target).198 However, as we discuss next, the
manipulation claim could include other positions owned by the generator that tie
to the affected price, a factor not generally considered in antitrust actions.
4. Positions That Could Be Targeted by a Manipulation
Any position that derives its value from a market price affected by the
manipulations trigger could serve as a target. As we discussed in depth
concerning the passage of Dodd-Frank in the United States and REMIT, MAD,
and MiFID in the European Union, financial derivatives tied to commodity
prices are of particular concern in this regard because would-be manipulators can
accumulate leverage in such positions in a manner that is currently unobservable
absent legal discovery. The creation of tracking systems designed to monitor the
accumulation of major derivatives positions may assist the detection of
manipulations. For example, knowledge of the size of the put options position
held by the hypothetical natural gas producer discussed earlier in this section
could inform a preliminary determination of whether the position was leveraged
above a size needed to hedge the producers physical position. However, in the
absence of complete information across multiple trading platforms and products,
any attempt to conclusively determine a market participants net exposure to
specific market prices may be incomplete and potentially spurious.
The case of economic withholding by the electric generator demonstrates
that price-taking quantities of the underlying commodity may also be a potential
manipulation target. Specifically, the higher electricity price triggered by the
withholding increases the value of the electricity sold by the generators other
units, thus benefitting the value of the underlying physical commodity. Such
concerns of commodity price manipulation are particularly relevant to U.S.
natural gas markets, in which a significant portion of the physical commodity is
traded at index with a reference price set by the weighted average of a
relatively small number of trades. Firms holding large index positions can
leverage the profits derived therefrom against losses accrued from the
transactions used to trigger the manipulation. In fact, indexed volumes can even
be used to execute trades that set the index price199 and could ultimately be used
to manipulate the value of production assets to the extent that forward prices are
affected. Such manipulations of physical index positions are also possible in
those EU energy markets where indexed physical energy is traded and will
become increasingly likely as these markets continue to integrate and mature.
198. See generally Ledgerwood & Carpenter, supra note 10, at 20-21 (discussing United States v.
KeySpan Corp., 763 F. Supp. 2d 633 (2011)).
199. For example, in its case against Energy Transfer Partners, the FERC alleged that the company
purchased large quantities of gas that was priced at index to the Houston Ship Channel, then sold some of
this gas at uneconomically low prices in a manner that set this index price. Energy Transfer Partners, L.P.,
120 F.E.R.C. 61,086 at PP 1, 3 (2007).
For a multinational entity that trades energy as a subset of a broad portfolio
of commodities and products exchanged internally and externally among
multiple subsidiaries and affiliates, the real-time tracking of all positions that
could collaterally tie to a particular energy price is likely impossible. That said,
the framework demonstrates that the accumulation of leveraged positions that
could benefit from directional price-making trades is a necessary condition for
manipulation to occur. It is therefore desirable for regulators to begin to
assemble and integrate the means and methods needed to monitor the
accumulation of such positions to the extent possible, recognizing that only a
patchwork of such positions will be discernible. By comparison, greater
immediate focus should be placed on the monitoring of price-making trades, as
they are fully transparent and can provide immediate indicia of trading which
could involve manipulative intent.
5. The Importance of the Nexus
In hypothetical manipulation examples, the causative nexus between the
trigger and target is almost an afterthought because it refers to the same price,200
i.e., the price set by the price-making trades used to trigger the manipulation is
the same price that sets the value of the targeted price-taking positions.
However, reality is rarely so clean, as the price that triggers the manipulation
may tie to many other prices and price-taking positions that extend across
products, geography and time.201 The establishment of a causative nexus is
therefore essential to prove manipulation, as it simultaneously demonstrates
the intent and ability to manipulate, the causal link between trigger and target,
and the linkage that enables the manipulative scheme to succeed.202
For a party seeking to prove the manipulation of a particular targeted position by a
given trigger, a statistical analysis will often be needed to demonstrate the direction,
strength and reliability of the nexus asserted as causative. Practically speaking, this
will foreclose from consideration many positions that were likely impacted by the
manipulation, but for which insufficient proof of causation is shown. Likewise, a
manipulation defense wishing to introduce evidence that incidental positions should
be used to evaluate the net exposure of its portfolio to a directional price movement
must also be prepared to demonstrate the strength and relevance of any causative
nexuses.203
To limit the analysis of market nexuses to contexts ex post suspected
manipulations would ignore the market characteristics that accentuate the
likelihood of successful manipulation as identified by the framework.
Tighter cross-market linkages [typically will strengthen causative relationships]
between price-making trades and price-taking positions, as is often magnified at
times such as settlement when fixities in supply and demand emerge. Ex ante
[analyses of] such phenomena therefore provide[] critical information as to the
markets most in need of monitoring and surveillance and the times, instruments and
trading behaviors of greatest concern. This can assist the allocation of regulatory
resources to serve their most efficient use and may direct the coordination of
reporting requirements within and across regulatory authorities. Knowledge of
such efforts will deter manipulative behavior at the times most critical to price
Ledgerwood & Carpenter, supra note 10, at 48.
formation, [thus] benefitting compliant market participants in the long run through
the increased market efficiency derived from better . . . liquidity[, improved
transparency] and reduced bid-ask spreads.204
ANALYSIS, AND PROOF (OR DISPROOF) OF MANIPULATIVE BEHAVIOR
Breaking a manipulation into the three components identified by the
framework can unravel the sometimes counterintuitive logic that has
complicated past conversations on this topic.
The Components of a Market Manipulation as Described By the
As an organizational tool, the framework provides a stable and consistent
structure to establish and implement energy market monitoring and surveillance
programs, compliance programs, and enforcement. In this section, we discuss
how uniformity of the approach used for detecting and analyzing market
manipulation will provide consistency across cases and allow for better
coordination across agencies within and between the United States and European
Union. Such cooperation and unity of approach will be essential to the future
detection, analysis, and enforcement of manipulation cases brought against
multinational firms that may use global markets as the triggers and targets of
opportunity. The use of a single rulebook will also benefit market participants
through better certainty as to the legitimacy of their trades, with the requirements
of compliance being consistent and known across jurisdictions and as behavioral
safe harbors are established. As we will discuss, these benefits are available
immediately, as the analytical approach of the framework is equally applicable to
the various manipulation laws currently in place in the European Union and
A. Using the Framework to Assist Market Monitoring and Surveillance
The main benefit to market monitoring and surveillance efforts of breaking
the analysis of a manipulation into components is that resources can focus on
manageable issues on a step-by-step basis, with later iterations of the process
feeding the development of better techniques over time. Pragmatically, the
starting point for all such analyses is the nexus, for an understanding of the
behavior to be monitored first requires the identification and understanding of
the various market linkages through which a manipulation can occur. Once
these are identified, the nexus is again useful for identifying the times, locations
and trading instruments that are of the greatest concern to regulators such that
scarce resources can focus on issues with the highest prioritization.205 The nexus
can also identify the type of behavior that is most likely to be used to trigger a
manipulation under different scenarios. For example, in electricity markets,
market power might be of concern during peak periods of a day, whereas
uneconomic transactions might be of greater concern off-peak. The nexus will
also assist the identification of the price-taking positions most likely to be the
manipulations targets such that reporting of these positions might be required.206
Continual monitoring of the trades that could trigger a manipulation is an
achievable goal. Assuming the enforcement agencies already possess regulatory
authority over the transactions that set prices within their jurisdictional markets,
they have the ability to continually analyze this data for evidence of
manipulative behavior, i.e., the use of market power or the placement of
uneconomic trades.207 Ideally, this process would rely upon automated screens
designed to detect indicia of manipulative behavior, with human input required
when suspicious activity is detected and when calibration of the screens is
needed over time.208 The market monitor must always be mindful that every
screen can generate false positives and false negatives, and natural variances in
the market will necessitate the development of multiple screens and intuitive
interpretations to distinguish legitimate trading from suspect behavior.209 The
detection of outright fraud is also well suited to these agencies, for market
participants are likely to raise concerns of their competitors inappropriate
behavior to regulators as a matter of practice.210
As discussed above, the number, size, scale, and scope of price-taking
positions held by traders is unknowable absent the investment of substantial
search costs. For example, a global energy provider may simultaneously hold
physical positions in natural gas, electricity, oil, and LNG on multiple
continents, hedged against each other and with financial derivatives traded on
multiple exchanges around the world, interlaced with countless speculative plays
held by multiple subsidiaries and legged across markets, currencies, and time.
Dodd-Frank and the REMIT Proposal will provide a glimpse into some of the
positions that may serve as the target of manipulation attempts but cannot
possibly track and interconnect them all continuously. The cross-agency
cooperation required to continually match manipulative triggers against targeted
positions likewise may not be present.211 This is not meant to discourage the
207. Id. at 51.
208. See generally Ledgerwood, supra note 160, at 41-56.
209. Ledgerwood & Carpenter, supra note 10, at 45-52. Every screen should be structured in a manner
designed to test the hypothesis that the trading behavior in question is legitimate, which gives the trader the
benefit of a presumption of innocence. Failing a screen will occur if this hypothesis is rejected, suggesting the
need for further analysis and corroboration as provided by other screens and market intelligence.
210. For example, the FERC has established an Enforcement Hotline designed to provide market
participants with an outlet for reporting fraudulent behavior on an anonymous basis. For further information,
see generally, Enforcement Hotline, FERC, http://www.ferc.gov/enforcement/staff-guid/enforce-hot.asp. (last
viewed Mar. 5, 2012).
211. As discussed previously, the CFTC disputed the FERCs jurisdiction in Amaranth. Amicus Brief of
Futures Industry Assn et al., Amaranth Advisors, L.L.C. v. FERC, No. 07-1491 (D.C. Cir. 2008), 2008 WL
4960210. The FERC did not rule on its ALJs decision until after this appeal was deemed to be unripe. Brian
Hunter v. FERC, 403 F. Appx 525, 527 (D.C. Cir. Dec. 22, 2010). More recently, the CFTC has suggested
that some historically FERC jurisdictional instruments (such as financial transmission rights) may require
public interest exemptions to avoid CFTC jurisdiction. Proposed Rules & Interpretations, Further Definition of
collection of data that relate to such positions, especially those that could provide
a would-be manipulator with a large, leveraged target. However, enforcement
authorities must be judicious enough to avoid hasty and fallacious
determinations that the ownership of such positions equates to manipulative
intent, for such visible positions could well be only a tip of an iceberg, the full
extent of which is knowable only through protracted and expensive discovery.
B. Interaction of Market Monitoring with Compliance Programs
The thought of enforcement authorities screening every price-making trade
for some indicia of manipulation may seem harrowing for market participants.
For example, suppose it is known that a market monitor is screening for indicia
of uneconomic trading, presumptively indicated by sales made below market or
purchases made above the market price. However, any economics text will
verify that every sale tends to lower market prices and every purchase tends to
raise them, suggesting that every price-making could be a candidate for
manipulation. Alternatively, the monitor might screen for evidence of losses
accrued intentionally; however, in a fair market, about half of all of a traders
trades will lose money irrespective the traders intent. While they will
undoubtedly not wish to reveal their exact screening methodologies and
thresholds, market monitoring authorities must communicate that their screens
are attuned to find market anomalies, as adjusted over time based on lessons
learned, best practices, the availability of data, and the ability to coordinate with
other agencies.212 Compliance programs then can focus on the proactive
function of maximizing legitimate trading without fear of future reprisals, rather
than a constant reactive posture drawn from inconsistent and opaque outcomes
of enforcement actions over time.
If the frameworks logic is adopted and used consistently by the antimanipulation authorities in the United States and European Union, the
compliance departments of the various market participants which trade energy
stand to benefit greatly. There is at present little guidance concerning the
behavior that constitutes a market manipulation and no guidance as to potential
safe harbors defining the bounds of legitimate trading. The consistent
application of the framework could add certainty to both sides of this calculus,
such that specific behavior considered to be prohibited is clearly distinguished
and distanced from that which is legitimate. The resulting consistency in
enforcement would add certainty to the market through the encouragement of
legitimate trading, ultimately maximizing liquidity over time and reducing
compliance costs as concerns of unwarranted enforcement actions abate.
Likewise, certainty that manipulative behavior will be detected and punished
will provide greater trust in indices and other reference prices as indicative of
true value, ultimately improving the efficiency of the market through increased
participation and reduced bid-ask spreads.213
Agreement Recordkeeping, 76 Fed. Reg. 29,818, 29,839 (2011) (to be codified at 17 C.F.R. pt. 240).
212. ACER has provided examples of behavior it may consider suspicious, presumptively suggesting that
market screens will be attuned thereto. See generally Section 4.4.2-Possible signals of market manipulation,
ACER Guidance, supra note 126, at 21-22.
213. Ledgerwood & Carpenter, supra note 10, at 49.
C. Consistency in Enforcement
If the analysis of the trigger provides sufficient evidence of a manipulated
price to warrant the opening of an investigation or the initiation of a lawsuit, the
investigator must ascertain the totality of the suspected manipulators positions
that tie to that price. Data availability across agencies is imperative to this
function, making possible preliminary investigations without the need to
subpoena records from the suspect or even to alert the suspect that it is under
investigation. If a formal investigation commences, these data can be used to
audit the responses of the suspect and to identify holes in records kept across the
various agencies, as will occur with the evolution of physical and financial
markets and instruments over time. If it is proven that the suspect used the
trigger in benefit to its net targeted positions and a nexus between the two
likewise is proven, then the trier of fact must determine whether the behavior
demonstrates sufficient intent to find that a manipulation occurred. Thus, while
the fact issue of intent should vary from one case to the next, proof of the
mechanical characteristics that define a manipulation should not.
A systemic approach to analyzing the interactions between manipulation
triggers and targets will ultimately optimize scarce regulatory resources within
and across enforcement agencies with an anti-manipulation mandate.214 Crossagency cooperation is essential to this process, such that a uniform and systemic
approach to compliance and enforcement emerges to the benefit of the agencies
and the traders they regulate.215 As new financial instruments develop and new
linkages across products emerge, a loop of continual learning should develop
and help the agencies keep pace with the evolution of the industries they
regulate. This ultimately will allow for better understanding of the pricing
nexuses that simultaneously provide liquidity to the market and potentiate
manipulative behavior.216 Consistency in enforcement will also inform the
compliance functionaries of market participants as to the behavior prohibited,
thus reducing uncertainty as to compliance, promoting legitimate trading,
increasing market liquidity, and thereby mitigating the market characteristics that
make manipulation possible.217
D. Consistency of the Framework Across Different Market Manipulation
The framework is structured to satisfy the specific elements required to
meet the burden of proof for manipulation claims brought under either a fraudbased statute (which includes statutes that prohibit either outright fraud or the
use of a fraudulent device, scheme, or contrivance) or a statute based on artificial
price.218 Functionally equivalent statutes are now in place in the U.S. and EU, as
is summarized below in Table 2.
LEDGERWOOD ET AL., supra note 142, at 7.
For further discussion, see generally LEDGERWOOD ET AL., supra note 6, at 3-4.
U.S. and EU Manipulation Statutes Relevant to Gas and Electricity
Prohibitions Against Outright Fraud:
REMIT - Art. 2, Sections (2)(a)(i), (2)(b), (3)(a)(i), and (3)(b)
MAD - Article 1, Sections (a) and (c)
FERC - 15 U.S.C. 717c-1 and 16 U.S.C. 824v;
CFTC - 7 U.S.C. 6(c)(1)
Prohibitions Against Fraudulent Devices, Schemes, and Contrivances:
REMIT - Article 2, Sections (2)(a)(iii) and (3)(a)(iii);
MAD - Article 1, Section (b)
Prohibitions Against Artificial Price:
REMIT - Article 2, Section (2)(a)(ii) and (3)(a)(ii);
MAD - Article 1, Section (a)
FERC - No direct parallel, but see Penalty Guidelines;219
CFTC - 7 U.S.C. 6(c)(3)
Under fraud-based statutes, the proof of a market manipulation requires
showing that (1) a jurisdictional transaction (2) was used to execute a fraudulent
device, scheme, or artifice (3) with the requisite scienter.220 Analysis of the
manipulations trigger demonstrates that jurisdictional transactions were used
intentionally in an attempt to move a price through uneconomic trades, outright
fraud, or the exertion of market power. Analysis of the manipulations target
provides evidence that the manipulator intended to assemble a manipulative
device, scheme, or artifice and had the ability to make it work. Finally,
demonstration of a nexus between the trigger and target proves the linkage
mechanically needed to perpetrate the manipulation. Proof of an effect from the
manipulation is necessary for obtaining disgorgement of profits in regulatory
actions or for the proof of damages in private lawsuits. However, a fraud-based
statute does not require the proof of a manipulations success, allowing
regulators to obtain fines and/or civil penalties through enforcement actions
brought for attempted manipulation. The ability to levy penalties on market
participants for behavior that is poorly defined and that has been enforced under
a patchwork of cases is unconscionable in the absence of a clear demonstration
of manipulative cause and effect. The framework provides a vehicle for
evaluating such cases in a manner that is internally consistent in its logic across
cases, statutes, and agencies.
Penalty Guidelines, supra note 34.
See, e.g., Ledgerwood, supra note 160, at 8-11.
The framework also satisfies three of the four elements for meeting the
burden of proof under artificial price statutes. For example, proof under the
CFTCs statute requires showing that the manipulator had (1) the ability (2) and
intent (3) to create an artificial price (4) and caused that price to occur. Analysis
of the trigger demonstrates intent through the showing of uneconomic trades,
outright fraud, or the exertion of market power. Analysis of the manipulations
target demonstrates that the actor intended to assemble a manipulative scheme
and had the ability to make it work. Proof of the nexus demonstrates the linkage
needed to show causation. All that remains is showing a measurable price effect,
which is equivalent to the requirement needed to prove disgorgement or damages
under a fraud-based statute. The frameworks ability to unify the analysis of
market manipulation across statutes therefore serves as a further vehicle for
enforcement agencies to align their methodologies such that a common approach
to the analysis of market manipulation results. This would extend to the
European Unions energy markets under REMIT and MAD, both of which
include fraud-based and artificial price provisions.
The historical precedent set by manipulation cases tried in the United States
represents an inconsistent set of categorical determinations of specific behaviors
as illegal, with no functional linkage to common economic contexts across the
cases tried by each agency, much less across agencies.221 This I know it when I
see it approach provides little clear guidance to traders as to the types of
behavior that each Commission perceives as manipulative, leading them to either
avoid legitimate trades to prevent suspicion under uncertain and shifting
enforcement standards or pay no attention at all to the standard, given knowledge
of the agencies historical difficulty in bringing successful cases.222 As the
United States and European Union implement broad anti-manipulation rules, a
more consistent and logical approach to the detection and analysis of
manipulation is warranted. To this purpose, the framework we propose would
clarify what does and does not constitute manipulation for market participants
and enforcement agencies. The framework does not prescribe a single algorithm
for detecting and proving (or disproving) manipulation, but rather reduces the
scope for subjectivity in evaluating the issue of manipulative intent by providing
an analytical structure that is uniform across circumstances. We summarize this
LEDGERWOOD ET AL., supra note 6, at 1-4.
A Hypothetical Analysis of a Market Manipulation Using the Framework
The framework also assists the measurement of harm from the manipulation
by separating damages incurred in the trigger, target, and other markets
collaterally affected.223 Harm from the trigger accrues to those duped into
trading at a loss based on the misinformation injected by the manipulator.224
Harm in the targeted positions accrues to the counterparties of the manipulators
price-taking positions.225 Finally, to the extent the effects of the manipulation
may spill into other markets or disrupt asset values over time, other parties may
be damaged.226 In theory, the harm caused by a manipulation in one market
could reverberate infinitely into other markets, opening a suspected manipulator
to potentially limitless damages.227 The framework we propose provides a
solution to this concern through the nexus, as furnishing proof of a strong causal
linkage between the trigger and target must be established before any discussions
of potential liability attach.228
223. See generally, Constellation Settlement, supra note 1, at PP 22, 27.
224. Uneconomic trades misrepresent value and may induce other market participants on the same side as
the triggering transactions to buy/sell at a loss, whereas outright fraud induces the entirety of the loss to be
taken by other traders. The damages caused by an abuse of market power are an antitrust injury. Ledgerwood
& Carpenter, supra note 10, at 44-45.
225. Id. at 45.
Some of our prior publications concerning the framework focused on the
use of uneconomic trading as a manipulation trigger.229 These works are
important, as this type of manipulation is understudied, previously unexplained,
and of great concern because it may not be easily distinguishable from
aggressive legitimate trading.230 However, other types of behavior can trigger a
manipulation and its associated harms, including outright fraud and the exercise
of market power.231 As we have discussed herein, the framework we propose is
equally applicable under all such circumstances, as the logic of the trigger,
target, and nexus is consistent across all such cases.
229. See generally Ledgerwood, supra note 160, at 1; see also, e.g., LEDGERWOOD ET AL., supra note 6,
230. Three of our colleagues from The Brattle Group filed comments in the CFTCs rulemaking
proceeding concerning its new anti-manipulation rules, attaching Dr. Ledgerwoods paper Screens for the
Detection of Manipulative Intent (supra note 160) thereto. See also Comments of Daniel Arthur, Romkaew
Broehm, & Gerald Taylor to the CFTC on Notice of Proposed Rulemaking Prohibition of Market Manipulation
(Jan. 3, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=26909&Search
Text=26909DanielArthur.pdf. During its July 7, 2011 open meeting, the CFTC considered these comments,
narrowly, as proposing uneconomic trading as the only potential trigger for manipulative behavior. Open
Meeting on Five Final Rule Proposals Under the Dodd-Frank Act, CFTC, at timestamps 58:37 and 59:05 (July
7, 2011), available at http://www.capitolconnection.net/capcon/cftc/webcastarchive.htm#. Our discussion
herein is designed to demonstrate that the framework is applicable to a much broader set of behavioral triggers
than uneconomic trading alone.
231. This article has focused on actions that use price as the mechanism for triggering a manipulation.
However, other types of nexuses could be exploited to manipulate markets, including market output. Shaun D.
Ledgerwood & Wesley J. Heath, Rummaging Through the Bottom of Pandoras Box: Funding Predatory
Pricing Through Contemporaneous Recoupment, VA. L. & BUS. REV. (forthcoming 2012), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1906062 (last revision Dec. 11, 2011). Indeed, institutional
or informational processes could be used to trigger a manipulative outcome, including (but not limited to) the
use of inside information obtained through political processes or by other means to trigger a manipulation. 60
Minutes: Congress: Trading Stock on Inside Information? (CBS television broadcast Nov. 13, 2011), available
at http://www.cbsnews.com/8301-18560_162-57323527/congress-trading-stock-on-inside-information/?tag=co
ntentMain;cbsCarousel. The framework is sufficiently dynamic so as to provide a foundation for discussing
and analyzing such behavior.
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